TOKYO (Reuters) - Honda ( HMC ) and Nissan ( NSANF ) are considering producing vehicles in one another's factories as part of their talks to deepen ties, news agency Kyodo reported on Saturday without citing sources.

The report added that Honda ( HMC ) will also consider supplying hybrid vehicles to Nissan ( NSANF ) as part of the potential merger, without mentioning the source of the information.

Honda ( HMC ), Japan's second-largest car company, and Nissan ( NSANF ), its third-largest, are in talks to deepen ties with an eye on potentially setting up a holding company, according to two people familiar with the matter. One of the people said the automakers are also discussing a potential merger.

A merger could create the world's third-largest auto group by vehicle sales behind Toyota ( TM ) and Volkswagen, with an annual output of 7.4 million vehicles.

The two automakers forged a strategic partnership in March to cooperate in electric vehicle development, but Nissan ( NSANF ) has faced ongoing financial and strategic troubles in recent months.