Has the bank's situation deteriorated or did it call it badly wrong in its half-yearly results, asks Simon Carswell,Finance Correspondent

HOW QUICKLY the economic situation has deteriorated for AIB, the State's largest bank. Or did the bank call it badly wrong at its half-year results presentation in July?

Just over three months ago, AIB said bad debts would peak at up to 0.8 per cent of average loans next year, and in a worse-case scenario at 1 per cent.

On that basis, the bank boldly raised its half-year dividends by 10 per cent, saying it was "entirely appropriate" to reward shareholders while the bank was profitable and strongly capitalised.

AIB's tune turned considerably more sombre yesterday when it released a far more pessimistic trading statement to the market.

Chief executive Eugene Sheehy began a conference call to analysts saying how "very disappointed" the bank was to be presenting these results.

The bank said it was cutting its final cash dividend and guiding towards its worst-case bad debt charge - between 0.9 and 1.1 per cent - next year.

AIB slashed its earnings per share forecast for 2008 by more than a third.

The bank is expecting to write off €950 million in bad debts this year, an increase to 0.75 per cent of loans from 0.35 per cent in July. This will leave AIB with pretax profits of €1.3 billion this year, down from €2.5 billion last year.

The very recent and dramatic economic deterioration, and losses on loans to Irish residential developers, are to blame for the change.

The bank is biting the bullet on loans for undeveloped land where average prices have fallen - peak to trough - up to 40 per cent and up to 30 per cent on completed homes due to "anaemic" activity levels in the property market.

More worrying was AIB's prediction that there won't be "any meaningful market recovery until the first half of 2011". The bank is assuming a bad debt charge of up to 3 per cent on its Irish residential development loans this year and up to 4.8 per cent next year.

AIB finance director John O'Donnell said this charge of up to 7.8 per cent was "pretty horrendous" but should "more than take care of the issues in the portfolio".

The bank said these bad debt forecasts amount to double its previous worst performance in 1992.

Bank of Ireland and Anglo Irish Bank will come under pressure to follow suit and write down development loans more aggressively.

About 7 per cent of Anglo Irish Bank's loans are to Irish residential developers, slightly lower than the proportion of AIB's book, while Bank of Ireland has 3.4 per cent of its loan book to this sector.

Bank of Ireland said in September that bad debts would peak at a maximum of 0.9 per cent - the lower end of AIB's scale - in 2010.

Analysts expect Anglo, which has a larger loan exposure to commercial property, to report a much higher bad debt charge next year than the level forecast by the bank in the year to September 30th.

Bank of Ireland will issue results next week, followed by Anglo early next month. In the meantime both banks will be pouring over their loans to residential developers.