Q3 2024 Morgan Stanley Direct Lending Fund Earnings Call
Please stand by.
Welcome to the Morgan Stanley Direct Lending Fund's 3rd 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 Osi, Head of Investor Relations and Chief Administrative Officer. Please go ahead.
Michael Osi: Good morning, and welcome to Morgan Stanley Direct Lending Fund's 3rd Quarter 2024 Earnings Call. Joining me this morning are Jeff Levin, President and Chief Executive Officer, David Pesa, Chief Financial Officer, and Rebecca Shaul, Head of Portfolio Management.
Michael Osi: Morgan Stanley Direct Lending Fund's third quarter 2024 financial results were released yesterday after market closed and can be accessed on the investor relations section of our website at www.msdl.com. We have arranged for a replay of today's event that will be accessible from the Morgan Stanley Direct Lending Fund website.
Michael Osi: During this call, I want to remind you that we may make forward-looking statements based on current expectations.
Michael Osi: 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.
Michael Osi: and are subject to uncertainties and other factors that could cause actual results to differ materially from those expressed in the forward-looking statements.
Michael Osi: including, and without limitation, market conditions, uncertainty surrounding interest rates, changing economic conditions, and other factors we have identified in our filings with the SEC.
Michael Osi: 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.
Michael Osi: The forward-looking statements contained on this call are made of, as of the date hereof, and we assume no obligation to update the forward-looking statements or subsequent events. To obtain copies of SEC-related filings, please visit our website. With that, I will now turn the call over to Jeff Levin.
Jeff Levin: Thank you, Michael. Thank you for joining us today for Morgan Stanley Direct Lending's third quarter 2024 conference call.
Jeff Levin: We are proud of the strong results that we generated during the quarter. I will first begin with an overview of our performance in the quarter before discussing our market outlook. Dave will then provide updates on our portfolio and comment on the financial results.
Jeff Levin: Our team delivered portfolio growth and solid operating results for the third quarter, supported by strong credit performance.
Jeff Levin: At $20.83, that asset value per share was unchanged quarter over quarter.
Jeff Levin: We generated net investment income of $0.66 per share, an increase from the $0.63 per share of net investment income earned in the second quarter, and comfortably in excess of the $0.50 per share regular dividend we declared for the quarter, combined with a $0.10 special dividend.
Jeff Levin: Recall that the latter had been declared by the Board of Directors around the time of the IPO and was paid to shareholders of record as of August 5, 2024.
Jeff Levin: For the third quarter, new investment commitments told approximately $455 million in 37 portfolio companies.
Jeff Levin: Net funded deployment for the quarter was $124 million as compared with $210 million in the second quarter.
Jeff Levin: During the quarter, MSDL's debt to NAV increased from 0.9 times to 0.99 times, which is effectively at the low end of our 1 to 1.25 target leverage range. I'm proud to say that we accomplished that without stretching on credit.
Jeff Levin: Our deployment activity in the quarter showcased once again our ability to leverage our unique origination engine to drive quality deal flow. During the third quarter, we led or co-led approximately 90% of the new borrowers added to MSDL's portfolio.
Jeff Levin: We believe sponsors are drawn to the quality of our team and our ability to be a value-add partner given the broader Morgan Stanley platform we are a part of. In our view, these deals continue to be favorable from a credit perspective when you consider the leverage and loan-to-value profiles, among other attributes.
That's a good segue to the market outlook.
Jeff Levin: A resilient backdrop has defined the first nine months of 2024, marked by strong economic outperformance against the backdrop of a potential soft landing and anticipated policy easing.
Jeff Levin: The Federal Reserve's 50 basis point rate cut in September spurred market optimism, followed more than a year of base rates in excess of 5%.
Jeff Levin: While we believe that base rates will trend modestly lower, gross asset yields are likely to continue to remain elevated, offering attractive opportunities for us, particularly when risk adjusted.
Jeff Levin: Credit performance has continued to be solid, which we believe is a reflection of the resilience of the middle market economy.
