What Loss Given Default measures
Loss Given Default (LGD) is the share of a credit exposure a lender expects to lose if a borrower defaults, after accounting for whatever gets recovered — through collateral sale, litigation, or a workout process — net of the costs of collecting it. LGD is one of the three core inputs of expected credit loss, alongside Probability of Default (PD) and Exposure at Default (EAD). This calculator computes LGD and the loss-severity dollar amount (EAD × LGD) using the standard economic (workout) LGD method.
The formula
LGD is defined as one minus the recovery rate:
LGD = 1 − RR, where RR = Discounted Net Recovery ÷ EAD
Net recovery is the expected gross recovery amount minus collection or workout costs. Because recoveries typically arrive after the default date — sometimes years later — the standard economic LGD approach discounts that net recovery back to the default date at an appropriate discount rate before comparing it to the exposure:
Discounted Net Recovery = (Gross Recovery − Collection Costs) ÷ (1 + discount rate)time
The recovery rate is bounded between 0% and 100% of exposure, so LGD is also reported between 0% and 100%. If costs exceed recovery, or the discounted recovery is negative, LGD is capped at 100% (a full loss of exposure).
Worked example
A lender has a $250,000 exposure at default. Liquidating the collateral is expected to bring in $150,000, but collection and legal costs will run $12,000, and the process is expected to take 1.5 years. Discounting the $138,000 net recovery ($150,000 − $12,000) back 1.5 years at a 6% discount rate gives about $126,450. Dividing by the $250,000 exposure gives a recovery rate of about 50.6%, so LGD ≈ 49.4% — meaning the lender expects to lose about $123,550 of the exposure if the default occurs.
What moves LGD most
- Recovery value: higher expected collateral or asset recovery directly lowers LGD, since it raises the recovery rate.
- Collection costs: legal fees, servicing costs, and liquidation expenses reduce net recovery and push LGD up — unsecured or contested claims tend to have higher costs relative to recovery.
- Time to recovery: a longer workout period means more discounting, which shrinks the present value of the recovery and raises LGD, even if the nominal recovery amount is unchanged.
- Discount rate: a higher discount rate penalizes slow recoveries more heavily, since it compounds over the recovery period.
How LGD fits into expected loss
LGD by itself measures loss severity conditional on default. To estimate the full expected loss on an exposure, it is combined with the probability that a default happens at all: Expected Loss = PD × EAD × LGD. This calculator's "Loss severity" result is the EAD × LGD portion of that formula — multiply it by your own PD estimate (from a rating model, historical default rates, or credit scoring) to get the expected loss in dollars. This tool performs computation only; it is not personalized credit or investment advice.