Q1 2024 Morgan Stanley Direct Lending Fund Earnings Call
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Okay.
Welcome to Morgan Stanley's direct lending funds first quarter 2024 earnings call. At this time all participants are in a listen only mode. A question and answer session will follow the prepared remarks as a reminder, this conference call is being recorded at this time I'd like to turn the call over to Michael <unk> head of Investor Relations.
And Chief administrative officer. Please go ahead.
Michael: Good morning, and welcome to Morgan Stanley direct lending funds first quarter 2024 earnings call.
Joining me are Jeff Levin, President and Chief Executive Officer, David <unk>, Chief Financial Officer.
Michael: MS Raunchy, Chief operating officer, and Rebecca Shaw head of portfolio management Morgan Stanley direct lending funds first quarter 2024 financial results were released yesterday after market close and can be accessed on the Investor Relations section of our website at Www Dot M. S. D. L. Dot com, we have arranged for a replay of today.
Michael: As events that will be accessible from the Morgan Stanley direct lending fund website. During this call I want to remind you that we may make forward looking statements based on current expectations. The statements on this call that are not purely historical are forward looking statements. These forward looking statements are not a guarantee of future performance and are subject to uncertainties.
And other factors that could cause actual results to differ materially from those expressed in the forward looking statements, including and without limitation market conditions uncertainty surrounding rising interest rates changing economic conditions and other factors, we have identified in our filings with the SEC.
Michael: Although we believe that the assumptions on which these forward looking statements are based are reasonable any of those assumptions can prove to be inaccurate and as a result, the forward looking statements based on those assumptions can be incorrect you should not place undue reliance on these forward looking statements. The forward looking statements contained on this call are made as of the date hereof.
We assume no obligation to update the forward looking statements or subsequent events to obtain copies of <unk> SEC related filings. Please visit our website with that I will now turn the call over to Jeff Leiden.
Thank you Michael and.
And thank you for joining us today for Morgan Stanley direct Lendings first quarter of 2024 conference call.
Proud of the strong results that we generated during the first quarter, our first as a public company.
We completed our IPO in January and I'd like to welcome our existing and new shareholders as well as members of the investment community who have been following the Morgan Stanley direct lending Fund story I'll first begin with an overview of our first quarter 2024 results before discussing our market outlook. Dave will then provide updates on our portfolio.
And comments on the financial results.
Our team delivered solid operating results for the first quarter supported by continued strong credit performance quarter.
Quarter end net asset value per share was unchanged from the prior quarter. Despite the dilution from the IPO and being comfortably below target leverage.
Michael: We generated net investment income per share well in excess of the 50 per share dividend that we declared for the quarter.
For the first quarter, new investment commitments totaled approximately $232 million and 30 portfolio companies.
We remain confident in our ability to reestablish leverage back within our target range over the coming quarters as previously communicated during our last earnings call.
I would also highlight that we believe the quality of our origination activity remained high and we served as the lead or joint lead arranger on about 80% of Morgan Stanley direct lending new platform originations during the first quarter.
We believe this showcases our ever increasing presence in the marketplace and private equity firms preference for us as a partner.
We believe sponsors want to work with us not just because of the extensive experience of our investment team, but also due to the strategic benefits that come with partnering with Morgan Stanley and that this structure is unique in the direct lending ecosystem and we will continue to differentiate us as investors.
<unk> continues to be highly focused on delivering value for our shareholders. We believe that the combination of relatively low expenses, a thoughtful fee structure and our defensive investment strategy will help drive shareholder value.
Turning now to the market outlook, we believe that the direct lending market environment remains highly attractive providing strong risk adjusted returns for our investors gross asset yields remain elevated in credit has continued to perform well deal flow has been resilient and we believe is poised to accelerate.
Year to date, we've generally witnessed a continuation of the risk on and tell them that emerge in late 2023, driven by a more reassuring economic outlook and signals that the fed may shift course.
Well those interest rate cuts may now be delayed we believe the prevailing economic trends persist.
