Table of Contents

 

 

 

**UNITED STATES**

**SECURITIES 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  JUNE 30, 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**

 

**CMR Mortgage Fund II, LLC**

(Exact name of registrant asspecified in its charter)

 

| **California**

**(**State or other  jurisdiction of   incorporation or organization)                      | ** ** | **20-0671528**

(I.R.S. Employer   Identification No.) |
|------------------------------------------------------------------------------------------------------------|------------|--------------------------------------------------------|
|                                                                                                       |       |                                                   |
| **62 First Street, 4th Floor   San Francisco, California**

(Address of  principal executive offices) | ** ** | **94105**

(Zip Code)                                  |

 

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

**(415) 974-1100**

 

Indicate bycheck mark whether the registrant (1) has filed all reports required to befiled by Section 13 or 15(d) of the Securities Exchange Act of 1934during the preceding 12 months (or for such shorter period that the registrantwas required to file such reports), and (2) has been subject to the filingrequirements for at least the past 90 days. Yes o  No  x

 

Indicate bycheck mark whether the registrant is a large accelerated filer, an acceleratedfiler, a non-accelerated filer, or a smaller reporting company. See thedefinitions of “large accelerated filer,” “accelerated filer” and “smallerreporting company” in Rule 12b-2 of the Exchange Act.  (Check one):

 
|   | Large  accelerated filer o |   | Accelerated  filer o         |
|--------|----------------------------|--------|------------------------------|
|   | Non-accelerated  filer o   |   | Smaller  reporting company x |

(Do not check if a smallerreporting company)

 

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

 

There is notrading market for the registrant’s membership interests.

 

 

 

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**TABLE OFCON****TENTS**

 
| ** **                         | ** **                                                                                           | ** ** | **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 |       | 22       |
|                               |                                                                                                 |       |     |
|                               | Item 3.  Quantitative and Qualitative Disclosures about Market Risk                                  |       | 35       |
|                               |                                                                                                 |       |     |
|                               | Item 4.  Controls and Procedures                                                                     |       | 35       |
|                               |                                                                                                 |       |     |
| PART II. OTHER INFORMATION    |                                                                                                 | 37         |
|                               |                                                                                                 |       |     |
|                               | Item 1. Legal Proceedings                                                                            |       | 37       |
|                               |                                                                                                 |       |     |
|                               | Item 1A. Risk Factors                                                                                |       | 37       |
|                               |                                                                                                 |       |     |
|                               | Item 2.  Unregistered Sales of Equity Securities and Use of Proceeds                                 |       | 37       |
|                               |                                                                                                 |       |     |
|                               | Item 3.  Defaults Upon Senior Securities                                                             |       | 37       |
|                               |                                                                                                 |       |     |
|                               | Item 4.  Submission of Matters to a Vote of Security Holders                                         |       | 37       |
|                               |                                                                                                 |       |     |
|                               | Item 5. Other Information                                                                            |       | 38       |
|                               |                                                                                                 |       |     |
|                               | Item 6. Exhibits                                                                                     |       | 38       |

 

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# **PART I.                 FINANCIAL INFORMATION**

#  

## **Item 1.                   FinancialStatements**

##  

**CMR MORTGAGE FUND II, LLC**

**CONDENSED BALANCE SHEETS**

 
| ** **                                                                                                                                               | ** ** | **June 30, 2008  (Unaudited)** | ** **  | **December 31,  2007** | ** ** |
|----------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-------------------------------------|-------------|-----------------------------|------------|
| **ASSETS**                                                                                                                                               |       |                                |        |                        |       |
| Cash and cash equivalents                                                                                                                                |       | $                                   | 614,865     |                        | $          | 1,458,635 |   |
| Loans, secured by deeds of trust, net of  allowance for loan losses of $24,646,611 as of June 30, 2008 and  $6,309,000 as of December 31, 2007 |       | 64,258,078                          |        | 87,474,484                  |       |
| Notes receivable from Manager, secured by  deeds of trust                                                                                                |       | 5,461,091                           |        | 8,598,011                   |       |
| Advances to borrowers                                                                                                                                    |       | 4,835,616                           |        | 5,905,561                   |       |
| Due from related parties, net of reserve  for uncollectible amounts of $900,000 as of June 30, 2008, and none as  of December 31, 2007         |       | 1,268,615                           |        | 1,533,247                   |       |
| Real estate owned                                                                                                                                        |       | 23,081,232                          |        | 8,578,275                   |       |
| Accrued interest receivable and other  assets                                                                                                            |       | 4,181,612                           |        | 2,831,203                   |       |
| **Total Assets**                                                                                                                                         |       | $                                   | 103,701,109 |                        | $          | 116,379,416 |   |
| **LIABILITIES  AND MEMBERS’ CAPITAL**                                                                                                               |       |                                |        |                        |       |
| Liabilities:                                                                                                                                             |       |                                |        |                        |       |
| Accounts payable                                                                                                                                         |       | $                                   | 840,384     |                        | $          | 605,681 |   |
| Accrued expenses                                                                                                                                         |       | 622,394                             |        | 116,035                     |       |
| Accrued distributions                                                                                                                                    |       | —                              |        | 296,225                     |       |
| Due to related parties                                                                                                                                   |       | 1,107,909                           |        | 258,118                     |       |
| Other payables and accrued interest - real  estate owned                                                                                                 |       | 9,324,632                           |        | —                      |       |
| Note payable to related party - real estate  owned                                                                                                       |       | 6,000,000                           |        | 6,000,000                   |       |
| Note payable and accrued interest to  related party                                                                                                      |       | 20,350,767                          |        | 21,395,630                  |       |
| **Total Liabilities**                                                                                                                                    |       | 38,246,086                          |        | 28,671,689                  |       |
| Commitments and contingencies                                                                                                                            |       |                                |        |                        |       |
| Members’ Capital                                                                                                                                    |       | 65,455,023                          |        | 87,707,727                  |       |
| **Total Liabilities and Members’ Capital**                                                                                                          |       | $                                   | 103,701,109 |                        | $          | 116,379,416 |   |
|                                                                                                                                                          |            |                                     |             |                             |            |  |  |  |  |

 

The accompanying notes are an integral part of these unauditedcondensed financial statements.

 

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**CMR MORTGAGE FUND II, LLC**

**CONDENSED STATEMENTS OF OPERATIONS**

**(UNAUDITED)**

 
| ** **                                         | ** ** | **For the Three Months   Ended   June 30,** | ** **  | **For the Six Months   Ended   June 30,** | ** ** |
|----------------------------------------------------|------------|--------------------------------------------------|-------------|------------------------------------------------|------------|
| ** **                                         | ** ** | **2008**                                         | ** **  | **2007**                                       | ** ** | **2008** | ** ** | **2007** | ** ** |
| Revenues:                                          |       |                                             |        |                                           |       |   |   |   |   |
| Interest income:                                   |       |                                             |        |                                           |       |   |   |   |   |
| Interest on loans                                  |       | $                                                | 1,136,897   |                                           | $          | 2,581,141 |   | $ | 3,676,875 |   | $ | 5,956,411 |   |
| Interest on notes receivable - related  party      |       | 264,793                                          |        | —                                         |       | 400,127 |   | — |   |
| Interest on advances to borrowers                  |       | (103,788                                         | )           | 165,996                                        |       | 123,006 |   | 238,632 |   |
| Other interest income                              |       | 244,985                                          |        | 201,757                                        |       | 443,624 |   | 450,855 |   |
| Total interest income                              |       | 1,542,887                                        |        | 2,948,894                                      |       | 4,643,632 |   | 6,645,898 |   |
| Less: Loan servicing fees                          |       | 541,859                                          |        | 360,959                                        |       | 1,013,445 |   | 1,176,985 |   |
| Total interest income, net of servicing  fees      |       | 1,001,028                                        |        | 2,587,935                                      |       | 3,630,187 |   | 5,468,913 |   |
| Loss on sale of real estate owned                  |       | (3,674                                           | )           | —                                         |       | (3,674 | ) | — |   |
| Total revenues, net of servicing fees              |       | 997,354                                          |        | 2,587,935                                      |       | 3,626,513 |   | 5,468,913 |   |
| Interest expense                                   |       | 474,484                                          |        | 711,744                                        |       | 1,037,363 |   | 1,522,400 |   |
| Interest expense – related party              |       | 187,500                                          |        | —                                         |       | 375,000 |   | — |   |
| Provision for loan losses                          |       | 20,829,479                                       |        | 450,315                                        |       | 20,829,479 |   | 675,315 |   |
| Net revenues                                       |       | (20,494,109                                      | )           | 1,425,876                                      |       | (18,615,329 | ) | 3,271,198 |   |
| Operating expenses:                                |       |                                             |        |                                           |       |   |   |   |   |
| Professional services                              |       | 1,021,894                                        |        | 426,024                                        |       | 1,467,944 |   | 525,814 |   |
| Asset management fees                              |       | 231,262                                          |        | 242,481                                        |       | 309,781 |   | 493,575 |   |
| Impairment loss on amounts due from related  party |       | 900,000                                          |        | —                                         |       | 900,000 |   | — |   |
| Other operating expenses                           |       | 295,132                                          |        | 4,777                                          |       | 312,680 |   | 8,228 |   |
| Total operating expenses                           |       | 2,448,288                                        |        | 673,282                                        |       | 2,990,405 |   | 1,027,617 |   |
| Net (loss) income                                  |       | $                                                | (22,942,397 | )                                              | $          | 752,594 |   | $ | (21,605,734 | ) | $ | 2,243,581 |   |

 

The accompanying notes are an integral part of these unauditedcondensed financial statements.

 

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**CMR MORTGAGE FUND II, LLC**

**STATEMENT OF CHANGES IN MEMBERS’ CAPITAL**

**For the Six Months Ended June 30, 2008**

 

**(UNAUDITED)**

 
| ** **                        | ** ** | ** ** | ** ** | ** **  | ** ** | **Members’ Capital** | ** ** |
|-----------------------------------|------------|------------|------------|-------------|------------|---------------------------|------------|
| ** **                        | ** ** | **Units**  | ** ** | **Members** | ** ** | **Unallocated  Capital**  | ** ** | **Total  Members’  Capital** | ** ** |
| Balance January 1, 2008      |       | 87,708     |       | $           | 87,707,727 |                      | $          | — |   | $ | 87,707,727 |   |
| Net loss                          |       | (21,606    | )          |        |       | (21,605,734               | )          | (21,605,734 | ) |
| Allocation of net loss to members |       |       |       | (21,605,734 | )          | 21,605,734                |       |   |   |
| Distributions to members          |       | (647       | )          | (646,970    | )          |                      |       | (646,970 | ) |
|                              |       |       |       |        |       |                      |       |   |   |
| Balance June 30, 2008        |       | 65,455     |       | $           | 65,455,023 |                      | $          | — |   | $ | 65,455,023 |   |

 

The accompanying notes are an integral part of these unauditedcondensed financial statements.

 

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

 
| ** **                                                                                          | ** ** | **For the Six Months Ended   June 30,** | ** **  |
|-----------------------------------------------------------------------------------------------------|------------|----------------------------------------------|-------------|
| ** **                                                                                          | ** ** | **2008**                                     | ** **  | **2007** | ** ** |
| Cash flows from operating activities:                                                               |       |                                         |        |   |   |
| Net (loss) income                                                                                   |       | $                                            | (21,605,734 | ) | $ | 2,243,581 |   |
| Adjustments to reconcile net (loss) income  to net cash (used in) provided by operating activities: |       |                                         |        |   |   |
| Provision for loan losses                                                                           |       | 20,829,479                                   |        | 675,315 |   |
| Impairment loss on amounts due from related  party                                                  |       | 900,000                                      |        | — |   |
| Loss on sale of REO                                                                                 |       | 3,674                                        |        | — |   |
| Net changes in operating assets and  liabilities:                                                   |       |                                         |        |   |   |
| Accrued interest receivable and other  assets                                                       |       | (1,350,409                                   | )           | (406,548 | ) |
| Accounts payable and accrued expenses                                                               |       | 741,062                                      |        | 561,316 |   |
| Due from related parties                                                                            |       | (635,368                                     | )           | 1,413,524 |   |
| Due to related parties                                                                              |       | 786,745                                      |        | 940,897 |   |
| Net cash (used in) provided by operating  activities                                                |       | (330,551                                     | )           | 5,428,085 |   |
| Cash flows from investing activities:                                                               |       |                                         |        |   |   |
| Proceeds from sale of real estate owned                                                             |       | 216,757                                      |        | — |   |
| Net decrease (increase) advances to  borrowers                                                      |       | 1,069,945                                    |        | (1,006,645 | ) |
| Net (increase) decrease in loans                                                                    |       | (3,011,829                                   | )           | 2,894,614 |   |
| Net decrease in notes receivable from  Manager                                                      |       | 3,136,920                                    |        | — |   |
| Net cash provided by investing activities                                                           |       | 1,411,793                                    |        | 1,887,969 |   |
| Cash flows from financing activities:                                                               |       |                                         |        |   |   |
| Contributions from members                                                                          |       | —                                       |        | 297,918 |   |
| Distributions/redemptions to members                                                                |       | (943,195                                     | )           | (9,601,153 | ) |
| Repayment of note payable to related party                                                          |       | (981,817                                     | )           | (1,786,887 | ) |
| Net cash used in financing activities                                                               |       | (1,925,012                                   | )           | (11,090,122 | ) |
|                                                                                                |       |                                         |        |   |   |
| Net decrease in cash and cash equivalents                                                           |       | (843,770                                     | )           | (3,774,068 | ) |
|                                                                                                |       |                                         |        |   |   |
| Cash and cash equivalents at beginning of  period                                                   |       | 1,458,635                                    |        | 4,138,948 |   |
| Cash and cash equivalents at end of period                                                          |       | $                                            | 614,865     |   | $ | 364,880 |   |
|                                                                                                |       |                                         |        |   |   |
| *Supplemental disclosure of cash flow  information:*                                                | * *   | * *                                     | * *    | * * | * * |
| Cash paid during the year for:                                                                      |       |                                         |        |   |   |
| Interest expense                                                                                    |       | $                                            | 1,537,909   |   | $ | 1,477,245 |   |
| Franchise taxes                                                                                     |       | $                                            | 12,590      |   | $ | 12,590 |   |
| Non-cash investing activities:                                                                      |       |                                         |        |   |   |
| Real estate acquired through foreclosure                                                            |       | $                                            | 5,865,756   |   | $ | 2,553,935 |   |
| Loans originated in connection with the  sale of REO                                                |       | $                                            | 467,000     |   | $ | — |   |
| Non-cash financing activities:                                                                      |       |                                         |        |   |   |
| Debt assumed REO related party                                                                      |       | $                                            | —      |   | $ | 6,000,000 |   |
| Debt assumed REO other                                                                              |       | $                                            | 9,852,201   |   | $ | — |   |
| Debt assumed by purchaser in sale of REO                                                            |       | $                                            | 527,569     |   | $ | — |   |

 

Theaccompanying notes are an integral part of these unaudited condensed financialstatements.

