Morgan Stanley Direct Lending Fund (NYSE:MSDL) plans to lower its management and incentive fees starting in 2027, a move executives said could boost shareholder returns as the lender works through credit problems that weighed on its third-quarter net asset value.
The company reported third-quarter net investment income of $40.3 million, or $0.48 per share, up from $38.2 million, or $0.45 per share, in the previous quarter. Net asset value fell to $18.76 per share from $19.50, with the restructuring of pet food company BrightPet the largest contributor to the decline.
Fee Cuts and Distributions
Effective January 1, 2027, the management fee will fall to 0.75% of assets from 1%, while the incentive fee will decline to 15% from 17.5%, Chief Executive Officer Michael Occi said. The company also retains an existing incentive fee cap.
Occi said the changes were intended to strengthen shareholder returns and help offset the yield normalization experienced across the industry. Using results from the past 12 months, the company estimated that the reduced advisory fees would have increased net investment income return on net asset value by approximately 64 basis points, or about $0.03 per share per quarter. The benefit from the lower incentive fee rate will depend on whether the cap is in effect in a given period.
The board declared a fourth-quarter regular distribution of $0.45 per share and a supplemental distribution of $0.015 per share. Occi said the supplemental payment equals 50% of excess net investment income per share above the regular distribution. The regular distribution is payable to shareholders of record on December 31, 2026, and the supplemental distribution to holders of record on November 30, 2026.
Occi said management remained confident in the regular distribution, citing potential earnings contributions from the fee cuts and the continued expansion of the Capstone joint venture. He cautioned that credit performance remains a harder variable to gauge.
Credit Losses Pressure Net Asset Value
The company recorded $67.6 million in combined net unrealized depreciation and realized losses during the quarter. Chief Financial Officer David Pessah said unrealized losses reflected underperformance at a handful of portfolio companies, while realized losses were tied to BrightPet’s restructuring.
Co-President Jeff Day said ownership of BrightPet, formally AMCP Pet Holdings, transferred from its sponsor to the lender group after operational and execution problems hurt performance. Existing debt was reorganized, and the resulting realized loss was partly offset by the reversal of previously recognized unrealized losses.
Day said three additional investments—Any Hour Group, LogRhythm and FPG Intermediate Holdco—were placed on non-accrual during the quarter, representing $17.2 million at cost. He described the challenges as company-specific and said the fund was engaged in restructuring discussions on several non-accrual investments.
Occi said the five largest valuation movers accounted for more than 70% of the quarter’s unrealized mark-to-market movement. He also disclosed that another restructuring had occurred in the fourth quarter but said the company’s name was not yet public.
Despite the troubled positions, Day said 93.4% of the portfolio was in assets rated one or two under the fund’s risk-rating system. Payment-in-kind income represented 5.4% of total income, down slightly from the prior quarter.
Portfolio and Lending Activity
The portfolio totaled $3.43 billion at fair value at quarter end and included 233 companies across 37 industries, Pessah said. Approximately 96% consisted of first-lien debt or the joint venture entity.
Investment fundings totaled $75.1 million during the quarter, compared with $140.9 million in repayments. Occi said roughly $45 million of the repayments reflected assets transferred into the joint venture. The fund closed 12 investments, including six new platforms.
Day said the median spread on new deals was 538 basis points, up from 475 basis points in the prior two quarters. He said lenders were also seeing more conservative leverage and greater sponsor equity contributions, although overall direct lending volumes remained subdued.
The Capstone joint venture’s balance sheet grew by $132 million during the quarter. Occi said the fund contributed $25 million in equity late in September and that the venture was approximately 65% utilized, with its ramp expected to finish by mid-2027.
The company repurchased approximately $12.8 million of shares below net asset value during the quarter, adding $0.04 to net asset value per share, Pessah said. About $71 million remained available under its $100 million repurchase program.
About Morgan Stanley Direct Lending Fund (NYSE:MSDL)
Morgan Stanley Direct Lending Fund (NYSE: MSDL) is a business development company focused on providing financing to privately held, middle-market companies. The fund seeks to generate current income and, to a lesser extent, capital appreciation by investing primarily in senior secured loans and other debt investments.
MSDL generally targets established companies with strong market positions and invests across a range of industries. Its portfolio may include first-lien and unitranche loans, as well as selectively structured junior debt and equity investments.
