Morgan Stanley Direct Lending Fund

Welcome to Morgan Stanley Direct Lending Fund's second quarter 2026 earnings call. At this time, all participants are in listen-only mode. A question-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 Sanna Johnson, Head of Investor Relations. Please go ahead.

Good morning and welcome to Morgan Stanley Direct Lending Fund's second quarter 2026 earnings call. I am joined this morning by Michael Occi, Chief Executive Officer, Jeff Day, Co-President, David Pessah, Chief Financial Officer, and Rebecca Schewel, Head of Portfolio Management. Morgan Stanley Direct Lending Fund's second quarter 2026 financial results were released yesterday after market close 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 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 interest rates, Cheney, changing economic conditions, and other factors we have identified in our filings with the SEC. 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, 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 Michael Occi.

Good morning, everyone, and thank you for joining us today. I'll begin with our second quarter performance and outlook before turning the call over to Jeff to discuss the market environment and deployment activity. David will then review our financial results in greater detail, after which we will open the call up for Q&A. Beginning with operating results, We generated net investment income of 45 cents per share compared with 47 cents per share in the prior quarter. Second quarter earnings reflected a growing contribution from the capstone JB offset by the income drag associated with new non-accruals added during the quarter and higher other financing costs. For the third quarter, the Board declared a dividend of 45 cents per share unchanged from the prior quarter. Second quarter net investment income covered the dividend. and we continue to believe the reset dividend level is aligned with MSDL's normalized earnings power. Transitioning to credit, MSDL's overall portfolio health remains solid. NAV compression in the quarter was attributable in large part to a handful of underperforming investments which had previously exhibited weakness. The increase in non-accruals reflected the weighting of one net borrower addition to non-accrual status. Importantly, the proportion of the portfolio in the risk-rated two or better categories remained stable quarter over quarter, with approximately 95% of the portfolio generally performing in line with the original underwriting case. Consistent with the first quarter, we took a disciplined approach to capital allocation amid a more dynamic market landscape, seeking to thoughtfully manage leverage and maximize risk-adjusted returns. We remained active in utilizing our share repurchase program. which added $0.05 to NAV per share during the quarter and brought total program-related accretion to $0.10 for the first half of 2026. In parallel, we continued to scale the JV, which we expect to further ramp over the coming year. While conventional investment activity remained measured as we balanced these levers, origination momentum remained solid with three new platform investments added during the quarter. On the liability side, we successfully executed two proactive financing initiatives, the amendment and extension of our corporate revolver in April and a subsequent unsecured notes offering in June designed to pre-fund a portion of our February 2027 maturity. Together, these transactions underscore proactive management of the right-hand side of the balance sheet and our continued access to diversified financing sources supported by the strength of our business, and the depth of MSPC's relationships with bank partners and the fixed income community. Turning now to our outlook, we would characterize the first half of 2026 as a period of transition for direct lending. Public market valuations are pricing in a more negative outlook than our current portfolio fundamentals support. At the same time, there have been isolated instances of credit softness and we recognize that several legitimate pressures persist in the market. Borrowers continue to face elevated interest rates, geopolitical uncertainty, and the evolving impact of AI. But the underlying fundamentals of the middle market economy remain resilient. Credit performance will vary across the industry as these headwinds affect companies and sectors differently. However, we believe several of these pressures are beginning to ease, and the MSDL portfolio is well positioned to navigate them. Jeff will discuss these dynamics in greater detail shortly. We also remain constructive on the medium- to long-term outlook for New Deal activity. Although industry lending volume during the first half of the year was more uneven than anticipated, sponsors remained selective in the second quarter amid geopolitical developments in the Middle East. Encouragingly, we have seen a rebound in private equity exit activity, supported by efficient financing markets and strong demand from strategics. We expect new deployment could accelerate as sponsors gain greater conviction in the geopolitical and macro backdrop. Even amid subdued market-wide activity relative to expectations at the start of the year, opportunity levels remained respectable in the second quarter. Our deep integration within the Morgan Stanley ecosystem continued to provide what we consider to be a meaningful sourcing advantage. We reviewed a higher number of deals year over year and closed on less than 5% of the opportunities we originated in the last 12 months. Reflecting both our broad funnel and our high quality bar. While headlines around direct lending fund flows have weighed on retail investor sentiment, we have observed constructive investor engagement across channels through the lens of our platform's diversified capital base. Notably, industry-wide institutional demand for the asset class remains strong globally, with many investors continuing to seek increased allocations. Retail outflows also showed signs of deceleration in the second quarter, reinforcing our confidence that direct lending will remain a durable allocation for individual investors. And there will be a need for this capital as private equity dry powder is deployed and sponsor-backed M&A volume builds. Morgan Stanley Investment Management recently surpassed an important $2 trillion AUM milestone. As a visible component of MSIM's growing credit platform, We remain confident in our ability to continue optimizing the performance of MSDL, leveraging the strength of our team, track record, and broader support of the Morgan Stanley platform. When we constructed MSDL, we endeavored to provide a differentiated BDC offering, aligned with shareholders through our thoughtful fee structure, competitive expense profile, and defensive investment strategy. We remain intently focused on these priorities. positioning MSDL to capitalize on this dynamic backdrop and to continue delivering value to shareholders. With that, I'll turn the call over to Jeff Day.

