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, 2012 was $1,469,656,071, 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, 2013 was 204,780,075.

Portions of the registrant's Proxy Statement for the 2013 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; "KKR" refers to Kohlberg Kravis Roberts & Co. L.P. and its affiliated companies; "Management Agreement" means the amended and restated management agreement between us and the Manager, as amended; "operating agreement" means the amended and restated operating agreement of KKR Financial Holdings LLC, as amended; "common shares" refers to our common shares, no par value, representing limited liability company membership interests in us; "preferred shares" refers to a class of our shares with preference or priority over any other class of our shares with respect to distribution rights or rights upon our dissolution or liquidation; and "shares" refers to limited liability company membership interests issued by us of any class or series.

This Annual Report on Form 10-K contains a summary of some of the terms of our operating agreement and our Management Agreement. 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, 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 Amendment No. 2 is included as an exhibit to the current report on Form 8-K that we filed with the SEC on January 11, 2013 and a copy of a share designation amending our operating agreement is included as an exhibit to the current report on Form 8-K that we filed with the SEC on January 17, 2013. 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, a copy of the first 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 and a copy of the second amendment thereto is included as exhibit 10.17 to this Annual Report. 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.

The following is a description of the meanings of certain terms that are used in this report and may be used in the financial services and oil and gas industries.

Basin. A large area with a relatively thick accumulation of sedimentary rocks.

Bbl. One stock tank barrel or 42 United States ("U.S.") gallons liquid volume.

Bcfe. One billion cubic feet equivalent, determined using a ratio of six Mcf of natural gas to one Bbl of oil, condensate or natural gas liquids.

Btu. One British thermal unit, which is the heat required to raise the temperature of a one-pound mass of water by one degree Fahrenheit.

Collateralized loan obligations. A special purpose vehicle set up to hold and manage pools of leveraged loans. The special-purpose vehicle is financed with several tranches of debt that have rights to the collateral and payment stream in descending order.

Development well. A well drilled within the proved area of a reservoir to the depth of a stratigraphic horizon known to be productive.

Derivative instrument. A financial instrument or contract with another party (counterparty) that is designed to meet any of a variety of risk management objectives, including those related to fluctuations in interest rates, currency exchange rates or commodity prices. Options, forwards and swaps are the most common derivative instruments we employ.

Dry hole or well. A well found to be incapable of producing hydrocarbons in sufficient quantities such that proceeds from the sale of such production would exceed production expenses and taxes.

Field. An area consisting of a single reservoir or multiple reservoirs all grouped on or related to the same individual geological structural feature and/or stratigraphic condition.

Formation. A stratum of rock that is recognizable from adjacent strata consisting mainly of a certain type of rock or combination of rock types with thickness that may range from less than two feet to hundreds of feet.

Gross acres or gross wells. The total acres or wells, as the case may be, in which a working interest is owned.

London interbank offered rate ("LIBOR") floor. A feature sometimes used in pricing debt instruments whose interest payments are linked to LIBOR, especially loans. Loans with a LIBOR floor pay an interest rate of LIBOR plus the applicable margin so long as LIBOR remains above the specified floor level. If, however, LIBOR falls below the floor, the interest rate is the floor level plus the applicable margin.

Mcfe. One thousand cubic feet equivalent, determined using the ratio of six Mcf of natural gas to one Bbl of oil, condensate or natural gas liquids.

MMBoe. One million barrels of oil equivalent determined using a ratio of one Bbl of oil, condensate or natural gas liquids to six Mcf.

MMcfe. One million cubic feet equivalent, determined using a ratio of six Mcf of natural gas to one Bbl of oil, condensate or natural gas liquids.

Net acres or net wells. The sum of the fractional working interests owned in gross acres or gross wells, as the case may be.

NGL. Natural gas liquids, which are the hydrocarbon liquids contained within natural gas.

Overriding royalty interest. A non-cost bearing interest in the production from a well that is carved out of the working interest. It expires when the underlying oil and/or natural gas lease expires.

Reinvestment period. When principal proceeds are reinvested in new collateral assets and usually is five to seven years long.

Productive well. A well that is found to be capable of producing hydrocarbons in sufficient quantities such that proceeds from the sale of such production exceeds production expenses and taxes.

Proved developed reserves. Reserves that can be expected to be recovered through existing wells with existing equipment and operating methods or in which the cost of the required equipment is relatively minor compared to the cost of a new well. Additional reserves expected to be obtained through the application of fluid injection or other improved recovery techniques for supplementing the natural forces and mechanisms of primary recovery are included in "proved developed reserves" only after testing by a pilot project or after the operation of an installed program has confirmed through production response that increased recovery will be achieved.

Proved reserves. Reserves that by analysis of geoscience and engineering data can be estimated with reasonable certainty to be economically producible from a given date forward, from known reservoirs, and under existing economic conditions, operating methods, and government regulations prior to the time at which contracts providing the right to operate expire, unless evidence indicates that renewal is reasonably certain. The project to extract the hydrocarbons must have commenced or the operator must be reasonably certain that it will commence the project within a reasonable time.

Proved undeveloped drilling location. A site on which a development well can be drilled consistent with spacing rules for purposes of recovering proved undeveloped reserves.

Proved undeveloped reserves. Reserves that are expected to be recovered from new wells on undrilled acreage, or from existing wells where a relatively major expenditure is required for recompletion. Reserves on undrilled acreage are limited to those directly offsetting development spacing areas that are reasonably certain of production when drilled, unless evidence using reliable technology exists that establishes reasonable certainty of economic producibility at greater distances. Undrilled locations can be classified as having undeveloped reserves only if a development plan has been adopted indicating that they are scheduled to be drilled within five years, unless the specific circumstances justify a longer time. Estimates for proved undeveloped reserves are not attributed to any acreage for which an application of fluid injection or other improved recovery technique is contemplated, unless such techniques have been proved effective by actual projects in the same

reservoir or an analogous reservoir, or by other evidence using reliable technology establishing reasonable certainty.

Royalty interest. An interest that entitles the owner of such interest to a share of the mineral production from a property or to a share of the proceeds there from. It does not contain the rights and obligations of operating the property and normally does not bear any of the costs of exploration, development and operation of the property.

Standardized measure of discounted future net cash flows. The present value of estimated future net revenues to be generated from the production of proved reserves, determined in accordance with the regulations of the Securities and Exchange Commission, without giving effect to non-property related expenses such as general and administrative expenses, debt service, future income tax expenses or depreciation, depletion and amortization; discounted using an annual discount rate of 10%.

Undeveloped acreage. Lease acreage on which wells have not been drilled or completed to a point that would permit the production of commercial quantities of oil, natural gas and NGL regardless of whether such acreage contains proved reserves.

Unproved reserves. Reserves that are considered less certain to be recovered than proved reserves. Unproved reserves may be further sub-classified to denote progressively increasing uncertainty of recoverability and include probable reserves and possible reserves.

Working interest. The operating interest that gives the owner the right to drill, produce and conduct operating activities on the property and a share of production.

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, interests in joint ventures and partnerships, and working and royalty interests in oil and gas properties. The corporate loans that we hold are typically 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 seven 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"), KKR Financial CLO 2011-1, Ltd. ("CLO 2011-1") and KKR Financial CLO 2012-1, Ltd. ("CLO 2012-1") (collectively the "Cash Flow CLOs"). 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 that we 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 enterprise value. We seek to achieve our objective by deploying capital opportunistically across capital structures and asset classes, including bank loans and high yield securities, natural resources, special situations, mezzanine, commercial real estate and private equity. 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, 2012, we determined that we operate our business through multiple reportable business segments, which are differentiated primarily by their investment focuses.

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 us. For further financial information related to our segments, refer to "Item 8. Financial Statements and Supplementary Data—Note 15. Segment Reporting."

taxable income and losses for the taxable year to be allocated to our shares and then prorate that amount on a monthly basis. 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.

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 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, for United States federal income tax purposes so long as it is not required to register under the Investment Company Act of 1940 (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 and real estate. It is likely that the income from natural resources 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. In addition, if any REIT subsidiary in which we own an interest recognizes gain on the disposition of a United States real property interest, or if we recognize gain on the disposition of a United States real property interest that we hold through a pass-through entity (including gain from the sale of stock in a REIT subsidiary that invests primarily in real estate), such gain will be treated as effectively connected with the conduct of a United States trade or business. Further, our investments in real estate through pass-through entities may generate operating income that is 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.

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 gain from the sale or exchange. Moreover, if the fair market value of our investments in "United States real property interests," which include our investments in natural resources, real estate and certain REIT subsidiaries that invest primarily in real estate, represent more than 10% of the total fair market value of our assets, our shares could be treated as "United States real property interests". In such case, gain recognized by an investor who is a non-United States person on the sale or exchange of its shares would be treated for United States federal income tax purposes as effectively connected income (unless the gain is attributable to a class of our shares that is regularly traded on a securities market and the non-United States person owns 5% or less of the shares of that class). We do not believe that the fair market value of our investments in United States real property interests represents more than 10% of the total fair market value of our assets at this time. No assurance can be provided that our future investments in United States real property interests will not cause us to exceed the 10% threshold described above. If gain from the sale of our shares is treated as effectively connected income, the holder may be subject to United States federal income and/or withholding tax on the sale or exchange.

In addition, all holders of our shares will likely have state tax filing obligations in jurisdictions in which we have made investments in natural resources or real estate (other than through a REIT subsidiary). 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. Our current investments may cause our holders to have state tax filing obligations in the following states: Kansas, Louisiana, Mississippi, North Dakota, Ohio, Oklahoma, Pennsylvania and Texas. We may make investments in other states in the future.

For holders of our shares that are regulated investment companies, to the extent that our income from our investments in natural resources and real estate exceeds 10% of our gross income, then we will likely be treated as a "qualified publicly traded partnership" for purposes of the income and asset diversification tests that apply to regulated investment companies. Because such qualification will depend on the nature of our future investments, no assurance can be provided that we will or will not be treated as a "qualified publicly traded partnership" in any particular year.

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 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 majority-owned 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, many of our majority-owned 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, the securities of those subsidiaries that we own and hold are not investment securities 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 our real estate subsidiaries, including those that are taxed as REITs for United States federal income tax purposes, generally rely 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 our subsidiaries that rely on Section 3(c)(5)(C) of the Investment Company Act, as our "real estate subsidiaries." 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 subsidiaries might be required to change its investment strategy to comply with the changed position. We cannot predict whether such a change would be adverse.

Based on current guidance, our real estate subsidiaries classify 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 real estate subsidiaries consider 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 real estate subsidiaries 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 real estate subsidiaries' investment in non-agency mortgage-backed securities is the "functional equivalent" of owning the underlying mortgage loans, our real estate subsidiaries 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 real estate subsidiaries as real estate-related assets. Therefore, based upon the specific terms and circumstances related to each non-agency mortgage-backed security that our real estate subsidiaries own, our real estate subsidiaries 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 real estate subsidiaries acquire 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 real estate subsidiaries 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 real estate subsidiaries 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 real estate subsidiaries own more than one subordinate class, then, to determine the classification of subordinate classes other than the first loss class, our real estate subsidiaries 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 real estate subsidiaries own), whether our real estate subsidiaries own the entire amount of each such class and whether our real estate subsidiaries 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 real estate subsidiaries 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 any non-majority-owned subsidiaries and 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 effective the date immediately prior to our becoming an investment company. 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.

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 may 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, 2013 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, 2012, 2011 and 2010. For the year ended December 31, 2012, $28.2 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, 2012, we incurred reimbursable expenses to our Manager of $10.2 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. In addition, any shares that by their terms are entitled to a specified periodic distribution, including the Company's 7.375% Series A LLC Preferred Shares, will not be treated as shares, nor included as shares offered or outstanding, for the purpose of calculating incentive compensation, and instead the aggregate distribution amount that accrues to these shares during the fiscal quarter of such calculation will be subtracted from our Net Income, before incentive compensation for purposes of clause (i)(A). 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, 2012, $37.6 million of incentive fees were earned by our Manager.

As of December 31, 2012, the CLO management fees for all CLOs, except for CLO 2005-1 and CLO 2012-1, are being waived or are not entitled to be received. For the year ended December 31, 2012, the collateral manager waived aggregate CLO management fees of $32.2 million and we recorded an expense for CLO management fees totaling $4.2 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, oil and natural gas companies, public and private funds, commercial and investment banks and commercial finance companies. Some of the competitors are large and may have greater financial and technical resources and greater access to deal flow than are available to us. In addition, some competitors may have a lower cost of funds than us and access to financing sources that are not available to us. Finally, 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 that we 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 income 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 ending within or with their taxable year.

We own equity interests in entities that have elected or intend to elect to be taxed as a real estate investment trust (a "REIT") under the Code. 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, 2012 were recorded; however, we will be required to include their current taxable income in our calculation of our taxable income allocable to shareholders.

We own equity interests in entities that have elected or intend to elect to be taxed as REITs. 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, 2012, we believe our REITs were 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 qualification and taxation as a REIT depends upon the ability to meet various qualification tests imposed under the Code (such as those described above), including through actual annual operating results, asset composition, distribution levels and diversity of share ownership. Accordingly, no assurance can be given that any REIT in which we own an equity interest 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, including common shares or preferred shares. 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 investments in the oil and natural gas industry. The operations underlying these investments are substantially affected by federal, state and local laws and

regulations. In particular, oil and natural gas production and related operations are, or have been, subject to price controls, taxes and numerous other laws and regulations, including those relating to the transportation of oil and natural gas. All of the jurisdictions in which we own or operate properties for oil and natural gas production have statutory provisions regulating the exploration for and production of oil and natural gas, including provisions related to permits for the drilling of wells, bonding requirements to drill or operate wells, the location of wells, the method of drilling and casing wells, the surface use and restoration of properties upon which wells are drilled, sourcing and disposal of water used in the drilling and completion process and the abandonment of wells. The operations underlying our investments are also subject to various conservation laws and regulations. These include regulation of the size of drilling and spacing units or proration units, the number of wells which may be drilled in an area, and the unitization or pooling of oil and natural gas wells, as well as regulations that generally prohibit the venting or flaring of natural gas and impose certain requirements regarding the ratability or fair apportionment of production from fields and individual wells.

The exploration, development and production operations underlying our investments in oil and gas are also subject to stringent federal, regional, state and local laws and regulations governing occupational health and safety, the discharge of materials into the environment or otherwise relating to environmental protection. These laws and regulations may, among other things, require the acquisition of permits to conduct exploration, drilling and production operations; govern the amounts and types of substances that may be released into the environment; limit or prohibit construction or drilling activities in sensitive areas such as wetlands, wilderness areas or areas inhabited by endangered species; require investigatory and remedial actions to mitigate pollution conditions; impose obligations to reclaim and abandon well sites and pits; and impose specific criteria addressing worker protection. Failure to comply with these laws and regulations may result in the assessment of administrative, civil and criminal penalties, the imposition of remedial obligations and the issuance of orders enjoining some or all of our operations in affected areas. These laws and regulations may also restrict the rate of oil and natural gas production below the rate that would otherwise be possible. The regulatory burden on the oil and gas industry increases the cost of doing business in the industry and consequently affects profitability.

The trend in environmental regulation is to place more restrictions and limitations on activities that may affect the environment, and thus, any changes in federal or state environmental laws and regulations or re-interpretation of applicable enforcement policies that result in more stringent and costly well construction, drilling, water management or completion activities, or waste handling, storage, transport, disposal or remediation requirements could have a material adverse effect on our financial position. The operators of the oil and gas properties in which we invest may be unable to pass on such increased compliance costs to their customers. Moreover, accidental releases or spills may occur in the course of those operations, and we cannot assure you that we will not incur significant costs and liabilities as a result of such releases or spills, including any third party claims for damage to property, natural resources or persons. Failure to comply with applicable laws and regulations can result in substantial penalties.

Although we believe that the operations underlying our oil and gas investments are in substantial compliance with all applicable laws and regulations, and that continued substantial compliance with existing requirements will not have a material adverse effect on the value of our natural resources investments, our ability to use these investments as collateral, or our results of operations, such laws and regulations are frequently amended or reinterpreted. Additionally, currently unforeseen environmental incidents may occur or past non-compliance with environmental laws or regulations may be discovered. Therefore, we are unable to predict the future costs or impact of compliance. Additional proposals and proceedings that affect the oil and natural gas industry are regularly considered by Congress, the states, the Federal Energy Regulatory Commission and the courts. We cannot predict when or whether any such proposals may become effective.

Under the Iran Threat Reduction and Syrian Human Rights Act of 2012, which added Section 13(r) of the Exchange Act, we are required to include certain disclosures in our periodic reports if we or any of our "affiliates" knowingly engaged in certain specified activities during the period covered by the report. We are not presently aware that we and our consolidated subsidiaries have knowingly engaged in any transaction or dealing reportable under Section 13(r) of the Exchange Act during the year ended December 31, 2012. We note, however, that KKR & Co. L.P., an affiliate of our Manager, has informed us that it has included the disclosure reproduced below (relating to two companies in which its private equity funds have invested) in Exhibit 99.1 to its annual report on Form 10-K as filed with the SEC on February 22, 2013 as required by Section 13(r) of the Exchange Act (the "KKR Disclosure").

"During the year ended December 31, 2012, a European company in which our private equity funds have invested sold television content to the Islamic Republic of Iran Broadcasting ("IRIB") for less than €45,000. We have been advised by the company that it does not intend to sell any further content to the IRIB.

A European subsidiary of a company in which our private equity funds have invested shipped a cancer drug to Medical Equipment and Pharmaceutical Holding Co. in June 2012. The company has informed us that anticipated gross revenue from such shipment was approximately €92,000."

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, inflation rates, economic uncertainty, default rates, commodity prices, currency exchange rates, changes in laws (including laws relating to taxation), possible further downgrades in the credit ratings of the U.S. or other developed nations] and other national and international political circumstances. While the adverse effects of the unprecedented turmoil in the global credit and securities markets in late 2007 through early 2009 have abated, ongoing developments in the U.S. and global financial markets following that period, market volatility, slow economic growth and regulatory developments continue to illustrate that the current environment is still one of uncertainty.

These economic conditions resulted in, and may in future again 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 continued to recover in 2012, there can be no assurance that these markets will continue to improve and persistently high unemployment rates in the United States, slow recovery in many real estate markets, recessions in a number of European nations and slowing growth in developing countries 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.

In addition, low interest rates related to monetary stimulus and economic stagnation may negatively impact expected returns on all types of investments as the demand for relatively higher return assets increases and the supply decreases.

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. 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 economic difficulties 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, changes to tax laws, 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 common 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 and 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, 2012, the only contractual limitation on our ability to leverage our portfolio is a covenant contained in our revolving credit facility that our leverage ratio cannot exceed 1.5 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 common 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, 2012, $350.4 million par amount, or 5.0%, of our corporate debt portfolio was denominated in foreign currencies, of which 69.6% was denominated in Euros, and $147.5 million par amount, or 42.6%, of other assets, which includes equity investments at estimated fair value and interests in joint ventures and partnerships, was denominated in foreign currencies, of which 43.7% was denominated in Euros and 21.7% 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, continued economic contraction, 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.

The majority of our assets consist of high-yield, below investment grade or unrated debt, which generally has a greater risk of loss than investment grade rated debt 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 common shares.

Our assets include below investment grade or unrated debt, including loans and bonds, each of which generally involves a higher degree of risk than investment grade rated debt. Issuers of high yield or unrated debt may be 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 or unrated debt is often less liquid than investment grade rated debt.

In addition to the above, numerous other factors may affect a company's ability to repay its debt, including the failure to meet its business plan, a downturn in its industry or negative economic conditions. Deterioration in a company's financial condition and prospects may be accompanied by deterioration in the collateral for the high yield debt. Losses on our high yield debt holdings 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 common shares.

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. This lack of diversification may subject our investment portfolio to more rapid changes in value than would be the case if our assets were more widely diversified. For example, as of December 31, 2012, the 20 largest issuers which we have invested in represented approximately 42% 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. If such impairments exceed our recorded allowance for loan losses our net income will be adversely affected. Moreover, securities issued by some of our largest issuers are recorded at estimated fair value and our net income may be adversely affected if these fair value determinations are materially higher than the values that we ultimately realize upon disposal of such securities. 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, 2012, we had approximately 22% 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 or other similar financing vehicles successfully, we may be unable to grow or fully execute our business strategy and our results of operations may be adversely affected.

We have historically financed a substantial portion of our investments through, and derived a substantial portion of our revenue from, our CLO subsidiaries. These CLOs have served as long-term, non-recourse financing for debt 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 or other similar financing vehicles 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 decline. 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, CLO 2006-1 and CLO 2007-A have

ended and the reinvestment period for CLO 2007-1 will end in May 2014. In addition, CLO 2011-1 has no reinvestment period and is an amortizing static pool CLO transaction.

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, CLO 2011-1 and CLO 2012-1, 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 CLOs in which we invest may experience increases in downgrades, depreciations in market value and defaults in respect of their collateral. The CLOs' 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 CLOs 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 CLOs' 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, 2012, there can be no assurance that all of our CLOs will remain in compliance with their respective compliance tests during 2013 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 CLOs 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 were 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.

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 common 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, during periods of 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 common 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.

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.

The enforceability of agreements underlying hedging transactions may depend on compliance with applicable statutory 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.

The full impact of regulatory changes, including the Dodd-Frank Act, on our business is 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 imposes additional disclosure requirements for public companies and generally requires 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."

Many of the Dodd-Frank Act's provisions are subject to final rulemaking by the U.S. financial regulatory agencies, and the implications of the Dodd-Frank Act for our business will depend to a large extent on how such rules are adopted and implemented by various U.S. financial regulatory agencies, such as the FSOC, CFTC and SEC. For example, if the FSOC were to determine that we are a systemically important nonbank financial company, we would be subject to a heightened degree of regulation and supervision. In addition, the CFTC and SEC have 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. We continue to analyze the impact of rules adopted under the Dodd-Frank Act. However, the full impact will not be known until the rules, and other regulatory initiatives that overlap with the rules, are finalized and their combined impacts can be understood.

In addition, in November 2012, the Financial Stability Board, an international body of which the United States is a member, issued an initial set of policy recommendations to strengthen oversight and regulation of the so-called "shadow banking system", broadly described as credit intermediation involving entities and activities outside the regular banking system, such as private equity funds and hedge funds. The policy recommendations outlined initial steps to define the scope of the shadow banking system and proposed general governing principles for a monitoring and regulatory framework. The Financial Stability Board is expected to finalize policy recommendations concerning the shadow banking sector before the G-20 meets in Russia in early September 2013. 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, as well as the public scrutiny we face, would increase, which may have a material adverse effect on our business.

Legal, tax and regulatory changes could occur and may adversely affect our ability to pursue our hedging strategies and/or increase the costs of implementing such strategies.

The enforceability of agreements underlying hedging transactions may depend on compliance with applicable statutory and other regulatory requirements and, depending on the identity of the counterparty, applicable international requirements. New or amended regulations may be imposed by the CFTC, the SEC, the U.S. Federal Reserve or other financial regulators, other governmental regulatory authorities or self-regulatory organizations that supervise the financial markets that could adversely affect us. In particular, these agencies are empowered to promulgate a variety of new rules pursuant to recently enacted financial reform legislation in the United States. We also may be adversely affected by changes in the enforcement or interpretation of existing statutes and rules by these governmental regulatory authorities or self-regulatory organizations.

In addition, the securities and futures markets are subject to comprehensive statutes, regulations and margin requirements. For example, the Dodd-Frank Act provides for new regulation of the derivatives market, including clearing, margin, reporting, recordkeeping, and registration requirements. Although the CFTC has released final rules relating to clearing, reporting, recordkeeping and registration requirements under the Dodd-Frank Act, many of the provisions are subject to further final rulemaking, and thus the Dodd-Frank Act's ultimate impact remains unclear. New regulations could, among other things, restrict our ability to engage in derivatives transactions (for example, by making certain types of derivatives transactions no longer available to us) and/or increase the costs of such derivatives transactions (for example, by increasing margin or capital requirements), and we may be unable to execute our hedging strategies as a result. It is unclear how the regulatory changes will affect counterparty risk.

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 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, 2012, we had approximately $829.8 million of total recourse debt outstanding.

A breach of any of the covenants in certain of our debt agreements could result in a default under our revolving credit facility, maturing on November 30, 2015 (the "2015 Facility"), 7.5% convertible senior notes due January 15, 2017 ("7.5% Notes"), 8.375% senior notes due November 15, 2041 ("8.375% Notes") and 7.500% senior notes due March 20, 2042. In addition, any distributions on our 7.375% Series A LLC Preferred Shares (the "Series A LLC Preferred Shares"), which were issued on January 17, 2013, could be negatively impacted. 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 and preferred shares 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 2015 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 2015 Facility credit agreement includes covenants restricting our ability to:

In addition, the 2015 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 2015 Facility credit agreement. Upon the occurrence of an event of default under the 2015 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.

In addition, the terms of our Series A LLC Preferred Shares restrict our ability make distributions on our common shares under certain circumstances and future issuances of preferred shares may contain similar or more restrictive terms. For more information about the restrictions imposed by our Series A LLC Preferred Shares see the risk described in this report under the caption "The terms of our preferred shares restrict our ability to make future distributions on our common shares and may adversely affect the rights of the holders of our common shares."

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 2015 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 2015 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, 2012, 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 common 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.

Certain of our investments may not be readily convertible to cash due to their illiquidity. 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, securities and partnership interests 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, 2012, we held residential mortgage-backed securities with an aggregate estimated fair value of $83.8 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 and real estate investments.

We have made and may continue to make certain investments in real estate and oil and gas industries, which present inherent environmental and safety risks. The oil and gas industries, in particular, 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. Our investments in oil and gas and real estate also present inherent risk of personal and property injury. We are not insured against all losses or liabilities that could arise from these investments. On-going compliance with environmental laws, ordinances and regulations applicable to these investments 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.

In addition, the trend in environmental regulation is to place more restrictions and limitations on activities that may affect the environment, and thus, any changes in federal or state environmental laws and regulations or re-interpretation of applicable enforcement policies that result in more stringent and costly well construction, drilling, water management or completion activities, or waste handling, storage, transport, disposal or remediation requirements could have a material adverse effect on our financial position. The operators of the oil and gas properties in which we invest may be unable to pass on such increased compliance costs to their customers.

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.

If commodity prices decline and remain depressed for a prolonged period, a significant portion of our development projects may become uneconomic and cause write downs of the value of our oil and natural gas properties, which may reduce the value of our natural resources investments, have a negative impact on our ability to use these investments as collateral or otherwise have a material adverse effect on our results of operations.

Oil and natural gas are commodities and, therefore, their prices are subject to wide fluctuations in response to relatively minor changes in supply and demand. Historically, the markets for oil and natural gas have been volatile. For example, for the five years ended December 31, 2012, the WTI oil spot price ranged from a high of $145.31 per Bbl to a low of $30.28 per Bbl, while the Henry Hub natural gas spot price ranged from a high of $13.32 per MMBtu to a low of $1.83 per MMBtu. These markets will likely continue to be volatile in the future. The prices we receive for our production, and the levels of our production, depend on numerous factors beyond our control, including:

Significantly and sustained lower natural gas prices, and to a lesser extent significantly lower crude oil prices, could render many of our development and production projects uneconomical and result in a downward adjustment of our reserve estimates. Further, deteriorating commodity prices may cause us to recognize impairments in the value of our oil and natural gas properties. In addition, if our estimates of development costs increase, production data factors change or drilling results deteriorate, accounting rules may require us to write down, as a non-cash charge to earnings, the carrying value of our oil and natural gas properties for impairments. This could reduce the value of our natural resources investments, have a negative impact on our ability to use these investments as collateral or 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.

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.

Certain provisions of our operating agreement will make it difficult for third parties to acquire control of us and could deprive holders of our common shares of the opportunity to obtain a takeover premium for their common 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 common shares obtaining a takeover premium for their common 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. In addition, provisions in agreements governing our current or future indebtedness may affect the likelihood of a change in control by requiring us to offer to redeem, repurchase or repay outstanding indebtedness and/or increasing the costs of such indebtedness.

The terms of our preferred shares restrict our ability to make future distributions on our common shares and may adversely affect the rights of the holders of our common shares.

