(Recasts to add annual lending growth rate in paragraph 1, comments, details throughout)
By Guillermo Parra-Bernal and Luciana Otoni
SAO PAULO/BRASILIA, June 25 (Reuters) - Brazilian banks extended credit at the lowest annual pace in over seven years while defaults edged higher in May, in a sign that the nation's flagging economy and rising borrowing costs weighed on the ability of companies and individuals to borrow.
Outstanding loans in Brazil's banking system reached 2.803 trillion reais ($1.27 trillion) last month, up 1 percent from April, central bank data showed on Wednesday. On an annual basis, lending growth slowed to 12.7 percent in May from 13.4 percent in April and 16.1 percent a year earlier.
Banks are scaling back disbursements as economic activity has lost steam in recent years, consumer debt hit record levels, and quickening inflation hampered income.
Annual growth in auto, payroll and personal credit fell sharply in the month while flagging demand for working capital, receivable discounts, credit card and subsidized credit weighed down corporate credit, the data showed.
Loan origination fell in May on a year-on-year basis for the first time since 2012, while loan delinquencies rose sequentially for the first time since September 2013.
Shares of Brazil's largest banks fell after the report, signaling investors are growing concerned about earnings trends for the coming quarters.
Borrowing costs rose for a fifth month in six in the wake of a year of central bank interest-rate increases aimed at controlling inflation. Spreads, or the difference between the rate at which banks lend and their cost of funding, also widened for a fifth straight month.
As a result, loans in arrears for 90 days or more, the industry's benchmark gauge of credit delinquencies, rose to 5 percent in May, the highest since October, from 4.8 percent in April. Loans in arrears between 15 days and 90 days fell.
"Decelerating loan growth and increasing rates were trends from past months, but weaker asset quality came as a relative surprise, partially foreshadowed by leading indicators from prior months," said Carlos Macedo, an analyst with Goldman Sachs Group Inc.
Private-sector banks led the rise in defaults, as their non-performing loans ratio climbed 0.10 percentage points to 4.2 percent in May from April.
"It may be too early to say this is the beginning of a worsening credit cycle, especially given the improvement in early delinquencies, but it is consistent with the view that a declining cost of risk may not be a strong earnings tailwind beyond the first half for private-sector banks in Brazil," said Saúl Martínez, an analyst with JPMorgan Securities.
State-owned banks continue to grow their loan books faster than private-sector banks, particularly if state development bank BNDES, is excluded. Private-sector banks' disbursements rose about 4.9 percent in the 12 months through May, compared with 19.4 percent at state-run lenders.
BNDES is Brazil's main source for long-term corporate lending.
So-called earmarked loans, or credit aimed at investments and homebuilding in accordance with government mandates, rose 1.3 percent from April, while non-earmarked loans increased 0.7 percent.
($1 = 2.21 Brazilian reais) (Reporting by Guillermo Parra-Bernal and Luciana Otoni; Additional reporting by Silvio Cascione; Editing by Chizu Nomiyama, W Simon and Nick Zieminski)