Table of Contents

 

 

 

**UNITED STATESSECURITIES AND EXCHANGE COMMISSION**

**WASHINGTON,D.C. 20549**

 

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**Form 10-Q**

 

| **(Mark One)** |
|----------------|
| **x**          | ** ** | **QUARTERLY REPORT UNDER SECTION 13 OR  15(d) OF THE SECURITIES EXCHANGE ACT OF 1934** |
|           |   |   |
|           |   | **FOR THE  QUARTERLY PERIOD ENDED MARCH 31, 2008** |
|           |   |   |
| **o**          | ** ** | **TRANSITION REPORT PURSUANT TO SECTION 13 OR  15(d) OF THE SECURITIES EXCHANGE ACT OF 1934** |
|           |   |   |
|           |   | **FOR THE  TRANSITION PERIOD FROM TO** |

 

**Commission File No. 000-52903**

 

**CMRMortgage Fund II, LLC**

(Exact name of registrant asspecified in its charter)

 

| **California**                                                   | ** ** | **20-0671528**                         |
|------------------------------------------------------------------|------------|----------------------------------------|
| (State  or other jurisdiction of  incorporation or organization) |       | (I.R.S.  Employer  Identification No.) |
|                                                             |       |                                   |
| **62  First Street, 4th Floor  San Francisco, California**       | ** ** | **94105**                              |
| (Address  of principal executive offices)                   |       | (Zip  Code)                            |

 

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**Registrant’s telephonenumber, including area code:**

**(415) 974-1100**

 

Indicate by check mark whether the registrant (1) hasfiled all reports required to be filed by Section 13 or 15(d) of theSecurities Exchange Act of 1934 during the preceding 12 months (or for suchshorter period that the registrant was required to file such reports), and (2) hasbeen subject to the filing requirements for at least the past 90 days.  Yes o No  x

 

Indicate by check mark whether the registrant is alarge accelerated filer, an accelerated filer, a non-accelerated filer, or asmaller reporting company. See the definitions of “large accelerated filer,” “acceleratedfiler” and “smaller reporting company” in Rule 12b-2 of the ExchangeAct.  (Check one):

 

| Large accelerated filer o                      |   | Accelerated filer o         |
|------------------------------------------------|--------|-----------------------------|
| Non-accelerated filer o                        |   | Smaller reporting company x |
| (Do not check if a smaller  reporting company) |   |                        |

 

Indicate by check mark whether the registrant is ashell company (as defined in Rule 12b-2 of the Exchange Act).  Yes o  No x

 

There is no trading market for the registrant’smembership interests.

 

 

 

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**TABLE OFCONTENTS**

 
| ** **                         | **Page**                                                                                    |
|------------------------------------|---------------------------------------------------------------------------------------------|
|                               |                                                                                        |
| PART I. FINANCIAL INFORMATION | 2                                                                                           |
|                               |                                                                                        |   |
| Item 1.                            | Financial Statements                                                                        | 2 |
|                               |                                                                                        |   |
| Item 2.                            | Management’s  Discussion and Analysis of Financial Condition and Results of Operations | 19 |
|                               |                                                                                        |   |
| Item 3.                            | Quantitative  and Qualitative Disclosures About Market Risk                                 | 29 |
|                               |                                                                                        |   |
| Item 4.                            | Controls  and Procedures                                                                    | 29 |
|                               |                                                                                        |   |
| PART II.  OTHER INFORMATION   | 30                                                                                          |
|                               |                                                                                        |   |
| Item 1.                            | Legal  Proceedings                                                                          | 30 |
|                               |                                                                                        |   |
| Item  1A.                          | Risk Factors                                                                                | 30 |
|                               |                                                                                        |   |
| Item 2.                            | Unregistered  Sales of Equity Securities and Use of Proceeds                                | 31 |
|                               |                                                                                        |   |
| Item 3.                            | Defaults  Upon Senior Securities                                                            | 31 |
|                               |                                                                                        |   |
| Item 4.                            | Submission  of Matters to a Vote of Security Holders                                        | 31 |
|                               |                                                                                        |   |
| Item 5.                            | Other  Information                                                                          | 31 |
|                               |                                                                                        |   |
| Item  6.                           | Exhibits                                                                                    | 31 |

 

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# **PART I.                 FINANCIALINFORMATION**

 

## **Item 1.                   FinancialStatements**

 

**CMR MORTGAGE FUND II, LLCCONDENSED BALANCE SHEETS**

 
| ** **                                                                                                                              | ** ** | **March 31,  2008 ** | ** **  | **December 31,  2007** | ** ** |
|-----------------------------------------------------------------------------------------------------------------------------------------|------------|--------------------------------|-------------|-----------------------------|------------|
| ** **                                                                                                                              | ** ** | **(Unaudited)**                | ** **  | ** **                  | ** ** |
| **ASSETS**                                                                                                                              |       |                           |        |                        |       |
| Cash and cash equivalents                                                                                                               |       | $                              | 37,217      |                        | $          | 1,458,635 |   |
| Loans, secured by deeds of trust, net of  allowance for loan losses of $6,309,000 as of March 31, 2008 and  December 31, 2007 |       | 88,007,871                     |        | 87,474,484                  |       |
| Loans receivable from Manager                                                                                                           |       | 8,641,763                      |        | 8,598,011                   |       |
| Advances to borrowers                                                                                                                   |       | 4,923,193                      |        | 5,905,561                   |       |
| Due from related parties                                                                                                                |       | 2,030,141                      |        | 1,533,247                   |       |
| Real estate owned                                                                                                                       |       | 8,582,275                      |        | 8,578,275                   |       |
| Accrued interest receivable and other  assets                                                                                           |       | 4,378,193                      |        | 2,831,203                   |       |
| **Total Assets**                                                                                                                        |       | $                              | 116,600,653 |                        | $          | 116,379,416 |   |
| **LIABILITIES  AND MEMBERS’ CAPITAL**                                                                                              |       |                           |        |                        |       |
| Liabilities:                                                                                                                            |       |                           |        |                        |       |
| Accounts payable                                                                                                                        |       | $                              | 789,586     |                        | $          | 605,681 |   |
| Accrued expenses                                                                                                                        |       | 381,565                        |        | 116,035                     |       |
| Accrued distributions                                                                                                                   |       | —                         |        | 296,225                     |       |
| Due to related party                                                                                                                    |       | 660,898                        |        | 258,118                     |       |
| Note payable and accrued interest to  related party                                                                                     |       | 20,368,901                     |        | 21,395,630                  |       |
| Notes payable to related party – real  estate owned                                                                                |       | 6,000,000                      |        | 6,000,000                   |       |
| **Total Liabilities**                                                                                                                   |       | 28,200,950                     |        | 28,671,689                  |       |
| Commitments and contingencies                                                                                                           |       |                           |        |                        |       |
| Members’ Capital                                                                                                                   |       | 88,399,703                     |        | 87,707,727                  |       |
| **Total Liabilities and Members’ Capital**                                                                                         |       | $                              | 116,600,653 |                        | $          | 116,379,416 |   |

 

The accompanying notes are an integral part of theseunaudited condensed financial statements.

 

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**CMR MORTGAGE FUND II, LLCCONDENSED STATEMENTS OF INCOME**(UNAUDITED)

 
| ** **                                   | ** ** | **For the Three Months  Ended March 31,** | ** ** |
|----------------------------------------------|------------|--------------------------------------------------------------------|------------|
| ** **                                   | ** ** | **2008**                                                           | ** ** | **2007** | ** ** |
| Revenues:                                    |       |                                                               |       |   |   |
| Interest income:                             |       |                                                               |       |   |   |
| Interest on loans                            |       | $                                                                  | 2,539,978  |   | $ | 3,375,270 |   |
| Interest on loans receivable - related party |       | 135,334                                                            |       | — |   |
| Interest on advances to borrowers            |       | 226,794                                                            |       | 72,636 |   |
| Other interest income                        |       | 198,639                                                            |       | 249,098 |   |
| Total interest income                        |       | 3,100,745                                                          |       | 3,697,004 |   |
| Less: Loan servicing fees                    |       | 471,586                                                            |       | 816,026 |   |
| Total interest income, net of servicing fees |       | 2,629,159                                                          |       | 2,880,978 |   |
| Interest expense                             |       | 562,879                                                            |       | 810,656 |   |
| Interest expense – related party        |       | 187,500                                                            |       | — |   |
| Provision for loan losses                    |       | —                                                             |       | 225,000 |   |
| Net revenues                                 |       | 1,878,780                                                          |       | 1,845,322 |   |
| Operating expenses:                          |       |                                                               |       |   |   |
| Asset management fees                        |       | 78,519                                                             |       | 251,094 |   |
| Professional services                        |       | 446,050                                                            |       | 99,790 |   |
| Other operating expenses                     |       | 17,548                                                             |       | 3,451 |   |
| Total operating expenses                     |       | 542,117                                                            |       | 354,335 |   |
| Net income                                   |       | $                                                                  | 1,336,663  |   | $ | 1,490,987 |   |

 

The accompanying notes are an integral part of theseunaudited condensed financial statements.

 

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**CMR MORTGAGE FUND II, LLCSTATEMENT OF CHANGES IN MEMBERS’ CAPITALFor the Quarter Ended March 31, 2008**

 
| ** **                                             | ** ** | ** **                               | ** ** | ** ** | ** ** | **Members’ Capital** | ** ** |
|--------------------------------------------------------|------------|------------------------------------------|------------|------------|------------|--------------------------------|------------|
| ** **                                             | ** ** | **Investors in  Applicant  Status** | ** ** | **Units**  | ** ** | **Members**                    | ** ** | **Unallocated  Capital** | ** ** | **Total  Members’  Capital** | ** ** |
| Balance January 1, 2008                           |       | $                                        | —     |       | 87,707     |                           | $          | 87,707,727 |   | $ | — |   | $ | 87,707,727 |   |
| Net income                                             |       |                                     |       | 1,337      |       |                           |       | 1,336,663 |   | 1,336,663 |   |
| Purchase of additional membership units  from earnings |       |                                     |       |       |       | 640,853                        |       | (640,853 | ) |   |   |
| Distributions to members                               |       |                                     |       | (644       | )          | —                         |       | (644,687 | ) | (644,687 | ) |
|                                                   |       |                                     |       |       |       |                           |       |   |   |   |   |
| Balance March 31, 2008                            |       | $                                        | —     |       | 88,400     |                           | $          | 88,399,703 |   | $ | — |   | $ | 88,399,703 |   |

 

The accompanying notes are an integral part of theseunaudited condensed financial statements.

 

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**CMR MORTGAGE FUND II, LLCCONDENSED STATEMENT OF CASH FLOWS(UNAUDITED)**

 
| ** **                                                                         | ** ** | **For the Three Months  Ended  March 31,** | ** ** |
|------------------------------------------------------------------------------------|------------|----------------------------------------------------------------|------------|
| ** **                                                                         | ** ** | **2008**                                                       | ** ** | **2007** | ** ** |
| Cash flows from operating activities:                                              |       |                                                           |       |   |   |
| Net income                                                                         |       | $                                                              | 1,336,663  |   | $ | 1,490,987 |   |
| Adjustments to reconcile net income to net  cash provided by operating activities: |       |                                                           |       |   |   |
| Provision for loan losses                                                          |       | —                                                         |       | 225,000 |   |
| Net changes in operating assets and  liabilities:                                  |       |                                                           |       |   |   |
| Accrued interest receivable and other  assets                                      |       | (1,546,990                                                     | )          | (808,451 | ) |
| Accounts payable and accrued expenses                                              |       | 449,435                                                        |       | 79,958 |   |
| Due from related parties                                                           |       | (496,894                                                       | )          | 685,118 |   |
| Due to related parties                                                             |       | 357,867                                                        |       | 656,061 |   |
| Net cash provided by operating activities                                          |       | 100,081                                                        |       | 2,328,673 |   |
| Cash flows from investing activities:                                              |       |                                                           |       |   |   |
| Net decrease (increase) advances to  borrowers                                     |       | 982,368                                                        |       | (910,911 | ) |
| Net increase in loans                                                              |       | (537,387                                                       | )          | (4,444 | ) |
| Net decrease (increase) in loans receivable  from Manager                          |       | (43,752                                                        | )          | — |   |
| Net cash provided by (used in) investing  activities                               |       | 401,229                                                        |       | (915,355 | ) |
| Cash flows from financing activities:                                              |       |                                                           |       |   |   |
| Contributions from members                                                         |       | —                                                         |       | 280,509 |   |
| Distributions to members                                                           |       | (940,912                                                       | )          | (4,776,963 | ) |
| Repayment of note payable to related party                                         |       | (981,816                                                       | )          | (892,483 | ) |
| Net cash used in financing activities                                              |       | (1,922,728                                                     | )          | (5,388,937 | ) |
|                                                                               |       |                                                           |       |   |   |
| Net decrease in cash and cash equivalents                                          |       | (1,421,418                                                     | )          | (3,825,757 | ) |
|                                                                               |       |                                                           |       |   |   |
| Cash and cash equivalents at beginning of  period                                  |       | 1,458,635                                                      |       | 4,138,948 |   |
| Cash and cash equivalents at end of period                                         |       | $                                                              | 37,217     |   | $ | 313,191 |   |
|                                                                               |       |                                                           |       |   |   |
| *Supplemental disclosure of cash flow  information:*                               |       |                                                           |       |   |   |
| Cash paid during the year for:                                                     |       |                                                           |       |   |   |
| Interest expense                                                                   |       | $                                                              | 703,184    |   | $ | 705,764 |   |
| Franchise taxes                                                                    |       | $                                                              | 983        |   | — |   |
| Non-cash investing activities:                                                     |       |                                                           |       |   |   |
| Real estate acquired through foreclosure                                           |       | $                                                              | 4,000      |   | — |   |

 

The accompanying notes are an integral part of theseunaudited condensed financial statements.