As of January 17, 2013, we had 14.95 million Series A LLC Preferred Shares outstanding and our operating agreement permits our Board of Directors to authorize, without shareholder approval, the issuance of up to an additional approximate 35 million preferred shares with distribution, liquidation, conversion, voting and other rights which could adversely affect the rights of holders of our common

shares. Our Series A LLC Preferred Shares rank senior to the common shares with respect to payment of distributions and distribution of our assets upon our dissolution and any future preferred shares that we issue may do so as well. Distributions on the Series A LLC Preferred Shares are cumulative and are paid quarterly when, as, and if declared by our Board of Directors. We may not declare or pay distributions on our common shares unless all accrued distributions have been declared and paid, or set aside for payment, on the Series A LLC Preferred Shares. The Series A LLC Preferred Shares have limited voting rights, however, in the event that we miss six quarterly distributions (whether or not consecutive) on the Series A LLC Preferred Shares, the holders of such shares will be entitled to appoint two directors to our Board until such time as all accrued distributions on the Series A LLC Preferred Shares have been declared and paid or set aside for payment. Any preferred shares that we issue in the future may contain restrictions on our ability to make distributions on our common shares and have rights and preferences that have a similar or more adverse affect on the rights of holders of our common shares.

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 common 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 additional equity securities, which could include issuances of secured liquidity notes, medium-term notes, senior notes, subordinated notes or additional 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. 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 common shares and of any securities we may issue whose value is linked to the value of our common shares will bear the risk of our future offerings reducing the value of their common 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 common shares.

Our board of directors has broad authority to change many of the terms of our common shares and may change our distribution policy without the approval of holders of our common 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 common shares without the consent of holders of our common shares. Distributions on our common shares and our distribution policy are made at the sole discretion of our board of directors. As a result, our board of directors may, without the approval of holders of our common shares, make changes to our distribution policy or make changes to many of the terms of our common shares that are adverse to the holders of our common 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 common 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 common 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 common 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," the 2015 Facility includes covenants that restricts our ability to make distributions on, and to redeem or repurchase, 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 2015 Facility occur at a time when we have any amounts outstanding under the 2015 Facility.

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, 2012, we have declared cumulative cash distributions on our common shares of $0.86 per common share.

Our ability to pay quarterly distributions on our common shares will be subject to, among other things, general business conditions, our financial results, the impact of paying distributions on our credit ratings, the amount of ordinary taxable income or loss earned by us, gains or losses recognized by us on the disposition of assets, our liquidity needs and legal and contractual restrictions on the payment of distributions under our borrowing agreements and the terms of our preferred shares and any other equity securities that we may issue that are senior to the common shares with respect to distributions. Any reduction or discontinuation of quarterly distributions could cause the market price of our common shares to decline significantly. 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, 2012, our Manager and its affiliates collectively owned approximately 5.8% 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 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, 2012 comprised $83.8 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 separate investment funds and separately managed accounts ("KKR Funds and Accounts"), including proprietary investment accounts that invest in the same non-mortgage-backed securities investments that we invest in, including other fixed income,

natural resources and real estate investments. With respect to these other KKR 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 KKR 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 KKR Funds and Accounts may participate in investment opportunities on more favorable terms than us.

Conflicts may arise between our investments and investments held by other funds and accounts managed by our Manager and its affiliates.

We may invest in the same issuers as other KKR Funds and Accounts, although their investments may include different obligations of such issuer. For example, we might invest in senior loans issued by a borrower and one or more KKR Funds and Accounts might invest in the borrower's junior debt and/or equity. Conflicts of interest may arise where we and other KKR Funds and Accounts simultaneously hold securities representing different parts of the capital structure of a stressed or distressed issuer. In such circumstances, decisions made with respect to the securities held by one KKR Fund or Account may cause (or have the potential to cause) harm to the different class of securities of the issuer held by us or other KKR Funds and Accounts. For example, if such an issuer goes into bankruptcy or reorganization, becomes insolvent or otherwise experiences financial distress or is unable to meet its payment obligations or comply with covenants relating to credit obligations held by us or by the other KKR Funds and Accounts, such other KKR Funds and Accounts may have an interest that conflicts with our interests. If additional financing for such an issuer is necessary as a result of financial or other difficulties, it may not be in our best interests to provide such additional financing, but such additional financing could be seen to benefit investments held by other KKR Funds and Accounts. In addition, other KKR Funds and Accounts may engage in short sales of (or otherwise take short positions in) securities or other instruments of issuers in which we invest, which could be seen as harming our performance for the benefit of the accounts taking short positions if such short positions cause the market value of our investments to fall. In conflict situations such as the ones discussed in this paragraph, the Manager and its affiliates will seek to resolve any such conflicts in accordance with its compliance procedures.

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. In addition, if our investment strategy evolves, our investment objectives may overlap with an increasing number of such entities. As a result we compete with these entities and may compete with an increasing number of such 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 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 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 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, disregarded entities or foreign corporations for United States federal income tax purposes), partnerships generally 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. 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 shares, you may be taxed on amounts that accrued economically before you became a shareholder. Consequently, in some taxable years, holders of our 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 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 shares and thus could result in a substantial reduction in the value of our 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 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 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.

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 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 shares and thus could result in a substantial reduction in the value of our 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 shares for any particular holder of our shares.

Each holder of our shares will determine its tax liability attributable to its ownership of our shares based on its own unique circumstances. Holders of our shares may have different tax liabilities attributable to our 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 shares for any particular holder and such tax liability may exceed the amount of cash actually distributed to such holder for the year.

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.

Common shareholders that are individuals, trusts, or estates may have a higher tax liability if the Internal Revenue Service (the "IRS") successfully challenges our treatment of distributions paid on our Series A LLC Preferred Shares.

The treatment of interests in a partnership, such as our Series A LLC Preferred Shares, and the payments received in respect of such interests is uncertain. Our Series A LLC Preferred Shares will accrue distributions at an annual rate of 7.375%. In general, we will specially allocate to our Series A LLC Preferred Shares items of our gross income (excluding any gross income from the sale or exchange of capital assets) (our "gross ordinary income") in an amount equal to the distributions paid in respect of our Series A LLC Preferred Shares during the taxable year. The amount of gross ordinary

income that we allocate to our Series A LLC Preferred Shares will reduce the amount of income that is allocable to our common shares.

We intend to treat our Series A LLC Preferred Shares as partnership interests in us and the amounts paid to our Series A LLC Preferred Shares as distributions related to allocations of our items of income. The IRS, however, may contend that payments on our Series A LLC Preferred Shares represent "guaranteed payments." In that case, no portion of our income would be allocated to our Series A LLC Preferred Shares, but our common shareholders would be entitled to a deduction for their allocable share of the distributions treated as "guaranteed payments." Although not entirely free from doubt, deductions attributable to "guaranteed payments" should generally be treated as "miscellaneous itemized deductions." In general, "miscellaneous itemized deductions" may be deducted by a common shareholder 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. As a result of those restrictions, common shareholders may not be able to deduct all or a portion of their allocable share of deductions attributable to any "guaranteed payments," and, therefore, common shareholders that are individuals, trusts, or estates may have a higher tax liability if the IRS successfully challenges our treatment of distributions paid on our Series A LLC Preferred Shares.

Holders of our 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 shares. However, we generally do not intend to adjust the tax basis of our assets with respect to purchasers of our Series A LLC Preferred Shares, except in extraordinary circumstances. We believe that treatment is appropriate under the applicable Treasury regulations because the holders of the Series A LLC Preferred Shares do not participate in the income or gain from the sale of our assets and are entitled only to fixed distributions, but the IRS may successfully challenge that position. 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 real estate, that generate income that is treated as "effectively connected" with a United States trade or business with respect to holders of our shares that are not "United States persons."

We have made and may make investments, such as investments in natural resources and real estate that generate income that is treated as "effectively connected" with a United States trade or business with respect to holders that are not "United States persons" within the meaning of section 7701(a)(30) of the Code. It is likely that income from our natural resources investments will be treated as effectively connected income. 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 a United States trade or business. Our investments in real estate may also generate income that would be treated as effectively connected income. 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 (and possibly state income tax returns) for such year reporting its allocable share, if any, of our income effectively connected with such trade or business and (ii) pay United States federal income tax (and possibly state 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 federal income 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.

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 gain from the sale or exchange. Moreover, if the fair market value of our investments in "United States real property interests," which include our investments in natural resources, real estate and certain REIT subsidiaries that invest primarily in real estate, represent more than 10% of the total fair market value of our assets, our shares could be treated as "United States real property interests." In such case, gain recognized by an investor who is a non-United States person on the sale or exchange of its shares would be treated for United States federal income tax purposes as effectively connected income (unless the gain is attributable to a class of our shares that is regularly traded on a securities market and the non-United States person owns 5% or less of the shares of that class). If gain from the sale of our shares is treated as effectively connected income, the 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 shares may be subject to other taxes, including foreign, state and local taxes, unincorporated business taxes and estate, inheritance or intangible property taxes that are imposed by the various jurisdictions in which we conduct business or own property, even if the holders of our shares do not reside in any of those jurisdictions. For example, our holders may have state filing obligations in jurisdictions in which we have made investments in natural resources or real estate (other than through a REIT subsidiary). 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 shares may be subject to California income taxes or withholding on their allocable share of our income and gains.

Our Manager has offices in California, and thus we could be deemed to have California source income. Based on our current and anticipated investment activities, we believe that holders of our shares who are not residents of California and corporate holders of our shares who do not have other income derived from California should not be subject to California income taxes on their share of our income or gains. However, no assurance can be provided that our future activities will not cause holders of our shares who are not residents of California and such corporate holders of our shares to be subject to California income tax on all or a portion of their share of our income or gains, and no assurance can be provided that the California Franchise Tax Board will not successfully challenge our current position that such holders are not subject to California income tax on their share of our income and gains. If it were determined that we had California source income, we would be required to withhold at a rate of 7% of the distributions of California source income to domestic (non-foreign) nonresident holders of our shares and at the highest rate of tax imposed on individuals and corporations, respectively, of the allocated share of California source income for foreign (non-U.S.) holders of our shares.

Holders of our shares may recognize a greater taxable gain (or a smaller tax loss) on a disposition of our 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 shares, who will realize the benefit of including their allocable share of the debt in the tax basis of their shares. The tax basis in our 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 shares later sells its shares, the holder's amount realized on the sale will include not only the sales price of the shares but also will include such holder's portion of debt allocable to those shares (which is treated as proceeds from the sale of those 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 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 or more partnership tax years.

We could incur a significant tax liability if the IRS 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 shares and thus could result in a reduction of the value of those 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 shares and thus could result in a reduction of the value of those shares.

Tax-exempt holders of our 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 and real estate, 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. Any such withholding taxes would further reduce the amount of cash available for distribution to us.

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, one of our REIT subsidiaries 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 regulated investment company 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 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, our REIT subsidiaries and foreign corporate subsidiaries will not qualify for the reduced tax rates generally applicable to corporate dividends paid to taxpayers taxed at individual rates.

The maximum tax rate applicable to "qualified dividend income" payable to domestic shareholders taxed at individual rates is 20%. Dividends paid by, and certain income inclusions derived with respect to the ownership of, REITs, passive foreign investment companies ("PFICs") and certain controlled foreign corporations ("CFCs"), however, generally are not eligible for the reduced rates on qualified dividend income. 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. The more favorable rates applicable to regular corporate qualified dividends could cause investors who are taxed at individual rates to perceive investments in companies such as us whose holdings include foreign corporations and REITs to be relatively less attractive than investments in the stocks of domestic non-REIT corporations that pay dividends treated as qualified dividend income, 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 shares after December 31, 2016.

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, without duplication, 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, 2016. 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 under FATCA.

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 may restrict a change of control in which our holders might receive a premium for their shares.

In order for each of our REIT subsidiaries to continue to qualify as REITs, 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 each of our REIT subsidiaries to be owned, directly or indirectly, by us and by holders of the preferred shares issued by such REIT subsidiary. In order to preserve our current REIT subsidiaries 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 any class or series 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 our REIT subsidiaries to continue to qualify as REITs 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 any 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 each of our current and any future REIT subsidiaries will operate and continue to 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 any 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 any REIT subsidiary will satisfy such requirements for any particular taxable year. If any 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, such 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.

A holder whose shares are loaned to a "short seller" to cover a short sale of shares may be considered as having disposed of those shares. If so, the holder would no longer be treated for tax purposes as a partner with respect to those shares during the period of the loan and may recognize gain or loss from the disposition.

Because a holder whose shares are loaned to a "short seller" to cover a short sale of shares may be considered as having disposed of the loaned shares, the holder may no longer be treated for tax purposes as a partner with respect to those shares during the period of the loan to the short seller and the holder may recognize gain or loss from such disposition. Moreover, during the period of the loan to the short seller, any of our income, gain, loss, or deduction with respect to those shares may not be reportable by the holder and any cash distributions received by the holder as to those shares could be fully taxable as ordinary income. Holders desiring to assure their status as partners and avoid the risk of gain recognition from a loan to a short seller are urged to modify any applicable brokerage account agreements to prohibit their brokers from borrowing their shares.

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 shares may be required to request an extension of the time to file their tax returns.

Holders of our 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 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 shares with tax information on a timely basis. Because holders of our 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 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 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 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 shares and any other securities we may issue.

The United States federal income tax treatment of holders of our 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 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 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

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 shares and of any 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 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 shares and of any other 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.

Information concerning proved reserves, production, wells, acreage and related matters are contained in "Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations."

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

On February 21, 2013, the closing price of our common shares, as reported on the NYSE, was $10.98. The following table sets forth the high and low sale prices for our common shares for the period indicated as reported on the NYSE:

As of February 21, 2013, we had 204,780,075 issued and outstanding common shares that were held by 22 holders of record. The 22 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, our liquidity needs, legal and contractual restrictions on the payment of distributions, including those under the terms of our preferred shares, 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 common shares. Shareholders may have taxable income or tax liability attributable to our common 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 Common Shareholders" for further discussion. We may not declare or pay distributions on our common shares unless all accrued distributions have been declared and paid, or set aside for payment, on our Series A LLC Preferred Shares.

The following table shows the distributions declared for the years ended December 31, 2012 and 2011:

The following table summarizes as of December 31, 2012, 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, 2007 to the Standard & Poor's 500 Index ("S&P 500 Index") 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, 2007, and that all dividends were

reinvested. The total return performance shown on the graph is not necessarily indicative of future total return performance.

On February 14, 2013, the Compensation Committee of the board of directors granted the Manager 292,009 restricted common shares subject to graded vesting over three years with the final vesting date of March 1, 2016. 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, 2012, our non-employee directors deferred $0.1 million of cash compensation in exchange for 4,520 phantom shares pursuant to the KKR Financial Holdings LLC Non-Employee Directors' Deferred Compensation and Share Award Plan. In addition, on November 21, 2012, our non-employee directors deferred $0.1 million of cash distribution in exchange for 10,574 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 our election, 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 us. 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, 2012, 2011, 2010, 2009 and 2008. 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, 2012			Year ended December 31, 2011		Year ended December 31, 2010		Year ended December 31, 2009			Year ended December 31, 2008

Consolidated Statements of Operations Data:
Total revenues	$	555,473		$	542,021	$	505,359	$	572,725		$	948,588
Total investment costs and expenses		318,375			215,162		188,952		329,169			1,046,102
Total other income (loss)		205,822			93,447		143,352		(96,275	)		(906,837	)
Total other expenses		98,157			94,223		87,993		70,061			73,250

Income (loss) from continuing operations before income taxes		344,763			326,083		371,766		77,220			(1,077,601	)
Income tax (benefit) expense		(3,467	)		8,011		702		284			107

Income (loss) from continuing operations		348,230			318,072		371,064		76,936			(1,077,708	)
Income from discontinued operations		—			—		—		—			2,668

Net income (loss)	$	348,230		$	318,072	$	371,064	$	76,936		$	(1,075,040	)

Net income (loss) per common share:
Basic
Income (loss) per share from continuing operations	$	1.95		$	1.79	$	2.33	$	0.50		$	(7.71	)

Income per share from discontinued operations	$	—		$	—	$	—	$	—		$	0.02

Net income (loss) per share	$	1.95		$	1.79	$	2.33	$	0.50		$	(7.69	)

Diluted
Income (loss) per share from continuing operations	$	1.87		$	1.75	$	2.32	$	0.50		$	(7.71	)

Income per share from discontinued operations	$	—		$	—	$	—	$	—		$	0.02

Net income (loss) per share	$	1.87		$	1.75	$	2.32	$	0.50		$	(7.69	)

Weighted average number of common shares outstanding:
Basic		177,838			177,560		157,936		153,756			140,027

Diluted		187,423			180,897		158,771		153,756			140,027

Distributions declared per common share	$	0.86		$	0.67	$	0.43	$	0.05		$	1.30

(in thousands, except per share data)	As of December 31, 2012		As of December 31, 2011		As of December 31, 2010		As of December 31, 2009		As of December 31, 2008

Consolidated Balance Sheets Data:
Cash and cash equivalents	$	237,606	$	392,154	$	313,829	$	97,086	$	41,430
Restricted cash and cash equivalents		896,396		399,620		571,425		342,706		1,233,585
Securities		533,520		922,603		932,823		803,258		658,779
Corporate loans, net		5,947,857		6,443,399		6,321,444		6,543,643		7,571,446
Residential mortgage loans(1)		—		—		—		2,097,699		2,620,021
Equity investments, at estimated fair value		161,621		189,845		99,955		120,269		5,287
Oil and gas properties, net		289,929		138,525		33,797		—		—
Total assets		8,358,879		8,647,228		8,418,412		10,300,005		12,515,082
Total borrowings		6,338,407		6,778,208		6,642,455		8,970,591		11,461,610
Total liabilities		6,519,757		6,971,396		6,775,364		9,133,347		11,851,737
Total shareholders' equity		1,839,122		1,675,832		1,643,048		1,166,658		663,345
Book value per common share	$	10.31	$	9.41	$	9.24	$	7.37	$	4.40

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 2012, we witnessed spread tightening in the high yield debt markets and overall increased appetite for risk from certain investors in the search for yield, which led to price appreciation for certain riskier assets as evidenced through the leveraged loan and high yield bond indices. In comparison, 2011 experienced significant market swings with constrained liquidity and wider credit spreads triggered by downside macroeconomic and political concerns. Specifically, the S&P/LSTA Loan

Index returned 9.7% for 2012 (as compared to 1.5% for 2011) while the Bank of America Merrill Lynch U.S. High Yield Master II index returned 15.6% for 2012 (as compared to 4.4% for 2011).

The rally in both indices drove unrealized mark-to-market gains, which had a positive impact on certain of our equity investments carried at estimated fair value and loans held for sale, which are carried at the lower of cost or estimated fair value. The price appreciation also drove substantially higher net realized gains on investments relative to the prior year period as we disposed of certain assets, most notably from our high yield bond portfolio.

As the majority of our assets and liabilities include floating interest rate provisions indexed to three-month London interbank offered rate ("LIBOR"), changes in interest rates impact our net income through interest income and expense. Interest rates in the U.S. remained low during 2012 with the three-month LIBOR ending at 0.31% as of December 31, 2012 compared to 0.58% the year before. However, the average three-month LIBOR rate increased to 0.43% for the year ended December 31, 2012, from 0.34% for the year ended December 31, 2011. As a result of the low interest rates, we saw an increase of assets available on the market, both through new issue and amendments of existing facilities, offering a LIBOR floor.

In addition to our financial assets consisting primarily of bank loans and high yield bonds, which are impacted by the factors above, we hold real assets including oil and natural gas properties, which are impacted by the relevant commodity prices. The Henry Hub spot natural gas price increased to $3.41 per million British thermal units ("MMBtu") as of December 31, 2012, from $3.03 per MMBtu as of December 31, 2011. Separately, the WTI Cushing crude oil spot price decreased to $91.83 per barrel ("Bbl") as of December 30, 2012, from $98.83 per Bbl as of December 30, 2011. Revenue earned on our oil and natural gas properties are dependent on volumes produced as well as price. As such, commodity price volatility will impact our net income through total revenues and net realized and unrealized gains and losses on our commodity swaps.

Our net income for the year ended December 31, 2012 totaled $348.2 million (or $1.87 per diluted common share), as compared to net income of $318.1 million (or $1.75 per diluted common share) and $371.1 million (or $2.32 per diluted common share) for the years ended December 31, 2011 and 2010, respectively. Additional discussion around our consolidated results, as well as the components of net income for our reportable segments for the years ended December 31, 2012, 2011 and 2010 are detailed further below under "Results of Operations."

Book value per share increased $0.90 from $9.41 as of December 31, 2011 to $10.31 as of December 31, 2012. The increase in book value per share from December 31, 2011 was attributable to (i) earnings for the year ended December 31, 2012 of $1.95 per basic common share, partially offset by (ii) an increase in accumulated other comprehensive loss, a component of shareholders' equity, of $0.19 per share primarily as a result of reclassification adjustments for gains realized in net income from the sale of certain corporate debt securities, and (ii) the distribution to shareholders during the year ended December 31, 2012 of $0.86 per common share.

During 2012, we paid aggregate cash distributions totaling $153.4 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, our liquidity needs, legal and contractual restrictions on the payment of distributions, including those under the terms of our preferred shares, 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 common shares. Shareholders may have taxable income or tax liability attributable to our common shares for a taxable year that is greater than our cash distributions for such taxable year. See "Non-Cash 'Phantom' Taxable Income" below for further discussion about taxable income allocable to holders of our common shares. We may not declare or pay distributions on our common shares unless all accrued distributions have been declared and paid, or set aside for payment, on our 7.375% Series A LLC Preferred Shares ("Series A LLC Preferred Shares").

On March 20, 2012, we issued $115.0 million par amount of 7.500% senior notes due March 20, 2042 ("7.500% Senior Notes"), resulting in net proceeds of $111.4 million. The notes trade under the ticker symbol "KFI" on the NYSE. Interest on the 7.500% Senior Notes is payable quarterly in arrears on June 20, September 20, December 20 and March 20 of each year.

On November 30, 2012, we entered into a credit agreement for a three-year $150.0 million revolving credit facility (the "2015 Facility"), maturing on November 30, 2015. We may obtain additional commitments under the 2015 Facility so long as the aggregate amount of commitments at any time does not exceed $350.0 million. We have the right to prepay loans under the 2015 Facility in whole or in part at any time. In connection with entering into the 2015 Facility, we terminated the commitments under our existing asset-based revolving credit facility. Loans under the 2015 Facility bear interest at a rate equal to, at our option, LIBOR plus 2.25% per annum, or an alternate base rate plus 1.25% per annum. The 2015 Facility contains customary covenants, including ones that require us to satisfy a net worth financial test and maintain certain ratios relating to leverage and consolidated total assets. In addition, the 2015 Facility contains customary negative covenants applicable to us.

On December 7, 2012, our five-year non-recourse, asset-based revolving credit facility (the "2015 Natural Resources Facility"), maturing on November 5, 2015, was adjusted and reduced to $126.1 million, 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. As of December 31, 2012, we had $107.8 million of borrowings outstanding under the 2015 Natural Resources Facility.

On December 21, 2012, we closed CLO 2012-1, a $412.4 million secured financing transaction maturing December 16, 2024. We issued $367.5 million par amount of senior secured notes to unaffiliated investors, of which $342.5 million was floating rate with a weighted-average coupon of three-month LIBOR plus 2.09% and $25.0 million was fixed rate at 2.39%. We also issued $21.5 million of subordinated notes. The investments that are owned by CLO 2012-1 collateralize the CLO 2012-1 debt, and as a result, those investments are not available to us, our creditors or shareholders.

On January 17, 2013, we issued 14.95 million of Series A LLC Preferred Shares for gross proceeds of $373.8 million, and net proceeds of $362.0 million. The Series A LLC Preferred Shares trade on the New York Stock Exchange under the ticker symbol "KFN.PR" and began trading on January 28, 2013. Distributions on the Series A LLC Preferred Shares are cumulative and are payable, when, as, and if declared by our board of directors, quarterly on January 15, April 15, July 15 and October 15 of each year, beginning April 15, 2013, at a rate per annum equal to 7.375%.

On January 18, 2013, in accordance with the indenture relating to our $172.5 million of 7.5% convertible senior notes due January 15, 2017 (the "7.5% Notes"), we issued a conversion rights termination notice ("Termination Notice") to holders of the 7.5% Notes whereby we terminated the right to convert the 7.5% Notes to common shares. Holders of $172.5 million 7.5% Notes submitted their notes for conversion for which we satisfied by physical settlement with 26.1 million common shares, or 151.0580 shares per $1,000 principal amount of 7.5% Notes.

Our Cash Flow CLOs are all variable interest entities ("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 Cash Flow 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, disregarded entities or foreign corporations for United States federal income tax purposes), partnerships generally 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. We generally allocate our taxable income and loss using a monthly convention, which means that we determine our taxable income and losses for the taxable year to be allocated to our shares and then prorate that amount on a monthly basis. 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 our 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:

Refer to "Results of Operations—Investment Portfolio" below for a reconciliation of these six core strategies, which differs from our reportable segments, to the line items on our consolidated balance sheets.

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, 2012, our Cash Flow CLOs, which were structured as financing vehicles engaged in holding primarily corporate debt investments, held $6.3 billion par amount or $6.0 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, 2012:

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, 2012, the contractual notional balance of these amortizing interest rate swaps was $378.8 million.

As of December 31, 2012, these Cash Flow CLOs had aggregate secured debt outstanding totaling $5.1 billion held by unaffiliated third parties and aggregate junior secured notes outstanding totaling $296.6 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. We hold the majority or all of the subordinated notes in each of the Cash Flow CLOs and we consolidate all of the Cash Flow CLOs. All income and losses related to the assets in these Cash Flow CLOs are reflected on our consolidated statement of operations even though a minority interest in three of our CLO transactions is not held by us.

An affiliate of our Manager has entered into separate management agreements with our Cash Flow CLOs and is entitled to receive fees for the services performed as collateral manager. The indentures governing the CLO transactions stipulate the reinvestment period during which the collateral 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, both CLO 2005-1 and CLO 2005-2 ended their reinvestment periods in the second quarter of 2011 and CLO 2006-1 ended its reinvestment period in the third quarter of 2012. 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, 2012, $886.6 million of original CLO 2007-A, CLO 2005-1, CLO 2005-2 and CLO 2006-1 senior notes were repaid. CLO 2007-1 and CLO 2012-1 will end their reinvestment periods during May 2014 and December 2016, 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, 2012, $93.0 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, 2012:

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 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. Our assessment of the significance of a particular input to the fair value measurement in its entirety requires judgment and consideration of factors specific to the asset. 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 yield analysis techniques, where the key inputs are based on relative value analyses, which incorporate similar instruments from similar issuers. In addition, an illiquidity discount is applied where appropriate.

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 market and income (discounted cash flow) approaches, in which various internal and external factors are considered. Factors include key financial inputs and recent public and private transactions for comparable investments. Key inputs used for the discounted cash flow approach include the weighted average cost of capital and assumed inputs used to calculate terminal values, such as earnings before interest, taxes, depreciation and amortization ("EBIDTA") exit multiples. The fair value recorded for a particular investment will generally be within the range suggested by the two approaches. Upon completion of the valuations conducted, an illiquidity discount is applied where appropriate.

Interests in Joint Ventures and Partnerships: Interests in joint ventures and partnerships include certain equity investments related to the oil and gas and commercial real estate sectors. Interests in joint ventures and partnerships 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 an income (discounted cash flow) approach, in which various internal and external factors are considered and key inputs include the weighted average cost of capital. In addition, an illiquidity discount is applied where appropriate.

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. OTC derivatives are initially valued using quoted market prices, if available, or models using a series of techniques, including closed-form analytic formulae, such as the Black-Scholes option-pricing model, and/or simulation models in the absence of quoted market prices. Many pricing models employ methodologies that have pricing inputs 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 a third party valuation servicer. The most significant inputs to the valuation of these instruments are default and loss expectations and constant prepayment rates.

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, 2012, share-based compensation totaled $3.2 million. As of December 31, 2012, a $1 increase in the price of our common shares would have increased our future share-based compensation expense by approximately $0.4 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, 2012, the common share options were fully vested and expire in August 2014. As of December 31, 2012, future unamortized share-based compensation totaled $2.9 million, of which $1.9 million, $0.8 million and $0.2 million will be recognized in 2013, 2014 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 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.

