UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the Quarterly Period Ended September 30, 2005
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the transition period from ______________ to ______________
Commission File Number: 000-19992
REDWOOD MORTGAGE INVESTORS VII,
a California Limited Partnership
(Exact name of registrant as specified in its charter)
California 94-3094928
(State or other jurisdiction of incorporation (I.R.S. Employer
or organization) Identification No.)
900 Veterans Blvd., Suite 500, Redwood City, CA 94063-1743
(Address of principal executive offices) (Zip Code)
(650) 365-5341
(Registrant's telephone number, including area code)
NOT APPLICABLE
(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 such reports), and (2) has been subject to such
filing requirements for the past 90 days.
Yes XX No
-------------- -------------
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act).
Yes No XX
-------------- -------------
Indicate by check mark whether the registrant is a shell company (as
defined in Rule 12b-2 of the Exchange Act).
Yes No XX
-------------- --------------
1
Part I - Item 1. FINANCIAL STATEMENTS
REDWOOD MORTGAGE INVESTORS VII
(A California Limited Partnership)
BALANCE SHEETS
SEPTEMBER 30, 2005 and DECEMBER 31, 2004 (unaudited)
ASSETS
September 30, December 31,
2005 2004
---------------- ---------------
Cash and cash equivalents $ 658,700 $ 346,393
---------------- ---------------
Loans
Loans, secured by deeds of trust 6,318,264 7,388,478
Loans, unsecured, net discount of $91,318 and $107,433 for
September 30, 2005 and December 31, 2004, respectively 245,300 238,484
---------------- ---------------
6,563,564 7,626,962
Allowance for loan losses (746,356) (745,476)
---------------- ---------------
Net loans 5,817,208 6,881,486
Interest and other receivables
Accrued interest and late fees 157,842 190,105
Advances on loans 256 8,188
---------------- ---------------
Total interest and other receivables 158,098 198,293
---------------- ---------------
Investment in limited liability company 881,617 -
Real estate held for sale, net 1,825,548 1,782,182
---------------- ---------------
Total assets $ 9,341,171 $ 9,208,354
================ ===============
LIABILITIES AND PARTNERS' CAPITAL
Liabilities
Accounts payable $ 3,678 $ 4,951
Payable to affiliate 78,607 74,987
---------------- ---------------
Total liabilities 82,285 79,938
---------------- ---------------
Partners' capital
Limited partners' capital, subject to redemption 9,246,913 9,116,443
General partners' capital 11,973 11,973
---------------- ---------------
Total partners' capital 9,258,886 9,128,416
---------------- ---------------
Total liabilities and partners' capital $ 9,341,171 $ 9,208,354
================ ===============
The accompanying notes are an integral part of these financial statements.
2
REDWOOD MORTGAGE INVESTORS VII
(A California Limited Partnership)
STATEMENTS OF INCOME
FOR THE THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2005 and 2004 (unaudited)
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
------------------------------- ------------------------------
2005 2004 2005 2004
----------- ----------- ----------- -----------
Revenues
Interest on loans $197,654 $198,818 $517,709 $594,290
Interest - interest bearing accounts 770 629 2,005 2,435
Late fees 5,526 7,115 9,274 17,703
Other 641 8,747 2,311 25,939
----------- ----------- ----------- -----------
204,591 215,309 531,299 640,367
----------- ----------- ----------- -----------
Expenses
Mortgage servicing fees 22,729 20,457 54,692 60,219
Interest expense - 1,444 - 2,512
Clerical costs through Redwood Mortgage Corp. 3,498 4,337 10,284 13,753
Asset management fees 8,642 8,520 25,824 25,507
Provisions for (recovery of) losses on loans and
real estate held for sale 5,372 16,185 (32,493) 42,438
Professional services 13,222 7,293 38,746 37,066
Printing, supplies and postage 1,412 1,378 5,843 5,664
Other 1,141 6,362 5,384 25,334
----------- ----------- ----------- -----------
56,016 65,976 108,280 212,493
----------- ----------- ----------- -----------
Net income $148,575 $149,333 $423,019 $427,874
=========== =========== =========== ===========
Net income: to general partners (1%) 1,486 1,493 4,230 4,279
to limited partners (99%) 147,089 147,840 418,789 423,595
----------- ----------- ----------- -----------
$148,575 $149,333 $423,019 $427,874
=========== =========== =========== ===========
Net income per $1,000 invested by limited
partners for entire period
-where income is compounded and retained $ 16.05 $ 16.35 $ 46.55 $ 47.68
=========== =========== =========== ===========
-where partner receives income in monthly
distributions $ 15.97 $ 16.26 $ 45.62 $ 46.70
=========== =========== =========== ===========
The accompanying notes are an integral part of these financial statements.
3
REDWOOD MORTGAGE INVESTORS VII
(A California Limited Partnership)
STATEMENTS OF CASH FLOWS
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2005 and 2004 (unaudited)
2005 2004
-------------- -------------
Cash flows from operating activities
Net income $ 423,019 $ 427,874
Adjustments to reconcile net income to net cash provided
by operating activities
Provisions for (recovery of) losses on loans and real estate (32,493) 42,438
Early withdrawal penalty credited to income (1,844) (1,777)
Amortization of discount on unsecured loans (16,115) (16,115)
Change in operating assets and liabilities
Accrued interest and advances on loans (20,278) (183,164)
Accounts payable and other liabilities 2,347 20,215
Prepaid expenses - (1,741)
-------------- -------------
Net cash provided by operating activities 354,636 287,730
-------------- -------------
Cash flows from investing activities
Principal collected on loans 4,462,402 3,020,006
Loans originated (4,168,416) (3,360,068)
Recoveries of (payments for) real estate held for sale (9,994) 17,010
Investment in limited liability company (44,915) -
Proceeds from unsecured loans 9,299 11,804
-------------- -------------
Net cash provided by (used in) investing activities 248,376 (311,248)
-------------- -------------
Cash flows from financing activities
Net increase in line of credit - 500,000
Partners' withdrawals (290,705) (346,415)
-------------- -------------
Net cash provided by (used in) financing activities (290,705) 153,585
-------------- -------------
Net increase in cash and cash equivalents 312,307 130,067
Cash and cash equivalents - beginning of period 346,393 321,114
-------------- -------------
Cash and cash equivalents - end of period 658,700 451,181
============== =============
Cash payments for interest $ - $ 2,512
============== =============
The accompanying notes are an integral part of these financial statements.
