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UNITED STATES
SECURITIES & EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
Quarterly Report Under Section 13 or 15 (d)
of the Securities Exchange Act of 1934
For Quarterly Period Ended September 30, 2003
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Commission file number 333-83882
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REDWOOD MORTGAGE INVESTORS VIII, a California Limited Partnership
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(exact name of registrant as specified in its charter)
CALIFORNIA 94-3158788
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(State or other jurisdiction of I.R.S. Employer
incorporation or organization) Identification No.
900 Veterans Blvd., Suite 500, Redwood City, CA 94063
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(address of principal executive office)
(650) 365-5341
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(Registrant's telephone number, including area code)
NOT APPLICABLE
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(Former name, former address and former fiscal year, if changed since last
report.)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15 (d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file reports), and (2) has been subject to such
filing requirements for the past 90 days.
YES XX NO
---------------- ---------------
APPLICABLE ONLY TO ISSUERS INVOLVED IN BANKRUPTCY PROCEEDINGS DURING THE
PRECEDING FIVE YEARS:
Indicate by check mark whether the registrant has filed all documents and
reports required to be filed by Sections 12, 13 or 15 (d) of the Securities
Exchange Act of 1934 subsequent to the distribution of securities under a plan
confirmed by a court.
YES NO NOT APPLICABLE XX
------------- -------------- -------------
APPLICABLE ONLY TO CORPORATE ISSUERS:
Indicate the number of shares outstanding of each of the issuer's class of
common stock, as of the latest date.
NOT APPLICABLE
1
REDWOOD MORTGAGE INVESTORS VIII
(A California Limited Partnership)
CONSOLIDATED BALANCE SHEETS
SEPTEMBER 30, 2003 and DECEMBER 31, 2002 (unaudited)
(in thousands)
ASSETS
September 30, December 31,
2003 2002
---------------- ----------------
Cash and cash equivalents $ 5,564 $ 7,188
---------------- ----------------
Loans
Loans secured by deeds of trust 127,177 83,650
Loans, unsecured 34 0
Allowance for loan losses (2,618) (3,021)
---------------- ----------------
Net loans 124,593 80,629
---------------- ----------------
Interest and other receivables
Accrued interest and late fees 3,929 3,913
Advances on loans 207 279
Other receivables 250 888
---------------- ----------------
4,386 5,080
---------------- ----------------
Loan origination fees, net 10 22
Real estate held for sale, net of allowance of $500 6,886 9,286
---------------- ----------------
Total assets $ 141,439 $ 102,205
================ ================
LIABILITIES AND PARTNERS' CAPITAL
Liabilities
Accounts payable $ 225 $ 449
Payable to affiliate 368 294
Deferred interest - 112
Notes payable
Deed of Trust 635 1,782
Bank line of credit 6,500 -
---------------- ----------------
Total liabilities 7,728 2,637
---------------- ----------------
Minority interest 780 1,213
---------------- ----------------
Investors in applicant status 1,976 2,578
---------------- ----------------
Partners' capital
Limited partners' capital, subject to redemption net of unallocated
syndication costs of $819 and $592 for 2003 and 2002 , respectively;
and formation loan receivable of $7,254 and $5,257
for 2003 and 2002, respectively 130,838 95,690
General partners' capital, net of unallocated syndication costs of $9
and $6 for 2003 and 2002, respectively 117 87
---------------- ----------------
Total partners' capital 130,955 95,777
---------------- ----------------
Total liabilities and partners' capital $ 141,439 $ 102,205
================ ================
The accompanying notes are an integral part of the consolidated financial
statements.
2
REDWOOD MORTGAGE INVESTORS VIII
(A California Limited Partnership)
CONSOLIDATED STATEMENTS OF INCOME
FOR THE THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2003 AND 2002 (unaudited)
(in thousands, except for per limited partner amounts)
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
---------------------------------------------------------------------
2003 2002 2003 2002
-------------- ------------ ------------- ------------
Revenues
Interest on loans $ 3,159 $ 3,159 $ 8,865 $ 8,252
Interest-bank 8 - 48 -
Late fees 55 4 155 24
Other 3 2 18 6
-------------- ------------ ------------- ------------
3,225 3,165 9,086 8,282
-------------- ------------ ------------- ------------
Expenses
Mortgage servicing fees 287 198 734 662
Interest expense 7 177 8 401
Amortization of loan origination fees 3 3 12 9
Provisions for losses on loans and real estate 193 528 438 934
Asset management fees 125 82 334 237
Clerical costs from Redwood Mortgage Corp. 73 67 215 198
Professional services 13 8 80 60
Broker expense - 240 181 240
Other 21 8 90 35
-------------- ------------ ------------- ------------
722 1,311 2,092 2,776
-------------- ------------ ------------- ------------
Net income $ 2,503 $ 1,854 $ 6,994 $ 5,506
============== ============ ============= ============
Net income: general partners (1%) $ 25 $ 18 $ 70 $ 55
limited partners (99%) 2,478 1,836 6,924 5,451
-------------- ------------ ------------- ------------
$ 2,503 $ 1,854 $ 6,994 $ 5,506
============== ============ ============= ============
Net income per $1,000 invested by limited
partners for entire period
-where income is reinvested and compounded $18.48 $21.45 $58.70 $64.82
============== ============ ============= ============
-where partner receives income in periodic
distributions $18.37 $20.93 $57.22 $63.03
============== ============ ============= ============
The accompanying notes are an integral part of the consolidated financial
statements.
3
REDWOOD MORTGAGE INVESTORS VIII
(A California Limited Partnership)
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2003 AND 2002 (unaudited)
(in thousands)
NINE MONTHS ENDED SEPTEMBER 30,
------------------------------------
2003 2002
-------------- ---------------
Cash flows from operating activities
Net income $ 6,994 $ 5,506
Adjustments to reconcile net income to net cash
provided by operating activities
Provision for loan and real estate losses 438 934
Change in operating assets and liabilities
Accrued interest and late fees (2,490) (188)
Advances on loans (240) (94)
Other receivables 638 -
Amortization of loan origination fees 12 (16)
Accounts payable (224) 166
Payable to affiliate 74 -
Deferred interest (112) -
-------------- --------------
Net cash provided by operating activities 5,090 6,308
-------------- --------------
Cash flows from investing activities
Loans originated (64,477) (37,756)
Principal collected on loans 22,861 23,762
Proceeds from sale of real estate 3,094 -
Payments for development of real estate (694) (675)
Reduction in minority interest (433) -
-------------- --------------
Net cash used in investing activities (39,649) (14,669)
-------------- --------------
Cash flows from financing activities
Borrowings (repayments) on line of credit, net 6,500 6,850
Repayments on note payable (1,147) -
Contributions by partner applicants 33,735 5,253
Partners' withdrawals (3,738) (2,679)
Syndication costs paid (376) (202)
Formation loan lending (2,475) (378)
Formation loan collections 436 412
-------------- --------------
Net cash provided by financing activities 32,935 9,256
Net increase (decrease) in cash and cash equivalents (1,624) 895
Cash and cash equivalents - beginning of year 7,188 1,917
-------------- --------------
Cash and cash equivalents - end of period $ 5,564 $ 2,812
============== ==============
Supplemental disclosures of cash flow information
Cash paid for interest $ 8 $ 401
============== ==============
The accompanying notes are an integral part of these consolidated financial
statements.
4
REDWOOD MORTGAGE INVESTORS VIII
(A California Limited Partnership)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2003 (unaudited)
NOTE 1 - GENERAL
In the opinion of the management of the partnership, the accompanying
unaudited consolidated financial statements contain all adjustments, consisting
of normal, recurring adjustments, necessary to present fairly the consolidated
financial information included therein. These consolidated financial statements
should be read in conjunction with the audited consolidated financial statements
included in the partnership's Form 10-K for the fiscal year ended December 31,
2002 filed with the Securities and Exchange Commission. The results of
operations for the three and nine month periods ended September 30, 2003 are not
necessarily indicative of the operating results to be expected for the full
year.
Sales commissions - Formation Loans
The following summarizes Formation Loan transactions to September 30, 2003
(in thousands):
Initial Second Third Fourth
Offering of Offering of Offering of Offering of
$15,000 $30,000 $30,000 $50,000 Total
------------- -------------- ------------- -------------- ------------
Limited partner contributions $ 14,932 $ 29,993 $ 29,999 $ 49,982 $124,906
============= ============== ============= ============== ============
Formation Loan made $ 1,075 $ 2,272 $ 2,218 $ 3,775 $ 9,340
Repayments to date (667) (795) (342) (98) (1,902)
Early withdrawal penalties applied (59) (80) (45) - (184)
------------- -------------- ------------- -------------- ------------
Balance September 30, 2003 $ 349 $ 1,397 $ 1,831 $ 3,677 $ 7,254
============= ============== ============= ============== ============
Percent loaned 7.2% 7.6% 7.4% 7.6% 7.5%
============= ============== ============= ============== ============
The Formation Loan has been deducted from limited partners' capital in the
consolidated balance sheets. As amounts are collected from Redwood Mortgage
Corp., a general partner of the partnership, the deduction from capital will be
reduced.