 

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**CMR Mortgage FundII, LLCNotes to Condensed Financial Statements (Unaudited)**

** **

**Note 1.  Organization and General Fund Provisions**

** **

CMR Mortgage Fund II, LLC (the “Fund”) is a California limited liability company organized for the purpose ofmaking or investing in business loans secured by deeds of trust and mortgageson real properties—predominately commercial income producing structures or landheld by businesses—located primarily in California.  The land can be income producing (*e.g.*, farms, vineyards, parking lots) ormay be held for commercial or residential development. The Fund’s loans arearranged and serviced by its manager, California Mortgage and Realty, Inc.,a Delaware corporation (the “Manager”), which is licensed as a California realestate broker and a California finance lender. In addition, the Fund has theability to invest in loans that were not originated by the Manager. The Managerprovides certain operating and administrative services to the Fund. The Managerhas complete control of the Fund’s business, subject to the voting rights ofthe Fund’s members on specified matters and on any other matters which theManager wishes to submit to a vote.  Neitherthe Manager nor any of its affiliated entities held any of the Fund’smembership interests at March 31, 2008, December 31 2007 or March 31,2007.

 

In addition to arranging and servicing the Fund’s loans, the Managersells loans in the Fund’s loan portfolio and purchases existing loans for theFund, including partial undivided interests in loans. The Manager sells andpurchases loans for the Fund primarily to and from its affiliates and itsclients and occasionally from non-affiliated third parties.

 

**Basis ofAccounting**

** **

Theaccompanying unaudited condensed financial statements have been prepared inaccordance with accounting principles generally accepted in the United Statesof America (“GAAP”) for interim financial statements and do not contain all ofthe information and footnotes required for annual financial statements under GAAP.  However, these condensed financial statementscontain all adjustments (consisting of normal recurring adjustments andaccruals) which in the Fund’s opinion are necessary for a fair presentation ofthe interim periods.  These condensedfinancial statements should be read in conjunction with the audited financialstatements as of and for the year ended December 31, 2007, and the notesthereto included in the Fund’s Annual Report on Form 10-K for the yearended December 31, 2007  (the “2007Annual Report”) filed with the Securities and Exchange Commission (the “SEC”).

 

Theaccounting policies used by the Fund are described in Note 2 of the 2007 AnnualReport.

 

Theresults of operations for the three months ended March 31, 2008, may notbe indicative of the results of operations that may be expected for any otherinterim period or for the year ending December 31, 2008.

 

**ManagementEstimates**

** **

Thepreparation of financial statements in conformity with GAAP requires theManager to make estimates and assumptions. These estimates and assumptionsaffect the reported amounts of assets and liabilities at the date of thefinancial statements and the reported amounts of revenues and expenses duringthe reported period. Actual results could differ significantly from theseestimates.

 

The Manager estimates, at least quarterly, the value of the collateralunderlying the loans, the value of real estate owned (“REO”), and the relateddisposal costs. The estimates are derived from information available in thereal estate markets including similar property, and often require theexperience and judgment of third parties, such as commercial real estatebrokers and appraisers. The estimates figure materially in the Manager’sdetermination of the adequacy of the allowance for loan losses.

 

**Going Concern**

** **

TheFund’s financial statements have been prepared on a going concern basis, whichcontemplates the realization of assets and the discharge of liabilities in thenormal course of business for the foreseeable future. Due 

 

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to unprecedented dislocations in the real estate andcapital markets since 2007, the Fund has incurred a significant reduction inloan payoffs from borrowers and an increase in delinquencies, non-performingloans and real estate owned, resulting in a substantial reduction of cashflows. In addition, a number of the Fund’s loans are in default. The Fund’silliquid position may prevent the Fund from protecting its position withrespect to properties securing the defaulted loans.

 

The Fund has also pledged $48,000,000 of its loan portfolio as securityfor a note payable to CMR Income Fund, LLC (“Income Fund”), a relatedparty.  At March 31, 2008, the Fundwas in technical default under this loan, resulting in a technical defaultunder Income Fund’s note payable to Wells Fargo Foothill, the lender on a loanto Income Fund in the original principal amount of $25,000,000. The currentcarrying amount of this note payable to Income Fund includes principal of$20,199,951 and accrued unpaid interest of $168,950.  Since the date of default, the Fund has continuedto make monthly interest payments of approximately $165,000.  The Manager subsequently negotiatedamendments to the promissory notes between Income Fund and Wells Fargo Foothilland between Income Fund and the Fund that were made effective as of July 1,2008, under which Wells Fargo Foothill and Income Fund, respectively, waivedthe existing defaults and extended the maturity date until December 31,2008.

 

In March 2008,the Fund began making debt service payments on the senior debt on thecollateral that secures the Fund’s $2,920,000 participation in a $42,900,000subordinated loan made by various funds managed by the Manager following theborrower’s default on the senior and subordinate loans. The Fund’s pro ratashare of the debt service on the senior note totals approximately $62,000 permonth (11.3% of the aggregate $550,000), although the Fund may advance more orless than its pro rata share.  Due toliquidity issues in the various funds managed by the Manager, it has becomenecessary from time to time for one participant to pay more than its pro ratashare of the senior debt service. Through August 31, 2008, the Fund has made payments totaling$274,607 relating to this obligation. Under an agreement among the various participating funds, these advanceswill have a priority repayment position relative to loan principal and interestearned thereon.  The Manager is currentlynegotiating an agreement to extend the term of the senior debt beyond itscurrent maturity.  If the Fund is unableto sell the property before the senior debt matures, the Fund may also need toassume debt service on a portion of the $5,000,000 of other third partysubordinated debt in order to prevent foreclosure.

 

On April 9,2008, the Manager, on behalf of the Fund and three other funds it services,foreclosed on 20 of 22 properties which comprised approximately $20,450,000, or85% of the $24,300,000 total collateral securitizing three junior loans to thefunds.  The total amount of junior debtsecured by these properties, including principal, advances, and accruedinterest was approximately $21,858,000, including approximately $11,113,000owed to the Fund.  The senior liens,which are held by outside third parties, total approximately $7,080,000 andbear interest at an effective average interest rate of approximately 8.0%.  In order to fully maintain its junior liensecurity interests, the funds will be obligated to keep the senior lienscurrent until it sells these properties. The pro rata share of this debt service will increase monthly interestexpense of the Fund by approximately $30,000 per month.  The Manager anticipates that it willforeclose on the two remaining properties in the fourth quarter of 2008.

 

Whilethe Fund does continue to accrue and collect interest on a portion of its loanportfolio, it does not have sufficient funds to satisfy its obligations orrepay all the outstanding principal balances of the senior debt as they becomedue, which would allow the senior debt holders to foreclose on the underlyingcollateral and effectively eliminate the Fund’s equity therein.  Additional sources of cash from the sale ofREO, loan principal repayments or loan sales are required to continueoperations beyond December 31, 2008. These events have raised substantialdoubt about the Fund’s ability to continue as a going concern. The financialstatements do not include any adjustments that might result from the outcome ofthese uncertainties.

 

TheFund is dependent on sales of foreclosed properties and support from theContribution Agreement (described below) to meet cash needs and to continueoperations.  The Manager initiated thefollowing actions in response to these unprecedented market conditions toconserve cash and build cash reserves:

 

a)              Commencing in January 2008, the Managerset monthly distributions at an amount equal to the amount of net income (ascompared to the targeted return as was done in prior periods).

 

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b)             As of March 31, 2008, the Managersuspended indefinitely monthly cash distributions of net income and members’redemption requests. As of March 31, 2008 and August 31, 2008,outstanding member redemption requests totaled $24,598,595 and $35,812,117,respectively.

 

c)              On April 11, 2008, David Choo, thesole director of the Manager, executed a Contribution Agreement with the Fundand certain other entities that the Manager sponsors. Pursuant to theContribution Agreement, Mr. Choo agreed to use his diligent good faith andbest efforts to sell, or cause to be sold, certain properties that he owns orcontrols, and to contribute or advance $5,000,000 to the Manager to be used topay notes and other obligations of the Manager, including obligations theManager has to the Fund and other entities. The agreement also commits Mr. Chooto fund an operating reserve of at least $1,500,000 to be used solely for theManager’s operating costs and overhead. The agreement further provides thatuntil the maximum funding requirements described above and detailed in theContribution Agreement are satisfied, a substantial portion of any net cashsales proceeds remaining be held by Mr. Choo or the Manager, such thatthey remain available to the Manager and us and these entities as reasonablyrequired to pay the Fund’s and their current operating expenses and otherwiseremain solvent.

 

d)             The Manager is continuing a program begunin the third quarter of 2006 to pursue an assertive collection process,including timely filing of a notice of default (generally, within two daysafter the second missed payment or sooner), timely filing of notice offoreclosure sale (generally, as soon as permitted by law or regulation),preparing in advance of the foreclosure sale to market aggressively thecollateral/real estate taken back (including interviewing and retainingbrokers), and filing legal claims against the borrower/guarantors. As analternate collection strategy, the Fund has, when appropriate, entered intoformal forbearance agreements with certain borrowers which require the borrowerto perform specific actions within agreed upon timeframes. These actions mayinclude making partial loan payments, providing additional collateral, listingthe property for sale, or entering property sale contracts with the objectiveof full payoff or reinstatement of the Fund’s loan.

 

e)              The Manager is negotiating actively withthird-party senior lien holders to forebear and/or reduce payments due from theborrower.

 

f)                The Manager sold propertiescollateralizing the notes owing by the Manager to the Fund with a loss on sale(borne by the Manager) to raise cash for the Fund. These transactions closed onApril 25, 2008 and July 1, 2008 and generated cash totaling$4,363,068 for the Fund.

 

The above actions, taken together, bolster the Fund’scash resources and improve the likelihood of continued operations by the Fund,including the ability to pay the debt service to senior lien holders, through December31, 2008.  As noted elsewhere, the Fundis dependent on the repayment of loan principal and sale of REO to continueoperations through 2008 into 2009 and beyond, including eventual resumption ofdistributions.  The Manager has hadcertain of the collateral securing the Fund’s loans (with the consent andcooperation of the borrower), and most of the Fund’s REO listed with nationallyrecognized and otherwise experienced brokers with strong presence in theapplicable local markets and experience with the collateral type. These brokersare diligent and committed to completing a transaction, but caution againstforecasting the timing and pricing of a transaction in a historicallylow-volume market with limited credit financing available. The dislocations anduncertainty in the capital and real estate markets have created a challengingenvironment which may continue through 2008 into 2009-2010 and may necessitatefurther liquidations of assets at sub-optimum prices, particularly ifconditions deteriorate further.

 

**Note 2.  Summary of Significant Accounting Policies**

** **

*Fair Value Measurements*

* *

In September 2006,the FASB issued Statement No. 157 (“SFAS 157”), *Fair Value Measurements*. SFAS 157defines fair value, establishes a framework for measuring fair value andexpands disclosures about fair value measurements. SFAS 157 applieswhenever other standards require (or permit) assets or liabilities to bemeasured at fair value but does not expand the use of fair value in any newcircumstances.  In this standard, theFASB clarifies the principle that fair value should be based on the assumptionsmarket participants would use when pricing the asset or liability.  In support of this principle, SFAS 157establishes a fair value hierarchy that prioritizes the information used todevelop those assumptions. The provisions of SFAS 157 are effective forfinancial 

 

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statements issued for fiscal years beginning after November 15,2007 and interim periods within those fiscal years. The Fund adoptedSFAS 157 on January 1, 2008. The adoption did not have a materialimpact to the Fund’s financial position or results of operations or cash flows.

 

*Fair Value Accounting*

* *

In February 2007,the FASB issued FAS 159, “*The FairValue Option for Financial Assets and Financial Liabilities—Including anAmendment of FASB Statement 115*” (“SFAS 159”). SFAS 159permits entities to choose to measure many financial instruments and certainother items at fair value at specified election dates.  The entity will report unrealized gains andlosses on items for which the fair value option has been elected in earnings ateach subsequent reporting date.  The fairvalue option (a) may be applied instrument by instrument, with a fewexceptions, such as investments otherwise accounted for by the equity method, (b) isirrevocable (unless a new election date occurs), and (c) is applied onlyto entire instruments and not to portions of instruments.  The Fund adopted SFAS 159 on January 1,2008 and the Manager did not elect the fair value option for any of the Fund’sfinancial instruments.

 

*Accounting for Business Combinations*

* *

In December 2007,the FASB issued Statement of Financial Accounting Standards No. 141(revised 2007), *Business Combinations*“SFAS141(R)”).  SFAS 141(R), among otherthings, establishes principles and requirements for how the acquirer in abusiness combination (i) recognizes and measures in its financialstatements the identifiable assets acquired, the liabilities assumed, and anynon-controlling interest in the acquired business, (ii) recognizes andmeasures the goodwill acquired in the business combination or a gain from abargain purchase, and (iii) determines what information to disclose toenable users of the financial statements to evaluate the nature and financialeffects of the business combination.  TheFund is required to adopt SFAS 141(R) for all business combinations forwhich the acquisition date is on or after January 1, 2009.  Earlier adoption is prohibited.  This standard will change the accountingtreatment for business combinations on a prospective basis.

 

**Note 3.  Related Party Transactions**

** **

TheManager is responsible for all management decisions related to the operationsand investments of the Fund.  Inaccordance with the Operating Agreement and other loan servicing agreementswith the Fund, the Manager is entitled to receive fees for the various servicesit provides and to be reimbursed for certain costs incurred on behalf of theFund.  The Manager may also, at its solediscretion, agree to forego the fees for services and expense reimbursementotherwise due and payable from the Fund. When the Manager agrees to forego these items, the Manager may collectadditional fees and reimbursements, limited to the amount previously foregone,in subsequent years if and only if the rate of return of the Fund is in excessof 8.0% and limited each year to the amount in excess of that return. TheManager elected to forego $155,704  inasset management fees, but did not elect to forego any other fees during thequarter ended March 31, 2008. The Manager did not forego any of these feesand reimbursements during the quarter ended March 31, 2007.

 

*Loan Servicing Fees*

* *

TheManager is entitled to receive a monthly fee for loan servicing of up to 2% perannum (1/12th of 2% per month) of the outstanding principal balanceof each loan. The fee is payable monthly as the Fund receives interest paymentsfrom borrowers.  The Manager may at itssole discretion, agree to forego loan servicing fees otherwise due and payablefrom the Fund. Loan servicing fees for the quarters ended March 31, 2008and 2007 were $471,586 and $816,026, respectively.

 

*Asset Management Fees*

* *

TheManager is entitled to receive a monthly fee for management services providedto the Fund equal to 1% per annum (1/12th of 1% per month) of netassets under management, which is payable on the last day of the month. Netassets, as defined by the Fund’s Operating Agreement, is equal to total members’capital as of the first day of the month. The Manager may, at its solediscretion, agree to forego asset management fees otherwise due and 

 

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payable from the Fund. Asset management fees for the quarter ended March 31, 2008 and 2007were $78,519 and $251,094, respectively. The Manager elected to forego $155,704in asset management fees in the quarter ended March 31, 2008.

