Morgan Stanley Direct Lending Fund: FY2019 Form 10-K Summary
Business Context and Reporting Period
Morgan Stanley Direct Lending Fund is an externally managed business development company focused on directly originated senior secured loans to U.S. middle-market companies, generally those with EBITDA of approximately $15 million to $100 million. The Fund was formed on May 30, 2019, completed its BDC conversion and elected BDC status on November 25, 2019, and completed its initial private offering closing on December 23, 2019.
The filing covers the period from May 30, 2019, inception, through December 31, 2019. The Fund had not commenced investment activities by year-end; investment activities began on January 31, 2020. Its common stock was privately offered, with no established public market as of March 20, 2020.
Financial Metrics and Liquidity
| Metric | Period ended December 31, 2019 |
|---|---|
| Total investment income | $0 |
| Gross expenses | $1.235 million |
| Expense waiver | $78,673 |
| Net expenses | $1.156 million |
| Net loss | $1.156 million |
| Cash flow from operating activities | $0 |
| Cash flow from financing activities | $35,000 |
| Cash at year-end | $35,000 |
| Total assets | $1.464 million |
| Total liabilities | $2.585 million |
| Net assets | $(1.121) million |
| Capital commitments received at initial closing | Approximately $755 million |
Year-end assets consisted primarily of deferred offering costs, deferred financing costs, prepaid expenses and cash; the Fund held no investment portfolio. Liabilities included $1.399 million payable to an affiliate and $1.186 million of accrued expenses and other liabilities. No management or incentive fees were accrued or paid to the Adviser, and no dividends were declared.
The Fund entered into a CIBC subscription facility on December 31, 2019, with initial borrowing capacity of $100 million and a maturity date of December 31, 2022. No borrowings were outstanding at year-end, and the Fund reported compliance with the facility’s covenants. The facility was subsequently increased to $325 million effective February 3, 2020.
The filing contains an apparent presentation inconsistency regarding net asset value per share: the selected financial data table shows $640.54, while the audited balance sheet reports $(640.54). The audited balance sheet is consistent with total net assets of $(1.121) million and 1,750 shares outstanding.
Material Changes and Subsequent Developments
- The Fund transitioned from a Delaware limited liability company to a Delaware corporation and elected BDC status in November 2019.
- MS Credit Partners Holdings, an Morgan Stanley affiliate, contributed $35,000 and held a commitment of $150 million, representing approximately 20% of total accepted commitments.
- From January 1 through March 20, 2020, the Fund committed $93 million across three portfolio companies.
- A February 5, 2020 capital drawdown closed for approximately $57.5 million through the issuance of 2,874,810 shares.
- A further approximately $45 million drawdown was expected to close on March 27, 2020.
- The Fund formed DLF CA SPV LLC on February 26, 2020 to hold investments.
Guidance, Outlook, Risks and Unusual Items
Management expects revenue to consist primarily of interest income from floating-rate senior secured loans, supplemented by fees, dividends and capital gains. The Fund intends to invest mainly in first-lien and second-lien loans to sponsor-backed middle-market companies, with a smaller allocation to mezzanine debt, unsecured debt and equity investments. No earnings, distribution or portfolio-return guidance was provided.
The Fund intends to elect RIC treatment beginning with the taxable year commencing on its initial drawdown date and expects to distribute substantially all investment company taxable income. Failure to satisfy RIC or BDC qualification requirements could result in corporate-level taxation, restricted operations or adverse effects on distributions.
- The Fund is newly formed and has no meaningful operating or investment performance history.
- Its investments are expected to be illiquid, below investment grade and subject to default, valuation and recovery risk.
- Leverage may magnify gains and losses and is subject to a 150% asset-coverage requirement, subject to applicable disclosure conditions.
- Floating-rate investments and borrowings create interest-rate risk; the filing also highlights the planned transition away from LIBOR.
- Potential conflicts exist because the Adviser and its affiliates manage other accounts, allocate investment opportunities and may co-invest with the Fund. Requested SEC co-investment exemptive relief had not been granted.
- The Fund depends on Morgan Stanley, the Adviser, the Administrator and their investment professionals and has no employees.
- Shares are illiquid, restricted and not publicly traded; no exchange listing or repurchase program was assured.
- The filing identifies the emerging COVID-19 pandemic, reported after year-end, as a potentially material risk to portfolio companies, markets, operations, investment sourcing and valuations.
- Fair values of future portfolio investments are expected to rely substantially on Level 3 inputs and significant judgment.
Important Facts for Investors to Verify
- Reconcile the conflicting net asset value per share figures of $640.54 and $(640.54).
- Confirm the timing and terms of the initial and subsequent capital drawdowns and the extent to which commitments were funded.
- Review the portfolio established after January 31, 2020, including investment concentrations, credit quality, yields, non-accruals and fair-value changes.
- Assess the final terms, borrowing base and covenant compliance of the expanded CIBC subscription facility.
- Monitor the Fund’s qualification as a BDC and RIC, required distributions and compliance with asset-coverage tests.
- Evaluate the impact of COVID-19, interest-rate movements, LIBOR replacement and broader credit-market conditions on portfolio companies and valuations.
- Review management, incentive-fee, expense-reimbursement and affiliate-allocation arrangements for conflicts and total shareholder costs.