Syndication costs
The partnership bears its own syndication costs, other than certain sales
commissions, including legal and accounting expenses, printing costs, selling
expenses, and filing fees. Syndication costs are charged against partners'
capital and are being allocated to the individual partners consistent with the
partnership agreement.
Through September 30, 2003, syndication costs of $2,447,000 had been
incurred by the partnership with the following distribution (in thousands):
Costs incurred $ 2,447
Early withdrawal penalties applied (83)
Allocated and amortized to date (1,536)
--------------
September 30, 2003 balance $ 828
==============
5
REDWOOD MORTGAGE INVESTORS VIII
(A California Limited Partnership)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2003 (unaudited)
NOTE 1 - GENERAL (continued)
Syndication costs attributable to the fourth offering ($50,000,000) were
limited to the lesser of 10% of the gross proceeds or $2,000,000 with any excess
to be paid by the general partners. As of September 30, 2003, the fourth
offering had incurred syndication costs of $636,000 (1.3% of contributions).
NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Basis of presentation
The partnership's consolidated financial statements include the accounts of
its 100%-owned subsidiary, Russian Hill Property Company, LLC ("Russian") and
its 66%-owned subsidiary, Stockton Street Property Company, LLC ("Stockton").
All significant intercompany transactions and balances have been eliminated in
consolidation.
Reclassifications
Certain reclassifications, not affecting previously reported net income or
total partner capital, have been made to the previously issued consolidated
financial statements to conform to the current year classification.
Loans, secured by deeds of trust
At September 30, 2003 and December 31,2002, the partnership had fifteen and
twenty loans past due 90 days or more approximating $21,397,000 and $28,650,000,
respectively. The partnership does not consider these loans to be impaired
because there is sufficient collateral to cover the amount outstanding to the
partnership and the partnership is still accruing interest on these loans.
At September 30, 2003 and December 31, 2002, loans categorized as impaired
by the partnership were $0. The reduction in the carrying value of impaired
loans is included in the allowance for loan losses. The average impaired
recorded investment in impaired loans was $355,000 for 2002.
Allowance for loan losses
The composition of the allowance for loan losses as of September 30, 2003
and December 31, 2002 was as follows (in thousands):
September 30, December 31,
2003 2002
----------------- -----------------
Impaired loans $ - $ -
Specified loans 120 120
General 2,498 2,901
Unsecured loans - -
----------------- -----------------
$ 2,618 $ 3,021
================= =================
6
REDWOOD MORTGAGE INVESTORS VIII
(A California Limited Partnership)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2003 (unaudited)
NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)
Allowance for loan losses
Activity in the allowance for loan losses is as follows for the nine months
through September 30, 2003 and for the year ended December 31, 2002 (in
thousands):
September 30, December 31,
2003 2002
----------------- -----------------
Beginning balance $ 3,021 $ 2,247
Restructured loans - 11
Additions charged to income 438 780
Write-offs (841) (17)
----------------- -----------------
$ 2,618 $ 3,021
================= =================
Income taxes
No provision for federal and state income taxes (other than an $800 state
minimum tax) is made in the consolidated financial statements since income taxes
are the obligation of the partners if and when income taxes apply.
Net income per $1,000 invested
Amounts reflected in the consolidated statements of income as net income
per $1,000 invested by limited partners for the entire period are amounts
allocated to limited partners who held their investment throughout the period
and have elected to either leave their earnings to compound or have elected to
receive periodic distributions of their net income. Individual income is
allocated each month based on the limited partners' pro rata share of partners'
capital. Because the net income percentage varies from month to month, amounts
per $1,000 will vary for those individuals who made or withdrew investments
during the period, or selected other options.
Profits and losses
Profits and losses are allocated among the limited partners according to
their respective capital accounts monthly after 1% of the profits and losses are
allocated to the general partners.
Management estimates
The preparation of financial statements in conformity with accounting
principles generally accepted in the United States of America requires
management to make estimates and assumptions about the reported amounts of
assets and liabilities and disclosures of contingent assets and liabilities at
the date of the financial statements and the reported amounts of revenues and
expenses during the reported periods. Such estimates relate principally to the
determination of the allowance for loan losses, including the valuation of
impaired loans and the valuation of real estate held for sale. Actual results
could differ significantly from these estimates.
7
REDWOOD MORTGAGE INVESTORS VIII
(A California Limited Partnership)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2003 (unaudited)
note 3 - General Partners and Related Parties
The following are commissions and/or fees, which are paid to the general
partners.
Mortgage brokerage commissions
For fees in connection with the review, selection, evaluation, negotiation
and extension of loans, Redwood Mortgage Corp. may collect an amount equivalent
to 12% of the loaned amount until six months after the termination date of the
offering. Thereafter, loan brokerage commissions (points) will be limited to an
amount not to exceed 4% of the total partnership assets per year. The loan
brokerage commissions are paid by the borrowers and thus, are not an expense of
the partnership.
Mortgage servicing fees
Monthly mortgage servicing fees of up to 1/8 of 1% (1.5% annual) of the
unpaid principal are paid to Redwood Mortgage Corp., based on the unpaid
principal balance of the loan portfolio, or such lesser amount as is reasonable
and customary in the geographic area where the property securing the mortgage is
located. Once a loan is categorized as impaired, mortgage servicing fees are no
longer accrued thereon. Additional service fees are recorded upon the receipt of
any subsequent payments on impaired loans.
Asset management fees
The general partners receive monthly fees for managing the partnership's
loan portfolio and operations up to 1/32 of 1% (3/8 of 1% annual) of the "net
asset value", which is the partnership's total assets less its total
liabilities.
Other fees
The Partnership Agreement provides for other fees such as reconveyance,
mortgage assumption and mortgage extension fees. Such fees are incurred by the
borrowers and are paid to the general partners.
Operating expenses
The general partners are reimbursed by the partnership for all operating
expenses incurred by them on behalf of the partnership, including without
limitation, out-of-pocket general and administration expenses of the
partnership, accounting and audit fees, legal fees and expenses, postage and
preparation of reports to limited partners.
8
REDWOOD MORTGAGE INVESTORS VIII
(A California Limited Partnership)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2003 (unaudited)
note 4 - Real Estate Held for Sale
During 2002, the partnership contributed its interests in two foreclosed
real properties to two limited liability companies ("LLCs"). The partnership's
investments in the LLCs are reflected at the lower of cost or fair value,
including estimated costs of property disposition. During 2003 sales of portions
of one property were made for $3,094,000. The partnership has reflected no gain
or loss related to these sales.
The following schedule reflects the cost of the LLCs' properties and
recorded reductions to estimated fair values (in thousands):
September 30, December 31,
2003 2002
----------------- ----------------
Costs of properties $ 10,480 $ 9,786
Reduction in value (500) (500)
Sale of units (3,094) -
----------------- ----------------
Real estate held for sale $ 6,886 $ 9,286
================= ================
Russian
During 2002, a single-family residence that secured a Partnership loan
totaling $4,402,000, including accrued interest and advances, was transferred
via a statutory warranty deed to a new entity named Russian Hill Property
Company, LLC ("Russian"). Russian was formed by the Partnership to complete the
development and sale of the property. The assets and liabilities of Russian have
been consolidated into the accompanying consolidated balance sheets of the
Partnership.
Stockton
During 2002, six condominium units that secured a Partnership loan totaling
$2,163,000, including accrued interest and advances, were transferred via a
statutory warranty deed to a new entity named Stockton Street Property Company,
LLC ("Stockton"). In addition, senior debt was assumed by Stockton on the
property in the amount of $1,789,000 (see Note 6). Stockton was formed by the
Partnership and an affiliate to complete development and sales of the
condominium units. The Partnership is co-manager of Stockton along with the
other member and is to receive 66% of the profits or losses. As such, the assets
and liabilities of Stockton have been consolidated into the accompanying
consolidated balance sheets of the Partnership.
note 5 - Bank Line of Credit
The partnership has a bank line of credit expiring July 10, 2004 of up to
$20,000,000 at prime secured by its loan portfolio. The outstanding balances
were $6,500,000 and $0 at September 30, 2003 and December 31, 2002,
respectively. The interest rate was 4.00% (prime) at September 30, 2003. The
line of credit requires the partnership to meet certain financial covenants. The
partnership was in compliance with these covenants for the nine month period
ended September 30, 2003 and for the year ended December 31, 2002.
Should the general partners choose not to renew the line of credit in 2004,
any balance then outstanding would be converted to a three-year term loan with
interest at prime.
9
REDWOOD MORTGAGE INVESTORS VIII
(A California Limited Partnership)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2003 (unaudited)
note 6 - Note Payable
The partnership assumed a bank loan of $1,789,000 in connection with the
foreclosure on a property in 2002 (see Note 4). During the quarter ended
September 30, 2003 portions of the property were sold, resulting in a reduction
in the note. As of September 30, 2003, $635,000 was outstanding on this note.
