Mortgage lenders have had a rough ride, and no doubt more tough times are ahead.

Housing sales and prices are down, interest rates are rising, and credit risk is growing. Some industry watchers expect prime mortgage rates to hit 7% by the end of the year, further depressing loan volumes across the board.

But whenever negativity is present, so is opportunity.

Indeed, hedge funds and other traders continue to eye mortgage lender stocks for profitable long and short ideas. And opportunity is plentiful for individual investors as well -- though they should tread carefully.

Although the subprime meltdown is already well under way, problems with Alt-A loans, or so-called "liars' mortgages," are only starting to rear their heads in the form of increasing delinquency rates.

Alt-A borrowers have higher average credit scores than subprime borrowers, but they usually lack the documentation typically needed for loans. In many cases, underwriting for these loans was sloppy, and the homebuyers were given more housing debt than they could actually afford.

Impac Mortgage Holdings

(IMH) - Get Report

and

IndyMac

(IMB)

are two lenders with considerable exposure to this market, but each offers a different compelling short-term trade.

Impac's Potential Boost

Impac is a small-cap mortgage real estate investment trust that acquires, originates and sells Alt-A mortgages. Most of the company's taxable income is derived from the mortgage assets it holds as investments.

Impac, like other holders of mortgage assets, is now dealing with increased delinquencies and defaults from homeowners as adjustable-rate loans made in recent years begin to reset from low "teaser" rates. Buyers are facing a tougher refinancing market, because of higher interest rates and falling housing prices.

Thus, a good chunk of Impac's mortgage assets likely will go bad.

The bull case on Impac, however, is that the worst of times are behind it because the company has adequately set up loss reserves to handle loan defaults.

The added bonus is that the company may raise its dividend back to the level of a year ago, says Roth Capital Partners analyst Richard Eckert.

News of a dividend boost could propel the stock, which trades at a 33% discount to book value and has a 32% short interest. Impac shares currently trade around $5.90. Assuming a 0.35% loss rate on its loan assets held for investment, Impac can generate $1.05 per share of taxable income and pay a $1 annual dividend, up from the current 40-cent annual level, according to Eckert's projection.

The notion of taxable EPS is important for Impac, since the company must pay out at least 90% of its taxable income to maintain its REIT status.

If Eckert is correct and Impac pays a $1 dividend, the stock's dividend yield would jump to 16% from its current 6.5%.

Of course, trying to get a handle on loss rates is no easy task. Eckert's analysis assumes that Impac's first-quarter 60-day delinquency rate of 6.5% won't get much worse, since the fallout from the subprime meltdown in the credit markets was most severe in that period.

In actuality, delinquency rates could increase further this year. Nationally, the 60-day delinquency rate on Alt-A loans for all lenders was 3.1% in March, up from 1.2% a year earlier and the highest level since 2003, according to data firm First American Loan Performance.

If delinquency rates head to higher levels of 10% in Impac's portfolio, then the stock is expensive. The losses could begin to meaningfully eat into the company's loan loss reserves, says a trader who closely follows the stock.

IndyMac Attack

On the flip side of the Alt-A coin is IndyMac, a large-cap mortgage bank that grabs most of its profits from buying and selling Alt-A mortgages. Historically, this business represents about 75% of IndyMac's net income, and lately it has been under pressure.

Originations are down, and so are margins for selling loans. Wall Street banks that purchase IndyMac's loans are driving down prices because of fears of increased default risk from home borrowers. Those fears are similar to what happened with the subprime market.

"They're getting squeezed by lower gains on sale margins. That business is under severe pressure," says an institutional broker who is advising hedge fund clients to sell IndyMac's stock.

"I don't see the capital markets coming back anytime soon on the gain-on-sale mortgage business," the broker says.

In a research note Friday, Bank of America analyst Robert Lacoursiere reiterated his sell rating on IndyMac and

Countrywide Financial

(CFC)

.

The

demise of two leveraged mortgage funds managed by

Bear Stearns

(BSC)

"could bethe tipping point of a broader fallout from subprime mortgage credit deterioration that would lead to cascading deleveraging and ultimately ending with higher rates to new mortgage borrowers," Lacoursiere wrote in his note.

The Bear Stearns fallout "foreshadows pressured gain-on-sale margins and more residual writedowns for originators while feeding back into weaker house prices by taking the marginal buyer out of the market through higher rates and further credit tightening," he wrote.

"We believe that Countrywide and IndyMac's credit risk and anticipated increase in future credit losses are not yet reflected in their current stock prices and that their risk/reward profile support our sell rating," he wrote.