REDWOOD MORTGAGE INVESTORS VIII (A California Limited Partnership) Index to Form 10-K December 31, 2003 Part I Page No. ----------- Item 1 - Business 3 Item 2 - Properties 7 Item 3 - Legal Proceedings 7 Item 4 - Submission of Matters to a Vote of Security Holders (Partners) 7 Part II Item 5 - Market for the Registrant's "Limited Partnership Units" and Related Unitholder Matters 7 Item 6 - Selected Consolidated Financial Data 8 Item 7 - Management's Discussion and Analysis of Financial Condition and Results of Operations 9 Item 7a - Quantitative and Qualitative Disclosures About Market Risk 18 Item 8 - Consolidated Financial Statements and Supplementary Data 20 Item 9 - Changes in and Disagreements with Accountants on Accounting and Financial Disclosure 48 Item 9a - Controls and Procedures 48 Part III Item 10 - Directors and Executive Officers of the Registrant 48 Item 11 - Executive Compensation 49 Item 12 - Security Ownership of Certain Beneficial Owners and Management 50 Item 13 - Certain Relationships and Related Transactions 50 Item 14 - Principal Accountant Fees & Services 50 Part IV Item 15 - Exhibits, Financial Statement Schedules, and Reports on Form 8-K 51 Signatures 52 Certifications 54 1 SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 Form 10-K Annual Report Pursuant to Section 13 or 15 (d) of the Securities Exchange Act of 1934 For the year ended December 31, 2003 Commission file number 333-106900 - ----------------------------------------------------------------------------- REDWOOD MORTGAGE INVESTORS VIII - ----------------------------------------------------------------------------- (Exact name of registrant as specified in its charter) California 94-3158788 - ----------------------------------------------------------------------------- (State or other jurisdiction of (I.R.S. Employer Identification) Incorporation or organization) 900 Veterans Blvd., Suite 500, Redwood City, CA 94063 - ----------------------------------------------------------------------------- (address of principal executive offices) (zip code) Registrant's telephone number including area code (650) 365-5341 - ----------------------------------------------------------------------------- Securities registered pursuant to Section 12(b) of the Act: Title of each class Name of each exchange on which registered - ----------------------------------------------------------------------------- None None - ----------------------------------------------------------------------------- Securities registered pursuant to Section 12(g) of the Act: Limited Partnership Units Indicate by check mark whether the registrant (1) has filed all reports to be filed by Section 13 or 15 (d) of the Securities Exchange Act of 1934 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 XXXX NO ------------------------- ---------------------- As of December 31, 2003, the limited partnership units purchased by non-affiliates was 130,059,325 units aggregating $131,268,870. Documents incorporated by reference: Portions of the Prospectus effective October 7, 2003, and post effective Amendment No. 1 dated January 30, 2004, containing supplement No. 1 dated January 30, 2004, (the "Prospectus"), are incorporated in Parts II, III, and IV. Exhibits filed as part of Form S-11 Registration Statement #333-106900 are incorporated by reference in part IV. 2 Part I Item 1 - Business Redwood Mortgage Investors VIII, a California Limited Partnership (the "Partnership"), was organized in 1993. Michael R. Burwell, Gymno Corporation and Redwood Mortgage Corp., both California Corporations, are the general partners. The partnership is organized to engage in business as a mortgage lender, for the primary purpose of making loans secured primarily by first and second deeds of trust on California real estate. Loans are arranged and serviced by Redwood Mortgage Corp. The partnership's objectives are to make loans that will: (i) yield a high rate of return from mortgage lending; and (ii) preserve and protect the partnership's capital. Investors should not expect the partnership to provide tax benefits of the type commonly associated with limited partnership tax shelter investments. The partnership is intended to serve as an investment alternative for investors seeking current income. However, unlike other investments, which are intended to provide current income, an investment in the partnership will be less liquid, not readily transferable, and not provide a guaranteed return over its investment life. Initially, the partnership offered a minimum of $250,000 and a maximum of $15,000,000 in units, of which $14,932,000 were sold. This initial offering closed on October 31, 1996. Subsequently, the partnership commenced a second offering of up to $30,000,000 in units commencing on December 4, 1996. This offering sold $29,993,000 in units and was closed on August 30, 2000. On August 31, 2000 the partnership commenced its third offering for another 30,000,000 units ($30,000,000). This offering sold $29,999,000 in units and was closed on April 23, 2002. On October 30, 2002 the partnership commenced its fourth offering for an additional 50,000,000 units ($50,000,000). This offering sold $49,985,000 in units and was closed on October 6, 2003. On October 7, 2003 the partnership commenced its fifth and current offering of 75,000,000 units ($75,000,000). As of December 31, 2003, $6,360,000 in units was sold in this fifth offering, bringing the aggregate sale of units to $131,269,000. Units in the fifth offering are being offered on a "best efforts" basis, which means that no one is guaranteeing that any minimum number of units will be sold, through broker-dealer member firms of the National Association of Securities Dealers, Inc. (See Section of the prospectus entitled "TERMS OF THE OFFERING" and "PLAN OF DISTRIBUTION"). The partnership began selling units in February 1993, and began investing in mortgages in April 1993. At December 31, 2003, the partnership has investments in secured loans with principal balances totaling $147,173,814. Interest rates ranged from 7.50% to 18.00%. Currently First Trust Deeds comprise 57.37% of the total amount of the secured loan portfolio, an increase of 2.24% over 2002 level of 55.13%. Junior loans (2nd and 3rd Trust Deeds) make up 42.63%, a decrease of 2.24% over 2002 level of 44.87%. Loans secured by owner-occupied homes, combined with loans secured by non-owner occupied homes, total 45.27% of the secured loan portfolio. Loans