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(Adds details, CEO comments)
MILAN, March 13 (Reuters) - Deteriorated loans at UBI Banca , Italy's No.5 bank by number of branches, rose by nearly 30 percent last year, showing the impact a prolonged economic recession is having on the country's lenders.
UBI, which reported its full-year results on Wednesday, said problematic loans totalled 8.1 billion euros at the end of 2012, compared with 6.3 billion a year earlier.
Writedowns on loans rose to 847.2 million euros, up nearly 40 percent from a year earlier, after a Bank of Italy audit of problematic loans at the country's main lenders forced several among them to raise their provisions for bad debt.
UBI CEO Victor Massiah told a conference call the central bank's inspection prompted UBI to up its loan loss rate to 0.91 percent in 2012 from 0.61 percent at the end of 2011. Before the audit, UBI's own estimate stood at 0.75-0.8 percent, he said.
Loan losses this year are expected to be slightly below 2012 levels.
Reflecting gloomy sentiment among bankers and businessmen about Italy's economy - which has contracted for the past six quarters - Massiah said hard-hit families and companies were ever more reluctant to ask for loans.
UBI's loans and advances to customers fell by 7 percent, partly because it is lending less to big firms and to riskier clients, but also because of weak demand.
"We have not seen a healthy demand for new credit," Massiah said. "Unemployment is rising, young people are living with their parents, they rae not getting married and they are not buying a house - the demand for private mortgages has halved," he said.
The bank posted a net profit of 82.7 million euros for 2012, recovering from a loss of 1.8 billion euros for 2011 which was due to writedowns on goodwill impairments.
Like bigger peer Intesa, which reported earnings on Tuesday, UBI's profit was helped by strong trading gains while the net interest income - a key measure of a bank's performance in its core business - fell.
Also like Intesa, UBI increased its exposure to Italian government bonds in 2012 - which turned into a big liability for Italian banks at the height of the euro zone debt crisis.
At the end of last year it had 18 billion euros in domestic government bond holdings, up from 7.8 billion euros a year earlier. (Reporting by Silvia Aloisi and Lisa Jucca; Editing by David Cowell)