* Provisions drop 70 pct to 2.5 bln euros as losses fall
* Net interest margin rises quarter on quarter
* No significant deposit movement on Cyprus crisis - CFO
DUBLIN, March 27 (Reuters) - State-owned Allied Irish Banks (AIB) declared that it is moving back towards profitability after cutting its operating loss by a quarter last year and improving margins this year.
AIB cost taxpayers more than 20 billion euros during the financial crisis - the most handed out to any lender still operating - and is cutting jobs, closing branches and reducing its funding costs.
Now focused on its home market after a property crash forced it to ditch its international ambitions, the bank said that demand in Ireland would be constrained in 2013 but is showing signs of stability, echoing comments made by rival Bank of Ireland this month.
"It's a similar message, maybe a number of months behind Bank of Ireland, but certainly a similar one in terms of seeing a turn in performance," AIB acting finance chief Paul Stanley said.
There is "good momentum", he added, with the net interest margin improving and cost efficiencies coming through.
The bank doesn't expect any fallout from developments in Cyprus, where bank deposit holders face a hefty levy as part of the government's EU bailout deal.
"There has been some noise in terms of a few customers with queries, but nothing in terms of movements in actual deposits that would indicate a concern," Stanley said.
Unlike its main rival, AIB failed to attract private capital two years ago, triggering its effective nationalisation. Its margins have been slower to recover partly because of a loan book still weighed down by mortgage arrears.
Its proportion of owner-occupiers in arrears for more than 90 days rose at a slower pace to 9.1 percent last year, against an industry average of 11.9 percent, and the bank reiterated that it expects arrears to peak towards the middle of this year.
While the comparative figure for buy-to-let mortgage holders in trouble - 17.7 percent - was also below the 18.9 percent reported by the central bank for the sector as a whole, those investors represented 44 percent of the entire buy-to-let book.
That was significantly above the 24 percent at Bank of Ireland and 30 percent at permanent tsb.
The bank's net interest margin - measuring the profitability of its lending - was broadly unchanged at 0.91 percent versus 0.9 percent at the end of June but grew quarter-on-quarter for the first time in 10 years in the final three months of 2012.
That remains some way from the 1.5 percent that AIB believes would convince investors to take a stake in the bank. But after excluding the costly state guarantee on deposits, which is due to be lifted this week, AIB says the full-year figure is 1.22 percent.
Acting CFO Stanley told a conference call that the 388 million euros ($499 million) in fees related to the guarantee should fall by about 200 million euros this year.
COCO BOND SALE
After the government cut its exposure to Bank of Ireland by selling 1 billion euros of contingent capital notes in January, Stanley said there is a reasonable amount of investor interest in these CoCo bonds. While nothing immediate is on the table, there may be a sale this year, he said.
The bank, which also narrowed its provisions by 70 percent to 2.5 billion euros, added that it had largely completed a restructuring that will cut its workforce by almost 20 percent.
"Whilst arrears are slowing, impairments look higher than expected as the bank continues to cleanse its balance sheet ahead of 2013/14," Eamonn Hughes, an analyst at Goodbody Stockbrokers, wrote in a note.
"The margin stabilisation is a helpful sign, but the turnaround here is likely to trail Bank of Ireland."
The bank's shares, which no longer trade on Ireland's main stock exchange, were down 1 percent at 0.07 euros by 0920 GMT.
AIB had also met 89 percent of a 20.5 billion euro deleveraging target set under Ireland's bailout by the end of last year and said its deposit base remained stable in the second half, rising 5 percent year on year.