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Executives

Laurie Poggi – Director, IR

Bill Sonneborn – CEO

Michael McFerran – Interim COO

Analysts

Gabe Poggi – FBR Capital Markets

John Hecht – JMP Securities

Lee Cooperman – Omega Advisors

Steve Monathan [ph] – Monathan Jack Partners [ph]

Sam Martini – ECI

Robert Schwartzberg – Compass Point

KKR Financial Holdings LLC (KFN) Q1 2010 Earnings Call Transcript April 29, 2010 5:00 PM ET

Operator

Welcome to the KKR Financial Holdings LLC first quarter conference call. During today's presentation all parties will be in a listen-only mode. Following managements' prepared remarks the conference will be open for questions. Today's call is being recorded.

I would now like to turn the conference over to Ms. Laurie Poggi. Please go ahead, Ma’am.

Laurie Poggi

Thank you, Marvin. Good afternoon, and welcome to KFN’s first quarter 2010 conference call. I am Laurie Poggi, Director of Investor Relations for KFN and participating on today’s call are Bill Sonneborn, the company’s Chief Executive Officer; Michael McFerran, the company’s Chief Operating Officer and Jeff Van Horn, the company’s Chief Financial Officer.

Our financial results released for the quarter ended March 31st, was issued today, and as with prior quarters a supplemental information packet was posted on our Website. Today we also filed our first quarter Form 10-Q with the Securities and Exchange Commission. Today’s call is being webcast live on our website. The audio webcast will be archived in the Investor Relations section of our website and a telephonic replay will be available beginning later today through May 13.

At this time, I would like to remind you that this conference call contains forward-looking statements that are based on the beliefs of the management team regarding the operations and the results of the operations of the company, as well as general economic conditions. These beliefs and the related forward-looking statements are subject to substantial risks and uncertainties, which are described in greater detail in the filings we have made with the Securities and Exchange Commission. These filings are available on the Securities Exchange Commissions' website at www.sec.gov. Our actual results may vary materially from those described in these forward-looking statements.

Now, I will turn the call over to Bill.

Bill Sonneborn

Thank you, Laurie, and thank you everyone for being on the call. We are pleased with our results for the quarter. Fortunately we were able to achieve the objectives we discussed in last quarter’s earnings call, given the continued progression of healing within the capital market. Specifically, we are able to grow our book value per share, earnings per share and raise our distribution per share for the quarter.

With the actions our team has taken in the continued compression and credit spread, we’re able to generate on a sequential quarter-over-quarter basis, growth of nearly 13% in book value per share, and taking to account today’s decoration of the distribution over 40% in our cash distribution per share. We’re able to achieve this by continuing to maintain strength in our liquidity position in our balance sheet.

Between the quarter, we purchased over 900 million of corporate debt holdings, primarily to our CLOs subsidiaries that will create long-term value for shareholders. We reduced the risks of our asset liability duration mismatch. We’ve eliminate all mark-to-mark leverage other than that contained within our credit facility and as the quarter end, all of our CLOs were incompliance with their respective over collateralization tests.

Most importantly, KFN continues to be well positioned to participate in new and attractive market opportunities that we believe will generate attractive total returns for our shareholders.

Today, our Board of Directors declared the cash distribution for the quarter of $0.10 per share. This distribution represent a 43% increase from last quarter’s distribution of $0.07 per share, and a doubling over the distribution of $0.05 declared for the third quarter of 2009.

During the first quarter, we're into 129.5 million or $0.82 per diluted common share. Our earnings included other income primarily consisting of gain from debt repurchases and realize and unrealized gains on our investments totaling $0.45 per diluted common share. In operating income, which we defined is net investment income less non-investment expenses up $0.37 per diluted common share.

As I mentioned a moment ago, all of our CLOs are in compliance with their respective OC test as a result of CLO 2007-1 regaining compliance with its over-collateralization test in late March. We continue to focus on both building additional over collateralization portion [ph] within these structures, and maximizing returns on equity and redeployment of the substantial early pay downs we have been receiving given the strength of the credit market.

