What is exposure at default (EAD)?

Exposure at default estimates the outstanding balance at the moment of default. For a fully drawn term loan, EAD is close to the current balance. For revolving lines and credit cards, it also includes the portion of the unused commitment the borrower is expected to draw before defaulting, since borrowers in distress tend to use available credit.

The expected additional draw is estimated with a credit conversion factor, sometimes called a loan equivalent factor, applied to the undrawn amount. EAD is one of the three inputs to expected loss and is used in reserve models, capital calculations and limit management. Under CECL, lenders must also estimate expected losses on unfunded commitments that are not unconditionally cancellable.

Using only the current drawn balance understates EAD for revolving products, especially for weaker borrowers. Conversion factors drawn from benign periods may be too low for a downturn. Line management actions, such as reducing limits for deteriorating accounts, can reduce EAD, so models should reflect how the institution actually manages lines.