 

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**CMR Mortgage Fund II, LLC**

**Notes to Condensed Financial Statements (Unaudited)**

 

**Note 1:  Organizationand General Fund Provisions**

 

CMRMortgage Fund II, LLC (the “Fund”) is a California limited liability companyorganized for the purpose of making or investing in business loans secured bydeeds of trust and mortgages on real properties—predominately commercial incomeproducing structures or land held by businesses—located primarily inCalifornia.  The land can be incomeproducing (*e.g.*, farms, vineyards,parking lots) or may be held for commercial or residential development. TheFund’s loans are arranged and serviced by its manager, California Mortgage andRealty, Inc., a Delaware corporation (the “Manager”), which is licensed asa California real estate broker and a California finance lender. In addition,the Fund has the ability to invest in loans that were not originated by theManager. The Manager provides certain operating and administrative services tothe Fund. The Manager has complete control of the Fund’s business, subject tothe voting rights of the Fund’s members on specified matters and on any othermatters which the Manager wishes to submit to a vote.  Neither the Manager nor any of its affiliatedentities held any of the Fund’s membership interests at June 30, 2008, December 31,2007 or June 30, 2007.

 

Inaddition to arranging and servicing the Fund’s loans, the Manager sells loansin the Fund’s loan portfolio and purchases existing loans for the Fund,including partial undivided interests in loans. The Manager sells and purchasesloans for the Fund primarily to and from its affiliates and its clients andoccasionally from non-affiliated third parties.

** **

**Basis of Accounting**

 

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 underGAAP.  However, these condensed financialstatements contain all adjustments (consisting of normal recurring adjustmentsand accruals) which in the Fund’s opinion are necessary for a fair presentationof the 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.

 

 The results of operations for the three andsix months ended June 30, 2008, may not be indicative of the results ofoperations that may be expected for any other interim period or for the yearending December 31, 2008.

 

**Management Estimates**

 

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.

 

TheManager estimates, at least quarterly, the value of the collateral underlyingthe loans, the value of real estate owned (“REO”), and the related disposalcosts. The estimates are derived from information available in the real estate marketsincluding similar property, and often require the experience and judgment ofthird parties, such as commercial real estate brokers and appraisers. Theestimates figure materially in the Manager’s determination of the adequacy ofthe allowance for loan losses.

 

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**Going Concern**

 

*The Fund*

 

TheFund 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 to unprecedenteddislocations in the real estate and capital markets since 2007, the Fund hasincurred a significant reduction in loan payoffs from borrowers and an increasein delinquencies, non-performing loans and REO, resulting in a substantialreduction of cash flows. In addition, a number of the Fund’s loans and loanssenior to the Fund’s loans are in default. The Fund’s illiquid position mayprevent the Fund from protecting its position with respect toproperties/collateral securing these defaulted loans.

 

AtJune 30, 2008, the Fund had also pledged $48,000,000 of its loan portfolioas security for a note with an original principal balance of $25,000,000payable to CMR Income Fund, LLC (“Income Fund”), a related party.  At June 30, 2008, the Fund was intechnical default under this loan, resulting in a technical default underIncome Fund’s note payable to Wells Fargo Foothill, the lender on a loan toIncome Fund, also in the original principal amount of $25,000,000. The carryingamount of the Fund’s note payable to Income Fund includes principal of$20,199,951 and accrued unpaid interest of $150,816.  While in default, the Fund continued to makemonthly 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.

 

InMarch 2008, the Fund began making debt service payments on the senior debtrelated to the collateral that secures the Fund’s $3,043,447 participation in a$42,900,000 subordinated loan made by a fund managed by the Manager followingthe borrower’s default on the senior and subordinate loans. Due to liquidityissues in the various funds managed by the Manager, it has become necessaryfrom time to time for one participant to pay more than its pro rata share ofthe senior debt service.  Through September 30,2008, the Fund has made payments totaling $274,607 compared to its pro ratashare of $86,490 relating to this obligation. Under an agreement among the various participating funds, these advanceswill have a priority repayment position relative to loan principal and accruedinterest. The Fund may also need to assume debt service on a portion of the$5,000,000 of other third party subordinated debt in order to preventforeclosure.

 

OnApril 9, 2008, the Manager, on behalf of the Fund and three other funds itmanaged, foreclosed on 20 of 22 properties which comprised approximately$16,095,000, or 85% of the $18,857,100 total collateral securitizing threejunior loans to the funds.  The totalamount of junior debt secured by these properties, including principal,advances, and accrued interest was approximately $21,858,000, includingapproximately $11,113,000 owed to the Fund. The senior liens, which are held by outside third parties, totalapproximately $7,368,569 and bear interest at an effective average interestrate of approximately 8.0%.  In order tofully maintain its junior lien security interests, the funds will be obligatedto keep the senior liens current until these properties are sold.  The pro rata share of this debt service willincrease monthly interest expense of the Fund by approximately $30,000.

 

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:

 

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

 

b)    As of March 31, 2008, the Managersuspended indefinitely monthly cash distributions of net income and members’redemption requests. As of June 30, 2008 and September 30, 2008,outstanding member redemption requests totaled $28,099,174 and $32,201,007respectively.

 

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 manages. 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 apply certain of the proceeds for specified purposes, one of whichis to contribute or advance funds to the Manager until the obligations of theManager described below have been satisfied. Contributions from Mr. Choounder the Contribution Agreement are to approximate $6,100,000. From theseamounts, the Manager has agreed to use up to $5,000,000 of the funds to bereceived from Mr. Choo to pay notes and other obligations of the Managerto the Fund and other funds managed by the Manager, and all of the Manager’sdebts to third parties. The Contribution Agreement also commits the Manager touse at least $1,100,000 of the funds to be received from Mr. Choo as anoperating reserve to be used solely for the Manager’s operating costs andoverhead.

 

d)    Since the Contribution Agreement wassigned, the following events have occurred: (1) proceeds of approximately$1,102,000 were contributed or have been committed to the Manager from the saleof two properties listed in the Contribution Agreement, net of $375,000 thatwas used to support the real estate property activities which were part of theContribution Agreement; (2) an additional $206,000 was contributed to theManager, including $60,000 of proceeds from the sale of an additional propertynot listed in the Contribution Agreement (although this was not required by theContribution Agreement, the proceeds counts toward the future contributions); (3) Mr. Chooaffected a sale in the second quarter 2008 of certain other mortgage and realproperty assets that were not listed in the Contribution Agreement resulting innet cash proceeds of approximately $2,192,000 (net of $330,000 that waswithdrawn), which net proceeds were contributed to the Manager as an advance onand in lieu of the approximately $2,235,000 of net proceeds that he laterreceived from the subsequent sales of two other properties that were listed inthe Contribution Agreement. The net proceeds from the sales of these latter twoproperties were then used to pay pre-existing debts of Mr. Choo and werenot contributed to the Manager. The sales of various properties listed in theContribution Agreement have thus far yielded net cash proceeds to Mr. Chooand his affiliates of approximately $3,712,000, of which Mr. Choo hascontributed substantially all, totaling approximately $3,500,000 as of November 10,2008 ($2,067,000 as of June 30, 2008) to the Manager since theContribution Agreement was signed. The remaining commitment under the terms ofthe Contribution Agreement is $2,600,000, which proceeds are to be received ifand when the remaining properties are sold.

 

e)     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 beginning in 2007, the Fund has, whenappropriate, entered into formal forbearance agreements with certain borrowerswhich require the borrower to perform specific actions within agreed upontimeframes. These actions may include making partial loan payments, providingadditional collateral, listing the property for sale, or entering property salecontracts with the objective of full payoff or reinstatement of the Fund’sloan.

 

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

 

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

 

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Theabove actions, taken together have bolstered the Fund’s cash resources andimproved the likelihood of continued operations by the Fund, including theability to pay the debt service to some but not all senior lien holders,through December 31, 2008.  As notedelsewhere, the Fund is dependent on the repayment of loan principal and sale ofREO to continue operations through 2008 into 2009 and beyond, includingeventual resumption of distributions. The Manager has had certain of the collateral securing the Fund’s loans(with the consent and cooperation of the borrower), and most of the Fund’s REOlisted with nationally recognized and otherwise experienced brokers with strongpresence in the applicable local markets and experience with the collateraltype. These brokers are diligent and committed to completing a transaction, butcaution against forecasting the timing and pricing of a transaction in ahistorically low-volume market with limited credit financing available. The dislocationsand uncertainty in the capital and real estate markets have created achallenging environment which may continue through 2008 into 2009-2010 and maynecessitate further liquidations of assets at sub-optimum prices, particularlyif conditions deteriorate further.

 

*The Fund’s Manager*

 

Dueto unprecedented dislocations in the real estate and capital markets since2007, including an increase in the number of past due loans and a decrease inthe number of loan payoffs experienced by certain of the funds managed by theManager, the Manager has experienced a significant decrease in cash flows andhas limited cash resources.  While thefunds that the Manager manages do continue to accrue and collect interest on aportion of their loan portfolios, receive payoffs on loan balances owed andreceive proceeds from the sale of real estate acquired through foreclosure,thereby allowing the Manager to collect servicing and asset management fees,those cash flows may not be sufficient to fund the Manager’s operations as theybecome due. The Manager generated additional cash from the collection ofprincipal, advances, and interest on its loans, the sale of its REO it acquiredthrough foreclosure and from contributions from its sole director. Furthermore,the Fund cannot be sure that additional sales of properties under theContribution Agreement will be made on a timely basis. While these collection,sale and contribution actions improve the likelihood of the Manager continuingits operations, the limited cash resources compared to the operating and debtservice requirements of the Manager raise substantial doubt about the Manager’sability to continue as a going concern. Should the Manager be unable tocontinue to serve as Manager to the Fund, the Fund may incur additionalexpenses to find a replacement manager and to support the operational needs ofthe Fund. While potential replacement managers exist within the marketplace,their capacity or willingness to serve as the Fund’s manager is unknown. Achange in the manager may impact negatively the operating results of the Fundand the cash available for distribution. In the event that the operations orcash position of the Fund deteriorate significantly, the Fund may need toliquidate loans and REO in order to keep senior lien positions current orforestall the foreclosure of properties serving as collateral on the Fund’sjunior liens.

 

**Note 2:  Summary ofSignificant Accounting Policies**

 

*Fair Value Measurements*

 

InSeptember 2006, the FASB issued Statement No. 157 *Fair Value Measurements*(“SFAS 157”).SFAS 157 defines fair value, establishes a framework for measuring fairvalue and expands disclosures about fair value measurements. SFAS 157applies whenever other standards require (or permit) assets or liabilities tobe measured 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 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.

 

OnOctober 10, 2008, the FASB issued FSP FAS 157-3, *Determining the Fair Value of a Financial Asset Whenthe Market for That Asset Is Not Active* (“FSP SFAS 157-3”). The FSPclarifies the application of FASB Statement No. 157, Fair ValueMeasurements, in a market that is not active and provides an example toillustrate key considerations in determining the fair value of a financialasset when the market for that financial asset is not active. The FSP iseffective immediately, and includes prior period financial statements that havenot yet been 

 

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issued,and therefore the Fund is subject to the provision of the FSP effective June 30,2008. The implementation of FSP SFAS 157-3 did not affect the Fund’s fair valuemeasurement.

 

*Fair ValueAccounting*

 

In February 2007, the FASBissued FAS 159, *The Fair Value Optionfor Financial Assets and Financial Liabilities—Including an Amendment of FASBStatement 115* (“SFAS 159”). SFAS 159 permits entities tochoose to measure many financial instruments and certain other items at fairvalue at specified election dates.  Theentity will report unrealized gains and losses on items for which the fairvalue option has been elected in earnings at each subsequent reportingdate.  The fair value option (a) maybe applied instrument by instrument, with a few exceptions, such as investmentsotherwise accounted for by the equity method, (b) is irrevocable (unless anew election date occurs), and (c) is applied only to entire instrumentsand not to portions of instruments.  TheFund adopted SFAS 159 on January 1, 2008 and the Manager did notelect the fair value option for any of the Fund’s financial instruments.

 

*Accounting forBusiness Combinations*

 

In December 2007, the FASBissued 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.

 

*Hierarchy ofGenerally Accepted Accounting Principles*

 

In May 2008, the FASB issuedSFAS No. 162, *The Hierarchy ofGenerally Accepted Accounting Principles* (“SFAS No. 162”)*.* This standard identifies the sources ofaccounting principles and the framework for selecting the principles to be usedin the preparation of financial statements of nongovernmental entities that arepresented in conformity with GAAP. The provisions of SFAS No. 162 did nothave a material impact on the Fund’s financial statements.

 

**Note 3:  Related Party Transactions**

 

The Manager is responsible for allmanagement decisions related to the operations and investments of theFund.  In accordance with the OperatingAgreement and other loan servicing agreements with the Fund, the Manager isentitled to receive fees for the various services it provides and to bereimbursed for certain costs incurred on behalf of the Fund.  The Manager may also, at its sole discretion,agree to forego the fees for services and expense reimbursement otherwise dueand payable from the Fund.  When theManager agrees to forego these items, the Manager may collect additional feesand reimbursements, limited to the amount previously foregone, in subsequentyears if and only if the rate of return of the Fund is in excess of 8.0% andlimited each year to the amount in excess of that return. The Manager electedto forego $155,704 in asset management fees in the quarter ended March 31,2008, but did not elect to forgo any other fees during the quarter ended June 30,2008. The Manager did not forego any fees or reimbursements during the sixmonths ended June 30, 2007.

 

*Loan ServicingFees*

 

The Manager is entitled to receivea monthly fee for loan servicing of up to 2% per annum (1/12th of 2%per month) of the outstanding principal balance of each loan. The fee ispayable monthly as the Fund receives interest payments from borrowers.  The Manager may at its sole discretion, agreeto forego loan servicing fees otherwise due and payable from the Fund. Loanservicing fees for the quarters ended June 30, 2008 and 2007 were $541,859and $360,959, respectively. For the six months ended June 30, 2008 and2007, loan servicing fees were $1,013,445 and $1,176,985, respectively.

 

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*Asset ManagementFees*

 

The Manager is entitled to receivea monthly fee for management services provided to the Fund equal to 1% perannum (1/12th of 1% per month) of net assets under management, whichis payable on the last day of the month. Net assets, as defined by the Fund’sOperating Agreement, is equal to total members’ capital as of the first day ofthe month. The Manager may, at its sole discretion, agree to forego asset managementfees otherwise due and payable from the Fund. Asset management fees for the quarters ended June 30, 2008 and 2007were $231,262 and $242,481, respectively. For the six months ended June 30,2008 and 2007, asset management fees were $309,781 and $493,575, respectively.The Manager elected to forego $155,704 in asset management fees in the quarterended March 31, 2008, but did not elect to forgo any asset management feesduring the quarter ended June 30, 2008. The Manager did not forego anyasset management fees during the six months ended June 30, 2007.

