By Georgina Prodhan
VIENNA (Reuters) - Austria's Erste Group Bank (EBS.VI) surprised the market with a noticeable improvement in bad loans ahead of a key health check by the European Central Bank, lifting its shares on Wednesday.
Its non-performing loans (NPL) ratio fell to 9.6 percent in the third quarter from 9.7 percent a quarter earlier, helped by the first decline in Romania since the start of the financial crisis.
Coverage - a measure of the bank's ability to absorb potential loan losses - rose to 63 percent from 61.7 percent.
"In dire times, you're happy with little things," Chief Executive Andreas Treichl told analysts in London.
The bank said its core Tier 1 capital ratio under Basel 3 rules was 10.3 percent, well above expected requirements, thanks to a repayment of participation capital and an equity issue.
"Going into the asset quality review, we are above our internally set and defined targets. This makes us comfortable," Chief Financial Officer Gernot Mittendorfer said, referring to the ECB's planned tests of banks' assets at the end of this year.
Shares in Erste rose to a two-month high and were trading up 3.8 percent at 25.94 euros by 1216 GMT, as investors forgave the central and eastern European (CEE) lender for missing profit expectations.
European banking analyst Eleni Papoula of Berenberg Bank said: "The improvement in asset quality in the current quarter is encouraging."
Erste's net profit after minorities fell 10 percent to 129 million euros ($178 million), missing the average estimate of 148 million euros in a Reuters poll, despite signs of slight improvement in CEE economies.
The former communist region, pressing to catch up with its western neighbors, was one of Europe's few sources of more dynamic growth before the 2008 financial crisis, and one on which Erste and its competitors bet heavily.
Rival Raiffeisen Bank International (RBI.VI) in September raised its forecast for bad loan provisions by as much as a fifth, raising concerns about its emerging-markets exposure.
Erste - which also competes with top CEE lender Bank Austria, a unit of UniCredit (UCG.MI) - kept its risk provisions steady at a better-than-expected 428 million euros.
Net interest income fell 7 percent to 1.22 billion euros due to subdued credit demand, low market interest rates and weakness in corporate and investment banking (GCIB), but was better than forecast.
The GCIB segment was hurt by a drop in loans and higher provisions for corporate and commercial customers, especially shopping centers, as consumers curtailed spending, pushing struggling retailers to negotiate lower rents or shut down.
Treichl said, however: "Some encouraging signs of renewed loan growth in the third quarter - in line with the brightening macroeconomic performance - occurred particularly in Austria and the Czech Republic."
Erste trades at 11.4 times 12-month forward earnings, according to Thomson Reuters StarMine, compared with 8.8 times for Raiffeisen.
Erste confirmed its full-year forecast for a decline of up to 5 percent in its operating result, in line with developments in the first nine months, and for risk provisions to fall by 10 to 15 percent, mainly due to an improvement in Romania.
The forecast did not include any negative effects from a planned Hungarian government scheme to help homeowners cope with escalating costs of foreign-currency mortgages, which is due to be unveiled next month.
Treichl said he was confident of reaching a "negotiated, reasonable solution" with the government in the next four weeks. ($1 = 0.7262 euros)
(Editing by Mark Trevelyan)