secured by multi-family properties make up 15.39% of the total secured loans. Commercial loans now comprise 35.67% of the secured portfolio, a decrease of 2.69% from last year and land made up 3.67% of the secured loan portfolio. Of the total secured loans, 72.85% are in six counties of the San Francisco Bay Area, and 13.85% are in counties adjacent to the San Francisco Bay Area. The balance of secured loans, 13.30% are in other counties located in California. Average loan size increased this year, and is now averaging $1,817,000 per loan, up $622,000 from the average loan balance of $1,195,000 in 2002. This increase is due to the ability of the Partnership by virtue of its increasing size to invest in larger loans. Additionally, there is less competition due to fewer lenders being capable of funding larger loans, which allows the partnership to charge a higher rate of interest than on smaller sized loans. The average loan as of December 31, 2003, represents 1.31% of partner capital and 1.23% of outstanding secured loans, compared to December 31, 2002 when average loan size of 1.25% of partners capital and 1.43% of outstanding secured loans. Some of the loans are fractionalized between affiliated partnerships with objectives similar to those of the partnership to further reduce risk. However, as the partnership has grown in size the number of fractionalized loans has decreased and represents less than 35% of the loan portfolio. Average equity per loan transaction at the time the loans were made based upon appraisals and prior liens, which is our loan plus any senior loans, divided by the property's appraised value, subtracted from 100%, stood at 46.03%, an increase in equity of 6.64% from the previous year. This average equity is considered conservative. Generally, the more equity, the more protection for the lender. The general partners believe the partnership's loan portfolio is in good condition with three properties in foreclosure as of the end of December 2003. The principal balances of these foreclosed properties represent 1.99% of the secured loan portfolio. All of these foreclosures have entered into workout agreements. The number of foreclosures and principal amounts are relatively low. The partnership does expect that during 2004 additional foreclosures may need to be filed in order to collect payment from borrowers who have become delinquent. This is typical of our market and the partnership expects to have a level of delinquency higher than banking institutions within its portfolio. 3 Delinquencies are discussed under Item 7 - Management's Discussion and Analysis of Financial Condition and Results of Operations. For the year ended December 31, 2003, the partnership did not take back any collateral from defaulted borrowers. During 2002 the partnership took back its real estate security on two defaulted loans. One through a foreclosure sale and the other as a deed in lieu of foreclosure. To assist in protecting its own assets and to reduce liability, the partnership subsequently transferred the properties to two newly formed Limited Liability Companies "LLCs". One of the LLCs, Russian Hill Property Company, is 100% owned by the partnership and in the other, Stockton Street Property Company, the partnership owned controlling interest with an affiliate, the other investor in the foreclosed loan. Assets of the Stockton Street Property Company were completely sold in 2003. This LLC will be dissolved after its final tax return for year 2003 is filed. The partnership also intends to sell the property of Russian Hill Property Company and dissolve this LLC in the future. The two LLCs are further discussed under Notes to Consolidated Financial Statements (Note 5). The partnership's net income continued to take an upward trend. The net income increased from $6,093,000 in 2001 to $7,486,000 in 2002 and to $9,594,000 in 2003. This was made possible largely through investment of additional capital derived from sales of partnership units into loans. The secured loan portfolio increased from $82,790,000 in 2001, to $83,650,000 in 2002, to $147,174,000 in 2003, an increase of 78% over the two-year period. Although net income increased it did not increase in direct proportion to the increased size of the loan portfolio mainly because newly originated loans were placed at lower interest rates. Interest rates have been declining steadily since 2001. In order to be competitive the partnership has placed its loans at interest rates competitive in the marketplace. Mortgage interest income increased from $8,920,000 in 2001 to $11,416,000 in 2002, and to $12,496,000 in 2003, an increase of 40.09%. During the year 2003 the partnership's annualized yield on compounding accounts was 7.76% and 7.50% on monthly distributing accounts. Competition and General Economic Conditions. The partnership's major competitors in providing mortgage loans are banks, savings and loan associations, thrifts, conduit lenders, mortgage brokers, and other entities both larger and smaller than the partnership. The partnership is competitive in large part because the general partners generate all of their loans. Many of these competitors are unable, due to their size, to compete with the partnership's ability to make loans larger than $1,000,000 per transaction. The partnership's ability to regularly entertain loan requests at or above $1,000,000 reduces competition and can provide either higher quality loans, higher returns, or both. The general partners have been in the business of making or investing in mortgage loans in Northern California since 1978 and have developed a quality reputation and recognition within the field. Mortgage interest rates have fallen during the last 24 to 36 months. This has been partially due to actions by the Federal Reserve Bank to reduce the discount rate on borrowings charged to member banks, a slowing economy and low rates of inflation. Although the general trend for interest rates has been down, many lenders have tightened their credit standards and reduced their lending exposure in various markets and property types. This credit tightening from competing lenders would generally provide the partnership with additional lending opportunities at attractive interest rates. However, as a result of the slowing economy, there are now fewer transactions in the marketplace, which could potentially reduce the number of lending opportunities to the partnership. Additionally, lower general interest rates generally mean that borrowers can reduce their interest rates on existing debt, thereby lowering their monthly payments, which in many instances enhances a borrower's credit worthiness. In these situations borrowers generally seek financing at lower rates from institutional lenders. Continued rate reductions by the Federal Reserve Bank, a continued sluggish economy, and a low inflation rate could have the effect of reducing mortgage yields in the future. Current loans with relatively high yields could be replaced with loans with lower yields, which in turn could reduce the net yield paid to the limited partners. In addition, if there is less demand by borrowers for loans and, thus, fewer loans for the partnership to invest in, it will invest its excess cash, including proceeds from the offering of the units, in shorter-term alternative investments yielding considerably less than the current investment portfolio. 