4
REDWOOD MORTGAGE INVESTORS VII
(A California Limited Partnership)
NOTES TO FINANCIAL STATEMENTS
SEPTEMBER 30, 2005 (unaudited)
NOTE 1 - GENERAL
In the opinion of the management of the Partnership, the accompanying
unaudited financial statements contain all adjustments, consisting of normal,
recurring adjustments, necessary to present fairly the financial information
included therein. These financial statements should be read in conjunction with
the audited financial statements included in the Partnership's Form 10-K for the
fiscal year ended December 31, 2004 filed with the Securities and Exchange
Commission. The results of operations for the nine month period ended September
30, 2005 are not necessarily indicative of the operating results to be expected
for the full year.
NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Loans, secured by deeds of trust
At September 30, 2005 and December 31, 2004 there were no loans and one
loan categorized as impaired by the Partnership totaling $0 and $96,716,
respectively. In 2004 it was determined that a reduction in carrying value was
no longer required on this loan. The real estate securing this loan appreciated
in value over a period of time and the borrower began to pay down the advances
and accrued interest. The increase in value had been determined to be other than
temporary. As of September 30, 2005, all the advances were paid in full together
with a portion of the accrued interest. This loan was evaluated and it was
established that the loan was no longer impaired and as of September 30, 2005 it
was recategorized and all interest and late charges owed by the borrower were
accrued and recognized as income. Thereafter, interest and late charges will be
accrued.
As of September 30, 2005 the Partnership had a combined total of three
loans with outstanding principal balances of $161,486 that were either past due
90 days or more in interest payments and/or past maturity. These three loans
included two loans totaling $64,770 that were past maturity and one loan
totaling $96,716 that was past due 90 days or more in interest payments. This
compares to a combined total of five loans totaling $1,049,730 that were either
past due 90 days or more in interest payments and/or past maturity as of
December 31, 2004. These five loans included two loans totaling $64,850 that
were past maturity and three loans totaling $984,880 that were past due 90 days
or more in interest payments. A past maturity loan is a loan in which the
principal and/or any accrued interest is due and payable, but the borrower has
failed to make such payment of principal and/or accrued interest. In the opinion
of management, the delinquent and/or past maturity loans as of September 30,
2005 have sufficient collateral to cover the amount outstanding to the
Partnership and are still accruing interest on these loans.
Allowance for loan losses
The composition of the allowance for loan losses as of September 30, 2005
and December 31, 2004 was as follows:
September 30, December 31,
2005 2004
---------------- ----------------
Specified loans $ 290,464 $ 290,464
General 226,952 231,443
Unsecured loans 228,940 223,569
---------------- ----------------
$ 746,356 $ 745,476
================ ================
5
REDWOOD MORTGAGE INVESTORS VII
(A California Limited Partnership)
NOTES TO FINANCIAL STATEMENTS
SEPTEMBER 30, 2005 (unaudited)
NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)
Allowance for loan losses (continued)
Activity in the allowance for loan losses for the nine month period ended
September 30, 2005 and the year ended December 31, 2004 was as follows:
September 30, December 31,
2005 2004
--------------- ---------------
Beginning balance $ 745,476 $ 680,469
Provision for (recoveries of)
loan losses (32,493) 65,007
Transfers 33,373 -
--------------- ---------------
$ 746,356 $ 745,476
=============== ===============
Investment in limited liability company
Investment in limited liability company ("LLC") is accounted for using the
equity method as one of the Partnership's general partners is the managing
member of the LLC. In February, 2005 the Partnership acquired an 8% interest in
Larkin Property Company, LLC (see note 5).
Income taxes
No provision for federal and state income taxes (other than an $800 state
minimum tax) is made in the financial statements since income taxes are the
obligation of the partners if and when income taxes apply.
Reclassifications
Certain reclassifications, not affecting previously reported net income or
total partners' capital, have been made to the previously issued financial
statements to conform to the current year classification.
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 dates 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.
6
REDWOOD MORTGAGE INVESTORS VII
(A California Limited Partnership)
NOTES TO FINANCIAL STATEMENTS
SEPTEMBER 30, 2005 (unaudited)
NOTE 3 - GENERAL PARTNERS AND RELATED PARTIES
The following are commissions and fees, which will be 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., an affiliate of the general
partners, 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. 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 of up to 1/32 of 1% of the "net asset value" (3/8
of 1% annually).
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 parties related to the general partners.
Operating expenses
Redwood Mortgage Corp., an affiliate of the general partners, is reimbursed
by the Partnership for all operating expenses actually incurred by it 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.
Redwood Mortgage Corp. waived reimbursement of approximately $755 in operating
expenses during the second quarter of 2005.
NOTE 4 - REAL ESTATE HELD FOR SALE
In 1993 the Partnership, together with two other affiliates, acquired
through foreclosure a parcel of land located in East Palo Alto, CA, which is on
the market for sale. The general partners believe that this property is worth
considerably more than its carrying value, but it may take a considerable amount
of additional time to sell the property and realize its full potential. The
property is unique in that it may only be utilized for commercial or industrial
uses. Until recently, land sales activity has been slow. Interest in land sales
for commercial sites has been improving. As of September 30, 2005 the
Partnership's investment in this property was $62,720.
7
REDWOOD MORTGAGE INVESTORS VII
(A California Limited Partnership)
NOTES TO FINANCIAL STATEMENTS
SEPTEMBER 30, 2005 (unaudited)
NOTE 4 - REAL ESTATE HELD FOR SALE (continued)
In December 2004, the Partnership acquired undeveloped parcels of land
through a deed in lieu of foreclosure. The land is located in Stanislaus County,
California. It is comprised of three separate lots, which total approximately 14
acres. The parcels are currently for sale. As of September 30, 2005 the
Partnership's investment in this property totaled $1,762,828, including accrued
interest and advances, as of the date of the acquisition. Management believes
that the full value of this investment will be recovered from the eventual sale
of the property based upon its current estimate of the fair value of the
property. This property is jointly owned by two other affiliated partnerships.
As such, during the quarter ended September 30, 2005, the Partnership
transferred the entire reserve against real estate of $33,373 to the allowance
for loan losses.
In February, 2005 the Partnership acquired another property through
foreclosure (see Note 5).
