KKR FINANCIAL HOLDINGS LLC
(Exact name of registrant as specified in its charter)

Securities registered pursuant to Section 12(b) of the Act:
Shares representing limited liability company membership interests listed on the New York Stock Exchange

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. ý Yes o No

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. o Yes ý No

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. ý Yes o No

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). ý Yes o No

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§ 229.405 of this chapter) is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. ý

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of "large accelerated filer," "accelerated filer" and "smaller reporting company" in Rule 12b-2 of the Exchange Act. (Check one):

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). o Yes ý No

The aggregate market value of the common shares held by non-affiliates of the registrant as of June 30, 2011 was $1,691,516,149, based on the closing price of the common shares on such date as reported on the New York Stock Exchange.

The number of shares of the registrant's common shares outstanding as of February 21, 2012 was 178,403,785.

Portions of the registrant's Proxy Statement for the 2012 Annual Shareholders' Meeting to be filed within 120 days after the close of the registrant's fiscal year are incorporated by reference into Part III of this Annual Report on Form 10-K.

Except where otherwise expressly stated or the context suggests otherwise, the terms "we," "us" and "our" refer to KKR Financial Holdings LLC and its subsidiaries; the "Manager" refers to KKR Financial Advisors LLC; and "KKR" refers to Kohlberg Kravis Roberts & Co. L.P. and its affiliated companies.

This Annual Report on Form 10-K contains a summary of some of the terms of our operating agreement and our management agreement (the "Management Agreement") with our Manager. Those summaries are not complete and are subject to, and qualified in their entirety by reference to, all of the provisions of our operating agreement and the Management Agreement. A copy of our operating agreement is included as an exhibit to the quarterly report on Form 10-Q that we filed with the SEC on August 6, 2009 and a copy of Amendment No. 1 thereto is included as an exhibit to the annual report on Form 10-K that we filed with the SEC on March 1, 2010. A copy of our Management Agreement is included as an exhibit to the current report on Form 8-K that we filed with the SEC on May 4, 2007 and a copy of an amendment thereto is included as an exhibit to the current report on Form 8-K that we filed with the SEC on June 15, 2007. Copies of all such reports and exhibits are available on the SEC website at www.sec.gov.

CAUTIONARY STATEMENT FOR PURPOSES OF THE "SAFE HARBOR" PROVISIONS OF
THE PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995

Certain information contained in this Annual Report on Form 10-K constitutes "forward-looking" statements within the meaning of Section 27A of the Securities Act of 1933, as amended, or the Securities Act, and Section 21E of the Securities Exchange Act of 1934, as amended, or the Exchange Act, that are based on our current expectations, estimates and projections, including, but not limited to, statements regarding the level of future collateralized loan obligation investments, our liquidity and the potential to issue future capital or refinance or replace existing indebtedness. Pursuant to those sections, we may obtain a "safe harbor" for forward-looking statements by identifying and accompanying those statements with cautionary statements, which identify factors that could cause actual results to differ from those expressed in the forward-looking statements. Statements that are not historical facts, including statements about our beliefs and expectations, are forward-looking statements. The words "believe," "anticipate," "intend," "aim," "expect," "strive," "plan," "estimate," and "project," and similar words identify forward-looking statements. Such statements are not guarantees of future performance, events or results and involve potential risks and uncertainties. Accordingly, actual results and the timing of certain events could differ materially from those addressed in forward-looking statements due to a number of factors including, but not limited to, changes in interest rates and market values, financing and capital availability, changes in prepayment rates, general economic and political conditions and events, changes in market conditions, particularly in the global fixed income, credit and equity markets, the impact of current, pending and future legislation, regulation and legal actions, and other factors not presently identified. Other factors that may impact our actual results are discussed under "Risk Factors" in Item 1A of this Annual Report on Form 10-K. We do not undertake, and specifically disclaim, any obligation to publicly release the result of any revisions that may be made to any forward-looking statements to reflect the occurrence of anticipated or unanticipated events or circumstances after the date of such statements, except for as required by federal securities laws.

Our Internet website is http://ir.kkr.com/kfn_ir/kfn_overview.cfm. Our annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Exchange Act are available free of charge through our website, at http://ir.kkr.com/kfn_ir/kfn_sec.cfm as soon as reasonably practicable after they are electronically filed with, or furnished to, the Securities and Exchange Commission (the "SEC"). Our Corporate Governance Guidelines, board of directors' committee charters (including the charters of the Affiliated Transactions Committee, Audit Committee, Compensation Committee, and Nominating and Corporate Governance Committee) and Code of Business Conduct and Ethics are available on our website at http://ir.kkr.com/kfn_ir/kfn_governance.cfm. Information on our website does not constitute a part of, and is not incorporated by reference into, this Annual Report on Form 10-K.

We are a specialty finance company with expertise in a range of asset classes. Our core business strategy is to leverage the proprietary resources of our manager with the objective of generating both current income and capital appreciation by deploying capital to our strategies, which include bank loans and high yield securities, natural resources, special situations, mezzanine, commercial real estate and private equity. Our holdings across these strategies primarily consist of below investment grade syndicated corporate loans, also known as leveraged loans, high yield debt securities, private equity and working and royalty interests in oil and gas properties. The corporate loans that we hold are purchased via assignment or participation in the primary or secondary market.

The majority of our holdings consist of corporate loans and high yield debt securities held in collateralized loan obligation ("CLO") transactions that are structured as on-balance sheet securitizations and are used as long term financing for our investments in corporate debt. The senior secured debt issued by the CLO transactions is primarily owned by unaffiliated third party investors and we own the majority of the subordinated notes in the CLO transactions. Our CLO transactions consist of six CLO transactions, KKR Financial CLO 2005-1, Ltd. ("CLO 2005-1"), KKR Financial CLO 2005-2, Ltd. ("CLO 2005-2"), KKR Financial CLO 2006-1, Ltd. ("CLO 2006-1"), KKR Financial CLO 2007-1, Ltd. ("CLO 2007-1"), KKR Financial CLO 2007-A, Ltd. ("CLO 2007-A"), and KKR Financial CLO 2011-1, Ltd. ("CLO 2011-1") (collectively the "Cash Flow CLOs"). In addition, our CLO transactions include KKR Financial CLO 2009-1 Ltd. ("CLO 2009-1"). However, as all of the debt of CLO 2009-1 was retired in July 2009, CLO 2009-1 is excluded from our six Cash Flow CLOs above. We execute our core business strategy through our majority-owned subsidiaries, including CLOs.

We are a Delaware limited liability company and were organized on January 17, 2007. We are the successor to KKR Financial Corp., a Maryland corporation. Our common shares are publicly traded on the New York Stock Exchange ("NYSE") under the symbol "KFN". We intend to continue to operate so as to qualify, for United States federal income tax purposes, as a partnership and not as an association or publicly traded partnership taxable as a corporation.

We are externally managed and advised by KKR Financial Advisors LLC (our "Manager"), a wholly-owned subsidiary of KKR Asset Management LLC ("KAM" or "the parent of our Manager"), pursuant to a management agreement (the "Management Agreement"). KAM is a wholly-owned subsidiary of Kohlberg Kravis Roberts & Co. L.P. ("KKR").

Our Manager is responsible for our operations and performs all services and activities relating to the management of our assets, liabilities and operations. Pursuant to the terms of the Management Agreement, our Manager provides us with our management team, along with appropriate support personnel. All of our executive officers are employees or members of KKR or one or more of its affiliates. Our Manager is under the direction of our board of directors and is required to manage our business affairs in conformity with the Investment Guidelines that are approved by a majority of our independent directors.

The executive offices of our Manager are located at 555 California Street, 50^th Floor, San Francisco, California 94104 and the telephone number of our Manager's executive offices is (415) 315-3620.

Our objective is to provide long-term value for our shareholders by generating an attractive total return through cash distributions and increased share price. We seek to achieve our objective by deploying capital opportunistically across capital structures and asset classes. As part of our strategy, we seek opportunities in those asset classes that can generate competitive leveraged risk-adjusted returns, subject to maintaining our exemption from registration under the Investment Company Act of 1940, as amended (the "Investment Company Act").

Our Manager utilizes its access to the global resources and professionals of KKR, along with the same philosophy of value creation that KKR employs, in order to create a portfolio that is constructed to generate recurring cash flows, long-term capital appreciation and overall competitive returns to investors. We make asset class allocation decisions based on various factors including: relative value, leveraged risk-adjusted returns, current and projected credit fundamentals, current and projected supply and demand, credit risk concentration considerations, current and projected macroeconomic considerations, liquidity, all-in cost of financing and financing availability, and maintaining our exemption from the Investment Company Act.

As of December 31, 2011, we determined that we operate our business through multiple reportable business segments, which we have determined to be credit ("Credit") and other segments ("Other"). Our segments are differentiated primarily by our investment focuses. The Credit segment includes primarily below investment grade corporate debt. The Other segments include all other portfolio holdings, including oil and natural gas working interests and overriding royalty interests. Our segments are differentiated primarily by our investment focuses. For financial information by segment, see "Item 8. Financial Statements and Supplementary Data—Note 15. Segment Reporting."

We intend to continue to operate so as to qualify, for United States federal income tax purposes, as a partnership and not as an association or a publicly traded partnership taxable as a corporation. In general, if a partnership is "publicly traded" (as defined in the Internal Revenue Code of 1986, as amended (the "Code")), it will be treated as a corporation for United States federal income tax purposes. A publicly traded partnership will be taxed as a partnership, however, and not as a corporation, if it is not required to register under the Investment Company Act and at least 90% of its gross income for each taxable year constitutes "qualifying income" within the meaning of

Section 7704(d) of the Code. We refer to this exception as the "qualifying income exception." Qualifying income generally includes rents, dividends, interest (to the extent such interest is neither derived from the "conduct of a financial or insurance business" nor based, directly or indirectly, upon "income or profits" of any person), income and gains derived from certain activities related to minerals and natural resources, and capital gains from the sale or other disposition of stocks, bonds and real property. Qualifying income also includes other income derived from the business of investing in, among other things, stocks and securities.

If we fail to satisfy the "qualifying income exception" described above, items of income, gain, loss, deduction and credit would not pass through to holders of our common shares and such holders would be treated for United States federal (and certain state and local) income tax purposes as shareholders in a corporation. In such case, we would be required to pay income tax at regular corporate rates on all of our income. In addition, we would likely be liable for state and local income and/or franchise taxes on all of our income. Distributions to holders of our common shares would constitute ordinary dividend income taxable to such holders to the extent of our earnings and profits, and these distributions would not be deductible by us. If we were taxable as a corporation, it could result in a material reduction in cash flow and after-tax return for holders of our common shares and thus could result in a substantial reduction in the value of our common shares and any other securities we may issue.

As referenced above, we have made and may make certain investments in natural resources. It is likely that the income from such investments will be treated as effectively connected with the conduct of a United States trade or business with respect to holders of our shares that are not "United States persons" within the meaning of Section 7701(a)(30) of the Code. Furthermore, any notional principal contracts that we enter into, if any, in connection with investments in natural resources likely would generate income that would be treated as effectively connected with the conduct of a United States trade or business. To the extent our income is treated as effectively connected income, a holder who is a non-United States person generally would be required to (i) file a United States federal income tax return for such year reporting its allocable share, if any, of our income or loss effectively connected with such trade or business and (ii) pay United States federal income tax at regular United States tax rates on any such income. Moreover, if such a holder is a corporation, it might be subject to a United States branch profits tax on its allocable share of our effectively connected income. In addition, distributions to such a holder would be subject to withholding at the highest applicable tax rate to the extent of the holder's allocable share of our effectively connected income. Any amount so withheld would be creditable against such holder's United States federal income tax liability, and such holder could claim a refund to the extent that the amount withheld exceeded such holder's United States federal income tax liability for the taxable year. Finally, if we are engaged in a United States trade or business, a portion of any gain recognized by an investor who is a non-United States person on the sale or exchange of its shares may be treated for United States federal income tax purposes as effectively connected income, and hence such holder may be subject to United States federal income tax on the sale or exchange.

In addition, for all of our holders, investments in natural resources would likely constitute doing business in the jurisdictions in which such assets are located. As a result, holders of our shares will likely be required to file foreign, state and local income tax returns and pay foreign, state and local income taxes in some or all of these various jurisdictions. Further, holders may be subject to penalties if they fail to comply with those requirements.

Section 3(a)(1)(A) of the Investment Company Act defines an investment company as any issuer that is, holds itself out as being, or proposes to be, primarily engaged in the business of investing,

reinvesting or trading in securities and Section 3(a)(1)(C) of the Investment Company Act defines an investment company as any issuer that is engaged or proposes to engage in the business of investing, reinvesting, owning, holding or trading in securities and owns or proposes to acquire "investment securities" (within the meaning of the Investment Company Act) having a value exceeding 40% of the value of the issuer's total assets (exclusive of United States government securities and cash items) on an unconsolidated basis (the "40% test"). Excluded from the term "investment securities" are, among others, securities issued by majority-owned subsidiaries unless the subsidiary is an investment company or relies on the exceptions from the definition of an investment company provided by Section 3(c)(1) or Section 3(c)(7) of the Investment Company Act (a "fund").

We are organized as a holding company. We conduct our operations primarily through our majority-owned subsidiaries. Each of our subsidiaries is either outside of the definition of an investment company in Sections 3(a)(1)(A) and 3(a)(1)(C), described above, or excepted from the definition of an investment company under the Investment Company Act. We believe that we are not, and that we do not propose to be, primarily engaged in the business of investing, reinvesting or trading in securities and we do not believe that we have held ourselves out as such. We intend to continue to conduct our operations so that we are not required to register as an investment company under the Investment Company Act.

We monitor our holdings regularly to confirm our continued compliance with the 40% test. In calculating our position under the 40% test, we are responsible for determining, among other things, whether any of our subsidiaries is majority-owned. We treat as majority-owned subsidiaries for purposes of the 40% test entities, including those that issue CLOs, in which we own at least 50% of the outstanding voting securities or that are otherwise structured consistent with applicable SEC staff guidance. Some of our subsidiaries may rely solely on the exceptions from the definition of "investment company" found in Section 3(c)(1) or Section 3(c)(7) of the Investment Company Act. In order for us to satisfy the 40% test, our ownership interests in those subsidiaries or any of our subsidiaries that are not majority-owned for purposes of the Investment Company Act, together with any other "investment securities" that we may own, may not have a combined value in excess of 40% of the value of our total assets on an unconsolidated basis and exclusive of United States government securities and cash items. However, most of our subsidiaries either fall outside of the general definitions of an investment company or rely on exceptions provided by provisions of, and rules and regulations promulgated under, the Investment Company Act (other than Section 3(c)(1) or Section 3(c)(7) of the Investment Company Act) and, therefore, are not investment companies for purposes of the Investment Company Act. In order to conform to these exceptions, these subsidiaries are limited with respect to the assets in which each of them can invest and/or the types of securities each of them may issue. We must, therefore, monitor each subsidiary's compliance with its applicable exception and our freedom of action relating to such a subsidiary, and that of the subsidiary itself, may be limited as a result. For example, our subsidiaries that issue CLOs generally rely on the exception provided by Rule 3a-7 under the Investment Company Act, while KKR Financial Holdings II, LLC ("KFH II"), our subsidiary that is taxed as a real estate investment trust (a "REIT") for United States federal income tax purposes, generally relies on the exception provided by Section 3(c)(5)(C) of the Investment Company Act. Each of these exceptions requires, among other things that the subsidiary (i) not issue redeemable securities and (ii) engage in the business of holding certain types of assets, consistent with the terms of the exception. Similarly, any subsidiaries engaged in the ownership of oil and gas assets may, depending on the nature of the assets, be outside the definition of an investment company or rely on exceptions provided by Section 3(c)(5)(C) or Section 3(c)(9) of the Investment Company Act. While Section 3(c)(9) of the Investment Company Act does not limit the nature of the securities issued, it does impose business engagement requirements that limit the types of assets that may be held.

We do not treat our interests in majority-owned subsidiaries that are outside of the general definition of an investment company or that rely on Section 3(c)(5)(C) or Section 3(c)(9) of, or Rule 3a-7 under, the Investment Company Act as investment securities when calculating our 40% test.

We sometimes refer to our subsidiaries that rely on Rule 3a-7 under the Investment Company Act as "CLO subsidiaries." Rule 3a-7 under the Investment Company Act is available to certain structured financing vehicles that are engaged in the business of holding financial assets that, by their terms, convert into cash within a finite time period and that issue fixed income securities entitling holders to receive payments that depend primarily on the cash flows from these assets, provided that, among other things, the structured finance vehicle does not engage in certain portfolio management practices resembling those employed by management investment companies (e.g., mutual funds). Accordingly, each of these CLO subsidiaries is subject to an indenture (or similar transaction documents) that contains specific guidelines and restrictions limiting the discretion of the CLO subsidiary and its collateral manager. In particular, these guidelines and restrictions prohibit the CLO subsidiary from acquiring and disposing of assets primarily for the purpose of recognizing gains or decreasing losses resulting from market value changes. Thus, a CLO subsidiary cannot acquire or dispose of assets primarily to enhance returns to the owner of the equity in the CLO subsidiary; however, subject to this limitation, sales and purchases of assets may be made so long as doing so does not violate guidelines contained in the CLO subsidiary's relevant transaction documents. A CLO subsidiary generally can, for example, sell an asset if the collateral manager believes that its credit quality has declined since its acquisition or that the credit profile of the obligor will deteriorate and the proceeds of permitted dispositions may be reinvested in additional collateral, subject to fulfilling the requirements set forth in Rule 3a-7 under the Investment Company Act and the CLO subsidiary's relevant transaction documents. As a result of these restrictions, our CLO subsidiaries may suffer losses on their assets and we may suffer losses on our investments in those CLO subsidiaries.

We sometimes refer to KFH II, our subsidiary that relies on Section 3(c)(5)(C) of the Investment Company Act, as our "REIT subsidiary." Section 3(c)(5)(C) of the Investment Company Act is available to companies that are primarily engaged in the business of purchasing or otherwise acquiring mortgages and other liens on and interests in real estate. While the SEC has not promulgated rules to address precisely what is required for a company to be considered to be "primarily engaged in the business of purchasing or otherwise acquiring mortgages and other liens on and interests in real estate," the SEC's Division of Investment Management, or the "Division," has taken the position, through a series of no-action and interpretive letters, that a company may rely on Section 3(c)(5)(C) of the Investment Company Act if, among other things, at least 55% of the company's assets consist of mortgage loans, other assets that are considered the functional equivalent of mortgage loans and certain other interests in real property (collectively, "qualifying real estate assets"), and at least 25% of the company's assets consist of real estate-related assets (reduced by the excess of the company's qualifying real estate assets over the required 55%), leaving no more than 20% of the company's assets to be invested in miscellaneous assets. The Division has also provided guidance as to the types of assets that can be considered qualifying real estate assets. Because the Division's interpretive letters are not binding except as they relate to the companies to whom they are addressed, if the Division were to change its position as to, among other things, what assets might constitute qualifying real estate assets our REIT subsidiary might be required to change its investment strategy to comply with the changed position. We cannot predict whether such a change would be adverse.

Examples of agencies that issue whole pool certificates are the Federal National Mortgage Association, the Federal Home Loan Mortgage Corporation and the Government National Mortgage Association. An agency whole pool certificate is a certificate issued or guaranteed as to principal and interest by the United States government or by a federally chartered entity, which represents the entire beneficial interest in the underlying pool of mortgage loans. By contrast, an agency certificate that represents less than the entire beneficial interest in the underlying mortgage loans is not considered to be a qualifying real estate asset, but is considered by our REIT subsidiary to be a real estate-related asset.

Most non-agency mortgage-backed securities do not constitute qualifying real estate assets because they represent less than the entire beneficial interest in the related pool of mortgage loans; however, based on Division guidance, where our REIT subsidiary's investment in non-agency mortgage-backed securities is the "functional equivalent" of owning the underlying mortgage loans, our REIT subsidiary may treat those securities as qualifying real estate assets. Moreover, investments in mortgage-backed securities that do not constitute qualifying real estate assets are classified by our REIT subsidiary as real estate-related assets. Therefore, based upon the specific terms and circumstances related to each non-agency mortgage-backed security that our REIT subsidiary owns, our REIT subsidiary will make a determination of whether that security should be classified as a qualifying real estate asset or as a real estate-related asset; and there may be instances where a security is recharacterized from being a qualifying real estate asset to a real estate-related asset, or conversely, from being a real estate-related asset to being a qualifying real estate asset based upon the acquisition or disposition or redemption of related classes of securities from the same securitization trust. If our REIT subsidiary acquires securities that, collectively, receive all of the principal and interest paid on the related pool of underlying mortgage loans (less fees, such as servicing and trustee fees, and expenses of the securitization), and that subsidiary has unilateral foreclosure rights with respect to those mortgage loans, then our REIT subsidiary will consider those securities, collectively, to be qualifying real estate assets. If another entity acquires any of the securities that are expected to receive cash flow from the underlying mortgage loans, then our REIT subsidiary will consider whether it has appropriate foreclosure rights with respect to the underlying loans and whether its investment is a first loss position in deciding whether these securities should be classified as qualifying real estate assets. If our REIT subsidiary owns more than one subordinate class, then, to determine the classification of subordinate classes other than the first loss class, our REIT subsidiary will consider whether such classes are contiguous with the first loss class (with no other classes absorbing losses after the first loss class and before any other subordinate classes that our REIT subsidiary owns), whether our REIT subsidiary owns the entire amount of each such class and whether our REIT subsidiary would continue to have appropriate foreclosure rights in connection with each such class if the more subordinate classes were no longer outstanding. If the answers to any of these questions is no, then our REIT subsidiary would expect not to classify that particular class, or classes senior to that class, as qualifying real estate assets.

We have made or may make oil and gas and other mineral investments that are held through one or more subsidiaries and would refer to those subsidiaries as our "Oil and Gas Subsidiaries". Depending upon the nature of the oil and gas assets held by an Oil and Gas Subsidiary, such Oil and Gas Subsidiary may rely on Section 3(c)(5)(C) or Section 3(c)(9) of the Investment Company Act or may fall outside of the general definition of an investment company. An Oil and Gas Subsidiary that does not engage primarily, propose to engage primarily or hold itself out as engaging primarily in the business of investing, reinvesting or trading in securities will be outside of the general definition of an investment company provided that it passes the 40% test. This may be the case where an Oil and Gas Subsidiary holds a sufficient amount of oil and gas assets constituting real estate interests together with other assets that are not investment securities such as equipment. Oil and Gas Subsidiaries that hold oil and gas assets that constitute real property interests, but are unable to pass the 40% test, may rely on Section 3(c)(5)(C), subject to the requirements and restrictions described above. Alternately, an Oil and Gas Subsidiary may rely on Section 3(c)(9) of the Investment Company Act if substantially all of its business consists of owning or holding oil, gas or other mineral royalties or leases, certain fractional

interests, or certificates of interest or participations in or investment contracts relating to such royalties, leases or fractional interests. These various restrictions imposed on our Oil and Gas Subsidiaries by the Investment Company Act may have the effect of limiting our freedom of action with respect to oil and gas assets (or other assets) that may be held or acquired by such subsidiary or the manner in which we may deal in such assets.

As noted above, if the combined values of the securities issued to us by our subsidiaries that must rely on Section 3(c)(1) or Section 3(c)(7) of the Investment Company Act, together with any other investment securities we may own, exceed 40% of the value of our total assets (exclusive of United States government securities and cash items) on an unconsolidated basis, we may be deemed to be an investment company. If we fail to maintain an exception, exemption or other exclusion from the Investment Company Act, we could, among other things, be required either (i) to change substantially the manner in which we conduct our operations to avoid being subject to the Investment Company Act or (ii) to register as an investment company. Either of these would likely have a material adverse effect on us, the type of investments we make, our ability to service our indebtedness and to make distributions on our shares, and on the market price of our shares and any other securities we may issue. If we were required to register as an investment company under the Investment Company Act, we would become subject to substantial regulation with respect to our capital structure (including our ability to use leverage), management, operations, transactions with certain affiliated persons (within the meaning of the Investment Company Act), portfolio composition (including restrictions with respect to diversification and industry concentration) and other matters. Additionally, our Manager would have the right to terminate our Management Agreement. Moreover, if we were required to register as an investment company, we would no longer be eligible to be treated as a partnership for United States federal income tax purposes. Instead, we would be classified as a corporation for tax purposes and would be able to avoid corporate taxation only to the extent that we were able to elect and qualify as a regulated investment company ("RIC") under applicable tax rules. Because our eligibility for RIC status would depend on our assets and sources of income at the time that we were required to register as an investment company, there can be no assurance that we would be able to qualify as a RIC. If we were to lose partnership status and fail to qualify as a RIC, we would be taxed as a regular corporation. See "Partnership Tax Matters—Qualifying Income Exception".

comment on the nature and operation of issuers that rely on Rule 3a-7 and indicated various steps it may consider taking in connection with Rule 3a-7, although it did not formally propose any changes to the rule. Among the issues for which the SEC has requested comment in the 3a-7 Release is whether Rule 3a-7 should be modified so that parent companies of subsidiaries that rely on Rule 3a-7 should treat their interests in such subsidiaries as investment securities for purposes of the 40% test. The SEC also published on August 31, 2011 a concept release seeking information about the nature of entities that invest in mortgages and mortgage-related pools and public comment on how the SEC staff's interpretive positions in connection with Section 3(c)(5)(C) affect these entities, although it did not propose any new interpretive positions or changes to existing interpretive positions in connection with Section 3(c)(5)(C). Any guidance or action from the SEC or its staff, including changes that the SEC may ultimately propose and adopt to the way Rule 3a-7 applies to entities or new or modified interpretive positions related to Section 3(c)(5)(C), could further inhibit our ability, or the ability of a subsidiary, to pursue our current or future operating strategies, which could have a material adverse effect on us.

If the SEC or a court of competent jurisdiction were to find that we were required, but failed, to register as an investment company in violation of the Investment Company Act, we would have to cease business activities, we would breach representations and warranties and/or be in default as to certain of our contracts and obligations, civil or criminal actions could be brought against us, our contracts would be unenforceable unless a court were to require enforcement and a court could appoint a receiver to take control of us and liquidate our business, any or all of which would have a material adverse effect on our business.

We are party to a Management Agreement with our Manager, pursuant to which our Manager will provide for the day-to-day management of our operations.

The Management Agreement requires our Manager to manage our business affairs in conformity with the Investment Guidelines that are approved by a majority of our independent directors. Our Manager is under the direction of our board of directors. Our Manager is responsible for (i) the selection, purchase and sale of our investments, (ii) our financing and risk management activities, and (iii) providing us with investment advisory services.

The Management Agreement expires on December 31, 2012 and is automatically renewed for a one-year term on such date and each anniversary date thereafter, unless terminated. Our independent directors review our Manager's performance annually and the Management Agreement may be terminated annually (upon 180 day prior written notice) upon the affirmative vote of at least two-thirds of our independent directors, or by a vote of the holders of a majority of our outstanding common shares, based upon (1) unsatisfactory performance by the Manager that is materially detrimental to us or (2) a determination that the management fees payable to our Manager are not fair, subject to our Manager's right to prevent such a termination under this clause (2) by accepting a mutually acceptable reduction of management fees. We must provide a 180 day prior written notice of any such termination and our Manager will be paid a termination fee equal to four times the sum of the average annual base management fee and the average annual incentive fee for the two 12-month periods preceding the date of termination, calculated as of the end of the most recently completed fiscal quarter prior to the date of termination.

We may also terminate the Management Agreement without payment of the termination fee with a 30 day prior written notice for cause, which is defined as (i) our Manager's continued material breach of any provision of the Management Agreement following a period of 30 days after written notice thereof, (ii) our Manager's fraud, misappropriation of funds, or embezzlement against us, (iii) our Manager's gross negligence in the performance of its duties under the Management Agreement,

(iv) the commencement of any proceeding relating to our Manager's bankruptcy or insolvency, (v) the dissolution of our Manager, or (vi) a change of control of our Manager. Cause does not include unsatisfactory performance, even if that performance is materially detrimental to our business. Our Manager may terminate the Management Agreement, without payment of the termination fee, in the event we become regulated as an investment company under the Investment Company Act. Furthermore, our Manager may decline to renew the Management Agreement by providing us with a 180 day prior written notice. Our Manager may also terminate the Management Agreement upon 60 days prior written notice if we default in the performance of any material term of the Management Agreement and the default continues for a period of 30 days after written notice to us, whereupon we would be required to pay our Manager the termination fee described above.

We do not employ personnel and therefore rely on the resources and personnel of our Manager to conduct our operations. For performing these services under the Management Agreement, our Manager receives a base management fee and incentive compensation based on our performance. Our Manager also receives reimbursements for certain expenses, which are made on the first business day of each calendar month.

Base Management Fee. We pay our Manager a base management fee monthly in arrears in an amount equal to ¹/12 of our equity, as defined in the Management Agreement, multiplied by 1.75%. We believe that the base management fee that our Manager is entitled to receive is generally comparable to the base management fee received by the managers of comparable externally managed specialty finance companies. Our Manager uses the proceeds from its management fee in part to pay compensation to its officers and employees who, notwithstanding that certain of them also are officers of us, receive no compensation directly from us.

For purposes of calculating the base management fee, our equity means, for any month, the sum of (i) the net proceeds from any issuance of our common shares, after deducting any underwriting discount and commissions and other expenses and costs relating to the issuance, (ii) the net proceeds of any issuances of preferred shares or trust preferred stock (iii) the net proceeds of any issuances of convertible debt or other securities determined to be "equity" by our board of directors, provided that such issuances are approved by our board of directors, and (iv) our retained earnings at the end of such month (without taking into account any non-cash equity compensation expense incurred in current or prior periods), which amount shall be reduced by any amount that we pay for the repurchases of our common shares. The foregoing calculation of the base management fee is adjusted to exclude special one-time events pursuant to changes in accounting principles generally accepted in the United States of America ("GAAP"), as well as non-cash charges, after discussion between our Manager and our independent directors and approval by a majority of our independent directors in the case of non-cash charges.

Our Manager is required to calculate the base management fee within fifteen business days after the end of each month and deliver that calculation to us promptly. We are obligated to pay the base management fee within twenty business days after the end of each month. We may elect to have our Manager allocate the base management fee among us and our subsidiaries, in which case the fee would be paid directly by each entity that received an allocation.

Our Manager is waiving base management fees related to the $230.4 million common share offering and $270.0 million common share rights offering that occurred during the third quarter of 2007 until such time as our common share closing price on the NYSE is $20.00 or more for five consecutive trading days. Accordingly, our Manager permanently waived approximately $8.8 million of base management fees during each of the years ended December 31, 2011, 2010 and 2009. For the year ended December 31, 2011, $26.3 million of base management fees were earned by our Manager.

Reimbursement of Expenses. Because our Manager's employees perform certain legal, accounting, due diligence tasks and other services that outside professionals or outside consultants otherwise would perform, our Manager is paid or reimbursed for the documented cost of performing such tasks, provided that such costs and reimbursements are no greater than those which would be paid to outside professionals or consultants on an arm's-length basis.

We also pay all operating expenses, except those specifically required to be borne by our Manager under the Management Agreement. The expenses required to be paid by us include, but are not limited to, rent, issuance and transaction costs incident to the acquisition, disposition and financing of our investments, legal, tax, accounting, consulting and auditing fees and expenses, the compensation and expenses of our directors, the cost of directors' and officers' liability insurance, the costs associated with the establishment and maintenance of any credit facilities and other indebtedness of ours (including commitment fees, accounting fees, legal fees and closing costs), expenses associated with other securities offerings of ours, expenses relating to making distributions to our shareholders, the costs of printing and mailing proxies and reports to our shareholders, costs associated with any computer software or hardware, electronic equipment, or purchased information technology services from third party vendors, costs incurred by employees of our Manager for travel on our behalf, the costs and expenses incurred with respect to market information systems and publications, research publications and materials, and settlement, clearing, and custodial fees and expenses, expenses of our transfer agent, the costs of maintaining compliance with all federal, state and local rules and regulations or any other regulatory agency, all taxes and license fees and all insurance costs incurred by us or on our behalf. In addition, we will be required to pay our pro rata portion of rent, telephone, utilities, office furniture, equipment, machinery and other office, internal and overhead expenses of our Manager and its affiliates required for our operations. Except as noted above, our Manager is responsible for all costs incident to the performance of its duties under the Management Agreement, including compensation of our Manager's employees and other related expenses, except that we may elect to have our Manager allocate expenses among us and our subsidiaries, in which case expenses would be paid directly by each entity that received an allocation. For the year ended December 31, 2011, we incurred reimbursable expenses to our Manager of $8.2 million.

Incentive Compensation. In addition to the base management fee, our Manager receives quarterly incentive compensation in an amount equal to the product of: (i) 25% of the dollar amount by which: (a) our Net Income, before incentive compensation, per weighted average share of our common shares for such quarter, exceeds (b) an amount equal to (A) the weighted average of the price per share of the common stock of KKR Financial Corp. in its August 2004 private placement and the prices per share of the common stock of KKR Financial Corp. in its initial public offering and any subsequent offerings by KKR Financial Holdings LLC multiplied by (B) the greater of (1) 2.00% and (2) 0.50% plus one-fourth of the Ten Year Treasury Rate for such quarter, multiplied by (ii) the weighted average number of our common shares outstanding in such quarter. The foregoing calculation of incentive compensation will be adjusted to exclude special one-time events pursuant to changes in GAAP, as well as non-cash charges, after discussion between our Manager and our independent directors and approval by a majority of our independent directors in the case of non-cash charges. The incentive compensation calculation and payment shall be made quarterly in arrears. For purposes of the foregoing: "Net Income" will be determined by calculating the net income available to shareholders before non-cash equity compensation expense, in accordance with GAAP; and "Ten Year Treasury Rate" means the average of weekly average yield to maturity for United States Treasury securities (adjusted to a constant maturity of ten years) as published weekly by the Federal Reserve Board in publication H.15 or any successor publication during a fiscal quarter.

Our ability to achieve returns in excess of the thresholds noted above in order for our Manager to earn the incentive compensation described in the preceding paragraph is dependent upon various factors, many of which are not within our control.

Our Manager is required to compute the quarterly incentive compensation within 30 days after the end of each fiscal quarter, and we are required to pay the quarterly incentive compensation with respect to each fiscal quarter within five business days following the delivery to us of our Manager's written statement setting forth the computation of the incentive fee for such quarter. We may elect to have our Manager allocate the incentive fee among us and our subsidiaries, in which case the fee would be paid directly by each entity that received an allocation.

For the year ended December 31, 2011, $34.2 million of incentive fees were earned by our Manager.

An affiliate of our Manager entered into separate management agreements with the respective investment vehicles CLO 2005-1, CLO 2005-2, CLO 2006-1, CLO 2007-1, CLO 2007-A, CLO 2009-1 and CLO 2011-1 and is entitled to receive fees for the services performed as collateral manager for all of these CLOs, except for CLO 2009-1 (as described below) and CLO 2011-1. The collateral manager has the option to waive the fees it earns for providing management services for the CLOs and has done so in prior periods.

Beginning April 2007, the collateral manager ceased waiving fees for CLO 2005-1 and beginning January 2009, the collateral manager ceased waiving fees for CLO 2005-2, CLO 2006-1, CLO 2007-1, CLO 2007-A and Wayzata Funding LLC (restructured and replaced with CLO 2009-1 on March 31, 2009). However, starting in July 2009, the collateral manager reinstated waiving the CLO management fees for CLO 2005-2 and CLO 2006-1, and starting in 2010, the collateral manager reinstated waiving the CLO management fees for CLO 2007-A and CLO 2007-1. Due to the deleveraging of CLO 2009-1 completed in July 2009 whereby all the senior notes were retired, the collateral manager is no longer entitled to receive fees for CLO 2009-1. As such, the CLO management fees for all CLOs, except for CLO 2005-1, are being waived or are no longer entitled to be received as of December 31, 2011. For the year ended December 31, 2011, the collateral manager waived aggregate CLO management fees of $34.0 million and we recorded an expense for CLO management fees totaling $5.3 million.

Our net income depends, in large part, on our ability to acquire assets at favorable spreads over our borrowing costs. A number of entities compete with us to make the types of investments that we make. We compete with financial companies, energy exploration and production businesses, public and private funds, commercial and investment banks and commercial finance companies. Several other entities have recently raised, or are expected to raise, significant amounts of capital, and may have investment objectives that overlap with ours, which may create competition for investment opportunities. Some competitors may have a lower cost of funds than us and access to financing sources that are not available to us. In addition, some of our competitors may have higher risk tolerances or different risk assessments, which could allow them to consider a wider variety of investments and establish more relationships than us.

We cannot assure our shareholders that the competitive pressures we face will not have a material adverse effect on our business, financial condition and results of operations. Also, as a result of this competition, we may not be able to take advantage of attractive investment opportunities from time to time, and we do not offer any assurance that we will be able to identify and make investments that are consistent with our investment objectives.

We do not have any employees. We are managed by KKR Financial Advisors LLC, our Manager, pursuant to the Management Agreement. Our Manager is a wholly-owned subsidiary of KAM and all of our executive officers are members or employees of KKR or one or more of its affiliates.

We intend to continue to operate so as to qualify, for United States federal income tax purposes, as a partnership and not as an association or publicly traded partnership taxable as a corporation. Therefore, we generally are not subject to United States federal income tax at the entity level, but are subject to limited state income taxes. Holders of our shares will be required to take into account their allocable share of each item of our income, gain, loss, deduction, and credit for our taxable year ending within or with their taxable year.

We hold an equity interest in KFH II, which elected to be taxed as a REIT under the Code. KFH II holds certain real estate mortgage-backed securities. A REIT is not subject to United States federal income tax to the extent that it currently distributes its income and satisfies certain asset, income and ownership tests, and recordkeeping requirements, but it may be subject to some amount of federal, state, local and foreign taxes based on its taxable income.

We have wholly-owned domestic and foreign subsidiaries that are taxable as corporations for United States federal income tax purposes and thus are not consolidated by us for United States federal income tax purposes. For financial reporting purposes, current and deferred taxes are provided for on the portion of earnings recognized by us with respect to our interest in the domestic taxable corporate subsidiaries, because each is taxed as a regular corporation under the Code. Deferred income tax assets and liabilities are computed based on temporary differences between the GAAP consolidated financial statements and the United States federal income tax basis of assets and liabilities as of each consolidated balance sheet date. The foreign corporate subsidiaries were formed to make certain foreign and domestic investments from time to time. The foreign corporate subsidiaries are organized as exempted companies incorporated with limited liability under the laws of the Cayman Islands, and are anticipated to be exempt from United States federal and state income tax at the corporate entity level because they restrict their activities in the United States to trading in stock and securities for their own account. They generally will not be subject to corporate income tax in our financial statements on their earnings, and no provisions for income taxes for the year ended December 31, 2011 were recorded; however, we will be required to include their current taxable income in our calculation of our taxable income allocable to shareholders. CLO 2005-1, CLO 2005-2, CLO 2006-1, CLO 2007-1, CLO 2007-A, CLO 2009-1 and CLO 2011-1 are our foreign subsidiaries that elected to be treated as disregarded entities or partnerships for United States federal income tax purposes. These subsidiaries were established to facilitate securitization transactions, structured as secured financing transactions.

As of December 31, 2011, we believe that KFH II qualified as a REIT under the Code. The Code requires, among other things, that at the end of each calendar quarter at least 75% of a REIT's total assets must be "real estate assets" as defined in the Code. The Code also requires that each year at least 75% of a REIT's gross income come from real estate sources and at least 95% of a REIT's gross income come from real estate sources and certain other passive sources itemized in the Code, such as dividends and interest. As of December 31, 2011, we believe KFH II was in compliance with all requirements necessary to be taxed as a REIT. However, the sections of the Code and the corresponding United States Treasury Regulations that relate to qualification and taxation as a REIT are highly technical and complex, and KFH II's qualification and taxation as a REIT depends upon its ability to meet various qualification tests imposed under the Code (such as those described above),

including through its actual annual operating results, asset composition, distribution levels and diversity of share ownership. Accordingly, no assurance can be given that KFH II will be deemed to have been organized and to have operated, or to continue to be organized and operated, in a manner so as to qualify or remain qualified as a REIT.

Due to limitations on the concentration of ownership of a REIT imposed by the Code, our amended and restated operating agreement, among other limitations, generally prohibits any shareholder from beneficially or constructively owning more than 9.8% in value or in number of shares, whichever is more restrictive, of any class or series of the outstanding shares of our company. Our board of directors has discretion to grant exemptions from the ownership limit, subject to terms and conditions as it deems appropriate.

We have made and may continue to make certain investments in the oil and gas industries. These industries present inherent environmental and safety risks and are subject to stringent and complex foreign, federal, state and local environmental laws, ordinances and regulations. Under these laws, ordinances and regulations, regardless of fault, owners and operators of oil and gas properties and facilities can be held jointly and severally liable for the cost of remediating contamination and providing compensation for damages to natural resources. The oil and gas industries also present inherent risk of personal and property injury. On-going compliance with environmental laws, ordinances and regulations applicable to the oil and gas industries, including compliance with more stringent legal requirements that may be imposed in the future, may entail significant expense. Environmental and safety obligations and liabilities can be substantial and could adversely impact the value of our natural resources investments, our ability to use these investments as collateral and may otherwise have a material adverse effect on our results of operations.

Our shareholders should carefully consider the risks described below and the information contained in this Annual Report on Form 10-K and other filings that we make from time to time, including our consolidated financial statements and accompanying notes. Any of the following risks could materially adversely affect our business, financial condition or results of operations. The risks described below are not the only risks we face. We have only described the risks we consider to be material. However, we may face additional risks that are viewed by us as not material or are not presently known to us.

Our business and the businesses in which we invest are materially affected by conditions in the global financial markets and economic conditions generally.

Our business and the businesses of the companies in which we invest are materially affected by conditions in the global financial markets and economic conditions generally, such as interest rates, availability and cost of capital, economic uncertainty, default rates, commodity prices, currency exchange rates, the ongoing sovereign debt crises in Europe, possible further downgrades in the credit ratings of the U.S. or other developed nations and other national and international political circumstances. Ongoing developments in the U.S. and global financial markets following the unprecedented turmoil in the global credit and securities markets in late 2007 through early 2009 and the recent downgrades of the credit ratings of the U.S. and a number of other developed countries continue to illustrate that the current environment is still one of uncertainty and instability.

These economic conditions have resulted in, and may continue to result in, significant declines in the values of nearly all asset classes. a serious lack of liquidity in the credit markets, increases in margin calls for investors, requirements that derivatives counterparties post additional collateral, redemptions by mutual and hedge fund investors and outflows of client funds across the financial services industry. Although the global financial markets exhibited signs of recovery in 2011, there can be no assurance that these markets will continue to improve and persistently high unemployment rates in the United States, continued weakness in many real estate markets, increased austerity measures by several European governments, uncertainty about the future of the euro and growing sovereign debt loads all highlight the fact that economic conditions are still unstable and unpredictable. If the overall business environment worsens, our results of operations may be adversely affected.

Dislocations in the corporate credit sector could adversely affect us and one or more of our lenders, which could result in increases in our borrowing costs, reductions in our liquidity and reductions in the value of the investments in our portfolio.

Dislocations in the corporate credit sector, such as those experienced beginning in the third quarter of 2007 through the beginning of 2011, could adversely affect one or more of the counterparties providing funding for our investments and could cause those counterparties to be unwilling or unable to provide us with additional financing which may adversely affect our liquidity and financial condition. This could potentially limit our ability to finance our investments and operations, increase our financing costs and reduce our liquidity. This risk is exacerbated by the fact that a substantial portion of our financing is provided by a relatively small number of counterparties. If one or more major market participants were to fail or withdraw from the market, it could negatively impact the marketability of all fixed income securities and this could reduce the value of the securities in our portfolio, thus reducing our net book value. Furthermore, if one or more of our counterparties were unwilling or unable to provide us with ongoing financing, we could be forced to sell our investments at a time when prices are depressed.

Liquidity is essential to our businesses and we rely on external sources to finance a significant portion of our operations. If we are unable to raise funding from these external sources, we may be forced to liquidate certain of our assets and our results of operations may be adversely affected.

Liquidity is essential to our business. Our liquidity could be substantially adversely affected by an inability to raise funding in the long-term or short-term debt capital markets or the equity capital markets or an inability to access the secured lending markets. Factors that we cannot control, such as disruptions in the financial markets, the ongoing sovereign debt crises in Europe, the failure of the United States to reduce its deficit in amounts deemed to be sufficient, possible downgrades in the credit ratings of U.S. debt, contractions or limited growth in the economy or negative views about corporate credit investing and the specialty finance industry generally, could impair our ability to raise funding. In addition, our ability to raise funding could be impaired if lenders develop a negative perception of our long-term or short-term financial prospects. Such negative perceptions could develop if we incur large trading losses, or we suffer a decline in the level of our business activity, among other reasons. If we are unable to raise funding using the methods described above, we would likely need to liquidate unencumbered assets, such as our investment and trading portfolios, to meet maturing liabilities. We may be unable to sell some of our assets, or we may have to sell assets at a discount from market value, either of which could adversely affect our results of operations and may have a negative impact on the market price of our shares and any other securities we may issue.

We seek to generate both current income and capital appreciation. The assets in which we invest may not appreciate in value, however, and, in fact, may decline in value, and the debt securities in

which we invest may default on interest and/or principal payments. Accordingly, we may not be able to realize gains or income from our investments. Additionally, any gains that we do realize may not be sufficient to offset any other losses we experience or offset our expenses.

We leverage a portion of our portfolio investments, which may adversely affect our return on our investments and may reduce cash available for distribution.

We leverage a portion of our portfolio investments through borrowings, generally through the use of bank credit facilities, long-term bonds, securitizations, including the issuance of CLOs, and other secured and unsecured borrowings. The percentage of leverage varies depending on our ability to obtain credit facilities and the lenders' and rating agencies' estimate of the stability of the portfolio investments' cash flow. As of December 31, 2011, the only contractual limitation on our ability to leverage our portfolio is a covenant contained in our senior secured credit facility that our leverage ratio cannot exceed 2.0 to 1.0, computed on a basis that generally excludes the debt of variable interest entities that we consolidate under GAAP such as our CLO subsidiaries. Our ability to generate returns on our investments and make cash available for distribution to holders of our shares would be reduced to the extent that changes in market conditions cause the cost of our financing to increase relative to the income that can be derived from the assets acquired and financed.

We make non-United States dollar denominated investments, which subject us to currency rate exposure and the uncertainty of foreign laws and markets.

From time to time, we make investments that are denominated in foreign currencies. For example, as of December 31, 2011, $351.0 million par amount, or 4.4%, of our corporate debt portfolio was denominated in foreign currencies, of which 74.8% was denominated in euros, and $67.1 million par amount, or 37.1%, of our equity investments at estimated fair value was denominated in foreign currencies, of which 47.3% was denominated in Canadian dollars. A change in foreign currency exchange rates, in particular that of the euro relative to the dollar, may have an adverse impact on returns on any of these non-dollar denominated investments. For example, our returns on these investments may be adversely affected by events in eurozone countries that could cause the euro to fall versus the dollar such as defaults on sovereign debt, rating downgrades, the need for further financial relief of impacted countries, successions from the eurozone or the perception that any such event may occur. See "Quantitative and Qualitative Disclosures About Market Risk—Foreign Currency Risks" in Item 7 of this Annual Report for further information about our currency rate exposure.

Although we may choose to hedge our foreign currency risk, we may not be able to do so successfully and may incur losses on these investments as a result of exchange rate fluctuations. Investments in foreign countries also subject us to certain additional risks, including risks relating to the potential imposition of non-United States taxes, compliance with multiple and potentially conflicting regulatory schemes and political and economic instability abroad, any of which could adversely affect our returns on these investments.

