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 primarily on directly originated senior secured loans to U.S. middle-market, sponsor-backed companies. The filing covers the three months ended March 31, 2021; interim financial statements are unaudited and were reviewed by Deloitte & Touche LLP.
Key financial metrics
| Metric | Three months ended March 31, 2021 | Comparable period or balance |
|---|---|---|
| Total investment income | $17.345 million | $0.923 million in Q1 2020 |
| Net investment income | $10.059 million | $0.109 million in Q1 2020 |
| Net increase in net assets from operations | $14.701 million | $(3.681) million in Q1 2020 |
| Net investment income per share | $0.59 | $0.04 in Q1 2020 |
| Net earnings per share | $0.87 | $(1.19) in Q1 2020 |
| Dividend declared per share | $0.45 | None in Q1 2020 |
| Net asset value per share | $20.49 at March 31, 2021 | $20.08 at December 31, 2020 |
| Net assets | $390.213 million | $301.620 million at December 31, 2020 |
| Portfolio investments at fair value | $947.979 million | $636.981 million at December 31, 2020 |
| Cash | $64.154 million | $11.263 million at December 31, 2020 |
| Debt outstanding | $592.350 million | $333.850 million at December 31, 2020 |
Investment income consisted of $14.956 million of interest income, $0.188 million of payment-in-kind interest and $2.201 million of other income. Net expenses were $7.281 million after a $1.475 million management-fee waiver and $0.011 million of expense support. Expenses before waivers and support were $8.745 million, including $2.758 million of interest expense, $1.967 million of management fees, $2.306 million of income-based incentive fees and $0.812 million of capital-gains incentive fees.
Cash flow from operating activities was $(276.456) million, primarily reflecting $329.692 million of investment purchases and related changes in payables, partially offset by investment proceeds and operating income. Financing activities provided $329.347 million, including $305.500 million of borrowings and $79.790 million of common-stock issuance proceeds. Cash increased by $52.891 million during the quarter.
The portfolio comprised 53 companies across 21 industries. At fair value, 88.8% of investments were first-lien debt, 10.2% second-lien debt and 1.0% other securities. Approximately 99.8% of debt investments carried floating rates, and the weighted-average yield on debt and income-producing investments at amortized cost was 7.4%.
Material changes versus the prior comparable period
- Investment income increased substantially as the portfolio expanded, with fair value increasing from $89.4 million at March 31, 2020 to $948.0 million at March 31, 2021.
- Net investment income increased to $10.059 million from $0.109 million, while net assets from operations changed from a $3.681 million decrease to a $14.701 million increase.
- Unrealized appreciation was $4.642 million versus $3.790 million of unrealized depreciation in Q1 2020. Management attributed the appreciation primarily to tighter credit spreads and improved broadly syndicated loan market conditions.
- New investments committed or purchased totaled $568.087 million gross, or $500.587 million net of syndications and sell-downs. Investments sold or repaid totaled $42.528 million.
- Debt increased by $258.500 million from year-end 2020. The BNP Funding Facility had $214.500 million outstanding at March 31, 2021 versus none at year-end, while CIBC Subscription Facility borrowings increased to $377.850 million from $333.850 million.
- Unfunded loan commitments increased to $380.872 million from $206.540 million at December 31, 2020.
- Capital commitments from stockholders totaled $1.496 billion at March 31, 2021, of which $1.118 billion remained unfunded. The fund issued $80.0 million of common stock during the quarter and declared an $8.570 million dividend.
Outlook, management commentary, risks and unusual items
Management stated that the fund intends to deploy capital at a measured pace while emphasizing companies with strong management, sustainable business models, substantial free cash flow and leading market positions. From April 1 through May 10, 2021, the fund closed or had investment-committee commitments or approvals for approximately $463.4 million of new or add-on investments, including 94.8% first-lien loans, 1.3% second-lien loans and 3.9% preferred or common equity investments.
Management believes available cash, borrowing capacity and uncalled capital commitments are sufficient for near-term investing and operations. No formal earnings or dividend guidance was provided. The April 12, 2021 closing of the $110.0 million capital call occurred after quarter-end. Capital commitments closed on April 1 and April 30, 2021 increased total commitments to $1.5238 billion.
- COVID-19, economic recovery, vaccine rollout and potential virus variants could impair portfolio-company operations, credit quality, investment values and repayment capacity.
- The portfolio is predominantly composed of illiquid Level 3 investments. Fair values depend substantially on management judgment, discount rates, indicative quotes, credit performance and other unobservable inputs.
- Leverage creates interest-rate, refinancing and liquidity risk. The CIBC facility matures December 31, 2022; the BNP facility matures October 13, 2025.
- The fund had $189.891 million of borrowing availability at March 31, 2021, subject to borrowing-base limitations, despite $407.650 million of unused committed facility capacity.
- Nearly all debt investments bear floating rates, while borrowings also bear floating rates. The filing estimates that a 100-basis-point increase in rates would reduce annualized net income by approximately $3.675 million under the stated assumptions.
- The fund accrued incentive fees partly on unrealized appreciation, although capital-gains incentive fees are generally payable only upon realization and crystallization under the advisory agreement.
- The fund reported compliance with facility covenants and applicable leverage restrictions, no material pending or threatened litigation, no defaults upon senior securities and effective disclosure controls.
Investor verification checklist
- Verify the valuation assumptions supporting the $947.979 million portfolio fair value, particularly Level 3 discount rates and borrower credit performance.
- Review borrowing-base availability, facility covenants, maturity dates and the effect of additional leverage on liquidity and distributions.
- Assess the $380.872 million of unfunded loan commitments and the $1.118 billion of uncalled investor capital commitments against expected funding needs.
- Confirm the sustainability of the $0.45 per-share dividend relative to net investment income, PIK income and required RIC distributions.
- Monitor COVID-19-related effects, interest-rate and LIBOR-transition exposure, portfolio concentration and any emergence of non-accrual or underperforming loans.
- Review related-party advisory, administration, fee-waiver and incentive-fee arrangements, including the $200 million affiliate capital commitment.