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, 2012, the estimated fair value of our net derivative liabilities totaled $94.1 million.

Securities Available-for-Sale: 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 loss.

This process involves a considerable amount of judgment by our management. As of December 31, 2012, we had aggregate unrealized losses on our securities classified as available-for-sale of approximately $9.8 million, which if not recovered may result in the recognition of future losses. During the year ended December 31, 2012, we recorded charges for impairments of securities that we determined to be other-than-temporary totaling $8.4 million.

Long Lived Assets: We evaluate our proved oil and natural gas properties and related equipment and facilities for impairment on a field-by-field basis, 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. The factors used to determine fair value include, but are not limited to, estimates of proved reserves, future commodity pricing, future production estimates, anticipated capital expenditures, future operating costs and a discount rate commensurate with the risk on the properties and cost of capital. Unproved oil and natural gas

properties are assessed periodically and, at a minimum, annually on a property-by-property basis, and any impairment in value is recognized when incurred.

Based on certain events and circumstances that indicated a need for impairment, which included a projection of future oil and natural gas reserves that will be produced from a field, the timing of this future production, future costs to produce the oil and natural gas and future inflation levels, we determined that an impairment was necessary in 2012. During the year ended December 31, 2012, we recorded $3.3 million of impairments which are included in net realized and unrealized gain on investments on our consolidated statements of operations. These impairments were recognized on certain fields in Texas related to working interests acquired during the fourth quarter of 2010.

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 typically 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 present value of expected future cash flows discounted at the loan's effective interest rate, except as a practical expedient, the loan's observable estimated fair value may be used. We also estimate the probable credit losses inherent in our unfunded loan commitments as of the balance sheet date. Any credit loss reserve for unfunded loan commitments is recorded in accounts payable, accrued expenses and other liabilities on our consolidated balance sheets.

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 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.

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, 2012, 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, 2012, 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.

Oil, natural gas and natural gas liquids revenues are recognized when production is sold to a purchaser at fixed or determinable prices, when delivery has occurred and title has transferred and collectability of the revenue is reasonably assured. We follow the sales method of accounting for natural gas revenues. Under this method of accounting, revenues are recognized based on volumes sold, which may differ from the volume to which we are entitled based on our working interest. An imbalance is recognized as a liability only when the estimated remaining reserves will not be sufficient to enable the under-produced owners to recoup our entitled share through future production. Under the sales method, no receivables are recorded when we take less than our share of production and no payables are recorded when we take more than our share of production.

Proved reserves are based on the quantities of oil, natural gas and natural gas liquids ("NGL") that by analysis of geoscience and engineering data can be estimated with reasonable certainty to be economically producible from a given date forward, from known reservoirs, and under existing economic conditions, operating methods, and government regulations prior to the time at which contracts providing the right to operate expire, unless evidence indicates that renewal is reasonably certain. The independent engineering firms, Netherland, Sewell & Associates, Inc. ("NSAI") and LaRoche Petroleum Consultants, Ltd. ("LaRoche"), prepared reserve and economic evaluations of all

of our properties, except for overriding royalty interests in certain properties in the Eagle Ford Shale, on a well-by-well basis as of December 31, 2012, and the reserve estimates reported herein were prepared by NSAI and LaRoche and aggregated by us. The reserve estimates were reviewed with the petroleum engineers and geoscience professionals from the managers of our oil and gas properties and approved by us.

Reserves and their relation to estimated future net cash flows impact our depletion and impairment calculations. As a result, adjustments to depletion and impairment are made concurrently with changes to reserve estimates. The process performed by the independent engineers to prepare reserve amounts included their estimation of reserve quantities, future producing rates, future net revenue and the present value of such future net revenue, based in part on data provided by the managers of our oil and gas properties and us. The estimates of reserves conform to the guidelines of the SEC, including the criteria of "reasonable certainty," as it pertains to expectations about the recoverability of reserves in future years.

The accuracy of reserve estimates is a function of many factors including the following: the quality and quantity of available data, the interpretation of that data, the accuracy of various mandated economic assumptions and the judgments of the individuals preparing the estimates. In addition, reserve estimates are a function of many assumptions, all of which could deviate significantly from actual results. As such, reserve estimates may materially vary from the ultimate quantities of oil, natural gas and NGL eventually recovered.

For additional information regarding estimates of reserves, including the standardized measure of discounted future net cash flows, see "Item 8. Financial Statements and Supplementary Data-Supplemental Oil and Natural Gas Data (Unaudited)".

In January 2013, the FASB clarified the scope of offsetting disclosure requirements which 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 fiscal years beginning on or after January 1, 2013, and interim periods within those annual periods, with retrospective disclosures required for all comparative periods presented. We do not expect the guidance to have a material impact on our consolidated financial statements.

In February 2013, the FASB amended guidance to require entities to disclose additional information about reclassification adjustments, including (i) changes in accumulated other comprehensive income balances by component and (ii) significant items reclassified out of accumulated other comprehensive income. The guidance is effective for fiscal years, and interim periods within those years, beginning after December 15, 2012 and is to be applied prospectively. The adoption of this guidance will not have a material impact on our consolidated financial statements and we will include the required disclosure in the first quarter ended March 31, 2013.

The following table presents the consolidated results by segments for the years ended 2012, 2011 and 2010 (amounts in thousands):

	Credit							Natural Resources							Other						Reconciling Items(1)									Total Consolidated

For the years ended December 31	2012			2011		2010		2012		2011		2010			2012		2011		2010		2012			2011			2010			2012			2011		2010
Total revenues	$	490,861		$	511,392	$	504,471	$	64,535	$	30,629	$	888		$	77	$	—	$	—	$	—		$	—		$	—		$	555,473		$	542,021	$	505,359
Total investment costs and expenses		257,269			196,415		187,345		60,668		18,747		1,607			438		—		—		—			—			—			318,375			215,162		188,952
Total other income (loss)		199,278			85,499		143,578		1,881		7,948		(226	)		4,663		—		—		—			—			—			205,822			93,447		143,352
Total other expenses		48,640			46,371		37,149		5,111		3,823		586			217		—		—		44,189			44,029			50,258			98,157			94,223		87,993
Income tax (benefit) expense		(3,468	)		7,941		697		—		70		5			1		—		—		—			—			—			(3,467	)		8,011		702

Net income (loss)	$	387,698		$	346,164	$	422,858	$	637	$	15,937	$	(1,536	)	$	4,084	$	—	$	—	$	(44,189	)	$	(44,029	)	$	(50,258	)	$	348,230		$	318,072	$	371,064

Net income for the year ended December 31, 2012 was $348.2 million, consisting of revenues totaling $555.5 million, investment costs and expenses totaling $318.4 million, other income totaling $205.8 million and other expenses totaling $98.2 million. Comparatively, net income for the year ended December 31, 2011 was $318.1 million, consisting of revenues totaling $542.0 million, investment costs and expenses totaling $215.2 million, other income totaling $93.4 million and other expenses totaling $94.2 million, while net income for the year ended December 31, 2010 was $371.1 million, consisting of revenues totaling $505.4 million, investment costs and expenses totaling $189.0 million, other income totaling $143.4 million and other expenses totaling $88.0 million.

Revenues consist primarily of interest income and discount accretion from our investment portfolio, as well as oil and gas revenue from our working and royalty interests in oil and gas properties. Revenues increased $13.5 million from the year ended December 31, 2011 to 2012 primarily due to $33.9 million of incremental oil and gas revenue as a result of the acquisition of additional working and royalty interests in 2011 and 2012. This was partially offset by a reduction in loan and securities interest income and discount accretion of $6.4 million and $11.2 million, respectively.

Revenues increased $36.7 million from the year ended December 31, 2010 to 2011 primarily due to $29.7 million of incremental oil and gas revenue as a result of the acquisition of additional working and royalty interests in 2011, as well as a $20.5 million increase in loan interest income and discount accretion. These were partially offset by a $16.5 million reduction in securities interest income and discount accretion.

Investment costs and expenses include interest expense, provision for loan losses, oil and gas production costs, depreciation, depletion and amortization expense ("DD&A") related to oil and gas properties, and other investment expenses. Investment costs and expenses increased $103.2 million from the year ended December 31, 2011 to 2012 primarily due to $35.1 million of incremental oil and gas production costs and DD&A as a result of the acquisition of additional working and royalty interests in

2011 and 2012, a $32.3 million increase in provision for loan losses and a $31.4 million increase in interest expense primarily related to our November 2011 and March 2012 senior note offerings.

Investment costs and expenses increased $26.2 million from the year ended December 31, 2010 to 2011 primarily due to an increase in interest expense to affiliates of $24.3 million due to an increase in CLOs that passed compliance tests thereby resuming payments to mezzanine and subordinate debt holders, including an affiliate of our Manager. In addition, the increase was driven by $15.3 million of incremental oil and gas production costs and DD&A as a result of the acquisition of additional working and royalty interests in 2011. This was partially offset by a reduction in the provision for loan losses of $14.9 million.

Other income increased $112.4 million from the year ended December 31, 2011 to 2012 primarily as a result of larger realized gains on sales and paydowns of certain individual investments during 2012.

Other income decreased $49.9 million from the year ended December 31, 2010 to 2011 primarily due to the one-time gain on extinguishment of debt totaling $38.7 million recorded in 2010. In addition, there was a decrease in realized and unrealized gains on investments.

Other expenses include related party management compensation, general, administrative and directors expenses and professional services. 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 is 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. In addition, our Manager is 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.

Professional services expenses consist of legal, accounting and other professional services. General, administrative and directors' expenses include share-based compensation, expenses and reimbursements due to the board of directors for their services, as well as other expenses incurred by us or reimbursable by us to our Manager.

Consolidated other expenses increased $3.9 million from the year ended December 31, 2011 to 2012. The majority of this change was related to an increase in related party management compensation as a result of an increase in base management fees as well as incentive fees. Base management fees increased $1.9 million from the year ended December 31, 2011 to 2012 primarily due to an increase in "equity" resulting from incremental net income earned during 2012. In addition, incentive fees totaled $37.6 million for the year ended December 31, 2012 compared to $34.2 million for the year ended December 31, 2011.

Consolidated other expenses increased $6.2 million from the year ended December 31, 2010 to 2011. Base management fees increased $7.2 million from the year ended December 31, 2010 to 2011 primarily due to an increase in "equity" resulting from incremental net income earned during 2011. Partially offsetting this increase was the decline in incentive fees, which totaled $34.2 million for the year ended December 31, 2011 compared to $38.8 million for the year ended December 31, 2010.

We operate our business through multiple reportable business segments, which are differentiated primarily by their investment focuses.

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 us.

We evaluate the performance of our segments based on several components including total revenues, total investment costs and expenses, total other income (loss), and total other expenses. Net income includes: (i) revenues; (ii) related investment costs and expenses; (iii) other income (loss), which is comprised primarily of unrealized and realized gains and losses on investments and derivatives, and (iv) other expenses, including related party management compensation and general and administrative expenses. Certain corporate assets and expenses that are not directly related to the individual segments, including interest expense and related costs on borrowings, base management fees and professional services are allocated to individual segments based on the carrying value of the assets within those segments. These allocations are calculated based on the investment portfolio balance in each respective segment as of the most recent year end. 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 our assessment of segment performance. Collectively, these items are included as reconciling items between reported segment amounts and consolidated totals. For further financial information related to our segments, refer to "Part II—Item 8. Financial Statements and Supplementary Data—Note 15. Segment Reporting."

The following discussion and analysis regarding our results of operations is based on our reportable segments. Certain prior period information has been reclassified to conform to the current year presentation to provide additional detailed financial information as a result of the growth in our natural resources segment.

The following table presents the net income components of our credit segment for the years ended 2012, 2011, and 2010 (amounts in thousands):

	For the year ended December 31, 2012			For the year ended December 31, 2011			For the year ended December 31, 2010

Revenues:
Corporate loans and securities interest income	$	394,108		$	388,974		$	369,387
Residential mortgage-backed securities interest income		11,649			14,616			23,924
Net discount accretion		82,621			102,404			108,718
Dividend income		2,302			5,287			2,266
Other		181			111			176

Total revenues		490,861			511,392			504,471

Investment costs and expenses:
Interest expense:
Collateralized loan obligation secured debt		71,749			61,875			59,242
Credit facilities		3,423			2,186			12,796
Convertible senior notes		18,595			26,467			28,047
Senior notes		26,937			2,727			—
Junior subordinated notes		14,885			15,253			15,532
Interest rate swaps		22,556			22,734			15,562
Other interest expense		331			514			227

Total interest expense		158,476			131,756			131,406
Interest expense to affiliates		51,586			49,458			25,152
Provision for loan losses		46,498			14,194			29,121
Other		709			1,007			1,666

Total investment costs and expenses		257,269			196,415			187,345

Other income (loss):
Realized and unrealized (loss) gain on derivatives and foreign exchange:
Interest rate swaps		—			—			310
Credit default swaps		(5,138	)		(6,030	)		1,970
Total rate of return swaps		141			49			1,771
Common stock warrants		1,677			(890	)		663
Foreign exchange(1)		(3,047	)		(4,795	)		(9,182	)
Options		—			(94	)		—

Total realized and unrealized (loss) gain on derivatives and foreign exchange		(6,367	)		(11,760	)		(4,468	)
Net realized and unrealized gain (loss) on residential mortgage-backed securities, at estimated fair value		9,299			2,825			(11,396	)
Net realized and unrealized gain on investments(2)		193,133			96,229			122,199
Net realized and unrealized (loss) gain on securities sold, not yet purchased		(2,089	)		431			(756	)
Impairment of securities available for-sale and private equity at cost		(8,759	)		(7,705	)		(12,890	)
Net (loss) gain on restructuring and extinguishment of debt		(445	)		(1,736	)		39,999
Other income		14,506			7,215			10,890

Total other income (loss)		199,278			85,499			143,578

Other expenses:
Related party management compensation:
Base management fees		26,706			25,828			19,030
CLO management fees		4,237			5,289			5,396

Total related party management compensation		30,943			31,117			24,426
Professional services		5,697			5,703			5,234
Other general and administrative		12,000			9,551			7,489

Total other expenses		48,640			46,371			37,149

Income before income taxes		384,230			354,105			423,555
Income tax (benefit) expense		(3,468	)		7,941			697

Net income	$	387,698		$	346,164		$	422,858

Revenues decreased $20.5 million from $511.4 million for the year ended December 31, 2011 to $490.9 million for the year ended December 31, 2012. The decrease was primarily attributable to a $19.8 million decrease in net discount accretion as a net result of (i) a $15.2 million decline in recurring accretion income due to a smaller overall corporate debt portfolio and comparatively smaller discounts on the remaining portfolio and (ii) a $4.6 million decrease in accelerated discount accretion as a result of fewer paydowns in 2012. Partially offsetting this decline was $5.1 million of additional corporate loans and securities interest income earned primarily from a higher yielding corporate debt portfolio. The average three-month LIBOR rate increased to 0.43% for the year ended December 31, 2012, from 0.34% for the year ended December 31, 2011. In addition, the percentage of our floating rate corporate debt portfolio with LIBOR floors increased to 51.6% as of December 31, 2012 from 32.2% as of December 31, 2011.

These positive changes to rates outweighed the reductions in the corporate debt portfolio. The weighted average par balances for our corporate loan portfolio declined by $478.3 million from $7.1 billion to $6.6 billion for the years ended December 31, 2011 and 2012, respectively. This reduction was the result of fewer purchases subsequent to December 31, 2011 within certain of our CLOs that ended their reinvestment periods. CLO 2007-A ended its reinvestment period during the fourth quarter of 2010, both CLO 2005-1 and CLO 2005-2 ended their reinvestment periods during the second quarter of 2011 and CLO 2006-1 ended its reinvestment period during the third quarter of 2012. Refer to "Investment Portfolio Overview" above for further discussion on the principal proceeds from the assets held in each of these CLO transactions used to amortize the outstanding balance of the CLO senior notes outstanding.

Revenues increased $6.9 million from $504.5 million for the year ended December 31, 2010 to $511.4 million for the year ended December 31, 2011. The increase was primarily attributable to corporate loans and securities interest income, which increased $19.6 million from the year ended December 31, 2011 as compared to 2010. The increase in corporate loans and securities interest income 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. Partially offsetting this increase in revenue was a decline in residential mortgage-backed securities interest income of $9.3 million from December 31, 2010 to 2011, as well as a reduction in net discount accretion of $6.3 million from December 31, 2010 to 2011.

Total investment costs and expenses increased $60.9 million, from $196.4 million for the year ended December 31, 2011 to $257.3 million for the year ended December 31, 2012. The increase was primarily attributable to additional provision for loan losses and higher interest expense. Provision for loan losses increased $32.3 million from $14.2 million for the year ended December 31, 2011 to $46.5 million for the year ended December 31, 2012. The increase in provision for loan losses was largely as a result of an increase in the allowance for loan losses based on a review of our unimpaired,

held for investment loan portfolio, with particular sensitivity to the loans that we designated as high risk within our internally assigned risk grades.

Interest expense increased on both our senior notes and collateralized loan obligation secured debt. As described above, we issued senior notes in November 2011 and March 2012 and therefore incurred related interest expense of $26.9 million for the year ended December 31, 2012 compared to $2.7 million for the year ended December 31, 2011. Interest expense on our collateralized loan obligation secured debt also increased, as a result of the increase in LIBOR combined with the fact that we closed CLO 2011-1 on March 31, 2011, partially offset by the amortization of outstanding senior notes for those CLOs that ended their reinvestment periods. The weighted average par balance of our collateralized loan obligation secured debt decreased $447.6 million from the year ended December 31, 2011 to the year ended December 31, 2012.

Total investment costs and expenses increased $9.1 million, from $187.3 million for the year ended December 31, 2010 to $196.4 million for the year ended December 31, 2011. The increase was primarily attributable to an increase in interest expense to affiliates of $24.3 million, which as discussed above was due to all Cash Flow CLOs passing certain compliance tests in 2011 and thereby, resuming payments to mezzanine and subordinate debt holders, including an affiliate of our Manager. This was partially offset by a $14.9 million reduction in the provision for loan losses from the year ended December 31, 2010 to 2011 from $29.1 million to $14.2 million which was largely the result of a decrease in the allocated component of our allowance for loan losses.

Total other income increased $113.8 million from $85.5 million for the year ended December 31, 2011 to $199.3 million for the year ended December 31, 2012, largely driven by a $96.9 million increase in net realized and unrealized gain on investments primarily attributable to two factors.

First, there was a $62.5 million beneficial change in the lower of cost or estimated fair value adjustment on our corporate loans held for sale portfolio, from a $65.2 million charge recorded for the year ended December 31, 2011 to a $2.7 million charge for the year ended December 31, 2012, which was a result of price appreciation in our corporate loans held for sale portfolio during 2012 compared to the same period in 2011. Second, realized and unrealized gains on our corporate debt portfolio increased year over year. Specifically gains on our (i) corporate loan portfolio increased $16.5 million from $25.7 million for the year ended December 31, 2011 to $42.2 million for the year ended December 31, 2012 and (ii) securities available-for-sale portfolio increased $7.2 million from $107.6 million for the year ended December 31, 2011 to $114.8 million for the year ended December 31, 2012. While both years included significant realized gains from sales of investments, the gains recorded during the year ended December 31, 2012 exceeded those recorded during 2011. Particularly, during the year ended December 31, 2012, we had realized gains totaling $28.3 million from three corporate loan holdings combined with aggregate gains of $13.9 million from various other sales. Comparatively, during the year ended December 31, 2011, we recognized $16.6 million in gains from one of our largest corporate loan positions with aggregate gains of $9.1 million from various other sales. In addition, during the year ended December 31, 2012, we had realized gains totaling $67.0 million from sales of three corporate debt security holdings combined with aggregate gains of $47.8 million from various other sales. Comparatively, during the year ended December 31, 2011, we recognized $88.7 million in gains on partial sales from two of our largest corporate debt holdings and aggregate gains of $19.0 million from various other sales.

In addition to the contributors above, the increase in other income was attributable to a $6.5 million increase in realized and unrealized gains on residential mortgage-backed securities, at

estimated fair value from the year ended December 31, 2011 to 2012. These gains were partially due to price appreciation on the securities from the year ended December 31, 2011 to 2012.

These gains were partially offset by a $4.7 million increase in impairment losses recorded during 2012 for securities available-for-sale that we determined to be other-than-temporarily impaired.

Total other income decreased $58.1 million from $143.6 million for the year ended December 31, 2010 to $85.5 million for the year ended December 31, 2011, primarily due 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 prices of our corporate loans held for sale portfolio, particularly during the third quarter of 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% convertible senior notes (the "7.0% Notes") due July 2012.

Other expenses increased $2.3 million from $46.4 million for the year ended December 31, 2011 to $48.6 million for the year ended December 31, 2012, primarily due to $2.4 million of additional other general and administrative expenses. The increase in other general and administrative expenses from $9.6 million for the year ended December 31, 2011 to $12.0 million for the year ended December 31, 2012 was primarily attributable to $2.0 million of higher expenses incurred by our Manager on our behalf that were reimbursable to our Manager pursuant to the Management Agreement. For the years ended December 31, 2011 and 2012, we incurred reimbursable general and administrative expenses to our Manager totaling $8.2 million and $10.2 million, respectively. These reimbursable general and administrative expenses to our Manager include costs related to information technology systems and subscriptions, as well as certain other costs required for business and investment operations.

Total other expenses increased $9.2 million from $37.1 million for the year ended December 31, 2010 to $46.4 million for the year ended December 31, 2011, primarily due to $6.8 million of additional base management fees and $2.1 million of additional other general and administrative expenses incurred in 2011. Base management fees increased from $19.0 million for the year ended December 31, 2010 to $25.8 million for the year ended December 31, 2011 due to higher "equity" resulting from both net income earned during 2011 and the equity offering of 19.4 million common shares, which generated proceeds of $175.7 million in December 2010. Other general and administrative expenses increased from $7.5 million for the year ended December 31, 2010 to $9.6 million for the year ended December 31, 2011 primarily due to $3.6 million of higher expenses incurred by our Manager on our behalf that were reimbursable to our Manager pursuant to the Management Agreement. For the years ended December 31, 2010 and 2011, we incurred reimbursable general and administrative expenses to our Manager of $4.6 million and $8.2 million, respectively. These reimbursable general and administrative expenses to our Manager include costs related to information technology systems and subscriptions, as well as certain other costs required for business and investment operations.

The following table presents the net income (loss) components of our natural resources segment for the years ended 2012, 2011, and 2010 (amounts in thousands):

	For the year ended December 31, 2012			For the year ended December 31, 2011		For the year ended December 31, 2010

Revenues:
Oil and gas revenue:
Natural gas sales	$	22,203		$	10,224	$	550
Oil sales		26,353			9,023		145
Natural gas liquids sales		12,773			9,888		193
Other		3,206			1,494		—

Total revenues		64,535			30,629		888

Investments costs and expenses:
Interest expense:
Credit facilities		3,042			1,050		103
Convertible senior notes		944			478		123
Junior subordinated notes		755			275		68
Senior notes		1,366			49		—

Total interest expense		6,107			1,852		294
Oil and gas production costs:
Lease operating expenses		14,562			4,415		177
Workover expenses		3,335			941		—
Transportation and marketing expenses		7,477			985		—
Severance and ad valorem taxes		3,606			1,425		—

Total oil and gas production costs		28,980			7,766		177
Oil and gas depreciation, depletion and amortization		21,931			8,015		324
Other		3,650			1,114		812

Total investment costs and expenses		60,668			18,747		1,607

Other income:
Net realized and unrealized gain (loss) on derivatives and foreign exchange:
Commodity swaps		4,275			7,948		(226	)
Net realized and unrealized gain on investment(1)		(3,191	)		—		—
Other income		797			—		—

Total other income (loss)		1,881			7,948		(226	)

Other expenses:
Related party management compensation:
Base management fees		1,355			466		83
Professional services		930			495		97
Insurance		126			7		1
Other general and administrative		2,700			2,855		405

Total other expenses		5,111			3,823		586

Income before income taxes		637			16,007		(1,531	)
Income tax expense		—			70		5

Net income (loss)	$	637		$	15,937	$	(1,536	)

Our oil and gas results depend substantially on natural gas and oil prices and production levels, as well as drilling and operating costs. The price we realize for our production is affected by our hedging

activities. In order to help mitigate the potential exposure and effects of changing commodity prices on our revenues and cash flows from operations, we have entered into commodity swaps for a portion of our working interests. Our policy has been to hedge a majority portion of the total estimated oil, natural gas and NGL production on our working interests for a specified amount of time. Our commodity derivatives are described further below under "Other Income (Loss)".

	For the year ended December 31, 2012		For the year ended December 31, 2011		For the year ended December 31, 2010

Average daily production:
Natural gas (Mcf/d)		24,032		7,087		1,382
Oil (Bbls/d)		754		305		20
NGL (Bbls/d)		759		648		69

Total (Mcfe/d)(1)		33,110		12,805		1,916
Weighted average prices (hedged)(2):
Natural gas (MMBtu)	$	2.87	$	3.96	$	4.76
Oil (Bbl)	$	95.86	$	80.99	$	78.13
NGL (Bbl)	$	48.09	$	43.29	$	30.59
Weighted average prices (unhedged)(3):
Natural gas (MMBtu)	$	2.53	$	3.95	$	4.76
Oil (Bbl)	$	95.82	$	81.02	$	78.13
NGL (Bbl)	$	46.11	$	41.80	$	30.59
Average Henry Hub and WTI spot prices:
Natural gas (MMBtu)	$	2.75	$	3.99	$	4.37
Oil (Bbl)	$	94.05	$	94.88	$	79.48
Costs per Mcfe of production:
Lease operating expenses	$	1.21	$	1.00	$	1.01
Transportation and marketing expenses	$	0.62	$	0.22	$	—
General and administrative expenses	$	0.57	$	0.91	$	7.39
Depreciation, depletion and amortization	$	1.81	$	1.81	$	1.84
Taxes, other than income taxes	$	0.30	$	0.32	$	—

Revenue increased $33.9 million from $30.6 million for the year ended December 31, 2011 to $64.5 million for the year ended December 31, 2012 due to the increase in production resulting from the acquisitions of producing oil and natural gas properties in 2011 and 2012 described further below under "Investment Portfolio—Other Holdings", as well as drilling and completion of existing

undeveloped overriding royalty interest property. As of December 31, 2012 and 2011, our working and overriding royalty interests had a carrying value of $297.0 million and $138.6 million, respectively.

Average daily production volumes increased 159% from the year ended December 31, 2011 to 2012 primarily due to acquisitions of producing properties completed during 2012.

Revenue increased $29.7 million for the year ended December 31, 2011 as compared to 2010 due to the increase in production resulting from the acquisitions of producing oil and natural gas properties made in 2011, as well as drilling and completion of existing undeveloped overriding royalty interest property purchased in the first quarter of 2011. As of December 31, 2011 and 2010, our working and overriding royalty interests had a carrying value of $138.6 million and $32.8 million, respectively.

In addition, based on the oil and natural gas properties acquired, average daily production volumes increased 568% from the year ended December 31, 2010 to 2011 primarily due to acquisitions of producing properties in 2011.

Investment costs and expenses consist of production costs, DD&A and other expenses related to acquisitions.

Production costs represent costs incurred to operate and maintain our wells, or lease operating expenses, as well as transportation and marketing costs. Lease operating expenses include expenses such as labor, rented equipment, field office, saltwater disposal, maintenance, tools and supplies and workover expenses. As we continue to acquire working interests in oil and natural gas properties, lease operating expenses will continue to increase in conjunction with an increase in oil, natural gas and natural gas liquids production. Furthermore, we have agreements with third parties to act as managers of certain of our oil and natural gas properties. Services provided by these third party managers include making the business and operating decisions related to the production and sale of oil, natural gas and natural gas liquids, collection and disbursement of revenues, operating expenses, general and administrative expenses and other necessary and useful services for the operation of the assets. Again, as the overall number of oil and natural gas properties increase, the related costs to manage these properties increase correspondingly.