 

*Operating Expenses*

* *

TheManager may be reimbursed by the Fund for any operating expenses and othercosts it incurs on behalf of the Fund. The Manager may also, at its solediscretion, agree to forego operating expense reimbursement otherwise due andpayable from the Fund or absorb the expenses itself.  The Manager absorbed $45,621 in Fundoperating expenses in the quarter ended March 31, 2008. The Managerneither absorbed nor was reimbursed for operating expenses in the quarter endedMarch 31, 2007.

 

*Lending and Borrowing Arrangements*

* *

At March 31,2008, there was an outstanding balance of $2,395,576 on a loan to the Managerused to purchase real estate held for sale from the Fund (see Note 9). Inaddition, at March 31, 2008, there was an outstanding balance of$6,246,187 on a loan to the Manager used to purchase certain impaired loansfrom the Fund.

 

In 2006, as discussed in Note 1, the Fund originated a $48,000,000 loanby deeds of trust (see Note 4 and 9). As part of this transaction, theFund invested $23,000,000 of its own capital in the loan, and also entered intoan agreement with Income Fund, a related party, to borrow up to $25,000,000secured by the Fund’s interest in the loan and all properties securing theloan. At March 31, 2008, the related party loan payable and accruedinterest due was $20,368,901. In conjunction with the loan, costs of $452,753were deferred.  Amortization of $104,892of this amount was recorded in the quarter ended March 31, 2007, with theremaining balance of the deferred costs fully amortized in 2007. The Fund wasin technical default on this indebtedness as of March 31, 2008 resultingin a technical default under Income Fund’s note to Wells Fargo Foothill, thelender. The Manager subsequently negotiated amendments to the promissory notesbetween Income Fund and Wells Fargo Foothill and between Income Fund and theFund that were made effective as of July 1, 2008, under which Wells FargoFoothill and Income Fund, respectively, waived the existing defaults andextended the maturity date until December 31, 2008. The Fund has continuedto make monthly payments on its promissory note, and Wells Fargo Foothill, thelender, continues to accept these payments.

 

In June 2007, the Fund foreclosed on its lien junior to a $6,000,000note with an interest rate of 12.5% per annum payable to CMR Fund I, LLC, CMRFund III, LLC and various direct investors for whom the Manager provides loanservicing.  As owner of the property, theFund is making payments on the senior note to protect its equity in theproperty.

 

**Note 4.  Loans Secured by Deeds of Trust,Concentrations and Characteristics**

** **

All ofthe Fund’s loans are fixed rate loans with interest rates that ranged from12.5% to 13.95% at March 31, 2008 and 12.0% to 13.5% at March 31,2007.

 

**Concentrations ofCredit Risk**

** **

Whilethe Manager may consider the income level and general credit worthiness of aborrower to determine a borrower’s ability to repay the loan according to itsterms, such considerations are typically subordinate to a determination thatthe value of secured collateral will provide a sufficient source of funds forloan repayment. When a loan is collateralized by multiple property types theloan is categorized as “Mixed use properties”. A significant portion of the Fund’s loans are secured by two or morereal estate parcels, which may be secured by differing positions for the deedsof trust. When the collateral deed trust types are different for a loan (e.g.secured by a combination of first, second and/or third trust deeds), the loanis categorized as “mixed”. The Fund’s loan portfolio as of March 31, 2008and 2007 had the following characteristics:

 

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**Loan Portfolio in Dollars as of March 31,2008:**

 
| ** **                   | ** ** | **First Trust  Deeds** | ** ** | **Second Trust  Deeds** | ** ** | **Third Trust  Deeds** | ** ** | **Mixed Trust  Deeds** | ** ** | **Totals** | ** ** |
|------------------------------|------------|-----------------------------|------------|------------------------------|------------|-----------------------------|------------|-----------------------------|------------|------------|------------|
| Commercial real estate       |       | $                           | 2,395,576  |                         | $          | 10,000                      |       | $                           | —     |       | $          | 10,918,000 |   | $ | 13,323,576 |   |
| Residential real estate      |       | —                      |       | 3,103,573                    |       | —                      |       | —                      |       | 3,103,573  |       |
| Improved and unimproved land |       | 9,410,511                   |       | 957,000                      |       | 13,791,744                  |       | 62,332,230                  |       | 86,491,485 |       |
| Mixed use properties         |       | —                      |       | 40,000                       |       | —                      |       | —                      |       | 40,000     |       |
| Total(1)                     |       | $                           | 11,806,087 |                         | $          | 4,110,573                   |       | $                           | 13,791,744 |       | $          | 73,250,230 |   | $ | 102,958,634 |   |

 

**Loan Portfolio inDollars as of March 31, 2007:**

 
| ** **                   | ** ** | **First Trust  Deeds** | ** ** | **Second Trust  Deeds** | ** ** | **Third Trust  Deeds** | ** ** | **Mixed Trust  Deeds** | ** ** | **Totals** | ** ** |
|------------------------------|------------|-----------------------------|------------|------------------------------|------------|-----------------------------|------------|-----------------------------|------------|------------|------------|
| Commercial real estate       |       | $                           | 16,348,000 |                         | $          | 220,000                     |       | $                           | 600,000    |       | $          | — |   | $ | 17,168,000 |   |
| Residential real estate      |       | —                      |       | 2,400,000                    |       | 800,000                     |       | —                      |       | 3,200,000  |       |
| Improved and unimproved land |       | 60,353,725                  |       | 18,465,000                   |       | 18,175,744                  |       | —                      |       | 96,994,469 |       |
| Mixed use Properties         |       | —                      |       | —                       |       | —                      |       | —                      |       | —     |       |
| Total                        |       | $                           | 76,701,725 |                         | $          | 21,085,000                  |       | $                           | 19,575,744 |       | $          | — |   | $ | 117,362,469 |   |

 

**Number of Loans inthe Portfolio as of March 31, 2008 and 2007:**

 
| ** **                   | ** ** | **2008**                | ** ** | **2007**                 | ** ** |
|------------------------------|------------|-------------------------|------------|--------------------------|------------|
| ** **                   | ** ** | **First  Trust  Deeds** | ** ** | **Second  Trust  Deeds** | ** ** | **Third  Trust  Deeds** | ** ** | **Mixed  Trust  Deeds** | ** ** | **Totals** | ** ** | **First  Trust  Deeds** | ** ** | **Second  Trust  Deeds** | ** ** | **Third  Trust  Deeds** | ** ** | **Mixed  Trust  Deeds** | ** ** | **Totals** | ** ** |
| Commercial real estate       |       | 1                       |       | 1                        |       | — |   | 3 |   | 5 |   | 6 |   | 4 |   | 1 |   | — |   | 11 |   |
| Residential real estate      |       | —                  |       | 2                        |       | — |   | — |   | 2 |   | — |   | 2 |   | 1 |   | — |   | 3 |   |
| Improved and unimproved land |       | 4                       |       | 1                        |       | 2 |   | 6 |   | 13 |   | 9 |   | 6 |   | 3 |   | — |   | 18 |   |
| Mixed use Properties         |       | —                  |       | 1                        |       | — |   | — |   | 1 |   | — |   | — |   | — |   | — |   | — |   |
| Total(2)                     |       | 5                       |       | 5                        |       | 2 |   | 9 |   | 21 |   | 15 |   | 12 |   | 5 |   | — |   | 32 |   |

 

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**Schedule of Maturitiesas of March 31, 2008:**

 
| ** **         | ** ** | **First Trust  Deeds** | ** ** | **Second Trust  Deeds** | ** ** | **Third Trust  Deeds** | ** ** | **Mixed Trust  Deeds** | ** ** | **Totals** | ** ** |
|--------------------|------------|-----------------------------|------------|------------------------------|------------|-----------------------------|------------|-----------------------------|------------|------------|------------|
| **March 31,** |       |                        |       |                         |       |                        |       |                        |       |       |       |
| 2008               |       | $                           | —     |                         | $          | 957,000                     |       | $                           | 8,000,000  |       | $          | 10,918,000 |   | $ | 19,875,000 |   |
| 2009               |       | 3,224,450                   |       | 10,000                       |       | 5,791,744                   |       | 62,237,230                  |       | 71,263,423 |       |
| 2010               |       | 6,186,062                   |       | 3,103,573                    |       | —                      |       | 95,000                      |       | 9,384,635  |       |
| 2011               |       | —                      |       | 40,000                       |       | —                      |       | —                      |       | 40,000     |       |
| 2012               |       | 2,395,576                   |       | —                       |       | —                      |       | —                      |       | 2,395,576  |       |
| Total(1)           |       | $                           | 11,806,087 |                         | $          | 4,110,573                   |       | $                           | 13,791,744 |       | $          | 73,250,230 |   | $ | 102,958,634 |   |

 

**Schedule ofMaturities as of March 31, 2007:**

 
| ** **         | ** ** | **First Trust  Deeds** | ** ** | **Second Trust  Deeds** | ** ** | **Third Trust  Deeds** | ** ** | **Mixed Trust  Deeds** | ** ** | **Totals** | ** ** |
|--------------------|------------|-----------------------------|------------|------------------------------|------------|-----------------------------|------------|-----------------------------|------------|------------|------------|
| **March 31,** |       |                        |       |                         |       |                        |       |                        |       |       |       |
| 2007               |       | $                           | 55,000     |                         | $          | 10,000                      |       | $                           | —     |       | $          | — |   | $ | 65,000 |   |
| 2008               |       | 10,348,000                  |       | 57,000                       |       | 8,600,000                   |       | —                      |       | 19,005,000 |       |
| 2009               |       | 55,493,300                  |       | 13,868,000                   |       | 10,175,744                  |       | —                      |       | 79,537,044 |       |
| 2010               |       | 10,801,425                  |       | 2,300,000                    |       | 800,000                     |       | —                      |       | 13,901,425 |       |
| 2011               |       | 4,000                       |       | 4,850,000                    |       | —                      |       | —                      |       | 4,854,000  |       |
| Total              |       | $                           | 76,701,725 |                         | $          | 21,085,000                  |       | $                           | 19,575,744 |       | $          | — |   | $ | 117,362,469 |   |

 

**Number of Loans inthe Portfolio by Maturity Date as of March 31, 2008 and 2007:**

 
| ** ** | ** ** | **2008**                | ** ** | **2007**                 | ** ** |
|------------|------------|-------------------------|------------|--------------------------|------------|
| ** ** | ** ** | **First  Trust  Deeds** | ** ** | **Second  Trust  Deeds** | ** ** | **Third  Trust  Deeds** | ** ** | **Mixed  Trust  Deeds** | ** ** | **Totals** | ** ** | **First  Trust  Deeds** | ** ** | **Second  Trust  Deeds** | ** ** | **Third  Trust  Deeds** | ** ** | **Mixed  Trust  Deeds** | ** ** | **Totals** | ** ** |
| 2007       |       | —                  |       | —                   |       | — |   | — |   | — |   | 1 |   | 1 |   | — |   | — |   | 2 |   |
| 2008       |       | —                  |       | 1                        |       | 1 |   | 3 |   | 5 |   | 4 |   | 1 |   | 2 |   | — |   | 7 |   |
| 2009       |       | 2                       |       | 1                        |       | 1 |   | 5 |   | 9 |   | 6 |   | 7 |   | 2 |   | — |   | 15 |   |
| 2010       |       | 2                       |       | 2                        |       | — |   | 1 |   | 5 |   | 3 |   | 1 |   | 1 |   | — |   | 5 |   |
| 2011       |       | —                  |       | 1                        |       | — |   | — |   | 1 |   | 1 |   | 2 |   | — |   | — |   | 3 |   |
| 2012       |       | 1                       |       | —                   |       | — |   | — |   | 1 |   | — |   | — |   | — |   | — |   | — |   |
| Total(2)   |       | 5                       |       | 5                        |       | 2 |   | 9 |   | 21 |   | 15 |   | 12 |   | 5 |   | — |   | 32 |   |

 

**Loan PortfolioSummarized by Quartile as of March 31, 2008 and 2007:**

 
| ** **   | ** ** | **2008**  | ** ** | **2007**   | ** **  |
|--------------|------------|-----------|------------|------------|-------------|
| **Quartile** | ** ** | **Count** | ** ** | **Total**  | ** **  | **Average** | ** ** | **Percent of  Total** | ** ** | **Count** | ** ** | **Total** | ** ** | **Average** | ** ** | **Percent  of  Total** | ** ** |
| 1            |       | 6         |       | $          | 1,263,000   |   | $ | 210,500 |   | 1 | % | 8 |   | $ | 191,000 |   | $ | 23,875 |   | 0 | % |
| 2            |       | 5         |       | 6,259,873  |        | 1,251,975 |   | 6 | % | 8 |   | 2,968,000 |   | 371,000 |   | 3 | % |
| 3            |       | 5         |       | 14,190,087 |        | 2,838,017 |   | 14 | % | 8 |   | 20,128,725 |   | 2,516,091 |   | 17 | % |
| 4            |       | 5         |       | 81,245,674 |        | 16,249,135 |   | 79 | % | 8 |   | 94,074,744 |   | 11,759,343 |   | 80 | % |
| Total(1)     |       | 21        |       | $          | 102,958,634 |   | $ | 4,902,792 |   | 100 | % | 32 |   | $ | 117,362,469 |   | $ | 3,667,577 |   | 100 | % |

 

----

(1)Includesnotes receivable from the Manager totaling $8,641,763.

 

(2)Includesfour loans to the Manager as of March 31, 2008 and none in 2007,respectively.

 

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It isthe Fund’s experience that loans may not be repaid or refinanced in accordancewith contractual maturity date of the note; therefore the above tabulation forscheduled maturities should not be used as a forecast of future cash receipts.

 

Loansvary by size and over time the mix in the portfolio changes. The number of loansin the portfolio and the outstanding balances of total loans at March 31,2008 have decreased from March 31, 2007. The largest quartile of loansdecreased by 1% of the total portfolio from 80% as of March 31, 2007 to79% at March 31, 2008.  Expressed asaverage dollar size of loans, the largest quartile increased by $4,489,792 from$11,759,343 as of March 31, 2007 to $16,249,135 as of March 31, 2008.

