What Is Original Face?
Let me explain what original face means in the context of mortgage-backed securities. Original face is the par value of a mortgage-backed security (MBS) right when it's issued. You see, an MBS is basically an investment that bundles together a bunch of home mortgage loans from different banks, and investors like you earn income from the payments on those loans.
The original face is the total principal amount that was originally owed on all those mortgage loans, which tells you how much the MBS is worth at the start. Sometimes it's called the original face value.
This original face value is useful because it gives you, the investor, a clear picture of the initial total of all the loans in the MBS. But remember, it doesn't tell you what the MBS will be worth down the line.
Key Takeaways
- Original face is the total outstanding balance of a mortgage-backed security (MBS) at the time it is issued.
- Over time, the outstanding balance declines as the underlying loans are repaid, resulting in a lower current value versus the original face value.
- Mortgage-backed securities with the same issue date and original face can have different current values due to the varying pace of loan repayments.
Understanding Original Face
Mortgage-backed securities (MBSs) are home loans sold by issuing banks to a government-sponsored enterprise (GSE) or financial company, then bundled into a single security you can invest in. Unlike most bonds, MBSs pay back both principal and interest in periodic payments, usually monthly.
When an MBS is first put together, the par value assigned to the pool is the original face—the total outstanding balance at the beginning. As time goes on, this balance drops because borrowers pay down their loans, so the actual value of the MBS ends up lower than the original face.
You can have an MBS tailored to specific needs. For example, if an institutional investor wants a certain face value along with other features, the issuer tries to match it.
Mortgages don't always add up to neat round numbers, especially with specific borrower profiles in mind, so the targeted original face and the actual one might differ slightly. We call this variance, and it's usually small, like a $1 million MBS ending up with a $1,010,000 original face.
Original Face vs. Current Face
Once borrowers start making payments, the total outstanding balance on the MBS goes down, and that's what we call the current face value.
The original face stays fixed because it's the initial value of the total loans in the MBS, but the current face changes over time. It's influenced by borrowers making payments or paying off loans early.
Original Face and Pool Factor
The pool factor measures how much of the original loan principal is left, calculated by dividing the current face by the original face. A new MBS starts with a pool factor of one, meaning original face equals current face. If half the mortgages are paid down, the pool factor drops to 0.50.
You, as an investor, should watch the current face and the forecasted pool factor to gauge the predictability of income from the MBS. Early payoffs, or prepayments, can speed up the pool factor decline and reduce the current face. Late payments from borrowers also affect it.
Mortgage Refinancing
When interest rates drop and borrowing gets cheaper, homeowners often refinance their mortgages, leading to more prepayments on the original loans in the MBS. This shows up in the pool factor as the current face shrinks faster than usual, dropping the pool factor more than the normal monthly average.
Interest Rate Risk
As an MBS investor, you generally don't want the pool factor dropping faster than expected because it means lower overall returns. When principal is paid off early, you lose out on future interest payments on that amount.
Faster repayments from refinancing also mean you suddenly have cash to reinvest. In a falling interest-rate environment, you're stuck putting that money into lower-yielding investments that return less than your original MBS.
Benefits of Original Face
The original face lets you choose how much potential earnings you want from an investment. Later, it serves as a key reference to compare how the MBS is performing now against its start, helping you figure out the return on investment (ROI).
Traders and investors use the original face in modeling and valuing an MBS over its life. By comparing the original face at inception to the current face, you can see if initial valuation assumptions were reliable.
Examining both values can show if the assumed prepayment rate was accurate and whether the current valuation is higher or lower than expected based on actual prepayment risk so far.
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