4 Secured Loan Portfolio. A summary of the partnership's secured loan portfolio as of December 31, 2003, is set forth below (in thousands): Loans as a Percentage of Appraised Values First Trust Deeds $ 84,437 Appraised Value of Properties at Time of Loan 178,381 ----------- Total Investment as a % of Appraisal 47.34% =========== First Trust Deed Loans 84,437 Second Trust Deed Loans 61,247 Third Trust Deed Loans 1,490 ----------- Total of Trust Deed Loans 147,174 Priority Positions due other Lenders: First Trust Deed Loans due other Lenders 113,051 Second Trust Deed Loans due other Lenders 3,819 ----------- Total Debt $264,044 =========== Appraised Property Value at Time of Loan 489,219 Total Debt as a % of Appraisal based on appraised values and prior liens at date loan was consummated 53.97% =========== Number of Secured Loans Outstanding 81 Average Secured Loan $ 1,817 Average Secured Loan as a % of Secured Loans Outstanding 1.23% Largest Secured Loan Outstanding 16,010 Largest Secured Loan as a % of Secured Loans Outstanding 10.88% Largest Secured Loan as a % of Partnership Assets 9.84% Secured Loans as a Percentage of Total Secured Loans Percent - ----------------------------------------------------------------- ----------- First Trust Deed Loans 57.37% Second Trust Deed Loans 41.62% Third Trust Deed Loans 1.01% ----------- Total Trust Deed Loan Percentage 100.00% =========== Type of Secured Loans by Property Amount Percent - ------------------------------------------------- ------------ ----------- Owner Occupied Homes $ 13,656 9.28% Non-Owner Occupied Homes 52,975 35.99% Apartments 22,649 15.39% Commercial 52,502 35.67% Land 5,392 3.67% ------------ ----------- Total $147,174 100.00% ============ =========== 5 The following is a distribution of secured loans outstanding as of December 31, 2003 by Counties (in thousands): Total California County Secured Loans Percent ------------------------------------------ ------------- ----------- San Francisco Bay Area Counties Alameda $ 38,956 26.47% San Francisco 25,830 17.55% Santa Clara 23,569 16.01% San Mateo 12,105 8.23% Marin 3,924 2.67% Contra Costa 2,827 1.92% ----------- ----------- 107,211 72.85% San Francisco Bay Area Adjacent Counties Napa 10,846 7.37% Stanislaus 4,774 3.24% San Joaquin 4,017 2.73% Sonoma 749 0.51% ----------- ----------- 20,386 13.85% Other California Counties Los Angeles 5,816 3.95% Riverside 5,150 3.50% All others 8,611 5.85% ----------- ----------- 19,577 13.30% Total $ 147,174 100.00% =========== =========== Statement of Condition of Secured Loans Number of Secured Loans in Foreclosure 3 Scheduled maturity dates of secured loans as of December 31, 2003 are as follows (in thousands): Year Ending December 31, ------------------ 2004 $ 41,774 2005 59,496 2006 31,165 2007 8,138 2008 3,390 Thereafter 3,211 ---------- $147,174 ========== The scheduled maturities for 2004 include nine loans totaling $10,767,000, and representing 7.32%% of the portfolio, past maturity at December 31, 2003. Several borrowers are in process of selling the properties or refinancing their loans through other institutions, as this is an opportune time for them to do so and/or take advantage of lower interest rates. The partnership allows borrowers to occasionally continue to make the payments on debt past maturity for periods of time. Interest payments on eight of these loans were delinquent. Of these past maturity loans, the partnership has begun foreclosure on two with principal balances totaling $2,535,000. These two foreclosures are included in the total number of foreclosures begun by the partnership, which total three. 6 Item 2 - Properties The partnership did not take back any collateral security from borrowers in 2003. During 2002, the partnership took back the collateral real estate security on two of its loans. In each instance, in order to reduce potential liabilities the partnership subsequently transferred at its book value the real estate taken back to two newly formed Limited Liability Companies "LLCs". One property was transferred to Stockton Street Property Company, LLC. This property, taken back through foreclosure, was comprised of six condominium units. Management of the LLC was through its managing member, Michael Burwell, a general partner of the partnership. All six units held by the Stockton Street Property Company, LLC were sold in 2003 at an overall loss of $127,000. The partnership's proportionate share of this loss was $85,000. It is anticipated that in 2004 the Stockton Street Property Company, LLC will be closed, remaining assets transferred back to the partnership in proportion to its ownership, and its operations will cease. The other property taken back in 2002 was transferred at its book value to Russian Hill Property Company, LLC. The real estate was held off the market during 2003, as the real estate market for this luxury view condominium in a prestigious neighborhood of San Francisco was very slow. The management of this LLC, in consultation with real estate professionals, will continue to review the market activity during 2004 and will place the property for sale when the timing is considered to be opportune. The partnership's net interest in the LLC was $3,979,000 net of a valuation allowance of $500,000. Michael R. Burwell, general partner of the partnership, is manager of this LLC. Item 3 - Legal Proceedings In the normal course of business, the partnership may become involved in various types of legal proceedings such as assignment of rents, bankruptcy proceedings, appointment