BUY OR SELL-Will South African banks' caution pay off?

* Banks close to earnings trough

* FirstRand set to bounce most from turn in cycle

* Bad debts still plague retail, corporate units

By Serena Chaudhry

JOHANNESBURG, June 30 (Reuters) - South African banks are under pressure as the country sinks deeper into recession, with trading proving to be tougher than expected as bad debts mount and the value of their investment portfolios shrinks.

Absa (ASAJ.J) and FirstRand Ltd (FSRJ.J) released worse than expected trading updates last Tuesday, and peers Nedbank (NEDJ.J) and Standard Bank (SBKJ.J) have forecast lower profit.

But despite the negative news, analysts say the banks hold value, with excess capital and relatively healthy balance sheets, and look set for a strong recovery when the cycle turns.

A row of interest rate cuts by the central bank should ease some pressure off consumers struggling to repay loans, and corporate balance sheets have so far withstood the recession.

So are South African banks being more cautious than necessary at the worst point in the cycle, "kitchen-sinking" any even vaguely risky loans, or are their actions necessary to ensure a sustainable recovery?

BAD DEBTS

2009 bank earnings are expected to be lower and 2010 earnings will likely remain weak due to a tough environment.

"The banks from an earnings point of view are at the worst point possible in the cycle," Jan Meintjes, a portfolio manager at Gryphon Asset Management said.

"They're earning less interest on their capital, bad debts are rising, and to protect themselves, they are lending less."

"So from a volumes point of view they are under pressure, from a margins point of view, they are under pressure. And they have to cope with significantly more bad debt."

FirstRand, South Africa's No. 2 banking group, said last Tuesday its earnings would be lower due to a rise in non-performing loans at its FNB banking unit and vehicle financing business Wesbank. Absa, which owns the country's biggest retail bank, also forecast lower earnings.