Exposure at default (EAD)
Exposure at default (EAD) is the amount a borrower owes the lender at default, including undrawn credit that may be drawn before then. For an installment loan, it is close to the outstanding balance at default.
Example
A card has a 5,000 limit, with 2,000 drawn and 3,000 undrawn. For illustration, applying a 50% conversion factor gives 2,000 + (50% × 3,000) = 3,500 EAD.
Estimating EAD for loans and revolving credit
For an installment loan, the estimate is close to the outstanding balance at default. The balance at the point of default is the relevant amount.
For a revolving line, such as a credit card, apply the credit conversion factor to the undrawn limit, then add that result to the drawn balance. The factor estimates how much of the unused limit may be drawn before default.
EAD in expected loss, provisions and capital
Expected loss is calculated as PD × LGD × EAD. EAD also feeds the IFRS 9 provision and regulatory capital.
Borrowers heading for default often draw more of their line first. That is why the credit conversion factor is estimated from accounts that defaulted.
Questions we get asked
How does exposure at default differ from the outstanding balance?
EAD is the amount owed at default, including undrawn credit expected to be drawn before default. It is close to the outstanding balance for an installment loan. For a revolving line, the undrawn limit contributes to EAD through a credit conversion factor.
What does a credit conversion factor mean in EAD?
For a revolving line, the credit conversion factor is the estimated share of the undrawn limit that will be drawn by default. It is estimated from accounts that defaulted, then applied to the undrawn limit and added to the drawn balance.
Can exposure at default be higher than the credit limit?
Yes, EAD can exceed the credit limit. Interest, fees and charges can add to a fully drawn balance before default, and some lenders allow balances over the limit.
Decisimo’s expected loss calculator calculates expected loss from PD, LGD and EAD by segment and for the book, and shows how PD and LGD stress changes the result.
