InsIghts GLOBAL MACRO TRENDS

March 2012

U.S. Housing: A Changing Dynamic

The housing market was the first to unravel in this latest economic crisisand it is among the last to recover. As we look ahead, we see a number of key positive developments unfolding in the new home market. Despite these improvements, however, headwinds still remain in the existing home market. We detail how these cross-currents are likely to unfold and what are the key implications for the U.S. economy and its investor base.

KKR global MacRo & asset allocatIon teaM henRy h. McVey Head of Global Macro & Asset Allocation +1 (212) 519.1628 henry.mcvey@kkr.com DaVID R. McnellIs +1 (212) 519.1629 david.mcnellis@kkr.com FRances b. lIM +1 (212) 519.1630 frances.lim@kkr.com Rebecca J. RaMsey +1 (212) 519.1631 rebecca.ramsey@kkr.com

MaIn oFFIce Kohlberg Kravis roberts & co. l.P. 9 West 57th street suite 4200 new York, new York 10019 + 1 (212) 750-8300
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InsIghts: global Macro trends

In our inaugural paper of KKrs Insights series in october 2011, we noted that we try to counter the uncertainties inherent in making predictions through consistency of process, meaning that we tend to look at the same data series month-in and month-outrather than simply jumping from one data point to the next just because it may support our existing thesis. and since one of the key inputs for nearly all our models is the outlook for housing and its related businesses, we thought we would discuss our perspective on the U.s. housing market and its effect on our broader macro outlook. as detailed later, we offer five key conclusions: 1. subdued housing activity is one of the primary reasons the 1 current recovery has been so lackluster in historical termsa point we consider from two angles. the first is that the cyclical upswing in the housing market that typically accompanies the outset of an economic recovery did not occur this time. housing only accounted for 3% of the gdP recovery in 2009 versus a historical average of about 19% in the first year of a recovery cycle. second, we estimate that 48% of the jobs lost during the downturn were broadly related to housinga major headwind to job growth in the United states. 2. We believe that household formation and, as a result, hous2 ing starts have now bottomed, are running below the historical trend, and are likely to improve in the quarters ahead. our base case is that new construction reaches 750,000 units in 2012; 850,000 units in 2013; and 1.05 million units in 2014. by comparison, the consensus is at 707,000 for 2012 and 828,000 for 2013, respectively. (there is no consensus about the year 2014 as of yet.) over the next three years, we believe rising housingrelated activity could add more than 30,000 potential jobs to average monthly U.s. payrolls and incrementally boost U.s. gdP growth by 2550 basis points on average per year. given that lost housing investment and jobs accounted for more than an annualized 125-basis-point drag on gdP from 2007 to 2010, a turnaround like this one would be good news. 3. the bad news is that we do not think an uptick in new housing 3 volume is enough to materially lift the price of existing homes. We estimate that there is still a total hidden inventory of 6.4 million houses coming out for sale. that includes 3.3 million houses in excess of historical trendsall of which need to be sold, destroyed, or rented before home prices can again materially appreciate. We predict that this excess inventory will push home prices down 60 basis points this year, followed by a 1.3% appreciation in 2013 and a 3.3% appreciation in 2014 (Exhibit 1). What our lukewarm price forecast implies is that the net worth per household is unlikely to rebound quickly and will therefore probably cap consumption for the next three years until the excess inventory clears and the total inventory comes back down in line with historical trends. 4. how does housing affect our gdP forecasts? net of all con4 struction- and pricing-related effects, we estimate the housing market will account for 0.4 percentage points of our 2012 U.s. real gdP growth forecast of 2.3%. Included in this forecast is a gross tailwind of approximately 45 basis points stemming from

a faster pace of new and existing home sales, offset by a very modest headwind from continuing home price depreciation this year. 5. 5 What does our outlook imply for capital allocation? First, we

expect private capital to flow increasingly into the home-rental business, because the gap between the diminished carrying costs of ownership and the robust pricing of rental apartments is just too wide, in our view. however, we do believe that recent initiatives by the Federal housing Finance agency (FhFa) are important first steps towards narrowing this gap. We also think that home repair and furnishing companies are likely to see their earnings start to rebound from extremely depressed levels, and may present attractive investment opportunities. homebuilding companies may still perform well, too, though their stocks have exhibited major swings of late, and many of those companies equity and debt securities have traditionally not been appealing destinations for investor capital. Finally, our view on the tepid appreciation of home prices over the next few years implies that U.s. consumers will likely not experience a significant rebound in net worth. We thus maintain that U.s. consumers will continue pursuing value items such as private label consumer goods, discount clothing, and generic pharmaceuticalsa noteworthy theme not only at the low end of the income spectrum but also among middle-to-high-income consumers.

nobody told me thered be days like these. strange days indeed, John lennon once wrote, in a thought that reflects our bigger-picture conclusion on the state of the housing market. simply put, we have a housing sector that is, according to our forecasts, on its way from being a drag of over 125 basis points on U.s. gdP to a positive contributor of 2550 basis pointsand it feels like a bull market for housing to many investors, in our view. strange days, indeed. heres our bottom-line: Yes, housing-related activity has gone from being a major drag to a mild positive, but its an important positive because (i) it is consistent with the economic recovery we now see in many U.s. cyclical businesses, including manufacturing and autos; and (ii) even a modest rebound in housing could help bring greater growth sustainability to the private sector, which is necessary to offset the continued burden of excess government debt and downsizing.

