CROESUS:We are now deep into the banks' reporting season. In normal times, that tends to be a good period for share prices. But these are not normal times for the financial sector, in particular, and this has been reflected in further large-scale asset writedowns at many financial institutions.

Earlier in the week Credit Suisse announced writedowns of €2.8 billion, resulting in a 10 per cent plus fall in its share price. This continued a pattern of large-scale writeoffs by many continental European banks.

The week was also a busy one for British bank results. On the positive side, a theme that has emerged is that British (and Irish) banks have much lower exposure to subprime-related writedowns compared with their international peers. There are, however, plenty of negatives relating to funding costs and a sharp slowdown in growth in both the British and Irish economies.

These recent British bank results highlight the difficulties being faced by the smaller and more narrowly focused banks such as Alliance & Leicester and Bradford & Bingley, compared with the more robust performances from larger banks such as Barclays. At the end of last week, Bradford & Bingley announced results where management highlighted a sharp rise in bad debt charges and a steady rise in arrears levels through 2007. On Wednesday, Alliance & Leicester (A&L) announced historic results that were in line with forecasts but included asset writedowns of £185 million in relation to its treasury portfolio. A&L's big problem is not deterioration in overall credit quality but a sharp rise in its funding costs.

When the Northern Rock crisis broke, A&L was seen as being vulnerable, given its reliance on the wholesale money market for funding. A&L said it had organised additional funding facilities that will cost it some £150 million extra per annum. This will bring its net interest margin down to around 1 per cent. By comparison, Bank of Ireland's net interest margin is around 1.8 per cent. As a result, A&L's profits will be under severe pressure in 2008 and 2009.

The news from Barclays on Tuesday was much better, as the bank reported pre-tax profits of £7 billion and increased its dividend by 10 per cent. The capital markets division, Barclays Capital, delivered pre-tax profits growth of 5 per cent to £2.35 billion, which included net losses of £1.63 billion arising from credit market turbulence.

Of particular relevance to the Irish banks was news that its UK retail banking arm reported a 9 per cent rise in profits. Charges for bad debts improved across unsecured lending to consumers and small business, and there was no deterioration to the credit quality of the mortgage book.

On Wednesday, AIB's results were quite well received by the market. By any standard, 2007 was a very good year for the bank, as pre-tax profits rose to €2.38 billion, a rise of 15 per cent. There were asset writedowns of €131 million and €177 million of writedowns were charged to reserves. In any other year these would be a cause for concern, but in the context of what is happening across the global sector, these writedowns rank as very modest. The dividend was raised by 10 per cent in line with market expectations.

Regarding the outlook, AIB reduced its guidance for 2008. It is now targeting a low single-digit percentage rise in earnings per share (EPS). This is likely to lead brokers to marginally reduce their EPS forecasts for 2008 and 2009.

In its update to the market last week, Bank of Ireland reduced its earnings guidance for the 12 months to end of March 2008. It is now guiding EPS growth in the 3-5 per cent range, which led brokers to downgrade their forecasts in the year to end-March 2009 to a 3 per cent fall in EPS.

Croesus believes there will be virtually no growth in Irish bank earnings over the next two to three years. The threat from subprime and credit crunch-related issues is minimal. The key threat is a much sharper than anticipated deterioration in the Irish and British economies. A recession in Ireland and Britain would lead to sharp profit falls due to bad debt writedowns in all lending categories. In this scenario, profit falls would be such that it would be difficult for banks to avoid cutting dividends.

Croesus's view is that the recession scenario will probably be avoided, but growth over the next year or two will be well below par. Earnings forecasts for 2008 and 2009 are still too high and will be pared back as more information comes to light. However, earnings stagnation, or modest earnings declines, will enable banks to maintain their dividend payouts.

Bank of Ireland's dividend yield is 7.4 per cent and AIB's is 6.5 per cent. Even assuming no growth in dividends over the next two to three years, these yields now offer excellent investment value.