Allied Irish margins up, bad loans down as eyes debt issue

* AIB says defaulted loans fall by over 10 percent in Q3

* Core tier 1 capital 12.2 pct post-capital reorganisation

* Mandates dealers to sell Lower Tier 2 bond (Adds debt issuance mandated, fin min comments)

By Padraic Halpin

DUBLIN, Nov 17 (Reuters) - Allied Irish Banks (EUREX: 558453.EX - news) (AIB) generated more capital, reduced its bad loans and increased its net interest margin in the third quarter, it said on Tuesday, adding it had mandated dealers to look at raising debt to start repaying a state bailout.

The government has pumped 21 billion euros ($22.4 billion) into AIB since the financial crisis, the biggest bailout given to any Irish bank still trading, and is now beginning the process of recovering the public money.

The bank, which almost tripled its first-half pretax profit, said on Tuesday it had increased its core tier one capital ratio by 90 basis points in the quarter under fully loaded Basel III industry rules, driven primarily by profits.

The bank's stock of defaulted loans fell 2 billion euros from the end of June to 16 billion euros while its net loan book remained stable. Performing loans have risen 2.3 billion euros to 56 billion this year, reflecting more new lending.

AIB's net interest margin, which shows how profitable its lending is, rose to 1.94 percent from 1.92 percent three months earlier. A mortgage rate reduction announced in August will temper the rate of increase in the fourth quarter, it said.

AIB got the green light from European regulators earlier this month to repay 1.7 billion euros of state bailout funds and will repay another 1.6 billion euros next July when state-owned contingent capital notes (CoCos) mature.

As part of the agreement, the 99 percent state-owned bank will issue at least 750 million euros of Lower Tier 2 (LT2) and 500 million euros of Additional Tier 1 bonds (AT1). It (Other OTC: ITGL - news) has mandated a number of banks to arrange investor meetings for Wednesday to look at issuing the Tier 2 bond.

The bank said its Core Tier 1 capital adequacy ratio would have increased to 12.2 percent of assets on a fully loaded basis from 9.2 percent had each element been completed at the end of September, a level Davy Stockbrokers said would form a positive backdrop for any issuance.

The bank's shares will be valued at around 11.7 billion euros after the capital reorganisation, which Ireland (Other OTC: IRLD - news) 's finance minister said represented a 15 percent increase from the end of 2014 when the funds due to be repaid to the state were counted as part of the valuation.

The government expects to recoup more than it invested in the bank over a number of years and, if re-elected early next year, plans to sell a 25 percent stake on the stock market.

($1 = 0.9386 euros) (Additional reporting by Alice Gledhill; Editing by David Clarke (Toronto: CKI.TO - news) and Mark Potter)