Glossary term
Exposure at Default (EAD)
Exposure at default estimates how much a lender or investor would be exposed to if a borrower defaults.
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What Is Exposure at Default (EAD)?
Exposure at default, or EAD, is the amount a lender, bank, or investor expects to be exposed to if a borrower defaults. It is one of the main inputs in credit-risk modeling, alongside probability of default and loss given default.
EAD matters because the balance outstanding at default may not equal today's balance. Borrowers may repay some debt, draw more on a credit line, accrue interest, or use unused commitments before default occurs.
Key Takeaways
- EAD estimates the exposure amount if default occurs.
- It is a core input in expected loss and credit capital models.
- For term loans, EAD may be close to the outstanding balance.
- For revolving credit, EAD may include expected future draws.
- Model assumptions, credit conversion factors, and borrower behavior can change EAD.
How Exposure at Default Works
For a simple fully drawn loan, EAD may start with the current outstanding principal plus accrued interest or fees. For a credit card, line of credit, or revolving facility, the lender may estimate how much of the undrawn commitment the borrower could use before default.
Credit models often apply a credit conversion factor to unused commitments. That factor estimates the share of the unused line likely to become outstanding by the time default occurs.
Current exposure is the amount already outstanding. Undrawn commitment is the remaining available credit. The credit conversion factor is the estimated portion of that undrawn amount expected to be drawn before default.
EAD by Credit Type
Credit type | EAD issue | Why it matters |
|---|---|---|
Term loan | Outstanding balance may amortize | Exposure can decline over time |
Credit card | Borrower may draw more before default | Exposure can rise quickly |
Revolving credit facility | Unused commitment may convert to balance | Commitment risk matters |
Derivative | Market value can change | Exposure depends on future prices |
Limits and Misunderstandings
EAD is not the same as loss. Loss depends on both exposure and recoveries. A high EAD loan with strong collateral may produce a lower loss than a smaller unsecured loan with poor recovery prospects.
EAD also is not always observable in advance. It is an estimate based on borrower behavior, contract terms, utilization patterns, collateral, market conditions, and stress assumptions.
For portfolio managers, EAD helps identify concentration risk. A bank may have modest current balances but large unused commitments that could become exposure during a downturn.
The Bottom Line
Exposure at default estimates the amount at risk when default occurs. It is essential for expected-loss modeling because credit risk depends not only on whether default happens, but also on how much exposure exists at that moment.