March 31 (Bloomberg) -- KKR Financial Holdings Inc., the debt-investment affiliate of buyout firm Kohlberg Kravis Roberts & Co., settled with lenders by agreeing to turn over collateral and said it will sell shares to fund new investments.

The holders of commercial paper issued by two KKR Financial funds will terminate the debt in exchange for the assets, the San Francisco-based company said today in a statement. The agreement will remove about $3.5 billion in notes and mortgage- backed securities from the company's balance sheet. KKR Financial wrote off the assets last year at a cost of about $243.7 million.

The company also agreed to sell a controlling interest in KFN Financial Corp., the real-estate investment trust that sponsored the commercial paper, to Rock Capital 2 LLC for an undisclosed amount. KKR Financial has sought to pull out of real-estate and mortgage markets amid the global credit meltdown and shift completely to buying corporate debt.

``This agreement and the sale of our REIT subsidiary mark a constructive resolution to an issue created by the unprecedented dislocations in the credit markets,'' Saturnino Fanlo, chief executive officer of KKR Financial, said in the statement.

With the agreement, the company will have more than $8.5 billion in investments, with more than 95 percent of that in corporate debt, according to the statement.

KKR Financial said separately that it would sell 20 million shares and use the proceeds to repay debt and make investments. The firm is taking advantage of others' unwillingness to buy debt, according to a prospectus filed with the U.S. Securities and Exchange Commission.

``Because certain of our competitors have withdrawn from the market for corporate debt investments, we will be well- positioned to take advantage of the attractive investment environment,'' KKR Financial said in the filing.

The stock rose 18 cents, or 1.4 percent, to $12.66 in New York Stock Exchange composite trading at 4 p.m., before the announcement.

To contact the reporter on this story: Jason Kelly in New York at jkelly14@bloomberg.net.

Last Updated: March 31, 2008 21:44 EDT