By Clara Ferreira-Marques

LONDON (Reuters) - Britain's largest building society Nationwide saw a 40 percent drop in home loans over the past year and its market share shrank, as the credit crunch forced it to rely on savings to fund mortgage lending.

Nationwide, which became Britain's second-largest mortgage lender after its merger with Portman last year, said residential lending fell to 6.7 billion pounds in the year to April, from 11.2 billion -- a market share of 7.1 percent.

That compares with an 11 percent slice of the UK market in the previous year and Nationwide's "natural" share of 10-11 percent, Chief Executive Graham Beale said on Thursday. Its share of prime home loans dropped to 5.2 percent from 9.2 percent.

"Until we are confident we have normality back in the market place, in terms of our ability to fund comfortably, we will continue to run on a cash flow model, so we will continue to moderate our lending activities," Beale told reporters after the company released its annual results.

"If we are in 7 percent (market share) territory, we would not be uncomfortable with that in current market conditions."

Market conditions in the housing and mortgage markets are expected to remain "subdued", but Beale said he saw the drop in UK property prices in 2008 remaining within a single-digit percentage, after Nationwide last month published the first annual decline in house prices in 12 years.

Nationwide said it had begun to shift to a more prudent policy early in the year after expanding aggressively in 2007, but net lending fell away most sharply in the second half, as wholesale markets dried up and it turned to savings.

The group's 8.9 billion pounds of total net lending -- including commercial lending -- was covered by retail deposits of 9.1 percent, as it benefited from the "flight to quality" after the near-collapse of lender Northern Rock and took a 19 percent share of the savings market.