Morgan Stanley Direct Lending Fund 2026 Q2 Earnings Call

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 Shaoul, 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, 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. 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 $0.45 per share compared with $0.47 per share in the prior quarter. Second quarter earnings reflected a growing contribution from the Capstone JV, 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 $0.45 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 2 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. 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. 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, 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 remained favorable relative to what we observed in mid-2025. Financial covenant packages, EBITDA definitions, requests for PIK toggles 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 than 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 on 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 and the credit through the addition of significant additional cash equity from the sponsor beneath us in the capital structure, while further reducing risk through improved documentation protections.