Production costs also include severance and ad valorem taxes, which increase or decrease primarily when prices of natural gas and oil increase or decrease, but are also affected by changes in production, as well as appreciated property values.

DD&A represents recurring charges related to the exhaustion of mineral reserves for our natural resources investments. DD&A is calculated using the units-of-production method, which depletes capitalized costs of producing oil and natural gas properties based on the ratio of current production to estimated total net proved oil, natural gas and NGL reserves, and total net proved producing oil, natural gas and natural gas liquid reserves. Our depletion expense is affected by factors including reserve revisions primarily related to well performance and commodity prices.

As described above, we acquired additional producing oil and natural gas properties during 2011 and 2012 and thus, the costs associated with operating and managing the wells increased. Production costs increased $21.2 million from $7.8 million for the year ended December 31, 2011 to $29.0 million for the year ended December 31, 2012. Most notably was the increase in lease operating expenses of $10.1 million and transportation and marketing expenses of $6.5 million related to an increase in wells and production from 2012 acquisitions. Similarly, DD&A increased $13.9 million from $8.0 million for

the year ended December 31, 2011 to $21.9 million for the year ended December 31, 2012 due to an increase in production and depletable costs that resulted from 2012 acquisitions.

In addition, interest expense increased $4.3 million from the year ended December 31, 2011 to 2012 as a result of additional drawdowns on our 2015 Natural Resources Facility to partially fund acquisitions, as well as allocated holding company debt expense. As of December 31, 2012 and 2011, we had $107.8 million and $38.3 million, respectively, of borrowings under our 2015 Natural Resources Facility.

Production costs increased $7.6 million from $0.2 million for the year ended December 31, 2010 to $7.8 million for the year ended December 31, 2011. DD&A increased $7.7 million from $0.3 million for the year ended December 31, 2010 to $8.0 million for the year ended December 31, 2011. These increases were primarily attributable to acquisitions made in 2011 and the fact that we only began acquiring oil and natural gas properties during the fourth quarter of 2010. As such, expenses in 2011 represented costs that were incurred during the full year of 2011.

In addition, interest expense increased $1.6 million from the year ended December 31, 2010 to 2011 as a result of additional drawdowns on our asset-based borrowing facility to partially fund acquisitions, as well as allocated holding company debt expense. As of December 31, 2011 and December 31, 2010, we had $38.3 million and $18.4 million, respectively, of borrowings under our 2015 Natural Resources Facility.

Total other income decreased $6.1 million from $7.9 million for the year ended December 31, 2011 to $1.9 million for the year ended December 31, 2012, primarily attributable to lower unrealized gains on our commodity swaps and impairment recorded on certain of our oil and natural gas properties.

We currently use commodity derivative contracts, consisting of oil, natural gas and certain NGL products receive-fixed, pay-floating swaps for certain years through 2016. Our unhedged production may expose us to commodity price declines or alternatively, provide the potential upside from commodity price increases. Our price hedging strategy and future hedging transactions, including the prices at which we hedge our production, are dependent upon several factors, including expected production and commodities prices at the time we enter into these transactions.

Net realized and unrealized gains on commodity swaps decreased $3.7 million from $7.9 million for the year ended December 31, 2011 to $4.3 million for the year ended December 31, 2012. Unrealized gains and losses on commodity swaps result from changes in commodity prices from period to period, as well as changes in market valuations of derivatives as future commodity price expectations change compared to the contract prices on the derivatives. If the expected future commodity prices increase compared to the contract prices on the derivatives, unrealized losses are recognized; if the expected future commodity prices decrease compared to the contract prices on the derivatives, unrealized gains are recognized. The fair value of our open derivative contracts decreased $0.3 million from a net asset $7.4 million as of December 31, 2011 to a net asset of $7.1 million as of December 31, 2012 primarily due to the settlement of open contracts at December 31, 2011 in 2012, partially offset by new contracts entered into during 2012 that have appreciated in value.

Realized gains (losses) represent amounts related to the settlement of derivative instruments, which for commodity derivatives, are aligned with the underlying production. During the year ended December 31, 2012 and 2011, net realized gains on commodity swaps totaled $3.6 million and $0.4 million, respectively.

Included in the $6.1 million total other income decrease was $3.3 million of impairment charges recorded during the year ended December 31, 2012 on certain of our oil and natural gas properties acquired during the fourth quarter of 2010. We evaluate our 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. Downward revisions in estimates of reserve quantities or expectations of falling commodity prices or rising operating or development costs could indicate and result in impairments. 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. In addition, we periodically and, at a minimum, annually evaluate our unproved oil and natural gas properties for impairment on a property-by-property basis.

Total other income increased $8.2 million from an other loss of $0.2 million for the year ended December 31, 2010 to $7.9 million for year ended December 31, 2011, primarily attributable to unrealized gains on our commodity swaps. For the year ended December 31, 2011, the fair value of our open derivative contracts changed from a net liability of $0.2 million as of December 31, 2010 to a net asset of $7.4 million as of December 31, 2011 primarily due to the decrease in future commodity prices as of December 31, 2011 compared to 2010. During the years ended December 31, 2011 and 2010, net realized gains on commodity swaps totaled $0.4 million and zero, respectively.

Total other expenses increased $1.3 million from $3.8 million for the year ended December 31, 2011 to $5.1 million for the year ended December 31, 2012 primarily due to additional allocated corporate expenses, including base management fees and professional services expenses.

Total other expenses increased $3.2 million from $0.6 million for the year ended December 31, 2010 to $3.8 million for the year ended December 31, 2011 primarily due to higher other general and administrative expenses. As we began acquiring oil and natural gas assets during the fourth quarter of 2010, the $2.9 million of total other general and administrative expenses for the year ended December 31, 2011 represented costs for a full year, compared to expenses for a single quarter in 2010.

The following table presents the net income components of our other segments for the years ended 2012, 2011, and 2010 (amounts in thousands):

	For the year ended December 31, 2012		For the year ended December 31, 2011		For the year ended December 31, 2010

Revenues:
Other interest income	$	77	$	—	$	—

Total revenues		77		—		—

Investment costs and expenses:
Interest expense		438		—		—

Total investment costs and expenses		438		—		—

Other income
Net realized and unrealized gain on investment		4,663		—		—

Total other income		4,663		—		—

Other expenses:
Related party management compensation:
Base management fees		183		—		—
Professional services		34		—		—

Total other expenses		217		—		—

Income before income taxes		4,085		—		—
Income tax expense		1		—		—

Net income	$	4,084	$	—	$	—

Revenues totaled $0.1 million for the year ended December 31, 2012. As of December 31, 2012, our commercial real estate holdings had a carrying value of $52.5 million and are included within other assets on our consolidated balance sheets. We began acquiring commercial real estate investments during the second quarter of 2012 and as such, all prior years have zero balances.

Investment costs and expenses totaled $0.4 million for the year ended December 31, 2012. Certain corporate assets and expenses that are not directly related to a segment, including interest expense and related costs on borrowings are allocated to individual segments based on the investment portfolio balance in each segment as of the most recent year end. We began acquiring commercial real estate investments during the second quarter of 2012 and as such, all prior years have zero balances.

Other income totaled $4.7 million for the year ended December 31, 2012. As our commercial real estate holdings are recorded at estimated fair value on our consolidated balance sheets, the $4.7 million represented net unrealized gains on our holdings. We began acquiring commercial real estate investments during the second quarter of 2012 and as such, all prior years have zero balances.

Other expenses totaled $0.2 million for the year ended December 31, 2012. The expenses incurred were comprised of certain corporate expenses that were not directly related to the segment, but were allocable costs based on the portfolio balance within the segment as of the most recent year end. We began acquiring commercial real estate investments during the second quarter of 2012 and as such, all prior years have zero balances.

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 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 equity interests in certain subsidiaries which have elected or intend to elect to be taxed as real estate investment trusts ("REIT subsidiaries") under the Internal Revenue Code of 1986, as amended (the "Code"). 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.

Our REIT subsidiaries are not expected to incur a federal tax expense, but are subject to limited state income tax expense related to the 2012 tax year. For the year ended December 31, 2012, we recorded $2.8 million of federal and $0.8 million of state tax benefit for our domestic corporate subsidiaries. Additionally, we recorded $0.1 million of state and foreign tax expense for our non-corporate subsidiaries for the year ended December 31, 2012. Accordingly, for the year ended December 31, 2012, we recorded income tax benefit of $3.5 million. As of December 31, 2012, cumulative tax liability net of deferred tax asset is included in accounts payable, accrued expenses and other liabilities on our consolidated balance sheet.

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 other holdings, including oil and gas working and royalty interests, equity investments, and interests in joint ventures and partnerships, which are all discussed below under "Other Holdings".

The following table summarizes the carrying value of our investment portfolio by strategy as of December 31, 2012 (amounts in thousands):

The table above reconciles our assets as presented on our consolidated balance sheets to our six core strategies, which differs from our reportable segments. For segment reporting purposes, the majority of our corporate debt portfolio and equity investments, at estimated fair value are included within our Credit segment. Our Natural Resources and Other segments include our oil and natural gas properties and commercial real estate investments, respectively. Our Natural Resources segment excludes the private equity and interests in joint ventures and partnerships focused on the oil and gas sector (included in equity investments, at estimated fair value and other assets on our consolidated balance sheets).

Our corporate debt investment portfolio primarily consists of investments in corporate loans and corporate 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 $6.5 billion as of December 31, 2012 and $7.1 billion as of December 31, 2011. 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, 2012 and 2011. 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, 2012(1)									December 31, 2011(1)

	Par		Carrying Value			Amortized Cost		Estimated Fair Value		Par		Carrying Value			Amortized Cost		Estimated Fair Value
Senior secured	$	5,761,308	$	5,575,437		$	5,575,437	$	5,494,676	$	6,329,636	$	6,085,696		$	6,085,696	$	5,826,951
Second lien		457,333		433,020			433,020		334,191		474,903		434,705			434,705		351,484
Subordinated		264,722		174,694			174,694		233,308		251,124		165,228			165,228		183,975

Subtotal		6,483,363		6,183,151			6,183,151		6,062,175		7,055,663		6,685,629			6,685,629		6,362,410
Lower of cost or fair value adjustment		—		(14,047	)		—		—		—		(50,906	)		—		—
Allowance for loan losses		—		(223,472	)		—		—		—		(191,407	)		—		—
Unrealized gains.		—		2,225			—		—		—		83			—		—

Total	$	6,483,363	$	5,947,857		$	6,183,151	$	6,062,175	$	7,055,663	$	6,443,399		$	6,685,629	$	6,362,410

As of December 31, 2012, $6.5 billion par amount, or 99.7%, of our corporate loan portfolio was floating rate and $22.3 million par amount, or 0.3%, was fixed rate. In addition, as of December 31, 2012, $328.9 million par amount, or 5.1%, of our corporate loan portfolio was denominated in foreign currencies, of which 68.8% was denominated in Euros. 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.

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 5.3% and 4.6% as of December 31, 2012 and December 31, 2011, respectively, and the weighted average coupon spread to LIBOR of our floating rate corporate loan portfolio was 4.5%

and 3.9% as of December 31, 2012 and December 31, 2011, respectively. The weighted average years to maturity of our floating rate corporate loans was 4.3 years and 4.1 years as of December 31, 2012 and December 31, 2011, respectively.

As of December 31, 2012, our fixed rate corporate loans had a weighted average coupon of 12.5% and a weighted average years to maturity of 1.5 years, as compared to 11.7% and 3.7 years, respectively, as of December 31, 2011.

Non-accrual Loans. 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, 2012 and 2011 (amounts in thousands):

The $367.6 million increase in non-accrual loans from $168.7 million as of December 31, 2011 to $536.3 million as of December 31, 2012 is primarily due to our determination that Texas Competitive Electric Holdings Company LLC ("TXU") loans, with a recorded investment of $310.9 million at December 31, 2012, were impaired. In addition, we held TXU loans held for sale with a recorded investment of $29.8 million at December 31, 2012. During the years ended December 31, 2012 and 2011, we recognized $19.6 million and $11.9 million, respectively, of interest income from cash receipts for loans on non-accrual status.

Impaired Loans. Impaired loans consist of loans held for investment where we have determined that it is probable 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 on a recorded investment basis increased from $68.7 million as of December 31, 2011 to $445.4 million as of December 31, 2012 primarily due to $413.0 million of additions to impaired loans, $310.9 million of which are related to TXU and the remaining $102.1 related to two other issuers, and $6.5 million of transfers from held-for-sale to held-for-investment, partially offset by $19.1 million of transfers from held-for-investment to held-for-sale, $14.3 million of sales and paydowns and $9.4 million of restructurings.

Defaulted Loans. 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, 2012, the Company held two corporate loans that were in default with a total amortized cost of $50.4 million from one issuer and were included in the loans for which the allocated component of the Company's allowance for loan losses was related to. As of December 31, 2011, the Company had no corporate loans in default.

Troubled Debt Restructurings. During the year ended December 31, 2012, we exchanged an aggregate recorded investment of $67.7 million of loans from a single issuer for new loans of varying extended maturities and equity with a combined estimated fair value of $25.6 million, in a modification which qualified as a troubled debt restructuring. The interest rate did not change as a result of this modification. Prior to the restructuring, certain of the loans were included in the allocated component of the allowance for loan losses, while the remaining loans were in loans held for sale and were on non-accrual status. The difference between the recorded investment of the loans and the estimated fair value of the new loans and equity was charged-off against the allowance for loan losses and the lower of cost or estimated fair value allowance. The new loans were included in the allocated component of the allowance for loan losses and in loans held for sale and will be maintained on non-accrual status until performance has been demonstrated by the borrower for a suitable period of time, while the equity was carried at estimated fair value. The loans modified in the troubled restructuring were not in default at December 31, 2012. As of December 31, 2012, there were no commitments to lend additional funds to the borrower whose loans had been modified in the troubled debt restructuring. 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. The loans modified in the troubled restructuring were not in default at December 31, 2011. As of December 31, 2011, there were no commitments to lend additional funds to the borrower whose loans had been modified in the troubled debt restructuring.

During the years ended December 31, 2012 and 2011, we modified $1.7 billion and $1.3 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.

Allowance For Loan Losses. The following table summarizes the changes in our allowance for loan losses for the years ended December 31, 2012, 2011 and 2010 (amounts in thousands):

As of December 31, 2012 and December 31, 2011, we had an allowance for loan loss of $223.5 million and $191.4 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 possible 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, 2012, the allocated component of our allowance for loan losses totaled $94.9 million and relates to investments in certain loans issued by six issuers with an aggregate par amount of $484.1 million and an aggregate recorded investment of $445.4 million. 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.

The unallocated component of our allowance for loan losses totaled $128.6 million and $157.6 million as of December 31, 2012 and 2011, respectively. As discussed above, we estimate the unallocated reserve by first categorizing our corporate loans held for investment portfolio based on their assigned risk grade and then based on the seniority of the loan in the issuer's capital structure. Of the three internally assigned risk grades, as of December 31, 2012, we had loans issued from seven issuers with an aggregate par value of $846.5 million and amortized cost amount of $822.1 million that we classified as high risk. Approximately 92.9% of the amortized cost balance of loans classified as high risk consisted of the following holdings: i) $312.7 million amortized cost amount of loans issued by Modular Space Corporation; ii) $154.2 million amortized cost amount of loans issued by TL Acquisitions, Inc.; iii) $137.7 million amortized cost amount of loans issued by First Data Corporation; iv) $98.0 million amortized cost amount of loans issued by Education Management LLC; and v) $61.2 million amortized cost amount of loans issued by Caesars Entertainment Operating Company.

At September 30, 2012, we transferred TXU, from the high risk grade of the unallocated component to the allocated component of our allowance for loan losses upon determination that the loans were impaired. Management believed it probable that we would be unable to collect all payments due in accordance with the contractual terms of the loan agreement. To calculate the recovery value of the loans, we estimated the loss as being the difference between our current cost basis of the loan, including accrued interest receivable, and the present value of expected future cash flows discounted using the effective discount rate. At December 31, 2012, the calculation resulted in a specific reserve of $49.1 million related to TXU, or an implied recovery value of approximately 81% of par. As of December 31, 2012, TXU had a total amortized cost of $310.9 million.

During the years ended December 31, 2012, 2011 and 2010, we recorded charge-offs totaling $14.4 million, $31.8 million and $57.4 million, respectively, comprised primarily of loans transferred to loans held for sale.

Loans Held For Sale and the Lower of Cost or Fair Value Adjustment. The following table summarizes the changes in our loans held for sale balance as of December 31, 2012 and 2011 (amounts in thousands):

As of December 31, 2012, we had $128.3 million of loans held for sale, a decrease of $189.0 million from December 31, 2011 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 $2.7 million net charge to earnings during the year ended December 31, 2012 for the lower of cost or estimated fair value adjustment for certain loans held for sale which had a carrying value of $128.3 million as of December 31, 2012. We recorded a $65.2 million and $14.7 million net charge to earnings during years ended December 31, 2011 and 2010, respectively, for the lower of cost or estimated fair value adjustment for certain loans held for sale.

During the years ended December 31, 2012 and 2011, we transferred $115.0 million and $862.2 million 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, 2012 and 2011, we transferred $114.9 million and $448.3 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, 2012, approximately 46% 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, TXU and Modular Space Corporation, which combined represented $1.0 billion, or approximately 16% of the aggregated amortized cost basis of our corporate loans. 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, TXU and Modular Space Corporation, which combined represented $992.5 million, or approximately 15% of the aggregated amortized cost basis of our corporate loans.

Our corporate debt securities portfolio had an aggregate par value of $466.1 million and $869.7 million as of December 31, 2012 and 2011, 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, 2012 and 2011:

As of December 31, 2012, $395.4 million, or 84.8%, of our corporate debt securities portfolio was fixed rate and $70.7 million, or 15.2%, was floating rate. In addition, as of December 31, 2012,

$21.5 million par amount, or 4.6%, of our corporate debt securities portfolio, was denominated in foreign currencies, of which 81.8% was denominated in Euros. 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, 2012, our fixed rate corporate debt securities had a weighted average coupon of 9.2% and a weighted average years to maturity of 4.6 years, as compared to 9.6% and 6.0 years, respectively, as of December 31, 2011. 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 8.2% and 6.0% as of December 31, 2012 and December 31, 2011, respectively, and the weighted average coupon spread to LIBOR of our floating rate corporate debt securities was 7.3% and 5.3% as of December 31, 2012 and December 31, 2011, respectively. The weighted average years to maturity of our floating rate corporate debt securities was 3.0 years and 2.8 years as of December 31, 2012 and December 31, 2011, respectively.

During the years ended December 31, 2012 and December 31, 2011, we recorded impairment losses totaling $8.2 million and $1.5 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, 2010, we recorded losses totaling $2.6 million for corporate debt securities that we determined to be other-than-temporarily impaired.

As of December 31, 2012 and 2011, we had no corporate debt securities in default.

Our corporate debt securities portfolio has certain credit risk concentrated in a limited number of issuers. As of December 31, 2012, approximately 51% of the estimated fair value of our corporate debt securities was concentrated in ten issuers, with the three largest concentrations of corporate debt securities issued by Sanmina Corporation, Avaya Inc. and iPayment, Inc., which combined represented $87.0 million, or approximately 19% of the estimated fair of value of our corporate debt securities. 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 three largest concentrations of debt securities in securities issued by First Data Corporations, SandRidge Energy, Inc. and Equinox Holdings Inc., which combined represented $174.3 million, or approximately 21% of the estimated fair value of our corporate debt securities.

Our other holdings primarily consist of working and royalty interests, marketable and private equity investments, as well as interests in joint ventures and partnerships.

Our natural resources properties are located in the United States, in the operating regions of the Barnett Shale, Eagle Ford Shale and other parts of Louisiana, Mississippi and Texas.

Our natural resources holdings include non-operated working interests in producing oil and natural gas fields located in Louisiana, Mississippi and Texas. As of December 31, 2012 and 2011, the working

interests had a carrying value of $249.7 million and $86.9 million, respectively. These interests are in proved developed, proved undeveloped and unproved properties, with the majority of our exposure to natural gas, followed by NGL and then oil. The acquisition of these working interests was partially financed with $107.8 million of borrowings through our 2015 Natural Resources Facility. Our acquisitions included the following:

During 2011, we acquired certain oil and natural gas properties located in the Barnett Shale in Texas by funding approximately $56.7 million including costs. The acquisition included proved reserves as of the acquisition date.

During 2012, we executed several transactions through which we funded approximately $179.7 million, including transaction costs, for: (i) acquisitions of certain oil and natural gas properties located in Louisiana, Mississippi and Texas (most notably in the Barnett Shale and Eagle Ford Shale), which included proved reserves as of the acquisition date, (ii) agreements providing the rights to participate and earn working interest in oil and natural gas wells and acreage in the Permian Basin in Texas whereby we will provide development capital for drilling in exchange for working interests in the wells and acreage being developed and (iii) agreement providing us with the rights to participate and earn working interest in oil and natural gas wells in the Eagle Ford Shale in Texas whereby we will provide development capital for drilling in exchange for working interests in the wells being developed.

The following sets forth proved oil, natural gas and NGL reserves at December 31, 2012 and 2011, based on reserve reports prepared by independent engineers:

During the year ended December 31, 2012, our proved undeveloped reserves ("PUD") increased to 39.4 one billion cubic feet equivalent ("Bcfe") from 19.8 Bcfe at December 31, 2011. The increase was primarily due to 13.4 Bcfe added as a result of our acquisitions and 12.0 Bcfe added as a result of our drilling activities primarily in the Eagle Ford Shale, partially offset by approximately 5.8 Bcfe from PUD locations that are no longer economical.

Based on the December 31, 2012 reserve reports, the amounts of capital expenditures estimated to be incurred in 2013, 2014 and 2015 to develop our PUDs are approximately $39.1 million, $36.9 million and $27.4 million, respectively. The amount and timing of these expenditures will depend on a number of factors, including actual drilling results, service costs and product prices.

Reserve engineering is inherently a subjective process of estimating underground accumulations of oil, natural gas and NGL that cannot be measured exactly. The accuracy of any reserve estimate is a function of the quality of available data, as well as engineering and geological interpretation and judgment. Accordingly, reserve estimates may materially vary from the quantities of oil, natural gas and NGL that are ultimately recovered. The technologies and economic data used to establish reserve estimates include well logs, geologic maps, well test data, production data, historical price and cost information, and property ownership interests.

The reserve estimates reported herein were prepared by independent engineers, NSAI and LaRoche, and aggregated by us. The process performed by the independent engineers to prepare reserve amounts included their estimation of reserve quantities, future producing rates, future net revenue and the present value of such future net revenue, is based in part on data provided by the managers of our oil and gas properties and us. When preparing the reserve estimates, the independent engineering firm did not independently verify the accuracy and completeness of the information and data furnished by the managers of our oil and gas properties and us with respect to ownership interests, production, well test data, historical costs of operation and development, product prices, or any agreements relating to current and future operations of the properties and sales of production. However, if in the course of their work, something came to their attention that brought into question the validity or sufficiency of any such information or data, they did not rely on such information or data until they had satisfactorily resolved their questions relating thereto. The estimates of reserves conform to the guidelines of the SEC, including the criteria of "reasonable certainty," as it pertains to expectations about the recoverability of reserves in future years. The independent engineering firms also prepared estimates with respect to reserve categorization, using the definitions for proved reserves set forth in Regulation S-X Rule 4-10(a) and subsequent SEC staff interpretations and guidance.

NSAI was founded in 1961 and performs consulting petroleum engineering services under Texas Board of Professional Engineers Registration No. F-2699. Within NSAI, the technical persons primarily responsible for preparing the estimates set forth in the NSAI reserve reports incorporated herein are Mr. J. Carter Henson, Jr., Mr. Edward C. Roy III, and Mr. Connor B. Riseden. J. Carter Henson, Jr. has been practicing consulting petroleum engineering at NSAI since 1989. Mr. Henson is a Licensed Professional Engineer in the State of Texas (License No. 73964) and has over 30 years of practical experience in petroleum engineering, with over 22 years of experience in the estimation and evaluation of reserves. He graduated from Rice University in 1981 with a Bachelor of Science Degree in Mechanical Engineering. Edward C. Roy III has been practicing consulting petroleum geology at NSAI since 2008. Mr. Roy is a Licensed Professional Geoscientist in the State of Texas (License No. 2364) and has over 20 years of practical experience in petroleum geosciences, with over 4 years of experience in the estimation and evaluation of reserves. He graduated from Texas Christian University in 1992 with a Bachelor of Science Degree in Geology and from Texas A&M University in 1998 with a Master of Science Degree in Geology. Connor B. Riseden has been practicing consulting petroleum engineering at NSAI since 2006. Mr. Riseden is a Licensed Professional Engineer in the State of Texas (License No. 100566) and has over 11 years of practical experience in petroleum engineering, with over 6 years of experience in the estimation and evaluation of reserves. He graduated from Texas A&M University in 2001 with a Bachelor of Science Degree in Petroleum Engineering and from Tulane University in 2005 with a Master of Business Administration Degree. All meet or exceed the education, training, and experience requirements set forth in the Standards Pertaining to the Estimating and Auditing of Oil and Gas Reserves Information promulgated by the Society of Petroleum Engineers; all are proficient in judiciously applying industry standard practices to engineering and geoscience evaluations as well as applying SEC and other industry reserves definitions and guidelines.

LaRoche performs consulting petroleum engineering services under Texas Board of Professional Engineers Registration No. F-1360. Within LaRoche, the technical person primarily responsible for preparing the estimates set forth in the LaRoche reserve reports incorporated herein is Mr. William M. Kazmann. William M. Kazmann has been practicing consulting petroleum engineering at LaRoche for 16 years. Mr. Kazmann is a Licensed Professional Engineer in the State of Texas (License No. 45012) and has over 38 years of practical experience in petroleum engineering. He earned Bachelor of Science and Master of Science degrees in Petroleum Engineering from the University of Texas at Austin. Mr. Kazmann meets or exceeds the education, training, and experience requirements set forth in the Standards Pertaining to the Estimating and Auditing of Oil and Gas Reserves Information promulgated by the Society of Petroleum Engineers; he is proficient in judiciously applying industry standard practices

to engineering and geoscience evaluations as well as applying SEC and other industry reserves definitions and guidelines.

Our internal controls over the preparation of reserve estimates is a process designed to provide reasonable assurance regarding the reliability of our reserve estimates in accordance with SEC regulations. The managers of our oil and gas properties employ a team of petroleum engineers and geoscience professionals who work closely with NSAI and LaRoche to ensure the integrity, accuracy and timeliness of data furnished to NSAI and LaRoche in their reserve estimation process. The petroleum engineers discuss with NSAI and LaRoche and review the assumptions and forecast methods that they use in their preparation of the year-end reserve estimates. We review this data with the managers of our oil and gas properties, ensure that they are performing all of these functions, and approve the estimates. The preparation of the year-end reserve estimates was overseen by the Vice President of Engineering for one of our managers and the Vice President of Acquisitions and Engineering for the other manager. Each of these individuals has a bachelor's degree in engineering, and they have over 46 years of combined oil and gas industry experience.

The following sets forth the wells drilled during the periods indicated. Gross wells refers to the total number of productive wells in which we have a working interest. Net wells refers to the sum of our fractional working interests in gross wells. Productive wells consist of producing wells and wells capable of production, including wells awaiting pipeline or other connections to commence deliveries.

We do not operate any of our working interest wells, but a majority of our wells are operated by a third party that we have engaged to also act as the manager of a certain portion of our interests. As

such, all of our well information relates to non-operated wells. Among our productive wells, the following table separates them by commodity type as of December 31, 2012:

The following sets forth information relating to leasehold acreage as of December 31, 2012:

In addition to natural resources working interests, we own overriding royalty interests in acreage located in south Texas. During the first quarter of 2011, we completed the purchase of certain overriding royalty interests located in the Eagle Ford Shale in Texas by investing approximately $55.0 million. The overriding royalty interests include producing oil and natural gas properties. We have approximately 220 and 78 gross productive wells as of December 31, 2012 and 2011, respectively, in which we own an overriding royalty interest only, but most of the acreage is still under development. The overriding royalty interest properties are operated by unaffiliated third parties and as of December 31, 2012 and 2011, had a carrying value of $47.3 million and $51.7 million, respectively.