Additionally, during March we purchased 73 million par amount of mezzanine and subordinated notes issued by CLO 2007-1 and 10.3 million par amount of mezzanine notes issued by CLO 2007-A. These purchases were done to a third party administered public auction in the form of the (inaudible) or bids run it in competition and certain notes issued by this two CLOs that we did not own previously.

The purchase of these notes across these two structures was done at a weighted average price of $0.53 a face value and resulted in a onetime non-cash reported gain of 39 million. The connection with this transaction KFN's manager elected to forgo 9.7 million in incentive fees but it otherwise would have earned on that gain.

Next our capital structure. As discussed on our last earnings call, we issued a 172.5 million of 7.5% convertible notes due January 2017. Today, we have used approximately 120 million of the net proceeds from this transaction to reduce existing indebtedness to paying down our credit facility by 25 million reducing the outstanding amount to a 150 million.

We also retired 95 million of 7% convertible notes to 2012, reducing the amount of outstanding from 275.8 million to a 180.6 million. Our credit facility is due to mature in November 2011 and we are proactively seeking alternatives to replace this facility in order to provide us the increased flexibility to continue to achieve the objectives we iterated at the beginning of this call and at the beginning of this year.

Last, I want to spend few on our strategy. Today 90% of our corporate debt holdings are held in our majority CLO subsidiaries. These transactions have final maturities ranging between 2017 and 2021. CLOs provide us with the benefit of being able to finance senior secured and high yield corporate credit investments at a weighted average cost of LIBOR plus 57 basis points. With the weighted average remaining reinvestment period of about 2.3 years, we expect to continue to recycle capital in our CLOs to continue to produce strong earnings and cash flows after the reinvestment periods end.

In fact, CLO 2007-1, CLO we just acquired addition sub-notes, which are largest CLO has not reached the end of its reinvestment period until May of 2014 near the end of what we expect to be in active refinancing period for global corporation. We continue to operate with a portfolio that asset sensitive to interest rates.

Given our focus on protecting earning and cash flow as well as our ability to provide distribution to shareholders from threats of inflation, we retain approximately 1.6 billion of net asset sensitivity today to short-term rates. All those being equal, if LIBOR were to return to previous historical average levels of say 5% gross earnings per share and cash flow per share would increase by approximately $0.10 per quarter.

The CLO market has recently found some signs and new transactions are starting to get done. We intend to establish additional majority own CLO subsidiaries in the future, but at terms with the financial and structural characteristics are appealing to permit mid teens returns on capital deployed. While there is a market for senior trenches, the senior notes spreads provided recent deals when combined with other structural terms such as leverage in reinvestment on call period not allow us to achieve an appropriate higher rate for our shareholders.

That said, spreads continue to tighten, another terms continue to improve, so the market may become more interesting in the weeks and months ahead. With respect to our current holdings, we remained pleased with our portfolios performance during this current credit cycle. As of March 31st, the weighted-average market value of our corporate debt holdings was 91% of par value. The weighted-average carrying value of our holdings, which is what our book value of 831, reflects was 90% of par value.

Simply put today, our book value is below the estimated market or liquidation value of our holdings as if quarter end by 1% of the par value of our entire corporate debt portfolio to about 80.3 million. While 90% of our aggregate corporate debt holdings are in CLOs today, we had expected to decline modestly overtime as we deploy capital to other opportunities outside of CLOs.

I think it is worth recapping our framework for the deploying capital as reviewed in our last earnings call. Our framework is based on our internal strategic capital allocation model. As we discussed last quarter, there are three core tenets to our capital allocation methodology.

First, to provide our shareholders with an attractive total return by balancing holdings that generate solid recurring cash flows enable us to make distributions to the shareholders and those that present opportunities to the long-term capital appreciation with substantial positive skew and to share our cash profits with our share holders.

Second, positioned our portfolio to generate attracting total returns across economic cycles. We have a bias towards addressing inflation risk in our portfolio. We seek to position that portfolio to perform well during periods of high inflation, which correspond with higher rates. We want to focus on creating a return profile and a dividend paying capability which will benefit in arising rate environment. Third pursue opportunities where we at KKR believe we have a competitive advantage. The combination of our global investment team and our deep relationships across many industries provide us with an unparalleled ability to source unique opportunities across many asset classes.