The following schedule reflects the costs of real estate acquired through
foreclosure and the recorded reductions to estimated fair values, including
estimated costs to sell as of September 30, 2005 and December 31, 2004:
September 30, December 31,
2005 2004
---------------- ---------------
Costs of properties $ 1,825,548 $ 1,815,555
Reduction in value - (33,373)
---------------- ---------------
Real estate held for sale, net $ 1,825,548 $ 1,782,182
================ ===============
NOTE 5 - INVESTMENT IN LIMITED LIABILITY COMPANY
In February, 2005, the Partnership acquired a multi-unit property through
foreclosure. This property is located in an upscale neighborhood in San
Francisco. At the time the Partnership took ownership of the property, the
Partnership's investment totaled $836,702 including accrued interest and
advances. This property is jointly owned by three other affiliated Partnerships.
Upon acquisition the Partnership transferred its interest (principally land and
building) to a limited liability company ("LLC"), Larkin Property Company, LLC
("Larkin"), which is 8% owned by the Partnership, and 92% owned by three other
affiliates. No allowance for loss has been set aside as management believes that
the fair value of the property exceeds the combined Partnerships' investment in
the property. The Partnership intends to undertake additional improvements to
the property. As of September 30, 2005 the Partnership has capitalized
approximately $44,915 in costs related to this property.
NOTE 6 - BANK LINE OF CREDIT
The Partnership has a bank line of credit secured by its loan portfolio of
up to $2,500,000 at .25% over prime. There were no balances outstanding as of
September 30, 2005 and December 31, 2004 and the interest rate was 7.00% (6.75%
prime plus .25%) at September 30, 2005. This line of credit expires December
2007 and requires the Partnership to meet certain financial covenants. To the
best of its knowledge, the Partnership was in compliance with all loan covenants
for the nine month period ended September 30, 2005 and for the year ended
December 31, 2004. The Partnership anticipates that the line of credit will be
renewed at its maturity. In the event that a renewal is not forthcoming, the
Partnership has the option to convert the line of credit to a three year term
loan beginning December 2007.
8
REDWOOD MORTGAGE INVESTORS VII
(A California Limited Partnership)
NOTES TO FINANCIAL STATEMENTS
SEPTEMBER 30, 2005 (unaudited)
NOTE 7 - NON-CASH TRANSACTIONS
During the nine month period ended September 30, 2005 the Partnership
foreclosed on a property (see Note 5), which resulted in an increase in
investment in limited liability company of $836,702, a decrease in loans
receivable of $776,228, a decrease in accrued interest of $51,598, a decrease in
advances of $5,876, and a decrease in late charge receivable of $3,000.
NOTE 8 - FAIR VALUE OF FINANCIAL INSTRUMENTS
The following methods and assumptions were used to estimate the fair value
of financial instruments:
Secured loans had a carrying value of $6,318,264 and $7,388,478 at
September 30, 2005 and December 31, 2004, respectively. The fair value of these
loans of $6,429,255 and $7,531,668, 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.
NOTE 9 - ASSET CONCENTRATIONS AND CHARACTERISTICS
Most loans are secured by recorded deeds of trust. At September 30, 2005
and December 31, 2004 there were 26 and 28 secured loans outstanding,
respectively, with the following characteristics:
September 30, December 31,
2005 2004
---------------- ----------------
Number of secured loans outstanding 26 28
Total secured loans outstanding $ 6,318,264 $ 7,388,478
Average secured loan outstanding $ 243,010 $
263,874
Average secured loan as percent of total secured loans 3.85% 3.57%
Average secured loan as percent of partners' capital 2.63% 2.89%
Largest secured loan outstanding $ 686,400 $ 800,000
Largest secured loan as percent of total secured loans 10.86% 10.83%
Largest secured loan as percent of partners' capital 7.42% 8.76%
Largest secured loan as percent of total assets 7.35% 8.69%
Number of counties where security is located (all California) 13 13
Largest percentage of loans in one county 24.19% 24.64%
Average secured loan to appraised value of security based on
appraised values and prior liens at time loan was consummated 71.29% 71.30%
Number of secured loans in foreclosure status None 1
Amount of secured loans in foreclosure status None $ 776,228
Over time, loans may exceed 10% of the secured loan portfolio or
Partnership assets as the loan portfolio and assets of the Partnership decrease
due to limited partner withdrawals and/or loan payoffs.
9
REDWOOD MORTGAGE INVESTORS VII
(A California Limited Partnership)
NOTES TO FINANCIAL STATEMENTS
SEPTEMBER 30, 2005 (unaudited)
NOTE 9 - ASSET CONCENTRATIONS AND CHARACTERISTICS (continued)
The following categories of secured loans were held at September 30, 2005
and December 31, 2004:
September 30, December 31,
2005 2004
---------------- ----------------
First trust deeds $ 4,756,452 $ 5,937,736
Second trust deeds 1,337,246 1,450,742
Third trust deeds 224,566 -
---------------- ----------------
Total loans 6,318,264 7,388,478
Prior liens due other lenders at time of loan 5,148,635 1,944,172
---------------- ----------------
Total debt $ 11,466,899 $ 9,332,650
================ ================
Appraised property value at time of loan $ 16,085,038 $ 13,089,113
---------------- ----------------
Total secured loans as percent of appraisals based on appraised
values and prior liens at time loan was consummated 71.29% 71.30%
---------------- ----------------
Secured loans by type of property
Owner occupied homes $ 2,866,033 $ 2,532,045
Non-owner occupied homes 250,000 1,961,474
Apartments 666,716 971,864
Commercial 2,100,349 1,923,095
Land 435,166 -
---------------- ----------------
$ 6,318,264 $ 7,388,478
================ ================
Scheduled maturity dates of secured loans as of September 30, 2005 are as
follows:
Year Ending December 31,
------------------------------
2005 $ 64,770
2006 916,716
2007 1,681,919
2008 -
2009 1,806,127
Thereafter 1,848,732
----------------
Total $ 6,318,264
================
The scheduled maturities for 2005 above include approximately $64,770 in
two loans, which were past maturity at September 30, 2005. Interest payments on
both of these loans were current as of September 30, 2005.
10
REDWOOD MORTGAGE INVESTORS VII
(A California Limited Partnership)
NOTES TO FINANCIAL STATEMENTS
SEPTEMBER 30, 2005 (unaudited)
NOTE 9 - ASSET CONCENTRATIONS AND CHARACTERISTICS (continued)
At times, the Partnership's cash deposits exceed federally insured limits.
Management believes deposits are maintained in financially secure financial
institutions.
