Secured Income Fund II

From 2010 through 2016, SIF distributed a flat 7.75% (annualized, after fees, in monthly income) by taking the average weighted return of the loan portfolio, subtracting expenses, and letting the variability be reflected in the loan loss reserve.

Starting in January 2017, SIF set a fixed allocation formula for the loan loss reserve amount, allowing a natural variability and floating return to investors. In the letter, we anticipated SIF’s 2017 return to float between 7.0-7.5%. The actual 2017 distribution averaged 7.61% for investors who elected cash dividends and 7.88% for investors who elected to reinvest dividends due to monthly compounding effect.

Stonecrest previously managed our mortgage strategy with a floating distribution in Private Capital Fund (PCF), launched in 2004. PCF is SIF’s predecessor and model fund. Prior to 2008, PCF distributed a floating rate return between 9.2 – 9.8%. After 2008, PCF has been distributed a monthly fixed dividend of 7.2% until 2019 before winding down the fund.

SIF distributions are taxed as ordinary income. The investor receives a California K-1 around the end of February for the previous tax year. Many investors including CPAs and CFPs hold SIF in retirement accounts for the tax advantages. In some cases, UBTI filing may be required by the custodian. This is either due to the size of the account with us or having other investments that also generate UBTI since UBTI is cumulative.

Unlike many private placements, especially real estate investment structures and products, SIF has no lockups, no redemption fees, and no pre–determined gating levels.

SIF is a non-amortizing fund. Investor income is distributed monthly. To receive a return of principal, our PPM calls for best efforts redemption terms with 60-day written notice, such as an email. While historically we have been able to provide redemptions within 30 days, we do not commit to less than 60 days’ best efforts. However, Stonecrest has an expectation of a two year minimum hold which is further explained below in item 4.

Determining appropriate allocations depends on the specifics of each investor and situation. To guide financial advisors and investors, Stonecrest suggests a * minimum two-year * initial holding period for SIF. This helps new investors align more closely with current shareholders by ensuring new investor capital gets a chance to be put to work. Therefore, we recommend any capital that clients might need within two years be invested in more liquid, cash–like products than ours.

Please note that Stonecrest will not accept an investor’s allocation if we believe there is a mis– alignment with our current shareholders.

None. Stonecrest does not offer any products that pay commissions to financial advisors. We focus on raising capital from fiduciary allocators, mostly RIAs. At Stonecrest, one hundred percent of the capital raised is invested and put to work for clients.

No, SIF (not Stonecrest) uses a Line of Credit to avoid sitting on cash that would otherwise drag down the yield. Pre–funding enables capital raised to be put to work immediately. The purpose of the line is not to generate investor returns, though to the extent that the line is utilized, there is a small yield enhancement for investors typically.

The PPM says the SIF fund will end on 12/31/2025, and all assets (loans plus any property) will be sold, and the proceeds distributed to the partners.

To clarify, this fund is a private placement that does not trade, is illiquid (subject to 60–day best efforts redemption terms) and has no fluctuating share price. The managers expect to extend SIF beyond 2025 for multiple terms of five years each. If the term were not extended, then SIF would be wound down over time. Since the weighted average maturity of SIF’s loan portfolio ranges between 2 to 3 years, it should take about that long to wind down through natural payoffs. In addition, there are many note investors who stand ready to buy our loans should we ever make them available.

Since the inception of our first fund in 2004 through the 2008–09 financial crisis to this day, Stonecrest’s fund investors have never missed a monthly distribution or experienced a loss of principal with us. Since past performance does not guarantee future results, we pour everything we know into each loan we underwrite and the way we manage SIF’s portfolio. Still, there is no guarantee we’ll never have losses or won’t miss a distribution in the future.

Another risk an investor faces with SIF is that we may call a redemption moratorium (a halt on redemptions, with some exceptions provided), like we did in 2008. To protect investor capital during massive market dislocations such as the 2008 global financial and real estate crisis, redemption moratoriums may be necessary. Examples of relatively minor market disruptions that *do not* warrant Stonecrest calling a redemption moratorium include oil price collapses, taper tantrum of 2013, Greek credit crisis, China–related equity market volatility of 2015, negative European bond rates and BREXIT. The company has weathered the COVID pandemic with no major disruption to operations or returns to our investors.

Typical Stonecrest borrowers are equity rich in California real estate and have good credit profiles. Borrowers pay our rates because we solve short term financing problems that traditional banks cannot or will not meet with conventional loan programs. Stonecrest’s loan terms are less than 4 years, while banks want to lend for much longer terms, like 15 and 30 years.

Some common problems we solve for borrowers with our non-conventional loan products include:

1. 1. 1. Swinging equity to make non- contingent offers Specialized lending for reverse 1031 exchanges avoid capital gains exposure.
      2. Closing within 2 weeks
      3. Cross-collateralizing a portfolio of properties over multiple sectors (we underwrite both residential and commercial)
      4. Meeting working capital needs (using our business line of credit secured against real estate)
      5. Offering serial entrepreneurs, a highly attractive alternative to venture capital financing, etc.

Stonecrest has been in the business since 1986 and is known in the industry for longevity, expertise, reliability, and integrity. Most of our borrowers are referred to us by underwriters and loan officers at conventional banks, as well as real estate and other mortgage professionals. Stonecrest builds strategic relationships as a preferred lender for real estate and mortgage brokerages across California. Most recently, we expanded our borrower pipeline by launching a new wholesale division to distribute our private loans through other retail mortgage originators.