In addition, syndicated corporate debt, we are wait to see opportunities to meaningfully deploy capital to unique and special situations which range some private debt transactions that resourced to rescue finance, the stress to mezzanine opportunities we see the potential for attractive total returns from both debt and equity components.

Examples of recent transactions we completed this past quarter include harden health care and (inaudible) also which present opportunities for expected unlevered meet the high teams returns. The next area of opportunity we see room to allocate incremental capital today in two private equity.

Broad industry meeting roll in this asset class we expected to be a growing a way of opportunities for KFN to deployed capital side-by-side with KKRs private equity funds and select private equity opportunities. For example this past quarter we made a modest side-by-side investment with KKRs private equity funds and fix it whole.

And finally, we review investments in real assets such as conventional oil and gas working interest as attractive in the current environment. In February KKR announced the partnership with Premier Natural Resources. A firm whose executive have the fantastic track record in conventional resource place and with whom we have worked in a number of private equity transactions over the years.

To peruse investments in conventional oil and gas properties in North America. KFN will be a beneficiary this partnership as we plan to make investments and producing oil and gas properties with attractive cash-on-cash and total return characteristics and little to no exploration risk. We view opportunities in this sector as particularly compelling as they present both attractive return profiles, good current cash flow and a sound hedge in our portfolio against inflation.

To summarize, we remain optimistic in our ability to achieve the strategy we have put forth to you. Now, I would like to hand the call over to Mike to review the results for the quarter in more detail.

Michael McFerran

Thanks, Bill, and good afternoon, everyone. Before going to details of the quarter, I want to briefly review the impact of the adoption of the new accounting standard we had in our financial statements. I refer to simply effect January 1st, we reported our actual interest in residential mortgage backed securities they are no longer consolidating the securitization trusts and I wish those securities for reporting purposes.

Our March 31st, balance sheet reflects the fair value of our holdings in RMBS, which totaled $114 million. The change of presentation is a result of our adoption of FAS 157, which amended the consolidated requirements of variable interest entities previously covered by FIN 46. Neither the prior consolidation of the MBS Trust nor they recent deconsolidation of these trusts had any impact of book value, cash flows or our results of operations.

Now for the quarter. As Bill highlighted, our results for the first quarter was net income $129.5 million or $0.82 per diluted common share. The quarter’s earnings were largely driven by $71.1 million or $0.45 per diluted common share of other income. The two largest contributors of other income were $27.3 million of realized gains from sales of certain holdings and $40 million in gains from repurchases of debt, including $38.7 million in the purchase of CLO notes issued CLO 2007-1 and CLO 2007-A.

As you know, we consolidate our CLOs under GAAP. As such, the assets of our CLOs and debt issued by our CLOs, that we do not own is reflected in our balance sheet at par. Purchases of note issued by our CLOs are kind of force reductions of debt in our balance sheet. The gain is recorded for the difference between our purchase price and the face amount of the notes.

The $27.3 million of realize gains during the quarter stems from the sales of certain equity loan and bond positions. We achieved desirable outcomes based on current market value. Putting the $27.3 million, our gains from holdings that were previously in default and have restructured with us existing at a gain above our regional purchase price. These will put some over all of our holdings in layer and by law, which are examples of situations where the loans defaulted. We patiently worked through the process to achieve returns above if not only our cost basis, the actual reason par value be loan to be invested in.

Respect to cash flows, our net operating cash flows this quarter totaled approximately $36 million. Put some color on this, we didn’t receive any payments on our CLO 2007-1 and to CLO 2007-A, suborned note holdings during the quarter. Both CLO 2007-1 and CLO 2007-A we’re out of complains for the respective over quarterization test throughout 2009. As Bill mentioned, both these CLOs were in compliance with those test as of today. The mezzanine bonds issued by CLO 2007-1 or 2007-A, which we on the majority of accrued interest through the period of those CLOs were out to compliance the OC tests of 2009.

