March 24 (Bloomberg) -- Bank of China Ltd., the world’s third-largest lender by market value, had a wider-than-expected 59 percent drop in fourth-quarter profit on writedowns of U.S. mortgage investments and higher bad-loan provisions.

Net income declined to 4.42 billion yuan ($647 million) from 10.77 billion yuan a year earlier, based on figures released by the Shanghai-based company. That fell short of the average 7.59 billion yuan estimate among 25 analysts surveyed by Bloomberg.

Bank of China has lost more on mortgage investments than all other Chinese lenders combined as the U.S. housing collapse sparked a credit seizure. Speculation that most of the bank’s writedowns are behind it has helped push the stock 12 percent higher in Hong Kong this year, the second-best performance among Chinese lenders traded there.

“People knew Bank of China would underperform peers in 2008 because of the investment loss, but we are still surprised by how much it missed the estimate,” said Liu Yinghua, a Shenzhen-based analyst at Ping An Securities Ltd. who plans to maintain her “neutral” rating on the stock. “There’s a silver lining though: it has a clean slate to start in 2009.”

Bank of China wrote down the value of subprime-related assets and other securities by $894 million in the three months, taking total writedowns to about $4.46 billion since the quarter ended December 2007.

Remaining Investments

The Chinese lender still held $2.59 billion of subprime- mortgage investments, $1.15 billion of securities backed by Alt- A home loans and $3.51 billion of other “non-agency” mortgage investments as of Dec. 31.

“After the 2008 writedowns, those investments won’t be a major problem,” Lee Yuk-Kei, a Hong Kong-based analyst at Core Pacific-Yamaichi International Ltd., said before the announcement. “We think the bank will recover in 2009 and its profit and shares will start to outperform peers.”

Bank of China’s quarterly profit was derived by subtracting net income for the first nine months from the 2008 figures released today. For the full year, the lender’s net income gained 14 percent to 64.36 billion yuan.

The stock gained 2.2 percent to close at HK$2.38 in Hong Kong today before the earnings were announced. It has dropped 21 percent in the past year.

Losses on overseas credit investments haven’t kept Bank of China Chairman Xiao Gang, 51, from trying to catch up with local rivals that avoided the contagion because of limited operations abroad. Industrial & Commercial Bank of China Ltd. and China Construction Bank Corp., the world’s two largest lenders by market value, get less than 3 percent of revenue from overseas.

Loan Target

Bank of China aims to increase lending by 17 percent this year, Vice President Zhu Min said at a pres briefing in Hong Kong today. It will add 10,000 employees, the most since becoming a publicly traded company in 2006, Xiao said this month.

Chinese Premier Wen Jiabao this month set a new loan growth target of 5 trillion yuan for the banking industry in 2009 to help finance the government’s 4 trillion yuan stimulus package and “reverse the economic slide as soon as possible.” Chinese banks offered a record 2.69 trillion yuan of new loans in the first two months, more than half of the total for 2008.

Even so, China’s six largest publicly traded banks may report an 11 percent drop in profit in 2009, after growth of 35 percent last year, hurt by “narrowed net interest margin and decelerated fee growth,” Credit Suisse AG said on March 11.

Loan Profitability

The People’s Bank of China has cut lending rates by 216 basis points since mid-September to stimulate the economy while lowering the deposit rate by 189 basis points, hurting loan profitability at banks. One basis point is 0.01 percentage point.

Bank of China faces less pressure on net interest margins, a measure of lending profitability, than local rivals, partly because its lower loan-to-deposit ratio shields it from the impact of falling lending rates, said Sarah Wu, an analyst at Macquarie Securities Ltd.

The lender’s net interest income, or revenue earned on loans after deducting interest paid for deposits, rose 6.7 percent to 162.9 billion yuan for the full year. Non-interest income gained 56 percent to 65.96 billion yuan. Net interest margin contracted 13 basis points to 2.63 percent in 2008.

Bank of China expanded lending by 15.7 percent in 2008 to 3.2 trillion yuan. It set aside 16.8 billion yuan to cover bad loans last year, more than double of the amount for 2007, after the banking regulator required publicly-traded banks to boost their coverage ratio to 130 percent. The lender’s non-performing loan ratio narrowed to 2.65 percent as of Dec. 31.

Economic Slump

Loan defaults are the single biggest threat to Chinese banks, which face “a choppy 2009” as the economy weakens, Fitch Ratings said in January. About 7.5 percent of the country’s 42 million smaller and medium-sized firms closed down or suspended operations by the end of last year, official estimates show.

Bank of China’s Hong Kong unit said today 2008 profit fell 78 percent on provisions, its first full-year earnings decline since a 2002 initial public offering.

Central Huijin Investment Co., a unit of China’s $200 billion sovereign wealth fund and Bank of China’s biggest stakeholder, bought 74.6 million shares in the lender in the fourth quarter.

To contact the reporter of this story: Luo Jun in Shanghai at jluo6@bloomberg.net; Kelvin Wong in Hong Kong at kwong40@bloomberg.net

Last Updated: March 24, 2009 07:40 EDT