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Executives

Angela Yang – IR

William Sonneborn – CEO

Michael McFerran – COO and CFO

Analysts

John Hecht – JMP Securities

Michael Sarcone – Sandler O'Neill

Steven Kwok – KBW

Gabe Poggi – FBR

Jasper Burch – Macquarie

Wayne Cooperman – Cobalt Capital

KKR Financial Holdings LLC (KFN) Q1 2011 Earnings Call May 2, 2011 5:00 PM ET

Operator

Good day, ladies and gentlemen, and welcome to the KKR Financial Holdings first quarter earnings conference call. Today's call is being recorded. For opening remarks and introductions, I would like to turn the call over to Ms. Angela Yang. Please go ahead, ma’am.

Angela Yang

Thank you, operator. And good afternoon, everyone. I’m Angela Yang, Head of Investor Relations for KKR Financial Holdings LLC. And joining me on the call today are Bill Sonneborn, our Chief Executive Officer, and Michael McFerran, our Chief Operating and Financial Officer.

This afternoon's call is being webcast on our website at www.kkr.com in the Investor Relations section. There will be a replay of the call available as well. Our financial results for the first quarter ended March 31, 2011 were issued today. And as with prior quarters, a supplemental information packet is available in the Investor Relations section of our website.

Before we get started, I would like to caution you that this conference call and webcast contain forward-looking statements that are based on the beliefs of the management team regarding the operations and the results of 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 and Exchange Commission’s website on www.sec.gov.

KFN's actual results may vary materially from those expressed in the forward-looking statements. In addition, some of the discussion today will include references to non-GAAP financial measures. Information about these measures as well as their corresponding GAAP reconciliations may be found in the supplemental information packet available on our website. The supplemental information packet on our website includes information that we will be referring to on our call today. We encourage you to have this information available during the call.

With that, I'll turn the call over to our CEO, Bill Sonneborn.

William Sonneborn

Thank you, Angela. And thanks to all of you for joining our call today. I’ll begin my remarks with some highlights of the quarter followed by an update on the business as we look ahead. For the purpose of this call, we suggest you do refer to the supplemental information packet Angela described, which as she mentioned is available on our website.

First, the highlights of the quarter, which were listed on page two of our supplemental presentation. We were able to produce another strong quarter of financial results. We generated $0.51 in earnings per diluted share, representing a 22% return on equity during the quarter. This compares to $0.48 of earnings per diluted share for the fourth quarter of 2010.

Run rate cash earnings per share for the first quarter were $0.27 per share and total net cash earnings per share was $0.30. The $0.30 cash earnings per share represents a 13% cash yield on equity. Run rate cash earnings per share and total net cash earnings per share are two key non-GAAP metrics that we focus on, as they represent cash that we could either distribute to our shareholders or retain for future growth.

Next, on to our book value. As of March 31, our book value per share was $9.73, which represents an increase of $0.49 per share or 5% sequentially from $9.24 as of the end of the year and an increase of $1.42 per share or 17% from a year ago. The increase in book value this quarter primarily reflects retained earnings, appreciation in the market value of our high yield bond position, as well as depreciation in the values of our cash flow interest rate hedges.

As contained in the earnings release filed today, on April 27th, our Board of Directors declared a cash distribution of $0.16 per common share. This represents our sixth consecutive quarterly increase of cash distribution to shareholders. The $0.14 difference between our total net cash earnings per share and our distribution per share of $0.16 represent a rough estimate of retained cash that we will reinvest back into our business.

Now on to our portfolio, which continues to perform very well. As of March 31th, the weighted average estimated fair value of our corporate debt portfolio was 97% of par value. Compared to the weighted average carrying value, the purpose is of calculating our GAAP book value of 92% of par.

In other words, the estimated fair market value of our portfolio at quarter-end was approximately $2.04 higher per share than the $9.73 book value per share we reported. Accordingly, if we were a business development company, or BDC, and carried all of our corporate debt assets at fair value on our balance sheet, our net asset value per share would be $11.77, holding everything else constant.

Next, I would like to provide you with an update on the deployment of the $176 million of capital we raised this past December. We are pleased to announce that we have completed the deployment of capital to attractive opportunities that represented desired cross mix of our targeted strategies, approximately two quarters earlier than we anticipated.

Our largest transaction in the quarter was the closing of CLO 2011-1 for which we contributed $100 million of equity capital. This transaction represents our first CLO since the credit crisis and represents a transaction where we successfully leveraged our knowledge of CLO technologies with our relationships to privately place $300 million of senior financing at LIBOR plus 135 in an innovative structure.

We also deployed $55 million to acquire overriding royalty interest that both developed and undeveloped natural gas and oil acreage located in South Texas that was sourced on a proprietary basis. This investment was a great opportunity to acquire royalty interest in acreage managed by top quality operator that we believe has the potential to generate an attractive IRR over the life of the transaction.