Our assets generally consist of high-yield, below investment grade debt, which has greater risk of loss than secured senior loans and, if those losses are realized, it could adversely affect our results of operations, our ability to service our indebtedness and our cash available for distribution to holders of our shares.

Our assets include leveraged loans, high yield securities, mezzanine bonds and loans, marketable equity securities and private equity, each of which involves a higher degree of risk than senior secured loans. The leveraged loans and high yield securities may not be secured by mortgages or liens on assets. Even if secured, these leveraged loans and high yield securities may have higher loan-to-value ratios than senior secured loans. Furthermore, our right to payment and the security interest in any collateral underlying such loans may be subordinated to the payment rights and security interests with respect to

a more senior lender. Therefore, we may be limited in our ability to enforce our rights to collect these loans and to recover any of the loan balances through a foreclosure of collateral.

Certain of these leveraged loans and high yield securities may have an interest-only payment schedule, with the principal amount remaining outstanding and at risk until the maturity of the loan. In this case, a borrower's ability to repay its loan may be dependent upon a refinancing or a liquidity event that will enable the repayment of the loan.

High yield bonds are rated below investment grade by one or more nationally recognized statistical rating organizations or are unrated but of comparably low credit quality. This lower rating, or lack of a rating, reflects a greater possibility that the obligor may fail to make payments of principal and interest, and ultimately default, under these securities. For example, many issuers of high yield bonds are highly leveraged, and their relatively high debt-to-equity ratios create increased risks that their operations might not generate sufficient cash flow to service their debt obligations. As a result, high yield securities are often less liquid than higher rated bonds.

In addition to the above, numerous other factors may affect a company's ability to repay its loan, including the failure to meet its business plan, a downturn in its industry or negative economic conditions. A deterioration in a company's financial condition and prospects may be accompanied by deterioration in the collateral for the high yield securities and leveraged loans. Losses on our high yield securities and leveraged loans could adversely affect our results of operations, which could adversely affect our ability to service our indebtedness and cash available for distribution to holders of our shares.

In addition, marketable equity securities and private equity may also have a greater risk of loss than senior secured loans since such equity investments are subordinate to debt of the issuer and are not secured by property underlying the investment.

Our investment portfolio is and may continue to be concentrated in a limited number of companies and industries, which will subject us to a risk of significant loss if any of these companies defaults on its obligations to us or if there is a downturn in a particular industry.

Our investment portfolio is and may continue to be concentrated in a limited number of companies and industries. For example, as of December 31, 2011, the 20 largest issuers which we have invested in represented approximately 43% of our total debt investment portfolio on an estimated fair value basis. As a result, our results of operations, financial condition and ability to pay distributions to our shareholders may be adversely affected if a small number of borrowers default in their obligations to us or if we need to write down the value of any one investment. Additionally, a downturn in any particular industry in which we are invested could also negatively impact our results of operations and our ability to pay distributions. For example, as of December 31, 2011, we had approximately 20% of our total debt investment portfolio on an estimated fair value basis in two industries—Healthcare, Education and Childcare and Diversified/Conglomerate Services.

If we are unable to continue to utilize CLOs successfully, we may be unable to grow or fully execute our business strategy and our results of operations may be adversely affected.

We finance a substantial portion of our investments through, and derive a substantial portion of our revenue from, our CLO subsidiaries. These CLOs serve as long-term, non-recourse financing for fixed income investments and as a way to minimize refinancing risk, minimize maturity risk and secure a fixed cost of funds over an underlying market interest rate. An inability to continue to utilize CLOs successfully could limit our ability to fund future investments, grow our business or fully execute our business strategy and our results of operations may be adversely affected.

A number of our CLOs are outside of reinvestment periods, which may adversely affect our returns on investment and ability to maintain compliance with certain overcollateralization and interest coverage tests.

Our CLOs generally have periods during which, subject to certain restrictions, their managers can sell or buy assets at their discretion and can reinvest principal proceeds into new assets, commonly referred to as a "reinvestment period". Outside of a reinvestment period, the principal proceeds from the assets held in the CLO must generally be used to pay down the related CLO's debt, which causes the leverage on the CLO to decrease. Such leverage decreases may cause our return on investment to be lower. In addition, in the past the ability to reinvest has been important in maintaining compliance with the overcollateralization and interest coverage tests for certain of our CLOs. Outside of a reinvestment period, our ability to maintain compliance with such tests for that CLO may be negatively impacted. The reinvestment periods for CLO 2005-1, CLO 2005-2 and CLO 2007-A have ended and the reinvestment periods for CLO 2006-1 and CLO 2007-1 will end in August 2012 and May 2014, respectively.

Downturns in the global credit markets may affect the collateral in our CLO investments, which may adversely affect our cash flows from CLO investments.

Among the sectors particularly challenged by adverse economic conditions, including those experienced during the credit crisis, are the CLO and leveraged finance markets. We have significant exposure to these markets through our investments in CLO 2005-1, CLO 2005-2, CLO 2006-1, CLO 2007-1, CLO 2007-A and CLO 2011-1, each of which is a Cayman Islands incorporated special purpose company that issued to us and other investors notes secured by a pool of collateral consisting primarily of corporate leveraged loans. In most cases, our Cash Flow CLO investments are in deeply subordinated securities issued by the CLO issuers, representing highly leveraged investments in the underlying collateral, which increases both the opportunity for higher returns as well as the magnitude of losses when compared to other investors in these CLO structures that rank more senior to us in right of payment. As a result of our subordinated position in these CLO structures, we and our investors are at greater risk of suffering losses on our cash flow CLO investments during periods of adverse economic conditions.

During an economic downturn, the CLO issuers in which we invest may experience increases in downgrades, depreciations in market value and defaults in respect of leveraged loans in their collateral. The CLO issuers' portfolio profile tests set limits on the amount of discounted obligations a CLO can hold. During any time that a CLO issuer exceeds such a limit, the ability of the CLO's manager to sell assets and reinvest available principal proceeds into substitute assets is restricted. In addition, discounted assets and assets rated "CCC" or lower in excess of applicable limits in the CLO issuers' investment criteria are not given full par credit for purposes of calculation of the CLO issuers' over-collateralization tests. As a result, these CLO issuers may fail one or more of their over-collateralization tests, which would cause diversions of cash flows away from us as holders of the more junior CLO securities in favor of investors more senior than us in right of repayment, until the relevant over-collateralization tests are satisfied. This diversion of cash flows may have a material adverse impact on our business and our ability to make distributions to shareholders. In addition, it is possible that our cash flow CLO issuers' collateral could be depleted before we realize a return on our cash flow CLO investments.

At various times during the credit crisis, a number of our CLOs were out of compliance with the compliance tests outlined in their respective indentures. Although all of our CLOs were in compliance as of December 31, 2011, there can be no assurance that all of our CLOs will remain in compliance with their respective compliance tests during 2012 and that we will not, as a result, be required to pay cash flows to the senior note holders of the CLOs that were out of compliance that we would otherwise have expected to receive from our CLOs.

The ability of the CLO issuers to make interest payments to the holders of the senior notes of those structures is highly dependent upon the performance of the CLO collateral. If the collateral in those structures was to experience a significant decrease in cash flow due to an increased default level, the issuer may be unable to pay interest to the holders of the senior notes, which would allow such holders to declare an event of default under the indenture governing the transaction and accelerate all principal and interest outstanding on the senior notes. In addition, our CLO structures also contain certain events of default tied to the value of the CLO collateral, which events of default could also cause an acceleration of the senior notes. If the value of the CLO collateral within a CLO were to be less than the amount of senior notes issued and outstanding, the senior note holders would have the ability to declare an event of default.

There can be no assurance that market conditions giving rise to these types of consequences will not occur, subsist or become more acute in the future. Because our CLO structures involve complex collateral and other arrangements, the documentation for such structures is complex, is subject to differing interpretations and involves legal risk.

The impact of proposed regulations, including the Dodd-Frank Act, on our business is currently uncertain.

On July 21, 2010, the United States enacted the Dodd-Frank Wall Street Reform and Consumer Protection Act (the "Dodd-Frank Act"). The Dodd-Frank Act affects almost every aspect of the United States financial services industry, including certain aspects of the markets in which we operate. For example, the Dodd-Frank Act will impose additional disclosure requirements for public companies and generally require issuers or originators of asset-backed securities to retain at least five percent of the credit risk associated with the securitized assets. In addition, the Dodd-Frank Act:

In addition, the Dodd-Frank Act could affect our Investment Company Act status. See the risk factor entitled "If the SEC were to disagree with our Investment Company Act determinations, our business could be adversely affected."

As of December 31, 2011, approximately 80% of the rule making required by the Dodd-Frank Act had yet to be proposed or was not yet finalized. Accordingly, many provisions of the Dodd-Frank Act are subject to further rule making and to the discretion of regulatory bodies, such as the FSOC and Commodities Future Trading Commission (the "CFTC"), and there can be no assurance that, as result of such rule making or decision making, we will not become subject to new restrictions or requirements. For example, if the FSOC were to determine that we were a systemically important nonbank financial company, we would be subject to a heightened degree of regulation. In addition, the CFTC has proposed or adopted rules to establish a new regulatory framework for commodity swaps and security-based swaps which could limit our positions or trading in such instruments. As a result, we currently are uncertain as to whether the Dodd-Frank Act will have a significant and potentially adverse impact on our business.

In addition, in October 2011, the Financial Stability Board (FSB) issued a report that recommended strengthening oversight and regulation of the so-called shadow banking system, broadly described as credit intermediation involving entities and activities outside the regular banking system. The report outlined initial steps to define the scope of the shadow banking system and proposed general governing principles for a monitoring and regulatory framework. While at this stage it is difficult to predict the scope of any new regulations, if such regulations were to extend the regulatory and supervisory requirements currently applicable to banks, such as capital and liquidity standards, to our business, or were to otherwise classify all or a portion of our business as "shadow banking", our regulatory and operating costs would increase, which may have a material adverse affect on our business.

We may enter into derivative contracts that could expose us to contingent liabilities in the future.

Part of our investment strategy involves entering into derivative contracts that could require us to fund cash payments in the future under certain circumstances, including an event of default or other early termination event, or the decision by a counterparty to request margin securities under the terms of the derivative contract. The amounts due with respect to swaps would generally be equal to the unrealized loss of the open swap positions with the respective counterparty and could also include other fees and charges. These payments are contingent liabilities and therefore may not appear on our balance sheet. Our ability to fund these contingent liabilities will depend on the liquidity of our assets and access to capital at the time, and the need to fund these contingent liabilities could adversely impact our financial condition.

The derivatives that we use to hedge against interest rate, foreign currency and commodity exposure are volatile and may adversely affect our results of operations, which could adversely affect our ability to make payments due on our indebtedness and cash available for distribution to holders of our shares.

From time to time, we enter into various hedging instruments such as swaps, options, forwards and futures as part of our strategy to manage our risk related to interest rates, holdings denominated in foreign currencies and energy prices in connection with our natural resources investments. In the future we may enter into additional hedging instruments as part of these or other risk management strategies. Our hedging activity varies in scope based on the level of interest rates, the type of portfolio

investments held, market prices for natural resources, and other changing market conditions. These hedging instruments may fail to protect us from interest rate, foreign currency or commodity price volatility or could adversely affect us because, among other things:

The cost of using hedging instruments increases as the period covered by the instrument increases and, with respect to interest rate hedges, during periods of rising and volatile interest rates, with respect to foreign currency hedges, during periods of volatile foreign currencies or, with respect to commodity hedges, falling and volatile commodity prices. We may increase our hedging activity and thus increase our hedging costs during such periods when hedging costs have increased.

Any hedging activity we engage in may adversely affect our results of operations, which could adversely affect our ability to make payments due on our indebtedness and cash available for distribution to holders of our shares. Therefore, while we may enter into such transactions to seek to reduce interest rate, foreign currency and commodity risks related to our natural resources investments, unanticipated changes in interest rates, foreign currency and commodity prices may result in poorer overall investment performance than if we had not engaged in any such hedging transactions. In addition, the degree of correlation between price movements of the instruments used in a hedging strategy and price movements in the portfolio positions or liabilities being hedged may vary materially. Moreover, for a variety of reasons, we may not seek to establish a perfect correlation between such hedging instruments and the portfolio holdings or liabilities being hedged. Any such imperfect correlation may expose us to risk of loss.

Hedging instruments often are currently subject to limited regulation and involve risks and costs.

While provisions of the Dodd-Frank Act granted specified United States regulatory bodies the authority to regulate the trading of certain derivatives, including many hedging instruments, many of these provisions remain subject to final rule making. For example, the Dodd-Frank Act may require many over-the-counter security-based swaps to be centrally cleared through regulated clearinghouses and traded on exchanges or comparable trading facilities. Dealers and major market participants in certain derivatives and their end-user counterparties may be required to comply with margin and capital requirements. In addition, swap counterparties will be subject to recordkeeping and reporting requirements to provide transaction and pricing data on both cleared and uncleared swaps. Furthermore, the enforceability of agreements underlying hedging transactions may depend on compliance with applicable statutory, commodity and other regulatory requirements and, depending on the identity of the counterparty, applicable international requirements. The business failure of a hedging counterparty with whom we enter into a hedging transaction will most likely result in a default. Default by a party with whom we enter into a hedging transaction may result in the loss of unrealized profits, leave us with unsecured exposure and force us to cover our resale commitments, if any, at the then current market price. It may not always be possible to dispose of or close out a hedging position without the consent of the hedging counterparty, and we may not be able to enter into an offsetting

contract in order to cover our risk. We cannot assure our shareholders that a liquid secondary market will exist for hedging instruments purchased or sold, and we may be required to maintain a position until exercise or expiration, which could result in losses.

We may make investments or obtain credit that may require us to post additional collateral in periods of adverse market volatility, which could adversely affect our financial condition and liquidity.

We may make investments or have credit sources in the future that, during periods of adverse market volatility, such as the periods we observed during the global credit crisis, could require us to post additional margin collateral, which may have a material adverse impact on our liquidity. For example, in the past, certain of our financing facilities allowed the counterparties to determine a new market value of the collateral to reflect current market conditions. In such cases, if a counterparty had determined that the value of the collateral had decreased, it could have initiated a margin call and required us to either post additional collateral or repay a portion of the outstanding borrowing, on minimal notice. If we make investments or obtain credit on similar terms in the future, periods of adverse market volatility could result in a significant increase in margin calls and our liquidity, results of operations, financial condition, and business prospects could suffer. In such a case, it is possible that in order to obtain cash to satisfy a margin call, we would be required to liquidate assets or raise capital at a disadvantageous time, which could cause us to incur further losses or otherwise adversely affect our results of operations and financial condition, could impair our ability to pay distributions to our shareholders and could have a negative impact on the market price of our shares and any other securities we may issue. In the event we are required to post additional collateral on investments, our contingent liquidity reserves may not be sufficient at such time in the event of a material adverse change in the credit markets and related market price market volatility.

We are subject to risks in using prime brokers, custodians, administrators and other agents.

We depend on the services of prime brokers, custodians, administrators and other agents to carry out certain of our securities transactions. In the event of the insolvency of a prime broker and/or custodian, we may not be able to recover equivalent assets in full as we will rank among the prime broker's and custodian's unsecured creditors in relation to assets which the prime broker or custodian borrows, lends or otherwise uses. In addition, our cash held with a prime broker or custodian may not be segregated from the prime broker's or custodian's own cash, and we therefore may rank as unsecured creditors in relation thereto. The inability to recover assets from the prime broker or custodian could have a material impact on the performance of our business, financial condition and results of operations.

We currently have indebtedness, some of which matures in the near term. We may not be able to generate sufficient cash to service or make required repayments of our indebtedness and we may be forced to take other actions to satisfy our obligations under our indebtedness, which may not be successful.

As of December 31, 2011, we had approximately $849.9 million of total recourse debt outstanding.

A breach of any of the covenants in our debt agreements could result in a default under our senior secured credit facility, maturing on May 3, 2014 (the "2014 Facility"), 7.0% convertible senior notes due July 15, 2012 ("7.0% Notes"), 7.5% convertible senior notes due January 15, 2017 ("7.5% Notes") and 8.375% senior notes due November 15, 2041 ("8.375% Notes") . If a default occurs under any of these obligations and we are not able to obtain a waiver from the requisite debt holders, then, among other things, our debt holders could declare all outstanding principal and interest to be immediately due and payable. If our outstanding indebtedness were to be accelerated, we cannot assure you that our assets would be sufficient to repay in full that debt and any potential future indebtedness, which would cause the market price of our common shares to decline significantly. We could also be forced into bankruptcy or liquidation.

The terms of our indebtedness may restrict our ability to make future distributions, make cash payments in respect of any conversion or repurchases of indebtedness and impose limitations on our current and future operations.

The agreement governing the 2014 Facility contains, and any future indebtedness may also contain, a number of restrictive covenants that impose operating and other restrictions on us, including restrictions on our ability to engage in our current and future operations or to make distributions to holders of our shares. The 2014 Facility credit agreement includes covenants restricting our ability to:

In addition, the 2014 Facility credit agreement also includes financial covenants, including requirements that we:

As a result of these covenants, we are limited in the manner in which we conduct our business and we may be unable to engage in favorable business activities or finance future operations or capital needs. Our ability to comply with the covenants and restrictions contained in the agreements governing our indebtedness may be affected by economic, financial and industry conditions beyond our control. A breach of any of these covenants could result in a default under the 2014 Facility credit agreement. Upon the occurrence of an event of default under the 2014 Facility credit agreement, the lenders are not required to lend any additional amounts to us and could elect to declare all borrowings outstanding thereunder, together with accrued and unpaid interest and fees, to be due and payable, which could also result in an event of default under our other agreements relating to our borrowings. If we were unable to refinance these borrowings on favorable terms, our results of operations and financial condition could be adversely impacted by increased costs and less favorable terms, including higher interest rates and more restrictive covenants. The instruments governing the terms of any future refinancing of any borrowings are likely to contain similar or more restrictive covenants.

There can be no assurances that our operations will generate sufficient cash flows or that credit facilities will be available to us in an amount sufficient to enable us to pay our indebtedness or to fund other liquidity needs.

Our ability to make scheduled payments or prepayments on our debt and other financial obligations will depend on our future financial and operating performance and the value of our investments. There can be no assurances that our operations will generate sufficient cash flows or that new sources of credit will be available to us in an amount sufficient to enable us to pay our indebtedness or to fund our other liquidity needs. Our financial and operating performance is subject to prevailing economic and industry conditions and to financial, business and other factors, some of which are beyond our control. Our substantial leverage exposes us to significant risk during periods of economic downturn such as the one we recently experienced, as our cash flows may decrease, but our required principal payments in respect of indebtedness do not change and our interest expense obligations could increase due to increases in interest rates.

If our cash flows and capital resources are insufficient to fund our debt service obligations, we will likely face increased pressure to dispose of assets, seek additional capital or restructure or refinance our indebtedness. These actions could have a material adverse effect on our business, financial condition and results of operations. In addition, we cannot assure that we would be able to take any of these actions, that these actions would be successful and permit us to meet our scheduled debt service obligations or that these actions would be permitted under the terms of our existing or future debt agreements, including our 2014 Facility credit agreement. For example, we may need to refinance all or a portion of our indebtedness on or before maturity. There can be no assurance that we will be able to refinance any of our indebtedness on commercially reasonable terms or at all. In the absence of improved operating results and access to capital resources, we could face substantial liquidity problems and might be required to dispose of material assets or operations to meet our debt service and other obligations. The 2014 Facility credit agreement restricts our ability to dispose of assets and use the proceeds from such dispositions. We may not be able to consummate those dispositions or to obtain the

proceeds realized. Additionally, these proceeds may not be adequate to meet our debt service obligations then due.

If we cannot make scheduled payments or prepayments on our debt, we will be in default and, as a result, among other things, our debt holders could declare all outstanding principal and interest to be due and payable and we could be forced into bankruptcy or liquidation or required to substantially restructure or alter our business operations or debt obligations.

Variable rate indebtedness subjects us to interest rate risk, which could cause our debt service obligations to increase significantly.

As of December 31, 2011, approximately $128.9 million of our recourse borrowings, consisting of our junior subordinated notes issued in connection with our trust preferred securities, were at variable rates of interest and expose us to interest rate risk. If interest rates increase, our debt service obligations on the variable rate indebtedness would increase even though the amount borrowed remained the same. We may use interest rate derivatives such as interest rate swap agreements to hedge the variability of the cash flows associated with our existing or forecasted variable rate borrowings. Although we may enter into additional interest rate swaps, involving the exchange of floating for fixed rate interest payments, to reduce interest rate volatility, such hedging may increase our costs of funding. We cannot provide assurances that we will be able to enter into interest rate hedges that effectively mitigate our exposure to interest rate risk.

If credit spreads on our borrowings increase and the credit spreads on our investments do not also increase, we are unlikely to achieve our projected leveraged risk-adjusted returns. Also, if credit spreads on investments increase in the future, our existing investments will likely experience a material reduction in value.

We make investment decisions based upon projected leveraged risk-adjusted returns. When making such projections we make assumptions regarding the long-term cost of financing such investments, particularly the credit spreads associated with our long-term financings. We define credit spread as the risk premium for taking credit risk which is the difference between the risk free rate and the interest rate paid on the applicable investment or loan, as the case may be. If credit spreads on our long-term financings increase and the credit spreads on our investments are not increased accordingly, we will likely not achieve our targeted leveraged risk-adjusted returns and we will likely experience a material adverse reduction in the value of our investments.

Ratings agencies may downgrade our credit ratings, which could make it more difficult for us to raise capital and could increase our financing costs.

We are currently rated by two nationally recognized statistical rating organizations. These rating agencies regularly evaluate us based on a number of factors, including our financial strength and leverage as well as factors not within our control, including conditions affecting our industry generally and the wider state of the economy. A negative change in our ratings outlook or any downgrade in our current investment-grade credit ratings by our rating agencies, particularly below investment grade, could, among other things, adversely affect our access to sources of liquidity and capital, cost of borrowing and may result in more stringent covenants under the terms of any new debt.

Declines in the fair values of our investments may adversely affect our results of operations and credit availability, which may adversely affect, in turn, our ability to make payments due on our indebtedness and our cash available for distribution to holders of our shares.

Certain of our assets are required to be carried at (i) estimated fair value, including our securities available-for-sale, residential mortgage-backed securities, and corporate debt and equity for which we

elected to carry at estimated fair value, (ii) lower of cost of estimated fair value for our corporate loans held for sale, or (iii) amortized cost with a related allowance for credit losses for our corporate loans.

Changes in the fair values of certain assets will directly affect our results of operations as unrealized gains or losses, or be charged or credited to our shareholders' equity in each period even if no sale is made. As a result, a decline in values would reduce our book value per share. Moreover, if the decline in value of an available-for-sale security is considered by our management to be other-than-temporary, such decline will be recorded as a charge which will adversely affect our results of operations.

A decline in the market value of our assets may adversely affect our results of operations, particularly in instances where we have borrowed money based on the market value of those assets. If the market value of those assets declines, the lender may require us to post additional collateral to support the loan. If we were unable to post the additional collateral, we would have to sell the assets at a time when we might not otherwise choose to do so. A reduction in credit available may adversely affect our results of operations, our ability to make payments due on our indebtedness and cash available for distribution to holders of our shares.

Further, financing counterparties may require us to maintain a certain amount of cash or to set aside unlevered assets sufficient to maintain a specified liquidity position intended to allow us to satisfy our collateral obligations. As a result, we may not be able to leverage our assets as fully as we would choose, which may reduce our return on equity. In the event that we are unable to meet these contractual obligations, our financial condition could deteriorate rapidly because we may be required to sell our investments at distressed prices in order to meet such margin or liquidity requirements.

Market values of our investments may decline for a number of reasons, such as causes related to changes in prevailing market rates, increases in defaults, increases in voluntary prepayments for those investments that we have that are subject to prepayment risk, and widening of credit spreads.

Certain of our investments are illiquid and we may not be able to vary our portfolio in response to changes in economic and other conditions.

The securities that we purchase in privately negotiated transactions are not registered under the relevant securities laws, resulting in restrictions on their transfer, sale, pledge or other disposition except in a transaction that is exempt from the registration requirements of, or is otherwise in accordance with, securities laws. For example, we are party to certain private, unregistered debt transactions in which the securities issued to us are not widely held and trade only in secondary, less established markets. As a result, our ability to vary our portfolio in response to changes in economic and other conditions may be limited relative to our investment in securities that trade in more liquid markets. In addition, if we are required to liquidate all or a portion of our portfolio quickly, we may realize significantly less than the value at which we have previously recorded our investments. Furthermore, our Manager conducts diligence on our investments and employees of our Manager may serve on the boards of directors of business entities in which we invest. These activities may provide our Manager with material non-public information with respect to business entities in which we invest. As a result, we may face additional restrictions on our ability to liquidate an investment in such business entities to the extent that we or our Manager has, or could be attributed with, material non-public information. See the risk factor entitled "Our access to confidential information may restrict our ability to take action with respect to some investments, which, in turn, may negatively affect our results of operations."

Some of our portfolio investments are recorded at fair value as determined by our Manager and, as a result, there is uncertainty as to the value of these investments.

Some of our portfolio investments are, and we believe are likely to continue to be, in the form of loans and securities that have limited liquidity or are not publicly traded. The fair value of investments that have limited liquidity or are not publicly traded may not be readily determinable. We generally value these investments quarterly at fair value as determined by our Manager pursuant to applicable United States GAAP accounting guidance. Because such valuations are inherently uncertain and may fluctuate over short periods of time and be based on estimates, our determinations of fair value may differ materially from the values that would have been used if a ready market for these investments existed. The market value of our shares and any other securities we may issue could be adversely affected if our determinations regarding the fair value of these investments are materially higher than the values that we ultimately realize upon their disposal.

Our rights under our indirect investments in corporate leveraged loans may be more restricted than direct investments in such loans.

We hold interests in corporate leveraged loans originated by banks and other financial institutions. We acquire interests in corporate leveraged loans either directly by a direct purchase or an assignment, or indirectly through a participation. The purchaser of an assignment typically succeeds to all the rights and obligations of the assigning institution and becomes a lender under the credit agreement with respect to the debt obligation. In contrast, participation interests in a portion of a debt obligation typically result in a contractual relationship only with the institution participating out the interest, not with the borrower. Thus, in purchasing participations, we generally will have no right to enforce compliance by the borrower with the terms of the credit agreement, nor any rights of offset against the borrower, and we may not directly benefit from the collateral supporting the debt obligation in which we have purchased the participation. As a result, we will assume the credit risk of both the borrower and the institution selling the participation.

The mortgage loans underlying the mortgage-backed securities we invest in are subject to delinquency, foreclosure and loss, which could result in losses to us.

As of December 31, 2011, we held residential mortgage-backed securities with an aggregate estimated fair value of $86.5 million. Residential mortgage-backed securities evidence interests in or are secured by pools of residential mortgage loans. Accordingly, the mortgage-backed securities we invest in are subject to all of the risks of the underlying mortgage loans. Residential mortgage loans are secured by single-family residential property and are subject to risks of delinquency, foreclosure and risk of loss. The ability of a borrower to repay a loan secured by a residential property is dependent upon the income or assets of the borrower. A number of factors, including a general economic downturn, acts of God, terrorism, social unrest and civil disturbances, may impair borrowers' abilities to repay their loans. Foreclosure of a mortgage loan can be an expensive and lengthy process that could have a substantial negative effect on our anticipated return on the foreclosed mortgage loan.

Credit default swaps are subject to risks related to changes in credit spreads, credit quality and expected recovery rates of the underlying credit instrument.

We may enter into credit default swaps ("CDS") as investments or hedges. CDS involve greater risks than investing in the reference obligation directly. In addition to general market risks, CDS are subject to risks related to changes in interest rates, credit spreads, credit quality and expected recovery rates of the underlying credit instrument. A CDS is a contract in which the contract buyer pays, in the case of a short position, or receives, in the case of a long position, a periodic premium until the contract expires or a credit event occurs. In return for this premium, the contract seller receives a payment from, in the case of a short position, or makes a payment to, in the case of a long position,

the buyer if there is a credit default or other specified credit event with respect to the issuer of the underlying credit instrument referenced in the CDS. The contract buyer will lose its investment and recover nothing should no event of default occur. If an event of default were to occur, the value of the reference obligation received by the contract seller (if any), coupled with the periodic payments previously received, may be less than the full notional value it pays to the buyer, resulting in a loss of value to the seller. If we act as the contract seller of a CDS, we would be exposed to many of the same risks of leverage described herein since if an event of default occurs the seller must pay the buyer the full notional value of the reference obligation.

We may change our investment strategy without shareholder consent, which may result in our making investments that entail more risk than our current investments.

Our investment strategy may evolve, in light of existing market conditions and investment opportunities, and this evolution may involve additional risks. Investment opportunities that present unattractive risk-return profiles relative to other available investment opportunities under particular market conditions may become relatively attractive under changed market conditions and changes in market conditions may therefore result in changes in the investments we target. Decisions to make investments in new asset categories present risks that may be difficult for us to adequately assess and could therefore reduce the stability of our distributions or have adverse effects on our financial condition. A change in our investment strategy may also increase our exposure to interest rate, commodity, foreign currency or credit market fluctuations. Our failure to accurately assess the risks inherent in new asset categories or the financing risks associated with such assets could adversely affect our results of operations and our financial condition.

Our dependence on the management of other entities may adversely affect our business.

We do not control the management, investment decisions or operations of the business entities in which we invest. Management of those enterprises may decide to change the nature of their assets, or management may otherwise change in a manner that is not satisfactory to us or value enhancing for the investment we have made in such entities. We typically have no ability to affect these management decisions and we may have only limited ability to dispose of our investments.

Due diligence conducted by our Manager may not reveal all of the risks of the businesses in which we invest.

Before making an investment in a business entity, our Manager typically assesses the strength and skills of the entity's management and other factors that it believes will determine the success of the investment. In making the assessment and otherwise conducting due diligence, our Manager relies on the resources available to it and, in some cases, an investigation by third parties. This process is particularly important and subjective with respect to newly organized entities because there may be little or no information publicly available about the entities. Accordingly, there can be no assurance that this due diligence process will uncover all relevant facts or that any investment will be successful. In addition, we and KKR have established certain procedures relating to conflicts of interests that may restrict us from accessing certain confidential information in the possession of KKR or one of its affiliates. As a result, we may pursue investments without obtaining access to such confidential information, which information, if reviewed, might otherwise impact our judgment with respect to such investments.

We compete for investments with various other investors, such as other public and private funds, commercial and investment banks and other companies, including funds and companies affiliated with our Manager. Some of our competitors have greater resources than we possess or have greater access to capital or various types of financing structures than are available to us and may have investment

objectives that overlap with ours, which may create competition for investment opportunities with limited supply. The competitive pressures we face could impair our business, financial condition and results of operations. As a result of this competition, we may not be able to take advantage of attractive investment opportunities from time to time. Furthermore, competition for investments may lead to a decrease in returns available from such investments, which may further limit our ability to generate our desired returns.

There is an inherent risk that we may incur environmental costs and liabilities as a result of our natural resources investments.

Our estimated oil, natural gas, and natural gas liquids reserve quantities and future production rates are based on many assumptions that may prove to be inaccurate. Any material inaccuracies in these reserve estimates or the underlying assumptions will materially affect the quantities and value of our reserves.

Numerous uncertainties are inherent in estimating quantities of oil, natural gas, and natural gas liquids reserves. The process of estimating oil, natural gas, and natural gas liquids reserves is complex, requiring significant decisions and assumptions in the evaluation of available geological, engineering and economic data for each reservoir, and reserve estimates also rely upon various assumptions, including assumptions regarding future oil, natural gas, and natural gas liquids prices, production levels, and operating and development costs. As a result, estimated quantities of proved reserves and projections of future production rates and the timing of development expenditures may prove to be inaccurate. Over time, we may make material changes to reserve estimates taking into account the results of actual drilling and production. Any significant variance in our assumptions and actual results could greatly affect our estimates of reserves, the economically recoverable quantities of oil, natural gas, and natural gas liquids attributable to any particular group of properties, the classifications of reserves based on risk of recovery, and estimates of the future net cash flows.

Our natural resources investments are subject to complex federal, state, local and other laws and regulations that could adversely affect the value of our natural resources investments.

The natural resources operations in which we invest are subject to complex federal, state and local laws and regulations as interpreted and enforced by governmental authorities possessing jurisdiction over various aspects of the exploration, production and transportation of natural resources. These operations must obtain and maintain numerous permits, approvals and certificates from various governmental authorities that may entail significant expense, impose onerous conditions on operations or place limitations on production methods or quantity. While compliance with such processes has not yet had a material impact on the value of our natural resources investments, new regulations, laws or enforcement policies could be more stringent and significantly increase compliance costs or otherwise materially decrease the value of our natural resources properties. For example, some states have

adopted, and other states and the federal government are considering adopting, regulations that place restrictions of the use of an extraction process called hydraulic fracturing, used by the oil and gas operations in which we invest. This or other added regulation could lead to operational delays, increased operating costs, increased liability risks and reduced production of oil and gas, which could adversely impact the value of our natural resources investments, our ability to use these investments as collateral and may otherwise have a material adverse effect on our results of operations.

The performance of our natural resources investments depend on the skill, ability and decisions of third party operators.

The success of the drilling, development and production of the oil and natural gas properties in which we have working interests is substantially dependent upon the decisions of third-party operators and their diligence to comply with various laws, rules and regulations affecting such properties. The failure of any third-party operator to make decisions, perform their services, discharge their obligations, deal with regulatory agencies, and comply with laws, rules and regulations, including environmental laws and regulations in a proper manner with respect to properties in which we have an interest could result in material adverse consequences to our interest in such properties. Such adverse consequences could result in liabilities to us, reduce the value of our working interests and adversely affect our cash flows from such investments and our results of operations. In addition, our royalty interests in oil and natural gas properties are predicated on the overall operating performance of third party operators, which could result in a reduction in value of our royalty interests and adversely affect our cash flows from such investments.

Maintenance of our Investment Company Act exemption imposes limits on our operations, which may adversely affect our results of operations.

As described above in "Item 1. Business—Our Investment Company Act Status" we conduct our operations through our subsidiaries. In order for us to exclude from "investment securities" our subsidiaries' securities that we hold, each such subsidiary must be structured to both meet the definition of "majority-owned subsidiary" in the Investment Company Act, and to not fall within the definition of investment company in the Investment Company Act or meet an applicable exception from that definition. As a result of this structuring, our subsidiaries are limited with respect to the assets in which each of them can invest and/or the types of securities each of them may issue, and we could suffer losses on our investments in our subsidiaries or be unable to take full advantage of all available investment opportunities. For example, our CLO subsidiaries cannot acquire or dispose of assets primarily to enhance returns to the owner of the equity in the CLO subsidiary, and, as a result, may suffer losses on their assets and we may suffer losses on our investments in those CLO subsidiaries. And our REIT subsidiary and Oil and Gas Subsidiaries are each limited in the type of assets they can acquire and must ensure that a large portion of their total assets relate to those assets, which may have the effect of limiting our freedom of action with respect to real estate and oil and gas assets that may be held or acquired by such subsidiaries or the manner in which we may deal in such assets.

If the SEC were to disagree with our Investment Company Act determinations, our business could be adversely affected.

We have not requested approval or guidance from the SEC with respect to our Investment Company Act determinations, including, in particular: our treatment of any subsidiary as majority-owned; the compliance of any subsidiary with Section 3(c)(5)(C) or Section 3(c)(9) of, or Rule 3a-7 under, the Investment Company Act, including any subsidiary's determinations with respect to the consistency of its assets or operations with the requirements thereof; or whether our interests in one or

more subsidiaries constitute investment securities for purposes of the 40% test. If the SEC were to disagree with our treatment of one or more subsidiaries as being excepted from the Investment Company Act pursuant to Rule 3a-7, Section 3(c)(5)(C), Section 3(c)(9) or any other exception, with our determination that one or more of our other holdings do not constitute investment securities for purposes of the 40% test, or with our determinations as to the nature of the business in which we engage or the manner in which we hold ourselves out, we and/or one or more of our subsidiaries would need to adjust our operating strategies or assets in order for us to continue to pass the 40% test or register as an investment company, either of which could have a material adverse effect on us. Moreover, we may be required to adjust our operating strategy and holdings, or to effect sales of our assets in a manner that, or at a time or price at which, we would not otherwise choose, if there are changes in the laws or rules governing our Investment Company Act status or that of our subsidiaries, or if the SEC or its staff provides more specific or different guidance regarding the application of relevant provisions of, and rules under, the Investment Company Act. The SEC published on August 31, 2011 an advance notice of proposed rulemaking to potentially amend the conditions for reliance on Rule 3a-7 and the treatment of asset-backed issuers that rely on Rule 3a-7 under the Investment Company Act (the "3a-7 Release"). The SEC, in the 3a-7 Release, requested public comment on the nature and operation of issuers that rely on Rule 3a-7 and indicated various steps it may consider taking in connection with Rule 3a-7, although it did not formally propose any changes to the rule. Among the issues for which the SEC has requested comment in the 3a-7 Release is whether Rule 3a-7 should be modified so that parent companies of subsidiaries that rely on Rule 3a-7 should treat their interests in such subsidiaries as investment securities for purposes of the 40% test. The SEC also published on August 31, 2011 a concept release seeking information about the nature of entities that invest in mortgages and mortgage-related pools and public comment on how the SEC staff's interpretive positions in connection with Section 3(c)(5)(C) affect these entities, although it did not propose any new interpretive positions or changes to existing interpretive positions in connection with Section 3(c)(5)(C). Any guidance or action from the SEC or its staff, including changes that the SEC may ultimately propose and adopt to the way Rule 3a-7 applies to entities or new or modified interpretive positions related to Section 3(c)(5)(C), could further inhibit our ability, or the ability of a subsidiary, to pursue our current or future operating strategies, which could have a material adverse effect on us.

Certain provisions of our operating agreement will make it difficult for third parties to acquire control of us and could deprive holders of our shares of the opportunity to obtain a takeover premium for their shares.

Our operating agreement contains a number of provisions that could make it more difficult for a third party to acquire, or may discourage a third party from acquiring, control of us. These provisions include, among others:

These provisions, as well as other provisions in the operating agreement, may delay, defer or prevent a transaction or a change in control that might otherwise result in holders of our shares obtaining a takeover premium for their shares.

Certain provisions of the Management Agreement also could make it more difficult for third parties to acquire control of us by various means, including limitations on our right to terminate the Management Agreement and a requirement that, under certain circumstances, we make a substantial payment to the Manager in the event of a termination.

We may issue additional debt and equity securities which are senior to our common shares as to distributions and upon our dissolution, which could materially adversely affect the market price of our shares.

In the future, we may attempt to increase our capital resources by entering into additional debt or debt-like financings that are secured by all or some of our assets, or issuing debt or equity securities, which could include issuances of secured liquidity notes, medium-term notes, senior notes, subordinated notes or preferred and common shares. In the event of our dissolution, liabilities of our creditors, including our lenders and holders of our debt securities, would be satisfied from our available assets in priority to distributions to holders of our common or preferred shares. Any preferred shares may have a preference over our common shares with respect to distributions made at the discretion of our board of directors, which could further limit our ability to make distributions to holders of our common shares. Because our decision to incur debt and issue shares in any future offerings will depend on the terms of our operating agreements, market conditions and other factors beyond our control, we cannot predict or estimate the amount, timing or nature of our future offerings or our future debt and equity financings. Further, market conditions could require us to accept less favorable terms for the issuance of our securities in the future, including, but not limited to, issuing common shares at a discount to market value. Accordingly, holders of our shares and of any securities we may issue whose value is linked to the value of our shares will bear the risk of our future offerings reducing the value of their shares or any such other securities and diluting their interest in us. In addition, we can change our leverage strategy and investment policies from time to time without approval of holders of any of our shares, which could adversely affect the market price of our shares.

Our board of directors has broad authority to change many of the terms of our shares without the approval of holders of our shares.

Our operating agreement gives our board of directors broad authority to effect amendments to the provisions of our operating agreement that could change many of the terms of our shares without the consent of holders of our shares. As a result, our board of directors may, without the approval of

holders of our shares, make changes to many of the terms of our shares that are adverse to the holders of our shares.

Our board of directors has full authority and discretion over distributions on our shares and it may decide to reduce or eliminate distributions at any time, which may adversely affect the market price for our shares and any other securities we may issue.

Our board of directors has full authority and sole discretion to determine whether or not a distribution will be declared and paid, and the amount and timing of any distribution that may be paid, to holders of our shares and (unless otherwise provided by our board of directors if and when it establishes the terms of any new class or series of our shares) any other class or series of shares we may issue in the future. Our board of directors may, in its sole discretion, determine to reduce or eliminate distributions on our common shares and (unless otherwise so provided by our board of directors) any other class or series of shares we may issue in the future, which may have a material adverse effect on the market price of our shares, any such other shares and any other securities we may issue. In addition, in computing United States federal income tax liability for a taxable year, each holder of our shares will be required to take into account its allocable share of items of our income, gain, loss, deduction and credit for our taxable year ending within or with such holder's taxable year, regardless of whether such holder has received any distributions. Each holder's tax liability will depend on its unique circumstances. As a result, it is possible that a holder's United States federal income tax liability with respect to its allocable share of these items in a particular taxable year could exceed the cash distributions received by such holder. Accordingly, each holder should ensure that it has sufficient cash flow from other sources to pay all tax liabilities attributable to its investment in our shares.

In addition, as discussed above under "Risks Related to our Organization and Structure—The terms of our indebtedness may restrict our ability to make future distributions and impose limitations on our current and future operations," our credit facility includes covenants that restricts our ability to make distributions on, and to redeem or repurchase, our shares, including a prohibition on distributions on, and redemptions and repurchases of, our shares if an event of default, or certain events that with notice or passage of time or both would constitute an event of default, under the credit facility occur and a requirement that we maintain a specified minimum level of consolidated tangible net worth. In addition, our credit facility contains a covenant which limits our ability to make distributions to our shareholders in an amount in excess of 65% of our annual taxable income calculated in accordance with the 2014 Facility credit agreement.

We intend to pay quarterly distributions to holders of our common shares, but our ability to do so may be limited, which could cause the market price of our common shares to decline significantly.

We resumed paying quarterly dividends beginning in the fourth quarter of 2009 and we currently intend to continue paying cash distributions to holders of our common shares on a quarterly basis. For all quarters and year ended December 31, 2011, we have declared cumulative cash distributions on our common shares of $0.78 per share.

Our ability to pay quarterly distributions will be subject to, among other things, general business conditions, our financial results, the impact of paying distributions on our credit ratings, and legal and contractual restrictions on the payment of distributions under borrowing agreements, including restrictions imposed by our 2014 Facility credit agreement, the amount of ordinary taxable income or loss earned by us, gains or losses recognized by us on the disposition of assets and our liquidity needs. Any reduction or discontinuation of quarterly distributions could cause the market price of our common shares to decline significantly. Our payment of distributions to holders of our common shares has also resulted, and may in certain future quarters results, in upward adjustments to the conversion rate of the 7.5% Notes and/or the 7.0% Notes thus resulting in an increase in dilution upon conversion of these notes. Moreover, in the event our payment of quarterly distributions is reduced or

discontinued, our failure or inability to resume paying distributions could result in a persistently low market valuation of our common shares.

We are highly dependent on our Manager and may not find a suitable replacement if our Manager terminates the Management Agreement.

We have no employees. Our Manager, and its officers and employees, allocate a portion of their time to businesses and activities that are not related to, or affiliated with, us and, accordingly, its officers and employees do not spend all of their time managing our activities and our investment portfolio. We expect that the portion of our Manager's time that is allocated to other businesses and activities will increase in the future as our Manager and KKR expand their investment focus to include additional investment vehicles, including vehicles that compete more directly with us, which time allocations may be material. We have no separate facilities and are completely reliant on our Manager, which has significant discretion as to the implementation and execution of our business and investment strategies and our risk management practices. We are also subject to the risk that our Manager will terminate the Management Agreement and that no suitable replacement will be found. We believe that our success depends to a significant extent upon the experience of our Manager's executive officers, whose continued service is not guaranteed.

The departure of any of the senior management and investment professionals of our Manager or the loss of our access to KKR's senior management and investment professionals may adversely affect our ability to achieve our investment objectives.

We depend on the diligence, skill and network of business contacts of the senior management and investment professionals of our Manager. We also depend on our Manager's access to the investment professionals and senior management of KKR and the information and deal flow generated by the KKR investment professionals and senior management during the normal course of their investment and portfolio management activities. The senior management and the investment professionals of our Manager evaluate, negotiate, structure, close and monitor our investments. Our future success will depend on the continued service of the senior management team and investment professionals of our Manager. The departure of any of the senior management or investment professionals of our Manager, or of a significant number of the investment professionals or senior management of KKR, could have a material adverse effect on our ability to achieve our investment objectives. In addition, we can offer no assurance that our Manager will remain our Manager or that we will continue to have access to KKR's investment professionals or senior management or KKR's information and deal flow.

If our Manager ceases to be our manager pursuant to the Management Agreement, financial institutions providing our credit facilities may not provide future financing to us.

The financial institutions that finance our investments may require that our Manager continue to manage our operations pursuant to the Management Agreement as a condition to making continued advances to us under these credit facilities. Additionally, if our Manager ceases to be our manager, each of these financial institutions under these credit facilities may terminate their facility and their obligation to advance funds to us in order to finance our current and future investments. If our Manager ceases to be our manager for any reason and we are not able to continue to obtain financing under these or suitable replacement credit facilities, our growth may be limited or we may be forced to sell our investments at a loss.

Our board of directors has approved very broad investment policies for our Manager and does not approve individual investment decisions made by our Manager except in limited circumstances.

Our Manager is authorized to follow very broad investment policies (our "Investment Policies") and, in connection with the conversion transaction, these Investment Policies were revised to provide even greater latitude to our Manager with respect to certain matters relating to transactions with our affiliates. Our directors periodically review and approve our Investment Policies. Our board of directors generally does not approve any individual investments, other than approving a limited set of transactions with affiliates that require the prior approval of the Affiliated Transactions Committee of our board of directors. Furthermore, transactions entered into by our Manager may be difficult or impossible to terminate or unwind. Our Manager has significant latitude within the broad parameters of the Investment Policies in determining the types of assets it may decide are proper investments for us.

Certain of our investments may create a conflict of interest with KKR and other affiliates and may expose us to additional legal risks.

Subject to complying with our Investment Policies and the charter of the Affiliated Transactions Committee of our board of directors, a core element of our business strategy is that our Manager will at times cause us to invest in corporate leveraged loans, high yield securities and equity securities of companies affiliated with KKR, provided that such investments meet our requirements.

To the extent KKR is the owner of a majority of the outstanding equity securities of such companies, KKR may have the ability to elect all of the members of the board of directors of a company we invest in and thereby control its policies and operations, including the appointment of management, future issuances of shares or other securities, the payments of dividends, if any, on its shares, the incurrence of debt by it, amendments to its certificate of incorporation and bylaws and entering into extraordinary transactions, and KKR's interests may not in all cases be aligned with the interests of the holders of the securities we own. In addition, with respect to companies in which we have an equity investment, to the extent that KKR is the controlling shareholder it may be able to determine the outcome of all matters requiring shareholder approval and will generally be able to cause or prevent a change of control of a company we invest in or a change in the composition of its board of directors and could preclude any unsolicited acquisition of that company regardless as to whether we agree with such determination. So long as KKR continues to own a significant amount of the voting power of a company we invest in, even if such amount is less than 50%, it will continue to influence strongly, or effectively control, that company's decisions. Our interests with respect to the management, investment decisions, or operations of those companies may at times be in conflict with those of KKR. In addition, to the extent that affiliates of our Manager or KKR invest in companies in which we have an investment, similar conflicts between our interests and theirs may arise. In addition, our Manager has implemented policies and procedures to mitigate potential conflicts of interest, which policies impose limitations on our ability to make certain investments in companies affiliated with KKR.