Thank you, Michael, and good morning. As we reflect on the market environment, we see a backdrop for private credit in which selectivity and underwriting discipline remain critical. We saw improved supply-demand technicals support a positive shift in deal terms during the second quarter which was a continuation of the dynamics experienced in the first quarter. We believe this trend is driven primarily by slower capital formation in the market. Pricing for new loans generally stabilized quarter over quarter in the SOFR plus 500 basis point range with our weighted average spread on closed deals in the second quarter unchanged relative to the first quarter. While spreads remain wide to the mid to high 400s trough reached in mid 2025, and others. Competition remains high for non-software assets and we have witnessed some modest tightening in this part of the market third quarter to date. Beyond pricing, documentation and overall lender protections remain favorable relative to what we observed in mid-2025. Financial covenant packages, EBITDA definitions, requests for pictogels at close and other structural protections continue to compare favorably with what we were seeing several quarters ago Allowing disciplined lenders with strong sponsor relationships to continue generating improved risk-adjusted returns. In general, we continue to find better compensation for risk in the upper middle market where larger financings typically require more lender participation than in prior years or then in the lower middle market. From a use of proceeds perspective, we have also seen a healthy shift in deal composition With LBOs and add-on acquisition activity accounting for more than 75% of our new platform activity in the first half of the year. As it relates to second quarter originations, we closed an 11 first lien senior secured transactions, totaling 85 million of new commitments. These included three new platforms, four refinancings of existing borrowers, and four incremental commitments to existing portfolio companies, highlighting both the strength of our sponsor relationships and the continued opportunity within our incumbent portfolio. One transaction to highlight from the quarter was Bridgepoint. During the quarter, Bridgepoint approached the market with a leveraged buyout financing opportunity. Our platform's familiarity with the business and ability to speak for a sizable commitment allowed MSPC to take on leadership roles as both a lender and administrative agent. The transaction improved our lender position in the credit to the addition of significant additional cash equity from the sponsor beneath us in the capital structure while further reducing risk through improved documentation protections. In addition to balance sheet deployment, we deployed an additional $10 million of equity into the capstone JV. David will elaborate on the current profile of the JV, and I would invite you to review the new slide we added to our investor presentation this quarter with additional details on the JV. While the investment strategy within the JV is identical to that of on-balance sheet deployment, accounting for the JV portfolio modestly diversifies our top borrowers' weights as of June 30, 2026. The JV provides an additional source of portfolio growth, which we expect to support NAI generation as it continues to scale. Turning to credit, overall portfolio performance remained broadly stable during the quarter. Revenue growth, EBITDA growth, and interest coverage ratios remained healthy and improved from the prior quarter. While payment in kind income has increased slightly, the number of borrowers utilizing PIC remained relatively unchanged from the prior quarter. We continue to closely monitor PIC utilization and have prioritized lending to borrowers who have the cash flows to support the capital structures that we are providing to them. Our mid-single-digit level of PIC remains low relative to publicly traded BDC peers, which we believe is a strength of our portfolio. As part of these ongoing portfolio management efforts, we also placed U.S. Infra Services Buyer, Spectrio, and BPG Holdings on non-accrual status. These were not new issues that emerged during the quarter. Each company had been experiencing company-specific operational challenges over an extended period, and the move to non-accrual reflects the continued progression of those situations. We do not view their performance as indicative of broader portfolio stress or specific sector trends. These three credits contributed to the NAV mark-to-market movement in the quarter and increased non-accruals to 2.9% of the portfolio at cost as of June 30th. Restructuring efforts remain active and we continue to work closely with all relevant parties to preserve principle and achieve timely resolutions for our non-accrual investments in the coming quarters. During the second quarter, we continued to actively manage challenge situations and successfully completed restructurings for both DCA Bayer and Abracon. These outcomes reflect the deep experience of our senior team and our hands-on approach to portfolio management, as well as our ability to work constructively with sponsors and management teams to maximize value through periods of operational stress. While several variables may impact how MSDL's credit will evolve over the coming quarters, we believe that the portfolio remains well positioned to navigate different economic scenarios, and importantly, the risk ratings distribution is indicative of stability. As Michael alluded to, the proportion of the book risk rated three and four declined modestly during the quarter on a fair value basis. We have a proven track record of preserving capital for shareholders, and while NAV may fluctuate from quarter to quarter, We believe our active management of the affected credits positions us to preserve value, maximize recoveries, and support NAV stability over time. MSDL's NAV per share remains within 2.5% of its starting NAV per share at inception in 2019. Turning now to software, we have seen the conversation around artificial intelligence become more balanced over the last few months. We believe AI will remain an important area of focus for every industry and its company specific impact is going to vary meaningfully by business model and market and product offering. As such, we believe AI is unlikely to drive near term sector wide disruption. Our software investments remain concentrated in mission critical system of record platforms with high switching costs, recurring revenue characteristics and strong customer retention. Through our ongoing portfolio monitoring and teams proprietary AI scorecard We continue to identify a low single digit percentage of our portfolio we consider in the high risk category. We believe our portfolio companies are well equipped to leverage AI to enhance product functionality, improve operating efficiency, and strengthen their competitive positioning over time. Beyond AI, we continue to closely monitor the evolving macroeconomic and geopolitical environment, including renewed volatility in energy markets as tensions in the Middle East have intensified. In line with other macro-related reviews we conducted over the last several quarters, this quarter we conducted an assessment of potential exposure impacts across the portfolio. Based on that analysis, we remain confident that our portfolio is well positioned. Where fuel is a more meaningful input cost, we currently expect the majority of those borrowers will be able to pass higher costs through to customers over time. Given our concentration in service-oriented businesses, We believe direct exposure remains limited. Overall, while we continue to monitor a small number of company-specific situations in an evolving macro backdrop, we believe the portfolio remains well positioned. I will now turn the call over to David Pessah.

