UPDATE 4-Italian banks sees first signs of improvement on bad loans
* UBI hikes H1 writedowns on non-performing loans
* But bank sees full-year improvement
* Banco Popolare lowers loan loss provisions in Q2
* Says bad loans stabilising
* Profit at both hit by lower lending, supported by trading (Recasts with Banco Popolare results)
By Silvia Aloisi and Stephen Jewkes
MILAN, Aug 27 (Reuters) - Two mid-sized Italian lenders reported slower growth in bad debts on Tuesday, pointing to a tentative recovery in the euro zone's third-biggest economy.
Bad loans on Italian banks' balance sheets have nearly tripled since 2007 as the country suffers its longest recession since the Second World War, and have fuelled speculation that some of them may need to raise more capital.
Banco Popolare, Italy's No. 4 bank by number of branches, said its net writedowns on bad loans in the second quarter stood at 212 million euros ($284 million) - down 8 percent from the first quarter.
That made it the only lender among Italy's top five banks that has lowered loan loss provisions in the three months between April and June, even though CEO Pier Francesco Saviotti said he could not promise lower charges in the second half.
Total non-performing loans totalled 12.6 billion euros, a 0.4 percent increase on the quarter, far below the 5 percent quarterly growth posted in the previous three months.
Domestic rival UBI increased loan writedowns by 43 percent in the second quarter to 226 million euros, but it stuck to its forecast of a slight improvement in overall loan loss charges this year compared with 2012.
Last year the lender, Italy's No. 5 by number of branches, booked net writedowns on bad loans of 847 million euros after an industry-wide inspection by the Bank of Italy that forced most lenders to set aside more money to cover for bad debts.
UBI said bad loans stood at 8.7 billion euros at the end of the second quarter, with the growth pace slowing to 2.4 percent from 4.9 percent in the previous three months.
Echoing comments by bigger Italian lenders like UniCredit , UBI CEO Victor Massiah said there had been some signs pointing to a fledgling economic recovery in Italy, which came close to a Greek-style meltdown at the height of the euro zone debt crisis in 2011.
"Demand for healthy credit is not high, but after six years of bad news we are starting to see some positive signs," he said, adding his bank had seen a pickup in demand for mortgages in July.
Adding to the evidence of a tentative recovery, UBI said the gross amount of loans that turned bad in the second quarter fell 9.5 percent from the first three months of the year.
Analysts said both banks' results pointed to an initial stabilisation on the credit quality front, but warned it was too early to say the tide had turned for Italian lenders.
"I think we still have a long way to go, it's premature to say this is the turning point," said Alessandro Frigerio, fund manager at RMJ.
DEALS IN THE PIPELINE?
Some industry executives think smaller Italian banks may be forced to merge and tap investors for capital as the European Central Bank prepares a check-up of bank assets ahead of taking over the supervision of euro zone lenders next year.
A newspaper report on Sunday said both UBI and Banco Popolare had held informal discussions with peer Banca Popolare di Milano over possible tie-ups.
Massiah from UBI denied the report, although he said it would not be "irrational" to expect some consolidation in the sector. "We've had no contacts whatsoever," he said.
Saviotti said his priority was to strengthen his own bank and he had "no interest" in mergers and acquisitions.
Massiah, pressed by analysts about whether his bank could resist potential pressure from the Bank of Italy to ride to the rescue of weaker lenders, said: "We are a private company, we have every right to say no. But let me say that I have never been asked by a regulator to make a special transaction."
Like other Italian lenders, both banks have been scaling back on lending in an attempt to reduce bad debts, although economists say that by doing so banks may be hampering a recovery.
Customer loans fell by 0.8 percent at Banco Popolare and by 1.7 at UBI from the end of last year.
Lower lending volumes and interest rates hit net interest income at both lenders, highlighting the challenge for Italian banks to make money from their core business.
However, both lenders benefited from one-off gains. Banco Popolare posted a fivefold increase in its first-half profit, helped by a 106 million euros reduction in a previous impairment of its consumer credit Agos Ducato joint venture with Credit Agricole.
UBI's profit more than halved in the second quarter to 26.5 million euros, but was still better than analyst forecasts thanks to gains from trading securities.
Shares in both banks closed down more than 3 percent, in line with the European banking index. ($1 = 0.7466 euros) (Editing by Pravin Char)
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