St George Plays Smart Game To Lift Deposits

The Age

Wednesday May 7, 2008

Michael West

Australia's fifth-largest bank was aggressive in building its loan book last year but lately it has been attracting investors to its lucrative term deposits.

GAIL Kelly said the worst was over last week. But Paul Fegan said yesterday "we are still bracing for further volatility". Kelly headed off to Westpac last year and Fegan succeeded her in the top job at St George. He did well to raise some equity straight off the bat, and more recently - as evinced in yesterday's result - managed to somehow deliver a stupendous rise in deposits.

It was this growth in deposits that has countervailed St George's dependence on wholesale funding in the subprime-stricken commercial paper markets. St George has a smaller depositor base than its big-bank rivals and relies more on other funding sources.

The worst is not over, though, as Fegan diplomatically put it, either for the banking sector or St George. While gross domestic product has marched along at 4% for more than a decade, the banks have grown their assets (loans) by GDP plus 10% by shovelling the credit into households. To believe this can continue is to adopt the glass-four-fifths-full perspective on the credit cycle, whether for St George or its rivals.

The most notable thing in the result, apart from the fact that net profit was down 10%, was the spectacular lift in deposits. Along with Macquarie, St George has been aggressively marketing its high-yield deposits. And it's worked. The bank's funding, particularly deposits, rose pretty sharply but the big item of growth is certificates of deposit (CDs). CDs are up from $15.8 billion to $24.8 billion over the year.

These flows are often price sensitive, though. If a bank starts flogging attractive deposit rates it hits margins. Moreover, it cannibalises the existing deposit base. If a customer has savings on the usual piddling bank rate but sees a "you-beaut" rate of 8.4% when the cash rate is 7.25%, a switch is a no-brainer. This is where banks rely on customer apathy.

Staggeringly, Fegan said after yesterday's news conference that the attractive deposit rates had had no impact on the St George "back book", or existing depositor base. Looking at the deliberate kinks in the term-deposit curve, St George has been clever. From one to six months you get 5.25% a year, except for four to less than five months, which is 8%.

To get the high rate you need an eight to nine, or 11-12-month term deposit. Nobody asks to roll an 11-month term deposit - so what they are doing is deliberately asking for a price point and knowing the existing customers rolling 12-month term deposits do not decide suddenly to do 11-month term deposits. Smart.

The standout item in the St George accounts for growth is the bank acceptances on the asset side. This is effectively short-dated paper it owns (almost all less than three months). In the past this has had a high concentration in manufacturing and other commercial businesses - nothing that St George has particular expertise in. It is odd to be aggressively chasing deposits and then to make such low-spread loans.

St George has been one of the most aggressive lenders in the country. This from a recent ad campaign:

"No deposit or savings but ready to buy? Whether you've started getting your deposit together, or you need to borrow the full purchase price, the St George No Deposit Home Loan gives you options to make the dream of owning your own home a reality.

"Choose the No Deposit Home Loan - Loan Extension Fee option where you can borrow up to 100% of the purchase price or valuation (whichever is lower) at a competitive interest rate. You can build and own your home sooner by paying the upfront Loan Extension Fee."

Zero-deposit loans sound too good to be true. What happens when house prices fall and defaults rise?

It was this kind of aggressive lending under Kelly that catapulted St George from a regional building society to the fifth-biggest bank in the country. Kelly jumped ship at the apogee of the cycle last year for Westpac - which ironically looks the cleanest play of the big banks - leaving her successor Fegan with quite a dilemma.

How does the bank cope with margin compression?

The guts of today's interim result is that St George's asset growth was up while its revenue growth was flat (stripping out the Visa one-off and perhaps interest on the equity Fegan raised when he started the job).

That means margins are under pressure.

Whether the dividend is sustainable is another matter.

The dividend is 86? a share and the earnings per share is 93?. Retained earnings are thin. The problem is that the asset growth is 10% or so - and asset growth requires retained earnings to fund.

So either margins get better or they will have to cut the dividend.

The result was a modest disappointment to the market. After constantly reaffirming profit guidance over the past few months, St George conceded growth will not be as high as expected.

Profit guidance is now 8%-10% for this year, whereas analysts had 10%-plus in their spreadsheets. The net result of $603 million was some $17 million below consensus forecasts.

Costs were up 4.8%, slightly less than revenue growth and a tad better than the market was tipping.