Morgan Stanley Direct Lending Fund: 10-Q Summary
Business context and reporting period
The filing covers the quarterly and six-month periods ended June 30, 2021, with comparative periods ended June 30, 2020. Morgan Stanley Direct Lending Fund is an externally managed business development company and regulated investment company focused primarily on directly originated senior secured loans to U.S. middle-market, sponsor-backed companies.
The interim financial information was reviewed by Deloitte & Touche LLP and was presented in accordance with U.S. GAAP. The Company had 62 portfolio companies across 22 industries at June 30, 2021, compared with 36 companies across 19 industries at December 31, 2020.
Key financial metrics
| Metric | Three months ended June 30, 2021 | Six months ended June 30, 2021 |
|---|---|---|
| Total investment income | $26.4 million | $43.8 million |
| Net investment income | $16.0 million | $26.1 million |
| Net realized and unrealized gains | $3.9 million | $8.5 million |
| Net increase in net assets from operations | $19.9 million | $34.6 million |
| Net investment income per share | $0.63 | $1.23 |
| Net earnings per share | $0.78 | $1.63 |
| Dividends declared per share | $0.49 | $0.94 |
For the six months ended June 30, 2021, net investment income represented approximately 59.6% of total investment income. The filing does not present a conventional operating margin because the Company is an investment company.
- Net assets were $593.4 million at June 30, 2021, up from $301.6 million at December 31, 2020.
- Net asset value was $20.81 per share, compared with $20.08 at December 31, 2020.
- Portfolio investments at fair value were $1.352 billion, compared with $636.981 million at December 31, 2020.
- Debt outstanding was $719.850 million, consisting of $348.850 million under the CIBC Subscription Facility and $371.000 million under the BNP Funding Facility.
- Cash was $28.181 million. Available facility capacity, subject to borrowing-base restrictions, was $182.211 million, and uncalled stockholder capital commitments were approximately $1.012 billion.
- Operating cash flow was negative $628.8 million for the six months, principally reflecting substantial investment purchases. Financing cash flow was positive $645.7 million, driven by borrowings and $275.0 million of common-stock issuance proceeds.
- The portfolio was 88.3% first-lien debt, 9.6% second-lien debt and 2.1% other securities by fair value. Approximately 99.9% of debt investments had floating interest rates, and the weighted-average yield on debt securities at amortized cost was 7.5%.
Material changes versus comparable periods
- Six-month investment income increased to $43.8 million from $4.8 million, primarily because of significant portfolio growth and capital deployment.
- Six-month net investment income increased to $26.1 million from $2.1 million, while net assets resulting from operations increased to $34.6 million from $1.6 million.
- The six-month 2021 period included $8.5 million of net unrealized appreciation, compared with $1.8 million of net unrealized depreciation in the prior-year period. Management attributed the appreciation primarily to tighter credit spreads and strong portfolio-company performance.
- Capital raised through drawdowns increased to $275.0 million from $117.4 million. Shares outstanding at period-end increased to 28.5 million from 6.1 million at June 30, 2020.
- Debt increased to $719.9 million from $333.9 million at December 31, 2020, reflecting increased investment activity and the use of the BNP Funding Facility.
- Unfunded investment commitments increased to $431.5 million from $206.5 million at December 31, 2020.
- Net asset value increased to $20.81 per share from $19.21 at June 30, 2020. The six-month total return based on NAV was 8.37%, compared with negative 2.52% in the prior-year period.
Outlook, risks and unusual items
Management reported that all first- and second-lien debt investments were performing and current on interest payments at June 30, 2021, and all portfolio investments were classified as internal Risk Rating 2. However, most investments were Level 3 fair-value measurements, requiring significant judgment and unobservable inputs. The reported fair value may differ materially from amounts realized in a forced or liquidation sale.
Management stated that it intended to deploy capital at a measured pace, focus on non-cyclical industries and avoid sectors directly affected by the COVID-19 pandemic. It also noted continuing uncertainty related to COVID-19 variants, vaccine rollout, inflation, economic recovery and potential portfolio-company defaults. The filing does not provide formal earnings or dividend guidance.
- Interest-rate sensitivity is material because substantially all debt investments and borrowings are floating rate. The filing estimates that a 100-basis-point increase in rates would reduce annualized net income by approximately $4.5 million under the stated assumptions, while decreases below current floors would have a limited additional effect.
- Management fees were subject to a waiver before a national exchange listing; $3.6 million of management fees were waived during the six months ended June 30, 2021. Income-based and capital-gains incentive fees accrued were $5.8 million and $1.5 million, respectively.
- The Company was in compliance with the covenants of both credit facilities and applicable leverage restrictions at June 30, 2021. No material litigation or defaults were reported.
- After quarter-end, the Company closed a July capital drawdown of approximately $149.9 million and entered into a $650 million Truist revolving credit facility maturing July 16, 2026, with potential accordion capacity up to $1.0 billion.
- From July 1 through August 10, 2021, the Company closed or had approved approximately $618.9 million of new or add-on investments, of which 99.7% were first-lien senior secured loans.
Important facts for investors to verify
- Reconcile portfolio growth, capital raises, borrowings and leverage against the Company’s investment strategy and applicable BDC asset-coverage requirements.
- Review the valuation assumptions for the predominantly Level 3 portfolio, including discount rates, EBITDA multiples and the effect of spread movements on NAV.
- Assess the $431.5 million of unfunded investment commitments and the $1.012 billion of uncalled stockholder commitments for liquidity and funding risk.
- Monitor the maturity and borrowing-base availability of the CIBC, BNP and subsequent Truist facilities, including refinancing and interest-rate exposure.
- Evaluate the effect of management-fee waivers, incentive fees and related-party arrangements on distributions and shareholder returns.
- Confirm the sustainability of dividends relative to net investment income, including the effect of payment-in-kind income and unrealized gains.
- Review subsequent investment activity and COVID-19, inflation, credit-spread and portfolio-company default risks before relying on the quarter-end performance.