The U S economy has been resilient throughout this inflationary environment, we think the strong performance of our middle market borrower base as an extension of that in terms of the ability to withstand elevated interest costs that are accruing to the benefit of our investors. We are not complacent about the ongoing geopolitical and macroeconomic uncertainty, but we like our defense.
<unk> positioning in the market focused at the top of the capital structure and avoiding the deeply cyclicals.
Michael: Regarding deal activity with confidence on our last earnings call that we will see increased fuel volumes with visible green shoots in the M&A market as the year progresses.
While financing volumes from new middle market leverage buyouts remain subdued in the first quarter pipelines are starting to build and we remain optimistic that activity may accelerate with more visibility on the trajectory for interest rates.
Private equity sponsors are sitting on record levels of dry powder and they are motivated to put that capital to work.
The fact that debt financing is abundant as well both in terms of private debt capital as well as due to the fact that the broadly syndicated loan markets functioning could serve as another catalyst to help jumpstart sponsor related M&A activity.
We believe our nimble lending approach to borrowers up and down the size spectrum enhances our ability to continue to capitalize on opportunities as they present themselves in the coming quarters with that I would like to hand, the call over to David who will provide details on Morgan Stanley direct lending funds portfolio investment activity and financial results.
Thank you, Jeff starting with our portfolio. We ended the first quarter with a total portfolio at fair value of $3 3 billion, which is comprised of 95% first lien debt, 4% second lien debt and then the remainder in equity and other investments.
As of March 31, we had investments in 178 portfolio companies spanning across 31 industries with nearly 100% of our investments and floating rate debt. Our two largest industry exposures remain in insurance services and software, which accounted for 15, 1% and 14, 8%.
Portfolio at fair value, respectively. The average position size of our investments was approximately $18 5 million.
Or <unk>, 6% of our total portfolio on a fair value basis.
Further our top 10 portfolio companies, representing approximately 20% of fair value of the total portfolio.
We believe that our portfolio diversification, including by loan size in the industry is a significant risk mitigation tool that is further insulated by the fact that we look to maintain diversity by selectively targeting non cyclical industries, while preserving low borrower concentration.
At the end of the first quarter, our weighted average loan to value was 43% and a weighted average EBITDA of our portfolio of companies was $155 million. Additionally, the median EBITDA of our portfolio of companies was $82 million.
As of March 31, our weighted average yield on debt and income producing investments was 12% at fair value and $11 nine at cost.
With respect to our return on risk weighted as of March 31, 2024 over 98% of our total portfolio had an internal risk rating of two or better which is unchanged relative to the December 31 2023 period.
Additionally, we had three investments on nonaccrual status, representing approximately $12 4 million or 40 basis points of the portfolio at cost, which is down from 60 basis points as of December 31, 2023 of the three investments there was one new investment and placed on non accrual status, which was a first lien position in matrix parent or <unk>.
Second lien tranche and major Exterran was placed on nonaccrual status last quarter.
There was one investment removed from non accrual status that being bottom in black which was restructured in the current quarter.
Michael: Our investment activity in the first quarter, our team made new investment commitments of approximately $232 million in nine new portfolio companies and 21 existing portfolio companies across 14 industries.
<unk> fundings totaled $168 4 million with $71 7 million in repayments, which included full repayments from three portfolio companies for net funded investment activity of $96 7 million.
Turning to our financial results for the first quarter. Our total investment income was $99 1 million for the first quarter as compared to $100 8 million in the prior quarter. The slight decrease was driven by a reduction in nonrecurring repayment related income Pik income continues to remain relatively low amounted to only 3%.
Total investment income.
Net investment income for the first quarter was $54 7 million or <unk> 63 per share compared to $55 5 million or 67 per share from the prior quarter.
Total expenses for the first quarter of 2024 were $44 5 million compared to $45 3 million in the prior quarter.
As a reminder, we have instituted a partial labor of our management and income based incentive fees in connection with our IPO commencing on January 24, 2024 through January 24 2025.
For the first quarter ended March 31, 2024, the net change in unrealized gains was $2 7 million offset by realized losses of $5 6 million.