During the quarter, we deployed capital to our other strategies, including $40 million to 10 primarily distressed special situations transactions, predominantly in Europe and in Australia; $10.5 million to a mezzanine transaction involving Bain Capital’s acquisition of IMCD, a large chemicals distribution business in Europe; and a $10 million private equity investment in Delmonte that was made alongside KKR’s private equity funds.

As we look ahead, we believe there is a healthy pipeline of opportunities. We have agreed to acquire from Carrizo Oil & Gas, a public company, a portion of its Barnett Shale Tier 1 properties for approximately $58 million. KFN purchased working interest in approximately 13,000 acres, containing 75 gross natural gas wells currently producing at an approximate gross rate of 15.7 Mcf per day. We expect this transaction to close by mid-May.

This transaction will bring the total net capital we have allocated to our upstream natural resources strategy to approximately $150 million, funding approximately $190 million in assets across natural gas, oils, and natural gas liquids, with the difference being total borrowings related to the strategy after the closing of the acquisition from Carrizo.

I point you to slide seven of our supplemental materials, which shows both gross assets and net holding company capital at risk across our business lines. In addition, we have further increased disclosure this quarter, as described on pages eight through ten in the supplemental materials, in order to provide greater transparency of the capital risk, cash earnings, and total expected rates of return across the various strategies we deploy capital.

In addition, we are actively evaluating new CLO transactions and are working on new opportunities across our other strategies that we believe will enable us to continue deploy capital while targeting our mid-teen total rate with the majority of such returns and consistent cash earnings that we can share with shareholders.

With that, I will turn the call over to Mike to review first quarter performance and to provide you with an update on our capital structure as we continue to focus on growth.

Michael McFerran

Thanks, Bill, and good afternoon. I’ll begin my remarks with a review of our results for the quarter and then spend just a few minutes talking about our capital structure. As disclosed in today’s filings, on April 27th, our Board of Directors declared a $0.16 per share cash distribution for the first quarter of 2011. This represents a $0.01 per share increase from the fourth quarter of 2010 and a $0.06 per share or 60% increase from the first quarter of 2010.

I do want to update you on our cash distribution policy. Our Board of Directors has approved an amendment to our existing policy whereby our Board of Directors will consider declaring a special cash distribution in addition to our recurring quarterly distributions. The determination of whether to declare a special distribution and the amount to declare will be based on our review of various factors, including current market conditions, existing restrictions in our borrowing agreements, the amount of ordinary taxable income or loss we earn, and gains or losses we recognize on the disposition of assets and/or liquidity.

We will generally determine gains or losses on dispositions based upon the price the company paid for the assets, which due to the tax rules applicable to partnerships may differ from the gains or losses recognized by a shareholder as the shareholder’s gain or loss of the sale of an asset may be higher or lower depending on the purchase price that the shareholder paid for our shares. We currently expect that our Board of Directors will consider a special distribution on an annual basis after the end of each fiscal year. However, there is no guarantee that a special distribution will be declared after any fiscal year.

Next, our financial results for the quarter. We had a good quarter, as witnessed by both balance sheet and income statement performance. Earnings per diluted share for the quarter totaled $0.51, which translates to a 22% return on GAAP equity. Investment income totaled $135.3 million for the quarter, which represents a 13% increase year-over-year, and net interest margin totaled $91.1 million, which represents a 9% year-over-year increase from $83.3 million for the first quarter of 2010.

The difference in growth of total investment income and net interest margin was primarily due to an increase in interest expense to affiliates of $7.6 million from $4.5 million for the first quarter of 2010 to $12.1 million for the first quarter of this year. As you may recall, prior to the end of 2010, subordinated notes issued by CLO 2007-1 and 2007-A were not received in full interest payments as the accrued interest on mezzanine notes issued by these CLOs was being repaid.

This quarter represents the first full quarter where the accrued interest of subordinated notes was paid to the subordinated note holders. The increase in interest expense to affiliates reflects full distributions on these notes, which weren’t occurring in the corresponding period last year and has no impact on economic value, that is simply a result of our inability to record it as an accounting convention, minority interest for the portions of these two CLOs not held by KFN.

During the quarter, we recorded the provision for loan losses of $11.7 million. This provision was recorded to increase the unallocated components of our allowance for loan losses, which relates to our loan portfolio held for investment in an entirety as opposed to relating to specific investments. And as reported, it reflects growth in our portfolio since year-end and remains at 3.4% of our loans held for investment.

Our results for the quarter also reflect $46.4 million of other income, which was primarily driven by realized and unrealized gains on our investments totaling $39.2 million, and gains on foreign currency translation of approximately $6 million. As Bill already highlighted, two key non-GAAP metrics that we used to assess our performance on a cash basis are run rate cash earnings per share and total net cash earnings per share.

