Haunted by the specter of their holdings being diluted, investors in Sumitomo Mitsui Financial Group Inc. (8316.TO) scrambled to sell the stock early Friday after the bank said it plans to issue up to $8 billion in new common shares to shore up its creaking capital base.

With sell orders outweighing buy orders by about 4 to 1, shares in SMFG, Japan's third-biggest bank by assets, failed to trade early Friday. They ended the morning session in Tokyo quoted ask-only at their daily technical limit-down level of Y3,110, dragging down other banks as observers wondered who might be next to issue fresh shares. The Y3,110 level is 14% below Thursday's close of Y3,610, while the Nikkei 225 Stock Average was up 0.5%.

Like other Japanese banks, SMFG's fortunes have been roiled by inflated credit costs amid worsening business conditions. Losses of Y53.2 billion on its investment in Barclays PLC (BCS) in which SMFG paid about $930 million to take a 2% stake last June also weighed on its earning outlook.

A SMFG bank executive said at a briefing yesterday that the lender needed to strengthen its capital base both in quality and quantity amid the economic downturn and deteriorating business conditions.

The bank's plan to issue up to Y800 billion in common stock within a one-year period starting April 17, would be the fourth-biggest common stock offering on record by a Japanese company, according to data firm Dealogic.

Jangling investors' nerves further, the issuance plan comes on top of a severe profit warning. Thursday SMFG also said its now expects a net loss of Y390 billion for the fiscal year ended March 31, compared with its previous forecast for a net profit of Y180 billion.

"Although the bank's loss estimate was the bigger-than-expected, we kind of knew the bank would likely fall into the red," said a bank analyst at Japanese brokerage firm. "But (the plan to) raise this much capital, that was quite surprising."

Speaking on condition of anonymity, the analyst said, "it looks like the capital boost is more for covering losses rather than having a buffer for future business strategy."

SMFG itself said the capital injection could cause share dilution of up to 30%. But another analyst at a foreign brokerage said the share drop could be deeper than 30%, falling further until investors see more specific justifications for the capital boost.

At the shares' current value, the bank's market capitalization stands at about Y2.11 trillion: Y800 billion would be equivalent to about 38% of that.

So far, among Japanese major financial institutions, Mitsubishi UFJ Financial Group Inc. (8306.TO) last year raised Y400 billion and Nomura Holdings Inc. (8604.TO) raised about Y276 billion this year by issuing common stock.

While the U.S. financial peers enjoyed a rise overnight, Tokyo market participants just don't see any reasons to buy shares in the Japanese banking sector, according to Mitsushige Akino, general manager at Ichiyoshi Asset Management, citing domestic banks' own problems such as massive equity holdings and the economic downturn. "We also wonder if SMFG can raise that much capital," Akino said.

SMFG's capital boost also weighed on Topix's banking subsector, sending the sector down 4%, compared with Topix's 0.5% rise. Among major banks, Mizuho Financial Group Inc. (8411.TO) took a beating as investors became wary of another possible new share issuance by Japan's second largest lender.

"People are now wondering who's the next (after SMFG)?," said a banking analyst at a Japanese brokerage, saying that until Mizuho makes its intentions clear regarding any plans to boost capital, shares in the bank, Japan's second-biggest by assets, could be squeezed.

Unlike Japan's biggest bank, Mitsubishi UFJ, which has raised capital by issuing common shares, Mizuho so far has only raised capital by issuing preferred securities and subordinated bond several times, which doesn't help strengthen its core capital ratio, known as Tier-1.

Mizuho was down 9.1% at Y199 midday, while MUFG was off 2.5% at Y506.

-By Atsuko Fukase, Dow Jones Newswires; 813-5255-2957; atsuko.fukase@dowjones.com

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