The Partnership has a substantial amount of its loan receivable balance due
on two loans from one borrower. This borrower accounted for approximately 19.73%
of the loan balance and approximately 16.26% of interest revenue for the nine
month period ended September 30, 2005. The value of collateral securing these
loans was less than the principal balance due under the loans. Redwood Mortgage
Corp. has provided an indemnity to the Partnership whereby it has agreed to
indemnify and hold harmless, the Partnership from any expenses or losses
incurred by the Partnership by reason of the Partnership's inability to collect
all principal due under the loans after the Partnership has exhausted all
reserves set aside for these loans and all remedies available to it including
foreclosure of the underlying collateral. Real estate values in the San
Francisco Bay Area have appreciated considerably over the years and a recent
appraisal of these two properties by an independent party revealed a
loan-to-value ratio of 68%. This revised valuation, backed by the indemnity,
enhances the Partnership's portfolio. Therefore, these loans are not considered
impaired. Neither of these loans is past due 90 days or more on interest
payments nor are they past maturity.
NOTE 10 - COMMITMENTS AND CONTINGENCIES
Workout agreements
The Partnership has negotiated a contractual workout agreement with one
borrower who is delinquent in making payments. Under the terms of the workout
agreement the Partnership is not obligated to make any additional monetary
advances for the maintenance or repair of the collateral securing the loan as of
September 30, 2005. As of September 30, 2005 the Partnership had one loan under
workout agreement totaling $96,716.
Construction loans
The Partnership makes construction and rehabilitation loans which are not
fully disbursed at loan inception. The Partnership approves the borrowers up to
a maximum loan balance; however, disbursements are made periodically during
completion phases of the construction or rehabilitation or at such other times
as required under the loan documents. At September 30, 2005, there was $52,334
in undisbursed loan funds pertaining to one loan. The Partnership does not
maintain a separate cash reserve to hold the undisbursed obligations, which are
intended to be funded.
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.
11
Part I - Item 2.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION OF THE PARTNERSHIP
Critical Accounting Policies.
In preparing the 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 dates and income and expenses
during 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, 2005, the partnership owned five
pieces of real property.
Loans and the related accrued interest, late fees and advances are analyzed
on a regular basis for recoverability. Delinquencies are identified and followed
as part of the loan system. A provision is made for loan losses to adjust the
allowance for loan losses to an amount considered by management to be adequate,
with due consideration to collateral value, to provide for unrecoverable loans
and receivables, including impaired loans, other loans, accrued interest, late
fees and advances on loans and other accounts receivable (unsecured). The
Partnership charges off uncollectible loans and related receivables directly to
the allowance account once it is determined that the full amount is not
collectible.
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 further
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.
Recent trends in the economy have been taken into consideration in the
aforementioned process of arriving at the allowance for loan losses. Actual
results could vary from the aforementioned provisions for losses.
Real estate held for sale includes real estate acquired through foreclosure
and is stated at the lower of the recorded investment in the loan, plus any
senior indebtedness, or at the property's estimated fair value, less estimated
costs to sell.
The Partnership periodically compares the carrying value of real estate to
expected undiscounted future cash flows for the purpose of assessing the
recoverability of the recorded amounts. If the carrying value exceeds future
undiscounted cash flows, the assets are reduced to estimated fair value.
Forward Looking Statements.
Certain statements in this Report on Form 10-Q which are not historical
facts may be considered forward-looking statements within the meaning of Section
27A of the Securities Act of 1933, as amended, and Section 21E of the Securities
and Exchange Act of 1934, as amended, including statements regarding the
Partnership's expectations, hopes, intentions, beliefs and strategies regarding
the future. Forward-looking statements include statements regarding future loan
payoffs, future interest rates and economic conditions and their effect on the
Partnership and its assets, future sales of properties held by the Partnership
and the proceeds from such sales, trends in the California real estate market,
estimates as to the allowance for loan losses, estimates of future limited
partner withdrawals and 2005 annualized yield estimates. Actual results may be
materially different from what is projected by such forward-looking statements.
Factors that might cause such a difference include unexpected changes in
economic conditions and interest rates, the impact of competition and
competitive pricing and downturns in the real estate markets in which the
Partnership has made loans. All forward-looking statements and reasons why
results may differ included in this Form 10-Q are made as of the date hereof,
and we assume no obligation to update any such forward-looking statement or
reason why actual results may differ.
12
Related Parties.
The general partners of the Partnership are Gymno Corporation and Michael
R. Burwell. Most Partnership business is conducted through Redwood Mortgage
Corp., an affiliate of the general partner, which arranges, services, and
maintains the loan portfolio for the benefit of the Partnership. Michael R.
Burwell is President and Chief Financial Officer of Gymno Corporation and
Redwood Mortgage Corp. The fees received by the affiliate to the general
partners are paid pursuant to the Partnership Agreement and are determined at
the sole discretion of the affiliate to the general partner. In the past, the
affiliate to the general partners has elected not to take the maximum
compensation. 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 $103,848 and $59,128 for the
nine month periods ended September 30, 2005 and 2004, and $50,198 and $9,600 for
the three month periods ended September 30, 2005 and 2004, 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 $54,692 and $60,219 were incurred for the
nine month periods ended September 30, 2005 and 2004, and $22,729 and $20,457
were incurred for the three month periods ended September 30, 2005 and 2004,
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 $25,824 and $25,507 were incurred by the Partnership for the nine
month periods ended September 30, 2005 and 2004, and $8,642 and $8,520 were
incurred for the three month periods ended September 30, 2005 and 2004,
respectively.
o Other Fees The Partnership Agreement provides that the general partners
may receive other fees such as processing and escrow, reconveyance, mortgage
assumption and mortgage extension fees. Such fees are incurred by the borrowers
and are paid to the general partners. Such fees aggregated $7,629 and $6,606 for
the nine month periods ended September 30, 2005 and 2004, and $3,474 and $906
for the three month periods ended September 30, 2005 and 2004, respectively.
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%, which was $4,230 and
$4,279 for the nine month periods ended September 30, 2005 and 2004, and $1,486
and $1,493 for the three month periods ended September 30, 2005 and 2004,
respectively.
o Operating Expenses An affiliate of the Partnership, Redwood Mortgage
Corp., is reimbursed by the Partnership for all operating expenses actually
incurred by it 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. Such reimbursements are reflected as expenses in the
statements of income. Operating expenses totaling $10,284 and $13,753 for the
nine month periods ended September 30, 2005 and 2004, and $3,498 and $4,337 for
the three month periods ended September 30, 2005 and 2004, respectively, were
reimbursed to Redwood Mortgage Corp. In June, 2005, Redwood Mortgage Corp waived
approximately $755 of this cost.
o Contributed Capital The general partners jointly and severally
contributed 1/10 of 1% in cash contributions as proceeds from the offerings were
received from the limited partners. As of September 30, 2005 and 2004, a general
partner, Gymno Corporation, had contributed $11,973 as capital in accordance
with Section 4.02(a) of the Partnership Agreement.
