INVESTOR/FINANCIAL:The global banking sector has been one of the few sectors of the market to produce positive returns to investors during 2002. It therefore came as something of a shock to the UK banking sector earlier this week when UK mortgage bank Abbey National issued a profit warning saying that full year pre-tax profits would be "substantially lower" than market expectations and last years results.

The bank stated that it had been hit by write-offs and a more conservative policy of provisioning for risks at its wholesale bank. It also warned that dividend growth this year would be lower than last year "reflecting a cautious view on current trading conditions".

The key to Abbey National's problems is its decision last year to increase lending to several high- risk sectors to diversify away from its core mortgage lending business. Lending was increased to the risky and volatile high yield debt market and exposure to the cable and telecoms sector was also increased.

Unfortunately for Abbey National the higher returns from this form of lending have been offset as a significant number of these loans have quickly turned sour forcing Abbey to write-off these bad debts.

Investors in Irish banks, who have enjoyed stellar returns over the past three months (see table), may be wondering whether the bad news from Abbey National has any more general implications for the Irish and UK banking sectors. UK banks have performed reasonably well over the past three months with the Royal Bank of Scotland (RBOS) up by 7 per cent and HBOS, the merged Halifax and Bank of Scotland, up by a similar amount.

This compares with rises of over one-third in Anglo-Irish Bank and First Active, both of whom are small niche banks. Ireland's two largest banks are comparable with their UK counterparts and these have also enjoyed strong share price rises of 18 per cent and 25 per cent for AIB and Bank of Ireland respectively over the past three months. Fortunately, the problems that have arisen at Abbey National probably do not have any significant implications for the Irish banking sector. The strong fundamentals that underpin the core business of the Irish banks continue to apply.

The Irish economy is still growing at a healthy pace and the mortgage market in particular is buoyant due to the very strong housing market.

Analysts will undoubtedly look more carefully at the wholesale and syndicated loan portfolios of the two main banks. However, it does seem as if the problem loans that have arisen at Abbey National are due to the specific high-risk strategy adopted by that bank.

Assuming that the Irish economy maintains economic growth above the European average, then Irish financial stocks offer good relative investment value at current share prices. The two large banks are currently trading on price-earnings ratios (PER's) that are a little lower than those of Northern Rock and RBOS (see table). The dividend yield offered by AIB is 3 per cent while Bank of Ireland offers a yield of 2.4 per cent.

This compares with a similar yield from Northern Rock and a somewhat lower yield of 1.7 per cent from RBOS. The yield on Abbey National is 5 per cent although at best this dividend will grow more slowly than the sector average and at worst there is a risk that it could be cut sometime in the future if further problems emerge in its loan book.

On balance, therefore the positive arguments in favour of investing in Irish financial shares remain intact and probably the share prices of Irish banks can probably hold up even if the UK banks go through a somewhat more difficult patch. However, the prospects for another bout of strong price appreciation over summer months are low.

In part this is due to the fact that Irish financial stocks have done so well during 2002 that further absolute price appreciation will require a better overall trend in share prices.

Equity markets throughout the world show little sign of sustained improvement and the summer months could continue to witness trendless and volatile markets. In this scenario Irish financial stocks will probably hold their own but will find it difficult to appreciate significantly in price.