Last month’s improvements in credit card defaults appears to be an outlier. Credit card defaults have resumed their natural tendency to track rising unemployment.

Inquiring minds are reading U.S. credit card defaults up, signal consumer stress.

Bank of America Corp and Citigroup Inc customers defaulted on their credit card debts in August at the highest rates since the onset of the recession, a sign that the banks’ consumer lending woes are far from over.

“The defaults are a wake-up call for those expecting a V-shaped recovery,” said Elliot Spar, options market strategist at Stifel Nicolaus & Co.

Bank of America said its charge off-rate — loans the company does not expect to be repaid — rose to 14.54 percent in August from 13.81 percent in July.

Citigroup, the largest issuer of MasterCard-branded credit cards, said its charge-off rate rose to 12.14 percent in August from 10.03 percent in July.

The charge-off rates for both Citi and Bank of America, two of the biggest recipients of U.S. government bailouts, were the highest yet during the financial crisis.

JPMorgan Chase & Co, the largest issuer of Visa-branded credit cards, said its charge-off rate rose to 8.73 percent from 7.92 percent, while smaller Discover Financial Services said its rate rose to 9.16 percent from 8.43 percent.

American Express Co’s default rate fell to 8.5 percent from 8.9 percent as the company increased its lending portfolio.

JPMorgan, Discover and Capital One Financial Corp reported late payments on credit cards — an indicator of future defaults — rose in August after several monthly declines.

As credit card losses rose to record highs in recent months, credit card companies closed millions of accounts, trimmed lending limits and slashed rewards.

Lenders are also raising fees and interest rates ahead of a new law that increases protection for consumers. The law is expected to shrink the industry and limit subprime borrowers’ access to plastic money.
Unemployment is likely to rise for another year, then flatten out so it is likely that card defaults keep rising for quite some time.

Rising fees will make up some of the difference. However, the millions of closed accounts and reduced minimums will curtail consumer spending going forward. That is a good thing as well as part of the healing process. Yet, along with secular changes in consumer attitudes, curtailed credit does portend weak earnings growth across the board for a wide array of companies.

This is a story that has been brewing for a while and we’ve tried to cover it when we’re not tracking hedge fund portfolios. So far in 2009, the data surrounding credit card charge offs and mortgage delinquencies has not been pretty… at all. Just now after the close of the second quarter, we see that both metrics have hit the highest rates since the Federal Reserve began tracking them.

Credit card delinquencies (payments more than 30 days late) rose to 6.7% up from 6.68%. Charge-offs (listed as ‘uncollectable’ by the banks) rose to 9.55%, up from 7.64%. The scary thing here is that this trend is accelerating (as illustrated by the graph below, courtesy of CreditCards.com).

(Click to enlarge)

An acceleration in charge-offs and delinquencies obviously means bad things for financial institutions and the economy in general. Much like the impending (and already current) problems in commercial real estate, we’ve likened credit card charge-offs as a ‘second wave’ in this economic crisis. The first tidal wave came through and washed out a whole lot in the economy. As people begin to lose work and fall behind on their massive debt repayments, they drown. This creates a second wave of writedowns for financial institutions and another set of problems for an economy trying desperately to recover. The initial tidal wave hits and knocks America down. Then, when America starts to get enough strength to stand up, they will be washed away again with a whole new slew of problems.

This is due to the delayed effect the first wave had on the consumer. After people are laid off, they scramble to find new jobs and dwindle what little savings they have left. (Remember, America’s savings rate has not been the best and we’ve concluded that it needs to rise in order to help get out of this mess). And, the fact that the unemployment rate keeps rising is not helping things either. Once their savings is gone, they rely on credit cards as a flotation device. And, this scenario is only the people who don’t already have credit card debt. Those already suffering under this burden begin to bear an even heavier load until they simply can’t make payments at all.

This effectual lag has slowly but steadily been building for months and the latest charge-off and delinquency data has begun to spike. In fact, we started posting about rising delinquencies back in August of 2008 when we saw delinquency rates starting to near 5%. We then touched on the impending credit card squeeze back in November as well, as we began to look at things in-depth. Nowadays, charge-offs are nearing 7% and in the span of one year we’ve seen a surge in credit card delinquencies of almost 2%. This just begins to show the lagging effect this phenomenon will have.

So, this is nothing new. Charge-offs and delinquencies are accelerating and even the CEO of JPMorgan (JPM) Jamie Dimon himself says that consumer loans and credit cards will be a house of pain for financial institutions. Well, he should know since his firm is in the eye of the rising storm. As such, we penned a piece announcing our downgrade of the American consumer’s credit rating where we examined the potential impact of credit line reductions.

The main thing to take away here is that credit card charge-offs and delinquencies are getting pretty bad and have the potential to go to ‘worse.’ The lagging effect of these charge-offs and delinquencies cannot be overstated as these problems slowly fester. Too many consumers have been struggling and now find themselves caught in the undertow; the wave has been building for some time now. The only questions now are how big will it get and when will it crash down?