KBC Bank reported a surprise profit that was attributed to boosted CDO value from narrowing credit spreads, published reports said.

The bank’s 2Q09 net income declined to €302 million ($427.8 million) from €493 million a year earlier. The median estimate of 10 analysts in a Bloomberg survey was for a loss of €36 million, although the shares had their biggest gain in six months.

Wider margins on retail lending, trading gains and a thaw in credit markets that boosted the value of CDOs and the insurance cover from MBIA resulted in the profit after the bank sought state support three times in the past year.

KBC is winding down its London-based derivatives business and plans to reduce corporate lending outside Belgium and eastern Europe, shrinking its balance sheet to reduce the need for regulatory capital, the reports said.

KBC soared €3.67, or 22%, to €19.99  on Euronext Brussels, the steepest one-day advance since Jan. 22. It has lost 6.8% this year, the fifth-worst performance of the 52 companies in the Dow Jones Stoxx 600 Banks Index.

Second-quarter profit included a €1.3 billion pretax writeback on the value of CDOs and credit risk backed by MBIA. KBC paid a €1.1 billion pretax fee in the quarter for accepting a state guarantee covering 90% of cash losses exceeding €3.16 billion on CDOs and MBIA-insured risk.

Provisions for bad loans rose to €567 million in the quarter, including €138 million set aside to cover potential losses on U.S. RMBS. Actual credit losses in central and eastern Europe were little changed at an annualized 1.75% of loans outstanding in the region.

Loans more than three months in arrears increased to 2.8% as of June 30 compared with 2.5%  three months earlier. KBC’s cover ratio for nonperforming loans decreased to 50% from 53% at the end of March.

KBC said it has a lot of collateral in Ireland, and is comfortable with a 12% cover ratio for Irish loans in arrears.

KBC Bank Ireland contributed €42 million to profit in the first half. Mortgages account for 74% of KBC’s €18.3 billion loan book in the country.

The bank and insurer also wrote down derivatives positions being unwound at KBC Financial Products by about €750 million over the quarter, the reports said.

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