10-Q: Morgan Stanley Direct Lending Fund Q3 2025 Update

Morgan Stanley Direct Lending Fund reports a decrease in net investment income and net asset value per share for Q3 2025, alongside an increase in non-accrual investments.

Summary

• Net asset value per share decreased to $20.41 as of September 30, 2025, from $20.81 as of December 31, 2024.
• Net investment income after taxes decreased to $43,730 for the three months ended September 30, 2025, compared to $58,729 for the same period in 2024.
• Total investment income decreased due to declining base rates and repricing on the existing portfolio, with the weighted average yield at cost falling to 9.7% from 11.0% year-over-year.
• The company recorded a net change in unrealized depreciation on investments of $16,131 for the three months and $40,990 for the nine months ended September 30, 2025.
• Non-accrual investments significantly increased to an amortized cost of $47,551 as of September 30, 2025, from $8,117 as of December 31, 2024.
• The asset coverage ratio decreased to 185.00% as of September 30, 2025, from 200.03% as of December 31, 2024.
• A $401.2 million term debt securitization (CLO 2025-1 Debt Securitization) was completed on September 17, 2025.
• The company repurchased 1,699,876 shares under its share repurchase plan for the nine months ended September 30, 2025.
• Distributions declared were $0.50 per share for the quarter, totaling $1.50 per share for the nine months ended September 30, 2025.

Sentiment

Score: 4

Explanation: The significant decrease in net investment income, NAV per share, and weighted average yield, coupled with a notable increase in non-accrual and higher-risk investments, indicates a deteriorating financial performance and credit quality. While new debt securitization provides liquidity, the overall trend is negative.

Positives

• Completed a $401.2 million term debt securitization (CLO 2025-1) on September 17, 2025, diversifying funding sources.
• Maintained an asset coverage ratio of 185.00% as of September 30, 2025, exceeding the 150% regulatory requirement.
• Continued its share repurchase program, acquiring 1,699,876 shares for the nine months ended September 30, 2025, which can be accretive to NAV if shares are bought below NAV.
• A high percentage of performing debt bears a floating rate (99.6%), which could benefit from a rising interest rate environment.
• 99.1% of debt investments are sponsor-backed, indicating institutional support and potentially more structured oversight.

Negatives

• Net asset value per share decreased to $20.41 as of September 30, 2025, from $20.81 as of December 31, 2024.
• Net investment income after taxes decreased to $43,730 for the three months ended September 30, 2025, from $58,729 for the same period in 2024.
• Total investment income decreased due to declining base rates and repricing on the existing portfolio.
• Weighted average yield on debt and income-producing investments (at cost) decreased to 9.7% as of September 30, 2025, from 10.4% as of December 31, 2024.
• Significant net change in unrealized depreciation on investments of $16,131 for the three months and $40,990 for the nine months ended September 30, 2025, primarily due to changes in spreads and financial performance of certain portfolio companies.
• Non-accrual investments increased substantially to $47,551 as of September 30, 2025, from $8,117 as of December 31, 2024, indicating deteriorating credit quality in a portion of the portfolio.
• The asset coverage ratio decreased to 185.00% from 200.03% as of December 31, 2024.
• Risk Rating 4 investments (performing substantially below expectations) increased to $22,017 (0.6% of total) from $4,929 (0.1% of total) as of December 31, 2024.
• Risk Rating 3 investments (increased risk to recoup initial cost) increased to $92,819 (2.5% of total) from $61,597 (1.6% of total) as of December 31, 2024.
• The percentage of debt investments with one or more financial covenants decreased to 59.1% from 64.6%.

Risks

• Dependence on distributions from Collateralized Loan Obligations (CLOs), including the 2025-1 Debt Securitization, to make distributions to shareholders, subject to the terms and covenants of the CLO debt.
• The Subordinated Notes and Class D Notes retained in CLOs are junior and subject to payment restrictions, meaning cash could be diverted if asset coverage or interest coverage tests are not met.
• A decline in the credit quality of loans in a CLO due to poor operating results or increases in defaults may reduce earnings and cash available for distribution, with losses borne first by the company as owner of equity interests.
• Failure to receive necessary cash flow from CLOs to satisfy annual distribution requirements for Regulated Investment Company (RIC) status could lead to loss of RIC qualification, materially adversely affecting investment in shares.
• Investments are primarily in illiquid debt and equity securities without readily available market prices, requiring significant management judgment in fair value determination, and liquidation in a forced sale may yield different, potentially lower, amounts.
• Market value fluctuations due to single issuer, industry, sector, or broader economic, political, social, or global conditions (including health crises, natural disasters, war, terrorism, trade policies, government shutdowns, power outages) can adversely affect investments and net asset value.
• Net investment income is affected by the difference between investment rates and borrowing rates, and significant changes in market interest rates could materially adversely affect net investment income.
• The company has unfunded commitments of $519,349 to fund delayed draw and revolving senior secured loans, requiring adequate financial resources to satisfy these obligations when requested.