 

TheOperating Agreement specifies that no more than 25% of total Fund capital(equal to members’ equity) will be invested in any one loan, calculated as ofthe time the investment is made.    In2006, the Fund indirectly borrowed $25,000,000 from Wells Fargo Foothillthrough Income Fund (“Wells Fargo Foothills Loan”), in order to fund the$48,000,000 loan described in Notes 1, 3 and 9.  Although the entire $48,000,000 loan tothe borrower was more than 25% of the Fund’s total capital at the time the Fundmade this loan, the Fund’s own investment in the loan was $23,000,000, whichwas 21.8% of the $105,569,652 total capital at the time the investment was madein June 2006. The Manager and its affiliates made additional loans to thisborrower aggregating approximately $19,400,000. The Fund also has an interestaggregating $2,584,000 in a junior loan which is secured by the sameproperty.  The Manager believes thetransaction is in compliance with the provisions of the Operating Agreement.

 

Becausethe terms of the original loan from Wells Fargo Foothill required monthlypayments of interest and amortized principal, the original loan balance of theloan decreased. As a consequence of the additional loans and the reducedprincipal balance of the Wells Fargo Foothill Loan (which increased theinvestment of the Fund’s own funds in the loan to $30,384,049), and the overallreduction in the level of capital to $88,348,580 at March 31, 2008, theamount of funds invested in loans to this borrower secured by the same propertytotaled 34.4% of total capital at March 31, 2008. The percentage of theFund’s total capital that this investment represents may continue to grow ifadditional advances are made to this borrower or if the Fund’s capital isfurther reduced as a result of redemptions by members from their capitalaccounts.

 

**Note 5.  Allowance for Loan Losses**

** **

Changesin the allowance for loan losses were as follows:

 
| ** **                      | ** ** | **As of March 31,** | ** ** |
|---------------------------------|------------|------------------------------------|------------|
| ** **                      | ** ** | **2008**                           | ** ** | **2007** | ** ** |
|                            |       |                               |       |   |   |
| Balance, beginning of period    |       | $                                  | 6,309,000  |   | $ | 684,845 |   |
| Provision charged to operations |       | —                             |       | 225,000 |   |
| Losses charged to allowance     |       | —                             |       | — |   |
| Balance, end of period          |       | $                                  | 6,309,000  |   | $ | 909,845 |   |

 

**Loans ninety daysor more past due and still accruing interest:**

 
| ** **              | ** ** | **As of March  31, 2008** | ** ** | **As of March  31, 2007** | ** ** |
|-------------------------|------------|-------------------------------------|------------|------------------------------------------|------------|
|                    |       |                                |       |                                     |       |
| Number of loans         |       | —                              |       | 8                                        |       |
| Total principal balance |       | $                                   | —     |                                     | $          | 18,654,425 |   |
|                         |            |                                     |            |                                          |            |  |  |

 

Therewere no loans as of March 31, 2008 that were ninety days or more past dueand still accruing interest.

 

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**Impaired and nonaccrual loans:**

 
| ** **                                                  | ** ** | **As of March 31,** | ** ** |
|-------------------------------------------------------------|------------|------------------------------------|------------|
| ** **                                                  | ** ** | **2008**                           | ** ** | **2007** | ** ** |
| Number of loans                                             |       | 8                                  |       | 11 |   |
| Total principal balance plus advances and  accrued interest |       | $                                  | 79,523,743 |   | $ | 30,171,100 |   |
| Interest income recognized during the  quarter              |       | 1,700,234                          |       | 802,629 |   |
| Foregone interest income                                    |       | 801,011                            |       | 48,459 |   |
| Total balance of loans with specific  reserves              |       | 11,598,000                         |       | — |   |
| Specific loan loss reserve                                  |       | $                                  | 4,926,000  |   | $ | 95,000 |   |

 

At March 31,2008 and 2007, all of the impaired and non-accrual loans were in the process offoreclosure. When a loan is placed on nonaccrual status, the accrual ofinterest is discontinued; however, previously recorded accrued interest is notreversed. Payments received on impaired loans are applied to reduce principalto the extent necessary to ensure collection of principal. Subsequent paymentson these loans, and payments received on nonaccrual loans for which theultimate collectability of principal is not in doubt, are applied first toearned but unpaid interest and then to principal. Depending on the borrowers’ability to bring a loan current through payment, refinancing by a third partyor the Fund, and other legal courses of action available to the borrower andthe Fund, the foreclosure of properties may be postponed or not completed.  At March 31, 2008 and 2007 there were nooutstanding commitments to lend additional funds to borrowers whose loans wereidentified as impaired.

 

Theweighted average balance of principal plus advances and accrued interest ofimpaired and nonaccrual loans during the quarters ended March 31, 2008,and 2007 was $78,627,518 and $28,454,443, respectively.

 

**Note 6.  Real Estate Owned**

** **

At March 31,2008, the Fund held three commercial real estate properties as a result offoreclosing on the loan collateral. The Fund recorded two of the REOs at thenet realizable value of the properties at the time of foreclosure of $24,340and $4,000, respectively. The Fund is holding both properties and is fundingimprovements while actively marketing them for sale.

 

TheFund is also holding the third property and intends to fund ongoingentitlement, engineering and other site development work as it actively marketsthe property for sale. The Manager believes that the fair market value of theproperty less estimated costs to sell approximates the carrying value of theREO at March 31, 2008. The Fund’s portion of the carrying value of theproperty at the time of foreclosure was $8,553,935.

 

**Note 7.  Commitments and Contingencies**

** **

**FinancialInstruments with Off-Balance Sheet Risk**

** **

TheFund is a party to financial instruments with off-balance sheet risk in thenormal course of business in order to meet the financing needs of itsborrowers. These financial instruments include commitments to extend credit.These instruments involve, to varying degrees, elements of credit and interestrate risk in excess of the amount recognized on the balance sheet.

 

Commitmentsto extend credit are arrangements to lend to a customer as long as there is noviolation of any condition established in the contract. Commitments generallyhave fixed expiration dates or other termination clauses and may require thepayment of a fee payable to the Manager. Since some of the commitments areexpected to expire without being drawn upon and certain commitments may befunded through other resources provided by the Manager, the total commitmentamount does not necessarily represent future cash requirements to the Fund.There were no outstanding credit commitments as of March 31, 2008 or 2007.

 

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**Contingencies**

 

TheFund is subject to legal proceedings and claims that arise in the ordinarycourse of business. In the opinion of Manager, the amount of ultimate liabilitywith respect to such actions will not materially affect the financial positionor results of operations of the Fund.

 

TheFund registered under Section 12(g) of the Securities Exchange Act of1934, as amended, effective as of January 8, 2008.  The SEC has notified the Manager that it isconducting an informal inquiry relating to the Manager and the Fund in order todetermine whether there have been violations of the federal securities laws. Inconjunction with this inquiry, certain information was requested from the Fund.The Manager responded to the information requests related to the inquiry andwill continue to cooperate with the SEC in responding to its request. TheManager believes that there will not be a material impact on the Fund’sfinancial position or operations as a result of the inquiry.

 

**Note 8.  Fair Value Disclosure**

 

On January 1, 2008, theFund adopted SFAS 157, *Fair ValueMeasurements*, which defines fair value, establishes a framework formeasuring fair value, establishes a three-level valuation hierarchy fordisclosure of fair value measurement and enhances disclosure requirements forfair value measurements.  There was nocumulative effect adjustment to beginning members’ capital recorded uponadoption and no impact on the financial statements as of or during the threemonths ended March 31, 2008.  Thevaluation hierarchy is based upon the transparency of inputs to the valuationof an asset or liability as of the measurement date. The three levels aredefined as follows:

 
| Level 1: |   | Inputs to the valuation  methodology are quoted priced (unadjusted) for identical assets or  liabilities in active markets.                                                                                                                                                                                                   |
|----------|--------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|     |   |                                                                                                                                                                                                                                                                                                                               |
| Level 2: |   | Inputs to the valuation  methodology include quoted prices for similar assets and liabilities in  active markets; or, for markets that are not active, inputs that are  observable or can be corroborated for the asset or liability, either directly  or indirectly, for substantially the full term of the financial instrument. |
|     |   |                                                                                                                                                                                                                                                                                                                               |
| Level 3: |   | Inputs that are  significant to the fair value measurement valuation methodology are  unobservable and reflect the Manager’s own assumptions about the assumptions  that market participants would use in pricing assets or liabilities.                                                                                      |

 

The following is adescription of the valuation methodologies used by the Manager for instrumentsmeasured at fair value, as well as the general classification of suchinstruments pursuant to the valuation hierarchy:

 

***ASSETS***

*** ***

*Loans held for sale*

* *

Loans held for sale arerequired to be measured at the lower of cost or fair value. UnderSFAS 157, market value is to represent fair value. The market value ofloans held for sale, if any, is determined by calculating the present valueusing a discounted cash flow model. Assumptions for the model include estimatesof average life, prepayment speeds and market rates.

 

*Impaired loans*

* *

SFAS 157 requires loansto be measured for impairment using methodologies as detailed by SFAS No. 114,*Accounting by Creditors for Impairment of aLoan*(“SFAS 114”),including impaired loans measured at an observable market price (if available),discounted cash flow, or at the fair value of the loan’s collateral (if theloan is collateral dependent). Fair value of the loan’s collateral, when theloan is dependent on collateral, is determined by appraisals or independentvaluation which is then adjusted for the estimated costs to sell thecollateral.

 

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*Other Real Estate Owned*

 

Certain assetssuch as other REO are carried at the lower of cost or fair value less cost tosell.  The Company determined the fairvalue of REO at March 31, 2008 from recently obtained appraisals.

 

As of March31, 2008, the Fund had no assets or liabilities measured at fair value on arecurring basis.  Certain assets aremeasured at fair value on a nonrecurring basis. Adjustments to fair value on a nonrecurring basis generally result fromthe application of lower-of-cost-or-market accounting or write-downs ofindividual assets due to impairment.

 

The following table presentsinformation about the Fund’s assets and liabilities measured at fair value on anonrecurring basis as of March 31, 2008.

** **
| ** **              | ** ** | **Fair Value at March 31, 2008** | ** ** |
|-------------------------|------------|-----------------------------------------------------------|------------|
| ** **              | ** ** | **(Amounts in thousands)**                                | ** ** |
| ** **              | ** ** | **Total**                                                 | ** ** | **Quoted Prices in  Active Markets  for Identical  Assets (Level 1)** | ** ** | **Significant Other  Observable Inputs  (Level 2)** | ** ** | **Significant Unobservable  Inputs (Level 3)** | ** ** |
|                    |       |                                                      |       |   |   |   |   |   |   |   |   |   |
| Impaired loans          |       | $                                                         | 71,139,000 |   | — |   | $ | 57,637,000 |   | $ | 13,502,000 |   |
| Other real estate owned |       | $                                                         | 8,582,275  |   | — |   | $ | 8,582,275 |   | $ | — |   |
|                         |            |                                                           |            |  |  |  |  |  |  |  |  |  |  |  |  |

 

Level 2 impaired loans arecommercial real estate secured by collateral with fair values estimated byappraisals; REO market value is estimated by appraisals.

 

***LIABILITIES***

*** ***

The Fund did not identifyany liabilities that are required to be presented at fair value.

 

**Note 9.  Due From/To Related Parties**

** **

**Due from relatedparties consisted of the following as of:**

 
| ** **                                        | ** ** | **March 31, 2008** | ** ** | **December 31, 2007** | ** ** |
|---------------------------------------------------|------------|------------------------------|------------|---------------------------------|------------|
| Loans Receivable from Manager (Note 4)            |       | $                            | 8,641,763  |                            | $          | 8,598,011 |   |
| Due from Manager                                  |       | 1,976,288                    |       | 1,484,497                       |       |
| Due from other funds serviced by Manager          |       | 53,853                       |       | —                          |       |
| Due from escrowed interest reserve trust  account |       | —                       |       | 48,750                          |       |
|                                              |       | $                            | 10,671,904 |                            | $          | 10,131,258 |   |

 

**Due to relatedparties consisted of the following as of:**

 
| ** **                             | ** ** | **March 31, 2008** | ** ** | **December 31, 2007** | ** ** |
|----------------------------------------|------------|------------------------------|------------|---------------------------------|------------|
| Servicing fees payable to Manager      |       | $                            | 328,203    |                            | $          | 121,547 |   |
| Due to other funds serviced by Manager |       | 332,695                      |       | 136,561                         |       |
|                                   |       | $                            | 660,898    |                            | $          | 258,118 |   |

 

**Notes payable andaccrued interest to related parties:**

 
| ** **                                               | ** ** | **March 31, 2008** | ** ** | **December 31, 2007** | ** ** |
|----------------------------------------------------------|------------|------------------------------|------------|---------------------------------|------------|
| Note payable to CMR Income Fund LLC,  principal          |       | $                            | 20,199,951 |                            | $          | 21,181,768 |   |
| Accrued interest on note payable to CMR  Income Fund LLC |       | 168,950                      |       | 213,862                         |       |
|                                                     |       | $                            | 20,368,901 |                            | $          | 21,395,630 |   |

 

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**Notes payable torelated parties – real estate owned:**

 
| ** **                                             | ** ** | **March 31, 2008** | ** ** | **December 31, 2007** | ** ** |
|--------------------------------------------------------|------------|------------------------------|------------|---------------------------------|------------|
| Note payable to CMR Fund, LLC                          |       | $                            | 275,000    |                            | $          | 275,000 |   |
| Note payable to CMR Fund III, LLC                      |       | 1,590,000                    |       | 1,590,000                       |       |
| Notes payable to direct investors serviced  by Manager |       | 4,135,000                    |       | 4,135,000                       |       |
|                                                   |       | $                            | 6,000,000  |                            | $          | 6,000,000 |   |

 

In June 2007,the Fund foreclosed on its lien junior to a $6,000,000 note serviced by theManager on behalf of Fund I, Fund III and others for whom the Manager providesloan servicing. As owner of the property, the Fund is making payments on thesenior note to protect its equity in the property until such time as it sellsthe asset. The Fund recorded interest expense of $187,500 on this note duringthe quarter ended March 31, 2008.

