KKR Financial Holdings LLC — a former real estate investment trust that is attempting to liquidate its residential mortgage assets — said it lost $40 million selling off $5.1 billion in residential mortgage loans and could lose its entire $200 million stake in its remaining mortgage-backed securities.

The recent sale of $5.1 billion in residential mortgage loans and related interest-rate swaps left the San Francisco-based company with $5.8 billion in mortgage loans, mostly in the form of residential mortgage backed securities (MBS). Those securities are financed primarily by non-recourse, asset-backed secured liquidity note facilities, with the company’s equity in those notes totaling $200 million.

In a Securities and Exchange Commission filling, KKR said it could lose all of that money — and up to $50 million more — because of “unprecedented disruption in the residential mortgage and global commercial paper markets.”

Although KKR has initiated discussions with investors in its asset-backed secured liquidity note facilities about ways to resolve potential funding disruptions, it said “no assurance can be made that any of the strategies being evaluated by the company will be successfully executed.”

In its last quarterly report to investors, KKR said its investment portfolio totaled $18 billion as of June 30, including $11.2 billion in residential mortgage loans and securities, and $6.5 billion in corporate loans and securities.

As a real estate investment trust (REIT), KKR was required to generate at least 75 percent of its income from real estate-related assets. In May, KKR converted from a REIT to a limited liability company (LLC). KKR was attempting to dispose of its existing portfolio through a run-off of the assets through principal payments and prepayments, or through “strategic alternatives” such as the sale of the common stock of its REIT subsidiary.

The company’s residential mortgage loans and securities consist of ARM loans, hybrid ARM loans, or securities backed by such loans.

At the end of 2006, under new accounting rules, KKR wrote down the value of its residential mortgage investments by $55.7 million to reflect their fair value on the company’s books. The value of KKR’s residential mortgage portfolio was written down $35.6 million, to $5.07 billion, while MBS investments were valued at $7.5 billion, or $21.6 million less than before implementation of the rules.

On June 30, KKR’s residential mortgage loan portfolio totaled $4.6 billion, with an average original FICO score of 735 and loan-to-value ratio of 68.4 percent. The estimated fair value of KKR’s residential MBS was reported as $6.6 billion.

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