13
Results of Operations - For the nine and three months ended September 30,
2005 and 2004
Changes in the Partnership's operating results for the nine and three month
periods ended September 30, 2005 versus 2004 are discussed below:
Changes during the Changes during the
nine months ended three months ended
September 30, 2005 September 30, 2005
versus 2004 versus 2004
---------------------- ----------------------
Net income increase/(decrease) $ (4,855) $ (758)
=============== ==============
Revenue
Interest on loans $ (76,581) $ (1,164)
Interest - interest bearing accounts (430) 141
Late fees (8,429) (1,589)
Other (23,628) (8,106)
--------------- ---------------
$ (109,068) $ (10,718)
--------------- ---------------
Expenses
Mortgage servicing fees $ (5,527) $ 2,272
Interest expense (2,512) (1,444)
Clerical costs through Redwood Mortgage Corp. (3,469) (839)
Asset management fees 317 122
Provisions for (recovery of) losses on loans and
real estate held for sale (74,931) (10,813)
Professional services 1,680 5,929
Printing, supplies and postage 179 34
Other (19,950) (5,221)
--------------- ---------------
$ (104,213) $ (9,960)
--------------- ---------------
Net income increase/(decrease) $ (4,855) $ (758)
=============== ===============
The decrease in interest on loans of $76,581 (12.89%) for the nine month
period and $1,164 (0.59%) for the three month period ended September 30, 2005 as
compared to the same periods in 2004 was primarily due to a decrease in the loan
portfolio outstanding to $6,318,264 as of September 30, 2005 from $8,620,888 as
of September 30, 2004. Average loan portfolio balance for the nine month period
ended September 30, 2005 and 2004 was $6,512,678 and $7,993,287, respectively.
The decrease in interest is also attributed to a decrease in the average
interest rate, which stood at 9.24% as of September 30, 2005 as compared to
9.66% as of September 30, 2004. The decrease in interest on loans of $1,164
during the third quarter of 2005 as compared to the same period in 2004 was
mitigated, as to the continuing nine month downward trend, by accrual of
interest totaling $42,472 on a loan that was previously considered to be
impaired. There is a strong likelihood that during the fourth quarter of 2005
two loans with principal balances totaling approximately $1,450,000 will be paid
off. Should this occur, interest income may be significantly reduced until the
funds can be placed into new mortgage loans.
The decrease in other income of $23,628 (91.09%) for the nine month period
and $8,106 (92.67%) for the three month period ended September 30, 2005 as
compared to the same periods in 2004 was primarily due to the Partnership no
longer receiving non-refundable option payments on a property sold in October,
2004. During the first nine months of 2004 these option payments totaled
$23,143. The property against which the payments were being made was sold in
October, 2004.
The decrease in late charges of $8,429 (47.61%) for the nine month period
and $1,589 (22.33%) for the three month period ended September 30, 2005 as
compared to the same periods in 2004 was primarily due to a reduction in
delinquent loans.
14
The decrease in mortgage servicing fees of $5,527 (9.18%) for the nine
month period ended September 30, as compared to the same period in 2004, was
primarily due to a decrease in the loan portfolio balance to $6,318,264 as of
September 30, 2005 from a portfolio balance of $8,620,888 as of September 30,
2004. The average loan portfolio balance for the nine month periods ended
September 30, 2005 and 2004 was $6,512,678 and $7,993,287, respectively. The
increase in mortgage servicing fees of $2,272 (11.11%) for the three month
period ended September 30, 2005 as compared to the same period in 2004 was due
to the accrual of servicing fees of $8,014 on a loan that was previously
considered to be impaired. Mortgage servicing fees on impaired loans are due as
borrower payments are received. The servicing fees on the previously impaired
loan also reduced the decrease in servicing fees for the nine month period ended
September 30, 2005.
The decrease in provisions for losses on loans and real estate held for
sale of $74,931 (176.57%) for the nine month period and $10,813 (66.81%) for the
three month period ended September 30, 2005 as compared to the same periods in
2004 is due to management's determination that the allowance for loan losses of
$746,356 as of September 30, 2005 was adequate to offset potential losses on
loans. There were no filed notices of default as of September 30, 2005 and none
are expected in the foreseeable future.
The increase in professional fees of $1,680 (4.53%) for the nine month
period and $5,929 (81.30%) for the three month period ended September 30, 2005
as compared to the same periods in 2004 is due to an increase in fees and timing
of billings in 2005 compared to 2004.
The decrease in interest expense of $2,512 (100%) for the nine month period
and $1,444 (100%) for the three month period ended September 30, 2005 as
compared to the same periods in 2004, is due to non-usage of the line of credit
facility during the first nine months of 2005 compared to an average usage of
$236,667 during the corresponding period of 2004.
The decrease in other expenses of $19,950 (78.75%) for the nine month
period and $5,221 (82.07%) for the three month period ended September 30, 2005
as compared to the same periods in 2004 was primarily due to a reduction in
upkeep costs for the real estate held for sale properties. The Partnership spent
$2,745 and $21,772 during the nine month periods ended September 30, 2005 and
2004, and $1,116 and $6,286 during the three month periods ended September 30,
2005 and 2004.
The decrease in clerical costs of $3,469 (25.22%) for the nine month period
and $839 (19.35%) for the three month period ended September 30, 2005 as
compared to the same periods in 2004 is primarily due to lower servicing costs.
The decrease of $3,469 for the nine months ended September 30, 2005 would have
been only $2,714 had Redwood Mortgage Corp. not waived $755 in such costs in
June 2005.