In addition, interests and those of KKR may at times be in conflict because the CLO issuers in which we invest hold corporate leveraged loans the obligors on which are KKR-affiliated companies. KKR may have an interest in causing such companies to pursue acquisitions, divestitures, exchange offers, debt restructurings and other transactions that, in KKR's judgment, could enhance its equity investment, even though such transactions might involve risks to holders of indebtedness, which include our CLO issuers. For example, KKR could cause a company that is the obligor on a loan held by one of our CLO issuers to make acquisitions that increase its indebtedness or to sell revenue generating assets, thereby potentially decreasing the ability of the company to repay its debt. In cases where a company's debt undergoes a restructuring, the interests of KKR as an equity investor and our CLO issuers as debt investors may diverge, and KKR may have an interest in pursuing a restructuring

strategy that benefits the equity holders to the detriment of the lenders, such as our CLO issuers. This risk may be exacerbated in the current economic environment given reduced liquidity available for debt refinancing, among other factors.

If a KKR-affiliated company were to file for bankruptcy or similar action, we face the risk that a court may subordinate our debt investment in such company to the claims of more junior debt holders or may recharacterize our investment as an equity investment. Any such action by a court would have a material adverse impact on the value of these investments.

There are various potential conflicts of interest in our relationship with our Manager and its affiliates, including KKR, which could result in decisions that are not in the best interests of holders of our shares.

We are subject to potential conflicts of interest arising out of our relationship with our Manager and its affiliates. As of December 31, 2011, our Manager and its affiliates collectively owned approximately 3% of our outstanding common shares on a fully diluted basis.

Our Management Agreement with our Manager was negotiated between related parties, and its terms, including fees payable, may not be as favorable to us as if it had been negotiated with an unaffiliated third party. Pursuant to the Management Agreement, our Manager will not assume any responsibility other than to render the services called for thereunder and will not be responsible for any action of our board of directors in following or declining to follow its advice or recommendations. See the risk factor entitled "Our Manager's liability is limited under the Management Agreement, and we have agreed to indemnify our Manager against certain liabilities."

As noted above, our Manager will at times cause us to invest in loans and securities of companies affiliated with KKR, provided that such investments meet our requirements, and the terms of which such investments are made may not be as favorable as if they were negotiated with unaffiliated third parties. In addition, from time to time, the Manager may cause us to buy loans or securities from, or to sell loans or securities to, other clients of KKR or its affiliates. The Manager has implemented policies and procedures to mitigate conflicts of interest in such transactions.

The incentive fee provided for under the Management Agreement may induce our Manager to make certain investments, including speculative investments.

The management compensation structure to which we have agreed with our Manager may cause our Manager to invest in high risk investments or take other risks, which, if they result in a loss, could harm our financial results. In addition to its base management fee, our Manager is entitled to receive incentive compensation based in part upon our achievement of specified levels of net income. See "Item 1. Business—Management Agreement" for further information regarding our management compensation structure. In evaluating investments and other management strategies, the opportunity to earn incentive compensation based on net income may lead our Manager to place undue emphasis on the maximization of net income at the expense of other criteria, such as preservation of capital, maintaining sufficient liquidity, and/or management of credit risk or market risk, in order to achieve higher incentive compensation. Investments with higher yield potential are generally riskier or more speculative. In addition, our Manager's compensation is partly based on GAAP results, which may not always correlate to economic results that increase the market price of our shares. As a result, our Manager may still receive management fees and incentive compensation even in times of poor economic financial results that precipitate a decline in the market price of our shares. If there is a disconnect between our GAAP results and the market value of our shares, the incentive fees paid to our Manager may be higher than our share price would suggest is warranted. Furthermore, the Compensation Committee of our board of directors may make grants of options and restricted shares to our Manager in the future and the factors considered by the Compensation Committee in making these grants may include performance related factors which may also induce our Manager to make

investments that are riskier or more speculative. This could result in increased risk to the value of our investment portfolio.

Conflicts may arise in connection with the allocation of investment opportunities by affiliates of our Manager.

Our Management Agreement with our Manager does not prevent our Manager and its affiliates from engaging in additional management or investment opportunities. The Management Agreement does not restrict our Manager and its affiliates from raising, sponsoring or advising any new investment fund, company or other entity, including a REIT, or holding proprietary investment accounts, unless such fund, account, company or other entity invests primarily in domestic mortgage-backed securities. This restriction is of significantly less relevance since the May 4, 2007 restructuring pursuant to which we succeeded KKR Financial Corp., because since then our investments in domestic mortgage-backed securities have significantly decreased and as of December 31, 2011 comprised $86.5 million of our investment portfolio. As a result, our Manager and its affiliates, including KKR, currently are engaged in and may in the future engage in management or investment opportunities on behalf of others or themselves that would have been suitable for us and we may have fewer attractive investment opportunities.

In addition, affiliates of our Manager currently manage a separate investment fund and separately managed accounts, including proprietary investment accounts for the purpose of developing, evaluating and testing potential trading strategies that invest in the same non-mortgage-backed securities investments that we invest in, including other fixed income investments. With respect to these other funds and accounts and any other funds or accounts that may be established in the future, our Manager and its affiliates will face conflicts in the allocation of investment opportunities. Such allocation is at the discretion of our Manager and its affiliates in accordance with their respective allocation policies and procedures. These policies take into account a number of factors, including mandatory minimum investment rights, investment objectives, available capital, concentration limits, risk profiles and other investment restrictions applicable to us and these competing funds and accounts. Our Manager and its affiliates have broad discretion in administering these policies and there is no guarantee that in making allocations our Manager and its affiliates will act in the best interests of holders of our shares or any other securities we may issue. In addition, certain of such other managed funds and accounts may participate in investment opportunities on more favorable terms than us.

We compete with other investment entities affiliated with KKR for access to KKR's investment professionals.

KKR and its affiliates, including the parent of our manager, manage several private equity funds, other funds and separately managed accounts, and we believe that KKR and its affiliates, including the parent of our manager, will establish and manage other investment entities in the future. Certain of these investment entities have, and any newly created entities may have, an investment focus similar to our focus, and as a result we compete with those entities and will compete with any such newly created entities for access to the benefits that our relationship with KKR provides to us. Our ability to continue to engage in these types of opportunities in the future depends, to a significant extent, on competing demands for these investment opportunities by other investment entities established by KKR and its affiliates. To the extent that we and other KKR affiliated entities or related parties compete for investment opportunities, there can be no assurances that we will get the best of those opportunities or that the performance of the investments allocated to us, even within the same asset classes, will perform as favorably as those allocated to others.

Termination of the Management Agreement with our Manager by us is difficult and costly.

The Management Agreement expires on December 31 of each year, but is automatically renewed for a one-year term on each December 31 unless terminated upon the affirmative vote of at least two-thirds of our independent directors, or by a vote of the holders of a majority of our outstanding

common shares, based upon (i) unsatisfactory performance by our Manager that is materially detrimental to us or (ii) a determination that the management fee payable to our Manager is not fair, subject to our Manager's right to prevent such a termination under this clause (ii) by accepting a mutually acceptable reduction of management fees. Our Manager must be provided with 180 days' prior written notice of any such termination and will be paid a termination fee equal to four times the sum of the average annual base management fee and the average annual incentive fee for the two 12-month periods immediately preceding the date of termination, calculated as of the end of the most recently completed fiscal quarter prior to the date of termination. These provisions would result in substantial cost to us if we terminate the Management Agreement, thereby adversely affecting our ability to terminate our Manager.

Our access to confidential information may restrict our ability to take action with respect to some investments, which, in turn, may negatively affect our results of operations.

We, directly or through our Manager, may obtain confidential information about the companies in which we have invested or may invest. If we do possess confidential information about such companies, there may be restrictions on our ability to make, dispose of, increase the amount of, or otherwise take action with respect to, an investment in those companies. Our relationship with KKR could create a conflict of interest to the extent our Manager becomes aware of inside information concerning investments or potential investment targets. We have implemented compliance procedures and practices designed to ensure that inside information is not used for making investment decisions on our behalf. We cannot assure our shareholders, however, that these procedures and practices will be effective. In addition, this conflict and these procedures and practices may limit the freedom of our Manager to make potentially profitable investments which could have an adverse effect on our results of operations. Conversely, we may pursue investments without obtaining access to confidential information otherwise in the possession of KKR or one of its affiliates, which information, if reviewed, might otherwise impact our judgment with respect to such investments.

Our Manager's liability is limited under the Management Agreement, and we have agreed to indemnify our Manager against certain liabilities.

Pursuant to the Management Agreement, our Manager will not assume any responsibility other than to render the services called for thereunder in good faith and will not be responsible for any action of our board of directors in following or declining to follow its advice or recommendations. Our Manager and its members, managers, officers and employees will not be liable to us, any subsidiary of ours, our directors, our shareholders or any subsidiary's shareholders for acts or omissions pursuant to or performed in accordance with the Management Agreement, except by reason of acts constituting bad faith, willful misconduct, gross negligence, or reckless disregard of their duties under the Management Agreement. Pursuant to the Management Agreement, we have agreed to indemnify our Manager and its members, managers, officers and employees and each person controlling our Manager with respect to all expenses, losses, damages, liabilities, demands, charges and claims arising from acts or omissions of such indemnified party not constituting bad faith, willful misconduct, gross negligence, or reckless disregard of duties, performed in good faith in accordance with and pursuant to the Management Agreement.

Holders of our common shares will be subject to United States federal income tax and generally other taxes, such as state, local and foreign income tax, on their share of our taxable income, regardless of whether or when they receive any cash distributions from us, and may recognize income or have tax liability in excess of our cash distributions.

We intend to continue to operate so as to qualify, for United States federal income tax purposes, as a partnership and not as an association or a publicly traded partnership taxable as a corporation. Holders of our common shares are subject to United States federal income taxation and generally other taxes, such as state, local and foreign income taxes, on their allocable share of our items of income, gain, deduction, and credit for each of our taxable years ending with or within the holder's taxable year, regardless of whether or when they receive cash distributions. In addition, certain of our investments, including investments in certain foreign corporate subsidiaries, CLO issuers (which are treated as partnerships or disregarded entities for United States federal income tax purposes) and debt securities, may produce taxable income without corresponding distributions of cash to us or produce taxable income prior to or following the receipt of cash relating to such income. Those investments typically produce ordinary income on a current basis, but any losses we would recognize from those investments would typically be treated as capital losses. In addition, we have recognized and may recognize in the future cancellation of indebtedness income upon the retirement of our debt at a discount. Because of our methods of allocating income and gain among holders of our common shares, you may be taxed on amounts that accrued economically before you became a shareholder. Consequently, in some taxable years, holders of our common shares may recognize taxable income in excess of our cash distributions, and holders may be allocated capital losses either in the same or future years that cannot be used to offset such taxable income. Furthermore, even if we did not pay cash distributions with respect to a taxable year, holders of our common shares may still have a tax liability attributable to their allocation of our taxable income. Accordingly, each shareholder should ensure that it has sufficient cash flow from other sources to pay all tax liabilities.

If we were treated as a corporation for United States federal income tax purposes, all of our income will be subject to an entity-level tax, which could result in a material reduction in cash flow and after-tax return for holders of our common shares and thus could result in a substantial reduction in the value of our common shares and any other securities we may issue.

The value of your investment in us depends in part on our being treated as a partnership for United States federal income tax purposes. We intend to continue to operate so as to qualify, for United States federal income tax purposes, as a partnership and not as an association or a publicly traded partnership taxable as a corporation. In general, if a partnership is "publicly traded" (as defined in the Code), it will be treated as a corporation for United States federal income tax purposes. A publicly traded partnership will, however, be taxed as a partnership, and not as a corporation, for United States federal income tax purposes, so long as it is not required to register under the Investment Company Act and at least 90% of its gross income for each taxable year constitutes "qualifying income" within the meaning of Section 7704(d) of the Code. We refer to this exception as the "qualifying income exception." Qualifying income generally includes rents, dividends, interest (to the extent such interest is neither derived from the "conduct of a financial or insurance business" nor based, directly or indirectly, upon "income or profits" of any person), income and gains derived from certain activities related to minerals and natural resources, and capital gains from the sale or other disposition of stocks, bonds and real property. Qualifying income also includes other income derived from the business of investing in, among other things, stocks and securities.

in a corporation. In such case, we would be required to pay income tax at regular corporate rates on all of our income. In addition, we would likely be liable for state and local income and/or franchise taxes on all of our income. Distributions to holders of our common shares would be taxable as ordinary dividend income to such holders to the extent of our earnings and profits, and these distributions would not be deductible by us. If we were taxable as a corporation, it could result in a material reduction in cash flow and after-tax return for holders of our common shares and thus could result in a substantial reduction in the value of our common shares and any other securities we may issue.

Complying with certain tax-related requirements may cause us to forego otherwise attractive business or investment opportunities.

To be treated as a partnership for United States federal income tax purposes, and not as an association or publicly traded partnership taxable as a corporation, we must satisfy the qualifying income exception, which requires that at least 90% of our gross income each taxable year consist of interest, dividends, capital gains and other types of "qualifying income." Interest income will not be qualifying income for the qualifying income exception if it is derived from "the conduct of a financial or insurance business." This requirement limits our ability to originate loans or acquire loans originated by our Manager and its affiliates. In order to comply with this requirement, we (or our subsidiaries) may be required to invest through foreign or domestic corporations that are subject to corporate income tax or forego attractive business or investment opportunities. Thus, compliance with this requirement may adversely affect our return on our investments and results of operations.

We cannot predict the tax liability attributable to our common shares for any particular holder of our common shares.

Each holder of our common shares will determine its tax liability attributable to its ownership of our common shares based on its own unique circumstances. Holders of our common shares may have different tax liabilities attributable to our common shares for many reasons unique to the holders, including among other things, limitations on miscellaneous itemized deductions, alternative minimum tax liabilities, differing tax bases in our assets or the holder's status as a non-United States person or tax-exempt entity. As a result, we cannot predict the tax liability attributable to our common shares for any particular holder.

The ability of holders of our common shares to deduct certain expenses incurred by us may be limited.

In general, expenses incurred by us that are considered "miscellaneous itemized deductions" may be deducted by a holder of our common shares that is an individual, estate or trust only to the extent that such holder's allocable share of those expenses, along with the holder's other miscellaneous itemized deductions, exceed, in the aggregate, 2% of such holder's adjusted gross income. In addition, these expenses are also not deductible in determining the alternative minimum tax liability of a holder. We treat the management fees that we pay to our Manager and certain other expenses incurred by us as miscellaneous itemized deductions. A holder's inability to deduct all or a portion of such expenses could result in an amount of taxable income to such holder with respect to us that exceeds the amount of cash actually distributed to such holder for the year.

Holders of our common shares may recognize gain for United States federal income tax purposes when we sell assets that cause us to recognize a loss for financial reporting purposes.

We have elected under Section 754 of the Code to adjust the tax basis in all or a portion of our assets upon certain events, including the sale of our common shares. Because our holders are treated as having differing tax bases in our assets, a sale of an asset by us may cause holders to recognize different amounts of gain or loss or may cause some holders to recognize a gain and others to recognize a loss. Depending on the purchase price the shareholder paid for our shares, our holders may

recognize gain for United States federal income tax purposes from the sale of certain of our assets even though the sale would cause us to recognize a loss for financial accounting purposes.

We have made and may make investments, such as investments in natural resources and commercial real estate, that generate income and gain that is treated as effectively connected with respect to holders of our common shares that are not "United States persons."

We have made and may make investments, such as investments in natural resources and commercial real estate, the income and gain from which likely will be treated as effectively connected with the conduct of a United States trade or business with respect to holders of our shares that are not "United States persons" within the meaning of Section 7701(a)(30) of the Code. Furthermore, notional principal contracts that we enter into, if any, in connection with investments in natural resources likely would generate income that would be treated as effectively connected with the conduct of a United States trade or business. To the extent our income and gain is treated as effectively connected income, a holder who is a non-United States person generally would be required to (i) file a United States federal income tax return for such year reporting its allocable share, if any, of our income or loss effectively connected with such trade or business and (ii) pay United States federal income tax at regular United States tax rates on any such income. Moreover, if such a holder is a corporation, it might be subject to a United States branch profits tax on its allocable share of our effectively connected income. In addition, distributions to such a holder would be subject to withholding at the highest applicable tax rate to the extent of the holder's allocable share of our effectively connected income. Any amount so withheld would be creditable against such holder's United States federal income tax liability, and such holder could claim a refund to the extent that the amount withheld exceeded such person's United States federal income tax liability for the taxable year. Finally, if we are engaged in a United States trade or business, a portion of any gain recognized by an investor who is a non-United States person on the sale or exchange of its shares may be treated for United States federal income tax purposes as effectively connected income, and hence such holder may be subject to United States federal income tax on the sale or exchange.

Holders of our shares may be subject to foreign, state and local taxes and return filing requirements as a result of investing in our shares.

In addition to United States federal income taxes, holders of our common shares may be subject to other taxes, including foreign, state and local taxes, unincorporated business taxes and estate, inheritance or intangible taxes that are imposed by the various jurisdictions in which we conduct business or own property, even if the holders of our common shares do not reside in any of those jurisdictions. For example, we will likely be treated as doing business in any foreign, state or local jurisdiction in which our natural resources investments are located and we may be treated as doing business in any foreign, state or local jurisdiction in which our commercial real estate is located. As a result, our holders may be required to file foreign, state and local income tax returns and pay foreign, state and local income taxes in some or all of these various jurisdictions. Further, holders may be subject to penalties for failure to comply with those requirements. It is the responsibility of each holder to file all United States federal, state and local tax returns that may be required of such holder.

Holders of our common shares may recognize a greater taxable gain (or a smaller tax loss) on a disposition of our common shares than expected because of the treatment of debt under the partnership tax accounting rules.

We will incur debt for a variety of reasons, including for acquisitions as well as other purposes. Under partnership tax accounting principles (which apply to us), our debt is generally allocable to holders of our common shares, who will realize the benefit of including their allocable share of the debt in the tax basis of their common shares. The tax basis in our common shares will be adjusted for,

among other things, distributions of cash and allocations of our losses, if any. At the time a holder of our common shares later sells its common shares, the holder's amount realized on the sale will include not only the sales price of the common shares but also will include such holder's portion of debt allocable to those common shares (which is treated as proceeds from the sale of those common shares). Depending on the nature of our activities after having incurred the debt, and the utilization of the borrowed funds, a later sale of our common shares could result in a larger taxable gain (or a smaller tax loss) than anticipated.

If we have a termination for United States federal income tax purposes, holders of our shares may be required to include more than 12 months of our taxable income in their taxable income for the year of the termination.

We will be considered to have been terminated for United States federal income tax purposes if there is a sale or exchange of 50% or more of the total interests in our capital and profits within a 12-month period. A termination of our partnership would, among other things, result in the closing of our taxable year for all holders. In the case of a holder reporting on a taxable year other than a fiscal year ending on our year end, which is expected to continue to be the calendar year, the closing of our taxable year may result in more than 12 months of our taxable income or loss being includable in the holder's taxable income for the year of termination. We would be required to satisfy the 90% "qualifying income" test for each tax period and to make new tax elections after a termination, including a new tax election under Section 754 of the Code. A termination could also result in penalties if we were unable to determine that the termination had occurred. In the event that we become aware of a termination, we will use commercially reasonable efforts to minimize any such penalties. Moreover, a termination might either accelerate the application of, or subject us to, any tax legislation enacted before the termination. We have experienced terminations in the past, and it is likely that we will experience terminations in the future. The IRS has announced a publicly traded partnership technical termination relief program whereby, if the taxpayer requests relief and such relief is granted by the IRS, among other things, the partnership would only have to provide one Schedule K-1 to most holders of shares for the year notwithstanding two partnership tax years.

We could incur a significant tax liability if the Internal Revenue Service successfully asserts that the "anti-stapling" rules apply to certain of our subsidiaries, which could result in a reduction in cash flow and after-tax return for holders of common shares and thus could result in a reduction of the value of those common shares.

If we were subject to the "anti-stapling" rules of Section 269B of the Code, we would incur a significant tax liability as a result of owning (i) more than 50% of the value of both a domestic corporate subsidiary and a foreign corporate subsidiary, or (ii) more than 50% of both a REIT and a domestic or foreign corporate subsidiary. If the "anti-stapling" rules applied, our foreign corporate subsidiaries would be treated as domestic corporations, which would cause those entities to be subject to United States federal corporate income taxation, and any REIT subsidiary would be treated as a single entity with our domestic and foreign corporate subsidiaries for purposes of the REIT qualification requirements, which could result in the REIT subsidiary failing to qualify as a REIT and being subject to United States federal corporate income taxation. Currently, we have several subsidiaries that could be affected if we were subject to the "anti-stapling" rules, including one subsidiary taxed as a REIT and several foreign and domestic corporate subsidiaries. Because we own, or are treated as owning, a substantial proportion of our assets directly for United States federal income tax purposes, we do not believe that the "anti-stapling" rules have applied or will apply. However, there can be no assurance that the IRS would not successfully assert a contrary position, which could result in a reduction in cash flow and after-tax return for holders of common shares and thus could result in a reduction of the value of those shares.

Tax-exempt holders of our common shares will likely recognize significant amounts of "unrelated business taxable income."

An organization that is otherwise exempt from United States federal income tax is nonetheless subject to taxation with respect to its "unrelated business taxable income" ("UBTI"). Generally, a tax-exempt partner of a partnership would be treated as earning UBTI if the partnership regularly engages in a trade or business that is unrelated to the exempt function of the tax-exempt partner, if the partnership derives income from debt-financed property or if the partner interest itself is debt-financed. Because we have incurred "acquisition indebtedness" with respect to certain equity and debt securities we hold (either directly or indirectly through subsidiaries that are treated as partnerships or disregarded entities for United States federal income tax purposes), a proportionate share of a holder's income from us with respect to such securities will be treated as UBTI. In addition, we have made and may make investments, such as investments in natural resources, that likely will generate income treated as effectively connected with a United States trade or business. Accordingly, tax-exempt holders of our shares will likely recognize significant amounts of UBTI. Tax-exempt holders of our shares are strongly urged to consult their tax advisors regarding the tax consequences of owning our shares.

Although we anticipate that our foreign corporate subsidiaries will not be subject to United States federal income tax on a net basis, no assurance can be given that such subsidiaries will not be subject to United States federal income tax on a net basis in any given taxable year.

We anticipate that our foreign corporate subsidiaries will generally continue to conduct their activities in such a way as not to be deemed to be engaged in a United States trade or business and not to be subject to United States federal income tax. There can be no assurance, however, that our foreign corporate subsidiaries will not pursue investments or engage in activities that may cause them to be engaged in a United States trade or business. Moreover, there can be no assurance that as a result of any change in applicable law, treaty, rule or regulation or interpretation thereof, the activities of any of our foreign corporate subsidiaries would not become subject to United States federal income tax. Further, there can be no assurance that unanticipated activities of our foreign subsidiaries would not cause such subsidiaries to become subject to United States federal income tax. If any of our foreign corporate subsidiaries became subject to United States federal income tax (including the United States branch profits tax), it would significantly reduce the amount of cash available for distribution to us, which in turn could have an adverse impact on the value of our shares and any other securities we may issue. Our foreign corporate subsidiaries are generally not expected to be subject to United States federal income tax on a net basis, and such subsidiaries may receive income that is subject to withholding taxes imposed by the United States or other countries.

Certain of our investments may subject us to United States federal income tax and could have negative tax consequences for our shareholders.

A portion of our distributions likely will constitute "excess inclusion income." Excess inclusion income is generated by residual interests in real estate mortgage investment conduits ("REMICs") and taxable mortgage pool arrangements owned by REITs. We own through a disregarded entity a small number of REMIC residual interests. In addition, KFH II has entered into financing arrangements that are treated as taxable mortgage pools. We will be taxable at the highest corporate income tax rate on any excess inclusion income from a REMIC residual interest that is allocable to the percentage of our shares held in record name by disqualified organizations. Although the law is not clear, we may also be subject to that tax if the excess inclusion income arises from a taxable mortgage pool arrangement owned by a REIT in which we invest. Disqualified organizations are generally certain cooperatives, governmental entities and tax-exempt organizations that are exempt from unrelated business tax (including certain state pension plans and charitable remainder trusts). They are permitted to own our shares. Because this tax would be imposed on us, all of the holders of our shares, including holders that

are not disqualified organizations, would bear a portion of the tax cost associated with our ownership of REMIC residual interests and with the classification of any of our REIT subsidiaries or a portion of the assets of any of our REIT subsidiaries as a taxable mortgage pool. A RIC or other pass-through entity owning our shares may also be subject to tax at the highest corporate rate on any excess inclusion income allocated to their record name owners that are disqualified organizations. Nominees who hold our common shares on behalf of disqualified organizations also potentially may be subject to this tax.

Excess inclusion income cannot be offset by losses of our shareholders. If the shareholder is a tax-exempt entity and not a disqualified organization, then this income would be fully taxable as UBTI under Section 512 of the Code. If the shareholder is a foreign person, it would be subject to United States federal income tax withholding on this income without reduction or exemption pursuant to any otherwise applicable income tax treaty.

Dividends paid by, and certain income inclusions derived with respect to our ownership of, KFH II and foreign corporate subsidiaries will not qualify for the reduced tax rates generally applicable to corporate dividends paid to taxpayers taxed at individual rates.

Tax legislation enacted in 2003, 2006 and 2010 reduced the maximum United States federal income tax rate on certain corporate dividends payable to taxpayers taxed at individual rates to 15% through 2012. Dividends payable by, or certain income inclusions derived with respect to the ownership of, passive foreign investment companies ("PFICs"), certain controlled foreign corporations ("CFCs"), and REITs, however, are generally not eligible for the reduced rates. We have treated and intend to continue to treat our foreign corporate subsidiaries as the type of CFCs whose income inclusions are not eligible for lower tax rates on dividend income. Although this legislation does not generally change the taxation of our foreign corporate subsidiaries and REITs, the more favorable rates applicable to regular corporate dividends could cause investors taxed at individual rates to perceive investments in PFICs, CFCs or REITs, or in companies such as us, whose holdings include foreign corporations and REITs, to be relatively less attractive than holdings in the stocks of non-CFC, non-PFIC and non-REIT corporations that pay dividends, which could adversely affect the value of our shares and any other securities we may issue.

Under the Foreign Account Tax Compliance Act ("FATCA"), withholding tax may apply to the portion of our distributions that constitute "withholdable payments" other than gross proceeds after December 31, 2013 and to distributions of gross proceeds of certain asset sales by us and proceeds of sales in respect of our common shares after December 31, 2014.

Under current law, holders of our shares that are not United States persons are generally subject to United States federal withholding tax at the rate of 30% (or such lower rate provided by an applicable tax treaty) on their share of our gross income from dividends, interest (other than interest that constitutes "portfolio interest" within the meaning of the Code) and certain other income that is not treated as effectively connected with a United States trade or business. For payments made after December 31, 2013, in addition to this withholding tax that currently applies, FATCA will impose a United States federal withholding tax at a 30% rate on "withholdable payments" made to foreign financial institutions (and their more than 50% affiliates) unless the payee foreign financial institution agrees, among other things, to disclose the identity of certain United States persons and United States owned foreign entities with accounts at the institution (or the institution's affiliates) and to annually report certain information about such accounts. "Withholdable payments" include payments of interest (including original issue discount), dividends, and other items of fixed or determinable annual or periodical gains, profits, and income, in each case, from sources within the United States, as well as gross proceeds from the sale of any property of a type which can produce interest or dividends from sources within the United States. FATCA will also require withholding on the gross proceeds of such

sales for payments made after December 31, 2014. The FATCA withholding tax will also apply to withholdable payments to certain foreign entities that do not disclose the name, address, and taxpayer identification number of any substantial United States owners (or certify that they do not have any substantial United States owners). We expect that some or all of our distributions will constitute "withholdable payments." Thus, if a holder holds our shares through a foreign financial institution or foreign corporation or trust, a portion of payments to such holder made after December 31, 2013 may be subject to 30% withholding.

If we are required to withhold any United States federal withholding tax on distributions made to any holder of our shares, we will pay such withheld amount to the IRS. That payment, if made, will be treated as a distribution of cash to the holder of the shares with respect to whom the payment was made and will reduce the amount of cash to which such holder would otherwise be entitled.

Ownership limitations in the operating agreement that apply so long as we own an interest in a REIT, such as KFH II, may restrict a change of control in which our holders might receive a premium for their shares.

In order for KFH II to continue to qualify as a REIT, no more than 50% in value of its outstanding capital stock may be owned, directly or indirectly, by five or fewer individuals during the last half of any calendar year and its shares must be beneficially owned by 100 or more persons during at least 335 days of a taxable year of 12 months or during a proportionate part of a shorter taxable year. "Individuals" for this purpose include natural persons, private foundations, some employee benefit plans and trusts, and some charitable trusts. We intend for KFH II to be owned, directly or indirectly, by us and by holders of the preferred shares issued by KFH II. In order to preserve the REIT status of KFH II and any future REIT subsidiary, the operating agreement generally prohibits, subject to exceptions, any person from beneficially owning or constructively owning shares in excess of 9.8% in value or in number of our outstanding shares, whichever is more restrictive, excluding shares not treated as outstanding for United States federal income tax purposes. This restriction may be terminated by our board of directors if it determines that it is no longer in our best interests for KFH II and any future REIT subsidiary to continue to qualify as a REIT under the Code or that compliance with those restrictions is no longer required to qualify as a REIT, and our board of directors may also, in its sole discretion, exempt a person from this restriction.

The ownership limitation could have the effect of discouraging a takeover or other transaction in which holders of our shares might receive a premium for their shares over the then prevailing market price or which holders might believe to be otherwise in their best interests.

The failure of KFH II, or any future REIT subsidiary to qualify as a REIT would generally cause it to be subject to United States federal income tax on its taxable income, which could result in a reduction in cash flow and after-tax return for holders of our shares and thus could result in a reduction of the value of those shares and any other securities we may issue.

We intend that KFH II will continue to operate, and any future REIT subsidiary will operate, in a manner so as to qualify to be taxed as a REIT for United States federal income tax purposes. No ruling from the IRS, however, has been or will be sought with regard to the treatment of KFH II, or any future REIT subsidiary as a REIT for United States federal income tax purposes, and the ability to qualify as a REIT depends on the satisfaction of certain asset, income, organizational, distribution, shareholder ownership and other requirements on a continuing basis. Accordingly, no assurance can be given that KFH II, or any future REIT subsidiary will satisfy such requirements for any particular taxable year. If KFH II, or any future REIT subsidiary were to fail to qualify as a REIT in any taxable year, it would be subject to United States federal income tax, including any applicable alternative minimum tax, on its net taxable income at regular corporate rates, and distributions would not be deductible by it in computing its taxable income. Any such corporate tax liability could be substantial and could reduce the amount of cash available for distribution to us, which in turn would reduce the

amount of cash available for distribution to holders of our shares and could have an adverse impact on the value of those shares and any other securities we may issue. Unless entitled to relief under certain Code provisions, KFH II, or such future REIT subsidiary also would be disqualified from taxation as a REIT for the four taxable years following the year during which it ceased to qualify as a REIT.

The IRS Schedules K-1 we will provide will be significantly more complicated than the IRS Forms 1099 provided by REITs and regular corporations, and holders of our common shares may be required to request an extension of the time to file their tax returns.

Holders of our common shares are required to take into account their allocable share of items of our income, gain, loss, deduction and credit for our taxable year ending within or with their taxable year. We will use reasonable efforts to furnish holders of our common shares with tax information (including IRS Schedule K-1), which describes their allocable share of such items for our preceding taxable year, as promptly as possible. However, we may not be able to provide holders of our common shares with tax information on a timely basis. Because holders of our common shares will be required to report their allocable share of each item of our income, gain, loss, deduction, and credit on their tax returns, tax reporting for holders of our common shares will be significantly more complicated than for shareholders in a REIT or a regular corporation. In addition, delivery of this information to holders of our common shares will be subject to delay in the event of, among other reasons, the late receipt of any necessary tax information from an investment in which we hold an interest. It is therefore possible that, in any taxable year, holders of our common shares will need to apply for extensions of time to file their tax returns.

Our structure involves complex provisions of United States federal income tax law for which no clear precedent or authority may be available, and which is subject to potential change, possibly on a retroactive basis. Any such change could result in adverse consequences to the holders of our common shares and any other securities we may issue.

The United States federal income tax treatment of holders of our common shares depends in some instances on determinations of fact and interpretations of complex provisions of United States federal income tax law for which no clear precedent or authority may be available. The United States federal income tax rules are constantly under review by the IRS, resulting in revised interpretations of established concepts. The IRS pays close attention to the proper application of tax laws to partnerships and investments in foreign entities. The present United States federal income tax treatment of an investment in our common shares may be modified by administrative, legislative or judicial interpretation at any time, and any such action may affect investments and commitments previously made. We and holders of our common shares could be adversely affected by any such change in, or any new tax law, regulation or interpretation. Our operating agreement permits our board of directors to modify (subject to certain exceptions) the operating agreement from time to time, without the consent of the holders of our common shares. These modifications may address, among other things, certain changes in United States federal income tax regulations, legislation or interpretation. In some circumstances, such revisions could have an adverse impact on some or all of the holders of our common shares and of other securities we may issue. Moreover, we intend to apply certain assumptions and conventions in an attempt to comply with applicable rules and to report income, gain, deduction, loss and credit to holders of our common shares in a manner that reflects their distributive share of our items, but these assumptions and conventions may not be in compliance with all aspects of applicable tax requirements. It is possible that the IRS will assert successfully that the conventions and assumptions we use do not satisfy the technical requirements of the Code and/or United States Treasury Regulations and could require that items of income, gain, deduction, loss or credit be adjusted or reallocated in a manner that adversely affects holders of our common shares and of any securities we may issue.

We may be subject to adverse legislative or regulatory tax changes that could reduce the market price of our shares.

At any time, the federal income tax laws or regulations governing publicly traded partnerships or the administrative interpretations of those laws or regulations may be amended. We cannot predict when or if any new federal income tax law, regulation or administrative interpretation, or any amendment to any existing federal income tax law, regulation or administrative interpretation, will be adopted or promulgated or will become effective and any such law, regulation or interpretation may take effect retroactively. We and our holders could be adversely affected by any change in, or any new, federal income tax law, regulation or administrative interpretation. Additionally, revisions in federal tax laws and interpretations thereof could cause us to change our investments and commitments and affect the tax considerations of an investment in us.

Our administrative and principal executive offices are located at 555 California Street, 50^th Floor, San Francisco, California 94104 and are leased by our Manager. We do not own any real estate or other physical properties materially important to our operations.

Item 5. MARKET FOR REGISTRANT'S COMMON EQUITY, RELATED SHAREHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES

On February 21, 2012, the closing price of our common shares, as reported on the NYSE, was $9.33. The following table sets forth the high and low sale prices for our common shares for the period indicated as reported on the NYSE:

	Sales Price

	High		Low
Year ended December 31, 2010
First Quarter ended March 31, 2010	$	8.50	$	5.55
Second Quarter ended June 30, 2010	$	9.49	$	7.01
Third Quarter ended September 30, 2010	$	8.95	$	7.02
Fourth Quarter ended December 31, 2010	$	9.50	$	8.50
Year ended December 31, 2011
First Quarter ended March 31, 2011	$	10.60	$	8.80
Second Quarter ended June 30, 2011	$	10.35	$	9.43
Third Quarter ended September 30, 2011	$	9.92	$	7.36
Fourth Quarter ended December 31, 2011	$	8.85	$	6.68

As of February 21, 2012, we had 178,403,785 issued and outstanding common shares that were held by 21 holders of record. The 21 holders of record include Cede & Co., which holds shares as nominee for The Depository Trust Company, which itself holds shares on behalf of the beneficial owners of our common shares.

The amount and timing of distributions to our common shareholders, including quarterly distributions or any special distributions, is determined by our board of directors and is based upon a review of various factors including current market conditions, existing restrictions under borrowing agreements, the amount of ordinary taxable income or loss earned by us, gains or losses recognized by us on the disposition of assets and our liquidity needs. For this purpose, we will generally determine gains or losses based upon the price we paid for those assets. We note, however, because of the tax rules applicable to partnerships, the gains or losses recognized by a shareholder on the sale of assets held by us may be higher or lower depending upon the purchase price the shareholder paid for our shares. Shareholders may have taxable income or tax liability attributable to our shares for a taxable year that is greater than our cash distributions for such taxable year. See "Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations—Non-Cash 'Phantom' Taxable Income" for further discussion about taxable income allocable to holders of our common shares and "Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations—Cash Distributions to Shareholders" for further discussion about the restrictions on the amount of cash distributions we can pay.

The following table shows the distributions declared for our 2011 and 2010 fiscal years:

The following table summarizes as of December 31, 2011, the total number of securities outstanding in our incentive plan and the number of securities remaining for future issuance, as well as the weighted average exercise price of all outstanding securities.

The following graph presents a total return comparison from a $100 investment in our common shares on December 31, 2006 to the Standard & Poor's 500 Index ("S&P 500 Index"), Russell 1000 Index ("Russell 1000") and Russell 2000 Index ("Russell 2000").

We obtained information for the table below from sources that we believe to be reliable, but we do not guarantee its accuracy or completeness. The graph assumes that the value of the investment in our common shares and each index was $100 on December 31, 2006, and that all dividends were reinvested. The total return performance shown on the graph is not necessarily indicative of future total return performance.

On January 21, 2011, the Compensation Committee of the board of directors granted the Manager 240,845 restricted common shares subject to graded vesting over four years with the final vesting date of March 1, 2015. The grant made to our Manager was exempt from the registration requirements of the Securities Act pursuant to Section 4(2) thereof.

On October 15, 2011, our non-employee directors deferred an immaterial amount of cash compensation in exchange for 5,042 phantom shares pursuant to the KKR Financial Holdings LLC Non-Employee Directors' Deferred Compensation and Share Award Plan. Each phantom share is the economic equivalent of one of our common shares. The phantom shares become payable, in cash or common shares, at the election of the Company, upon the earlier of (i) the first day of January following the applicable non-employee director's termination of service as a director or (ii) an election date pre-selected by the applicable non-employee director, and in any event in cash or common shares, at the election of the applicable non-employee director, upon the occurrence of a change in control of the Company. The grants made to our non-employee directors were exempt from the registration requirements of the Securities Act pursuant to Section 4(2) thereof. For further discussion of the 2007 Share Incentive Plan, see "Item 8. Financial Statements and Supplementary Data—Note 11. Common Shares, Restricted Shares and Share Options" of this Annual Report on Form 10-K.

The following selected financial data is derived from our audited consolidated financial statements as of and for the years ended December 31, 2011, 2010, 2009, 2008 and 2007. The selected financial data should be read together with the more detailed information contained in the consolidated financial statements and associated notes, and "Management's Discussion and Analysis of Financial Condition and Results of Operations" included elsewhere in this Annual Report on Form 10-K.

(in thousands, except per share data)	Year ended December 31, 2011		Year ended December 31, 2010		Year ended December 31, 2009			Year ended December 31, 2008			Year ended December 31, 2007

Consolidated Statements of Operations Data:
Net investment income (loss):
Total investment income	$	542,021	$	505,359	$	572,725		$	948,588		$	872,373
Interest expense		133,609		131,700		268,087			521,313			556,565
Interest expense to affiliates		49,458		25,152		21,287			43,301			60,939
Provision for loan losses		14,194		29,121		39,795			481,488			25,000

Net investment income (loss)		344,760		319,386		243,556			(97,514	)		229,869
Other income (loss):
Total other income (loss)		93,447		143,352		(96,275	)		(906,837	)		62,012
Non-investment expenses:
Related party management compensation		68,185		69,125		44,323			36,670			52,535
General, administrative and directors expenses		37,741		16,516		10,393			19,038			18,294
Professional services		6,198		5,331		7,384			8,098			4,706
Loan servicing		—		—		7,961			9,444			11,346

Total non-investment expenses		112,124		90,972		70,061			73,250			86,881

Income (loss) from continuing operations before equity in income of unconsolidated affiliate and income tax expense		326,083		371,766		77,220			(1,077,601	)		205,000
Equity in income of unconsolidated affiliate		—		—		—			—			12,706

Income (loss) from continuing operations before income tax expense		326,083		371,766		77,220			(1,077,601	)		217,706
Income tax expense		8,011		702		284			107			256

Income (loss) from continuing operations		318,072		371,064		76,936			(1,077,708	)		217,450
Income (loss) from discontinued operations		—		—		—			2,668			(317,655	)

Net income (loss)	$	318,072	$	371,064	$	76,936		$	(1,075,040	)	$	(100,205	)

Net income (loss) per common share:
Basic
Income (loss) per share from continuing operations	$	1.79	$	2.33	$	0.50		$	(7.71	)	$	2.38

Income (loss) per share from discontinued operations	$	—	$	—	$	—		$	0.02		$	(3.53	)

Net income (loss) per share	$	1.79	$	2.33	$	0.50		$	(7.69	)	$	(1.15	)

Diluted
Income (loss) per share from continuing operations	$	1.75	$	2.32	$	0.50		$	(7.71	)	$	2.38

Income (loss) per share from discontinued operations	$	—	$	—	$	—		$	0.02		$	(3.53	)

Net income (loss) per share	$	1.75	$	2.32	$	0.50		$	(7.69	)	$	(1.15	)

Weighted average number of common shares outstanding:
Basic		177,560		157,936		153,756			140,027			89,953

Diluted		180,897		158,771		153,756			140,027			89,953

Distributions declared per common share	$	0.67	$	0.43	$	0.05		$	1.30		$	2.16

(in thousands, except per share data)	As of December 31, 2011		As of December 31, 2010		As of December 31, 2009		As of December 31, 2008		As of December 31, 2007

Consolidated Balance Sheets Data:
Cash and cash equivalents	$	392,154	$	313,829	$	97,086	$	41,430	$	524,080
Restricted cash and cash equivalents		399,620		571,425		342,706		1,233,585		1,067,797
Securities		922,603		932,823		803,258		658,779		1,491,229
Corporate loans, net		6,443,399		6,321,444		6,543,643		7,571,446		8,634,208
Residential mortgage loans(1)		—		—		2,097,699		2,620,021		3,921,323
Equity investments, at estimated fair value		189,845		99,955		120,269		5,287		—
Assets of discontinued operations		—		—		—		—		3,049,758
Total assets		8,647,228		8,418,412		10,300,005		12,515,082		19,046,025
Total borrowings		6,778,208		6,642,455		8,970,591		11,461,610		13,425,106
Liabilities of discontinued operations		—		—		—		—		3,644,083
Total liabilities		6,971,396		6,775,364		9,133,347		11,851,737		17,401,486
Total shareholders' equity		1,675,832		1,643,048		1,166,658		663,345		1,644,539
Book value per common share	$	9.41	$	9.24	$	7.37	$	4.40	$	14.27

Item 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Except where otherwise expressly stated or the context suggests otherwise, the terms "we," "us" and "our" refer to KKR Financial Holdings LLC and its subsidiaries.

The following discussion and analysis of our financial condition and results of operations should be read in conjunction with Part II, Item 6, "Selected Consolidated Financial Data" and our consolidated financial statements included elsewhere in this Annual Report on Form 10-K. In addition to historical data, this discussion contains forward-looking statements about our business, operations and financial performance based on current expectations that involve risks, uncertainties and assumptions. Our actual results may differ materially from those in this discussion as a result of various factors, including but not limited to those discussed in Item I, Part 1A, "Risk Factors" included elsewhere in this Annual Report on Form 10-K.

We are managed by KKR Financial Advisors LLC (our "Manager"), a wholly-owned subsidiary of KKR Asset Management LLC ("KAM"), pursuant to a management agreement (the "Management Agreement"). KAM is a wholly-owned subsidiary of Kohlberg Kravis Roberts & Co. L.P. ("KKR").

Throughout 2011, downside macroeconomic and political concerns triggered significant market swings. During 2011, we witnessed a market with increased capital availability and tighter credit spreads transform to one with constrained liquidity and wider credit spreads. As of the quarter ended

September 30, 2011, the S&P/LSTA Loan index had returned -1.3% and the Merrill Lynch High Yield index had returned -1.7% for the year. In addition, during the third quarter of 2011, the S&P 500 index fell approximately 15%, its biggest quarterly loss since the fourth quarter of 2008, and more than half of the trading days in the quarter had intraday price moves over 2%. Despite the recovery in corporate debt prices during the fourth quarter of 2011, the uncertainty around the eurozone debt crisis and global economic conditions remained. By December 31, 2011, the S&P/LSTA Loan index had returned a modest 1.5% for 2011 (compared to 10.2% for 2010), the Merrill Lynch High Yield Master II index had returned 4.4% for 2011 (compared to 15.2% for 2010) and the S&P 500 index had ended the year exactly where it began.

As of December 31, 2011, the three-month LIBOR interbank offered rate ("LIBOR") was 0.58% compared to 0.30% a year ago. However, for the year 2011, the three-month LIBOR averaged 0.34%, which remained unchanged from the average three-month LIBOR rate in 2010. As a result of the low interest rates, we saw an increase in the number of assets offering an income premium, or LIBOR floor. As of December 31, 2011, 32.2% of our floating corporate debt portfolio had LIBOR floors compared to 23.3% as of December 31, 2010.

In addition, given the continued market volatility and lack of market liquidity, increased investment opportunities domestically and abroad were identified across our six strategies to which we deploy capital. For example, during 2011, we closed CLO 2011-1, a $600.0 million secured financing transaction, whereby CLO 2011-1 was able to borrow up to a total of $450.0 million. The total borrowings of $439.4 million under CLO 2011-1 were fully deployed by the end of the third quarter to acquire corporate loans. We also deployed approximately $140 million to natural resources and approximately $165 million to various debt and equity stressed and distressed opportunities through our special situations strategy during 2011. In line with our objective to lower our weighted average cost of capital, following the receipt of our investment grade ratings, we issued 30-year senior notes. The net proceeds from this offering of $250.7 million are primarily for the repurchase or repayment of our existing senior indebtedness due in 2012 and for general corporate purposes, including the acquisition of attractive opportunities provided through existing market conditions.

Our net income for the year ended December 31, 2011 totaled $318.1 million (or $1.75 per diluted common share), as compared to net income of $371.1 million (or $2.32 per diluted common share) and net income of $76.9 million (or $0.50 per diluted common share), for the years ended December 31, 2010 and 2009, respectively. The decrease in net income of $53.0 million from 2010 to 2011 was largely attributable to (i) a decline in other income of $49.9 million primarily as a result of an aggregate one-time gain on extinguishment of debt totaling $38.7 million recorded in 2010, as well as an additional $50.4 million lower of cost or estimated fair value adjustment to corporate loans held for sale recorded during 2011 partially offset by realized gains from the sale of corporate debt securities, (ii) an increase in non-investment expenses of $21.2 million primarily due to $20.2 million of expenses related to our working interests and overriding royalty interests acquired through our natural resources strategy in 2011 and (iii) an income tax expense of $8.0 million recorded in the year ended December 31, 2011. These three factors were partially offset by an increase in net investment income of $25.4 million, largely attributable to the revenues earned on our working and overriding royalty interests during 2011. The increase in net income of $294.1 million from 2009 to 2010 is attributable to an increase in net investment income of $75.8 million and an increase in other income of $239.6 million primarily due to realized gains on the sale of certain corporate debt securities driven by capital appreciation, partially offset by an increase in non-investment expenses of $20.9 million. The components of these amounts for the years ended December 31, 2011, 2010 and 2009 are detailed further below under "Results of Operations."