of receivers, unlawful detainers, judicial foreclosure, etc., to enforce the provisions of the deeds of trust, collect the debt owed under the promissory notes, or to protect, or recoup its investment from the real property secured by the deeds of trust. None of these actions would typically be of any material importance. As of the date hereof, the partnership is not involved in any legal proceedings other than those that would be considered part of the normal course of business. Item 4 - Submission of Matters to Vote of Security Holders (Partners) No matters have been submitted to a vote of the partnership. Part II Item 5 - Market for the Registrant's "Limited Partnership Units" and Related Unitholder Partnership Matters 75,000,000 units at $1 each (minimum purchase of 2,000 units) are currently being offered ($125,000,000 in units were previously offered and sold through a series of offerings) through broker-dealer member firms of the National Association of Securities Dealers on a "best efforts" basis (as indicated in Part I item 1). Investors have the option of withdrawing earnings on a monthly, quarterly, or annual basis or reinvesting and compounding the earnings. Limited partners may withdraw from the partnership in accordance with the terms of the limited partnership agreement subject to possible early withdrawal penalties. There is no established public trading market. As of December 31, 2003, 3,830 limited partners had a capital balance of $138,649,000, net of Formation Loans and syndication costs. A description of the partnership units, transfer restrictions and withdrawal provisions is more fully described under the section of the prospectus entitled "Description of Units" and "Summary of Limited Partnership Agreement", pages 72 through 73 of the prospectus, a part of the referenced registration statement, which is incorporated by reference. 7 Item 6 - Selected Consolidated Financial Data Redwood Mortgage Investors VIII began operations in April 1993. Consolidated financial condition and results of operation for the partnership as of and for the five years ended December 31, 2003 were (in thousands, except for net income per $1,000 invested by limited partners for entire period): Consolidated Balance Sheets Assets December 31, --------------------------------------------------------------------------- 2003 2002 2001 2000 1999 ---------- ---------- ---------- ---------- ---------- Cash and cash equivalents $ 8,921 $ 7,188 $ 1,917 $ 1,460 $ 1,603 Loans Loans secured by deeds of trust 147,174 83,650 82,790 68,571 35,693 Loans, unsecured 34 - 4 54 49 Accrued interest and late fees 4,735 3,913 3,345 1,039 712 Advances on loans 416 279 195 172 33 Less allowance for losses (2,649) (3,021) (2,247) (1,345) (834) Other receivables - 888 - - - Investment in LLC - - - 373 Real estate owned (REO), net 3,979 9,286 - - - Other assets 44 22 6 13 6 ---------- ---------- ---------- ---------- ---------- $ 162,654 $ 102,205 $ 86,010 $ 69,964 $ 37,635 ========== ========== ========== ========== ========== Liabilities and Partners Capital December 31, --------------------------------------------------------------------------- 2003 2002 2001 2000 1999 ---------- ---------- ---------- ---------- ---------- Liabilities Accounts payable $ 224 $ 449 $ 74 $ 30 $ 29 Payable to affiliate 448 294 109 - - Line of credit 22,000 - 11,400 16,400 - Note payable - 1,782 - - - Deferred interest - 112 - 82 214 Minority interest - 1,213 - - - Subscriptions to partnership in applicant status 1,210 2,578 673 225 330 ---------- ---------- ---------- ---------- ---------- 23,882 6,428 12,256 16,737 573 ---------- ---------- ---------- ---------- ---------- Partners' capital Limited partners subject to redemption 138,649 95,690 73,687 53,180 37,030 General partners subject to redemption 123 87 67 47 32 ---------- ---------- ---------- ---------- ---------- Total partners' capital 138,772 95,777 73,754 53,227 37,062 ---------- ---------- ---------- ---------- ---------- $ 162,654 $ 102,205 $ 86,010 $ 69,964 $ 37,635 ========== ========== ========== ========== ========== 8 Consolidated Statements of Income December 31, ---------------------------------------------------------------------------- 2003 2002 2001 2000 1999 ----------- ----------- ----------- ----------- ----------- Gross revenue $ 12,958 $ 11,691 $ 9,088 $ 6,396 $ 4,478 Expenses 3,369 4,204 2,994 2,104 1,534 ----------- ----------- ----------- ----------- ----------- Income before interest credited to partners in applicant status 9,589 7,487 6,094 4,292 2,944 Interest credited to partners in applicant status 37 1 1 5 2 ----------- ----------- ----------- ----------- ----------- Minority interest share of subsidiary loss 42 - - - - Net income $ 9,594 $ 7,486 $ 6,093 $ 4,287 $ 2,942 =========== =========== =========== =========== =========== Net income to general partners (1%) 96 75 61 43 29 Net income to limited partners (99%) 9,498 7,411 6,032 4,244 2,913 ----------- ----------- ----------- ----------- ----------- Total net income $ 9,594 $ 7,486 $ 6,093 $ 4,287 $ 2,942 =========== =========== =========== =========== =========== Net income per $1,000 invested by limited partners for entire period (annualized) - where income is compounded and retained $ 78 $ 87 $ 90 $ 86 $ 84 =========== =========== =========== =========== =========== - where partner receives income in monthly distributions $ 75 $ 84 $ 86 $ 83 $ 81 =========== =========== =========== =========== =========== The annualized yield, when income is compounded and retained for 1999 was 8.42%, for 2000 it was 8.58%, for 2001 it was 8.98%, for 2002 it was 8.69% and for 2003 it was 7.76%. The annualized yield, when income is distributed monthly for 1999 was 8.11%, for 2000 it was 8.26%, for 2001 it was 8.63%, for 2002 it was 8.36% and for 2003 it was 7.50%. The average annualized yield, when income is compounded and retained, from inception through December 31, 2003, was 8.43%. The average annualized yield, when income is distributed monthly, from inception through December 31, 2003 was 8.07% 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 presentation. Item 7 - Management's Discussion and Analysis of Financial Condition and Results of Operations 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 dates and income and expenses during the reported 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 owned through foreclosure. At December 31, 2003, the partnership owned one real estate property, which was taken back from a defaulted borrower. 