Standard & Poor's, the international ratings agency, has announced that it may cut Irish Life's credit rating following the announcement that the company is in merger talks with Irish Permanent.

S&P said it had placed Irish Life Assurance's AA- rating, and those of its US subsidiaries, on CreditWatch with negative implications. This means it may consider reducing the rating by a notch to A+ although the rating could also be reaffirmed depending on developments.

The agency currently has no rating for Irish Permanent. It said that if the two companies agreed a deal, it expected it would take the form of an acquisition of Irish Life by Irish Permanent in a share-for-share transaction which would mean Irish Life's available capital would not be eroded. But the agency said there was more uncertainty about the impact of a merger on the life assurance company's capital adequacy.

"Irish Life Assurance's overall capital adequacy potentially could be adversely affected by the requirements of its prospective partner," S&P said in a statement.

S&P also said that, although a merger would provide Irish Life with a sizeable branch network through which to distribute its products, it was uncertain how Irish Life's existing distribution arrangements with other institutions, including First Active, Ulster Bank and TSB, would be affected. Together these distribution channels accounted for around 12 per cent of Irish Life's retail business sales last year and their loss could initially hit the business in the event of a merger.

"Operating performance is expected to deteriorate to a modest extent in the medium term as reduced investment earnings will offset the expected improvements in the profit drivers of the core business - cost efficiency and product persistency," the ratings agency said.

However, analysts said that if the merger went ahead and led to an S&P downgrade, the merged company would still have an A-rating which is investment grade. The main affect of the possible downgrade would be to make it slightly more costly for the enlarged company to raise money in the financial markets.

Meanwhile, the share prices of both companies gave up some of Tuesday's gains yesterday as investors took profits. Irish Permanent closed 20p lower at 975p and Irish Life was off 10p at 590p. Both stocks had risen by more than 15 per cent on news of the merger talks when trading resumed on the Irish stock market on Tuesday.