Allied Irish Banks returns to operating profit

* AIB FY loss halves, operating profit 445 mln euros

* Impairments 1.9 bln euros, pace of arrears decreasing

* Examining potential conversion of preference shares

* Does not expect to need fresh capital after stress test

By Padraic Halpin

DUBLIN, March 5 (Reuters) - State-owned Allied Irish Banks (Irish: AIB.IR - news) (AIB) more than halved its full-year loss in 2013 and returned to an operating profit as margins improved and cost cuts took hold.

It cost taxpayers more than 20 billion euros to bail out AIB, the most given to any lender that survived Ireland (Other OTC: IRLD - news) 's debt crisis. The bank has shut branches and is cutting almost a fifth of its staff as it tries to return to profit by the end of the year.

Excluding a provision of 1.9 billion euros for impaired loans, down a quarter on a year ago, the bank made an operating profit of 445 million euros in a year its chief executive described as one of steady progress.

"We remain focused on sustainable growth and returning to profitability during 2014," said Chief Executive David Duffy. "Notwithstanding the ongoing challenges facing the bank, we are more optimistic for the outlook of both the bank and the Irish economy."

Duffy said he did not think AIB would need further capital as a result of European stress tests later this year.

While lenders shrunk their balance sheets dramatically as part of Ireland's EU/IMF bailout, soured loans have made a return to profitability elusive. AIB made a post-impairment loss of 1.68 billion euros in 2013 versus 3.72 billion a year earlier.

Its net interest margin - measuring the profitability of its lending - rose to 1.37 percent from 1.06 percent at the end of June. It said the pace of increase in Irish residential mortgages in arrears decreased in the second half.

The bank's proportion of owner-occupiers in arrears for more than 90 days stood at 11.1 percent at the end of December, while almost a quarter of all buy-to-let mortgage holders were behind on payments for the same timespan.

The bank said its was reviewing options in relation to its capital structure and would provide further guidance during the course of 2014 following talks with the government.

The possibilities included a conversion of the bank's preference shares into equity and the sale of the bank's contingent capital notes, Duffy told Newstalk radio.