Partnership capital increased by $130,470 during the first nine months of
2005 as the aggregate of earnings distributions and capital liquidations was
less than the net income level of the Partnership. For the nine month period
ended September 30, 2005 limited partners' net income was $418,789 as compared
to earnings distributions of $135,245 and capital liquidations of $153,218,
which totaled $288,463, as compared to limited partners' net income of $423,595
as compared to earnings distributions of $145,076 and capital liquidations of
$198,838, which totaled $343,914 for the corresponding period in 2004. During
the third quarter of 2005 limited partners' net income was $147,089 as compared
to earnings distributions of $44,961 and capital liquidations of $36,198, which
totaled $81,159, as compared to limited partners' net income of $147,840 as
compared to earnings distributions of $49,828 and capital liquidations of
$51,018, which totaled $100,846 for the corresponding period in 2004. Earnings
and capital liquidations are a factor of limited partner elections and currently
limited partners seeking liquidations of earnings or their capital account
continues to decline. Limited partner income, which has continued to be higher
than earnings distributions and capital liquidations for the past several
quarters, has grown the limited partners' capital.
At September 30, 2005 there were no outstanding loans with filed notices of
default.
15
Redwood Mortgage Corp., an affiliate of the general partners, received
mortgage brokerage commissions from loan borrowers of $103,848 and $50,198 for
the nine and three month periods ended September 30, 2005 as compared to $59,128
and $9,600 for the same periods in 2004. The increase of $44,720 for the nine
month period and $40,598 for the three month period ended September 30, 2005 as
compared to the same periods in 2004 is due to more loans that were funded
totaling $4,168,416 and $3,360,068, respectively.
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
2002 and 2003, the California economy stabilized. During 2004 and continuing in
2005 the economy and the Northern California Real Estate Market has
strengthened. At September 30, 2005 the Partnership had one loan past due 90
days or more in interest payments totaling $96,716 with no loans in foreclosure.
In addition, two loans with total principal balance of $64,770 were current in
interest payments but were past maturity as of September 30, 2005, for a
combined total of three loans past due 90 days or more in interest payments
and/or past maturity totaling $161,486.
Periodically, the Partnership enters into workout agreements with borrowers
who are past maturity or delinquent in their regular payments. The Partnership
has one loan totaling $96,716 in a workout agreement with the borrower.
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 balloon
payments and allows time to pay the loan in full. 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 generally rise during difficult
economic times and conversely fall during good economic times. The number and
amount of workout agreements existing at September 30, 2005, in management's
opinion, does not have a material effect on our results of operations or
liquidity. Workout agreements are considered when management arrives at an
appropriate allowance for loan losses, and based on our experience; they are
reflective of our loan marketplace segment. In the remainder of 2005, we may
initiate foreclosure by filing notices of default on delinquent borrowers or
borrowers who become delinquent during the year. 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 held for sale through foreclosure of $746,356 at September 30,
2005. These provisions for losses were made to guard against collection losses.
The total provision for losses as of September 30, 2005 is considered by the
general partners to be adequate. 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. Total provision for
losses on loans and real estate held for sale of $746,356 as of September 30,
2005 is considered to be reasonable.
As of September 30, 2005, the Partnership had an average loan to value
ratio computed based on appraised values and prior liens as of the date the loan
was made of 71.29%. 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.
16
PORTFOLIO REVIEW - For the nine months ended September 30, 2005 and 2004
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, 2005
and 2004 the Partnership's loans secured by real property collateral in five San
Francisco Bay Area counties (San Francisco, San Mateo, Santa Clara, Alameda, and
Contra Costa) represented $4,718,050 (74.67%) and $5,417,331 (62.84%) of the
outstanding secured loan portfolio. The remainder of the portfolio represented
loans secured by real estate located primarily in Northern California.
As of September 30, 2005 and 2004, the Partnership held 26 and 29 loans
respectively in the following categories:
September 30, 2005 September 30, 2004
------------------------------- ------------------------------
Single Family Homes (1-4 units) $ 3,116,033 49% $ 3,716,448 43%
Commercial 2,100,349 33% 2,598,804 30%
Apartments (5+ units) 666,716 11% 1,012,221 12%
Land 435,166 7% 1,293,415 15%
-------------- ------------- -------------- -------------
Total $ 6,318,264 100% $ 8,620,888 100%
============== ============= ============== =============
As of September 30, 2005, the Partnership held 26 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, 2005:
PRIORITIES, ASSET CONCENTRATIONS AND MATURITIES OF LOANS
As of September 30, 2005
# of Loans Amount Percent
------------- --------------- -------------
1st Mortgages 16 $ 4,756,452 75%
2nd Mortgages 8 1,337,246 21%
3rd Mortgages 2 224,566 4%
============= =============== =============
Total 26 $ 6,318,264 100%
Maturing 12/31/05 and prior 2 $ 64,770 1%
Maturing prior to 12/31/06 3 916,716 14%
Maturing prior to 12/31/07 3 1,681,919 27%
Maturing after 12/31/07 18 3,654,859 58%
============= =============== =============
Total 26 $ 6,318,264 100%
Average Secured Loan $ 243,010 4%
Largest Secured Loan 686,400 11%
Smallest Secured Loan 11,541 0.18%
Average Loan-to-Value based upon appraisals and prior
liens at time loan was consummated 71.29%
The Partnership's largest loan in the principal amount of $686,400
represents 10.86% of outstanding secured loans and 7.35% of Partnership assets.
Over time, loans may increase above 10% of the secured loan portfolio or
Partnership assets as the loan portfolio and assets of the Partnership decrease
due to limited partner withdrawals and/or loan payoffs.
17
Liquidity and Capital Resources.
The Partnership relies upon loan payoffs and borrowers' mortgage payments
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.
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 experience 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. Cash is constantly being
generated from borrower interest payments, late charges, amortization of loan
principal and loan payoffs. Currently, cash flow exceeds Partnership expenses,
earnings and limited partner capital payout requirements. Excess cash flow will
be invested in new loan opportunities, when available, and in other Partnership
business. During the fourth quarter of 2005 it is anticipated that two loans
with outstanding principal balances of approximately $1,450,000 will be paid
off. Alone, payoff of these two loans represents 23% of the Partnership's loan
portfolio at September 30, 2005. The Partnership will endeavor to place cash
proceeds into suitable mortgage loan investments. However, it is unlikely that
the cash will immediately be placed in new loans. As a result, interest income
may decline until suitable replacement loans are funded.
At the time of subscription to the Partnership, limited partners made a
decision to either take distributions of earnings monthly, quarterly or annually
or to compound earnings in their capital account. For the nine and three month
periods ended September 30, 2005 and 2004, the Partnership made distributions of
earnings to limited partners of $135,245 and $145,076 for the nine months, and
$44,961 and $49,828 for the three months, respectively. Distribution of earnings
to limited partners, which were not withdrawn for the nine and three month
periods ended September 30, 2005 and 2004 were $283,544 and $278,519 for the
nine months, and $102,128 and $98,012 for the three months, respectively. As of
September 30, 2005 and 2004, limited partners electing to withdraw earnings
represented 35% and 34% of the limited partners' capital.