Jeff Levin: Regarding deal activity, we view the capital market rebound as firmly on track with sponsor M&A likely to accelerate into 2025 as we emerge from the U.S. election and gain more visibility on the direction for interest rates.
Jeff Levin: We see a growing desire for private equity firms and other asset owners to transact due to LP dynamics and generally more conducive private and public financing markets. We expect that sponsors are increasingly likely to deploy capital which we believe will create lending opportunities for us.
Jeff Levin: As the market environment evolves, we believe MSDL differentiation among direct lenders will continue to come into full focus.
Jeff Levin: Since our IPO in January, we've highlighted the clear benefits of our ability to leverage the broader Morgan Stanley platform.
Jeff Levin: Our breadth and depth of sponsor relationships allows us to see a vast range of deal flow and that deal flow grossly exceeds our capital base, which breeds selectivity and flexibility.
Jeff Levin: We think that this supply-demand imbalance will continue to serve as a key competitive advantage. We look forward to continuing to source and underwrite lending opportunities that offer strong risk-adjusted returns and, in turn, create value for MSDL shareholders.
Speaker Change: With that, I would like to hand the call over to David who will provide details on Morgan Stanley Direct Lending Fund's portfolio, investment activity, and financial results.
David Pesa: Thank you, Jeff. Starting with our portfolio, we ended the third quarter with a total portfolio at fair value of $3.6 billion, which was comprised of 96% first lien debt, 2% second lien debt, and the remainder in equity and other investments.
David Pesa: As of September 30th, we had investments in 200 portfolio companies spanning across 33 industries with nearly 100% of our investments in floating rate debt.
David Pesa: Our two largest industry exposures remain in software and insurance services, which accounted for 17.7% and 12.6% of the portfolio at fair value, respectively.
David Pesa: The average position size of our investments was approximately 18.2 million or approximately 50 basis points of our total portfolio on a fair value basis. Further, our top 10 portfolio companies represented approximately 17% at fair value of the total portfolio.
David Pesa: At the end of the third quarter, our weighted average loan to value was approximately 40% and the weighted average EBITDA of our portfolio companies was 145 million and the median EBITDA was approximately 85 million.
David Pesa: As of September 30th, our weighted average yield on debt and income produced in investments was 11% at both fair value and cost.
David Pesa: Turning to credit quality, over 98% of our total portfolio had an internal risk rating of 2 or better, which is relatively unchanged from the second quarter.
David Pesa: During the quarter, our first lien investment in Matrix Parent was restructured into first lien debt and common equity and was subsequently restored to accrual status.
David Pesa: As of September 30th, we had investments in two portfolio companies on non-accrual status, which represents 8.1 million or 20 basis points of the portfolio at cost.
David Pesa: For our investment activity in the third quarter, we made new investment commitments of approximately $455 million in 19 new portfolio companies and 18 existing portfolio companies across nine industries.
David Pesa: Investment fund has totaled $377 million with $253 million in repayments for net funded investment activity of $124 million.
David Pesa: Turning to our financial results for the third quarter, our total investment income was $110 million for the third quarter as compared to $104.2 million at the prior quarter. The increase was driven by recurrent interest income from deployment and repayment-related income.
David Pesa: PIC income continues to remain relatively low, amounted to only 2% of total investment income. Net investment income for the third quarter was $58.7 million or $0.66 per share compared to $56.1 million or $0.63 per share from the prior quarter.
David Pesa: Total net expenses for the third quarter was $51 million compared to $48.1 million in the prior quarter.
David Pesa: As you may recall, we have instituted an incentive fee cap associated with realized capital gains and losses over a trial period.
David Pesa: With the restructuring of the Matrix Parent, we were limited to our total amount of incentive fees earned, which we believe highlights a strong alignment of interest between us and our shareholders.
David Pesa: For the third quarter, the net change in unrealized gains was $5.4 million, which includes the reversal of the unrealized depreciation from the restructuring of Matrix Parent, offset by net realized losses of $11 million.