The realized losses for the period was a result of three portfolio companies that were restructured during the period.
At the end of March 31, total assets were $3 4 billion and total net assets was $1 8 billion, our ending NAV per share for the first quarter remained unchanged at $20 67.
Our core earnings in excess of our dividend fully offset the dilution from our IPO and unrealized and realized activity our supplemental materials for this call provide a full quarter over quarter and average on slide 14 that illustrates these changes.
Michael: At the end of the first quarter, our debt to equity ratio was <unk> eight one times compared to $8 seven times as of December 31, 2023 in conjunction with our IPO. The initial proceeds were used to pay down a portion of our existing debt obligations with our available dry powder, we plan to remain active in the current investment.
And expect to achieve our target leverage of one to 125 times over the coming quarters, although that likely won't be linear.
As of March 31, approximately 47% of our funded debt was in the form of unsecured notes with well latter maturities ranging from 2025 to 2027.
Subsequent to quarter end, our available liquidity was further enhanced as we successfully executed an extension of our secured revolving credit facility from January 2028 to April 2029.
Increasing our total commitments for 112 billion to $1 3 billion by maintaining or growing our financing relationships, all while preserving our attractive pricing.
We remain pleased with our debt capital stack and we'll continue to strategically evaluate opportunities to further diversify our sources of leverage.
Last our board of directors declared a regular distribution for the second quarter of <unk> 50 per share to shareholders of record on June 28, 2024, which is consistent with our first quarter 2024 dividend.
Our estimated spillover net investment income is $52 1 million or <unk> 59 on a per share basis, which provides continued stability for our consistent regular distributions.
As a reminder, with our IPO earlier this year, our board of directors declared to <unk> special dividends to be paid on October 25, 2024, and January 27 2025, respectively.
Speaker Change: Operator, please open the line for questions.
Thank you.
If you would like to ask a question. Please signal by pressing star one on your telephone keypad. If you are using a speaker phone. Please make sure. Your mute function is turned off to allow your signal to retire equipment again press star one to ask a question.
Well pause for just a moment to allow everyone an opportunity to signal.
Okay.
Speaker Change: Okay.
Yeah.
And we can go with our first question from Robert Dodd with Raymond James.
Hi, guys congratulations on the quarter.
A question Jeff.
The green shoots and hopes for acceleration activity et cetera.
Along with these metrics.
Record dry powder for P firms et cetera, that's been true for a while.
Initial bill.
The M&A pipeline.
Speaker Change: Truthfully this time last year.
We've heard these things before.
Speaker Change: It hasn't manifested itself, partly why you see.
Why is your confidence higher now.
Speaker Change: Given that many of the themes have been Lp's capital back as well that's been I think the two years at this point so.
Speaker Change: What is the confidence high today.
Yeah sure. Thanks for the question. This is Jeff I think it's a few things.
Jeff: The first would be that the marketplace private equity the loan market. The private credit market has now been living in this elevated rate environment for longer.
We've been living with macroeconomic uncertainty geopolitical.
<unk> as well for a decent period of time now.
And businesses.
Generally speaking had been performing well.
Jeff: Across the market and so I think thats that as more time passes I think that will continue to give private equity owners.
Increased conviction in terms of transacting how.
How long will there be.
Jeff: Relatively wide bid ask spread so to speak in terms of what sellers are looking for.
Further our existing assets and what buyers are willing to pay only time will tell the clock does tick of course on private equity capital and so as time goes by those investment periods. They shorten.
Jeff: So I think it's a confluence of all those factors Robert we have seen an uptick.
And pipelines over the last several weeks.
Jeff: March was a busier months in January and February were so generally speaking.
Jeff: That's the trend that we're seeing real time in terms of what that ultimately means and how the rest of the year plays out only time will tell.
Got it got it I appreciate it all on one of the things Thats been true as well in the last few weeks, including in this quarter a lot of follow on activity.
The advantage of being an incumbent lender.
Is that.
Expected to stay.
Jeff: Elevated pool.
Some of this activity.
