JERUSALEM, May 23 (Reuters) - Mizrahi-Tefahot's first-quarter profit fell 7%, the Israeli bank said on Thursday, but it doubled its dividend payout after cutting it at the outset of Israel's war with Palestinian Hamas militants in October.

The bank said it earned 1.3 billion shekels ($354 million), down from 1.4 billion a year earlier, for a return on equity of 18.1%.

A drop in net interest income to 2.7 billion shekels from 3.1 billion weighed on the bottom line, but expenses due to credit losses dipped to 175 million shekels from 227 million.

Israel's third-largest bank, with a market leading 36% share of mortgage loans, said it would pay a dividend of 508.8 million shekels, or 40% of its quarterly net profit, doubling a 20% payout in the fourth quarter.

The bank had cut its third-quarter payout to 15% from 35% in the second after Israel's banking regulator directed lenders to remain conservative on dividends while providing credit with the country at war and the economy set to slow.

Chief executive Moshe Lari said the higher distribution comes after "examining the capital ratios of the bank in various scenarios".

He cited a letter from the regulator last week, seen by Reuters, that directed banks to take into account the economic and security situation, as well as ensuring banks had proper capital cushions, when forming dividend policies.

Supervisor of Banks Daniel Hahiashvili on Tuesday told Reuters he had no issue with commercial banks lifting their dividend payouts, citing improved capital buffers and the ability to provide needed credit.

Earlier this week, banks Hapoalim and Israel Discount also sharply raised dividend payouts.

There has been public and political outrage over high bank profits and dividends at a time when a spike in interest rates led to a jump in mortgage and other loan repayments, with bank also slow to pass on higher rates to savers.

Mizrahi's Tier-1 ratio of equity to risk components rose to 10.60% at end-March from 10.12% a year earlier.

Its shares were flat at midday in Tel Aviv, after rising more than 1% earlier in the session. They are down 6.5% so far in 2024. ($1 = 3.6718 shekels) (Reporting by Steven Scheer Editing by Tomasz Janowski, Kirsten Donovan)