Morgan Stanley Direct Lending Fund — Form 10-K Summary
Reporting period: Fiscal year ended December 31, 2020. The comparable 2019 period covers May 30, 2019 inception through December 31, 2019, before investment operations began. The filing was dated March 19, 2021.
Business Context
The Company is an externally managed business development company and regulated investment company focused primarily on directly originated senior secured loans to U.S. middle-market companies, generally businesses with $15 million to $100 million of EBITDA and financial sponsor backing. Morgan Stanley affiliates provide investment advisory and administrative services. The Company commenced investment operations on January 31, 2020 and had no investments at December 31, 2019.
As of December 31, 2020, the Company had investments in 36 portfolio companies across 19 industries. The portfolio was 100% U.S.-based and consisted primarily of floating-rate debt.
Financial Performance and Key Metrics
| Metric | 2020 | 2019 comparable period |
|---|---|---|
| Total investment income | $21.9 million | $0 |
| Net expenses | $11.3 million | $1.2 million |
| Net investment income | $10.6 million | $(1.2) million |
| Net realized gain | $2.2 million | $0 |
| Net unrealized appreciation | $5.5 million | $0 |
| Net increase in net assets from operations | $18.3 million | $(1.2) million |
| Net investment income per share | $1.41 | $(660.54) |
| Earnings per share | $2.42 | Not meaningful for the stub period |
| Net asset value per share | $20.08 | $(640.54) |
- Interest income was $20.3 million and other income was $1.6 million.
- Net expenses included $3.7 million of interest expense, $2.2 million of gross management fees, $2.5 million of income-based incentive fees and $1.3 million of capital-gains incentive fees. Adviser waivers reduced expenses by $1.9 million, including $1.7 million of waived management fees.
- Total return based on net asset value was 7.07%. Net investment income represented 6.62% of average net assets; net expenses represented 7.02% after waivers and 8.20% before waivers.
- Portfolio fair value was $637.0 million, compared with no investments at December 31, 2019. Amortized cost was $631.5 million, producing approximately $5.5 million of net unrealized appreciation.
- First-lien debt represented 91.2% of investments at fair value, second-lien debt 8.3%, and other securities 0.5%.
- The weighted-average yield on debt and income-producing investments was 7.5% at cost and 7.4% at fair value. Approximately 99.8% of debt investments bore floating rates, and approximately 95.2% had LIBOR floors.
- All first- and second-lien debt investments were reported as performing and current on interest payments at year-end. The Adviser rated 4.9% of the portfolio in risk rating 1 and 95.1% in risk rating 2; no investments were reported in ratings 3 or 4.
- Cash was $11.3 million and total assets were $656.8 million. Total net assets were $301.6 million.
Capital, Liquidity and Debt
- Total investor capital commitments were $1.446 billion, of which $297.4 million had been called and approximately $1.148 billion remained uncalled.
- The Company had $333.9 million outstanding under its CIBC Subscription Facility, with $66.2 million of available capacity. The facility matures December 31, 2022 and is secured by certain unfunded investor commitments.
- The BNP Funding Facility provided $300.0 million of committed capacity, none of which was drawn at year-end. It had a reinvestment period through October 2023 and final maturity in October 2025, subject to potential extensions.
- Total asset coverage was 190.35%, above the applicable 150% BDC requirement. The Company reported compliance with facility covenants and 1940 Act leverage requirements.
- Unfunded delayed-draw and revolving investment commitments totaled $206.5 million.
- Operating cash flow was negative $613.4 million, primarily reflecting $714.7 million of investment purchases, partly offset by investment repayments and sales. Financing activities generated $624.6 million, including $297.3 million of equity issuance and $333.9 million of net facility borrowings. Ending cash was $11.3 million.
Distributions and Fees
The Company declared 2020 distributions totaling $1.30 per share, or $13.9 million, including a $0.18-per-share special distribution. The distributions were derived from ordinary income for tax purposes. The Company maintains an opt-in dividend reinvestment plan.
