Morgan Stanley Direct Lending Fund Q2 FY2025 earnings call

Leadership Transitions

• Michael Occi named CEO of Morgan Stanley Direct Lending Fund, Ashwin Krishnan named Chief Investment Officer and Chair of Investment Committee, Jeff Day and Orit Mizrachi as co-Presidents.

Second Quarter Performance

• Generated net investment income of $0.50 per share, in line with the $0.50 dividend. High-quality earnings due to stable credit performance with low contributions from payment in kind and other income.

Liability Management

• Fund-level leverage increased modestly to 1.15x; refinanced legacy unsecured debt with a new 5-year bond at a yield improvement; priced inaugural CLO to diversify leverage mix.

Deployment

• Gross and net investment activity relatively consistent quarter-over-quarter with $204 million of investment fundings offset by repayments. Unique sourcing engine generated diverse lending opportunities; nearly 2/3 of non-refinancing volume from new platforms added, led or co-led.

Portfolio Composition

• Ended the quarter with a total portfolio at fair value of $3.8 billion; ~96% first lien debt, 2% second lien debt, remainder in equity and other; 214 portfolio companies across 34 industries, nearly 100% in floating rate debt.

The total portfolio at fair value ended the quarter at $3.8 billion. The portfolio was composed of approximately 96% first lien debt, 2% second lien debt, and the remainder in equity and other debt investments. There were 214 portfolio companies across 34 industries. The weighted average loan-to-value was approximately 40%, median EBITDA was ~$90 million. The weighted average yield on debt and income-producing investments was 10.1% at cost and 10.2% at fair value, a decline of approximately 10 basis points quarter-over-quarter. Net investment income was $0.50 per share, in line with the declared dividend.

• Declared a $0.50 regular distribution for the third quarter. - Fund-level leverage at 1.15x, with a target sweet spot of 1.15 to 1.25x. - Anticipate ~5% quarterly churn rate, with capacity to deploy given repayments and leverage capacity.

• Macro uncertainty including volatility in financial markets, trade policy impacts, and changing economic conditions. - Potential tariff impacts on certain industries, though portfolio is relatively insulated. - Monitoring nonaccrual positions and potential credit risks.

Q: It seems that there's a lot going on in terms of managing the liability stack, that all makes sense. Also noticed that you guys really leaned into the share repurchase this quarter. I wanted to just revisit that a bit. And I assume it looked like that stepped up with the discount to NAV increasing, I assume we should expect more of the same and also just wanted to confirm. It looks like you've got about half of the repurchase authorization left. Can you update us on that?

A: Yes, Melissa, thanks. It's Michael. Just on the buyback, as we've talked about in prior quarters, it's formulaic. It's a 10b5-1 program. We have subscribed to the accretion arguments, which we obviously benefited from modestly given your discount comment, a little bit more utilization in 2Q versus 1Q in light of the more elevated volatility following Liberation Day. We've got about 70% left. So call it $30 million of cumulative utilization in the first half of the year. We kind of size that program based on market precedent, but we think it's appropriately sized relative to the equity base.

Q: This is Cory Johnson on for Doug. In the press release, you just mentioned that one of the reasons for decrease in investment income from 1Q was a result of like lower base rates. I guess given that those cuts took place in 4Q, should we expect any further impact from those? And certainly, like how long does it take to run through the portfolio? Is it maybe about 2 quarters or so?