9 Loans and the related accrued interest, late fees and advances are analyzed on a continuous basis for recoverability. Delinquencies are identified and followed as part of the loan system. Delinquencies are determined based upon contractual terms. 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 values, 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 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. Forward Looking Statements. Some of the information in the Form 10-K 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 foregoing 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 fees received by the general partners are paid pursuant to the partnership agreement and are determined at the sole discretion of the general partner. In the past the general partner 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, the partnership 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. In 2001, 2002 and 2003, loan brokerage commissions paid by the borrowers were $1,156,000, $996,000 and $2,621,000, 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 are 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 $552,000, $1,098,000 and $1,057,000 were incurred for the years ended December 31, 2001, 2002 and 2003, respectively. These servicing fees were charged at 1%, on an annual basis, of the outstanding principal balances. If the maximum mortgage servicing fee of 1.5%, on an annual basis, had been charged to the partnership, then net income would have been reduced by approximately $528,000. Reducing net income reduces the annualized yields. An increase or decrease in this fee within the limits set by the partnership's agreement directly impacts the yield to the limited partners. 10 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 $158,000, $325,000 and $468,000 were incurred by the partnership for years 2001, 2002 and 2003, 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 may be 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. o Contributed Capital The general partners jointly or severally are required to contribute 1/10 of 1% in cash contributions as proceeds from the offerings are received from the limited partners. As of December 31, 2002 and 2003, a general partner, Gymno Corporation, had contributed $93,000 and $133,000, respectively, as capital in accordance with Section 4.02(a) of the partnership agreement. 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 sales. 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. Formation Loans made to Redwood Mortgage Corp. were on a per offering basis. The following table summarizes Formation Loan transactions through December 31, 2003 (in thousands): Offering -------------------------------------------------------------------- 1st 2nd 3rd 4th 5th Total ---------- ---------- ---------- ---------- ----------- ----------- Limited partner contributions $ 14,932 $ 29,993 $ 29,999 $ 49,985 $ 6,360 $131,269 ========== ========== ========== ========== =========== =========== Formation Loans made 1,075 2,272 2,218 3,777 453 9,795 Payments to date (690) (837) (384) (130) - (2,041) Early withdrawal penalties applied (63) (88) (53) - - (204) ---------- ---------- ---------- ---------- ----------- ----------- Balance, December 31, 2003 $ 322 $ 1,347 $ 1,781 $ 3,647 $ 453 $ 7,550 ========== ========== ========== ========== =========== =========== The amount of the annual installments paid by Redwood Mortgage Corp. are determined at annual installments of one-tenth of the principal balance of the Formation Loan at December 31 of each year until the offering period is closed. Thereafter, the remaining Formation Loan is paid in ten equal amortizing payments over a period of ten years. On December 31, 2003, the partnership was in the offering stage of its fifth offering, ($75,000,000). Contributed capital equaled $14,932,000 for the first offering, $29,993,000 for the second offering, $29,999,000 for the third offering, $49,985,000 for the fourth offering and $6,360,000 for the fifth offering, totaling an aggregate of $131,269,000 as of December 31, 2003. Of this amount, $1,210,000 remained in applicant status. 11 Results of Operations - For the years ended December 31, 2001, 2002 and 2003. The net income increase of $1,806,000 (42%) for the year ended December 31, 2001 was due primarily to an increase in interest earned on loans of $2,659,000, an increase in late fees of $33,000, and a decrease in professional fees of $51,000; offset by expense increases due primarily to the increased size of the partnership loan portfolio of $46,000 for mortgage servicing fees, $85,000 for interest expense, $596,000 for provisions for losses on loans, $97,000 for asset management fees, and $127,000 for clerical cost from Redwood Mortgage Corp. The net income increase of $1,393,000 (23%) for the year ended December 31, 2002 was due primarily to an increase in interest earned on loans of $2,496,000, an increase in late fees of $15,000, a decrease in interest expense of $456,000; offset by expense increases due primarily to the increased size of the partnership of $546,000 for mortgage servicing fees, $323,000 for provisions for losses on loans and provisions for losses on real estate, $167,000 for asset management fees, $25,000 for clerical costs from Redwood Mortgage Corp., $53,000 for professional fees and $444,000 for broker expense. The net income increase of $2,108,000 (28%) for the year ended December 31, 2003 was due primarily to an increase in interest earned on loans of $1,080,000, an increase in late fees of $87,000, an increase in bank interest of $48,000, an increase in miscellaneous income of $12,000, a decrease in the provisions for losses on loans and real estate of $498,000, a decrease in loan servicing fees of $41,000, a decrease in interest expense of $445,000, and a decrease in broker expense of $263,000; offset by expense increases due primarily to the increased size of the partnership of $45,000 for professional services, $143,000 for asset management fees, $24,000 for clerical costs through Redwood Mortgage Corp., $36,000 for subscription interest and $142,000 in other expenses after the consideration of the minority interest's share of the subsidiary loss. The increase in interest on loans of $2,659,000 (42%), $2,496,000 (28%) and $1,080,000 (9%) for the years ended December 31, 2001, 2002 and 2003, respectively, was due primarily to the increased