Run rate cash earnings per share for the quarter totaled $0.27, and total net cash earnings per share totaled $0.30 for the quarter. Our cash earnings per share metrics both reflect $12.8 million of semi-annual coupon payments on our convertible notes paid during the first quarter. As these paid in January and July, our second quarter cash per share performance will reflect this cash outflow. I refer you to page 18 in our supplemental materials for a reconciliation of GAAP and the detail of the components of these per-share cash calculation.

Next, our balance sheet and capital structure. As of March 31, our book value per share was $9.73, which represents an increase of $0.49 per share or 5% from $9.24 per share from year-end and a 17% increase from a year ago. One metric Bill highlighted that bears being repeated is that at quarter-end, related average estimated fair value of our corporate debt portfolio was 97% of par value compared to a weighted average carrying value, which is used for purposes of calculating GAAP book value, of 92% of par.

This differential results in $2.04 of fair value per share embedded in our balance sheet above our reported book value. Historical trending of our book value per share and the fair value of our corporate debt portfolio are detailed on pages four and five of our supplemental presentation.

We ended the quarter with $129.3 million of unrestricted cash, and similar to last quarter, we have no borrowings outstanding under our $250 million revolving credit facility. We remain very focused on growing our weighted average cost of capital by evaluating opportunities in the term debt capital markets to capital fund flow. The opportunities that we focused on includes incremental CLO transactions, which represents a form of non-recourse leverage that we like and a deep experience in utilizing.

On March 31, we closed CLO 2011-1 through which we contributed $100 million of capital and are able to borrow up to $300 million to finance senior leverage loans at three-month LIBOR plus 135 basis points. This transaction differs from our other CLOs in a couple of ways, including aspects of it being an innovative structure. First, this is a status quo transaction. Accordingly, there is no reinvestment period once the aggregate portfolio is ramped. The attractive feature of this is that’s subject to maintain certain compliance measures in the transaction. As assets are sold or paid down, we receive our pro rata share of principal cash as compared to traditional CLOs, under which should we see the principal back after the senior debt had been repaid.

With respect to future transactions, we will continue to evaluate opportunities to leverage CLOs for both growth and to replace our existing transactions as they begin amortizing post reinvestment period.

Now I’m going to hand this back to Bill.

William Sonneborn

Thank you, Mike. We are pleased with the positive momentum occurring within our business. On past calls, we have discussed our views on asset allocation, with our focus being long-term growth and shareholder value. We increased cash distributions and growth in enterprise value. I’ll sum up this past quarter as one where we executed on our business model by meaningfully deploying capital to opportunities that leveraged all of the capabilities of KKR.

These opportunities were consistent with our core tenants to capital deployment that we discussed on previous calls, which include, first, focusing on growing enterprise value on cash distribution by deploying capital to opportunities that balance capital appreciation with cash flow growth; second, sourcing opportunities that give us options to increase risk-adjusted returns by constructing a portfolio of holdings that will perform well in a higher rate or even inflationary environment; third and finally, leveraging the global KKR team to deploy capital situation where we believe we have a competitive and proprietary advantage.

Slide 11 in our supplemental presentation provides an illustration of how our balance sheet capital at risk is deployed today and provides a theoretical example of our potential future allocations as we continue to deploy capital based on our key tenants. The pie chart for KFN today on slide 11 tied to an allocation of net holding company capital at risk provided on the bottom of page seven.

As depicted here, corporate debt in its entirety includes CLOs, mezzanine and special situations funded directly has and will continue to be the asset class where we expect to deploy the majority of our capital. But the CLO market remains a key focus for us as a source of interesting risk adjusted returns.

As this slide depicts, we intend to continue to diversify our holdings as we execute on our targeted asset class strategy that are shown here and summarized both on pages eight to ten of that supplemental presentation and discussed in more detailed in the executive overview section of management’s discussion and analysis contained in our Form 10-Q that we filed today.

As we move forward in 2011, we sit here with a strong balance sheet, characterized by a well-performing portfolio and low leverage. We believe we have an attractive pipeline of opportunities across our business that we are working on. And needless to say, we are excited about where we are going as we work to grow value for our shareholders. We believe KFN is a unique specialty finance company that has tremendous opportunity to continue to deliver shareholder value in proprietary ways. We look forward to continuing to update you on the progress we make on executing on our strategy next quarter.

With that, we will open this call for questions. Operator, please go ahead.

Question-and-Answer Session

Operator

Thank you. (Operator instructions) Our first question will come from John Hecht with JMP Securities.

John Hecht – JMP Securities

Thanks, guys. Thanks for taking my questions. First one is regarding the CLO you announced a few weeks back, is there a formal or informal arrangement with the counterparty in that? And if there is some sort of arrangement where you might have some follow-up activity, would the terms be similar or can it evolve over time?