Jeff: Quick quick companies, taking the opportunity to acquire even more.
Or do you expect more to expect.
So over the next 12 months to shift back to somewhat towards more new platform deals.
Speaker Change: Yeah, that's a great question.
I think in the absence of.
LBO volume, increasing pretty substantially I think we will continue to see.
Incremental facility add ons to to fund acquisitions by existing portfolio companies with sponsors.
As they try and create value with what they have versus versus paying up for new platforms.
So I do think that trend will continue.
Our 200 plus portfolio companies across our private credit platform here, obviously is a significant asset to us.
The existing portfolio is also an asset to us away from the incremental financings, but also should LBO activity pick up.
Speaker Change: And there will be change of control across an increased number of the portfolio given the origination we have and the reach that we have with the private equity community.
From our dedicated team here of about 60 people dedicated to private credit in the U S as well as obviously the broader institution given the reach of the sell side of the firm notably.
Financial sponsor coverage group in the leveraged finance business here.
We think we're well positioned in either environment frankly, the beauty of having a portfolio of that size and scale is these are assets that we know inside and out and so there may be certain assets that we want to continue to hold in a change of control environment. There may be certain assets that were great performers over the last three or four years, but we don't necessarily think will be a position we will.
On a hold to a contractual six or seven year maturity in the future and so.
Getting back to the investment mindset that we have as we deploy capital we think we're really well positioned here for those reasons.
Got it I appreciate that color one more if I can on the credit quality side obviously.
It goes down some restructuring.
You waited for assets zero again now.
Credit quality looks really robust.
Uh huh.
Emerging signs of the portfolio any industry.
Incrementally, becoming more worried about that don't seem to be a lot.
Issue industries or credits in the portfolio.
Yeah, No I think you're I think you're spot on generally speaking I'd say no the issues in the portfolio, which as you probably noted have been exceptionally are few and far between in total dollar quantities have been.
Effectively de Minimis.
More idiosyncratic.
Two sectors were the longest by design software and insurance brokers continue to perform really well.
As it stands today, we feel really good about the quality of our portfolio. It's obviously almost entirely first lien credit risk loan to value of 40% to 45%. We've avoided a deeply cyclical is intentionally the book is extraordinarily well diversified both by company by sector by sponsor so from.
Credit standpoint, we feel really good about where we are and we will use the dry powder that we have within our financing lines to continue to invest in new deals, where we find the optimal risk adjusted return.
Got it thank you.
Yes.
Our next question comes from Melissa Wedel with JP Morgan.
Good morning, Thanks for taking my question.
Wanted to start with.
Following on some of the things that we've heard across the space. There. It seems there has been some.
Proactive repricing on some investments, particularly outperformers and portfolios, where they might have other options.
So market is opened up I'm curious, how you're thinking about that are you seeing any of those opportunities in the portfolio is that something youre spending samira.
Samira: Yes, that's a great question.
Yes, it's certainly no secret that the syndicated loan market.
Has become extraordinarily strong and is a I'd say a significant competitive threat to the largest end of the private credit market.
So the businesses that have access to the syndicated loan market now of course are actively contemplating what the right product is I think private credit from a macro standpoint, we will continue to grow over time irrespective of the health of the public credit markets for a lot of the reasons why businesses of all sizes, including <unk>.
<unk> do use private credit, but repricing volume.
Unquestionably has picked up in Q1 I think it will continue to over the course of the year, assuming the public markets stay as healthy as they are today and maybe they tightened further who knows.
That's something that we're watching closely.
One way that we're somewhat well positioned relative to some of our competitors is that our.
Our portfolio does span up and down the size spectrum. So there are plenty of businesses in our portfolio that are not candidates for the public markets. Those are the those are the deals that would be most prone to repricing, but we are seeing repricing up and down the size, but its satisfactory, but it's generally geared towards the highest end of the market.
And from a in terms of where that how that plays out over the course of the year I do think it will continue I think.
We are constant dialogue with the borrowers and private equity owners within our portfolio.
In that regard I also think.
