Lacklustre lending activity in Japan's earthquake-ravaged economy and a shrinking retail investment business capped earnings of the country's top banks and brokerages in the fiscal first quarter, raising pressure on them to take more risks and find revenue sources overseas.

Mitsubishi UFJ Financial Group <8306.T>, Mizuho Financial Group <8411.T> and Sumitomo Mitsui Financial Group <8316.T>, the top three banks, are facing anemic loan demand in Japan where companies are paying down debt instead of expanding.

Bank lending in Japan, which makes up the bulk of their revenues, fell for the 19th straight month in June from a year earlier, with the expected boost to loan demand from the March 11 disaster not materializing yet.

Lending at home is weak and prospects are not bright. The point is how much the banks can offset that by increasing overseas loans, said Chikako Horiuchi, an analyst at Fitch Ratings in Tokyo.

Investment banking and brokerage units were a drag on the banks, hurt by weak underwriting business.

Top brokerage Nomura Holdings <8604.T> fared better, as its quarterly profit topped forecasts but domestic rival Daiwa Securities <8601.T> struggled, posting its fifth quarterly loss out of six.

MUFG BOOKS MORGAN STANLEY GAIN

MUFG posted a 500.6 billion yen ($6.4 billion) net profit in the quarter after booking a 290.6 billion yen gain from conversion of its preferred shares in Morgan Stanley into common stock which raised its stake in the Wall Street firm to 22 percent.

The profit tripled from 166.4 billion yen a year earlier and was above the 400 billion yen estimated by Citigroup Global Markets Japan.

Mizuho's profit slumped 36 percent to 96.4 billion for the quarter, slightly below the 100 billion yen estimated by Citigroup. Sumitomo Mitsui's profit fell 2.4 percent to 206.6 billion yen, but above the 100 billion yen estimated by Citigroup.

Loans taken to help northeastern Japan rebuild after the devastating March quake are likely to provide a modest boost.

If there will be loan demand growth driven by capital expenditure, it is likely to come in the third quarter or later. And even then, I don't expect to see an explosive growth, rather I'm expecting to see a sign of recovery, said Takehito Yamanaka, analyst at MF Global FXA Securities in Tokyo.

The banks are stepping up their overseas presence not only to combat weak loan take-up at home but also to benefit from a strengthening currency that is driving much of corporate Japan to shop overseas.

The dollar hit a four-month low of 77.48 yen on Friday morning, prompting Japan to escalate its warning to markets against testing the yen's upside further.

Mizuho is set to seal a deal soon to buy as much as 20 percent of Vietnam's Vietcombank , sources have said, while MUFG last month began talks with CIMB to take a bigger stake in the Malaysian lender.

Sumitomo Mitsui teamed up with Brazil's BTG Pactual in April to offer project finance and advisory services in the Latin American nation.

BROKERS GO OFFSHORE

Brokerages Nomura and Daiwa are also ramping up efforts overseas, but with markets jittery and companies wary of inking deals amid global economic uncertainty, succeeding abroad may become more difficult.

In a sign of the headwinds they face, Goldman Sachs Group Inc , the biggest U.S. investment bank, earlier this month posted earnings that were well below market expectations.

Harsh market conditions persist, Nomura's chief financial officer, Junko Nakagawa said at a press briefing in Tokyo. We see an improvement in the second half of the year, but a lot of uncertainty remains, she added.

In the quarter ended June 30, Nomura, which is expanding in Asia, Europe and the United States after buying part of Lehman Brothers in 2008, posted a 17.7 billion yen ($228 million) net profit compared with a profit of 2.3 billion yen a year earlier.

The result was better than the mean forecast of a 13.7 billion yen profit from three analysts surveyed by Thomson Reuters I/B/E/S.

Pretax profit in asset management rose 86 percent and losses in its wholesale business shrank. Investment bank losses however rose to 20.6 billion from 14.8 billion yen.

Its wholesale sector has been performing well, despite the difficulties it is facing, with business progressing in the U.S. market, said SMBC Friend Securities Investment Sector strategist Yasushi Noguchi. It has managed to create a balance between cutting costs and investment in the correct places.

Daiwa, which is expanding investment banking in a competitive Asian market, posted a 9.4 billion yen net loss, compared with a loss of 1.2 billion yen a year earlier.

The result was worse than the average forecast of a 2.1 billion yen loss from two analysts surveyed by Thomson Reuters I/B/E/S.

Daiwa cut its global investment banking recurring loss by a third to 5.8 billion yen, but that better performance was offset by a 70 percent dip in earnings from its retail business at home.

Daiwa is at a stage where it still has to go through restructuring, said SMBC Friend Securities' Noguchi.

Labor COSTS WEIGHING

At both securities companies, the cost of hiring bankers overseas has also weighed on profitability and, analysts say, will need to be controlled to prevent further earnings erosion.

In the last quarter Nomura said general expenses rose by 13 percent from the previous quarter with staff costs nudging up 7.3 percent. At Daiwa non-interest expenses fell 0.7 percent but remained 6.8 percent higher that at the same time in 2010.

Both Nomura and Daiwa pledged to rein in costs. When Nomura bought the Lehman parts, it offered many of its new employees guaranteed bonuses to keep them from leaving. That splurge kept the Lehman talent in place but thrust up expenses.

Jesse Bhattal, president and CEO of the wholesale business, told Reuters in an interview that Nomura plans to cut costs in the wholesale division by $400 million this business year, in both personnel and operating expenses with implementation starting in the next few weeks.

Nomura in June cut cash bonuses paid to directors and executives for the previous business year by as much as 95 percent after lackluster profits.

Daiwa's chief financial officer, Nobuyuki Iwamoto, on Friday promised to trim outlays by 100 billion yen over the mid-term.

(Editing by Muralikumar Anantharaman and Lincoln Feast)

Japan