Book value per share increased $0.17 to $9.41 as of December 31, 2011 from $9.24 as of December 31, 2010. The increase was primarily attributable to earnings for the year of $1.79 per common share, partially offset by a decrease in our accumulated other comprehensive income, a component of shareholders' equity of $0.95 per common share, and our cash distributions to shareholders of $0.67 per common share. The $0.95 per common share change in accumulated other comprehensive income was primarily as a result of lower unrealized gains from securities available-for-sale due to sales of certain securities available-for-sale and changes in value of other securities available-for-sale, as well as a decline in value of our interest rate swaps designated as cash flow hedges.

During 2011, we paid aggregate cash distributions totaling $119.4 million. The amount and timing of our distributions to our common shareholders, including any special distributions, is determined by our board of directors and is based upon a review of various factors including current market conditions, existing restrictions under borrowing agreements, the amount of ordinary taxable income or loss earned by us, gains or losses recognized by us on the disposition of assets and our liquidity needs.

Our $250.0 million asset-based revolving credit facility (the "2014 Facility") of which zero is outstanding as of December 31, 2011, contains negative covenants that restrict our ability, among other things, to pay distributions or make certain other restricted payments, including a restriction from making distributions to holders of common shares in excess of 65% of our estimated annual taxable income calculated in accordance with the 2014 Facility credit agreement. In addition, no distributions shall be paid if a deficiency in the required collateral per the agreement exists or would exist as a result of such distributions.

During the second half of 2011, we repurchased $45.5 million par amount of our 7.0% convertible senior notes (the "7.0% Notes") due July 15, 2012, reducing the amount outstanding to $135.1 million as of December 31, 2011. These transactions resulted in us recording a loss of $1.7 million and a write-off of $0.1 million of unamortized debt issuance costs. As of December 31, 2011, we had committed to purchase an additional $0.8 million par amount of our 7.0% Notes, which settled in January 2012. As of December 31, 2011, the conversion rate for each $1,000 principal amount of the notes was 32.2581, which is equivalent to a conversion price of approximately $31.00 per common share.

On May 13, 2011, we entered into an amendment to our $49.7 million asset-based revolving credit facility (the "2015 Natural Resources Facility"), maturing on November 5, 2015, increasing the commitment from $49.7 million to $81.1 million.

As of December 31, 2011, we had $38.3 million of borrowings outstanding under the 2015 Natural Resources Facility. In addition, under the 2015 Natural Resources Facility, we had a letter of credit outstanding totaling $1.0 million as of December 31, 2011.

During November 2011, following the receipt of a BBB rating from Fitch Ratings and a BBB- rating from Standard & Poor's, we issued $258.8 million par amount of 8.375% senior notes due November 15, 2041 ("8.375% Notes"). The total net proceeds from this offering were $250.7 million, which will be used to repurchase or repay a portion of our existing senior indebtedness and for general corporate purposes.

Effective January 1, 2010, we adopted new guidance that amended the accounting for the transfers of financial assets, eliminated the concept of a qualified special purpose entity and significantly changed the criteria by which an enterprise determines whether or not it must consolidate a variable interest entity ("VIE"). Under the new guidance, consolidation of a VIE requires both the power to direct the activities that most significantly impact the VIE's economic performance and either the obligation to absorb losses of the VIE or the right to receive benefits of the VIE that could potentially be significant to the VIE.

As a result of the adoption of the new guidance regarding the amended consolidation model based on power and economics, we determined that six residential mortgage loan securitization trusts, which were previously consolidated by us as we were deemed to be the primary beneficiary, were required to be deconsolidated. We determined that we did not have the power to direct the activities that most significantly impacted the economic performance of the securitization trusts or the performance of the securitization trusts' underlying asset and deconsolidated them as of January 1, 2010. This resulted in the reduction of both assets and liabilities of approximately $2.0 billion. In addition, loan interest income, interest expense, loan servicing expense, and net unrealized and realized gain (loss) associated with the residential mortgage loan securitization trusts are no longer reported on our consolidated financial statements. Our deconsolidation of the six residential mortgage loan securitization trusts had no net impact on shareholders' equity, results of operations and cash flows.

CLO 2005-1, CLO 2005-2, CLO 2006-1, CLO 2007-1, CLO 2007-A, CLO 2009-1 and CLO 2011-1 are all VIEs that we consolidate as we have determined we have the power to direct the activities that most significantly impact these entities' economic performance and we have both the obligation to absorb losses of these entities and the right to receive benefits from these entities that could potentially be significant to these entities.

As our consolidated financial statements in this Annual Report on Form 10-K are presented to reflect the consolidation of the CLOs we hold investments in, the information contained in this Management's Discussion and Analysis of Financial Condition and Results of Operations reflects the CLOs on a consolidated basis, which is consistent with the disclosures in our consolidated financial statements.

We intend to continue to operate so that we qualify, for United States federal income tax purposes, as a partnership and not as an association or a publicly traded partnership taxable as a corporation. Holders of our shares are subject to United States federal income taxation and generally other taxes, such as state, local and foreign income taxes, on their allocable share of our taxable income, regardless of whether or when they receive cash distributions. In addition, certain of our investments, including investments in foreign corporate subsidiaries, CLO issuers (which are treated as partnerships or disregarded entities for United States federal income tax purposes) and debt securities, may produce taxable income without corresponding distributions of cash to us or may produce taxable income prior to or following the receipt of cash relating to such income. In addition, we have recognized and may recognize in the future cancellation of indebtedness income upon the retirement of our debt at a discount. Consequently, in some taxable years, holders of our shares may recognize taxable income in excess of our cash distributions. Furthermore, even if we did not pay cash distributions with respect to a taxable year, holders of our shares may still have a tax liability attributable to their allocation of taxable income from us during such year.

Our core business strategy is to leverage the proprietary resources of our Manager with the objective of generating both current income and capital appreciation by deploying capital to different strategies that reflect the opportunity set that our Manager specializes in. These strategies and a summary of each are as follows:

The majority of our investments are held through CLO transactions that are managed by an affiliate of our Manager and for which we own the majority, and in some cases all, of the residual economic interests in the transaction through the subordinated notes in the transaction. As of December 31, 2011, our Cash Flow CLOs, which were structured as financing vehicles engaged in holding primarily corporate debt investments, held $7.4 billion par amount or $6.8 billion estimated fair value of corporate debt investments. Our corporate debt investments held through our Cash Flow CLOs consist of the following as of December 31, 2011:

Weighted average coupon and coupon spreads are calculated based on par values. Fixed and floating percentages are also calculated based on par values.

In addition to the corporate debt portfolio, we hold two pay-fixed, receive-variable interest rate swaps through certain of our CLOs. These interest rate derivatives consist of swaps to hedge a portion of the interest rate risk associated with our borrowings under the CLO senior secured notes. As of December 31, 2011, the contractual notional balance of these amortizing interest rate swaps was $383.3 million.

As of December 31, 2011, these Cash Flow CLOs had aggregate secured debt outstanding totaling $5.5 billion held by unaffiliated third parties and aggregate junior secured notes outstanding totaling $365.8 million held by an affiliate of our Manager. In CLO transactions, subordinated notes effectively represent the equity in such transactions as they have the first risk of loss and conversely, the residual value upside of the transactions. As we hold the majority or all of the subordinated notes in each of the Cash Flow CLOs, we consolidate all of the Cash Flow CLOs and reflect all income and losses related to the assets in these Cash Flow CLOs on our consolidated statement of operations even though a minority interest in two of our CLO transactions is not held by us.

The indentures governing the CLO transactions stipulate the reinvestment period during which the collateral manager, an affiliate of our Manager, can generally sell or buy assets at its discretion and can reinvest principal proceeds into new assets. CLO 2007-A ended its reinvestment period during the fourth quarter of 2010 and both CLO 2005-1 and CLO 2005-2 ended their reinvestment periods in the second quarter of 2011. As a result, principal proceeds from the assets held in each of these three transactions are generally used to amortize the outstanding balance of senior notes outstanding. During the year ended December 31, 2011, $528.2 million of original CLO 2007-A, CLO 2005-1 and CLO 2005-2 senior notes were repaid. CLO 2006-1 and CLO 2007-1 will end their respective reinvestment periods during August 2012 and May 2014, respectively. CLO 2011-1 does not have a reinvestment period and all principal proceeds from holdings in CLO 2011-1 will be used to amortize the transaction. During the year ended December 31, 2011, $2.9 million of original CLO 2011-1 senior notes were repaid. Accordingly, absent any new CLO transactions that we may enter into, our total investments held through CLOs will continue to decline as investments are paid down or paid off once the reinvestment period ends. In addition, pursuant to the terms of the indentures governing our CLO transactions, we have the ability to call in a CLO transaction by redeeming the notes and reinvesting the proceeds into a new CLO.

On an unconsolidated basis, which reflects our interests in our CLO subsidiaries as notes versus actual corporate loans and high yield securities on a consolidated basis, our investment portfolio primarily consists of the following holdings as of December 31, 2011:

Our consolidated financial statements are prepared by management in conformity with GAAP. Our significant accounting policies are fundamental to understanding our financial condition and results of operations because some of these policies require that we make significant estimates and assumptions that may affect the value of our assets or liabilities and financial results. We believe that certain of our policies are critical because they require us to make difficult, subjective, and complex judgments about matters that are inherently uncertain. We have reviewed these critical accounting policies with our board of directors and our audit committee.

Fair value is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. Where available, fair value is based on observable market prices or parameters or derived from such prices or parameters. Where observable prices or inputs are not available, valuation models are applied. These valuation techniques involve some level of management estimation and judgment, the degree of which is dependent on the price transparency for the instruments or market and the instruments' complexity for disclosure purposes. Assets and liabilities recorded at fair value in the consolidated balance sheets are categorized based upon the level of judgment associated with the inputs used to measure their value. Hierarchical

levels, as defined under GAAP, are directly related to the amount of subjectivity associated with the inputs to fair valuations of these assets and liabilities, and are as follows:

A significant decrease in the volume and level of activity for the asset or liability is an indication that transactions or quoted prices may not be representative of fair value because in such market conditions there may be increased instances of transactions that are not orderly. In those circumstances, further analysis of transactions or quoted prices is needed, and a significant adjustment to the transactions or quoted prices may be necessary to estimate fair value.

The availability of observable inputs can vary depending on the financial asset or liability and is affected by a wide variety of factors, including, for example, the type of product, whether the product is new, whether the product is traded on an active exchange or in the secondary market, and the current market condition. To the extent that valuation is based on models or inputs that are less observable or unobservable in the market, the determination of fair value requires more judgment. Accordingly, the degree of judgment exercised by us in determining fair value is greatest for instruments categorized in Level 3. In certain cases, the inputs used to measure fair value may fall into different levels of the fair value hierarchy. In such cases, for disclosure purposes, the level in the fair value hierarchy within which the fair value measurement in its entirety falls is determined based on the lowest level input that is significant to the fair value measurement in its entirety. The variability of the observable inputs affected by the factors described above may cause transfers between Levels 1, 2, and/or 3, which we recognize at the end of the reporting period.

Many financial assets and liabilities have bid and ask prices that can be observed in the marketplace. Bid prices reflect the highest price that we and others are willing to pay for an asset. Ask prices represent the lowest price that we and others are willing to accept for an asset. For financial assets and liabilities whose inputs are based on bid-ask prices, we do not require that fair value always be a predetermined point in the bid-ask range. Our policy is to allow for mid-market pricing and adjusting to the point within the bid-ask range that meets our best estimate of fair value.

Depending on the relative liquidity in the markets for certain assets, we may transfer assets to Level 3 if we determine that observable quoted prices, obtained directly or indirectly, are not available. The valuation techniques used for the assets and liabilities that are valued using Level 3 of the fair value hierarchy are described below.

Corporate Debt Securities: Corporate debt securities are initially valued at transaction price and are subsequently valued using market data for similar instruments (e.g., recent transactions or broker quotes), comparisons to benchmark derivative indices or valuation models. Valuation models are based on discounted cash flow techniques, for which the key inputs are the amount and timing of expected future cash flows, market yields for such instruments and recovery assumptions. Inputs are determined based on relative value analyses, which incorporate similar instruments from similar issuers.

Equity Investments, at Estimated Fair Value: Equity investments, at estimated fair value, are initially valued at transaction price and are subsequently valued using observable market prices, if available, or internally developed models in the absence of readily observable market prices. Valuation models are generally based on a market and income (discounted cash flow) approaches, in which various internal and external factors are considered. Factors include the price at which the investment was acquired, the nature of the investment, current market conditions, recent public market and private transactions for comparable securities, and financing transactions subsequent to the acquisition of the investment. The fair value recorded for a particular investment will generally be within the range suggested by the two approaches.

Over-the-counter ("OTC") Derivative Contracts: OTC derivative contracts include forward, swap and option contracts related to interest rates, foreign currencies, credit standing of reference entities, and equity prices. The fair value of OTC derivative products can be modeled using a series of techniques, including closed-form analytic formulae, such as the Black-Scholes option-pricing model, and simulation models or a combination thereof. Many pricing models do not entail material subjectivity because the methodologies employed do not necessitate significant judgment, and the pricing inputs are observed from actively quoted markets, as is the case for generic interest rate swap and option contracts.

Residential Mortgage-Backed Securities at Estimated Fair Value: Residential mortgage-backed securities are initially valued at transaction price and are subsequently valued using industry recognized models (including Intex and Bloomberg) and data for similar instruments (e.g., nationally recognized pricing services or broker quotes). The most significant inputs to the valuation of these instruments are default and loss expectations and market credit spreads.

We account for share-based compensation issued to members of our board of directors and our Manager using the fair value based methodology in accordance with GAAP. We do not have any employees, although we believe that members of our board of directors are deemed to be employees for purposes of interpreting and applying accounting principles relating to share-based compensation. We record as compensation costs the restricted common shares that we issued to members of our board of directors at estimated fair value as of the grant date and we amortize the cost into expense over the three-year vesting period using the straight-line method. We record compensation costs for restricted common shares and common share options that we issued to our Manager at estimated fair value as of the grant date and we remeasure the amount on subsequent reporting dates to the extent the awards have not vested. Unvested restricted common shares are valued using observable secondary market prices. Unvested common share options are valued using the Black-Scholes model and assumptions based on observable market data for comparable companies. We amortize compensation expense related to the restricted common shares and common share options that we granted to our Manager using the graded vesting attribution method.

Because we remeasure the amount of compensation costs associated with the unvested restricted common shares and unvested common share options that we issued to our Manager as of each reporting period, our share-based compensation expense reported in our consolidated financial statements will change based on the estimated fair value of our common shares and this may result in

earnings volatility. For the year ended December 31, 2011, share-based compensation totaled $3.3 million. As of December 31, 2011, a $1 increase in the price of our common shares would have increased our future share-based compensation expense by approximately $0.2 million and this future share-based compensation expense would be recognized over the remaining vesting periods of our outstanding restricted common shares. As of December 31, 2011, the common share options were fully vested and expire in August 2014. As of December 31, 2011, future unamortized share-based compensation totaled $2.1 million, of which $1.2 million, $0.7 million and $0.2 million will be recognized in 2012, 2013 and beyond, respectively.

We recognize all derivatives on our consolidated balance sheets at estimated fair value. On the date we enter into a derivative contract, we designate and document each derivative contract as one of the following at the time the contract is executed: (i) a hedge of a recognized asset or liability ("fair value" hedge); (ii) a hedge of a forecasted transaction or of the variability of cash flows to be received or paid related to a recognized asset or liability ("cash flow" hedge); (iii) a hedge of a net investment in a foreign operation; or (iv) a derivative instrument not designated as a hedging instrument ("free-standing derivative"). For a fair value hedge, we record changes in the estimated fair value of the derivative instrument and, to the extent that it is effective, changes in the fair value of the hedged asset or liability in the current period earnings in the same financial statement category as the hedged item. For a cash flow hedge, we record changes in the estimated fair value of the derivative to the extent that it is effective in other comprehensive (loss) income and subsequently reclassify these changes in estimated fair value to net income in the same period(s) that the hedged transaction affects earnings. The effective portion of the cash flow hedges is recorded in the same financial statement category as the hedged item. For free-standing derivatives, we report changes in the fair values in other income (loss).

We formally document at inception our hedge relationships, including identification of the hedging instruments and the hedged items, our risk management objectives, strategy for undertaking the hedge transaction and our evaluation of effectiveness of our hedged transactions. Periodically, we also formally assess whether the derivative designated in each hedging relationship is expected to be and has been highly effective in offsetting changes in estimated fair values or cash flows of the hedged item using either the dollar offset or the regression analysis method. If we determine that a derivative is not highly effective as a hedge, we discontinue hedge accounting.

We are not required to account for our derivative contracts using hedge accounting as described above. If we decide not to designate the derivative contracts as hedges or if we fail to fulfill the criteria necessary to qualify for hedge accounting, then the changes in the estimated fair values of our derivative contracts would affect periodic earnings immediately potentially resulting in the increased volatility of our earnings. The qualification requirements for hedge accounting are complex and as a result, we must evaluate, designate, and thoroughly document each hedge transaction at inception and perform ineffectiveness analysis and prepare related documentation at inception and on a recurring basis thereafter. As of December 31, 2011, the estimated fair value of our net derivative liabilities totaled $96.9 million.

We monitor our available-for-sale securities portfolio for impairments. A loss is recognized when it is determined that a decline in the estimated fair value of a security below its amortized cost is other-than-temporary. We consider many factors in determining whether the impairment of a security is deemed to be other-than-temporary, including, but not limited to, the length of time the security has had a decline in estimated fair value below its amortized cost and the severity of the decline, the amount of the unrealized loss, recent events specific to the issuer or industry, external credit ratings

and recent changes in such ratings. In addition, for debt securities we consider our intent to sell the debt security, our estimation of whether or not we expect to recover the debt security's entire amortized cost if we intend to hold the debt security, and whether it is more likely than not that we will be required to sell the debt security before its anticipated recovery. For equity securities, we also consider our intent and ability to hold the equity security for a period of time sufficient for a recovery in value.

The amount of the loss that is recognized when it is determined that a decline in the estimated fair value of a security below its amortized cost is other-than-temporary is dependent on certain factors. If the security is an equity security or if the security is a debt security that we intend to sell or estimate that it is more likely than not that we will be required to sell before recovery of its amortized cost, then the impairment amount recognized in earnings is the entire difference between the estimated fair value of the security and its amortized cost. For debt securities that we do not intend to sell or estimate that we are not more likely than not to be required to sell before recovery, the impairment is separated into the estimated amount relating to credit loss and the estimated amount relating to all other factors. Only the estimated credit loss amount is recognized in earnings, with the remainder of the loss amount recognized in other comprehensive income (loss).

This process involves a considerable amount of judgment by our management. As of December 31, 2011, we had aggregate unrealized losses on our securities classified as available-for-sale of approximately $13.6 million, which if not recovered may result in the recognition of future losses. During the year ended December 31, 2011, we recorded charges for impairments of securities that we determined to be other-than-temporary totaling $3.7 million.

Our corporate loan portfolio is comprised of a single portfolio segment which includes one class of financing receivables, that is, high yield loans that are purchased via assignment or participation in either the primary or secondary market and are held primarily for investment. High yield loans are generally characterized as having below investment grade ratings or being unrated and generally consist of leveraged loans.

Our allowance for loan losses represents our estimate of probable credit losses inherent in our corporate loan portfolio held for investment as of the balance sheet date. Estimating our allowance for loan losses involves a high degree of management judgment and is based upon a comprehensive review of our loan portfolio that is performed on a quarterly basis. Our allowance for loan losses consists of two components, an allocated component and an unallocated component. The allocated component of our allowance for loan losses pertains to specific loans that we have determined are impaired. We determine a loan is impaired when we estimate that it is probable that we will be unable to collect all amounts due according to the contractual terms of the loan agreement. On a quarterly basis we perform a comprehensive review of our entire loan portfolio and identify certain loans that we have determined are impaired. Once a loan is identified as being impaired we place the loan on non-accrual status, unless the loan is already on non-accrual status, and record a reserve that reflects our best estimate of the loss that we expect to recognize from the loan. The expected loss is estimated as being the difference between our current cost basis of the loan, including accrued interest receivable, and the loan's estimated fair value.

recorded as described in the preceding paragraph. Such indicators include, but are not limited to, the current and/or forecasted financial performance and liquidity profile of the issuer, specific industry or economic conditions that may impact the issuer, and the observable trading price of the loan if available. All loans are first categorized based on their assigned risk grade and further stratified based on the seniority of the loan in the issuer's capital structure. The seniority classifications assigned to loans are senior secured, second lien and subordinate. Senior secured consists of loans that are the most senior debt in an issuer's capital structure and therefore have a lower estimated loss severity than other debt that is subordinate to the senior secured loan. Senior secured loans often have a first lien on some or all of the issuer's assets. Second lien consists of loans that are secured by a second lien interest on some or all of the issuer's assets; however, the loan is subordinate to the first lien debt in the issuer's capital structure. Subordinate consists of loans that are generally unsecured and subordinate to other debt in the issuer's capital structure.

There are three internally assigned risk grades that are applied to loans that have not been identified as being impaired: high, moderate and low. High risk means that there is evidence of possible loss due to the financial or operating performance and liquidity of the issuer, industry or economic concerns specific to the issuer, or other factors that indicate that the breach of a covenant contained in the related loan agreement is possible. Moderate risk means that while there is not observable evidence of loss, there are issuer and/or industry specific trends that indicate a loss may have occurred. Low risk means that while there is no identified evidence of loss, there is the risk of loss inherent in the loan that has not been identified. All loans held for investment, with the exception of loans that have been identified as impaired, are assigned a risk grade of high, moderate or low.

We apply a range of default and loss severity estimates in order to estimate a range of loss outcomes upon which to base our estimate of probable losses that results in the determination of the unallocated component of our allowance for loan losses. As of December 31, 2011, the range of outcomes used to estimate concern as to the probability of default was between 1% and 20% and the range of loss severity assumptions was between 5% and 85%. The estimates and assumptions we use to estimate our allowance for loan losses are based on our estimated range of outcomes that are determined from industry information providing both historical and forecasted empirical performance of the type of corporate loans that we invest in, as well as from our own estimates based on the nature of our corporate loan portfolio. These estimates and assumptions are susceptible to change due to our corporate loan portfolio's performance as well as industry and general economic conditions. Changes in the assumptions and estimates used to estimate our allowance for loan losses could have a material impact on our financial condition and results of operations. The default and loss severity estimates used in determining our allowance for loan losses are assessed on a quarterly and annual basis. As of December 31, 2011, management believes that these estimates are appropriate and consistent with historical and forecasted estimates evidenced and used in both industry and our corporate loan portfolio.

In May 2011, the FASB amended existing standards to achieve common fair value measurement and disclosure requirements in GAAP and International Financial Reporting Standards, including prohibiting the application of block discounts for all fair value measurements and providing an exception allowing a company to consider the sale or transfer of its net position for a particular risk exposure if certain criteria are met. Disclosure requirements include quantitative information about significant unobservable inputs used for Level 3 measurements, a description of the company's valuation processes and a qualitative discussion about the sensitivity of recurring Level 3 measurements

to changes in the unobservable inputs disclosed. The guidance is effective during interim and annual periods beginning after December 15, 2011; early adoption is not permitted. We do not expect the guidance to have a material impact on our consolidated financial statements.

In June 2011, the FASB amended existing standards to comprehensive income to require all nonowner changes in stockholders' equity be presented either in a single continuous statement of comprehensive income or in two separate but consecutive statements. This new update eliminates the option to present the components of other comprehensive income as part of the statement of changes in stockholders' equity. In addition, it requires an entity to present reclassification adjustments on the face of the financial statements from other comprehensive income to net income. The guidance is effective during interim and annual periods beginning after December 15, 2011; early adoption is permitted.

In December 2011, the FASB deferred the changes made in June 2011 that relate to the presentation of reclassification adjustments in order to allow the board time to deliberate whether to present on the face of the financial statements the effects of reclassifications out of accumulated other comprehensive income on the components of net income and other comprehensive income for all periods presented. All other requirements according to the June 2011 update were not affected by this December 2011 update, including the requirement to report comprehensive income either in a single continuous financial statement or in two separate but consecutive financial statements. The guidance is effective during interim and annual periods beginning after December 15, 2011; early adoption is permitted. We do not expect the guidance to have a material impact on our consolidated financial statements.

In December 2011, the FASB amended existing standards to require an entity to disclose information about offsetting and related arrangements to enable users of its financial statements to evaluate the effect or potential effect of netting arrangements on an entity's financial position, including the effect or potential effect of rights of setoff associated with certain financial instruments and derivative instruments. The guidance is effective for annual reporting periods beginning on or after January 1, 2013, and interim periods within those annual periods, with retrospective disclosures required for all comparative periods presented. We are currently evaluating the impact of this accounting update on our financial disclosures.

The following discussion presents an analysis of our results of operations on a comparative basis for the fiscal years ended December 2011, 2010 and 2009. Our results of operations may be materially affected by market fluctuations and current economic events, particularly in the fixed income and equity markets.

A summary of key financial results for the years ended December 31, 2011, 2010 and 2009 are as follows (amounts in thousands, except per share information):

The following table presents the components of our net investment income for the years ended December 31, 2011, 2010 and 2009:

	For the year ended December 31, 2011		For the year ended December 31, 2010		For the year ended December 31, 2009

Investment Income:
Corporate loans and securities interest income	$	388,974	$	369,387	$	380,704
Residential mortgage loans and securities interest income		14,615		23,924		120,985
Other investment income		30,741		1,064		580
Dividend income		5,287		2,266		339
Net discount accretion		102,404		108,718		70,117

Total investment income		542,021		505,359		572,725

Interest Expense:
Collateralized loan obligation secured notes		61,875		59,242		112,798
Credit facilities		3,236		12,852		16,356
Senior notes		2,777		—		—
Convertible senior notes		26,945		28,171		20,444
Junior subordinated notes		15,528		15,600		16,610
Residential mortgage-backed securities issued		—		—		82,052
Interest rate swaps		22,734		15,562		14,432
Other interest expense		514		273		5,395

Total interest expense		133,609		131,700		268,087
Interest expense to affiliates		49,458		25,152		21,287
Provision for loan losses		14,194		29,121		39,795

Net investment income	$	344,760	$	319,386	$	243,556

Due to our adoption of the new guidance related to consolidation of variable interest entities (as described above under "Executive Overview"), certain amounts for the year ended December 31, 2009, which were related to the six residential mortgage loan securitization trusts that we deconsolidated effective January 1, 2010, should be disregarded for comparative purposes. For the year ended

December 31, 2009, residential mortgage-backed securities issued ("RMBS Issued") interest expense totaled $82.1 million and residential mortgage loans interest income totaled $90.0 million, related to the six residential mortgage loan securitization trusts which were deconsolidated.

As presented in the table above, net investment income increased by $25.4 million from $319.4 million for 2010 to $344.8 million for 2011. Total investment income, consisting primarily of interest income and discount accretion from our investment portfolio, totaled $542.0 million for 2011 as compared to $505.4 million for 2010. The increase in total investment income of approximately $36.7 million was primarily attributable to corporate loans and securities interest income increasing $19.6 million and other investment income increasing $29.7 million. The increase in corporate loans and securities interest income of $19.6 million for the year ended December 31, 2011 as compared to the year ended December 31, 2010 is primarily attributable to a larger corporate debt portfolio, combined with an increase in the weighted average coupon of our corporate debt portfolio from 4.6% for the year ended December 31, 2010 to 4.9% for the year ended December 31, 2011, calculated based on the average par balances for the respective periods. The increase in the weighted average coupon of our corporate debt portfolio is due to an increase in the percentage of our corporate debt portfolio with LIBOR floors from 23.3% as of December 31, 2010 to 32.2% as of December 31, 2011, as well as the acquisition of holdings during the year ended December 31, 2011 with comparatively higher rates. The increase in other investment income of $29.7 million for the year ended December 31, 2011 as compared the year ended December 31, 2010 is primarily attributable to an increase in revenue earned on our working and royalty interests in oil and gas properties. We began acquiring working and royalty interests in oil and gas properties during the fourth quarter of 2010. We expect that as we continue to grow our natural resources holdings, the related net revenue will steadily increase as production increases through the acquisition of additional oil and gas assets and drilling of existing undeveloped property. These revenues are included within the Other segments.

Net investment income also increased as a result of a decrease in the provision for loan losses of $14.9 million, from $29.1 million for the year ended December 31, 2010 to $14.2 million for the year ended December 31, 2011. The increase in investment income was partially offset by an increase in interest expense to affiliates of $24.3 million from the year ended December 31, 2010 to 2011 due to all Cash Flow CLOs passing certain compliance tests in 2011 and thereby, resuming payments to mezzanine and subordinate note holders, including an affiliate of our Manager.

Net investment income increased by $75.8 million from $243.6 million for 2009 to $319.4 million for 2010. Total investment income, consisting primarily of interest income and discount accretion from our investment portfolio, totaled $505.4 million for 2010 as compared to $572.7 million for 2009. The decrease in total investment income of approximately $67.4 million is primarily attributable to two factors. First, the majority of our investment portfolio is floating rate and indexed to either one-month or three-month LIBOR. The average one-month and three-month LIBOR rates were 0.27% and 0.34%, respectively, for 2010, as compared to 0.33% and 0.69%, respectively, for 2009. Accordingly, the declines in LIBOR significantly reduced interest income earned from our investment portfolio in 2010 as compared to 2009. The second factor that contributed to lower investment income was the reduced size of our investment portfolio during 2010 as compared to 2009. The par value of our corporate loan portfolio decreased by approximately $0.4 billion, or 5.9%, from $7.4 billion as of December 31, 2009 to $6.9 billion as of December 31, 2010. The decline in the par balances of our corporate loans was partially attributable to additional paydowns during 2010. The decrease in investment income on our corporate debt portfolio was partially offset by an increase in net discount accretion of $38.6 million. A significant portion of the net discount accretion was due to accelerated accretion from prepayments on

our corporate debt portfolio. During 2010, our corporate debt portfolio had paydowns of $1.7 billion par value, as compared to $659.9 million par value during 2009.

Interest expense decreased by approximately $136.4 million from $268.1 million for 2009 to $131.7 million for 2010. Similar to the decline in total investment income, the decline in interest expense is primarily attributable to the decline in LIBOR as the majority of our debt is floating rate, and reduced debt balances in 2010. The largest decline in debt was attributable to the decline in CLO senior secured notes of approximately $37.4 million from $5.7 billion as of December 31, 2009 to $5.6 billion as of December 31, 2010. The decline in CLO senior secured notes was primarily attributable to the retirement of the $1.6 billion of senior secured notes during 2009 that were issued by Wayzata.

The following table presents the components of other income (loss) for the years ended December 31, 2011, 2010 and 2009:

	For the year ended December 31, 2011			For the year ended December 31, 2010			For the year ended December 31, 2009

Net realized and unrealized (loss) gain on derivatives and foreign exchange:
Interest rate swaps	$	—		$	311		$	(3,328	)
Commodity swaps		7,948			(226	)		—
Credit default swaps		(6,030	)		1,970			17,632
Total rate of return swaps		49			1,771			45,607
Common stock warrants		(890	)		663			457
Foreign exchange(1)		(4,795	)		(9,183	)		540
Options		(94	)		—			—

Total realized and unrealized (loss) gain on derivatives and foreign exchange		(3,812	)		(4,694	)		60,908
Net realized and unrealized gain (loss) on residential mortgage-backed securities, residential mortgage loans, and residential mortgage-backed securities issued, carried at estimated fair value		2,825			(11,396	)		(107,028	)
Net realized and unrealized gain (loss) on investments(2)		96,229			122,199			(48,381	)
Net realized and unrealized gain (loss) on securities sold, not yet purchased		431			(756	)		3,582
Impairment of securities available-for-sale and private equity at cost		(7,705	)		(12,890	)		(43,906	)
Net (loss) gain on restructuring and extinguishment of debt		(1,736	)		39,999			30,836
Other income		7,215			10,890			7,714

Total other income (loss)	$	93,447		$	143,352		$	(96,275	)

As presented in the table above, other income totaled $93.4 million for 2011 as compared to other income of $143.4 million for 2010. The decrease in total other income of $49.9 million was primarily attributable to two factors. First, net realized and unrealized gain on investments declined $26.0 million primarily as a result of an additional $50.4 million lower of cost or estimated fair value adjustment to corporate loans held for sale recorded during the year ended December 31, 2011 as compared to the prior period, partially offset by additional unrealized gains on investments and realized gains from the sale of corporate debt securities during 2011 of $24.5 million. The $50.4 million of additional lower of cost or estimated fair value adjustment was primarily due to an overall decline in corporate loan prices during the third quarter of 2011, whereby the weighted average estimated fair value of our corporate loan portfolio decreased from 94.7% of par value as of June 30, 2011 to 88.9% of par value as of September 30, 2011. Second, during 2010, in an open market auction, we purchased $83.0 million of notes issued by CLO 2007-A and CLO 2007-1, both of which were previously held by an affiliate of our Manager. These transactions resulted in us recording an aggregate one-time gain on extinguishment of debt totaling $38.7 million for the year ended December 31, 2010. Comparatively, during the year ended December 31, 2011, we recorded a $1.7 million loss related to the $45.5 million repurchase of our 7.0% Notes due July 2012.

Other income totaled $143.4 million for 2010 as compared to other loss of $96.3 million for 2009. Net realized and unrealized gains on investments totaled $122.2 million in 2010 as compared to losses of $48.4 million in 2009. In addition, impairment of securities available-for-sale and private equity at cost totaled $12.9 million in 2010 as compared to $43.9 million in 2009. The year over year improvement with respect to both realized and unrealized losses on investments, and impairment losses is primarily due to higher asset prices. The weighted average market value of our corporate debt portfolio, as a percentage of par, increased 8.4% from 87.3% as of December 31, 2009 to 94.7% as of December 31, 2010. These improvements were partially offset by realized and unrealized loss on derivatives and foreign exchange. Net realized and unrealized gains on total rate of return swaps decreased $43.8 million, from $45.6 million in 2009 to $1.8 million in 2010 primarily due to the unrealized gains on certain foreign denominated total rate of return swaps in 2009. Total rate of return swaps are derivatives that are used to finance investments in corporate loans with changes in market value reflected in income. During 2010, we unwound all of our total rate of return swaps. In addition, net realized and unrealized gains on credit default swaps decreased $15.7 million, from $17.6 million in 2009 to $2.0 million in 2010 primarily due to the unwind of a certain credit default swap in 2009. Credit default swaps are bilateral contracts between a buyer and seller of protection as it relates to a credit default or other specified credit event with respect to the issuer.

The following table presents the components of non-investment expenses for the years ended December 31, 2011, 2010 and 2009:

	For the year ended December 31, 2011		For the year ended December 31, 2010		For the year ended December 31, 2009

Related party management compensation:
Base management fees	$	26,294	$	19,113	$	14,904
Incentive fees		34,154		38,832		4,472
Share-based compensation		2,447		5,784		3,451
CLO management fees		5,290		5,396		21,496

Related party management compensation		68,185		69,125		44,323
Professional services		6,198		5,331		7,384
Loan servicing		—		—		7,961
Insurance		2,170		2,443		1,879
Directors' expenses		1,657		2,733		2,117
Other general and administrative		33,914		11,340		6,397

Total non-investment expenses	$	112,124	$	90,972	$	70,061

As presented in the table above, our non-investment expenses increased from 2010 to 2011 by approximately $21.2 million. The significant components of non-investment expense are described below.

Related party management compensation consists of base management fees payable to our Manager pursuant to the Management Agreement, incentive fees, collateral management fees, and share-based compensation related to restricted common shares and common share options granted to our Manager.

The base management fee payable was calculated in accordance with the Management Agreement and is based on an annual rate of 1.75% times our "equity" as defined in the Management Agreement. Base management fees increased by $7.2 million from 2010 to 2011 due to an increase in "equity" resulting from net income earned throughout the year ended December 31, 2011, as well as the December 2010 equity offering of 19.4 million common shares, which generated proceeds of $175.7 million.

Our Manager is also entitled to a quarterly incentive fee provided that our quarterly "net income," as defined in the Management Agreement, before the incentive fee exceeds a defined return hurdle. Incentive fees of $34.2 million were earned by the Manager during 2011 as compared to $38.8 million in 2010, a decrease of $4.7 million.

An affiliate of the Manager entered into separate management agreements with the respective investment vehicles CLO 2005-1, CLO 2005-2, CLO 2006-1, CLO 2007-1, CLO 2007-A, CLO 2009-1 and CLO 2011-1 and is entitled to receive fees for the services performed as collateral manager for all of these CLOs, except for CLO 2009-1 and CLO 2011-1. The collateral manager has the option to waive the fees it earns for providing management services for the CLOs and has done so in prior periods.

During the year ended December 31, 2011, the collateral manager waived management fees for all CLOs, except for CLO 2005-1, totaling $34.0 million. During the year ended December 31, 2010, the collateral manager waived management fees for all CLOs, except for CLO 2005-1, totaling $30.6 million. For the years ended December 31, 2011 and 2010, we recorded an expense for CLO management fees totaling $5.3 million and $5.4 million, respectively.

Professional services expenses consist of legal, accounting and other professional services. Directors' expenses represent share-based compensation, as well as expenses and reimbursements due to the board of directors for their services.

Other general and administrative expenses increased $22.6 million from 2010 to 2011. The increase was primarily attributable to $20.2 million of expenses related to the acquisition, management and operation of our working interests and overriding royalty interests natural resources investments, including recurring charges for depreciation, depletion and amortization. As we began acquiring working interests and overriding royalty interests through our natural resources strategy during the fourth quarter of 2010, less than $1.0 million of related expenses were incurred during the year ended December 31, 2010. These expenses are included within the Other segments. We expect that as we continue to increase our holdings in natural resources assets, our total expenses will increase accordingly as certain acquisition and transaction costs are nonrecurring and expensed upfront at the time of purchase. In addition, for the year ended December 31, 2011, other general and administrative expenses included expenses incurred by our Manager on our behalf that were reimbursable to our Manager pursuant to the Management Agreement. Comparatively, for most of the first half of 2010, our Manager permanently waived reimbursement of allocable general and administrative expenses in an amount equal to the incremental CLO management fees received by our Manager, which it had begun waiving again on January 1, 2009. For the year ended December 31, 2010, our Manager permanently waived reimbursement of allocable general and administrative expenses totaling $2.4 million. Due to the reinstatement of waived CLO management fees beginning in 2009, effective June 2010, all incremental CLO management fees received by our Manager had been fully applied to offset these reimbursable expenses. Accordingly, for the year ended December 31, 2011, there were no reimbursable general and administrative expenses waived by our Manager; rather, we incurred reimbursable general and administrative expenses to our Manager of $8.2 million, as compared to $4.6 million for the year ended December 31, 2010.

Non-investment expenses increased from 2009 to 2010 by $20.9 million primarily due to three factors. First, incentive fees of $38.8 million were earned by the Manager during 2010 as compared to $4.5 million in 2009. The increase in incentive fees was attributable to the increase in net income of $294.1 million primarily driven by corporate debt price appreciation in 2010.

Second, beginning April 2007, the collateral manager ceased waiving fees for CLO 2005-1 and beginning January 2009, the collateral manager ceased waiving fees for CLO 2005-2, CLO 2006-1, CLO 2007-1, CLO 2007-A and Wayzata (restructured and replaced with CLO 2009-1 on March 31, 2009). However, starting in July 2009, the collateral manager reinstated waiving the CLO management fees for CLO 2005-2 and CLO 2006-1, and starting in 2010, the collateral manager reinstated waiving the CLO management fees for CLO 2007-A and CLO 2007-1. Due to the deleveraging of CLO 2009-1 completed in July 2009 whereby all the senior notes were retired, the collateral manager is no longer entitled to receive fees for CLO 2009-1. As such, the CLO management fees for all CLOs, except for CLO 2005-1, were being waived or were no longer entitled to be received as of December 31, 2010. The aggregate amounts waived were inversely related to the total CLO management fees recorded. Accordingly, for the years ended December 31, 2010 and 2009, the collateral manager waived aggregate CLO management fees of $30.6 million and $5.2 million, respectively, while for the years ended December 31, 2010 and 2009, we recorded an expense for CLO management fees totaling $5.4 million

and $21.5 million, respectively. CLO management fees decreased $16.1 million from 2009 to 2010 as all six CLOs were paying CLO management fees during the first half of 2009.

Third, general and administrative expenses include expenses incurred by our Manager on our behalf that are reimbursable to our Manager pursuant to the Management Agreement. Beginning January 1, 2009, our Manager permanently waived reimbursable general and administrative expenses allocable to us in an amount equal to the incremental CLO management fees received by the Manager. For the years ended December 31, 2010 and 2009, our Manager permanently waived reimbursement of allocable general and administrative expenses totaling $2.4 million and $9.8 million, respectively. Due to the reinstatement of waived CLO management fees described above, effective June 2010, all incremental CLO management fees received by our Manager had been fully applied to offset these reimbursable expenses. Accordingly, for the year ended December 31, 2010, we reimbursed our Manager for allocable general and administrative expenses of $4.6 million, as compared to zero for the year ended December 31, 2009.

We intend to continue to operate so as to qualify, for United States federal income tax purposes, as a partnership and not as an association or publicly traded partnership taxable as a corporation. Therefore, we generally are not subject to United States federal income tax at the entity level, but are subject to limited state and foreign taxes. Holders of our shares are required to take into account their allocable share of each item of our income, gain, loss, deduction and credit for our taxable year end ending within or with their taxable year.

We hold an equity interest in KKR Financial Holdings II, LLC ("KFH II"), which elected to be taxed as a real estate investment trust (a "REIT") under the Internal Revenue Code of 1986, as amended (the "Code"). KFH II holds certain real estate mortgage-backed securities. A REIT is not subject to United States federal income tax to the extent that it currently distributes its income and satisfies certain asset, income and ownership tests, and recordkeeping requirements, but it may be subject to some amount of federal, state, local and foreign taxes based on its taxable income.

KFH II, our REIT subsidiary, is not expected to incur a federal tax expense, but is subject to limited state income tax expense related to the 2011 tax year. For the year ended December 31, 2011,

we recorded $5.8 million of federal and $1.9 million of state tax expense for our domestic corporate subsidiaries. Additionally, we recorded $0.3 million of state and foreign tax expense for our non-corporate subsidiaries for the year ended December 31, 2011. Accordingly, for the year ended December 31, 2011, we recorded income tax expense of $8.0 million. As of December 31, 2011, the tax liability of $6.0 million associated with the deferred portion of the $8.0 million tax expense was included in accounts payable, accrued expenses and other liabilities on our consolidated balance sheet.

Prior to 2011, we operated under a single business segment of Credit. However, during 2011, we began purchasing additional working interests and overriding royalty interests in oil and natural gas properties. As of December 31, 2011, we determined that we met certain segment reporting requirements and accordingly, we began to disclose information by segment based on our acquisition of additional natural resources assets, combined with our belief that other areas of investment focus including natural resources, while currently not material, may become a significant part of our business. The segments currently reported are consistent with the way decisions regarding the allocation of resources are made, as well as how we review our operating results.

We evaluate our performance based on our segments described above. Consolidated net investment income for the year ended December 31, 2011 increased $25.4 million primarily due to an increase in net investment income of $28.8 million related to the Other segments. The $28.8 million increase in the Other segments was largely attributable to the revenue earned on our acquisition of working interests and overriding royalty interests. Total assets in our Other segments increased $72.8 million from $85.8 million as of December 31, 2010 to $158.6 million as of December 31, 2011 primarily due to our acquisition of working interests and overriding royalty interests in oil and natural gas properties. Consolidated net income for the year ended December 31, 2011 decreased $53.0 million primarily due to a decline in other income of $58.1 million in the Credit segment, which was largely as a result of the absence of an aggregate one-time gain on extinguishment of debt totaling $38.7 million recorded in 2010, as well as an additional $50.4 million lower of cost or estimated fair value adjustment to corporate loans held for sale recorded in 2011, partially offset by realized gains from the sale of corporate debt securities. This decline was partially offset by an increase in other income of $8.2 million in the Other segments, primarily due to net unrealized gains on commodity derivatives. For further financial information related to our segments, refer to "Item 8. Financial Statements and Supplementary Data—Note 15. Segment Reporting".

Our investment portfolio primarily consists of corporate debt holdings, consisting of corporate loans and corporate debt securities. The details of our corporate debt portfolio are discussed below under "Corporate Debt Portfolio". Also included in our investment portfolio are our equity holdings carried at estimated fair value, and our oil and gas working interests and overriding royalty interests.

The following table summarizes the carrying value of our investment portfolio by strategy as of December 31, 2011 (amounts in thousands):

Our corporate debt investment portfolio primarily consists of investments in corporate loans and debt securities. Our corporate loans primarily consist of senior secured, second lien and subordinated loans. The corporate loans we invest in are generally below investment grade and are primarily floating rate indexed to either one-month or three-month LIBOR. Our investments in corporate debt securities primarily consist of fixed rate investments in below investment grade corporate bonds that are senior secured, senior unsecured and subordinated. We evaluate and monitor the asset quality of our investment portfolio by performing detailed credit reviews and by monitoring key credit statistics and trends. The key credit statistics and trends we monitor to evaluate the quality of our investments include credit ratings of both our investments and the issuer, financial performance of the issuer including earnings trends, free cash flows of the issuer, debt service coverage ratios of the issuer, financial leverage of the issuer, and industry trends that have or may impact the issuer's current or future financial performance and debt service ability.

We do not require specific collateral or security to support our corporate loans and debt securities; however, these loans and debt securities are either secured through a first or second lien on the assets of the issuer or are unsecured. We do not have access to any collateral of the issuer of the corporate loans and debt securities, rather the seniority in the capital structure of the loans and debt securities determines the seniority of our investment with respect to prioritization of claims in the event that the issuer defaults on the outstanding debt obligation.

Our corporate loan portfolio had an aggregate par value of $7.1 billion as of December 31, 2011 and $6.9 billion as of December 31, 2010. Our corporate loan portfolio consists of debt obligations of corporations, partnerships and other entities in the form of senior secured loans, second lien loans and subordinated loans.

The following table summarizes our corporate loans portfolio stratified by type as of December 31, 2011 and 2010. Loans that are not deemed to be held for sale are carried at amortized cost net of

allowance for loan losses on our consolidated balance sheets. Loans that are classified as held for sale are carried at the lower of net amortized cost or estimated fair value on our consolidated balance sheets. We also have certain loans that we elected to carry at estimated fair value.

	December 31, 2011(1)									December 31, 2010(1)

	Par		Carrying Value			Amortized Cost		Estimated Fair Value		Par		Carrying Value			Amortized Cost		Estimated Fair Value
Senior secured	$	6,329,636	$	6,085,696		$	6,085,696	$	5,826,951	$	6,110,495	$	5,829,691		$	5,829,691	$	5,820,754
Second lien		474,903		434,705			434,705		351,484		631,896		576,160			576,160		533,450
Subordinated		251,124		165,228			165,228		183,975		195,964		129,371			129,371		180,007

Subtotal		7,055,663		6,685,629			6,685,629		6,362,410		6,938,355		6,535,222			6,535,222		6,534,211
Lower of cost or fair value adjustment		—		(50,906	)		—		—		—		(4,748	)		—		—
Allowance for loan losses		—		(191,407	)		—		—		—		(209,030	)		—		—
Unrealized gains.		—		83			—		—		—		—			—		—

Total	$	7,055,663	$	6,443,399		$	6,685,629	$	6,362,410	$	6,938,355	$	6,321,444		$	6,535,222	$	6,534,211

As of December 31, 2011, $7.0 billion par amount, or 99.9%, of our corporate loan portfolio was floating rate and $9.4 million par amount, or 0.1%, was fixed rate. In addition, as of December 31, 2011, $278.5 million par amount, or 3.9%, of our corporate loan portfolio was denominated in foreign currencies, of which 76.7% was denominated in euros. As of December 31, 2010, $6.9 billion par amount, or 99.8%, of our corporate loan portfolio was floating rate and $15.9 million par amount, or 0.2%, was fixed rate. In addition, as of December 31, 2010, $273.5 million par amount, or 3.9%, of our corporate loan portfolio was denominated in foreign currencies, of which 91.7% was denominated in euros.

