The boards of Anglo Irish Bank and First Active have confirmed they are in preliminary discussions about a possible merger of the two banks.

In a statement issued to the Irish Stock Exchange yesterday, the two boards of directors emphasised there is no certainty that a merger will be agreed at this stage. The statement adds that any merger will be subject to regulatory approvals and no further details will be announced until the deal is concluded.

Shares in both banks were weaker on the Dublin market yesterday amid scepticism about the benefits of the link-up.

Anglo Irish Bank's shares closed at €2.57, down 8 cents, with analysts questioning the merits of a union between its successful operation and the beleaguered former building society.

First Active shares were also sharply lower, ending the day at €2.30, down 20 cents, having risen in value in recent days on foot of continuing speculation about a merger.

The international credit rating agency, Moody's, took a more positive view of the announcement, confirming First Active's ratings and stating that it was placing Anglo on review for a possible upgrade. Moody's said the merged entity would have a stronger business franchise and would also improve First Active's funding base.

Sources close to the negotiations say the financial aspects of the deal have now been concluded, but it will be some days yet before boardroom and senior management positions are agreed and a detailed announcement can be made. First Active's chairman and acting chief executive officer, Mr John Callaghan, is expected to be appointed chairman of the new entity, while Anglo chief executive, Mr Sean Fitzpatrick, will assume day-to-day control of the enlarged organisation. The two banks will be run as separate entities in the medium term, with Anglo continuing to operate in the small and medium-sized business market and First Active effectively running its largely mortgage-based activities. A new name will be established for the overall holding company.

Together, the two banks will form a financial institution with a market valuation of £1.1 billion (€1.4 billion). Anglo Irish Bank, with a market capitalisation of €725 million, is roughly twice the size of First Active, with €317 million. As First Active is protected by building society legislation until 2003, the deal will have to be structured as a reverse takeover by First Active and will be based on a share swap.

When the deal is announced, First Active will have to call an extraordinary general meeting of its shareholders to approve it. This has to be done within 28 days of the announcement, and shareholders must be given 30 days' notice of the meeting. It is therefore unlikely that the merger will be approved within the next two months. The bank holds its annual general meeting in Dublin today.

The proposed merger is being viewed in the markets as a very positive step for First Active, but analysts remain to be convinced about its merits for Anglo.

Mr Seamus Murphy, financial analyst at Merrion Capital, said that while Anglo will gain access to a substantial equity base through First Active, the potential for cost savings and cross-selling is fairly limited. The addition of First Active's lower-margin residential mortgage business should also slow down earnings growth at Anglo, he said.

Mr Stuart Draper, analyst at Dolmen Butler Briscoe, said Anglo's acquisition of the less competitive mortgage business has harmed its share price. The merger was opportunistic rather than a purely strategic move, and presented greater risks for Anglo's shareholders than for First Active's, he said.

The deal would, however, improve the liquidity of the shares, and would add scale to two relatively small players in the financial services sector.

Bank of Ireland Asset Management is advising Anglo Irish Bank on the merger, while First Active is being advised by KPMG.