Stress Testing Private Credit: How Conservative Underwriting Protects Capital

Private credit is no longer a niche—it’s a mainstream income strategy for accredited investors, family offices, and institutions. But behind every yield promise is a critical question: What happens when the economy slows or borrowers face pressure?

The answer lies in risk management—and specifically, in conservative underwriting. Unlike public bonds that rely on market liquidity, private loans depend on careful borrower selection, collateral quality, and stress-tested deal structures.

As the Federal Reserve noted in 2024, while private credit offers higher yield opportunities, “risk management, credit discipline, and recovery processes are paramount to protect investors in less liquid lending markets.”

What “Conservative Underwriting” Really Means

In private debt, underwriting is the process of evaluating the borrower, collateral, cash flow, and exit strategy before a loan is funded. Conservative underwriting isn’t about pessimism—it’s about building buffers that ensure capital survives when things go wrong.

At LBC Capital Income Fund, LLC, that translates to four fundamentals:

1. First-Lien Security.
   Every loan is secured by a real, verifiable U.S. asset—often real estate. This first-position claim ensures investors stand first in line for repayment.
2. Low Loan-to-Value Ratios (LTV).
   Typical LTVs range between 55–65 %. This margin of safety protects investor capital even if collateral values decline.
3. Cash-Flow Coverage and Exit Plan.
   Borrowers must demonstrate proven income or a credible liquidity event. Each project includes multiple exit strategies—sale, refinance, or liquidation.
4. Independent Valuation and Legal Control.
   Third-party appraisals and U.S. escrow structures provide transparency and enforceability under state and federal law.

This disciplined structure mirrors the practices highlighted by the CAIA Association: “Strong underwriting—particularly first-lien, asset-backed exposure—is the main determinant of capital preservation in private credit.”

How Stress Testing Works

Stress testing simulates adverse economic or market conditions to measure how loans and portfolios would perform. In LBC Capital Income Fund, LLC’s process, each loan scenario is evaluated under at least three conditions:

• Interest Rate Shock: What if benchmark rates rise by 100–200 basis points?
• Collateral Decline: What if property values fall 20 %?
• Borrower Delay: What if payments are delayed for 60 days?

Each scenario must demonstrate a satisfactory recovery ratio before approval. This approach mirrors best practices described by Future Standard and Heart & Crown, where effective private credit managers “stress test underwriting assumptions to account for valuation shocks and refinancing risk.”

The Role of Ongoing Monitoring

Underwriting is not a one-time event. LBC Capital Income Fund, LLC’s portfolio team performs continuous monitoring through borrower updates, site inspections, and financial reviews. Any deviation—late payment, covenant breach, declining metrics—triggers a review and, if needed, early intervention.

This “active surveillance” approach aligns with the Federal Reserve’s recommendation that lenders “maintain real-time data and early warning systems for emerging borrower stress.”

Why Conservative Underwriting Matters More in 2025

Higher Base Rates

With benchmark rates still near 5 %, refinancing risk is elevated. Conservative structures ensure borrowers can withstand cost pressure.

Slower Growth

As the Fed projects modest GDP expansion and tighter liquidity, borrower selection and covenant strength are key defenses.

More Competition

New entrants are chasing yield, sometimes at the expense of quality. LBC Capital Income Fund, LLC intentionally limits leverage, focusing on select U.S. markets with transparent asset values and consistent demand.

The CAIA Association summarizes it well: “Yield compression can tempt lenders to loosen standards, but disciplined underwriting remains the most reliable safeguard.”

Case Study: Testing the Downturn

In 2023, an LBC Capital Income Fund, LLC borrower—a California-based developer—faced delays due to permit backlogs. Because the loan was first-lien at 58 % LTV with verified pre-sales, the fund restructured repayment while maintaining full collateral coverage. Within 10 months, the project sold, principal and interest were repaid in full, and investors experienced zero loss.

The takeaway: even when markets shift, conservative underwriting protects capital before problems appear.

What Investors Should Look for in a Private Credit Manager

1. Documented underwriting policies—LTV caps, minimum DSCR, independent valuations.
2. Track record of defaults and recoveries, not just headline yields.
3. Active risk monitoring—regular reports, covenant tracking, and borrower engagement.
4. Alignment of interest—manager co-investment in every loan.
5. Transparent communication—quarterly updates with stress-test results and portfolio metrics.

LBC Capital Income Fund, LLC’s investor communications include precisely these metrics, providing a transparent view of risk and performance in U.S.-based private credit portfolios.

Final Thoughts

Private credit offers higher yields—but yield means little without protection. Conservative underwriting, ongoing stress testing, and active management form the backbone of true private credit risk management.

In the U.S., where economic cycles are turning and liquidity is tightening, these practices separate sustainable funds from speculative ones. For accredited investors, managers like LBC Capital Income Fund, LLC demonstrate that disciplined underwriting is not about being cautious—it’s about being prepared. Book your call with us.