As of December 31, 2012, our equity investments consisted of (i) private equity investments carried at cost (included in other assets on our consolidated balance sheet) with an aggregate cost amount of $0.4 million and an estimated fair value of $1.6 million and (ii) equity investments carried at estimated fair value, with an aggregate cost amount of $140.7 million and an estimated fair value of $161.6 million. Equity investments carried at estimated fair value primarily consist of private equity investments. In comparison, 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.

As of December 31, 2012, our interests in joint ventures and partnerships had an aggregate cost amount of $137.6 million and estimated fair value of $142.5 million.

Our shareholders' equity at December 31, 2012, 2011 and 2010 totaled $1.8 billion, $1.7 billion and $1.6 billion, respectively. Included in our shareholders' equity as of December 31, 2012, 2011 and 2010 is accumulated other comprehensive (loss) income totaling $(70.2) million, $(35.6) million and $133.6 million, respectively.

Our average shareholders' equity and return on average shareholders' equity for the year ended December 31, 2012 was $1.8 billion and 19.7%, respectively, and for the year ended December 31, 2011 was $1.7 billion and 18.5%, respectively. Our average shareholders' equity and return on average shareholders' equity for the year ended December 31, 2010 was $1.3 billion and 27.9%, respectively. Return on average shareholders' equity is defined as net income divided by weighted average shareholders' equity.

Our book value per share as of December 31, 2012 and 2011 was $10.31 and $9.41, respectively, and was computed based on 178,437,078 and 178,145,482 shares issued and outstanding as of December 31, 2012 and 2011, respectively.

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 was paid on March 1, 2012. In addition, on February 2, 2012, our board of directors declared a 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 was paid on March 29, 2012.

On April 24, 2012, our board of directors declared a cash distribution for the quarter ended March 31, 2012 of $0.18 per share to shareholders of record on May 8, 2012. The distribution was paid on May 22, 2012.

On July 26, 2012, our board of directors declared a cash distribution for the quarter ended June 30, 2012 of $0.21 per share to shareholders of record on August 9, 2012. The distribution was paid on August 23, 2012.

On October 25, 2012, our board of directors declared a cash distribution for the quarter ended September 30, 2012 of $0.21 per share to shareholders of record on November 7, 2012. The distribution was paid on November 21, 2012.

On January 31, 2013, our board of directors declared a cash distribution for the quarter ended December 31, 2012 of $0.21 per share to common shareholders of record on February 19, 2013. The distribution is payable on February 28, 2013. Also, on January 31, 2013, our board of directors declared a special cash distribution for the year ended December 31, 2012 of $0.05 per share to common shareholders of record on March 14, 2013. The distribution is payable on March 28, 2013.

On March 1, 2012, we repurchased and cancelled 10,264 of our common shares in connection with the satisfaction of tax withholding obligations related to common shares previously awarded to certain of our officers and vesting on that date.

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.

Through February 17, 2013, $172.5 million of our 7.5% convertible senior notes (the "7.5% Notes") had been tendered for conversion, which were settled with 26.1 million shares. See "Sources of Funds" below for further discussion.

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. As of December 31, 2012, we had unrestricted cash and cash equivalents totaling $237.6 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. As described in further detail below, during the full year ended December 31, 2012, all our Cash Flow CLOs were in compliance with their respective coverage tests (specifically, their OC Tests and interest coverage ("IC") tests) and made cash distributions to mezzanine and/or subordinate note holders, including us.

On March 20, 2012, we issued $115.0 million par amount of 7.500% Senior Notes, resulting in net proceeds of $111.4 million. The notes trade under the ticker symbol "KFI" on the NYSE. Interest on the 7.500% Senior Notes is payable quarterly in arrears on June 20, September 20, December 20 and March 20 of each year.

On November 15, 2011, we issued $258.8 million par amount of 8.375% Senior Notes, resulting in net proceeds of $250.7 million. The notes trade under the ticker symbol "KFH" on the NYSE. Interest on the 8.375% Senior Notes is payable quarterly in arrears on February 15, May 15, August 15 and November 15 of each year.

As of December 31, 2012, we had seven 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 $296.6 million as of December 31, 2012 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 or 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.

three-month LIBOR plus 2.09% and $25.0 million was fixed rate at 2.39%. We also issued $21.5 million of subordinated notes. The investments that are owned by CLO 2012-1 collateralize the CLO 2012-1 debt, and as a result, those investments are not available to us, our creditors or shareholders.

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

The following table summarizes the PVR Test for CLO 2011-1. This information is based on the December 2012 monthly report which is prepared by the independent third party trustee for CLO 2011-1:


(dollar amounts in thousands)	CLO 2011-1
Portfolio total	$	429,360
Par value test minimum		120.0	%
Par value test ratio		133.3	%
Cushion / (Excess)	$	45,798
Par value portfolio collateral value	$	457,980
Outstanding loan balance	$	343,485

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, 2012, 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 2012 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	$	633,713		$	658,062		$	960,113		$	3,354,990		$	901,085
Senior IC ratio minimum		115.0	%		125.0	%		115.0	%		115.0	%		120.0	%
Actual senior IC ratio		809.3	%		1160.8	%		421.2	%		472.3	%		697.2	%
CCC amount	$	94,801		$	86,766		$	216,857		$	578,879		$	203,609
CCC percentage of portfolio		15.0	%		13.2	%		22.6	%		17.3	%		22.6	%
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		165.1	%		156.9	%		171.0	%		182.3	%		168.4	%
Cushion / (Excess)	$	167,086		$	139,237		$	146,824		$	411,988		$	247,034
Subordinated OC Test minimum		106.2	%		106.9	%		114.0	%		120.1	%		109.9	%
Actual subordinated OC Test		121.5	%		127.7	%		142.7	%		127.0	%		125.8	%
Cushion / (Excess)	$	76,263		$	104,848		$	180,932		$	175,272		$	107,705

As CLO 2012-1 closed on December 21, 2012, it was excluded from the results above.

During the year ended December 31, 2012, we issued $119.7 million par amount of CLO 2007-1 class D notes for proceeds of $95.1 million. In addition, during the year ended December 31, 2012, we issued $11.3 million par amount of CLO 2007-A class C notes for proceeds of $10.6 million.

On November 30, 2012, we entered into a credit agreement for a three-year $150.0 million revolving credit facility, maturing on November 30, 2015. We may obtain additional commitments under the 2015 Facility so long as the aggregate amount of commitments at any time does not exceed $350.0 million. We have the right to prepay loans under the 2015 Facility in whole or in part at any time. In connection with entering into the 2015 Facility, we terminated the commitments under our existing asset-based revolving credit facility. Loans under the 2015 Facility bear interest at a rate equal to, at our option, LIBOR plus 2.25% per annum, or an alternate base rate plus 1.25% per annum. The 2015 Facility contains customary covenants, including ones that require us to satisfy a net worth financial test and maintain certain ratios relating to leverage and consolidated total assets. In addition, the 2015 Facility contains customary negative covenants applicable to us.

Previously, we had a $250.0 million asset-based revolving credit facility (the "2014 Facility") maturing on May 3, 2014, that was subject to, among other things, the terms of a borrowing base derived from the value of eligible specified financial assets. As described above, the 2014 Facility was terminated in connection with us entering into the 2015 Facility. The 2014 Facility bore interest at a rate equal to LIBOR plus 3.25% per annum and contained negative covenants that restricted 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 were allowed to be paid if a deficiency in the required collateral per the agreement existed or would exist as a result of such distributions.

As of December 31, 2012, we had no borrowings outstanding under the 2015 Facility.

On December 7, 2012, our 2015 Natural Resources Facility, maturing on November 5, 2015, was adjusted and reduced to $126.1 million, 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.

As of December 31, 2012, we had $107.8 million of borrowings outstanding under the 2015 Natural Resources Facility.

As of December 31, 2012, we believe we were in compliance with the covenant requirements for both credit facilities discussed above.

In 2010, we issued $172.5 million of 7.5% Notes, which will mature on January 15, 2017 unless previously redeemed, repurchased or converted in accordance with their terms prior to such date. As of December 31, 2012, holders of the 7.5% Notes had the ability to 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. On January 18, 2013, in accordance with the indenture relating to the 7.5% Notes, we issued a Termination Notice to holders of the 7.5% Notes whereby we terminated the right to convert the 7.5% Notes to common shares. Per the indenture, we were able to terminate the conversion rights of the notes if the closing price of our shares exceeded 150% of the conversion price then in effect for 20 or more trading days in a period of 30 consecutive trading days ending on the trading day prior to the date on which we provide notice of the election to terminate the conversion rights. Holders of $172.5 million 7.5% Notes submitted their notes for conversion for which we satisfied by physical settlement with 26.1 million common shares, or 151.0580 shares per $1,000 principal amount of 7.5% Notes. As set forth in the Termination Notice, the 7.5% Notes were no longer convertible to common shares as of February 17, 2013.

During 2011, we repurchased $45.5 million par amount of our 7.0% Notes, which resulted in us recording a loss of $1.7 million and a write-off of $0.1 million of unamortized debt issuance costs. During the first quarter of 2012, we repurchased $23.1 million par amount of our 7.0% Notes. These transactions resulted in us recording a loss of $0.4 million and a $0.2 million write-off of unamortized debt issuance costs. On July 13, 2012, we repaid in full our $112.0 million of outstanding 7.0% Notes, which matured on July 15, 2012.

As of December 31, 2012, we had committed to purchase corporate loans with aggregate commitments totaling $254.2 million. In addition, we participate in certain financing arrangements,

whereby we are committed to provide funding of up to a specific predetermined amount at the discretion of the borrower or have entered into an agreement to acquire interests in certain assets. As of December 31, 2012, we had unfunded financing commitments, including financial guarantees, totaling $9.8 million for corporate loans and approximately $220.9 million related to other assets, including equity investments and interests in joint ventures and partnerships. Of the total unfunded financing commitments, $106.8 million was related to our credit segment, $119.0 million was related to our natural resources segment and $4.7 million was related to our other segments.

The table below summarizes our contractual obligations as of December 31, 2012 and are subject to material changes based on factors including interest rates, compliance with OC Tests and pay downs subsequent to December 31, 2012. 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)	$	442,676	$	2,955	$	5,911	$	433,810	$	—
CLO 2005-2 senior secured notes(1)		490,048		3,154		6,309		480,585		—
CLO 2006-1 senior secured notes(1)		624,698		4,172		8,344		8,344		603,838
CLO 2007-1 senior secured notes(1)		2,224,685		17,868		35,736		35,736		2,135,345
CLO 2007-1 junior secured notes(2)		285,888		6,376		12,752		12,752		254,008
CLO 2007-A senior secured notes(1)		644,673		9,020		18,041		617,612		—
CLO 2007-A junior secured notes(2)		12,919		437		874		11,608		—
CLO 2011-1 senior debt(1)		375,691		5,720		11,440		11,440		347,091
CLO 2012-1 senior secured notes(1)		487,940		7,100		18,933		18,933		442,974
CLO 2012-1 junior secured notes(2)		21,500		—		—		—		21,500
CLO 2007-1 junior secured notes to affiliates(2)		311,709		7,474		14,948		14,948		274,339
CLO 2007-A junior secured notes to affiliates(2)		60,790		2,781		5,562		52,447		—
Asset-based borrowing facility(3)		116,102		2,923		113,179		—		—
Convertible senior notes(4)		224,789		12,938		25,875		185,976		—
Senior notes(5)		1,251,522		30,295		60,591		60,591		1,100,045
Junior subordinated notes(6)		495,900		15,380		30,759		19,418		430,343
Other commitments(7)		466,859		273,546		142,356		—		50,957

Total	$	8,538,389	$	402,139	$	511,610	$	1,964,200	$	5,660,440

(2): Includes interest to be paid over the maturity of the CLO junior notes which has been calculated assuming no pay downs are made and debt outstanding as of December 31, 2012 is held until its final maturity date. The future interest payments are calculated using the weighted average borrowing rates as of December 31, 2012.
(3): Interest has been calculated assuming no prepayments are made and debt outstanding as of December 31, 2012 is held until its final maturity date. The future interest payments are calculated using rates in effect as of December 31, 2012, at spreads to market rates pursuant to the credit facility agreement, which is 2.7%. 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, 2012 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 7.5% interest rate. As a result of our Termination Notice issued on January 18, 2013, holders of $172.5 million 7.5% Notes submitted their notes for conversion (see "Liquidity and Capital Resources—Convertible Debt").
(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, 2012 is held until its final maturity date. The future interest payments are calculated using the stated 8.375% and 7.5% interest rates.
(6): Includes interest to be paid over the maturity of the junior subordinated notes which has been calculated assuming no prepayments are made and debt outstanding as of December 31, 2012 is held until its final maturity date. The future interest payments are calculated using fixed and variable rates in effect as of December 31, 2012, at spreads to market rates pursuant to the financing agreements, and range from 2.6% to 8.1%.
(7): Represents commitments to purchase corporate loans, as well as commitments to provide funding at the discretion of the borrower up to a specific predetermined amount, excluding financial guarantees. Refer to "Off-Balance Sheet Commitments" above for further discussion.

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, disregarded entities or foreign corporations for United States federal income tax purposes), partnerships generally 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. We generally allocate our taxable income and loss using a monthly convention, which means that we determine our taxable income and losses for the taxable year to be allocated to our shares and then prorate that amount on a monthly basis. 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.

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 tax purposes. A publicly traded partnership will be taxed as a partnership, however, 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.

the extent that the amount withheld exceeded such holder's United States federal income tax liability for the taxable year.

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. Moreover, if the fair market value of our investments in United States real property interests, which include our investments in natural resources, real estate and REIT subsidiaries that invest primarily in real estate, represent more than 10% of the total fair market value of our assets, our shares could be treated as United States real property interests. In such case, gain recognized by an investor who is a non-United States person on the sale or exchange of its shares would be treated for United States federal income tax purposes as effectively connected income (unless the gain is attributable to a class of our shares that is regularly traded on a securities market and the non-United States person owns 5% or less of the shares of that class). We do not believe that the fair market value of our investments in United States real property interests represents more than 10% of the total fair market value of our assets at this time. No assurance can be provided that our future investments in United States real property interests will not cause us to exceed the 10% threshold described above. If gain from the sale of our shares is treated as effectively connected income, the holder may be subject to United States federal income and/or withholding tax on the sale or exchange.

We expect to mail the 2012 Schedule K-1 (Form 1065), Partner's Share of Income, Deductions, Credits, etc. to shareholders by the end of March 2013.

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 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.

mortgage-backed securities that do not constitute qualifying real estate assets are classified by our real estate subsidiaries as real estate-related assets. Therefore, based upon the specific terms and circumstances related to each non-agency mortgage-backed security that our real estate subsidiaries own, our real estate subsidiaries 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 real estate subsidiaries acquire 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 real estate subsidiaries 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 real estate subsidiaries 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 real estate subsidiaries own more than one subordinate class, then, to determine the classification of subordinate classes other than the first loss class, our real estate subsidiaries 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 real estate subsidiaries own), whether our real estate subsidiaries own the entire amount of each such class and whether our real estate subsidiaries 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 real estate subsidiaries would expect not to classify that particular class, or classes senior to that class, as qualifying real estate assets.

(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 effective the date immediately prior to our becoming an investment company. 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".

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.

In August 2012, the U.S. Commodities Futures Trading Commission ("CFTC") adopted a series of rules to establish a new regulatory framework for swaps that may cause certain users of swaps to be deemed commodity pools or to register as commodity pool operators. In October 2012, the CFTC delayed the implementation of the relevant rules until December 31, 2012. Although we believe that KKR Financial Holdings LLC is not a commodity pool, we have requested confirmation of this conclusion from the CFTC. To the extent that any of our subsidiaries may be deemed to be a commodity pool, we believe they should satisfy certain exemptions to these rules available to privately offered entities. However, if the CFTC were to take the position that KKR Financial Holdings LLC is a commodity pool, our directors may be required to register as commodity pool operators. Such registration would add to our operating and compliance costs and could affect the manner in which we use swaps as part of our operating and hedging strategies.

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, 2012, $350.4 million par amount, or 5.0%, of our corporate debt portfolio was denominated in foreign currencies, of which 69.6% was denominated in Euros. In addition, as of December 31, 2012, $147.5 million par amount, or 42.6%, of other assets, which includes our equity investments at estimated fair value and interests in joint ventures and partnerships, was denominated in foreign currencies, of which 43.7% was denominated in Euros and 21.7% 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. As of December 31, 2012, the net contractual notional balance of our foreign exchange options and forward contracts totaled $208.1 million, all of which related to certain of our foreign currency denominated corporate debt holdings. Refer to "Derivative Risk" below for further discussion on our derivatives.

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, could have a material adverse impact on our 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. Based on our variable rate investments and related variable rate borrowings as of December 31, 2012, we estimated that increases in interest rates would impact net income by approximately (amounts in thousands):


Change in interest rates	Annual Impact
Increase of 1.0%	$	(17,436	)
Increase of 2.0%	$	(3,356	)
Increase of 3.0%	$	12,934
Increase of 4.0%	$	29,224
Increase of 5.0%	$	45,513

As of December 31, 2012, approximately 51.6% of our corporate debt portfolio had LIBOR floors with a weighted average floor of 1.4%. Given these LIBOR floors, increases in short-term interest rates above a certain point between 2% and 3% will result in a greater impact as yields on interest-earning assets are expected to rise faster than the cost of funding sources. The simulation above assumes that the asset and liability structure of the consolidated balance sheet would not be changed as a result of the simulated changes in interest rates.

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 interest rate swaps was $503.8 million as of December 31, 2012. Of the $503.8 million, $378.8 million was related to two pay-fixed, receive-variable interest rate swaps through certain of our CLOs. These interest rate derivatives consisted of swaps to hedge a portion of the interest rate risk associated with our borrowings under the CLO senior secured notes. The remaining $125.0 million of interest rate swaps were used to hedge a portion of the interest rate risk associated with our floating rate junior subordinated notes. The objective of the interest rate swaps is to eliminate the variability of cash flows in the interest payments of these notes due to fluctuations in the indexed rate. Refer to "Derivative Risk" below for further discussion on our derivatives.

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 currently no regulatory requirement concerning the amount of collateral that a counterparty must post to secure its obligations under certain derivative instruments. Currently, 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 aggregate notional amount and estimated net fair value of our derivative instruments held as of December 31, 2012 (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 estimated net fair values of

our primary derivative investments by remaining contractual maturity as of December 31, 2012 (amounts in thousands):

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, which may cause our revenues and cash flows to be volatile. As of December 31, 2012, natural gas comprised approximately 64.0% of our total working interest reserves, while natural gas liquids and oil comprised approximately 27.0% and 9.0%, respectively. In order to help mitigate the potential exposure and effects of changing commodity prices on our revenues and cash flows from operations, we have entered into, and expect to continue to use, commodity swaps for our working interests. Our policy has been to hedge a majority portion of the total estimated oil, natural gas and natural gas liquid production on our working interests for a specified amount of time. We currently use commodity derivative contracts, consisting of oil, natural gas and certain natural gas liquid products receive-fixed, pay-floating swaps for certain years through 2016. Our unhedged production may expose us to commodity price declines or alternatively, provide the potential upside from commodity price increases. Our price hedging strategy and future hedging transactions, including the prices at which we hedge our production, are dependent upon several factors, including expected production and commodities prices at the time we enter into these transactions.

We do not designate any of our commodity derivatives as cash flow hedges for accounting purposes. As such, the changes in fair value of these instruments are recorded in current period earnings. For the year ended December 31, 2012, we had $3.6 million of commodity derivatives settlements, which are settled monthly. The estimated fair value of our commodity swaps as of December 31, 2012 totaled $7.1 million. As a significant portion of our commodity derivatives hedge the majority of our estimated natural gas production through 2015, a 40% decrease in the future prices of natural gas as compared to the future prices at December 31, 2012 would result in an estimated unhedged production value decrease of approximately $2.8 million or less for any year through 2015.

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 mark-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-71 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, 2012. Based on that evaluation, our Chief Executive Officer and Chief Financial Officer concluded that as of December 31, 2012, 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, 2012, 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, 2012, 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, 2012, 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 following information is being provided pursuant to "Item 1.01 Entry into a Material Definitive Agreement" of Form 8-K:

On February 27, 2013, the Company entered into a Second Amendment Agreement to the Amended and Restated Management Agreement dated as of May 4, 2007 by and among the Company, KKR Financial Advisors LLC and KKR Financial Corp. (the "Second Amendment Agreement"). This agreement amended the definition of "Incentive Compensation" to provide that any of the Company's shares that by their terms are entitled to a specified periodic distribution, including the Company's 7.375% Series A LLC Preferred Shares, will not be treated as shares for the purpose of calculating incentive compensation, and instead the aggregate distribution amount that accrues to these shares during the quarter will be subtracted from Net Income, before incentive compensation for purposes of the calculation.

A copy of the Second Amendment Agreement is attached to this Annual Report as Exhibit 10.17 and is incorporated herein by reference.

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, 2012.

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, 2012.

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 2013 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, 2012.

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, 2012.

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, 2012.

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

	3.3	Amendment No. 2 to the Amended and Restated Operating Agreement of the Company, effective as of January 10, 2013	8-K		001-33437		3.1	01/11/13

	3.4	Share Designation of the 7.375% Series A LLC Preferred Shares, dated as of January 17, 2013	8-K		001-33437		3.1	01/17/13

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

	4.2	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

	4.3	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

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

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

	4.6	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

	4.7	Form of 8.375% Senior Note due November 15, 2041	8-K		001-33437		4.3	11/15/11

				Incorporated by Reference

Exhibit Number			Exhibit Description	Form	File No.		Exhibit		Filing Date	Filed Herewith
	4.8		Supplemental Indenture, dated as of March 20, 2012, between the Company, Wilmington Trust, National Association, as Trustee, and Citibank N.A., as Authenticating Agent, Paying Agent and Security Registrar	8-K		001-33437		4.2	03/20/12

	4.9		Form of 7.500% Senior Note due March 20, 2042	8-K		001-33437		4.2	03/20/12

	4.10		Form of 7.375% Series A LLC Preferred Share Global Certificate	8-K		001-33437		3.1	01/17/13

	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

				Incorporated by Reference

Exhibit Number			Exhibit Description	Form	File No.		Exhibit		Filing Date	Filed Herewith
	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

	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 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	05/02/11

	10.15		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	08/04/11

	10.16		Credit Agreement, dated as of November 30, 2012, among KKR Financial Holdings LLC, each lender from time to time party thereto, Citibank, N.A., as Swingline Lender and Issuing Bank, and Citibank, N.A., as Administrative Agent	8-K		001-33437		10.1	12/05/12

	10.17		Second Amendment Agreement to the Amended and Restated Management Agreement, dated as of February 27, 2013, between the Registrant and KKR Financial Advisors LLC							X

	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

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, 2012, to be signed on its behalf by the undersigned, and in the capacities indicated, thereunto duly authorized, on February 28, 2013.

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, 2012

KKR FINANCIAL HOLDINGS LLC AND SUBSIDIARIES
Index to Consolidated Financial Statements

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, 2012, 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, 2012, 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, 2012 of the Company and our report dated February 28, 2013 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, 2012 and 2011, and the related consolidated statements of operations, changes in shareholders' equity, comprehensive income and cash flows for each of the three years in the period ended December 31, 2012. 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, 2012 and 2011, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 2012, in conformity with accounting principles generally accepted in the United States of America.

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, 2012, 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, 2013 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, 2012			December 31, 2011

Assets
Cash and cash equivalents	$	237,606		$	392,154
Restricted cash and cash equivalents		896,396			399,620
Securities		533,520			922,603
Corporate loans, net (includes $128,289 and $317,332 loans held for sale as of December 31, 2012 and December 31, 2011, respectively)		5,947,857			6,443,399
Equity investments, at estimated fair value ($7,187 and $12,222 pledged as collateral as of December 31, 2012 and December 31, 2011, respectively)		161,621			189,845
Oil and gas properties, net		289,929			138,525
Derivative assets		23,207			28,463
Interest and principal receivable		46,960			62,124
Other assets		221,783			70,495

Total assets	$	8,358,879		$	8,647,228

Liabilities
Collateralized loan obligation secured notes	$	5,122,338		$	5,540,037
Collateralized loan obligation junior secured notes to affiliates		296,557			365,848
Credit facilities		107,789			38,300
Convertible senior notes		166,028			299,830
Senior notes		362,178			250,676
Junior subordinated notes		283,517			283,517
Accounts payable, accrued expenses and other liabilities		25,931			24,680
Accrued interest payable		20,519			25,536
Accrued interest payable to affiliates		6,632			6,561
Related party payable		10,998			11,078
Derivative liabilities		117,270			125,333

Total liabilities		6,519,757			6,971,396

Shareholders' Equity
Preferred shares, no par value, 50,000,000 shares authorized and none issued and outstanding at December 31, 2012 and December 31, 2011		—			—
Common shares, no par value, 500,000,000 shares authorized, and 178,437,078 and 178,145,482 shares issued and outstanding at December 31, 2012 and December 31, 2011, respectively		—			—
Paid-in-capital		2,762,584			2,759,478
Accumulated other comprehensive loss		(70,226	)		(35,619	)
Accumulated deficit		(853,236	)		(1,048,027	)

Total shareholders' equity		1,839,122			1,675,832

Total liabilities and shareholders' equity	$	8,358,879		$	8,647,228

KKR FINANCIAL HOLDINGS LLC AND SUBSIDIARIES

Consolidated Statements of Operations

(Amounts in thousands, except per share information)

	Year ended December 31, 2012			Year ended December 31, 2011			Year ended December 31, 2010

Revenues:
Loan interest income	$	411,736		$	418,142		$	397,634
Securities interest income		76,642			87,851			104,395
Oil and gas revenue		64,535			30,629			888
Other		2,560			5,399			2,442

Total revenues		555,473			542,021			505,359

Investment costs and expenses:
Interest expense		165,022			133,609			131,700
Interest expense to affiliates		51,586			49,458			25,152
Provision for loan losses		46,498			14,194			29,121
Oil and gas production costs		28,980			7,766			177
Oil and gas depreciation, depletion and amortization		21,931			8,015			324
Other		4,358			2,120			2,478

Total investment costs and expenses		318,375			215,162			188,952

Other income:
Net realized and unrealized gain on investments		183,757			88,955			108,553
Net realized and unrealized loss on derivatives and foreign exchange		(2,091	)		(3,812	)		(4,694	)
Net realized and unrealized gain (loss) on residential mortgage-backed securities, carried at estimated fair value		9,299			2,825			(11,396	)
Net (loss) gain on restructuring and extinguishment of debt		(445	)		(1,736	)		39,999
Other income		15,302			7,215			10,890

Total other income		205,822			93,447			143,352

Other expenses:
Related party management compensation		72,339			68,185			69,125
General, administrative and directors expenses		19,157			19,840			13,537
Professional services		6,661			6,198			5,331

Total other expenses		98,157			94,223			87,993

Income before income taxes		344,763			326,083			371,766
Income tax (benefit) expense		(3,467	)		8,011			702

Net income	$	348,230		$	318,072		$	371,064

Net income per common share:
Basic	$	1.95		$	1.79		$	2.33

Diluted	$	1.87		$	1.75		$	2.32

Weighted average number of common shares outstanding:
Basic		177,838			177,560			157,936

Diluted		187,423			180,897			158,771

KKR FINANCIAL HOLDINGS LLC AND SUBSIDIARIES

Consolidated Statements of Comprehensive Income

(Amounts in thousands)

KKR FINANCIAL HOLDINGS LLC AND SUBSIDIARIES

Consolidated Statements of Changes in Shareholders' Equity

(Amounts in thousands)

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

Balance at January 1, 2010	158,360		$	2,563,634		$	152,728		$	(1,549,704	)	$	1,166,658

Net income	—			—			—			371,064			371,064
Other comprehensive loss	—			—			(19,132	)		—			(19,132	)
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
Other comprehensive loss	—			—			(169,215	)		—			(169,215	)
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

Net income	—			—			—			348,230			348,230
Other comprehensive loss	—			—			(34,607	)		—			(34,607	)
Cash distributions on common shares	—			—			—			(153,439	)		(153,439	)
Grant of restricted common shares	302			—			—			—			—
Repurchase and cancellation of common shares	(10	)		(96	)		—			—			(96	)
Share-based compensation expense related to restricted common shares	—			3,202			—			—			3,202