William Sonneborn

There is not a formal arrangement, John, for future transactions with that investor. However, based on their interest and our interest of doing a similar transaction in the future, it’s definitely possible. As far as future terms will be dictated, a combination of what’s meaningful for us and what makes sense compared to other transactions, we could do more revolving in the market.

John Hecht – JMP Securities

Okay. Can you guys discuss maybe over the last three months where you are seeing any changes in risk-adjusted returns? Are there anything that’s getting a little tight relative to where you’d want to invest? And is there types of asset classes where there might be incremental opportunities at this point?

William Sonneborn

That’s a good question, John. I think in the US distress market, we’ve seen very little opportunity both in the context of credit spread compression. And I think that extends into the high yield market in the US, both because of absolute yield as well as credit spreads. But we are seeing opportunity continuously as the tightening of liability spreads faster than that of spreads in the loan side, which is making CLOs attractive for deploying capital. Special situations in Europe and Australia, particularly in Europe, as a result of banks finally starting to deleverage by selling assets in the marketplace. And then finally, we still see in the middle market, interesting mez transactions above and beyond what we are doing in natural resources. But I’d say, generally speaking, the high-yield market in the US, we think, is pretty tight.

John Hecht – JMP Securities

Okay. And my final question is, given that Texas Competitive Electric Holdings Company’s, your biggest investment, I believe they just went through a restructuring that involved an increase in remuneration for the creditors. Could you just talk about what that – the specifics to that and how that may or may not benefit you?

William Sonneborn

Sure. For those of you who understand from the public filing of what the transaction that Energy Future Holdings’ subsidiary TXU did, they extended their senior secured term loan through an amendment in extension exercise, the result of which, just to simplify, is that holders that did agree to extend under the transaction of which more than 80% of term loan holders did do receive four points effectively of cash upfront is the effective consideration for the extension plus an additional 100 basis point spread in terms of credit spread over the new extended term, extending the term loan from 2014 to 2017.

John Hecht – JMP Securities

Is there any GAAP accrual in the near-term on that four points or is that something you just accrue over the life of the loan?

William Sonneborn

The cash comes in right away. GAAP, Michael, I’ll let you answer that question.

Michael McFerran

The cash comes in right away. John, we’ll have to work through the accounting to decide whether or not cash under GAAP should be recognized A-1 or if it should be capitalized part of our base based of the investment, amortized over the remaining life, we will update you on the next quarter. Total amount of cash that came in, primarily two are CLOs, was about $16.5 million.

John Hecht – JMP Securities

Okay. Thank you guys very much.

William Sonneborn

Thank you.

Operator

We’ll take our next question from Michael Sarcone with Sandler O'Neill.

Michael Sarcone – Sandler O'Neill

Hi, good afternoon, guys.

William Sonneborn

Hi, Michael, how are you?

Michael Sarcone – Sandler O'Neill

Good, thanks. First question, just on your thoughts about the CLO market, can you give us any color on timing as it relates to current CLOs, which have reinvestment periods ending soon?

William Sonneborn

Sure. We have disclosed in the past 2007-A ended its reinvestment period last October. 2005-1 just ended its reinvestment period in April, some few weeks back. 2005-2 ends its reinvestment period this month, May. 2006-1 will end a year from now in our largest CLO, which represents almost half our total exposure to the market. It’s got reinvestments running at May of 2014. As far as how we think about that, Michael, we’re focused on two items. One, based on our modeling, we think there is still a fair amount of opportunity with the CLOs post reinvestment period. That notwithstanding, we still think at some point between the end of the reinvestment period and ultimately the maturity of the deal will actually want to replace these deals or call them and replace them with another opportunity, we are focused on looking at the market as we evaluate our CLOs and are looking at one new CLO over the long run that was replaced some. Or two, potentially amending our current deals. So we will have more information on that in the quarters to come.

Michael Sarcone – Sandler O'Neill

Got it. And then just on G&A, is the $8 million a good run rate going forward?

William Sonneborn

No, I’d say that’s a high number. I would probably assume closer to $5 million is more of a reasonable number prospectively. There were some one-time non-cash write-off that took place this quarter, but that’s just a one-time event.

Michael Sarcone – Sandler O'Neill

Okay. And my last question just – can you give us any color on credit, just what you’re seeing in the portfolio?

William Sonneborn

Sure. Generally across the portfolio, credit conditions are benign. You’ve seen that in terms of any default statistics as well as depreciation as the value of the portfolio at much faster rates over the course of the last six quarters and the overall market. Credit spreads have tightened, as we talked about previously, particularly in subordinated capital in the high-yield market much faster than the loan market, predominantly because loans are floating rate instruments priced up the short end of the curve.