 

**Note 10.  Subsequent Events**

 

***Subsequent delinquency experience***

 

Since March 31,2008, delinquencies in the Fund’s portfolio have increased as shown below.

 
| **Delinquent Status** | ** ** | **Outstanding Loan  Balance at  March 31,  2008** | ** ** | **Percent of Total  Balance at  March 31, 2008** | ** ** | **Outstanding Loan  Balance at  August 31, 2008** | ** ** | **Percent of Total  Balance at  August 31, 2008** | ** ** |
|----------------------------|------------|----------------------------------------------------------------------------|------------|---------------------------------------------------------------------------|------------|-----------------------------------------------------------------------|------------|----------------------------------------------------------------------------|------------|
| 30 – 59 Days          |       | $                                                                          | 2,584,000  |                                                                      | 3          | %                                                                     | $          | —                                                                     |       | 0 | % |
| 60 – 89 Days          |       | 48,957,000                                                                 |       | 47                                                                        |       | 12,718,258                                                            |       | 13                                                                         |       |
| 90+ Days                   |       | 19,598,000                                                                 |       | 19                                                                        |       | 73,948,424                                                            |       | 74                                                                         |       |
| Total                      |       | $                                                                          | 71,139,000 |                                                                      | 69         | %                                                                     | $          | 86,666,682                                                                 |       | 87 | % |

 

Delinquencieswithin the loan portfolio increased $15.5 million from March 31, 2008 to August 31,2008.  This increase resulted primarilyfrom two loans to the same borrower totaling $12.7 million which became 60 - 89days delinquent as of August 31, 2008, and one loan totaling $2.9 millionwhich became 90+ days delinquent as of August 31, 2008.  In addition, three loans totaling $51.6million that were 30 to 59 days delinquent on March 31, 2008, became 90+days delinquent as of August 31, 2008.

 

**Realestate foreclosures**

** **

*HonoluluLoan*:  As of June 30,2008, the Fund held a $3,043,447 interest in a loan with a principal balance of$37,670,560 million and bearing interest at a rate of 13% per annum for whichthe borrower was in default.  This loanis a junior portion of a $97,900,000 original loan facility and is junior to a$55,000,000 senior position held by an entity unaffiliated with the Fund or theManager.  The security for the loan is approximately 161 acres ofresidentially zoned property. The borrower has defaulted on both the senior andthe Fund’s junior note. The Manager is currently conducting negotiations withthe borrower and the holder of the senior participation to assume the debtservice payments under the senior participation and to acquire ownership of thecollateral. The Fund’s pro rata share of the debt service payments under thesenior participation totals approximately $62,000 per month (11.3% of the total$550,000) although the Fund may advance more or less than its pro rata share ofthis payment.  Under an agreement amongthe various participating funds, these advances will have a priority repaymentposition relative to loan principal and interest earned thereon. On March 11,2008, the Manager paid an extension fee of $1,375,000 to the senior lender onbehalf of the funds it manages that participate in this loan.  The Manager also paid an extension fee of$90,000 to a third party lender participating in the junior note.  The Fund’s pro rata share of these paymentswas approximately $128,000.

 

*Northern California Mixed-Use Portfolio Loan:* As of March 31, 2008, the Fund held $10,600,000 in loans secured by 22different properties on a basis junior to liens securing $19,093,165 of seniorloans. These senior loans included one owned by two other funds managed by theManager, in the principal amount of $8,363,020. Another loan in the amount of$2,098,145 is held by another fund managed by the Manager, and the remaining$8,632,000 represents third party senior liens, which are in first position onseveral of the properties securing the 

 

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Fund’s $10,600,000 loan position.  On April 9,2008, the Manager, on the Fund’s behalf, completed foreclosure sales andacquired 20 of the 22 properties.  Theestimated net realizable value of these foreclosed properties was $24,300,000,net of $8,416,000 in amounts owed to senior lien holders. In June, one of thetwo remaining properties was lost as a result of foreclosure by the holder of asenior lien, and the borrower on the other property filed bankruptcy. Theestimated net realizable value of this remaining property is $507,000, net of$2,200,000 in amounts owed to senior lien holders. As a result of the shortfallin net realizable value compared with the outstanding balances owed to the Fundon these collateral dependent loans, the Fund recorded loan charge-offs in theamount of $600,000 as of April 9, 2008. In June, the Fund sold one of the properties that had been acquired on April 9,2008 and received $637,000 in net proceeds from the sale, including a notereceivable note in the amount of $467,000.

 

*Fremont REOSale:* The Fund’s interest in a light industrialbuilding located in Fremont, California with approximately 45,000 square feetwas acquired as REO in July 2006.  OnDecember 31, 2006, the Manager bought the property from the Fund for$6,000,000, which represented the carrying value of the REO, plus the provisionfor loan loss of $1,400,000 recorded at the time of foreclosure.  The Manager paid 10% of the purchase price incash and delivered the Fund a note for the balance.  In December 2007, the Manager paid down$600,000 of principal on the note, which allowed the Fund to recognize a gainunder the installment method of accounting of $1,300,000.  The Manager sold the property on July 1, 2008for $4,430,000.  Because the saleproceeds were less than the Manager’s note to the Fund, the Fund now holds anunsecured note receivable from the Manager in the amount of $670,854 at August31, 2008.

 

**Contributionagreement**

** **

***Contribution Agreement with Sole Director of the Manager***

*** ***

On April 11,2008, David Choo, the sole director of the Manager, executed a ContributionAgreement with the Fund and certain other entities that the Manager sponsors.Pursuant to the Contribution Agreement, Mr. Choo agreed to use hisdiligent good faith and best efforts to sell, or cause to be sold, certainproperties that he owns or controls, and to contribute or advance $5,000,000 tothe Manager to be used to pay notes and other obligations of the Manager,including obligations the Manager has to the Fund and other entities. Theagreement also commits Mr. Choo to fund an operating reserve of at least$1,500,000 to be used solely for the Manager’s operating costs and overhead.The agreement further provides that until the maximum funding requirementsdescribed above and detailed in the Contribution Agreement are satisfied, asubstantial portion of any net cash sales proceeds remaining be held by Mr. Chooor the Manager, such that they remain available to the Manager, the Fund andthese entities as reasonably required to pay the Fund’s and their currentoperating expenses and otherwise remain solvent.

*** ***

**Suspension ofdistribution payments and redemptions**

** **

In aneffort to conserve cash for debt service on senior liens which encumberproperties collateralizing loans made by the Fund, the Manager, on March 31,2008, suspended indefinitely monthly cash distributions of net income andmembers’ redemptions.  As of March 31,2008 and August 31, 2008, outstanding member redemption requests totaled$24,598,595 and $35,812,117, respectively.

 

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## **Item 2.**                                                           Management’s Discussion andAnalysis of Financial Condition and Results of Operations

##  

**FORWARD-LOOKINGSTATEMENTS**

** **

*This Quarterly Report on Form 10-Q, including particularly**the Management’s Discussion and Analysis ofFinancial Condition and Results of Operations (“MD&A”)  contains “forward-looking” statements withinthe meaning of the Private Securities Litigation Reform Act of 1995, whichprovides a “safe harbor” for statements about future events, products andfuture financial performance that are based on the beliefs of, estimates madeby and information currently available to the management of CMR Mortgage FundII, LLC (“we,” “our” or the “Company”). The outcome of the events described inthese forward-looking statements is subject to risks and uncertainties. Actualresults and the outcome or timing of certain events may differ significantlyfrom those projected in these forward-looking statements due to the factorslisted under “Risk Factors,” in our Annual Report on Form 10-K for theyear ended December 31, 2007 (the “2007 Annual Report”)  and from time to time in our other filingswith the Securities and Exchange Commission (“ SEC”). For this purpose, statementsconcerning future liquidity, interest rates, availability of mortgage credit,and economic conditions and their effect on us and our assets, trends in realestate markets in which we do business, future loan payoffs, foreclosures andvalue recovered from property sales, estimates as to the allowance for loanlosses and the valuation of real estate held for sale, our growth and estimatesof future member distributions or redemptions, as well as actions expected tobe taken by California Mortgage and Realty, Inc., (the “Manager”)  and David Choo, the sole director of theManager; and any statements using the terms “believe,” “expect,” “expectation,”“anticipate,” “can,” “should,” “would,” “could,” “estimate,” “appear,” “basedon,” “may,” “intended,” “potential, “are emerging” and “possible” or similarstatements are forward-looking statements that involve risks and uncertaintiesthat could cause our actual results and the outcome and timing of certainevents to differ materially from those projected or management’s currentexpectations.  By making forward-lookingstatements, we have not assumed any obligation to, and you should not expect usto, update or revise those statements because of new information, future eventsor otherwise.*

 

Thefollowing discussion is designed to provide a better understanding ofsignificant trends related to our financial condition and results ofoperations. The discussion should be read in conjunction with our financialstatements and notes thereto appearing elsewhere in this Quarterly Report on Form 10-Qand in the 2007 Annual Report, including Management’s Discussion and Analysisof Financial Condition and Results of Operations contained in the 2007 AnnualReport.

 

***Overview***

*** ***

We are a California limited liability company organized for the purposeof making or investing in business loans secured by deeds of trust or mortgageson real properties located primarily in California. The loans are arranged andserviced for us by the Manager. We previously funded our lending activities throughloan pay downs or pay offs, as well as by selling our membership interests, andby selling all or a portion of our interests in the loans to individualinvestors.  We commenced operations in February 2004.  We ceased accepting new members in the thirdquarter of 2006 and are unlikely to accept new members for the foreseeablefuture, if ever.

 

All ofour loans are fixed-rate mortgage loans. Interest that we earn on our loans hasbeen and is expected to continue to represent our primary source of revenue solong as loan defaults by our borrowers do not ultimately result in significantforeclosure of the underlying property collateral. In the case of real estateowned (“REO”), revenue, gains or losses would result from the operation of theproperty and/or its sale.

 

Generallyspeaking, the underwriting by the Manager focuses primarily on the value of thecollateral securing the loan, and secondarily on the general creditworthinessand reputation of the borrower. The collateral is generally real property—predominantlyland held by businesses or individuals, or commercial buildings. As a result ofthe nature of our underwriting and lending, our business model generallyresults in higher delinquency and foreclosures than experienced by conventionalcommercial mortgage lenders. In the difficult present economic environment,generally, and given the lack of liquidity and the unprecedented turmoil in thecapital markets and the 

 

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gridlock in the real estate markets, specifically,there are presently significant risks of losses and higher charge-offs.  In addition, certain loans have been and willbe written down in value to reflect what we believe may be risks to fullrecovery of the loan amount.

 

Ourcurrent operating results are primarily affected by:

 

·                  the level of loan losses experienced,including the gains and losses from the operation and/or disposition offoreclosed properties;

·                  general national and local economicconditions and trends that influence the real estate investment industry,investment activity and property prices which in turn impact the demand for thefinancing of real estate investments;

·                  the amount of funding availablethrough borrowing; and

·                  our operating costs, which consist ofamounts paid to the Manager (servicing and asset management fees) andprofessional services, primarily legal, accounting, audit and tax.

 

Formany commercial property types, such as apartment buildings, office buildings,hotels and retail buildings, values have generally risen over the past fiveyears, through the third quarter of 2007. During the same period,capitalization rates, a popular method of valuing income properties, decreasedto their lowest levels in decades. As capitalization rates decrease, propertyvalues increase since the same net income results in higher valuations.

 

InCalifornia and some other states, office properties increased in valuesignificantly through the third quarter of 2007, resulting in part from lowvacancy rates and rising rental rates. Hotels also experienced higher occupancyand average daily rates, increasing their values. Apartment values rose withhigher occupancy rates and, in some areas, a significant interest frominvestors competing to purchase well-located buildings for conversion tocondominiums.

 

Thecommercial property markets also experienced unprecedented demand frominvestors and lenders through the third quarter of 2007. Many of theseinvestors and lenders came from overseas as the global economy expandedresulting in sizable amounts of liquidity in the real estate, private equityand financial markets.

 

Thestrong increase in property values, the falling capitalization rates, theincreased number of other lenders engaged in our type of mortgage lending andthe general availability of credit and liquidity resulted in a very competitivelending environment over the past several years, through the third quarter of2007. Home prices throughout the United States also had risen dramaticallybeginning in the last half of the 1990s and continuing through 2006.

 

The Managerhas always believed in the cyclical nature of the real estate market and thatdownturns, such as that which began in the residential area after 2006 and inthe commercial real estate market after the third quarter of 2007 areinevitable.  Since the third quarter of2007, commercial real estate values have generally fallen. In addition, therehave been unprecedented dislocations in the credit markets negatively affectingnot only mortgage lending but also corporate financing and consumer lending,creating a general lack of liquidity for many financial institutions.

 

Due tothe significance of loans collateralized by land held for residentialdevelopment, the reversal in housing markets and the recent turmoil of thecapital markets, particularly those elements that provide funding to subprime,Alt-A, and prime jumbo (non-conforming) lenders and borrowers, are expected tochallenge our results of operations and cash flows.  Housing prices are generally declining; withmuch of the larger declines in California, Nevada, Florida and Arizona. Takentogether, the slow home absorption rates and an increasing inventory of vacantdeveloped lots are creating financial difficulties and an uncertain future forthe home builders and land developers who are our borrowers.  There is no way to predict when conditionswill improve.

 

Thegeneral decline in value of land held for residential development is in somecases offset to varying degrees by an increase in value attributed to progresson land development, such as annexation by a town or municipality or grantingof entitlement or development approvals and/or building permits which moves theproject 

 

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closer to a stage where lots can be sold, individuallyor in bulk.  Several of the loans in ourportfolio have moved forward in their entitlement process and this has servedto offset the general overall decline in land values in these specific cases.

 

TheManager reviews the collateral value for each project in making thedetermination to recognize in the current period interest income for financialreporting and to determine if adjustments to the allowance for loan lossesand/or adjustments to the carrying values of REO are required. However, becausethe number of commercial real estate sales and financings dropped dramaticallyduring the past year, it is difficult to ascertain actual current market valuesof commercial real estate.  The lack ofavailability of real estate financing and the fact that sellers are unwillingto sell at what may be significantly lower prices has led to gridlock in thereal estate markets.

