Current Face refers to the remaining outstanding principal balance of a Mortgage-Backed Security (MBS) after a portion of the principal has been paid off. It is an important metric used by investors to determine the current value of a pool of mortgages within an MBS, which influences investment decisions and risk assessments.
Definition and Calculation
The Current Face value of an MBS can be expressed mathematically as:
Where:
- Original Face is the initial principal amount of the MBS.
- Principal Paid Off is the cumulative amount of the principal that has been repaid by borrowers.
Types of Mortgage-Backed Securities
Pass-Through MBS
In pass-through MBS, investors receive monthly payments that combine both interest and principal from homeowners. The Current Face value decreases over time as borrowers make their mortgage payments.
Collateralized Mortgage Obligations (CMOs)
In CMOs, cash flows are divided into different tranches with varying maturities and payment structures. The Current Face value for each tranche may differ, reflecting the principal repayments allocated to each.
Special Considerations
Prepayment Risk
The Current Face value can be affected by prepayment risk, where homeowners pay off their mortgages earlier than expected. This can alter the expected cash flows and the duration of the MBS.
Default Risk
If homeowners default on their mortgages, the projected Current Face value may not be fully realized, posing a risk to investors.
Market Conditions
Interest rate fluctuations and market conditions also impact the Current Face, as they influence the rate of prepayments and refinancings in the mortgage pool.
Examples
Example 1: A Simple Calculation
Suppose an MBS was originally issued with a principal balance of $200,000 (Original Face). Over time, $50,000 of that principal has been repaid. The calculation for the Current Face would be:
Example 2: Monthly Amortization
Consider an MBS that receives monthly principal payments. If the initial balance was $1,000,000 and $100,000 has been repaid over 12 months, the Current Face would be:
Historical Context
The concept of Current Face became prominent with the advent of MBS markets in the 1970s. It provided a standardized measure for investors to track the remaining unpaid principal and assess the value of their investments over time.
Applicability
Investment Decisions
Investors use the Current Face to evaluate the potential return and remaining principal in an MBS, guiding their investment choices.
Risk Assessment
Lenders and investors assess the risk of MBS portfolios by monitoring changes in the Current Face, which reflects borrowers’ repayment behavior and economic conditions.
Comparisons
Current Face vs. Original Face
- Current Face represents the remaining unpaid principal, whereas Original Face is the initial principal amount when the MBS was issued.
Current Face vs. Par Value
- Par Value refers to the face value of a bond or MBS at issuance, which differs from the Current Face that decreases over time as principal payments are made.
Related Terms
- Original Face: - The initial principal balance of an MBS when it is first issued.
- Prepayment Risk: - The risk that borrowers will repay their mortgage loans early, impacting the expected cash flows of an MBS.
- Tranche: - A portion or slice of a CMO that bears different risks and rewards, affecting its Current Face differently.
FAQs
Why is the Current Face value important to investors?
How does prepayment affect the Current Face?
Can the Current Face be higher than the Original Face?
References
- Ginnie Mae: Understanding Mortgage-Backed Securities. [Link]
- Securities and Exchange Commission (SEC): Mortgage-Backed Securities Overview. [Link]
- Federal Reserve Bank: Risk and Return in Mortgage-Backed Securities. [Link]
Summary
The Current Face of a Mortgage-Backed Security is a crucial financial term indicating the remaining principal balance after some principal has been paid off. It plays a vital role in investment decisions, risk assessment, and the overall valuation of mortgage-backed securities.
By understanding the Current Face and its implications, investors can better manage their portfolios and make informed financial decisions, considering various factors such as prepayment and default risks.
