BANK OF Scotland (Ireland) has reported a smaller increase in profits for the first half of the year compared with its earnings last year, blaming higher bad debts and bank funding costs.

The bank, which reported its figures with its British parent, HBOS, made pretax profits of €124 million (£85 million) for the half-year to June 30th, up 5 per cent on the same period last year. This compares with a 14 per cent increase in the first half of 2007.

Chief executive Mark Duffy said the lower rise in profit was due to higher bad debts and also because Halifax, the bank's 42-branch retail network, had not passed on higher funding costs to customers for 15 months, in a bid to increase its share of the market.

Bad debts rose to 0.16 per cent of loans at the end of June, from 0.12 per cent a year earlier, "reflecting deteriorating economic conditions" and a lower level of recovery in its bad debts portfolio.

Mr Duffy said the arrears had risen from "an incredibly low base". Bad debts remained around 0.2 per cent from 2004 to 2006.

"The late entrance of Halifax meant we missed an awful lot of the excess that has allowed us to produce a reasonably good set of results and escape many of the problems affecting the industry."

The bank said it was seeing "stress at higher levels than previously experienced, particularly in residential property development". Loans to this sector represented 8 per cent of loans, about €2.6 billion, at the end of June.

"The hotstop is property," said Mr Duffy. "We were lucky that we have less than 8 per cent on our book in that, but we are not escaping those problems and we particularly see it in residential property developers, similar to AIB's experience. It is very difficult for a lot of these people."

He said the market was going to see more "pain" among property developers as the year progressed.

Residential property prices would fall a further 7-8 per cent this year, Mr Duffy estimated, but the market would "bottom out" in the first three months of next year.

Chief financial officer Tom FitzGerald said the bank typically had 2.5 per cent of its loans, about €810 million, on "watch". He said this was "an early warning signal" for potential losses, and these loans were not always in arrears.

Loans rose 17 per cent to €32.4 billion in the six-month period, with business loans rising 15 per cent to €22.4 billion and retail loans growing 25 per cent to €10 billion. Net interest income rose 13 per cent to €253 million.Since the end of last year, deposits fell 18 per cent, or €800 million, to €8.8 billion, reflecting the competition in the market.

Mr Duffy said the bank had provided "a minuscule" number of 100 per cent mortgages, and the average loan-to-value was 53 per cent at the end of June, down from 49 per cent six months earlier.

"Our late entrance to the marketplace and our reluctance and inability to provide loans to first-time buyers allowed us to escape a lot of the excess in the market."

He declined to comment on speculation that HBOS, which recently raised £4 billion in a rights issue, would sell its Irish operations as the bank comes under pressure to sell assets in a deteriorating economic climate.

He said HBOS continued to invest in its Irish business and it was "absolutely committed to continuing that success in Ireland".

The bank said longer-term prospects for Irish economic growth were considered "favourable".

The Edinburgh-based bank gained 7.1 per cent in London after reporting that its first-half profits fell 56 per cent, less than expected, following £1.1 billion of credit crunch-related writedowns.

Analysts estimated the bank would earn net income of £790 million in the half-year, compared to the £931 million reported.