Some Key Observations on KKR Financial

I am sharing with you some of the key observations on KKR Financial Holdings (KFN), company that I had a short position in, but covered some time ago. I would appreciate any info or insight that my readers may have on this company. I initially saw this company as the next Carlyle Capital or Peloton Holdings. In order to put on another position at these levels, I would have to assume a total equity wipeout, as was witnessed in the two aforementioned companies. We shall see...

On December 31, 2007, KFN's economic book value per share was $14.62 and fair value per share was $16.06. As of March 06, 2008, when the company held a conference call with the analysts, it highlighted that both economic book value and fair value per share are broadly in the range of on the low side, $13.50 per share, and on the high side, $14.50 per share.

Liquidity

On the liquidity front, at the end of December 31, 2007, KFN had $1.04 billion of available liquidity which included unrestricted cash and cash equivalents of $524.1 million, restricted cash available for investment worth $430.1 million and restricted cash available for debt service amounting to $85.5 million. As of March 06, 2008, it had free cash and cash equivalents approximating $400 million and restricted cash available for investment of just under $500 million. $100 million worth of liquidity lost in two months!

In terms funding capacity, KFN mentioned that it currently has $1.8 billion of capacity available under the non-recourse secure transaction executed in November 2007, $340 million available under secured credit facility, and an additional EUR800 million. However, in a recent filing with the SEC, KFN asked for more time to make payments to holders of the non-recourse secured liquidity notes that were issued by two of its asset-backed conduit facilities.

This isn't the first time the company has run into trouble. Last year, it said the credit market turmoil was weighing on its ability to make payments on some of its asset-backed commercial paper. In October 2007, the company reached a pact to extend the maturity date of the secured liquidity notes so that roughly half of the principal was due on February 15, 2008 and the rest on March 13, 2008.

Repo agreements with "Investment Banks"

KFN also mentioned that it has large warehouses which are structured as repo agreements with Goldman Sachs (GS), Citigroup (C), J P Morgan Chase (JPM) and Morgan Stanley (MS).

Credit exposure to RMBS

Asset Backed Commercial Paper [ABCP] where they took a charge of $243 million for discontinued operations. That has underlying in it assets that are in excess of $3.5 billion. Apart from this, as of December 31, KFN held approximately $337 million of residential mortgage backed securities. These were AA to unrated pieces of which, approximately $288 million was rated investment grade and just under $50 million was below investment grade.

They mentioned that these securities were the remnants of the whole loans that KFN bought from Wells Fargo (WFC) and First Republic securitized with most of them being originated in 2004 and 2005 (FICO in the 730ish range and LTV's of 65-66). The cumulative static pool net losses on the underlying $10.5 billion of mortgages at the end of December 31, 2007 were 1.9 to 2 basis points. However, it may have gone up significantly with the worsening of the crisis and widening credit spreads.

The CEO had the following comment on the business in 2008:

We had January was the second worst month in loan history after July of last year and then February came right after it and was the third worst figure in loan history.

I did not have enough time to go through the company's 10K and see if there are some discrepancies that can be looked into, but will follow up in a few days.

Comments

[paulibloom:]

The above comments are just factually incorrect. The author seems to not understand the meaning of the word non-recourse. KFN has no residual liability on the ABCP. By virtue of this fatal mistake, the author completely misunderstands the liquidity situation. He can help himself by listening to the conference call again. In addition he will hear that KFN can in fact effectively take out their short term financing via a facility they put in place last November.

2008 Mar 28 09:12 AM

[dashingdwl:]

With the latest announcement regard reit and mbs situation, I think the problems are behind KFN. I shorted it from 14 to 12.50 and now will go long at <12. I like the corporate senior secured loan risk (worst is priced in from a liquidity standpoint, defaults will pick up but we are pricing loans below recovery value). Nice dividend.

2008 Apr 01 03:00 PM

[paulibloom:]

We have not seen Reggie review the 10K and report back to us - I wonder why. Could it be he does not understand the material, or that he now feels foolish that he really did not do his homework. I was an analyst on Wall Street for over 20 years-this is way minor league stuff that would get your fired because the professionals would tell the salesmen that you had no clue.

2008 Apr 16 08:55 PM

[paulibloom:]

Oh I forgot to add that subsequent to your article some "fools" invested over $350 million in the company in roughly two days-I wonder why

2008 Apr 16 09:04 PM

[Reggie Midd...:]

The reason why you haven’t heard from me Mr. Bloom is that I generally do no comment on Seeking Alpha – whose comments section is rife with the negative, unprofessional attitude that is represented by your posts. It is time consuming and I have my own blog for commenting and interaction that I am quite active with. Feel free to come over to boombustblog.com and we can engage until your heart is content. The issue with KFN was an error and oversight on behalf of one of my younger analysts which I take full responsibility for since I hired him and the post was made under my name. It was an egregious error, but an error nonetheless – and they do happen.
It is highly irrelevant what would have happened to an analyst on the street (I didn’t fire my analyst for this, since mistakes do happen and we’re not on the Street), how long you have been working as an analyst, or how much other (big or name brand) investors invested in KFN. I often invest contrary to much larger or name brand investors, and do so quite profitably, regularly. One should never base their investment thesis on what XYZ investor did or did not do. Since I am not an analyst or bank employee, but a buy side investor that eats what he kills, my theses are either correct or I don’t eat. In general, I have eaten quite well.
My track record speaks for itself, and a quick perusal of my blog, marked to market, should be deserving of more than the disrespectful tone resonating from your comments. I am also quite confident the record reflects quite favorably compared to whatever institution you may be referring to in regards to the bar for analysts. It is quite possible to disagree without being derogatory, but if you are going to be derogatory (which is lacking in professionalism and plain old fashioned manners) you should at least have a firm empirical basis for doing so.
The aforementioned litany is basically the reason why I don’t comment on Seeking Alpha, but since an error was made on my watch and printed under my name, I felt compelled to bend the rules this time around to address it. Will I see you on my blog, Mr. Bloom? You are quite welcome there.

2008 Apr 17 10:05 AM

[paulibloom:]

Reggie-you are right my manner was unprofessional. Does not change any of my conclusions, but you are right. What I find troubling in general is analyst wannabe's who are really momentum players-on either side of the story.

2008 Apr 19 05:00 PM

[Reggie Midd...:]

Thanks for being polite this time around. I can assure you that I am neither an analyst wannabe or a momentum player, but a fundamental investor. I hold my positions until my thesis is proven right or proven wrong, usually a bare minimum of three months but I will go long or short over a year with no problem. Since Seeking Alpha usually rejects much of my work due to its length and complexity, you don't get to see most of it, but if you go to boombustblog.com you will see: Ambac, MBIA, WAMU and Countrywide since 9/07 (or thereabouts), Bear Stearns since January 08, home builders since September, etc.

Download the reports, which average about 20 pages each of original and proprietary research. It should be well worth it. This is it for comments on Alpha for right now, but I look forward to seeing you on m blog.

2008 Apr 20 06:46 PM