THE CORPORATE LIBRARY

Related Party Transactions and Outside Related Director Information

KKR Financial Corp. (KFN)

4/5/2006 Proxy Information

In the ordinary course of business, we invest in entities that are affiliated with KKR. As of December 31, 2005, 4.9% of our investment portfolio was comprised of investments in entities affiliated with KKR. These investments consisted of fifteen corporate and commercial real estate loans and three investments in senior secured notes for an aggregate of approximately $782.4 million extended to KKR portfolio companies. Additionally, during 2005 we co-invested $52.5 million in four private equity transactions on a paris passu basis with one or more private equity funds affiliated with KKR. Therefore, our Board has adopted a set of investment guidelines and procedures to govern our relationship with KKR. According to these investment guidelines and procedures, we are required to seek the approval of the majority of the independent members of our Board before we make any investment in an entity affiliated with KKR. Mr. Nuttall has been a member of KKR & Co. L.L.C. since June 2005.

Relationships With The Manager

Saturnino S. Fanlo, our Chief Executive Officer and David A. Netjes, our Chief Financial Officer and Chief Operating Officer, also serve in those capacities for our Manager and as of February 28, 2006, beneficially owned 4.5% and 4.4% of our common stock, respectively. In addition, as of February 28, 2006, our chairman, Paul M. Hazen, who serves as a member of our Manager's investment committee and one of our directors, Scott C. Nuttall, who serves as a member of our Manager's investment committee and is an executive of KKR, beneficially owned 4.5% and 4.2% of our common stock, respectively. As of February 28, 2006, our Manager and its affiliates collectively owned approximately 12.0% of our common stock on a fully diluted basis. Furthermore, our Manager is wholly owned by KKR Financial LLC and KKR Financial LLC is owned by KKR and Saturnino S. Fanlo and David A. Netjes, the Chief Executive Officer and the Chief Financial Officer and Chief Operating Officer, respectively, of both our Manager and us. As a result, the Management Agreement 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.

Our Management Agreement does not prevent our manager and its affiliates from engaging in additional management or investment opportunities, although the Management Agreement generally restricts our Manager and its affiliates from raising, sponsoring or advising any new investment fund, company or entity, including a real estate investment trust, that invests primarily in domestic mortgage-backed securities; provided that for purposes of the foregoing limitation, any portfolio company of any private equity fund controlled by KKR shall not be deemed to be an affiliate of our Manager. As a result, we expect that our Manager and its affiliates, including KKR, will engage from time to time in additional management or investment opportunities that have overlapping objectives with us. In particular, we have been informed by our Manager that one of its affiliates is expecting to establish and manage a separate investment fund that will invest in the same non-mortgage-backed securities investments that we invest in, including other fixed income investments and KKR private equity investments. With respect to any competing entities, our Manager and its affiliates will face conflicts in the allocation of investment opportunities. Such allocation is at the discretion of our Manager and there is no guarantee that this allocation would be made in the best interest of our stockholders. In addition, based upon our available liquidity, investment policies, REIT and other legal restrictions applicable to us and other relevant considerations, we may not be given the opportunity to participate in certain investments made available to entities managed by our Manager or its affiliates.

To address the risks related to these potential conflicts of interest with our Manager, we have adopted certain policies that are designed to eliminate or minimize potential conflicts of interest. Our Board and our Manager's investment committee have established and approved a set of investment policies and procedures that govern our investments, borrowings and operations, including our interaction with our Manager. Although our Manager performs our day-to-day investment operations, our Board reviews our investment policies and procedures and investment guidelines at each regularly scheduled Board meeting. In such reviews, the directors rely primarily, however, on information provided by our Manager and transactions subject to such review may be difficult or impossible to unwind if not deemed appropriate.

We have not entered into any investment opportunity in which our Manager has an interest. In the event that any such investment opportunity is made available to us in the future, the transaction will require the approval of a majority of our independent directors.