 

*OperatingExpenses*

 

The Manager may be reimbursed bythe Fund for any operating expenses and other costs it incurs on behalf of theFund. The Manager may also, at its sole discretion, agree to forego operatingexpense reimbursement otherwise due and payable from the Fund or absorb theexpenses itself.  The Manager neitherabsorbed nor was reimbursed for operating expenses in the quarters ended June 30,2008 and June 30, 2007. The Manager absorbed $45,621 in Fund operatingexpenses in the six months ended June 30, 2008. The Manager neitherabsorbed nor was reimbursed for operating expenses in the six months ended June 30,2007.

 

*Note Receivable From Manager Secured By Deedsof Trust*

* *

*The Manager may take other actions in order to support thereturns on the Fund. On December 31, 2007, the Manager took such actionand purchased the principal, advance, and accrued interest on three nonaccrualloans from the Fund for a total of $7,525,777. The Manager made a cash paymentto the Fund of $1,279,590 and issued a Note Receivable from the Manager to theFund in the amount of $6,246,187 and agreed to make monthly interest paymentsto the Fund at the original interest rates on the loans. The Manager also at December 31,2007, made an additional $600,000 cash payment on an REO that was purchased bythe Manager from the Fund on December 30, 2006 which allowed the Fund torecognize a deferred gain of $1,263,195. During April, 2008, the Manager sold one of the loans in which the Fundheld a $3,103,573 loan receivable from the Manager.  The result of that sale left an unsecuredreceivable of $194,199 from the Manager at June 30, 2008, which was paidin October 2008. On July 1, 2008, the Manager sold the property forless than the amount of debt secured by the property, resulting in the Fundholding an unsecured note. The unsecured balance owed to the Fund totaled$670,854 at September 30, 2008.*

* *

*Lending Arrangements*

* *

At June 30,2008, there was an outstanding balance of $2,124,278 on a loan to the Managerused to purchase real estate held for sale from the Fund and a remainingbalance of $3,336,813 on a loan to the Manager used to purchase certainimpaired loans from the Fund. In addition, $9,324,632 of other payables and accruedinterest related to senior liens on REO held by the Fund were payable to otherfunds managed by the Manager.

 

*Borrowing Arrangements*

* *

In 2006, as discussed in Note 1, the Fund originated a $48,000,000 loansecured by deeds of trust (see Note 4 and 9). As part of this transaction,the Fund invested $23,000,000 of its own capital in the loan, and also enteredinto an agreement with Income Fund, a related party, to borrow $25,000,000secured by the Fund’s interest in the loan and all properties securing theloan. At June 30, 2008, the related party loan payable and accruedinterest due was $20,350,767. In conjunction with the loan, costs of $419,570were deferred.  Amortization of $104,892and $184,820 of this amount was recorded in the three and six months ended June 30,2007, with the remaining balance of the deferred costs fully amortized in 2007.The Fund was in technical default on this indebtedness as of June 30, 2008resulting in a technical default under Income Fund’s note to Wells FargoFoothill, the lender. The Manager subsequently negotiated amendments to thepromissory notes between Income Fund and Wells Fargo Foothill and betweenIncome Fund and the Fund that were made effective as of July 1, 2008,under which Wells Fargo Foothill and Income Fund, respectively, waived theexisting defaults and extended the maturity date until December 31, 2008. 

 

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* *

The Fund has continued to make monthly payments on its promissory note,and Wells Fargo Foothill, the lender, continues to accept these payments.

 

As of the end of October 2008 the Fund had acquired throughforeclosure, interests in three properties related to two loans with a totalcarrying value of approximately $38,685,000 as of June 30, 2008. One of thoseproperties is encumbered by the deed of trust used to secure the Income Fundand Wells Fargo Foothill note which combined with accrued unpaid interest had abalance payable of approximately $20,351,000 at September 30, 2008.

 

**Note 4:  LoansSecured 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 June 30, 2008 and 12.0% to 13.5% at June 30, 2007.

 

**Concentrations of Credit 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 June 30, 2008and 2007 had the following characteristics:

 

**Loan Portfolio in Dollars as of June 30,2008:**

 
| ** **                   | ** ** | **Trust Deeds** | ** ** |
|------------------------------|------------|----------------------|------------|
| ** **                   | ** ** | **First**            | ** ** | **Second** | ** ** | **Third** | ** ** | **Mixed** | ** ** | **Totals** | ** ** |
| Commercial real estate       |       | $                    | 2,124,278  |   | $ | 477,000 |   | $ | — |   | $ | 3,080,101 |   | $ | 5,681,379 |   |
| Residential real estate      |       | —               |       | 194,199 |   | — |   | — |   | 194,199 |   |
| Improved and unimproved land |       | 9,624,160            |       | 957,000 |   | 13,791,744 |   | 64,077,298 |   | 88,450,202 |   |
| Mixed use properties         |       | —               |       | 40,000 |   | — |   | — |   | 40,000 |   |
| Total(1)                     |       | $                    | 11,748,438 |   | $ | 1,668,199 |   | $ | 13,791,744 |   | $ | 67,157,399 |   | $ | 94,365,780 |   |

 

**Loan Portfolio inDollars as of June 30, 2007:**

 
| ** **                    | ** ** | **Trust Deeds** | ** ** |
|-------------------------------|------------|----------------------|------------|
| ** **                    | ** ** | **First**            | ** ** | **Second** | ** ** | **Third** | ** ** | **Mixed** | ** ** | **Totals** | ** ** |
| Commercial real  estate       |       | $                    | 2,820,000  |   | $ | 2,078,296 |   | $ | — |   | $ | 12,788,000 |   | $ | 17,686,296 |   |
| Residential real  estate      |       | —               |       | 3,100,000 |   | — |   | — |   | 3,100,000 |   |
| Improved and  unimproved land |       | 29,308,619           |       | — |   | — |   | 60,937,000 |   | 90,245,619 |   |
| Mixed use  Properties         |       | —               |       | — |   | — |   | — |   | — |   |
| Total                         |       | $                    | 32,128,619 |   | $ | 5,178,296 |   | $ | — |   | $ | 73,725,000 |   | $ | 111,031,915 |   |

 

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**Number of Loans inthe Portfolio as of June 30, 2008 and 2007:**

 
| ** **                    | ** ** | **2008**             | ** ** | **2007**             | ** ** |
|-------------------------------|------------|----------------------|------------|----------------------|------------|
| ** **                    | ** ** | **Trust Deeds** | ** ** | **Trust Deeds** | ** ** |
| ** **                    | ** ** | **First**            | ** ** | **Second**           | ** ** | **Third** | ** ** | **Mixed** | ** ** | **Totals** | ** ** | **First** | ** ** | **Second** | ** ** | **Third** | ** ** | **Mixed** | ** ** | **Totals** | ** ** |
| Commercial real  estate       |       | 1                    |       | 2                    |       | — |   | 3 |   | 6 |   | 2 |   | 4 |   | — |   | 5 |   | 11 |   |
| Residential real  estate      |       | —               |       | 1                    |       | — |   | — |   | 1 |   | — |   | 2 |   | — |   | — |   | 2 |   |
| Improved and  unimproved land |       | 4                    |       | 1                    |       | 2 |   | 6 |   | 13 |   | 12 |   | — |   | — |   | 5 |   | 17 |   |
| Mixed use  Properties         |       | —               |       | 1                    |       | — |   | — |   | 1 |   | — |   | — |   | — |   | — |   | — |   |
| Total(2)                      |       | 5                    |       | 5                    |       | 2 |   | 9 |   | 21 |   | 14 |   | 6 |   | — |   | 10 |   | 30 |   |

 

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**Schedule ofMaturities as of June 30, 2008:**

 
| ** **        | ** ** | **First**  | ** ** | **Second** | ** ** | **Third**  | ** ** | **Mixed**  | ** ** | **Totals** | ** ** |
|-------------------|------------|------------|------------|------------|------------|------------|------------|------------|------------|------------|------------|
| **June 30,** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| 2008              |       | $          | —     |       | $          | 957,000    |       | $          | 8,000,000  |       | $          | 3,080,101 |   | $ | 12,037,101 |   |
| 2009              |       | 3,224,450  |       | 10,000     |       | 5,791,744  |       | 63,982,298 |       | 73,008,492 |       |
| 2010              |       | 6,399,710  |       | 661,199    |       | —     |       | 95,000     |       | 7,155,909  |       |
| 2011              |       | —     |       | 40,000     |       | —     |       | —     |       | 40,000     |       |
| 2012              |       | 2,124,278  |       | —     |       | —     |       | —     |       | 2,124,278  |       |
| Total(1)          |       | $          | 11,748,438 |       | $          | 1,668,199  |       | $          | 13,791,744 |       | $          | 67,157,399 |   | $ | 94,365,780 |   |

 

**Schedule ofMaturities as of June 30, 2007:**

 
| ** **        | ** ** | **First**  | ** ** | **Second** | ** ** | **Third**  | ** ** | **Mixed**  | ** ** | **Totals** | ** ** |
|-------------------|------------|------------|------------|------------|------------|------------|------------|------------|------------|------------|------------|
| **June 30,** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| 2007              |       | $          | 55,000     |       | $          | 1,688,296  |       | $          | —     |       | $          | — |   | $ | 1,743,296 |   |
| 2008              |       | 8,577,000  |       | —     |       | —     |       | 10,918,000 |       | 19,495,000 |       |
| 2009              |       | 10,541,194 |       | 350,000    |       | —     |       | 61,007,000 |       | 71,898,194 |       |
| 2010              |       | 8,201,425  |       | 3,100,000  |       | —     |       | 1,800,000  |       | 13,101,425 |       |
| 2011              |       | 4,754,000  |       | 40,000     |       | —     |       | —     |       | 4,794,000  |       |
| Total             |       | $          | 32,128,619 |       | $          | 5,178,296  |       | $          | —     |       | $          | 73,725,000 |   | $ | 111,031,915 |   |

 

**Number of Loans inthe Portfolio by Maturity Date as of June 30, 2008 and 2007:**

 
| ** ** | ** ** | **2008**  | ** ** | **2007**   | ** ** |
|------------|------------|-----------|------------|------------|------------|
| ** ** | ** ** | **First** | ** ** | **Second** | ** ** | **Third** | ** ** | **Mixed** | ** ** | **Totals** | ** ** | **First** | ** ** | **Second** | ** ** | **Third** | ** ** | **Mixed** | ** ** | **Totals** | ** ** |
| 2007       |       | —    |       | —     |       | — |   | — |   | — |   | 1 |   | 1 |   | — |   | — |   | 2 |   |
| 2008       |       | —    |       | 1          |       | 1 |   | 3 |   | 5 |   | 3 |   | — |   | — |   | 3 |   | 6 |   |
| 2009       |       | 2         |       | 1          |       | 1 |   | 5 |   | 9 |   | 5 |   | 2 |   | — |   | 6 |   | 13 |   |
| 2010       |       | 2         |       | 2          |       | — |   | 1 |   | 5 |   | 3 |   | 2 |   | — |   | 1 |   | 6 |   |
| 2011       |       | —    |       | 1          |       | — |   | — |   | 1 |   | 2 |   | 1 |   | — |   | — |   | 3 |   |
| 2012+      |       | 1         |       | —     |       | — |   | — |   | 1 |   | — |   | — |   | — |   | — |   | — |   |
| Total(2)   |       | 5         |       | 5          |       | 2 |   | 9 |   | 21 |   | 14 |   | 6 |   | — |   | 10 |   | 30 |   |

 

**Loan PortfolioSummarized by Quartile as of June 30, 2008 and 2007:**

 
| ** **   | ** ** | **2008**  | ** ** | **2007**   | ** ** |
|--------------|------------|-----------|------------|------------|------------|
| **Quartile** | ** ** | **Count** | ** ** | **Total**  | ** ** | **Average** | ** ** | **Percent of  Total** | ** ** | **Count** | ** ** | **Total** | ** ** | **Average** | ** ** | **Percent  of  Total** | ** ** |
| 1            |       | 5         |       | $          | 339,200    |   | $ | 67,840 |   | 0 | % | 8 |   | $ | 424,000 |   | $ | 53,000 |   | 0 | % |
| 2            |       | 5         |       | 2,622,000  |       | 524,400 |   | 3 | % | 7 |   | 4,395,000 |   | 627,857 |   | 4 | % |
| 3            |       | 5         |       | 11,914,128 |       | 2,382,826 |   | 13 | % | 8 |   | 19,263,721 |   | 2,407,965 |   | 18 | % |
| 4            |       | 6         |       | 79,490,452 |       | 13,248,409 |   | 84 | % | 7 |   | 86,949,194 |   | 12,421,313 |   | 78 | % |
| Total(1)     |       | 21        |       | $          | 94,365,780 |   | $ | 4,493,609 |   | 100 | % | 30 |   | $ | 111,031,915 |   | $ | 3,701,064 |   | 100 | % |

 

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(1)Includes notes receivable fromthe Manager totaling $5,461,091.

 

(2)Includes four loans to theManager as of June 30, 2008 and none in 2007, respectively.

 

It is the Fund’s experience thatloans may not be repaid or refinanced in accordance with contractual maturitydate of the note; therefore the above tabulation of scheduled maturities shouldnot be used as a forecast of future cash receipts.

 

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Loans vary by size and over timethe mix in the portfolio changes. The number of loans in the portfolio and theoutstanding balances of total loans at June 30, 2008 have decreased from June 30,2007. The largest quartile of loans increased by 6% of the total portfolio from78% as of June 30, 2007 to 84% at June 30, 2008.  Expressed as average dollar size of loans,the largest quartile increased by $827,096 from $12,421,313 as of June 30,2007 to $13,248,409 as of June 30, 2008.

 

The Operating Agreement specifiesthat no more than 25% of total Fund capital (equal to members’ equity) will beinvested in any one loan, calculated as of the time the investment ismade.  In 2006, the Fund indirectlyborrowed $25,000,000 from Wells Fargo Foothill through Income Fund (“WellsFargo Foothill Loan”), in order to fund the $48,000,000 loan described in Notes3 and 9.  Although the entire$48,000,000 loan to the borrower was more than 25% of the Fund’s totalcapital at the time the Fund made this loan, the Fund’s own investment in theloan was $23,000,000, which was 21.8% of the $105,569,652 total capital at thetime the investment was made in June 2006. The Manager and its affiliatesmade additional loans to this borrower aggregating approximately $19,400,000.The Fund also has an interest aggregating $2,584,000 in a junior loan which issecured by the same property.  TheManager believes the transaction is in compliance with the provisions of theOperating Agreement.

