When the $17.5 billion all paper merger between St George and Westpac was originally suggested in May, it was claimed that St George’s cost of funding, indeed its future, was threatened by the clouded outlook for banks and the credit crunch.

It was claimed by Westpac and banking analysts that to remain viable St George needed a higher rated owner, which was Westpac. Westpac’s superior funding ability would help St George weather the storm.

Well, guess what? St George has weathered the credit crunch very well so, far. So well in fact that the market pushed its shares back over $31 for the first time in two months today. It had already risen off the back of Westpac’s solid trading update on Friday and expectations that the deal would be winner.

Judging by St George’s trading update it will certainly be a winner for Westpac management and big shareholders in particular.

St George Bank reaffirmed its annual September 30 earnings guidance after posting a 12.5% rise in cash profit for the first 10 months of the year. It said it was on track to meet its earnings per share (EPS) growth target of 8%-10% for the September 30 year.

That compares very nicely with Westpac’s forecast of a 6%-8% rise in cash earnings for its September 30 year, so on the face of it, the lower rated St George Bank with higher exposure to the shutdown securitisation markets had plucked a superior result out of the worst conditions for banks since the 1991 recession.

It’s partly a tribute to former CEO, Gail Kelly, now running Westpac, but it’s also a tribute to her replacement and the replacements found to fill the slots left vacant after she raided her old employer.

St George said that its unaudited cash profit was $1.073 billion for the first 10 months of fiscal 2008, which St George said was 12.5% ahead of July 2007 which was a much more benign credit environment and on the eve of the eruption of the crunch a year ago this month (although signs of problems were emerging in credit spreads and hedge fund problems in the US).

“Against the backdrop of a challenging operating environment, St George continues to perform well with strong growth across its core businesses and product lines, sound asset quality and effective cost control,” chief executive Paul Fegan said.

St George said this morning that the board intends to recommend the merger proposal subject to it remaining in the best interests of St George shareholders compared to the position when the proposal was announced on May 13.

You could argue that St George’s survival and the improved profit figures for such a tough year means that the offer is no longer in the best interests of its shareholders because the bank’s position is stronger and more assured than it was in May.

Westpac’s opportunistic swoop came off the back of the credit market problems after the near collapse of Bear Stearns, with the Reserve Bank seemingly committed to maintaining a tight monetary policy through high interest rates.

Now the economy is slowing, especially in housing and retailing, which will hurt all banks, not just St George. And the impending drop in official interest rates next month, and then over the next year, opens the way for a possible revival in housing, and lower funding costs for St George.

It no longer needs Westpac.