Feb. 18 (Bloomberg) -- Australia & New Zealand Banking Group Ltd. fell to a 2 1/2-year low in Sydney trading after Chief Executive Officer Michael Smith said the ``bloodbath'' in debt markets will erase profit growth this year.

``Credit costs are going up, well above underlying earnings growth,'' said Smith, who joined ANZ from HSBC Holdings Plc last year, in a webcast briefing. The Melbourne-based bank, Australia's third largest, will make a $200 million provision for derivatives linked to U.S. debt insurer ACA Capital Holdings Inc.

A gauge of Australian financial stocks slumped to the lowest since November 2005 on concern that earnings growth at banks will stall. The U.S. subprime mortgage collapse that's spread through credit markets may lead to $400 billion of write-offs from financial institutions around the world, according to Group of Seven estimates.

``People are facing up to the fact that they've got to adjust their figures on the banks,'' said Angus Gluskie, who helps manage the equivalent of $500 million, including ANZ shares, at White Funds Management in Sydney. ``Bad debts are going to be higher and the banks are going to wear them for the rest of the year.''

ANZ slid 6.1 percent to A$22.46 at the close in Sydney, its lowest since September 2005. The stock's lost 18 percent this year. National Australia Bank, the country's largest by assets, fell 3.7 percent and Westpac Banking Corp. dropped 3.7 percent.

Provisions including the $200 million linked to ACA will ``offset'' forecast profit growth of 11.5 percent in the year ending Sept. 30, ANZ said in a statement today.

Charges

It will also make a A$51 million ($47 million) provision for the ``failure of a resources client,'' and take a A$90 million charge resulting from a credit rating downgrade of a commercial property customer. It didn't identify either company.

The bank said a ``substantial'' portion of the $200 million provision may be written back in the future. ANZ spokesman Paul Edwards confirmed the insurer as New York-based ACA, which had its rating sliced 12 levels to CCC by Standard & Poor's in December, casting doubt on more than $75 billion of debt the company guarantees, including $69 billion of securities such as collateralized debt obligations.

``This is a financial services bloodbath,'' Smith said of the subprime fallout in credit markets. He said the Australian banking system was in ``remarkably good shape'' given global conditions.

Still, profit margins in Australia have narrowed and banks are raising mortgage interest rates faster than changes in the central bank's benchmark as funding costs rise.

Bad Debts

Commonwealth Bank of Australia, the nation's biggest mortgage lender, last week posted the slowest profit growth in more than three years as provisions for bad debts jumped 71 percent and its bad-loan ratio increased. Westpac said Feb. 5 that rising short- term borrowing prices will cost the company about A$85 million in the first half.

ANZ was expected to post a full-year net profit of A$4.34 billion, 3.8 percent higher than last year, according to the estimates of 15 analysts compiled by Bloomberg before today's announcement.

Growth in lending and deposits in the first four months of fiscal 2008 at ANZ ``have been overshadowed by higher credit costs on commercial lending,'' Smith said in today's statement. ``The turmoil in global financial markets has impacted a small number of customers and counterparties which is likely to result in higher credit costs.''

Australian banks have an estimated A$5.5 billion of investments linked to companies troubled by the global debt crisis, the Sydney Morning Herald reported on Feb. 15, citing brokerages including UBS AG.

Funding Costs

ANZ this year joined rivals in raising interest rates on its variable home loans to recoup higher funding costs by more than changes in the central bank's benchmark. It was the first time in a decade that banks lifted rates without any action from the Reserve Bank of Australia.

The nation's one-month bank bill swap rate, which banks use to determine yields on variable-rate loans, today climbed to an 11-year high of 7.41 percent. It was 6.32 percent a year ago, according to Bloomberg data.

U.S. bond insurers such as ACA may lose $34 billion on securities they guaranteed, Citigroup Global Markets said this month. They are likely to take losses of $32 billion on collateralized debt obligations backed partly by U.S. subprime mortgages, Citigroup said.

ANZ had bought default protection on a portfolio of investment grade companies from ACA using a credit-default swap, a derivative used to speculate on corporate credit quality. After ACA was cut to non-investment grade, the bank was required to raise an ``individual provision'' of $200 million, it said.

To contact the reporter for this story: Stuart Kelly in Sydney skelly22@bloomberg.net

Last Updated: February 18, 2008 01:32 EST