Investor An insider's guide to the market: The earnings reporting season is now in full swing and on Tuesday, the Irish market's largest company, AIB, reported a very impressive set of results. In recent years AIB's underlying business performance has been marred by the Rusnak fraud in the US and the high profile revelations regarding customer overcharging at home.

The bank now seems to have successfully put these mishaps behind it and has revealed a business performance second to none in the industry. With a market capitalisation of approximately €14 billion, AIB ranks as a medium-sized European bank.

For 2004 AIB generated pre- tax profits of €1.4 billion and it increased the dividend payable to shareholders by 10 per cent. All of AIB's geographic businesses performed well in 2004, including its Polish operation where profits soared by 135 per cent.

Poland had been a difficult banking market in 2002 and 2003, so the turnaround in 2004 augurs well for the future. Poland is still quite small within the group but over the medium to long term it has the potential to become a significant contributor to AIB's overall business.

The core retail banking business in Ireland and the UK continue to be the key driver of growth for AIB. Loan growth in Ireland and the UK was 30 per cent and 29 per cent respectively in 2004 and as a consequence pre-tax profits rose by 19 per cent in the Republic of Ireland and by 17 per cent in the UK.

Profit margins, as measured by net interest margins, continued to contract but at a slower pace than in previous years. Although competitive pressures will continue to intensify, net interest margins are probably now close to bottoming out. Rapid growth in volumes has been the key to AIB's recent profit growth and therefore it is the sustainability of this volume growth that will determine the prospects for AIB's share price.

Annual loan growth of 25-30 per cent is clearly unsustainable in the long run and the Central Bank has been pointing out the potential risks posed by the rapid build up in debt over recent years. Nevertheless, the period of rapid growth in loans and associated financial products seems set to continue for some time yet.

The Irish economy is now growing at an annual rate of 5 per cent, which most economists believe is its medium-term trend rate of growth. The public finances are in rude good health and membership of the euro protects the economy from sudden shifts in foreign exchange and interest rates. Infrastructural investment is set to remain high for the foreseeable future, while house completions are running at close to 80,000 units per annum.

There continue to be legitimate worries regarding the sustainability of current trends, particularly in the residential housing market. There is clearly justification for these concerns given the absolute level of house prices. Furthermore, some economists have expressed the view that the sustainable medium-term demand for housing output is no more than 50,000 units per annum.

However, in recent years analysts have underestimated the scale of housing demand and therefore all forecasts need to be assessed with the usual grain of salt. Investor takes the view that a slowdown in the rate of housing output and in house price growth is inevitable. There are now clear signs that the rate of house price increase is slowing. The most recent Permanent TSB/ESRI house price index shows that in the 12 months to January 2005, house prices rose by 8.5 per cent nationally compared with 13.3 per cent in the previous 12-month period. Several respected forecasters now expect Irish house price growth of about 5 per cent in 2005.

With euro interest rates not now expected to rise for the foreseeable future, the slowdown in the Irish housing market is likely to be measured. From the perspective of investors in AIB such a scenario should still allow the bank to continue to generate acceptable profits. Clearly, an unexpected rise in interest rates has the potential to lead to considerable weakness, but the probability of such a rise occurring remains quite low.

Therefore, for 2005 and into 2006 Investor takes the view that developments in the Irish economy will continue to provide a favourable business backdrop for AIB's banking business. The group should be capable of managing the impact of any slowdown when it occurs given that its overseas businesses seem set to continue to perform well.

Its minority interest in M&T Bank in the US is performing well, while the UK market remains strong. Although the relative importance of Poland is still small in the overall group context, AIB's operations there seem to have turned the corner and could become an important source of medium-term growth.

Despite the recent increase in its share price Investor continues to take the view that AIB offers investors exceptional medium-term value.