Balance at December 31, 2012	178,437		$	2,762,584		$	(70,226	)	$	(853,236	)	$	1,839,122

KKR FINANCIAL HOLDINGS LLC AND SUBSIDIARIES

Consolidated Statements of Cash Flows

(Amounts in thousands)

	Year ended December 31, 2012			Year ended December 31, 2011			Year ended December 31, 2010

Cash flows from operating activities:
Net income	$	348,230		$	318,072		$	371,064
Adjustments to reconcile net income to net cash provided by operating activities:
Net realized and unrealized loss on derivatives and foreign exchange		2,091			3,812			5,378
Net loss (gain) on restructuring and extinguishment of debt		445			1,736			(39,999	)
Write-off of debt issuance costs		4,224			2,194			8,160
Lower of cost or estimated fair value adjustment on corporate loans held for sale		2,656			65,163			14,725
Provision for loan losses		46,498			14,194			29,121
Impairment charges		12,067			7,705			12,890
Share-based compensation		3,202			3,278			6,892
Net unrealized (gain) loss on residential mortgage-backed securities, carried at estimated fair value		(9,299	)		(2,825	)		11,396
Net realized and unrealized gain on investments		(198,480	)		(161,823	)		(136,924	)
Deferred interest expense		—			—			4,427
Depreciation and net amortization		(51,982	)		(83,630	)		(103,430	)
Changes in assets and liabilities:
Interest receivable		11,415			1,902			12,008
Other assets		5,329			6,608			(36,739	)
Related party payable		(80	)		(1,910	)		9,621
Accounts payable, accrued expenses and other liabilities		1,304			9,417			1,151
Accrued interest payable		(5,017	)		2,690			(2,451	)
Accrued interest payable to affiliates		71			245			3,405

Net cash provided by operating activities		172,674			186,828			170,695

Cash flows from investing activities:
Principal payments from corporate loans		1,829,492			1,441,426			1,611,502
Principal payments from securities available-for-sale and other securities, at estimated fair value		83,930			106,098			139,794
Principal payments from residential mortgage-backed securities, at estimated fair value		8,990			7,365			14,289
Proceeds from sale of corporate loans		349,279			654,379			1,118,440
Proceeds from sale of securities available-for-sale and other securities, at estimated fair value		505,015			202,059			342,833
Proceeds from sale of residential mortgage-backed securities, at estimated fair value		—			—			7,246
Proceeds from equity investments		86,573			49,734			123,047
Proceeds from securities sold, not yet purchased		26,792			40,980			—
Purchases of corporate loans		(1,595,317	)		(2,228,360	)		(2,463,752	)
Purchases of securities available-for-sale and other securities, at estimated fair value		(135,354	)		(321,087	)		(439,754	)
Purchases of equity and other investments		(347,853	)		(205,193	)		(38,565	)
Cover securities sold, not yet purchased		(28,978	)		(39,320	)		(78,727	)
Net change in proceeds, purchases, and settlements of derivatives		(6,401	)		1,926			13,454
Net change in reverse repurchase agreements		—			—			80,250
Net change in restricted cash and cash equivalents		(496,776	)		172,156			(228,719	)

Net cash provided by (used in) investing activities		279,392			(117,837	)		201,338

	Year ended December 31, 2012			Year ended December 31, 2011			Year ended December 31, 2010

Cash flows from financing activities:
Issuance of collateralized loan obligation secured notes		489,480			439,409			—
Retirement of collateralized loan obligation secured notes		(979,667	)		(531,060	)		(104,734	)
Retirement of collateralized loan obligation junior secured notes to affiliates		—			(276	)		(67,519	)
Proceeds from credit facilities		69,489			19,900			68,719
Repayment of credit facilities		—			—			(227,805	)
Proceeds from convertible senior notes		—			—			167,325
Repayment of convertible senior notes		(135,531	)		(47,197	)		(93,922	)
Proceeds from senior notes		111,418			250,669			—
Net proceeds from common share offerings		—			—			175,701
Distributions on common shares		(153,439	)		(119,351	)		(68,108	)
Issuance of common shares		—			1,297			—
Repurchase and cancellation of common shares		(96	)		(1,297	)		—
Other capitalized costs		(8,268	)		(2,760	)		(4,947	)

Net cash (used in) provided by financing activities		(606,614	)		9,334			(155,290	)

Net (decrease) increase in cash and cash equivalents		(154,548	)		78,325			216,743
Cash and cash equivalents at beginning of year		392,154			313,829			97,086

Cash and cash equivalents at end of year	$	237,606		$	392,154		$	313,829

Supplemental cash flow information:
Cash paid for interest	$	186,131		$	147,750		$	99,308
Net cash (refunded) paid for income taxes	$	(274	)	$	2,081		$	768
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	$	2,849		$	2,755		$	470
Loans transferred from held for investment to held for sale	$	114,995		$	862,244		$	1,052,040
Loans transferred from held for sale to held for investment	$	114,871		$	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, interests in joint ventures and partnerships, and working and royalty interests in oil and gas properties. The corporate loans that the Company holds are typically 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 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 to provide additional detailed information related to the Company's oil and gas costs as a result of the growth in the Company's oil and gas business. These costs were previously included in general, administrative and directors expenses.

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.

The Company uses historical experience and various other assumptions and information that are believed to be reasonable under the circumstances in developing its estimates and judgments. Estimates and assumptions about future events and their effects cannot be predicted with certainty and, accordingly, these estimates may change as new events occur, as more experience is acquired, as additional information is obtained and as the Company's operating environment changes. While the

Company believes that the estimates and assumptions used in the preparation of the consolidated financial statements are appropriate, actual results could differ from those estimates.

Estimates of oil, natural gas and natural gas liquids reserves and their values, future production rates and future costs and expenses are inherently uncertain, including many factors beyond the Company's control. Reservoir engineering is a subjective process of estimating underground accumulations of oil, natural gas and natural gas liquids that cannot be measured in an exact manner. The accuracy of any reserve estimate is a function of many factors including the following: the quality and quantity of available data, the interpretation of that data, the accuracy of various mandated economic assumptions and the judgments of the individuals preparing the estimates. In addition, reserve estimates are a function of many assumptions, all of which could deviate significantly from actual results. As such, reserve estimates may materially vary from the ultimate quantities of oil, natural gas and NGL eventually recovered, and could materially affect the Company's future depreciation, depletion and amortization expense ("DD&A"), its asset retirement obligations or impairment considerations.

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 2011-1, Ltd. ("CLO 2011-1") and KKR Financial CLO 2012-1, Ltd. ("CLO 2012-1") (collectively the "Cash Flow CLOs") are entities established to complete secured financing transactions. These entities are variable interest entities ("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.

The Company finances the majority of its corporate debt investments through its CLOs. As of December 31, 2012, the Company's seven CLOs held $6.3 billion par amount, or $6.0 billion estimated fair value, of corporate debt investments. As of December 31, 2011, the Company's six CLOs held $7.4 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, 2012, the aggregate CLO debt totaled $5.1 billion of secured debt outstanding held by unaffiliated third parties and $296.6 million of junior secured notes outstanding held by an affiliate of the Manager. 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 secured notes outstanding held by an affiliate of the Manager.

The Company consolidates all non-VIEs in which it holds a greater than 50 percent voting interest.

In addition, the Company has non-controlling interests in joint ventures and partnerships that do not qualify as VIEs and do not meet the control requirements for consolidation as defined by GAAP.

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

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 Company's

assessment of the significance of a particular input to the fair value measurement in its entirety requires judgment and consideration of factors specific to the asset. 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.

models using a series of techniques, including closed-form analytic formulae, such as the Black-Scholes option-pricing model, and/or simulation models in the absence of quoted market prices. Many pricing models employ methodologies that have pricing inputs 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: RMBS are initially valued at transaction price and are subsequently valued using a third party valuation servicer. The most significant inputs to the valuation of these instruments are default and loss expectations and constant prepayment rates.

Key unobservable inputs that have a significant impact on the Company's Level 3 valuations as described above are included in Note 14. The Company utilizes several unobservable pricing inputs and assumptions in determining the fair value of its Level 3 investments. These unobservable pricing inputs and assumptions may differ by asset and in the application of the Company's valuation methodologies. The reported fair value estimates could vary materially if the Company had chosen to incorporate different unobservable pricing inputs and other assumptions or, for applicable investments, if the Company only used either the discounted cash flow methodology or the market comparables methodology instead of assigning a weighting to both methodologies.

The valuation process involved in Level 3 measurements for assets and liabilities is completed on a quarterly basis and is designed to subject the valuation of Level 3 investments to an appropriate level of consistency, oversight and review. The Company utilizes a valuation committee, whose members consist of the Company's Chief Executive Officer, Chief Financial Officer, General Counsel and certain other employees of the Manager. The valuation committee is responsible for coordinating and implementing the Company's quarterly valuation process. For assets classified as Level 3, the investment professionals are responsible for documenting preliminary valuations based on various factors including their evaluation of financial and operating data, company specific developments, market valuations of comparable companies and model projections discussed above. The Company engages an independent valuation firm to opine on its internal valuation assessments for certain holdings over a specific dollar threshold. All valuations are approved by the valuation committee.

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 within total revenues on the consolidated statements of operations.

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 within total revenues on the consolidated statements of operations.

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. 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.

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 net realized and unrealized gains on investments in the consolidated statements of operations.

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 net realized and unrealized gain (loss) on RMBS, carried at estimated fair value in the consolidated statements of operations.

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

The Company has elected the fair value option of accounting for certain non-controlling interests in joint ventures and partnerships, 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 interests. These interests in joint ventures and partnerships are presented within other assets on the consolidated balance sheets with unrealized gains and losses reported in net realized and unrealized gains on investments in 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 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 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 one or a combination of the following: a reduction of the stated interest rate; payment extensions; forgiveness of principal; or an exchange of assets. Such modifications typically qualify as troubled debt restructurings. In order to determine whether the borrower is experiencing financial difficulty, an evaluation is performed including the following considerations: whether the borrower is or will be in payment default on any of his or her debt in the foreseeable future without the modification; whether there is a potential for a bankruptcy filing; whether there is a going-concern issue; or whether the borrower is unable to secure financing elsewhere. 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.

Corporate loans which have been modified in a troubled debt restructuring are typically placed on non-accrual status, but can be moved to accrual status when, among other criteria, payment in full of all amounts due under the restructured terms is expected and the borrower has demonstrated a sustained period of repayment performance, typically six months.

Troubled debt restructurings are separately identified for impairment disclosures and are measured at either the fair market value or the present value of estimated future cash flows using the respective loan's effective rate at inception. Impairments associated with troubled debt restructurings are included within the allocated component of the Company's allowance for loan losses.

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 typically 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 an allowance 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 present value of expected future cash flows discounted at the loan's effective interest rate, except as a practical expedient, the loan's observable estimated fair value may be used. The Company also estimates the probable credit losses inherent in its unfunded loan commitments as of the balance sheet date. Any credit loss reserve for unfunded loan commitments is recorded in accounts payable, accrued expenses and other liabilities on the Company's consolidated balance sheets.

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 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 possible 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.

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 may 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 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 net realized and unrealized gains on investments in the consolidated statement of operations.

Oil and natural gas producing activities are accounted for under the successful efforts method of accounting. Under this method, exploration costs, other than the costs of drilling exploratory wells, are charged to expense as incurred. Costs that are associated with the drilling of successful exploration wells are capitalized if proved reserves are found. Lease acquisition costs are capitalized when incurred. Costs associated with the drilling of exploratory wells that do not find proved reserves, geological and geophysical costs and costs of certain nonproducing leasehold costs are expensed as incurred.

The capitalized costs of producing oil and natural gas properties are depleted on a field-by-field basis using the units-of production method based on the ratio of current production to estimated total net proved oil, natural gas and natural gas liquids reserves. Proved developed reserves are used in computing depletion rates for drilling and development costs and total proved reserves are used for depletion rates of leasehold costs.

Estimated dismantlement and abandonment costs for oil and natural gas properties, net of salvage value, are capitalized at their estimated net present value and amortized on a unit-of-production basis over the remaining life of the related proved developed reserves.

Oil, natural gas and natural gas liquids revenues are recognized when production is sold to a purchaser at fixed or determinable prices, when delivery has occurred and title has transferred and

collectability of the revenue is reasonably assured. The Company follows the sales method of accounting for natural gas revenues. Under this method of accounting, revenues are recognized based on volumes sold, which may differ from the volume to which we are entitled based on the Company's working interest. An imbalance is recognized as a liability only when the estimated remaining reserves will not be sufficient to enable the under-produced owners to recoup its entitled share through future production. Under the sales method, no receivables are recorded when the Company has taken less than its share of production and no payables are recorded when the Company has taken more than its share of production.

The Company evaluates its proved oil and natural gas properties and related equipment and facilities for impairment on a field-by-field basis, 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. The factors used to determine fair value include, but are not limited to, estimates of proved reserves, future commodity pricing, future production estimates, anticipated capital expenditures, future operating costs and a discount rate commensurate with the risk on the properties and cost of capital. Unproved oil and natural gas properties are assessed periodically and, at a minimum, annually on a property-by-property basis, and any impairment in value is recognized when incurred.

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 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.

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.

The Company owns equity interests in entities that have elected or intend to elect to be taxed as a real estate investment trust (a "REIT") under the Internal Revenue Code of 1986, as amended (the "Code"). 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.

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 per share ("Diluted EPS") reflects the potential dilution of common share options, unvested restricted common shares and convertible senior notes using the treasury method or if-converted method.

In January 2013, the FASB clarified the scope of offsetting disclosure requirements which 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 fiscal years 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 does not expect the guidance to have a material impact on its consolidated financial statements.

In February 2013, the FASB amended guidance to require entities to disclose additional information about reclassification adjustments, including (i) changes in accumulated other comprehensive income balances by component and (ii) significant items reclassified out of accumulated other comprehensive income. The guidance is effective for fiscal years, and interim periods within those years, beginning after December 15, 2012 and is to be applied prospectively. The adoption of this guidance will not have a material impact on the Company's consolidated financial statements and the Company will include the required disclosure in the first quarter ended March 31, 2013.

The following table presents a reconciliation of basic and diluted net income per common share for the years ended December 31, 2012, 2011 and 2010 (amounts in thousands, except per share

information), as well as the distributions declared per common share during the years ended December 31, 2012, 2011 and 2010:

	Year ended December 31, 2012		Year ended December 31, 2011		Year ended December 31, 2010

Net income	$	348,230	$	318,072	$	371,064
Less: Dividends and undistributed earnings allocated to participating securities		1,116		1,082		3,108

Net income applicable to common shareholders	$	347,114	$	316,990	$	367,956

Effect of dilutive securities:
Interest on convertible senior notes		3,234		—		—

Net income applicable to common shareholders for diluted earnings per share	$	350,348	$	316,990	$	367,956

Basic:
Basic weighted average shares outstanding		177,838		177,560		157,936

Net income per share	$	1.95	$	1.79	$	2.33

Diluted:
Basic weighted average shares outstanding		177,838		177,560		157,936
Dilutive effect of convertible senior notes(1)		9,585		3,337		835

Diluted weighted average shares outstanding(2)		187,423		180,897		158,771

Net income per share	$	1.87	$	1.75	$	2.32

Distributions declared per common share	$	0.86	$	0.67	$	0.43

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; (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, 2012, which are carried at estimated fair value (amounts in thousands):

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 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, 2012 and 2011 (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, 2012, the Company recognized a loss totaling $8.2 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, 2011 and 2010, the Company recognized losses totaling $1.5 million and $2.6 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 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 on investments in the consolidated statements of operations.

During the year ended December 31, 2012, the Company recognized a loss totaling $0.2 million for common and preferred stock that it determined to be other-than-temporary impaired. During the years ended December 31, 2011 and 2010, the Company recognized losses totaling $2.2 million and zero, respectively, for common and preferred stock that it determined to be other-than-temporarily impaired.

As of both December 31, 2012 and 2011, the Company had no corporate debt securities in default.

Securities available-for-sale sold at a loss typically include those that the Company determined to be other-than-temporarily impaired or had a deterioration in credit quality. The following table shows the net realized gains 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, 2012 (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, 2012, approximately 54% of the estimated fair value of the Company's securities available-for-sale portfolio was concentrated in ten issuers, with the three largest concentrations of securities available-for-sale in securities issued by Sanmina Corporation, Avaya, Inc. and iPayment, Inc., which combined represented $87.0 million, or approximately 21% of the estimated fair of value of the Company's securities available-for-sale. 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 three largest concentrations of securities available-for-sale in securities issued by First Data Corporation, SandRidge Energy, Inc. and Equinox Holdings Inc., which combined represented $174.3 million, or approximately 21% of the estimated fair 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, 2012 and 2011 (amounts in thousands):

As of December 31, 2012 and 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 principal plus or minus unaccreted purchase discounts and unamortized purchase premiums, net of an allowance for loan losses; (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, 2012 (amounts in thousands):

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

As of December 31, 2012 and 2011, the Company had an allowance for loan losses of $223.5 million and $191.4 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, 2012, 2011 and 2010 (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, 2012 and 2011 (amounts in thousands):

	December 31, 2012		December 31, 2011

Allowance for loan losses:
Ending balance: individually evaluated for impairment	$	223,472	$	191,407
Ending balance: collectively evaluated for impairment		—		—
Ending balance: loans acquired with deteriorated credit quality		—		—

	$	223,472	$	191,407

Corporate loans (recorded investment)(1):
Ending balance: individually evaluated for impairment	$	6,029,059	$	6,334,232
Ending balance: collectively evaluated for impairment		—		—
Ending balance: loans acquired with deteriorated credit quality		—		—

	$	6,029,059	$	6,334,232

As of December 31, 2012, the allocated component of the allowance for loan losses totaled $94.9 million and relates to investments in certain loans issued by six issuers with an aggregate par amount of $484.1 million and an aggregate recorded investment of $445.4 million. 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.

During the year ended December 31, 2012, the Company determined that its Texas Competitive Electric Holdings Company LLC ("TXU") loans, with an aggregate amortized cost of $310.9 million as of December 31, 2012, were impaired. Accordingly, the Company increased the allocated component of its allowance for loan losses to account for the impairment of TXU. As of December 31, 2012, $49.1 million of the Company's allocated reserve was for TXU.

The following table summarizes the Company's recorded investment and unpaid principal balance in impaired loans, as well as the related allowance for credit losses as of December 31, 2012 and 2011 (amounts in thousands):

The following table summarizes the Company's average recorded investment in impaired loans and interest income recognized for the years ended December 31, 2012, 2011 and 2010 (amounts in thousands):

As of December 31, 2012 and 2011, 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, 2012 and 2011 (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 $19.6 million, which included $9.5 million for impaired loans that were held for investment and $10.1 million for non-accrual loans held for sale for the year ended December 31, 2012. 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.

As of December 31, 2012, the Company had two corporate loans past due with a total amortized cost of $50.4 million from one issuer, as a result of a missed interest payment due in December 2012 (see "Defaulted Loans" section below). The Company did not have any corporate loans past due at December 31, 2011.

The unallocated component of the allowance for loan losses totaled $128.6 million and $157.6 million as of December 31, 2012 and 2011, 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, 2012 and 2011 (amounts in thousands):

Internally Assigned Grade	Capital Hierarchy	Recorded Investment December 31, 2012(1)		Recorded Investment December 31, 2011(1)

High	Senior Secured Loan	$	525,562	$	926,258
	Second Lien Loan		287,892		310,971
	Subordinated		10,621		14,392

		$	824,075	$	1,251,621

Moderate	Senior Secured Loan	$	826,107	$	645,939
	Second Lien Loan		27,585		—
	Subordinated		38,374		6,951

		$	892,066	$	652,890

Low	Senior Secured Loan	$	3,716,831	$	4,184,094
	Second Lien Loan		68,917		65,695
	Subordinated		81,733		111,240

		$	3,867,481	$	4,361,029

	Total Unallocated	$	5,583,622	$	6,265,540
	Total Allocated		445,437		68,692

	Total Loans Held for Investment	$	6,029,059	$	6,334,232

During the years ended December 31, 2012, 2011 and 2010, the Company recorded charge-offs totaling $14.4 million, $31.8 million and $57.4 million, respectively, comprised primarily of loans transferred to loans held for sale.

As of December 31, 2012 and December 31, 2011, the Company had $128.3 million and $317.3 million of loans held for sale, respectively. During the year ended December 31, 2012, the Company transferred $115.0 million amortized cost amount of loans from held for investment to 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. 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, 2012, the Company transferred $114.9 million amortized cost amount from loans held for sale back to loans held for investment at the lower of cost or estimated fair value. 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. These transfers back to held for investment occurred as the circumstances that led to the initial transfer to held for sale were no longer present. Such circumstances may 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 Company recorded a $2.7 million net charge to earnings during the year ended December 31, 2012 for the lower of cost or estimated fair value adjustment for certain loans held for sale, which had a carrying value of $128.3 million as of December 31, 2012. Comparatively, the Company recorded a $65.2 million net charge to earnings for the lower of cost or estimated fair value adjustment during the year ended December 31, 2011 for certain loans held for sale, which had a carrying value of $317.3 million as of December 31, 2011.

As of December 31, 2012, the Company held two corporate loans that were in default with a total amortized cost of $50.4 million from one issuer and were included in the loans for which the allocated component of the Company's allowance for loan losses was related to. As of December 31, 2011, the Company had no corporate loans in default.

During the year ended December 31, 2012, the Company exchanged an aggregate recorded investment of $67.7 million of loans from a single issuer for new loans of varying extended maturities and equity with a combined estimated fair value of $25.6 million, in a modification which qualified as a troubled debt restructuring. The interest rate did not change as a result of this modification. Prior to the restructuring, certain of the loans were included in the allocated component of the allowance for loan losses, while the remaining loans were in loans held for sale and were on non-accrual status. The difference between the recorded investment of the loans and the estimated fair value of the new loans and equity was charged-off against the allowance for loan losses and the lower of cost or estimated fair value allowance. The new loans were included in the allocated component of the allowance for loan losses and in loans held for sale and will be maintained on non-accrual status until performance has been demonstrated by the borrower for a suitable period of time, while the equity was carried at estimated fair value. The loans modified in the troubled restructuring were not in default at December 31, 2012. As of December 31, 2012, there were no commitments to lend additional funds to the borrower whose loans had been modified in the troubled debt restructuring.

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. The loans modified in the troubled restructuring were not in default at December 31, 2011. As of December 31, 2011, there were no commitments to lend additional funds to the borrower whose loans had been modified in the troubled debt restructuring.

During the years ended December 31, 2012 and 2011, the Company modified $1.7 billion and $1.3 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, 2012, approximately 46% 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 $1.0 billion, or approximately 16% of the aggregated amortized cost basis of the Company's corporate loans. 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.

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 held for investment and corporate loans held for sale pledged as collateral as of December 31, 2012 and 2011 (amounts in thousands):

As of December 31, 2012 and 2011, no corporate loans carried at estimated fair value were pledged as collateral for the Company's borrowings.

The following table summarizes the Company's oil and gas properties as of December 31, 2012 and 2011 (amounts in thousands):

For the years ended December 31, 2012 and 2011, the Company recorded $3.3 million and zero, respectively, of impairments which are included in net realized and unrealized gain on investments in the consolidated statements of operations.

The Company accounts for certain of its oil and natural gas properties as business combinations under the acquisition method of accounting.

During 2011, the Company completed the acquisition of certain oil and natural gas properties located in the Barnett Shale in Texas by funding approximately $56.7 million including costs, partially financed through its asset-based borrowing facility. The acquisition included proved reserves as of the acquisition date.

During 2012, the Company completed the acquisition of certain oil and natural gas properties located in Louisiana, Mississippi, and Texas (most notably in the Barnett and Eagle Ford Shale), by funding approximately $178.3 million including costs, partially financed through its asset-based borrowing facility.

The results of operations of these properties have been included in the consolidated financial statements since the acquisition dates. As these acquisitions were accounted for under the acquisition method of accounting, the Company conducted assessments of net assets acquired and recognized amounts for identifiable assets acquired and liabilities assumed at their estimated acquisition date fair values. Transaction and integration costs associated with the acquisitions were expensed as incurred. The initial accounting for the 2012 business combinations are not complete and adjustments to provisional amounts, or recognition of additional assets acquired or liabilities assumed, may occur as more detailed analyses are completed and additional information is obtained about the facts and circumstances that existed as of the acquisition dates.

The recognized fair values of the identifiable assets acquired and liabilities assumed in connection with all of these acquisitions are as follows (amounts in thousands):

In addition to the acquisitions above, during 2011, the Company purchased overriding royalty interests in the Eagle Ford Shale for approximately $55.0 million. During 2012, the Company participated and earned working interests in oil and natural gas properties located in Texas by funding approximately $1.4 million including costs. These amounts are included in oil and gas properties, net on the consolidated balance sheets.

Certain information with respect to the Company's borrowings as of December 31, 2012 is summarized in the following table (dollar amounts in thousands):

	Outstanding Borrowings					Fair Value of Collateral(1)

CLO 2005-1 senior secured notes	$	427,317	0.69	%	1,577	$	510,187
CLO 2005-2 senior secured notes		470,516	0.66		1,791		618,000
CLO 2006-1 senior secured notes		601,091	0.69		2,063		846,365
CLO 2007-1 senior secured notes		2,075,040	0.86		3,057		2,298,373
CLO 2007-1 junior secured notes(2)		209,555	—		3,057		232,109
CLO 2007-A senior secured notes		601,375	1.50		1,749		698,569
CLO 2007-A junior secured notes(3)		10,179	—		1,749		11,824
CLO 2011-1 senior debt		343,485	1.67		2,053		421,584
CLO 2012-1 senior secured notes(4)		362,280	2.58		4,367		40,180
CLO 2012-1 junior secured notes(4)		21,500	—		4,367		2,351

Total collateralized loan obligation secured debt		5,122,338					5,679,542
CLO 2007-1 junior secured notes to affiliates(5)		249,115	—		3,057		275,927
CLO 2007-A junior secured notes to affiliates(6)		47,442	—		1,749		55,110

Total collateralized loan obligation junior secured notes to affiliates		296,557					331,037
Senior secured credit facility		—	2.56		1,064		—
Asset-based borrowing facility		107,789	2.71		1,039		227,415

Total credit facilities		107,789					227,415
7.5% Convertible senior notes		166,028	7.50		1,476		—
8.375% Senior notes		250,735	8.38		10,546		—
7.500% Senior notes		111,443	7.50		10,671		—
Junior subordinated notes		283,517	5.43		8,712		—

Total borrowings	$	6,338,407				$	6,237,994

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		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		—
8.375% 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

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, both CLO 2005-1 and CLO 2005-2 ended their reinvestment periods in the second quarter of 2011, and CLO 2006-1 ended its reinvestment period during the third quarter of 2012. 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 years ended December 31, 2012 and 2011, $886.6 million and $528.2 million, respectively, of original CLO 2007-A, CLO 2005-1, CLO 2005-2 and CLO 2006-1 senior notes were repaid. CLO 2007-1 and CLO 2012-1 will end their reinvestment periods during May 2014 and December 2016, respectively. CLO 2011-1 does not have a reinvestment period and all principal proceeds from holdings in CLO 2011-1 are used to amortize the transaction. During the years ended December 31, 2012 and 2011, $93.0 million and $2.9 million, respectively, of original CLO 2011-1 senior notes were repaid.

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 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 London interbank offered rate ("LIBOR") plus 1.35%.

On December 21, 2012, the Company closed CLO 2012-1, a $412.4 million secured financing transaction maturing December 16, 2024. The Company issued $367.5 million par amount of senior secured notes to unaffiliated investors, of which $342.5 million was floating rate with a weighted-average coupon of three-month LIBOR plus 2.09% and $25.0 million was fixed rate at 2.39%. The Company also issued $21.5 million of subordinated notes. The investments that are owned by CLO 2012-1 collateralize the CLO 2012-1 debt, and as a result, those investments are not available to the Company, its creditors or shareholders.