David Pesa: As of September 30th, total assets were $3.8 billion and total net assets was $1.85 billion. Our ending NAV per share for the third quarter remained unchanged at $20.83.
David Pesa: At the end of the third quarter, our debt-to-equity ratio was 0.99 times compared to 0.90 times as of the previous quarter, which was driven by our continued deployment throughout this year.
David Pesa: As of September 30th, approximately 57% of our funded debt was in the form of unsecured notes with well-louded maturities ranging from 2025 to 2029.
David Pesa: During the quarter, we executed an extension and repricing of our BNP facility from S2.85% to S2.25%. We continue to remain pleased with our debt capital stack and will continue to strategically evaluate opportunities to further diversify our sources of leverage.
David Pesa: Focusing now on our distributions, our Board of Directors declared a regular distribution for the fourth quarter of $0.50 per share to shareholders of record on December 31, 2024.
David Pesa: Our estimated spillover net investment income is $69 million or $0.77, which continues to provide stability for a consistent regular distribution in a potential decline in rate environment. And lastly, our second $0.10 special dividend that Jeff mentioned earlier will be paid in January 2025.
With that, operator, please open the line for questions.
Speaker Change: Thank you. If you would like to signal with questions, please press star 1 on your touchtone telephone. If you're joining us today using a speakerphone, please make sure your mute function is turned off to allow your signal to reach our equipment. Again, that will be star 1 if you would like to signal with questions.
Speaker Change: And the first question today comes from Sean Paul Adams with Raymond James.
Good morning. Regarding the activity outlook,
Speaker Change: What are your guys' thoughts towards Originations for 2025? Do you think it's going to be front-end loaded in the first half or a little bit lumpy with it kind of picking up towards the 4th quarter of 2025?
Jeff Levin: Yeah, this is Jeff. Great question and thank you for it.
Jeff Levin: I'd say really hard to predict, you know, the deal flow can be somewhat lumpy in any given calendar year. I think there's natural tailwinds now.
Jeff Levin: deal flow in general with regards to a little bit more clarity regarding the rate environment with rates coming down but the election now behind us
Thank you.
And then the just the shot clock
Speaker Change: that exists within private equity capital, right? With every passing quarter, there's one quarter less that private equity firms have to invest.
Speaker Change: And I don't believe that they will end up returning the capital to their LPs. I think they will find ways to invest it. Of course, the bid-ask spread between buyers and sellers needs to narrow.
Speaker Change: for us to see deal flow pick up pretty meaningfully. But I do believe that 25 will be a better year. Like I said, hard to predict.
Speaker Change: Pipelines are better than they were, say, earlier in 2024, but there's just so much money sitting on the sideline right now that I do think will be invested, which is a great tailwind for 25 and both 26 as well, I think.
Speaker Change: But I think also, you know, if you look at our, at least the first three quarters of this year.
Speaker Change: you know, in light of a market where LBO volumes were quite modest.
Speaker Change: You know, we really didn't have an issue finding really good ways to deploy capital without stretching on risk.
And I think that speaks to the quality of.
not just our direct origination team.
Speaker Change: Within our business and so as a reminder we have about 75 people
dedicated.
to private credit in the U.S. here.
Speaker Change: with a meaningful subset of that focused on deal sourcing, but also we're a direct beneficiary of the fact that
Speaker Change: There is no other direct lending investment business within Morgan's family in the U.S. It's just us.
the way we collaborate with the institution to optimize.
Deal flow
Speaker Change: and then be really selective in terms of how we invest. We are firm believers.
that because of the size of our institution.
we're getting the benefit of.
a lot more origination power.
Speaker Change: effectively anyone else in the private credit space in the U.S., and so we feel really good about obviously the first three quarters of the year deploying capital despite the backdrop of LBO volume being down.
Speaker Change: and good tailwinds for the future. I also think the sheer size of our portfolio.