And so their absolute levels of cash yield are less to investors than high yield because there continues to be a lot of liquidity in the system as a result of Q2 and a search particularly amongst retail investors’ group sources of yield. But in terms of our overall portfolio, I think you would see, comparing and contrasting our largest 50 positions contained within the supplemental materials, continued diversification of that portfolio from some of the large concentrated positions. When you go through that list, the number of items that an average person should be worried about continues to dwindle in terms of size and scale.

Michael Sarcone – Sandler O'Neill

Okay, great. Thanks, guys.

Operator

Our next question will come from Steven Kwok with KBW.

Steven Kwok – KBW

Hi, thanks for taking my questions. I was wondering first on credit, I was – I noticed that there was a loan loss provision of about $12 million and charge-offs of $22 million during the quarter. I was wondering if you guys could talk about that.

William Sonneborn

Sure. Mike can talk a little bit about the charge-offs, but that’s just a balance sheet movement from held for investment in which hold loans at basically cost less the allowance and then move them to lower cost to market. But in the case of provision, especially we saw this quarter is just to an unallocated, we’ll call it, for potential rainy day sources since there’s no specific credits in mind, a consistent approach both top-down of the 3.4% of our loans held for investment held within the allowance. Mike, do you want to talk a little about the classification between held for investment and available for sale?

Michael McFerran

Yes. Steven, the charge-offs took place this quarter were all transferring loans to held for sale where they carry lower cost to market. This is simply a balance sheet convention. It doesn’t change the carrying value of the portfolio. No change to value. None of the charge-offs actually related to credit loss, rather just movements to be held for sale. You will see those periodically. I would view that number being pretty separate and apart from the 11 million of provision according to Bill’s point. But again we’ll just increase our overall provision of our unallocated reserve, but again, not relating to any specific credits.

William Sonneborn

A good example is a LIBOR plus 200 loan with no four that was done in first quarter of 2007. It’s still market today. Even though company has performed well, it’s going to be 96. And so if you move that loan to available for sale, you take the four points of the loan balance as a charge-off against the allowance for loan losses.

Steven Kwok – KBW

Great. And any forward commentary on future provisions for losses or –? I’m just wondering, is it’s been – this is the third consecutive month where you guys have had provisions. Just curious what the trajectory is.

William Sonneborn

No, if we think – we've held the allowance constant for the last several quarters at 3.4%. The amortized cost basis of our loans held for investment portfolio. We think that’s a prudent and conservative reserve based on the class win. If we look at how loans are performing, our portfolio in particular, we have no looming credit events that have us concerned. But as the portfolio continues to grow, we think it’s prudent to increase our allowance accordingly.

Michael McFerran

One of the reasons for that is that we’ve been taking advantage of opportunities in distress in Europe and in Australia as an example. We buy a loan of a company we expect to go through restructuring even though we are using traditional loan accounting and having that loan as held for investment. And the underlying loan has very attractive return parameters. Maintaining a reasonable allowance against that portion of our balance sheet makes sense as well.

Steven Kwok – KBW

Great. And final question, with regard to the net discount accretion, I noticed that it ticked down a little bit this quarter, but still higher than the typical average run rate of, say, $20 million to $25 million. Just wondering, are there any one-timers in that line?

William Sonneborn

Every quarter, Steven, we have – the way we report the loans prepay is the difference of that accelerated accretion goes and the discount accretion line. So that number is going to have some volatility as a function of just the level of prepayments we’ve experienced. To your point, fourth quarter of 2010, we had a higher level of prepayments of loans, credit discounts that we have this quarter. But I believe about $5 million of that number this quarter was related to prepayments.

Steven Kwok – KBW

Okay. Great. Thanks.

William Sonneborn

Thank you.

Operator

We’ll now hear from Gabe Poggi with FBR.

Gabe Poggi – FBR

Hey, good afternoon, guys.

William Sonneborn

Hi, Gabe, how are you?

Gabe Poggi – FBR

Good. How are you, guys? A few questions, kind of more macro questions. Bill and Mike, you guys have said now for seem like nine months or so as the CLO market has headed back up and folks would ask questions that you were kind of waiting for the market to come to you. You guys obviously did a CLO in the first quarter. But that was a unique transaction that was smaller with static. Is it safe to say that with other transactions pricing in the market that have higher leverage continue to squeeze on cost of funds at the market, continues to kind of come your way and you guys are now seeing more avenues to potentially do something, and I don’t necessarily want to say bigger, but more leverage, things of that nature?