 

Because the terms of the originalloan from Wells Fargo Foothill required monthly payments of interest andamortized principal, the original loan balance of the loan decreased. As aconsequence of the additional loans and the reduced principal balance of theWells Fargo Foothill Loan (which increased the investment of the Fund’s ownfunds in the loan to $30,384,049), and the overall reduction in the level ofcapital to $65,455,023 at June 30, 2008, the amount of funds invested in loansto this borrower secured by the same property totaled 46.4% of total capital atJune 30, 2008. The percentage of the Fund’s total capital that thisinvestment represents may continue to grow if additional advances are made tothis borrower or if the Fund’s capital is further reduced as a result ofredemptions by members from their capital accounts.

 

**Note 5:  Allowance for Loan Losses**

 

Changes in the allowance for loanlosses were as follows:

 
| ** **                       | ** ** | **As of June 30,** | ** ** |
|----------------------------------|------------|-----------------------------------|------------|
| ** **                       | ** ** | **2008**                          | ** ** | **2007** | ** ** |
|                             |       |                              |       |   |   |
| Balance, beginning  of period    |       | $                                 | 6,309,000  |   | $ | 684,845 |   |
| Provision charged  to operations |       | 20,829,479                        |       | 675,315 |   |
| Losses charged to  allowance     |       | (2,491,868                        | )          | — |   |
| Balance, end of  period          |       | $                                 | 24,646,611 |   | $ | 1,360,160 |   |

 

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

 
| ** **               | ** ** | **As of June 30,  2008** | ** ** | **As of June 30,  2007** | ** ** |
|--------------------------|------------|-----------------------------------------|------------|-----------------------------------------|------------|
|                     |       |                                    |       |                                    |       |
| Number of loans          |       | —                                  |       | 3                                       |       |
| Total principal  balance |       | $                                       | —     |                                    | $          | 18,020,000 |   |
|                          |            |                                         |            |                                         |            |  |  |

 

There were no loans as of June 30,2008 that were ninety days or more past due and still accruing interest.

 

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** **

**Impaired andnonaccrual loans:**

 
| ** **                                                                     | ** ** | **As of June 30,** | ** ** |
|--------------------------------------------------------------------------------|------------|-----------------------------------|------------|
| ** **                                                                     | ** ** | **2008**                          | ** ** | **2007** | ** ** |
| Number of loans                                                                |       | 10                                |       | 8 |   |
| Total principal  balance plus advances and accrued interest                    |       | $                                 | 72,533,198 |   | $ | 28,348,747 |   |
| Interest income  recognized during the quarter                                 |       | 95,185                            |       | 641,244 |   |
| Foregone interest  income                                                      |       | 2,153,493                         |       | 214,573 |   |
| Total principal,  advance and accrued interest of loans with specific reserves |       | 59,778,963                        |       | 6,181,425 |   |
| Specific loan  loss reserve                                                    |       | $                                 | 23,263,611 |   | $ | 805,000 |   |

 

At June 30, 2008 and 2007, allimpaired and non-accrual loans were in the process of foreclosure. When a loanis placed on nonaccrual status, the accrual of interest is discontinued;however, previously recorded accrued interest is not reversed. Paymentsreceived on impaired loans are applied to reduce principal to the extentnecessary to ensure collection of principal. Subsequent payments on theseloans, and payments received on nonaccrual 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 the Fund,and other legal courses of action available to the borrower and the Fund, theforeclosure of properties may be postponed or not completed. At June 30,2008 and 2007, there were no outstanding commitments to lend additional fundsto borrowers whose loans were identified as impaired.

 

The weighted average balance ofprincipal plus advances and accrued interest of impaired and nonaccrual loansduring the quarters ended June 30, 2008, and 2007 was $83,411,916 and$27,646,789, respectively. For the six months ended June 30, 2008 and2007, the weighted average balance of principal plus advances and accruedinterest of impaired and nonaccrual loans was $81,019,717 and $28,050,616,respectively.

 

**Note 6:  Real Estate Owned**

 

During 2007, the Fund foreclosed ontwo commercial properties that were loan collateral. It is holding the firstproperty while actively marketing the property for sale.  The Fund recorded the REO at the netrealizable value of the property at the time of foreclosure of $24,340. TheFund is also holding the other property and is funding ongoing entitlement,engineering and other site development work as it actively markets the propertyfor sale. The Manager believes that the fair market value of the property lessestimated costs to sell exceeds the carrying value of the REO at June 30,2008. The Fund’s portion of the carrying value of the property at the time offoreclosure was $8,553,935.

 

On April 9, 2008, the Manager,on the Fund’s behalf, completed foreclosure sales and acquired 20 of the 22properties that secured $10,600,000 in loans held by the Fund. These loans werejunior to senior debt totaling $17,829,734. Senior loans of $8,363,020 and$2,098,145 are held by other funds managed by the Manager.  The remaining $7,368,569 represents seniorloans held by outside third parties. In June, one of the two remainingproperties was lost as a result of foreclosure by the holder of a senior lien,and the borrower on the other property filed bankruptcy. The estimated netrealizable value of this remaining property is $579,100, net of $2,183,000 owedto third party senior lien holders.

 

In June, the Fund sold one of theproperties that had been acquired on April 9, 2008 and received $216,757in net proceeds from the sale, in addition to a note in the amount of $467,000.

 

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**Changes in thebalance of real estate owned were as follows:**

 
| ** **                                | ** ** | **As of June 30,** | ** ** |
|-------------------------------------------|------------|-----------------------------------|------------|
| ** **                                | ** ** | **2008**                          | ** ** | **2007** | ** ** |
|                                      |       |                              |       |   |   |
| Balance,  beginning of period             |       | $                                 | 8,578,275  |   | $ | — |   |
| Real estate  acquired through foreclosure |       | 15,553,708                        |       | 8,553,935 |   |
| Funded  improvements                      |       | 164,249                           |       | — |   |
| Impairment  charges                       |       | —                            |       | — |   |
| Sales of real  estate                     |       | (1,215,000                        | )          | — |   |
| Balance, end of  period                   |       | $                                 | 23,081,232 |   | 8,553,935 |   |
|                                           |            |                                   |            |  |  |  |  |

 

**Note 7.  Commitments and Contingencies**

 

**FinancialInstruments with Off-Balance Sheet Risk**

 

The Fund is a party to financialinstruments with off-balance sheet risk in the normal course of business inorder to meet the financing needs of its borrowers. These financial instrumentsinclude commitments to extend credit. These instruments involve, to varyingdegrees, elements of credit and interest rate risk in excess of the amountrecognized on the balance sheet.

 

Commitments to extend credit arearrangements to lend to a customer as long as there is no violation of anycondition established in the contract. Commitments generally have fixedexpiration dates or other termination clauses and may require the payment of afee payable to the Manager. Since some of the commitments are expected toexpire without being drawn upon and certain commitments may be funded throughother resources provided by the Manager, the total commitment amount does notnecessarily represent future cash requirements to the Fund. There were nooutstanding credit commitments as of June 30, 2008 or 2007.

 

**Contingencies**

 

The Fund is subject to legalproceedings and claims that arise in the ordinary course of business. In theopinion of Manager, the amount of ultimate liability with respect to suchactions will not materially affect the financial position or results ofoperations of the Fund.

 

The Fund registered under Section 12(g) ofthe Securities Exchange Act of 1934, as amended, effective as of January 8,2008.  The SEC has notified the Managerthat it is conducting an informal inquiry relating to the Manager and the Fundin order to determine whether there have been violations of the federalsecurities laws. In conjunction with this inquiry, certain information was requestedfrom the Fund. The Manager responded to the information requests related to theinquiry and will continue to cooperate with the SEC in responding to itsrequest. The Manager believes that there will not be a material impact on theFund’s financial position or operations as a result of the inquiry.

 

**Note 8.  Fair Value Disclosure**

 

On January 1, 2008, the Fundadopted SFAS 157, *Fair Value Measurements*,which defines fair value, establishes a framework for measuring fair value,establishes a three-level valuation hierarchy for disclosure of fair valuemeasurement and enhances disclosure requirements for fair value measurements.The valuation hierarchy is based upon the transparency of inputs to thevaluation of an asset or liability as of the measurement date. The three levelsare defined as follows:

 

| Level 1: | Inputs to the valuation methodology are  quoted priced (unadjusted) for identical assets or liabilities in active  markets. |
|----------|----------------------------------------------------------------------------------------------------------------------------------|

 

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| 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 a description ofthe valuation methodologies used by the Manager for instruments measured atfair value, as well as the general classification of such instruments pursuantto the valuation hierarchy:

 

***ASSETS***

 

*Impaired loans*

 

SFAS 157 requires loans to bemeasured for impairment using methodologies as detailed by SFAS No. 114, *Accounting by Creditors for Impairment of a Loan*(“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. All impaired loans as of June 30, 2008 were subject to SFAS114 analysis.

 

*Other Real EstateOwned*

 

The fair value of real estate ownedis based primarily on the values obtained through appraisals of property withsimilar characteristics. As of June 30, 2008, the Fund had no assets orliabilities measured at fair value on a recurring basis.** **Impairedloans and other REO are measured at fair value on a nonrecurring basisgenerally resulting from the provision of specific reserves in the allowancefor loan losses for impairment of individual loans and from the application of fairvalue accounting for REO.  For REO, fairvalue is based on appraisals obtained in the late second and early thirdquarter of 2008, less estimated cost to sell.

 

The following table presentsinformation about the Fund’s assets and liabilities measured at fair value on anonrecurring basis as of June 30, 2008.

** **
| ** **                                                              | ** ** | **Fair Value at June 30, 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)** | ** ** |
| Principal balance  plus advances and accrued interest on impaired loans |       | $                                                        | 49,269,587 |   | — |   | $ | 47,981,789 |   | $ | 1,287,798 |   |
| Other real estate  owned                                                |       | $                                                        | 23,081,232 |   | — |   | $ | 19,160,382 |   | $ | 3,920,850 |   |

 

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

 

***LIABILITIES***

 

TheFund did not identify any liabilities that are required to be presented at fairvalue.

 

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

 

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

 
| ** **                                                                                                                               | ** ** | **June 30, 2008** | ** ** | **December 31, 2007** | ** ** |
|------------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------------------|------------|---------------------------------|------------|
| Loans Receivable  from Manager (Note 4)                                                                                                  |       | $                           | 5,461,091  |                            | $          | 8,598,011 |   |
| Due from Manager,  net of reserve for uncollectible amounts of $900,000 as of June 30,  2008, and none as of December 31, 2007 |       | 1,075,325                   |       | 1,484,497                       |       |
| Due from other funds  serviced by Manager                                                                                                |       | 193,290                     |       | —                          |       |
| Due from escrowed  interest reserve trust account                                                                                        |       | —                      |       | 48,750                          |       |
|                                                                                                                                     |       | $                           | 6,729,706  |                            | $          | 10,131,258 |   |

 

Due to the uncertainty of both thetiming and the amount of the net realized sales proceeds on those propertiesincluded in the Contribution Agreement, the Fund provided a $900,000 allowancefor loan loss at June 30, 2008 on the unsecured Due from Manager balanceof $1,975,325, resulting in a net Due from Manager of $1,075,325.  During April, 2008 the Manager sold a loan inwhich the Fund held a $3,103,573 loan receivable from the Manager.  The result of that sale left an unsecuredreceivable of $194,199 from the Manager at June 30, 2008, which was paidin October 2008.

 

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

 
| ** **                              | ** ** | **June 30, 2008** | ** ** | **December 31, 2007** | ** ** |
|-----------------------------------------|------------|-----------------------------|------------|---------------------------------|------------|
| Servicing fees  payable to Manager      |       | $                           | 758,537    |                            | $          | 121,557 |   |
| Due to other  funds serviced by Manager |       | 349,372                     |       | 136,561                         |       |
|                                    |       | $                           | 1,107,909  |                            | $          | 258,118 |   |

 

**Other payables andaccrued interest - real estate owned:**

 
| ** **                                              | ** ** | **June 30, 2008** | ** ** | **December 31, 2007** | ** ** |
|---------------------------------------------------------|------------|-----------------------------|------------|---------------------------------|------------|
| Other payables -  real estate owned                     |       | $                           | 9,271,846  |                            | $          | — |   |
| Accrued interest  on other payables - real estate owned |       | 52,786                      |       | —                          |       |
|                                                    |       | $                           | 9,324,632  |                            | $          | — |   |

 

**Note payable torelated party - real estate owned:**

 
| ** **                                         | ** ** | **June 30, 2008** | ** ** | **December 31, 2007** | ** ** |
|----------------------------------------------------|------------|-----------------------------|------------|---------------------------------|------------|
| Note payable to  related party - real estate owned |       | $                           | 6,000,000  |                            | $          | 6,000,000 |   |
|                                               |       | $                           | 6,000,000  |                            | $          | 6,000,000 |   |

 

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

 
| ** **                                               | ** ** | **June 30, 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 |       | 150,816                     |       | 213,862                         |       |
|                                                     |       | $                           | 20,350,767 |                            | $          | 21,395,630 |   |

 

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In June 2007, the Fundforeclosed on its lien junior to a $6,000,000 note serviced by the Manager onbehalf of Fund I, Fund III and others for whom the Manager provides loanservicing. As owner of the property, the Fund is making payments on the seniornote to protect its equity in the property until such time as it sells theasset. The Fund recorded interest expense of $187,500 on this note during thequarter ended June 30, 2008 and $375,000 during the six months ended June 30,2008.

 

On April 8, 2008 the Fund helda $600,000 loan previously secured by 22 properties. This loan was junior to a$10,000,000 loan from the Fund and other senior debt totaling $17,829,734.Senior loans of $8,363,020 and $2,098,145 are held by other funds managed bythe Manager. Senior loans held by outside third parties amounted to $7,368,569.On April 9, 2008, the Manager, on the Fund’s behalf, completed foreclosuresales and acquired 20 of the 22 properties. In June, one of the two remainingproperties was lost as a result of foreclosure by the holder of a senior lien,and the borrower on the other property filed bankruptcy. The estimated netrealizable value of this remaining property is $579,100, net of $2,183,000 owedto third party senior lien holders.

 

**Note 10.  Subsequent Events**

 

**Subsequentdelinquency experience**

 

Since June 30, 2008,delinquencies in the Fund’s portfolio have increased as shown below.

 
| **Delinquent Status** | ** ** | **Outstanding Loan  Balance at  September 30,   2008** | ** ** | **Percent of Total  Balance at  September 30,  2008** | ** ** | **Outstanding Loan  Balance at  June 30, 2008** | ** ** | **Percent of Total  Balance at  June 30, 2008** | ** ** |
|----------------------------|------------|----------------------------------------------------------------------------|------------|---------------------------------------------------------------------------|------------|---------------------------------------------------------------------|------------|--------------------------------------------------------------------------|------------|
| 30 – 59 Days          |       | $                                                                          | —     |                                                                      | 0          | %                                                                   | $          | —                                                                   |       | 0 | % |
| 60 – 89 Days          |       | —                                                                     |       | 0                                                                         | %          | 40,000                                                              |       | nm                                                                       | %          |
| 90+ Days                   |       | 79,645,194                                                                 |       | 86                                                                        | %          | 66,558,197                                                          |       | 71                                                                       | %          |
| Total                      |       | $                                                                          | 79,645,194 |                                                                      | 86         | %                                                                   | $          | 66,598,197                                                               |       | 71 | % |

 

Delinquencies within the loanportfolio increased $13,046,997 from June 30, 2008 to September 30,2008.  This increase resulted from twoloans to the same borrower totaling $13,046,997.