KKR

InsIghts: global Macro trends

exhIbIt 1

exhIbIt 3

Housing Forecasts
2012 hoUsehold ForMatIon (000s) hoUsIng starts (000s) hoMe PrIce aPPrecIatIon Y/Y 850 750 -0.6% 2013 1,000 850 1.3% 2014

Unprecedented Amount of Stimulus

troUgh gdP stIMUlUs as % oF gdP declIne In real gdP length (Months) FIscal MonetarY PeaK gdP

1,300 1,050 3.3%

aUg-29 MaY-37 noV-48

Mar-33 JUn-38 oct-49 MaY-54 aPr-58 Feb-61 noV-70 Mar-75 JUl-80 noV-82 Mar-91 noV-01 JUn-09

43 13 11 10 8 10 11 16 6 16 8 8 18

27.0% 3.4 1.7 2.7 3.2 1.0 0.2 3.1 2.2 2.6 1.3 0.2 5.1

3.4% 0.0 -2.2 0.0 0.0 0.7 0.3 0.9 0.4 0.3 1.0 1.3 18.3*

4.9% 2.2 5.5 -1.4 3.2 1.0 2.4 3.1 1.1 3.5 1.8 5.9 19.2*

source: KKr global Macro and asset allocation estimates as at February 29, 2012.

How much has housing affected the recovery?

before we touch on where the housing sector is headed, lets review where it has been. despite unprecedented amounts of liquidity injected into the system, the U.s. economy has failed to deliver the robust recovery to which politicians, central bankers, and homeowners have been aspiring. given how far economic growth fell during the great recession1, one can see how lackluster the subsequent recovery was relative to history (Exhibit 2). Further, there is no historical precedent for such a lackluster recovery.
exhIbIt 2

JUl-53 aUg-57 aPr-60 dec-69 noV-73 Jan-80 JUl-81 JUl-90 Mar-01

Thus Far, the Recovery in GDP Growth Has Been Subpar

12% Real GDP Growth in First Year of Recovery (%) 10% 8%
1961

2009 Regression Predicted

dec-07

1982 1954 1975 1970 1991

1958

*KKr Macro and asset allocation estimated total as at January 31, 2012. source: Federal reserve, congressional budget office, grants Interest rate observer dated april 3, 2009.

6% 4%

2009

2%

2001 1980

Actual

0% 0% -1%

y = -1.8453x + 0.0162 R = 0.7821 -2% -3% -4% -5% -6%

Peak to Trough Real GDP Decline (%)

data as at January 31, 2012. source: bureau of economic analysis, KKr global Macro and asset allocation.

Why has recovery been so different this time? despite unprecedented stimulus efforts (Exhibit 3), housing activity represented the smallest share of contribution to the initial economic recovery this time around in the cycle since 1960. as Exhibit 4 shows, private residential real estate represented just 3% of the rebound in gdP compared to a historical average of 19%. all told, housing-related contribution to gdP was just 7% in 2009 compared to 27% on average. this makes sense because, even as the economy was recovering after 2009, the U.s. housing market was still headed in the opposite direction, which in turn curtailed consumption (Exhibit 5).

recession that began in december 2007 and ended in June 2009 and was the longest since World War II. source: nber http://www.nber.org/cycles.html.
KKR InsIghts: global Macro trends

coMbIned 8.3% 2.2 3.3 -1.4 3.2 1.7 2.7 4.0 1.5 2.8 2.8 7.2 37.5*

exhIbIt 4

exhIbIt 5

Unlike Normal Recoveries, Housing is Not Acting as a Tailwind

real gdP groWth, FIrst Year oF recoVerY hoUsIng contrIbUtIon to FIrst Year oF reboUnd In real gdP total hoUsIng related PrIVate resIdentIal InVestMent

Private Consumption Normally Acts as an Offset to a Drop in GDP

Private Consumption Contribution to Real GDP during Recessions
120% 100% 80% 60%
Consumption was a big offset to the recessions in 1982 and 2001

