* MUFG says to raise up to $10.6 bln with new shares
* Japan PM pledges action to stabilise Japan markets
* Nikkei average tumbles to 26-year low (Recasts, adds details)
By David Dolan
TOKYO, Oct 27 (Reuters) - Mitsubishi UFJ Financial Group (8306.T), Japan’s biggest bank, said it would raise up to $10.6 billion to replenish a capital base depleted by a plunging stock market and its investment in Morgan Stanley (MS.N).
News of Mitsubishi UFJ’s fundraising came as Tokyo stocks tumbled to their lowest in 26 years, prompting Japan’s government to beef up a bailout package for the country’s ailing banks, which are big investors in domestic equities.
Prime Minister Taro Aso said the government would expand a scheme to gives lenders access to public money and strengthen rules on short-selling, and he called on the state to buy shares directly from banks to reduce their market exposure.
He has also called for extending tax relief on income from stocks and dividends, as a means of reviving investor appetite for stocks.
Although Japanese banks have had little exposure to the risky credit instruments that crippled Wall Street, investors now fear lenders’ extensive shareholdings and rising bad-loan costs will unravel profits this year.
“The problem here is that the stock market has fallen. It has nothing to do with derivatives or anything like that. As stocks have dropped, banks are faced with rising paper losses,” said Koichi Ogawa, chief portfolio manager at Daiwa SB Investments.
The government measures underscore the difficulties now facing lenders in the world’s No.2 economy, which at first appeared to have avoided the credit crisis, allowing them to invest in overseas rivals.
Tokyo's Nikkei share average .N225 briefly dropped as low as 7,141 on Monday, its lowest since 1982.
The benchmark has lost about half of its value so far this year -- falling by nearly a third this month alone -- as a rise in the yen and a weakening outlook for the economy has curbed appetite for Japanese stocks.
The losses, which drove more risk-averse investors away from currencies such as the Australian dollar and back into the yen, overshadowed Group of Seven warnings on Monday that the yen’s sharp swings posed a threat to financial and economic stability.
Mitsubishi UFJ said it planned to raise up to 990 billion yen ($10.6 billion), with up to 600 billion of that in common stock and 390 billion in preferred shares.
“MUFG’s capital issuance will cause much concern among investors, because many had assumed that Japanese banks were safe compared to other global banks and that MUFG was the safest of them all,” Kristine Li, banking analyst at KBC Securities, said in a note to clients.
Li cut her rating on the bank to “sell” from “hold” following the news of the capital raising.
The preferred shares will not be convertible to common stock, and will pay an annual dividend of 115 yen, the bank said, representing a yield of 4.6 percent.
The terms of the common stock issuance have yet to be determined, as do the buyers of the preferred shares, Mitsubishi UFJ said.
Mitsubishi UFJ’s capital has also been stretched by its ambitious expansion plans.
The bank recently spent $9 billion on a 21 percent stake in Morgan Stanley, $3.5 billion to take full control of California lender UnionBanCal Corp UB.N, and about 150 billion yen to raise its stake in consumer loan affiliate Acom (8572.T).
Mitsubishi UFJ rivals Mizuho Financial Group (8411.T), Japan’s second-largest bank, and third-ranked Sumitomo Mitsui Financial Group (8316.T), are both looking to raise as much as 500 billion yen ($5.4 billion), newspapers reported on Monday.
Both lenders said in statements that they had made no decisions regarding their capital plans.
Traditionally, Japanese lenders hold large stakes in their corporate clients as a means to cement business ties. The value of those stocks totalled more than $250 billion at the end of March, data from the Japan Bankers Association shows.
Small, local banks, which are tied to Japan’s dwindling regional economies have also been hit hard.
In response, the government recently announced a plan to make up to 2 trillion yen ($21.3 billion) in public funds available to the country’s lenders, although Economics Minister Kaoru Yosano has said that should be increased to around 10 trillion yen.
Aso is also planning to announce an economic stimulus package later this week to support the economy.
That package, Japan’s second in just a few months, is expected to include a total of 5 trillion yen in new spending, with almost half of that in the form of temporary income tax cuts.
The Bank of Japan’s new deputy governor also signalled the central bank would examine resuming a scheme to buy back shares held by lenders.
“For banks, the risk from stock market volatility has become one that cannot be ignored,” Hirohide Yamaguchi told a news conference.
Shares of Japan’s top three banks fell by their maximum limit allowed on the Tokyo Stock Exchange.
Mitsubishi UFJ tumbled 14.6 percent to 583 yen. Mizuho dropped 14.8 percent to 230,000 yen while Sumitomo Mitsui fell 11.5 percent.
The Nikkei closed 6.4 percent down, hitting its lowest closing level since October 1982. (Reporting by David Dolan, Tetsushi Kajimoto, Yasuhiko Seki, Hideyuki Sano, Leika Kihara, Nathan Layne and Sachi Izumi; Editing by Hugh Lawson)