Mitsubishi UFJ Financial Group <8306.T> became the third major Japanese bank to post upbeat results, underscoring the improving outlook for the sector, and said it would raise $11 billion to meet stricter capital rules.

Japan's top bank also said it would adjust its plan to merge its brokerage with Morgan Stanley's Tokyo operation, cancelling its original target of full-scale integration. Mitsubishi UFJ owns one-fifth of the U.S. investment bank.

Japanese lenders have suffered smaller credit losses than their Western rivals, but have been slow on the rebound, hampered by their dependence on Japan's sluggish economy.

It appears that the worst is behind, but revenue momentum is still not strong and the outlook for Japanese banks is unclear, given the uncertainties about the economy and the possibility of deflation, said Masahiko Watanabe, credit analyst at Fitch Ratings in Tokyo.

Economists expect Japan's deflation to persist until at least the second quarter of 2011, a recent Reuters poll showed, meaning that interest rates and revenue from lending will have little chance to rise.

Mitsubishi UFJ confirmed earlier reports that it planned to raise up to 1 trillion yen ($11.2 billion), becoming one of scores of Japanese firms to tap a modest rebound in share prices for much-needed cash.

Japanese companies have so far raised about $40 billion this year by issuing common stock and convertible bonds to shore up balance sheets depleted by the economic downturn.

EYES ON MIZUHO, SUMITOMO MITSUI

Almost three-quarters of the fundraising has been by financial firms, and analysts say that Mizuho Financial Group <8411.T> and Sumitomo Mitsui Financial Group <8316.T>, Japan's other big banks, will also need to raise more funds.

Speculation about the possibility of further fundraising has weighed on bank shares this year.

These companies issuing their own shares is a big burden on the market, said Koichi Ogawa, chief portfolio manager at Daiwa SB Investments.

And now you have to wonder if Mizuho will do it, and how big, as well as a lot of smaller banks, he said.

All three banks have already completed a round of fundraising, but only Mitsubishi UFJ is out of the lock-period, meaning it is the only one able to issue new shares now. The timing may be a critical advantage, analysts have said, if Japan's stock market slides again.

Mitsubishi UFJ and Morgan Stanley said that they would be forming two separate companies to share their Japanese securities businesses, instead of one, fully merged unit. The creation of the two firms will be completed by May 2010 the said, two months later than originally planned.

Mitsubishi UFJ President Nobuo Kuroyanagi told a news conference that Mitsubishi UFJ Morgan Stanley Securities, to be owned 60 percent by the Japanese bank, will concentrate on the retail business.

Morgan Stanley MUFG Securities will focus on international investors and Morgan Stanley will hold 51 percent of the voting rights, Kuroyanagi said.

An official for Mitsubishi UFJ said that differences in risk management and internal systems made it difficult to fully integrate the two companies.

INTEREST INCOME REBOUNDS

Quarterly earnings were aided by a rebound in income from domestic and overseas loans.

Group net profit for the July-September quarter rose by 59.3 percent to 65 billion yen ($728 million) against 40.8 billion yen a year earlier. The results beat the average forecast of 34.7 billion yen in a survey of three analysts by Reuters.

Mitsubishi UFJ stuck to its forecast for a full-year profit of 300 billion yen. That compares with an average estimate for a net profit of 280.6 billion yen in a poll of 11 analysts by Thomson Reuters I/B/E/S.

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Graphic tracking MUFG's earnings: http://link.reuters.com/zak32

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Net interest income, a gauge of earnings from lending, rose nearly 12 percent from the same period a year earlier. Losses on stocks fell by nearly three-quarters.

But as lending income increased, so did bad-loan costs. Mitsubishi UFJ was the only one of Japan's top three megabanks to post a year-on-year rise in credit costs for the quarter. Credit costs include the reserves banks set aside to cover future bad loans.

Mizuho and Sumitomo Mitsui, Tokyo's other two megabanks, posted consensus-beating results last week, with Mizuho returning to profit for the first time in five quarters and Sumitomo Mitsui doubling its quarterly profit.

Mitsubishi UFJ's shares finished down 0.6 percent ahead of the results on Wednesday. The shares have fallen 11 percent so far this year, outperforming a 17 percent slide in Tokyo's index of bank stocks.

(Additional reporting by Elaine Lies; Editing by Muralikumar Anantharaman and Jon Loades-Carter)

Japan Morgan Stanley Investment