UPDATE 1-KKR Financial to sell stake in REIT unit

(Adds details of the sale, background throughout)

PHILADELPHIA, March 31 (Reuters) - KKR Financial Holdings LLC (KFN.N), an affiliate of private equity firm Kohlberg Kravis Roberts & Co [KKR.UL], said on Monday it would sell a controlling stake in its REIT subsidiary and refinance notes to complete its exit from the mortgage-related business.

KKR Financial agreed to sell a controlling interest in its REIT subsidiary to Rock Capital 2 LLC for an undisclosed price. The deal, which is scheduled to close in the second quarter of 2008 will complete KKR Financial's conversion from a real estate investment trust structure to a limited liability company.

The firm also said it entered an agreement with the noteholders of certain secured commercial paper issued by two asset-backed entities. The noteholders will receive collateral in the REIT's asset-backed conduits in exchange for terminating notes with out default.

KKR Financial also proposed a public offering of 20 million common shares. Net proceeds from the offering will be used for general corporate purposes.

KKR Financial said it remains focused on making "opportunistic investments" in corporate debt and will continue to underwrite and purchase "attractively priced assets." It said its balance sheet consists of over $8.5 billion in investments, more than 95 percent of which are in corporate debt.

The company said it would take a charge of about $5.5 million to refinance the notes and finalize the exit of its mortgage-related business.

As part of the refinancing of the notes, KKR Financial said all of the AAA-rated residential mortgage-backed securities funding the secured notes have been returned to the noteholders. About $3.5 billion of secured liquidity notes and related RMBS will be removed from its balance sheet. The company said it has been released from any future obligations or liabilities to the noteholders.

Exclusive of the $3.5 billion of secured liquidity notes and related RMBS, which will be removed from the company's balance sheet, as of December 31, 2007, KKR Financial said its exposure to the residential mortgage market consists of $337.6 million of RMBS.

Those securities do not include any assets that are collateralized or backed by subprime or non-prime residential mortgage loans, the company said. KKR Financial said it does not have any off-balance sheet exposure to residential mortgage assets. (Reporting by Jessica Hall; Editing by Andre Grenon) (For more M&A news and our DealZone blog, go to here)