* Core Tier 1 capital rises more than expected on CDO sale
* Surprise sale of 4.6 billion euros of CDO derivatives, ABS
* Quarterly net income 517 mln euros vs forecast 372 mln
* Shares gain 7 percent to trade near 3-year high (Recasts, adds details on CDO portfolio, state aid, share price reaction)
By Robert-Jan Bartunek
BRUSSELS, Aug 8 (Reuters) - Belgian financial group KBC's unexpected sale of billions of euros of derivatives allowed it to boost its capital, sending its shares up 7 percent.
The group, which received 7 billion euros ($9.32 billion) of state aid at the height of the 2008 credit crunch, said it reduced its exposure to collateralised debt obligations (CDO) and asset-backed securities (ABS) by about 4.6 billion euros to 6.3 billion euros.
That sale allowed KBC to boost its Core Tier 1 capital ratio, the main measure of a bank's health, to 14.5 percent at the end of the second half, compared with 11.7 percent at the end of 2012.
Combined with better-than-expected quarterly profit, due to its core European markets, that pushed KBC's shares to their highest level since September 2009, making them a top gainer on the FTSEurofirst 300 index of leading European shares.
"The most positive point of the results was the better capital, i.e. stronger Core Tier 1 ratio than expected," Berenberg analyst Eleni Papoula said.
"The capital boost was driven by the sale of KBC's Russian business Absolut Bank, as expected, and the opportunistic disposal of 4.6 billion CDOs that I had not factored in my numbers, and that was a positive surprise," she said.
In line with a European Commission-imposed programme in exchange for state aid, KBC has sold a string of assets to focus on its main markets in Belgium, the Czech Republic and to a lesser extent Bulgaria, Hungary, Ireland and Slovakia.
In Belgium, the group said its net profit rose by more than two thirds compared to last year, boosted by a 21 percent increase in fee and commission income and the sharply improved value of its financial instruments.
Overall, net income in the second quarter was 517 million euros ($690 million), higher than the 372 million expected in a Reuters poll of seven analysts. KBC posted a loss in the same period last year.
Many banks reporting results over the last few weeks have beaten analysts' expectations as restructuring pays off, legacy issues recede and economies pick up.
KBC, which has already repaid all of the money it received from Belgium federal state and a first tranche of the 3.5 billion euros it owes to the Flemish regional government, said it was considering speeding up the repayment process.
It said, however, that this was conditional on the outcome of a stress test by the European Central Bank, expected by early next year.
"It would not be very prudent to go ahead with the repayment not knowing what the parameters for the stress test are," Chief Executive Johan Thijs told a conference call.
KBC said its loan loss impairments in Ireland, where it has 15.6 billion euros outstanding in mortgages, and loans to project developers, fell to 88 million in the second quarter from 99 million in the first quarter.
Irish residential property prices in June recorded their first annual rise since a property crash crippled the country's economy in 2008. $1 = 0.7508 euros) (Additional reporting by Ben Deighton; Editing by Louise Ireland)