Year oF troUgh real gdP

109%

hoUsIng & UtIlItIes serVIces

69% 39% 23% 14%

1961 1970 1975 1982 1991 2001 2009 aVerage

6.3% 4.5% 6.1% 7.7% 2.6% 2.3% 3.3% 4.7%

11% 38% 22% 27% 23% 11% 3% 19%

11% 15% 5% 8% 11% 3% 3% 8%

21% 53% 27% 35% 35% 14% 7% 27%

40% 20% 0% -20% -40% -60% -12% -22%

-16% -33% -46%

1954 1958 1961 1970 1975 1980 1982 1991 2001 2009

data as at January 31, 2012. source: bureau of economic analysis, KKr global Macro and asset allocation.

data as at January 31, 2012. rebound in the first year of recovery following trough real gdP2. source: bureau of economic analysis, KKr global Macro and asset allocation.
2

Subdued housing activity is

one must also consider the relationship between job losses and the housing market. broadly defined, our research shows construction and housing-related jobs typically make up 1316% of total non-farm payrolls, but 48% of job losses in the great recession stemmed from what we deem construction-related industries (Exhibit 6). to date, employment in these sectors is still close to its trough, with housing and construction-related jobs at 17.9 million, slightly up from a trough of 17.6 million in 2010but a far cry from their peak of 21.8 million in 2007. not surprisingly, the huge contraction in construction and housing-related jobs has been a major detractor from the broader employment situation in the United states. If there is good news, it is that job growth is improving, particularly among younger age groups, which are significant contributors to home sales and construction (Exhibit 7).

2 We excluded the year 1980 in our study, as that years recession lasted only six months according to the national bureau of economic research (nber) and was also relatively minor in magnitude, as real gdP grew 1.22%. the 1980 recession took place in a context of extremely high interest rates, and private residential investment was a 116bp drag to growth, or in other words, its contribution to growth was -95% the following year. the economy subsequently relapsed into recession again in 1982.
KKR InsIghts: global Macro trends

exhIbIt 6

exhIbIt 7

Half of the Jobs Lost in the Great Recession were Construction and Housing Related
aUto related 4.20 3.40 0.80 -19% constrUctIon & hoUsIng related 21.83 17.61 4.22 -19% total nonFarM PaYrolls 138.02

The Younger Age Groups are Gaining Jobs, and These Matter Most for Home Sales
age groUP (Yrs) nonFarM PaYroll groWth Y/Y -8.5% 7.0% 3.4% 1.4% -0.6% -1.0%

MIllIons oF Jobs PeaK In 2007 troUgh In 2010 Jobs lost % change contrIbUtIon to total Jobs lost as oF Jan 2012 % vS. TroUgh

16-17 18-19 129.24 20-24 8.78 25-34 -6% 35-44 9% 48% 100% 45-54

3.63 7%

17.91 2%

132.41 2%

correlatIon oF eMPloYMent bY age groUP agaInst exIstIng hoMe sales age (Yrs) 20-24 25-34 35-44 45-54 55-64 correlatIon 50.7% 43.1% 28.8% 24.6% 17.7% lead (lag) 10 13 11 13 11

auto related industries include Motor Vehicles and Parts Manufacturing, retail Motor Vehicle & Parts dealers, and repair & Maintenance services. construction related industries include logging, construction, Wood Products, nonmetallic Mineral Products, Furniture & related Products, Wholesale trade of durable goods, Furniture & home Furnishings stores, electronics & appliance stores, building Material & garden supply stores, truck transportation, real estate, rental & leasing, architectural & engineering services, and services to buildings & dwellings. data as at January 31, 2012. source: bureau of labor statistics.

data as at december 31, 2011. correlation based on data from 1967-2011. source: bureau of labor statistics, national association of realtors, KKr global Macro and asset allocation research.

Our base case for housing demand is now a constructive one

albert einstein once said: Its not that I am so smart, its just that I stay with problems longer. We adopt einsteins approach when trying to better understand the dynamics of the U.s. housing market, since there are hosts of different inputs to consider. For those who havent been paying attention, housing demand, we believe, has been plagued by a serious contraction in household formation, which in turn was driven by a weak economy and stagnant wage growth, among other factors. all in all, as Exhibit 8 shows, household formation is now at merely 600,000 households per yearor just 0.5% on an annualized basis (given the nationwide base of 114 million households). Yet we think the rate of household formation is about to change since job growth has improved and credit conditions are stabilizinga trend reflected in the latest senior loan-officer opinion survey, which showed a net loosening of credit standards for mortgage approvals.3

We do not think an uptick in new housing volume is enough to materially lift the price of existing homes.

3 as of 1Q2012. source: Federal reserve, haver.

