Exposure at default (EAD) is the amount outstanding at the time customer defaults. In other words, EAD is the amount a Bank or a lander might loose in case borrower fails to make payment.
Bank use statistical model to estimate the expected losses. Banks often calculate an EAD value for each loan and then use these figures to determine their overall default risk. EAD is a dynamic number, which changes as a borrower repays the lender.
Let us look into an example: Suppose, you’ve taken a loan worth $100,000 and paid back $40,000. Now if you default then bank’s exposure will be $60,000 ($100,000 – $40,000).
Computation of EAD varies with the type of product(loan/line of credit) i.e whether the product is fixed(like term loan) or revolving(like credit card).
For fixed loans, EAD is simply the current outstanding amount while for revolving products, EAD is divided into drawn and undrawn amount. Banks knows about the drawn amount but how much the borrower will draw from undrawn amount is estimated using “credit conversion factor”/ “loan equivalent”.