Sumitomo Mitsui Financial Group, Japan's third-largest bank, posted a 30 percent drop in April-September profit, hit by falls in the share price of consumer loan affiliates and losses on subprime investments, but it kept its full-year forecast unchanged.

SMFG has been the most aggressive of Japan's megabanks in expanding in the consumer finance sector, looking to increase its presence as others bail out of an industry smarting from new government caps on interest rates.

But the expansion has not been painless. SMFG bought a 32 percent stake in credit card firm OMC Card Inc in July, and since then, shares of the company have lost about 40 percent of their value, on concern about the outlook for the industry.

Shares of another consumer loan affiliate, Central Finance Co Ltdx, fell about a third during the same period.

SMFG said it expected to post up to 87 billion yen ($790 million) in valuation losses on subprime-related investments in the current business year to March as the deterioration of global credit markets takes its toll on Japanese banks.

Japanese banks have kept saying their exposure to subprime loans is limited, but rating agencies are now moving to downgrade Alt-A products, so uncertainties remain, Takeshi Osawa, senior fund manager at Norinchukin Zenkyoren Asset Management.

SMFG booked a group first-half net profit of 170.6 billion yen ($1.54 billion), down from 243.7 billion yen a year earlier.

The result was widely expected after the bank last month cut its first-half estimate by 23 percent to 170 billion yen, citing a decline in the value of OMC's shares.

For the full year, SMFG kept to its latest forecast for a 29 percent profit increase to 570 billion yen. That compares with a market consensus of 576.3 billion yen in a poll of 16 analysts by Reuters Estimates.

SMFG last month raised its full-year outlook by 5.6 percent because of an extraordinary gain from a merger involving its leasing subsidiary.

SUBPRIME EXPOSURE

For the first half, the bank said it booked a loss of 32 billion yen due to subprime-related losses and loss provisions.

But that could nearly triple, to 87 billion yen, by the end of the financial year, SMFG President Teisuke Kitayama said at a news conference.

I don't think it is small number, Kitayama said, referring to the 87 billion yen. But I do think we've managed to avoid the potential for much greater loss.

SMFG said its total exposure to the subprime market totalled 95 billion yen at the end of September, or about 0.1 percent of its total investments and loans.

The bank also said that none of its subsidiaries had subprime exposure as of that date.

The bank also showed a slight improvement in an important indicator of earnings from lending. Net interest income at the bank's core lending unit rose 2 percent in the first half.

The Bank of Japan began raising interest rates from zero more than a year ago, but tough competition to lend and healthier company balance sheets have made it difficult for commercial banks to pass on rate hikes to borrowers.

Last week, second-ranked Mizuho Financial Group Inc posted a 17 percent drop in first-half profit and cut its full-year forecast after U.S. subprime market turmoil sparked losses at its brokerage unit and increased credit costs.

Fourth-ranked Resona Holdings Inc posted a 74 percent drop in six-month profit following losses on investments, but it raised its full-year forecast, while smaller lenders Shinsei Bank Ltd and Aozora Bank Ltd posted profit declines because of turmoil in the subprime market.

Market leader Mitsubishi UFJ Financial Group Inc is due to announce its results on Wednesday.

Although Japanese lenders have fewer investments in subprime-related products than overseas rivals, they have not escaped unscathed. In addition to valuation losses, the global market turmoil has prompted Japan's central bank to forgo a rate increase that was initially expected in the summer.

So far this year, SMFG shares have fallen by a third, roughly in line with a 30 percent drop in Tokyo's banking sector sub-index.

Prior to the earnings announcement, SMFG's stock closed up 0.3 percent at 789,000 yen. The banking sector index rose 0.2 percent. (Additional reporting by Taiga Uranaka; Editing by Mike Miller)

Japan Citigroup