AIB'S Baltic banking subsidiary, Amcredit, is facing a major threat to its euro-based mortgage loan book if the Latvian central bank is forced to devalue the country's currency, the lat, to avoid an Iceland-style economic collapse.

Analysts believe Latvia's economic crisis could force its central bank to devalue the currency by 40%, making it virtually impossible for most Latvian mortgage borrowers to pay back their euro-denominated loans, leading to massive defaults for Amcredit.

If Latvia's problems spread to its neighbours, Estonia and Lithuania, as many commentators believe they will, it could spell the end for AIB's nascent Baltic venture.

AIB bought Amcredit, the mortgage finance business of the Baltic-American Enterprise Fund, which operates in Latvia, Lithuania and Estonia, in early 2008 for €116m. The idea was to replicate the success of its Polish subsidiary, BZWBK, but business has gone badly in the last year.

By the end of 2008, AIB had written off €33m of on the acquisition: €15m of goodwill and €18m of combined operating and loan losses. Impaired loans reached €19m, or 16.8% of the total, as the three Baltic states struggled mightily with the effects of the credit crunch and global recession.

Now the €113m Amcredit mortgage book could be in jeopardy as Latvia fights desperately to survive the economic chaos and its Baltic neighbours are exposed to financial contagion and possible devaluations of their own.

The country's economy shrank 18% already in the first quarter alone following a 10.3% contraction in the fourth quarter of 2008. So far the public finances have been surviving on installments from a €7.5bn loan advanced by the International Monetary Fund and the EU.

The IMF precipitated the currency crisis by threatening to withhold further payments until the Latvian government brought spending under control. Late last week the government agreed €500m in spending cuts, expected to be approved tomorrow, sending stocks soaring. But many commentators, including recession guru Nouriel Roubini, believe only a devaluation can save the economy now.

What is good for Latvia will surely prove bad for the foreign-owned banks such as AIB which provide much of the private credit in the economy. As the lat devalues, local wages will fall dramatically relative to the euro debts Latvians are paying off, forcing widespread delinquencies and write-downs.