* Dutch property market stable after years of decline
* No firm date set for return of ABN to private hands
* Financial rescues cost Dutch state 40 bln euros (Adds context, float, CEO quote)
By Thomas Escritt
AMSTERDAM, Aug 22 (Reuters) - Dutch bank ABN Amro , polishing up its balance sheet for a possible privatisation next year, said a stronger mortgage market, fewer bad loans and signs of economic recovery lifted its underlying profit in the first half of 2014.
Although net income fell sharply because of two one-off charges, a second quarter of underlying profit growth brought closer the moment when the Dutch state can return the bank to the stock market, Chief Executive Gerrit Zalm said.
"I think we are on schedule," he said. "The development in the third quarter is important so you have some quarters that show you are well on track."
Once a leader in international finance, ABN Amro was bought by the Dutch state in 2008 as part of a 16.8 billion euro bailout. It now aims to re-list in the first half of 2015.
After nearly five years of consecutive declines in real estate prices, the Dutch property market appeared to have bottomed out earlier this year, with transaction volumes rising sharply and a revival of orders of new homes.
Zalm has said it would take three such quarters of solid performance for him to recommend to the government that it was time to re-privatise the bank.
The proceeds would help the Duch governemnt, one of the strictest advocates of fisacl discipline in the euro zone, keep its deficit comfortably below the European Union's ceiling of 3 percent of gross domestic product.
Final approval for an IPO on the Euronext stock exchange will come from the Finance Ministry, which has said ABN Amro will be re-listed if market conditions are favourable, the bank is healthy and there is sufficient investor appetite.
Underlying profit growth of 47 percent to 322 million euros was driven in part by a drop in impairments for residential mortgages and loans to small and medium-sized businesses.
Net profit fell to 39 million euros from 402 million a year earlier. The charges included a 216 million euro transfer to the bank's new defined contribution pension scheme and a 67 million euro levy paid for the nationalisation of Dutch bank SNS Reaal.
The Dutch government paid out nearly 40 billion euros to rescue the domestic financial sector during the 2008 financial crisis, when it provided capital injections for banking and insurance group ING, insurer Aegon and SNS Reaal, as well as nationalising ABN AMRO.
The Dutch government aims to reprivatise ABN AMRO, but has not set a date.
The bank reported a decline of 164 million euros in the volume of impaired loans in its credit portfolio to 342 million.
"It is clear that the housing market is improving. There are more transactions, more houses being sold. This means we have lower impairments for mortgage loans not being paid back," Zalm said.
He said the bank was well on the way toward achieving financial targets it had set for itself for 2017. The bank has previously said progress on these targets is a precondition for recommending to the government that it be privatised again.
In the first six months of the year, the bank achieved a return on equity of 10.1 percent - a significant increase from the 7.6 percent in the same period of 2013, and meeting the bank's 2017 target of between 9 and 12 percent.
Net interest income, the large majority of the bank's income, was up 6 percent in the second quarter, while the underlying cost-to-income ratio stood at 61 percent, just short of ABN's 2017 goal. Return on equity fell slightly compared to the previous quarter, from 10.9 percent to 9.2 percent.
The bank said geopolitical developments, particularly in Russia and Ukraine, might pose a risk to future performance by putting the economy under pressure. The bank said it had limited direct exposure to Russia and "negligible" exposure to Ukraine. (Editing by Anthony Deutsch and Tom Pfeiffer)