The loan is secured by the property and bears interest at a variable rate of
5.08% at September 30, 2003.
Future maturities on the note payable are as follows (in thousands):
2003 $ 2
2004 10
2005 10
2006 11
2007 12
Thereafter 590
-------------
$ 635
=============
NOTE 7 - FAIR VALUE OF FINANCIAL INSTRUMENTS
The following methods and assumptions were used to estimate the fair value
of financial instruments:
Secured loans carrying value was $127,177,000 and $83,650,000 at September
30, 2003 and December 31, 2002, respectively. The fair value of these loans of
$127,013,253 and $84,976,000, respectively, was estimated based upon projected
cash flows discounted at the estimated current interest rates at which similar
loans would be made. The applicable amount of the allowance for loan losses
along with accrued interest and advances related thereto should also be
considered in evaluating the fair value versus the carrying value.
10
REDWOOD MORTGAGE INVESTORS VIII
(A California Limited Partnership)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2003 (unaudited)
NOTE 8 - ASSET CONCENTRATIONS AND CHARACTERISTICS (in thousands)
Loans are secured by recorded deeds of trust. At September 30, 2003 and
December 31, 2002 there were 75 and 70 secured loans outstanding, respectively,
with the following characteristics:
September 30, December 31,
2003 2002
---------------- ----------------
Number of secured loans outstanding 75 70
Total secured loans outstanding $ 127,177 $ 83,650
Average secured loan outstanding $ 1,696 $ 1,195
Average secured loan as percent of total 1.33% 1.43%
Average secured loan as percent of partners' capital 1.30% 1.25%
Largest secured loan outstanding $ 14,106 $ 4,943
Largest secured loan as percent of total 11.09%* 5.91%
Largest secured loan as percent of partners' capital 10.77%* 5.16%
Number of counties where security is located (all California) 18 15
Largest percentage of secured loans in one county 27.29% 27.22%
Average secured loan to appraised value of security
at time loan was consummated 56.32% 60.61%
Number of secured loans in foreclosure status 5 6
Amount of secured loans in foreclosure $ 4,361 $ 4,029
* Largest loan as a percent of partnership assets 9.97%
The following loan categories were held at September 30, 2003, and December
31, 2002:
September 30, December 31,
2003 2002
---------------- ----------------
First Trust Deeds $ 78,598 $ 46,117
Second Trust Deeds 45,789 30,930
Third Trust Deeds 2,790 6,603
---------------- ----------------
Total loans 127,177 83,650
Prior liens due other lenders 104,335 79,846
---------------- ----------------
Total debt $ 231,512 $ 163,496
---------------- ----------------
Appraised property value at time of loan $ 411,081 $ 269,773
---------------- ----------------
Total investment as a percent of appraisals 56.32% 60.61%
---------------- ----------------
Investments by type of property
Owner occupied homes $ 17,114 $ 12,854
Non-owner occupied homes 36,569 23,720
Apartments 23,273 6,572
Commercial 44,576 32,089
Land 5,645 8,415
---------------- ----------------
$ 127,177 $ 83,650
================ ================
11
REDWOOD MORTGAGE INVESTORS VIII
(A California Limited Partnership)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2003 (unaudited)
NOTE 8 - ASSET CONCENTRATIONS AND CHARACTERISTICS (in thousands) (continued)
The interest rates on the loans range from 7.50% to 18.00% at September 30,
2003.
Scheduled maturity dates of loans as of September 30, 2003 are as follows:
Year Ending
December 31, Amount
------------------------- ----------------
2003 $ 11,227
2004 32,806
2005 46,054
2006 23,883
2007 8,244
Thereafter 4,963
----------------
$ 127,177
================
The remaining scheduled maturities for 2003 include twelve loans totaling
$11,227,000, which are past maturity at September 30, 2003. Interest payments on
ten of these loans were 90 days or more delinquent.
Cash deposits at September 30, 2003 of $514,000, before clearing deposits
in transit and outstanding checks, were in one bank. The balances exceeded FDIC
insurance limits (up to $100,000 per bank) by $414,000. This bank is the same
financial institution that has provided the partnership with the $20,000,000
limit line of credit (LOC). As and when deposits in the partnership's bank
accounts increase significantly beyond the insured limit, the funds are
typically either placed on new loans or used to pay-down the line of credit
balance.
NOTE 9 - COMMITMENTS & CONTINGENCIES
Construction Loans
The partnership has construction loans, which are at various stages of
completion of the construction process and loans which are not fully disbursed
at September 30, 2003. The partnership has approved the borrowers up to a
maximum loan balance; however, disbursements are made during completion phases
throughout the construction process or incrementally upon certain conditions
being met. At September 30, 2003, there were $16,393,000 of undistributed loans
which will be funded by a combination of borrower monthly mortgage payments,
line of credit draw-downs, retirement of principal on current loans, cash and
capital contributions from investors.
Workout Agreements
The partnership has negotiated various contractual workout agreements with
borrowers whose loans are past maturity or who are delinquent in making
payments. The partnership is not obligated to fund additional money on these
loans as of September 30, 2003. There are approximately 6 loans totaling
$5,025,000 in workout agreements as of September 30, 2003.
Legal proceedings
The partnership is involved in various legal actions arising in the normal
course of business. In the opinion of management, such matters will not have a
material effect upon the financial position of the partnership.
12
REDWOOD MORTGAGE INVESTORS VIII
(A California Limited Partnership)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2003 (unaudited)
NOTE 10 - NON-CASH TRANSACTIONS
During the nine months ended September 30, 2003, the partnership sold two
loans that resulted in an increase to secured loans receivable of $466,000 and a
decrease to the accrued interest and late fees, advances and allowance for loan
losses of $944,000, $183,000 and $661,000, respectively.
During the nine months ended September 30, 2003, the partnership
restructured several loans that resulted in an increase to secured loans
receivable of $1,659,000 and a decrease to accrued interest and late fees and
advances of $1,529,000 and $130,000, respectively.
NOTE 11 - SUBSEQUENT EVENTS
The partnership's fifth offering of 75,000,000 units ($75,000,000) became
effective October 7, 2003.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION OF THE PARTNERSHIP
Critical Accounting Policies.
In preparing the consolidated financial statements, management is required
to make estimates based on the information available that affect the reported
amounts of assets and liabilities as of the balance sheet date and revenues and
expenses for the reporting periods. Such estimates relate principally to the
determination of (1) the allowance for loan losses (i.e. the amount of allowance
established against loans receivable as an estimate of potential loan losses)
including the accrued interest and advances that are estimated to be
unrecoverable based on estimates of amounts to be collected plus estimates of
the value of the property as collateral and (2) the valuation of real estate
acquired through foreclosure. At September 30, 2003, there were two real estate
properties owned by the partnership.
Loans and related accrued interest, fees, and advances are analyzed on a
continuous basis for recoverability. Delinquencies are identified and followed
as part of the loan system. Provisions are made to adjust the allowance for loan
losses and real estate to an amount considered by management to be adequate,
with due consideration to collateral values and to provide for unrecoverable
loans receivable, including impaired loans, other loans, accrued interest, late
fees and advances on loans, and other accounts receivable (unsecured).
Recent trends in the economy have been taken into consideration in the
aforementioned process of arriving at the allowance for loan losses and real
estate. Actual results could vary from the aforementioned provisions for losses.
Statement of Financial Accounting Standards Nos. 114 and 118 provide that
if the probable ultimate recovery of the carrying amount of a loan, with due
consideration for the fair value of collateral, is less than amounts due
according to the contractual terms of the loan agreement and the shortfall in
the amounts due are not insignificant, the carrying amount of the investment
shall be reduced to the present value of future cash flows discounted at the
loan's effective interest rate. If a loan is collateral dependent, it is valued
at the estimated fair value of the related collateral.
If events and/or changes in circumstances cause management to have serious
doubts about the collectibility of the contractual payments, a loan may be
categorized as impaired and interest is no longer accrued. Any subsequent
payments on impaired loans are applied to reduce the outstanding loan balances,
including accrued interest and advances.
13
Forward Looking Statements.
Some of the information in the Form 10-Q may contain forward looking
statements. Uses of words such as "will", "may", "anticipate", "estimate",
"continue" or other forward looking words, discuss future expectations or
predictions. The analysis of 2003 includes forward looking statements and
predictions about the possible future events, results of operations and
financial condition. As such, this analysis may prove to be inaccurate because
of assumptions made by the general partners or the actual development of the
future events. No assurance can be given that any of these statements or
predictions will ultimately prove to be correct or substantially correct.
Related Parties.
