Morgan Stanley Direct Lending Fund — Form 10-Q Summary
Business context and reporting period
The filing covers the three and six months ended June 30, 2022, with comparative periods ended June 30, 2021. The Company is a non-diversified, externally managed business development company and regulated investment company focused primarily on directly originated senior secured loans to U.S. middle-market companies backed by financial sponsors. It is advised by MS Capital Partners Adviser Inc. and is not a subsidiary of, or consolidated with, Morgan Stanley.
As of June 30, 2022, the portfolio included 129 companies across 29 industries. First-lien debt represented 93.2% of investments at fair value, second-lien debt 5.0%, and other securities 1.8%. More than 99.9% of the debt portfolio was floating rate.
Financial condition and key metrics
| Metric | Three months ended June 30, 2022 | Six months ended June 30, 2022 |
|---|---|---|
| Total investment income | $50.0 million | $94.3 million |
| Net investment income after taxes | $29.4 million | $55.9 million |
| Net realized gain | $0.5 million | $0.5 million |
| Net unrealized appreciation (depreciation) | $(33.1) million | $(37.5) million |
| Net increase in net assets from operations | $(3.3) million | $19.0 million |
| Net investment income per share | $0.50 | $0.96 |
| Earnings per share | $(0.06) | $0.33 |
Net investment income represented approximately 58.8% of total investment income for the quarter and 59.3% for the six-month period. The weighted average yield on debt and income-producing investments was 8.2% at cost and 8.3% at fair value as of June 30, 2022.
- Total assets were $2.787 billion, including $2.682 billion of investments at fair value.
- Net assets were $1.241 billion, compared with $1.189 billion at December 31, 2021.
- Net asset value per share was $20.32, down from $20.91 at year-end 2021.
- Cash was $80.8 million.
- Debt was $1.477 billion carrying value, comprising $1.058 billion of secured facilities and $425.0 million of 4.50% unsecured notes due 2027, net of issuance costs.
- Total committed debt capacity was $2.280 billion, with approximately $796.0 million of stated unused capacity, subject to borrowing-base restrictions.
- Unfunded portfolio investment commitments were $395.8 million, and stockholder capital commitments were $1.626 billion, of which $391.0 million remained unfunded.
- The asset coverage ratio was 183.62%.
Material changes versus comparable periods
- Six-month investment income increased to $94.3 million from $43.8 million, primarily reflecting substantial portfolio growth. Investment fair value increased from $1.352 billion at June 30, 2021 to $2.682 billion at June 30, 2022.
- Six-month net investment income increased to $55.9 million from $26.1 million, while net investment income per share declined to $0.96 from $1.23 because the share base expanded significantly.
- Net investment income remained positive, but unrealized depreciation of $37.5 million caused six-month earnings to fall to $19.0 million from $34.6 million. Management attributed the depreciation primarily to credit-market volatility and spread widening.
- Interest and other financing expenses increased to $24.1 million from $7.0 million for the six-month period. Average borrowings increased to approximately $1.450 billion from $553.8 million, and the weighted average borrowing rate rose to 2.77% from 2.08%.
- Debt increased from $1.250 billion at December 31, 2021 to $1.477 billion at June 30, 2022, including the February 2022 issuance of the 2027 Notes.
- Unfunded portfolio commitments declined from $509.4 million at year-end 2021 to $395.8 million.
- Distributions declared increased to $0.95 per share for the six-month period from $0.94 per share, while total distributions increased to $56.1 million from $22.5 million because of the larger share base.
- The internal risk rating profile weakened modestly: 98.9% of portfolio fair value was rated Category 2 and 1.1% Category 3 at June 30, 2022, versus 98.1% Category 2 and 1.9% Category 1 at December 31, 2021. No investments were rated Category 4.
Outlook, commentary, risks and unusual items
Management stated that the Company and its adviser remained operational and believed the portfolio was positioned to manage the market environment. However, management highlighted recession uncertainty, inflation, Federal Reserve rate increases, high oil prices, supply-chain disruption, COVID-19 developments, credit-market volatility, spread widening, and the potential effects of higher interest rates on portfolio companies and financing costs.
- Subsequent to June 30 through August 9, 2022, the Company closed or committed approximately $63.9 million of new or add-on investments, including $62.9 million of first-lien loans and $1.0 million of equity investments. All senior secured loans were floating rate.
- The Company reported that all first- and second-lien debt investments were current on interest payments. One unsecured debt investment with fair value of $0.5 million was on non-accrual status.
- Approximately 98.9% of portfolio fair value was internally rated Category 2, while $29.1 million, or 1.1%, was Category 3.
- Most portfolio investments were Level 3 assets valued using significant management judgment and unobservable inputs. Higher discount rates would reduce reported fair value and net asset value.
- A 100-basis-point increase in interest rates was estimated to increase annualized net income by $12.5 million, while a 100-basis-point decrease was estimated to reduce annualized net income by $9.1 million, assuming no change in portfolio or financing structure.
- The Company was in compliance with all debt covenants as of June 30, 2022 and reported no material legal proceedings.
- After quarter-end, the Company raised approximately $80 million through an equity capital drawdown, completed an exchange that registered notes representing 85.87% of the then-restricted 2027 Notes, and reduced the CIBC Subscription Facility commitment from $280 million to $235 million. The filing contains conflicting references to whether the equity sale closed on July 28 or July 29, 2022.
The interim financial information was reviewed by Deloitte & Touche LLP, which reported that it was not aware of material modifications needed for conformity with U.S. GAAP. A review is substantially less extensive than an audit.
Important facts for investors to verify
- Reconcile the reported debt availability with borrowing-base restrictions and the July 2022 reduction of the CIBC facility.
- Assess the effect of spread widening, discount-rate changes and Level 3 valuation assumptions on net asset value.
- Monitor Category 3 exposures, non-accrual investments and the ability of portfolio companies to service floating-rate debt.
- Evaluate interest-rate sensitivity, including the offset between higher portfolio income and higher financing costs.
- Review the sustainability of distributions relative to net investment income, realized gains, unrealized losses and required RIC distributions.
- Verify the conflicting July 28 versus July 29 closing date for the $80 million equity issuance.
- Consider leverage, secured borrowing arrangements, collateral requirements and the February 2027 maturity of the 2027 Notes.
- Review related-party fees, management-fee waivers, incentive fees and the absence of any Morgan Stanley obligation to provide financial support beyond its capital commitment.