* Q4 net drops on overseas assets, HK exposure
* Hong Kong unit posts second-half loss
* Books $4.46 bln allowance against U.S. mortgage securities
(Adds quotes from company, analyst in paragraphs 7-9)
By Tony Munroe
HONG KONG, March 24 (Reuters) - Bank of China <3988.HK>, the country's largest foreign exchange lender, reported a 58 percent drop in fourth-quarter earnings, weighed down by its overseas assets and exposure to recession-hit Hong Kong.
Bank of China and other mainland banks are expected to face margin pressure and higher credit costs this year, with industry watchers also predicting an increase in soured loans as slowing economic growth erodes asset quality.
The state-controlled lender posted October-December net income of 4.5 billion yuan ($659 million), lagging analysts' forecasts for 7.96 billion yuan, according to Reuters Estimates.
Full-year profit of 64.4 billion yuan was an increase of 14 percent from the 56.2 billion earned a year earlier.
Bank of China <601988.SS>, hardest-hit among mainland Chinese banks by its exposure to U.S. mortgage-related securities, booked impairment allowances against those holdings of $4.46 billion.
Overall impairment losses on assets more than doubled for the year to 45 billion yuan, but its non-performing loan ratio improved to 2.65 percent for the year from 3.12 percent.
"Our provisions increased a lot last quarter but it does not mean that the quality of our assets deteriorated. It was because we normally make most of the provisions in the fourth quarter," bank president Li Lihui told reporters.
"The low interest rate environment will continue to have an impact on our margins in 2009," he said, adding the bank was looking to buy a life insurance business.
Samuel Chen, analyst at JP Morgan, said the bank took a "kitchen sink" approach to booking provisions in the final quarter.
Bank of China's credit costs for the year rose, while net interest margins narrowed slightly to 2.63 percent from 2.76 percent.
OVERSEAS WOES
Its overseas flagship, Bank of China (Hong Kong) Ltd <2388.HK>, posted a second-half loss of HK$3.75 billion ($480 million), compared with net profit of HK$7.98 billion a year earlier. Analysts polled by Reuters Estimates had expected BOC Hong Kong to post a second-half loss of HK$552 million.
For the full year, BOC Hong Kong's earnings fell 78 percent to HK$3.34 billion, dragged down by $1.52 billion in provisions on its investments in U.S. mortgage-backed securities and a stake in Hong Kong lender Bank of East Asia <0023.HK>.
BOC Hong Kong, which is nearly two-thirds owned by Bank of China, recommended no final dividend due to the earnings hit in the second half and the need to preserve capital.
Royal Bank of Scotland said in a research note it expects that 4.5 percent of new loans made by mainland Chinese banks between 2005 and 2008 could become non-performing between the second half of 2008 and the end of 2010, higher than the 3.5 percent seen in the 2004-2005 downturn.
Mainland banks have made a flurry of new loans in recent months to support Beijing's stimulus measures to maintain economic growth at 8 percent or more.
Spared the worst of the global downturn thanks to a relatively strong domestic economy, China's three biggest listed banks -- Industrial and Commercial Bank of China <1398.HK> <601398.SS>, China Construction Bank <0939.HK><601939.SS> and Bank of China are the world's three most valuable lenders.
Bank of China has a market value of $113 billion.
Given its exposure to sluggish overseas markets, Bank of China trades at a discount to its peers at 1.26 times fourth-quarter profit, which still managed to beat analysts' forecasts.
Shares of Bank of China have risen 12 percent this year, outperforming the index for major Chinese companies listed in Hong Kong <.HSCE>, which was up 2 percent. But the stock fell 28 percent in the last quarter of 2008 against a 13 percent drop on the H-share index. (US$=6.8335 yuan = HK$7.8) (Additional reporting by Clare Jim. Editing by Ian Geoghegan and Jon Loades-Carter) (tony.munroe@thomsonreuters.com; Reuters Messaging: tony.munroe.reuters.com@reuters.net; +852 2843 6358, Fax +852 2845 0636)) ((If you have a query or comment on this story, send an email to news.feedback.asia@thomsonreuters.com))
