What is loss given default (LGD)?

Loss given default measures the severity of loss once a borrower defaults. It is expressed as a percentage of exposure at default and reflects collateral proceeds, guarantor payments and other recoveries, reduced by the costs of collection and the time it takes to recover. LGD equals one minus the recovery rate when both are measured on the same basis.

LGD depends mainly on collateral type and coverage, seniority, guarantees and the legal environment. Secured real estate loans usually have lower LGD than unsecured lines. Lenders use LGD in expected loss, CECL models, pricing and capital calculations, and some institutions assign a separate facility rating that reflects LGD alongside the borrower's PD rating.

LGD data are sparse and recoveries can take years to finish, so estimates often rely on limited history. Ignoring workout costs and the time value of money understates LGD. Recoveries also tend to fall when defaults rise, because collateral values decline at the same time, so many frameworks use a downturn LGD for stress testing and capital purposes.