Mizuho Financial Group Inc, Japan's second-largest bank, posted a 17 percent drop in its first-half profit and cut its full-year forecast on Wednesday, after the subprime-market turmoil sparked losses at its brokerage unit and increased credit costs.

Mizuho also said it would delay the merger of brokerage unit Mizuho Securities and affiliate Shinko Securities Co Ltd by four months due to the difficulty of pricing Mizuho Securities' sub-prime related investments.

The losses overshadowed a marginal improvement in a key measure of lending earnings, although the outlook for further gains remained uncertain due to strong competition for corporate lending and little chance of a central bank rate increase in the near future.

The bank said it had a total of 800 billion yen ($7.2 billion) invested in products related to residential mortgage-backed securities (RMBS), with 106 billion yen of that exposed to the subprime-mortgage market.

Mizuho had previously said it had little exposure to subprime products.

These (subprime) products have all had their ratings downgraded and there is very little liquidity. The market just keeps going down, President Terunobu Maeda told a news conference.

In a sense, the market is crashing and you can't accurately determine prices, Maeda said.

Although Japanese lenders have fewer investments in subprime-related products than their overseas rivals, they have not escaped unscathed. In addition to valuation losses, the global market turmoil has prompted Japan's central bank to forgo a rate increase that was initially expected in the summer.

The business environment for banks is not good, said Katsuhiko Mori, a senior portfolio manager at the equity management department of Daiwa SB Investments.

People now expect the Bank of Japan to hold off on raising interest rates until after March next year, later than the January-March period when many had initially thought the central bank would take action, Mori said.

The Bank of Japan began raising interest rates from zero more than a year ago, but tough competition to lend and healthier company balance sheets have made it difficult for commercial banks to pass on rate hikes to borrowers.

MERGER DELAY

Mizuho said in a statement it would delay the merger of unlisted Mizuho Securities and Shinko Securities, in which it holds about a 15 percent stake, to May 7.

The deal, originally set for January, would create Japan's fourth-largest brokerge in terms of assets under management.

We have no intention to call off the merger, Maeda told reporters.

If we work out the merger ratio during a time when the market isn't stable it will likely be a disadvantage to shareholders of one company or the other, Maeda said.

The bank now expects a net profit of 650 billion in the full year to March, falling 13 percent short of its previous estimate.

It reported a group net profit of 327.1 billion yen for the six months to Sept. 30, against 392.3 billion yen a year earlier.

In the first half Mizuho said it suffered around 70 billion yen ($631 million) in subprime-related losses in the April-September, with about half of that coming from Mizuho Securities' trading losses on securitised products.

It said it was also hit by higher credit costs, after market turmoil forced it to revise its ratings of some debtors.

But net interest income, a key measure of earnings from lending, rose 0.5 percent, or 2.8 billion yen, from last year.

SHINSEI, AOZORA

Smaller lenders Shinsei Bank Ltd and Aozora Bank Ltd also posted profit declines on Wednesday due to turmoil in the subprime market.

Shinsei booked a 40 percent slide in its first-half net profit, to 23.2 billion yen. The bank left its full-year forecast of 62 billion yen untouched, having reduced its forecast by 14 percent last month.

Aozora reported a 20 percent loss in its first-half net profit, to 42.8 billion yen, and lowered its full-year forecast by 26 percent, to 62.6 billion yen.

The bank's chairman told a news conference that it may see subprime-related losses of up to 8 billion yen in the second half.

Prior to the announcement, Mizuho's stock closed up 6.4 percent at 550,000 yen, in line with a 6.1 percent gain by Tokyo's index of bank stocks.

Aozora rose 7.2 percent to 343 yen following its results, while Shinsei gained 4.6 percent before releasing its earnings. (Additional reporting by Aiko Hayashi and Taro Fuse, Editing by Michael Watson, Greg Mahlich)

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