ULSTER BANK and its subsidiary bank, First Active, contributed less profit to its parent company, Royal Bank of Scotland (RBS), in the first half of the year due to the economic downturn.

The Irish banks contributed profits of £376 million to RBS, an increase of 8 per cent from £374 million a year earlier, although the contribution was down 2 per cent to €486 million in euro terms on a constant currency basis.

The fall reflected the "changes in the economic environment", RBS said, and the completion of its Irish investment programme.

Cormac McCarthy, chief executive of RBS Europe and Middle East, which now covers the Irish operations, said Ulster Bank had seen "a gradual deterioration" in the economy over the six months.

Bad debts rose 43 per cent to €74 million (or 54 per cent to £57 million in sterling terms) due primarily to loan losses to the commercial and property sector.

Mr McCarthy said this equalled 0.23 per cent of loans. "Given the economic outlook that we see in Ireland, it is not unreasonable to expect that to rise," he said.

He said bad debts had risen from "very historical lows" of 0.17- 0.18 per cent of average loans, but declined to say how high loan losses would rise this year. The increase in bad debts was on commercial borrowings and, in particular, on loans to property developers. "We have business in the construction-property sector and that has seen some stresses in the last six months."

He declined to say how much of the bank's property development loans were "on watch". "We have more cases that are getting careful management than we would have had six months or 12 months ago."

The commercial property portfolio had an average loan- to-value (LTV) ratio of 67 per cent. The bank said speculative developments accounted for 3 per cent of commercial property loans.

Ulster Bank Group, including First Active, is the second largest mortgage lender in the State.

Mr McCarthy said the bank had seen no deterioration in its mortgage book, but he expected mortgages to come under pressure due to rising unemployment, inflation and mortgage rates.

Ulster Bank's loan book rose 12 per cent to €64 billion and customer deposits increased by 1 per cent to €29 billion in euro terms.

The banking group has been one of the most aggressive to pass on higher mortgage rates to customers, as the credit crisis has increased the cost of bank funding.

"Competition drives that. I make no apologies for the fact that we were one of the first to increase prices," said Mr McCarthy.

Mortgage rates were at "unsustainably low levels" in terms of the interest margin for the banks, and the pressure was on rates to rise further. However, he added that rates were still low and that property prices were falling and becoming more affordable. He said property values had fallen 10-15 per cent and he expected prices to fall another 10 per cent.

"At some time in the next 12 months, the market will start to grow again."

Total income rose 6 per cent to €832 million, while expenses were up 15 per cent to €271 million.

The bank has invested £56 million (€72 million) in expanding its branch network. It opened two more branches and five "business centres" in the six months.

Some 53,000 new current accounts were opened due to a promotional campaign that paid new customers €150 if they switched their account to Ulster Bank.

Mr McCarthy said the bank accounted for 16-17 per cent of new current accounts opened in the three months to June 30th.

He said the economic downturn was due to "a natural correction" and the effect of the credit crunch.

"We are not going to get out of it any time soon. We are in for a difficult, challenging 12-18 months."