The general partners of the partnership are Redwood Mortgage Corp., Gymno
Corporation and Michael R. Burwell. Most partnership business is conducted
through Redwood Mortgage Corp., which arranges, services and maintains the loan
portfolio for the benefit of the partnership. The following is a list of various
partnership activities for which related parties are compensated.
o Mortgage Brokerage Commissions For fees in connection with the review,
selection, evaluation, negotiation and extension of loans, Redwood Mortgage
Corp. may collect an amount equivalent to 12% of the loaned amount until 6
months after the termination date of the offering. Thereafter, the loan
brokerage commissions (points) will be limited to an amount not to exceed 4% of
the total partnership assets per year. The loan brokerage commissions are paid
by the borrowers, and thus, are not an expense of the partnership. Loan
brokerage commissions paid by the borrowers were $1,660,000 and $887,000 for the
nine months ended September 30, 2003 and 2002, and $408,000 and $371,000 for the
three months ended September 30, 2003 and 2002, respectively.
o Mortgage Servicing Fees Monthly mortgage servicing fees of up to 1/8 of
1% (1.5% on an annual basis) of the unpaid principal of the partnership's loans
is paid to Redwood Mortgage Corp., or such lesser amount as is reasonable and
customary in the geographic area where the property securing the mortgage is
located. Mortgage servicing fees of $734,000 and $662,000 were incurred for the
nine months ended September 30, 2003 and 2002, and $287,000 and $198,000 were
incurred for the three months ended September 30, 2003 and 2002, respectively.
o Asset Management Fees The general partners receive monthly fees for
managing the partnership's portfolio and operations up to 1/32 of 1% of the `net
asset value' (3/8 of 1% on an annual basis). Management fees to the general
partners of $334,000 and $237,000 were incurred by the partnership for the nine
months ended September 30, 2003 and 2002, and $125,000 and $82,000 were incurred
for the three months ended September 30, 2003 and 2002, respectively.
o Other Fees The partnership agreement provides that the general partners
may receive other fees such as reconveyance, mortgage assumption and mortgage
extension fees. Such fees are incurred by the borrowers and are paid to the
general partners.
o Income and Losses All income and losses are credited or charged to
partners in relation to their respective partnership interests. The allocation
to the general partners (combined) shall be a total of 1%.
o Operating Expenses The general partners are reimbursed by the partnership
for all operating expenses actually incurred by them on behalf of the
partnership, including without limitation, out-of-pocket general and
administration expenses of the partnership, accounting and audit fees, legal
fees and expenses, postage and preparation of reports to limited partners.
o Contributed Capital The general partners jointly and severally were to
contribute 1/10 of 1% in cash contributions as proceeds from the offerings are
received from the limited partners. As of September 30, 2003, a general partner,
Gymno Corporation, had cumulatively contributed $126,000 as capital in
accordance with Section 4.02(a) of the partnership agreement.
14
o Sales Commission - "Formation Loan" to Redwood Mortgage Corp. Sales
commissions relating to the capital contributions by limited partners are not
paid directly by the partnership out of the offering proceeds. Instead, the
partnership loans to Redwood Mortgage Corp., a general partner, amounts
necessary to pay all sales commissions and amounts payable in connection with
unsolicited orders. The loan is referred to as the "Formation Loan". It is
unsecured and non-interest bearing and is applied to reduce limited partners'
capital in the consolidated balance sheets. The sales commissions range between
0% (for units sold by the general partners) and 9%. It is estimated that the
total amount of the formation loan will approximate 7.6% based on the assumption
that 65% of the investors will reinvest earnings, which qualify for the higher
commission percentage.
The following summarizes formation loan transactions through September 30,
2003 (in thousands):
Initial Second Third Fourth
Offering of Offering of Offering of Offering of
$15,000 $30,000 $30,000 $50,000 Total
------------- -------------- ------------- -------------- ------------
Limited partner contributions $ 14,932 $ 29,993 $ 29,999 $ 49,982 $124,906
============= ============== ============= ============== ============
Formation Loan made $ 1,075 $ 2,272 $ 2,218 $ 3,775 $ 9,340
Repayments to date (667) (795) (342) (98) (1,902)
Early withdrawal penalties applied (59) (80) (45) - (184)
------------- -------------- ------------- -------------- ------------
Balance September 30, 2003 $ 349 $ 1,397 $ 1,831 $ 3,677 $ 7,254
============= ============== ============= ============== ============
Percent loaned 7.2% 7.6% 7.4% 7.6% 7.5%
============= ============== ============= ============== ============
For the initial offering, the formation loan will be repaid in ten equal
installments of principal commencing December 31, 1997. For the second, third
and fourth offerings, payments were due on the formation loan at one-tenth of
the outstanding principal balance of the formation loan each December 31, until
each offering terminated. Upon the termination of each offering the remaining
balance at December 31 is paid in equal amortizing payments over 10 years.
On October 30, 2002, the partnership's fourth offering of $50,000,000 in
units became effective, and as of October, 2003, the fourth offering of
$50,000,000 has been fully subscribed and closed. Contributed capital equaled
$14,932,000 for the first offering, $29,993,000 for the second offering,
$29,999,000 for the third offering, and $49,982,000 for the fourth offering as
of September 30, 2003, totaling an aggregate of $124,906,000 as of September 30,
2003. Of this amount, $1,976,000 remained in applicant status.
Results of Operations - For the nine and three months ended September 30,
2003 and 2002
The net income increase of $1,488,000 for the nine months, and $649,000 for
the three months ended September 30, 2003 versus September 30, 2002 was due
primarily to an increase in interest earned on loans of $613,000 for the nine
months, and $0 for the three months, and reduced interest costs of $393,000 for
the nine months, and $170,000 for the three months, on the partnership's debt.
In addition, significant expense increases or decreases for the nine and three
months ended September 30, 2003 versus September 30, 2002 included an increase
in mortgage servicing fees of $72,000 for the nine months, and an increase of
$89,000 for the three months, a decrease in the provision for losses on loans
and real estate acquired through foreclosure of $496,000 for the nine months,
and $335,000 for the three months, increase in asset management fees of $97,000
for the nine months, and $43,000 for the three months, and a decrease in
brokerage fees of $59,000 for the nine months, and $240,000 for the three
months.
15
The increase in interest on loans of $613,000 for the nine months, and $0
for the three months ended September 30, 2003 versus September 30, 2002, was due
primarily to the increased size of the partnership secured loan portfolio at
September 30, 2003 as compared to September 30, 2002 of $127,177,000 and
$90,859,000, offset by lower average portfolio interest rates in 2003 and due to
collection of "additional interest" of $362,000 derived from one of the
partnership's loans in 2002.
The decrease in interest expense of $393,000 for the nine months, and
$170,000 for the three months ended September 30, 2003 versus September 30, 2002
is due to little usage of the line of credit during the first nine months of
2003. This low credit line usage was due primarily to loan payoffs and a high
number of partnership unit sales occurring in the fourth offering, offset by
good loan production volume. Interest on the note payable relating to real
estate held for sale was being capitalized for most of the nine month period.
The increase in mortgage servicing fees of $72,000 for the nine months, and
an increase of $89,000 for the three months ended September 30, 2003 versus
September 30, 2002 is primarily due to mortgage servicing fees earned on
impaired loans during the first quarter of 2002, offset by the larger loan
portfolio, which existed during the nine months and the three months ended
September 30, 2003.
The decrease of $496,000 and $335,000 in provision for losses on loans and
real estate acquired through foreclosure for the nine and three months ended
September 30, 2003 versus the respective nine and three months ended September
30, 2002 indicates the general partners' expectation on loan losses. Despite the
fact that the partnership's loan portfolio has increased, and the partnership
acquired two properties through borrower defaults in the third quarter of 2002,
the general partners considered that the amount of provision was reasonable. At
September 30, 2003, total allowance for losses on loans and real estate acquired
through foreclosure equaled $3,118,000, which the general partners consider to
be adequate. See additional discussions below.
The increase in the asset management fees of $97,000 and $43,000 for the
nine and three months ended September 30, 2003 versus the respective periods
ended September 30, 2002 is due to an increase in the partners' capital under
management at September 30, 2003 and 2002 to $139,037,000 and $86,899,000,
respectively.
The increase in professional fees of $20,000 and $5,000 for the nine and
three months ended September 30, 2003 versus September 30, 2002 is due to
increased expense due to the larger partnership size.
The decrease in brokerage fees of $59,000 and $240,000 for the nine and
three months ended September 30, 2003 versus September 30, 2002 is due to the
partnership incurring an obligation to pay one-half of the "additional interest"
collected on one of its loans to a non-affiliated real estate broker. This
obligation was fully met as of June 30, 2003, therefore, there was no expense
during the third quarter of 2003, hence the large reduction in this expense.
Partnership capital continued to increase as the partnership received new
limited partner capital contributions of $33,667,000 and retained the earnings
of limited partners that have chosen to compound their earnings of $4,398,000
for the nine months ended September 30, 2003, as compared to $5,247,000 and
$3,474,000 for the nine months ended September 30, 2002. The increased
partnership capital helped increase loans outstanding to $127,177,000 at
September 30, 2003, as compared to $90,859,000 at September 30, 2002. The
limited partner contributions of $33,667,000 versus $5,247,000, is due to the
completion of the third offering in April 2002, and the beginning of the fourth
offering, effective October 30, 2002, of $50,000,000, which brought about large
sales of units.
