Loss given default (LGD)
Loss given default (LGD) is the share of a lender’s exposure it loses when a borrower defaults, after collateral and other recoveries. It is one minus the recovery rate: if 40% of the defaulted exposure is recovered, LGD is 60%. Workout LGD discounts recoveries back to the default date.
Example
For illustration, suppose a lender has an exposure of $10,000 at default and recovers $4,000 after collateral and other recoveries. The recovery rate is 40%, so LGD is 60%, or $6,000 of the original exposure.
How exposure, collateral and recovery timing shape LGD
Start with exposure at default, then estimate what can be recovered. For collateral, use its forced-sale value: market value less a haircut and the costs of selling it.
Include other recoveries and when they arrive. Workout LGD discounts later recoveries back to the default date, since money received two years later is worth less.
Why LGD varies across products and enters expected loss
LGD varies with what can be recovered. Unsecured consumer loans often have much higher LGD than mortgages because nothing secures them.
Downturn LGD refers to an LGD estimate for downturn conditions. Expected loss is PD multiplied by LGD and exposure at default.
Questions we get asked
What is the difference between LGD and expected loss?
LGD is the share of exposure lost after default, after collateral and recoveries. Expected loss combines PD, LGD and exposure at default: expected loss = PD × LGD × exposure at default.
Why does workout LGD account for when recoveries arrive?
A recovery received later is worth less than the same amount received at the default date. Workout LGD discounts recoveries back to that date, so timing affects the estimate.
How does LGD translate into a loss amount?
Apply LGD to the exposure at default to express the loss in money. For example, a 60% LGD on an exposure of $10,000 corresponds to $6,000.
The LGD calculator calculates workout LGD from collateral, its forced-sale haircut, sale costs, recovery timing and a discount rate.