During the years ended December 31, 2012 and 2011, the Company issued $119.7 million par amount of CLO 2007-1 class D notes for proceeds of $95.1 million and zero, respectively. In addition, during years ended December 31, 2012 and 2011, the Company issued $11.3 million par amount of CLO 2007-A class C notes for proceeds of $10.6 million and zero, respectively.

On November 30, 2012, the Company entered into a credit agreement for a three-year $150.0 million revolving credit facility, maturing on November 30, 2015 (the "2015 Facility"). The Company may obtain additional commitments under the 2015 Facility so long as the aggregate amount of commitments at any time does not exceed $350.0 million. The Company has the right to prepay loans under the 2015 Facility in whole or in part at any time. In connection with entering into the 2015 Facility, the Company terminated the commitments under its existing asset-based revolving credit facility. Loans under the 2015 Facility bear interest at a rate equal to, at the Company's option, LIBOR plus 2.25% per annum, or an alternate base rate plus 1.25% per annum. The 2015 Facility contains customary covenants, including ones that require the Company to satisfy a net worth financial test and maintain certain ratios relating to leverage and consolidated total assets. In addition, the 2015 Facility contains customary negative covenants applicable to the Company. As of December 31, 2012, the Company had no borrowings outstanding under the 2015 Facility.

On December 7, 2012, the Company's five-year nonrecourse, asset-based revolving credit facility (the "2015 Natural Resources Facility"), maturing on November 5, 2015, was adjusted and reduced to $126.1 million, 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. As of December 31, 2012 and 2011, the Company had $107.8 million and $38.3 million of borrowings outstanding under the 2015 Natural Resources Facility.

As of December 31, 2012, 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. As of

December 31, 2012, the conversion rate for each $1,000 principal amount of 7.5% Notes was 141.8256 common shares (equal to a conversion price of approximately $7.05 per share). On January 18, 2013, the Company issued a conversion rights termination notice ("Termination Notice") to holders of the 7.5% Notes whereby it terminated the right to convert the 7.5% Notes to common shares (see Note 17).

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, 2012 and 2011. The remaining liability component of $166.0 million and $164.7 million, included within convertible senior notes on the Company's consolidated balance sheets as of December 31, 2012 and 2011, respectively, is comprised of the principal $172.5 million less the unamortized debt discount of $6.5 million and $7.8 million as of December 31, 2012 and 2011, respectively. The total debt discount amortization recognized for the years ended December 31, 2012, 2011 and 2010 was $1.3 million, $1.2 million and $1.0 million, respectively. The debt discount amortized at the effective interest rate of 8.6%. For the years ended December 31, 2012, 2011 and 2010, the total interest expense recognized on the 7.5% Notes was $12.9 million, $12.9 million and $12.4 million, respectively.

During the first quarter of 2012, the Company repurchased $23.1 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 $0.4 million and a $0.2 million write-off of unamortized debt issuance costs. During 2011, the Company repurchased $45.5 million par amount of its 7.0% Notes, which resulted in the Company recording a loss of $1.7 million and a write-off of $0.1 million of unamortized debt issuance costs. On July 13, 2012, the Company repaid in full its $112.0 million of outstanding 7.0% Notes, which matured on July 15, 2012.

On March 20, 2012, the Company issued $115.0 million par amount of 7.500% senior notes due March 20, 2042 ("7.500% Senior Notes"), resulting in net proceeds of $111.4 million. Interest on the 7.500% Senior Notes is payable quarterly in arrears on June 20, September 20, December 20 and March 20 of each year.

On November 15, 2011, the Company issued $258.8 million par amount of 8.375% senior notes due November 15, 2041 ("8.375% Senior Notes"), resulting in net proceeds of $250.7 million. Interest on the 8.375% Senior Notes is payable quarterly in arrears on February 15, May 15, August 15 and November 15 of each year.

The table below summarizes the Company's contractual obligations (excluding interest) under borrowing agreements as of December 31, 2012 (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	$	429,903	$	—	$	—	$	429,903	$	—
CLO 2005-2 senior secured notes		474,538		—		—		474,538		—
CLO 2006-1 senior secured notes		601,091		—		—		—		601,091
CLO 2007-1 senior secured notes		2,075,040		—		—		—		2,075,040
CLO 2007-1 junior secured notes		232,491		—		—		—		232,491
CLO 2007-A senior secured notes		601,375		—		—		601,375		—
CLO 2007-A junior secured notes		10,821		—		—		10,821		—
CLO 2011-1 senior debt		343,485		—		—		—		343,485
CLO 2012-1 senior secured notes		367,500		—		—		—		367,500
CLO 2012-1 junior secured notes		21,500		—		—		—		21,500
CLO 2007-1 junior secured notes to affiliates		249,115		—		—		—		249,115
CLO 2007-A junior secured notes to affiliates		47,442		—		—		47,442		—
Asset-based borrowing facility		107,789		—		107,789		—		—
Convertible senior notes		172,500		—		—		172,500		—
Senior notes		373,750		—		—		—		373,750
Junior subordinated notes		283,517		—		—		—		283,517

Total	$	6,391,857	$	—	$	107,789	$	1,736,579	$	4,547,489

The remaining contractual maturities in the table above were allocated assuming no prepayments and represent the principal amount of all notes, excluding any discount and accounting adjustments. 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, 2012 and December 31, 2011 (amounts in thousands):

	As of December 31, 2012						As of December 31, 2011

	Notional			Estimated Fair Value			Notional			Estimated Fair Value
Cash Flow Hedges:
Interest rate swaps	$	503,833		$	(90,618	)	$	508,333		$	(100,718	)
Free-Standing Derivatives:
Commodity swaps		—			7,056			—			7,371
Credit default swaps—protection sold		—			19			33,500			(7,177	)
Credit default swaps—protection purchased		(47,321	)		(1,140	)		—			—
Total rate of return swaps		—			—			—			152
Foreign exchange forward contracts		(338,313	)		(20,975	)		(234,524	)		(12,224	)
Foreign exchange options		130,207			8,277			130,207			13,394
Common stock warrants		—			3,318			—			2,332

Total				$	(94,063	)				$	(96,870	)

The Company uses interest rate 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 interest rate swaps as cash flow hedges. As of December 31, 2012 and 2011, the Company had interest rate swaps with notional amounts totaling $503.8 million and $508.3 million, respectively. Changes in the estimated fair value of the interest rate swaps are recorded through other comprehensive loss, with gains or losses representing hedge ineffectiveness, if any, recognized in earnings during the reporting period.

During 2011, the Company entered into a $25.0 million notional pay-fixed, receive-variable interest rate swap. The swap has been designated as a cash flow hedge, 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 due to fluctuations in the indexed rate. The hedged transaction period is through July 2037, which is the stated maturity of the floating rate debt. As of both December 31, 2012 and 2011, the total interest rate swaps used to hedge a portion of the interest rate risk associated with the Company's floating rate junior subordinated notes was $125.0 million.

The following table shows the net gains (losses) recognized in other comprehensive loss related to derivatives in cash flow hedging relationships for the years ended December 31, 2012, 2011 and 2010 (amounts in thousands):

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, 2012, 2011 and 2010, the Company did not recognize any ineffectiveness in income on the consolidated statements of operations from its cash flow hedges.

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 in net realized and unrealized gain (loss) on derivatives and foreign exchange in the consolidated statements of operations. Unrealized gains (losses) represent the change in fair value of the derivative instruments and are noncash items.

The Company holds certain positions that are denominated in a foreign currency, whereby movements in foreign currency exchange rates may impact earnings if the United States dollar significantly strengthens or weakens against foreign currencies. In an effort to minimize the effects of these fluctuations on earnings, the Company will from time to time enter into foreign exchange options or foreign exchange forward contracts related to the assets denominated in a foreign currency. As of December 31, 2012 and 2011, the net contractual notional balance of our foreign exchange options and forward contracts totaled $208.1 million and $104.3 million, respectively, all of which related to certain of our foreign currency denominated corporate debt holdings.

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 reference entity) of the underlying credit instrument referenced in the CDS. Typical credit events include bankruptcy, dissolution or insolvency of the reference entity, failure to pay and restructuring of the obligations of the reference entity.

As of December 31, 2012 and 2011, the Company had sold protection with a notional amount of zero and $33.5 million, respectively. In addition, as of December 31, 2012 and 2011, the Company had purchased protection with a notional amount of $47.3 million and zero, respectively. The Company sells or purchases protection to replicate fixed income securities and to complement the spot market when cash securities of the reference entity of a particular maturity are not available or when the derivative alternative is less expensive compared to other purchasing alternatives. In addition, the Company may purchase protection to hedge economic exposure to declines in value of certain credit positions. The

Company purchases its protection from banks and broker dealers, other financial institutions and other counterparties.

The following table shows the net realized losses on the Company's CDS for the years ended December 31 2012, 2011 and 2010 (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 2016. Realized gains (losses) represent amounts related to the settlement of derivative instruments, which occur monthly, and for commodity derivatives, are aligned with the underlying production. Unrealized gains (losses) represent the change in fair value of the derivative instruments and are noncash items.

The following presents the Company's reported gains and losses on commodity derivative instruments (amounts in thousands):

The following table summarizes open positions as of December 31, 2012, and represents, as of such date, derivatives in place through December 31, 2016, on annual production volumes:

	Year ended December 31, 2012		Year ended December 31, 2013		Year ended December 31, 2014		Year ended December 31, 2015		Year ended December 31, 2016

Natural gas positions:
Fixed price swaps:
Hedged volume (MMMBtu)		—		6,742		5,821		3,788		1,805
Average price ($/MMBtu)	$	—	$	3.92	$	4.34	$	4.79	$	4.44
Natural gas liquid positions:
Fixed price swaps:
Hedged volume (MBbls)		—		189.5		—		—		—
Average price ($/Bbl)	$	—	$	35.82	$	—	$	—	$	—
Oil positions:
Fixed price swaps:
Hedged volume (MBbls)		—		18.5		16.7		3.9		—
Average price ($/Bbl)	$	—	$	92.63	$	91.75	$	95.55	$	—

The following table summarizes by derivative instrument type the effect on income from free-standing derivatives for the years ended December 31, 2012, 2011 and 2010 (amounts in thousands):

Free-Standing Derivatives:	For the year ended December 31, 2012			For the year ended December 31, 2011			For the year ended December 31, 2010

Interest rate swaps	$	—		$	—		$	311
Commodity swaps		4,275			7,948			(226	)
Credit default swaps—protection sold		1,746			(6,030	)		1,970
Credit default swaps—protection purchased		(6,884	)		—			—
Total rate of return swaps		141			49			1,771
Foreign exchange forward contracts		(9,312	)		5,072			(17,296	)
Foreign exchange options		(5,406	)		(1,398	)		14,630
Common stock warrants		1,677			(890	)		663

Net realized and unrealized (losses) gains on free-standing derivatives	$	(13,763	)	$	4,751		$	1,823

The components of accumulated other comprehensive loss were as follows (amounts in thousands):

The components of changes in other comprehensive loss were as follows (amounts in thousands):

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, subject to certain conditions, 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. In addition, the Company also commits to purchase corporate loans in the secondary market that similar to the above, the Company bears the risks and benefits of changes in the fair value from the trade date forward. As of December 31, 2012 and 2011, the Company had committed to purchase corporate loans with aggregate commitments totaling $254.2 million and $97.2 million, respectively. In addition, the Company participates in certain contingent financing arrangements, whereby the Company is committed to provide funding of up to a specific predetermined amount at the discretion of the borrower or has entered into an agreement to acquire interests in certain assets. As of December 31, 2012 and 2011, the

Company had unfunded financing commitments for corporate loans totaling $9.8 million and $8.1 million, respectively. In addition, as December 31, 2012 and 2011, the Company had unfunded financing commitments, including financial guarantees, related to other assets, including equity investments and interests in joint ventures and partnerships, totaling approximately $220.9 million and $40.9 million, respectively. The Company did not have any significant losses as of December 31, 2012, nor does it expect any significant losses related to those assets for which it committed to purchase and fund.

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, 2012, the 2007 Share Incentive Plan authorizes a total of 8,714,625 shares that may be used to satisfy awards under the 2007 Share Incentive Plan. 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 August 9, 2012, certain members of the board of directors were granted 43,557 restricted common shares subject to graded vesting over three years with the final vesting date of August 9, 2015.



Unvested shares as of January 1, 2010	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
Issued	258,303		43,557		301,860
Vested	(60,211	)	(96,980	)	(157,191	)

Unvested shares as of December 31, 2012	438,937		92,253		531,190

The restricted common shares granted to the directors were valued using the fair value at the time of grant, which was $9.26, $7.91, and $8.90 per share, for the restricted common shares granted in 2012,

2011, and 2010, 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 $10.56, $8.73 and $9.30 per share at December 31, 2012, 2011 and 2010, respectively. There were $2.9 million, $2.1 million and $1.3 million of total unrecognized compensation costs related to unvested restricted common shares granted as of December 31, 2012, 2011 and 2010, respectively. These costs are expected to be recognized through 2015.

		Weighted Average Exercise Price

Outstanding as of January 1, 2010	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
Granted	—		—
Exercised	—		—
Forfeited	—		—

Outstanding as of December 31, 2012	1,932,279	$	20.00

As of December 31, 2012, 2011 and 2010, 1,932,279 common share options were exercisable. As of December 31, 2012, the common share options were fully vested and expire in August 2014. For the years ended December 31, 2012, 2011 and 2010, 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, 2012, the Company incurred $28.2 million in base management fees. As of December 31, 2012, the Company had $2.4 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 $2.3 million for the year ended December 31, 2012 (see Note 11). For the year ended December 31, 2011, the Company incurred $26.3 million in base management fees. 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). 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.

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, 2012, 2011 and 2010.

For the year ended December 31, 2012, the Manager earned $37.6 million of incentive fees. As of December 31, 2012, the Company had $6.1 million incentive fee payable to the Manager. Incentive fees of $34.2 million and $38.8 million were earned by the Manager during the years ended December 31, 2011 and 2010, 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 consolidated statements 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 2011-1 and CLO 2012-1 and is entitled to receive fees for the services performed as collateral manager for all of these CLOs, except for CLO 2011-1. The collateral manager has the option to waive the fees it earns for providing management services for the CLO.

During the years ended December 31, 2012, 2011 and 2010, the collateral manager waived management fees for all CLOs, except for CLO 2005-1 and CLO 2012-1, and waived aggregate CLO management fees totaling $32.2 million, $34.0 million and $30.6 million, respectively. For years ended December 31, 2012, 2011 and 2010, the Company recorded an expense for CLO management fees totaling $4.2 million, $5.3 million and $5.4 million, respectively.

Certain general and administrative expenses are incurred by the Company's Manager on its behalf that are reimbursable to the Manager pursuant to the Management Agreement. For the year ended December 31, 2012, the Company incurred reimbursable general and administrative expenses to its Manager of $10.2 million, as compared to $8.2 million and $4.6 million for the years ended December 31, 2011 and 2010, respectively. Expenses incurred by the Manager and reimbursed by the Company are reflected in general, administrative and directors expenses on the consolidated statements of operations.

The Company has invested in corporate loans, debt securities and other investments of entities that are affiliates of KKR. As of December 31, 2012, the aggregate par amount of these affiliated investments totaled $2.1 billion, or approximately 29% of the total investment portfolio, and consisted of 32 issuers. The total $2.1 billion in affiliated investments was comprised of $2.0 billion of corporate loans, $39.3 million of corporate debt securities, and $73.8 million of equity investments, at estimated fair value. 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.

In addition, the Company has invested in certain joint ventures and partnerships alongside KKR and its affiliates. As of December 31, 2012 and 2011, the aggregate cost amount of these interests in joint ventures and partnerships, which are included in other assets on the consolidated balance sheets, totaled $137.6 million and zero, respectively.

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 subsidiaries are not expected to incur federal tax expense but are subject to limited state income tax expense related to the 2012 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 2012 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 (benefit) expense for the years ended December 31, 2012, 2011 and 2010 consisted of the following components (amounts in thousands):

The tax provision for domestic taxable corporate subsidiaries taxed as regular corporations was based on a combined federal and state income tax rate of 39.55% at December 31, 2012, 41.02% at December 31, 2011 and 40.75% at December 31, 2010. 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 table below discloses the carrying value and the estimated fair value of the Company's financial instruments, as well as the respective hierarchy classifications, as of December 31, 2012 (amounts in thousands):

	As of December 31, 2012				Fair Value Hierarchy

	Carrying Amount		Estimated Fair Value		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
Financial Assets:
Cash, restricted cash, and cash equivalents	$	1,134,002	$	1,134,002	$	1,134,002	$	—	$	—
Securities available-for-sale		412,293		412,293		—		370,072		42,221
Other securities, at estimated fair value		37,385		37,385		—		34,476		2,909
Residential mortgage-backed securities		83,842		83,842		—		—		83,842
Corporate loans, net of allowance for loan losses of $223,472 as of December 31, 2012		5,783,689		5,831,218		—		5,203,763		627,455
Corporate loans held for sale		128,289		195,078		—		151,327		43,751
Corporate loans, at estimated fair value		35,879		35,879		—		19,738		16,141
Equity investments, at estimated fair value		161,621		161,621		23,790		40,085		97,746
Derivative assets		23,207		23,207		1,744		11,327		10,136
Private equity investments, at cost(1)		405		1,635		—		—		1,635
Interests in joint ventures and partnerships(1)		142,477		142,477		—		—		142,477
Other assets		17,148		16,777		—		16,439		338
Financial Liabilities:
Collateralized loan obligation secured debt	$	5,122,338	$	5,020,115	$	—	$	—	$	5,020,115
Collateralized loan obligation junior secured notes to affiliates		296,557		290,948		—		—		290,948
Credit facilities		107,789		107,789		—		—		107,789
Convertible senior notes		166,028		268,238		—		268,238		—
Senior notes		362,178		412,126		412,126		—		—
Junior subordinated notes		283,517		134,351		—		—		134,351
Securities sold, not yet purchased(2)		1,158		1,158		1,158		—		—
Derivative liabilities		117,270		117,270		—		116,985		285

The table below discloses the carrying value and the estimated fair value of the Company's financial instruments as of December 31, 2011 (amounts in thousands):

	As of December 31, 2011

	Carrying Amount		Estimated Fair Value
Financial Assets:
Cash, restricted cash, and cash equivalents	$	791,774	$	791,774
Securities available-for-sale		816,453		816,453
Other securities, at estimated fair value		19,671		19,671
Residential mortgage-backed securities		86,479		86,479
Corporate loans, net of allowance for loan losses of $191,407 as of December 31, 2011		6,122,891		5,999,771
Corporate loans held for sale		317,332		359,463
Corporate loans, at estimated fair value		3,176		3,176
Equity investments, at estimated fair value		189,845		189,845
Interest and principal receivable		62,124		62,124
Derivative assets		28,463		28,463
Private equity investments, at cost(1)		780		780
Financial Liabilities:
Collateralized loan obligation secured debt	$	5,540,037	$	5,200,534
Collateralized loan obligation junior secured notes to affiliates		365,848		283,914
Credit facilities		38,300		38,300
Convertible senior notes		299,830		368,502
Senior notes		250,676		261,834
Junior subordinated notes		283,517		262,962
Accounts payable, accrued expenses and other liabilities		23,424		23,424
Accrued interest payable		25,536		25,536
Accrued interest payable to affiliates		6,561		6,561
Related party payable		11,078		11,078
Securities sold, not yet purchased		1,256		1,256
Derivative liabilities		125,333		125,333

The following table presents information about the Company's financial assets and liabilities measured at fair value on a recurring basis as of December 31, 2012 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, 2012

Assets:
Securities:
Corporate debt securities	$	—		$	370,072		$	42,221		$	412,293
Other securities, at estimated fair value		—			34,476			2,909			37,385
Residential mortgage-backed securities		—			—			83,842			83,842

Total securities		—			404,548			128,972			533,520
Corporate loans, at estimated fair value		—			19,738			16,141			35,879
Equity investments, at estimated fair value		23,790			40,085			97,746			161,621
Derivatives:
Foreign exchange options		—			—			8,562			8,562
Commodity swaps		—			8,557			—			8,557
Common stock warrants		1,744			—			1,574			3,318
Foreign exchange forward contracts		—			2,615			—			2,615
Credit default swaps—protection sold		—			19			—			19
Credit default swaps—protection purchased		—			136			—			136

Total derivatives		1,744			11,327			10,136			23,207
Other assets:
Interests in joint ventures and partnerships		—			—			142,477			142,477
Other assets		—			319			—			319

Total other assets		—			319			142,477			142,796

Total	$	25,534		$	476,017		$	395,472		$	897,023

Liabilities:
Securities sold, not yet purchased	$	(1,158	)	$	—		$	—		$	(1,158	)
Derivatives:
Interest rate swaps		—			(90,618	)		—			(90,618	)
Foreign exchange forward contracts		—			(23,590	)		—			(23,590	)
Credit default swaps—protection purchased		—			(1,276	)		—			(1,276	)
Commodity swaps		—			(1,501	)		—			(1,501	)
Foreign exchange options		—			—			(285	)		(285	)

Total derivatives		—			(116,985	)		(285	)		(117,270	)

Total	$	(1,158	)	$	(116,985	)	$	(285	)	$	(118,428	)

The following table presents information about the Company's assets measured at fair value on a non-recurring basis as of December 31, 2012, 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 financial 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:
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
Derivatives:
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

Total derivatives		1,066			7,371			14,812		23,249
Other assets		—			—			567		567

Total	$	23,466		$	793,143		$	322,831	$	1,139,440

Liabilities:
Securities sold, not yet purchased	$	(1,256	)	$	—		$	—	$	(1,256	)
Derivatives:
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	)

Total derivatives		—			(120,119	)		—		(120,119	)

Total	$	(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 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, 2012 (amounts in thousands):

	Securities Available- For-Sale: Corporate Debt Securities			Other Securities, at Estimated Fair Value		Residential Mortgage- Backed Securities			Corporate Loans, at Estimated Fair Value		Equity Investments, at Estimated Fair Value			Total Rate of Return Swaps			Common Stock Warrants		Foreign Exchange Options, Net			Interest in Joint Ventures and Partnerships			Other Assets

Beginning balance as of January 1, 2012	$	67,233		$	2,778	$	86,479		$	—	$	150,962		$	152		$	1,266	$	13,394		$	—		$	567
Total gains or losses (for the period):
Included in earnings(1)		1,171			131		6,306			429		1,708			141			308		(5,117	)		4,391			342
Included in other comprehensive loss		12,202			—		—			—		—			—			—		—			—			—
Transfers into Level 3(2)		—			—		—			—		—			—			—		—			34,230			—
Transfers out of Level 3(2)		(2,721	)		—		—			—		(34,230	)		—			—		—			—			—
Purchases		—			—		—			15,056		18,060			—			—		—			104,728			—
Sales		(24,660	)		—		—			—		(4,365	)		—			—		—			—			(706	)
Settlements		(11,004	)		—		(8,943	)		656		(34,389	)		(293	)		—		—			(872	)		(203	)

Ending balance as of December 31, 2012	$	42,221		$	2,909	$	83,842		$	16,141	$	97,746		$	—		$	1,574	$	8,277		$	142,477		$	—

Change in unrealized gains or losses for the period included in earnings for assets held at the end of the reporting period(1)	$	506		$	131	$	28,543		$	429	$	14,579		$	—		$	308	$	(5,117	)	$	4,391		$	—

The following table presents additional information about valuation techniques and inputs used for assets and liabilities, including derivatives, that are measured at fair value and categorized within Level 3 as of December 31, 2012 (dollar amounts in thousands):

	Balance as of December 31, 2012			Valuation Techniques(1)	Unobservable Inputs(2)	Range (Weighted Average)(3)

Assets:
Securities available-for-sale:	$	42,221		Yield Analysis	Yield	11% - 46% (16%)	Decrease
Corporate debt securities					Discount margin	1100bps - 4550bps	Decrease
						(1450bps)
					Net leverage	3x - 13x (6x)	Decrease
					Illiquidity discount	3% (3%)	Decrease
					EBITDA multiple	6x - 8x (7x)	Increase
				Broker quotes	Offered quotes	69 - 105 (88)	Increase
Other securities, at estimated fair value	$	2,909		Yield Analysis	Yield	10% (10%)	Decrease
Residential mortgage-backed securities	$	83,842		Discounted cash flows	Probability of default	0% - 21% (6%)	Decrease
					Loss severity	18% - 80% (30%)	Decrease
					Constant prepayment rate	1% - 35% (13%)		(5)
Corporate loans, at estimated fair value	$	16,141		Yield Analysis	Illiquidity discount	15% (15%)	Decrease
					Net leverage	8x - 9x (9x)	Decrease
					EBITDA multiple	9x - 10x (10x)	Increase
				Broker quotes	Offered quotes	8 - 40 (39)	Increase
Equity investments, at estimated fair value	$	97,746		Market comparables	LTM EBITDA multiple	7x - 12x (10x)	Increase
					Forward EBITDA multiple	6x - 12x (10x)	Increase
					Control premium	0% (0%)	Increase
				Discounted cash flows	Weighted average cost of capital	6% - 16% (10%)	Decrease
					LTM EBITDA exit multiple	7x - 12x (9x)	Increase
Common stock warrants	$	1,574		Market comparables	LTM EBITDA multiple	7x (7x)	Increase
					Forward EBITDA multiple	7x (7x)	Increase
					Illiquidity discount	15% (15%)	Decrease
				Discounted cash flows	Weighted average cost of capital	12% (12%)	Decrease
					LTM EBITDA exit multiple	7x (7x)	Increase
Foreign exchange options	$	8,562		Option pricing model	Forward and spot rates	0 - 2 (1)		(6)
Interests in joint ventures and partnerships	$	142,477		Discounted cash flows	Illiquidity discount	10% - 15% (10%)	Decrease
					Weighted average cost of capital	13% - 30% (18%)	Decrease
Liabilities:
Foreign exchange options	$	(285	)	Option pricing model	Forward and spot rates	0.02 (0.02)		(6)

(1): For the assets that have more than one valuation technique, the Company may rely on the techniques individually or in aggregate based on a weight ascribed to each one ranging from 0-100%. Broker quotes obtained for valuation purposes are reviewed by the Company through other valuation techniques. Equity investments, at estimated fair value are assigned a minimum 5% illiquidity discount, with the exception of certain investments related to natural resources.
(2): The significant unobservable inputs used in the fair value measurement of the Company's assets and liabilities may include the last twelve months ("LTM") EBITDA multiple, weighted average cost of capital, discount margin, probability of default, loss severity and constant prepayment rate. In determining certain of these inputs, management evaluates a variety of factors including economic, industry and market trends and developments; market valuations of comparable companies; and company specific developments including potential exit strategies and realization opportunities. Significant increases or decreases in any of these inputs in isolation could result in significantly lower or higher fair value measurement.
(3): Weighted average amounts are based on the estimated fair values.
(4): Unless otherwise noted, this column represents the directional change in the fair value of the Level 3 investments that would result from an increase to the corresponding unobservable input. A decrease to the unobservable input would have the opposite effect. Significant changes in these inputs in isolation could result in significantly higher or lower fair value measurements.
(5): The impact of changes in prepayment speeds may have differing impacts depending on the seniority of the instrument. Generally, an increase in the constant prepayment speed will positively impact the overall valuation of traditional mortgage assets. In contrast, an increase in the constant prepayment rate will negatively impact the overall valuation of interest-only strips.
(6): The directional change from an increase in forward and spot rates varies and is dependent on the specific option.

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

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. Prior to 2011, the Company operated under a single business segment of credit ("Credit"). However, during 2011, the Company began purchasing additional working interests and overriding royalty interests in oil and natural gas properties, as well as other non-credit investments. As of December 31, 2011, the Company determined that it met certain segment reporting requirements and accordingly, began disclosing 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 not significant at that time, may become a significant part of its business. In aggregate, these business segments were reported as other ("Other"). Effective September 30, 2012, based on the growing significance of natural resources, the Company changed the basis of presentation from reporting solely the Credit and Other segments to reporting Credit, natural resources ("Natural Resources") and Other. The prior period balances have been reclassified for comparative purposes.