The partnership utilized its bank line of credit less during the first nine
months of 2003 as compared to the corresponding period in 2002. Cash generated
from interest earnings, late charges, amortization of principal, loan payoffs
and capital contributions by limited partners was utilized to fund new loans and
meet distributions and capital liquidations to limited partners.
At September 30, 2003, outstanding foreclosures were five ($4,361,000)
compared to the five ($3,824,000) that existed at September 30, 2002. Of the
foreclosures at September 30, 2003, three have entered into workout agreements,
which require regular monthly payments. These foreclosures are a reflection of
the difficult economic times that existed at September 30, 2003 and September
30, 2002, yet are not unusual in the general partners' experience.
16
The general partners received mortgage brokerage commissions from the loan
borrowers of $1,660,000 and $408,000 for the nine and three months ended
September 30, 2003 as compared to $887,000 and $371,000 for the nine and three
months ended September 30, 2002. The increase is due to more loans written in
the nine and three months ended September 30, 2003 than the nine and three
months during the corresponding periods of 2002.
Since January 2001, and through September 30, 2003, the Federal Reserve has
reduced interest rates significantly by cutting the Federal Funds Rate to 1.00%.
The effect of the cuts has greatly reduced short-term interest rates and to a
lesser extent reduced long-term interest rates. New loans will be originated at
then existing interest rates. In the future, the general partners anticipate
that interest rates likely will change from their current levels. The general
partners cannot at this time predict at what levels interest rates will be in
the future. The general partners anticipate that new loans will be placed at
rates approximately 1% lower than similar loans during 2002. The lowering of
interest rates has encouraged those borrowers that hold higher interest rate
loans than those currently available to seek refinancing of their existing
obligations to take advantage of these lower rates. The Partnership may face
prepayments in the existing portfolio from borrowers taking advantage of these
lower rates. However, demand for loans from qualified borrowers continues to be
strong and as prepayments occur, we expect to replace these loans with loans at
somewhat lower interest rates. At this time, the general partners believe that
the average loan portfolio interest rate will decline approximately .75% to
1.25% over the year 2003. Nevertheless, based upon the rates expected in
connection with the existing loans, and anticipated interest rates to be charged
by the Partnership and the general partners' experience, the general partners
anticipate, but do not guarantee, that the annualized yield for compounding
limited partners will range between 7.50% and 8.00% for the year 2003.
Additionally, the general partners expect, but do not guarantee, the annualized
yield to be higher during the first half of 2003 as compared to the second half
of 2003 due to the lower interest rate environment that currently exists.
Allowance for Losses.
The general partners regularly review the loan portfolio, examining the
status of delinquencies, the underlying collateral securing these loans,
borrowers' payment records, etc. Based upon this information and other data, the
allowance for loan losses is increased or decreased. Borrower foreclosures are a
normal aspect of partnership operations. The partnership is not a credit based
lender and hence while it reviews the credit history and income of borrowers,
and if applicable, the income from income producing properties, the general
partners expect that we will on occasion take back real estate security. During
2001, and continuing in 2002 and 2003, the Northern California real estate
market slowed and the national and local economies have slipped into recession.
As of September 30, 2003, five notices of default are currently filed beginning
the process of foreclosing five of our loans. The principal amounts of the five
foreclosed loans total $4,361,000 or 3.43% of the loan portfolio. Three of these
borrowers have entered into workout agreements, with the borrowers making
regular monthly payments.
The partnership has also entered into workout agreements with borrowers who
are past maturity or delinquent in their regular payments. The partnership had
workout agreements on approximately 6 loans totaling $5,025,000 as of September
30, 2003. Typically, a workout agreement allows the borrower to extend the
maturity date of the balloon payment and/or allows the borrower to make current
monthly payments while deferring for periods of time, past due payments, and
allows time to pay the loan in full. These workout agreements and foreclosures
generally exist within our loan portfolio to greater or lesser degrees,
depending primarily on the health of the economy. The number of foreclosures and
workout agreements will rise during difficult economic times and conversely fall
during good economic times. The number and amount of foreclosures existing at
September 30, 2003, in management's opinion, does not have a material effect on
our results of operations or liquidity. These workouts and foreclosures have
been considered when management arrived at appropriate loan loss reserves and
based on our experience, are reflective of our loan marketplace segment. The
partnership did not acquire any properties through foreclosure during the first
nine months of 2003. During 2002, the partnership completed foreclosure of two
loans resulting in the acquisition of two real estate properties. The
partnership's principal balances were $6,565,000 after excluding an affiliated
partnership's interest in one of the properties. In 2003, the partnership may
acquire additional real estate through the foreclosure process. Borrower
foreclosures are a normal aspect of partnership operations and the general
partners anticipate that they will not have a material effect on liquidity. As a
prudent guard against potential losses, the general partners have made
provisions for losses on loans and real estate acquired through foreclosure of
$3,118,000 at September 30, 2003. These provisions for losses were made to guard
against collection losses. The total provision for losses as of September 30,
17
2003, is considered by the general partners to be adequate. During the second
quarter of 2003, the partnership sold two of its delinquent loans totaling
$3,240,000 in principal at a discount sustaining an overall loss of $661,000.
This loss had been previously provided for in the allowance for loan losses.
Because of the number of variables involved, the magnitude of the swings
possible and the general partners' inability to control many of these factors,
actual results may and do sometimes differ significantly from estimates made by
the general partners.
PORTFOLIO REVIEW - For the nine months ended September 30, 2003 and 2002.
Loan Portfolio.
The partnership's loan portfolio consists primarily of short-term (one to
five years), fixed rate loans secured by real estate. As of September 30, 2003
and 2002 the partnership's loans secured by real property collateral in the six
San Francisco Bay Area counties (San Francisco, San Mateo, Santa Clara, Alameda,
Contra Costa, and Marin) represented $98,207,000 (77.22%) and $73,335,000
(80.71%) of the outstanding loan portfolio. The remainder of the portfolio
represented loans secured by real estate located primarily in Northern
California. No partnership loan equals or exceeds 10% of the partnership's
assets.
As of September 30, 2003, approximately 42.21% ($53,683,000), was invested
in loans secured by single family homes (1-4 units), approximately 18.30%
($23,273,000), was invested in loans secured by multifamily dwellings
(apartments over 4 units), approximately 35.05% ($44,576,000), was invested in
loans secured by commercial properties, and approximately 4.44% ($5,645,000) was
invested in loans secured by land. As of September 30, 2002, approximately,
47.09% ($42,782,000), was invested in loans secured by single family homes (1-4
units), approximately 7.23% ($6,574,000) was invested in loans secured by
multifamily dwellings (apartments over 4 units), approximately 39.17%
($35,588,000) was invested in loans secured by commercial properties, and
approximately 6.51% ($5,915,000) was invested in loans secured by land.
As of September 30, 2003, the partnership held 75 loans secured by deeds of
trust. The following table sets forth the priorities, asset concentrations and
maturities of the loans held by the partnership as of September 30, 2003.
PRIORITIES, ASSET CONCENTRATIONS AND MATURITIES OF LOANS
As of September 30, 2003 (in thousands)
# of Loans Amount Percent
------------- ------------- -------------
1st Mortgages 36 $ 78,598 61.80%
2nd Mortgages 34 45,789 36.00%
3rd Mortgages 5 2,790 2.20%
============= ============= =============
Total 75 $ 127,177 100.00%
Maturing 12/31/03 and prior 12 $ 11,227 8.83%
Maturing prior to 12/31/04 15 32,806 25.80%
Maturing prior to 12/31/05 14 46,054 36.21%
Maturing after 12/31/05 34 37,090 29.16%
============= ============= =============
Total 75 $ 127,177 100.00%
Average Loan $ 1,696 1.33%
Largest Loan 14,106 11.09%*
Smallest Loan 70 0.06%
Average Loan-to-Value 56.32%
* Largest loan is 9.97% of the total assets.
18
Borrower Liquidity and Capital Resources.