size of the partnership secured loan portfolio, which increased from $68,571,000 at December 31, 2000, to $82,790,000 at December 31, 2001, to $83,650,000 at December 31, 2002 and to $147,174,000 at December 2003. The lower percentage rate of interest increase on loans (9%) in 2003 is in part due to the lower interest rate environment in 2003 as compared to 2001 and 2002 and reduced collection of "additional interest" on one of the partnership's loans of $525,000 in 2003 than in 2002. Additional interest is only negotiated on a small percentage of loans and occasionally adds to income. The partnership has imputed interest on its Formation Loan. The resulting interest income and offsetting amortization of discount on imputed interest of $53,000, $159,000 and $195,000 in 2001, 2002 and 2003, respectively, has been reflected in the accompanying consolidated financial statements. The imputed amounts increased over 2001, 2002 and 2003 due to increases in the Formation Loan from the sale of additional limited partnership investments. The increase in other income of $92,000 (133%) and $101,000 (63%) for the years ended December 31, 2002 and 2003, respectively, was primarily due to increased imputed interest income from the larger formation loan existing at year ends 2001, 2002 and 2003. Additionally, during 2003 bank interest earned was higher than in previous years as the partnership kept more cash in interest bearing accounts than in 2002 and 2001. The late charge income increases of $33,000 (50%), $15,000 (15%) and $87,000 (76%) for the years ended 2001, 2002 and 2003, respectively, is largely attributed to the growth in the loan portfolio. The increase in interest on the line of credit of $85,000 (10%) during the year ended 2001 is reflective of higher credit line usage in 2001. Our credit line is tied to prime and the prime rate declined from 9.5% in May, 2000 to 4.00% during 2003. The decrease of $445,000 (86%) and $456,000 (47%) in interest expense in 2003 and in 2002, respectively, is primarily due to lower average credit line usage and the reduction of the credit line interest rate. The partnership utilized its bank line of credit substantially less during 2003. Instead it relied largely on the new capital of investors, which totaled $40,030,000 in 2003. During 2003 credit line interest expense was $71,000, a drop of $445,000 (86%) from 2002. The increase/(decrease) in mortgage servicing fees for 2001, 2002 and 2003 was $46,000 (9%), $546,000 (99%) and ($41,000) (4%). Mortgage servicing fees increased primarily due to increases in the outstanding loan portfolio. During 2002, additional servicing fees were earned related to impaired loans. The partnership does not accrue servicing fees to Redwood Mortgage Corp. on impaired loans. Rather, servicing fees on impaired loans are incurred as borrower payments are received. These servicing fees were charged at 1%, on an annual basis, of the outstanding principal balances. If the maximum mortgage servicing fee of 1.5%, on an annual basis, had been charged to the partnership, then net income would have been reduced by approximately $528,000. Reducing net income reduces the annualized yields. An increase or decrease in this fee within the limits set by the partnership's agreement directly impacts the yield to the limited partners. 12 The increase in the provision for losses on loans and real estate in 2001 and 2002 of $596,000 (159%) and $323,000 (34%), respectively, is primarily due to the loan portfolio increasing in amount and due to recognition that we were in more difficult economic times. As the partnership's loan portfolio has increased and since the partnership acquired two properties in 2002, the provisions for loss have also been increased. The decrease in the provision for losses on loans and real estate of $498,000 (39%) in 2003 was because management felt that the overall reserve accumulation of $3,149,000 was adequate and that the magnitude of provisions already made in 2002 and prior years was not necessary to be carried forward in 2003. The real estate market and economic times seem to have stabilized and may perhaps be improving. Real estate owned has been substantially reduced by $5,307,000 from the December 31, 2002 balance of $9,286,000 to the December 31, 2003 balance of $3,979,000. In addition, loans in foreclosure have come down considerably from six totaling $4,029,000 at December 31, 2002, to three totaling $2,931,000 at December 31, 2003. The increase in management fees of $97,000 (150%), $167,000 (106%) and $143,000 (44%) for 2001, 2002 and 2003, respectively, is due to the increase in capital under management in 2001, 2002 and 2003. In addition, the general partners began collecting the full asset management fees of .375% during 2002 and 2003, as compared to .25% in 2001. The increase in clerical costs of $127,000 (112%), $25,000 (10%) and $24,000 (9%) for 2001, 2002 and 2003, respectively, is due primarily to an increase in the partnership size and in 2001 to an upgrade of computer hardware and software. In 2003 the net loss of $85,000 in subsidiary interest resulted through a sale of one of the real estate owned properties. The partnership did not take any losses on real estate owned property sales in 2001 or 2002 since the partnership did not own any properties in 2001 and did not sell either of the two properties owned in 2002. Broker expense of $0 in 2001, $444,000 in 2002 and $181,000 in 2003 was due to the partnership having an obligation to pay one-half of "additional interest" collected on one of its loans to a non-affiliated real estate broker. This expense ended in 2003 with the full collection of the "additional interest" totaling $1,250,000. The increase in other expense of $9,000 (26%) and $184,000 (418%) for the years ended December 31, 2002 and 2003, respectively, was due to growth of the partnership size, and the large increase in 2003 was due to the loss sustained on the sale of the Stockton Street Property Company, LLC real estate and increased subscription interest while new funds from limited partners awaited entry into the partnership. Partnership capital continued to increase as the partnership received new limited partner capital contributions of $19,712,000, $21,563,000 and $40,030,000 and retained the earnings of limited partners that have chosen to do so of $3,892,000, $4,716,000 and $5,958,000 for the years 2001, 2002 and 2003, respectively. The partnership ceased raising funds