 

**Impaired loans**

 

As of October 31, 2008, theFund held a $3,257,096 participation interest in a loan with a principalbalance of $41,855,381 and bearing interest at a rate of 13% per annum forwhich the borrower was in default.  Thebalance of the participation interests are held by other funds managed by theManager. This loan is a junior portion of a $97,900,000 total loan facilitywith a $55,000,000 senior position held by an entity unaffiliated with the Fundor the Manager.  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 has been attempting to negotiate with the holderof the senior participation to assume the debt service payments under thesenior participation on a modified payment schedule and to acquire ownership ofthe collateral. The participants in the loans do not currently have sufficientliquid assets to pay the full amount of past due payments and to assure paymentof future payments. Under agreements among the various participating funds,these advances will have a priority repayment position relative to loanprincipal and interest earned thereon. On March 11, 2008, the Manager madea short-term loan of $1,375,000 to the funds it manages that participate inthis loan which enabled them to pay an extension fee of $1,375,000 to thesenior lender. The various funds managed by the Manager have paid down theshort-term note by $727,471. The Fund’s pro rata share of payments made as of October 31,2008 was $123,447 and its share of the balance owed was $0. The Manager alsopaid an extension fee of $90,000 to a third party lender participating in thejunior note. On October 16, 2008 the senior lender informed the borrowerand the Manager of its intent to conduct a UCC foreclosure sale of themembership interests in the borrower on November 20, 2008. Under theco-lender agreement with the senior lender, if the senior lender completes thisforeclosure and acquires the membership interest at the foreclosure sale, thejunior portion of the loan (and thus our interest) will likely terminate. On November 19,2008, the fund from which the Fund acquired its participation interest filed avoluntary petition for relief under Chapter 11

 

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ofthe Bankruptcy Code. The automatic stay of this fund’s bankruptcy has stayedthe scheduled UCC foreclosure sale.

 

**Real estate owned**

 

As of June 30, 2008, the Fundheld two loans with carrying values totaling $54,251,000 and secured by liensof various priorities on three properties. The estimated value of the total collateral base at June 30, 2008was $82,050,000 securing total debt of $112,369,000.  Two of the three properties are subject tothird party senior debt totaling approximating $39,101,000 at June 30, 2008,which includes the note payable to Income Fund / Wells Fargo Foothill of$20,351,000.  On July 7, 2008, alimited liability company owned by the Fund and other funds managed by theManager, (specifically organized for the purpose of acquiring the property)acquired the first property at a foreclosure sale conducted on behalf of theFund. Because the aforementioned limited liability company was unable to makedebt service payments to the holder of the third party senior loan and couldnot reach an agreement with the holder of that note regarding restructuring oftheir note, the limited liability company was forced to file for Chapter 11bankruptcy protection on July 16, 2008 to prevent the loss of thecollateral to a foreclosure sale being conducted by the senior lender which wasscheduled for July 17, 2008. That bankruptcy case is pending as of thedate of this filing. On September 16, 2008 the Fund completed aforeclosure sale on the second property. On October 14, 2008, the Fund completeda foreclosure sale on the third property.

 

On December 30, 2006, the Fundsold to the Manager a property on which it had previously foreclosed with theManager paying 10% of the purchase price in cash and borrowing the remainingbalance from the Fund under a note secured by the property. On July 1,2008, the Manager sold the property for less than the amount of debt secured bythe property, resulting in the Fund holding an unsecured note. The unsecuredbalance owed to the Fund totaled $670,854 at September 30, 2008.

 

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**Item 2.****                                                           Management’sDiscussion and Analysis of Financial Condition and Results of Operations**

 

**FORWARD-LOOKINGSTATEMENTS**

 

*This QuarterlyReport on Form 10-Q, including particularly the Management’s Discussionand Analysis of Financial 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.*

 

The following discussion isdesigned to provide a better understanding of significant trends related to ourfinancial condition and results of operations. The discussion should be read inconjunction with our financial statements and notes thereto appearing elsewherein this Quarterly Report on Form 10-Q and in the 2007 Annual Report, aswell as the Management’s Discussion and Analysis of Financial Condition andResults of Operations contained in the 2007 Annual Report.

 

***Overview***

 

                                                Weare a California limited liability company organized for the purpose of makingor investing in business loans secured by deeds of trust or mortgages on realproperties located primarily in California. The loans are arranged and servicedfor us by the Manager. We previously funded our lending activities through loanpay downs or pay offs, as well as by selling our membership interests, and byselling 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 of our loans are fixed-ratemortgage loans. Interest that we earn on our loans has been and is expected tocontinue to represent our primary source of revenue so long as loan defaults byour borrowers do not ultimately result in significant foreclosure of theunderlying property collateral. In the case of real estate owned (“REO”),revenue, gains or losses would result from the operation of the property and/orits sale.

 

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Generally speaking, theunderwriting by the Manager focuses primarily on the value of the collateralsecuring the loan, and secondarily on the general creditworthiness andreputation of the borrower. The collateral is generally realproperty—predominantly land held by businesses or individuals, or commercialbuildings. As a result of the nature of our underwriting and lending, ourbusiness model generally results in higher delinquency and foreclosures thanexperienced by conventional commercial mortgage lenders. In the difficultpresent economic environment, generally, and given the lack of liquidity andthe unprecedented turmoil in the capital markets and the gridlock in the realestate markets, specifically, there are presently significant risks of lossesand higher charge-offs.  In addition,certain loans have been and will be written down in value to reflect what webelieve may be risks to full recovery of the loan amount.

 

Our current operating results areprimarily affected by:

 

·                  thelevel of loan losses experienced, including the gains and losses from theoperation and/or disposition of foreclosed properties;

·                  generalnational and local economic conditions and trends that influence the realestate investment industry, investment activity and property prices which inturn impact the demand for the financing of real estate investments;

·                  theamount of funding available through borrowing; and

·                  ouroperating costs, which consist of amounts paid to the Manager (servicing andasset management fees) and professional services, primarily legal, accounting,audit and tax.

 

For many commercial property types,such as apartment buildings, office buildings, hotels and retail buildings,values have generally risen over the past five years, through the third quarterof 2007. During the same period, capitalization rates, a popular method ofvaluing income properties, decreased to their lowest levels in decades. Ascapitalization rates decrease, property values increase since the same netincome results in higher valuations.

 

In California and some otherstates, office properties increased in value significantly through the thirdquarter of 2007, resulting in part from low vacancy rates and rising rentalrates. Hotels also experienced higher occupancy and average daily rates,increasing their values. Apartment values rose with higher occupancy rates and,in some areas, a significant interest from investors competing to purchasewell-located buildings for conversion to condominiums.

 

The commercial property marketsalso experienced unprecedented demand from investors and lenders through thirdquarter of 2007. Many of these investors and lenders came from overseas as theglobal economy expanded resulting in sizable amounts of liquidity in the realestate, private equity and financial markets.

 

The strong increase in propertyvalues, the falling capitalization rates, the increased number of other lendersengaged in our type of mortgage lending and the general availability of creditand liquidity resulted in a very competitive lending environment over the pastseveral years, through the third quarter of 2007. Home prices throughout theUnited States also had risen dramatically beginning in the last half of the1990s and continuing through 2006.

 

The Manager has always believed inthe cyclical nature of the real estate market and that downturns, such as thatwhich began in the residential area after 2006 and in the commercial realestate market after the third quarter of 2007 are inevitable.  Since the third quarter of 2007, commercialreal estate values have fallen for the most part.  In addition, there have been unprecedenteddislocations in the credit markets negatively affecting not only mortgagelending but also corporate financing and consumer lending, creating a generallack of liquidity for many financial institutions.

 

Due to the significance of loans collateralizedby land held for residential development, the reversal in housing markets andthe recent turmoil of the capital markets, particularly those elements thatprovide funding to subprime, Alt-A, and prime jumbo (non-conforming) lendersand borrowers, are expected to challenge our results of operations and cashflows.  Housing prices are generallydeclining; however much of the larger declines are in California, Nevada,Florida and Arizona. Taken together, the slow home absorption rates and anincreasing 

 

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inventory of vacant developed lotsare creating financial difficulties and an uncertain future for the homebuilders and land developers who are our borrowers.  There is no way to predict when conditionswill improve.

 

The general decline in value ofland held for residential development is in some cases offset to varyingdegrees by an increase in value attributed to progress on land development,such as annexation by a town or municipality or granting of entitlement ordevelopment approvals and/or building permits which moves the project closer toa stage where lots can be sold, individually or in bulk.

 

The Manager reviews the collateralvalue for each project in making the determination to recognize in the currentperiod interest income for financial reporting and to determine if adjustmentsto the allowance for loan losses and/or adjustments to the carrying values ofREO are required. However, because the number of commercial real estate salesand financings dropped dramatically during the past year, it is difficult toascertain actual current market values of commercial real estate.  The lack of availability of real estatefinancing and the fact that sellers are unwilling to sell at what may besignificantly lower prices has led to gridlock in the real estate markets.

 

As described in the 2007 AnnualReport, there are indications that land values have dropped quickly and reachedprices at which buyers are prepared to buy and sellers are prepared tosell.  The sales prices have reflecteddeep discounts to previously stated values. In our portfolio of land loans and considering valuation from thisperspective, we have noted a substantial increase in loan-to-value ratios. Insome situations, the amounts owed to us exceed the current 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 may allow us to realizehigher prices if and when the economy and real estate markets, including thosefor land, stabilize and transaction volumes increase.  Our ability to do so, however, depends onmaintaining a continued forbearance from Wells Fargo Foothill, Inc.(“Wells Fargo Foothill”) and CMR Income Fund, LLC (“Income Fund”) and ouraccess to funds that are sufficient to keep senior loans current, make otheradvances to protect our interests, and support our ongoing operations.

 

***Liquidityand Capital Resources***

 

Our financial statements have beenprepared assuming that we will continue as a going concern.  However, our independent registered publicaccounting firm has included in its audit report on our financial statementsfor our fiscal years ended December 31, 2007 and 2006, a going-concernexplanatory paragraph indicating that we have experienced a significant decreasein cash flows. In addition, a number of our loans are in default. Our illiquidposition may prevent us from protecting our position with respect to theproperty securing the defaulted loans. In addition, we are in default on a loan collateralized by a significantportion of the loan portfolio. These conditions cause substantial doubt aboutour ability to continue as a going-concern. By issuing an opinion stating that there is substantial doubt about ourability to continue as a going concern, our auditors have indicated that theyare uncertain as to whether we have the ability to continue our operationswithout additional funding.

 

Our current primary sources ofon-going, long-term liquidity and capital are loan interest received, loanpayoffs and REO sales.  Short-termliquidity needs are met by selling both partial and whole interests in loaninvestments.  Member redemptions aresubject to waiting periods, may be limited to available cash and may be cappedat 10% of aggregate members’ capital accounts over any 12-month period.  Early in our operating history, loan payoffswere received regularly and redemption requests could and would be met in lessthan 60 days. More recently, loan duration, defaults and foreclosures have beenincreasing due to constriction in liquidity as a result of the turmoil in thecapital markets and the overall downturn in real estate salestransactions.  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 theredemption request 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.

 

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Net cash used by financingactivities totaled $1.9 million in the first six months of 2008 compared to netcash used by financing activities of $11.1 million in the first six months of2007. The net change of $9.2 million was primarily the result of decreases indistributions to members of $8.7 million and repayments on a note held by arelated party of $0.8 million between the first six months of 2007 and thefirst six months of 2008. The effects of these uses of cash were partiallyoffset by $0.3 million in capital contributions from new and existing membersduring the first six months of 2007. Cash distributions to members totaled $0.9million including a $0.3 million reduction in accrued distributions, in thefirst six months of 2008 compared to $9.7 million in the first six monthsof 2007.

 

Investing activities provided cashtotaling $1.4 million in the first six months of 2008 compared to cash providedof $1.9 million in the first six months of 2007. The net decrease of $0.5million resulted from a $5.9 million net increase in loans during the first sixmonths of 2008 compared to the first six months of 2007, partially offset by a$3.1 million decrease in loans from the Manager, a $2.1 net decrease inadvances from borrowers in the first six months of 2008 compared to the firstsix month of 2007 and $0.2 million in proceeds from sale of REO.

 

Operating activities used cash of$0.3 million in the first six months of 2008, a $5.7 million net decrease fromthe $5.4 million of cash provided in the first six months of 2007. The decreasebetween the first six months of 2008 and the first six months of 2007 wascomprised of a net decrease in earnings of $23.8 million, an increase of $2.2million in amounts due from related parties and an increase of $0.9 million inaccrued interest receivable, partially offset by a $20.1 million increase inthe loan loss provision, an increase of $0.9 million in an impairment loss onamounts due from related party, and an increase of $0.2 million in accountspayable and accrued expenses.  Our cashand cash equivalents amounted to $0.6 million at June 30, 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 and REO, or collect receivables or borrow from the Manageror third parties.

 

Our significant obligations at June 30,2008 consisted of our $20.4 million promissory note to Income Fund bearinginterest at 8.97% and a $6.0 million senior note bearing interest at 12.5% towhich an REO was subject when we foreclosed. See Note 3 of the CondensedFinancial Statements.

 

In addition, at June 30, 2008,outstanding member redemption requests totaled $28.1 million compared to $0.6million at June 30, 2007.

 

Currently, we must depend on salesof foreclosed properties and any support we receive as a result of 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:

 

·                  Commencingin January 2008, the Manager set monthly distributions at an amount equalto the amount of net income (as compared to the targeted return as was done inprior periods).

 

·                  OnMarch 31, 2008, the Manager suspended indefinitely monthly cashdistributions of net income and members’ redemptions.

 

·                  OnApril 11, 2008, David Choo, the sole director of the Manager, executed aContribution Agreement with the Fund and certain other entities that theManager manages. Pursuant to the Contribution Agreement, Mr. Choo agreedto use his diligent good faith and best efforts to sell, or cause to be sold,certain properties that he owns or controls and to apply certain of theproceeds for specified purposes, one of which is to contribute or advance fundsto the Manager until the obligations of the Manager described below have beensatisfied. Contributions from Mr. Choo under the Contribution Agreementare to approximate $6.1 million. From these amounts, the Manager has agreed touse up to $5.0 million of the funds to be received from Mr. Choo to paynotes and other obligations of the Manager to us and other funds managed by theManager, and all of the Manager’s debts to third parties. The ContributionAgreement also commits the Manager to use at least $1.1 million of the funds tobe received from Mr. Choo as an operating reserve to be used solely forthe Manager’s operating costs and overhead.