 

As described in the 2007 Annual Report, there are indications that landvalues have dropped quickly and reached prices at which buyers are prepared tobuy and sellers are prepared to sell. The sales prices have reflected deep discounts to previously statedvalues.  In our portfolio of land loansand considering valuation from this perspective, we have noted a substantialincrease in loan-to-value ratios, however, we have only identified a limitednumber of loans in which the amounts owed to us exceed the collateral values.Furthermore, if we acquire title to the underlying land collateral as a resultof foreclosure, it is not our general intent to quickly sell into a depressedmarket and realize potential losses.  Webelieve that holding onto land in a depressed market would allow us to realizehigher prices as the economy and real estate markets, including those for land,stabilize and transaction volumes increase. Our ability to do so, however, depends on maintaining a continuedforbearance from Wells Fargo Foothill, Inc. (“Wells Fargo Foothill”) andCMR Income Fund, LLC (“Income Fund”) and our access to funds that aresufficient to keep senior loans current, make other advances to protect ourinterests, and support our ongoing operations.

 

***Liquidityand Capital Resources***

*** ***

Ourfinancial statements have been prepared assuming that we will continue as agoing concern.  However, our independentregistered public accounting firm has included in its audit report on ourfinancial statements for our fiscal years ended December 31, 2007 and2006, a going-concern explanatory paragraph indicating that we have experienceda significant decrease in cash flows. In addition, a number of our loans are indefault. Our illiquid position may prevent us from protecting our position withrespect to the property securing the defaulted loans.  In addition, we were in default on a loancollateralized by a significant portion of the loan portfolio. These conditionscause substantial doubt about our ability to continue as a going-concern.  By issuing an opinion stating that there issubstantial doubt about our ability to continue as a going concern, ourauditors have indicated that they are uncertain as to whether we have theability to continue our operations without additional funding.

 

Ourcurrent primary sources of on-going, long-term liquidity and capital are loaninterest received, loan payoffs and REO sales. Short-term liquidity needs are met by selling both partial and wholeinterests in loan investments.  Member redemptionsare subject to waiting periods, may be limited to available cash and may becapped at 10% of aggregate members’ capital accounts over any 12-monthperiod.  Early in our operating history,loan payoffs were received regularly and redemption requests could and would bemet in less than 60 days. More recently, loan duration, defaults andforeclosures have been increasing due to constriction in liquidity as a resultof the turmoil in the capital markets and the overall downturn in real estatesales transactions.  Additionally, weexperienced an increase in member redemption requests associated with thegeneral market uncertainty and the downturn in the real estate market in2007.  Due to this slow down in payoffsand the increase in redemption requests, the time from the date of the redemptionrequest to actual redemption lengthened and redemptions were in factindefinitely suspended on March 31, 2008. Monthly cash distributions of our net income were also suspended. Anyloan pay downs and interest received will be applied to build cash reserves forpayments due on senior debt and operating costs, and then to cash distributionsand redemption requests, and only after these are satisfied to investment inloan interests.

 

Netcash used by financing activities totaled $1.9 million in the first threemonths of 2008 compared to net cash used by financing activities of $5.4million in the first three months of 2007. The net change of $3.5 million wasprimarily the result of a decline in distributions to members of $3.8 million,partially offset by $0.3 million in cash capital contributions provided fromnew and existing members during the first three months of 2007. 

 

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Distributions to members totaled $0.6 million in thefirst three months of 2008 and $4.8 million in the first three months of2007.

 

Investingactivities provided cash totaling $0.4 million in the first three months of2008 compared to cash used of $0.9 million in the first three months of2007. The net increase of $1.3 million resulted from a $1.0 decrease inadvances to borrowers during the first three months of 2008 compared with a$0.9 million increase in advances to borrowers in the first three months of2007, and a $0.6 million increase in loan balances in the first three months of2008.  New loan originations used $2.3million of cash in the first three months of 2007, whereas there were no newloans made in the first three months of 2008.

 

Operatingactivities provided cash of $0.1 million in the first three months of 2008, a$2.2 million net decrease from the $2.3 million of cash provided in the firstthree months of 2007. The decrease was comprised of a net increase of $1.1million in amounts due from related parties, and an increase of $0.8 million inaccrued interest receivable, a decrease of $0.1 million in net income, and adecrease of $0.2 million in specific loan loss reserves.

 

Ourcash and cash equivalents amounted to $37,217 at March 31, 2008, comparedto $1.5 million at December 31, 2007, a level insufficient to fund memberdistributions or to provide for loan payments necessary to prevent foreclosureby senior lien-holders, or otherwise provide for payment of taxes, insurance orother expenses on properties securing our loans. To generate liquiditysufficient to provide for these latter amounts requires that interest be timelycollected, that loans be repaid, or that we sell some of our loans or interestsin some of our loans, or collect receivables or borrow from the Manager orthird parties.

 

Oursignificant obligations at that date consisted of our $20.4 million promissorynote to Income Fund bearing interest at 6.94% and a $6.0 million senior notebearing interest at 12.5% to which an REO was subject when we foreclosed.  See Notes 3 and 4 to the Notes to theCondensed Financial Statements.  At March 31,2008, unfilled redemption requests amounted to $24.6 million compared to $0.6million at March 31, 2007.

 

Currently,we must depend on sales of foreclosed properties and any support we receive asa result of the Contribution Agreement described below to meet cash needs andto continue operations.  The Managerinitiated the following actions in response to these unprecedented marketconditions to conserve cash and build cash reserves:

 

·                  Commencing in January 2008, theManager set monthly distributions a an amount equal to the amount of net income(as compared to the targeted return as was done in prior periods).

·                  On March 31, 2008, the Managersuspended indefinitely monthly cash distributions of net income and members’redemptions.

·                  On April 11, 2008, David Choo,the sole director of the Manager, executed a Contribution Agreement with us andcertain other entities that the Manager sponsors, pursuant to which Mr. Chooagreed to use his diligent good faith and best efforts to sell or cause to besold certain properties that he owns or controls and to contribute or advance$5.0 million to the Manager to be used to pay notes and other obligations ofthe Manager, including obligations the Manager has to us and otherentities.  The agreement also commits Mr. Chooto fund an operating reserve at the Manager of at least $1.5 million to be usedsolely for the Manager’s operating costs and overhead.  The agreement further provides that until themaximum funding requirements described above and detailed in the ContributionAgreement are satisfied, a substantial portion of any net cash sales proceedsremaining be held by Mr. Choo or the Manager such that they remainavailable to the Manager and us and these entities as reasonably required topay our and their current operating expenses and otherwise remain solvent.

·                  The Manager is continuing a programbegun in the third quarter of 2006 to pursue an assertive collection process,including timely filing of a notice of default (generally within two days afterthe second missed payment – or sooner), timely filing of notice of foreclosuresale (generally as soon as permitted by law or regulation), preparing inadvance of the foreclosure sale to market aggressively the collateral/realestate taken back (including interviewing and retaining brokers) and filinglegal claims against the borrower/guarantors. As an alternate collectionstrategy we have, when appropriate, entered into formal forbearance agreementswith specific borrowers which require the borrower to perform specific actionswithin agreed upon timeframes. These actions may include making partial loan 

 

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payments, providingadditional collateral, listing the property for sale, or entering property salecontracts with the objective of full payoff or reinstatement of our loan.

·                  The Manager is negotiating activelywith third-party, senior lienholders to forebear and/or reduce payments owingfrom the borrower.

·                  The Manager sold propertiescollateralizing the notes owing by the Manager to us at a loss on sale (borneby the Manager) to raise cash for us. These transactions closed on April 25, 2008 and July 1, 2008and generated cash totaling $4.4 million for us.

 

Theabove actions, taken together, bolster our cash resources and improve thelikelihood of our continuing operations, including our ability to meet the debtservice on loans with liens senior to ours, through December 31, 2008.  As noted elsewhere, we are dependent on therepayment of loan principal and sale of REO to continue operations through 2008into 2009 and beyond, including eventual resumption of distributions. TheManager has had certain of the collateral securing our loans (with the consentand cooperation of the borrower) and most of our REO listed with nationallyrecognized and otherwise experienced brokers with strong presence in theapplicable local markets and experience with the collateral type (*e.g*., land held for residential development in Hawaii orland held for commercial development in Southern California).These brokers arediligent and committed to completing a transaction, but caution againstforecasting the timing and pricing of a transaction in a historicallylow-volume market with limited credit financing available.  The dislocations and uncertainty in thecapital and real estate markets have created a challenging environment whichmay continue through 2008 into 2009 and may necessitate further liquidations ofassets at sub-optimum prices, particularly if conditions deteriorate further.

 

***Resultsof Operations***

*** ***

Setforth below are summaries of our financial results for the three months ended March 31,2008 and 2007.

 
| ** **                                        | ** ** | **Three  Months  Ended  March 31,  2008** | ** ** | **Percent of  Revenues,  net** | ** ** | **Three  Months  Ended March  31, 2007** | ** ** | **Percent of  Revenues,  net** | ** ** |
|---------------------------------------------------|------------|------------------------------------------------|------------|-------------------------------------|------------|----------------------------------------------------|------------|-------------------------------------|------------|
| Revenues:                                         |       |                                           |       |                                |       |                                               |       |                                |       |
| Interest income:                                  |       |                                           |       |                                |       |                                               |       |                                |       |
| Interest on loans                                 |       | $                                              | 2,539,978  |                                | 96.6       | %                                                  | $          | 3,375,270                           |       | 117.2 | % |
| Interest on notes receivable – related party |       | 135,334                                        |       | 5.1                                 |       | —                                             |       | —                              |       |
| Interest on advances to borrowers                 |       | 226,794                                        |       | 8.6                                 |       | 72,636                                             |       | 2.5                                 |       |
| Other interest income                             |       | 198,639                                        |       | 7.6                                 |       | 249,098                                            |       | 8.6                                 |       |
| Total interest income                             |       | 3,100,745                                      |       | 117.9                               |       | 3,697,004                                          |       | 128.3                               |       |
| Less: Loan servicing fees                         |       | 471,586                                        |       | 17.9                                |       | 816,026                                            |       | 28.3                                |       |
| Total interest income, net of servicing  fees     |       | 2,629,159                                      |       | 100.0                               |       | 2,880,978                                          |       | 100.0                               |       |
|                                              |       |                                           |       |                                |       |                                               |       |                                |       |
| Interest expense                                  |       | 562,879                                        |       | 21.4                                |       | 810,656                                            |       | 28.1                                |       |
| Interest expense – related party             |       | 187,500                                        |       | 7.1                                 |       | —                                             |       | —                              |       |
|                                              |       |                                           |       |                                |       |                                               |       |                                |       |
| Provision   for loan losses                  |       | —                                         |       | —                              |       | 225,000                                            |       | 7.8                                 |       |
| Net revenues                                      |       | 1,878,780                                      |       | 71.5                                |       | 1,845,322                                          |       | 64.1                                |       |
| Operating expenses:                               |       |                                           |       |                                |       |                                               |       |                                |       |
| Asset management fees                             |       | 78,519                                         |       | 3.0                                 |       | 251,094                                            |       | 8.7                                 |       |
| Professional services                             |       | 446,050                                        |       | 17.0                                |       | 99,790                                             |       | 3.5                                 |       |
| Other operating expenses                          |       | 17,548                                         |       | 0.7                                 |       | 3,451                                              |       | 0.1                                 |       |
| Total operating expenses                          |       | 542,117                                        |       | 20.6                                |       | 354,335                                            |       | 12.3                                |       |
| Net income                                        |       | $                                              | 1,336,663  |                                | 50.8       | %                                                  | $          | 1,490,987                           |       | 51.8 | % |

 

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*Revenues, Net of Servicing Fees*

* *

Totalinterest income amounted to 117.9% of total revenues, net of servicing fees, inthe first three months of 2008 and 128.3% in the first three months of 2007.Interest income totaled approximately $3.1 million in the first threemonths of 2008, a $0.6 million (16.1%) decrease over the first three months of2007. The decrease in interest income was due to the overall decrease in thelevel of earning assets which resulted both from a $51.8 million (200.4%)increase in non-accrual loans and an increase of $8.6 million in REO betweenthe 2007 and 2008 periods.  Non-accrualloans totaled $23.6 million at March 31, 2008 and $3.1 million at March 31,2007.  REO totaled $8.6 million at March 31,2008 as compared to none at March 31, 2007.

 

Theyield on loans and advances in the first three months of 2008 was 10.75% onaverage loans and advances of $108.0 million (loans: $103.0 million plusadvances: $5.0 million) compared to 12.00% in the first three months of 2007 onaverage loans and advances of $114.9 million (loans: $113.4 million plusadvances: $1.6 million).  The decline of125 basis points is primarily attributable to the increase in loans onnon-accrual status.

 

Loanservicing fees decreased to approximately $0.5 million in the first threemonths of 2008 (a decrease of $0.3 million or 42.2%) from $0.8 million inthe first three months of 2007. The decrease is primarily due to an increase inloans on non-accrual status.  Loanservicing fees were 2% of the principal of each loan and were paid as interestincome was received.

 

*Interest Expense*

* *

Interestexpense (including related party interest expense) in the first three months of2008 was approximately $0.8 million a decrease of $0.1 million from thefirst quarter of 2007. The decrease was due to a decline in the one month LIBORinterest rate on the $20.4 million note payable to Income Fund, which resultedin lower overall interest expense of $0.2 million and a reduction in loan feeamortization of $0.1 million.  Theeffective rate of this borrowing was 9.64% during the first quarter of 2008, ascompared to 11.58% in the first quarter of 2007.  This decrease was partially offset by a $0.2million increase in interest expense in the first three months of 2008associated with the $6.0 million note payable to other parties related to theManager, secured by our REO.  Theeffective rate of this borrowing was 12.50%. In addition, debt service payment to holders of external senior debtliens on properties collateralizing junior lien positions in the amount of$29,607 was also made during the first three months of 2008.

 

*Provision for Loan Losses*

* *

Theprovision for loan losses decreased $0.2 million in the first quarter of 2008from the first quarter of 2007. The decrease resulted from a $.2 milliondecrease in provisions made for specific loan loss reserves.

 

*Operating Expenses*

* *

Operatingexpenses increased $.2 million (53.0%) during the first three months of 2008compared to the first three months of 2007. The increase resulted from anincrease of $0.4 million in professional services due to increases in legal andaccounting fees associated with the 2007 Annual Report, SEC inquiry, and compliancerelated  matters. This increase waspartially offset by a $0.2 million decrease in asset management fees resultingfrom the Manager’s forgoing of these fees in the first two months of 2008.

