Morgan Stanley Direct Lending Fund — Q3 2023 Form 10-Q
Business context and reporting period. The Fund is an externally managed, non-diversified business development company focused on middle-market lending. This filing covers the quarter and nine months ended September 30, 2023. The interim financial statements were reviewed by Deloitte, not audited. The Fund’s common stock had no established public market as of November 2, 2023.
Financial and portfolio highlights
- Q3 results: Investment income was $94.5 million, up 51% from $62.7 million. Net investment income was $50.6 million ($0.70 per share), versus $33.8 million ($0.53 per share). Net realized and unrealized gains were $22.8 million, compared with a $24.4 million loss; net increase in net assets from operations was $73.4 million, or $1.02 per share, versus $9.4 million, or $0.15 per share.
- Nine-month results: Investment income was $267.0 million, compared with $157.0 million; net investment income was $142.6 million ($2.00 per share), compared with $89.7 million ($1.49 per share). Net realized and unrealized gains were $31.0 million, versus losses of $61.3 million. Net increase in net assets from operations was $173.6 million ($2.43 per share), versus $28.4 million ($0.47 per share).
- Expenses and income conversion: Q3 net expenses were $43.9 million, including $29.7 million of interest and financing expense and $10.7 million of income-based incentive fees. Nine-month net expenses were $124.4 million, including $84.3 million of financing expense and $30.2 million of income-based incentive fees. Net investment income was about 54% of investment income in both comparable nine-month periods.
- Assets and NAV: At September 30, total assets were $3.277 billion, total liabilities $1.795 billion, and net assets $1.481 billion. NAV was $20.57 per share, up from $19.81 at December 31, 2022. Nine-month total return based on NAV was 12.56%, versus 2.43% in 2022.
- Investments: Portfolio fair value was $3.123 billion, up from $2.874 billion at year-end. First-lien debt represented 93.9% of portfolio fair value and second-lien debt 4.3%. The Fund held investments in 165 companies across 29 industries; 99.9% of debt investments by fair value were floating-rate. Weighted-average debt yield at amortized cost was 12.0%, versus 10.9% at year-end.
- Credit and valuation: Two investments with $8.8 million amortized cost were on non-accrual, versus one investment at $1.5 million at year-end. Adviser risk ratings placed 1.6% of portfolio fair value in Category 3 and none in Category 4. Most investments are Level 3 fair-value measurements using significant unobservable inputs.
- Cash flow and distributions: Nine-month operating cash flow was negative $106.8 million, reflecting investment purchases and other operating movements; financing cash flow was positive $113.6 million. Cash rose to $88.1 million. Distributions declared were $1.67 per share ($119.3 million), including supplemental amounts, versus $1.42 per share ($86.7 million) in 2022.
Debt, liquidity, and material changes
- Debt carrying value increased to $1.718 billion from $1.523 billion at year-end. Outstanding principal was $1.725 billion. Available capacity was $255.0 million under the BNP facility and $438.5 million under the Truist facility, subject to borrowing-base restrictions; reported cash was $88.1 million.
- The combined weighted-average borrowing rate was 6.64% for Q3 and 6.45% for the nine months, compared with 4.37% and 3.47%, respectively, in 2022. Management attributed higher financing costs to higher average borrowings, increased reference rates, and higher-cost unsecured debt.
- Management said available cash and facility capacity were expected to support near-term operations and that it believed resources were adequate for $287.2 million of unfunded portfolio commitments. The Fund reported compliance with debt covenants at September 30.
- A September capital drawdown notice for approximately $220.5 million closed October 4, 2023. After the drawdown, the Fund reported no remaining undrawn investor capital commitments. The balance sheet at September 30 included $213.2 million of subscribed but unissued shares and an equal subscription receivable.
- From October 1 through November 2, the Fund closed approximately $118.2 million of new or add-on investments, all first-lien senior secured loans. The filing provides no formal earnings or investment guidance.
Management commentary, risks, and unusual items
- Management attributed higher investment income to capital deployment and rising SOFR on floating-rate assets. It described the market as offering potential risk-adjusted opportunities, while saying investment pace depends on market conditions, deal flow, and inflation’s impact on valuations and portfolio companies.
- Interest-rate movements affect both asset income and borrowing costs. The filing’s hypothetical annualized sensitivity estimates a $21.2 million increase in net income from a 100-basis-point rate rise and a $21.2 million decrease from a 100-basis-point fall, assuming the September portfolio and borrowing structure remain unchanged. The Fund reported no interest-rate hedging during the periods presented.
- Risks include borrower credit deterioration, inflation and supply-chain pressures, market volatility, illiquidity and estimation uncertainty in fair values, leverage and financing availability, conflicts involving the external adviser and affiliates, and geopolitical events including the Israel-Hamas and Russia-Ukraine conflicts. The filing also notes that Morgan Stanley has no obligation to support the Fund beyond its $200 million capital commitment, which was fully funded October 4.
- Non-cash PIK interest is included in investment income and can contribute to distributions despite not having been collected in cash. The Fund’s quarterly fair values are substantially based on Level 3 inputs; actual proceeds in a forced sale could differ materially from reported values.
- The filing reported no material legal proceedings, no defaults on senior securities, and effective disclosure controls. Management stated no material subsequent events requiring recognition or disclosure.
Important facts for investors to verify
- Whether non-accrual exposures and the 1.6% Category 3 portfolio share increase, and how borrower performance affects valuations and cash interest collections.
- How higher funding costs, interest-rate changes, and the Fund’s leverage affect net investment income and distribution coverage.
- Whether borrowing-base availability remains sufficient to fund commitments, especially after the final investor capital drawdown leaves no undrawn capital commitments.
- The assumptions behind Level 3 valuations and whether reported fair values can be realized in exits or secondary-market sales.
- Whether distributions, including supplemental components, are supported by recurring cash income rather than PIK accruals or other non-cash items.
- The Fund’s private-market liquidity, lack of an established public market, and reliance on Morgan Stanley-affiliated service providers; Morgan Stanley’s investment is not a broader financial-support commitment.