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UPDATE 3-Spanish banks' income drop overshadows capital improvement

* BBVA net interest income fell 6 pct vs Q4

* Caixabank lending income fell 2.4 pct quarter on quarter

* Shares in both banks fall following results (Adds details and quotes from BBVA’s CFO and CEO, Caixabank’s chairman)

BARCELONA/MADRID, April 28 (Reuters) - Spain’s BBVA and Caixabank both reported a fall in net interest income in the first three months of the year, overshadowing capital improvements and sending their shares lower on Thursday.

BBVA and Caixabank have contrasting business models, with BBVA drawing the majority of its revenue from abroad and Caixabank chiefly focused on Spain. But they face a similar challenge in raising earnings from loans as interest rates remain at historic lows.

Net interest income at BBVA, Spain’s second biggest bank, fell 6 percent versus the fourth quarter of last year to 4.15 billion euros ($4.7 billion). However, this was up 13.3 percent from a year earlier.

For Barcelona-based Caixabank, the most acquisitive bank during Spain’s financial crisis, lending income fell 2.4 percent quarter on quarter and 10.4 percent year on year to 1.02 billion euros.

This mirrored a similar trend at Spain’s biggest bank Santander, which on Wednesday reported a 3.3 percent fall in first-quarter net interest income from the three previous months.

Shares at Caixabank were down 2.9 percent at 1140 GMT, while BBVA fell by 8.4 percent as the lender was also hit by one-off charges in the United States.

“The market’s interpretation is that the results are disappointing, but we hope that they will improve in future quarters,” BBVA’s Chief Executive Officer Carlos Torres told a news conference in Madrid.

BBVA’s Chief Financial Officer Jaime Saenz de Tejada said the slowdown in the quarter owed to “fundamental changes” weathered by Spain’s commercial banking sector, where margins have shrunk compared to the previous three months.

GREAT CHALLENGES

Profitability ratios remained under pressure at both banks. While BBVA posted a slight increase of its return on tangible equity ratio to 7.0 percent from 6.4 percent, this measure dipped to 3.7 percent at Caixabank from 4.3 percent in the previous quarter.

This compared to profitability ratios of around 20 percent before Spain’s financial crisis in 2008.

BBVA’s first-quarter net profit fell 54 percent from a year earlier to 709 million euros and missed analysts’ forecasts. Its year-earlier profit had been bolstered by 583 million euros in one-off capital gains. Analysts polled by Reuters had expected a net profit of 844 million euros.

Caixabank’s net profit was 273 million euros, down 27 percent and below the 282 million expected by analysts polled by Reuters.

“We are in a more favourable business climate than a few years ago thanks to the recovery of the Spanish economy, but it is a climate still full of uncertainty and great challenges,” Caixabank’s Chairman Isidre Faine told shareholders in Barcelona.

Both Caixabank and BBVA are trying to limit the damage to their bottom lines and offset other factors such as rising regulatory expenditure and margin erosion from increased competition by cutting costs in Spain, but they have also undertaken deeper changes.

Like many of its European rivals, BBVA is trying to resolve this equation by embracing more efficient digital banking. Caixabank, meanwhile, is trying to raise loan volumes through acquisitions. Last week it launched a full takeover bid for Portugal’s Banco BPI.

The pressure on the banks’ core businesses overshadowed the higher capital ratios reported in the first quarter, also in line with improvements at Santander.

BBVA’s capital ratio under the strictest “fully-loaded” core tier one criteria at the end of March had risen to 10.54 percent from 10.33 percent in December while Caixabank’s ratio rose to 11.64 from 11.55 percent. ($1 = 0.8809 euros) (Editing by Julien Toyer, Keith Weir and Alexander Smith)

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