 

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·                  Sincethe Contribution Agreement was signed, the following events have occurred: (1) proceedsof approximately $1.1 million were contributed or have been committed to theManager from the sale of two properties listed in the Contribution Agreement,net of $0.4 million that was used to support the real estate propertyactivities which were part of the Contribution Agreement; (2) anadditional $0.2 million was contributed to the Manager, including $60,000 ofproceeds from the sale of an additional property not listed in the ContributionAgreement (although this was not required by the Contribution Agreement, theproceeds counts toward the future contributions); (3) Mr. Chooaffected a sale in the second quarter 2008 of certain other mortgage and realproperty assets that were not listed in the Contribution Agreement resulting innet cash proceeds of approximately $2.2 million (net of $0.3 million that waswithdrawn), of which net proceeds were contributed to the Manager as an advanceon and in lieu of the approximately $2.2 million of net proceeds that he laterreceived from the subsequent sales of two other properties that were listed inthe Contribution Agreement. The net proceeds from the sales of these latter twoproperties were then used to pay pre-existing debts of Mr. Choo and werenot contributed to the Manager. The sales of various properties listed in theContribution Agreement have thus far yielded net cash proceeds to Mr. Chooand his affiliates of approximately $3.7 million, of which Mr. Choo hascontributed substantially all, totaling approximately $3.5 million as of November 10,2008 ($2.1 million as of June 30, 2008) to the Manager since theContribution Agreement was signed. The remaining commitment under the terms ofthe Contribution Agreement is $2.6 million, which proceeds are to be receivedif and when the remaining properties are sold.

 

·                  TheManager is continuing a program begun in the third quarter of 2006 to pursue anassertive collection process, including timely filing of a notice of default(generally within two days after the second missed payment — or sooner), timelyfiling of notice of foreclosure sale (generally as soon as permitted by law orregulation), preparing in advance of the foreclosure sale to marketaggressively the collateral/real estate taken back (including interviewing andretaining brokers) and filing legal claims against the borrower/guarantors. Asan alternate collection strategy we have, when appropriate, entered into formalforbearance agreements with specific borrowers which require the borrower toperform 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 our loan.

 

·                  TheManager is negotiating actively with third-party, senior lien holders toforebear and/or reduce payments owing from the borrower.

 

·                  TheManager sold properties collateralizing the notes owing by the Manager to us ata loss on sale (borne by the Manager) to raise cash for us.  These transactions closed on April 25,2008 and July 1, 2008 and generated cash totaling $4.4 million for us.

 

The above actions, taken togetherhave bolstered our cash resources and improved the likelihood of our continuingoperations, including our ability to meet the debt service on loans with lienssenior to ours, through 2008.  Aspreviously noted elsewhere, we are dependent on the repayment of loan principaland sale of REO to continue operations through 2008 into 2009 and beyond,including eventual resumption of distributions. The Manager has had certain ofthe collateral securing our loans (with the consent and cooperation of theborrower) and most of our REO listed with nationally recognized and otherwiseexperienced brokers with strong presence in the applicable local markets andexperience with the collateral type (*e.g*.,land held for residential development in Hawaii or land held for commercialdevelopment in Southern California).These brokers are diligent and committed tocompleting a transaction, but caution against forecasting the timing andpricing of a transaction in a historically low-volume market with limitedcredit financing available.  Thedislocations and uncertainty in the capital and real estate markets havecreated a challenging environment which may continue through 2008 into 2009 andmay necessitate further liquidations of assets at sub-optimum prices,particularly if conditions deteriorate further.

 

Due to unprecedented dislocationsin the real estate and capital markets since 2007, including an increase in thenumber of past due loans and a decrease in the number of loan payoffsexperienced by certain of the funds managed by the Manager, the Manager hasexperienced a significant decrease in cash flows and has limited cashresources.  While the funds that theManager manages do continue to accrue and collect interest on a portion oftheir 

 

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loan portfolios, receive payoffs onloan balances owed and receive proceeds from the sale of real estate acquiredthrough foreclosure, thereby allowing the Manager to collect servicing andasset management fees, those cash flows may not be sufficient to fund theManager’s operations as they become due. The Manager generated additional cashfrom the collection of principal, advances, and interest on its loans, the saleof its REO it acquired through foreclosure and from contributions from its soledirector. Furthermore, the Fund cannot be sure that additional sales ofproperties under the Contribution Agreement will be made on a timely basis.While these collection, sale and contribution actions improve the likelihood ofthe Manager continuing its operations, the limited cash resources compared tothe operating and debt service requirements of the Manager raise substantialdoubt about the Manager’s ability to continue as a going concern. Should theManager be unable to continue to serve as Manager to the Fund, the Fund mayincur additional expenses to find a replacement manager and to support theoperational needs of the Fund. While potential replacement managers existwithin the marketplace, their capacity or willingness to serve as the Fund’smanager is unknown. A change in the manager may impact negatively the operatingresults of the Fund and the cash available for distribution. In the event thatthe operations or cash position of the Fund deteriorate significantly, the Fundmay need to liquidate loans and REO in order to keep senior lien positionscurrent or forestall the foreclosure of properties serving as collateral on theFund’s junior liens.

 

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***Resultsof Operations***

 

Set forth below are summaries ofour financial results for the three and six months ended June 30, 2008 and2007.

 
| ** **                                         | ** ** | **Three  Months  Ended  June 30,  2008** | ** **  | **Percent of  Revenues,  net** | ** ** | **Three Months  Ended  June 30,  2007** | ** ** | **Percent of  Revenues,  net** | ** ** |
|----------------------------------------------------|------------|-----------------------------------------------|-------------|-------------------------------------|------------|---------------------------------------------------|------------|-------------------------------------|------------|
| Revenues:                                          |       |                                          |        |                                |       |                                              |       |                                |       |
| Interest income:                                   |       |                                          |        |                                |       |                                              |       |                                |       |
| Interest on loans                                  |       | $                                             | 1,136,897   |                                | 113.6      | %                                                 | $          | 2,581,141                           |       | 99.7 | % |
| Interest on notes receivable – related  party |       | 264,793                                       |        | 26.5                                |       | —                                            |       | —                              |       |
| Interest on advances to borrowers                  |       | (103,788                                      | )           | (10.4                               | )          | 165,996                                           |       | 6.4                                 |       |
| Other interest income                              |       | 244,985                                       |        | 24.5                                |       | 201,757                                           |       | 7.8                                 |       |
| Total interest income                              |       | 1,542,887                                     |        | 154.1                               |       | 2,948,894                                         |       | 113.9                               |       |
| Less: Loan servicing fees                          |       | 541,859                                       |        | 54.1                                |       | 360,959                                           |       | 13.9                                |       |
| Total interest income, net of servicing  fees      |       | 1,001,028                                     |        | 100.0                               |       | 2,587,935                                         |       | 100.0                               |       |
| Loss on sale of real estate owned                  |       | (3,674                                        | )           | (0.4                                | )          | —                                            |       | —                              |       |
| Total revenues, net of servicing fees              |       | 997,354                                       |        | 99.6                                |       | 2,587,935                                         |       | 100.0                               |       |
| Interest expense                                   |       | 474,484                                       |        | 47.4                                |       | 711,744                                           |       | 27.5                                |       |
| Interest expense – related party              |       | 187,500                                       |        | 18.7                                |       | —                                            |       | —                              |       |
| Provision for loan losses                          |       | 20,829,479                                    |        | 2,080.8                             |       | 450,315                                           |       | 17.4                                |       |
| Net revenues                                       |       | (20,494,109                                   | )           | (2,047.3                            | )          | 1,425,876                                         |       | 55.1                                |       |
| Operating expenses:                                |       |                                          |        |                                |       |                                              |       |                                |       |
| Professional services                              |       | 1,021,894                                     |        | 102.1                               |       | 426,024                                           |       | 16.5                                |       |
| Asset management fees                              |       | 231,262                                       |        | 23.1                                |       | 242,481                                           |       | 9.4                                 |       |
| Allowance for loss on due from related  party      |       | 900,000                                       |        | 89.9                                |       | —                                            |       | —                              |       |
| Other operating expenses                           |       | 295,132                                       |        | 29.5                                |       | 4,777                                             |       | 0.2                                 |       |
| Total operating expenses                           |       | 2,448,288                                     |        | 244.6                               |       | 673,282                                           |       | 26.0                                |       |
| Net (loss) income                                  |       | $                                             | (22,942,397 | )                                   | (2,291.9   | )%                                                | $          | 752,594                             |       | 29.1 | % |

 

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| ** **                                         | ** ** | **Six Months  Ended June  30,2008** | ** **  | **Percent of  Revenues,  net** | ** ** | **Six Months  Ended  June 30, 2007** | ** ** | **Percent of  Revenues,  net** | ** ** |
|----------------------------------------------------|------------|-----------------------------------------------|-------------|-------------------------------------|------------|-----------------------------------------------------|------------|-------------------------------------|------------|
| Revenues:                                          |       |                                          |        |                                |       |                                                |       |                                |       |
| Interest income:                                   |       |                                          |        |                                |       |                                                |       |                                |       |
| Interest on loans                                  |       | $                                             | 3,676,875   |                                | 101.3      | %                                                   | $          | 5,956,411                           |       | 108.9 | % |
| Interest on notes  receivable – related party |       | 400,127                                       |        | 11.0                                |       | —                                              |       | —                              |       |
| Interest on  advances to borrowers                 |       | 123,006                                       |        | 3.4                                 |       | 238,632                                             |       | 4.4                                 |       |
| Other interest  income                             |       | 443,624                                       |        | 12.2                                |       | 450,855                                             |       | 8.2                                 |       |
| Total interest  income                             |       | 4,643,632                                     |        | 127.9                               |       | 6,645,898                                           |       | 121.5                               |       |
| Less: Loan  servicing fees                         |       | 1,013,445                                     |        | 27.9                                |       | 1,176,985                                           |       | 21.5                                |       |
| Total interest  income, net of servicing fees      |       | 3,630,187                                     |        | 100.0                               |       | 5,468,913                                           |       | 100.0                               |       |
| Loss on sale of  real estate owned                 |       | (3,674                                        | )           | (0.1                                | )          | —                                              |       | —                              |       |
| Total revenues,  net of servicing fees             |       | 3,626,513                                     |        | 99.9                                |       | 5,468,913                                           |       | 100.0                               |       |
| Interest expense                                   |       | 1,037,363                                     |        | 28.6                                |       | 1,522,400                                           |       | 27.8                                |       |
| Interest expense –  related party             |       | 375,000                                       |        | 10.3                                |       | —                                              |       | —                              |       |
| Provision for  loan losses                         |       | 20,829,479                                    |        | 573.8                               |       | 675,315                                             |       | 12.3                                |       |
| Net revenues                                       |       | (18,615,329                                   | )           | (512.8                              | )          | 3,271,198                                           |       | 59.8                                |       |
| Operating  expenses:                               |       |                                          |        |                                |       |                                                |       |                                |       |
| Professional  services                             |       | 1,467,944                                     |        | 40.4                                |       | 525,814                                             |       | 9.6                                 |       |
| Asset management  fees                             |       | 309,781                                       |        | 8.5                                 |       | 493,575                                             |       | 9.0                                 |       |
| Allowance for  loss on due from related party      |       | 900,000                                       |        | 24.8                                |       | —                                              |       | —                              |       |
| Other operating  expenses                          |       | 312,680                                       |        | 8.6                                 |       | 8,228                                               |       | 0.2                                 |       |
| Total operating  expenses                          |       | 2,990,405                                     |        | 82.4                                |       | 1,027,617                                           |       | 18.8                                |       |
| Net (loss) income                                  |       | $                                             | (21,605,734 | )                                   | (595.2     | )%                                                  | $          | 2,243,581                           |       | 41.0 | % |

 

*InterestIncome, Net of Servicing Fees*

 

Total interest income amounted to154.1% of total interest income, net of servicing fees in the quarter ended June 30,2008 and 113.9% in the quarter ended June 30, 2007. Interest incometotaled approximately $1.5 million in the quarter ended June 30,2008, a $1.4 million (47.7%) decrease over the quarter ended June 30,2007. Total interest income amounted to 127.9% of total interest income, net ofservicing fees in the six months ended June 30, 2008 and 121.5% in the sixmonths ended June 30, 2007. Interest income totaled approximately $4.6million in the six months ended June 30, 2008, a $2.0 million (30.1%)decrease compared to the six months ended June 30, 2007. The decrease ininterest income was due to the overall decrease in the level of earning assetsdue to an increase in both non-accrual loans and REO between both 2008 and 2007periods. Non-accrual loan principal plus advances and accrued interest averaged$83.4 million in the quarter ended June 30, 2008 and $27.6 million for thequarter ended June 30, 2007, while REO averaged $22.2 million for thequarter ended June 30, 2008 as compared to $2.1 million for the quarterended June 30, 2007. Non-accrual loan principal plus advances and accruedinterest averaged $81.0 million for the six months ended June 30, 2008 and$28.1 million for the six months ended June 30, 2007, while REO averaged$16.4 million for the six months ended June 30, 2008 as compared to $1.2million for the six months ended June 30, 2007.

 

The yield on loans and advances forthe quarter ended June 30, 2008 was 5.12% on average loans and advances of$101.5 million (loans: $96.3 million plus advances: $5.2 million) compared to9.40% in the quarter ended June 30, 2007 on average loans and advances of$116.9 million (loans: $114.6 million plus advances: $2.3 million).  The yield on loans and advances in the sixmonths ended June 30, 2008 was 8.05% on average loans and advances of$104.4 million (loans: $99.1 million plus advances: $5.3 million) compared to10.72% in the six months ended June 30, 2007 on average loans and advancesof $115.5 million(loans: $113.7 million plus advances: $1.8 

 

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million). The declines of 428 basispoints between quarters and 267 basis points between six months periods isprimarily attributable to the increases in loans on non-accrual status and REO.

 

Loan servicing fees increased toapproximately $0.5 million in the quarter ended June 30, 2008 (anincrease of $0.2 million or 50.1%) from $0.3 million in the quarter ended June 30,2007. Loan servicing fees decreased to approximately $1.0 million in thefirst six months of 2008 (a decrease of $0.2 million or 13.9%) from$1.2 million in the first six months of 2007. The decreases were primarilydue to the number and amount of loans on non-accrual status in the quarter andsix months ended June 30, 2008. Loan servicing fees were 2% of theprincipal of each loan and were paid as interest income was received.

