British Airways and Spanish airline Iberia say they have reached a preliminary agreement for a merger expected to be completed in late 2010, BBC reported.

The merger, which must be approved by the European Commission, would create the world's third biggest airline.

Under its terms, Iberia would take a 45% stake and BA, which last week reported a six-month pre-tax loss of £292m, a 55% stake in the company.

Iberia says it can pull out if BA fails to resolve its pension deficit problem.

The merger will create a strong European airline well able to compete in the 21st Century," said BA chief executive Willie Walsh.

"Both airlines will retain their brands and heritage while achieving significant synergies as a combined force."

The two airlines had been discussing the deal at separate board meetings.

It would create an airline with 419 aircraft flying to 205 separate destinations, and would save the two partners EUR 400 M in costs a year, they said.

Iberia's chairman Antonio Vazquez would take the same role at the new company, while Mr Walsh would become its chief executive.

News of the deal did not go down well with Virgin Atlantic, one of BA's big competitors in the UK, which raised concerns about the new company's market share.

"The merger will increase BA's dominance at Heathrow with 44% of take-off and landing slots this winter. It is impossible for any other airline to replicate their scale," the airline said.

Both BA and Iberia have been losing money during the downturn as businesses and individuals cut back on flying.