And as a result that accrued interest on those mezzanine bonds needs to be paid-off before we start receiving cash flows on the subordinate notes we own. The accrued amounts on the CLO 2007-A mezz bonds should be paid-off this month. However, for CLO 2007-1, approximate paying up that accrued should take about a year. Well, there’s no assurance that our CLOs will remaining compliance with these OC test, assuming that they do so and based on current LIBOR plus 30 basis points and the current holdings in CLO 2007-1 and 2007-A. We estimate that once we start receiving all the cash flows from these field once all the accrued interest and mezz notes is pay down those cash flows in aggregate should benefit the company to amount about a $100 million annually.

And this amount has the potential increase and we redeploy capital from pay downs and these portfolios are higher yielding assets. In addition, future increases in short-term rates by the positive impact on the cash flows that we earned from the new CLOs.

With that, I am going to hand it back to Bill.

Bill Sonneborn

Thanks, Mike. Before opening it up to questions from all of you I want to provide some closing remarks. 2009 was the year defined by addressing liquidity in market risks presented by the credit crises to improve the health of our portfolio, our capital structure and deploy capital and some interesting in that. 2010 is about growth opportunities. Our capital structure liquidity profile and balance sheet are positioned to support the next stage in KFN’s evolution. And we continue to seek substantial opportunities deploy capital in a manner that it accretive to shareholders.

We remained focused on refinancing our existing credit facility to improve our flexibility and may considering equity except we can deploy capital at attractive return levels. Having a flexible capital allocation model combined with KKRs global and talent professional’s knowledge from our existing portfolio businesses and experienced loan, bonds, mezzanine distress, private equity and real assets enable us to pursue opportunities that we like at any given time.

Our global reach across industries in asset classes positions us to identify broader way of opportunities that we are working on today. KFN is managed by all of us at KKR. We are exceptionally talented group of people that have worked together with creativity and determination to provide KFN with substantial opportunities for value creation. We have a tremendous team, which continues to grow in both size and strength. I look forward to sharing our progress with you in the quarters ahead.

With that, operator we’d be happy to turn it over for questions.

Question-and-Answer Session

Operator

Thank you. (Operator Instructions) Our first question will come from Gabe Poggi with FBR Capital Markets

Gabe Poggi – FBR Capital Markets

Good afternoon, Bill, Mike and Laurie. How are doing?

Bill Sonneborn

Good. How are you, Gabe?

Gabe Poggi – FBR Capital Markets

Doing good. Two quick questions for you but they are more, one is broader macro question and then one is more name [ph] is the credit specific. First question is, Bill, can you just provide your thoughts on what's happening in Europe and how that affects KFN's portfolio? And then the second question is Lyondell is emerging from bankruptcy, can you walk through how that helps or what the net effect is for KFN considering Lyondell 11th largest position?

Bill Sonneborn

Sure, absolutely. First on Europe and particularly Greece and thinking about the downgrades that are happening in Europe, and it just a macro causing move, really the same kind of challenges and issues we have here in the US when you look at state finance. And why I think that there is some potential for sparks of nervousness in the context to market volatility.

It's ultimately an issue of dealing with spending problem and balancing what sense of an entitlement in the context of state or country budget are relative to revenue production. And so, that ultimately is part of the de-leveraging process that I think the entire globe will need to face as result of large public debt balances that exist relatively globally at least in developed markets.

So I think in that particular case, it doesn’t necessarily have a specific direct risk in the context to KFN's portfolio. Other than we expect things like Greece or Portugal or Ireland or California can have an impact in the context to volatility underlying credit pries, which we are trying to position the, the company to take advantage of winning FA [ph] exist.

Gabe Poggi – FBR Capital Markets

Okay. Great, thanks.

Bill Sonneborn

And the other question on Lyondell?

Gabe Poggi – FBR Capital Markets

Yes.

Bill Sonneborn

The Lyondell was a substantial holding that we’ve had for a considerable period of time. The company went through restructuring, we not only basically persuading continue to hold our position to restructuring but also participate in the exit financing. So, what you seeing there is effectively kind of the life cycle of the situation where we were senior in the capital structure and move through the restructuring process.