Back in 2023, when the market was deploying capital Sofa $625 650, 675, I think the market generally had a feeling that that was not necessarily sustainable if rates were going to stay higher for longer that seems to be consensus now obviously, so even as spreads have tightened a bit here the ole.
Overall, the all in return profile in yield that we're able to generate even with the tightening we still think is very attractive given the risk that we're taking.
Okay. That's helpful.
Touched on my follow up question, which is around spread compression and we definitely heard there is.
Ben.
More spread compression in the upper middle market in particular, where BSO is more of an option.
But not necessarily as much spread tightening in sort of the core middle market as you look across your pipeline and opportunity set I am wondering if youre seeing that as well.
The core middle market opportunities are a little bit more attractive to you.
Environment with spreads being where they are in.
If thats the case would that impact do you think sort of the scaling our portfolio elaborate and how long it takes to sort of get to your target.
Speaker Change: Thanks, So much yes, yes, great question so the.
The capital that we invested over the first before during the first quarter was generally in line with the broader portfolio characteristics. So weighted average EBITDA of about $100 million.
Median EBITDA in the $60 million range, which is consistent with the broader business. We have here median EBITDA has generally been in the $60 million to $70 million range and then it's larger than that today because these business have generally grown.
In terms of where we see value, it's up and down the spectrum frankly.
One of the benefits of our origination footprint recover about 400 buyout funds across our team close coordination with the investment bank here as well and so there are the sponsors that we cover are truly up and down the size spectrum. If I look at our first quarter of deployment, it's really sponsors of all sizes Thoma Bravo.
On the high end Charles banking your core middle market sponsor Summit partners Harvest partners Vista, It is really up and down the size spectrum.
And that's one of the things that we like about our platform, which is we're not boxed into one part of the market. We don't have to live by deploying capital at the highest end of the market. We don't we certainly don't live in the lower middle market as well and so we do we'll toggle up and down the size spectrum based on where we see value and risk return in every deal.
Really structured.
Based on the based on the merits of considerations within that specific opportunity generally speaking, though the loan to value has been 40% to 45% as we mentioned earlier, we led or co led about 80% of the deals that we did in the quarter, we led or co led all of the <unk> that we did in the quarter. So.
Again, our leadership position in the market continues to improve.
An increase frankly, given the increased scale of our broader private credit business in terms of when we get to target leverage over the next few quarters, we would expect to accomplish that.
Is it in Q2 Q3 or Q4 I.
Frankly don't know I'm not worried at all though Melissa about our ability to deploy capital really well, we certainly have an extraordinarily strong origination engine here, but we've tried to balance that of course with with investing and what we see is the highest quality opportunities.
I always tell the team it's easy to make alone we could get the target leverage really quickly if we widened out a risk aperture.
Speaker Change: Or took larger positions, but we really are going to continue to stick to our defensive strategy be highly selective.
The hold sizes, we are big believers in diversification as a critical risk management tool. So I have a lot of conviction that we'll certainly get to our target leverage multiple TBD exactly when but we feel really good about the quality of the book right now our ability to deploy the capital that we have.
And the footprint that we have within the private equity ecosystem.
That's really helpful. I appreciate the information thank you.
And before we go to our next question I'll reminder, to our audience that is star one to join the queue.
Our next question comes from Paul Johnson with <unk>.
Hey, good morning, Thanks for taking my questions.
No what I was going to ask you pretty much answered.
Was this question.
But kind of ask it maybe a little bit of a different way at a high level.
You guys are generating a 12% Roe.
The waivers today.
Speaker Change: Yes.
How do you feel about.
Speaker Change: Operating leverage.
Low <unk>.
Patiently sort of.
Waiting to kind of get up into that range I guess.
How do you feel about kind of the sense of urgency I guess into that range that youre already generating pretty pretty solid Roe today.
Yes, I'll go first and then Dave feel free to opine as well.
We're not in a rush to do anything frankly accept.
Monitor the book really closely work with the sponsors and the companies to make sure that we have our arms around the performance of the credits.