The partnership relies upon purchases of units, loan payoffs, borrowers'
mortgage payments, and, to a lesser degree, its line of credit for the source of
funds for loans. Recently, mortgage interest rates have decreased somewhat from
those available at the inception of the partnership. If interest rates were to
increase substantially, the yield of the partnership's loans may provide lower
yields than other comparable debt-related investments. As such, additional
limited partner unit purchases could decline, which would reduce the overall
liquidity of the partnership. Additionally, since the partnership has made
primarily fixed rate loans, if interest rates were to rise, the likely result
would be a slower prepayment rate for the partnership. This could cause a lower
degree of liquidity as well as a slowdown in the ability of the partnership to
invest in loans at the then current interest rates. Conversely, in the event
interest rates were to decline, the partnership could see both or either of a
surge of unit purchases by prospective limited partners, and significant
borrower prepayments, which, if the partnership can only obtain the then
existing lower rates of interest may cause a dilution of the partnership's yield
on loans, thereby lowering the partnership's overall yield to the limited
partners. The partnership to a lesser degree relies upon its line of credit to
fund loans. Generally, the partnership's loans are fixed rate, whereas the
credit line is a variable rate loan. In the event of a significant increase in
overall interest rates, the credit line rate of interest could increase to a
rate above the average portfolio rate of interest. Should such an event occur,
the general partners would desire to pay off the line of credit. Retirement of
the line of credit would reduce the overall liquidity of the partnership. Cash
is constantly being generated from borrower payments of interest, principal and
loan payoffs. Currently, cash flow greatly exceeds partnership expenses and
earnings requirements. Excess cash flow is invested in new loan opportunities,
when available, and is used to reduce the partnership credit line or for other
partnership business.
At the time of subscription to the partnership, limited partners must elect
either to receive monthly, quarterly or annual cash distributions from the
partnership, or to compound earnings in their capital account. If an investor
initially elects to receive monthly, quarterly or annual distributions, such
election, once made, is irrevocable. If the investor initially elects to
compound earnings in his/her capital account, in lieu of cash distributions, the
investor may, after three (3) years, change the election and receive monthly,
quarterly or annual cash distributions. Earnings allocable to limited partners
who elect to compound earnings in their capital account, will be retained by the
partnership for making further loans or for other proper partnership purposes,
and such amounts will be added to such limited partners' capital accounts.
During the nine and three month periods ended September 30, 2003 and 2002,
the partnership, after allocation of syndication costs, made the following
allocation of earnings both to the limited partners who elected to compound
their earnings, and those that chose to distribute:
Nine months ended September 30, Three months ended September 30,
------------------------------------- -------------------------------------
2003 2002 2003 2002
------------- ------------- ------------- --------------
Compounding $4,398,000 $3,474,000 $1,551,000 $1,182,000
Distributing $2,392,000 $1,858,000 $ 882,000 $ 624,000
As of September 30, 2003 and 2002, limited partners electing to receive
cash distributions of earnings represented 36% and 35%, respectively of the
limited partners' outstanding capital accounts. These percentages have remained
relatively stable. The general partners anticipate that after all capital has
been raised, the percentage of limited partners electing to withdraw earnings
will decrease due to the dilution effect which occurs when compounding limited
partners' capital accounts grow through earnings reinvestment.
19
The partnership also allows the limited partners to withdraw their capital
account subject to certain limitations and penalties (see "Withdrawal From
Partnership" in the Limited Partnership Agreement). Once a limited partner's
initial five-year hold period has passed, the general partners expect to see an
increase in liquidations due to the ability of limited partners to withdraw
without penalty. This ability to withdraw five years after a limited partner's
investment has the effect of providing limited partner liquidity and the general
partners expect a portion of the limited partners to avail themselves of this
liquidity. This has the anticipated effect of increasing the net capital of the
partnership, primarily through retained earnings during the offering period. The
general partners expect to see increasing numbers of limited partner withdrawals
during a limited partner's 5th through 10th anniversary, at which time the bulk
of those limited partners who have sought withdrawal have been liquidated. Since
the five-year hold period for many limited partners has yet to expire, as of
September 30, 2003, many limited partners may not as yet avail themselves of
this provision for liquidation. Earnings and capital liquidations including
early withdrawals during the nine and three months ended September 30, 2003 and
2002 were:
Nine months ended September 30, Three months ended September 30,
-------------------------------------- -------------------------------------
2003 2002 2003 2002
-------------- ------------- ------------- -------------
Cash distributions $2,392,000 $1,858,000 $ 882,000 $ 624,000
Capital liquidation* $1,318,000 $ 785,000 $ 509,000 $ 215,000
-------------- ------------- ------------- -------------
Total $3,710,000 $2,643,000 $1,391,000 $ 839,000
============== ============= ============= =============
* These amounts represent gross of early withdrawal penalties.
Limited partners may liquidate their investment over a one-year period
subject to certain limitations and penalties. During the nine and three months
ended September 30, 2003 and 2002, capital liquidated subject to the 10% penalty
for early withdrawal was:
Nine months ended September 30, Three months ended September 30,
-------------------------------------- -------------------------------------
2003 2002 2003 2002
-------------- ------------ ------------- -------------
$ 527,000 $ 192,000 $ 216,000 $ 17,000
This represents 0.40%, 0.23%, 0.17% and 0.02% of the limited partners'
ending capital for the nine months and three months ended September 30, 2003 and
2002, respectively. These withdrawals are within the normally anticipated range
and represent a small percentage of limited partner capital.
In some cases in order to satisfy broker dealers and other reporting
requirements, the general partners have valued the limited partners' interest in
the partnership on a basis which utilizes a per unit system of calculation,
rather than based upon the investors' capital account. This information has been
reported in this manner in order to allow the partnership to integrate with
certain software used by the broker dealers and other reporting entities. In
those cases, the partnership will report to broker dealers, Trust Companies and
others a "reporting" number of units based upon a $1.00 per unit calculation.
The number of reporting units provided will be calculated based upon the limited
partner's capital account value divided by $1.00. Each investor's capital
account balance is set forth periodically on the partnership account statement
provided to investors. The reporting units are solely for broker dealers
requiring such information for their software programs and do not reflect actual
units owned by a limited partner or the limited partners' right or interest in
cash flow or any other economic benefit in the partnership. Each investor's
capital account balance is set forth periodically on the partnership account
statement provided to investors. The amount of partnership earnings each
investor is entitled to receive is determined by the ratio that each investor's
capital account bears to the total amount of all investor capital accounts then
outstanding. The capital account balance of each investor should be included on
any NASD member client account statement in providing a per unit estimated value
of the client's investment in the partnership in accordance with NASD Rule 2340.
20
While the general partners have set an estimated value for the partnership
units, such determination may not be representative of the ultimate price
realized by an investor for such units upon sale. No public trading market
exists for the partnership units and none is likely to develop. Thus, there is
no certainty that the units can be sold at a price equal to the stated value of
the capital account. Furthermore, the ability of an investor to liquidate his or
her investment is limited subject to certain liquidation rights provided by the
partnership, which may include early withdrawal penalties (See the section of
the prospectus entitled "Risk Factors - Purchase of Units is a Long Term
Investment").
Current Economic Conditions.
The partnership makes loans primarily in Northern California. As of
September 30, 2003, approximately 77.22% of the loans held were in the six San
Francisco Bay Area Counties. The remainder of the loans held were secured
primarily by Northern California real estate outside the San Francisco Bay Area.
Like the rest of the nation, the San Francisco Bay Area has also felt the
recession and accompanying slow down in economic growth and increasing
unemployment. The technology companies of Silicon Valley, the airline industry,
the tourism industry and other industries are feeling the effects of the overall
United States recession, which includes lower earnings, losses and layoffs.
As contained in an article in the San Francisco Chronicle dated October 4,
2003, mortgage rates are down again while home sales are soaring. The article
stated, "Rates on benchmark 30-year mortgages dropped for the fourth week in a
row, good news for people thinking about refinancing their home mortgage. For
the week ending October 3, the average rate on 30-year mortgages dipped to
5.77%, down from last week's rate of 5.98%, Freddie Mac, the mortgage giant,
reported Thursday in its weekly nation-wide survey of mortgage rates. This
week's rate was the lowest since the middle of July, when rates on 30-year
mortgage averaged 5.67%. Rates on 30-year mortgages slid to 5.21%, the lowest
level in more than four decades, in the middle of June. But in late June, those
rates started marching back up. They have retreated in the past four weeks. Even
with the recent gyration in mortgage rates, sales of both new homes and
previously owned ones soared in August and are on track to set record highs this
year. And, home-mortgage refinancing activity remains healthy, economists said."
According to the San Francisco Chronicle of the week of September 9, 2003,
house prices were showing steady appreciation across the U.S. The article
stated, "Defying gloom and doom predictions of impending deflation, the value of
the average U.S. home continues to appreciate at more than twice the rate of
inflation. In the latest nationwide survey of prices of existing houses, average
values rose by 5.56% from the second quarter of 2002 through the second quarter
of 2003. The study was done by the Office of Federal Housing Enterprise
Oversight (OFHEO), which monitors the market value changes of millions of
individual properties financed or refinanced by giant investors Fannie Mae and
Freddie Mac. Dozens of local markets experienced much higher average gains than
5.56%, including double-digit appreciation rates in large swaths of California
and Florida." The article also stated "Houses in the District of Columbia
appreciated at 10.1% on average, while California houses gained an average of
9.4%. Formerly superheated markets, such as San Francisco where values rose at
20% and more per year during the dot-com boom, continue to readjust. San Jose
houses gained an average 1.6% in resale value from 2002 to 2003 but lost 0.56%
during the last quarter measured by the study. San Francisco houses gained an
average 3.81% during the year, but rose by just 0.22% during the quarter ending
June 30." These articles and statistics imply that interest rates are
stabilizing near historical lows and that the real estate market for
single-family residences is strong, but that the San Francisco Bay Area values
are continuing to fall slightly as they readjust from the robust markets of the
late 1990's and early 2000.