The Partnership also allows the limited partners to withdraw their capital
account subject to certain limitations. For the nine and three month periods
ended September 30, 2005 and 2004, $23,045 and $22,213 for the nine months, and
$5,489 and $8,950 for the three months, respectively, were liquidated subject to
the 10% penalty for early withdrawal. These withdrawals are within the normally
anticipated range that the general partners would expect in their experience in
this and other Partnerships. The general partners expect that a small percentage
of limited partners will elect to liquidate their capital accounts over one year
with a 10% early withdrawal penalty. In originally conceiving the Partnership,
the general partners wanted to provide limited partners needing their capital
returned a degree of liquidity. Generally, limited partners electing to withdraw
over one year need to liquidate their investment to raise cash. The trend the
Partnership is experiencing in withdrawals by limited partners electing a one
year liquidation program is that such withdrawals represent a small percentage
of limited partner capital as of September 30, 2005 and 2004.
Additionally, for the nine and three month periods ended September 30, 2005
and 2004, $130,173 and $176,625 for the nine months, and $30,708 and $42,068 for
the three months, respectively, were liquidated by limited partners who have
elected a liquidation program over a period of five years or longer. This
ability to withdraw after five years by limited partners has the effect of
providing limited partner liquidity. The general partners expect a portion of
the limited partners to take advantage of this provision. This has the
anticipated effect of the Partnership growing, primarily through reinvestment of
earnings in years one through five. The general partners expect to see
increasing numbers of limited partner withdrawals in years five through eleven,
after which time the bulk of those limited partners who have sought withdrawal
have been liquidated. After year eleven, liquidation generally subsides.
18
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.
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's 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.
Current Economic Conditions.
From July 1, 2004 through September 30, 2005, the Federal Reserve increased
the Federal Funds Rate to 3.75% from 1%. The recent upward movement in the
Federal Funds Rate during 2004 and 2005 has raised short-term rates; and while
long-term interest rates have risen, they have not increased at a pace
comparable to the rise in short-term rates. In the future the general partners
anticipate that interest rates will likely 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 during 2005 at rates slightly above those that prevailed in 2004. The
recent increases in short term interest rates, and to a lesser extent long term
interest rates, have encouraged those borrowers with interest rates above the
current going rates to refinance their indebtedness to lock in these
historically low interest rates should they increase in the future. Demand for
loans from qualified borrowers continues to be strong and as loan repayments
occur, the general partners expect to replace the paid off loans with loans at
interest rates attainable in the then existing interest rate environment. At
this time, the general partners believe that the average loan portfolio interest
rate will remain relatively stable over the remainder of 2005. Based upon the
rates payable in connection with the existing loans, anticipated interest rates
to be charged by the Partnership, and the general partners' experience, the
general partners anticipate that the Partnership's annualized yield will range
between 5.75% and 6.50% in 2005.
During the third quarter of 2005, the United States economy as a whole
performed well. Early estimates of a 3.8% third quarter Real Gross Domestic
Product shows a continuation of the previous nine consecutive quarters of
expansion in excess of 3% (BEA 11/05). The United States unemployment rate for
October, 2005 was 5% and has hovered close to that level throughout the second
and third quarters of 2005. Regionally, the San Francisco Bay Area demonstrated
a very similar unemployment rate with an unemployment rate of 4.9% for the month
ended August, 2005. The San Francisco Bay area unemployment rate has been
declining from 5.3% in January, 2005 to the current 4.9% (United States
Department of Labor 11/05). The rate of inflation concerns many with energy
costs having risen significantly over the last year. The consumer price index
spiked upward 1.2% in September, 2005 and was 4.7% higher than in September,
2004 (United States Department of Labor 11/05). It remains to be seen whether
increased energy costs will ripple through the economy and drive inflation
upward, which could push interest rates higher. These statistics indicate an
economy that is continuing to grow, which is good for both mortgage lenders and
the real estate industry as a whole.
The Partnership makes loans primarily in Northern California. As such the
regional real estate market is of primary concern to the Partnership. As of
September 30, 2005 and 2004, approximately 74.67% ($4,718,050) and 62.84%
($5,417,331) of the loans held by the Partnership were in five San Francisco Bay
Area Counties, respectively. The remainder of the loans held was secured
primarily by Northern California real estate outside of the San Francisco Bay
Area.
19
California residential real estate continued to appreciate in value during
the third quarter of 2005. In the San Francisco Bay Area, as of September 2005
single family home median sales prices increased by 19.4%, 22.1%, 15.7% 10.3%,
21.0% and 18.5% to $616,000, $580,000, $899,000, $757,500, $816,500, and
$705,000 for the Alameda, Contra Costa, Marin, San Francisco, San Mateo and
Santa Clara counties from September 2004, respectively (DataQuick Information
Systems). The total sales volumes and the number of homes sold have been
declining. Sales volumes for the nine months ended September 2005 as compared to
September 2004 were typically 5% lower. Mortgage interest rates for both fixed
and adjustable rate loans have been rising, decreasing housing affordability.
During the week of October 14, 2005, 30 year fixed rate mortgages increased
above a 6% interest rate for the first time since March 2005 (Freddie Mac).
Rising interest rates will likely slow down the rate of housing appreciation we
have seen over the last two years. A strong residential real estate marketplace
increases lending opportunities and assists in providing adequate equity to help
repay mortgage debt should borrowers become delinquent in their payments.
Commercial real estate in the San Francisco Bay Area continued its rebound.
Occupancy is increasing and rents are either stagnant or increasing in most
markets throughout the San Francisco Bay Area. Grubb and Ellis reports that
class A space in San Francisco average rents are $32.60 up 3.6% from the second
quarter and that vacancy is at 17.6%t down from 18.5% in the second quarter and
21.2% in the third quarter of 2004. The San Francisco leasing market has
absorbed an estimated 1.9 million square feet net during 2005. Sales of
commercial office buildings are brisk with record per square foot prices being
attained and 2005 being on track to be a record volume sales year. A healthy
commercial real estate market increases lending opportunities and assists in
providing adequate equity to repay mortgage debt should borrowers become
delinquent in their payments.
For Partnership loans outstanding as of September 30, 2005, the Partnership
had an average loan-to-value ratio of 71.29%, computed based on appraised values
and senior liens as of the date the loan was made. 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 on senior
indebtedness 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.