A: Yes, Cory, the residual impact was really in reference to some incremental spread compression we saw in the quarter. You'll see we quoted 4.75% for the weighted average of new capital deployed in the quarter relative to where it had been for the prior 9 months at plus or minus 500. The band in the current market kind of look at the pipeline is anywhere between 450 and 550 mathematically. Some modest tightening. We do think it has troughed in terms of the tightening we've seen in the market. Said differently, the 10 bps of asset yield compression you saw in the second quarter, that has started to diminish. We expect there to be stability. There's a convergence in kind of the back book asset yield and where the market is today. So as we think about NII and the kind of confidence we communicated around the $0.50 for 3Q and what the Board kind of talked about, maybe some modest residual impact in terms of that portfolio churn I just referenced. With new deals coming in at modestly tighter spreads than they're coming off. But you do have the offset in terms of standing to benefit from the actions we've done on the debt side, the refinancing on the unsecured, we'll get the full benefit of from -- in the third quarter, a little bit of leverage upside. You kind of add it all together in the blender, and we continue to be confident in the $0.50. I think it's attractive on a NAV basis when you consider the senior orientation of the portfolio. Going from there, back to your question on reference rates, tough to predict what the Fed is going to do. And that will obviously be a factor, ultimately, it's a Board decision. But for now, we're very good with the $0.50.

Q: So I just wanted to follow up with a quick one on tariffs. Do you have any update to what you have got -- even size tariff impact on now that we have some clarity on it?

A: Yes, Heli, thanks for the question. The -- we've continued to update that dynamic assessment of potential impacts, as Ashwin said. We do expect kind of direct impacts given the orientation domestically also towards the services businesses. We are overweight the market in that regard. We quoted in the first quarter potential for kind of low to mid-single digits direct impact. I think just more taking a step back on macro, it does feel like the economy continues to fight through. And some of that, I think, is understandable, considering that a lot of the tariffs initially rolled out were deferred. But the -- through the lens of the portfolio, some good resiliency. If you look at kind of revenue and EBITDA growth rates continue to be in a very good place quarter-over-quarter in the teens and mid- to high single digits, respectively. We are monitoring it, to be clear, not complacent about tariffs. We're looking at input costs. But based on the kind of conversations we're having with the sponsors and the underlying borrowers over the last few months, we continue to feel good about this posture around less direct impact continued to face the unknown around secondary impacts, but we think we're pretty well positioned.

Q: Yes. Just kind of wondering, with the recent management transition, you guys have a rather large investment. With Jeff's departure, I guess what -- how does the committee changed? And is there any kind of change in like the dynamic or anything from Jeff's prior on that?

A: Yes. Paul, thanks for the question. I think the headline, which you've heard before, and I think the market has generally validated, is business as usual, and that includes for -- from the perspective of the investment strategy. So as Ashwin alluded to, continues to be a focus that very top of the capital structure avoiding the cyclicals. And from an investment committee composition point of view, it's a deep committee. I think the follow-through comment on that just on the depth of the team, also kind of business as usual from the point of view of redundancy in sponsor coverage. But the makeup and the DNA of what we do, how we invest, how we screen, how we deploy capital remains unchanged. I don't want to steal Ashwin's thunder, but his kind of presence on that committee as co-head previously continues on naturally in this seamless transition.

Q: I'd appreciate all that. And one on just the new written nonaccrual this quarter for 48Forty. Just kind of wondering if you can maybe kind of provide some color on kind of where maybe that's at and in the stage of restructuring kind of that has the lender sort of support in the lender group to kind of move forward? Or is it still very early in the process there?

A: Yes, Paul, it's still a little fresh. I don't have a lot of precision on predicting when there's going to be a resolution there, rest assured that we're working with the other lenders and the sponsor for a swift as possible of a conclusion there. In the meantime, kind of monitoring the liquidity situation. But I think in totality, as we talked about, the -- it's a small, less than a handful that fall in that mix. We continue to feel very good about the health of the book, the composition of the 3s and 4s actually mathematically going down quarter-over-quarter. Ashwin talked a little bit about the other credit stats, but we feel very good. It's not to say that we couldn't get some macro headwinds here. But if you think about the underlying credit performance vis-a-vis LTV or the fundamentals vis-a-vis LTV leverage and what it's thrown off quarter-over-quarter in terms of declining PIK, growing interest coverage and then kind of the name by name, sector by sector health of the portfolio, we continue to feel very good about our positioning ahead of that potential macro uncertainty.