UPDATE 2-Australia's Westpac says bad debts have peaked

* Westpac outlook the most confident of local banks

* Says peak of bad debt cycle reached

* H2 cash profit falls 10.5 pct, result above forecast

* Says not actively scanning for acquisitions (Adds details on credit and capital, analyst and fund manager quotes)

By Morag MacKinnon

SYDNEY, Nov 4 (Reuters) - Westpac Banking Corp (WBC.AX), Australia's third-biggest lender, forecast a fall in bad debts next year, marking the local banking industry's most confident outlook to date, even as it reported a fall in profits.

Westpac on Wednesday posted a 10.5 percent fall in second-half cash profit, hurt by higher bad-debt charges, but the result came in just above the top of market forecasts and contained an outlook that was far less cautious than its rivals.

"They're a little bit more definitive (than previously) in their statement suggesting that the bad and doubtful debt cycle has probably peaked," said Paul Xiradis, head of Ausbil Dexia in Sydney, which has A$10 billion in funds under management.

Westpac made a cash profit of A$2.332 billion ($2.11 billion) for the six months ended Sept 30, compared with a pro forma A$2.605 billion a year earlier. The year-ago figure was adjusted to include earnings from the recently acquired St George bank.

"We are right now at the top of the credit cycle," Chief Financial Officer Phil Coffey told reporters at a briefing.

Westpac shares rose by as much as 2.6 percent in early trading. At 23.13 GMT they were 1.9 percent higher at A$25.90 compared with its three main competitors, which were each trading at around 0.8 percent higher, in line with the market.

Westpac paid a final dividend of 60 cents a share, with the full-year payout falling 18 percent to 116 cents.

Total revenue for the group grew 10 percent as the merger of Westpac with St George, previously Australia's fifth-largest bank, resulted in increased market share.

Coffey said the group was expecting 2-3 percent credit growth in the year to end-September 2010, led by robust housing loan growth, which would make up for any slowing in business lending.

The average forecast of eight analysts surveyed by Reuters was for a cash profit of A$2.24 billion, with the forecasts ranging from A$2.18 billion to A$2.31 billion.

'WORST HAS PASSED'