They were providing capital for incremental deals when they do them both add on facilities as well as new platforms.
But we're not in a rush at all.
To get to target leverage for the sake of getting to target leverage I think it will happen very naturally for us, though just given the quality of our sourcing footprint.
The size of our existing portfolio.
And but we're not we're not in a rush I think the.
The $64000 question in terms of when we get there, we'll probably just be what our repayments look like over the course of the year and of course, no. One has a crystal ball, we can make certain assumptions, but.
We feel really good about our ability to get to target leverage over the next few quarters.
And I'll hand, it over to Dave.
Yes.
Add.
Operating at where we are today at eight one times levered.
Still significantly out, earning our regular distribution in this quarter in particular it was a 13th.
Over our regular distribution in our core NII, our NII, we feel pretty confident about as well. Our total investment income is primarily all interest paying coupons at the top we're not reliant on nonrecurring income there. So the ability to maintain our steady state NII in excess of our dividend, we feel pretty good about and then.
Obviously as Jeff mentioned.
As we look to ramp the portfolio, it's only going to further bolster what are what our core NII earnings power ultimately is.
Great. Thanks for that and then can you just.
Speaker Change: Remind us how much of the remaining.
Lockouts are set to expire.
The private shareholders.
Yeah.
Yes, good question Theres three equal installments.
All to transpire.
Speaker Change: Danny.
In July October of this year with the final installment in January 25.
Speaker Change: Okay. Thanks I appreciate it that's all for me.
Thank you one more reminder, to our audience star one to join the queue.
And we'll go to our next question from the loss Abraham with UBS.
Hey, everybody. Thanks for the question.
Can you update us on your latest thoughts just on the dividend payout and how youre thinking about.
Later, this year with potential special distributions.
Yes, great question.
Q1, and now Q2 with the board Declaration that we just announced a regular distribution has been <unk>.
Speaker Change: I think we're ultimately trying to stick to maintaining that regulate distribution in the coming quarters as well.
In the prepared remarks, we also highlighted that we do have two special dividends at the tail end of this year.
200 <unk>.
Dividend, so ultimately that that would be now looking at $2 20, and ultimate dividends that we're projecting for the current period.
Likely what we normally do we'll assess at the end of the year, what our excess spillover is at that point in time and to the extent that it makes sense that we have.
Speaker Change: Ample spillover into the following year, we will evaluate the need for a special.
Speaker Change: Okay, Great that's helpful. Thanks.
And then just one of the other teams I guess.
With this earning season has it been.
CLO issuance and just right side of the balance sheet.
Being diversified in that way.
Several bdcs have you guys.
Thought about that looked at that.
Anything there would be helpful.
Yes.
Absolutely.
Have a.
As you would expect frankly, a robust liability management practice here within our private credit business, we have a team dedicated to managing the liability side of our.
Our business here, both within this pool of capital as well as more broadly.
So maintaining highly diversified funding sources.
Both by source of capital as well as type of capital. So as you know within this capital structure, we have several different types of borrowing lines.
CLO technology.
And utilizing that is something that we absolutely have considered and will continue to we haven't yet as you noted.
We certainly may in the future. If we think it makes sense to layered into the liability side of our funding sources, but we havent yet.
But it's not because we don't have the institutional knowledge and insight here in terms of the merits of it obviously, but thats something that is under consideration along with of course, a handful of other <unk>.
Considerations on the liability side as well, David anything you'd add to that.
Okay. Thank you.
Okay.
Thank you at this time I would like to turn the call back to Jeff Weber for closing remarks.
Thank you.
On behalf of the management team greatly appreciate your interest and in support of the Morgan Stanley direct lending fund here, we remain pleased with our progress and believe that we are well positioned to generate strong risk adjusted returns for our investors as market trends evolve and we look forward to providing an update on our second quarter 2024.
Our earnings call in August.
Yes.
Okay.
Speaker Change: Okay.
This concludes today's call. Thank you for your participation you may now disconnect.
Yeah.
Speaker Change: [music].
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Speaker Change: Okay.
Okay.
Sure.