Thank you. Turning to our balance sheet, our portfolio totaled $3.6 billion at fair value as of quarter end. With our continued focus at the top of the capital structure, approximately 93% of the investments were classified as first lien debt, 3% in our JV, and the remainder in second lien equity and other investments as of June 30th. Inclusive of new investment commitments, total investment fundings amounted to about $146 million during the quarter, offset by $240 million in repayments. The portfolio remains well diversified. with 229 portfolio companies across 36 industries and an average borrower exposure of approximately 15.5 million. In addition to some of our credit metrics that Jeff provided, the weighted average loan to value across our portfolio was approximately 39% and median EBITDA remained relatively unchanged at 90 million. To provide some additional detail about our JV, The vehicle has total equity commitments of up to $250 million, of which $200 million is committed by MSDL. To date, approximately 52% of the total equity commitments have been called, supporting approximately $426 million of investment commitments across 58 portfolio companies in 25 industries. The weighted average yield on debt and income-producing investments is 8.8% at cost. On a lever basis, the dividend yield on MSDL's investments equated to approximately 13%. Moving to our operating results for the quarter, net investment income for the quarter was 38.2 million, or 45 cents per share. Total investment income was relatively unchanged at 89 million. Earnings from the JV increased meaningfully during the quarter. However, that benefit was offset by the impact of positions placed on non-accrual, which in turn decreased the weighted average yield on our portfolio. Total expenses increased to $50.6 million from $48.6 million in the previous quarter attributable to higher other debt expenses as well as an increase in incentive fees resulting from a smaller benefit from our incentive fee cap impact this quarter. The net change in unrealized depreciation and realized losses for the second quarter was $30.2 million. Unrealized losses were driven by underperformance in a handful of portfolio companies, which includes the aforementioned positions that were placed on non-accrual. Net realized losses during the period were related to the two restructurings that were completed. As of June 30th, our total assets were $3.7 billion and total net assets were $1.65 billion. Our ended NAV per share for the second quarter was $19.50 compared to $19.81 in the prior period. The gross debt-to-equity ratio closed the quarter at 1.21 times, modestly below the 1.22 times multiple from the previous quarter, and comfortably in the target range of where we like to operate. Unsecured debt was 56% of total funded debt at the quarter end. During the quarter, we successfully amended and extended MSCL Senior Secured Corporate Revolver, extending its maturity while maintaining both pricing and total commitments across the existing syndicate. After quarter end, we completed a new five-year unsecured notes issuance totaling $350 million at a coupon of 6.10%. This issuance was completed in advance of the upcoming February 2027 maturity, which has a $425 million outstanding notional. Overall, we remain confident in the strength and positioning of our debt profile through the remainder of 2026 and into 2027. During the period, we repurchased approximately $12.5 million of our shares at prices below NAV, leaving significant capacity remaining on our $100 million share repurchase program we refreshed earlier this year. Regarding distributions, we paid a $0.45 regular distribution in the second quarter. Additionally, our Board of Directors declared a $0.45 per share regular distribution for the third quarter of 2026, payable to shareholders of record as of September 30, 2026. Our spillover income was approximately 86 cents per share. With that, operator, please open the line for questions.

