UPDATE 2-UK Nationwide's profit dives, bad debts rise

* Full-year pretax profit falls 69 pct to 212 mln pounds

* Hit by 241 mln-stg charge for government protection scheme

* Sees further consolidation amongst societies

* Commercial and personal loan arrear cases up

* Expects increase in loan loss provisions (Adds further details, comments by CEO, analyst)

By Lorraine Turner

LONDON, May 27 (Reuters) - Nationwide [NAT.UL], Britain's largest building society, reported a 69 percent drop in its pretax profit on Wednesday, blaming the fall on the costs of a government consumer protection scheme, and also said it was braced for a rise in bad debt provisions.

The customer-owned mortgage provider and lender offered little sign of optimism in its outlook, warning of more loan loss provisions to come while low interest rates depressed margins and saying it expected a significantly reduced level of underlying profit in the second half of 2008/09 to continue throughout 2009/10.

"Market conditions will remain challenging throughout 2009 and beyond," Chief Executive Graham Beale said.

"In particular, the low interest rate environment will continue to depress margin and higher levels of unemployment and business failures will inevitably lead to increased loan loss provisions."

Analysts said the lender's 12 percent drop in margins in the second half and bleak outlook point to a worrying trend for the sector as a whole.

"That Nationwide can be flagging a potential decline in profits towards zero (or even negative?) in the next 12 months is clearly bad news for the UK domestic banks," said analysts at Credit Suisse.

The lender's statutory pretax profit, which includes an exceptional charge of 241 million pounds to cover its contributions to Britain's depositor protection scheme, came in at 212 million pounds, 69 percent lower than last year.

The mutual said the government levies accounted for more than half of the fall in its reported profit and complained that the level of Financial Services Compensation Scheme (FSCS) charges were not linked to the level of risk posed by individual institutions but to market share and said it is lobbying the authorities to alter them. [ID:nLK108751]

Stripping out exceptionals, the underlying profit before tax fell 49.7 percent to 393 million pounds, it said.

CONSOLIDATION CONTINUES

Nationwide, which bought part of troubled Dunfermline Building Society as well as rescued the Derbyshire and Cheshire building societies last year, said more mergers in the sector are likely.

"I think it's inevitable given the pressure that some societies are under that we will see some further consolidation activity over the next few months," Beale said, adding that "two or three more" societies will be forced to merge before the current year has ended.

"The capacity of our balance sheet is very significant, and we could certainly support one if not more transactions going forward," he added.

But the lender said integration of the smaller societies cost 107 million pounds also weighed on its balance sheet, whilst it provided 203 million to cover future losses on the 8.6 billion residential mortgage assets it acquired.

Nationwide said arrears in commercial property rose dramatically in the second half.

Impairment charges on loans rose to 394 million pounds in the year ending April 4, compared to 106 million in the same period last year.

And the lender warned that the savings markets and mortgage markets look set to contract in 2009/10.

Nevertheless, the society said it retained a strong balance sheet with a core Tier 1 capital adequacy ratio of 12.1 percent of risk-weighted assets and remained the largest UK banking institution not to have raised capital during the year. ($1=.6288 pounds) (Editing by Greg Mahlich)