UPDATE 2-Westpac Bank in takeover talks with St George

(Adds analyst comment)

By Victoria Thieberger

SYDNEY, May 12 (Reuters) - Westpac Banking Corp Ltd (WBC.AX), Australia's fourth-biggest lender, said it is in talks on an all-share bid for St George Bank Ltd SGB.AX, which has a market value of A$15 billion ($14 billion), to create Australia's largest home lending and wealth management provider.

A combination of Westpac, with a market value of A$49 billion, would create the country's largest bank, eclipsing Commonwealth Bank of Australia (CBA.AX) which has a market value of about A$58 billion. It would come amid tough times for banks as funding costs have soared amid the global credit crunch.

"Fascinating. It makes a lot of sense. St George is about a third of the size of Westpac and the cost synergies they can extract out of St George would be staggering," said Peter Vann, head of investment research at Constellation Capital Management.

"They will be paying a premium over St George's closing price, there's no doubt about that. Ten or twenty percent, it depends how the offer comes through."

Australian banks have largely dodged the subprime woes afflicting global banks, but the credit crunch has raised their funding costs and their customers are feeling the pinch of higher interest rates.

St George, which has a lower credit rating than its larger rivals, has been struggling with soaring funding costs in the debt markets. Earlier in the month, it had to pay more than 10 times the margin it paid a year ago for a debt issue.

Trading in the shares of both companies was placed on halt on Monday. St George said it requested the trading halt to allow confidential merger discussions with Westpac.

St George shares closed on Friday at A$26.65, down 15 percent for the year, compared with a 7 percent decline for Westpac which closed at A$25.97.

Westpac, whose chief executive, Gail Kelly, was until last August the CEO of St. George, said in a statement a deal would lower risks and costs for St George.

The combined group would have a larger balance sheet and greater access to funding, she added.

It would be the country's largest home lender with a market share of 25 percent, and the largest wealth management provider with funds under administration of A$108 billion.

Australia's banking sector is dominated by National Australia Bank Ltd (NAB.AX), Australia and New Zealand Banking Group Ltd (ANZ.AX), CBA and Westpac. Competition rules prevent the so-called "big four" from buying each other.

Westpac said it planned to keep the St George brands and branch networks.

"Westpac believes the respective brands would be better able to compete and flourish by belonging to the same larger, stronger, entity," the bank said in a statement.

St George said the talks followed an approach by Westpac after the market close on May 9, just days after St George disappointed markets after it trimmed its earnings target for the year due to higher funding costs caused by global financial market turmoil.

The bank said it expects to make a further announcement before trading begins on Tuesday.

Westpac earlier this month posted a 10 percent rise in first-half core profit, driven by growth in consumer and business lending, but also warned it expected lending growth to slow.

A Westpac-St George tie-up would require various regulatory approvals as well as that of the Federal Treasurer. ($1=A$1.06) (Additional reporting by Miranda Maxwell and Cecile Lefort; Editing by Jonathan Standing)