The management compensation structure that we have agreed to with our Manager may cause our Manager to invest in high risk investments. In addition to its management fee, our Manager may receive incentive compensation based in part upon our achievement of specified levels of net income. 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, in order to achieve a higher incentive return. Investments with higher yield potential are generally riskier or more speculative. This could result in increased risk to the value of our investment portfolio.

Termination by us of the Management Agreement with our Manager without cause is difficult and costly. The Management Agreement provides that it may only be terminated by us without cause annually after December 31, 2006 upon the affirmative vote of at least two-thirds of the independent directors, or by a vote of the holders of a majority of the outstanding shares of our common stock, based upon (1) unsatisfactory performance by our Manager that is materially detrimental to us or (2) a determination that the management fees payable to our Manager is not fair, subject to our Manager's right to prevent such a termination pursuant to clause (2) by accepting a reduction in the management fees agreed to by at least two-thirds of our independent directors and our Manager. We must provide at least 180 days' prior 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 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 will make it costly for us to terminate the Management Agreement, thereby adversely affecting our ability to terminate our Manager without cause.

Pursuant to the terms of the Management Agreement, we pay our Manager a monthly base management fee and, if earned, a quarterly incentive fee. We believe that the base management fee and incentive compensation that our Manager is entitled to receive is comparable to the base management fee and incentive compensation received by the managers of comparable externally managed REITs. The Management Agreement also provides that we will reimburse our Manager for certain expenses incurred by our Manager on our behalf. For the year ended December 31, 2005, we incurred $21.0 million in base management fees and incurred no incentive fees to our Manager. We also recorded reimbursements to our Manager of $4.9 million for certain expenses incurred on our behalf during the same period, which are included in general and administrative expenses on our financial statements.

Our Manager is authorized to follow very broad investment guidelines. Our Board periodically reviews our investment guidelines and investment portfolio. Our Board will not, however, review all of our proposed investments. In addition, in conducting periodic reviews, the directors rely primarily on information provided to them by our Manager. Furthermore, transactions entered into by our Manager may be difficult or impossible to unwind by the time they are reviewed by the directors. Our Manager has great latitude within the broad parameters of the investment guidelines in determining the types of assets it may decide are proper investments for us.

On July 1, 2005, the Compensation Committee granted our chairman 4,819 shares of restricted common stock and each then existing non-Excluded Director 2,812 shares of restricted common stock. In addition, on the same date, the Compensation Committee granted the then existing non-Excluded Directors shares of restricted common stock based upon their duration of service on our Board prior to July 1, 2005 as follows: 201 shares to Mr. Aldinger; 603 shares to each of Mr. deRegt, Mr. Licht and Ms. McAneny; and 1,808 shares to Mr. Hubbard. See "Director Compensation."

On July 14, 2005, the Compensation Committee granted our Manager 1,875,000 shares of restricted common stock. This grant was made pursuant to our 2004 Stock Incentive Plan. Such award vests in one-third increments on the first three anniversaries of the date of grant. Our Manager has the right in its discretion to allocate these stock options and shares of restricted stock to its officers, employees and other individuals who provide services to us. However, our Manager will not make any allocation of these restricted shares prior to the first anniversary of the grant date.

At the discretion of our Manager and us, our Manager may enter into a separate management agreement with KKR TRS Holdings, Inc., for the purpose of providing management services with respect to investments that are made through KKR TRS Holdings, Inc. Our Manager may enter into a separate management agreement with KKR TRS Holdings, Inc. so long as the aggregate compensation paid to our Manager by us and KKR TRS Holdings, Inc. does not exceed the aggregate compensation payable under the Management Agreement. Therefore, our Manager would not receive additional compensation for managing KKR TRS Holdings, Inc.

An affiliate of our Manager has entered into separate management agreements with the respective investment vehicles for CLO 2005-1 and CLO 2005-2 and is entitled to receive fees for the services performed as collateral manager. To date, the collateral manager has waived approximately $1.5 million of management fees payable to it from CLO 2005-1 which covers the period commencing in March 2005 and ending in April 2006 and has waived approximately $0.8 million of management fees payable to it from CLO 2005-2 which covers the period commencing November 2005 and ending in May 2006.