William Sonneborn

We’ve seen, Gabe, definitely to your point, an increase in activity in the CLO market. There is a broader investor base and there was even as recently as late last year. So with that, there are increasingly more opportunities. The key thing to keep in mind is we think about it as we use CLOs as financing. So we may have a different view on how much leverage we want to put on a transaction. Others are issued in for different reasons. But 2011-1 was a good example to your point of a transaction coming to us. We are focused on when the economics makes sense, we’d like to do these deals. If it’s a private transaction like 2011-1 that makes the most sense and meets our risk adjusted return, we’ll do it. If it’s a traditional market transaction, we’ll do that. We’re fairly agnostic between the two.

Michael McFerran

But as an example, Gabe, the CLO market was in the senior part of the liability side, more in the 140, 150 over range. And so we did this transaction. And then we brought the overall senior as a result of printing this transaction, new deals that are being marketed. Now we’re at the same pricing this one was done at. And so strategically, we’re protecting our downside of future credit compression through this privately negotiated transactions that we are going to principal out faster than you would in a traditional CLO.

At the same time, we brought the overall liability cost down for the industry. On top of that, which is kind of interesting from our perspective, is there is a new rule being proposed, which is the skin in the game rule, which could have substantial limit on the supply of CLOs in the marketplace other than potentially for providers of the structure sets of KFN, which makes us interestingly positioned to take advantage of more demand. And there is supply in terms of product available. Sometime over the summer when and if that rule becomes effective.

Gabe Poggi – FBR

You answered my second question which was going to be that. And I assumed and obviously that’s a very good thing for KFN if in fact that does move down the line. Bill, you talked about kind of in terms of asset classes where you’re seeing commissioning opportunities, you mentioned Europe, is that specifically in bank debt you guys have kind of in the forward pie chart? I’m just kind of thinking out of the box here, but do you have commercial real estate in there? Are you – have you guys – has KFN in aggregate begun to look more aggressively at commercial real estate opportunities? Is that still kind of low on the totem pole relative to natural resources and kind of the CLO gain?

William Sonneborn

It’s a great question, Gabe. But it’s something we are actually spending a lot of time now, because the opportunity is pretty right particularly in European commercial banks that have statutory agreed dates and asset disposition targets with their respective regulators or in some cases, majority owners. In the case of the European marketplace, it’s also that there is about $1 trillion of assets, predominantly commercial real estate debt-related, some performing, a lot non-performing that is likely going to be disposed over the course of the next four to six quarters. And we have had a team spending a tremendous amount of time in Europe meeting with these respective financial institutions to try to take advantage of what we think is an interesting opportunity. The opportunity has been there now for two years. It’s just there has been no paper to purchase. And what’s interesting now is that the supply could be enormous. And so, yes, we are preparing for an interesting opportunity in commercial real estate.

Gabe Poggi – FBR

Interesting. Okay, that’s helpful. And then one last kind of nuts-and-bolts question. Mike, you may have said this and I may have missed it. Any specifics on the delta between 4Q investment income and 1Q investment income as it pertains on the loan side of things? I know that your securities book is continuing to run down as you guys think high yield tight, but just the delta between 115, call it, million in loan interest income relative to call it 110, rounding up? Any specifics or just the portfolio day-to-day?

Michael McFerran

No, the specifics are having really to do with – if you look at total interest income on loans, we talked earlier about discount accretion and prepayments. That’s probably the biggest piece of it. The second of it, to some extent, Gabe, is the timing of when we divested assets and repurchased assets. So sometimes in any given quarter you could see some lumpiness as we had a fair amount of pay-downs at the end of Q4 and that capital wasn’t necessarily deployed at the first day of this quarter.

Gabe Poggi – FBR

Okay. That’s helpful. Thanks, guys. Good quarter.

William Sonneborn

Thank you, Gabe.

Operator

And Jasper Burch with Macquarie has the next question.

Jasper Burch – Macquarie

Hey, guys, thank you for taking my question. Good afternoon. I guess just starting off, staying on the CLO topics, looking at your new CLO and the $159 million of bank loans on your balance sheet, have you or are you selling any of those assets into the new CLO or is it going to be all new purchases and originations?

William Sonneborn

If you look in the supplemental presentation, I know it’s a footnote, Jasper, but we mentioned we have the $159 million. Footnote 1 of that at the bottom of page eight specifies about $159 million. $59 million of it is going into 2011-1, and the rest of it was being purchased outside of our balance sheet. Pro forma after 2011-1, we had about $100 million of loans on balance sheet held for future CLO deals.

Jasper Burch – Macquarie

Okay. And then could you provide what you guys internally expect to be a loss adjusted ROE on that deal?

William Sonneborn

We targeted mid-teens for CLO transactions, and this deal is consistent with that.

Jasper Burch – Macquarie

Okay. Excellent. And then moving on to the 2005 CLOs, I think it was April, May reinvestment periods ending. I think if you recall earlier, I was just wondering – could you give us a little more color so I can try and model out how those are going to be ramping down, specifically like the weighted average life on those and there was the prepayment rates you’ve seeing?

