SHARES IN AIB, the State's biggest bank, rose 6.8 per cent after it reported better-than-expected pretax profits of €1.28 billion for the half-year to the end of June - a decline of 3 per cent from €1.32 billion for same period last year.

The bank said adjusted earnings per share (EPS) fell 4 per cent to 104.9 cent, but it would still be raising its interim dividend by 10 per cent to 30.6 cent in a sign of confidence to the market.

This beat the forecasts of some analysts who had predicted earnings to fall 7-10 per cent and said that the bank would freeze its dividend due to weakening economic conditions.

AIB's share price closed at €7.85, outperforming Bank of Ireland and Anglo Irish Bank.

Emer Lang, analyst at Davy Stockbrokers, said: "It was a good day to bring out mixed news because US banks had enjoyed a big boost (late on Tuesday)."

The bank cut its earnings target for this year to a 8-10 per cent decline from the low single-digit percentage growth it had forecast in May, saying there was no sign of an improvement to tough condition in many of its markets.

AIB expects no economic recovery until the second half of 2010, and said that funding costs would rise and the quality of its loans would deteriorate further.

The bank's Irish profits were down 5 per cent and profits in its capital markets division fell 8 per cent. AIB's Polish business increased profits by 4 per cent.

Higher funding costs, driven by the credit crunch, have led AIB to match new loans to new deposits. Loans grew 6 per cent in the first half of the year, compared to a 9 per cent growth in deposits.

AIB showed a higher-than-expected number of risky loans "on watch", particularly to the beleaguered housebuilding sector.

"Criticised" loans - described as loans that require closer management - jumped by €3.5 billion to €10.2 billion, or 7.6 per cent of loans. Some 60 per cent of the increase related to its loan book in the Republic and 75 per cent this related to property.

Impaired loans, on which AIB anticipates some losses, rose to 1.1 per cent of loans, worth €1.4 billion, from 0.8 per cent, or just over €1 billion, over the six months. AIB said "criticised loans", which included impaired loans, were not necessarily in arrears and did not always end up as losses.

Ms Lang said the 52 per cent rise in criticised loans over six months was "staggering" and reflected the rapid recent deterioration in the property market.

AIB expects its bad debt charge to reach 0.6-0.8 per cent of average loans next year, compared with 0.21 per cent at the end of June and 0.04 per cent last year.

AIB finance director John O'Donnell said the bank had "an intense focus" on its loans, particularly to residential developers. "We acknowledge they are getting worse. We realise we are going to take more bad debts in relation to them and we have given guidance in relation to that."

Mr O'Donnell said the bank would not have to raise any money from shareholders for capital.

The bank is targeting earnings per share of 185-190 cent this year, down from 205.9 cent in 2007, but plans to keep raising its dividend.

Chief executive Eugene Sheehy said the dividend was "below average", amounting to 38 per cent of after-tax profits last year. "We have a strong capital position and we believe it is entirely appropriate to increase slightly the percentage of distribution to reward our shareholders."

Mr Sheehy said the bank had reviewed every Irish loan greater than €1 million. The bank has forecast a bad debt charge of 0.35 per cent of loans this year, up from its previous target of 0.2 per cent.

Arrears of greater than three months rose to 0.63 of the bank's Irish home loans book, from 0.36 per cent at the end of last year.

Mr Sheehy said there was "a significant drop-off" in new mortgages in May and June, despite an "encouraging" start to the year. He said that, of AIB's 100 per cent mortgage book, just nine of 2,318 mortgages were in arrears.

He ruled out any need for the Government to support the property market.