(May 9 )(Bloomberg) -- National Australia Bank Ltd., the country's biggest by assets, said first-half profit rose 26 percent as lending and deposits growth offset higher bad debts.

Net income increased to A$2.69 billion ($2.54 billion), or A$1.58 a share, in the six months ended March 31, from A$2.14 billion, or A$1.25, a year earlier, the Melbourne-based bank said in a statement today. National Australia's cash profit of A$2.24 billion, which excludes one-time items, met analysts' estimates.

Lending expanded 15 percent and deposits rose 10 percent and bad debts surged 86 percent to A$726 million from a year earlier. Chief Executive Officer John Stewart forecast loans growth to slow in the second half as economies cool in Australia, New Zealand and the U.K., where the bank gets most of its earnings.

``It's now all about where the economy's going and how that's going to play out in National Australia's profits,'' said Donald Williams, who manages $1.5 billion at Platypus Asset Management in Sydney. ``NAB is more worrying than some other banks because it does have greater exposure to the U.S. and the U.K., where the credit crisis is more acutely felt.''

The bank's shares rose 1.8 percent to A$31.59 as at 10:09 a.m. in Sydney, trimming their decline in the past year to 28 percent. The seven-company S&P/ASX 200 Banks Index has fallen 22 percent over the same period.

Bad debts rose to A$726 million from A$390 million. The bank is a lender to Centro Property Group, the Melbourne-based owner of more than 650 U.S. malls that's plunged 95 percent in market value the past year as it struggles to refinance debt.

Bad Debts

National Australia in March said it will take a provision for a A$110 million loan made to past and present executives of Allco Finance Group Ltd., the Sydney-based asset manager that's selling businesses as it tries to repay loans.

``We've been very conservative regarding our provisions,'' Stewart said in an interview. ``The signs of credit quality, while they are deteriorating, are only very slight indeed.''

Bad debts at Australia & New Zealand Banking Group Ltd., the nation's third-largest by assets, climbed four-fold in the half, while Westpac Banking Corp., the third-largest by market value, rose 86 percent. St. George Bank Ltd. this week said bad debts increased 27 percent.

Writedowns and credit losses sparked by the collapse of the U.S. subprime mortgage market total more than $318 billion worldwide and have caused and 65,000 jobs cuts.

Earnings from National Australia's domestic businesses grew 17 percent as it passed on higher funding costs to customers.

Mortgage Rates

While the Federal Reserve lowered the benchmark U.S. interest rate for a seventh time since September, National Australia and local rivals are raising interest rates to cope with higher funding costs and tighter monetary policy in Australia.

The bank has increased variable home loans 89 basis points this year, versus 50 basis points by the Reserve Bank of Australia, amid a 57 basis-point jump in short-term funding rates, Bloomberg data show. A basis point is 0.01 percentage point.

Recent reports suggest Australia's $1 trillion economy is slowing. March home-building approvals fell six times as much as economists forecast, sales of newly built houses dropped for a second month and consumer confidence plunged in April to the lowest since 1993.

The bank's earnings in the U.K. increased 18 percent. National Australia owns Yorkshire Bank and Clydesdale Bank in the U.K. The bank has hired local business leaders to help new branches in the south sell mortgages and deposits to business owners and wealthy individuals.

British Economy

The U.K. economy is cooling as the freeze in credit markets hurts banks and the housing market slump threatens consumer spending. The economy may slow further after the weakest pace of growth in three years during the first quarter. Bank of England policy makers have cut the benchmark interest rate three times since December to avert a recession.

National Australia is targeting expansion in U.S. agricultural banking. In November it announced the $798 million purchase of Omaha-based Great Western Bancorporation Inc., its biggest acquisition since buying HomeSide Lending Inc. in 1998.

National Australia increased revenue 7.1 percent to A$7.6 billion from a year earlier while its cost-to-income ratio, a measure of profitability, fell 48 basis points to 47 percent. Net interest margin, the difference between what the bank earns from loans and pays to hold deposits, fell 6 basis points to 2.4 percent in Australia, and dropped 50 basis points to 2.7 percent in the U.K., where the bank gets almost 16 percent of its sales.

National Australia will pay a second-half dividend of 97 cents, up from 87 cents a year earlier.

(Editor: Jia Fu)