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 is star 1 if you would like to signal with questions. And the first question will come from Finian O'Shea with Wells Fargo Securities.

Hey everyone, good morning. I want to ask about the Bridgepoint credit you highlighted. Can you hit on how Common is that that is for you to lead, agent, and so forth, like what portion of the portfolio is in that category. And given it was a more sort of vanilla type spread, like how competitive it was and how you were able to win that.

Yeah, Fid, thanks for the question. To answer the first piece, about 15 to 20% of the portfolio at large is agented business. Entirety of the portfolio is lead business. We don't have an agent-only model, but certainly from a visibility and an active involvement perspective, I think that speaks to the entirety of the portfolio. This is one we highlighted just given the migration in the role, which I think speaks to The improved visibility and presence in the marketplace more broadly. I don't know, Jeff, if there's anything more specific on Bridgepoint that you'd highlight.

Yeah. Hey, Finn. Good morning. We have a lot of experience in this sector more broadly, and we're able to leverage our experience here in the sector, as well as the firm from just a refreshed due diligence perspective, which obviously was helpful for us. and gaining conviction to provide financing here. And again, our ability to speak for a more sizable commitment in the transaction enabled us to take over the administrative agency transaction on this.

Great, it's helpful. I think you talked to this or around it a little bit, but with NOI, At the dividend, are there levers to build a little cushion on that, or will you run here, and is it something you're sort of visiting?

That's on NII more broadly. I missed the beginning of it.

Yeah, just NII and regular dividend coverage.

Yeah. So I think the two cents of contraction in the quarter... reflected a few headwinds. I can give maybe a little bit more color to what David outlined earlier, but you essentially had three cents of JV accretion that will continue to be a story that was two cents of incremental versus what we saw booked in the first quarter. Offsetting that, you had the uptick in financing costs in part driven by the fact that we ran at higher average leverage over the course of the quarter. and then a couple of credit related components in terms of foregone income associated with the new non-accruals and on the expense side, less of a lower effective, a higher effective incentive fee with the look back having a smaller impact in the second quarter. So as we think about the go forward, Finn, we've got to assume that the re-rate of the debt expense is more or less here to stay. Credit is obviously uncertain as some of these New non-accruals are restructured. Income comes back online. Maybe you get the offset with the incentive fee as our look-back kicks in. And then, of course, the accretion from the JV as we look to continue to build that. All told, we continue to feel pretty good about the foundation of NII and the read-through around the distribution as we look to the quarters ahead.

Okay, great. I appreciate that. Thanks.

and the next question will come from Melissa Waddell with UBS.

Good morning. Thanks for taking my questions today. I wanted to also, I think, follow on Finn's question. You know, you pointed to some pressure from the incremental monic rules in the portfolio yield in this quarter and obviously that can have an impact on NII quarter to quarter and you also have some spillover income. I guess I was trying to gauge how comfortable you think the board is with the existing dividend level, even if there were some quarter to quarter noise from any credit issues or things coming on the non-accrual list before others get resolved.

