* Bank says damages in FHFA lawsuit could be up to $1.6 bln
* H1 pretax up 10 pct to $14.1 bln as costs, bad debts fall
* Revenue drops 12 pct as emerging markets slow
* Expects to sell more U.S. loan portfolios in H2
* Shares down 4.4 pct (Releads with details on possible loss on U.S. lawsuit)
By Steve Slater
LONDON, Aug 5 (Reuters) - HSBC posted lower thanexpected earnings on Monday and said it might have to pay $1.6billion in damages over a U.S. lawsuit, reviving concerns overlegacy issues and growth prospects at Europe's biggest bank.
Its shares fell more than 4 percent, after a slowdown inemerging markets contributed to a steeper than expected 12percent drop in revenues in the first half of the year.
The London-based bank also said it may face a $1.6 billionsettlement with a U.S. regulator over allegations it mis-soldmortgage-backed bonds during the housing bubble.
The Federal Housing Finance Agency (FHFA), the conservatorof Fannie Mae and Freddie Mac, has alleged 18 banksmisrepresented the quality of the collateral backing securitiesthey sold between 2005 and 2008.
"Based upon the information currently available, it ispossible that these damages could be as high as $1.6 billion,"HSBC said.
HSBC had previously said the financial impact of anylitigation could be significant but had never estimated thescale. Analysts said it might be about $900 million.
Swiss bank UBS paid $885 million in a settlementwith the FHFA last month and two other lenders have settled forundisclosed sums. Other banks have set aside money for potentialsettlements.
HSBC Chief Executive Stuart Gulliver is attempting to repairthe bank's reputation in the United States after authoritiesthere last year fined it $1.9 billion for compliance failings inMexico.
That settlement included a deferred prosecution agreement,which meant HSBC avoided being criminally charged but agreed tohave a monitor evaluate its improvement in compliance.
The bank said it had added 1,600 compliance and regulatorystaff in the first half of this year, despite axing thousands ofjobs elsewhere.
HSBC's pretax profit rose 10 percent in the first half yearas the bank's three-year cost-cutting plan paid off and losseson bad debts declined.
Gulliver is two and a half years into a restructuring planand has sold, or exited, 54 businesses. He has cut $4.1 billionin annual costs and is making progress on returns.
But some analysts said growth will be a challenge given atough global economy and tighter regulations.
"For all the worthy progress in terms of strategicrepositioning ... weak revenues driven by anaemic loan growthand a declining margin constrain financial progress andreturns," said Ian Gordon, analyst at Investec.
Pretax profit rose to $14.1 billion from $12.7 billion ayear ago. But the outcome fell short of the average $14.6billion expected by analysts polled by the company.
"There has been a slowdown in faster-growing markets inrecent quarters, even emerging markets go through businesscycles," Gulliver said. "But the reality is those marketscontinue to grow relatively quickly."
Profits from Latin America more than halved to $466 millionas losses from bad loans jumped in Brazil and Mexico, continuingits troubled run in the region.
The bank also set aside another $367 million to compensatecustomers in Britain who were mis-sold insurance against loandefaults, taking its provision for that issue - which hasaffected British banks across the board - to $2.8 billion.
Shares in HSBC closed down 4.4 percent in London at 718pence, the weakest stock in the European banking index,having spiked to a more than two-month high on Friday.
SUSTAINABLE GROWTH
Gulliver said he expected China's GDP growth to slow to 7.4percent this year and next as the country shifts away fromeconomic stimulus toward reform measures, but said slowerexpansion should provide the basis for more sustainablelong-term growth.
China's annual economic growth was still more than its totalGDP was 18 years ago, he noted.
The bank continued to expand in mainland China and had 169outlets there at the end of June, up from 124 two years ago.
Hong Kong and the rest of Asia accounted for $8.1 billion offirst-half profit, or 62 percent of the group total.
Gulliver is increasing focus on those regions and also wantsto cut complexity within the organisation.
HSBC has slashed its number of customers to 55 million from89 million two years ago and the CEO has cut more than 35,000staff - a trend which could continue, reducing headcount to240,000 by 2016 from 259,400 at the end of June.
Gulliver said the biggest restructuring changes had occurredand the pace of deals is likely to slow, although he expects tosell more U.S. loans to accelerate the run-off of its consumerloan book there. It sold two portfolios of U.S. loans for $3.2billion in March, leaving it with a $36 billion loan book at theend of June, down $10 billion from a year ago.
HSBC Chairman Douglas Flint said the bank could bump upsalaries to counter European Union plans to cap bonuses at oneor two times salary, which he said could have a "highly damagingimpact on our competitive position".
Flint said he would consult with shareholders on how best topay competitively while keeping a remuneration framework heagreed with shareholders two years ago, which allowed for bonusawards of several times salaries. (Editing by David Holmes and David Cowell)
HSBC Holdings (HSBA)