All of our floating rate corporate loans have index reset frequencies of less than twelve months with the majority resetting at least quarterly. The weighted average coupon on our floating rate corporate loans was 4.6% and 4.5% as of December 31, 2011 and December 31, 2010, respectively, and the weighted average coupon spread to LIBOR of our floating rate corporate loan portfolio was 3.9% and 3.8% as of December 31, 2011 and December 31, 2010, respectively. The weighted average years to maturity of our floating rate corporate loans was 4.1 years and 4.3 years as of December 31, 2011 and December 31, 2010, respectively.

As of December 31, 2011, our fixed rate corporate loans had a weighted average coupon of 11.7% and a weighted average years to maturity of 3.7 years, as compared to 11.4% and 5.3 years, respectively, as of December 31, 2010.

We hold certain corporate loans designated as being non-accrual, impaired and/or in default. Non-accrual loans consist of both corporate loans held for investment and corporate loans held for sale. Loans are placed on non-accrual when there is uncertainty regarding whether future income amounts on the loan will be earned and collected. While on non-accrual status, interest income is recognized using the cost-recovery method, cash-basis method or some combination of the two methods. A loan is placed back on accrual status when the ultimate collectability of the principal and interest is not in doubt. When placed on non-accrual status, previously recognized accrued interest is reversed and charged against current income.

The following table summarizes our recorded investment in non-accrual loans for the years ended December 31, 2011 and 2010 (amounts in thousands):

The $3.6 million increase in non-accrual loans from $165.1 million as of December 31, 2010 to $168.7 million as of December 31, 2011 is primarily due to net new additions to loans on non-accrual status of $45.6 million, partially offset by $23.4 million of charge-offs during 2011 that were the result of transferring certain loans from held for investment to held for sale and $18.6 million of restructurings. During the years ended December 31, 2011 and 2010, we recognized $11.9 million and $12.9 million, respectively, of interest income from cash receipts for loans on non-accrual status.

Impaired loans consist of loans held for investment where we have determined that it is more likely than not that we will not recover our outstanding investment in the loan under the contractual terms of the loan agreement. Impaired loans may or may not be in default at the time a loan is designated as being impaired and all impaired loans are placed on non-accrual status. Impaired loans declined from $149.8 million as of December 31, 2010 to $68.7 million as of December 31, 2011 primarily due to $109.8 million of impaired loans transferred to held for sale, $3.8 million of paydowns and restructurings, partially offset by net new additions to impaired loans of $32.6 million.

Defaulted loans consist of corporate loans that have defaulted under the contractual terms of their loan agreements. The balance of defaulted loans may be comprised of loans held for investment and loans held for sale. Loans that are held for sale are carried at the lower of amortized cost or estimated market value and, accordingly, no allowance for loan losses is maintained for such loans. In contrast, loans that are specifically identified as being impaired have a specific allocated reserve that represents the excess of the loan's amortized cost amount over its estimated fair value. Since defaulted loans may primarily consist of loans classified as held for sale and impaired loans consist of only loans held for investment, fluctuations in the balances of defaulted loans will not necessarily correspond to fluctuations in impaired loans. As of December 31, 2011, we had no corporate loans in default. As of December 31, 2010, we had corporate loans in default with a total amortized cost of $18.6 million from one issuer.

During the year ended December 31, 2011, we modified $11.2 million amortized cost of one corporate loan that qualified as a troubled debt restructuring and resulted in us recording an $0.8 million loss. This modification involved the restructuring of a debt instrument to equity investment, resulting in a new asset. There were no modifications of any corporate loans that qualified as troubled debt restructurings during the year ended December 31, 2010.

During the years ended December 31, 2011 and 2010, we modified $1.3 million and $1.0 billion amortized cost of corporate loans, respectively, that did not qualify as troubled debt restructurings. These modifications involved changes in existing rates and maturities to prevailing market rates/maturities for similar instruments and did not qualify as troubled debt restructurings as the respective borrowers were neither experiencing financial difficulty nor were seeking (nor granted) a concession as

part of the modification. In addition, these modifications of non-troubled debt holdings were accomplished with modified loans that were not substantially different from the loans prior to modification.

The following table summarizes the changes in our allowance for loan losses for the years ended December 31, 2011, 2010 and 2009 (amounts in thousands):

As of December 31, 2011 and December 31, 2010, we had an allowance for loan loss of $191.4 million and $209.0 million, respectively. As described under "Critical Accounting Policies", our allowance for loan losses represents our estimate of probable credit losses inherent in our corporate loan portfolio held for investment as of the balance sheet date. Estimating our allowance for loan losses involves a high degree of management judgment and is based upon a comprehensive review of our loan portfolio that is performed on a quarterly basis. Our allowance for loan losses consists of two components, an allocated component and an unallocated component. The allocated component of our allowance for loan losses pertains to specific loans that we have determined are impaired. We determine a loan is impaired when we estimate that it is probable that we will be unable to collect all amounts due according to the contractual terms of the loan agreement. On a quarterly basis we perform a comprehensive review of our entire loan portfolio and identify certain loans that we have determined are impaired. Once a loan is identified as being impaired we place the loan on non-accrual status, unless the loan is already on non-accrual status, and record a reserve that reflects our best estimate of the loss that we expect to recognize from the loan. The expected loss is estimated as being the difference between our current cost basis of the loan, including accrued interest receivable, and the loan's estimated fair value.

The unallocated component of our allowance for loan losses represents our estimate of probable losses inherent in our loan portfolio as of the balance sheet date where the specific loan that the loan loss relates to is indeterminable. We estimate the unallocated component of our allowance for loan losses through a comprehensive quarterly review of our loan portfolio and identify certain loans that demonstrate possible indicators of impairment, including internally assigned credit quality indicators. This assessment excludes all loans that are determined to be impaired and as a result, an allocated reserve has been recorded as described in the preceding paragraph. Such indicators include, but are not limited to, the current and/or forecasted financial performance and liquidity profile of the issuer, specific industry or economic conditions that may impact the issuer, and the observable trading price of the loan if available. All loans are first categorized based on their assigned risk grade and further stratified based on the seniority of the loan in the issuer's capital structure. The seniority classifications assigned to loans are senior secured, second lien and subordinate. Senior secured consists of loans that are the most senior debt in an issuer's capital structure and therefore have a lower estimated loss severity than other debt that is subordinate to the senior secured loan. Senior secured loans often have a first lien on some or all of the issuer's assets. Second lien consists of loans that are secured by a second lien interest on some or all of the issuer's assets; however, the loan is subordinate to the first lien debt in the issuer's capital structure. Subordinate consists of loans that are generally unsecured and subordinate to other debt in the issuer's capital structure.

There are three internally assigned risk grades that are applied to loans that have not been identified as being impaired: high, moderate and low. High risk means that there is evidence of

possible loss due to the financial or operating performance and liquidity of the issuer, industry or economic concerns specific to the issuer, or other factors that indicate that the breach of a covenant contained in the related loan agreement is possible. Moderate risk means that while there is not observable evidence of loss, there are issuer- and/or industry-specific trends that indicate a loss may have occurred. Low risk means that while there is no identified evidence of loss, there is the risk of loss inherent in the loan that has not been identified. All loans held for investment, with the exception of loans that have been identified as impaired, are assigned a risk grade of high, moderate or low.

As of December 31, 2011, the allocated component of our allowance for loan losses totaled $33.8 million and relates to investments in certain loans issued by five issuers with an aggregate par amount of $83.5 million and an aggregate recorded investment of $68.7 million. As of December 31, 2010, the allocated component of our allowance for loan losses totaled $50.1 million and relates to investments in certain loans issued by five issuers with an aggregate par amount of $225.6 million and an aggregate recorded investment of $149.8 million.

The unallocated component of our allowance for loan losses totaled $157.6 million and $158.9 million as of December 31, 2011 and 2010, respectively.

During the years ended December 31, 2011, 2010 and 2009, we recorded charge-offs totaling $31.8 million, $57.4 million and $283.3 million, respectively, comprised primarily of loans transferred to loans held for sale.

The following table summarizes the changes in our loans held for sale balance as of December 31, 2011 and 2010 (amounts in thousands):

As of December 31, 2011, we had $317.3 million of loans held for sale, a decrease of $146.3 million from December 31, 2010 due to the sale of certain loans and the transfer of loans to held for investment for those we determined we no longer had the intention of selling. We recorded a $65.2 million net charge to earnings during the year ended December 31, 2011 for the lower of cost or estimated fair value adjustment for certain loans held for sale which had a carrying value of $317.3 million as of December 31, 2011. We recorded a $14.7 million and $51.0 million net charge to earnings during years ended December 31, 2010 and 2009, respectively, for the lower of cost or estimated fair value adjustment for certain loans held for sale.

During the years ended December 31, 2011 and 2010, we transferred $862.2 million and $1.1 billion amortized cost amount, respectively, of loans from held for investment to held for sale. The transfers of certain loans to held for sale were due to our determination that credit quality of a loan in

relation to its expected risk-adjusted return no longer met our investment objective and our determination to reduce or eliminate the exposure for certain loans as part of our portfolio risk management practices. Also, during the years ended December 31, 2011 and 2010, we transferred $448.3 million and $437.7 million amortized cost amount, respectively, from loans held for sale back to loans held for investment as the circumstances that led to the initial transfer to held for sale were no longer present. Such circumstances include deteriorated market conditions often resulting in price depreciation or assets becoming illiquid, changes in restrictions on sales and certain loans amending their terms to extend the maturity, whereby we determined that selling the asset no longer met our investment objective and strategy.

Our corporate loan portfolio has certain credit risk concentrated in a limited number of issuers. As of December 31, 2011, approximately 47% of the total amortized cost basis of our corporate loan portfolio was concentrated in twenty issuers, with the three largest concentrations of corporate loans in loans issued by U.S. Foodservice, Texas Competitive Electric Holdings Company LLC and Modular Space Corporation, which combined represented $992.5 million, or approximately 15% of the aggregated amortized cost basis of our corporate loans. As of December 31, 2010, approximately 51% of the total amortized cost basis of our corporate loan portfolio was concentrated in twenty issuers, with the three largest concentrations of corporate loans in loans issued by Texas Competitive Electric Holdings Company LLC, Modular Space Corporation, and U.S. Foodservice, which combined represented $1.1 billion, or approximately 16% of the aggregated amortized cost basis of our corporate loans.

Our corporate debt securities portfolio had an aggregate par value of $869.7 million and $843.7 million as of December 31, 2011 and 2010, respectively. Our corporate debt securities portfolio consists of debt obligations of corporations, partnerships and other entities in the form of senior secured, senior unsecured and subordinated bonds. Our corporate debt securities are included in securities on our consolidated balance sheets.

The following table summarizes our corporate debt securities portfolio stratified by type as of December 31, 2011 and 2010:

As of December 31, 2011, $660.5 million, or 75.9%, of our corporate debt securities portfolio was fixed rate and $209.2 million, or 24.1%, was floating rate. In addition, as of December 31, 2011, $72.4 million par amount, or 8.3%, of our corporate debt securities portfolio, was denominated in

foreign currencies, of which 67.5% was denominated in euros. As of December 31, 2010, $680.7 million, or 80.7%, of our corporate debt securities portfolio was fixed rate and $163.0 million, or19.3%, was floating rate. In addition, as of December 31, 2010, $10.1 million par amount, or 1.2%, of our corporate debt securities portfolio, was denominated in foreign currencies, of which 12.4% was denominated in euros.

As of December 31, 2011, our fixed rate corporate debt securities had a weighted average coupon of 9.6% and a weighted average years to maturity of 6.0 years, as compared to 9.5% and 6.3 years, respectively, as of December 31, 2010. All of our floating rate corporate debt securities have index reset frequencies of less than twelve months. The weighted average coupon on our floating rate corporate debt securities was 6.0% and 6.1% as of December 31, 2011 and December 31, 2010, respectively, and the weighted average coupon spread to LIBOR of our floating rate corporate debt securities was 5.3% and 5.4% as of December 31, 2011 and December 31, 2010, respectively. The weighted average years to maturity of our floating rate corporate debt securities was 2.8 years and 3.2 years as of December 31, 2011 and December 31, 2010, respectively.

During the years ended December 31, 2011 and December 31, 2010, we recorded impairment losses totaling $1.5 million and $2.6 million, respectively, for corporate debt securities that we determined to be other-than-temporarily impaired. These securities were determined to be other-than-temporarily impaired either due to our determination that recovery in value was no longer likely or because we decided to sell the respective security in response to specific credit concerns regarding the issuer. During the year ended December 31, 2009, we recorded losses totaling $43.9 million for corporate debt and equity securities that we determined to be other-than-temporarily impaired.

As of December 31, 2011, we had no corporate debt securities in default. As of December 31, 2010, we had one corporate debt security in default with an estimated fair value of $1.1 million.

Our corporate debt securities portfolio has certain credit risk concentrated in a limited number of issuers. As of December 31, 2011, approximately 46% of the estimated fair value of our corporate debt securities portfolio was concentrated in ten issuers, with the two largest concentrations of debt securities in securities issued by First Data Corporations and SandRidge Energy, Inc., which combined represented $138.3 million, or approximately 17% of the estimated fair value of our corporate debt securities. As of December 31, 2010, approximately 60% of the estimated fair value of our corporate debt securities was concentrated in ten issuers, with the two largest concentrations of corporate debt securities issued by NXP BV and First Data Corporation, which combined represented $208.6 million, or approximately 25% of the estimated fair of value of our corporate debt securities.

Our other holdings primarily consist of marketable and private equity investments and investments in real assets and royalty interests made through our natural resources strategy.

As of December 31, 2011, our equity investments consisted of (i) marketable equity securities (included in securities on our consolidated balance sheet) with an aggregate cost amount of $12.8 million and estimated fair value of $13.2 million, (ii) private equity investments carried at cost (included in other assets on our consolidated balance sheet) with both an aggregate cost amount and estimated fair value of $0.8 million, and (iii) equity investments, carried at estimated fair value, with an aggregate cost amount of $180.9 million and estimated fair value of $189.8 million. In comparison, as of December 31, 2010, our (i) marketable equity investments had an estimated fair value of $3.4 million, (ii) private equity investments carried at cost had an aggregate cost amount of $4.8 million and an estimated fair value of $5.1 million, and (iii) equity investments, carried at estimated fair value,

had an aggregate cost of $98.7 million and an estimated fair value of $100.0 million. Equity investments carried at estimated fair value primarily consist of private equity investments.

Our natural resources holdings include working interests in producing oil and natural gas fields primarily located in Texas. The working interests were acquired during the fourth quarter of 2010 and second quarter of 2011, and as of December 31, 2011, had a carrying value of $86.9 million. These interests are in both proved developed and proved undeveloped properties, with the majority of our exposure to natural gas, followed by natural gas liquids and then oil. The acquisition of these working interests was partially financed with $38.3 million of borrowings through a five-year $81.1 million non-recourse, asset-based credit facility maturing November 5, 2015.

In addition to natural resources working interests, during the first quarter of 2011, we acquired overriding royalty interests in acreage in south Texas for $55.0 million. The overriding royalty interests include producing oil and natural gas properties, but most of the acreage is still under development. The overriding royalty interest properties are operated by unaffiliated third party and as of December 31, 2011, had a carrying value of $51.7 million.

We made investment portfolio purchases of $2.7 billion par amount during the year ended December 31, 2011, as compared to $3.1 billion and $1.4 billion for the years ended December 31, 2010 and 2009, respectively, primarily comprised of the following:

In addition to the above, we acquired working interests and overriding royalty interests with a total carrying value of $105.8 million during the year ended December 31, 2011, compared to working interests acquired with a total carrying value of $32.8 million during the year ended December 31, 2010.

Our shareholders' equity at December 31, 2011, 2010 and 2009 totaled $1.7 billion, $1.6 billion and $1.2 billion, respectively. Included in our shareholders' equity as of December 31, 2011, 2010 and 2009 is accumulated other comprehensive (loss) income totaling $(35.6) million, $133.6 million and $152.7 million, respectively.

Our average shareholders' equity and return on average shareholders' equity for the year ended December 31, 2011 was $1.7 billion and 18.5%, respectively, and for the year ended December 31, 2010 was $1.3 billion and 27.9%, respectively. Our average shareholders' equity and return on average shareholders' equity for the year ended December 31, 2009 was $0.9 billion and 8.4%, respectively. Return on average shareholders' equity is defined as net income (loss) divided by weighted average shareholders' equity.

Our book value per share as of December 31, 2011 and 2010 was $9.41 and $9.24, respectively, and was computed based on 178,145,482 and 177,848,565 shares issued and outstanding as of December 31, 2011 and 2010, respectively.

On April 27, 2011, our board of directors declared a cash distribution for the quarter ended March 31, 2011 of $0.16 per share to shareholders of record on May 13, 2011. The distribution was paid on May 27, 2011.

On July 28, 2011, our board of directors declared a cash distribution for the quarter ended June 30, 2011 of $0.18 per share to common shareholders of record on August 11, 2011. The distribution was paid on August 25, 2011.

On November 3, 2011, our board of directors declared a cash distribution for the quarter ended September 30, 2011 of $0.18 per share to common shareholders of record on November 17, 2011. The distribution was paid on December 1, 2011.

On February 2, 2012, our board of directors declared a cash distribution for the quarter ended December 31, 2011 of $0.18 per share to common shareholders of record on February 16, 2012. The distribution is payable on March 1, 2012. Also, on February 2, 2012, our board of directors declared an annual special cash distribution for the year ended December 31, 2011 of $0.08 per share to common shareholders of record on March 15, 2012. The distribution is payable on March 29, 2012.

We actively manage our liquidity position with the objective of preserving our ability to fund our operations and fulfill our commitments on a timely and cost-effective basis. Although we believe our current sources of liquidity are adequate to preserve our ability to fund our operations and fulfill our commitments, we will continue to evaluate opportunities to issue incremental capital. This may include taking advantage of market opportunities to issue equity or refinance or replace indebtedness, including the issuance of new debt securities and retiring debt pursuant to privately negotiated transactions, open market purchases or otherwise.

Our 7.0% Notes with $135.1 million principal amount outstanding as of December 31, 2011, mature in July 2012. During the second half of 2011, we repurchased $45.5 million par amount of our 7.0% Notes. These transactions resulted in us recording a loss of $1.7 million and a write-off of $0.1 million of unamortized debt issuance costs. As of December 31, 2011, we had committed to purchase an additional $0.8 million par amount of our 7.0% Notes, which settled in January 2012. As of December 31, 2011, the conversion rate for each $1,000 principal amount of the notes was 32.2581, which is equivalent to a conversion price of approximately $31.00 per common share. We believe that we will have sufficient liquidity to meet this July 2012 debt maturity, however, if attractive market opportunities arise, we may raise capital either through debt or equity or a combination thereof to replace the funding represented by the 7.0% Notes. As of December 31, 2011, we had unrestricted cash and cash equivalents totaling $392.2 million.

The majority of our investments are held in Cash Flow CLOs. Accordingly, the majority of our cash flows have historically been received from our investments in the mezzanine and subordinated notes of our Cash Flow CLOs. However, during the period in which a Cash Flow CLO is not in compliance with an over-collateralization ("OC Test") as outlined in its respective indenture, the cash flows we would generally expect to receive from our Cash Flow CLO holdings are paid to the senior note holders of the Cash Flow CLOs. During the full year ended December 31, 2011, all our Cash Flow CLOs were in compliance with certain compliance tests (specifically, their respective OC Tests) and made cash distributions to mezzanine and/or subordinate note holders, including us.

On March 31, 2011, we closed CLO 2011-1, a $400.0 million secured financing transaction secured by the assets held in CLO 2011-1. At closing, we entered into a senior loan agreement (the

"CLO 2011-1 Agreement") through which CLO 2011-1 was able to borrow up to $300.0 million through a non-recourse loan secured by the assets held in CLO 2011-1. On July 6, 2011, we amended the CLO 2011-1 Agreement to upsize the transaction to $600.0 million, whereby CLO 2011-1 was able to borrow up to an additional $150.0 million, or total of $450.0 million. Under the amended CLO 2011-1 Agreement, the CLO 2011-1 senior loan matures on August 15, 2018 and borrowings under the CLO 2011-1 Agreement bear interest at a rate of the three-month LIBOR plus 1.35%. In addition, concurrent with the amendment to increase the size of CLO 2011-1, the transaction was amended to reduce the par value ratio test ("PVR Test") from 133.33% to 120.0%. Under CLO 2011-1, if the PVR Test is below 120.0%, up to 50% of all interest collections that otherwise are payable to us are used to amortize the senior loan amount outstanding by the lower of the amount required to bring the PVR Test into compliance and the outstanding loan amount. Similarly, if the PVR Test is below 120.0%, the principal collections that otherwise would be payable to us are used to amortize the senior loan amount outstanding by the lower of the amount required to bring the PVR Test into compliance and the outstanding loan amount. Once the total portfolio held by CLO 2011-1 is reduced below 35% of the total committed transaction size, all principal proceeds received by CLO 2011-1 are used to amortize the senior loan. As of December 31, 2011, we had $436.5 million of borrowings outstanding under the CLO 2011-1 Agreement.

On November 15, 2011, we issued $258.8 million par amount of 8.375% Notes, resulting in net proceeds of $250.7 million. The 8.375% Notes bear interest at a rate of 8.375% per year on the principal amount, accruing from November 15, 2011. Interest is payable quarterly in arrears on February 15, May 15, August 15 and November 15 of each year, beginning on February 15, 2012. The total net proceeds from this offering will be used to repurchase or repay a portion of our existing senior indebtedness and for general corporate purposes.

In December 2010, we completed an underwritten public offering of 19,436,000 common shares at a price of $9.04 per share, resulting in net proceeds of $175.7 million.

As of December 31, 2011, we had six Cash Flow CLO transactions outstanding. An affiliate of our Manager owns an interest in the junior notes of both CLO 2007-1 and CLO 2007-A. The aggregate carrying amount of the junior notes in CLO 2007-1 and CLO 2007-A held by the affiliate of our Manager is $365.8 million as of December 31, 2011 and is reflected as collateralized loan obligation junior secured notes to affiliates on our consolidated balance sheets.

In accordance with GAAP, we consolidate each of our CLO subsidiaries as we have the power to direct the activities of these VIEs, as well as the obligation to absorb losses of the VIEs and the right to receive benefits of the VIEs that could potentially be significant to the VIEs. We utilize CLOs to fund our investments in corporate loans and corporate debt securities.

The indentures governing our Cash Flow CLOs include numerous compliance tests, the majority of which relate to the CLO's portfolio.

For CLO 2011-1, which we closed on March 31, 2011, we receive all remaining interest collections on a quarterly basis after administrative expenses and interest expense on the senior loan are paid, unless the PVR Test is below 120.0%, in which case up to 50% of all interest collections that otherwise would be payable to us are used to amortize the senior loan amount outstanding by the lower of the

amount required to bring the PVR Test into compliance and the outstanding loan amount. Similarly, 25% of all principal collections received by CLO 2011-1 are distributed to us unless the PVR Test is below 120.0%, in which case the principal collections that otherwise would be payable to us are used to amortize the senior loan amount outstanding by the lower of the amount required to bring the PVR Test into compliance and the outstanding loan amount. Once the total portfolio held by CLO 2011-1 is reduced below 35% of the total committed transaction size, all principal proceeds received by CLO 2011-1 are used to amortize the senior loan. For purposes of the calculation, collateral value is the par value of the assets unless an asset is in default or is a CCC-rated asset in excess of the CCC-rated asset limit percentage specified for CLO 2011-1, in which case the collateral value of such asset is the market value of such asset.

The following table summarizes the PVR Test for CLO 2011-1. This information is based on the December 2011 monthly report which is prepared by the independent third party trustee for CLO 2011-1:


(dollar amounts in thousands)	CLO 2011-1
Portfolio total	$	575,550
Par value test minimum		120.0	%
Par value test ratio		133.4	%
Cushion / (Excess)	$	58,309
Par value portfolio collateral value	$	582,135
Outstanding loan balance	$	436,522

In the case of our other Cash Flow CLOs, which vary from CLO 2011-1's compliance tests, in the event that a portfolio profile test is not met, the indenture places restrictions on the ability of the CLO's manager to reinvest available principal proceeds generated by the collateral in the CLOs until the specific test has been cured. In addition to the portfolio profile tests, the indentures for these CLOs include OC Tests which set the ratio of the collateral value of the assets in the CLO to the tranches of debt for which the test is being measured, as well as interest coverage tests. For purposes of the calculation, collateral value is the par value of the assets unless an asset is in default, is a discounted obligation, or is a CCC-rated asset in excess of the percentage of CCC-rated asset limit specified for each CLO.

If an asset is in default, the indenture for each CLO transaction defines the value used to determine the collateral value, which value is the lower of market value of the asset or the recovery value proscribed for the asset based on its type and rating by Standard & Poor's or Moody's.

A discount obligation is an asset with a purchase price of less than a particular percentage of par. The discount obligation amounts are specified in each CLO and are generally set at a purchase price of less than 80% of par for corporate loans and 75% of par for corporate debt securities.

The indenture for each CLO specifies a CCC-threshold for the percentage of total assets in the CLO that can be rated CCC. All assets in excess of the CCC threshold specified for the respective CLO are also included in the OC Tests at market value and not par.

Defaults of assets in CLOs, ratings downgrade of assets in CLOs to CCC, price declines of CCC assets in excess of the proscribed CCC threshold amount, and price declines in assets classified as discount obligations may reduce the over-collateralization ratio such that a CLO is not in compliance. If a CLO is not in compliance with an OC Test, cash flows normally payable to the holders of junior classes of notes will be used by the CLO to amortize the most senior class of notes until such point as the OC Test is brought back into compliance. While being out of compliance with an OC Test would not impact our investment portfolio or results of operations, it would impact our unrestricted cash flows available for operations, new investments and cash distributions. As of December 31, 2011, all of our CLOs were in compliance with their respective OC Tests. The following table summarizes several

of the material tests and metrics for each of our CLOs. This information is based on the December 2011 monthly reports, which are prepared by the independent third party trustee for each CLO:

(dollar amounts in thousands)	CLO 2005-1			CLO 2005-2			CLO 2006-1			CLO 2007-1			CLO 2007-A

Investments	$	924,940		$	937,735		$	1,038,175		$	3,346,653		$	1,154,621
Senior IC ratio minimum		115.0	%		125.0	%		115.0	%		115.0	%		120.0	%
Actual senior IC ratio		514.7	%		644.8	%		500.5	%		782.7	%		500.7	%
CCC amount	$	83,953		$	103,548		$	191,257		$	616,173		$	182,239
CCC percentage of portfolio		9.1	%		11.0	%		18.4	%		18.4	%		15.8	%
CCC threshold percentage		5.0	%		7.5	%		7.5	%		7.5	%		7.5	%
Senior OC Test minimum		119.4	%		123.0	%		143.1	%		159.1	%		119.7	%
Actual senior OC Test		134.9	%		134.3	%		160.7	%		179.4	%		146.8	%
Cushion / (Excess)	$	101,313		$	77,266		$	107,063		$	359,957		$	202,264
Subordinated OC Test minimum		106.2	%		106.9	%		114.0	%		120.1	%		109.9	%
Actual subordinated OC Test		112.4	%		118.1	%		137.1	%		124.9	%		119.3	%
Cushion / (Excess)	$	48,590		$	87,237		$	165,084		$	123,241		$	86,484

During the first quarter of 2010, CLO 2007-A and CLO 2007-1, our two Cash Flow CLOs which were failing one or more of their respective OC Tests, were brought into compliance with all of their respective OC Tests. Accordingly, beginning in April 2010, CLO 2007-A resumed paying mezzanine and subordinate note holders, including us. In addition, beginning in August 2010 and February 2011, CLO 2007-1 resumed paying mezzanine and subordinate note holders, respectively, including us. For the full year ended December 31, 2011, all Cash Flow CLOs were in compliance with their respective OC Tests.

During the first quarter of 2010, in an open market auction, we purchased $10.3 million of mezzanine notes issued by CLO 2007-A for $5.5 million and $72.7 million of mezzanine and subordinate notes issued by CLO 2007-1 for $38.8 million, both of which were previously held by an affiliate of our manager. These transactions resulted in us recording an aggregate gain on extinguishment of debt totaling $38.7 million during 2010.

On February 6, 2012, we sold $24.5 million par amount of our class D notes issued by CLO 2007-1 for proceeds of $18.7 million.

On May 3, 2010, we entered into a credit agreement for a four-year $210.0 million asset-based revolving credit facility, maturing on May 3, 2014, that is subject to, among other things, the terms of a borrowing base derived from the value of eligible specified financial assets. The borrowing base is subject to certain caps and concentration limits customary for financings of this type. We may obtain additional commitments under the 2014 Facility so long as the aggregate amount of commitments at any time does not exceed $600.0 million. On May 5, 2010, we obtained additional commitments of $40.0 million, bringing the total amount of commitments under the 2014 Facility to $250.0 million.

We have the right to prepay loans under the 2014 Facility in whole or in part at any time. Loans under the 2014 Facility bear interest at a rate equal to LIBOR plus 3.25% per annum. The 2014 Facility contains customary covenants applicable to us, including a restriction from making annual distributions to holders of common shares in excess of 65% of our estimated annual taxable income calculated in accordance with the 2014 Facility credit agreement.

As of December 31, 2011, we had no borrowings outstanding under the 2014 Facility.

On May 26, 2010, we terminated our credit agreement, dated as of November 10, 2008 and maturing on November 10, 2011 (the "2011 Credit Agreement"). The 2011 Credit Agreement was terminated in connection with our initial borrowing under our new credit facility entered into on May 3, 2010 as described above. At the time of termination, there was $150.0 million of borrowings outstanding under the 2011 Credit Agreement which we repaid.

On November 5, 2010, we entered into a credit agreement for the 2015 Natural Resources Facility, that is subject to, among other things, the terms of a borrowing base derived from the value of eligible specified oil and gas assets. The borrowing base is subject to certain caps and concentration limits customary for financings of this type. We have the right to prepay loans under the 2015 Natural Resources Facility in whole or in part at any time. Loans under the 2015 Natural Resources Facility bear interest at a rate equal to LIBOR plus a tiered applicable margin ranging from 1.75% to 2.75% per annum. The 2015 Natural Resources Facility contains customary covenants applicable to us.

On May 13, 2011, we entered into an amendment to the 2015 Natural Resources Facility, increasing the commitment from $49.7 million to $81.1 million. Subsequently, on January 31, 2012, we entered into another amendment to this facility, further increasing the commitment from $81.1 million to $137.2 million.

As of December 31, 2011, we believe we were in compliance with the covenant requirements for both credit facilities.

On January 15, 2010, we issued $172.5 million of 7.5% convertible senior notes due January 15, 2017. The 7.5% Notes bear interest at a rate of 7.5% per year on the principal amount, accruing from January 15, 2010. Interest is payable semiannually in arrears on January 15 and July 15 of each year, beginning on July 15, 2010. The 7.5% Notes will mature on January 15, 2017 unless previously redeemed, repurchased or converted in accordance with their terms prior to such date. Holders of the 7.5% Notes may convert their notes at the applicable conversion rate at any time prior to the close of business on the business day immediately preceding the stated maturity date subject to our right to terminate the conversion rights of the notes. We may satisfy our obligation with respect to the 7.5% Notes tendered for conversion by delivering to the holder either cash, common shares, no par value, issued by us or a combination thereof. The initial conversion rate for each $1,000 principal amount of 7.5% Notes was 122.2046 common shares, which is equivalent to an initial conversion price of approximately $8.18 per share. The conversion rate is adjusted under certain circumstances, including the occurrence of certain fundamental change transactions and the payment of a quarterly cash distribution in excess of $0.05 per share, but will not be adjusted for accrued and unpaid interest on the 7.5% Notes. As of December 31, 2011, the conversion rate for each $1,000 principal amount of 7.5% Notes was 132.1235 common shares.

During 2010, we repurchased $95.2 million par amount of our 7.0% Notes. These transactions resulted in us recording a gain of $1.3 million, which was partially offset by a write-off of $0.6 million of unamortized debt issuance costs during 2010.

During the second half of 2011, we repurchased $45.5 million par amount of our 7.0% Notes due July 15, 2012. These transactions resulted in us recording a loss of $1.7 million and a write-off of $0.1 million of unamortized debt issuance costs. As of December 31, 2011, we had committed to purchase an additional $0.8 million par amount of our 7.0% Notes. As of December 31, 2011, the conversion rate for each $1,000 principal amount of the notes was 32.2581, which is equivalent to a conversion price of approximately $31.00 per common share.

On February 1, 2012, we repurchased $22.2 million par amount of our 7.0% Notes. This transaction resulted in us recording a loss of $0.4 million and an immaterial write-off of unamortized debt issuance costs.

As of December 31, 2011, we had committed to purchase corporate loans with aggregate commitments totaling $97.2 million. In addition, we participate in certain financing arrangements, including revolvers and delayed draw facilities, whereby we are committed to provide funding at the discretion of the borrower up to a specific predetermined amount. As of December 31, 2011, we had unfunded financing commitments totaling $8.1 million for corporate loans and $40.9 million for private equity investments. We do not expect material losses related to these assets for which we commit to purchase and fund.

The table below summarizes our contractual obligations as of December 31, 2011 and are subject to material changes based on factors including interest rates, compliance with OC Tests and pay downs subsequent to December 31, 2011. The remaining contractual maturities in the table below were allocated assuming no prepayments and represent the principal amount of all notes, excluding any discount. Expected maturities may differ from contractual maturities because we, as the borrower, may have the right to call or prepay certain obligations, with or without call or prepayment penalties. The table below excludes contractual commitments related to our derivatives and amounts payable under

the Management Agreement that we have with our Manager because those contracts do not have fixed and determinable payments:

	Payments Due by Period

	Total		Less than 1 year		1 - 3 years		3 - 5 years		More than 5 years
CLO 2005-1 senior secured notes(1)	$	747,295	$	5,404	$	10,807	$	10,807	$	720,277
CLO 2005-2 senior secured notes(1)		786,931		6,231		12,461		12,461		755,778
CLO 2006-1 senior secured notes(1)		723,036		5,973		11,946		11,946		693,171
CLO 2007-1 senior secured notes(1)		2,271,192		20,923		41,846		41,846		2,166,577
CLO 2007-1 junior secured notes(2)		80,992		2,080		4,160		4,160		70,592
CLO 2007-A senior secured notes(1)		876,265		11,025		22,051		22,051		821,138
CLO 2007-A junior secured notes(2)		13,378		441		882		882		11,173
CLO 2011-1 senior debt(1)		487,704		7,719		15,438		15,438		449,109
CLO 2007-1 junior secured notes to affiliates(2)		385,119		9,037		18,074		18,074		339,934
CLO 2007-A junior secured notes to affiliates(2)		86,340		3,601		7,203		7,203		68,333
Asset-based borrowing facility(3)		43,052		1,991		1,941		39,120		—
Convertible senior notes(4)		377,935		153,146		25,875		25,875		173,039
Senior notes(5)		906,151		21,670		43,341		43,341		797,799
Junior subordinated notes(6)		528,677		15,734		31,468		27,893		453,582
Loan commitments(7)		146,289		97,220		49,069		—		—

Total	$	8,460,356	$	362,195	$	296,562	$	281,097	$	7,520,502

(1): Includes interest to be paid over the maturity of the CLO senior secured notes which has been calculated assuming no pay downs are made and debt outstanding as of December 31, 2011 is held until its final maturity date. The future interest payments are calculated using the weighted average borrowing rates as of December 31, 2011.
(2): Includes interest to be paid over the maturity of the CLO mezzanine notes which has been calculated assuming no pay downs are made and debt outstanding as of December 31, 2011 is held until its final maturity date. The future interest payments are calculated using the weighted average borrowing rates as of December 31, 2011.
(3): Includes the letter of credit outstanding of $1.0 million as well as interest to be paid over the maturity of the debt. Interest has been calculated assuming no prepayments are made and debt outstanding as of December 31, 2011 is held until its final maturity date. The future interest payments are calculated using rates in effect as of December 31, 2011, at spreads to market rates pursuant to the credit facility agreement, which is 2.5%. Excludes commitment fees on the facility.
(4): Includes interest to be paid over the maturity of the convertible senior notes which has been calculated assuming no prepayments are made and debt outstanding as of December 31, 2011 is held until its final maturity date. Represents the principal amount of the notes, which excludes the accounting adjustment for convertible debt instruments that may be settled in cash upon conversion (see "Item 8. Financial Statements and Supplementary Data—Note 7. Borrowings"). The future interest payments are calculated using the stated 7.0% and 7.5% interest rates.
(5): Includes interest to be paid over the maturity of the senior notes which has been calculated assuming no redemptions are made and debt outstanding as of December 31, 2011 is held until its

We intend to continue to operate so that we qualify, for United States federal income tax purposes, as a partnership and not as an association or a publicly traded partnership taxable as a corporation. In general, if a partnership is "publicly traded" (as defined in the Code), it will be treated as a corporation for United States federal income purposes. A publicly traded partnership will, however, be taxed as a partnership, and not as a corporation, for United States federal income tax purposes, so long as it is not required to register under the Investment Company Act and at least 90% of its gross income for each taxable year constitutes "qualifying income" within the meaning of Section 7704(d) of the Code. We refer to this exception as the "qualifying income exception." Qualifying income generally includes rents, dividends, interest (to the extent such interest is neither derived from the "conduct of a financial or insurance business" nor based, directly or indirectly, upon "income or profits" of any person), income and gains derived from certain activities related to minerals and natural resources, and capital gains from the sale or other disposition of stocks, bonds and real property. Qualifying income also includes other income derived from the business of investing in, among other things, stocks and securities.

If we fail to satisfy the "qualifying income exception" described above, items of income, gain, loss, deduction and credit would not pass through to holders of our shares and such holders would be treated for United States federal (and certain state and local) income tax purposes as shareholders in a corporation. In such case, we would be required to pay income tax at regular corporate rates on all of our income. In addition, we would likely be liable for state and local income and/or franchise taxes on

all of our income. Distributions to holders of our shares would constitute ordinary dividend income taxable to such holders to the extent of our earnings and profits, and these distributions would not be deductible by us. If we were taxable as a corporation, it could result in a material reduction in cash flow and after-tax return for holders of our shares and thus could result in a substantial reduction in the value of our shares and any other securities we may issue.

As referenced above, we have made and may make certain investments in natural resources. It is likely that the income from such investments will be treated as effectively connected with the conduct of a United States trade or business with respect to holders of our shares that are not "United States persons" within the meaning of Section 7701(a)(30) of the Code. Furthermore, any notional principal contracts that we enter into, if any, in connection with investments in natural resources likely would generate income that would be treated as effectively connected income with the conduct of a United States trade or business. To the extent our income is treated as effectively connected income, a holder who is a non-United States person generally would be required to (i) file a United States federal income tax return for such year reporting its allocable share, if any, of our income or loss effectively connected with such trade or business and (ii) pay United States federal income tax at regular United States tax rates on any such income. Moreover, if such a holder is a corporation, it might be subject to a United States branch profits tax on its allocable share of our effectively connected income. In addition, distributions to such a holder would be subject to withholding at the highest applicable tax rate to the extent of the holder's allocable share of our effectively connected income. Any amount so withheld would be creditable against such holder's United States federal income tax liability, and such holder could claim a refund to the extent that the amount withheld exceeded such holder's United States federal income tax liability for the taxable year. Finally, if we are engaged in a United States trade or business, a portion of any gain recognized by an investor who is a non-United States person on the sale or exchange of its shares may be treated for United States federal income tax purposes as effectively connected income, and hence such holder may be subject to United States federal income tax on the sale or exchange.

We expect to mail the 2011 Schedule K-1 (Form 1065), Partner's Share of Income, Deductions, Credits, etc. to shareholders by the end of March 2012.

Section 3(a)(1)(A) of the Investment Company Act of 1940 (the "Investment Company Act") defines an investment company as any issuer that is, holds itself out as being, or proposes to be, primarily engaged in the business of investing, reinvesting or trading in securities and Section 3(a)(1)(C) of the Investment Company Act defines an investment company as any issuer that is engaged or proposes to engage in the business of investing, reinvesting, owning, holding or trading in securities and owns or proposes to acquire "investment securities" (within the meaning of the Investment Company Act) having a value exceeding 40% of the value of the issuer's total assets (exclusive of United States government securities and cash items) on an unconsolidated basis (the "40% test"). Excluded from the term "investment securities" are, among others, securities issued by majority-owned subsidiaries unless the subsidiary is an investment company or relies on the exceptions

from the definition of an investment company provided by Section 3(c)(1) or Section 3(c)(7) of the Investment Company Act (a "fund").

We monitor our holdings regularly to confirm our continued compliance with the 40% test. In calculating our position under the 40% test, we are responsible for determining, among other things, whether any of our subsidiaries is majority-owned. We treat as majority-owned subsidiaries for purposes of the 40% test entities, including those that issue CLOs, in which we own at least 50% of the outstanding voting securities or that otherwise are structured consistent with applicable SEC staff guidance. Some of our subsidiaries may rely solely on the exceptions from the definition of "investment company" found in Section 3(c)(1) or Section 3(c)(7) of the Investment Company Act. In order for us to satisfy the 40% test, our ownership interests in those subsidiaries or any of our subsidiaries that are not majority-owned for purposes of the Investment Company Act, together with any other "investment securities" that we may own, may not have a combined value in excess of 40% of the value of our total assets on an unconsolidated basis and exclusive of United States government securities and cash items. However, most of our subsidiaries either fall outside of the general definitions of an investment company or rely on exceptions provided by provisions of, and rules and regulations promulgated under, the Investment Company Act (other than Section 3(c)(1) or Section 3(c)(7) of the Investment Company Act) and, therefore, are not investment companies for purposes of the Investment Company Act. In order to conform to these exceptions, these subsidiaries are limited with respect to the assets in which each of them can invest and/or the types of securities each of them may issue. We must, therefore, monitor each subsidiary's compliance with its applicable exception and our freedom of action relating to such a subsidiary, and that of the subsidiary itself, may be limited as a result. For example, our subsidiaries that issue CLOs generally rely on the exception provided by Rule 3a-7 under the Investment Company Act, while KFH II, our subsidiary that is taxed as a REIT for United States federal income tax purposes, generally relies on the exception provided by Section 3(c)(5)(C) of the Investment Company Act. Each of these exceptions requires, among other things that the subsidiary (i) not issue redeemable securities and (ii) engage in the business of holding certain types of assets, consistent with the terms of the exception. Similarly, any subsidiaries engaged in the ownership of oil and gas assets may, depending on the nature of the assets, be outside the definition of an investment company or rely on exceptions provided by Section 3(c)(5)(C) or Section 3(c)(9) of the Investment Company Act. While Section 3(c)(9) of the Investment Company Act does not limit the nature of the securities issued, it does impose business engagement requirements that limit the types of assets that may be held.

resembling those employed by management investment companies (e.g., mutual funds). Accordingly, each of these CLO subsidiaries is subject to an indenture (or similar transaction documents) that contains specific guidelines and restrictions limiting the discretion of the CLO subsidiary and its collateral manager. In particular, these guidelines and restrictions prohibit the CLO subsidiary from acquiring and disposing of assets primarily for the purpose of recognizing gains or decreasing losses resulting from market value changes. Thus, a CLO subsidiary cannot acquire or dispose of assets primarily to enhance returns to the owner of the equity in the CLO subsidiary; however, subject to this limitation, sales and purchases of assets may be made so long as doing so does not violate guidelines contained in the CLO subsidiary's relevant transaction documents. A CLO subsidiary generally can, for example, sell an asset if the collateral manager believes that its credit quality has declined since its acquisition or that the credit profile of the obligor will deteriorate and the proceeds of permitted dispositions may be reinvested in additional collateral, subject to fulfilling the requirements set forth in Rule 3a-7 under the Investment Company Act and the CLO subsidiary's relevant transaction documents. As a result of these restrictions, our CLO subsidiaries may suffer losses on their assets and we may suffer losses on our investments in those CLO subsidiaries.

Based on current guidance, our REIT subsidiary classifies investments in mortgage loans as qualifying real estate assets, as long as the loans are "fully secured" by an interest in real estate on which we retain the unilateral right to foreclose. That is, if the loan-to-value ratio of the loan is equal to or less than 100%, then the mortgage loan is considered to be a qualifying real estate asset. Mortgage loans with loan-to-value ratios in excess of 100% are considered to be only real estate-related assets. Our REIT subsidiary considers agency whole pool certificates to be qualifying real estate assets. Examples of agencies that issue whole pool certificates are the Federal National Mortgage Association, the Federal Home Loan Mortgage Corporation and the Government National Mortgage Association. An agency whole pool certificate is a certificate issued or guaranteed as to principal and interest by the United States government or by a federally chartered entity, which represents the entire beneficial interest in the underlying pool of mortgage loans. By contrast, an agency certificate that represents less than the entire beneficial interest in the underlying mortgage loans is not considered to be a qualifying real estate asset, but is considered by our REIT subsidiary to be a real estate-related asset.

based on Division guidance, where our REIT subsidiary's investment in non-agency mortgage-backed securities is the "functional equivalent" of owning the underlying mortgage loans, our REIT subsidiary may treat those securities as qualifying real estate assets. Moreover, investments in mortgage-backed securities that do not constitute qualifying real estate assets are classified by our REIT subsidiary as real estate-related assets. Therefore, based upon the specific terms and circumstances related to each non-agency mortgage-backed security that our REIT subsidiary owns, our REIT subsidiary will make a determination of whether that security should be classified as a qualifying real estate asset or as a real estate-related asset; and there may be instances where a security is recharacterized from being a qualifying real estate asset to a real estate-related asset, or conversely, from being a real estate-related asset to being a qualifying real estate asset based upon the acquisition or disposition or redemption of related classes of securities from the same securitization trust. If our REIT subsidiary acquires securities that, collectively, receive all of the principal and interest paid on the related pool of underlying mortgage loans (less fees, such as servicing and trustee fees, and expenses of the securitization), and that subsidiary has unilateral foreclosure rights with respect to those mortgage loans, then our REIT subsidiary will consider those securities, collectively, to be qualifying real estate assets. If another entity acquires any of the securities that are expected to receive cash flow from the underlying mortgage loans, then our REIT subsidiary will consider whether it has appropriate foreclosure rights with respect to the underlying loans and whether its investment is a first loss position in deciding whether these securities should be classified as qualifying real estate assets. If our REIT subsidiary owns more than one subordinate class, then, to determine the classification of subordinate classes other than the first loss class, our REIT subsidiary will consider whether such classes are contiguous with the first loss class (with no other classes absorbing losses after the first loss class and before any other subordinate classes that our REIT subsidiary owns), whether our REIT subsidiary owns the entire amount of each such class and whether our REIT subsidiary would continue to have appropriate foreclosure rights in connection with each such class if the more subordinate classes were no longer outstanding. If the answers to any of these questions is no, then our REIT subsidiary would expect not to classify that particular class, or classes senior to that class, as qualifying real estate assets.

investment company. If we fail to maintain an exception, exemption or other exclusion from the Investment Company Act, we could, among other things, be required either (i) to change substantially the manner in which we conduct our operations to avoid being subject to the Investment Company Act or (ii) to register as an investment company. Either of these would likely have a material adverse effect on us, the type of investments we make, our ability to service our indebtedness and to make distributions on our shares, and on the market price of our shares and any other securities we may issue. If we were required to register as an investment company under the Investment Company Act, we would become subject to substantial regulation with respect to our capital structure (including our ability to use leverage), management, operations, transactions with certain affiliated persons (within the meaning of the Investment Company Act), portfolio composition (including restrictions with respect to diversification and industry concentration) and other matters. Additionally, our Manager would have the right to terminate our Management Agreement. Moreover, if we were required to register as an investment company, we would no longer be eligible to be treated as a partnership for United States federal income tax purposes. Instead, we would be classified as a corporation for tax purposes and would be able to avoid corporate taxation only to the extent that we were able to elect and qualify as a regulated investment company ("RIC") under applicable tax rules. Because our eligibility for RIC status would depend on our assets and sources of income at the time that we were required to register as an investment company, there can be no assurance that we would be able to qualify as a RIC. If we were to lose partnership status and fail to qualify as a RIC, we would be taxed as a regular corporation. See "Partnership Tax Matters—Qualifying Income Exception".

