Does This Mean Credit Cards Are Out of the Woods?

Stocks for credit card issuers exploded yesterday, on hopes the deep, dark trend in rising delinquencies and defaults is drawing to a close.   

Nearly every major card company saw declining delinquency rates in June. And since delinquencies are a precursor to defaults, declines are often viewed as a sign that future charge-offs will start to subside.

Default rates have hovered around all-time highs in recent months, and some companies were posting higher defaults than the Treasury's stress test assumed in the "worst-case" scenario. If default rates suddenly start falling, these stocks -- already expecting the worst -- could go bananas.

So let's get into the numbers. For June, here's how default rates fared for the largest card companies:

Not bad. With the exception of B of A, most saw stable (if not declining) default rates. No doubt about it -- that's great news.

Now, here are delinquency rates (for the companies that released data).

The decline in delinquencies is really getting people fired up. Unemployment increased from 9.4% in May to 9.5% in June. And while it's hardly compelling to search for patterns out of one month's data, the correlation between unemployment and credit cards is usually pretty tight. When unemployment rises and delinquencies fall, something's probably afoot.  

Ding ding ding!
And unfortunately, it is. There's a very distinct seasonal trend in credit card payments, affected by tax rebates in the spring and early summer. For example, a recent Associated Press-GfK poll showed more than one-third of consumers getting a tax rebate intended to use it to pay off debt.

These are big numbers we're talking about: According to the IRS, the average tax refund this year was $2,705. Since households have an average credit card balance of around $10,700, a few grand is a substantial boost that can keep you going for several months when you've been struggling to stay current.

But it's ultimately a short-term and nonrecurring bump that distorts reported numbers. Here's how Moody's (NYSE:MCO) put it in April: "We would expect these seasonal factors to help limit increases in the delinquency rate in the immediate months ahead, but the overwhelming influence of the negative economic environment should continue driving delinquencies to record-high levels by mid-year."

"Mid-year" is obviously already here, but the painful reality is the same: For delinquencies and defaults to start falling in a sustainable way, both unemployment and asset values in stocks and real estate need to not only stabilize, but actually improve. For the biggest factor -- unemployment -- that isn't even close to happening yet.

When even the president, who has an obvious incentive to butter up reality, admits that unemployment will top 10%, it's clearly premature to expect default rates to bottom in the near future. This will only be accentuated if we end up with a "jobless recovery" that some, including official economic cheerleader Ben Bernanke, think could happen.

Rally, meet reality
So does the latest data mean credit cards are out of the woods? I wouldn't count on it. As uberanalyst Meredith Whitney recently put it, "The banks are not prepared for double-digit unemployment, so that's going to be an issue for them that doesn't go away for the next, you know, year and half."

Saddle up.

For related Foolishness:

• The New Subprime
• Get Read for Credit Card Hell
• Meet the New Citigroup