The credit ratings agency, Moody’s Investors Service, just released a report citing deterioration in overall loan quality in the mortgage lending market.

And, the analysts there think the problem might get worse, before it gets better.

“Further weakening would heighten the risk of performance deterioration, a credit negative for certain financial institutions and residential mortgage-backed securities,” the report, led by senior analyst Jody Shenn, states.

Bear in mind that in its role as a CRA, Moody’s job is to call things risky and give it a measure. Mortgage bonds are no different, though the approach of this research is in that it mentions “the five C’s of credit” that are relaxing:

1. Character is relatively strong. Components of credit quality related to character, such as credit scores, are the strongest feature of originations currently, and have weakened little over the past few years.
2. Capacity is strong, but weakening quickly in some ways. Elements of origination quality related to the capacity of borrowers to afford payments on their loans, such as income verification and the use of loan products with variable payments, are strong but loans with high debt-to-income ratios (DTIs) have been increasing.
3. Collateral offers modest support for credit quality. Support for origination quality from practices related to collateral, such as loan-to-value (LTV) ratios and appraisal quality, is at moderate levels.
4. Capital is at moderate levels. Factors related to capital, such as borrower reserves, appear to be at generally moderate levels, based on our review of guidelines and policies, and discussions with originators.
5. Conditions have become riskier. Origination quality is not receiving much support from the conditions surrounding the granting of loans. In particular, the risk of a weaker macro environment during the initial years after loan origination is building.

For the most part, new mortgages are solid, especially considering the high credit scores; improved documentation and appraisal practices; and few loans with variable payments — regulatory restrictions on loan officer compensation arrangements would also help prevent riskier lending, Moody’s claims.

The problem is deeper than this, as “sources of potential vulnerability include lenders’ comfort with high debt-to-income and loan-to-value ratios, and elevated levels of first-time homebuyers.”

“In addition, the broad conditions under which loans are being granted have grown less favorable for future mortgage performance. For instance, home prices are no longer very affordable and rising interest rates are reducing refinancing incentives and prepayments,” the report states.

“Similarly, although the U.S. economy is broadly strong and strengthening, mortgages being originated today appear more likely to face a stressed environment within only a few years, differing from loans originated earlier during this long period of economic growth,” the analysts conclude.