We have not requested approval or guidance from the SEC or its staff with respect to our Investment Company Act determinations, including, in particular: our treatment of any subsidiary as majority-owned; the compliance of any subsidiary with Section 3(c)(5)(C) or Section 3(c)(9) of, or Rule 3a-7 under, the Investment Company Act, including any subsidiary's determinations with respect to the consistency of its assets or operations with the requirements thereof; or whether our interests in one or more subsidiaries constitute investment securities for purposes of the 40% test. If the SEC were to disagree with our treatment of one or more subsidiaries as being excepted from the Investment Company Act pursuant to Rule 3a-7, Section 3(c)(5)(C), Section 3(c)(9) or any other exception, with our determination that one or more of our other holdings do not constitute investment securities for purposes of the 40% test, or with our determinations as to the nature of the business in which we engage or the manner in which we hold ourselves out, we and/or one or more of our subsidiaries would need to adjust our operating strategies or assets in order for us to continue to pass the 40% test or register as an investment company, either of which could have a material adverse effect on us. Moreover, we may be required to adjust our operating strategy and holdings, or to effect sales of our assets in a manner that, or at a time or price at which, we would not otherwise choose, if there are changes in the laws or rules governing our Investment Company Act status or that of our subsidiaries, or if the SEC or its staff provides more specific or different guidance regarding the application of relevant provisions of, and rules under, the Investment Company Act. The SEC published on August 31, 2011 an advance notice of proposed rulemaking to potentially amend the conditions for reliance on Rule 3a-7 and the treatment of asset-backed issuers that rely on Rule 3a-7 under the Investment Company Act (the "3a-7 Release"). The SEC, in the 3a-7 Release, requested public comment on the nature and operation of issuers that rely on Rule 3a-7 and indicated various steps it may consider taking in connection with Rule 3a-7, although it did not formally propose any changes to the rule. Among the issues for which the SEC has requested comment in the 3a-7 Release is whether Rule 3a-7 should be modified so that parent companies of subsidiaries that rely on Rule 3a-7 should treat their interests in such subsidiaries as investment securities for purposes of the 40% test. The SEC also published on August 31, 2011 a concept release seeking information about the nature of entities that invest in mortgages and mortgage-related pools and public comment on how the SEC staff's interpretive positions in connection with Section 3(c)(5)(C) affect these entities, although it did not propose any new interpretive positions or changes to existing interpretive positions in connection with

Section 3(c)(5)(C). Any guidance or action from the SEC or its staff, including changes that the SEC may ultimately propose and adopt to the way Rule 3a-7 applies to entities or new or modified interpretive positions related to Section 3(c)(5)(C), could further inhibit our ability, or the ability of a subsidiary, to pursue our current or future operating strategies, which could have a material adverse effect on us.

From time to time, we may make investments that are denominated in a foreign currency through which we may be subject to foreign currency exchange risk. As of December 31, 2011, $351.0 million par amount, or 4.4%, of our corporate debt portfolio was denominated in foreign currencies, of which 74.8% was denominated in euros. In addition, as of December 31, 2011, $67.1 million par amount, or 37.1%, of our equity investments at estimated fair value was denominated in foreign currencies, of which 47.3% was denominated in Canadian dollars.

Based on these investments, we are exposed to movements in foreign currency exchange rates which may impact earnings if the United States dollar significantly strengthens or weakens against foreign currencies. Accordingly, we may use derivative instruments from time to time, including foreign exchange options and forward contracts, to manage the impact of fluctuations in foreign currency exchange rates.

Our investments are subject to spread risk. Our investments in floating rate loans and securities are valued based on a market credit spread over LIBOR and for which the value is affected by changes in the market credit spreads over LIBOR. Our investments in fixed rate loans and securities are valued based on a market credit spread over the rate payable on fixed rate United States Treasuries of like maturity. Increased credit spreads, or credit spread widening, will have an adverse impact on the value of our investments while decreased credit spreads, or credit spread tightening, will have a positive impact on the value of our investments. However, tightening credit spreads will increase the likelihood that certain holdings will be refinanced at lower rates that would negatively impact our earnings.

Interest rate risk is defined as the sensitivity of our current and future earnings to interest rate volatility, variability of spread relationships, the difference in repricing intervals between our assets and liabilities and the effect that interest rates may have on our cash flows and the prepayment rates experienced on our investments that have embedded borrower optionality. The objective of interest rate risk management is to achieve earnings, preserve capital and achieve liquidity by minimizing the negative impacts of changing interest rates, asset and liability mix, and prepayment activity.

We are exposed to basis risk between our investments and our borrowings. Interest rates on our floating rate investments and our variable rate borrowings do not reset on the same day or with the same frequency and, as a result, we are exposed to basis risk with respect to index reset frequency. Our

floating rate investments may reprice on indices that are different than the indices that are used to price our variable rate borrowings and, as a result, we are exposed to basis risk with respect to repricing index. The basis risks noted above, in addition to other forms of basis risk that exist between our investments and borrowings, may be material and could negatively impact future net interest margins.

Interest rate risk impacts our interest income, interest expense, prepayments, as well as the fair value of our investments, interest rate derivatives and liabilities. We generally fund our variable rate investments with variable rate borrowings with similar interest rate reset frequencies. As of December 31, 2011, approximately 32.2% of our corporate debt portfolio had LIBOR floors with a weighted average floor of 1.5%. Based on our variable rate investments and variable rate borrowings as of December 31, 2011, we estimated that net interest income would be negatively impacted by approximately $4.6 million annually in the event interest rates were to increase by 1% and be positively impacted by approximately $35.2 million annually in the event interest rates were to increase by 3%.

We manage our interest rate risk using various techniques ranging from the purchase of floating rate investments to the use of interest rate derivatives. The use of interest rate derivatives is a component of our interest risk management strategy. The contractual notional balance of our amortizing interest rate swaps was $508.3 million as of December 31, 2011.

Derivative transactions including engaging in swaps and foreign currency transactions are subject to certain risks. There is no guarantee that a company can eliminate its exposure under an outstanding swap agreement by entering into an offsetting swap agreement with the same or another party. Also, there is a possibility of default of the other party to the transaction or illiquidity of the derivative instrument. Furthermore, the ability to successfully use derivative transactions depends on the ability to predict market movements which cannot be guaranteed. As such, participation in derivative instruments may result in greater losses as we would have to sell or purchase an investment at inopportune times for prices other than current market prices or may force us to hold an asset we might otherwise have sold. In addition, as certain derivative instruments are unregulated, they are difficult to value and are therefore susceptible to liquidity and credit risks.

Collateral posting requirements are individually negotiated between counterparties and there is no regulatory requirement concerning the amount of collateral that a counterparty must post to secure its obligations under certain derivative instruments. Because they are unregulated, there is no requirement that parties to a contract be informed in advance when a credit default swap is sold. As a result, investors may have difficulty identifying the party responsible for payment of their claims. If a counterparty's credit becomes significantly impaired, multiple requests for collateral posting in a short period of time could increase the risk that we may not receive adequate collateral. Amounts paid by us as premiums and cash or other assets held in margin accounts with respect to derivative instruments are not available for investment purposes.

The following table summarizes the estimated net fair value of our derivative instruments held at December 31, 2011 (amounts in thousands):

For our derivatives, our credit exposure is directly with our counterparties and continues until the maturity or termination of such contracts. The following table sets forth the fair values of our primary derivative investments by remaining contractual maturity as of December 31, 2011 (amounts in thousands):

	Less than 1 year			1 - 3 years			3 - 5 years			More than 5 years			Total

Cash Flow Hedges:
Cash flow interest rate swaps	$	(2,852	)	$	—		$	—		$	(97,866	)	$	(100,718	)
Free-Standing Derivatives:
Commodity swaps		2,434			3,341			1,596			—			7,371
Credit default swaps—protection sold		77			—			(7,254	)		—			(7,177	)
Total rate of return swaps		152			—			—			—			152
Foreign exchange forward contracts		32			(12,291	)		35			—			(12,224	)
Foreign exchange options		—			13,394			—			—			13,394

Total	$	(157	)	$	4,444		$	(5,623	)	$	(97,866	)	$	(99,202	)

Certain of our natural resources holdings, including our working interests in producing oil and natural gas fields are subject to fluctuations in the prices of natural gas, natural gas liquids and oil. Changes in the prices of natural gas, natural gas liquids and oil may cause our revenues and cash flows to be volatile. We have used, and expect to continue to use, commodity derivative contracts to minimize our exposure to fluctuations in these prices.

We have entered into commodity derivative contracts, consisting of oil, natural gas and certain natural gas liquid products receive-fixed, pay-floating swaps for certain years through 2015. We currently maintain derivative contracts for a significant portion of our oil and natural gas production. Given that we do not designate any of these contracts as cash flow hedges, the changes in fair value of these instruments are recorded in current period earnings. For the year ended December 31, 2011, we had an immaterial amount of commodity derivatives settlements, which are settled monthly. The estimated fair value of our commodity swaps as of December 31, 2011 totaled $7.4 million.

We have credit risks that are generally related to the counterparties with which we do business. If a counterparty becomes bankrupt, or otherwise fails to perform its obligations under a derivative contract due to financial difficulties, we may experience significant delays in obtaining any recovery under the derivative contract in a bankruptcy or other reorganization proceeding. These risks of non-performance may differ from risks associated with exchange-traded transactions which are typically backed by guarantees and have daily marks-to-market and settlement positions. Transactions entered into directly between parties do not benefit from such protections and thus, are subject to counterparty default. It may be the case where any cash or collateral we pledged to the counterparty may be unrecoverable and we may be forced to unwind our derivative agreements at a loss. We may obtain only a limited recovery or may obtain no recovery in such circumstances, thereby reducing liquidity and earnings.

The preparation of our financial statements requires management to make estimates and assumptions that affect the amounts reported in our consolidated financial statements and accompanying notes. Significant estimates, assumptions and judgments are applied in situations including the determination of our allowance for loan losses and the valuation of certain investments. We revise our estimates when appropriate. However, actual results could materially differ from management's estimates.

See discussion of quantitative and qualitative disclosures about market risk in "Quantitative and Qualitative Disclosures About Market Risk" section of Item 7 of this Annual Report on Form 10-K.

Our consolidated financial statements and the related notes to the consolidated financial statements, together with the Report of Independent Registered Public Accounting Firm thereon, are set forth on pages F-1 through F-61 in this Annual Report on Form 10-K.

Item 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE

We have carried out an evaluation, under the supervision and with the participation of our management including our Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures, as that term is defined in Rules 13a-15(e) under the Securities Exchange Act of 1934, as amended, as of December 31, 2011. Based on that evaluation, our Chief Executive Officer and Chief Financial Officer concluded that as of December 31, 2011, our disclosure controls and procedures are effective.

Management is responsible for establishing and maintaining adequate internal control over financial reporting. Our internal control system was designed to provide reasonable assurance regarding

the reliability of our financial reports and preparation of our financial statements for external purposes in accordance with GAAP.

Management assessed the effectiveness of our internal control over financial reporting as of December 31, 2011, based on the framework set forth by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) in Internal Control—Integrated Framework. Based on that assessment, management concluded that, as of December 31, 2011, our internal control over financial reporting was effective.

Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

Our independent auditors, Deloitte & Touche LLP, an independent registered public accounting firm, have issued an audit report on our internal control over financial reporting and their report follows.

During the quarter ended December 31, 2011, there has been no change in our internal control over financial reporting that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

The information required by Item 10 is incorporated herein by reference to information in the Proxy Statement under the captions "Proposal One: Election of Directions," "Executive Officers," "Section 16(a) Beneficial Ownership Reporting Compliance," "Corporate Governance," "Proposals by Holders of Shares for the Next Annual Meeting" and "Board of Directors and Committees" to be filed with the SEC pursuant to Regulation 14A within 120 days after December 31, 2011.

The information required by Item 11 is incorporated herein by reference to information in the Proxy Statement under the caption "Executive Compensation," "Director Compensation" and "Compensation Committee Report" to be filed with the SEC pursuant to Regulation 14A within 120 days after December 31, 2011.

Item 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED SHAREHOLDER MATTERS

The information required by Item 12 is incorporated herein by reference from information in the Company's Proxy Statement for the 2012 Annual Shareholders' Meeting (the "Proxy Statement") under the caption "Security Ownership of Certain Beneficial Owners and Management" and "Equity Compensation Plan Information" to be filed with the SEC pursuant to Regulation 14A within 120 days after December 31, 2011.

Item 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE

The information required by Item 13 is incorporated herein by reference from information in the Proxy Statement under the captions "Certain Relationships and Related Transactions" and "Corporate Governance" to be filed with the SEC pursuant to Regulation 14A within 120 days after December 31, 2011.

The information required by Item 14 is incorporated herein by reference from information in the Proxy Statement under the caption "Audit Committee Matters" to be filed with the SEC Pursuant to Regulation 14A within 120 days after December 31, 2011.

All financial statement schedules are omitted because of the absence of conditions under which they are required or because the required information is included in our consolidated financial statements or notes thereto, included in Part II, Item 8, of this Annual Report on Form 10-K.

			Incorporated by Reference

Exhibit Number		Exhibit Description	Form	File No.	Exhibit		Filing Date		Filed Herewith
	2.1	Agreement and Plan of Merger, dated as of February 9, 2007, among the Registrant, KKR Financial Holdings Corp. and KKR Financial Merger Corp.	S-4	333-140586		2		02/09/07

	3.1	Amended and Restated Operating Agreement of the Registrant, dated May 3, 2007, as amended May 7, 2009	10-Q	001-33437		3.1		08/06/09

	3.2	Amendment No.1 to the Amended and Restated Operating Agreement of the Registrant, dated February 28, 2010	10-K	001-33437		3.2		03/01/10

	4.1	Form of Certificate for Common Shares	S-4	333-140586		A		02/09/07

	4.2	Indenture, dated as of July 23, 2007, by and among the Registrant, as Issuer, KKR Financial Corp., as Guarantor, and Wells Fargo Bank, N.A., as Trustee	8-K	001-33437		4.1		07/23/07

	4.3	Form of 7.0% Convertible Senior Note due 2012 and Form of Notation of Guarantee	8-K	001-33437		4.1		07/23/07

	4.4	Registration Rights Agreement, dated as of July 23, 2007, among the Registrant, KKR Financial Corp. and Citigroup Global Markets Inc.	8-K	001-33437		4.3		07/23/07

	4.5	Indenture, dated as of January 15, 2010, between the Registrant and Wells Fargo Bank, National Association	8-K	001-33437		4.1		01/15/10

	4.6	Supplemental Indenture, dated as of January 15, 2010, between the Registrant and Wells Fargo Bank, National Association	8-K	001-33437		4.2		01/15/10

	4.7	Form of 7.50% Convertible Senior Note due January 15, 2017	8-K	001-33437		4.2		01/15/10

	4.8	Indenture, dated as of November 15, 2011, between the Registrant and Wilmington Trust, National Association	8-K	001-33437		4.1		11/15/11

	4.9	Supplemental Indenture, dated as of November 15, 2011, between the Registrant and Wilmington Trust, National Association and Citibank, N.A.	8-K	001-33437		4.2		11/15/11

				Incorporated by Reference

Exhibit Number			Exhibit Description	Form	File No.	Exhibit		Filing Date		Filed Herewith
	4.10		Form of 8.375% Senior Note due November 15, 2041	8-K	001-33437		4.3		11/15/11

	10.1		Amended and Restated Management Agreement, dated as of May 4, 2007, among the Registrant, KKR Financial Advisors LLC and KKR Financial Corp.	8-K	001-33437		10.1		05/04/07

	10.2		First Amendment Agreement to Amended and Restated Management Agreement, dated as of June 15, 2007, among the Registrant, KKR Financial Advisors LLC and KKR Financial Corp.	8-K	001-33437		10.1		06/15/07

	10.3		2007 Share Incentive Plan	8-K	001-33437		10.2		05/04/07

	10.4		Non-Employee Directors' Deferred Compensation and Share Award Plan	8-K	001-33437		10.3		05/04/07

	10.5		Form of Nonqualified Share Option Agreement	8-K	001-33437		10.4		05/04/07

	10.6		Form of Restricted Share Award Agreement	8-K	001-33437		10.5		05/04/07

	10.7		Form of Restricted Share Award Agreement for Non-Employee Directors	8-K	001-33437		10.6		05/04/07

	10.8		Amended and Restated License Agreement, dated as of May 4, 2007, among the Registrant, Kohlberg Kravis Roberts & Co. L.P. and KKR Financial Corp.	8-K	001-33437		10.8		05/04/07

	10.9	*	Indenture, dated as of March 30, 2005, by and among KKR Financial CLO 2005-1, Ltd., KKR Financial CLO 2005-1 Corp. and JPMorgan Chase Bank, National Association(1)	S-11/A	333-124103		10.6		06/09/05

	10.10	**	Letter Agreement, dated as of August 12, 2004, between KKR Financial Corp. and KKR Financial Advisors LLC	S-11/A	333-124103		10.8		06/21/05

	10.11	**	Collateral Management Agreement, dated as of March 30, 2005, between KKR Financial CLO 2005-1, Ltd. and KKR Financial Advisors II, LLC	S-11/A	333-124103		10.11		06/21/05

				Incorporated by Reference

Exhibit Number			Exhibit Description	Form	File No.	Exhibit		Filing Date		Filed Herewith
	10.12	**	Fee Waiver Letter, dated April 15, 2005, between KKR Financial CLO 2005-1, Ltd., KKR Financial Advisors II, LLC and JPMorgan Chase Bank, N.A.	S-11/A	333-124103		10.12		06/21/05

	10.13		Letter Agreement, dated February 27, 2009, between the Company and KKR Financial Advisors LLC	10-K	001-33437		10.21		03/02/09

	10.14		Credit Agreement, dated as of May 3, 2010, by and among the Borrowers, Citibank, N.A., Bank of America, N.A., Deutsche Bank AG New York Branch and Morgan Stanley Bank, N.A.	10-Q	001-33437		10.17		08/4/10

	10.15		Credit Agreement, dated as of November 5, 2010, by and among the Borrower, JP Morgan Chase Bank, N.A., Bank of America, N.A., and Bank of Montreal	10-Q	001-33437		10.18		05/2/11

	10.16		First Omnibus Amendment, dated as of May 13, 2011, to Credit Agreement, dated as of November 5, 2010, by and among the Borrower, JP Morgan Chase Bank, N.A., Bank of America, N.A., and Bank of Montreal	10-Q	001-33437		10.19		08/4/11

	12.1		Computation of Ratios of Earnings to Fixed Charges								X

	21.1		List of Subsidiaries of the Registrant								X

	23.1		Consent of Deloitte & Touche LLP								X

	31.1		Certification pursuant to Rules 13a-14(a) and 15d-14(a) under the Securities Exchange Act of 1934, as amended								X

	31.2		Certification pursuant to Rules 13a-14(a) and 15d-14(a) under the Securities Exchange Act of 1934, as amended								X

	32		Certification pursuant to 18 U.S.C. Section 1350								X

	101.INS		XBRL Instance Document.								X

	101.SCH		XBRL Taxonomy Extension Schema Document.								X

Pursuant to the requirements of Section 13 of the Securities Exchange Act of 1934, the Registrant has duly caused this annual report on Form 10-K for the fiscal year ended December 31, 2011, to be signed on its behalf by the undersigned, and in the capacities indicated, thereunto duly authorized, on February 28, 2012.

Pursuant to the requirements of the Securities Exchange Act of 1934, this Annual Report on Form 10-K has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated.

KKR FINANCIAL HOLDINGS LLC AND SUBSIDIARIES
CONSOLIDATED FINANCIAL STATEMENTS
AND
REPORTS OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

For Inclusion in Form 10-K
Filed with
Securities and Exchange Commission
December 31, 2011

KKR FINANCIAL HOLDINGS LLC AND SUBSIDIARIES
Index to Consolidated Financial Statements


		Page
Reports of Independent Registered Public Accounting Firm		F-3
Consolidated Balance Sheets		F-6
Consolidated Statements of Operations		F-7
Consolidated Statements of Changes in Shareholders' Equity		F-8
Consolidated Statements of Cash Flows		F-9
Notes to Consolidated Financial Statements		F-11

To the Board of Directors and Shareholders of
KKR Financial Holdings LLC
San Francisco, California

We have audited the internal control over financial reporting of KKR Financial Holdings LLC and subsidiaries (the "Company") as of December 31, 2011, based on criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. The Company's management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Management's Report on Internal Control Over Financial Reporting. Our responsibility is to express an opinion on the Company's internal control over financial reporting based on our audit.

We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, testing and evaluating the design and operating effectiveness of internal control based on the assessed risk, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.

A company's internal control over financial reporting is a process designed by, or under the supervision of, the company's principal executive and principal financial officers, or persons performing similar functions, and effected by the company's board of directors, management, and other personnel to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company's internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company's assets that could have a material effect on the financial statements.

Because of the inherent limitations of internal control over financial reporting, including the possibility of collusion or improper management override of controls, material misstatements due to error or fraud may not be prevented or detected on a timely basis. Also, projections of any evaluation of the effectiveness of the internal control over financial reporting to future periods are subject to the risk that the controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

In our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2011, based on the criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission.

We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated financial statements as of and for the year ended December 31, 2011 of the Company and our report dated February 28, 2012 expressed an unqualified opinion on those financial statements.

To the Board of Directors and Shareholders of
KKR Financial Holdings LLC
San Francisco, California

We have audited the accompanying consolidated balance sheets of KKR Financial Holdings LLC and subsidiaries (the "Company") as of December 31, 2011 and 2010, and the related consolidated statements of operations, changes in shareholders' equity, and cash flows for each of the three years in the period ended December 31, 2011. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits.

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

In our opinion, such consolidated financial statements present fairly, in all material respects, the financial position of the Company as of December 31, 2011 and 2010, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 2011, in conformity with accounting principles generally accepted in the United States of America.

As discussed in Note 2 to the consolidated financial statements, effective January 1, 2010, the Company adopted the new accounting guidance which amended the accounting for the transfers of financial assets and the consolidation of variable interest entities.

We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the Company's internal control over financial reporting as of December 31, 2011, based on the criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated February 28, 2012 expressed an unqualified opinion on the Company's internal control over financial reporting.

KKR Financial Holdings LLC and Subsidiaries

Consolidated Balance Sheets

(Amounts in thousands, except share information)

	December 31, 2011			December 31, 2010

Assets
Cash and cash equivalents	$	392,154		$	313,829
Restricted cash and cash equivalents		399,620			571,425
Securities		922,603			932,823
Corporate loans, net (includes $317,332 and $463,628 loans held for sale as of December 31, 2011 and December 31, 2010, respectively)		6,443,399			6,321,444
Equity investments, at estimated fair value ($12,222 and $12,036 pledged as collateral as of December 31, 2011 and December 31, 2010, respectively)		189,845			99,955
Derivative assets		28,463			19,519
Interest and principal receivable		62,124			57,414
Other assets		209,020			102,003

Total assets	$	8,647,228		$	8,418,412

Liabilities
Collateralized loan obligation secured notes	$	5,540,037		$	5,630,272
Collateralized loan obligation junior secured notes to affiliates		365,848			366,124
Credit facilities		38,300			18,400
Convertible senior notes		299,830			344,142
Senior notes		250,676			—
Junior subordinated notes		283,517			283,517
Accounts payable, accrued expenses and other liabilities		24,680			14,193
Accrued interest payable		25,536			22,846
Accrued interest payable to affiliates		6,561			6,316
Related party payable		11,078			12,988
Derivative liabilities		125,333			76,566

Total liabilities		6,971,396			6,775,364

Shareholders' Equity
Preferred shares, no par value, 50,000,000 shares authorized and none issued and outstanding at December 31, 2011 and December 31, 2010		—			—
Common shares, no par value, 500,000,000 shares authorized, and 178,145,482 and 177,848,565 shares issued and outstanding at December 31, 2011 and December 31, 2010, respectively		—			—
Paid-in-capital		2,759,478			2,756,200
Accumulated other comprehensive (loss) income		(35,619	)		133,596
Accumulated deficit		(1,048,027	)		(1,246,748	)

Total shareholders' equity		1,675,832			1,643,048

Total liabilities and shareholders' equity	$	8,647,228		$	8,418,412

KKR Financial Holdings LLC and Subsidiaries

Consolidated Statements of Operations

(Amounts in thousands, except per share information)

	Year ended December 31, 2011			Year ended December 31, 2010			Year ended December 31, 2009

Net investment income:
Loan interest income	$	418,142		$	397,634		$	477,044
Securities interest income		87,851			104,395			94,762
Other investment income		36,028			3,330			919

Total investment income		542,021			505,359			572,725
Interest expense		133,609			131,700			268,087
Interest expense to affiliates		49,458			25,152			21,287
Provision for loan losses		14,194			29,121			39,795

Net investment income		344,760			319,386			243,556

Other income (loss):
Net realized and unrealized gain (loss) on investments		88,955			108,553			(88,705	)
Net realized and unrealized (loss) gain on derivatives and foreign exchange		(3,812	)		(4,694	)		60,908
Net realized and unrealized gain (loss) on residential mortgage-backed securities, residential mortgage loans, and residential mortgage-backed securities issued, carried at estimated fair value		2,825			(11,396	)		(107,028	)
Net (loss) gain on restructuring and extinguishment of debt		(1,736	)		39,999			30,836
Other income		7,215			10,890			7,714

Total other income (loss)		93,447			143,352			(96,275	)

Non-investment expenses:
Related party management compensation		68,185			69,125			44,323
General, administrative and directors expenses		37,741			16,516			10,393
Professional services		6,198			5,331			7,384
Loan servicing		—			—			7,961

Total non-investment expenses		112,124			90,972			70,061

Income from before income tax expense		326,083			371,766			77,220
Income tax expense		8,011			702			284

Net income	$	318,072		$	371,064		$	76,936

Net income per common share:
Basic	$	1.79		$	2.33		$	0.50

Diluted	$	1.75		$	2.32		$	0.50

Weighted average number of common shares outstanding:
Basic		177,560			157,936			153,756

Diluted		180,897			158,771			153,756

KKR Financial Holdings LLC and Subsidiaries

Consolidated Statements of Changes in Shareholders' Equity

(Amounts in thousands)

			Paid-In Capital			Accumulated Other Comprehensive (Loss) Income			Accumulated Deficit			Comprehensive Income			Total Shareholders' Equity

Balance at January 1, 2009	150,881		$	2,550,849		$	(268,782	)	$	(1,618,722	)				$	663,345

Net income	—			—			—			76,936		$	76,936			76,936
Net change in unrealized gain on cash flow hedges	—			—			34,739			—			34,739			34,739
Net change in unrealized gain on securities available-for-sale	—			—			386,771			—			386,771			386,771

Comprehensive income	—			—			—			—		$	498,446

Cash distributions on common shares	—			—			—			(7,918	)					(7,918	)
Proceeds from issuance of common shares, net of offering costs	7,258			8,808			—			—			—			8,808
Grant of restricted common shares	221			—			—			—			—			—
Share-based compensation expense related to restricted common shares	—			3,977			—			—			—			3,977

Balance at December 31, 2009	158,360			2,563,634			152,728			(1,549,704	)					1,166,658

Net income	—			—			—			371,064		$	371,064			371,064
Net change in unrealized loss on cash flow hedges	—			—			(13,935	)		—			(13,935	)		(13,935	)
Net change in unrealized gain on securities available-for-sale	—			—			(5,197	)		—			(5,197	)		(5,197	)

Comprehensive income	—			—			—			—		$	351,932

Cash distributions on common shares	—			—			—			(68,108	)					(68,108	)
Proceeds from issuance of common shares, net of offering costs	19,436			175,701			—			—			—			175,701
Grant of restricted common shares	53			—			—			—			—			—
Equity component of convertible notes issuance	—			9,973			—			—			—			9,973
Share-based compensation expense related to restricted common shares	—			6,892			—			—			—			6,892

Balance at December 31, 2010	177,849			2,756,200			133,596			(1,246,748	)					1,643,048

Net income	—			—			—			318,072		$	318,072			318,072
Net change in unrealized loss on cash flow hedges	—			—			(42,324	)		—			(42,324	)		(42,324	)
Net change in unrealized gain on securities available-for-sale	—			—			(126,891	)		—			(126,891	)		(126,891	)

Comprehensive income	—			—			—			—		$	148,857

Cash distributions on common shares	—			—			—			(119,351	)		—			(119,351	)
Issuance of common shares	171			1,297			—			—			—			1,297
Grant of restricted common shares	291			—			—			—			—			—
Cancellation of restricted common shares	(25	)		—			—			—			—			—
Repurchase and cancellation of common shares	(141	)		(1,297	)		—			—			—			(1,297	)
Share-based compensation expense related to restricted common shares	—			3,278			—			—			—			3,278

Balance at December 31, 2011	178,145		$	2,759,478		$	(35,619	)	$	(1,048,027	)				$	1,675,832

KKR Financial Holdings LLC and Subsidiaries

Consolidated Statements of Cash Flows

(Amounts in thousands)

	Year ended December 31, 2011			Year ended December 31, 2010			Year ended December 31, 2009

Cash flows from operating activities:
Net income	$	318,072		$	371,064		$	76,936
Adjustments to reconcile net income to net cash provided by operating activities:
Net realized and unrealized loss (gain) on derivatives and foreign exchange		3,812			5,378			(64,490	)
Net loss (gain) on restructuring and extinguishment of debt		1,736			(39,999	)		(59,635	)
Write-off of debt issuance costs		2,194			8,160			5,267
Lower of cost or estimated fair value adjustment on corporate loans held for sale		65,163			14,725			51,037
Provision for loan losses		14,194			29,121			39,795
Impairment on securities available-for-sale and private equity investments at cost		7,705			12,890			43,906
Share-based compensation		3,278			6,892			3,977
Net unrealized (gain) loss on residential mortgage-backed securities, residential mortgage loans, and residential mortgage-backed securities issued, carried at estimated fair value		(2,825	)		11,396			107,028
Net realized gain on sales of investments		(161,823	)		(136,924	)		(2,656	)
Deferred interest expense		—			4,427			20,783
Depreciation and net amortization		(83,630	)		(103,430	)		(58,118	)
Changes in assets and liabilities:
Interest receivable		1,902			12,008			43,482
Other assets		6,608			(36,739	)		(30,498	)
Related party payable		(1,910	)		9,621			491
Accounts payable, accrued expenses and other liabilities		9,417			1,151			(46,603	)
Accrued interest payable		2,690			(2,451	)		(35,822	)
Accrued interest payable to affiliates		245			3,405			1,715

Net cash provided by operating activities		186,828			170,695			96,595

Cash flows from investing activities:
Principal payments from corporate loans		1,441,426			1,611,502			1,213,947
Principal payments from securities available-for-sale and other securities, at estimated fair value		106,098			139,794			6,257
Principal payments from residential mortgage-backed securities, at estimated fair value		7,365			14,289			27,284
Proceeds from sale of corporate loans		654,379			1,118,440			1,132,802
Proceeds from sale of securities available-for-sale and other securities, at estimated fair value		202,059			342,833			321,841
Proceeds from sale of residential mortgage-backed securities, at estimated fair value		—			7,246			—
Proceeds from equity investments		49,734			123,047			—
Proceeds from securities sold, not yet purchased		40,980			—			—
Purchases of corporate loans		(2,228,360	)		(2,463,752	)		(997,495	)
Purchases of securities available-for-sale and other securities, at estimated fair value		(321,087	)		(439,754	)		(134,429	)
Purchases of equity and other investments		(205,193	)		(38,565	)		—
Cover securities sold, not yet purchased		(39,320	)		(78,727	)		(9,256	)
Net proceeds, purchases, and settlements of derivatives		1,926			13,454			32,510
Net change in reverse repurchase agreements		—			80,250			8,002
Net change in restricted cash and cash equivalents		172,156			(228,719	)		890,879

Net cash (used in) provided by investing activities		(117,837	)		201,338			2,492,342

	Year ended December 31, 2011			Year ended December 31, 2010			Year ended December 31, 2009

Cash flows from financing activities:
Repayment of residential mortgage-backed securities issued		—			—			(571,228	)
Issuance of collateralized loan obligation secured notes		439,409			—			—
Retirement of collateralized loan obligation secured notes		(531,060	)		(104,734	)		(1,846,738	)
Retirement of collateralized loan obligation junior secured notes to affiliates		(276	)		(67,519	)		—
Proceeds from credit facilities		19,900			68,719			—
Repayment of credit facilities		—			(227,805	)		(100,633	)
Repayment of junior subordinated notes		—			—			(1,392	)
Proceeds from convertible senior notes		—			167,325			—
Repayment of convertible senior notes		(47,197	)		(93,922	)		—
Proceeds from senior notes		250,669			—			—
Net proceeds from common share offerings		—			175,701			—
Distributions on common shares		(119,351	)		(68,108	)		(7,918	)
Issuance of common shares		1,297			—			—
Repurchase and cancellation of common shares		(1,297	)		—			—
Other capitalized costs		(2,760	)		(4,947	)		(5,372	)

Net cash provided by (used in) financing activities		9,334			(155,290	)		(2,533,281	)

Net increase (decrease) in cash and cash equivalents		78,325			216,743			55,656
Cash and cash equivalents at beginning of year		313,829			97,086			41,430

Cash and cash equivalents at end of year	$	392,154		$	313,829		$	97,086

Supplemental cash flow information:
Cash paid for interest	$	147,750		$	99,308		$	290,147
Net cash paid for income taxes	$	2,081		$	768		$	373
Non-cash investing and financing activities:
Deconsolidation of residential mortgage loans	$	—		$	2,034,772		$	—
Deconsolidation of residential mortgage-backed securities issued	$	—		$	(2,034,772	)	$	—
Subordinate tranche of the residential mortgage loan securitization trusts included in residential mortgage-backed securities	$	—		$	74,366		$	—
Equity component of the convertible senior notes	$	—		$	9,973		$	—
Issuance of restricted common shares	$	2,755		$	470		$	615
Exchange of convertible senior notes to equity	$	—		$	—		$	8,808
Exchange of CLO 2009-1 subordinated notes to affiliate for 20% interest in CLO 2009-1 assets	$	—		$	—		$	90,429
Loans transferred from held for investment to held for sale	$	862,244		$	1,052,040		$	1,229,531
Loans transferred from held for sale to held for investment	$	448,329		$	437,727		$	—

KKR Financial Holdings LLC and Subsidiaries

Notes to Consolidated Financial Statements

KKR Financial Holdings LLC together with its subsidiaries (the "Company") is a specialty finance company with expertise in a range of asset classes. The Company's core business strategy is to leverage the proprietary resources of its manager with the objective of generating both current income and capital appreciation by deploying capital to its strategies, which include bank loans and high yield securities, natural resources, special situations, mezzanine, commercial real estate and private equity. The Company's holdings across these strategies primarily consist of below investment grade syndicated corporate loans, also known as leveraged loans, high yield debt securities, private equity and working and royalty interests in oil and gas properties. The corporate loans that the Company holds are purchased via assignment or participation in the primary or secondary market.

The majority of the Company's holdings consist of corporate loans and high yield debt securities held in collateralized loan obligation ("CLO") transactions that are structured as on-balance sheet securitizations and are used as long term financing for the Company's investments in corporate debt. The senior secured debt issued by the CLO transactions is generally owned by unaffiliated third party investors and the Company owns the majority of the mezzanine and subordinated notes in the CLO transactions. The Company executes its core business strategy through its majority-owned subsidiaries, including CLOs.

KKR Financial Advisors LLC (the "Manager"), a wholly-owned subsidiary of KKR Asset Management LLC, manages the Company pursuant to a management agreement (the "Management Agreement"). KKR Asset Management LLC is a wholly-owned subsidiary of Kohlberg Kravis Roberts & Co. L.P. ("KKR").

The accompanying consolidated financial statements have been prepared in conformity with accounting principles generally accepted in the United States of America ("GAAP"). The consolidated financial statements include the accounts of the Company and entities established to complete secured financing transactions that are considered to be variable interest entities and for which the Company is the primary beneficiary.

Certain prior period information has been reclassified to conform to the current year presentation, including the aggregation of (i) securities available-for-sale, other securities at estimated fair value and residential mortgage-backed securities at estimated fair value into a single line item on the consolidated balance sheets called securities and (ii) corporate loans, corporate loans held for sale and corporate loans at estimated fair value into a single line item on the consolidated balance sheets called corporate loans, net.

The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the amounts reported in the Company's consolidated financial statements and accompanying notes. Actual results could differ from management's estimates.

Effective January 1, 2010, the Company adopted new accounting guidance which amended the accounting for the transfers of financial assets, eliminated the concept of a qualified special purpose entity and significantly changed the criteria by which an enterprise determines whether or not it must consolidate a variable interest entity ("VIE"). Under the new accounting guidance, consolidation of a VIE requires both the power to direct the activities that most significantly impact the VIE's economic performance and the obligation to absorb losses of the VIE or the right to receive benefits of the VIE that could potentially be significant to the VIE.

As a result of the adoption of the new accounting guidance regarding the amended consolidation model based on power and economics, the Company determined that six residential mortgage loan securitization trusts, which were previously consolidated by the Company as it was deemed to be the primary beneficiary, were required to be deconsolidated. The Company determined that it did not have the power to direct the activities that most significantly impact the economic performance of the securitization trusts or the performance of the securitization trusts' underlying assets as the Company was never the servicer of the trusts nor did it participate in any servicing activities. Accordingly, the Company determined that it was no longer the primary beneficiary of the six securitization trusts under the new accounting guidance and deconsolidated them as of January 1, 2010. This resulted in the reduction of both assets and liabilities of approximately $2.0 billion. In addition, loan interest income, interest expense, loan servicing expense, and net unrealized and realized gain (loss) associated with the residential mortgage loan securitization trusts are no longer reported on the Company's consolidated financial statements. The deconsolidation of the six residential mortgage loan securitization trusts had no net impact on the Company's shareholders' equity, results of operations and cash flows. Refer to Note 6 to these financial statements for the impact of the deconsolidation.

KKR Financial CLO 2005-1, Ltd. ("CLO 2005-1"), KKR Financial CLO 2005-2, Ltd. ("CLO 2005-2"), KKR Financial CLO 2006-1, Ltd. ("CLO 2006-1"), KKR Financial CLO 2007-1, Ltd. ("CLO 2007-1"), KKR Financial CLO 2007-A, Ltd. ("CLO 2007-A"), KKR Financial CLO 2009-1, Ltd. ("CLO 2009-1") and KKR Financial CLO 2011-1, Ltd. ("CLO 2011-1") are entities established to complete secured financing transactions. These entities are VIEs which the Company consolidates as the Company has determined it has the power to direct the activities that most significantly impact these entities' economic performance and the Company has both the obligation to absorb losses of these entities and the right to receive benefits from these entities that could potentially be significant to these entities. In CLO transactions, subordinated notes have the first risk of loss and conversely, the residual value upside of the transactions. These CLOs are considered non-recourse leverage to the Company.

The Company finances the majority of its corporate debt investments through its CLOs. Since all of the debt of CLO 2009-1 was retired in July 2009, CLO 2009-1 is excluded from the discussion below. As of December 31, 2011, the Company's six CLOs, which excluded CLO 2009-1, held $7.4 billion par amount, or $6.8 billion estimated fair value, of corporate debt investments. As of December 31, 2010, the Company's five CLOs, which excluded CLO 2009-1, held $7.1 billion par amount, or $6.8 billion estimated fair value, of corporate debt investments. The assets in each CLO can be used only to settle the debt of the related CLO. As of December 31, 2011, the aggregate CLO debt totaled $5.5 billion of secured debt outstanding held by unaffiliated third parties and $365.8 million of junior notes outstanding held by an affiliate of the Manager. As of December 31, 2010, the aggregate CLO debt

totaled $5.6 billion of secured debt outstanding held by unaffiliated third parties and $366.1 million of junior notes outstanding held by an affiliate of the Manager.

In addition, the Company continues to consolidate all non-VIEs in which it holds a greater than 50 percent voting interest.

All inter-company balances and transactions have been eliminated in consolidation.

further analysis of transactions or quoted prices is needed, and a significant adjustment to the transactions or quoted prices may be necessary to estimate fair value.

The availability of observable inputs can vary depending on the financial asset or liability and is affected by a wide variety of factors, including, for example, the type of product, whether the product is new, whether the product is traded on an active exchange or in the secondary market, and the current market condition. To the extent that valuation is based on models or inputs that are less observable or unobservable in the market, the determination of fair value requires more judgment. Accordingly, the degree of judgment exercised by the Company in determining fair value is greatest for instruments categorized in Level 3. In certain cases, the inputs used to measure fair value may fall into different levels of the fair value hierarchy. In such cases, for disclosure purposes, the level in the fair value hierarchy within which the fair value measurement in its entirety falls is determined based on the lowest level input that is significant to the fair value measurement in its entirety. The variability of the observable inputs affected by the factors described above may cause transfers between Levels 1, 2, and/or 3, which the Company recognizes at the end of the reporting period.

Many financial assets and liabilities have bid and ask prices that can be observed in the marketplace. Bid prices reflect the highest price that the Company and others are willing to pay for an asset. Ask prices represent the lowest price that the Company and others are willing to accept for an asset. For financial assets and liabilities whose inputs are based on bid-ask prices, the Company does not require that fair value always be a predetermined point in the bid-ask range. The Company's policy is to allow for mid-market pricing and adjusting to the point within the bid-ask range that meets the Company's best estimate of fair value.

Depending on the relative liquidity in the markets for certain assets, the Company may transfer assets to Level 3 if it determines that observable quoted prices, obtained directly or indirectly, are not available. The valuation techniques used for the assets and liabilities that are valued using Level 3 of the fair value hierarchy are described below.

and equity prices. The fair value of OTC derivative products can be modeled using a series of techniques, including closed-form analytic formulae, such as the Black-Scholes option-pricing model, and simulation models or a combination thereof. Many pricing models do not entail material subjectivity because the methodologies employed do not necessitate significant judgment, and the pricing inputs are observed from actively quoted markets, as is the case for generic interest rate swap and option contracts.

Residential Mortgage-Backed Securities, at Estimated Fair Value: Residential mortgage-backed securities are initially valued at transaction price and are subsequently valued using industry recognized models (including Intex and Bloomberg) and data for similar instruments (e.g., nationally recognized pricing services or broker quotes). The most significant inputs to the valuation of these instruments are default and loss expectations and market credit spreads.

Cash and cash equivalents include cash on hand, cash held in banks and highly liquid investments with original maturities of three months or less. Interest income earned on cash and cash equivalents is recorded in other investment income.

Restricted cash and cash equivalents represent amounts that are held by third parties under certain of the Company's financing and derivative transactions. Interest income earned on restricted cash and cash equivalents is recorded in other investment income.

On the consolidated statement of cash flows, net additions or reductions to restricted cash and cash equivalents are classified as an investing activity as restricted cash and cash equivalents reflect the receipts from collections or sales of investments, as well as payments made to acquire investments held by third parties.

The Company classifies its investments in securities as available-for-sale as the Company may sell them prior to maturity and does not hold them principally for the purpose of selling them in the near term. These investments are carried at estimated fair value, with unrealized gains and losses reported in accumulated other comprehensive (loss) income. Estimated fair values are based on quoted market prices, when available, on estimates provided by independent pricing sources or dealers who make markets in such securities, or internal valuation models when external sources of fair value are not available. Upon the sale of a security, the realized net gain or loss is computed on a weighted average cost basis. Purchases and sales of securities are recorded on the trade date.

The Company monitors its available-for-sale securities portfolio for impairments. A loss is recognized when it is determined that a decline in the estimated fair value of a security below its amortized cost is other-than-temporary. The Company considers many factors in determining whether the impairment of a security is deemed to be other-than-temporary, including, but not limited to, the length of time the security has had a decline in estimated fair value below its amortized cost and the

severity of the decline, the amount of the unrealized loss, recent events specific to the issuer or industry, external credit ratings and recent changes in such ratings. In addition, for debt securities, the Company considers its intent to sell the debt security, the Company's estimation of whether or not it expects to recover the debt security's entire amortized cost if it intends to hold the debt security, and whether it is more likely than not that the Company will be required to sell the debt security before its anticipated recovery. For equity securities, the Company also considers its intent and ability to hold the equity security for a period of time sufficient for a recovery in value.

The amount of the loss that is recognized when it is determined that a decline in the estimated fair value of a security below its amortized cost is other-than-temporary is dependent on certain factors. If the security is an equity security or if the security is a debt security that the Company intends to sell or estimates that it is more likely than not that the Company will be required to sell before recovery of its amortized cost, then the impairment amount recognized in earnings is the entire difference between the estimated fair value of the security and its amortized cost. For debt securities that the Company does not intend to sell or estimates that it is not more likely than not to be required to sell before recovery, the impairment is separated into the estimated amount relating to credit loss and the estimated amount relating to all other factors. Only the estimated credit loss amount is recognized in earnings, with the remainder of the loss amount recognized in other comprehensive (loss) income.

Unamortized premiums and unaccreted discounts on securities available-for-sale are recognized in interest income over the contractual life, adjusted for actual prepayments, of the securities using the effective interest method.

The Company has elected the fair value option of accounting for certain securities for the purpose of enhancing the transparency of its financial condition as fair value is consistent with how the Company manages the risks of these securities. Other securities, at estimated fair value are included within securities on the consolidated balance sheets with unrealized gains and losses reported in income.

The Company has elected the fair value option of accounting for its residential mortgage investments for the purpose of enhancing the transparency of its financial condition as fair value is consistent with how the Company manages the risks of its residential mortgage investments. RMBS, at estimated fair value are included within securities on the consolidated balance sheets with unrealized gains and losses reported in income.

The Company has elected the fair value option of accounting for certain marketable equity securities and private equity investments. The Company elects the fair value option of accounting for private equity investments received through restructuring debt transactions or issued by an entity in which the Company may have significant influence. The Company elected the fair value option for certain equity investments for the purpose of enhancing the transparency of its financial condition as fair value is consistent with how the Company manages the risks of these equity investments. Equity investments, at fair value, are managed based on overall value and potential returns. These equity

investments carried at fair value are presented separately on the consolidated balance sheets with unrealized gains and losses reported in net realized and unrealized gains and losses on investments on the consolidated statements of operations.

