Aug. 15 (Bloomberg) -- Mitsubishi UFJ Financial Group Inc. shares dropped to their lowest level in two years after Japan's largest bank reported losses related to the U.S. mortgage crisis that continues to roil global markets.

The Tokyo-based bank fell 5.3 percent after saying it had unrealized losses of about 5 billion yen ($42.6 million) on investments related to U.S. subprime loans as of the end of July. Smaller Sumitomo Mitsui Financial Group Inc. said it recorded ``several billion yen'' of losses in the three months to June 30, after selling about 350 billion yen in U.S. mortgage-backed securities, including some backed by subprime loans.

``The impact of subprime for Japanese banks is very limited but the market keeps dumping the stocks,'' said Yoji Takeda, who helps manage about $900 million at RBC Investment (Asia) Ltd. ``The whole picture is not clear yet with some problems in the pricing of CDOs related to the asset-backed securities market.''

The 86-member Topix banks index, including Aozora Bank Ltd. and Shinsei Bank Ltd., fell 19 percent since the start of July amid a global sell-off of financial stocks and after a weak set of earnings. Late payments on U.S. subprime mortgages rose to the highest since 2002, driving down the value of bonds backed by home loans and causing turmoil in credit markets.

Prices of collateralized debt obligations, or CDOs, which repackage bonds, loans and derivatives into new securities, have tumbled as rising defaults on home mortgages decrease investor appetite for risk.

`Not a Concern'

MUFG had its largest one-day percentage share decline since May 2006. Sumitomo Mitsui fell 5.9 percent to 920,000 yen, its largest one-day drop in more than three years. Japan's four biggest banks, including Resona Holdings Inc., have each lost a fifth of their market value in the past month.

``The loss at Mitsubishi UFJ is not a great concern,'' said Keisuke Moriyama, a Tokyo-based analyst at Nomura Holdings Inc. ``It's a small share of trading revenue.''

Mitsubishi UFJ had a balance of 280 billion yen in subprime- backed securities, 97 percent of which had the highest triple A credit rating, it said in a statement on its Web site. Sumitomo Mitsui had an outstanding balance of 100 billion yen in securities backed by mortgage loans at the end of June, it said in a separate statement yesterday.

Mizuho Financial Group Inc. said last week it recorded a loss of 600 million yen from selling most of its 50 billion yen of subprime-related holdings.

Pricing Risk

The disclosures increased the risk of owning bonds sold by the banks. Credit-default swaps based on the dollar-denominated subordinated debt of banking units belonging to Mitsubishi UFJ, Mizuho and Sumitomo Mitsui rose by 7 basis points to 62 basis points, according to prices provided by Merrill Lynch & Co. A basis point is 0.01 percentage point.

The credit swap price means the cost to protect 1 billion yen of the banks' debt from default rose to 6.2 million yen. An increase in price suggests deterioration in investor confidence. Subordinated debt is one of the forms of capital that regulators require banks to hold to absorb losses.

Net income at Mitsubishi UFJ declined 31 percent to 151.3 billion yen in the first quarter ended June 30, the Tokyo-based bank said on July 31. Mizuho said profit halved to 116.5 billion yen. Both banks left unchanged their full-year earnings forecasts.

Japanese banks have failed to capitalize on the nation's longest postwar expansion as companies flush with profits avoid borrowing and as costs related to lending soar. First quarter earnings, hit by higher credit costs, eroded investor optimism that banks will benefit from rising interest rates in Japan.

Asia Impact

The collapse of the subprime-mortgage market has pushed down prices on fixed-income securities around the globe, including corporate bonds and loans. The credit crunch forced hedge funds managed by Bear Stearns & Co. and Sowood Capital Management LP to liquidate last month, and has spilled over to equity markets, causing losses at computer-driven funds including those run by Goldman Sachs Group Inc.

Global credit rating companies Moody's Investors Service and Standard & Poor's said Aug. 3 the impact of the U.S. subprime mortgage crisis on Asian banks had been ``limited'' and ``manageable.''

Australia's Rams Home Loans Group Ltd. said yesterday the shakeout in global debt markets may cut profit, due to rising financing costs. The Sydney-based lender, which went public last month, gets almost half the funds for its mortgages by selling short-term debt in the U.S.

``Japanese banks are less attractive with confusion over subprime loans and structured products,'' said Yuichi Chiguchi, who helps manage $8.6 billion in assets at DLIBJ Asset Management Co. in Tokyo. ``It's always necessary to think of the relative attractiveness of different sectors.''

To contact the reporter on this story: Finbarr Flynn in Tokyo at fflynn3@bloomberg.net

Last Updated: August 15, 2007 03:12 EDT