 

*InterestExpense*

 

During the quarter ended June 30,2008, interest expense (including related party interest expense) wasapproximately $0.7 million, no change from the $0.7 million in interestexpense for the quarter ended June 30, 2007. The decrease resulted from a$0.2 million decrease in amortization of loan fees, partially offset by a $0.1million increase in interest expense on the $6.0 million note payable toFund I, Fund III and others for whom the Manager provides loanservicing secured by our REO. The effective rate of this borrowing was 12.50%at June 30, 2008.  For the sixmonths ended June 30, 2008, interest expense (including related partyinterest expense) was approximately $1.4 million, a decrease of $0.1million from the $1.5 million in interest expense for the six months ended June 30,2007. The decrease resulted from a reduction in loan fee amortization of $0.3million, a decrease in interest expense of $0.2 million on a $20.4 million notepayable to Income Fund, due to a decline in the one month LIBOR interest rate.The effective rate of this borrowing was 9.53% during the first six months of2008, as compared to 11.95% during the first six months of 2007. Partially offsettingthese decreases was a $0.4 million increase in interest as a result of the $6.0million note payable being assumed in connection with a REO foreclosure inJune, 2007.

 

*Provisionfor Loan Losses*

 

The provision for loan lossesincreased by $20.4 million to $20.8 million in the quarter ended June 30,2008 compared to $0.4 million for the quarter ended June 30, 2007. For thesix months ended June 30, 2008, the provision for loan losses increased by$20.2 million compared to the same period in 2007.  The increases were due to the decline in realestate property values which secure the loan portfolio.

 

*OperatingExpenses*

 

Operating expenses increased $1.8million in the quarter ended June 30, 2008 compared to the quarter ended June 30,2007. The increase primarily resulted from a $0.9 million impairment on thereceivable balance due from the Manager, increases of $0.6 million inprofessional services due to increases in both legal and accounting feesassociated with the 2007 Annual Report, SEC inquiry, and compliance relatedmatters, and $0.3 million in expenses associated with senior lien payments toentities not affiliated with the Manager.

 

Operating expenses increased $2.0million in the first six months ended June 30, 2008 compared to the sixmonths ended June 30, 2007. The increase consisted of the $0.9 millionimpairment on the receivable balance due from the Manager, a $0.9 millionincrease in professional services and a $0.5 million increase in expensesassociated with senior lien payments to entities not affiliated with theManager and other operating expenses, partially offset by a $0.2 milliondecrease in asset management fees resulting from the Manager’s forgoing ofthese fees in the first two months of 2008.

 

*NetLoss/Income*

 

The net loss for the quarter ended June 30,2008 was $22.9 million, a decrease of $23.7 million from the $0.8 million netincome for the quarter ended June 30, 2007. The decrease in net incomeresulted from a $20.4 million increase in the loan loss provision, a $1.4million decrease in total interest income, a $0.6 million increase inprofessional services expenses, a $1.3 million increase in other operatingexpenses, primarily related to the $0.9 million allowance on the receivablefrom the Manager and expenses associated with senior lien payments to entitiesnot affiliated with the Manager and a $0.2 million increase in loan servicingfees between the quarter ended June 30, 

 

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2007 and the quarter ended June 30,2008, partially offset by a $0.1 million decrease in interest expense.  For the first six months of 2008, the netloss was $21.6 million, a decrease of $23.8 million from the net income of $2.2million for the first six months of 2007. The decrease in net income resultedfrom a $20.2 million increase in the loan loss provision, a $2.0 milliondecrease in total interest income, a $1.0 million increase in professionalservices expenses, a $1.3 million increase in other operating expenses,partially offset by a $0.2 reduction in loan servicing fees, a $0.2 millionreduction in asset management fees, and a $0.1 decrease in interest expense.

 

***LendingCapacity and Assets***

 

Our lending capacity at June 30,2008 was $73.0 million (members’ capital of $65.5 million and notes and otherpayables of $35.7 million, less pending redemptions of $28.1 million), nearlyall of which had already been loaned. Cash and equivalents ($0.6 million), loansand notes receivable ($69.7 million), advances ($4.8 million), and REO ($23.1million) were $98.3 million or 134.5% of available capacity. The lendingcapacity at June 30, 2007 was $119.3 million (members’ capital of$92.2 million and note payable of $27.7 million, less pendingredemptions of $0.6 million), nearly all of which had already been loaned. Cashand equivalents ($0.4 million), loans ($111.0 million) and advances($2.2 million) were $113.6 million or 95.2% of available capacity.  We are no longer accepting new members atthis time.  Future lending capacity, ifany, will come from reinvestment of earnings, if any, and additionalcontributions from existing members and from borrowings.

 

***LoanPortfolio and Asset Quality***

 

As of June 30, 2008 and 2007,our mortgage investments aggregated $94.4 million and $111.0 million,respectively. The average loan and advance balance was $99.3 million as of June 30,2008 and $116.8 million as of June 30, 2007.

 

Approximately $66.6 million (71%)and $24.6 million (22%) of the loans we invested in were more than 90 daysdelinquent in monthly payments as of June 30, 2008 and June 30, 2007,respectively. Of these loans, the amounts attributable to borrowers who filedbankruptcy were approximately $20.4 million (28%) as of June 30, 2008 and$10.9 (10%) as of June 30, 2007. (For financial reporting purposes theTotal Outstanding Loan Balance is presented net of the allowance for loanlosses and the amounts in trusts for interest reserves and future advances; forpurposes of the discussion above it is presented on a gross basis.)

 

As of June 30, 2008 and 2007,we held the following types of mortgages.

 
| ** **                             | ** ** | **June 30, 2008** | ** ** | **June 30, 2007** | ** ** |
|----------------------------------------|------------|-----------------------------|------------|-----------------------------|------------|
| Trust Deeds:                           |       |                        |       |                        |       |
| First                                  |       | $                           | 11,748,438 |                        | $          | 32,128,619 |   |
| Second                                 |       | 1,668,199                   |       | 5,178,296                   |       |
| Third                                  |       | 13,791,744                  |       | —                      |       |
| Mixed                                  |       | 67,157,399                  |       | 73,725,000                  |       |
| Total                                  |       | $                           | 94,365,780 |                        | $          | 111,031,915 |   |
|                                   |       |                        |       |                        |       |
| Collateral Type:                       |       |                        |       |                        |       |
| Commercial Real  Estate                |       | $                           | 5,681,379  |                        | $          | 17,686,296 |   |
| Residential Real  Estate               |       | 194,199                     |       | 3,100,000                   |       |
| Land Held for  Residential Development |       | 88,450,202                  |       | 90,245,619                  |       |
| Mixed-Use  Properties                  |       | 40,000                      |       | —                      |       |
| Total Outstanding  Loan Balance        |       | $                           | 94,365,780 |                        | $          | 111,031,915 |   |

 

***AssetQuality***

 

A consequence of originating orinvesting in loans is that losses may occur. The actual amount of such losses,if any, may vary from time to time. Factors that affect such potential risksinclude general economic conditions of the real estate market as well asspecific conditions in a particular sub-market (*e.g.*, land development), 

 

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availability of funds in thecapital market, and the experience and expertise of the borrower. While many ofthese factors are beyond the control of the Manager, they can be monitored andused by the Manager in assessing potential risks.

 

The Manager also estimates at leastquarterly, the value of the collateral underlying the loans, the cost todispose of the property, and the costs to maintain the property, includinginsurance and payments made to retain development rights and entitlements. Asnecessary, provisions are made for loan losses to adjust the allowance for loanlosses to an amount considered by the Manager to be adequate, with dueconsideration for the value of the properties securing these loans (estimatedbased on information available in the real estate market including appraisalsand reviews of similar properties), to provide for probable losses on loans andreceivables, including impaired loans, other loans, accrued interest, late feesand advances on loans and other accounts receivable (unsecured).

 

Loan losses deemed to beuncollectible are charged against the allowance for loan losses. Recoveries ofpreviously written off amounts are credited to the allowance for loanlosses.  The Manager believes that theallowance for loan losses of $24.6 million at June 30, 2008 was adequatein amount to cover probable losses.

 

Changes in the allowance for loanlosses for the three months ended June 30, 2008 and 2007 were as follows.

 
| ** **                       | ** ** | **Three Months Ended  June 30,** | ** ** |
|----------------------------------|------------|-------------------------------------------------|------------|
| ** **                       | ** ** | **2008**                                        | ** ** | **2007** | ** ** |
| Balance,  beginning of period    |       | $                                               | 6,309,000  |   | $ | 909,845 |   |
| Provision charged  to operations |       | 20,829,479                                      |       | 450,315 |   |
| Losses charged to  allowance     |       | (2,491,868                                      | )          | — |   |
| Balance, end of  period          |       | $                                               | 24,646,611 |   | $ | 1,360,160 |   |

 

**MortgageLoan Delinquencies**

** **
| **Delinquent  Status  (Days)** | ** ** | **Outstanding  Loan  Balance at  June 30,  2008** | ** ** | **Percent of  Total  Balance at  June 30,  2008** | ** ** | **Outstanding  Loan  Balance at  December  31, 2007** | ** ** | **Percent of  Total  Balance at  December  31, 2007** | ** ** | **Outstanding  Loan  Balance at  June 30,  2007** | ** ** | **Percent  of Total  Balance at  June 30,  2007** | ** ** |
|--------------------------------|------------|-------------------------------------------------------------|------------|------------------------------------------------------------------|------------|-----------------------------------------------------------------|------------|-----------------------------------------------------------------|------------|-------------------------------------------------------------|------------|------------------------------------------------------------------|------------|
| 30 – 59                   |       | $                                                           | —     |                                                             | 0          | %                                                               | $          | —                                                          |       | 0                                                           | %          | $                                                                | —     |   | 0 | % |
| 60 – 89                   |       | 40,000                                                      |       | nm                                                               | %          | 10,254,290                                                      |       | 10                                                              | %          | —                                                      |       | 0                                                                | %          |
| 90+                            |       | 66,558,197                                                  |       | 71                                                               | %          | 21,706,000                                                      |       | 21                                                              | %          | 24,574,425                                                  |       | 22                                                               | %          |
| Total                          |       | $                                                           | 66,598,197 |                                                             | 71         | %                                                               | $          | 31,960,290                                                      |       | 31                                                          | %          | $                                                                | 24,574,425 |   | 22 | % |

 

The $34,637,907 increase indelinquencies from December 31, 2007 is primarily due to one loan with aprincipal balance of $48,000,000, and another of $3,257,096, which were currentas of December 31, 2007 but are included in the 90+ days delinquentcategory as of June 30, 2008. One loan for $957,000 that was current on December 31,2007 was 90+ days delinquent as of June 30, 2008, and another for $40,000was 60+ days delinquent as of June 30. 2008.

 

These are offset by two loans witha principal balance of $9,574,290 as of December 31, 2007 which were inthe 60-89 days category but had been brought current by a junior note as of June 30,2008. One loan for $200,000 that was 90+ days delinquent on December 31,2007 had been brought current as of June 30, 2008, and another for $4,000was paid off. In addition two loans to the same borrower became REO during theperiod, resulting in a reduction of 90+ days delinquent principal balancetotaling $7,837,899.

 

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

 
| ** **               | ** ** | **As of  June 30,** | ** ** |
|--------------------------|------------|-----------------------------------------|------------|
| ** **               | ** ** | **2008**                                | ** ** | **2007** | ** ** |
| Number of loans          |       | —                                  |       | 3 |   |
| Total principal  balance |       | $                                       | —     |   | $ | 18,020,000 |   |
|                          |            |                                         |            |  |  |  |  |

 

There were no loans as of June 30,2008 that were ninety days or more past due and still accruing interest.

 

**Impaired andnon-accrual loans:**

 
| ** **                                                                             | ** ** | **As of  June 30,** | ** ** |
|----------------------------------------------------------------------------------------|------------|-----------------------------------------|------------|
| ** **                                                                             | ** ** | **2008**                                | ** ** | **2007** | ** ** |
| Number of loans                                                                        |       | 10                                      |       | 8 |   |
| Total principal  balance plus advances and accrued interest                            |       | $                                       | 72,533,198 |   | $ | 28,348,747 |   |
| Interest income  recognized during the quarter                                         |       | 95,185                                  |       | 641,244 |   |
| Foregone interest  income                                                              |       | 2,153,493                               |       | 214,573 |   |
| Total principal,  advance and accrued interest balance of loans with specific reserves |       | 59,778,963                              |       | 6,181,425 |   |
| Specific loan  loss reserve                                                            |       | $                                       | 23,263,611 |   | $ | 805,000 |   |

 

At June 30, 2008 and 2007, allof the impaired and non-accrual loans were in the process of foreclosure. Whena loan is placed on non-accrual, the accrual of interest is discontinued,however previously recorded accrued interest is not reversed. Payments receivedon impaired loans are applied to reduce principal to the extent necessary toensure collection of principal. Subsequent payments on these loans, andpayments received on non-accrual loans for which the ultimate collectability ofprincipal is not in doubt, are applied first to earned but unpaid interest andthen to principal. Depending on the borrowers’ ability to bring a loan currentthrough payment, refinancing by a third party or us, and other legal courses ofaction available to the borrower and us, the foreclosure of properties may bepostponed or not completed. At June 30, 2008 and 2007, there were nooutstanding commitments to lend additional funds to borrowers whose loans wereidentified as impaired.

 

The weighted average balance ofprincipal plus advances and accrued interest of impaired and non-accrual loansduring the quarters ended June 30, 2008, and 2007 was $83,411,916 and$27,646,789, respectively. For the six months ended June 30, 2008 and2007, the weighted average balance of principal plus advances and accruedinterest of impaired and nonaccrual loans were $81,019,717 and $28,050,616,respectively.

 

***Subsequent delinquency experience***

 

Since June 30, 2008,delinquencies in our portfolio have increased as shown below.

 
| **Delinquent Status  (Days)** | ** ** | **Outstanding Loan  Balance at  September  30, 2008** | ** ** | **Percent of Total  Balance at  September 30,  2008** | ** ** | **Outstanding Loan  Balance at  June  30, 2008** | ** ** | **Percent of Total  Balance at  June  30, 2008** | ** ** |
|------------------------------------|------------|----------------------------------------------------------------------|------------|---------------------------------------------------------------------------|------------|-----------------------------------------------------------------|------------|----------------------------------------------------------------------|------------|
| 30 – 59                       |       | $                                                                    | —     |                                                                      | 0          | %                                                               | $          | —                                                               |       | 0 | % |
| 60 – 89                       |       | —                                                               |       | 0                                                                         | %          | 40,000                                                          |       | nm                                                                   | %          |
| 90+                                |       | 79,645,194                                                           |       | 86                                                                        | %          | 66,558,197                                                      |       | 71                                                                   | %          |
| Total                              |       | $                                                                    | 79,645,194 |                                                                      | 86         | %                                                               | $          | 66,598,197                                                           |       | 71 | % |

 

Delinquencies within the loanportfolio increased $13.0 million from June 30, 2008 to September 30,2008.

