Morgan Stanley Direct Lending Fund — Form 10-Q Summary
Business context and reporting period
Morgan Stanley Direct Lending Fund is an externally managed business development company and regulated investment company focused on directly originated senior secured loans to U.S. middle-market, sponsor-backed companies. The filing covers the quarter and nine months ended September 30, 2021, with comparisons to the same periods in 2020 and to December 31, 2020. The interim financial statements were reviewed by Deloitte & Touche LLP, not audited.
Key financial metrics
| Metric | Three months ended September 30 | Nine months ended September 30 |
|---|---|---|
| Total investment income | $31.7 million, versus $5.7 million | $75.5 million, versus $10.5 million |
| Net investment income | $18.8 million, versus $1.8 million | $44.9 million, versus $3.9 million |
| Net realized and unrealized gains | $3.4 million, versus $4.8 million | $11.9 million, versus $4.3 million |
| Net increase in net assets from operations | $22.2 million, versus $6.6 million | $56.8 million, versus $8.2 million |
| Net investment income per share | $0.54, versus $0.25 | $1.74, versus $0.71 |
| Net earnings per share | $0.64, versus $0.91 | $2.21, versus $1.48 |
| Dividend declared per share | $0.56, versus $0.40 | $1.50, versus $0.69 |
- Net assets were $749.2 million at September 30, 2021, compared with $301.6 million at December 31, 2020; NAV per share was $20.89 versus $20.08.
- The investment portfolio was $1.769 billion at fair value, compared with $636.98 million at December 31, 2020. First-lien debt represented 90.9% of portfolio fair value, second-lien debt 7.4%, and other securities 1.7%.
- The portfolio included 77 companies across 23 industries. Approximately 99.9% of debt investments were floating-rate, and the weighted-average total yield on debt securities at amortized cost was 7.3%.
- Total expenses were $37.0 million for the nine months, partially offset by $6.5 million of management-fee waivers; net expenses were $30.6 million. The annualized ratio of net expenses to average net assets was 6.55%.
- Annualized net investment income to average net assets was 11.42%; total return based on NAV was 11.69% for the nine months.
- Operating cash flow was negative $1.074 billion, primarily reflecting $1.339 billion of investment purchases, partly offset by $225.1 million of investment proceeds and repayments. Financing activities provided $1.108 billion, resulting in a $33.5 million increase in cash to $44.7 million.
Debt, liquidity, and capital resources
- Debt outstanding was $1.047 billion at September 30, 2021, versus $333.9 million at December 31, 2020. Debt consisted of $392.4 million under the CIBC Subscription Facility, $482.0 million under the BNP Funding Facility, and $172.5 million under the new Truist Credit Facility.
- Total committed borrowing capacity was $1.650 billion, with approximately $555.0 million available subject to borrowing-base limitations.
- Cash of $44.7 million, available facility capacity, and $863.5 million of unfunded stockholder capital commitments were expected by management to support near-term investment activity and operations.
- The asset coverage ratio was 171.56% at September 30, 2021, and management reported compliance with all credit-facility covenants and applicable leverage restrictions.
- Unfunded portfolio investment commitments increased to $530.0 million from $206.5 million at December 31, 2020. Total stockholder capital commitments were $1.586 billion, of which $863.5 million remained unfunded.
Material changes versus comparable periods
- Growth in investment income and net investment income was primarily driven by substantial deployment of capital and portfolio expansion.
- Investment fair value increased by approximately $1.132 billion from December 31, 2020, while debt outstanding increased by approximately $713.0 million.
- The fund issued 20.4 million shares through five capital calls during the first nine months of 2021, generating approximately $424.9 million, compared with $227.4 million from 11.6 million shares in the 2020 comparable period.
- The BNP Funding Facility became a significant financing source during 2021, and the $650 million Truist Credit Facility was entered into on July 16, 2021.
- Quarterly dividends increased from $0.40 per share in the 2020 comparable quarter to $0.56 per share in the current quarter.
- Portfolio composition broadened materially, from 36 companies across 19 industries at year-end 2020 to 77 companies across 23 industries at September 30, 2021.
- All debt investments were reported as performing and current on interest payments, and all 77 portfolio companies were classified as internal Risk Rating 2 at September 30, 2021. No investments were classified as Risk Rating 3 or 4.
Outlook, commentary, risks, and unusual items
- Management stated that the portfolio was constructed largely after the COVID-19 market dislocation and that capital would continue to be deployed at a measured pace, with emphasis on non-cyclical industries and companies with strong free cash flow and management teams.
- From October 1 through November 10, 2021, the fund closed or obtained commitments for approximately $786.9 million of new or add-on investments; 97.8% were first-lien loans, 1.6% second-lien loans, and 0.6% equity investments. All senior secured loans were floating-rate.
- Subsequent capital calls included approximately $164.0 million of shares sold on October 15, 2021, and an expected approximately $175.0 million offering scheduled to close on November 12, 2021.
- COVID-19 effects, supply-chain disruptions, inflation, interest-rate changes, portfolio-company defaults, valuation uncertainty, leverage, liquidity, and conflicts with the investment adviser remain principal risks.
- Approximately 99.9% of debt investments were floating-rate, creating sensitivity to benchmark-rate movements. The filing estimates that a 100-basis-point increase in rates would reduce annualized net income by approximately $7.1 million under the stated assumptions, while a 300-basis-point increase would increase it by approximately $7.1 million.
- Most investments were Level 3 assets valued using unobservable inputs and management judgment. The September 30, 2021 Level 3 portfolio fair value was $1.740 billion; higher discount rates would generally reduce fair value.
- The filing reports no material pending or threatened litigation, no defaults on senior securities, and effective disclosure controls.
- Investors should note that PIK income is non-cash but generally must be distributed to maintain RIC status. Nine-month PIK income was $0.7 million.
Most important facts to verify
- Whether portfolio growth and the $7.3% weighted-average debt yield are sustainable as leverage and financing costs increase.
- The borrowing-base availability, maturity and refinancing requirements of the CIBC, BNP, and Truist facilities, particularly the $392.4 million CIBC maturity in December 2022.
- The ability to fund $530.0 million of unfunded investment commitments while maintaining the 150% asset coverage requirement.
- The valuation sensitivity of the predominantly Level 3 portfolio to credit spreads, discount rates, borrower performance, and COVID-19 or inflation-related deterioration.
- The source and tax character of dividends, including the effect of PIK income and dividend reinvestment.
- The final closing and terms of the November 2021 capital call and whether subsequent investment commitments were funded as expected.
- The filing text contains an apparent inconsistency regarding capital gains incentive-fee amounts in the MD&A versus the accrued liability disclosures; investors should reconcile the $3.054 million balance-sheet accrual with the MD&A discussion of amounts payable on realized gains.