Gabe Poggi – FBR Capital Markets

How does that one follow-up there on Lyondell, how is that, if you guys get cash and equity out in the emergent, how does that affect OC tests? Because, is there any effect there what is the compliance trigger, how does that work its way out?

Bill Sonneborn

We are completely out of the, what was the cam [ph] position in the context of Lyondell which was the portion that would be converted to equity in the context of our CLOs to extends a existing loan or bond is converted to equity, one of the debt [ph], it does get convert into equity as the account zero for over-collateralization. The structured finance vehicles are not high yield places for purposes of holding securities that you are taking, a distract call in the context that we are restructuring, because of that impact in over-collateralization.

Situations where we have had a situation like that, we’ve held on to those positions until we thought that they were at fundamental value on the context of our vehicles and then sold the underline securities.

Gabe Poggi – FBR Capital Markets

Okay. Thanks very helpful and great quarter guys.

Bill Sonneborn

Thanks.

Operator

Thank you. Our next question is from John Hecht with JMP Securities.

John Hecht – JMP Securities

Good afternoon, guys. Congratulations in another great positive quarter and thanks for taking my questions.

Bill Sonneborn

Sure. John, thank you.

John Hecht – JMP Securities

First question is little bit of a modeling question. We deployed about $900 million of new investment this quarter. Are those that yields similar to the current average yield higher lower, how should we think about that?

Bill Sonneborn

One thing is spread, if you think of net interest margin crept up by about into numbers of about 40 basis points this quarter, some of that has to do with the LIBOR for effect and the supplemental materials we posted on the website, John, we disclosed in a very tiny font in the footnote (inaudible). The percentage of each of our CLOs now that having LIBOR floor and that is a – will be an interesting of being able to measure not only growth spread which we disclosed in the context of structures, but also the evidence of the floor which put LIBOR at 30 basis points in a weighted average floor north of 2%, for about I think the number is 15% of our portfolio from a much smaller base a quarter ago.

Although, we continue to hopefully build net interest spread in context of our structures. The one thing we have to adjust your model is what amount of bonds we have in the context of our bond basket within our structured finance subsidiary that can also affects spread.

John Hecht – JMP Securities

Okay. I see those footnotes. Thanks for putting those out. Second, Mike you mentioned '07-A, '07-1 when fully we have got them paid off to mezzanine cumulative interest will be tax rate on 100 million a year, if I heard you correctly. Can you just briefly give me the breakdown of those '07-A versus '07-1, given the different timing when you guys will start receiving those cash flows?

Michael McFerran

So, 07-A we expect all, in fact that accrued interest in those Mezz bond I referenced we paid off this month, so going forward we’d expect to start receiving all of our payments on the sub-notes. That will amount to get all of since that to about 25 million a year. And then in 07-1 it will take about 12 months before we payout all those mezz accrued interest, that amount to about 75 million, again based on everything static today. Obviously, (inaudible) with 07-1 and 07-A, we deal on the majority of the mezzanine as well. So, are certain to see substantial cash flows during that period.

John Hecht – JMP Securities

Okay, thanks very much for that color. Final question, you guys had substantial decline non-accrual and certain defaults I guess once again. Can you give us some color on this either outflows of that, was that some case related, some related to the (inaudible) events like that or was it some other activities going on in the portfolio?

Michael McFerran

It's a couple of things John. When you look at our historical defaults they really range from December 2008 to through May 2009, we saw slight defaults were after slight Tribune, Lyondell, (inaudible). On our last earnings call I mentioned I think our 2009, and our default was plus 9% but the second half of 2009 was about 90 basis points. And we haven't any defaults happened as far in 2010. So, we are seeing is that the capital markets have improved, issues are lot more flexibility to get amendments done and take other actions to avoid defaults in those positions. You’ve seen the defaults comes down and it seems they had defaults done are starting to work through as they don’t describe by Lyondell for example are showing a kind of really comparable cycle to encircle to exit defaults Lyondell is one example. They have but we are embedded with the traditions we’ve exhibit that’s why we’re not accruals to them.

John Hecht – JMP Securities

Wonderful. Thanks, guys. Very much.

Operator

Thank you, our next question comes from Lee Cooperman with Omega Advisors.

