Japan's top three banks forecast weaker annual earnings as aggressive monetary easing squeezes them out of a profitable government bond trade and forces them to rely more on bread-and-butter lending where margins remain razor-thin.

The cautious outlooks delivered by Mitsubishi UFJ Financial Group Inc (MUFG) <8306.T>, Mizuho Financial Group Inc, and Sumitomo Mitsui Financial Group Inc (SMFG) <8316.T> highlight the tough transition facing the industry after the central bank's radical easing in April, including a plan to purchase 70 percent of Japanese government bonds issued each month.

The Bank of Japan's emergence as a dominant buyer has sliced into a source of steady profits for banks, which for years have relied on JGB trading gains make up for weak loan demand from risk-averse corporations and individual borrowers.

"We had a large profit from selling (Japanese government) bonds) last financial year but we are expecting it to sharply fall this year," Nobuyuki Hirano, president of MUFG, Japan's largest bank, told an earnings briefing on Wednesday.

While the BOJ's goal is to stimulate lending and pull the economy out of deflation, loan demand is unlikely to show a significant pickup anytime soon, while low interest rates promise to put a lid on lending spreads.

The tough operating environment in Japan has given new importance to the efforts by lenders to find opportunities overseas, where they have been active in making acquisitions and branching out into new lending areas.

Japanese companies have been borrowing more to finance acquisitions but remain reluctant to take on debt to grow their existing operations, said Koichi Miyata, the president of SMFG, Japan's third-largest bank.

"We have yet to see strong growth in demand for financing for capex and working capital," Miyata said at a briefing.

Mitsubishi UFJ Financial Group <8306.T>, Japan's largest lender by assets, said net profit is likely to dip 11 percent for the year started in April. No. 2 Mizuho and SMFG also said net profit is expected to fall 10 percent and 27 percent respectively for the current financial year.

PAIN FIRST, GAIN LATER

Bank executives have said the BOJ's ultra-easy monetary policies are likely to exert further pressure on their lending margins.

Growth in outstanding loans by Japan's major banks turned into positive territory in December after 37 straight months of contraction, but that increase has not been strong enough to make up for low interest rates.

Against that backdrop, the banks have been stepping up acquisitions overseas.

SMFG said earlier this month it would buy a $1.5 billion stake in Indonesia's BTPN while in April MUFG acquired a U.S. commercial property loan portfolio from a Deutsche Bank unit worth $3.7 billion.

MUFG posted a 13 percent decline in net profit for the year ended in March due to the absence of a hefty one-time gain that it booked on its investment in Morgan Stanley in the previous business year.

MUFG, which owns a 22 percent stake in the Wall Street bank, made a net profit of 852.62 billion yen ($8.36 billion) in the year just ended, down from 981.33 billion yen a year earlier.

For the current year to March 2014, the lender is targeting net profit of 760 billion yen, down from the previous year, though marginally above an average forecast of 748.9 billion yen in a poll of 11 analysts by Thomson Reuters.

Mizuho expects annual net profit to come to 500 billion yen, down 10 percent from the year just ended, though slightly above analysts' average forecast of 478.6 billion yen.

SMFG predicted net profit would fall 27 percent to 580 billion yen, marginally above the market consensus of 574.4 billion yen.

($1 = 102.0350 Japanese yen)

(Editing by Daniel Magnowski)