We measure loan-to–value as principal divided by appraisal value at the time of origination. Appraisals are backward looking based on comparable transactions closed in the last six months.

In order to manage and report conservatively to investors, we do not recalculate loan LTVs as market values increase over time. We also assume all business lines of credit are fully extended.

When assessing collateral, Stonecrest requires historical valuations by third party, licensed appraisers based on timely and comparable transactions. We then carefully review the transactions to determine how comparable, in our opinion, they are to our subject property. We may also send additional boots–on–the–ground such as a broker we know or other market evaluator we trust to provide a marketability assessment that augments the usual appraisal report.

In the past, our average portfolio LTV has been below 60%. That margin of safety and our skills in underwriting as well as distressed asset disposition were enough to protect our investors.

In exceptional cases, we may feel comfortable going to higher LTV. Exceptional cases are limited to scenarios we believe are less risky such as a short term bridge loan where the buyer is swinging equity from one highly marketable property to another, clients with exceptional financial profiles, etc.

Our underwriting process distinguishes between marketability and appraisal value. We always ask ourselves, “Worst case scenario, if we ended up with the property, would we be able to cash flow or sell it—even in an unfavorable economy and market environment?” Therefore, we always stayed away from development deal, construction loans, fix–and–flips and all other lending based on future value.

SIF portfolio has loans with maturities between 6 months to 3 years typically. Our loan terms for our bridge loan product are 6 to 11 months. On the line of credit product, terms range 1 to 3 years. There is no prepayment penalty on our loans.

SIF’s historical default rate is less than 3%, with a foreclosure rate of less than 1%.

Unlike many other originators that securitize loans to offload risk, Stonecrest retains our loans and borrowers. Stonecrest aligns our risk management so that underwriting is dis–incentivized to approve a loan if we sense it may become a problem on the fund management side. That’s a huge difference in our incentive structure and culture that helps lead to industry–low default and foreclosure rates on Stonecrest-underwritten loans.

We apply “common sense underwriting” to our private loans, rather than rigid lending matrices necessary for the kind of volume lending done by entities such as national banks. As private lenders go, we underwrite conservatively and require our borrowers to be equity rich in California real estate. Historically, SIF’s average portfolio LTV was under 60% (although the short nature of our laddered loan portfolio makes this metric a moving target). In addition to the usual underwriting factors, we care a great deal about the borrower’s exit strategy. We incorporate the borrower’s exit plan as a key part of our underwriting process.

Beyond common sense underwriting for individual loans, the risk mitigation methods we apply to SIF portfolio management include:

1. Low LTVs based on historical values calculated at the time of origination only
2. Calculating portfolio LTV conservatively when reporting to fund investors, e.g., by assuming all business lines of credit are fully extended
3. Short maturities (6 month to 3-year average across the loan portfolio)
4. Avoidance of all loans based on future value (e.g., we do not offer any construction, fix and flip, or development programs)
5. Geographic diversification of the collateral pool throughout California
6. Diversification of borrower purpose and property types (income-producing commercial and residential)
7. Avoidance of high-risk property types due to a tendency toward binary outcomes in certain businesses and industries

Rising rates should benefit SIF investors over time. The average maturity across our laddered loan portfolio is short, between 2–3 years. The portfolio generates cash from natural payoffs and prepayments, so we are constantly redeploying capital into new originations. If we are redeploying into a higher private lending rate environment, then average portfolio yield and investor distributions should increase. Private lending rates generally lag conventional mortgage rates by about 18 to 24 months.

In any case since SIF does not trade and there is no mark-to–market of investor principle based on changes in interest rates or inflation, there is no duration risk. When redemptions occur, Stonecrest anticipates returning 100% of investor principal and any reinvested dividends regardless of prevailing interest rates, subject to the 60-day best efforts redemption terms described in our PPM.

From an asset allocation perspective, SIF aims to provide a diversifying, secured income stream and floating yield that helps protect the client’s fixed income portfolio from rising interest rates and limits inflation exposure while benefiting from any average SIF portfolio yield increases. The higher yields generated by private lending, their stickiness and low correlation to most benchmarks are hard-to–find, desirable attributes for most investors.

http://sonomacounty.ca.gov/Public-Safety/Press–Releases/Fire-Damage-Property–Tax–Relief/ https://www.fema.gov/news-release/2018/01/15/4353/southern–california-residents-may– register–disaster-assistance.

Since zero claims have been received by us, we believe the historic wildfires of 2017 and the latest deadly earthquake in 2014 had no impact on our lending portfolios.

Most of our investors are the accredited investor clients of Registered Investment Advisors. Stonecrest has no products, resources or personnel dedicated to raising capital from any investor groups other than RIAs. We do not make our fund documents readily available to the public; for example, none of Stonecrest’s subscription forms are downloadable from our website. We reach RIAs primarily through sponsorships of financial advisor organizations such as Financial Planning Association (FPA) chapters and Charter Financial Analyst (CFA) Societies. In addition, Christina Gray our Account Executive has served as directors for the boards of FPA San Francisco, FPA East Bay and/or FPA Silicon Valley.