Morgan Stanley Direct Lending Fund — FY2023 Form 10-K
Reporting period: Fiscal year ended December 31, 2023; comparisons are to FY2022. The filing is an annual report, not a Q4-only report. Morgan Stanley Direct Lending Fund is an externally managed BDC and RIC focused on lending to U.S. middle-market companies. Its common stock began NYSE trading in January 2024. Morgan Stanley is not obligated to provide financial support.
Financial and portfolio highlights
| Metric | FY2023 / Dec. 31, 2023 | FY2022 / Dec. 31, 2022 |
|---|---|---|
| Total investment income | $367.7 million | $230.6 million |
| Net investment income after taxes | $198.1 million | $128.0 million |
| Net increase in net assets from operations | $231.0 million | $48.5 million |
| Net asset value per share | $20.67 | $19.81 |
| Investments at fair value | $3.194 billion | $2.874 billion |
| Debt outstanding (principal) | $1.502 billion | $1.532 billion |
| Cash | $69.7 million | $81.2 million |
| Asset coverage ratio | 214.6% | 191.2% |
| Distributions per share | $2.27 | $1.92 |
Net investment income before taxes was $199.6 million. Net expenses were $168.2 million, including $112.9 million of interest and financing expense, $30.6 million of management fees and $42.0 million of income incentive fees, partly offset by a $22.9 million management-fee waiver. The filing does not present a conventional operating margin; NII after tax was approximately 53.9% of investment income.
Operating cash flow was negative $83.8 million, versus negative $429.8 million in FY2022, reflecting substantial investment purchases. Cash at year-end was $69.7 million. The company reported $318.0 million of BNP facility availability and $599.5 million of Truist facility availability, subject to borrowing-base limits, and said resources were adequate for $295.0 million of unfunded portfolio commitments.
The portfolio included 172 companies across 30 industries. At fair value, 94.1% was first-lien debt, 4.1% second-lien debt and 1.8% other investments; 96.0% was U.S.-based and 99.9% of debt investments bore floating rates. Weighted-average debt yield at cost was 12.0%; portfolio-company net leverage through the Fund’s tranche averaged 6.0x, loan-to-value 43.0%, and interest coverage 1.5x. Three investments were on non-accrual, with amortized cost of $19.4 million, compared with one investment and $1.5 million a year earlier.
Changes versus FY2022
- Investment income rose 59%, primarily from portfolio growth and higher SOFR rates; average debt yield at cost increased from 10.9% to 12.0%.
- Net investment income after tax increased 55%. Net realized and unrealized results improved to a $33.0 million gain from a $79.5 million loss, with unrealized appreciation of $32.8 million versus depreciation of $80.0 million.
- Financing costs increased: average borrowings rose to $1.576 billion from $1.432 billion, while the weighted-average borrowing rate increased to 6.51% from 4.05%.
- Portfolio fair value increased about 11%; new investment commitments declined to $627.1 million net of syndications from $739.8 million. Non-accrual exposure increased, and Risk Rating 4 investments were 0.4% of portfolio fair value, versus none in 2022.
- Annual distributions increased to $2.27 per share from $1.92, including supplemental or special amounts. FY2023 total distributions were $169.3 million.
Outlook, significant events and risks
- Management described the direct-lending market as attractive despite inflation, market volatility and macroeconomic uncertainty, and said investment pace will depend on market conditions and deal flow. No quantified earnings, yield or distribution guidance is provided.
- After year-end, the Fund completed its IPO on January 26, 2024, issuing 5.0 million shares at $20.67 and receiving approximately $97.1 million net of underwriting fees, before offering expenses. The filing also reports a $0.50-per-share distribution declared February 29, 2024.
- A January 2024 advisory agreement amendment added a cumulative three-year lookback and an income incentive-fee cap linked to realized capital losses. For one year from January 24, 2024, the Adviser waived base fees above 0.75% and incentive-fee components above 15%.
- A share repurchase plan authorizes up to $100 million of purchases below reported NAV, expected to begin March 26, 2024; purchases are not assured. An opt-out dividend reinvestment plan took effect January 26, 2024.
- Key risks include leveraged exposure to floating rates, rising borrower interest burdens and defaults, illiquid Level 3 valuations, non-accrual and PIK income collection risk, debt covenants and refinancing, and conflicts from the Adviser’s management of affiliated accounts. Insurance services and software were the largest industry exposures at 14.9% and 14.2% of fair value, respectively. About 24% of the portfolio by gross commitments was covenant-lite.
- Debt included $425 million of 4.50% notes due 2027 and $275 million of 7.55% notes due 2025. The notes are not guaranteed by Morgan Stanley; the 2027 notes are unsecured. The company reported compliance with debt covenants at year-end.
Investor verification priorities
- Review the audited statements and loan schedule for non-accrual developments, payment-in-kind income, realized losses and subsequent changes in portfolio valuations.
- Check borrowing-base availability, facility covenants, debt maturities and the sensitivity of NII to interest-rate changes; the filing estimates a $24.0 million annualized NII increase for a 100-basis-point rate rise, assuming the year-end structure remains unchanged.
- Assess whether distributions are supported by cash income and RIC requirements: the Fund estimated approximately $41.9 million of taxable income to carry forward for 2024, subject to tax-return finalization.
- Monitor post-IPO NAV, market-price discount, share repurchases, and the actual effect of the amended advisory fees and incentive-fee cap.
- Consider valuation uncertainty: most investments are Level 3 and depend on unobservable inputs. Deloitte issued an unqualified opinion on the financial statements; it did not attest to internal-control effectiveness. Management stated controls were effective.