Mortgage Mess Hits KKR Affiliate

KKR Financial Holdings is in talks with investors.
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Updated from 9:22 a.m. EDT

Kohlberg Kravis Roberts affiliate

KKR Financial Holdings LLC

(KFN)

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.