UPDATE 3-SMFG adds underwriting to Citi Japan acquisition

* SMFG to buy Nikko Citi underwriting operations -sources

* SMFG may combine those operations with Daiwa SMBC-sources

* SMFG seen building up to take on Japan No.1 Nomura

* Deal seen likely more than $5.2 bln; may come this week

By Taro Fuse

TOKYO, April 28 (Reuters) - Sumitomo Mitsui Financial Group Inc (8316.T) plans to expand its purchase of Citigroup Inc (C.N) assets in Japan to take in key investment banking businesses, two people with knowledge of the matter said, putting it head-to-head with industry leader Nomura.

After buying the stock and bond underwriting operations, SMFG may merge them with Daiwa SMBC Securities, its investment banking joint venture with Daiwa Securities Group (8601.T), another two people familiar with SMFG's strategy told Reuters.

The combination would be an investment banking powerhouse, ranking a close second in the latest quarter to Nomura Holdings (8604.T) in handling of yen bond and stock underwriting in Japan.

Sources say a deal for SMFG to buy the investment banking assets and Citi's Japanese retail broking arm, Nikko Cordial, for more than 500 billion yen ($5.2 billion) may be announced this week. The sources were not authorised to speak publicly about the deal.

"SMFG wants to create a big brokerage house that can offer both wholesale and retail services," said Shinichi Ina, a banking analyst at Credit Suisse.

SMFG said in a statement nothing has been decided. Yoshito Shimoyama, a spokesman for Nikko Citi Holdings, Citigroup's holding firm in Japan, declined to comment.

A deal would greatly expand previous plans for Citigroup to sell its retail broker arm and investment bank operations that handle IPOs and other services for small and medium-sized firms.

Citigroup put Nikko Cordial, a retail broker with 109 branches, and an unspecified portion of Nikko Citigroup up for sale as part of global efforts to raise cash after it was crippled by the global financial crisis.

But it had not previously been made clear which Nikko Citigroup assets would be sold and uncertainty over how the deal might impact Daiwa SMBC has weighed on Daiwa's stock.

Daiwa shares fell 1.2 percent on Tuesday, adding to a 5.5 percent fall on Monday as it announced a third straight quarterly loss [ID:nT361856].

The deal will not include Nikko Citigroup's markets division, which handles sales and trading, sources said.

RETAIL STRENGTH

Acquiring Nikko Cordial would also address SMFG's weakness in retail broking and bring it close to Nomura's size in that market too.

SMFG owns SMBC Friend Securities, a second-tier broker that logged about 60 billion yen in revenues in the past business year, a fraction of sales at retail leaders Nikko Cordial, Dawia and Nomura.

The Yomiuri newspaper reported on Tuesday that SMFG and Daiwa may even consider merging their brokerages along with Nikko Cordial. [ID:nT33361]

Daiwa's retail unit had 24.4 trillion yen in client assets in December, while Nikko Cordial held 24.9 trillion yen. Combined the two would be much closer to Nomura's 58.3 trillion yen in retail client assets.

"The deal makes sense for SMBC, which has the weakest retail securities presence of Japan's three megabanks," said Neil Katkov, head of Asia Research at financial consultancy Celent, referring to SMFG's core banking unit SMBC.

"SMBC has relied on a loose alliance with Daiwa Securities to access the retail market, and Nikko Cordial's nationwide branch network will make it a leading retail player overnight."

Citigroup spent about 1.5 trillion yen to acquire the Nikko Cordial franchise in a transaction completed early last year, aiming to expand in the world's second-largest economy.

But the U.S. bank, reeling from more than $85 billion of writedowns and credit costs since mid-2007, has been forced to retreat from that strategy and sell Nikko at what will likely be a considerable loss.

SMFG shares closed up 0.3 percent but outperformed the benchmark Nikkei average .N225, which fell 2.7 percent. ($1=96.33 Yen) (Additional reporting by David Dolan and Junko Fujita; Writing by Sachi Izumi and Nathan Layne; Editing by Rodney Joyce)