Future Outlook

General and administrative expenses are expected to be relatively stable or decline as a percentage of total assets during periods of asset growth and increase during periods of asset declines. The company may enter into new credit facilities, increase existing ones, or issue additional debt securities, subject to prevailing market conditions and liquidity requirements. The company expects to have sufficient financial resources for its investing activities and operations in the near term. There is no assurance that a significant change in market interest rates will not have a material adverse effect on net investment income.

Management Comments

• Michael Occi, CEO, certified that the report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading.
• Michael Occi, CEO, and David Pessah, CFO, certified that the financial statements and other financial information included in the report fairly present in all material respects the financial condition, results of operations, and cash flows of the registrant.
• The CEO and CFO concluded that the company's current disclosure controls and procedures are effective in timely alerting them of material information.

Industry Context

The decrease in total investment income and weighted average yield reflects a challenging interest rate environment, possibly due to declining base rates or increased competition leading to repricing. The increase in non-accrual investments and higher-risk ratings suggests a potential softening in credit quality within the middle-market lending sector, or specific challenges faced by portfolio companies. The completion of a CLO indicates continued access to securitization markets for funding, a common practice in direct lending.

Comparison to Industry Standards

• The company's weighted average 12-month EBITDA of $149.0 million and median of $86.5 million align with the general definition of middle-market companies, which typically generate annual EBITDA between $15 million and $200 million.

Corporate Governance

Legal Proceedings

• The Company, the Adviser, and the Administrator may become party to certain lawsuits in the ordinary course of business, including proceedings relating to the enforcement of rights under contracts with portfolio companies.
• The Company, the Adviser, and the Administrator are not currently subject to any material legal proceedings, nor is any material legal proceeding threatened against the Company to its knowledge.

Related Party Transactions

• Investment Advisory Agreement with MS Capital Partners Adviser Inc., an indirect wholly owned subsidiary of Morgan Stanley.
• Administration Agreement with MS Private Credit Administrative Services LLC, an indirect wholly owned subsidiary of Morgan Stanley.
• MS Credit Partners Holdings, Inc., a wholly owned subsidiary of Morgan Stanley and an affiliate of the Investment Adviser, held approximately 11.2% of the company's outstanding common stock as of September 30, 2025.
• Morgan Stanley & Co. LLC served as an underwriter in the IPO, receiving $1,241 in underwriting fees.
• Morgan Stanley & Co. LLC served as an initial purchaser for the 2029 Notes, receiving $210 in fees.
• Morgan Stanley & Co. LLC served as an underwriter for the 2030 Notes, receiving $210 in fees.

Stakeholder Impact

• Shareholders may experience negative impacts due to decreased NAV per share and lower net investment income, though share repurchases below NAV could be accretive.
• Creditors/Lenders face increased overall leverage due to new CLO debt and unsecured notes, despite the asset coverage ratio remaining above the regulatory minimum.
• Portfolio Companies, particularly those with increased non-accrual status and higher risk ratings, indicate potential challenges for their businesses, which could affect the company's investment performance.

Next Steps

• The Board declared a distribution of $0.50 per share, payable on or around January 23, 2026, to shareholders of record as of December 31, 2025.
• The Amended and Restated Company 10b5-1 Plan for share repurchases will continue until the earliest of 24 months from the original commencement date (February 28, 2025), or when $100 million in shares have been purchased.
• The company may enter into new credit facilities, increase existing ones, or issue additional debt securities, subject to market conditions and liquidity requirements.
• The company is evaluating the impact of ASU 2024-03 on its financial statement disclosures, effective for fiscal years beginning after December 15, 2026.

Key Dates

Recommendation

While the company maintains a strong asset coverage ratio and continues its share repurchase program, the notable decline in net investment income, NAV per share, and the increase in non-accrual and higher-risk investments signal deteriorating credit quality and financial performance. The new CLO provides funding, but the overall trend warrants caution. A 'hold' recommendation is appropriate to monitor if these negative trends stabilize or reverse, given the current uncertainties in the middle-market lending environment.

Keywords

Direct Lending, Middle-Market, Business Development Company, BDC, SEC Filing, 10-Q, Financial Results, Investment Portfolio, Debt Investments, Equity Investments, Credit Facility, Unsecured Notes, CLO, Collateralized Loan Obligation, Net Asset Value, NAV, Interest Income, Unrealized Depreciation, Non-Accrual Loans, Share Repurchase, Morgan Stanley