Securities sold, not yet purchased consist of equity and debt securities that the Company has sold short. In order to facilitate a short sale, the Company borrows the securities from another party and delivers the securities to the buyer. The Company will be required to "cover" its short sale in the future through the purchase of the security in the market at the prevailing market price and deliver it to the counterparty from which it borrowed. The Company is exposed to a loss to the extent that the security price increases during the time from when the Company borrowed the security to when the Company purchases it in the market to cover the short sale. Securities sold, not yet purchased are presented within accounts payable, accrued expenses and other liabilities on the consolidated balance sheets with gains and losses reported in net realized and unrealized gains and losses on investments on the consolidated statement of operations.

Corporate loans are generally held for investment and the Company initially records loans at their purchase prices. The Company subsequently accounts for loans based on their outstanding principal plus or minus unaccreted purchase discounts and unamortized purchase premiums. Corporate loans that the Company transfers to held for sale are transferred at the lower of cost or estimated fair value.

Interest income on loans includes interest at stated coupon rates adjusted for accretion of purchase discounts and the amortization of purchase premiums. Unamortized premiums and unaccreted discounts are recognized in interest income over the contractual life, adjusted for actual prepayments, of the loans using the effective interest method.

A loan is typically placed on non-accrual status at such time as: (i) management believes that scheduled debt service payments may not be paid when contractually due; (ii) the loan becomes 90 days delinquent; (iii) management determines the borrower is incapable of, or has ceased efforts toward, curing the cause of the impairment; or (iv) the net realizable value of the underlying collateral securing the loan decreases below the Company's carrying value of such loan. As such, loans placed on non-accrual status may or may not be contractually past due at the time of such determination. While on non-accrual status, previously recognized accrued interest is reversed if it is determined that such amounts are not collectible and interest income is recognized using the cost-recovery method, cash-basis method or some combination of the two methods. A loan is placed back on accrual status when the ultimate collectability of the principal and interest is not in doubt.

The Company may modify corporate loans in transactions where the borrower is experiencing financial difficulty and a concession is granted to the borrower as part of the modification. These concessions may include a reduction in interest rate, payment extensions, forgiveness of principal, an exchange of assets or a combination thereof. Such modifications typically qualify as troubled debt restructurings. The Company may also identify receivables that are newly considered impaired and

discloses the total amount of receivables and the allowance for credit losses as of the end of the period of adoption related to those receivables that are newly considered impaired.

In addition, the Company may also modify corporate loans which usually involve changes in existing interest rates combined with changes of existing maturities to prevailing market rates/maturities for similar instruments at the time of modification. Such modifications typically do not meet the definition of a troubled debt restructuring since the respective borrowers are neither experiencing financial difficulty nor are seeking a concession as part of the modification.

The corporate loans the Company invests in are generally deemed in default upon the non-payment of a single interest payment or as a result of the violation of a covenant in the respective loan agreement. The Company charges-off a portion or all of its amortized cost basis in a corporate loan when it determines that it is uncollectible due to either: i) the estimation based on a recovery value analysis of a defaulted loan that less than the amortized cost amount will be recovered through the agreed upon restructuring of the loan or as a result of a bankruptcy process of the issuer of the loan; or ii) the determination by the Company to transfer a loan to held for sale with the loan having an estimated market value below the amortized cost basis of the loan.

Loans acquired with deteriorated credit quality are recorded at initial cost and interest income is recognized as the difference between the Company's estimate of all cash flows that it will receive from the loan in excess of its initial investment on a level-yield basis over the life of the loan (accretable yield) using the effective interest method.

The Company's corporate loan portfolio is comprised of a single portfolio segment which includes one class of financing receivables, that is, high yield loans that are purchased via assignment or participation in either the primary or secondary market and are held primarily for investment. High yield loans are generally characterized as having below investment grade ratings or being unrated.

The Company's allowance for loan losses represents its estimate of probable credit losses inherent in its corporate loan portfolio held for investment as of the balance sheet date. Estimating the Company's allowance for loan losses involves a high degree of management judgment and is based upon a comprehensive review of the Company's loan portfolio that is performed on a quarterly basis. The Company's allowance for loan losses consists of two components, an allocated component and an unallocated component. The allocated component of the allowance for loan losses pertains to specific loans that the Company has determined are impaired. The Company determines a loan is impaired when management estimates that it is probable that the Company will be unable to collect all amounts due according to the contractual terms of the loan agreement. On a quarterly basis the Company performs a comprehensive review of its entire loan portfolio and identifies certain loans that it has determined are impaired. Once a loan is identified as being impaired, the Company places the loan on non-accrual status, unless the loan is already on non-accrual status, and records a reserve that reflects management's best estimate of the loss that the Company expects to recognize from the loan. The expected loss is estimated as being the difference between the Company's current cost basis of the loan, including accrued interest receivable, and the loan's estimated fair value.

The unallocated component of the Company's allowance for loan losses represents its estimate of probable losses inherent in the loan portfolio as of the balance sheet date where the specific loan that the loan loss relates to is indeterminable. The Company estimates the unallocated component of the allowance for loan losses through a comprehensive review of its loan portfolio and identifies certain loans that demonstrate possible indicators of impairment, including internally assigned credit quality indicators. This assessment excludes all loans that are determined to be impaired and as a result, an allocated reserve has been recorded as described in the preceding paragraph. Such indicators include, but are not limited to, the current and/or forecasted financial performance and liquidity profile of the issuer, specific industry or economic conditions that may impact the issuer, and the observable trading price of the loan if available. All loans are first categorized based on their assigned risk grade and further stratified based on the seniority of the loan in the issuer's capital structure. The seniority classifications assigned to loans are senior secured, second lien and subordinate. Senior secured consists of loans that are the most senior debt in an issuer's capital structure and therefore have a lower estimated loss severity than other debt that is subordinate to the senior secured loan. Senior secured loans often have a first lien on some or all of the issuer's assets. Second lien consists of loans that are secured by a second lien interest on some or all of the issuer's assets; however, the loan is subordinate to the first lien debt in the issuer's capital structure. Subordinate consists of loans that are generally unsecured and subordinate to other debt in the issuer's capital structure.

The Company applies a range of default and loss severity estimates in order to estimate a range of loss outcomes upon which to base its estimate of probable losses that results in the determination of the unallocated component of the Company's allowance for loan losses.

From time to time the Company makes the determination to transfer certain of its corporate loans from held for investment to held for sale. The decision to transfer a loan to held for sale is generally as a result of the Company determining that the respective loan's credit quality in relation to the loan's expected risk-adjusted return no longer meets the Company's investment objective and/or the Company deciding to reduce or eliminate its exposure to a particular loan for risk management purposes. Corporate loans held for sale are stated at lower of cost or estimated fair value and are assessed on an individual basis. Prior to transferring a loan to held for sale, any difference between the carrying amount of the loan and its outstanding principal balance is recognized as an adjustment to the yield by the interest method. The loan is transferred from held for investment to held for sale at the lower of its cost or estimated fair value and is carried at the lower of its cost or estimated fair value thereafter. Subsequent to transfer and while the loan is held for sale, recognition as an adjustment to yield by the

interest method is discontinued for any difference between the carrying amount of the loan and its outstanding principal balance.

From time to time the Company also makes the determination to transfer certain of its corporate loans from held for sale back to held for investment. The decision to transfer a loan back to held for investment is generally as a result of the circumstances that led to the initial transfer to held for sale no longer being present. Such circumstances include deteriorated market conditions often resulting in price depreciation or assets becoming illiquid, changes in restrictions on sales and certain loans amending their terms to extend the maturity, whereby the Company determined that selling the asset no longer met its investment objective and strategy. The loan is transferred from held for sale back to held for investment at the lower of its cost or estimated fair value, whereby a new cost basis is established based on this amount.

Interest income on corporate loans classified as held for sale is recognized through accrual of the stated coupon rate for the loans, unless the loans are placed on non-accrual status, at which point previously recognized accrued interest is reversed if it is determined that such amounts are not collectible and interest income is recognized using either the cost-recovery method or on a cash-basis.

The Company has elected the fair value option of accounting for certain corporate loans for the purpose of enhancing the transparency of its financial condition as fair value is consistent with how the Company manages the risks of these corporate loans. Corporate loans carried at estimated fair value are included within corporate loans, net on the consolidated balance sheets with unrealized gains and losses reported in income.

The Company evaluates its proved oil and natural gas properties and related equipment and facilities for impairment whenever events or changes in circumstances indicate that the carrying amounts of such properties may not be recoverable. The determination of recoverability is made based upon estimated undiscounted future net cash flows. The amount of impairment loss, if any, is determined by comparing the fair value, as determined by a discounted cash flow analysis, with the carrying value of the related asset. For the years ended December 31, 2011 and 2010, the Company did not record any impairments related to its oil and natural gas assets, which are included in other assets on the consolidated balance sheets.

The Company finances the majority of its investments through the use of secured borrowings in the form of securitization transactions structured as non-recourse secured financings and other secured and unsecured borrowings. In addition, the Company finances certain of its oil and gas asset acquisitions through borrowings. The Company recognizes interest expense on all borrowings on an accrual basis.

Trusts formed by the Company for the sole purpose of issuing trust preferred securities are not consolidated by the Company as the Company has determined that it is not the primary beneficiary of such trusts. The Company's investment in the common securities of such trusts is included in other assets on the consolidated balance sheets.

The Company recognizes all derivatives on the consolidated balance sheet at estimated fair value. On the date the Company enters into a derivative contract, the Company designates and documents each derivative contract as one of the following at the time the contract is executed: (i) a hedge of a recognized asset or liability ("fair value" hedge); (ii) a hedge of a forecasted transaction or of the variability of cash flows to be received or paid related to a recognized asset or liability ("cash flow" hedge); (iii) a hedge of a net investment in a foreign operation; or (iv) a derivative instrument not designated as a hedging instrument ("free-standing derivative"). For a fair value hedge, the Company records changes in the estimated fair value of the derivative instrument and, to the extent that it is effective, changes in the fair value of the hedged asset or liability in the current period earnings in the same financial statement category as the hedged item. For a cash flow hedge, the Company records changes in the estimated fair value of the derivative to the extent that it is effective in other comprehensive (loss) income and subsequently reclassifies these changes in estimated fair value to net income in the same period(s) that the hedged transaction affects earnings. The effective portion of the cash flow hedges is recorded in the same financial statement category as the hedged item. For free-standing derivatives, the Company reports changes in the fair values in other income (loss).

The Company formally documents at inception its hedge relationships, including identification of the hedging instruments and the hedged items, its risk management objectives, strategy for undertaking the hedge transaction and the Company's evaluation of effectiveness of its hedged transactions. Periodically, the Company also formally assesses whether the derivative it designated in each hedging relationship is expected to be and has been highly effective in offsetting changes in estimated fair values or cash flows of the hedged item using either the dollar offset or the regression analysis method. If the Company determines that a derivative is not highly effective as a hedge, it discontinues hedge accounting.

The Company makes investments in non-United States dollar denominated securities and loans. As a result, the Company is subject to the risk of fluctuation in the exchange rate between the United States dollar and the foreign currency in which it makes an investment. In order to reduce the currency risk, the Company may hedge the applicable foreign currency. All investments denominated in a foreign currency are converted to the United States dollar using prevailing exchange rates on the balance sheet date. Income, expenses, gains and losses on investments denominated in a foreign currency are converted to the United States dollar using the prevailing exchange rates on the dates when they are recorded. Foreign exchange gains and losses are recorded in the consolidated statements of operations.

The Management Agreement provides for the payment of a base management fee to the Manager, as well as an incentive fee if the Company's financial performance exceeds certain benchmarks. Additionally, the Management Agreement provides for the Manager to be reimbursed for certain expenses incurred on the Company's behalf. See Note 12 to these consolidated financial statements for additional discussion on the payment of the base management fee and incentive fee. The base management fee and the incentive fee are accrued and expensed during the period for which they are earned by the Manager.

The Company accounts for share-based compensation issued to its directors and to its Manager using the fair value based methodology in accordance with relevant accounting guidance. Compensation cost related to restricted common shares issued to the Company's directors is measured at its estimated fair value at the grant date, and is amortized and expensed over the vesting period on a straight-line basis. Compensation cost related to restricted common shares and common share options issued to the Manager is initially measured at estimated fair value at the grant date, and is remeasured on subsequent dates to the extent the awards are unvested. The Company has elected to use the graded vesting attribution method to amortize compensation expense for the restricted common shares and common share options granted to the Manager.

The Company intends to continue to operate so as to qualify, for United States federal income tax purposes, as a partnership and not as an association or publicly traded partnership taxable as a corporation. Therefore, the Company generally is not subject to United States federal income tax at the entity level, but is subject to limited state and foreign taxes. Holders of the Company's shares will be required to take into account their allocable share of each item of the Company's income, gain, loss, deduction, and credit for the taxable year of the Company ending within or with their taxable year.

During 2011, the Company owned an equity interest in KKR Financial Holdings II, LLC ("KFH II"), which elected to be taxed as a real estate investment trust (a "REIT") under the Internal Revenue Code of 1986, as amended (the "Code"). KFH II holds certain real estate mortgage-backed securities. A REIT generally is not subject to United States federal income tax to the extent that it currently distributes its income and satisfies certain asset, income and ownership tests, and recordkeeping requirements, but it may be subject to some amount of federal, state, local and foreign taxes based on its taxable income.

The Company has wholly-owned domestic and foreign subsidiaries that are taxable as corporations for United States federal income tax purposes and thus are not consolidated with the Company for United States federal income tax purposes. For financial reporting purposes, current and deferred taxes are provided for on the portion of earnings recognized by the Company with respect to its interest in the domestic taxable corporate subsidiaries, because each is taxed as a regular corporation under the Code. Deferred income tax assets and liabilities are computed based on temporary differences between the GAAP consolidated financial statements and the United States federal income tax basis of assets and liabilities as of each consolidated balance sheet date. The foreign corporate subsidiaries were formed to make certain foreign and domestic investments from time to time. The foreign corporate

subsidiaries are organized as exempted companies incorporated with limited liability under the laws of the Cayman Islands, and are anticipated to be exempt from United States federal and state income tax at the corporate entity level because they restrict their activities in the United States to trading in stock and securities for their own account. However, the Company will be required to include their current taxable income in the Company's calculation of its taxable income allocable to shareholders. CLO 2005-1, CLO 2005-2, CLO 2006-1, CLO 2007-1, CLO 2007-A, CLO 2009-1 and CLO 2011-1 are foreign subsidiaries of the Company that elected to be treated as disregarded entities or partnerships for United States federal income tax purposes. These subsidiaries were established to facilitate securitization transactions, structured as secured financing transactions.

The Company must recognize the tax impact from an uncertain tax position only if it is more likely than not that the tax position will be sustained on examination by the taxing authorities, based on the technical merits of the position. The tax impact recognized in the financial statements from such a position is measured based on the largest benefit that has a greater than 50% likelihood of being realized upon ultimate resolution. Penalties and interest related to uncertain tax positions are recorded as tax expense. Significant judgment is required in the identification of uncertain tax positions and in the estimation of penalties and interest on uncertain tax positions. If it is determined that recognition for an uncertain tax provision is necessary, the Company would record a liability for an unrecognized tax expense from an uncertain tax position taken or expected to be taken.

The Company presents both basic and diluted earnings per common share ("EPS") in its consolidated financial statements and footnotes thereto. Basic earnings per common share ("Basic EPS") excludes dilution and is computed by dividing net income or loss by the weighted average number of common shares, including vested restricted common shares, outstanding for the period. The Company calculates EPS using the more dilutive of the two-class method or the if-converted method. The two-class method is an earnings allocation formula that determines EPS for common shares and participating securities. Unvested share-based payment awards that contain non-forfeitable rights to dividends or dividend equivalents (whether paid or unpaid) are participating securities and shall be included in the computation of EPS using the two-class method. Accordingly, all earnings (distributed and undistributed) are allocated to common shares and participating securities based on their respective rights to receive dividends. Diluted earnings (loss) per share ("Diluted EPS") reflects the potential dilution of common share options and unvested restricted common shares using the treasury method, as well as the potential dilution of convertible senior notes using the number of shares it would take to satisfy the excess conversion obligation (average Company share price for the period in excess of the conversion price related to the Company's convertible senior notes), if they are not anti-dilutive.

exposure if certain criteria are met. Disclosure requirements include quantitative information about significant unobservable inputs used for Level 3 measurements, a description of the company's valuation processes and a qualitative discussion about the sensitivity of recurring Level 3 measurements to changes in the unobservable inputs disclosed. The guidance is effective during interim and annual periods beginning after December 15, 2011; early adoption is not permitted. The Company does not expect the guidance to have a material impact on its consolidated financial statements.

In December 2011, the FASB deferred the changes made in June 2011 that relate to the presentation of reclassification adjustments in order to allow the board time to deliberate whether to present on the face of the financial statements the effects of reclassifications out of accumulated other comprehensive income on the components of net income and other comprehensive income for all periods presented. All other requirements according to the June 2011 update were not affected by this December 2011 update, including the requirement to report comprehensive income either in a single continuous financial statement or in two separate but consecutive financial statements. The guidance is effective during interim and annual periods beginning after December 15, 2011. The Company does not expect the guidance to have a material impact on its consolidated financial statements.

In December 2011, the FASB amended existing standards to require an entity to disclose information about offsetting and related arrangements to enable users of its financial statements to evaluate the effect or potential effect of netting arrangements on an entity's financial position, including the effect or potential effect of rights of setoff associated with certain financial instruments and derivative instruments. The guidance is effective for annual reporting periods beginning on or after January 1, 2013, and interim periods within those annual periods, with retrospective disclosures required for all comparative periods presented. The Company is currently evaluating the impact of this accounting update on its financial disclosures.

The following table presents a reconciliation of basic and diluted net income per common share, as well as the distributions declared per common share for the years ended December 31, 2011, 2010 and 2009 (amounts in thousands, except per share information):

	Year ended December 31, 2011		Year ended December 31, 2010		Year ended December 31, 2009

Net income	$	318,072	$	371,064	$	76,936
Less: Dividends and undistributed earnings allocated to participating securities		1,082		3,108		614

Net income applicable to common shareholders	$	316,990	$	367,956	$	76,322

Basic:
Basic weighted average shares outstanding		177,560		157,936		153,756

Net income per share	$	1.79	$	2.33	$	0.50

Diluted:
Basic weighted average shares outstanding		177,560		157,936		153,756
Dilutive effect of convertible senior notes		3,337		835		—

Diluted weighted average shares outstanding(1)		180,897		158,771		153,756

Net income per share	$	1.75	$	2.32	$	0.50

Distributions declared per common share	$	0.67	$	0.43	$	0.05

The Company accounts for securities based on the following categories: (i) securities available-for-sale, which are carried at estimated fair value, with unrealized gains and losses reported in accumulated other comprehensive (loss) income; (ii) other securities, at estimated fair value, with unrealized gains and losses recorded in the consolidated statements of operations; and (iii) residential mortgage-backed securities, at estimated fair value, with unrealized gains and losses recorded in the consolidated statements of operations.

The following table summarizes the Company's securities as of December 31, 2011, which are carried at estimated fair value (amounts in thousands):

The following table summarizes the Company's securities as of December 31, 2010, which are carried at estimated fair value (amounts in thousands):

The following table shows the gross unrealized losses and fair value of the Company's available-for-sale securities, aggregated by length of time that the individual securities have been in a continuous unrealized loss position, as of December 31, 2011 and 2010 (amounts in thousands):

The unrealized losses in the table above are considered to be temporary impairments due to market factors and are not reflective of credit deterioration. The Company considers many factors when evaluating whether an impairment is other-than-temporary. For corporate debt securities included in the table above, the Company does not intend to sell them and does not believe that it is more likely than not that the Company will be required to sell any of its corporate debt securities prior to recovery. In addition, based on the analyses performed by the Company on each of its corporate debt securities, the Company believes that it is able to recover the entire amortized cost amount of the corporate debt securities included in the table above.

During the year ended December 31, 2011, the Company recognized a loss totaling $1.5 million for corporate debt securities that it determined to be other-than-temporarily impaired based on the criteria above. During the years ended December 31, 2010 and 2009, the Company recognized losses totaling $2.6 million and $43.3 million, respectively, for securities that it determined to be other-than-temporarily impaired. The Company intends to sell these securities and as a result, the entire amount is recorded through earnings in net realized and unrealized gain (loss) on investments in the consolidated statements of operations.

For common and preferred stock, the Company considers many factors when evaluating whether an impairment is other-than-temporary, including its intent and ability to hold the common and preferred stock for a period of time sufficient for recovery to cost. If the Company believes it will not recover the cost basis based on its intent or ability, an other-than-temporary loss will be recorded through earnings in net realized and unrealized gain (loss) on investments in the consolidated statements of operations.

During the year ended December 31, 2011, the Company recognized a loss totaling $2.2 million for common and preferred stock that it determined to be other-than-temporary impaired. During the years ended December 31, 2010 and 2009, the Company recognized losses totaling zero and $0.6 million, respectively, for common and preferred stock that it determined to be other-than-temporarily impaired.

As of December 31, 2011, the Company had no corporate debt securities in default. As of December 31, 2010, the Company had one corporate debt security in default with an estimated fair value of $1.1 million.

Corporate debt securities sold at a loss typically include those that the Company determined to be other-than-temporarily impaired or had a deteriorated credit quality. The following table shows the net realized gains (losses) on the sales of securities available-for-sale (amounts in thousands):

The following table summarizes the amortized cost and estimated fair value of corporate debt securities by remaining contractual maturity and weighted average coupon based on par values as of December 31, 2011 (dollar amounts in thousands):

The remaining contractual maturities in the table above were allocated assuming no prepayments. Expected maturities may differ from contractual maturities because borrowers may have the right to call or prepay obligations, with or without call or prepayment penalties.

The Company's securities available-for-sale portfolio has certain credit risk concentrated in a limited number of issuers. As of December 31, 2011, approximately 46% of the estimated fair value of the Company's securities available-for-sale portfolio was concentrated in ten issuers, with the two largest concentrations of securities available-for-sale in securities issued by First Data Corporation and SandRidge Energy, Inc., which combined represented $138.3 million, or approximately 17% of the estimated fair value of the Company's securities available-for-sale. As of December 31, 2010, approximately 60% of the estimated fair value of the Company's securities available-for-sale portfolio was concentrated in ten issuers, with the two largest concentrations of securities available-for-sale in securities issued by NXP BV and First Data Corporation, which combined represented $208.6 million, or approximately 25% of the estimated fair of value of the Company's securities available-for-sale.

Note 7 to these consolidated financial statements describes the Company's borrowings under which the Company has pledged securities for borrowings. The following table summarizes the estimated fair value of securities available-for-sale pledged as collateral as of December 31, 2011 and 2010 (amounts in thousands):

As of December 31, 2011, no other securities, at estimated fair value or RMBS were pledged as collateral for the Company's borrowings.

The Company accounts for loans based on the following categories (i) corporate loans held for investment, which are measured based on their outstanding principal plus or minus unaccreted purchase discounts and unamortized purchase premiums; (ii) corporate loans held for sale, which are measured at lower of cost or estimated fair value; and (iii) corporate loans, at estimated fair value, which are measured at fair value.

The following table summarizes the Company's corporate loans as of December 31, 2011 (amounts in thousands):

The following table summarizes the Company's corporate loans as of December 31, 2010 (amounts in thousands):

As of December 31, 2011 and 2010, the Company had an allowance for loan losses of $191.4 million and $209.0 million, respectively. As described in Note 2 to these consolidated financial statements, the allowance for loan losses represents the Company's estimate of probable credit losses inherent in its loan portfolio as of the balance sheet date. The Company's allowance for loan losses consists of two components, an allocated component and an unallocated component. The allocated component of the allowance for loan losses consists of individual loans that are impaired. The unallocated component of the allowance for loan losses represents the Company's estimate of losses inherent, but not identified, in its portfolio as of the balance sheet date.

The following table summarizes the changes in the allowance for loan losses for the Company's corporate loan portfolio during the years ended December 31, 2011, 2010 and 2009 (amounts in thousands):

The following table summarizes the ending balances of the allowance and corporate loans portfolio by basis of impairment method as of December 31, 2011 and 2010 (amounts in thousands):

	December 31, 2011		December 31, 2010

Allowance for loan losses:
Ending balance: individually evaluated for impairment	$	191,407	$	207,633
Ending balance: collectively evaluated for impairment		—		—
Ending balance: loans acquired with deteriorated credit quality		—		1,397

	$	191,407	$	209,030

Corporate loans (recorded investment)(1):
Ending balance: individually evaluated for impairment	$	6,334,232	$	6,065,596
Ending balance: collectively evaluated for impairment		—		—
Ending balance: loans acquired with deteriorated credit quality		—		25,007

	$	6,334,232	$	6,090,603

As of December 31, 2011, the allocated component of the allowance for loan losses totaled $33.8 million and relates to investments in certain loans issued by five issuers with an aggregate par amount of $83.5 million and an aggregate recorded investment of $68.7 million. As of December 31, 2010, the allocated component of the allowance for loan losses totaled $50.1 million and relates to investments in certain loans issued by five issuers with an aggregate par amount of $225.6 million and an aggregate recorded investment of $149.8 million.

The following table summarizes the Company's recorded investment in impaired loans and the related allowance for credit losses for the years ended December 31, 2011 and 2010 (amounts in thousands):

As of December 31, 2011 and 2010, the allocated component of the allowance for loan losses included all impaired loans. While all of the Company's impaired loans are on non-accrual status, the Company's non-accrual loans also include those held for sale that are measured at the lower of cost or fair value and are not reflected in the table above.

The following table summarizes the Company's recorded investment in non-accrual loans for the years ended December 31, 2011 and 2010 (amounts in thousands):

The amount of interest income recognized using the cash-basis method during the time within the period that the loans were impaired was $11.9 million, which included $2.6 million for impaired loans that were held for investment and $9.3 million for non-accrual loans held for sale for the year ended December 31, 2011. The amount of interest income recognized using the cash-basis method during the time within the period that the loans were impaired was $12.9 million, which included $11.1 million for impaired loans that were held for investment and $1.8 million for non-accrual loans held for sale for the year ended December 31, 2010.

The Company did not have any corporate loans past due at December 31, 2011 or 2010.

The unallocated component of the allowance for loan losses totaled $157.6 million and $158.9 million as of December 31, 2011 and 2010, respectively. As described in Note 2 to these consolidated financial statements, the Company estimates the unallocated components of the allowance for loan losses through a comprehensive review of its loan portfolio and identifies certain loans that demonstrate possible indicators of impairments, including credit quality indicators. The following table summarizes how the Company determines internally assigned grades related to credit quality based on

a combination of concern as to probability of default and the seniority of the loan in the issuer's capital structure for the years ended December 31, 2011 and 2010 (amounts in thousands):

Internally Assigned Grade	Capital Hierarchy	Recorded Investment December 31, 2011(1)		Recorded Investment December 31, 2010(1)

High	Senior Secured Loan	$	926,258	$	945,435
	Second Lien Loan		310,971		389,981
	Subordinated		14,392		—

		$	1,251,621	$	1,335,416

Moderate	Senior Secured Loan	$	645,939	$	494,433
	Second Lien Loan		—		38,448
	Subordinated		6,951		4,431

		$	652,890	$	537,312

Low	Senior Secured Loan	$	4,184,094	$	3,829,458
	Second Lien Loan		65,695		137,182
	Subordinated		111,240		101,450

		$	4,361,029	$	4,068,090

	Total Unallocated	$	6,265,540	$	5,940,818
	Total Allocated		68,692		149,785

	Total Loans Held for Investment	$	6,334,232	$	6,090,603

During the years ended December 31, 2011, 2010 and 2009, the Company recorded charge-offs totaling $31.8 million, $57.4 million and $283.3 million, respectively, comprised primarily of loans transferred to loans held for sale.

As of December 31, 2011, the Company had $317.3 million of loans held for sale, a decrease of $146.3 million from December 31, 2010 due to the sale of certain loans and the transfer of loans to held for investment for those the Company determined it no longer had the intention of selling. The Company recorded a $65.2 million net charge to earnings during the year ended December 31, 2011 for the lower of cost or estimated fair value adjustment for certain loans held for sale which had a carrying value of $317.3 million as of December 31, 2011. The Company recorded a $14.7 million and $51.0 million net charge to earnings during the years ended December 31, 2010 and 2009, respectively, for the lower of cost or estimated fair value adjustment for certain loans held for sale.

During the year ended December 31, 2011, the Company transferred $862.2 million amortized cost amount of loans from held for investment to held for sale. During the year ended December 31, 2010, the Company transferred $1.1 billion amortized cost amount of loans from held for investment to held for sale. The transfers of certain loans to held for sale were due to the Company's determination that credit quality of a loan in relation to its expected risk-adjusted return no longer met the Company's investment objective and the determination by the Company to reduce or eliminate the exposure for

certain loans as part of its portfolio risk management practices. Also, during the year ended December 31, 2011, the Company transferred $448.3 million amortized cost amount from loans held for sale back to loans held for investment as the circumstances that led to the initial transfer to held for sale were no longer present. Also, during the year ended December 31, 2010, the Company transferred $437.7 million amortized cost amount from loans held for sale back to loans held for investment as the circumstances that led to the initial transfer to held for sale were no longer present. Such circumstances include deteriorated market conditions often resulting in price depreciation or assets becoming illiquid, changes in restrictions on sales and certain loans amending their terms to extend the maturity, whereby the Company determined that selling the asset no longer met its investment objective and strategy.

As of December 31, 2011, the Company had no corporate loans in default. As of December 31, 2010, the Company held loans that were in default with a total amortized cost of $18.6 million from one issuer. The majority of corporate loans in default during 2010 were included in the loans for which the allocated component of the Company's allowance for losses was related to, or for which the Company determined were loans held for sale as of December 31, 2010.

During the year ended December 31, 2011, the Company modified $11.2 million amortized cost of one corporate loan that qualified as a troubled debt restructuring and resulted in the Company recording an $0.8 million loss. This modification involved the restructuring of a debt instrument to equity investment, resulting in a new asset. There were no modifications of any corporate loans that qualified as troubled debt restructurings during the year ended December 31, 2010.

During the years ended December 31, 2011 and 2010, the Company modified $1.3 billion and $1.0 billion amortized cost of corporate loans, respectively, that did not qualify as troubled debt restructurings. These modifications involved changes in existing rates and maturities to prevailing market rates/maturities for similar instruments and did not qualify as troubled debt restructurings as the respective borrowers were neither experiencing financial difficulty nor were seeking (nor granted) a concession as part of the modification. In addition, these modifications of non-troubled debt holdings were accomplished with modified loans that were not substantially different from the loans prior to modification.

The Company's corporate loan portfolio has certain credit risk concentrated in a limited number of issuers. As of December 31, 2011, approximately 47% of the total amortized cost basis of the Company's corporate loan portfolio was concentrated in twenty issuers, with the three largest concentrations of corporate loans in loans issued by U.S. Foodservice, Texas Competitive Electric Holdings Company LLC and Modular Space Corporation, which combined represented $992.5 million, or approximately 15% of the aggregated amortized cost basis of the Company's corporate loans. As of December 31, 2010, approximately 51% of the total amortized cost basis of the Company's corporate loan portfolio was concentrated in twenty issuers, with the three largest concentrations of corporate loans in loans issued by Texas Competitive Electric Holdings Company LLC, Modular Space

Corporation and U.S. Foodservice, which combined represented $1.1 billion, or approximately 16% of the aggregated amortized cost basis of the Company's corporate loans.

Note 7 to these consolidated financial statements describes the Company's borrowings under which the Company has pledged loans for borrowings. The following table summarizes the amortized cost of corporate loans and corporate loans held for sale pledged as collateral as of December 31, 2011 and 2010 (amounts in thousands):

As of December 31, 2011, no corporate loans, at estimated fair value were pledged as collateral for the Company's borrowings.

On January 1, 2010, the Company deconsolidated six residential mortgage securitization trusts as a result of the Company's adoption of new accounting guidance regarding the consolidation model for variable interest entities. The Company has no exposure to loss in excess of the estimated fair value of the $74.4 million RMBS which were issued by these six residential mortgage securitization trusts.

The following information represents the assets and liabilities removed from the Company's consolidated balance sheet as of January 1, 2010 as a result of the deconsolidation of the six residential mortgage loan securitization trusts (amounts in thousands):

Note 6. Deconsolidation of Residential Mortgage Loans Securitization Trusts (Continued)

As a result of the deconsolidation of the six residential mortgage loan securitization trusts, all references to residential mortgage loans interest income, residential mortgage-backed securities issued ("RMBS Issued") interest expense, net realized and unrealized gain (loss) on residential mortgage loans and RMBS Issued, and loan servicing expense relate to prior period balances and activities.

The Company carried its residential mortgage loans at estimated fair value with unrealized gains and losses reported in income. The Company had elected the fair value option for its residential mortgage loans for the purpose of enhancing the transparency of its financial condition as fair value was consistent with how the Company managed the risks of its residential mortgage investments.

RMBS Issued consisted of the senior tranches of six residential mortgage loan securitization trusts that the Company previously consolidated under GAAP and for which the Company reported the debt issued by these trusts that it did not hold on its consolidated balance sheets. The Company carried RMBS Issued at estimated fair value with unrealized gains and losses reported in income. The Company elected the fair value option for its RMBS Issued for the purpose of enhancing the transparency of its financial condition as fair value was consistent with how the Company managed the risks of its residential mortgage portfolio.

Certain information with respect to the Company's borrowings as of December 31, 2011 is summarized in the following table (dollar amounts in thousands):

	Outstanding Borrowings					Fair Value of Collateral(1)

CLO 2005-1 senior secured notes	$	715,354	0.75	%	1,943	$	798,876
CLO 2005-2 senior secured notes		745,226	0.83		2,157		870,712
CLO 2006-1 senior secured notes		683,265	0.87		2,429		884,873
CLO 2007-1 senior secured notes		2,075,040	1.01		3,423		2,343,420
CLO 2007-1 junior secured notes(2)		61,491	—		3,423		69,444
CLO 2007-A senior secured notes		812,318	1.36		2,115		900,660
CLO 2007-A junior secured notes(3)		10,821	—		2,115		11,997
CLO 2011-1 senior debt		436,522	1.77		2,419		557,389

Total collateralized loan obligation secured debt		5,540,037					6,437,371
CLO 2007-1 junior secured notes to affiliates(4)		300,396	—		3,423		337,407
CLO 2007-A junior secured notes to affiliates(5)		65,452	—		2,115		72,570

Total collateralized loan obligation junior secured notes to affiliates		365,848					409,977
Senior secured credit facility		—	3.83		854		—
Asset-based borrowing facility(6)		38,300	2.53		1,405		86,874

Total credit facilities		38,300					86,874
7.0% Convertible senior notes		135,086	7.00		197		—
7.5% Convertible senior notes		164,744	7.50		1,842		—
Senior notes		250,676	8.38		10,912		—
Junior subordinated notes		283,517	5.48		9,078		—

Total borrowings	$	6,778,208				$	6,934,222

Certain information with respect to the Company's borrowings as of December 31, 2010 is summarized in the following table (dollar amounts in thousands):

	Outstanding Borrowings					Fair Value of Collateral(1)

CLO 2005-1 senior secured notes	$	833,220	0.61	%	2,308	$	898,017
CLO 2005-2 senior secured notes		801,323	0.60		2,522		887,573
CLO 2006-1 senior secured notes		683,265	0.66		2,794		845,342
CLO 2007-1 senior secured notes		2,075,040	0.84		3,788		2,452,442
CLO 2007-1 junior secured notes(2)		61,504	—		3,788		72,689
CLO 2007-A senior secured notes		1,165,099	1.18		2,480		1,218,688
CLO 2007-A junior secured notes(3)		10,821	—		2,480		11,318

Total collateralized loan obligation secured debt		5,630,272					6,386,069
CLO 2007-1 junior secured notes to affiliates(4)		300,672	—		3,788		353,430
CLO 2007-A junior secured notes to affiliates(5)		65,452	—		2,480		68,462

Total collateralized loan obligation junior secured notes to affiliates		366,124					421,892
Senior secured credit facility		—	3.51		1,219		—
Asset-based borrowing facility(6)		18,400	2.76		1,770		32,760

Total credit facilities		18,400					32,760
7.0% Convertible senior notes		180,577	7.00		562		—
7.5% Convertible senior notes		163,565	7.50		2,207		—
Junior subordinated notes		283,517	5.42		9,443		—

Total borrowings	$	6,642,455				$	6,840,721

contractual coupon rate, but instead receive a pro rata amount of the net distributions from CLO 2007-1.

(3): CLO 2007-A junior secured notes consist of $6.2 million of mezzanine notes with a weighted average borrowing rate of 7.0% and $4.6 million of subordinated notes that do not have a contractual coupon rate, but instead receive a pro rata amount of the net distributions from CLO 2007-A.
(4): CLO 2007-1 junior secured notes to affiliates consist of $170.4 million of mezzanine notes with a weighted average borrowing rate of 5.1% and $130.3 million of subordinated notes that do not have a contractual coupon rate, but instead receive a pro rata amount of the net distributions from CLO 2007-1.
(5): CLO 2007-A junior secured notes to affiliates consist of $55.0 million of mezzanine notes with a weighted average borrowing rate of 6.4% and $10.5 million of subordinated notes that do not have a contractual coupon rate, but instead receive a pro rata amount of the net distributions from CLO 2007-A.
(6): Collateral for borrowings consists of oil and gas assets purchased during the fourth quarter of 2010 for an aggregate purchase price of approximately $32.8 million, whereby no impairment was deemed to exist. These oil and gas assets are included in other assets in the consolidated balance sheets of $32.8 million.

The indentures governing the Company's CLO transactions stipulate the reinvestment period during which the collateral manager, which is an affiliate of the Company's Manager, can generally sell or buy assets at its discretion and can reinvest principal proceeds into new assets. CLO 2007-A ended its reinvestment period during the fourth quarter of 2010 and both CLO 2005-1 and CLO 2005-2 ended their reinvestment periods in the second quarter of 2011. As a result, principal proceeds from the assets held in each of these transactions are generally used to amortize the outstanding balance of senior notes outstanding. During the year ended December 31, 2011, $528.2 million of original CLO 2007-A, CLO 2005-1 and CLO 2005-2 senior notes were repaid. CLO 2006-1 and CLO 2007-1 will end their respective reinvestment periods during August 2012 and May 2014, respectively. CLO 2011-1 does not have a reinvestment period and all principal proceeds from holdings in CLO 2011-1 will be used to amortize the transaction. During the year ended December 31, 2011, $2.9 million of original CLO 2011-1 senior notes were repaid.

The indentures governing the Company's CLO transactions include numerous compliance tests, the majority of which relate to the CLO's portfolio profile. In the event that a portfolio profile test is not met, the indenture places restrictions on the ability of the CLO's manager to reinvest available principal proceeds generated by the collateral in the CLOs until the specific test has been cured. In addition to the portfolio profile tests, the indentures for the CLO transactions include over-collateralization tests ("OC Tests") which set the ratio of the collateral value of the assets in the CLO to the tranches of debt for which the test is being measured, as well as interest coverage tests. If a CLO is not in compliance with an OC Test or an interest coverage test, cash flows normally payable to the holders of junior classes of notes will be used by the CLO to amortize the most senior class of notes until such point as the OC test is brought back into compliance. During the year ended

December 31, 2010, the Company paid down $90.3 million of original CLO 2007-1 senior secured notes, due to the failure of OC Tests. As of December 31, 2011, all of the Company's CLO transactions were in compliance with their respective OC and interest coverage tests.

During the first quarter of 2010, in an open market auction, the Company purchased $10.3 million of mezzanine notes issued by CLO 2007-A for $5.5 million and $72.7 million of mezzanine and subordinate notes issued by CLO 2007-1 for $38.8 million, both of which were previously held by an affiliate of the Company's manager. These transactions resulted in the Company recording an aggregate gain on extinguishment of debt totaling $38.7 million during 2010.

On March 31, 2011, the Company closed CLO 2011-1, a $400.0 million secured financing transaction secured by the assets held in CLO 2011-1. At closing, the Company entered into a senior loan agreement (the "CLO 2011-1 Agreement") through which CLO 2011-1 was able to borrow up to $300.0 million through a non-recourse loan secured by the assets held in CLO 2011-1. On July 6, 2011, the Company amended the CLO 2011-1 Agreement to upsize the transaction to $600.0 million, whereby CLO 2011-1 is able to borrow up to an additional $150.0 million, or total of $450.0 million. Under the amended CLO 2011-1 Agreement, the CLO 2011-1 senior loan matures on August 15, 2018 and borrowings under the CLO 2011-1 Agreement bear interest at a rate of the three-month London interbank offered rate ("LIBOR") plus 1.35%. As of December 31, 2011, the Company had $436.5 million of borrowings outstanding under the CLO 2011-1 Agreement.

On May 3, 2010, the Company entered into a credit agreement for a four-year $210.0 million asset-based revolving credit facility (the "2014 Facility"), maturing on May 3, 2014, that is subject to, among other things, the terms of a borrowing base derived from the value of eligible specified financial assets. The borrowing base is subject to certain caps and concentration limits customary for financings of this type. The Company may obtain additional commitments under the 2014 Facility so long as the aggregate amount of commitments at any time does not exceed $600.0 million. On May 5, 2010, the Company obtained additional commitments of $40.0 million, bringing the total amount of commitments under the 2014 Facility to $250.0 million.

The Company has the right to prepay loans under the 2014 Facility in whole or in part at any time. Loans under the 2014 Facility bear interest at a rate equal to LIBOR plus 3.25% per annum. The 2014 Facility contains customary covenants applicable to the Company, including a restriction from making distributions to holders of common shares in excess of 65% of the Company's estimated annual taxable income calculated in accordance with the 2014 Facility credit agreement.

As of December 31, 2011, the Company had no borrowings outstanding under the 2014 Facility.

On November 5, 2010, the Company entered into a credit agreement for a five-year $49.7 million non-recourse, asset-based revolving credit facility (the "2015 Natural Resources Facility"), maturing on November 5, 2015, that is subject to, among other things, the terms of a borrowing base derived from the value of eligible specified oil and gas assets. The borrowing base is subject to certain caps and concentration limits customary for financings of this type. The Company has the right to prepay loans

under the 2015 Natural Resources Facility in whole or in part at any time. Loans under the 2015 Natural Resources Facility bear interest at a rate equal to LIBOR plus a tiered applicable margin ranging from 1.75% to 2.75% per annum. The 2015 Natural Resources Facility contains customary covenants applicable to the Company.

On May 13, 2011, the Company entered into an amendment to the 2015 Natural Resources Facility, increasing the commitment from $49.7 million to $81.1 million.

As of December 31, 2011, the Company had $38.3 million of borrowings outstanding under the 2015 Natural Resources Facility. In addition, under the 2015 Natural Resources Facility, the Company had a letter of credit outstanding totaling $1.0 million.

As of December 31, 2011, the Company believes it was in compliance with the covenant requirements for both credit facilities.

On January 15, 2010, the Company issued $172.5 million of 7.5% convertible senior notes due January 15, 2017 ("7.5% Notes"). The 7.5% Notes bear interest at a rate of 7.5% per annum on the principal amount, accruing from January 15, 2010. Interest is payable semiannually in arrears on January 15 and July 15 of each year, beginning on July 15, 2010. The 7.5% Notes will mature on January 15, 2017 unless previously redeemed, repurchased or converted in accordance with their terms prior to such date. Holders of the 7.5% Notes may convert their notes at the applicable conversion rate at any time prior to the close of business on the business day immediately preceding the stated maturity date subject to the Company's right to terminate the conversion rights of the notes. The Company may satisfy its obligation with respect to the 7.5% Notes tendered for conversion by delivering to the holder either cash, common shares, no par value, issued by the Company or a combination thereof. The initial conversion rate for each $1,000 principal amount of 7.5% Notes was 122.2046 common shares, which is equivalent to an initial conversion price of approximately $8.18 per share. The conversion rate is adjusted under certain circumstances, including the occurrence of certain fundamental change transactions and the payment of a quarterly cash distribution in excess of $0.05 per share, but will not be adjusted for accrued and unpaid interest on the 7.5% Notes. As of December 31, 2011, the conversation rate for each $1,000 principal amount of 7.5% Notes was 132.1235 common shares. Net proceeds from the offering totaled $167.3 million, reflecting gross proceeds of $172.5 million from the issuance less $5.2 million for underwriting fees.

In accordance with accounting for convertible debt instruments that may be settled in cash upon conversion, the Company separately accounted for the liability and equity components to reflect the nonconvertible debt borrowing rate. The Company determined that the equity component of the 7.5% Notes totaled $10.0 million and is included in paid-in-capital on the Company's consolidated balance sheet as of December 31, 2011. The remaining liability component of $164.7 million, included within convertible senior notes on the Company's consolidated balance sheet as of December 31, 2011, is comprised of the principal $172.5 million less the unamortized debt discount of $7.8 million. The total debt discount amortization recognized for the year ended December 31, 2011 was $1.2 million. The debt discount will continue to be amortized at the effective interest rate of 8.6%. For the year ended December 31, 2011, the total interest expense recognized on the 7.5% Notes was $12.9 million.

During the second half of 2011, the Company repurchased $45.5 million par amount of its 7.0% convertible senior notes due July 15, 2012 (the "7.0% Notes"). These transactions resulted in the Company recording a loss of $1.7 million and a write-off of $0.1 million of unamortized debt issuance costs. As of December 31, 2011, the Company had committed to purchase an additional $0.8 million par amount of its 7.0% Notes. The 7.0% Notes are convertible into the Company's common shares at a conversion price of $31.00. This conversion rate for each $1,000 principal amount of 7.0% Notes is 32.2581 of the Company's common shares.

During the first quarter of 2010, the Company repurchased $95.2 million par amount of its 7.0% Notes. These transactions resulted in the Company recording a gain of $1.3 million, which was partially offset by a write-off of $0.6 million of unamortized debt issuance costs during 2010.

On November 15, 2011, the Company issued $258.8 million par amount of 8.375% Senior Notes due November 15, 2041 ("8.375% Notes"), resulting in net proceeds of $250.7 million. Interest on the 8.375% Notes will be paid quarterly in arrears on February 15, May 15, August 15 and November 15 of each year, beginning February 15, 2012.

The table below summarizes the Company's contractual obligations (excluding interest) under borrowing agreements as of December 31, 2011 (amounts in thousands):

	Payments Due by Period

	Total		Less than 1 year		1 - 3 years		3 - 5 years		More than 5 years
CLO 2005-1 senior secured notes	$	718,537	$	—	$	—	$	—	$	718,537
CLO 2005-2 senior secured notes		750,067		—		—		—		750,067
CLO 2006-1 senior secured notes		683,265		—		—		—		683,265
CLO 2007-1 senior secured notes		2,075,040		—		—		—		2,075,040
CLO 2007-1 junior secured notes		61,491		—		—		—		61,491
CLO 2007-A senior secured notes		812,318		—		—		—		812,318
CLO 2007-A junior secured notes		10,821		—		—		—		10,821
CLO 2011-1 senior debt		436,522		—		—		—		436,522
CLO 2007-1 junior secured notes to affiliates		300,396		—		—		—		300,396
CLO 2007-A junior secured notes to affiliates		65,452		—		—		—		65,452
Asset-based borrowing facility(1)		39,293		993		—		38,300		—
Convertible senior notes(2)		307,586		135,086		—		—		172,500
Senior notes(3)		258,750		—		—		—		258,750
Junior subordinated notes		283,517		—		—		—		283,517

Total	$	6,803,055	$	136,079	$	—	$	38,300	$	6,628,676

The remaining contractual maturities in the table above were allocated assuming no prepayments and represent the principal amount of all notes, excluding any discount. Expected maturities may differ from contractual maturities because the Company, as the borrower, may have the right to call or prepay certain obligations, with or without call or prepayment penalties.

