* Returns to net profit in Q2 after three quarterly losses
* Underlying net 409 million euros vs expected 374 million euros
* CDO portfolio marked up, 1.3 bln euro impact
* Declines in eastern Europe, merchant banking
* Shares surge to 8-week high
(Updates after news conference, updates shares)
By Philip Blenkinsop
BRUSSELS, Aug 6 (Reuters) - Belgian bancassurer KBC surprisingly returned to profit in the second quarter, after three straight losses, boosted by a mark-up of its credit portfolio, strong trading income and tight cost control.
The group, which has received 7 billion euros ($10.1 billion) of government cash to help it through the global financial crisis, reported on Thursday an underlying net profit, excluding exceptional items, that beat forecasts.
KBC shares rose as much as 23.8 percent to an eight-week high of 20.21 euros, against a 3.7 percent rise of the DJ Stoxx European banking index. Trading volume by 1400 GMT was more five times the average of the previous 30 days.
European banks such as HSBC and UniCredit have typically benefited in the second quarter from strong trading income despite reporting a surge in bad debts, suggesting the worst may be over for them..
But those without a major investment banking arm such as the Lloyds Banking Group, which is 43 percent owned by the British government, have found little to offset the pain of margin pressure and loan losses.
KBC's 409 million euro ($588.6 million) underlying net profit in the second quarter was down 49 percent year-on-year, but above the 374 million euros average of a Reuters poll of nine analysts, with higher interest and insurance premium income and fees off the first-quarter low. By division, the steepest declines were in the central and eastern Europe and in merchant banking. Its Belgian business was most robust, with earnings down only 9 percent. Operating expenses fell by 14 percent year-on-year.
Chief Executive Jan Vanhevel said the results were a sign of a positive trend that has developed since the start of the year.
"Business margins remained strong, sentiment on the capital markets improved, insurance results were solid and cost cutting is paying off. Trends for problem loans rose, but remained within expectations," the new chief said.
LARGE ONE-OFFS
KBC made a net loss of 3.6 billion euros in the first quarter because of credit writedowns, and secured further state guarantees to cover further potential hits.
Most of the first-quarter losses were caused by the worsening credit worthiness of U.S. bond insurer MBIA.
The group again took a large number of one-offs in the second quarter.
The main items were the 1.3 billion euro positive for CDO (collateralised debt obligation) revaluation, a 0.7 billion euros after-tax payment for the state guarantees and a 0.7 billion euro mark-down for trading positions that are being run off.
Bank Degroof analyst Ivan Lathouders said the CDO revaluation was the biggest surprise -- analysts had been expecting another loss. Other extraordinaries had helped clean the balance sheet. The underlying results, he said, were mixed.
"Net interest income is lower than I had expected, fee and commission income strong. Cost controls are working very well."
KBC, the fifth-largest bank by assets in emerging Europe, said that volume growth slowed in eastern Europe.
Loan-losses in its core Belgium and eastern Europe markets were stable compared with the first quarter, but rose elsewhere, such as for U.S. mortgage-backed securities and Irish residential mortgages.
Emerging Europe's economies are set to shrink 5 percent this year as exports to western Europe dwindle and capital inflows fall.
KBC's rivals in eastern Europe have generally beat forecasts in the second quarter, principally due to trading results, although a number have raised bad debt provisions.
The group said it was working on a comprehensive review of its strategy -- it has already cut corporate lending outside its home markets and begun running off structured finance activities.
Vanhevel said he hoped to be able to communicate details early in December. ($1=.6948 Euro) (Editing by Simon Jessop and Erica Billingham)