Yeah, Melissa, it's a good follow-up question. Yeah, I think we continue to feel good. Naturally, the board is going to continue to evaluate this in the quarters ahead as we think about the combined impacts of these components in consideration with the fact that the JV is only half ramped, and we've seen the benefits continue to build over the last quarter and a half. When we kind of take into account these various components, we continue to feel good about it. To your point, we can't necessarily bank on certain A deal or two of the new non-accruals necessarily coming back online on a certain timeline, but we're actively working to resolve these situations vis-a-vis restructurings, which could have an income benefit. But as a baseline NII foundation matter, we continue to feel good about supporting the 45 cents as we see things today.

Okay. Thanks for that. And then following up on the post-quarter end issuance, the $350 million issuance, I know that carried a rate of just over 6%. Are you guys swapping that? And can you just talk about your view on sort of that liability management right now? Thanks.

Thanks. This is Dave. Yes, we did effectively swap that transaction. Our goal is to align both the asset and liability side as much as possible across the board. The only note that's not swapped within our liability mix is the one that's coming due in February. So assume on a go forward that for the most part we look to swap any of these issuances that we ultimately do.

Okay, great. Thank you.

And our next question will come from Haley Sheath with Raymond James.

Good morning. Thanks for the question. So in an environment of elevated repayments, how are you on a go-forward basis weighing redeploying cash into new investments versus taking advantage of the current market discounts to repurchase stock?

Yeah, Hallie, great question. It certainly is a balance. The repay activity has been pretty sticky quarter over quarter. As we've talked about, it has generally run Maybe just above 5% of the portfolio. A little bit of mix in there in terms of pure prepays versus partials versus refinancing activity. But it's generally been tracking in line. So we think about the hierarchy in terms of capital consumption. Leverage stability continues to be paramount. And so the utilization on the buyback The NAB movement in the quarter effectively dictates what capital we have to consume. That answer happened to be just under $100 million this quarter. And then to answer your question most directly, it really is an optimization question as to whether that is going to be done on balance sheet versus the JV. You saw in the first quarter it was two-thirds JV. This quarter it was a little more than 10% JV. We're going to continue to evaluate that over time as we think about Hold Sizes, Diversification Readthroughs with the JV. It's a multivariable equation, but you should expect we'll continue to ramp that JV over the coming year, which we believe will be accretive to the diversification profile and the return profile of the business.

Got it. That makes sense. And then any sort of new trends or anything that you're seeing in the pipeline that Just in terms of spreads, LTVs, sponsor versus non-sponsor, anything there?

Yeah. Hey, Heli, it's Jeff. It's a great question. I would say, you know, for non-software assets, as we mentioned in the prepared remarks, we are seeing that segment be slightly more aggressive as, you know, some managers are looking to reduce their overall software exposure. So we are seeing some slight downward pressure in terms of spreads for non-software assets. I'd say those are now more likely in the 475 range for a really high quality down the middle of the fairway asset. But beyond that, we continue to see stability in terms of loan to values. Our LTV remains kind of just under 40% across the portfolio, and that's in line with what we're seeing for new transactions in the market today.

Okay, thank you for the call.

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 signal with questions. Our next question will come from Hongling Ningjing with JP Morgan.

Yeah, hey, this is Hongong for Rick. I guess as you think about ramping up the JV in the near term, could you talk about, I guess, what you think are the biggest constraints to do with it?

Yeah, it's a good question. There's a fair bit of flexibility as we think about the precise ramping of the portfolio. We obviously have the choice of drop downs versus direct deployment. I would highlight that the sourcing mousetrap is certainly not a constraint. I would start with capacity and leverage implications on the fund as we optimize back to my prior comment. Another constraint might be the single borrower exposure, industry exposure that the underlying investment, relevant investment would involve, but a fair bit of flexibility as we think about The deployment of the JV, being mindful of pro forma leverage and pro forma read-through portfolios, we've taken that into account.

Thanks, and have a great weekend. At this time, I would like to turn the call back to Michael Occi for closing remarks.

On behalf of the management team, thank you for joining us today. and for your continued support of Morgan Stanley Direct Lending Fund. Our private credit platform continues to benefit from the scale, sourcing capabilities and institutional infrastructure of Morgan Stanley. We remain confident in the resilience of the portfolio and believe our strategy positions us well to optimize the execution as we continue to seek to deliver high quality returns for investors. We look forward to speaking with you again on our third quarter 2026 earnings call in November.

Thank you and that does conclude today's conference. We do thank you for your participation.

Have an excellent day.