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InsIghts: global Macro trends

exhIbIt 8

Current Household Formation is Below Its Pre-Crisis Annual Rate of Around 1.2%

KKR

InsIghts: global Macro trends

looking ahead, we think it is reasonable to expect the houses-perhousehold ratio to continue reverting back to its pre-2001 equilibrium level of 1.13. our work shows that it took 8 years for the housing stock bubble to inflate (20012009), so we suggest a similar time frame for the houses to household ratio to return to equilibrium (20092017) as a solid, conservative base case, in our view. For this to occur by 2017, households will need to grow about 45 basis points faster on an average annual basis than the housing inventory. Exhibit 13 translates this premise into a construction forecast, after making some conservative assumptions about units of demolitions and competition from mobile homes (see table). We maintain a reasonable construction forecast of 750,000 residential units in the year 2012; 850,000 units in 2013; and 1.05 million in 2014. those forecasts are solidly above the consensus, which stands at 707,000 housing starts for 2012 and 828,000 for 2013. (there is no 2014 consensus forecast as of yet.)4 We suspect that our forecast varies from the consensus because of our view that the stock of excess housing will deflate at a measured pace between now and 2017. In essence, we forecast that new construction will be required to accommodate much of the new household growth between now and then. In keeping with this view, we also believe that a significant portion of the existing inventory surplus
4 data as at January 31, 2012. consensus starts based on estimates from goldman sachs, deutsche bank, bank or america Merrill lynch, JPM Morgan, Morgan stanley, and Zelman & associates. exhIbIt 13

is in poor condition or in economically depressed residential areas where people cannot find jobs. as a result, we think it will take years to find occupants for many of these units.
exhIbIt 12

We Think the Ratio of Houses Per Household May Correct Between Now and 2017
U.S. Housing Units Per Household 1.18 1.17 1.16 1.15 1.14 1.13 1.12 1.11 1.10 84 88 91 95 98 02 05 09 12 16
Consistently near 1.13 pre-2001 Rose rapidly for eight years starting in 2001

Jan-09 1.17 Dec-11 1.16

Jan-01 1.13

Our base case is for an eight-year correction cycle (i.e., through 2017)

data as at december 31, 2011. source: census bureau, haver.

Which Means the Housing Stock Growth Rate Needs to Hold Slightly Below the Household Growth Rate
u.s. HouseHolDs (000) start oF Year + net hoUsehold ForMatIon end oF Year groWTh rATE u.s. Housing units (000) start oF Year + neW UnIts constrUcted + MobIle hoMe PlaceMents - scraPPage end oF Year groWTh rATE hoUSES pEr hShlD (EnD of Yr.) 131,975 582 50 133 132,474 0.38% 1.16 132,474 750 60 175 133,109 0.48% 1.16 133,109 850 75 200 133,834 0.55% 1.15 133,834 1,050 90 225 134,749 0.68% 1.15 134,749 1,150 100 250 135,748 0.74% 1.14 135,748 1,250 110 200 136,908 0.85% 1.14 136,908 1,400 120 200 138,228 1.0% 1.13 113,402 656 114,058 0.58% 114,058 850 114,908 0.75% 114,908 1,000 115,907 0.87% 115,907 1,300 117,207 1.12% 117,207 1,400 118,608 1.19% 118,608 1,600 120,208 1.35% 120,208 1,800 122,007 1.50% 2011 2012e 2013e 2014e 2015e 2016e 2017e

data as at February 29, 2012. e = KKr gMaa estimate. source: census bureau, KKr global Macro and asset allocation research.

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InsIghts: global Macro trends

While our household formation and construction forecasts are not outsized, they may be sufficientassuming they materializeto provide moderate tailwinds for job creation and gdP growth in the coming years, particularly relative to where weve been in recent years. consider the following: the U.s. economy lost 4.2 million construction and housing-related jobs from peak to trough between 2007 and 2010. during that downturn, yearly housing completions fell by approximately 1.5 million, so the economy lost approximately 2.7 jobs for every housing unit completed (Exhibit 14). given our forecast that the pace of residential construction rises by 168,000 units in 2012, 100,000 in 2013 and 200,000 in 2014, proportional housing-related job gains would equate to approximately 454,000 jobs in 2012 (38,000 per month, on average), 270,000 jobs in 2013 (23,000 per month), and 540,000 jobs in 2014 (45,000 per month). In terms of gdP, our work shows the pre-tax wages and benefits of each new housing job will add approximately $63,000 of spending power to the U.s. economy. In addition, we estimate that each house constructed will add approximately $200,000 to residential fixed investment. Piecing these together, we estimate that every 100,000 incremental houses built per year could add about 0.25% to annual U.s. gdP growth. at that rate, our construction forecasts would equate to a 0.4% addition to gdP growth in 2012, 0.25% in 2013, and 0.5% in 2014.

exhIbIt 14

Housing Could Add About 40bp to GDP growth in 2012

constrUctIon Jobs 000s 21,827 17,606 -4,221 hoUsIng coMPletIons 000s 2,110 555 -1,555 2.7 hoUsIng coMPletIons 000s 582 750 850 1,050 168 100 200