during the period of May 2002 through October 2002 while it was in application status for a fourth offering of units. The fourth offering commenced October 30, 2002 and closed on October 6, 2003. On October 7, 2003 the partnership commenced its fifth offering and funds raised will be used to increase the partnership's capital base and provide funds for additional mortgage loans. The partnership began funding loans on April 14, 1993 and as of December 31, 2003, had credited earnings to limited partners who elected to retain earnings at an average annualized yield of 8.43%. Limited partners who elected to have their earnings distributed monthly had an average annualized yield of 8.07% since inception through December 31, 2003. In 1995, the partnership established a line of credit with a commercial bank secured by its loan portfolio. Since its inception, the credit limit has increased from $3,000,000 to $22,000,000. The size of the credit line facility could again increase as the partnership's capital increases. This added source of funds may help in maximizing the partnership's yield by permitting the partnership to minimize the amount of funds in lower yield investment accounts when appropriate loans are not available. Additionally, the loans made by the partnership bear interest at a rate in excess of the rate payable to the bank which extended the line of credit. The amount to be retained by the partnership, after payment of the line of credit cost, will be greater than without the use of the line of credit. As of December 31, 2001, 2002 and 2003, the outstanding balance on the line of credit was $11,400,000, $0 and $22,000,000, respectively. Cash generated from interest earnings, late charges, amortization on principal, loan payoffs and capital contributed by limited partners was utilized to pay down the credit line in full at year ended December 31, 2002. 13 Since January, 2001, and through December 31, 2003, the Federal Reserve reduced interest rates significantly by cutting the Federal Funds Rate to 1.00%. The effect of the previous 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 during 2004 at rates similar to those that prevailed in 2003. The lowering of interest rates has encouraged those borrowers that have mortgages with higher interest rates than those currently available to seek refinancing of their obligations. 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, the general partners expect to replace paid off 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 .50% over the year 2004. Based upon the rates payable 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 that the annualized yield will range between 7.00% and 7.50% in 2004. 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, the Northern California real estate market slowed and the national and local economies slipped into recession. During 2002 and 2003, the economy has stabilized, but is still stagnant. At December 31, 2003 the partnership had 16 loans past due 90 days or more totaling $27,182,000. Included in these 90 day or more delinquent loans are three notices of default beginning the process of foreclosing three of our loans. The principal amounts of the three foreclosed loans total $2,931,000 or 2.0% of the loan portfolio. In addition to the three workout agreements with borrowers in foreclosure, the partnership also entered into workout agreements with borrowers who are past maturity or delinquent in their regular payments. The total number of partnership workout agreements with borrowers is six, inclusive of matured, foreclosed or 90-day delinquent loans. 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 December 31, 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. In 2003, the partnership filed some foreclosure proceedings to enforce the terms of our loans. In some of these instances the borrowers have been able to remedy the foreclosures we have filed. The partnership did not own any properties taken back through foreclosure in 2001. During 2002, we completed foreclosure of two loans, which resulted in the partnership taking back two real estate properties. These properties are more fully discussed under Item 2 - Properties. The partnership's foreclosed principal balances were $6,565,000 after excluding an affiliated partnership's interest in one of the properties. During 2003, one of the properties owned through foreclosure was sold at an overall loss of $127,000, $85,000 to the partnership and $42,000 allocated to the minority interest. During 2003 the partnership did not take back any property through the foreclosure process. In 2004, we may initiate foreclosure on delinquent borrowers or borrowers who become delinquent during the year. We may take back additional real estate through the foreclosure process in 2004. 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 owned through foreclosure of $3,149,000 through December 31, 2003. These provisions for losses were made to guard against collection losses. The total cumulative provision for losses as of December 31, 2003, 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. 14 The partnership may restructure loans. This is done either through the modification of an existing loan or by re-writing a whole new loan. It could involve, among other conditions, an extension in maturity date, a reduction in repayment amount, a reduction in interest rate or granting an additional loan. During 2003, the partnership restructured three loans by granting one new loan and two other loans through modification. The total amount of restructure was $15,599,000. In 2002 the partnership restructured three loans by granting two new loans totaling $1,090,000. Borrower Liquidity and Capital Resources. The partnership relies upon sales of partnership 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. 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 will be used to reduce the partnership credit line or in other partnership business. 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 you initially elect 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 years stated below, 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: 2001 2002 2003 ------------- ------------- ------------- Compounding $3,892,000 $4,716,000 $5,958,000 Distributing $1,962,000 $2,517,000 $3,362,000 As of December 31, 2001, 2002 and 2003 limited partners electing to receive cash distributions of earnings represented 34%, 35% and 36%, 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. 