Speaker Change: with across our platform upwards of close to 300 names now.
Speaker Change: very helpful as those businesses either trade from sponsor to sponsor as volume picks up or as portfolio companies or sponsors need incremental financing for bulletin acquisition. So hopefully that's helpful.
Speaker Change: Thank you for all that clarity and I appreciate you going into such deep detail. I appreciate it.
Speaker Change: And our next question will come from Melissa Weddle with JP Morgan.
Speaker Change: Good morning. Thanks for taking my questions. I wanted to just start with the portfolio yield. Certainly, it looks like that moved a bit lower, certainly more than base rates would.
Speaker Change: drive organically. I'm wondering if you're seeing sort of elevated refinancing in the portfolio and if that's how you're approaching those opportunities and what outlook you have on the refinancing landscape going forward. Thank you.
Jeff Levin: Yeah, sure. It's Jeff. I'll start, and then maybe Dave, I'll hand it over to you. And thanks for the question, Melissa.
Jeff Levin: You know, I think the in general I'd say the backdrop on just
The market right now is
Just to give you a sense, it does feel like.
Jeff Levin: So the repricing activity has definitely slowed, and we saw that quarter over quarter from Q3 versus Q4.
Jeff Levin: Q2, which is good, obviously. And then I also think there was a period in 2024 where it felt like spreads were getting tighter, started to see more deals get done at the 475 level, some deals getting done at 450.
Jeff Levin: It feels like that tightening has really subsided as well, and we're in more of a SOFR plus 500 or so market today. TBD would spread due over the course of the year, over the course of the rest of this year into next year, given what is expected to happen with SOFR.
Speaker Change: But I think in terms of the pressure on new deal spreads and repricings, that does feel like it's subsided quite a bit. And Dave, maybe provide some color in terms of how we, in terms of the yield compression in the portfolio. Yes. So our yield quarter over quarter went down 60%.
Speaker Change: basis points. Majority of that was due to what Jeff just alluded to before, the impact of repricing of deals and incrementals, and then also the impact of the rate cut of the
basis points within the quarter.
Thank you. Okay. Thank you. Bye bye.
Speaker Change: You've mentioned the spillover income as well, that's always helpful to get an update on, so thank you for that.
Speaker Change: Going forward, you know, I think there's a lot of debate around what the interest rate environment will be and how quickly rates decline.
Speaker Change: and at what magnitude, but it does seem like you are well-situated to continue out earning that base dividend. As you head into 25, how are you thinking about excess earnings and dividend policy? Thank you.
Speaker Change: Yeah, and thank you for the question as quickly just our base dividends remain well covered as you mentioned It was 132 percent coverage for the given quarter
Speaker Change: I mentioned on the script, it was $0.77 of spillover. We do have that $0.10 special dividend from the IPO in the fourth quarter, so it's really spillover about $0.67.
Speaker Change: We look to maintain around one full quarter's worth of spillover, and given our levels today, I think this provides us with cushion to navigate, as you mentioned, the rate environment ahead.
Speaker Change: It really depends on the velocity of rate decreases, and we'll assess the need for supplemental dividends headed into 25. All in all, I think that provides us with a continuous stability going forward of our core dividend of 50 cents.
Thank you.
Speaker Change: As a reminder, if you would like to signal with questions, please press star 1 on your touchtone telephone. Again, that is star 1 if you would like to ask questions today.
Speaker Change: And our next question will come from Paul Johnson with KBW.
Paul Johnson: Yeah, thanks. Good morning. Thanks for taking my questions. So just curious, you know, how has
Paul Johnson: of LTV ratios, you know, leverage, how has that trended in any of the new deals that you've seen? Maybe kind of putting repricings aside, you know, versus kind of what's in the pipeline. Have LTVs remained pretty low as they've been or have you started to see that creep up?
Yeah, great question.
I'd say it's been quite stable.
Paul Johnson: We haven't seen all that much movement over the, you know, quarter over quarter in terms of LTVs and leverage ratios, I think.
