Mortgage lenders are facing a cyclical squeeze that in the past has meant trouble for their share prices. With interest rates bottoming and problem loans on the rise, investors should be wary of the floor getting yanked out from under them.

The number of residential mortgage holders who were 30 days or more delinquent on their loans rose to 4.87% in the third quarter, up 0.24% from the second quarter, the Mortgage Bankers Association said. "The weakening GDP and job losses in the technology and manufacturing sectors have affected homeowners' ability to keep their mortgage payments current," said Donald Duncan, the chief economist of MBA, in a written statement.

Some experts dispute the MBA's findings. "My husband and I got a delinquency letter

erroneously after Sept. 11," said Charlotte Chamberlain, an analyst at Jeffries. "When we called our mortgage company in New York City, they blamed the mail."

Nevertheless, the data are consistent with events in the savings and loan industry. In the third quarter, S&Ls saw a rise in the number ofnonperforming assets, or loans not collecting interest, putting weight on their stocks.

Red House

"Up until now, asset quality was the best it's been in years," said Paul Miller, an analyst at Friedman Billings Ramsey. "But, we're going tosee an uptick in nonperforming assets."

For

Washington Mutual

(WM) - Get Report

, the problem has been particularly acute. In the third quarter, nonperforming assets rose by $400 million, or 27%, led (as is usually the case) by residential mortgages. Problem debts now represent 0.91% of the company's total assets.

The credit quality issue has pressured shares of Washington Mutual in recent days. Even though the thrift reported record loan volume in the third quarter -- despite its bad loans -- the stock is down 16.3% since the release on Oct. 16. It's off 10.4% for the year.

Washington Mutual trades at a price-to-earnings multiple of 8.6 times 2001 earnings. That's down from 9.7 at the beginning of the year. Thrifts tend to bottom at 8 times earnings, with fair value being between 8 and 12, according to research analysts.

Among other thrifts,

Golden West Financial

( GDW) said its percentage of nonperforming assets has risen as well, in a monthly financial summary on Nov. 15. The lender noted that NPAs have climbed from 0.56% of total assets in July to 0.62% in October. Since then, Golden West's stock is up 2.7%. But it's down 24.4% for the year.

Castles in the Sand

The last time bad loans got so high was in the fourth quarter of 1991, the midst of the most recent recession. During that quarter, Golden West's stock price fell by 4%, followed by an 8.9% decline in the first quarter of 1992. The pattern for Washington Mutual was similar: a 16% decline in the fourth quarter of 1991, followed by a 3.3% drop in the first quarter of 1992.

When the stock market bubble burst this time around, thrift stocks became a safe place to park money. With a rapid decline in short-term interest rates, the savings and loan industry stood to benefit. Since July, when short-term interest rates were 3.75%, Golden West has seen a steady rise in its net interest spread, or the difference between the yield on earning assets and the cost of the funds, from 2.79% then to 3% at the end of October.

With the economy still contracting and the realization that interest rates can't fall much lower, however, times may be changing.

Driving South

Now the

Federal Reserve doesn't have much room to cut interest rates. At 2%, rates are at their lowest levels in four decades. "The drop in stock prices may well be signaling to us that the Fed isn't far from a change in sentiment," said James Bradshaw, an analyst at D.A. Davidson.

At the same time, a weakening economy raises concerns in the months ahead, since the rate of joblessness is closely tied to the pace of delinquencies. "Depending on how high unemployment gets," said Bradshaw, "I think you'll see more loan losses and foreclosures."