ANALYSIS-Lending, not subprime, real worry for Japan banks

By David Dolan

TOKYO, Dec 3 (Reuters) - The U.S. subprime credit crisis has slashed Japanese banks' earnings and pushed their already lacklustre share prices even lower, but lenders aren't likely to see relief without an improvement in loan demand.

On top of subprime-related losses, large banks such as Mitsubishi UFJ Financial Group Inc (8306.T), and Sumitomo Mitsui Financial Group Inc (8316.T) are bruised by slower lending, weak fee income and ties to the troubled consumer finance sector.

The banks have also been unable to pass on interest rate hikes to customers due to cut-throat competition, putting pressure on interest margins.

"It's hopeless," said Kristine Li, bank analyst at KBC Securities, when asked about the outlook for Japan's lenders.

"Their main banking businesses are not growing ... Before we hoped they could grow their earnings after the (Bank of Japan) brought interest rates to a normalised level."

Investors seem to agree, sending Tokyo's bank index .IBNKS.T to a three-year low last month, although it has since recouped some losses. For the year, banks are down about 21 percent, against a 9 percent drop in the TOPIX index .

Analysts said growth of the banks' net interest income, a measure of earnings from lending, has been razor thin.

Among Japan's top three banks, leader MUFG booked the biggest improvement for the six months to September, with a 2.2 percent year-on-year rise.

Sumitomo Mitsui, Japan's third-largest bank, was just slightly behind that, while Mizuho Financial Group Inc (8411.T) reported a dismal 0.5 percent increase.

In comparison, Europe's HSBC Holdings Plc (HSBA.L) booked an almost 9 percent rise for the six months to June. DOOM AND GLOOM

Mortgage lending, one of the few bright spots for Japan's banks, is expected to drop sharply following a plunge in housing starts due to stricter building codes adopted in June.

"In terms of mortgages, the change in the construction law will take about six months to have an impact," said Masaki Iso, chief investment officer at Yasuda Asset Management.

"Banks are going to start feeling the pinch from here."

Japan's housing starts fell 35 percent in October from a year earlier, marking their fourth straight monthly decline and following a record 44 percent drop in September.