 

*Net Income*

* *

Netincome in the first three months of 2008 was approximately $1.3 million, a$.2 million (10.4%) decrease from the $1.5 million recorded in thefirst three months of 2007.

 

***LendingCapacity and Assets***

** **

Ourlending capacity at March 31, 2008 was $90.2 million (members’ capital of$88.4 million and notes payable of $26.4 million, less pending redemptions of$24.6 million), nearly all of which had already been loaned. 

 

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Cash and equivalents ($37,217), loans and notesreceivable ($96.6 million), advances ($4.9 million), and REO ($8.6 million)were $110.2 million or 122.2% of available capacity.  The lending capacity at March 31, 2007was $119.8 million (members’ capital of $96.0 million and notepayable of $24.4 million, less pending redemptions of $0.6 million),nearly all of which had already been loaned. Cash and equivalents ($0.3million), loans ($115.3 million) and advances ($2.7 million) were$118.3 million or 98.7% of available capacity.  We are no longer accepting new members atthis time.  Future lending capacity, ifany, will come from reinvestment of earnings and additional contributions fromexisting members and from borrowings.

 

***LoanPortfolio and Asset Quality***

** **

As of March 31,2008 and 2007, our mortgage investments aggregated $103.0 million and $117.4million, respectively. The average loan and advance balance was $107.9 millionas of March 31, 2008 and $119.4 million as of March 31, 2007.

 

Approximately$19.6 million (19%) and $18.7 million (16%) of the loans we invested in weremore than 90 days delinquent in monthly payments as of March 31, 2008and March 31, 2007, respectively. Of these loans, the amounts attributableto borrowers who filed bankruptcy were approximately $10.6 million (10%) as of March 31,2008 and $10.9 (9%) as of March 31, 2007. Subsequent to March 31,2008, one loan totaling approximately $0.8 million as of March 31, 2008,was paid off in full and no other partial pay downs on the loan was received.

 

As of March 31,2008 and 2007, we held the following types of mortgages.

 
| ** **                         | ** ** | **March 31,  2008** | ** **  | **March 31,  2007** | ** ** |
|------------------------------------|------------|--------------------------|-------------|--------------------------|------------|
| First Trust Deeds                  |       | $                        | 11,806,087  |                     | $          | 76,701,725 |   |
| Second Trust Deeds                 |       | 4,110,573                |        | 21,085,000               |       |
| Third Trust Deeds                  |       | 13,791,744               |        | 19,575,744               |       |
| Mixed Trust Deeds                  |       | 73,250,230               |        | —                   |       |
| Total (1)                          |       | $                        | 102,958,634 |                     | $          | 117,362,469 |   |
|                               |       |                     |        |                     |       |
| Commercial Real Estate             |       | $                        | 13,323,576  |                     | $          | 17,168,000 |   |
| Residential Real Estate            |       | 3,103,573                |        | 3,200,000                |       |
| Land                               |       | 86,491,485               |        | 96,994,469               |       |
| Mixed-Use Properties               |       | 40,000                   |        | —                   |       |
| Total Outstanding Loan Balance (1) |       | $                        | 102,958,634 |                     | $          | 117,362,469 |   |

 

----

(1)          For financial reportingpurposes the Total Outstanding Loan Balance is presented net of the allowancefor loan losses and the amounts in trusts for interest reserves and futureadvances; it is presented on a gross basis in this table.

 

***AssetQuality***

** **

Aconsequence of originating or investing in loans is that losses may occur. Theactual amount of such losses, if any, may vary from time to time. Factors thataffect such potential risks include general economic conditions of the realestate market as well as specific conditions in a particular sub-market (*e.g.*, land development), availability offunds in the capital market, and the experience and expertise of the borrower.While many of these factors are beyond the control of the Manager, they can bemonitored and used by the Manager in assessing potential risks.

 

TheManager also estimates at least quarterly, the value of the collateralunderlying the loans, the cost to dispose of the property, and the costs tomaintain the property, including insurance and payments made to retaindevelopment rights and entitlements. As necessary, provisions are made for loanlosses to adjust the allowance for 

 

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loan losses to an amount considered by the Manager tobe adequate, with due consideration for the value of the properties securingthese loans (estimated based on information available in the real estate marketincluding appraisals and reviews of similar properties), to provide forprobable losses on loans and receivables, including impaired loans, otherloans, accrued interest, late fees and advances on loans and other accountsreceivable (unsecured).

 

Loanlosses deemed to be uncollectible are charged against the allowance for loanlosses. Recoveries of previously written off amounts are credited to theallowance for loan losses.  The Managerbelieves that the allowance for loan losses of $6.3 million at March 31,2008 was adequate in amount to cover probable losses.

 

Changesin the allowance for loan losses for the three months ended March 31, 2008and 2007 were as follows.

 
| ** **                      | ** ** | **Three Months Ended  March 31,** | ** ** |
|---------------------------------|------------|--------------------------------------------------|------------|
| ** **                      | ** ** | **2008**                                         | ** ** | **2007** | ** ** |
| Balance, beginning of period    |       | $                                                | 6,309,000  |   | $ | 684,845 |   |
| Provision charged to operations |       | —                                           |       | 225,000 |   |
| Losses charged to allowance     |       | —                                           |       | — |   |
| Balance, end of period          |       | $                                                | 6,309,000  |   | $ | 909,845 |   |

 

**Mortgage Loan Delinquencies**

 
| **Delinquent  Status** | ** ** | **Outstanding  Loan Balance  at March 31,  2008** | ** ** | **Percent of  Total  Balance at  March 31,  2008** | ** ** | **Outstanding  Loan Balance  at December  31, 2007** | ** ** | **Percent of  Total  Balance at  December  31, 2007** | ** ** | **Outstanding  Loan Balance  at March 31,  2007** | ** ** | **Percent of  Total  Balance at  March 31,  2007** | ** ** |
|------------------------|------------|------------------------------------------------------------------|------------|-------------------------------------------------------------------|------------|---------------------------------------------------------------------|------------|----------------------------------------------------------------------|------------|------------------------------------------------------------------|------------|-------------------------------------------------------------------|------------|
| 30 – 59 Days      |       | $                                                                | 2,584,000  |                                                              | 3          | %                                                                   | $          | 0                                                                    |       | 0                                                                | %          | $                                                                 | 0          |   | 0 | % |
| 60 – 89 Days      |       | 48,957,000                                                       |       | 47                                                                | %          | 10,254,290                                                          |       | 10                                                                   | %          | 8,030,000                                                        |       | 7                                                                 | %          |
| 90+ Days               |       | 19,598,000                                                       |       | 19                                                                | %          | 21,706,000                                                          |       | 21                                                                   | %          | 18,654,425                                                       |       | 16                                                                | %          |
| Total                  |       | $                                                                | 71,139,000 |                                                              | 69         | %                                                                   | $          | 31,960,290                                                           |       | 31                                                               | %          | $                                                                 | 26,688,425 |   | 23 | % |

 

Theincrease in delinquencies from December 31, 2007 is primarily due to oneloan with a principal balance of $48.0 million which was current as of December 31,2007 but is included in the 60-89 days delinquent category as of March 31,2008. We also have an additional $2.6 million loan to the same borrower whichis included in the 30-59 days delinquent category.  Our $957,000 investment in a $10,000,000 loanmoved from current status at December 31, 2007 to the 60-89 daysdelinquent category as of March 31, 2008. As of December 31, 2007, we had a $200,000 investment in a$1,000,000 loan which was reported in the over 90 day delinquent category.  As of March 31, 2008, that loan has beenreinstated by the borrower and been placed in the current category.  Another loan in which we had a $2,569,300investment moved from the over 90 days delinquent category at December 31,2007 to the 30-59 days delinquent category on March 31, 2008 as a resultof the application of proceeds received from the borrower resulting from itssale of an easement on the real property securing the loan.

 

**Loans ninety daysor more past due and still accruing interest:**

 
| ** **              | ** ** | **As of  March 31,** | ** ** |
|-------------------------|------------|------------------------------------------|------------|
| ** **              | ** ** | **2008**                                 | ** ** | **2007** | ** ** |
| Number of loans         |       | —                                   |       | 8 |   |
| Total principal balance |       | $                                        | —     |   | $ | 18,654,425 |   |
|                         |            |                                          |            |  |  |  |  |

 

Therewere no loans as of March 31, 2008 that were ninety days or more past dueand still accruing interest.

 

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**Impaired andnon-accrual loans:**

 
| ** **                                                  | ** ** | **As of  March 31,** | ** ** |
|-------------------------------------------------------------|------------|------------------------------------------|------------|
| ** **                                                  | ** ** | **2008**                                 | ** ** | **2007** | ** ** |
| Number of loans                                             |       | 8                                        |       | 11 |   |
| Total principal balance plus advances and  accrued interest |       | $                                        | 79,523,743 |   | $ | 30,171,100 |   |
| Interest income recognized during the quarter               |       | 1,700,234                                |       | 802,629 |   |
| Foregone interest income                                    |       | 801,011                                  |       | 48,459 |   |
| Total balance of loans with specific  reserves              |       | 11,598,000                               |       | — |   |
| Specific loan loss reserve                                  |       | $                                        | 4,926,000  |   | $ | 95,000 |   |

 

At March 31,2008 and 2007, all of the impaired and non-accrual loans were in the process offoreclosure. When a loan is placed on non-accrual, the accrual of interest isdiscontinued, however previously recorded accrued interest is not reversed.Payments received on impaired loans are applied to reduce principal to theextent necessary to ensure collection of principal. Subsequent payments onthese loans, and payments received on non-accrual loans for which the ultimatecollectability of principal is not in doubt, are applied first to earned butunpaid interest and then to principal. Depending on the borrowers’ ability tobring a loan current through payment, refinancing by a third party or us, andother legal courses of action available to the borrower and us, the foreclosureof properties may be postponed or not completed. At March 31, 2008 and2007, there were no outstanding commitments to lend additional funds toborrowers whose loans were identified as impaired.

 

Theweighted average balance of principal plus advances and accrued interest ofimpaired and non-accrual loans during the quarters ended March 31, 2008,and 2007 was $73,315,573 and $25,933,587, respectively.

 

***Subsequent delinquency experience***

* *

Since March 31,2008, delinquencies in the Fund’s portfolio have increased as shown below.

 
| **Delinquent Status** | ** ** | **Outstanding Loan  Balance at  March 31,  2008** | ** ** | **Percent of Total  Balance at  March 31, 2008** | ** ** | **Outstanding Loan  Balance at  August 31, 2008** | ** ** | **Percent of Total  Balance at  August 31, 2008** | ** ** |
|----------------------------|------------|----------------------------------------------------------------------------|------------|---------------------------------------------------------------------------|------------|-----------------------------------------------------------------------|------------|----------------------------------------------------------------------------|------------|
| 30 – 59 Days          |       | $                                                                          | 2,584,000  |                                                                      | 3          | %                                                                     | $          | —                                                                     |       | 0 | % |
| 60 – 89 Days          |       | 48,957,000                                                                 |       | 47                                                                        |       | 12,718,258                                                            |       | 13                                                                         |       |
| 90+ Days                   |       | 19,598,000                                                                 |       | 19                                                                        |       | 73,948,424                                                            |       | 74                                                                         |       |
| Total                      |       | $                                                                          | 71,139,000 |                                                                      | 69         | %                                                                     | $          | 86,666,682                                                                 |       | 87 | % |

 

Delinquencieswithin the loan portfolio increased $15.5 million from March 31, 2008 to August 31,2008.  This increase resulted primarilyfrom two loans to the same borrower totaling $12.7 million which became 60 – 89days delinquent as of August 31, 2008, and one loan totaling $2.9 millionwhich became 90+ days delinquent as of August 31, 2008.  In addition, three loans totaling $51.6million that were 30 to 59 days delinquent on March 31, 2008, became 90+days delinquent as of August 31, 2008.

 

***RealEstate Owned***

** **

During2007, we foreclosed on two commercial properties that were loancollateral.  We are holding the firstproperty and funding improvements to the property while actively marketing theproperty for sale.  We recorded the REOat the net realizable value of the property at the time of foreclosure of$24,340.

 

We arealso holding the second property and intends to fund ongoing entitlement,engineering and other site development work as the Manager actively markets theproperty for sale.  We own the propertysubject to a $6.0 million lien held by two other funds sponsored by the Managerand direct investors for whom the Manager provides loan servicing.  The Manager believes that the fair marketvalue of the property, net of selling and other costs to be incurred, approximatesthe carrying value of the REO as of March 31, 2008.  Our owned portion of the carrying value ofthe property at the time of foreclosure was $8.6 million.

 

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In March 2008,we foreclosed on a third commercial property with a net realizable value atforeclosure of $4,000.  We are fundingimprovements while actively marketing it for sale.  These properties do not currently generaterevenue.

 

*Subsequent events*

* *

*HonoluluLoan*:  As of June 30,2008, we held a $3,043,477 interest in a loan with a principal balance of$37,670,656 and bearing interest at a rate of 13% per annum for which theborrower was in default.  This loan is ajunior portion of a $97,900,000 original loan facility and is junior to a$55,000,000 senior position held by an entity unaffiliated with us or theManager.  The security for the loan is approximately 161 acres ofresidentially zoned property. The borrower has defaulted on both the senior andour junior note. The Manager is currently conducting negotiations with theborrower and the holder of the senior participation to assume the debt servicepayments under the senior participation and to acquire ownership of thecollateral. Our pro rata share of the debt service payments under the seniorparticipation is approximately $62,000 per month (11.3% of the total $550,000)although we may advance more or less than our pro rata share of this payment.Under an agreement among the various participating funds, these advances willhave a priority repayment position relative to loan principal and interestearned thereon. On March 11, 2008, the Manager paid an extension fee of$1.4 million to the senior lender on behalf of the funds it manages thatparticipate in this loan.  The Manageralso paid an extension fee of $90,000 to a third party lender participating inthe junior note.  Our pro rata share ofthese payments was approximately $0.1 million.