The base management fee is contractually 1.0% of average gross assets, excluding cash and cash equivalents, but the Adviser waived the portion above 0.25% before an exchange listing. The income-based incentive fee includes a 6.0% annualized hurdle and a 17.5% rate after the catch-up. The capital-gains incentive fee is 17.5% of cumulative realized gains, net of realized losses and unrealized depreciation, subject to prior fees paid.
Material Changes and Outlook
- The Company transitioned from a pre-investment start-up in 2019 to a substantially invested portfolio in 2020, funding $714.7 million of new investments and committing approximately $948.7 million before sales and repayments.
- Management characterized the post-COVID-19 market dislocation as potentially favorable for private lenders, citing opportunities for higher yields, lower leverage and stronger covenants, while emphasizing selectivity and capital preservation.
- From January 1 through March 19, 2021, the Company closed or received investment committee approval for approximately $538.0 million of new or add-on investments, primarily first-lien loans. It also raised approximately $80.0 million through January and March 2021 capital calls and increased total commitments to approximately $1.496 billion.
- On March 2, 2021, the BNP facility was amended to increase borrowing capacity from $300 million to $600 million and reduce certain borrowing margins, subject to revised terms and borrowing-base requirements.
- The Board declared a $0.45-per-share distribution payable April 22, 2021.
Principal Risks, Contingencies and Unusual Items
- COVID-19, economic recession, borrower defaults, supply-chain disruption and market volatility could reduce portfolio-company cash flows, collateral values, investment income and NAV.
- Nearly all debt investments and the credit facilities use floating rates linked primarily to LIBOR. Lower rates may reduce income, while higher rates may increase portfolio-company defaults and borrowing costs. LIBOR replacement creates documentation, valuation, operational and tax risks.
- Most investments are privately held and valued using Level 3 inputs, including management judgment and unobservable discount rates. Fair values may differ materially from realized proceeds.
- Leverage magnifies gains and losses and may restrict distributions if asset coverage falls below required levels. The CIBC facility matures in 2022 and must be refinanced or repaid.
- The Company has no employees and depends on the Adviser, Administrator, Morgan Stanley personnel, sponsor relationships and affiliated investment-allocation procedures. Conflicts of interest may arise, including with SLIC and other affiliated accounts.
- Shares were privately offered, restricted and had no established public market as of March 19, 2021. Liquidity depends on a future exchange listing, sale transaction, repurchase program or orderly liquidation.
- The Company must maintain BDC and RIC qualifications and distribute required taxable income. Non-cash PIK or original issue discount income may create distribution and liquidity pressure.
- The Adviser accrued $1.3 million of capital-gains incentive fees and $2.5 million of income-based incentive fees in 2020. Capital-gains incentive fees are based on cumulative gains and can be affected by valuation changes.
- No material legal proceedings were pending or threatened, and management concluded that internal control over financial reporting was effective. The independent auditor did not provide an internal-control attestation because of applicable emerging-growth-company and non-accelerated-filer exemptions.
Investor Verification Items
- Reconcile the $637.0 million portfolio fair value, Level 3 valuation assumptions and the $5.5 million unrealized appreciation to the detailed schedule of investments.
- Assess concentration and credit quality, including the largest issuer and industry exposures, the 95.1% risk-rating-2 concentration, and the absence of ratings 3 or 4 at year-end.
- Verify liquidity after considering $333.9 million of CIBC borrowings, the $206.5 million of unfunded portfolio commitments, facility covenants and the 2022 CIBC maturity.
- Evaluate the sustainability of investment income and distributions after management-fee waivers expire or change and after accounting for incentive fees and interest-rate movements.
- Review the effect of COVID-19, LIBOR transition, borrower defaults, PIK income and valuation changes on future NAV and taxable distributions.
- Track post-year-end investment approvals, capital calls, the BNP capacity increase and the $0.45-per-share 2021 distribution.
- Consider the absence of a public market, transfer restrictions, potential liquidity-event timing and the Company’s stated framework for winding down if no liquidity event occurs by the applicable anniversary.