On the commercial scene, according to the San Francisco Business Times for
the week of October 3, 2003, the San Francisco real estate market is showing
signs of life. The article stated, "San Francisco's office market, among the
most depressed in the nation, appears to have finally started to recover.
Slowly. Third-quarter numbers released this week from three major San Francisco
brokerage firms show leasing creeping upward, vacancy dropping slightly and
rents stabilizing after almost three years of free fall. Numbers from Newmark &
Co. Real Estate, for example, showed "positive absorption" - the amount of new
leases compared to new vacancies - of 415,000 square feet citywide in the third
quarter, with the vacancy rate declining to 16.7% from 17% overall and to 18.3%
from 19.3% among Class A buildings. Numbers from two other real estate firms
show the same trend, with Cushman & Wakefield reporting more than 500,000 square
feet absorbed, and Grubb & Ellis Co. showing 100,000 square feet absorption.
Both those firms also saw the vacancy rate declining 0.1% citywide." The article
also stated, "Newmark managing principal Monica Finnegan said the numbers make
her cautiously optimistic that the market has bottomed out, but she is still
keeping an eye out for what happens in the fourth quarter. Still, Newmark says
in its report that "we expect several consecutive years of positive absorption
21
beginning in 2004." Newmark's outlook is buoyed by federal employment statistics
that show the rate of job loss in San Francisco slowing dramatically, with jobs
falling 1.9% in the year to August, compared to declines of 5.8% in August 2002
and 4.9% in August 2001." The commercial real estate market seems to be
stabilizing but it will take a long time to absorb the large vacancies that have
built up in this recession. Values have decreased but lowered capitalization
rates have helped keep commercial property values from large reductions.
To the partnership, lower interest rates may mean more borrowers coming
forward for equity loans or for refinancing. Stabilizing commercial vacancies
and little appreciation in rental rates may mean that the economy is at the
vacancy rate bottom.
For partnership loans outstanding, as of September 30, 2003, the
partnership had an average loan to value ratio computed as of the date the loan
was made of 56.32%. This percentage does not account for any increases or
decreases in property values since the date the loan was made, nor does it
include any reductions in principal through amortization of payments after the
loan was made. This low loan to value ratio will assist the partnership in
weathering loan delinquencies and foreclosures should they eventuate.
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The following table contains information about the cash held in money
market accounts, loans held in the partnership's portfolio, a note payable, and
our line of credit as of September 30, 2003. The presentation, for each category
of information, aggregates the assets and liabilities by their maturity dates
for maturities occurring in each of the years 2003 through 2007 and separately
aggregates the information for all maturities arising after 2007. The carrying
values of these assets and liabilities approximate their fair market values as
of September 30, 2003 (in thousands):
2003 2004 2005 2006 2007 Thereafter Total
----------- ----------- ----------- ----------- ----------- ------------ -----------
Interest earning assets:
Money market accounts $ 6 $ 6
Average interest rate 0.46% 0.46%
Loans secured by deeds of trust $11,227 32,806 46,054 23,883 8,244 4,963 $127,177
Average interest rate 12.37% 10.69% 10.15% 10.33% 10.45% 10.07% 10.54%
Interest bearing liabilities:
Line of credit $ 6,500 $ 6,500
Average interest rate 4.00% 4.00%
Note-payable $ 2 10 10 11 12 590 $ 635
Average interest rate 5.08% 5.08%
Market Risk.
The partnership's line of credit bears interest at a variable rate, tied to
the prime rate. As a result, the partnership's primary market risk exposure with
respect to its obligations is to changes in interest rates, which will affect
the interest cost of outstanding amounts on the line. The partnership may also
suffer market risk tied to general trends affecting real estate values that may
impact the partnership's security for its loans.
The partnership's primary market risk in terms of its profitability is the
exposure to fluctuations in earnings resulting from fluctuations in general
interest rates. The majority of the partnership's mortgage loans, (100% as of
September 30, 2003) earn interest at fixed rates. Changes in interest rates may
also affect the value of the partnership's investment in mortgage loans and the
rates at which the partnership reinvests funds obtained from loan repayments and
new capital contributions from limited partners. If interest rates increase, the
interest rates the partnership obtains from reinvested funds will generally
increase, but the value of the partnership's existing loans at fixed rates will
generally tend to decrease. The risk is mitigated by the fact that the
partnership does not intend to sell its loan portfolio, rather such loans are
held until they are paid off. If interest rates decrease, the amounts becoming
available to the partnership for investment due to repayment of partnership
loans may be reinvested at lower rates than the partnership had been able to
22
obtain in prior investments, or than the rates on the repaid loans. In addition,
interest rate decreases may encourage borrowers to refinance their loans with
the partnership at a time where the partnership is unable to reinvest in loans
of comparable value.
The partnership does not hedge or otherwise seek to manage interest rate
risk. The partnership does not enter into risk sensitive instruments for trading
purposes.
ASSET QUALITY
A consequence of lending activities is that occasionally losses will be
experienced and that the amount of such losses will vary from time to time,
depending upon the risk characteristics of the loan portfolio as affected by
economic conditions and the financial experiences of borrowers. Many of these
factors are beyond the control of the general partners. There is no precise
method of predicting specific losses or amounts that ultimately may be charged
off on particular segments of the loan portfolio, especially in light of the
current economic environment.
The conclusion that a loan may become uncollectible, in whole or in part,
is a matter of judgment. Although institutional lenders are subject to
requirements and regulations that, among other things, require them to perform
ongoing analyses of their portfolios, loan-to-value ratios, reserves, etc., and
to obtain and maintain current information regarding their borrowers and the
securing properties, the partnership is not subject to these regulations and has
not adopted all of these practices. Rather, the general partners, in connection
with the periodic closing of the accounting records of the partnership and the
preparation of the financial statements, determine whether the allowance for
loan losses is adequate to cover potential loan losses of the partnership. As of
September 30, 2003 the general partners have determined that the allowance for
loan losses and real estate owned of $3,118,000 (2.38% of net assets) is
adequate in amount. Because of the number of variables involved, the magnitude
of the swings possible and the general partners' inability to control many of
these factors, actual results may and do sometimes differ significantly from
estimates made by the general partners. As of September 30, 2003, 15 loans were
delinquent over 90 days amounting to $21,397,000. Of these, $4,329,000
delinquent loans were subject to workout agreements, which require the borrower
to make regular monthly loan payments and/or payments plus additional catch up
amounts.
Controls and Procedures.
As of September 30, 2003, the general partner of the partnership carried
out an evaluation, under the supervision and with the participation of the
general partner's management, including the general partner's President and
Chief Financial Officer, of the effectiveness of the design and operation of the
partnership's disclosure controls and procedures pursuant to Exchange Act Rule
13a-14. Based upon that evaluation, the President and Chief Financial Officer of
the general partner concluded that the partnership's disclosure controls and
procedures are effective. There were no significant changes in the partnership's
internal controls or in other factors that could significantly affect these
controls subsequent to the date of their evaluation.
COMPENSATION OF THE GENERAL PARTNERS AND AFFILIATES BY PARTNERSHIP
The partnership has no officers or directors. The partnership is managed by
the General Partners. There are certain fees and other items paid to management
and related parties.
A more complete description of management compensation is found in the
Prospectus part of Form S-11 and subsequent amendments related to the offering
of partnership interests dated October 30, 2002, pages 5 and 6, under the
section "Compensation of the General Partners and the Affiliates," which is
incorporated by reference. Such compensation is summarized below.
The following compensation has been paid to the General Partners and
Affiliates for services rendered during the nine months ended September 30,
2003. All such compensation is in compliance with the guidelines and limitations
set forth in the Prospectus.
