(Recasts to add share performance, management and analyst comments in paragraphs 1-8)
SAO PAULO, Aug 10 (Reuters) - Banco do Brasil SA's loan book and interest income should shrink this year, executives said on Thursday, as a spike in second-quarter corporate defaults slowed the recovery of the nation's No. 1 state-controlled lender.
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. Gauges for loan book and non-interest expense growth also were revised downward, as a continuing credit downturn kept dragging along.
The dialing-down of forecasts underscores how state lenders are struggling more than their private-sector rivals to cope with Brazil's harshest recession ever due to more lax provisioning policies in the past and years of government interference in decision making.
While the revised guidance kept annual profit estimates unaltered, Chief Executive Officer Paulo Caffarelli said at an event that his focus on bolstering profitability and cutting the bank's cost and capital structures are bearing fruit.
Banco do Brasil's operations could soon be profitable as their return on equity equalizes the cost of capital. The gauge of profitability commonly known as ROE hit 10.7 percent last quarter, compared with cost of capital estimates around 13 percent.
"We're close to see ROE converging on our cost of capital," Chief Financial Officer Alberto Queiroz said at the same event.
Shares fell on Thursday noon as geopolitical tensions in Asia escalated. They rose 2 percent earlier in the day, signaling investor confidence on Caffarelli's strategy.
Banco do Brasil's second-quarter profit missed estimates because of a surprising jump in taxes. Still, expenses fell faster than at rivals, and early delinquency indicators improved on a sequential basis.
Profit excluding one-time items was 2.649 billion reais ($839 million) last quarter, up 5.3 percent from the prior three months but missing consensus estimates of 2.959 billion reais.
Non-interest expense could grow up to 1.5 percent and fall as much as 2.5 percent this year, down from a prior 1.5 percent-to-4.5 percent growth range.
"It's impressive what the bank is achieving in the expense front, particularly since it's a government-owned entity with less flexibility than private-sector peers," said Eduardo Rosman, an analyst with Banco BTG Pactual.
Recurring return on equity missed consensus estimates of 12.8 percent. The 90-day default ratio unexpectedly hit 4.1 percent last quarter - the highest in at least eight years - as two large corporate borrowers fell in arrears.
Without the impact of those cases, the ratio would have declined to 3.7 percent. Provisions came in slightly below expectations, hitting 6.658 billion reais last quarter.
($1 = 3.1556 reais) (Additional reporting by Aluísio Alves in São Paulo; Editing by Bernadette Baum and Bill Trott)