The Company enters into derivative transactions in order to hedge its interest rate risk exposure to the effects of interest rate changes. Additionally, the Company enters into derivative transactions in the course of its portfolio management activities. The counterparties to the Company's derivative agreements are major financial institutions with which the Company and its affiliates may also have other financial relationships. In the event of nonperformance by the counterparties, the Company is potentially exposed to losses. The counterparties to the Company's derivative agreements have investment grade ratings and, as a result, the Company does not anticipate that any of the counterparties will fail to fulfill their obligations.

The table below summarizes the aggregate notional amount and estimated net fair value of the derivative instruments as of December 31, 2011 and December 31, 2010 (amounts in thousands):

	As of December 31, 2011						As of December 31, 2010

	Notional			Estimated Fair Value			Notional			Estimated Fair Value
Cash Flow Hedges:
Interest rate swaps	$	508,333		$	(100,718	)	$	483,333		$	(58,365	)
Free-Standing Derivatives:
Commodity swaps		—			7,371			—			(226	)
Credit default swaps—protection sold		33,500			(7,177	)		13,500			492
Total rate of return swaps		—			152			—			104
Foreign exchange forward contracts		(234,524	)		(12,224	)		(154,405	)		(17,296	)
Foreign exchange options		130,207			13,394			130,207			14,791
Common stock warrants		—			2,332			—			3,453

Total	$	437,516		$	(96,870	)	$	472,635		$	(57,047	)

The Company uses interest rate derivatives consisting of swaps to hedge a portion of the interest rate risk associated with its borrowings under CLO senior secured notes as well as certain of its floating rate junior subordinated notes. The Company designates these financial instruments as cash flow hedges.

In September 2011, the Company entered into a $25.0 million notional pay-fixed, receive-variable interest rate swap. In June 2010, the Company entered into a $100.0 million notional pay-fixed, receive-variable interest rate swap. These swaps have been designated as cash flow hedges, the objective of which is to eliminate the variability of cash flows in the interest payments of the Company's floating rate junior subordinated notes debt due to fluctuations in the indexed rate. Changes in value of the interest rate swap are recorded through other comprehensive (loss) income, with gains or losses representing hedge ineffectiveness, if any, recognized in earnings during the reporting period. The hedged transaction period is through July 2037 for the $25.0 million interest rate swap and October 2036 for the $100.0 million interest rate swap; both dates are the stated maturities of the applicable floating rate junior subordinated debt.

The following table shows the net (losses) gains recognized in other comprehensive (loss) income related to derivatives in cash flow hedging relationships for the years ended December 31, 2011, 2010 and 2009 (amounts in thousands):

Free-standing derivatives are derivatives that the Company has entered into in conjunction with its investment and risk management activities, but for which the Company has not designated the derivative contract as a hedging instrument for accounting purposes. Such derivative contracts may include credit default swaps ("CDS"), foreign exchange contracts and options, interest rate swaps and commodity derivatives. Free-standing derivatives also include investment financing arrangements (total rate of return swaps) whereby the Company receives the sum of all interest, fees and any positive change in fair value amounts from a reference asset with a specified notional amount and pays interest on such notional amount plus any negative change in fair value amounts from such reference asset.

Gains and losses on free-standing derivatives are reported on the consolidated statements of operations in net realized and unrealized (loss) gain on derivatives and foreign exchange. Unrealized (losses) gains represent the change in fair value of the derivative instruments and are noncash items.

A CDS is a contract in which the contract buyer pays, in the case of a short position, or receives, in the case of long position, a periodic premium until the contract expires or a credit event occurs. In return for this premium, the contract seller receives a payment from or makes a payment to the buyer if there is a credit default or other specified credit event with respect to the issuer (also known as the referenced entity) of the underlying credit instrument referenced in the CDS. Typical credit events include bankruptcy, dissolution or insolvency of the referenced entity, failure to pay and restructuring of the obligations of the referenced entity.

As of December 31, 2011 and 2010, the Company had sold protection with a notional amount of $33.5 million and $13.5 million, respectively. The Company sells protection to replicate fixed income

securities and to complement the spot market when cash securities of the referenced entity of a particular maturity are not available or when the derivative alternative is less expensive compared to other purchasing alternatives.

The following table shows the net realized gains on the Company's CDS for the years ended December 31 2011, 2010 and 2009 (amounts in thousands):

In an effort to minimize the effects of the volatility of oil, natural gas and natural gas liquids prices, the Company will from time to time, enter into derivative instruments such as swap contracts to hedge its forecasted commodities sales. The Company does not designate these contracts as cash flow hedges and as such, the changes in fair value of these instruments are recorded in current period earnings.

The Company entered into commodity derivative contracts, consisting of oil, natural gas and certain natural gas liquid products receive fixed, pay-floating swaps for certain years through 2015. Realized gains (losses) represent amounts related to the settlement of derivative instruments, and for commodity derivatives, are aligned with the underlying protection. For both years ended December 31, 2011 and 2010, the Company had an immaterial amount of commodity derivatives settlements, which are settled monthly.

The following table summarizes by derivative instrument type the effect on income from free-standing derivatives for the years ended December 31, 2011, 2010 and 2009 (amounts in thousands):

Free-Standing Derivatives:	For the year ended December 31, 2011			For the year ended December 31, 2010			For the year ended December 31, 2009

Interest rate swaps	$	—		$	311		$	(3,328	)
Commodity swaps		7,948			(226	)		—
Credit default swaps—protection sold		(6,030	)		1,970			17,632
Total rate of return swaps		49			1,771			45,607
Foreign exchange forward contracts		5,072			(17,296	)		(255	)
Foreign exchange options		(1,398	)		14,630			—
Common stock warrants		(890	)		663			457

Net realized and unrealized gains on free-standing derivatives	$	4,751		$	1,823		$	60,113

For all hedges where hedge accounting is being applied, effectiveness testing and other procedures to ensure the ongoing validity of the hedges are performed at least quarterly. During the years ended

December 31, 2011, 2010 and 2009, the Company recognized an immaterial amount of ineffectiveness in income on the consolidated statements of operations from its cash flow and fair value hedges.

The components of accumulated other comprehensive (loss) income were as follows (amounts in thousands):

The components of changes in other comprehensive (loss) income were as follows (amounts in thousands):

	Year ended December 31, 2011			Year ended December 31, 2010			Year ended December 31, 2009

Unrealized (losses) gains on securities available-for-sale:
Unrealized (losses) gains arising during period	$	(30,799	)	$	74,521		$	357,535
Reclassification adjustments for (gains) losses realized in net income(1)		(96,092	)		(79,718	)		29,236

Unrealized (losses) gains on securities available-for-sale		(126,891	)		(5,197	)		386,771

Unrealized (losses) gains on cash flow hedges:
Unrealized (losses) gains arising during period		(42,324	)		(13,935	)		34,739

Unrealized (losses) gains on cash flow hedges		(42,324	)		(13,935	)		34,739

Total other comprehensive (loss) income	$	(169,215	)	$	(19,132	)	$	421,510

As part of its strategy of investing in corporate loans, the Company commits to purchase interests in primary market loan syndications, which obligate the Company to acquire a predetermined interest in such loans at a specified price on a to-be-determined settlement date. Consistent with standard industry practices, once the Company has been informed of the amount of its syndication allocation in a particular loan by the syndication agent, the Company bears the risks and benefits of changes in the

fair value of the syndicated loan from that date forward. As of December 31, 2011 and 2010, the Company had committed to purchase corporate loans with aggregate commitments totaling $97.2 million and $90.9 million, respectively. The Company also participates in certain contingent financing arrangements, whereby the Company is committed to provide funding of up to a specific amount at the discretion of the borrower. As of December 31, 2011 and 2010, the Company had unfunded financing commitments for loans totaling $8.1 million and $31.6 million, respectively. In addition, as of December 31, 2011 and 2010, the Company had unfunded financing commitments for private equity investments totaling $40.9 million and $13.1 million, respectively. The Company did not have any material losses as of December 31, 2011, nor does it expect material losses related to those assets for which it committed to purchase and fund.

In December 2010, the Company completed an underwritten public offering of 19,436,000 common shares at a price of $9.04, resulting in net proceeds of $175.7 million.

On May 4, 2007, the Company adopted an amended and restated share incentive plan (the "2007 Share Incentive Plan") that provides for the grant of qualified incentive common share options that meet the requirements of Section 422 of the Code, non-qualified common share options, share appreciation rights, restricted common shares and other share-based awards. The Compensation Committee of the board of directors administers the plan. Share options and other share-based awards may be granted to the Manager, directors, officers and any key employees of the Manager and to any other individual or entity performing services for the Company.

The exercise price for any share option granted under the 2007 Share Incentive Plan may not be less than 100% of the fair market value of the common shares at the time the common share option is granted. Each option to acquire a common share must terminate no more than ten years from the date it is granted. As of December 31, 2011, the 2007 Share Incentive Plan authorizes a total of 8,589,625 shares that may be used to satisfy awards under the 2007 Share Incentive Plan. On January 21, 2011, the Compensation Committee of the board of directors granted the Manager 240,845 restricted common shares subject to graded vesting over four years with the final vesting date of March 1, 2015. On August 9, 2011, the non-employee members of the board of directors were granted 50,566 restricted common shares subject to graded vesting over three years with the final vesting date of August 9, 2014.



Unvested shares as of January 1, 2009	1,097,000		66,282		1,163,282
Issued	—		220,519		220,519
Vested	—		(31,183	)	(31,183	)

Unvested shares as of December 31, 2009	1,097,000		255,618		1,352,618
Issued	—		52,808		52,808
Vested	—		(95,822	)	(95,822	)

Unvested shares as of December 31, 2010	1,097,000		212,604		1,309,604
Issued	240,845		50,566		291,411
Vested	(1,097,000	)	(92,903	)	(1,189,903	)
Cancelled	—		(24,591	)	(24,591	)

Unvested shares as of December 31, 2011	240,845		145,676		386,521

The restricted common shares granted to the directors were valued using the fair value at the time of grant, which was $7.91 and $8.90 and $2.79 per share, for the restricted common shares granted in 2011, 2010 and 2009, respectively. The Company is required to value any unvested restricted common shares granted to the Manager at the current market price. The Company valued the unvested restricted common shares granted to the Manager at $8.73, $9.30 and $5.80 per share at December 31, 2011, 2010 and 2009, respectively. There were $2.1 million, $1.3 million, and $3.0 million of total unrecognized compensation costs related to unvested restricted common shares granted as of December 31, 2011, 2010 and 2009, respectively. These costs are expected to be recognized over the next three years.

		Weighted Average Exercise Price

Outstanding as of January 1, 2009	1,932,279	$	20.00
Granted	—		—
Exercised	—		—
Forfeited	—		—

Outstanding as of December 31, 2009	1,932,279	$	20.00
Granted	—		—
Exercised	—		—
Forfeited	—		—

Outstanding as of December 31, 2010	1,932,279	$	20.00
Granted	—		—
Exercised	—		—
Forfeited	—		—

Outstanding as of December 31, 2011	1,932,279	$	20.00

As of December 31, 2011, 2010 and 2009, 1,932,279 common share options were exercisable. As of December 31, 2011, the common share options were fully vested and expire in August 2014. For the

years ended December 31, 2011, 2010 and 2009, the components of share-based compensation expense are as follows (amounts in thousands):

The Manager manages the Company's day-to-day operations, subject to the direction and oversight of the Company's board of directors. The Management Agreement expires on December 31 of each year, but is automatically renewed for a one-year term each December 31 unless terminated upon the affirmative vote of at least two-thirds of the Company's independent directors, or by a vote of the holders of a majority of the Company's outstanding common shares, based upon (1) unsatisfactory performance by the Manager that is materially detrimental to the Company or (2) a determination that the management fee payable by the Manager is not fair, subject to the Manager's right to prevent such a termination under this clause (2) by accepting a mutually acceptable reduction of management fees. The Manager must be provided 180 days prior notice of any such termination and will be paid a termination fee equal to four times the sum of the average annual base management fee and the average annual incentive fee for the two 12-month periods immediately preceding the date of termination, calculated as of the end of the most recently completed fiscal quarter prior to the date of termination.

The Management Agreement contains certain provisions requiring the Company to indemnify the Manager with respect to all losses or damages arising from acts not constituting bad faith, willful misconduct, or gross negligence. The Company has evaluated the impact of these guarantees on its consolidated financial statements and determined that they are not material.

For the year ended December 31, 2011, the Company incurred $26.3 million in base management fees. As of December 31, 2011, the Company had $2.3 million base management fee payable to the Manager. In addition, the Company recognized share-based compensation expense related to restricted common shares granted to the Manager of $2.4 million for the year ended December 31, 2011 (see Note 11). For the year ended December 31, 2010, the Company incurred $19.1 million in base management fees. In addition, the Company recognized share-based compensation expense related to restricted common shares granted to the Manager of $5.8 million for the year ended December 31, 2010 (see Note 11). For the year ended December 31, 2009, the Company incurred $14.9 million in base management fees. In addition, the Company recognized share-based compensation expense related to restricted common shares granted to the Manager of $3.5 million for the year ended December 31, 2009 (see Note 11).

Base management fees incurred and share-based compensation expense relating to common share options and restricted common shares granted to the Manager are included in related party management compensation on the consolidated statements of operations. Expenses incurred by the Manager and reimbursed by the Company are reflected in the respective consolidated statements of operations, non-investment expense category based on the nature of the expense.

The Manager is waiving base management fees related to the $230.4 million common share offering and $270.0 million common share rights offering that occurred during the third quarter of 2007 until such time as the Company's common share closing price on the NYSE is $20.00 or more for five consecutive trading days. Accordingly, the Manager permanently waived approximately $8.8 million of base management fees during each of the years ended December 31, 2011, 2010 and 2009.

For the year ended December 31, 2011, the Manager earned $34.2 million of incentive fees. As of December 31, 2011, the Company had $6.0 million incentive fee payable to the Manager. Incentive fees are included in related party management compensation on the Company's consolidated statement of operations. Incentive fees of $38.8 million and $4.5 million were earned by the Manager during the years ended December 31, 2010 and 2009, respectively. Of the $38.8 million of incentive fees earned for the year ended December 31, 2010, the Manager permanently waived payment of $9.7 million of incentive fees that were related to the $38.7 million gain recorded by the Company as a result of the repurchase of $83.0 million of mezzanine and subordinate notes issued by CLO 2007-1 and CLO 2007-A during the quarter ended March 31, 2010. Incentive fees are included in related party management compensation on the Company's consolidated statement of operations.

An affiliate of the Manager entered into separate management agreements with the respective investment vehicles for CLO 2005-1, CLO 2005-2, CLO 2006-1, CLO 2007-1, CLO 2007-A, CLO 2009-1 and CLO 2011-1 and is entitled to receive fees for the services performed as collateral manager for all of these CLOs, except for CLO 2009-1 and CLO 2011-1. The collateral manager has the option to waive the fees it earns for providing management services for the CLO.

Beginning April 2007, the collateral manager ceased waiving fees for CLO 2005-1 and beginning January 2009, the collateral manager ceased waiving fees for CLO 2005-2, CLO 2006-1, CLO 2007-1, CLO 2007-A and Wayzata Funding LLC (restructured and replaced with CLO 2009-1 on March 31, 2009). However, starting in July 2009, the collateral manager reinstated waiving the CLO management fees for CLO 2005-2 and CLO 2006-1 and starting in 2010, the collateral manager reinstated waiving the CLO management fees for CLO 2007-A and CLO 2007-1. Due to the deleveraging of CLO 2009-1 completed in July 2009 whereby all the senior notes were retired, the collateral manager is no longer entitled to receive fees for CLO 2009-1. As such, the CLO management fees for all CLOs, except for CLO 2005-1, are being waived or are no longer entitled to be received as of December 31, 2011.

The aggregate amounts waived are inversely related to the total CLO management fees recorded. Accordingly, for the years ended December 31, 2011, 2010 and 2009, the collateral manager waived aggregate CLO management fees of $34.0 million, $30.6 million and $5.2 million, respectively, while for the years ended December 31, 2011, 2010 and 2009, the Company recorded an expense for CLO management fees totaling $5.3 million, $5.4 million and $21.5 million, respectively.

Beginning January 2009, the Manager permanently waived reimbursable general and administrative expenses allocable to the Company in an amount equal to the incremental CLO management fees received by the Manager. For the years ended December 31, 2010 and 2009, the Manager permanently waived reimbursement of allocable general and administrative expenses totaling $2.4 million and $9.8 million, respectively. Due to the reinstatement of waived CLO management fees described above, effective June 2010, all incremental CLO management fees received by the Manager had been fully applied to offset these reimbursable expenses. Accordingly, for the years ended December 31, 2011 and 2010, the Company reimbursed the Manager for allocable general and administrative expenses of $8.2 million and $4.6 million, respectively. For the year ended December 31, 2009, the Company did not reimburse the Manager for any allocable general and administrative and other expenses.

The Company has invested in corporate loans, debt securities, and other investments of entities that are affiliates of KKR. As of December 31, 2011, the aggregate par amount of these affiliated investments totaled $2.4 billion, or approximately 29% of the total investment portfolio, and consisted of 28 issuers. The total $2.4 billion in affiliated investments was comprised of $2.2 billion of corporate loans, $168.1 million of corporate debt securities and $62.0 million of equity investments, at estimated fair value. As of December 31, 2010, the aggregate par amount of these affiliated investments totaled $2.4 billion, or approximately 30% of the total investment portfolio, and consisted of 27 issuers. The total $2.4 billion in affiliated investments was comprised of $2.1 billion of corporate loans, $314.2 million of corporate debt securities and $25.6 million of equity investments, at estimated fair value.

The Company intends to continue to operate so as to qualify, for United States federal income tax purposes, as a partnership, and not as an association or publicly traded partnership taxable as a corporation. As such, the Company generally is not subject to United States federal income tax at the entity level, but is subject to limited state and foreign taxes.

The Company owns both REIT and domestic taxable corporate subsidiaries. The Company's REIT subsidiary is not expected to incur federal tax expense but is subject to limited state income tax expense related to the 2011 tax year. The domestic taxable corporate subsidiaries taxed as regular corporations under the Code are expected to incur federal and state tax expense related to the 2011 tax year. The Company owns an interest in several foreign subsidiaries that from time to time generate income that is subject to state tax and United States tax withholding. The Company also owns foreign investments that generate income that is subject to foreign tax withholding. The income tax provision for the years

ended December 31, 2011, 2010 and 2009 consisted of the following components (amounts in thousands):

	Year ended December 31, 2011			Year ended December 31, 2010			Year ended December 31, 2009

Current provision:
Federal income tax	$	1,129		$	(79	)	$	79
Federal withholding tax		(16	)		63			—
State income tax		629			90			205
Foreign withholding tax		154			628			—

Total current provision		1,896			702			284

Deferred provision:
Federal income tax		4,709			—			—
State income tax		1,406			—			—

Total deferred provision		6,115			—			—

Total provision for income taxes	$	8,011		$	702		$	284

The tax provision for domestic taxable corporate subsidiaries taxed as regular corporations was based on a combined federal and state income tax rate of 41.02% at December 31, 2011 and 40.75% at December 31, 2010 and 2009. The tax rate is equivalent to the combined federal statutory income tax rate and the state statutory income tax rate, net of federal benefit.

The fair value of certain instruments including securities available-for-sale, corporate loans and derivatives is based on quoted market prices or estimates provided by independent pricing sources. The fair value of cash and cash equivalents, interest receivable, and interest payable, approximates cost due to the short-term nature of these instruments.

The table below discloses the carrying value and the estimated fair value of the Company's financial instruments as of December 31, 2011 and 2010 (amounts in thousands):

	As of December 31, 2011				As of December 31, 2010

	Carrying Amount		Estimated Fair Value		Carrying Amount		Estimated Fair Value
Financial Assets:
Cash, restricted cash, and cash equivalents	$	791,774	$	791,774	$	885,254	$	885,254
Securities available-for-sale		816,453		816,453		838,894		838,894
Other securities, at estimated fair value		19,671		19,671		—		—
Residential mortgage-backed securities		86,479		86,479		93,929		93,929
Corporate loans, net of allowance for loan losses of $191,407 and $209,030 as of December 31, 2011 and 2010, respectively		6,122,891		5,999,771		5,857,816		6,060,530
Corporate loans held for sale		317,332		359,463		463,628		473,681
Corporate loans, at estimated fair value		3,176		3,176		—		—
Equity investments, at estimated fair value		189,845		189,845		99,955		99,955
Derivative assets		28,463		28,463		19,519		19,519
Interest and principal receivable		62,124		62,124		57,414		57,414
Private equity investments, at cost(1)		780		780		4,800		5,051
Financial Liabilities:
Collateralized loan obligation secured notes	$	5,540,037	$	5,200,534	$	5,630,272	$	5,176,052
Collateralized loan obligation junior secured notes to affiliates		365,848		283,914		366,124		254,522
Credit facilities		38,300		38,300		18,400		18,400
Convertible senior notes		299,830		368,502		344,142		425,564
Senior notes		250,676		261,834		—		—
Junior subordinated notes		283,517		262,962		283,517		264,025
Accounts payable, accrued expenses and other liabilities		23,424		23,424		14,193		14,193
Accrued interest payable		25,536		25,536		22,846		22,846
Accrued interest payable to affiliates		6,561		6,561		6,316		6,316
Related party payable		11,078		11,078		12,988		12,988
Securities sold, not yet purchased		1,256		1,256		—		—
Derivative liabilities		125,333		125,333		76,566		76,566

The following table presents information about the Company's assets and liabilities (including derivatives that are presented net) measured at fair value on a recurring basis as of December 31, 2011, and indicates the fair value hierarchy of the valuation techniques utilized by the Company to determine such fair value (amounts in thousands):

	Quoted Prices in Active Markets for Identical Assets (Level 1)			Significant Other Observable Inputs (Level 2)			Significant Unobservable Inputs (Level 3)		Balance as of December 31, 2011

Assets:
Securities available-for-sale:
Corporate debt securities	$	—		$	736,010		$	67,233	$	803,243
Common and preferred stock		11,902			1,308			—		13,210

Total securities available-for-sale		11,902			737,318			67,233		816,453
Other securities, at estimated fair value		—			16,893			2,778		19,671
Residential mortgage-backed securities		—			—			86,479		86,479

Total securities		11,902			754,211			156,490		922,603
Corporate loans, at estimated fair value		—			3,176			—		3,176
Equity investments, at estimated fair value		10,498			28,385			150,962		189,845
Total rate of return swaps		—			—			152		152
Foreign exchange options, net		—			—			13,394		13,394
Commodity swaps, net		—			7,371			—		7,371
Common stock warrants		1,066			—			1,266		2,332
Other assets		—			—			567		567

Total	$	23,466		$	793,143		$	322,831	$	1,139,440

Liabilities:
Securities sold, not yet purchased	$	(1,256	)	$	—		$	—	$	(1,256	)
Cash flow interest rate swaps		—			(100,718	)		—		(100,718	)
Foreign exchange forward contracts, net		—			(12,224	)		—		(12,224	)
Credit default swaps—protection sold, net		—			(7,177	)		—		(7,177	)

	$	(1,256	)	$	(120,119	)	$	—	$	(121,375	)

The following table presents information about the Company's assets measured at fair value on a non-recurring basis as of December 31, 2011, and indicates the fair value hierarchy of the valuation

techniques utilized by the Company to determine such fair value (amounts in thousands). There were no liabilities measured at fair value on a non-recurring basis:

The following table presents information about the Company's assets and liabilities (including derivatives that are presented net) measured at fair value on a recurring basis as of December 31, 2010, and indicates the fair value hierarchy of the valuation techniques utilized by the Company to determine such fair value (amounts in thousands):

	Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)		Balance as of December 31, 2010

Assets:
Securities available-for-sale:
Corporate debt securities	$	—	$	752,423	$	83,097	$	835,520
Common and preferred stock		3,374		—		—		3,374

Total securities available-for-sale		3,374		752,423		83,097		838,894
Residential mortgage-backed securities		—		—		93,929		93,929

Total securities		3,374		752,423		177,026		932,823
Equity investments, at estimated fair value		—		15,023		84,932		99,955
Credit default swaps—protection sold		—		492		—		492
Total rate of return swaps		—		—		104		104
Foreign exchange options, net		—		—		14,791		14,791
Common stock warrants		—		—		3,453		3,453

Total	$	3,374	$	767,938	$	280,306	$	1,051,618

The following table presents information about the Company's assets measured at fair value on a non-recurring basis as of December 31, 2010, and indicates the fair value hierarchy of the valuation techniques utilized by the Company to determine such fair value (amounts in thousands). There were no liabilities measured at fair value on a non-recurring basis:

The following table presents additional information about assets, including derivatives, that are measured at fair value on a recurring basis for which the Company has utilized Level 3 inputs to determine fair value, for the year ended December 31, 2011 (amounts in thousands):

	Securities Available- For-Sale: Corporate Debt Securities			Other Securities, at Estimated Fair Value		Residential Mortgage- Backed Securities			Equity Investments, at Estimated Fair Value			Total Rate of Return Swaps		Common Stock Warrants			Foreign Exchange Options, Net			Other Assets

Beginning balance as of January 1, 2011	$	83,097		$	—	$	93,929		$	84,932		$	104	$	3,453		$	14,791		$	—
Total gains or losses (for the period):
Included in earnings(1)		7,599			2,378		(457	)		27,878			48		(4	)		(1,397	)		10
Included in other comprehensive income		(18,836	)		—		—			—			—		—			—			—
Transfers into Level 3(2)		12,986			—		—			—			—		—			—			—
Transfers out of Level 3(2)		(17,332	)		—		—			(28,546	)		—		—			—			—
Purchases		23,903			400		—			87,761			—		—			—			—
Sales		(10,772	)		—		—			(30,121	)		—		—			—			—
Settlements		(13,412	)		—		(6,993	)		9,058			—		(2,183	)		—			557

Ending balance as of December 31, 2011	$	67,233		$	2,778	$	86,479		$	150,962		$	152	$	1,266		$	13,394		$	567

Change in unrealized gains or losses for the period included in earnings for assets held at the end of the reporting period(1)	$	—		$	2,378	$	17,765		$	18,027		$	—	$	(1,448	)	$	(1,397	)	$	10

The following table presents additional information about assets, including derivatives that are measured at fair value on a recurring basis for which the Company has utilized Level 3 inputs to determine fair value, for the year ended December 31, 2010 (amounts in thousands):

	Securities Available- For-Sale: Corporate Debt Securities			Residential Mortgage- Backed Securities			Equity Investments, at Estimated Fair Value			Total Rate of Return Swaps			Common Stock Warrants			Foreign Exchange Options, Net		Free-Standing Derivatives Interest Rate Swaps

Beginning balance as of January 1, 2010	$	81,288		$	47,572		$	18,289		$	11,809		$	2,471		$	—	$	(281	)
Transfers in from deconsolidation(1)		—			74,366			—			—			—			—		—
Total gains or losses (for the period):
Included in earnings(2)		9,005			(7,971	)		(11,249	)		1,771			663			14,630		311
Included in other comprehensive income		10,107			—			—			—			—			—		—
Transfers into Level 3(3)		22,788			—			41,740			—			—			—		—
Purchases		41,841			—			38,620			—			2,716			161
Sales		(24,460	)		(7,246	)		—			(13,476	)		—			—
Settlements		(57,472	)		(12,792	)		(2,468	)		—			(2,397	)		—		(30	)

Ending balance as of December 31, 2010	$	83,097		$	93,929		$	84,932		$	104		$	3,453		$	14,791	$	—

Change in unrealized gains or losses for the period included in earnings for assets held at the end of the reporting period(2)	$	—		$	(1,586	)	$	(11,249	)	$	—		$	663		$	14,630	$	—

(1): Represents the subordinate tranches of the residential mortgage loan securitization trusts as a result of the Company's deconsolidation as of January 1, 2010, computed as $11.4 million of REO plus $62.9 million, which represents the difference between the residential mortgage loans of $2.1 billion less RMBS Issued, at estimated fair value, of $2.0 billion. See Note 2 for further discussion.
(2): Amounts are included in net realized and unrealized gain (loss) on investments, net realized and unrealized (loss) gain on derivatives and foreign exchange or net realized and unrealized gain (loss) on residential mortgage-backed securities, residential mortgage loans, and residential mortgage-backed securities issued, carried at estimated fair value in the consolidated statements of operations.
(3): Certain securities available-for-sale and equity investments, at estimated fair value, were transferred into Level 3 from Level 2 reflecting reduced transparency of prices for these financial instruments as a result of less trading activity. There were no transfers out of Level 3 into Level 1 or 2. The Company's policy is to recognize transfers into and out of Level 3 at the end of the reporting period.

Operating segments are defined as components of a company in which separate financial information is available and reviewed by the chief operating decision maker or group in determining how to allocate resources and assessing performance. The Company operates its business through multiple reportable business segments, which it has determined to be credit ("Credit") and all other segments ("Other"). The Company's segments are differentiated primarily by their investment focuses. The Credit segment includes primarily below investment grade corporate debt comprised of senior secured and unsecured loans, mezzanine loans, high yield bonds, and distressed and stressed debt securities. The Other segments include all other portfolio holdings, including oil and natural gas working interests and overriding royalty interests.

Prior to 2011, the Company operated under a single business segment of Credit. However, during 2011, the Company began acquiring additional working interests and overriding royalty interests in oil and natural gas properties. As of December 31, 2011, the Company determined that it met certain segment reporting requirements and accordingly, began to disclose information by segment based on its acquisition of additional natural resources assets, combined with its belief that other areas of

investment focus including natural resources, while currently not material, may become a significant part of its business. The segments currently reported are consistent with the way decisions regarding the allocation of resources are made, as well as how operating results are reviewed by the Company.

The Company evaluates the performance of its segments based on several components including total investment income, net investment income, other income (loss) and net income (loss). Net investment income is the difference between income earned on assets (or total investment income) and the cost of liabilities to fund those assets, as well as the related provision for loan losses, if applicable. Net income (loss) includes (i) net investment income, (ii) other income (loss), which is comprised primarily of unrealized and realized gains and losses on investments and derivatives, and (iii) non-investment expenses. Certain corporate assets and expenses that are not directly related to the individual segments, including base management fees and professional services are allocated to individual segments based on the carrying value of the assets within those segments. Certain other corporate assets and expenses, including prepaid insurance, incentive fees, insurance expenses, directors' expenses and share-based compensation expense are not allocated to individual segments in the Company's assessment of segment performance. Collectively, these items are included as reconciling items between reported segment amounts and consolidated totals.

The following table shows data of reportable segments reconciled to amounts reflected in the consolidated financial statements for the years ended December 31, 2011, 2010 and 2009 (amounts in thousands):

The following table shows total assets of reportable segments reconciled to amounts reflected in the consolidated financial statements as of December 31, 2011 and 2010 (amounts in thousands):

The following is a presentation of the quarterly results of operations for the years ended December 31, 2011 and December 31, 2010:

	2011

(amounts in thousands, except per share information)	Fourth Quarter			Third Quarter			Second Quarter		First Quarter
Net investment income:
Total investment income	$	136,408		$	134,440		$	135,843	$	135,330
Interest expense		35,906			32,604			32,978		32,121
Interest expense to affiliates		10,532			12,688			14,142		12,096
Provision for loan losses		—			2,533			—		11,661

Net investment income		89,970			86,615			88,723		79,452

Other income (loss):
Total other income (loss)		13,739			(29,306	)		62,578		46,436

Non-investment expenses:
Related party management compensation		14,471			8,198			24,315		21,201
General, administrative and directors expenses		10,649			8,554			10,367		8,171
Professional services		1,941			1,134			1,691		1,432

Total non-investment expenses		27,061			17,886			36,373		30,804

Income before income tax expense		76,648			39,423			114,928		95,084
Income tax (benefit) expense		(333	)		(397	)		7,424		1,317

Net income	$	76,981		$	39,820		$	107,504	$	93,767

Net income per common share:
Basic(1)
Net income per share	$	0.43		$	0.22		$	0.60	$	0.53
Diluted(1)
Net income per share	$	0.43		$	0.22		$	0.59	$	0.51
Weighted average number of common shares outstanding:
Basic		177,759			177,723			177,674		177,075
Diluted		179,675			180,220			182,393		181,292

	2010

(amounts in thousands, except per share information)	Fourth Quarter		Third Quarter		Second Quarter		First Quarter
Net investment income:
Total investment income	$	141,394	$	122,249	$	122,366	$	119,350
Interest expense		31,298		30,051		38,851		31,500
Interest expense to affiliates		8,080		5,791		6,740		4,541
Provision for loan losses		21,034		8,087		—		—

Net investment income		80,982		78,320		76,775		83,309

Other income:
Total other income		22,422		26,627		23,196		71,107

Non-investment expenses:
Related party management compensation		16,607		17,551		14,476		20,491
General, administrative and directors expenses		6,389		3,561		3,216		3,350
Professional services		1,996		1,041		1,230		1,064

Total non-investment expenses		24,992		22,153		18,922		24,905

Income before income tax expense		78,412		82,794		81,049		129,511
Income tax expense		213		452		21		16

Net income	$	78,199	$	82,342	$	81,028	$	129,495

Net income per common share:
Basic(1)
Net income per share	$	0.48	$	0.52	$	0.51	$	0.82
Diluted(1)
Net income per share	$	0.48	$	0.52	$	0.51	$	0.82
Weighted average number of common shares outstanding:
Basic		160,662		157,057		156,997		156,997
Diluted		163,173		157,461		157,423		156,997

On January 17, 2012, the Compensation Committee of the board of directors granted the Manager 258,303 restricted common shares subject to graded vesting over three years with the final vesting date of March 1, 2015.

On February 2, 2012, our board of directors declared a cash distribution for the quarter ended December 31, 2011 of $0.18 per share to common shareholders of record on February 16, 2012. The distribution is payable on March 1, 2012. In addition, on February 2, 2012, our board of directors declared an annual special cash distribution for the year ended December 31, 2011 of $0.08 per share to common shareholders of record on March 15, 2012. The distribution is payable on March 29, 2012.


(Mark One)
ý		ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 2011
or
o		TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from to


Delaware (State or other jurisdiction of incorporation or organization)		11-3801844 (I.R.S. Employer Identification No.)
555 California Street, 50^th Floor
San Francisco, CA		94104
(Address of principal executive offices)		(Zip Code)


Large accelerated filer ý		Accelerated filer o		Non-accelerated filer o (Do not check if a smaller reporting company)		Smaller reporting company o

Year ended December 31, 2010			Cash Distribution Declared per Common Share

First Quarter ended March 31, 2010	May 14, 2010	May 28, 2010	$	0.10
Second Quarter ended June 30, 2010	August 18, 2010	September 1, 2010	$	0.12
Third Quarter ended September 30, 2010	November 17, 2010	December 1, 2010	$	0.14
Fourth Quarter ended December 31, 2010	February 18, 2011	March 4, 2011	$	0.15

		Number of securities to be issued upon exercise of outstanding options, warrants and rights			Weighted average exercise price of outstanding options, warrants and rights			Number of securities remaining available for future issuance under equity compensation plans (excluding securities reflected in the first column)(1)

Equity compensation plan not approved by shareholders			1,932,279		$	20.00			1,747,572



Part I
Item 1.	Business	4
Item 1A.	Risk Factors	16
Item 1B.	Unresolved Staff Comments	49
Item 2.	Properties	49
Item 3.	Legal Proceedings	49
Item 4.	Mine Safety Disclosure	49
Part II
Item 5.	Market for Registrant's Common Equity, Related Shareholder Matters and Issuer Purchases of Equity Securities	50
Item 6.	Selected Consolidated Financial Data	53
Item 7.	Management's Discussion and Analysis of Financial Condition and Results of Operations	55
Item 7A.	Quantitative and Qualitative Disclosures about Market Risk	100
Item 8.	Financial Statements and Supplementary Data	100
Item 9.	Changes in and Disagreements with Accountants on Accounting and Financial Disclosure	100
Item 9A.	Controls and Procedures	100
Item 9B.	Other Information	101
Part III
Item 10.	Directors, Executive Officers and Corporate Governance	102
Item 11.	Executive Compensation	102
Item 12.	Security Ownership of Certain Beneficial Owners and Management and Related Shareholder Matters	102
Item 13.	Certain Relationships and Related Transactions, and Director Independence	102
Item 14.	Principal Accounting Fees and Services	102
Part IV
Item 15.	Exhibits and Financial Statement Schedules	102

Year ended December 31, 2011			Cash Distribution Declared per Common Share

First Quarter ended March 31, 2011	May 13, 2011	May 27, 2011	$	0.16
Second Quarter ended June 30, 2011	August 11, 2011	August 25, 2011	$	0.18
Third Quarter ended September 30, 2011	November 17, 2011	December 1, 2011	$	0.18
Fourth Quarter ended December 31, 2011	February 16, 2012	March 1, 2012	$	0.18
Annual Special Distribution	March 15, 2012	March 29, 2012	$	0.08

	Base Period		Years Ending

	12/31/2006		12/31/2007		12/31/2008		12/31/2009		12/31/2010		12/31/2011
KKR Financial Holdings LLC		100		58		7		27		46		46
S&P 500 Index		100		106		64		85		97		99
Russell 1000(1)		100		106		64		86		98		100
Russell 2000(1)		100		99		62		84		105		101

	Bank Loans & High Yield Bonds		Natural Resources		Special Situations		Private Equity		Mezzanine		Total

Corporate loans(1)	$	6,554,383	$	—	$	37,327	$	—	$	43,096	$	6,634,806
Securities(2)		733,328		—		99,529		—		3,267		836,124
Equity investments, at estimated fair value(3)		27,303		81,758		30,454		44,482		5,848		189,845
Other assets		—		138,525		9,434		450		330		148,739

Total	$	7,315,014	$	220,283	$	176,744	$	44,932	$	52,541	$	7,809,514

	December 31, 2011		December 31, 2010

Non-accrual loans (recorded investment):
Impaired loans held for investment	$	68,692	$	149,785
Loans held for sale		99,999		15,333

Total non-accrual loans	$	168,691	$	165,118

	2011			2010			2009

Balance at beginning of year	$	209,030		$	237,308		$	480,775
Provision for loan losses		14,194			29,121			39,795
Charge-offs		(31,817	)		(57,399	)		(283,262	)

Balance at end of year	$	191,407		$	209,030		$	237,308

	2011			2010

Loans Held for Sale:
Beginning balance	$	463,628		$	925,718
Transfers in		862,244			1,052,040
Transfers out		(448,329	)		(437,727	)
Sales, paydowns, restructurings and other		(495,048	)		(1,061,678	)
Lower of cost or estimated fair value adjustment(1)		(65,163	)		(14,725	)

Net carrying value	$	317,332		$	463,628

	Year ended December 31, 2011					Year ended December 31, 2010					Year ended December 31, 2009

	Par Amount		%			Par Amount		%			Par Amount		%
Corporate loans	$	2,289,540		83.8	%	$	2,567,007		83.8	%	$	1,216,082		88.6	%
Corporate debt securities		352,054		12.9			457,133		14.9			156,094		11.4
Equity investments, at estimated fair value		91,781		3.3			38,565		1.3			—		—

Total	$	2,733,375		100.0	%	$	3,062,705		100.0	%	$	1,372,176		100.0	%

Signature	Title	Date


/s/ WILLIAM C. SONNEBORN William C. Sonneborn	Chief Executive Officer and Director (Principal Executive Officer)	February 28, 2012
/s/ MICHAEL R. MCFERRAN Michael R. McFerran	Chief Financial Officer (Principal Financial and Accounting Officer)	February 28, 2012
/s/ PAUL M. HAZEN Paul M. Hazen	Chairman and Director	February 28, 2012
/s/ TRACY COLLINS Tracy Collins	Director	February 28, 2012
/s/ ROBERT L. EDWARDS Robert L. Edwards	Director	February 28, 2012
/s/ VINCENT PAUL FINIGAN Vincent Paul Finigan	Director	February 28, 2012
/s/ R. GLENN HUBBARD R. Glenn Hubbard	Director	February 28, 2012

	December 31, 2011(1)								December 31, 2010

	Par		Carrying Value		Amortized Cost		Estimated Fair Value		Par		Carrying Value		Amortized Cost		Estimated Fair Value
Senior secured	$	312,876	$	298,467	$	294,472	$	298,467	$	281,998	$	287,908	$	276,158	$	287,908
Senior unsecured		465,948		448,407		395,932		448,407		445,678		448,562		304,622		448,562
Subordinated		90,881		76,040		67,501		76,040		116,061		99,800		66,608		99,800

Total	$	869,705	$	822,914	$	757,905	$	822,914	$	843,737	$	836,270	$	647,388	$	836,270

Signature	Title	Date


/s/ ROSS J. KARI Ross J. Kari	Director	February 28, 2012
/s/ ELY L. LICHT Ely L. Licht	Director	February 28, 2012
/s/ DEBORAH H. MCANENY Deborah H. McAneny	Director	February 28, 2012
/s/ SCOTT C. NUTTALL Scott C. Nuttall	Director	February 28, 2012
/s/ SCOTT A. RYLES Scott A. Ryles	Director	February 28, 2012
/s/ WILLY STROTHOTTE Willy Strothotte	Director	February 28, 2012

	December 31, 2011

	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses			Estimated Fair Value
Securities available-for-sale:
Corporate debt securities	$	741,438	$	75,442	$	(13,637	)	$	803,243
Common and preferred stock		12,766		444		—			13,210

Total securities available-for-sale		754,204		75,886		(13,637	)		816,453
Other securities, at estimated fair value(1)		16,467		3,225		(21	)		19,671
Residential mortgage-backed securities, at estimated fair value(1)		209,502		4,132		(127,155	)		86,479

Total securities	$	980,173	$	83,243	$	(140,813	)	$	922,603

	Less Than 12 months					12 Months or More					Total

	Estimated Fair Value		Unrealized Losses			Estimated Fair Value		Unrealized Losses			Estimated Fair Value		Unrealized Losses
December 31, 2011
Corporate debt securities	$	252,467	$	(10,562	)	$	32,876	$	(3,075	)	$	285,343	$	(13,637	)
December 31, 2010
Corporate debt securities	$	41,656	$	(1,331	)	$	36,631	$	(2,283	)	$	78,287	$	(3,614	)

	Year ended December 31, 2011			Year ended December 31, 2010			Year ended December 31, 2009

Gross realized gains	$	100,565		$	68,411		$	24,163
Gross realized losses		(559	)		(7	)		(9,493	)

Net realized gains (losses)(1)	$	100,006		$	68,404		$	14,670

Description	Amortized Cost		Estimated Fair Value

Due within one year	$	—	$	—	—	%
One to five years		370,463		401,449	7.8
Five to ten years		383,044		416,479	9.7
Greater than ten years		4,398		4,986	4.3

Total	$	757,905	$	822,914

	As of December 31, 2011		As of December 31, 2010

Pledged as collateral for collateralized loan obligation secured notes and junior secured notes to affiliates	$	710,734	$	728,558

Total	$	710,734	$	728,558

	December 31, 2011

	Corporate Loans			Corporate Loans Held for Sale			Corporate Loans, at Estimated Fair Value			Total Corporate Loans
Principal(1)	$	6,501,679		$	470,562		$	3,655		$	6,975,896
Net unamortized discount		(187,381	)		(102,324	)		(562	)		(290,267	)

Total amortized cost		6,314,298			368,238			3,093			6,685,629
Lower of cost or fair value adjustment		—			(50,906	)		—			(50,906	)
Allowance for loan losses		(191,407	)		—			—			(191,407	)
Unrealized gains (losses)		—			—			83			83

Net carrying value	$	6,122,891		$	317,332		$	3,176		$	6,443,399

	Recorded Investment		Unpaid Principal Balance		Related Allowance		Average Recorded Investment		Interest Income Recognized

December 31, 2011
With no related allowance recorded	$	—	$	—	$	—	$	3,244	$	—
With an allowance recorded		68,692		83,452		33,836		76,933		2,645

Total	$	68,692	$	83,452	$	33,836	$	80,177	$	2,645

	Recorded Investment		Unpaid Principal Balance		Related Allowance		Average Recorded Investment		Interest Income Recognized

December 31, 2010
With no related allowance recorded	$	16,219	$	83,215	$	—	$	12,873	$	2,853
With an allowance recorded		133,566		142,377		50,112		133,014		8,256

Total	$	149,785	$	225,592	$	50,112	$	145,887	$	11,109

	As of December 31, 2011		As of December 31, 2010

Pledged as collateral for collateralized loan obligation secured notes and junior secured notes to affiliates	$	6,448,404	$	6,152,924

Total	$	6,448,404	$	6,152,924

	As of January 1, 2010

Assets
Residential mortgage loans, at estimated fair value(1)	$	2,023,333
Real estate owned (recorded within other assets on the consolidated balance sheets)		11,439
Interest receivable		4,529

	$	2,039,301

Liabilities
Residential mortgage-backed securities issued, at estimated fair value	$	2,034,772
Accrued interest payable		4,529

	$	2,039,301

		Year ended December 31, 2011			Year ended December 31, 2010			Year ended December 31, 2009

Net (losses) gains recognized in other comprehensive (loss) income on cash flow hedges		$	(42,324	)	$	(13,935	)	$	34,739

	Year ended December 31, 2011		Year ended December 31, 2010		Year ended December 31, 2009

Gross realized gains	$	—	$	—	$	58,967
Gross realized losses		—		—		(996	)

Net realized gains	$	—	$	—	$	57,971

	As of December 31, 2011			As of December 31, 2010

Net unrealized gains on available-for-sale securities	$	62,248		$	189,139
Net unrealized losses on cash flow hedges		(97,867	)		(55,543	)

Accumulated other comprehensive (loss) income	$	(35,619	)	$	133,596

	Year ended December 31, 2011		Year ended December 31, 2010		Year ended December 31, 2009

Restricted shares granted to Manager	$	2,448	$	5,784	$	3,451
Restricted shares granted to certain directors		830		1,108		526

Total share-based compensation expense	$	3,278	$	6,892	$	3,977

	Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)		Balance as of December 31, 2011

Loans held for sale(1)	$	—	$	159,120	$	6,698	$	165,818
Private equity investments(2)		—		—		780		780

Total	$	—	$	159,120	$	7,478	$	166,598

	Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)		Balance as of December 31, 2010

Loans held for sale(1)	$	—	$	254,682	$	14,443	$	269,125
Private equity investments(2)		—		—		1,800		1,800

Total	$	—	$	254,682	$	16,243	$	270,925

	Credit							Other							Reconciling Items									Consolidated Company

For the Years Ended December 31,	2011		2010		2009			2011		2010			2009		2011			2010			2009			2011		2010		2009
Total investment income	$	511,392	$	504,471	$	572,725		$	30,629	$	888		$	—	$	—		$	—		$	—		$	542,021	$	505,359	$	572,725
Net investment income	$	315,141	$	318,544	$	243,556		$	29,619	$	842		$	—	$	—		$	—		$	—		$	344,760	$	319,386	$	243,556
Other income (loss)	$	85,499	$	143,578	$	(96,275	)	$	7,948	$	(226	)	$	—	$	—		$	—		$	—		$	93,447	$	143,352	$	(96,275	)
Net income (loss)	$	345,322	$	422,611	$	89,575		$	16,779	$	(1,289	)	$	—	$	(44,029	)	$	(50,258	)	$	(12,639	)	$	318,072	$	371,064	$	76,936

	Credit				Other(1)				Reconciling Items				Consolidated Company

As of December 31,	2011		2010		2011		2010		2011		2010		2011		2010
Total assets	$	8,487,702	$	8,327,662	$	158,639	$	85,843	$	887	$	4,907	$	8,647,228	$	8,418,412

KKR FINANCIAL HOLDINGS LLC
(Registrant)

/s/ WILLIAM C. SONNEBORN

William C. Sonneborn

Chief Executive Officer