William Sonneborn

I think the easiest way, Jasper, to think about that is how Mike and I think about that is, as those start to effectively de-lever and pay down senior notes, at the point where the kind of IRRs or return on equity capital that we have get to mid-teens, at that point we will call and refinance into a new transaction to at least maintain mid-teens rate to return. So when I think about the business, I assume that as returns go from, say, 22%, because of the low cost liability, down to, say, 15%, then I’m going to redeploy that capital at 15% I perpetuity. That’s always how I think about it.

Michael McFerran

When we – Jasper, for the last couple years we were talking about we were redeploying pay-down each assets that are on average at higher yield than what we’ve initially put in the CLOs. And we’ve been benefiting from that the ROEs on those deals in the 20s now. To Bill’s point, we’re going to see that come down and then we’re going to cut it off and cut in new deals somewhere in that north of mid-teens or north of their returns. But this is – what you’re speaking of the high ROE is definitely a result of deploying capital over the last couple of years.

Jasper Burch – Macquarie

Okay. Thank you. That’s very helpful. And then I guess just lastly, real quick, of the $590 million of restricted cash at quarter-end, how much of that is still available to be invested within the remaining CLOs?

William Sonneborn

The majority of that is cash that’s available. That being said, that number fluctuates as you can appreciate any given day based on step-up prepayment failed, unsafe settlements of traits, that’s not necessarily a number that – you're going to find a big pay-down the day before, we could have had a tray that just hadn’t settled first.

Michael McFerran

Yes. The way to think about it is a large portion of that any one quarter-end has already been traded. It’s just in the loan market. It can take a couple weeks to settle the trade. And so it will still show up as restricted cash until the settlement date.

William Sonneborn

Yes.

Jasper Burch – Macquarie

Okay. Just think about the available cash that you still have to turn over to the balance sheet, I guess we should look at just 512-5 [ph] just the best, how you guys looking at it internally?

William Sonneborn

Yes. The way I would start with, we said unrestricted cash was $129 million. We have assets on balance sheet remains to be highlighted at $100 million. There are other assets outside of the $100 million targeted for CLOs that we could – that are fairly liquid that we could choose to divest the credit section in our balance sheet.

Michael McFerran

Where you see a fair amount of assets and from a liquidity standpoint, we also have the revolver we can always look to, which we haven’t used it quite some time, but that gives us flexibility. But as we mentioned, we think we have enough liquidity and access to our balance sheet to our borrowing facility to be able to continue to execute on the strategy without feeling constrained today.

Jasper Burch – Macquarie

Okay. Thank you, guys, very much.

William Sonneborn

Thank you, Jasper.

Jasper Burch – Macquarie

Our next question comes from Lee Cooperman with Omega Advisors.

Lee Cooperman – Omega Advisors

Yes, thank you. I just want to make sure I definitely understand everything I should understand. We have taxable income, we have total cash earnings, we have run rate cash earnings. So, the dividend policy of the corporation is set off of on the recurring quarterly earnings? As I read the footnote disclosure, the modified footnote disclosure in the current Q, basically that the distribution quarterly most likely is measured off the run rate of cash earnings. Is that a fair statement?

William Sonneborn

Yes, that’s a fair statement. But when we determine that, we’re not only looking at that current quarter, but we’re also, as we have talked about in previous quarters, making a risk analysis because it is the management and the Board’s desire to never have to reduce that number in the future.

Lee Cooperman – Omega Advisors

Yes. (inaudible) because the dividend of $0.16 is 59% of the run rate cash earnings.

William Sonneborn

That’s correct.

Lee Cooperman – Omega Advisors

What is the total taxable earnings in the quarter?

William Sonneborn

We don’t have the taxable earnings (inaudible) nor we disclose that for the quarter.

Lee Cooperman – Omega Advisors

Is that quite confidential?

William Sonneborn

No, it’s not confidential. I got to go back to every shareholder as we talked about at the different basis. So we’ve been hesitant to try and take guesses of what our shareholders (inaudible) original tax –

Lee Cooperman – Omega Advisors

Let me – I got three or four quick – yes.

William Sonneborn

However, Lee, for purposes of, I would say, directionally, run rate cash earnings should be or recurring taxable income, the best approximate or what I would direct the investors to.

Michael McFerran

Though we did have a substantial tax deduction in the first quarter, which has resulted restricted stock that was granted in first quarter of 2008 vesting, there was a substantial tax deduction that offset a large portion of the $0.30 for tax purposes. It really doesn’t affect GAAP.

