Little Red Bank Shows No Fear Of The Big Bad Credit Wolf

Sydney Morning Herald

Wednesday August 13, 2008

Michael West

St George, what a story! It's Alice In Wonderland. All the nasty problems that beset its rivals have vanished down a rabbit hole and there's Alice - she's eaten the magic cake and now stands nine feet tall and bullet-proof.

Yesterday's market update from the St George chief, Paul Fegan, and his numbers man, Michael Cameron, was so bright and shiny it demands examination, and possibly scepticism.

We were invited to believe that despite the credit crisis St George will rack up earnings growth of 25 per cent in the second half - with no notable queasy exposures or a deteriorating loan book - despite admissions things have got worse at ANZ, NAB, Commonwealth, second tier-competitor Suncorp and even, to a lesser extent, the St George suitor Westpac.

If this is the case, surely St George owes it to shareholders to immediately demand a better offer from Westpac.

But how much of the glimmering earnings growth can be put down to one-offs: the sale and leaseback of BankSA branches, job cuts and freezes, the sale of the remaining Visa shares, some front-end revenue booked from the deal with its life insurance partner AIG?

And what slice of this magic pudding owes to the bank's decision to shorten the duration of its debt-funding profile so it does not have to stump up for long-duration funding next year?

We may never know. The Westpac takeover is likely to succeed this year and such things would be buried in a bigger bank.

But half-answers were forthcoming on the composition of the result. Bear in mind that St George tilted at 20 per cent profit growth during the bull market, but now, when misery is all around, second half growth is suddenly 25 per cent.

Asked after the briefing if the bank was bulking up its profit via the sale and leaseback of BankSA branches, a spokesman said: "Any proceeds would be booked as income. However, this is not material and we expect it to be around $3 million. Contribution from property sales has been reducing year-on-year."

As to whether the bank might "front-end" profits (or book revenues upfront) under its contract with AIG, he said: "We are bound by a confidentiality agreement with AIG from disclosing the terms of the deal. Any payments received are not significant."

And on claims that funding would be raised by now in Japanese Samurai and US 144A bonds, the riposte was that the US market was on holiday and the Samurai market was "generally closed to most participants".

It should be said St George has a terrific record of growth, moving from 5 per cent to 9.5 per cent national market share in five years under former chief Gail Kelly, who now runs Westpac. Customer service is the best of the banks and there are no exposures to CDOs and other fancy derivatives in the balance sheet or related entities. But this kind of growth comes at a price. Look at Northern Rock.

Had it not been for Westpac, Paul Fegan's ascension to the top job at St George last November would have been one rough ride.

Unlike the Big Four banks with their massive depositor bases, St George relied on wholesale credit markets to fund its spectacular loan growth in the good times. The credit crisis has seen a dramatic escalation in its cost of funding and the bank has had to chase deposits to fund growth.

The numbers look impressive: big growth in deposits, big growth in loans. But both mask margin compression. Paying up to win deposits hits margins as does funding growth from wholesale markets and securitisation.

When asset values were rising and interest spreads were falling, St George flung itself headlong into commercial property development and margin lending. It beggars belief to think there won't be bad loan problems here.

It also bought distribution in home loans by acquiring mortgage brokers and financed the gap between its home loans and deposits by securitising. That avenue is no longer open to it. Even the Commonwealth Bank has announced it is prepared to take up the Reserve Bank's emergency offer to swap securitised assets for liquid securities.

These are not ordinary times in banking, and for St George the challenge is greater for than the big banks with their AA ratings as its credit rating is single A-plus.

Despite a higher risk rating, St George had kept on lowering its capital adequacy requirements in line with the bigger banks during the good times, clinging to its high dividend payout ratio.

With the help of Westpac standing over its shoulder it comfortably surpassed its $8 billion issuance requirements for 2008, raising $9.5 billion. But JP Morgan research last week found the requirement is bigger next year as St George "significantly shortened the duration of its debt funding profile over the course of 2008".

While the other banks are fessing up to deteriorating loan books, St George has merrily jawboned its trading performance as if there were no credit crisis at all.