What it means
Most ordinary bonds repay their full face value on one date at the end. Mortgage-backed and other asset-backed securities are different, because the loans behind them are repaid gradually every month, and those repayments are passed on to investors.
As principal is repaid, the amount still outstanding falls. Original face is the amount of principal when the security was issued, and current face is what remains today.
The ratio between them is known as the pool factor, which is published regularly and equals 1.0000 at issue and drops towards zero as the loans are repaid. Current face matters because interest is paid only on the principal still outstanding.
An investor who owns a security with an original face of $10,000,000 does not receive interest on that amount once part has been repaid, but on the smaller balance. This also means that the income from the security declines over time.
Prices of these securities are normally quoted per $100 of current face. A price of 98 therefore means 98% of the current balance, not of the original amount.
Anyone valuing a position must multiply the price by the current face to find the market value, and a common error is to use the original face instead. Prepayments add a layer of complexity.
Homeowners can repay their mortgages early, for example when they sell a house or refinance, and this speeds up the fall in current face. The speed of prepayment affects the investor's return and the life of the security, so analysts model it carefully.
For accounting and risk reporting, using the current face keeps figures realistic. Exposure, income forecasts and collateral values should all be based on the outstanding balance, and a report that shows original face can overstate how much the holder is owed.
In practice
Real-world examples.
Example
A pension fund holds mortgage-backed securities with an original face of $50,000,000. The monthly report shows a pool factor of 0.7000, so the current face is $35,000,000. The fund's analyst uses the current figure to forecast the interest it will receive next quarter. At a 5% coupon, that is about $437,500 for the quarter.
Example
A bank uses a mortgage-backed security as collateral for a short-term loan. The lender values the collateral at current face multiplied by the price, less a haircut of 3%. When the factor falls, the bank must post extra collateral to keep the same borrowing. Its treasury team therefore tracks the factor every month.
Example
A fund accountant is preparing the valuation of a portfolio on the last day of the quarter. She notices that a position has been recorded at original face. After correcting it to current face, the portfolio value falls by $1,400,000. She informs the fund's manager before the figures are released to investors.
Formula
Calculation
Current face = original face x pool factor. Market value = current face x (price / 100).
Suppose an investor holds a mortgage-backed security with an original face of $10,000,000. Borrowers have repaid part of the principal, and the latest pool factor is 0.8200. The current face is 10,000,000 x 0.8200 = $8,200,000. If the security is priced at 98 per $100 of current face, the market value is 8,200,000 x 0.98 = $8,036,000.Case study
Seen in the real world.
This fictional story is illustrative only. Bayfield Insurance is an invented insurer with a portfolio of asset-backed securities that it uses to match its long-term obligations.
The investment accountant builds a spreadsheet that lists each security with its original face, the monthly pool factor and the price. A newly hired analyst takes the figures from an older report that shows only the original amounts, and the total looks $6,000,000 higher than expected. The mistake is caught during the monthly review, when the chief investment officer asks for a reconciliation to the custodian's statement.
The team fixes the spreadsheet so that it pulls the factor automatically and calculates current face. It also adds a control check that compares the total with the custodian's balance each month. The change prevents a repeat and gives the auditors a clear trail from the statement to the financial statements. The chief investment officer also asks for the report to show the weighted average life of each security, which is the average time before principal is repaid. The extra column helps the team see which holdings are shrinking fastest and plan for the cash they will need to reinvest.
Watch out
Common mistakes.
- Valuing a position at original face. The market value depends on the current balance.
- Assuming income stays constant. Interest falls as the balance is repaid.
- Using an old factor. Factors are updated regularly, usually each month, so stale data produces errors in both value and income forecasts.
Questions
People also ask.
What is a pool factor?
It is the proportion of the original principal that is still outstanding, shown as a decimal such as 0.8200, and it is published regularly by the issuer or its agent.
Do all bonds have a current face?
Most bonds repay in one lump sum, so their current face equals their original face until maturity.
Why do prepayments matter?
They reduce current face faster than expected, which changes the income and average life of the security.
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