PeaK troUgh change

Jobs lost Per start constrUctIon Jobs gaIned 221 454 270 540

estIMates 2011 actUal 2012e 2013e 2014e

IncreMental coMPletIons

contrIbUtIon to gdP assUMIng IncreMental IncoMe oF $63K Per neW Job, and neW hoMe PrIce oF $200K $ bIllIons 2012e 2013e 2014e Jobs 29 17 34 starts 34 20 40 total 62 37 74 % gdP 0.4% 0.2% 0.5%

Even a modest rebound in housing could help bring greater growth sustainability to the private sector, which is necessary to offset the continued burden of excess government debt and downsizing.

housing and construction related industries include logging, construction, Wood Products, nonmetallic Mineral Products, Furniture & related Products, Wholesale trade of durable goods, Furniture & home Furnishings stores, electronics & appliance stores, building Material & garden supply stores, truck transportation, real estate, rental & leasing, architectural & engineering services, and services to buildings & dwellings. e = KKr gMaa estimate. data as at January 31, 2012. source: bureau of labor statistics, census bureau, IMF Weo, KKr global Macro and asset allocation research.

Supply headwinds will keep a lid on home prices

While forecasting demand is not easy, it can pale in comparison to the inherent difficulties associated with forecasting supply. the issue with excess supply in the current environment is that there are many sources and considerations throughout the foreclosure process. so, in an attempt to simplify our forecasting, we analyzed four major influences that we believe drive the supply side of the housing equation: (i) the visible supply of homes for sale; (ii) foreclosed homes; (iii) the inventory of mortgage delinquencies; and (iv) recent government intervention. We use vacant homes for sale as a proxy for visible sellable inventory, whereas we study foreclosed homes and the inventory of mortgage delinquencies to understand the excess (shadow) inventory. We then assess the impact of government intervention as an offset to our combined gross supply forecast. In our analysis, we use a macro approach by looking to see how much

KKR

InsIghts: global Macro trends

these three figures are still above their historical trend in order to estimate supply, as opposed to following a fundamental, bottom-up analysis of the issue. our best estimate is that there are still about 3.3 million homes that still need to be cleared just to get back to an environment more in keeping with historical trends of excess housing inventory (see Exhibit 20 for details). Four parameters underpin our logic: Visible supply of Homes for sale. this category includes new and existing homes for saleboth vacant and occupiedbut excludes the shadow inventory which consists of the supply of homes that have yet to hit the market but are in the foreclosure process, or are likely to enter foreclosure. as of december 2011, the stock of existing homes for sale was about 2.1 million, roughly in line with the average between 1982 and 2005, while the stock of new homes for sale was 157,000, which is well below the average of 313,000 between 1963 and 2004 (Exhibits 15 and 16).
exhIbIt 15

exhIbIt 16

Supply of New Homes for Sale is Below Historic Average

Units 600 500 400 300 200 100 0 1965
Dec-2011 157

New Homes Available for Sale Average 1963-2004

Average 1963-2004 = 313 thousand

1975

1985

1995

2005

Stock of Existing Homes for Sale is Roughly In-Line with Averages

Units 3,500,000 3,000,000 2,500,000 2,000,000 1,500,000 1,000,000 1980
Average 1982-2005 = 2.1 million

data as at december 31, 2011. source: census bureau, haver.

Existing Homes Available for Sale Average 1982-2005

Delinquencies. there are roughly 50.3 million mortgages outstanding in the United states, of which 4.1 million, or 8.15% of the total, are currently delinquent. before the financial crisis of 2008, the average run rate of delinquencies was about 4.7%5. Using our backto-trend framework, our analysis implies that excess delinquencies above and beyond the normal run rate is about 345 basis points, or 1.7 million homes (Exhibit 17). Foreclosures. In general, homes that are delinquent for about 90days or more move from the delinquent category to foreclosure. the foreclosure situation is the United states real estate market remains bleak, even at four and a half years since the start of the crisis.6 our analysis shows that the current foreclosure rate of 2.1 million (4.38% of total mortgages)7 is running significantly above its pre-crisis level of 1.07%. Put another way, we estimate foreclosures in excess of the normal foreclosure rate at above 3%, or 1.6 million units, through 2012 (Exhibit 18).

Dec-2011 2.1million

1990

2000

2010

data as at december 31, 2011. source: national association of realtors, haver.

