* Q2 net profit 290 mln shekels vs 161 mln forecast
* Leumi could be next in line for U.S. DOJ settlement
* Bank has already provisioned 950 mln shekels for settlement (Adds analyst comments, share reaction)
By Steven Scheer
JERUSALEM, Aug 21 (Reuters) - Israel's second-largest bank Leumi beat forecasts with a smaller-than-expected decline in quarterly net profit on Thursday despite setting aside a provision to settle a U.S. tax probe related to its Swiss unit.
In June, Leumi said it was close to reaching a deal with the U.S. Department of Justice, which has been investigating possible tax evasion by the bank's American clients. It is unclear when a settlement will be reached and Leumi has declined to offer a timetable.
Following Credit Suisse's settlement in May, in which the Swiss bank paid penalties of more than $2.5 billion, a banking source said Leumi's provision was a sign the bank could be the next to settle.
"We are probably closer to the end than the middle," said Adi Scop, financial services analyst at the IBI Brokerage.
Bank Leumi has urged U.S. clients to disclose information about their accounts to U.S. authorities, who are investigating Leumi and other foreign banks in a wide-ranging campaign to crack down on Americans using offshore banks to evade taxes.
Leumi said the probe covered the period 2002 to 2010.
It has so far provisioned 950 million shekels ($269 million) for the impending settlement, with 460 million coming in the second quarter and weighing on its bottom line and its share performance so far in 2014.
Its shares, though, were up 1.4 percent to 13.55 shekels in early afternoon trading in Tel Aviv. Since the start of the year, the shares are down 4 percent after gains of 28 percent in the prior two years.
In contrast, shares of its chief rival Hapoalim, Israel's largest bank, are up 1.3 percent in 2014.
Hapoalim and Mizrahi-Tefahot, Israel's fourth-largest bank, which also have Swiss units, may be targeted by the DOJ but analysts say any fines would be small since Leumi has the largest operations of an Israeli bank in Switzerland.
Barclays analyst Tavy Rosner reiterated his "overweight" rating for Leumi and has a price target of 16 shekels. He said the road to a higher rating will likely be bumpy but that "most of the overhangs are in the stock."
Trading at a 48 percent discount to its historical average, Leumi has a 20 percent upside in the medium-term, he said.
"We see the current valuation as attractive.".
Net profit fell 39 percent to 290 million shekels ($82 million) in the second quarter from 474 million a year earlier but beat the 161 million expected by analysts polled by Reuters.
Excluding the provision, profit in the April-June period was 765 million shekels, Leumi said.
Despite falling interest rates as policymakers try to boost a weakening economy, Leumi said net interest income rose 3.6 percent in the second quarter to 1.9 billion shekels.
"Even with the 460 million shekel provision for the DOJ settlement, it's a decent set of results," Scop said, pointing to interest income gains and 2 percent fall in salary expenses. "Leumi has been talking about operational efficiencies for a long time and now we are finally seeing the first signs of it."
Its Tier 1 ratio, which measures equity capital as a proportion of total risk-weighted assets, slipped to 9.34 percent from 9.43 percent at the end of 2013.
Like its peers, Leumi said it was focusing more on higher margin loans. In the first half of 2014, credit to small businesses grew 3.4 percent while credit to mid-sized companies rose 5.9 percent.
Last week, Hapoalim beat expectations with a quarterly profit of 783 million shekels.
(1 US dollar = 3.5344 Israeli shekel) (Reporting by Steven Scheer; Additional reporting by Katharina Bart; editing by Jason Neely and David Evans)