Lee Cooperman – Omega Advisors

Thank you. And I’ll add my congratulations to everybody else. Very nice to meet you.

Bill Sonneborn

Thank you, Lee.

Lee Cooperman – Omega Advisors

Just a few questions. If I can get a map and you can handle in and you have a lot of importance so might had – in the past calls, you’ve reiterated new numerous time that the intension of the board management is to have a 50% dividend payout ratio. And obviously results vary quarter-by-quarter but what was the taxable income in the quarter and kind of how you arrive with the $0.10 dividends it seems like a much lower than 50% pay out. Let me just kind of give you all the questions you can handle in order vector that doesn’t makes the more sense for you and may be related to that question is what's the most restricted covenant presently we have that will affect our ability to believe to pay dividend.

Thirdly, I’m trying to figure out the significance of the discount from part of the portfolio and so if you could help me out and appreciated we're roughly 90, 91% of par I believe with difference between par and that 91% numbers almost a $1 billion and so could one assume that if credit markets stay healthy the economy did better. At some significant part does that $1 billion discount would come back to us in the way it came into book value? And then lastly, since I've, always kind a look long-term in to the run-rates of earnings. Looking at a year from now if you're – forget about any capital gains, forget about the new reinvestment, what kind of run rate of earnings will be generating at about existing portfolio assuming all the five sellers, we have the cash flowing? Any help you could in that regard will be appreciated those are the questions for now?

Bill Sonneborn

Thanks. Lee, I'll trying to address each your question as we've indicate in the last earnings call it is our intention and it's been something we have discussed with the boards management intention and I think the boards intention as well to payout a minimum of 50% of our taxable income to shareholders that shareholders have the ample cash so satisfy any tax liabilities. As far as estimating taxable income, it’s very impossible to do because just being upon when people purchase stock that really drives the basis of their stock who strives with their pro added allocation of potential tax liabilities are.

A, B and the connection what's kind of restarting our dividend policy in the fourth quarter of last year, so maybe the board has discussed is focusing on situations that never having to hopefully decreased the dividend again, so we're seeing quarter-over-quarter now for the third quarter as a progressive increase in our distribution for share. And finally we still are under a restricted covenant our credit facility, which goes to your second question the limits our dividends to no more than 50% of taxable, estimated taxable income. But ultimately, it remains our goal to distribute at least 50% of taxable income to shareholders.

And your final question on the context of discount at par, yes, holding our portfolio at roughly 90, 91 as you suggest results to expect that we can recover full par on our portfolio, nearly $800 million of additional book value across the business, and it is hopefully the team's goal to achieve that objective but no guarantees.

As far as your point run rate or forecasting out what our run rate operating earnings or net income is, we do not give any forecast. Now, we try to disclose as much information in the context of the components of each of our CLOs, the assets we hold for investors to be able to calculate an expectation of that rate of return and ultimate earnings.

Lee Cooperman – Omega Advisors

Let me – since I know you don’t want me to be responsible, our work suggest that looking at a year from today, that you could be at a run rate of a couple of bucks which would imply $1 dividend, and we get some chuck of the $800 million back. Are we kind of in the right zip code or are we just missing something?

Bill Sonneborn

I think it really depends on what you are assuming rates over the next year, how we deploy capital. There is a lot of variables there as we talked about. If you look at our balance sheet, you can see we have a – we didn’t want a cash, we think about we fight [ph] with our CLOs, so there is a lot of – I could see how you can get up to that number based on different assumptions.

Lee Cooperman – Omega Advisors

All right, just give you a chance. Okay, thank you very much. Good work, we really appreciate it.

Bill Sonneborn

Thank you, Lee.

Operator

And our next question comes from Steve Monathan [ph] with Monathan Jack Partners [ph].

Steve Monathan – Monathan Jack Partners

Good afternoon. Just kind of following of along some of the strategic comments that you made. How do you plan to balance your capital allocation between debt and private equity investments?