Lee Cooperman – Omega Advisors

Secondly, you got a lot of money, and in December when you did your offering and you put that to work over a 60-day period. I know the nature of your business. You guys know your earnings on a daily basis, less than forthcoming at times. But with the earnings at the end of the quarter, on a monthly basis, running high to the average earnings of the quarter? In other words – just the way question was phrased. In other words, as you got this money to work at higher rates of return, then the earning near zero in cash, did the earnings ramp up over the quarter so that the month of March run rate cash earnings was higher than the month of January?

William Sonneborn

The answer to that is yes. And as you see, though the CLO 2011-1, which is the largest portion of the capital redeployment didn’t close until the end of the quarter and we just closed the ramp-up nature of that on its closed date as well as more recently. And as a result of that, you won’t see the full run rate effect. And you see the majority of the run rate effect into the second quarter and then full impact in the third quarter.

Lee Cooperman – Omega Advisors

Got you. In terms of capital for growth, we have this unrestricted cash of $129 million, we have zero borrowings on your revolver, and you mentioned on the last call and this call the term debt capital market. I have felt all along that we got to be very careful the way we sell new equity. I look at the book value, not the $9.73 number. I look at my book value, the $11.77 number. And I was curious you guys have any view of the need for additional equity or is that not in near-term time horizon. And you agree that you should be looking at the $11.77 number today as opposed to $9.73 number for any potential raise-up.

William Sonneborn

You raised an interesting question, because if I look at kind of other specified finance comps like GDP is 21.2 times book value, which is the equivalent of the $11.77 number. And then I compare that to where we trade relative to our GAAP book value, which is a discount to that number substantially. I find it kind of interesting and somewhat disturbing, to be honest with you. But the answer is, as we’ve talked about in previous quarters and when we raised the equity in the fourth quarter, the amount that we raised was all conditioned upon executing strategy we had to show the market that there is growth outside of the CLO market while we are waiting for it to become more attractive and at mid-teens rates of returns that we have stated we need to deliver to our shareholders as a use of capital. And we know that our equity is highly expensive as a result of what ROE we’re producing and can produce going forward. And so we’re very sensitive to raising equity that’s dilutive to our shareholders.

Lee Cooperman – Omega Advisors

So, is that one way of responding to the question that we have enough debt capacity and we’re cognizant to the real value of the business and we’re not likely to sell equity?

William Sonneborn

We talked about last quarterly that we want to lower our cost of capital. And the one way to do that is outside of the CLO market, have enough diversification where theoretically we can raise low coupon investment grade debt as a means of additional growth, which is highly accretive to our ability to maintain and generate attractive returns to our shareholders in the future.

Lee Cooperman – Omega Advisors

One other suggestion. I find very – not enough people know about you. It’s just a handle of us. Maybe you get on the road and tell the story a little bit.

William Sonneborn

Aye-aye, sir.

Lee Cooperman – Omega Advisors

You get some mileage, you know, mileage plus or some mileage called these days. Thank you very much.

William Sonneborn

Thank you, Lee.

Operator

We’ll take the next question from Wayne Cooperman with Cobalt Capital.

Wayne Cooperman – Cobalt Capital

Hey, guys. Can you talk a little bit about TXU or whatever you call these days? Has this restructuring gone through? What is your position now? Are your economic – I would think if I went through, your economics are actually relatively materially improved than they were before. Just give us a little color on your current situation.

William Sonneborn

Sure. If you have the supplemental materials, look on slide we’ve put up for you in slide 15, you’ll see our largest position with TXU, which is the Energy Future Holdings complex, which is the holding company. I think in our footnote disclosure in our financial statements, we added some stuff in terms of concentration of credit risk. Mike mentioned that the four points of upfront fee as a result and little over $12 million of – $15 million of cash that we’ll receive this quarter. Our position, as we’ve talked about in previous quarterly calls, is almost exclusively in the senior secured term loan. And so in addition to the four points and $16 million of net cash we will receive as a result of the amendment and extension in the second quarter of this year, we’ll also get an extra 100 basis points of credit spread on that same 400 million of exposure.

Wayne Cooperman – Cobalt Capital

And what’s the line of the maturity now?

William Sonneborn

2017, with a spring maturity that ties to the bond part of the capital structure to the extent the bonds aren’t refinanced.

Wayne Cooperman – Cobalt Capital

Do you think – I mean, are you guys any worse off from a credit standpoint than you were before?

William Sonneborn

We don’t believe so. So we wouldn’t have agreed to amend and extend. We think this is beneficial.

Wayne Cooperman – Cobalt Capital

Okay. Thanks.

William Sonneborn

You bet.

Operator

And ladies and gentlemen, that’s all the time we have for questions today. I’ll hand the call back over to management for any closing comments.

William Sonneborn

Thank you, all. We appreciate your interest in following the company and look forward to continue to execute on the company’s strategy. Have a good evening.

Operator

Ladies and gentlemen, that does conclude today’s conference call. We thank you for your participation.

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