CRU Portfolio Management & Strategy 3 — Questions and Answers
Question 1: An underwriter is reviewing a portfolio strategy that targets jumbo non-conforming loans exclusively. Which is the primary portfolio-level concern with this approach?
- Reduced yield compared to conforming loan portfolios
- Inability to sell or securitize loans through GSE channels, limiting liquidity (Correct answer)
- Higher prepayment speeds compared to conforming loans
- Stricter appraisal requirements mandated by Fannie Mae
Correct answer: Inability to sell or securitize loans through GSE channels, limiting liquidity
Non-conforming jumbo loans cannot be sold to GSEs like Fannie Mae or Freddie Mac, so the lender must rely on private secondary market outlets or retain loans on balance sheet, reducing liquidity options.
Question 2: In the context of residential mortgage portfolio performance, what does 'loss severity' measure?
- The percentage of loans in a pool that default within a given period
- The proportion of outstanding principal lost after foreclosure and property liquidation (Correct answer)
- The speed at which delinquent loans cure to current status
- The total interest income foregone on non-performing loans
Correct answer: The proportion of outstanding principal lost after foreclosure and property liquidation
Loss severity is the percentage of the outstanding loan balance that is ultimately unrecovered after foreclosure costs, sales discounts, and expenses are deducted.
Question 3: A portfolio manager is evaluating the impact of a 200 basis point interest rate increase on the portfolio's market value. This analysis is best described as:
- Stress testing for credit risk
- Duration and convexity analysis for rate sensitivity (Correct answer)
- Liquidity coverage ratio calculation
- Vintage analysis for cohort performance
Correct answer: Duration and convexity analysis for rate sensitivity
Duration and convexity analysis measures how much the market value of a mortgage portfolio changes in response to interest rate shifts.
Question 4: Which portfolio strategy involves retaining high-balance loans on the balance sheet while selling conforming loans to the secondary market?
- Tranching strategy
- Retained portfolio strategy for jumbos (Correct answer)
- Reverse repurchase agreement
- Covered bond issuance
Correct answer: Retained portfolio strategy for jumbos
Many institutions retain jumbo non-conforming loans on their balance sheet because they cannot be sold to GSEs, while offloading conforming loans to manage capital and liquidity.
Question 5: When assessing portfolio credit quality trends over time, an underwriter uses 'vintage analysis.' What does this technique primarily examine?
- The geographic distribution of loans originated in different regions
- Delinquency and loss performance of loan cohorts grouped by origination year (Correct answer)
- The evolution of interest rate spreads across product types
- Loan-to-value changes resulting from property value appreciation
Correct answer: Delinquency and loss performance of loan cohorts grouped by origination year
Vintage analysis groups loans by the year they were originated and tracks how each cohort performs over time, revealing underwriting quality trends and economic cycle effects.
Question 6: A residential mortgage portfolio manager decides to implement a 'portfolio rebalancing' strategy. In this context, rebalancing most likely involves:
- Recalculating borrower credit scores quarterly
- Adjusting the mix of loan products, maturities, or credit grades to align with target risk parameters (Correct answer)
- Modifying loan servicing agreements to reduce delinquency rates
- Renegotiating PMI contracts to lower insurance premiums
Correct answer: Adjusting the mix of loan products, maturities, or credit grades to align with target risk parameters
Portfolio rebalancing realigns the composition of loan types, credit quality tiers, or duration profiles to maintain the risk-return profile established in the portfolio strategy.
Question 7: Under Basel III capital framework, which type of residential mortgage loan generally receives the most favorable risk weight for capital purposes?
- Subprime loans with DTI above 50%
- Well-collateralized owner-occupied loans with low LTV and full documentation (Correct answer)
- Interest-only loans on investment properties
- Second-lien loans behind existing first mortgages
Correct answer: Well-collateralized owner-occupied loans with low LTV and full documentation
Basel III assigns lower risk weights to prudently underwritten, owner-occupied, first-lien mortgage loans with conservative LTVs, reflecting their historically low default rates.
CRU Portfolio Management & Strategy 3
An underwriter is reviewing a portfolio strategy that targets jumbo non-conforming loans exclusively.
Which is the primary portfolio-level concern with this approach?