23
Description of Compensation
Entity Receiving Compensation and Services Rendered Amount
- ------------------------------------ ------------------------------------------------------------------- ---------------
I. Redwood Mortgage Corp. Loan Servicing Fee for servicing loans ............................ $734,000
General Partners
&/or Affiliates Asset Management Fee for managing assets ......................... $334,000
General Partners 1% interest in profits ........................................... $70,000
Less allocation of syndication costs ............................. $1,000
---------------
$69,000
Redwood Mortgage Corp. Portion of early withdrawal penalties applied to reduce
Formation Loan ................................................... $43,000
General Partners Organization and Offering Expenses ............................... $0
&/or Affiliates
II. FEES PAID BY BORROWERS ON MORTGAGE LOANS PLACED BY COMPANIES RELATED TO
THE GENERAL PARTNERS WITH THE PARTNERSHIP (EXPENSES OF BORROWERS NOT OF THE
PARTNERSHIP)
Redwood Mortgage Corp. Mortgage Brokerage Commissions for services in connection
with the review, selection, evaluation, negotiation, and
extension of the loans paid by the borrowers and not by
the partnership .................................................. $1,660,000
Redwood Mortgage Corp. Processing and Escrow Fees for services in connection with
notary, document preparation, investigation, and escrow
fees payable by the borrowers and not by the partnership ......... $21,000
Gymno Corporation Reconveyance Fee ................................................. $1,135
Redwood Mortgage Corp. Assumption or Extension Fees...................................... $0
III. IN ADDITION, THE GENERAL PARTNERS AND/OR RELATED COMPANIES PAY CERTAIN
EXPENSES ON BEHALF OF THE PARTNERSHIP FOR WHICH IT IS REIMBURSED AS NOTED IN THE
CONSOLIDATED STATEMENTS OF INCOME . . . . . . . . . . . . . . . . . . $215,000
24
PART 2
OTHER INFORMATION
Item 1. Legal Proceedings
Refer to notes to consolidated financial statements No. 9
discussed earlier
Item 2. Changes in the Securities
Pending S-11 filed on July 9, 2003, effective October 7, 2003
Item 3. Defaults Upon Senior Securities
Not Applicable
Item 4. Submission of Matters to a Vote of Security Holders
Not Applicable
Item 5. Other Information
None
Item 6. Exhibits and Reports on Form 8-K.
(a) Exhibits
(99.1) Certification of Michael R. Burwell, General Partner
(99.2) Certification of Michael R. Burwell,
President, Secretary/Treasurer & Chief
Financial Officer of Redwood Mortgage Corp.
and Gymno Corporation, General Partners
(b) Form 8-K
Not Applicable
25
SIGNATURES
Pursuant to the requirements of Section 13 or 15 (d) of the Securities
Exchange Act of 1934 the registrant has duly caused this report to be signed on
its behalf by the undersigned, thereto duly authorized on the 14th day of
November 2003.
REDWOOD MORTGAGE INVESTORS VIII
By: /S/ Michael R. Burwell
---------------------------------------------
Michael R. Burwell, General Partner
By: Gymno Corporation, General Partner
By: /S/ Michael R. Burwell
-----------------------------------------------
Michael R. Burwell, President,
Secretary/Treasurer & Chief Financial Officer
By: Redwood Mortgage Corp.
By: /S/ Michael R. Burwell
-----------------------------------------------
Michael R. Burwell,
President, Secretary/Treasurer
26
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
registrant and in the capacity indicated on the 14th day of November 2003.
Signature Title Date
/S/ Michael R. Burwell
- ------------------------
Michael R. Burwell General Partner November 14, 2003
/S/ Michael R. Burwell
- -------------------------
Michael R. Burwell President of Gymno Corporation, November 14, 2003
(Principal Executive Officer);
Director of Gymno Corporation;
Secretary/Treasurer of Gymno
Corporation (Principal Financial
and Accounting Officer)
/S/ Michael R. Burwell
- -------------------------
Michael R. Burwell President, Secretary/Treasurer November 14, 2003
of Redwood Mortgage Corp.
(Principal Financial and
Accounting Officer); Director
of Redwood Mortgage Corp.
27
Exhibit 99.1
GENERAL PARTNER CERTIFICATION
I, Michael R. Burwell, General Partner, certify that:
1. I have reviewed this quarterly report on Form 10-Q of Redwood Mortgage
Investors VIII, a California Limited Partnership (the "Registrant");
2. Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to make
the statements made, in light of the circumstances under which such statements
were made, not misleading with respect to the period covered by this quarterly
report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
Registrant as of, and for, the periods presented in this quarterly report;
4. The Registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-14 and 15d-14) for the Registrant and we have:
(a) designed such disclosure controls and procedures to ensure that
material information relating to the Registrant, including its consolidated
subsidiaries, is made known to us by others within those entities, particularly
during the period in which this quarterly report is being prepared;
(b) evaluated the effectiveness of the Registrant's disclosure controls and
procedures as of September 30, 2003 (the "Evaluation Date"); and
(c) presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on our evaluation
as of the Evaluation Date.
5. The Registrant's other certifying officers and I have disclosed, based
on our most recent evaluation, to the Registrant's auditors and the audit
committee of Registrant's board of directors (or persons performing the
equivalent function):
(a) all significant deficiencies in the design or operation of internal
controls which could adversely affect the Registrant's ability to record,
process, summarize and report financial data and have identified for the
Registrant's auditors any material weaknesses in internal controls; and
(b) any fraud, whether or not material, that involves management or other
employees who have a significant role in the Registrant's internal controls.
6. The Registrant's other certifying officers and I have indicated in this
quarterly report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal controls
subsequent to the date of our most recent evaluation, including any corrective
actions with regard to significant deficiencies and material weaknesses.
/s/ Michael R. Burwell
- -----------------------------------
Michael R. Burwell, General Partner
November 14, 2003
28
Exhibit 99.1
CERTIFICATION PURSUANT TO
18 U.S.C SECTION 1350,
AS ADOPTED PURSUANT TO
SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002
In connection with the Quarterly Report of Redwood Mortgage Investors VIII
(the "Partnership") on Form 10-Q for the period ending September 30, 2003 as
filed with the Securities and Exchange Commission on the date hereof (the
"Report"), pursuant to 18 U.S.C. (S) 1350, as adopted pursuant to (S) 906 of the
Sarbanes-Oxley Act of 2002, I, Michael R. Burwell, General Partner of the
Partnership, certify, that to the best of my knowledge:
(1) The Report fully complies with the requirements of section 13(a) or
15(d) of the Securities Exchange Act of 1934; and
(2) The information contained in the Report fairly presents, in all
material respects, the financial condition and results of operations of the
Partnership.
/s/ Michael R. Burwell
- -----------------------------------
Michael R. Burwell, General Partner
November 14, 2003
29
Exhibit 99.2
PRESIDENT AND CHIEF FINANCIAL OFFICER CERTIFICATION
I, Michael R. Burwell, President and Chief Financial Officer of Gymno
Corporation, General Partner, and Redwood Mortgage Corp., General Partner,
certify that:
1. I have reviewed this quarterly report on Form 10-Q of Redwood Mortgage
Investors VIII, a California Limited Partnership (the "Registrant");
2. Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to make
the statements made, in light of the circumstances under which such statements
were made, not misleading with respect to the period covered by this quarterly
report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
Registrant as of, and for, the periods presented in this quarterly report;
4. The Registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-14 and 15d-14) for the Registrant and we have:
(a) designed such disclosure controls and procedures to ensure that
material information relating to the Registrant, including its consolidated
subsidiaries, is made known to us by others within those entities, particularly
during the period in which this quarterly report is being prepared;
(b) evaluated the effectiveness of the Registrant's disclosure controls and
procedures as of September 30, 2003 (the "Evaluation Date"); and
(c) presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on our evaluation
as of the Evaluation Date.
5. The Registrant's other certifying officers and I have disclosed, based
on our most recent evaluation, to the Registrant's auditors and the audit
committee of Registrant's board of directors (or persons performing the
equivalent function):
(a) all significant deficiencies in the design or operation of internal
controls which could adversely affect the Registrant's ability to record,
process, summarize and report financial data and have identified for the
Registrant's auditors any material weaknesses in internal controls; and
(b) any fraud, whether or not material, that involves management or other
employees who have a significant role in the Registrant's internal controls.
6. The Registrant's other certifying officers and I have indicated in this
quarterly report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal controls
subsequent to the date of our most recent evaluation, including any corrective
actions with regard to significant deficiencies and material weaknesses.
/s/ Michael R. Burwell
- ----------------------------------------
Michael R. Burwell, President and Chief
Financial Officer of Gymno Corporation,
General Partner, and Redwood Mortgage
Corp., General Partner
November 14, 2003
30
Exhibit 99.2
CERTIFICATION PURSUANT TO
18 U.S.C. SECTION 1350
AS ADOPTED PURSUANT TO
SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002
In connection with the Quarterly Report of Redwood Mortgage Investors VIII
(the "Partnership") on Form 10-Q for the period ending September 30, 2003 as
filed with the Securities and Exchange Commission on the date hereof (the
"Report"), pursuant to 18 U.S.C. (S) 1350, as adopted pursuant to (S) 906 of the
Sarbanes-Oxley Act of 2002, I, Michael R. Burwell, President,
Secretary/Treasurer & Chief Financial Officer of Gymno Corporation, General
Partner of the Partnership, and Redwood Mortgage Corp., General Partner of the
Partnership, certify that to the best of my knowledge:
(1) The Report fully complies with the requirements of section 13(a) or
15(d) of the Securities Exchange Act of 1934; and
(2) The information contained in the Report fairly presents, in all
material respects, the financial condition and results of operations of the
Partnership.
/s/ Michael R. Burwell
- ----------------------------------------------
Michael R. Burwell, President,
Secretary/Treasurer & Chief Financial
Officer of Gymno Corporation, General Partner,
and Redwood Mortgage Corp., General Partner
November 14, 2003
31