Bill Sonneborn

Well, by generally focused that we have indicated in the context of the strategy on to be a yield producing vehicle. And so, that would force us to focus predominantly on assets that generate cash flow for purposes of making distribution to shareholder. But we want to on top of that provide opportunities for increasing total rates of return with positive skew to the upside until that gives you an idea of how we think about, how private equity can complement the overall portfolio.

Steve Monathan – Monathan Jack Partners

In your mind, is there a rough percentage of the balance sheet that you would feel comfortable allocating to private equity?

Bill Sonneborn

We haven’t disclosed what and how we think about allocation from time-to-time to specific private equity investments. But again, if you think about our goal of producing, growing, distributions per share as well as book value per share in the context of what the objectives management is way out for the shareholders, you should probably will think about how we would allocate to and I think at last, that is non-cash flow producing until it exit.

Steve Monathan – Monathan Jack Partners

And, finally would a viewed toward the last couple of years as your current financial position, how do you see yourselves deploying the cash that’s on the balance sheet. Do you see it happening quickly or kind a slowly overtime?

Bill Sonneborn

If you think we have cash in the balance sheet, but it roughly equates to the maturities we have over the course of the next 18 months. So, fact that we’ve immunized or isolated the near-term maturities related to that cash. That being said, to except we were to refinance our credit facility as example and to a longer dated facility that would free up capital from investments. So many opportunities we discussed like hurdle or embed [ph] which have mid to high-teens rates of return with the longer duration for compounding those rates to return. So, we just balance, you know the ultimate duration of investments we make relative to risks sensitivity in the context of our capital structure.

Steve Monathan – Monathan Jack Partners

Thank you very much.

Operator

Our next question comes from Sam Martini with ECI.

Sam Martini – ECI

Hey, guys. Just two quick follow-ups. As ’07-1 turns back on, all the deferrals of the notes that are deferring should come back faster. They will get trued up pretty quickly. Would you expect to consider that contribute to taxable income as the see through each notes, cheer that deferrals. And secondly, I was hoping you could walk through some thoughts on incremental CLO as a follow I think the worlds cautioned (inaudible) a few others are coming out. It looks like 3.5 to 4.5 times leveraged. Would you be able to execute something from the HoldCo [ph] pool of debt that sits there and if so could you walk us through the economics that these current deals would imply? Thanks.

Bill Sonneborn

Sure. Thanks. On your first question, no, there is no tax – taxable income increases the result of these CLOs becoming on cash flow in either in the context is paying off picked interest in the Mezz notes we hold or making payments with subordinated hold – subordinated note holder which is us as a result of the fact that those are flow through structures in the context of for tax purposes.

Sam Martini – ECI

So that will just come over the deferrals when they care in the water fall and the time is right, that will be just cash to you, it wouldn’t have a taxable impact and I’ll just go straight to that the notes that are held at the HoldCo that will just be cash that goes right to HoldCo?

Bill Sonneborn

Exactly, the taxable allocation is been made already for the interest that’s back to our shareholders and their payment of the cash is just the cash received but our shareholders last year were allocated taxable income from the amount picked during 2009 as an example.

Sam Martini – ECI

Okay.

Bill Sonneborn

Your second question.

Sam Martini – ECI

Any idea for your pieces Bill, what that amount will be what piece of your ’07-1 and ’07-A Mezz notes are just the remaining pick piece, so the remaining piece has been differed?

Bill Sonneborn

We haven't disclosed that. We said, again for '07-A the PIK fees we paid off this month, 07-1 we’re seeing will take about year or so. Thinking about the cash flows in 07-1, that will come in same that order, assuming about four payments for those PIKs out there.

Sam Martini – ECI

Okay. But it's about 400 million of notional at the HOCO [ph] rates, so all of those pieces include, I’m assuming a year and half of PIK interest on top of it.

Bill Sonneborn

Yes

Sam Martini – ECI

That will just come – okay. Thanks. And then on the market for new deal?

Bill Sonneborn

We’ve looked at the new deals that have come out and can continue to kind of investigate how this prices and structures are working. We haven't seen one, even though we have the ability to do a structure or a deal without a management fee and with the equity funded off of our balance sheet which is kind of tough part of the capital structure to find in the context of the reinvention of the CLO marketplace.