Despite unprecedented stimulus efforts, housing activity represented the smallest share of contribution to the initial economic recovery this time around in the cycle since 1960.
10
KKR InsIghts: global Macro trends

5 as of 4Q2011. source: Mortgage bankers association and lender Processing services. 6 the crisis is generally viewed as having started in June 2007 with the collapse of two bear stearns subprime hedge funds that had been heavily invested in mortgage securities. source: new York times http://topics. nytimes.com/top/news/business/companies/bear_stearns_companies/ index.html. 7 Ibid. 5.

exhIbIt 17

Delinquencies are About 345 Basis Points Above the PreCrisis Levels
Loans Past Due % Total 12 11 10 9 8 7 6 5 4 3 2 1970 Average % Past Due 1972-2006 4.70% 1980 1990 2000 2010 Dec-2011 8.15% Unemployment Rate Jan-2010 10.97%

will be more impactful than some of the former ones because it does not require congressional approval, and because it is designed to attract private capital. Moreover, as more properties are foreclosed upon, we believe evicted households in search of new residences will likely rent. the home-ownership rate has already fallen 320 basis points to 66% while the rental rate has risen to 34% (Exhibit 19), and we think the trend favoring rentals versus ownership will continue as uncertainty about the global economy persists. With the help of haMP and harP, a growing number of homeowners have been able to extricate themselves from delinquency status (also known as getting cured). For the purpose of our analysis, we assume a cure rate of about 20%in line with some of the recent cure rates published by the U.s. banking sectorwhich could reduce the inventory of available homes by 0.7 million10. Pulling all these figures togetherof demand, supply, delinquencies, and foreclosures, less the benefit of government interventionour conclusion is that we still have about 3.3 million in excess supply of homes relative to historical trends that need to be cleared: 0.7 million from lack of demand for housing, 1.6 million from foreclosures, and 1.7 million from delinquencies less 0.7 million from government-induced reduction in supply (Exhibit 20).
exhIbIt 19

Unemployment rate as of January 31, 2012, loans past due as of december 31, 2011. source: bureau of labor statistics, 2006-2011 lPs applied analytics, pre-2006, Mortgage bankers association, haver.

exhIbIt 18

2.1m or 4.38% of Homes Are in Foreclosure

Foreclosures % Total Loans Average 1985-2006 KKR Estimate Dec-2010 4.64%

Rental Demand has Surged Ahead of Home Ownership Since the Great Recession
Homeownership Rate % (Left Axis) Dec-11 4.38% 70 Renter Occupied Rate % (Right Axis) 35

5 4 3 2 1 0 1980

Dec-12 3.2% Dec-13 2.0% Dec-14 1.1%

69

34

68

33

Average 1985-2006 = 1.07%

67

32

1985

1990

1995

2000 2005

2010

66

31

as of 4Q2011. source: Mortgage bankers association, haver.

65 2000

30 2002 2004 2006 2008 2010 2012

government intervention. recently, the obama administration put together a string of proposals represented by a slew of acronyms (from harP and haMP to harP 2.08) that are often too obscure to distinguish. the FhFa9 also recently announced an initiative to allow qualified investors to purchase pools of foreclosed properties for conversion into rental properties. We believe the latter initiative
8 harP is the home affordable refinance Program to assist homeowners who are current on their mortgage payments. haMP is the home affordable Modification Program to assist homeowners who are in danger of foreclosure. harP 2.0 is the revised harP homeowner assistance program which began to take effect in late december 2011. 9 the FhFa is the Federal housing Finance agency which was created as a result of the housing and economic recovery act of 2008. the FhFa oversees Fannie Mae, Freddie Mac, and the Federal home loan banks.

source: Morgan stanley research report dated dec 6, 2011 which cites loan modifications rate of 16%, 30%, 31%, 31%, and 45% at bofa, gMac, Wells, chase, and ocwen respectively.

10 source: baMl, credit suisse data from January 2012.

KKR InsIghts: global Macro trends

11

exhIbIt 23

exhIbIt 24

Supply Demand House Price Sensitivity

DisposAble income gRowtH y/y montHs supply 5.0 5.5 6.0 6.5 7.0 7.5 8.0 8.5 9.0 9.5 10.0 0% -2.3% -2.6% -2.8% -3.0% -3.3% -3.5% -3.7% -4.0% -4.2% -4.5% -4.7% 1% -1.1% -1.3% -1.6% -1.8% -2.0% -2.3% -2.5% -2.8% -3.0% -3.2% -3.5% 2% 0.1% -0.1% -0.3% -0.6% -0.8% -1.0% -1.3% -1.5% -1.8% -2.0% -2.2% 3% 1.4% 1.1% 0.9% 0.7% 0.4% 0.2% -0.1% -0.3% -0.5% -0.8% -1.0% 4% 2.6% 2.4% 2.1% 1.9% 1.6% 1.4% 1.2% 0.9% 0.7% 0.5% 0.2% 5% 3.8% 3.6% 3.3% 3.1% 2.9% 2.6% 2.4% 2.2% 1.9% 1.7% 1.5%

Debt to Income Ratios Have Soared, Particularly in the Middle Income Area
Debt-to-Income Ratios by Income Percentile 2001 2004 2007 2009

180% 160% 140% 120% 100% 80% 60% 40% 20% 0% 0-20

Middle income groups had the highest increase in debt-to-income ratios

Smaller increases in lower income brackets

20-40 40-60 60-80 80-90 90-100 Percentile Income

debt-to-Income using median total debt divided by median before tax income by income percentiles. as of 2009, next data release will be in Mar/april 2012. source: triennial survey of consumer Finances, Federal reserve, KKr global Macro and asset allocation research.

