By Stuart Kelly Oct. 23 (Bloomberg) -- Australia & New Zealand Banking Group Ltd., the worst-performing Australian bank stock this year, posted a 35 percent drop in second-half profit after provisions for delinquent loans surged. Net income fell to A$1.36 billion ($905 million) in the six months ended Sept. 30, based on subtracting first-half profit from full-year earnings announced by the bank today. The company more than tripled bad-loan provisions for fiscal 2008 to A$1.95 billion and set aside A$721 million for possible losses from derivatives trades. The stock dropped as much as 5.7 percent. Chief Executive Officer Mike Smith's plan to double earnings by 2012 through acquisitions in Asia is being undermined at home as Australia's 17-year economic expansion loses steam and bad loans rise. The Melbourne-based bank increased provisions after rising borrowing costs and plunging stock markets sparked the collapse of Australian margin lenders backed by the bank, including Opes Prime Group Ltd. ``The level of provisioning was surprising, and that disappointed us,'' said Paul Xiradis, who manages the equivalent of $11 billion as chief executive officer of Ausbil Dexia Ltd. in Sydney. ``We've been staying at arm's length from the stock until we see signs of an improvement.'' ANZ dropped 4.7 percent to A$18.15 1:14 p.m. in Sydney trading. Australia's benchmark stock index fell 3.7 percent, while Asian markets also declined. Liquidity is `Key' As the global credit crunch deepened, Smith spent the past six months shoring up ANZ's capital. ANZ increased liquid assets to A$53.9 billion from A$34.7 billion a year earlier, it said today. The bank's Tier 1 capital ratio under Basel II regulations rose to 7.7 percent from 6.9 percent in March. ``In a time of crisis, the key to any bank is the management of liquidity,'' Smith said in an interview. ``Liquidity is priority 1 to 10.'' The Tier 1 ratio is ``better than expected,'' Citigroup Inc. said in a report after the result. ``Barring further unforeseen credit quality issues this should preserve the dividend.'' Smith predicted a ``difficult'' year ahead as the economy weakens and bad debts continue to increase from historical lows. ANZ has slumped 34 percent in trading this year, the biggest decline on the seven-company index of Australia's biggest banks. National Australia Bank Ltd., which also posted a decline in earnings this week, has dropped 33 percent. No Recession ANZ will pay a dividend of A$1.36 cents for the year, unchanged from a year earlier. Its 21 percent full-year profit decline to A$3.32 billion beat the A$3.15 billion median of 16 analyst estimates compiled by Bloomberg. Deposits for the full year rose 21 percent while lending increased 16 percent. Net interest income climbed 8 percent to A$7.9 billion. ANZ's net interest margin, the difference between what the bank earns from loans and pays to depositors, fell 18 basis points to 2.01 percent. A basis point is 0.01 percent. Australia will sidestep a recession as global economic growth slows amid the credit crisis, Smith said at a media briefing today. He forecast the economy to grow 1.8 percent in 2009. That's more than the 1 percent growth predicted by National Australia Chief Executive Officer John Stewart this week. Smith said he was ``pleased'' that ANZ posted a 52 percent increase in profit from operations in Asia in 2008. ANZ's strategy of ``creating a super-regional bank remains a good one,'' he said. Asia's economy, excluding Japan, will grow 7 percent in 2009 as it avoids most of the $659 billion in global credit losses and writedowns, Smith predicted. Asia Strategy National Australia, the country's biggest bank by assets, this week posted a 24 percent drop in second-half profit to A$1.85 billion as funding costs rose and the company increased provisions for potential securities losses. Westpac, Australia's second-largest lender by market value, is forecasting an increase in profit after avoiding the credit- market turmoil. It's buying St. George Bank Ltd. to leapfrog Commonwealth Bank as the nation's biggest mortgage lender. Commonwealth Bank in August posted a 6 percent increase in second-half profit, and last month agreed to buy HBOS's BankWest and St. Andrew's businesses for A$2.1 billion. ``Smith will want to get ANZ's house in order in Australia first, at least for the next six to nine months until he's in a better position to consider taking on an Asian acquisition,'' said Angus Gluskie, who helps oversee A$450 million, including ANZ shares, at White Funds Management in Sydney. ``There's no doubt the economy is slowing and times are much tougher.'' To contact the reporter for this story: Stuart Kelly in Sydney skelly22@bloomberg.net

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