Paul Johnson: You know, what's been happening is, in the LBO market at least,
Paul Johnson: It feels like it's been, I'll call it flight to quality, so good businesses have been trading for very full enterprise values, so LTVs continue to be quite modest.
Paul Johnson: So I think and you know as we underwrite credit now
And I think this applies to...
Paul Johnson: You know, the competitive landscape as well, it's with a real eye towards conservatism in terms of...
how much debt to put on these companies because
You know, it's eyes wide open now versus.
Paul Johnson: A few years ago when rates were zero, I don't think anybody expected rates to spike to 5%. We all run downside case models, of course, that assume a spike in interest rates to make sure the companies can support the debt. But in this environment, given what we saw rates do and rates continue to be high, even if the SOFR curve, the forward curve, is accurate,
Paul Johnson: we're still going to be in an elevated SOFR environment relative to the last several years.
Paul Johnson: We're really conservative at the asset level in terms of our selection and how we structure these businesses.
Paul Johnson: But I'd say not not much movement. I'd say the LTV Continues to be around 40% on average. I'd say the goal posts
Paul Johnson: anywhere between 25 and 50 percent but the vast majority of deals are hovering around that 40 percent or so and the enterprise value multiples continues to be very full.
Speaker Change: Thanks for that, I appreciate the answer, that's all for me.
Speaker Change: And once again, if you would like to signal with questions, please press star 1 on your touchtone telephone. Again, star 1 if you would like to signal. And our next question comes from Kenneth Lee with RBC Capital Markets.
Hey, good morning. Thanks for taking my question.
in terms of your near-term outlook for potential.
Speaker Change: originations, you know, what are you seeing in your pipeline, any particular attractive sectors that you're looking at there, and could you see some shifts in terms of your sector allocation within your portfolio? Thanks.
Sure. Thanks for the question.
The, as I mentioned earlier, the pipelines.
feel better today than they did several months ago.
you know, always hard to predict.
Speaker Change: how much volume closes in any given quarter. We really never think about the business that way, right? We originate the best of our ability, we conduct the best diligence we can, and we deploy capital into what we think are the best situations in the market that are available to us.
You know, we're pleased, as mentioned, with...
you know, a few quarters.
Speaker Change: post IPO as we had advertised we thought we could and again we did that in an environment where LBO volumes were down and we continue to be really selective.
Um...
Speaker Change: So we feel good about, you know, the LBO market coming back.
Speaker Change: Even if it doesn't I'm not concerned about our ability to deploy capital really well in 2024 I think illustrates that the strength of our sourcing platform So we feel good about the deployment You know What is what is q4 look like in terms of? Volume relative to q3 or q2 only only time will tell too early in the quarter to predict what that looks like
But we're pleased with the
most importantly, the health of this portfolio.
We're really happy with the asset composition here.
Speaker Change: The sectors that were long, obviously that was by distinct design, and we're monitoring these portfolio companies extraordinarily closely. I think generally speaking, you know, as rates coming down, that means there will be more cash flow generation at the borrower level, which is helpful. In terms of sectors,
We
You know, we obviously use the...
information.
within our existing portfolio and information more broadly.
Speaker Change: Across the Morgan Stanley ecosystem whether that be what we're seeing, you know across the sell side of the firm within our private equity business Etc. So there's a lot of content here that we use as we invest money and monitor our portfolios
And as a reminder we
Speaker Change: We have historically and will continue to steer clear of the sectors that we deem to be more cyclical.
retail, restaurants, energy, those are the sectors that we.
generally don't invest in.
Speaker Change: and I don't envision that changing. We've avoided, generally speaking, businesses where there's significant reimbursable risk within the healthcare sector as well.
Speaker Change: So the plans for the future, I wouldn't say are much different than the past.
you know, the two sectors were the longest.
or software.
and insurance brokerage, both those sectors.
are performing really well.