change in home prices estimated using a linear model where change in home prices is a function of months supply of homes and disposable income. source: national association of realtors, census bureau, KKr global Macro and asset allocation research.

the aftermath of continued tepid home-price appreciation is significant, we believe. Why? because real estate, as Exhibit 25 shows, was still the single largest component of net worthat around 40% in the second half of 2005but declines in prices helped push it down to just 31% of net worth by the end of 2011. Indeed, in the most recent downturn net worth related to housing had its first decline ever, falling a sizeable $4.7 trillion12 during the financial crisis. by comparison, housing related net worth actually increased $387 billion during the 2001 downturn. at the same time that home prices were falling, real income was stagnating too. as a result, debt-to-pre-tax income spiked across nearly all segments of the U.s. population.

Housing demand has been plagued by a serious contraction in household formationbut we think the rate of household formation is about to change since job growth has improved and credit conditions are stabilizing.

12 the real estate component on household balance sheets fell by $4.7 trillion between 4Q2007 and 2Q2009, but peak-to-trough, real estate-related household wealth fell by $5.7 trillion between 2Q2007 and 1Q2009. source: Federal reserve board, Flow of Funds
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exhIbIt 25

Real Estate has Generally Been a Buffer for Net Worth, Except in 2009, When Equities and Home Prices Fell
u.s. HouseHolD bAlAnce sHeets DuRing pAst Recessions cHAnge in net woRtH FRom peAK to tRougH ReAl gDp (us$b) total lIabIlItIes eQUItIes total assets other assets real estate net Worth

household formation and stronger income growth may spur construction activity in 2012, which could translate into a 0.4% contribution to gdP growth. We believe a similar dynamic is being captured by the existing-home-sales factor of our quantitative model. In terms of home prices, the model suggests that the 60-basis-point decline we forecast for 2012 is an almost imperceptible drag on the 2012 gdP outlookone of merely a single basis point. the housing-wealth effects picked up by the model are small at this point, which we think makes fundamental sense, since home equity gains and losses seem to have recently faded as a driver of consumer psychology.
exhIbIt 26

1954 1958 1961 1970 1975 1980 1982 1991 2001 2009

us$b

49 37 59 116 546 1,061 1,020 752 -1,980 -13,569

55 39 76 125 616 1,161 1,127 896 -1,723 -13,832

21 13 29 70 -48 389 245 286 -2,372 -7,823

10 0 13 19 169 271 246 26 387 -4,704

24 26 34 36 495 501 635 585 262 -1,304

6 2 17 9 70 100 107 145 256 -263

Our U.S. GDP Indicator Forecasts a Modest Uptick in Real Growth in 2012
U.S. Real GDP Y/Y - Leading Indicator 10% 8% 6% 4% 2% 0% -2% -4% -6% 82 84 86 88 90 92 94 96 98 00 02 04 06 08 10 12 Dec-11a 1.6% Dec-12e 2.3% Actual Model Predicted
R-squared = 74%

Recent peAK, tRougH, AnD cuRRent net woRtH (us$b) Jun-07 mAR-09 sep-11 66,763 50,423 57,353 80,664 64,536 71,120 21,971 10,973 15,989 24,446 18,764 18,311 34,248 34,799 36,819 13,902 14,113 13,767

our gdP leading Indicator contains eight factor inputs that contribute the forecast. a = actual; e = estimate; gdP = gross domestic Product. data as at February 6, 2012. source: bloomberg, haver, KKr global Macro and asset allocation.

exhIbIt 27

as of 3Q2011. source: Federal reserve board, Flow of Funds, bureau of economic analysis, haver.

Boosted Meaningfully By an Uptick In Existing Home Sales

Impact of Housing-Related Factors on Our Real GDP Lead Indicator for Dec-2012
3.5% 3.0% 2.5% 2.0% 1.5% 1.0% 0.5% 0.0%
Baseline Faster Slight Existing Decline in Home Sales Housing Pace Wealth Other Factors Forecast

How does housing affect our U.S. economic outlook?

over the years, weve developed a variety of forecasting models, in which we use top-down macro inputs in an attempt to forecast growth trends, including our U.s. gdP growth-leading indicator. as Exhibit 26 below shows, the model has been effective in the past at identifying major turning points in the economic cycle. at the moment, the model is delivering a modestly constructive message, forecasting that year-over-year real gdP growth will accelerate to 2.3% in 2012 from the lukewarm 1.6% pace of 2011. housing influences our gdP indicator via a transaction-activity factor (specifically existing home sales) and a price factor (specifically the change in household wealth, of which 31.9% is housing-related). Exhibit 27 illustrates that the recent acceleration in existing home sales is an important positive factor for the model, adding 45 basis points to our 2012 gdP forecast. We view housing turnover as a proxy for the health of the labor market, for household formation, and for consumers animal spirits (human emotion that drives consumer confidence). as mentioned previously, our fundamental analysis is that faster

+0.45% 2.6% -0.01% -0.76% 2.3%

our gdP leading Indicator contains eight factor inputs that contribute the forecast. a = actual; e = estimate; gdP = gross domestic Product. data as at February 6, 2012. source: bloomberg, haver, KKr global Macro and asset allocation.

