* Hapoalim Q1 profit 753 mln shekels vs 638 mln forecast
* Leumi Q1 profit 625 mln shekels vs 514 mln forecast
* Hapoalim to pay 106 mln shekel dividend
By Steven Scheer and Tova Cohen
TEL AVIV, May 22 Israel's top banks posted quarterly profit that beat estimates, benefiting from improved credit quality that enabled a reversal of years of paying provisions to cushion against loan defaults.
The largest lender Hapoalim and chief rival Leumi have decreased loans to large corporations and focused on the more lucrative households and small and mid-size business segments.
"It's probably correct to assume that in the coming quarters, credit quality will continue to improve," said Micha Goldberg, head of equity research at the Excellence Nessuah brokerage. "Risk has come down."
The result was loan recoveries in the quarter for both banks. Hapoalim posted recoveries of 15 million shekels in the first quarter while Leumi had 51 million. Both banks have improved in recent quarters after provisioning hundreds of millions of shekels in credit expenses that had weighed down profits in the wake of the financial crisis.
Analysts attributed the improvement in Israel's banking sector to conservative lending policies - as mandated by the regulator - and an economy that was slowing somewhat from 2013 but not enough to harm credit quality.
"The economy is not doing great at 2-3 percent growth but it is probably enough to keep credit quality at current levels," Goldberg said. "There may not be growth but there is no deterioration."
Hapoalim's shares rose 1.3 percent, while Leumi was 0.8 percent higher.
Hapoalim shares have risen some 6 percent since the beginning of the year versus 0.8 percent for the industry.
"We believe that investors have demonstrated a clear preference for stable, dividend-generating companies over turnaround stories," Barclays analyst Tavy Rosner said in a client note.
Hapoalim said it would pay a dividend of 106 million shekels for the quarter, unchanged from the fourth quarter.
Leumi's shares, Rosner said, still have upside of about 12 percent. Trading at a 17 percent discount to its historical price to book value ratio, "the current valuation is attractive," he said.
Hapoalim earned first-quarter net profit of 753 million shekels ($216 million), compared with 621 million a year earlier and above expectations of 638 million in a Reuters poll of analysts. Net financing income was little changed at 2.056 billion shekels.
Leumi posted profit of 625 million shekels, up from 570 million a year earlier and above a forecast of 514 million. Net interest income slipped 0.3 percent to 1.757 billion shekels.
"Another solid quarter ... in the face of soft demand helped by super-low risk costs," said Citi analyst Michael Klahr.
During the quarter, Leumi's share of credit to households and small businesses grew 0.9 percent from the end of 2013, while the share of commercial and corporate credit declined 0.7 percent. Hapoalim's consumer credit rose 2.6 percent in the quarter, 1 percent for mortgages and 0.7 percent in commercial lending. Loans to big corporations fell 3.3 percent and its share has fallen to one-third of the bank's loan portfolio.
Hapoalim's core Tier 1 capital ratio to risk-weighted assets was 9.44 percent according to Basel III while Leumi's ratio rose to 9.41 percent.
Israeli banks are mandated to achieve 9 percent by the start of 2015. Hapoalim and Leumi must reach 10 percent by 2017.
($1 = 3.4928 Israeli Shekels) (Editing by John Stonestreet)