Sumitomo Mitsui Financial Group <8316.T>, Japan's third-biggest bank by assets, outshone it larger rivals and posted its biggest profit in seven quarters on Monday, helped by an improvement in its stock portfolio and a decline in bad loans.

While Mitsubishi UFJ Financial Group <8306.T> and Mizuho Financial Group <8411.T> have made a slow recovery from the global financial crisis, Sumitomo appears to be improving at a quicker pace.

The bank's October-December earnings outstripped the combined results of Mitsubishi UFJ and Mizuho in the same period, a rare result from the smallest of Japan's three megabanks.

However, analysts cautioned that it was still too early to declare a full-fledged recovery, given that Sumitomo Mitsui's lending business remains sluggish, due to chronic weakness in Japan's economy.

We absolutely have to see the fourth-quarter results. They are unlikely to fall into the red, but there is a good chance they will not be able to convincingly beat their forecast, said Tatsuo Majima, a senior analyst at Tokai Tokyo Research Center.

In terms of the third quarter, the bank has just announced fund-raising, so it's probably that they want to put out good numbers. So there is a chance that profit could fall, or not grow as much as expected.

In January, Sumitomo Mitsui raised 968 billion yen ($10.8 billion) in a share offering to help it meet potentially stricter global capital requirements and expand its business in Asia.

BILLION VS MILLION

Sumitomo Mitsui, which last year bought Citigroup's Japanese brokerage and has a 2 percent stake in Barclays Plc , reported a group net profit of 124.3 billion yen ($1.4 billion) for October-December versus 154 million yen in the year-ago quarter.

The results mark the bank's highest quarterly earnings since January-March 2008.

Reuters calculated the third-quarter figure by subtracting the bank's first-half results from the nine-month numbers released on Monday.

Sumitomo Mitsui stuck to its forecast for a full-y ear net profit of 220 billion yen. That compared with the average 230 billion yen estimate of 10 analysts, according to Thomson Reuters I/B/E/S.

The StarMine SmartEstimate, which predicts earnings by putting more weight on recent forecasts from top-rated analysts, has the bank posting a profit of 235.5 billion yen.

For the quarter, Sumitomo Mitsui booked a loss of 5.8 billion yen on its stock portfolio, much smaller than a loss of 86.3 billion yen a year earlier.

Unlike their Western rivals, Japanese banks take stakes in their corporate clients, making them sensitive to swings in stock prices.

Credit costs, which include the money set aside to cover bad loans, totaled 51 billion yen for the quarter, down from 97.3 billion yen in the year-earlier period.

Income from lending, however, saw little growth, gaining just 16 percent from the previous year.

Although the world's second-largest economy has begun to recover from its worst recession in post-war history, the improvement has been slight, making companies wary of taking on new loans.

Domestic lending fell in January for the second straight month, Bank of Japan data showed on Monday.

Core operating profit at Sumitomo Mitsui's main banking unit -- a measure of earnings that strips out contributions from affiliated businesses such as consumer finance -- fell from the previous year, meaning that its mainstay banking business actually weakened.

To offset the slow growth at home, Sumitomo Mitsui's president, Teisuke Kitayama, has said he aims to make the bank a major player in Asia.

Sumitomo Mitsui holds a 15 percent stake in Vietnam's Eximbank , as well as small stakes in South Korea's KB Financial Group <105560.KS> and Hong Kong's Bank of East Asia <0023.HK>.

Shares of Sumitomo Mitsui closed down 1.2 percent at 2,774 yen ahead of the results on Monday. They have gained 4.9 percent so far this year, after losing about 30 percent in 2009.

So far this year, Tokyo's index of bank stocks <.IBNKS.T> is up about 1.5 percent.

(Reporting by David Dolan; Editing by Muralikumar Anantharaman)

Japan