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Summary: Investment opportunities

as we detailed above, there is an important positive change taking place in the housing market. specifically, our research shows that pent up demand, as measured by household formation, is likely to drive housing starts above consensus expectations in the coming quarters. thats the good news and it is consistent with our view that the private, cyclical sectors of the economy are performing better than the consensus thinks. It is also consistent with a housing sector that is positively contributing 0.25-0.50% to annual gdP growth in the United states. against this backdrop, we see investment opportunities in several areas. First, we think there is a growing opportunity for private capital to buy and lease homes for rental purposes. at last, the Federal housing Finance agency has welcomed such capital to help shrink the excess inventory of 3.3 million homes available for sale. additionally, we think that home repair and improvement should re-accelerate. at the moment, home improvement only contributes $26.0 billion to retail sales, still well below its peak of $29.6 billion in 2006.13 by comparison, we think certain homebuilder equities are appealing, but given their beta of 2.0 relative to the market, it is important for investors to time their entry. We also believe that an acceleration in the velocity of housing activity may be a potentially positive factor for the trillions of fixed income investments structured and linked to housing-related securities. Within the existing home market, however, we think that activity and prices may take a little more time than the new home market to rebound. the good news is that government policies toward delinquencies and foreclosures are improving, which could affect as a meaningful positive in the future. this cautiously optimistic viewpoint is significant as real estate still accounts for 31.9% of individuals net worth in the United states.14

The good news is that government policies toward delinquencies and foreclosures are improving, which could affect as a meaningful positive in the future.

13 as of Jan 2012. home Improvement retail sales = building Materials, garden equipment & supply dealers retail sales. source: census bureau, haver. 14 as of 3Q2011. source: Federal reserve Flow of Funds, haver.
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Important Information the views expressed in this presentation are the personal views of henry McVey of KohlbergKravis roberts & co. l.P. (together with its affiliates, KKr) and do not necessarily reflect theviews of KKr itself. the views expressed reflect the current views of Mr. McVey as of the datehereof and neither Mr. McVey nor KKr undertakes to advise you of any changes in the viewsexpressed herein. In addition, the views expressed do not necessarily reflect the opinions of anyinvestment professional at KKr, and may not be reflected in the strategies and products thatKKr offers. KKr and its affiliates may have positions (long or short) or engage in securitiestransactions that are not consistent with the information and views expressed in thispresentation. this presentation has been prepared solely for informational purposes. the information contained herein is only as current as of the date indicated, and may be superseded by subsequent market events or for other reasons. charts and graphs provided herein are for illustrative purposes only. the information in this presentation has been developed internallyand/or

obtained from sources believed to be reliable; however, neither KKr nor Mr. McVeyguarantees the accuracy, adequacy or completeness of such information. nothing containedherein constitutes investment, legal, tax or other advice nor is it to be relied on in making aninvestment or other decision. there can be no assurance that an investment strategy will be successful. historic market trendsare not reliable indicators of actual future market behavior or future performance of anyparticular investment which may differ materially, and should not be relied upon as such. targetallocations contained herein are subject to change. there is no assurance that the targetallocations will be achieved, and actual allocations may be significantly different than thatshown here. this presentation should not be viewed as a current or past recommendation or asolicitation of an offer to buy or sell any securities or to adopt any investment strategy. the information in this presentation may contain projections or other forward-looking statements regarding future events, targets, forecasts or expectations regarding the strategiesdescribed herein, and is only current as of the date indicated. there is no assurance that

suchevents or targets will be achieved, and may be significantly different from that shown here. theinformation in this presentation, including statements concerning financial and housing market trends, is based on current market conditions, which will fluctuate and may be superseded by subsequent market events or for other reasons. the investment strategy and themes discussed herein may be unsuitable for investors depending on their specific investment objectives and financial situation. Please note that changes in the rate of exchange of a currency may affect the value, price or income of an investment adversely. neither KKr nor Mr. McVey assumes any duty to, nor undertakes to update forward looking statements. no representation or warranty, express or implied, is made or given by or on behalfof KKr, Mr. McVey or any other person as to the accuracy and completeness or fairness of theinformation contained in this presentation and no responsibility or liability is accepted for any such information. by accepting this presentation, the recipient acknowledges its understanding and acceptance of the foregoing statement.

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