May bank lending continues to decelerate, expanding just 5% YoY versus 8% a month ago. Despite government guarantee-programs, corporate credit growth remains weak - reflecting not just the de-risking of bank loan books, but also a retreat in credit demand as macro conditions remain stressed. Until the provisioning cycle washes through in response to the emerging market style loan growth seen over the past two years expect muted loan volume growth and negative earnings momentum.

Decelerating. On a YoY basis, general commerce, transport and large corporates all saw credit contraction. On a MoM basis, overall system loans were marginally positive, expanding 0.3% MoM. The key here was consumer lending, which saw an expansion compared to a 0.1% contraction in corporate credit despite government sponsored loan schemes. We believe this is not just purely a function of the Singapore banks’ unwillingness to lend, but it is also a reflection of the retreat in credit demand as macro conditions remain strained. Unless we see a turnaround going in to 2H09, the risk to our 3% YoY FY09 loan-growth target is on the downside.

Consumer loans were the only bright spot. Total mortgage loans expanded 8.8% YoY, the highest pace of growth since December 2008. To us, mortgage lending growth is not a surprise given the low risk capital allocation for housing loans under Basel II, making such lending attractive especially as banks de-risk their loan books. In addition, we believe that the recent revival of the Singapore residential property market should provide a further upside catalyst for mortgage demand. Non-housing consumer lending continues to remain healthy, expanding 6.3% YoY. The primary driver here was credit cards, which expanded 13% YoY. This is a concern, especially in the context of May credit-card charge-off rates, increasing 40bps MoM to 5.62%. Similarly, consumer credit classified as “other” (which includes unsecured consumer credit) expanded 12.2% YoY. This is a worry especially as the unemployment rate continues to increase.

Remain Underweight Singapore banks. The strong loan growth seen over the past two years (especially to small- and medium-enterprise (SME) and construction sectors) will drive the non-performing loan (NPL) cycle as macro conditions remain under pressure. Singapore banks have some of the lowest provisioning levels regionally and with respect to their own history. As a result, expect the provisioning cycle to take centre stage as NPL classifications flow through; recall DBS (DBS SP - S$11.80 - SELL) saw a 121% YoY increase in NPLs in 1Q09 alone. Consequently, expect any operational upside from improving margins to be offset by higher credit charges leading to negative earnings momentum. Hence, we remain Underweight Singapore banks with UOB (UOB SP - S$14.68 - BUY) our only pick for better loan-book quality.