What Is Original Face?
Original face is the par value of a mortgage-backed security (MBS) at the time it is issued. In other words, it tells us the total principal amount originally owed on loans made to buy homes or how much the MBS, the vehicle invested in these mortgages, is initially worth.
Original face is also referred to as original face value.
- Original face is the total outstanding balance of a mortgage-backed security (MBS) at the time it is issued.
- Over time, this balance will reduce as more payments come in, pulling the actual value of the MBS lower than the original face value.
- MBSs with the same issue date, coupon, and original face value can have greatly different current faces because they pay down at different rates.
Understanding Original Face
Mortgage-backed securities (MBSs) are home loans that are sold by their issuing banks to a government-sponsored enterprise (GSE) or financial company and then bundled together into a single investable security. Unlike most other types of bonds, MBSs return both principal and interest to the holder in periodic payments, usually on a monthly basis.
When an MBS is initially structured, the par value given to the pool is called the original face—the total outstanding balance at the time of its inception. Over time, this balance will reduce as more payments come in from borrowers, pulling the actual value of the MBS lower than the original face value.
MBSs are often tailored for specific needs. For instance, if an institutional investor made a request for a particular face value in addition to other characteristics, the issuer would do its best to match it.
Because mortgages don't always come in easily rounded numbers, especially when investors are looking for a particular borrower profile, the targeted original face and the actual original face will likely be a bit different. This is referred to as variance. Usually, the variance is fairly minimal, such as a $1 million MBS coming in with a $1,010,000 original face.
Original Face vs. Current Face
Once payments commence, the shrinking total outstanding balance owed on the MBS is referred to as current face. The pool factor, a measure of how much of the original loan principal remains, can be calculated by taking the current face and dividing it by the original face.
By definition, a newly issued MBS will have a pool factor of one at inception; in other words, the original face will equal the current face. As the principal is paid down, the change in the pool factor becomes a measure of prepayment rates.
MBSs start life with a pool factor of one and then move toward zero over time as payments are made on the underlying mortgages.
When interest rates are low and it becomes cheaper to borrow, homeowners are incentivized to refinance their mortgages, resulting in higher levels of prepayment of the original loans that the MBS are invested in. This increase will show in the pool factor as the outstanding principal balance (current face) shrinks faster than in previous months, and the pool factor drops further than its normal monthly average.
MBS investors generally do not want to see the pool factor dropping faster than planned because it results in a lower overall return for them. When principal is returned early, future interest payments will not be paid on that part of the principal. Quicker repayments also result in investors suddenly finding themselves saddled with capital to reinvest in a low-interest environment where yields are hard to come by.
Benefits of Original Face
The original face gives investors the option to choose how much money they potentially want to earn from an investment. Later on down the line, the figure continues to be consulted as a key reference point, enabling investors to establish how an MBS is doing now compared to when it first started out—and determine its return on investment (ROI).
The original face is used by traders and investors in valuations and models over the life of the MBS. Identifying the par value of an MBS at its time of creation and then comparing this to the current face should give them an idea of how reliable valuation assumptions were.
Looking at both can reveal, for example, whether the assumed prepayment rate was accurate and if the valuation is higher or lower than it should be in light of the actual prepayment risk to date.