 

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***RealEstate Owned (REO)***

 

*2007Foreclosures:* During 2007, we foreclosed on twocommercial properties that were loan collateral.  We are holding the first property whileactively marketing the property for sale. We recorded the REO at the net realizable value of the property at thetime of foreclosure of $24,340. We are also holding the other property and isfunding ongoing entitlement, engineering and other site development work as itactively markets the property for sale. The Manager believes that the fairmarket value of the property less estimated costs to sell exceeds the carryingvalue of the REO at June 30, 2008. Our portion of the carrying value ofthe property at the time of foreclosure was $8,553,935.

 

*NorthernCalifornia Mixed use Portfolio Loan:*On April 9, 2008, theManager, on our behalf, completed foreclosure sales and acquired 20 of the 22properties that secured $10,600,000 in loans held by us. This loan was juniorto senior debt totaling $17,829,734. Senior loans of $8,363,020 and $2,098,145 are held by other fundsmanaged by the Manager.  The remaining$7,368,569 represents senior loans held by outside third parties. In June, oneof the two remaining properties was lost as a result of foreclosure by theholder of a senior lien, and the borrower on the other property filedbankruptcy. The estimated net realizable value of this remaining property is$579,100, net of $2,183,000 owed to third party senior lien holders.

 

In June, we sold one of theproperties that had been acquired on April 9, 2008 and received $216,757in net proceeds from the sale, in addition to a note receivable in the amountof $467,000.

 

***Subsequentevents***

 

*Honolulu Loan*:  As of October 31, 2008, we held a$3,257,096 participation interest in a loan with a principal balance of$41,855,381 and bearing interest at a rate of 13% per annum for which theborrower was in default.  The balance ofthe participation interests are held by other funds managed by the Manager anda limited liability company owned by related and unrelated parties. This loanis a junior portion of a $97,900,000 total loan facility with a $55,000,000senior position held by an entity unaffiliated with the us or the Manager. Thesecurity for the loan is approximately 161 acres of residentially zonedproperty. The borrower has defaulted on both the senior and our junior note.The Manager has been attempting to negotiate with the holder of the seniorparticipation to assume the debt service payments under the seniorparticipation on a modified payment schedule and to acquire ownership of thecollateral. The participants in the loans do not currently have sufficientliquid assets to pay the full amount of past due payments and to assure paymentof future payments. Under agreements among the various participating funds,these advances will have a priority repayment position relative to loanprincipal and interest earned thereon. On March 11, 2008, the Manager madea short-term loan of $1,375,000 to the funds it manages that participate inthis loan which enabled them to pay an extension fee of $1,375,000 to thesenior lender. The various funds managed by the Manager have paid down theshort-term note by $727,471. Our pro rata share of payments made as of October 31,2008 was $123,447 and its share of the balance owed was $0. The Manager alsopaid an extension fee of $90,000 to a third party lender participating in thejunior note. On October 16, 2008 the senior lender informed the borrowerand the Manager of its intent to conduct a UCC foreclosure sale of themembership interests in the borrower on November 20, 2008. Under theco-lender agreement with the senior lender, if the senior lender completes thisforeclosure and acquires the membership interest at the foreclosure sale, thejunior portion of the loan (and thus our interest) will likely terminate. On November 19,2008, the fund from which the Fund acquired its participation interest filed avoluntary petition for relief under Chapter 11 of the Bankruptcy Code. Theautomatic stay of this fund’s bankruptcy has stayed the scheduled UCCforeclosure sale.

 

*California/ArizonaLand Portfolio Loan:* As of June 30, 2008, we held two loans with carrying values totaling$54,251,000 and secured by liens of various priorities on threeproperties.  The estimated value of thetotal collateral base at June 30, 2008 was $82,050,000 securing total debtof $112,369,000.  Two of the threeproperties are subject to third party senior debt totaling approximating$39,101,000 at June 30, 2008, which includes the note payable to Income Fund /Wells Fargo Foothill of $20,351,000.  On July 7,2008, a limited liability company owned by us and other funds managed by theManager

 

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* *

(specifically organized for thepurpose of acquiring the property) acquired the first property at a foreclosuresale conducted on behalf of us. Because the aforementioned limited liabilitycompany was unable to make debt service payments to the holder of the thirdparty senior loan and could not reach an agreement with the holder of that noteregarding restructuring of their note, the limited liability company was forcedto file for Chapter 11 bankruptcy protection on July 16, 2008 to preventthe loss of the collateral to a foreclosure sale being conducted by the seniorlender which was scheduled for July 17, 2008. That bankruptcy case ispending as of the date of this filing. On September 16, 2008 we completeda foreclosure sale on the second property. On October 14, 2008, weacquired the third property at a foreclosure sale.

 

*Fremont Loan:*OnDecember 30, 2006, we sold to the Manager a property on which it hadpreviously foreclosed with the Manager paying 10% of the purchase price in cashand borrowing the remaining balance from us under a note secured by theproperty. On July 1, 2008, the Manager sold the property for less than theamount of debt secured by the property, resulting in us holding an unsecurednote. The unsecured balance owed to us totaled $670,854 at September 30,2008.

 

***Off-BalanceSheet Arrangements***

 

We have no off-balance sheetarrangements, except for the obligations described above.

 

***CriticalAccounting Estimates***

 

Preparation of our financialstatements requires the Manager to make estimates and assumptions that affectthe reported amounts of assets, liabilities, revenues and expenses. Theseestimates and assumptions are based on historical experience, independentevaluations (such as appraisals of specific properties), market data on realestate and real estate transactions available from public sources, industry andmarket research and forecasts, discussions with real estate brokers, developersand investors and various other sources and factors we believe to be reasonableand reliable under the circumstances. The Manager periodically reviews ouraccounting policies and these estimates and assumptions and make adjustmentswhen facts and circumstances dictate. Our accounting policies that are affectedby estimates principally relate to the determination of (i) the allowancefor loan losses (*i.e.*, the amountof allowance established against loans receivable as an estimate of probableloan losses), including the accrued interest and advances that are estimated tobe unrecoverable based on estimates of amounts to be collected plus estimatesof the value of the property as collateral, and (ii) the valuation of REOowned through foreclosure.  Thesepolicies and their key characteristics are discussed in detail in the 2007Annual Report.  Different estimates andassumptions in the application of these policies could result in materialchanges in our financial condition, results of operations, or cash flows andactual results may differ substantially.

 

***RecentAccounting Pronouncements***

 

See Note 2 for further discussion.

 

## **Item 3.****                                                          ****Quantitative and Qualitative Disclosures about Market Risk**

##  

Not applicable.

 

## **Item 4.****                                                          ****Controls and Procedures**

##  

*Evaluation ofdisclosure 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 

 

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designed to ensure that informationrequired to be disclosed by us in such reports is accumulated and communicatedto our management, including the principal executive officer and principalfinancial officer of the Manager, as appropriate to allow timely decisionsregarding required disclosure because of material weaknesses identified in ourinternal control over financial reporting and by virtue of our failure totimely file our Annual Report on Form 10-K for the year ended December 31,2007, the immediately prior Quarterly Report 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:

 

·                  Managerpersonnel in the accounting function do not have the specific, requisitequalifications and training necessary to ensure the financial statements andall necessary disclosures are prepared and included in accordance withgenerally accepted accounting principles and other SEC reporting requirements.

 

·                  TheManager monitors property values supporting loan balances and REO by obtainingmarket information through a variety of sources, including appraisals, currentmarket data, and broker quotations. In certain instances where adjustments weremade to property values based on market data or broker quotations, the Managerdid not maintain sufficient contemporaneous documentation related to theanalysis, considerations and conclusions in support of the adjustments to theproperty values.

 

**Remediation**

 

The Manager’s limited liquidity andother demands on its resources may make it difficult to eliminate the materialweaknesses or otherwise increase our capability to satisfy our periodic andcurrent reporting requirements.

 

*Requisitequalifications and training*.  The Manager is not likely to successfullyrecruit an accounting manager or controller 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. The market for such individuals is competitiveand their compensation often includes stock or stock options which are notavailable from the Manager.  Thedifficulty of finding such a candidate is exacerbated by the financialcondition of the Manager and the funds it manages. Presently the Manager relieson the collective experience and knowledge of its finance staff with advice andguidance from third party consultants.

 

*PropertyValuation*.  The Managercontinues to implement a formal process to create and maintain supportingdocumentation for all changes in property values supporting loan balances andREO.

 

*Other.*There has been a build-up of leadership and staff capability since July 2006.Operations and accounting have been segregated. An executive with experience ininformation technology and financial services was recruited and has built an ITteam, implemented new core and supporting applications and has improved datamanagement. A separate real estate administration function was created and anexecutive hired to head it.  Improvementshave also been made to the authorization, processing and recordation oftransactions. Separate bank accounts are maintained for each entity managed bythe Manager and banking operations is a standalone function reporting to theOperations/Information Technology executive.

 

In addition, three critical coreapplications – General Ledger, Investor Management and Loan Processing — wereidentified, and associated operations and processes were designed.  Progress has been made, particularly throughthe implementation of an industry standard General Ledger system, and acustom-developed Investor Management System, each with associated processes andcontrols. The conversion to the new general ledger system was completed in July 2007,which streamlined the formal general ledger operations and control function.  Consolidation of loan information into astandard SQLServer database and spreadsheet model contributed to improvementsin loan processing controls and financial analysis capabilities. This databasesupplements the limited capability of an industry-standard software applicationfor loan administration and servicing. Taken together, these sub-ledgerapplications and databases provide the detailed systems of record that can bereconciled daily to the General Ledger and provide information to support andenhance financial reporting and management information.

 

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Further automation, standardizationand simplification in loan systems and processes is continuing throughout 2008and, if resources are available are expected to continue into 2009.

 

*Changes ininternal control over financial reporting.*Otherthan progress in addressing the above mentioned material weakness, there wereno changes in our internal control over financial reporting that occurredduring the second quarter of 2008 that have materially affected, or arereasonably likely to materially affect, our internal control over financialreporting.

 

# **PART II.****                                             ****OTHER INFORMATION**

#  

## **Item 1.****                                                          ****Legal Proceedings**

##  

There are no legal proceedings towhich we are a party or to which our property is subject, other thanforeclosures on borrower collateral in the ordinary course of our business.

 

The SEC has notified the Managerthat it is conducting an informal inquiry relating to the Manager and us inorder to determine whether there have been violations of the federal securitieslaws. In conjunction with this inquiry, certain information has been requestedfrom us. The Manager has responded to requests for information related to theinquiry and will continue to cooperate with the SEC in response to itsrequests. The Manager believes that there will not be a material impact on ourfinancial position or operations as a result of this inquiry.

 

Further, Fund III (a different fund managedby the Manager) had been offering and selling its membership interests duringthe first quarter of 2008 under a permit issued to it by the CaliforniaDepartment of Corporations (the “DOC”) on January 4, 2008 for the period expiring on January 3, 2009.  Because of the turmoil in the capitalmarkets, including the failure of a major investment bank in mid-March 2008,the concurrent dislocation in the real estate and credit markets as theeconomic crisis began spreading beyond sub-prime lending, the increasinguncertainty and difficulty in determining the fair value of Fund III’s loanportfolio and REO,  the need to conservecash and discontinue paying distributions and suspend member redemptions, FundIII ceased accepting new subscriptions as of April 10, 2008. By letter datedNovember 3, 2008, Fund III had sought to voluntarily surrender the permit, butthis action was declined by the DOC in favor of an anticipated summaryrevocation of the permit by the DOC.

 

By order dated December 9, 2008, the DOC  summarily suspended Fund III’s permit andseeks to revoke it. The order was accompanied by an accusation alleging thatFund III and the Manager violated terms of the permit by failing to timelyprovide its members with audited financial statements, a summary report for2007 and monthly account statements since May 2008.  The accusation also alleges that Fund III andthe Manager violated the California Corporate Securities Law by omitting tostate certain allegedly material facts in Fund III’s Offering Circular datedJanuary 4, 2008, including the following: (1) that Fund III had alreadyreceived redemption requests exceeding 10% of Fund III’s aggregate capital andthat there was a substantial probability that investors in Fund III would notbe able to withdraw their investments during 2008; and (2) that Fund I (adifferent fund managed by the Manager), had violated certain terms of its ownDOC offering permit which expired January 16, 2004, by (i) selling interests toan investor who did not meet the suitability standards imposed by the DOC, and(ii) by investing in a loan that exceeded the geographical and concentrationlimits applicable to Fund I, which limits are similar to those applicable toFund III.

 

As of the date hereof, the DOC has not soughtany relief or sanction against either Fund III or the Manager by reason of thematters described in the accusation other than the suspension and revocation ofthe permit.

 

## **Item 1A.****                                                 ****Risk Factors**

##  

Not applicable.

 

## **Item 2.****                                                          ****Unregistered Sales of Equity Securities and Use of Proceeds**

##  

Not applicable.

 

## **Item 3.****                                                          ****Defaults Upon Senior Securities**

##  

As of June 30, 2008, we werein default for failure to pay at maturity under one promissory note outstandingwith a principal amount of $20,199,951 in favor of Income Fund, an affiliate ofthe Manager, which Income Fund in turn assigned Wells Fargo Foothill.  Accrued interest at that date amounted to$150,816. Our promissory note to Income Fund, as well as the Wells FargoFoothill 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.  WellsFargo Foothill and Income Fund entered into a forbearance agreement (and anamendment thereto) in which Wells Fargo Foothill agreed not to exerciseremedies until November 30, 2007 The forbearance agreement also increased the interest rate on the loanto LIBOR plus 6.5% (9.64% at June 30, 2008), increasing our payments toIncome Fund correspondingly. The Manager subsequently negotiated additionalamendments 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.

 

We are current on the interestpayments to Income Fund and Income Fund is, in turn, current on its interestpayments to Wells Fargo Foothill.

 

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

##  

None

 

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## **Item 5.****                                                          ****Other Information**

##  

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**

 

Pursuant to the requirements of theSecurities Exchange Act of 1934, the registrant has duly caused this report tobe signed on its behalf by the undersigned thereunto duly authorized.

 

 
|                   | CMR Mortgage Fund II, LLC |
|------------------------|---------------------------|
|                   |                      |   |
|                   | By:                       | California Mortgage and  Realty, Inc., its Manager |
|                   |                      |   |
|                   |                      |
| December 18, 2008 | By:                       | /s/ David Choo |
|                   |                      | Name: David Choo |
|                   |                      | Title: President |
|                   |                      |   |
| December 18, 2008 | By:                       | /s/ James Gala |
|                   |                      | Name: James Gala |
|                   |                      | Title: | Chief Executive Officer and Chief  Financial Officer |
|                   |                      |   | (Principal Executive Officer,  Principal Financial |
|                   |                      |   | Officer and Principal Accounting  Officer) |
|                        |                           |  |  |  |

 

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**EXHIBITINDEX**

 
| **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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