Morgan Stanley Direct Lending Fund — Form 10-Q Summary
Business Context and Reporting Period
Quarterly report for the three months ended March 31, 2020, filed May 8, 2020. The company is an externally managed business development company and intends to qualify as a regulated investment company. It commenced investing operations on January 31, 2020 and invests primarily in senior secured loans to U.S. middle-market companies.
The company had five portfolio companies across software and services, transportation, and capital goods. There were no prior comparable operating periods because investing operations had not begun before January 31, 2020.
Financial Metrics
| Metric | March 31, 2020 | Prior period or commentary |
|---|---|---|
| Total assets | $227.3 million | $1.5 million at December 31, 2019 |
| Net assets | $97.6 million | $(1.1) million at December 31, 2019 |
| Net asset value per share | $18.47 | $(640.54) at December 31, 2019, before external capital issuance |
| Investment portfolio at fair value | $89.4 million | No investments at December 31, 2019 |
| Total investment income | $923 thousand | No comparable operating period |
| Net investment income | $109 thousand | $0.04 per share |
| Net unrealized depreciation | $(3.8) million | Primarily reflecting wider credit spreads and loan-market weakness |
| Net decrease in net assets from operations | $(3.7) million | $(1.19) per share |
| Cash | $134.1 million | $35 thousand at December 31, 2019 |
| Debt outstanding | $116.0 million | No debt at December 31, 2019 |
| Available credit facility capacity | $209.0 million | Facility commitment increased to $325.0 million |
Interest income was $917 thousand and other income was $6 thousand. Gross expenses were $972 thousand, reduced by a $109 thousand expense waiver and a $49 thousand management-fee waiver, resulting in net expenses of $814 thousand. The net expense ratio was 3.85% annualized, compared with 4.23% before waivers.
Operating cash flow was negative $83.1 million, largely reflecting $93.3 million of investment purchases. Financing activities provided $217.1 million, including $119.0 million of borrowings and $101.8 million of common-stock issuance proceeds. Ending cash increased by $134.0 million.
The portfolio consisted of $75.5 million of first-lien debt and $13.9 million of second-lien debt. Approximately 91.6% of net assets were represented by investments. All debt investments were floating-rate; the weighted-average debt yield at amortized cost was approximately 8.7%.
Material Changes Versus the Prior Comparable Period
- The company moved from a pre-investment position at December 31, 2019 to a $93.2 million cost-basis investment portfolio at March 31, 2020.
- External share issuance generated approximately $102.4 million from two capital calls, and shares outstanding increased to 5,286,873 from 1,750.
- Debt was introduced through the CIBC Subscription Facility; $119.0 million was borrowed and $3.0 million was repaid during the quarter.
- Total capital commitments increased from $755.3 million to $1.070 billion, while unfunded commitments increased from $755.3 million to $968.0 million.
- The portfolio recorded $3.8 million of unrealized depreciation, resulting in a quarterly net loss despite positive net investment income.
- The company had $9.1 million of unfunded investment commitments at quarter-end, compared with none at December 31, 2019.
Guidance, Outlook, Risks, and Unusual Items
Management reported that all investments were performing in line with initial underwriting expectations and had an internal risk rating of 2. Management emphasized the portfolio’s senior-secured composition, limited unfunded exposure, lack of airline, lodging, and leisure exposure, and substantial uncalled equity capital.
COVID-19 created significant uncertainty. Management expects to continue investing selectively during the market dislocation but stated that it cannot reasonably estimate the pandemic’s future impact on financial condition, results of operations, or cash flows. Risks include borrower defaults, covenant breaches, increased revolver draws, valuation declines, reduced refinancing availability, lower LIBOR, and disruptions to portfolio-company and adviser operations.
Liquidity consisted of $134.1 million of cash, $209.0 million of credit-facility availability subject to borrowing-base restrictions, and approximately $968.0 million of uncalled equity commitments. The credit facility matures December 31, 2022, and the company was in compliance with its covenants.
From April 1 through May 8, 2020, the company committed approximately $57.2 million to eight portfolio companies. On April 2, 2020, additional capital commitments of approximately $9.3 million increased total commitments to approximately $1.080 billion. These subsequent events were disclosed but do not affect the March 31 financial statements.
Approximately 97.5% of investment fair value was classified as Level 3, requiring significant judgment and unobservable inputs. A 100-basis-point increase in interest rates was estimated to reduce annualized net income by approximately $322 thousand, while a 100-basis-point decrease was estimated to increase annualized net income by approximately $9 thousand, after considering rate floors and debt costs.
No material legal proceedings, defaults upon senior securities, or material control changes were reported. The interim financial information was reviewed by Deloitte & Touche LLP and received a review conclusion without material modifications; it was not audited.
Most Important Facts for Investors to Verify
- Whether COVID-19 caused subsequent deterioration, non-accruals, covenant breaches, or additional unrealized losses in the five portfolio companies.
- The valuation assumptions supporting the predominantly Level 3 portfolio, including discount rates, indicative pricing, and borrower financial performance.
- The availability and borrowing-base requirements of the CIBC Subscription Facility, including the December 31, 2022 maturity.
- The company’s ability to deploy approximately $968 million of uncalled capital while maintaining leverage and asset-coverage compliance.
- The effect of lower LIBOR on interest income, including the protection and limitations provided by portfolio rate floors.
- The treatment and potential future reimbursement of adviser-funded expense and management-fee waivers.
- Whether subsequent investments and capital commitments changed portfolio concentration, liquidity, or risk after May 8, 2020.