Morgan Stanley Direct Lending Fund — Q1 2024 Form 10-Q
Business context and reporting period
Unaudited results for the three months ended March 31, 2024. The company is an externally managed business development company (BDC) and regulated investment company (RIC), focused primarily on senior secured loans to U.S. middle-market businesses. It is managed by a Morgan Stanley affiliate but is not a subsidiary of Morgan Stanley, which disclaims any obligation to provide financial support.
Key financial metrics
Amounts are in millions, except per-share data, percentages and ratios.
| Metric | Q1 2024 / March 31, 2024 | Comparable / prior period |
|---|---|---|
| Investment income | $99.1 | $83.6 in Q1 2023 |
| Net expenses, after waivers | $44.0 | $39.4 in Q1 2023 |
| Net investment income after tax | $54.7; $0.63 per share | $44.2; $0.62 per share |
| Net realized and unrealized loss | $3.0 | $0.4 loss in Q1 2023 |
| Increase in net assets from operations | $51.7; earnings per share $0.59 | $43.8; $0.62 per share |
| Net asset value (NAV) per share | $20.67 | $20.67 at Dec. 31, 2023 |
| Portfolio investments, at fair value | $3,293.2 | $3,193.6 at Dec. 31, 2023 |
| Cash and debt carrying value | $64.8 cash; $1,486.7 debt | $69.7 cash; $1,496.0 debt at Dec. 31, 2023 |
| Asset coverage ratio | 223.1% | 188.8% in Q1 2023 |
| Net expense ratio / NII ratio | 8.10% / 13.69% of average net assets, annualized as applicable | 9.19% / 14.57% in Q1 2023 |
Investment income was mostly interest: $94.6 million, plus $2.6 million of payment-in-kind (PIK) income. Operating cash flow was a use of $53.7 million, compared with a use of $16.4 million in Q1 2023; cash ended the quarter at $64.8 million. The cash-flow statement reflects investment purchases exceeding sales and repayments.
Material changes and portfolio
- Investment income rose 18% year over year, which management attributed primarily to capital deployment and higher SOFR rates. The portfolio’s amortized cost grew to $3,323.8 million from $2,992.7 million at March 31, 2023; weighted-average debt asset yield at cost increased to 11.9% from 11.5%.
- Net expenses increased to $44.0 million from $39.4 million. Financing expense rose modestly as reference rates and unsecured debt costs increased, partly offset by lower average borrowings. Management and incentive fees also increased; fee waivers totaled $4.3 million in Q1 2024.
- The portfolio comprised 178 companies, versus 172 at year-end. First-lien debt represented 94.6% of investment fair value; second-lien debt, 3.6%; and other investments, 1.8%. Insurance services and software were the largest industry exposures, at 15.1% and 14.8% of portfolio fair value.
- Nearly all performing debt investments bore floating rates (99.9%). Weighted-average net leverage through the company’s tranche was 6.0x and interest coverage was 1.5x. Three investments were on non-accrual, with amortized cost of $12.4 million, down from $19.4 million at year-end.
- Internal risk ratings showed 98.1% of portfolio fair value at rating 2 and 1.6% at rating 3; none was rated 4 at March 31. These are adviser assessments, not third-party credit ratings.
Liquidity, debt and capital
At March 31, debt principal outstanding was $1,492.3 million, against $2,420.0 million of aggregate commitments. Reported unused capacity was $923.7 million, including $300.0 million under the BNP facility and $623.7 million under the Truist facility, subject to borrowing-base availability. The combined weighted-average borrowing rate was 6.69% (7.12% effective, excluding unused fees); the company reported compliance with debt covenants. It also had $363.8 million of unfunded portfolio commitments, up from $295.0 million at year-end, and stated it believed resources were adequate to meet them.
The January IPO issued 5.0 million shares at $20.67 per share and raised approximately $97.1 million net of underwriting fees, before offering expenses. Net assets increased to $1,837.0 million, including $108.6 million of net capital transactions during the quarter. The company declared a $0.50-per-share distribution for Q1. The board also declared two special distributions totaling $0.20 per share for later 2024 and January 2025.
Outlook, commentary and risks
- No earnings or investment-return guidance was provided. Management said cash and available credit were expected to be sufficient for near-term operations and investing, including unfunded commitments.
- Three portfolio-company restructurings were the primary driver of $5.6 million in realized investment losses. Net unrealized appreciation was $2.7 million, primarily attributed to spread changes in primary and secondary markets.
- On April 19, 2024, after quarter-end, the Truist facility was amended: its size increased to $1.3 billion, and consenting lenders received extensions to the revolving period and maturity dates. On May 8, the board declared a further $0.50-per-share distribution, payable July 25, 2024.
- Investment fair values involve significant judgment: most portfolio assets are Level 3, based on unobservable inputs. The filing warns that forced-sale proceeds could differ materially from reported fair values. Interest-rate changes, borrower performance, market conditions, leverage, and potential conflicts with the adviser and affiliates are identified risks.
- A hypothetical 100-basis-point rate increase was estimated to raise annualized net interest income by $25.0 million; a 100-basis-point decrease was estimated to reduce it by the same amount, assuming the March 31 portfolio and borrowing structure remained unchanged. The company reported no interest-rate hedging during the periods presented.
- The adviser’s fee agreement includes a temporary fee waiver through January 24, 2025 and changes to incentive-fee calculations. Morgan Stanley has no obligation to support the fund. No material legal proceedings were reported.
Important facts for investors to verify
- Review borrower-level credit quality, particularly the three non-accrual investments, restructured exposures, and any PIK income that may not be collected in cash.
- Assess the valuation assumptions and sensitivities for Level 3 assets, alongside the $5.6 million of realized losses and portfolio concentration.
- Confirm borrowing-base availability, covenant headroom, facility-extension terms, and capacity to meet $363.8 million of unfunded commitments.
- Evaluate the sustainability of distributions against cash earnings, the effect of the opt-out dividend reinvestment plan, and the economics of the announced special distributions.
- Examine the adviser fee waivers, incentive-fee terms, related-party relationships, and market price relative to the $20.67 NAV per share.