When Irish Life & Permanent (IL&P) chief executive Kevin Murphy confirmed last week that the group would not be transferring any of its loans into Nama, the state bad bank, he curiously delivered the news in a litany of "challenges" the loss-making bancassurer would be facing in the coming months.

As Murphy said himself last Wednesday, IL&P will not be participating in Nama because its banking arm, Permanent TSB (PTSB), had a relatively low-risk loan book and had completely avoided lending to property developers.

Normally, this fact would be considered an unequivocally good thing. But in the upside-down world of Irish banking, being left out of Nama has left IL&P at a peculiar disadvantage.

Staying out – or rather being kept out – of Nama means IL&P is far from having its own significant problems sorted out by the government, which has been underwriting its liabilities for nearly a year now.

Unlike AIB and Bank of Ireland, whose bad loans to high-risk property developers have put them at risk of insolvency, IL&P merely gave out billions in plain-vanilla mortgages to ordinary middle-class customers who, for the most part, are paying back the bank. This strategy, however, created problems of its own.

IL&P's 'reward' for shovelling tens of thousands of home loans out the door during the boom is a truly staggering loan-to-deposit ratio that now tops 300%. That means PTSB has given out three euros for every one it has on deposit. It managed this stupendous feat by leaning heavily on wholesale credit markets where funding through various forms of securities was readily available. It wasn't the most prudent way to bank, but not that unusual before the credit crunch.

This all adds up to a major funding headache for the bank and, consequently, the group as a whole. Early this year, as the financial markets roiled with panic about the strength of Irish financial institutions, €3bn in corporate deposits exited IL&P's coffers in a "flight to home country", according to Murphy, degrading its loan-to-deposit ratio further. Just slightly more than €1bn of this has since been replaced by new retail deposits. Another €3bn has been raised in funding to replace other debt that was being rolled over.

Meanwhile, the bank continues to rely heavily on €12bn ECB emergency funding, without which it would be completely illiquid.

The other main problem is the blended cost of funding, which is putting major pressure on margins. On average, PTSB is paying 1.5%, mainly on customer accounts, to get money in the door.

At the other end, its average asset yield is just 2.4%, for a margin of just 0.87% – down from 1.05% at the end of 2008. According to Murphy, PTSB's recent variable rate increase of 0.5% has halted the margin erosion for this year, but the bank will be reviewing rates again in early 2010. The single biggest driver of margin pressure, the bank says, is cost of funding.

Here the bank is counting on an indirect benefit from Nama, according to Murphy.

"The expectation is that Nama will reduce competition in the retail deposit market and the cost of funding should go down," he said.

Already IL&P is benefitting from the state guarantee, which has effectively tied its funding cost to Irish government spreads – an improving number in recent months. Murphy believes more relief on this score should be forthcoming once the other banks get sorted out with Nama.

But there will be no direct government assistance apart from the extension of the bank guarantee. IL&P did try un­successfully to get some of its assets – mainly commercial finance to car dealerships – included in Nama, but the government insisted that all Nama assets had to be tied into development finance.

Nothwithstanding all this, its capital position remains "robust", according to finance director David McCarthy. This is mostly due to the strength of the life business . Even with a deteriorating mortgage book which is facing 1.8% impairments through 2011, there is little fear the bank will breach its regulatory capital minimums.

The group's options for dealing with its liquidity problem basically come down to consolidation and restructuring in the sector, which Murphy indicated would not happen until 2010 – so PTSB will have to soldier on as a virtual zombie bank until then.

IL&P was in merger talks with EBS from late 2008 into the spring of this year, but no agreement was reached after both sides determined a merger was premature until Nama was off the ground. Still, any IL&P solution is likely to involve combining PTSB with one or more of the remaining players in the Irish banking sector – EBS, Anglo and Irish Nationwide – to form a so-called 'third force'.

To be viable, according to Murphy, any third force would have to improve IL&P's dire loan-to-deposit ratio – its value would be in "accelerating" a rebalance in its funding.

In the meantime, IL&P is ploughing ahead with a restructuring which will allow the bank to be hived off much more easily. Currently, the group is a bank with an insurer attached. In reality, IL&P is an insurer with a deadweight mortgage lender dragging it down. The new group structure will have a holding company with the bank, insurer and asset management company below it, so much the better for a future break up.

For now, IL&P will simply have to limp along as best it can under very difficult market conditions as it isn't hurt badly enough for a full-scale Nama rescue.