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UPDATE 1-Banco do Brasil cuts guidance as recovery hits a snag

(Recasts to add details on guidance, quarterly performance throughout)

SAO PAULO, Aug 10 (Reuters) - Banco do Brasil SA's loan book and interest income are expected to shrink this year, magnifying the woes of the country's largest state-controlled lender as corporate defaults unexpectedly spiked in the second quarter.

Interest income, before loan recoveries, could have zero growth or fall as much as 4 percent this year, down from a prior estimate for growth of up to 4 percent, Banco do Brasil said in a securities filing on Thursday. Gauges for loan book and non-interest expense growth were also revised downward.

The dialing-down of forecasts underscores how state lenders are struggling more than their private-sector rivals amid Brazil's harshest recession ever, because of laxer provisioning policies in the past and years of government interference in decision making, analysts said.

Chief Executive Officer Paulo Rogêrio Caffarelli is focusing on bolstering profitability while drastically revising the bank's cost and capital structure.

His steps began to bear fruit in the last quarter as loan-loss provisions fell slightly and interest income held up despite declining domestic interest rates.

Earlier in the day, Brasilia-based Banco do Brasil reported second-quarter profit that missed estimates because of a surprising jump in taxes and as rising corporate defaults forced it to keep provisions at high levels.

Net income excluding one-time items was 2.649 billion reais ($839 million) last quarter, up 5.3 percent from the prior three months. That was below the average consensus estimate of 2.959 billion reais of analysts polled by Thomson Reuters.

Company officials will discuss results later in the day at a news conference.

Recurring return on equity totaled 10.7 percent, below consensus estimates of 12.8 percent. The 90-day default ratio, a benchmark for delinquencies, unexpectedly hit 4.1 percent last quarter - the highest in at least eight years - after two large corporate borrowers fell in arrears on their loans.

Without the impact of those two specific cases, the default ratio would have declined to 3.7 percent of Banco do Brasil's outstanding organic loan book. Provisions came in slightly below expectations, hitting 6.658 billion reais last quarter.

($1 = 3.1556 reais) (Editing by Jane Merriman and Bernadette Baum)