Morgan Stanley Direct Lending Fund — Form 10-Q Summary
Business Context and Reporting Period
The filing covers the quarterly and six-month periods ended June 30, 2020. Morgan Stanley Direct Lending Fund is an externally managed business development company that invests primarily in directly originated senior secured loans to U.S. middle-market, sponsor-backed companies. The Fund commenced investing operations on January 31, 2020; therefore, meaningful prior-period operating comparisons are not available.
The interim financial statements were reviewed by Deloitte & Touche LLP and were not audited. Management reported effective disclosure controls and no material changes to internal control over financial reporting.
Financial Performance and Key Metrics
| Metric | Three Months Ended June 30, 2020 | Six Months Ended June 30, 2020 |
|---|---|---|
| Total investment income | $3.9 million | $4.8 million |
| Net expenses after waivers | $1.9 million | $2.7 million |
| Net investment income | $2.0 million | $2.1 million |
| Net realized gains | $1.4 million | $1.4 million |
| Net unrealized appreciation (depreciation) | $1.9 million | $(1.8) million |
| Net increase in net assets from operations | $5.3 million | $1.6 million |
| Net investment income per share | $0.37 | $0.46 |
| Net earnings per share | $0.99 | $0.36 |
| Dividend declared per share | $0.29 | $0.29 |
At June 30, 2020, net assets were $116.3 million, net asset value was $19.21 per share, and cash was $93.1 million. The investment portfolio had a fair value of $204.5 million versus no investments at December 31, 2019. Total assets were $310.0 million and total liabilities were $193.6 million.
The portfolio comprised 93.1% first-lien debt and 6.9% second-lien debt at fair value, spread across 13 portfolio companies and eight industries. All debt investments were floating-rate instruments; approximately 84.7% had LIBOR floors, with a weighted-average LIBOR floor of 1.0%. Weighted-average yield on debt investments was 7.5% at cost and fair value.
Operating cash flow was negative $202.4 million, primarily reflecting $220.7 million of investment purchases. Financing activities provided $295.4 million, including $116.8 million from common share issuances and $179.4 million of net credit-facility borrowings. Cash increased by $93.1 million during the six months.
Debt, Liquidity, and Capitalization
- The CIBC Subscription Facility had a $325 million commitment, with $179.4 million outstanding and $145.7 million of available capacity at June 30, 2020. The facility matures December 31, 2022 and was secured by certain investors’ unfunded commitments.
- The weighted-average interest rate on borrowings, excluding unused fees and financing-cost amortization, was 2.04% for the quarter and 2.23% for the six-month period.
- Total stockholder capital commitments were $1.2 billion, of which approximately $1.1 billion remained unfunded. Approximately 9.8% of committed equity capital had been called.
- Unfunded commitments to portfolio companies totaled $25.5 million, primarily for delayed-draw and revolving senior secured loans.
- The asset coverage ratio was 164.87%, and the Fund reported compliance with all credit-facility covenants and other requirements.
Material Changes and Unusual Items
- The Fund expanded rapidly from a pre-operating balance sheet at December 31, 2019, issuing approximately $117.4 million of common stock and deploying capital into its initial portfolio.
- During the quarter, the Fund committed approximately $156.2 million to new investments, funded approximately $141.6 million, and sold approximately $22.2 million of investments, realizing gains of approximately $1.4 million.
- Quarterly unrealized appreciation of $1.9 million reflected improving credit spreads and broadly syndicated loan markets. For the six-month period, unrealized depreciation was $1.8 million, reflecting earlier market weakness and spread widening.
- The Investment Adviser waived $316,000 of management fees and $133,000 of excess organization and offering costs for the six-month period. The Fund accrued $418,000 of income-based incentive fees; no capital-gains incentive fee accrued.
- Most investments were valued using Level 3 inputs, including unobservable discount rates and indicative pricing. Level 3 investments totaled $174.9 million, or approximately 85.5% of portfolio fair value.
Guidance, Outlook, Commentary, and Risks
Management stated that it believed the Fund was well positioned for the COVID-19 environment because it had a limited legacy portfolio, substantial available capital, limited unfunded portfolio exposure, and no exposure to airlines, lodging, or leisure. All investments had an internal risk rating of 2 and were reported as performing in line with underwriting expectations and current on interest payments.
Management expected market dislocation to provide opportunities for lower leverage, higher yields, stronger documentation, and improved lender protections. From July 1 through August 7, 2020, the Fund closed or received commitments for approximately $189.1 million of new or add-on investments, all expected to be first-lien senior secured loans and all floating-rate.
The principal risks include the uncertain duration and severity of COVID-19, borrower defaults, covenant breaches, increased revolver draws, valuation volatility, illiquidity, refinancing risk, leverage, declining LIBOR, and dependence on capital calls and credit-facility availability. A prolonged decline in interest rates could reduce investment income. The Fund stated that it could not reasonably estimate the future effects of COVID-19 on financial condition, results of operations, or cash flows.
Subsequent to quarter-end, the Fund issued a $40 million capital call on July 30, 2020, with proceeds and related share issuance expected around August 11, 2020. No material litigation or other material subsequent events requiring disclosure were reported.
Important Facts for Investors to Verify
- Confirm the sustainability of the $0.29 per-share dividend relative to net investment income and future taxable income.
- Monitor Level 3 valuation assumptions, particularly discount rates, indicative quotes, borrower performance, and the effect of market volatility on NAV.
- Assess leverage, borrowing-base availability, facility maturity, covenant compliance, and the Fund’s ability to access or refinance debt.
- Track COVID-19 effects on portfolio-company cash flows, defaults, covenant waivers, non-accruals, and unfunded commitment draws.
- Evaluate interest-rate sensitivity: the filing estimates that a 100-basis-point increase in rates would reduce annualized net income by approximately $917,000, while a 100-basis-point decrease would increase it by approximately $192,000, assuming the stated portfolio and borrowing structure.
- Review the Fund’s ability to deploy approximately $1.1 billion of uncalled capital while maintaining diversification, underwriting discipline, and regulatory asset-coverage requirements.