Contractual Obligations Table.
A summary of the contractual obligations of the Partnership as of September
30, 2005 is set forth below:
Contractual Obligation Total Less than 1 Year 1-3 Years 3-5 Years
---------------------------- ----------------- ------------------ ----------------- ----------------
Line of credit - - - -
Rehabilitation loans $ 52,334 $ 52,334 - -
----------------- ----------------- ----------------- ----------------
Total $ 52,334 $ 52,334 - -
================= ================= ================= ================
20
Part I - Item 3. 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 and loans to the
partnership pursuant to its line of credit as of September 30, 2005. The
presentation, for each category of information, aggregates the assets and
liabilities by their maturity dates for maturities occurring in each of the
years 2005 through 2009 and separately aggregates the information for all
maturities arising after 2009. The carrying values of these assets and
liabilities approximate their fair market values as of September 30, 2005:
2005 2006 2007 2008 2009 Thereafter Total
----------------------------------------------------------------------------------------------
Interest earning assets:
Money market accounts $ 642,888 $ 642,888
Average interest rate 0.68% 0.68%
Unsecured loans $ 245,300 $ 245,300
Average interest rate 0% 0%
Loans secured by deeds
of trust $ 64,770 916,716 1,681,919 - 1,806,127 1,848,732 $6,318,264
Average interest rate 10.00% 8.91% 9.13% - 9.16% 9.25% 9.15%
Interest bearing liabilities:
Line of credit $ - $ -
Interest rate 7.00% 7.00%
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 of credit. 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 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 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.
21
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 certain 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, 2005 the general partners have determined that
the allowance for loan losses of $746,356 (8.06% 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, 2005, one loan totaling $96,716 was
delinquent 90 days or more in interest payments. Management believes that there
is sufficient collateral to cover the amount outstanding to the Partnership on
this loan. The allowance for loan losses of $746,356 as of September 30, 2005 is
considered reasonable to offset potential loss in loan collections in the
future.
Part I - Item 4. CONTROLS AND PROCEDURES
As of September 30, 2005, the Partnership carried out an evaluation, under
the supervision and with the participation of the general partners of the
effectiveness of the design and operation of the Partnership's disclosure
controls and procedures pursuant to Rule 13a-15 of the Securities Exchange Act
of 1934, as amended. Based upon that evaluation, the general partners concluded
that the Partnership's disclosure controls and procedures are effective in
timely alerting the general partners to material information relating to the
Partnership that is required to be included in our periodic filings with the
Securities and Exchange Commission. There were no significant changes in the
Partnership's internal control over financial reporting during the Partnership's
third fiscal quarter that have materially affected, or are reasonably likely to
materially affect, the Partnership's internal control over financial reporting.
22
PART II - OTHER INFORMATION
Item 1. Legal Proceedings
The Partnership periodically is a defendant in various legal
actions. Please refer to Note 10 of the Financial Statements.
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
Not Applicable
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
Not Applicable
Item 6. Exhibits
31.1 Certification of General Partner pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002
31.2 Certification of General Partner pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002
32.1 Certification of General Partner pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002
32.2 Certification of General Partner pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002
23
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 2005.
REDWOOD MORTGAGE INVESTORS VII
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
24
Exhibit 31.1
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 VII, 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, or caused such
disclosure controls and procedures to be designed under our supervision, 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 and presented in this report our conclusions about the effectiveness
of the disclosure controls and procedures, as of the end of the period covered
by this report based on such evaluation; and
(c) disclosed in this report any change in the Registrant's internal
control over financial reporting that occurred during the Registrant's most
recent fiscal quarter (the Registrant's fourth fiscal quarter in the case of an
annual report) that has materially affected, or is reasonably likely to
materially affect, the Registrant's internal control over financial reporting;
and
5. The Registrant's other certifying officers and I have disclosed, based
on our most recent evaluation of internal control over financial reporting, 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 and material weaknesses in the design or
operation of internal control over financial reporting which are reasonably
likely to adversely affect the Registrant's ability to record, process,
summarize and report financial data; and
(b) any fraud, whether or not material, that involves management or other
employees who have a significant role in the Registrant's internal control over
financial reporting.
/s/ Michael R. Burwell
- -----------------------------------
Michael R. Burwell, General Partner
November 14, 2005
25
Exhibit 31.2
PRESIDENT AND CHIEF FINANCIAL OFFICER CERTIFICATION
I, Michael R. Burwell, President and Chief Financial Officer of Gymno
Corporation, General Partner, certify that:
1. I have reviewed this quarterly report on Form 10-Q of Redwood Mortgage
Investors VII, 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, or caused such
disclosure controls and procedures to be designed under our supervision, 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 and presented in this report our conclusions about the effectiveness
of the disclosure controls and procedures, as of the end of the period covered
by this report based on such evaluation; and
(c) disclosed in this report any change in the Registrant's internal
control over financial reporting that occurred during the Registrant's most
recent fiscal quarter (the Registrant's fourth fiscal quarter in the case of an
annual report) that has materially affected, or is reasonably likely to
materially affect, the Registrant's internal control over financial reporting;
and
5. The Registrant's other certifying officers and I have disclosed, based
on our most recent evaluation of internal control over financial reporting, 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 and material weaknesses in the design or
operation of internal control over financial reporting which are reasonably
likely to adversely affect the Registrant's ability to record, process,
summarize and report financial data; and
(b) any fraud, whether or not material, that involves management or other
employees who have a significant role in the Registrant's internal control over
financial reporting.
/s/ Michael R. Burwell
- ---------------------------------
Michael R. Burwell, President and
Chief Financial Officer of Gymno
Corporation, General Partner
November 14, 2005
26
Exhibit 32.1
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 VII
(the "Partnership") on Form 10-Q for the period ending September 30, 2005 as
filed with the Securities and Exchange Commission on the date hereof (the
"Report"), pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section
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 at the dates and for the periods indicated.
/s/ Michael R. Burwell
- -----------------------------------
Michael R. Burwell, General Partner
November 14, 2005
27
Exhibit 32.2
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 VII
(the "Partnership") on Form 10-Q for the period ending September 30, 2005 as
filed with the Securities and Exchange Commission on the date hereof (the
"Report"), pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section
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, 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 at the dates and for the periods indicated.
/s/ Michael R. Burwell
- -----------------------------------
Michael R. Burwell, President,
Secretary/Treasurer & Chief Financial
Officer of Gymno Corporation, General Partner
November 14, 2005
28