The Company's segments are differentiated primarily by their investment focuses. The Credit segment consists primarily of below investment grade corporate debt comprised of senior secured and unsecured loans, mezzanine loans, private and public equity investments, and distressed and stressed debt securities. The Natural Resources segment, which was previously included within Other, consists of non-operated working and overriding royalty interests in oil and natural gas properties. The Other segment includes all other portfolio holdings, consisting solely of commercial real estate. 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 revenues, total investment costs and expenses, total other income (loss), and total other expenses. Net income includes (i) revenues, (ii) related investment costs and expenses, (ii) other income (loss), which is comprised primarily of unrealized and realized gains and losses on investments and derivatives, and (iii) other expenses, including related party management compensation and general and administrative expenses. Certain corporate assets and expenses that are not directly related to the individual segments, including interest expense on holding company debt, base management fees and professional services are allocated to individual segments based on the carrying value of the assets within those segments. These allocations are calculated based on the investment portfolio balance in each respective segment as of the most recent year-end. 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, 2012, 2011 and 2010 (amounts in thousands):

	Credit							Natural Resources							Other						Reconciling Items(1)									Total Consolidated

For the Years Ended December 31	2012			2011		2010		2012		2011		2010			2012		2011		2010		2012			2011			2010			2012			2011		2010
Total revenues	$	490,861		$	511,392	$	504,471	$	64,535	$	30,629	$	888		$	77	$	—	$	—	$	—		$	—		$	—		$	555,473		$	542,021	$	505,359
Total investment costs and expenses		257,269			196,415		187,345		60,668		18,747		1,607			438		—		—		—			—			—			318,375			215,162		188,952
Total other income (loss)		199,278			85,499		143,578		1,881		7,948		(226	)		4,663		—		—		—			—			—			205,822			93,447		143,352
Total other expenses		48,640			46,371		37,149		5,111		3,823		586			217		—		—		44,189			44,029			50,258			98,157			94,223		87,993
Income tax (benefit) expense		(3,468	)		7,941		697		—		70		5			1		—		—		—			—			—			(3,467	)		8,011		702

Net income (loss)	$	387,698		$	346,164	$	422,858	$	637	$	15,937	$	(1,536	)	$	4,084	$	—	$	—	$	(44,189	)	$	(44,029	)	$	(50,258	)	$	348,230		$	318,072	$	371,064

The following table shows total assets of reportable segments reconciled to amounts reflected in the consolidated financial statements as of December 31, 2012 and 2011 (amounts in thousands):

The following is a presentation of the quarterly results of operations for the years ended December 31, 2012 and December 31, 2011:

	2012

(amounts in thousands, except per share information)	Fourth Quarter		Third Quarter		Second Quarter		First Quarter
Total revenues	$	133,655	$	143,334	$	140,550	$	137,934
Total investment costs and expenses		72,568		70,900		67,115		107,792
Total other income		37,398		73,043		16,543		78,838
Total other expenses		21,391		33,196		18,570		25,000

Income before income taxes		77,094		112,281		71,408		83,980
Income tax expense (benefit)		81		317		203		(4,068	)

Net income	$	77,013	$	111,964	$	71,205	$	88,048

Net income per common share:
Basic(1)
Net income per share	$	0.43	$	0.63	$	0.40	$	0.49
Diluted(1)(2)
Net income per share	$	0.40	$	0.61	$	0.39	$	0.48
Weighted average number of common shares outstanding:
Basic		177,906		177,862		177,809		177,775
Diluted		202,371		183,431		181,642		182,247

	2011

(amounts in thousands, except per share information)	Fourth Quarter			Third Quarter			Second Quarter		First Quarter
Total revenues	$	136,408		$	134,440		$	135,843	$	135,330
Total investments costs and expenses		50,749			53,262			53,355		57,796
Total other income (loss)		13,739			(29,306	)		62,578		46,436
Total other expenses		22,750			12,449			30,138		28,886

Income before income taxes		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

On January 17, 2013, the Company issued 14.95 million of 7.375% Series A LLC Preferred Shares ("Series A LLC Preferred Shares") for gross proceeds of $373.8 million, and net proceeds of $362.0 million. The Series A LLC Preferred Shares trade on the New York Stock Exchange under the ticker symbol "KFN.PR" and began trading on January 28, 2013. Distributions on the Series A LLC Preferred Shares are cumulative and are payable, when, as, and if declared by the Company's board of directors, quarterly on January 15, April 15, July 15 and October 15 of each year, beginning April 15, 2013, at a rate per annum equal to 7.375%.

On January 18, 2013, in accordance with the indenture relating to the 7.5% Notes, the Company issued the Termination Notice to holders of the 7.5% Notes whereby it terminated the right to convert the 7.5% Notes to common shares. Per the indenture, the Company was able to terminate the conversion rights of the notes if the closing price of its shares exceeded 150% of the conversion price then in effect for 20 or more trading days in a period of 30 consecutive trading days ending on the trading day prior to the date on which it provided notice of the election to terminate the conversion rights. The conversion rate as of January 18, 2013 was equal to 141.8256 common shares for each $1,000 principal amount of 7.5% Notes, plus an additional 9.2324 common shares per $1,000 principal amount to account for the make-whole premium. As set forth in the Termination Notice, the 7.5% Notes were no longer convertible to common shares as of February 17, 2013. Through February 17, 2013, $172.5 million of the 7.5% Notes had been tendered for conversion, which were settled with 26.1 million shares.

On January 31, 2013, the Company's board of directors declared a cash distribution for the quarter ended December 31, 2012 of $0.21 per share to common shareholders of record on February 19, 2013. The distribution is payable on February 28, 2013. In addition, on January 31, 2013, the Company's board of directors declared a special cash distribution for the year ended December 31, 2012 of $0.05 per share to common shareholders of record on March 14, 2013. The distribution is payable on March 28, 2013.

KKR FINANCIAL HOLDINGS LLC AND SUBSIDIARIES

SUPPLEMENTAL OIL AND NATURAL GAS DATA (UNAUDITED)

The following discussion and analysis should be read in conjunction with the "Consolidated Financial Statements" and "Notes to Consolidated Financial Statements," which are included in this Annual Report on Form 10-K in Item 8. "Financial Statements and Supplementary Data."

Costs Incurred in Oil and Natural Gas Property Acquisition, Exploration and Development Activities

Costs incurred in oil and natural gas property acquisition, exploration and development, whether capitalized or expensed, are presented below (amounts in thousands):

Aggregate capitalized costs related to oil, natural gas and natural gas liquid production activities with applicable accumulated depreciation, depletion and amortization are presented below (amounts in thousands):

The results of operations for oil, natural gas and natural gas liquid producing activities (excluding corporate overhead and interest costs) are presented below (amounts in thousands):

	December 31, 2012		December 31, 2011		December 31, 2010

Revenues and other:
Oil, natural gas and natural gas liquid sales	$	61,329	$	29,135	$	888
Other(1)		3,206		1,494		—
Production costs:
Lease operating expenses		14,562		4,415		177
Workover expense		3,335		941		—
Transportation and marketing expenses		7,477		985		—
Severance and ad valorem taxes		3,606		1,425		—
Other costs:
Exploration		—		97		—
Depreciation, depletion and amortization		21,931		8,015		324
Impairment of long-lived assets		3,308		—		—
Margin tax expense		—		70		5
General, administrative and other expenses		6,242		4,304		1,302

Results of Operations	$	4,074	$	10,377	$	(920	)

There is no federal tax provision included in the results above because the Company's subsidiaries subject to federal tax do not own any of the Company's oil and natural gas interests.

The proved reserves of oil, natural gas and natural gas liquids of the Company have been prepared by the independent engineering firms, Netherland, Sewell & Associates, Inc. ("NSAI") and LaRoche Petroleum Consultants, Ltd. ("LaRoche"), and aggregated by the Company. In accordance with SEC regulations, reserves at December 31, 2012, 2011 and 2010, were estimated using the average price during the 12-month period, determined as an unweighted average of the first-day-of-the-month price for each month, unless prices are defined by contractual arrangements, excluding escalations based upon future conditions. An analysis of the change in estimated quantities of oil, natural gas and natural gas liquid reserves, all of which are located within the United States, is shown below.

The proved reserves of oil, natural gas, and natural gas liquids of the Company shown below (and information for the Standardized Measure of Discounted Future Net Cash Flows and Changes Therein Relating to Proved Reserves) does not include certain overriding royalty interests in the Eagle Ford Shale purchased in 2011 since this information is unavailable to the Company. In relation to these overriding royalty interests, the Company's share of oil, natural gas, and natural gas liquids produced in

2012 was 182.7 MBbls, 603.6 MMcf, and 60.8 MBbls and in 2011 was 97.4 MBbls, 224.3 MMcf, and 25.1 MBbls.

	Year Ended December 31, 2012

	Natural Gas (Bcf)			Oil (MMBbls)			NGL (MMBbls)			Total (Bcfe)
Proved developed and undeveloped reserves:
Beginning of year		44.4			0.2			4.6			73.2
Revisions of previous estimates		(12.1	)		—			(0.9	)		(17.5	)
Purchase of minerals in place		67.9			0.6			2.9			88.9
Extensions, discoveries and other additions		2.8			1.6			0.3			14.2
Production		(8.2	)		(0.1	)		(0.2	)		(10.0	)
End of year		94.8			2.3			6.7			148.8
Proved developed reserves:
Beginning of year		33.0			0.1			3.3			53.4
End of year		75.8			0.6			5.0			109.4
Proved undeveloped reserves:
Beginning of year		11.4			0.1			1.3			19.8
End of year		19.0			1.7			1.7			39.4

	Year Ended December 31, 2011

	Natural Gas (Bcf)			Oil (MMBbls)		NGL (MMBbls)			Total (Bcfe)
Proved developed and undeveloped reserves:
Beginning of year		14.4			0.1		1.2			22.2
Revisions of previous estimates		1.7			—		0.6			5.3
Purchase of minerals in place		30.2			0.1		3.0			48.8
Extensions, discoveries and other additions		0.5			—		—			0.5
Production		(2.4	)		—		(0.2	)		(3.6	)
End of year		44.4			0.2		4.6			73.2
Proved developed reserves:
Beginning of year		14.0			0.1		1.2			21.8
End of year		33.0			0.1		3.3			53.4
Proved undeveloped reserves:
Beginning of year		0.4			—		—			0.4
End of year		11.4			0.1		1.3			19.8

	Year Ended December 31, 2010

	Natural Gas (Bcf)			Oil (MMBbls)		NGL (MMBbls)		Total (Bcfe)
Proved developed and undeveloped reserves:
Beginning of year		—			—		—		—
Revisions of previous estimates		—			—		—		—
Purchase of minerals in place		14.5			0.1		1.2		22.3
Extensions, discoveries and other additions		—			—		—		—
Production		(0.1	)		—		—		(0.1	)
End of year		14.4			0.1		1.2		22.2
Proved developed reserves:
Beginning of year		—			—		—		—
End of year		14.0			0.1		1.2		21.8
Proved undeveloped reserves:
Beginning of year		—			—		—		—
End of year		0.4			—		—		0.4

The tables above include changes in estimated quantities of oil and natural gas liquid reserves shown in Mcf equivalents at a rate of one barrel per six Mcf.

Proved reserves increased by approximately 75.6 Bcfe to approximately 148.8 Bcfe for the year ended December 31, 2012, from 73.2 Bcfe for the year ended December 31, 2011. The year ended December 31, 2012, includes 17.5 Bcfe in negative revisions of previous estimates, due primarily to pricing and asset performance. Multiple acquisitions during the year ended December 31, 2012, increased proved reserves by approximately 88.9 Bcfe. In addition, extensions and discoveries, primarily from certain productive wells drilled during the year, contributed approximately 12.9 Bcfe to the increase in proved reserves.

Proved reserves increased by approximately 51.0 Bcfe to approximately 73.2 Bcfe for the year ended December 31, 2011, from 22.2 Bcfe for the year ended December 31, 2010. The year ended December 31, 2011, includes 5.3 Bcfe in positive revisions of previous estimates, due primarily to contractual and performance revisions. An acquisition made during the year ended December 31, 2011, increased proved reserves by approximately 48.8 Bcfe. In addition, extensions and discoveries contributed approximately 0.5 Bcfe to the increase in proved reserves.

Proved reserves totaled approximately 22.2 Bcfe for the year ended December 31, 2010. The Company made its first natural resources acquisition during the fourth quarter of 2010.

Standardized Measure of Discounted Future Net Cash Flows and Changes Therein Relating to Proved Reserves

Information with respect to the standardized measure of discounted future net cash flows relating to proved reserves is summarized below. Future cash inflows are computed by applying applicable prices relating to the Company's proved reserves to the year-end quantities of those reserves. Future production, development, site restoration and abandonment costs are derived based on current costs

assuming continuation of existing economic conditions. There are no future income tax expenses because the Company is not subject to federal income taxes.

In accordance with SEC regulations, reserves at December 31, 2012, 2011 and 2010 were estimated using the average price during the 12-month period, determined as an unweighted average of the first-day-of-the-month price for each month, unless prices are defined by contractual arrangements, excluding escalations based upon future conditions. The prices utilized in calculating our total estimated proved reserves at December 31, 2012, 2011 and 2010 were $91.21 per Bbl of oil and $2.76 per MMBtu of natural gas; $92.71 per Bbl of oil and $4.12 per MMBtu of natural gas; $75.96 per Bbl of oil and $4.38 per MMBtu of natural gas, respectively. The price used to estimate reserves is held constant over the life of the reserves.

The following summarizes the principal sources of change in the standardized measure of discounted future net cash flows (amounts in thousands):

	December 31, 2012			December 31, 2011			December 31, 2010

Standardized measure at beginning of period	$	107,684		$	34,641		$	—
Sales and transfers of oil, natural gas and natural gas liquid produced during the period		(16,274	)		(13,032	)		(706	)
Net change in sales and transfer prices and production costs related to future production		(43,603	)		3,887			—
Net change in future development costs		(2,104	)		(1,870	)		—
Purchase of minerals in place flows		81,845			71,059			35,347
Extensions, discoveries, and improved recovery		25,290			110			—
Previously estimated development costs incurred during the period		—			433			—
Net change due to revisions in quantity estimates		(26,209	)		7,686			—
Accretion of discount		10,768			3,464			—
Changes in timing and other		(1,674	)		1,306			—

Standardized measure of discounted future net cash flows	$	135,723		$	107,684		$	34,641


(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, 2012
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 (Address of principal executive offices)		94104 (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



	GLOSSARY OF TERMS	5
PART I
ITEM 1.	BUSINESS	8
ITEM 1A.	RISK FACTORS	22
ITEM 1B.	UNRESOLVED STAFF COMMENTS	58
ITEM 2.	PROPERTIES	58
ITEM 3.	LEGAL PROCEEDINGS	58
ITEM 4.	MINE SAFETY DISCLOSURE	58
PART II
ITEM 5.	MARKET FOR REGISTRANT'S COMMON EQUITY, RELATED SHAREHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES	59
ITEM 6.	SELECTED CONSOLIDATED FINANCIAL DATA	62
ITEM 7.	MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS	64
ITEM 7A.	QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK	123
ITEM 8.	FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA	123
ITEM 9.	CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE	123
ITEM 9A.	CONTROLS AND PROCEDURES	123
ITEM 9B.	OTHER INFORMATION	124
PART III
ITEM 10.	DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE	124
ITEM 11.	EXECUTIVE COMPENSATION	124
ITEM 12.	SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED SHAREHOLDER MATTERS	124
ITEM 13.	CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE	125
ITEM 14.	PRINCIPAL ACCOUNTING FEES AND SERVICES	125
PART IV
ITEM 15.	EXHIBITS AND FINANCIAL STATEMENT SCHEDULES	125

	Sales Price

	High		Low
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
Year ended December 31, 2012
First Quarter ended March 31, 2012	$	9.54	$	8.70
Second Quarter ended June 30, 2012	$	9.47	$	7.95
Third Quarter ended September 30, 2012	$	10.36	$	8.53
Fourth Quarter ended December 31, 2012	$	10.89	$	9.30

Year ended December 31, 2011	Record Date	Payment Date	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
Special Distribution	March 15, 2012	March 29, 2012	$	0.08

Year ended December 31, 2012	Record Date	Payment Date	Cash Distribution Declared per Common Share

First Quarter ended March 31, 2012	May 8, 2012	May 22, 2012	$	0.18
Second Quarter ended June 30, 2012	August 9, 2012	August 23, 2012	$	0.21
Third Quarter ended September 30, 2012	November 7, 2012	November 21, 2012	$	0.21
Fourth Quarter ended December 31, 2012	February 19, 2013	February 28, 2013	$	0.21
Special Distribution	March 14, 2013	March 28, 2013	$	0.05

		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			1,570,712

	Base Period		Years Ending

	12/31/2007		12/31/2008		12/31/2009		12/31/2010		12/31/2011		12/31/2012
KKR Financial Holdings LLC		100		13		46		78		79		105
S&P 500 Index		100		60		80		91		93		106
Russell 2000		100		63		85		106		102		116

		Page

EXECUTIVE OVERVIEW			65
Business Environment			65
Consolidated Summary of Results			66
Cash Distributions to Shareholders			66
Funding Activities			67
Investment Portfolio			69
CRITICAL ACCOUNTING POLICIES			71
RESULTS OF OPERATIONS			79
Consolidated Results			79
Segment Results			81
Credit Segment			82
Natural Resources Segment			86
Other Segments			91
Income Tax Provision			92
Investment Portfolio			93
Corporate Loans			94
Corporate Debt Securities			99
Other Holdings			100
Shareholders' Equity			105
LIQUIDITY AND CAPITAL RESOURCES			106
Sources of Funds			106
Off-Balance Sheet Commitments			110
Contractual Obligations			111
PARTNERSHIP TAX MATTERS			112
OUR INVESTMENT COMPANY ACT STATUS			114
OTHER REGULATORY ITEMS			119
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK			119

	Bank Loans & High Yield Bonds		Natural Resources		Special Situations		Mezzanine		Commercial Real Estate		Private Equity		Total

Corporate loans(1)	$	6,012,511	$	—	$	59,379	$	99,439	$	—	$	—	$	6,171,329
Securities(2)		372,758		—		76,920		—		—		—		449,678
Equity investments, at estimated fair value(3)		40,085		12,493		32,474		7,744		—		68,825		161,621
Oil and gas properties, net		—		289,929		—		—		—		—		289,929
Other assets(4)		—		79,043		35,137		330		52,503		75		167,088

Total	$	6,425,354	$	381,465	$	203,910	$	107,513	$	52,503	$	68,900	$	7,239,645

	December 31, 2012		December 31, 2011

Non-accrual loans (recorded investment):
Impaired loans held for investment	$	445,437	$	68,692
Loans held for sale		90,840		99,999

Total non-accrual loans	$	536,277	$	168,691

	2012			2011			2010

Beginning balance	$	191,407		$	209,030		$	237,308
Provision for loan losses		46,498			14,194			29,121
Charge-offs		(14,433	)		(31,817	)		(57,399	)

Ending balance	$	223,472		$	191,407		$	209,030

	2012			2011

Loans Held for Sale:
Beginning balance	$	317,332		$	463,628
Transfers in		114,995			862,244
Transfers out		(114,871	)		(448,329	)
Sales, paydowns, restructurings and other		(186,511	)		(495,048	)
Lower of cost or estimated fair value adjustment(1)		(2,656	)		(65,163	)

Net carrying value	$	128,289		$	317,332



December 31, 2012
Proved developed reserves	75.8	0.6	5.0	109.4
Proved undeveloped reserves	19.0	1.7	1.7	39.4
December 31, 2011
Proved developed reserves	33.0	0.1	3.3	53.4
Proved undeveloped reserves	11.4	0.1	1.3	19.8

	December 31, 2012(1)								December 31, 2011(1)

	Par		Carrying Value		Amortized Cost		Estimated Fair Value		Par		Carrying Value		Amortized Cost		Estimated Fair Value
Senior secured	$	218,872	$	211,716	$	201,360	$	211,716	$	312,876	$	298,467	$	294,472	$	298,467
Senior unsecured		191,737		183,003		169,961		183,003		465,948		448,407		395,932		448,407
Subordinated		55,453		54,959		51,491		54,959		90,881		76,040		67,501		76,040

Total	$	466,062	$	449,678	$	422,812	$	449,678	$	869,705	$	822,914	$	757,905	$	822,914

	Natural Gas Wells				Oil Wells				Total Wells

	Gross(1)		Net(2)		Gross(1)		Net(2)		Gross(1)		Net(2)
December 31, 2012		1,375		233		22		3		1,397		236

	Developed Acreage				Undeveloped Acreage				Total Acreage

	Gross(1)		Net(2)		Gross(1)		Net(2)		Gross(1)		Net(2)
December 31, 2012		209,582		39,833		42,370		5,885		251,952		45,718



Gross wells:
Productive	10	5	—
Dry	—	1	—

	10	6	—

Net development wells:
Productive	1	1	—
Dry	—	—	—

	1	1	—

Net exploratory wells:
Productive	—	—	—
Dry	—	—	—

	—	—	—

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

Cash Flow Hedges:
Interest rate swaps	$	(2,921	)	$	—		$	—		$	(87,697	)	$	(90,618	)
Free-Standing Derivatives:
Commodity swaps		3,186			3,819			51			—			7,056
Credit default swaps—protection sold		19			—			—			—			19
Credit default swaps—protection purchased		(60	)		—			(1,080	)		—			(1,140	)
Foreign exchange forward contracts		(1,036	)		(19,049	)		(890	)		—			(20,975	)
Foreign exchange options		290			7,987			—			—			8,277

Total	$	(522	)	$	(7,243	)	$	(1,919	)	$	(87,697	)	$	(97,381	)

Signature	Title	Date


/s/ WILLIAM C. SONNEBORN William C. Sonneborn	Chief Executive Officer and Director (Principal Executive Officer)	February 28, 2013
/s/ MICHAEL R. MCFERRAN Michael R. McFerran	Chief Financial Officer (Principal Financial and Accounting Officer)	February 28, 2013
/s/ PAUL M. HAZEN Paul M. Hazen	Chairman and Director	February 28, 2013
/s/ TRACY COLLINS Tracy Collins	Director	February 28, 2013
/s/ ROBERT L. EDWARDS Robert L. Edwards	Director	February 28, 2013
/s/ VINCENT PAUL FINIGAN Vincent Paul Finigan	Director	February 28, 2013
/s/ R. GLENN HUBBARD R. Glenn Hubbard	Director	February 28, 2013

Signature	Title	Date


/s/ ROSS J. KARI Ross J. Kari	Director	February 28, 2013
/s/ ELY L. LICHT Ely L. Licht	Director	February 28, 2013
/s/ DEBORAH H. MCANENY Deborah H. McAneny	Director	February 28, 2013
/s/ SCOTT C. NUTTALL Scott C. Nuttall	Director	February 28, 2013
/s/ SCOTT A. RYLES Scott A. Ryles	Director	February 28, 2013
/s/ WILLY STROTHOTTE Willy Strothotte	Director	February 28, 2013

		Page

Reports of Independent Registered Public Accounting Firm			F-1
Consolidated Balance Sheets			F-5
Consolidated Statements of Operations			F-6
Consolidated Statements of Comprehensive Income			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

	December 31, 2012

	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses			Estimated Fair Value
Securities available-for- sale:
Corporate debt securities	$	394,821	$	27,281	$	(9,809	)	$	412,293

Total securities available-for-sale		394,821		27,281		(9,809	)		412,293
Other securities, at estimated fair value(1)		27,991		9,768		(374	)		37,385
Residential mortgage-backed securities, at estimated fair value(1)		171,385		3,762		(91,305	)		83,842

Total securities	$	594,197	$	40,811	$	(101,488	)	$	533,520

	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, 2012
Corporate debt securities	$	45,900	$	(4,398	)	$	37,500	$	(5,411	)	$	83,400	$	(9,809	)
December 31, 2011
Corporate debt securities	$	252,467	$	(10,562	)	$	32,876	$	(3,075	)	$	285,343	$	(13,637	)

	Year ended December 31, 2012			Year ended December 31, 2011			Year ended December 31, 2010

Gross realized gains	$	85,982		$	100,565		$	68,411
Gross realized losses		(12	)		(559	)		(7	)

Net realized gains(1)	$	85,970		$	100,006		$	68,404

Description	Amortized Cost		Estimated Fair Value

Due within one year	$	—	$	—	—	%
One to five years		274,909		301,433	9.2
Five to ten years		145,137		145,310	9.0
Greater than ten years		2,766		2,935	1.2

Total	$	422,812	$	449,678

	As of December 31, 2012		As of December 31, 2011

Pledged as collateral for collateralized loan obligation secured debt and junior secured notes to affiliates	$	354,088	$	710,734

Total	$	354,088	$	710,734

	December 31, 2012

	Corporate Loans Held for Investment			Corporate Loans Held for Sale			Corporate Loans, at Estimated Fair Value			Total Corporate Loans
Principal(1)	$	6,143,599		$	231,231		$	56,931		$	6,431,761
Net unamortized discount		(136,438	)		(88,895	)		(23,277	)		(248,610	)

Total amortized cost		6,007,161			142,336			33,654			6,183,151
Lower of cost or fair value adjustment		—			(14,047	)		—			(14,047	)
Allowance for loan losses		(223,472	)		—			—			(223,472	)
Net unrealized gains		—			—			2,225			2,225

Net carrying value	$	5,783,689		$	128,289		$	35,879		$	5,947,857

	December 31, 2012						December 31, 2011

	Recorded Investment		Unpaid Principal Balance		Related Allowance		Recorded Investment		Unpaid Principal Balance		Related Allowance
With no related allowance recorded	$	6,490	$	19,931	$	—	$	—	$	—	$	—
With an allowance recorded		438,947		464,214		94,863		68,692		83,452		33,836

Total	$	445,437	$	484,145	$	94,863	$	68,692	$	83,452	$	33,836

	For the year ended December 31, 2012				For the year ended December 31, 2011				For the year ended December 31, 2010

	Average Recorded Investment		Interest Income Recognized		Average Recorded Investment		Interest Income Recognized		Average Recorded Investment		Interest Income Recognized
With no related allowance recorded	$	3,540	$	208	$	3,244	$	—	$	12,873	$	2,853
With an allowance recorded		199,083		9,310		76,933		2,645		133,014		8,256

Total	$	202,623	$	9,518	$	80,177	$	2,645	$	145,887	$	11,109

	As of December 31, 2012		As of December 31, 2011

Pledged as collateral for collateralized loan obligation secured debt and junior secured notes to affiliates	$	5,804,026	$	6,448,404

Total	$	5,804,026	$	6,448,404

	As of December 31, 2012			As of December 31, 2011

Proved oil and natural gas properties (successful efforts method)	$	315,446		$	146,457
Unproved oil and natural gas properties		2,596			344
Less: Accumulated depreciation, depletion and amortization		(28,113	)		(8,276	)

Oil and gas properties, net	$	289,929		$	138,525

	2012(1)			2011

Proved property	$	160,751		$	56,588
Unproved property		2,535			—
Other assets		16,724			—
Risk management liabilities		(1,037	)		—
Accounts payable and accrued liabilities		(5,229	)		(558	)
Asset retirement obligation		(5,440	)		(553	)

Total	$	168,304		$	55,477

		Year ended December 31, 2012			Year ended December 31, 2011			Year ended December 31, 2010

Net gains (losses) recognized in other comprehensive loss on cash flow hedges		$	10,169		$	(42,324	)	$	(13,935	)

	Year ended December 31, 2012			Year ended December 31, 2011		Year ended December 31, 2010

Gross realized gains	$	3,066		$	—	$	—
Gross realized losses		(7,676	)		—		—

Net realized losses	$	(4,610	)	$	—	$	—

	Year ended December 31, 2012		Year ended December 31, 2011		Year ended December 31, 2010

Realized gains	$	3,554	$	352	$	—
Unrealized gains (losses)		721		7,596		(226	)

Total realized and unrealized gains (losses)	$	4,275	$	7,948	$	(226	)

	As of December 31, 2012			As of December 31, 2011

Net unrealized gains on available-for-sale securities	$	17,472		$	62,248
Net unrealized losses on cash flow hedges		(87,698	)		(97,867	)

Accumulated other comprehensive loss	$	(70,226	)	$	(35,619	)

KKR FINANCIAL HOLDINGS LLC
(Registrant)

/s/ WILLIAM C. SONNEBORN

William C. Sonneborn

Chief Executive Officer