MERGER TRANSACTION

6 Months Ended

Jun. 30, 2014

MERGER TRANSACTION

MERGER TRANSACTION

NOTE 3. MERGER TRANSACTION

On December 16, 2013, the Company announced the signing of a definitive merger agreement pursuant to which KKR & Co. had agreed to acquire all of the Company’s outstanding common shares through an exchange of equity through which the Company’s shareholders would receive 0.51 common units representing the limited partnership interests of KKR & Co. for each common share of KFN. On April 30, 2014, the date of the Merger Transaction, the transaction was approved by the Company’s common shareholders and the merger was completed, resulting in KFN becoming a subsidiary of KKR & Co. The merger was a taxable transaction for the Company’s common shareholders for U.S. federal income tax purposes.

Pursuant to the merger agreement, on the date of the Merger Transaction, (i) each outstanding option to purchase a KFN common share was cancelled, as the exercise price per share applicable to all outstanding options exceeded the cash value of the number of KKR & Co. common units that a holder of one KFN common share is entitled to in the merger, (ii) each outstanding restricted KFN common share (other than those held by the Manager) was converted into 0.51 KKR & Co. common units having the same terms and conditions as applied immediately prior to the effective time, and (iii) each phantom share under KFN’s Non-Employee Directors’ Deferred Compensation and Share Award Plan was converted into a phantom share in respect of 0.51 KKR & Co. common units and otherwise remains subject to the terms of the plan.

The Merger Transaction was recorded under the acquisition method of accounting by KKR & Co. and pushed down to the Company by allocating the total purchase consideration of $2.4 billion to the cost of the assets purchased and the liabilities assumed based on their estimated fair values at the date of the Merger Transaction. The excess of the total estimated fair values of the assets acquired and liabilities assumed over the purchase price and value of the preferred shares, which constitute non-controlling interests in the Company, was recorded as a bargain purchase gain by KKR & Co.

In connection with the Merger Transaction, the Company recognized approximately $24.2 million of total transaction costs. Of this total, $22.7 million was recorded during the one and four months ended April 30, 2014 within general, administrative and directors expenses on the condensed consolidated statements of operations. These costs included the contingent consideration owed to the Company’s financial and legal advisors upon the merger closing.

The following table summarizes the estimated fair values assigned to the assets purchased and liabilities assumed (amounts in thousands):

Assets acquired:
Cash and cash equivalents	$	210,413
Restricted cash and cash equivalents	649,967
Securities	541,149
Corporate loans	6,649,054
Equity investments	297,054
Oil and gas properties, net	505,238
Interests in joint ventures and partnerships	491,324
Derivative assets	26,383
Interest and principal receivable	35,992
Other assets	208,144
Total assets	9,614,718
Liabilities assumed:
Collateralized loan obligation secured notes	5,663,666
Credit facilities	63,189
Senior notes	415,538
Junior subordinated notes	245,782
Accounts payable, accrued expenses and other liabilities	357,084
Accrued interest payable	17,647
Derivative liabilities	88,356
Total liabilities	6,851,262
Fair value of preferred shares	378,983
Fair value of net assets acquired	2,384,473
Less: Purchase price	2,369,559
Bargain purchase gain(1)	$	14,914

(1) Represents the excess of the fair value of the net assets acquired over the purchase price and value of the preferred shares, which constitute non-controlling interests in the Company. This difference was recorded as an adjustment to the Company’s additional paid-in-capital as of the Effective Date.

Fair value is defined as 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. The estimated fair values of assets acquired and liabilities assumed were primarily based on information that was available as of the Merger Transaction date. The methodology used to estimate the fair values to apply purchase accounting are summarized below.

The carrying values of cash, restricted cash, interest and principal receivable, credit facilities, accounts payable, accrued expenses and other liabilities, and accrued interest payable represented the fair values. Fair value measurements for financial instruments and other assets included (i) market data for similar instruments (e.g. recent transactions or broker quotes), comparisons to benchmark derivative indices or valuation models for corporate loans and securities, (ii) third party valuation servicers for residential mortgage-backed securities, (iii) observable market prices, if available, or internally developed models, for equity investments, oil and gas properties, interests in joint ventures and partnerships, and (iv) quoted market prices, if available, or models using a series of techniques for derivative assets and liabilities. The fair value measurements for the liabilities assumed included (i) third party valuation servicers for the collateralized loan obligation secured notes and junior subordinated notes and (ii) observable market prices for the senior notes.