Speaker Change: And, you know, I'd say the logistics sector is a space where we've seen increased softness. And so that's a sector that we, I would say, our foot is more in the brakes than gas there for sure. But all in all, you know, we'll continue to invest this money.
Speaker Change: on a very diversified basis, both at the borrower level, by industry sector, trying to play defense as it relates to the sectors that we are lending into, and obviously very selective on the borrower side, and then also
Speaker Change: as it relates to which sponsors were financing their businesses as well. And so hopefully that's helpful, Ken.
Speaker Change: That's a very helpful color there. And just one follow-up, if I may, any updated thoughts around the relative attractiveness between upper middle market or core middle market segment for region nations over the United States?
your term, especially given the competitive landscape there. Thanks.
Yeah, that's a great question. So, you know, we...
Speaker Change: We cover 400 sponsors within our business alone. We have New York, Chicago, L.A. offices.
Speaker Change: The senior layer of the investment team has been in this business for 20 plus years.
Speaker Change: So there's a lot of existing and incumbent knowledge within our investment committee. A lot of the deals in our book and ones that come through that either we do or we pass on, we've seen in some cases multiple times throughout the course of our career.
Speaker Change: The if you look at our portfolio generally, there's you know, roughly half the deals are above 100 of you but done half or below
Speaker Change: You know, I think when you look at the sponsors that we cover from our team, and then you layer on the sell side of the firm here, the reach is what we think is really best in class.
Speaker Change: And that allows us, frankly, to go, you know, way up market when the opportunity is really interesting and then go into the core middle market when we think the risk return is really attractive there as well. So for example, you know, in 2023, when the syndicated loan market was closed,
Speaker Change: There were businesses, you know, two, three, four, $500 million in EBITDA that were coming to the private credit market offering really good risk-adjusted return, you know, really diversified companies with great management teams with enormous value below us. And so we deployed capital into some of those situations.
Speaker Change: In 2024, you know, given the health of the syndicated loan market, there are fewer jumbo Unitron steals for obvious reasons. And so we've been, you know, investing.
Speaker Change: in the core end of the middle market. So I would define that as on the low end 30 to 40, upwards of call it 100, 125 million of EBITDA.
and we've had really no issue.
Deploying capital I think the
Speaker Change: You know, the risk return, though, and the attractiveness of it.
really varies depending on
Speaker Change: the market environment that we're in. And so I'd say generally speaking, the companies at the lowest end of the EBITDA range, you know, sub 25 of EBITDA, we generally don't lend to those size businesses.
I find those companies are just more fragile.
The management teams, in some cases.
Speaker Change: just aren't as sophisticated and there's more customer concentration and supplier concentration.
Speaker Change: in those types of companies and the spread premium there I also don't think is that compelling because there's so many lenders in the private credit space that can underwrite and hold a lower middle market deal and so I find the supply-demand dynamic there is not as compelling.
Speaker Change: So we're going to continue to move up and down the size spectrum based on where we see value. And that's a combination of the strength of the underlying company, the capital structure being proposed.
Speaker Change: the strength of the covenant package as well, both financial covenants and negative covenants. And so it's the full picture, but that's one thing that I really like about our strategy is that we have the flexibility.
Speaker Change: the origination capability to go up and down the size spectrum based on where we see value.
Great. That's a very helpful color there. Thanks again.
Thank you.
Speaker Change: At this time, I'd like to turn the call back to Jeff Levin.
for closing remarks.
Jeff Levin: Thank you. On behalf of the management team, I greatly appreciate you joining us today along with your support of Morgan Stanley Direct Lending Fund.
Jeff Levin: Our team remains focused on executing our defensive investment strategy to drive shareholder value, and I couldn't be more pleased with our continued execution.
Jeff Levin: We're well positioned to capitalize on any market environment due to our sourcing advantages and unique credit platform. We look forward to providing an update on our fourth quarter 2024 earnings call in February. Thank you.
Speaker Change: Thank you. That does conclude today's conference. We do thank you for your participation. Have an excellent day.