 

*Northern California Mixed-Use Portfolio Loan:* As of March 31, 2008, we held $10,600,000 in loans secured by 22 differentproperties on a basis junior to liens securing $19,093,165 of senior loans.These senior loans included one owned by two other funds managed by theManager, in the principal amount of $8,363,020. Another loan in the amount of$2,098,145 is held by another fund managed by the Manager, and the remaining$8,632,000 represents third party senior liens, which are in first position onseveral of the properties securing our $10,600,000 loan position.  On April 9,2008, the Manager, on our behalf, completed foreclosure sales and acquired 20of the 22 properties. The estimated net realizable value of these foreclosedproperties was $24,300,000, net of $8,416,000 in amounts owed to senior lienholders. In June, one of the two remaining properties was lost as a result offoreclosure by the holder of a senior lien, and the borrower on the remainingproperty filed bankruptcy. The estimated net realizable value of this remainingproperty is $507,000, net of $2,200,000 in amounts owed to senior lien holders.As a result of the shortfall in net realizable value compared with theoutstanding balances owed to us on these collateral dependent loans, werecorded loan charge-offs in the amount of $600,000 as of April 9,2008.  In June, we sold one of theproperties that had been acquired on April 9, 2008 and received $637,000in net proceeds from the sale, including a note receivable in the amount of$467,000.

 

*FremontREO Sale:* Our interest in a light industrial building locatedin Fremont, California with approximately 45,000 square feet was acquired asREO in July 2006.  On December 31, 2006,the Manager bought the property from us for $6,000,000, which represented thecarrying value of the REO, plus the provision for loan loss of $1,400,000recorded at the time of foreclosure.  TheManager paid 10% of the purchase price in cash and delivered us a note for thebalance.  In December 2007, the Managerpaid down $600,000 of principal on the note, which allowed us to recognize again under the installment method of accounting of $1,300,000. The Manager soldthe property on July 1, 2008 for $4,430,000. Because the sale proceeds were less than the Manager’s note to us, wenow hold an unsecured note receivable from the Manager in the amount of$670,854 at August 31, 2008.

 

***Off-BalanceSheet Arrangements***

** **

We have no off-balance sheet arrangements, except forthe obligations described above.

 

***CriticalAccounting Estimates***

** **

Preparationof our financial statements requires the Manager to make estimates andassumptions that affect the reported amounts of assets, liabilities, revenuesand expenses. These estimates and assumptions are based on historicalexperience, independent evaluations (such as appraisals of specificproperties), market data on real estate and real estate transactions availablefrom public sources, industry and market research and forecasts, discussionswith real estate brokers, developers and investors and various other sourcesand factors we believe to be reasonable and reliable under the circumstances.The Manager periodically reviews our accounting policies and these estimatesand assumptions and make adjustments when facts and circumstances dictate. Ouraccounting policies that are affected by estimates principally relate to thedetermination of (i) the allowance for loan losses (*i.e.*, the amount of allowance establishedagainst loans receivable as an estimate of probable loan losses), including theaccrued interest and advances that are estimated to be unrecoverable based onestimates of amounts to be collected plus estimates of the value of theproperty as collateral, and (ii) the valuation of real estate ownedthrough foreclosure.  These policies 

 

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and their key characteristics are discussed in detailin the 2007 Annual Report.  Differentestimates and assumptions in the application of these policies could result inmaterial changes in our financial condition, results of operations, or cashflows and actual results may differ substantially.

 

***RecentAccounting Pronouncements***

** **

SeeNote 2 for further discussion.

 

## **Item 3.                    Quantitativeand Qualitative Disclosures about Market Risk**

##  

Notapplicable.

 

## **Item 4.                    Controlsand Procedures**

##  

*Evaluation of disclosure controls and procedures.*  Based on the evaluation of our disclosurecontrols and procedures (as defined in the Rules 13a-15(e) and 15d-15(e) underthe Securities Exchange Act of 1934, as amended (the “Exchange Act”)) requiredby Exchange Act Rules 13a-15(b) or 15d-15(b), the principal executiveofficer and principal financial officer of the Manager have concluded that asof the end of the period covered by this Quarterly Report on Form 10-Q,our disclosure controls and procedures were not effective to ensure thatinformation required to be disclosed by us in reports that we file or submitunder the Exchange Act is recorded, processed, summarized and reported withinthe time periods specified in SEC rules and forms, and includes controlsand procedures designed to ensure that information required to be disclosed byus in such reports is accumulated and communicated to our management, includingthe principal executive officer and principal financial officer of the Manager,as appropriate to allow timely decisions regarding required disclosure becauseof material weaknesses identified in our internal control over financialreporting and by virtue of our failure to timely file our Annual Report on Form 10-Kfor the year ended December 31, 2007, and this Quarterly Report on Form 10-Q.  A material weakness is a deficiency orcombination of deficiencies, in internal control over financial reporting suchthat there is a more than reasonable possibility that a material misstatementof our annual or interim financial statements will not be prevented or detectedon a timely basis.  In our case, thematerial weaknesses stem from:

 

·                  Manager personnel in the controllerfunction do not have the specific, requisite qualifications and trainingnecessary to ensure the financial statements and all necessary disclosures areprepared and included in accordance with generally accepted accountingprinciples and other SEC reporting requirements.

 

·                  The Manager monitors property valuessupporting loan balances and real estate owned by obtaining market informationthrough a variety of sources, including appraisals, current market data, andbroker quotations. In certain instances where adjustments were made to propertyvalues based on market data or broker quotations, the Manager did not maintainsufficient contemporaneous documentation related to the analysis,considerations and conclusions in support of the adjustments to the propertyvalues.

 

**Remediation**

 

The Manager’s limited liquidity and other demands on its resources maymake it difficult to eliminate the material weaknesses or otherwise increaseour capability to satisfy our periodic and current reporting requirements.

 

*Requisite qualifications and training*.  The Manager is recruiting for an accountingmanager, controller, or executive officer with financial services and/or realestate experience, and with requisite knowledge of and experience with respectto internal control over financial reporting and the reporting requirementsunder federal securities laws.  Severalcandidates were identified with the assistance of a search firm, but theManager has to date been unsuccessful in hiring. The market for suchindividuals is competitive and their compensation often includes stock or stockoptions which are not available from the Manager.  The difficulty of finding such a candidate isexacerbated by the financial condition of the Manager and the funds it manages.Presently the Manager relies on the collective experience and knowledge of itsfinance staff with advice and guidance from third party consultants.

 

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The build-up of leadership and staff capacity and capability has beensignificant since July 2006 and is ongoing.  Operations and accounting have beensegregated. An executive with experience in information technology andfinancial services was recruited and has built an IT staff, implemented newcore and supporting applications and has improved data management. A separatereal estate administration function was created and an executive hired to headit.  Improvements have been made to theauthorization, processing and recordation of transactions. Separate bankaccounts are maintained for each entity managed by the Manager and bankingoperations is a standalone function reporting to the Operations/InformationTechnology executive.

 

Three critical core applications – General Ledger, Investor Managementand Loan Processing — were identified, and associated operations and processeswere designed.  Substantial progress hasbeen made, particularly through the implementation of an industry standardGeneral Ledger system, and a custom-developed Investor Management System, eachwith associated processes and controls. The conversion to the new generalledger system was completed in July 2007, which streamlined the formalgeneral ledger operations and control function. Consolidation of loan information into a standard SQLServer database andspreadsheet model contributed to improvements in loan processing controls andfinancial analysis capabilities. This database supplements the limitedcapability of an industry-standard software application for loan administrationand servicing. Taken together, these sub ledger applications and databasesprovide the detailed systems of record that can be reconciled daily to the GeneralLedger and provide information to support and enhance financial reporting andmanagement information Further automation, standardization and simplificationin loan systems and processes is continuing throughout 2008 and 2009.

 

*Property Valuation*.  The Manager is taking steps to implement aformal process to create and maintain supporting documentation for all changesin property values supporting loan balances and real estate owned.

 

Beginning in 2009 – earlier depending on resources – the Manager intendsto enhance the lending and underwriting processes and documentation by creatingand staffing of a standalone credit function. Historically – in equity and private mortgage lending – creditevaluation and documentation is not emphasized and is secondary toproperty/collateral valuation in underwriting loans with low LTV’s.  This approach has historically producedfavorable results, particularly for us, with limited REO’s and no losses. Onlyin the recent year, with the unprecedented turmoil in the capital markets,  have credit matters and the formal analysisand tracking of development and rehab projects, viability of and progresstoward exit strategies, and evaluating and monitoring credit worthiness of theprincipals and guarantors become business critical.  We expect that in 2009 – again depending onresources – we would add loan officer(s) with strong underwritingexperience and analytic skills to servicing and credit analyst(s) similarlyskilled and experienced to a nascent credit function.

 

*Changes in internal control over financialreporting.* Other than progress in addressing the above-mentioned materialweaknesses, there were no changes in our internal control over financialreporting that occurred during the our first fiscal quarter of 2008 that havematerially affected, or are reasonably likely to materially affect, ourinternal control over financial reporting.

 

# **PART II.                OTHERINFORMATION**

#  

## **Item 1.                    LegalProceedings**

##  

Thereare no legal proceedings to which we are a party or to which our property issubject, other than foreclosures on borrower collateral in the ordinary courseof our business.

 

TheSEC has notified the Manager that it is conducting an informal inquiry relatingto the Manager and us in order to determine whether there have been violationsof the federal securities laws. In conjunction with this inquiry, certaininformation has been requested from us. The Manager has responded to requestsfor information related to the inquiry and will continue to cooperate with theSEC in response to its requests. The Manager believes that there will not be amaterial impact on our financial position or operations as a result of thisinquiry.

 

## **Item 1A.                 RiskFactors**

##  

Not applicable.

 

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## **Item 2.                    UnregisteredSales of Equity Securities and Use of Proceeds**

 

Thefollowing table shows the amount of redemptions of members’ capital during eachmonth of the first quarter of 2008.

 
| **Period**               | ** ** | **Total Members’  Capital Redeemed** | ** ** | **Total  Members’ Capital Redeemed  as a Part of Publicly Announced  Plans or Programs** | ** ** | **Maximum Members’ Capital  that May Yet Be Redeemed  as a Part of Publicly  Announced Plans or  Programs** | ** ** |
|--------------------------|------------|-----------------------------------------------------|------------|--------------------------------------------------------------------------------------------------------------------------------------------|------------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|
| January 1-31, 2008  |       | 221,733                                             |       | —                                                                                                                                     |       | —                                                                                                                                                                       |       |
| February 1-29, 2008 |       | 8,000                                               |       | —                                                                                                                                     |       | —                                                                                                                                                                       |       |
| March 1-31, 2008    |       | 8,000                                               |       | —                                                                                                                                     |       | —                                                                                                                                                                       |       |
| Total                    |       | 237,733                                             |       | —                                                                                                                                     |       | —                                                                                                                                                                       |       |

 

## **Item 3.                    DefaultsUpon Senior Securities**

##  

As of March 31, 2008, we were in default for failure to pay atmaturity under one promissory note outstanding with a principal amount of$20,199,951 in favor of  Income Fund, anaffiliate of the Manager, which Income Fund in turn assigned Wells FargoFoothill.  Accrued interest at that dateamounted to $168,950. Our promissory note to Income Fund, as well as the WellsFargo Foothill loan to Income Fund, matured on June 30, 2007.  The Wells Fargo Foothill loan wasrenegotiated as of June 30, 2007 to provide for interest only payments anda maturity of August 31, 2007.  Ourpromissory note to Income Fund was concurrently amended to extend the maturitydate until June 30, 2008  2007.  Wells Fargo Foothill and Income Fund enteredinto a forbearance agreement (and an amendment thereto) in which Wells FargoFoothill agreed not to exercise remedies until November 30, 2007  The forbearance agreement also increased theinterest rate on the loan to LIBOR plus 6.5% (9.64% at March 31, 2008),increasing our payments to Income Fund correspondingly. The Managersubsequently negotiated additional amendments to the promissory notes betweenIncome Fund and Wells Fargo Foothill and between Income Fund and the Fund thatwere made effective as of July 1, 2008, under which Wells Fargo Foothilland Income Fund, respectively, waived the existing defaults and extended thematurity date until December 31, 2008.

 

We arecurrent on the interest payments to Income Fund and Income Fund is, in turn,current on its interest payments to Wells Fargo Foothill.

 

## **Item 4.                    Submissionof Matters to a Vote of Security Holders**

##  

None

 

## **Item 5.                    OtherInformation**

##  

None

 

## **Item 6.                    Exhibits**

 
| **Exhibit Number** | ** ** | **Description**                                                                                                                   |
|-------------------------|------------|-----------------------------------------------------------------------------------------------------------------------------------|
| ** **              | ** ** | ** **                                                                                                                        |
| 31.1                    |       | Chief Executive Officer Certification Pursuant to  Rule 13a-14(a) of the Securities Exchange Act.                       |
| 31.2                    |       | Chief Financial Officer Certification Pursuant to  Rule 13a-14(a) of the Securities Exchange Act.                       |
| 32.1                    |       | Certification pursuant to 18 U.S.C. Section 1350 as adopted  pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. |

 

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**SIGNATURES**

** **

Pursuantto the requirements of the Securities Exchange Act of 1934, the registrant hasduly caused this report to be signed on its behalf by the undersigned thereuntoduly authorized.

 

 
|                 | CMR Mortgage Fund II, LLC                                   |
|----------------------|-------------------------------------------------------------|
|                 |                                                        |
|                 | By: California Mortgage and  Realty, Inc., its Manager |
|                 |                                                        |
|                 |                                                        |
| October 1, 2008 | By:                                                         |  /s/ David Choo |
|                 |                                                        | Name: David Choo |
|                 |                                                        | Title: President |
|                 |                                                        |
| October 1, 2008 | By:                                                         |  /s/ James Gala |
|                 |                                                        | Name: James Gala |
|                 |                                                        | Title: CFO (Principal Financial  Officer and Principal |
|                 |                                                        | Accounting  Officer) |

 

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**EXHIBIT INDEX**

 
| **Exhibit Number** | ** ** | **Description**                                                                                                                   |
|-------------------------|------------|-----------------------------------------------------------------------------------------------------------------------------------|
|                    |       |                                                                                                                              |
| 31.1                    |       | Chief Executive Officer Certification Pursuant to  Rule 13a-14(a) of the Securities Exchange Act.                       |
| 31.2                    |       | Chief Financial Officer Certification Pursuant to  Rule 13a-14(a) of the Securities Exchange Act.                       |
| 32.1                    |       | Certification pursuant to 18 U.S.C. Section 1350 as adopted  pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. |

 

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