* MUFG Q1 net profit Y255.29 bln vs Y182.92 bln a year earlier
* Mizuho Q1 net profit Y247.95 bln vs Y183.92 bln a year earlier
* Profits driven by Japan stock rally on Abenomics hopes
* But Abenomics has yet to boost domestic loan demand significantly
TOKYO, July 31 (Reuters) - Japan's biggest banks got a pop in quarterly profits from Prime Minister Shinzo Abe's economic-revival policies, but the gains reflected surging stock prices while loan growth remained limp, further evidence that "Abenomics" has not yet stoked lasting economic activity.
The sharply improved April-June results at the three megabanks - Mitsubishi UFJ Financial Group Inc, Mizuho Financial Group Inc and Sumitomo Mitsui Financial Group Inc - showed that the effect of the massive monetary easing and hefty government spending over recent months remains largely confined to financial markets.
Growth in outstanding domestic loans was largely flat to slightly higher from the previous quarter, despite a burst of mortgage demand ahead of an expected sales-tax hike, indicating companies remain reluctant to borrow aggressively to expand factories or upgrade computers and software.
The Bank of Japan, with its huge stimulus, wants to nudge banks away from government debt and into lending money to generate growth. The banking results show that only the first part of that process is working.
"Balance-sheet changes are happening at banks," said Toyoki Sameshima, a senior banking analyst at BNP Paribas Securities in Tokyo.
"They are in the phase one now, in which banks reduce JGB holdings and change them into cash," Sameshima said. "I am expecting to see phase two, in which the cash will become loans, around the second half of this financial year to next."
Mitsubishi UFJ Financial Group (MUFG), Japan's top lender by assets, reported on Wednesday a 40 percent rise in first-quarter net profit to 255.29 billion yen ($2.6 billion). Second-ranked Mizuho posted first-quarter net profit of 247.95 billion yen, up 35 percent from a year earlier.
The banks benefited from a rally in Japanese equities that boosted fee income from investment-trust sales and pushed up the value of their enormous equity portfolios.
Similarly, third-ranked Sumitomo Mitsui Financial Group (SMFG) on Monday reported a more than doubling of quarterly profit, helped by the stock market, which climbed 52 percent over the year to June and hit a five-year high in May.
Japan's banks have been forced to reduce the long-lucrative business of trading Japanese government bonds after the Bank of Japan launched its unprecedented easing in April. It seeks to beat two decades of deflation by doubling Japan's base money through gigantic purchases of JGBs and other assets.
The massive presence of the BOJ in the JGB market has driven other players largely to the sidelines. Gains from JGB trading fell by 70 percent to 80 percent from a year earlier at all three banks, which sharply reduced their JGB holdings during the latest quarter.
Mizuho said JGB holdings at its core banking units fell to 24.5 trillion yen at the end of June from 30.7 trillion yen at the end of March. MUFG reduced its JGB holdings on a consolidated basis by 8.4 trillion yen from March to 40.3 trillion yen.
MUFG said net interest income, or profits from lending, at its banking units rose to 316.1 billion yen during the first quarter from 297.6 billion yen a year earlier. Mizuho said net interest income at its core banking units rose by 11.5 billion yen to 241.7 billion yen. But the gains were mostly from growth in overseas lending. The yen's fall under Abenomics has driven up the yen value of Japanese companies' overseas earnings.
MUFG, which owns California-based Union Bank, is the most aggressive among Japanese banks in overseas expansion.
It said this month it is set to make a tender offer to buy up to 75 percent in Thailand's Bank of Ayudhya Pcl for about 560 billion yen, in what would be the biggest acquisition by a Japanese financial company in that region.
MUFG kept its full-year forecast for net profit unchanged at 760 billion yen, below the average estimate of 810.9 billion yen in a poll of 14 analysts by Thomson Reuters.
Mizuho also stuck to its forecast for the year ending in March 2014. It expects 500 billion yen in net profit, below the average estimate of 538.8 billion yen in a poll of 16 analysts.
In the year to date, shares of MUFG have risen 30 percent, Mizuho has gained 29 percent and SMFG is up 44 percent, compared with a 32 percent rise in the broad Topix index.
MUFG closed down 1.3 percent and Mizuho dropped 1 percent prior to the earnings announcement on Wednesday, versus a 1.5 percent fall in the Topix. SMFG slipped 0.4 percent.