The waivers for CLO 2005-1 and CLO 2005-2 expire in April 2006 and May 2006, respectively, and there is no guarantee that the collateral manager will waive such management fees subsequent to those dates.

Relationships With KKR

In the ordinary course of business, we invest in entities that are affiliated with KKR. As of December 31, 2005, 4.9% of our investment portfolio was comprised of investments in entities affiliated with KKR. These investments consisted of fifteen corporate and commercial real estate loans and three investments in senior secured notes for an aggregate of approximately $782.4 million extended to KKR portfolio companies. Additionally, during 2005 we co-invested $52.5 million in four private equity transactions on a paris passu basis with one or more private equity funds affiliated with KKR. Therefore, our Board has adopted a set of investment guidelines and procedures to govern our relationship with KKR. According to these investment guidelines and procedures, we are required to seek the approval of the majority of the independent members of our Board before we make any investment in an entity affiliated with KKR. Notwithstanding the foregoing, certain of our investments in securities of companies affiliated with KKR are deemed to be pre-approved by our independent directors:

debt securities and loans rated less than CCC- by Standard & Poor's Ratings Service ("Standard & Poor's") or Caa3 by Moody's Investors Services, Inc. ("Moody's"), provided that the investment does not exceed 2.5% of our consolidated stockholders' equity computed in accordance with GAAP as of the most recent quarter-ended;

debt securities and loans rated CCC- through CCC+ by Standard & Poor's or Caa3 through Caa1 by Moody's, provided that the investment does not exceed 5% of our consolidated stockholders' equity computed in accordance with GAAP as of the most recent quarter-ended;

debt securities and loans rated B- through B+ by Standard & Poor's or B3 through B1 by Moody's, provided that the investment does not exceed 10% of our consolidated stockholders' equity computed in accordance with GAAP as of the most recent quarter-ended;

debt securities and loans rated BB- and above by Standard & Poor's or Ba3 or above by Moody's, provided that the investment does not exceed 15% of our consolidated stockholders' equity computed in accordance with GAAP as of the most recent quarter-ended;

investments that we propose to acquire in secondary transactions from bona fide third party sellers which at the time of such transaction bear the full economic risk of loss on such investment; and

any investment that has been approved in advance by a majority approval of the Affiliated Transactions Committee.

Notwithstanding the pre-approval policies described above, the following investments by us in entities affiliated with KKR require majority approval of the Affiliated Transactions Committee to be deemed to be pre-approved by our independent directors:

debt securities or bank loans if any of the following criteria are met: (i) the investment is a type of security or loan that our Manager's investment committee has a current policy of disfavoring as a general matter; (ii) the structure or pricing of the securities or loans is worse than current market comparables; (iii) the security or loan is not being offered generally to other potential investors on the same or less favorable terms; (iv) in our Manager's judgment, the transaction would not be fully subscribed in the absence of our investment; or (v) our investment is greater than 12.5% of the proposed or outstanding issue amount of the transaction; and

any investment where, after giving effect to the investment, our aggregate amount of assets consisting of investments in entities affiliated with KKR would exceed a percentage of total assets established from time to time by the Audit Committee (such percentage currently equal to 7.5%).

We have also adopted compliance policies to govern our interactions with KKR, including when KKR is in receipt of material non-public information.

Other Relationships and Related Transactions

During January 2006, we invested $40 million in a series of corporate floating rate notes which were rated BB by Standard and Poor's and were issued by an unaffiliated third party. KKR Financial Advisors II, LLC, a wholly-owned subsidiary of our Manager, is the collateral manager for the unaffiliated third party in connection with this corporate floating rate note transaction.

We have not entered into any other transactions in which any of our other director or officer, stockholder or affiliate or of our Manager had any material interest.