Mortgage Mess Hits KKR Affiliate

Updated from 9:22 a.m. EDT

Kohlberg Kravis Roberts affiliate KKR Financial Holdings LLC (KFN Quote - Cramer on KFN - Stock Picks) said that because of the "unprecedented disruption" in the residential mortgage and commercial paper markets, it's holding talks with investors in its asset-backed secured liquidity note facilities regarding various alternatives to resolve potential funding issues.

Shares of the specialty finance company sank 29% to $10.82 in morning trading.

KKR Financial also said it might be forced to record a charge related to its mortgage-backed securities investments. The company said no assurance can be made that any of the strategies being evaluated will be successful.

The company said Wednesday that it has sold roughly $5.1 billion of residential mortgage loans. Prior to KKR Financial's conversion from a real estate investment trust to a limited liability company in May, it invested in residential real estate assets in order to satisfy the requirements to be treated as a REIT for federal income tax purposes.

The sale of the residential mortgage assets and the termination of related interest rate swaps will result in a loss of around $40 million. After the sale, KKR Financial owns about $5.8 billion of mortgage loans, primarily in the form of residential mortgage-backed securities.

KKR Financial currently finances about $5.3 billion of its remaining securities portfolio through nonrecourse asset-backed secured liquidity note facilities, and it has an aggregate net equity investment in the facilities of about $200 million.

"In connection with the execution of or failure to execute any of the strategies [being considered], the company presently estimates that it may need to record a charge of up to the amount of its approximately $200.0 million net equity investment in the asset-backed liquidity note facilities described above and additional liabilities in an estimated range of $0 to $50.0 million," it said in a press release.

KKR Financial has previously announced that it no longer intends to invest in residential real estate assets. It plans to dispose of its existing portfolio through either a run-off of the assets through principal payments and prepayments or through some other means, including actively pursuing the sale of the common stock of its REIT subsidiary.