We haven't found the structural term yet both in the context of the amount of leverage, the cost of the senior leverage and the call provisions or the reinvestment provision for us to feel comfortable in terms of how we look at risk and those structures and sources of return for our shareholders to get to mid teen. There are couple 100 basis points short in the context of our estimation. But they have come in towards kind of our target a lot in the past kind of 30 to 45 days, and so it's getting closer to the point where there will be attractive source to deployment of capital.

Sam Martini – ECI

But, am I thinking about it at the right way, Bill, that rather than traditional structure we had at the warehouse facility to buy the collateral. You actually own the collateral already right now, retained piece would basically be almost like a – basically be almost like a block trade or liquidation of let's say, on a four times leveraged structure of 75% of your collateral, which will replaced by cash coming into you from the CLO notes?

Bill Sonneborn

That’s exactly right. If you think about it outside of our CLOs we have a bunch of corporate credit assets, those corporate credit assets could be used. Some portion of them could be used as collateral for a securitization as non balance sheet term financing like we've done in the past without using a third party provided warehouse like historically we're used in the context restructured finance.

Sam Martini – ECI

And in terms of your – in terms of your higher bonds, it looks like they're all basically at par. So, that you extend the ratios almost to work out. Would it be fair to say that, that would free up if you did a four times leverage structure closed to $350 million in cash to you? From the whole co-collateral assuming it was all….

Bill Sonneborn

Assuming, it was all eligible for a structure but that’s an incorrect assumption. If you look through the fair value discloser, I’ll thank you, you will see that our numbers and the positions our balance sheet either a private or it's in transactions or distressed position that we've acquired, which would not be still eligible.

Sam Martini – ECI

It will be safe to say that if that – that if we win through the CLO eligible pieces that methodology would be reasonable?

Bill Sonneborn

Yes. It will…

Sam Martini – ECI

If we shifted out from the 580, what was CLO eligible? That’s kind of the right way to think about it?

Bill Sonneborn

Yes.

Sam Martini – ECI

Okay. Thanks, guys.

Operator

And our next question comes from Robert Schwartzberg with Compass Point.

Robert Schwartzberg – Compass Point

Good evening. I just had a quick book keeping question. I noticed the related party management compensation 20.5 million versus 8.2 million looks like in the fourth quarter. I assume that incentive comps which you've more than earned? But I just wanted to double check that there are no onetime expenses in there?

Bill Sonneborn

That's exactly correct. The entire amount of the increase is due to an incentive fee net of what we’ve raised because of the accounting gain from the purchases of the CLO note. So, would have been roughly a $20 million incentive fee and we raised 9.7 million of that into interest accounting on the balance sheet and not through economic gain for shareholders and so that’s the net amount.

Robert Schwartzberg – Compass Point

Great. And then I sort of came out a little late. Did you discussed in terms of the yield on the loans paid down versus the yield on the 900 million of new investments the differential there?

Bill Sonneborn

Yeah. We didn’t disclose that specifically. We talked a little bit about what net interest margin is increased by approximately 20 basis points of spread 20 or 30 basis points of spread quarter-over-quarter in aggregate, which gives you a little bit of idea and we started the disclosure in our supplemental materials of each of our CLOs in the context in the overall portfolio, what spread the quite sort of easier to understand how reinvestment is affecting overall spreads in our portfolio is going forward.

Robert Schwartzberg – Compass Point

And then my last question if I can ask one more is there anything – any status update on Tribune you can provide?

Bill Sonneborn

Yes, the only thing we can talk about Tribune is what you would be able to access publicly in the context still looking any other company’s filings.

Robert Schwartzberg – Compass Point

Okay. Thank you. Great quarter.

Bill Sonneborn

Thank you.

Operator

And there are no other questions from the phones at this time, Mr. Sonneborn I will turn the conference back over to you.

Bill Sonneborn

Thank you very much. And thank you all for listening to the call today and we appreciate your support and we will continue try to execute on your behalf. Thanks, have a good evening.

Operator

This concludes today’s conference. Thank you for your participation.

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Source: KKR Financial Holdings LLC Q1 2010 Earnings Call Transcript
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