15 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 holding 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 most limited partners has yet to expire, as of December 31, 2003, many limited partners may not as yet avail themselves of this provision for liquidation. Earnings and capital liquidations including early withdrawals during the three years ended December 31, 2003 were: 2001 2002 2003 ------------ ------------- ------------ Cash distributions $1,962,000 $2,517,000 $3,362,000 Capital liquidation* $1,425,000 $1,049,000 $1,845,000 ------------ ------------- ------------ Total $3,387,000 $3,566,000 $5,207,000 ============ ============= ============ * These amounts represent gross of early withdrawal penalties. Additionally, limited partners may liquidate their investment over a one-year period subject to certain limitations and penalties. During the past three years ended December 31, 2003, capital liquidated subject to the 10% penalty for early withdrawal was: 2001 2002 2003 ------------ ------------ ------------ $730,000 $244,000 $786,000 This represents 0.99%, 0.26% and 0.57% of the limited partners' ending capital for the years ended December 31, 2001, 2002 and 2003, 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. 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 (See the section of the Prospectus entitled "Risk Factors - Purchase of Units is a Long Term Investment"). 16 Current Economic Conditions. The partnership makes loans primarily in Northern California. As of December 31, 2003, approximately 72.85% of the loans held were in the six San Francisco Bay Area Counties, 13.85% were in counties adjacent to the San Francisco Bay Area and the balance 13.30% were in other counties throughout California. Like the rest of the nation, the San Francisco Bay Area felt the recession and accompanying slow down in economic growth and increasing unemployment. Recently the national Northern California economies seem to be improving. Job creation remains a concern, as little job creation seems to be evident. The partnership makes loans primarily in Northern California and real estate values of residential, commercial, multi-family properties and land are of particular interest to the partnership. Real estate is the primary security for the partnership's loans. The residential real estate market in California continues to appreciate. The Office of Federal Housing Enterprise Oversight reported that the state average home prices rose 13.8% in 2003. Southern California home price appreciation outpaced Northern California home price appreciation. Yet, even Santa Clara County had positive price appreciation in 2003. The residential market is not all positive. The luxury home market in the San Francisco Bay Area is still well below values posted in 1999 and 2000. The strong residential real estate outlook implies that collateral values behind the partnership's loans should remain firm and assist in reducing losses if the take back of collateral through the foreclosure process should eventuate. While the residential market outlook remains strong overall the commercial real estate market is not as strong. Commercial property values are chiefly tied to the income a property can produce. Vacancies in office properties since 2000 have risen sharply in the San Francisco Bay Area. In the fourth quarter of 2003 both BT Commercial Real Estate and Cornish and Carey Commercial/Oncor International reported declines in San Francisco peninsula office vacancies. Each reported about 1% declines to about 27.3%. Colliers International reported a decline in San Francisco office vacancy in the fourth quarter of 2003 from 17.3% to 16.9%. Rents have also continued to fall and in San Francisco the average is $29.31, which is down from $30.04 at the start of 2003. These statistics seem to indicate that the commercial rental market is stabilizing but that existing vacancies will take a long time to fill. Commercial real estate values have decreased but lowered capitalization rates have helped keep commercial property from large value reductions. The decrease in vacancies could mean improved cash flows for owners, which translates into improved debt service abilities As of December 31, 2003, the partnership had an average loan to value ratio based upon appraisals and prior liens as of the date the loan was made of 53.97%. This did 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. The foregoing analysis of year 2003 issues includes forward-looking statements and predictions about possible or 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 future events. No assurance can be given that any of these statements or predictions will ultimately prove to be correct or substantially correct. 17 Item 7a - 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 our line of credit as of December 31, 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 2004 through 2008 and separately aggregates the information for all maturities arising after 2008. The carrying values of these assets and liabilities approximate their fair market values as of December 31, 2003 (in thousands). 2004 2005 2006 2007 2008 Thereafter Total --------- --------- --------- --------- --------- ---------- --------- Interest earning assets: Money market accounts $ 7,503 $ 7,503 Average interest rate 1.00% 1.00% Loans secured by deeds of trust $ 41,774 $ 59,496 $ 31,165 $ 8,138 $ 3,390 $ 3,211 $147,174 Average interest rate 11.17% 10.17% 10.19% 10.45% 9.89% 10.32% 10.47% Interest bearing liabilities Line of credit $ 22,000 - - - - - $ 22,000 Average interest rate 4.00% - - - - - 4.00% 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 (100% as of December 31, 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 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. PORTFOLIO REVIEW - For the years ended December 31, 2001, 2002 and 2003. Secured Loan Portfolio. The partnership's secured loan portfolio consists primarily of short-term (one to five years), fixed rate loans secured by real estate. As of December 31, 2001, 2002 and 2003 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 $68,291,000 (82.50%), $61,741,000 (73.81%) and $107,211,000 (72.85%) of the outstanding secured 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. 18 The following table sets forth the distribution of loans held by the partnership by property type for the years ended December 31, 2001, 2002 and 2003 (in thousands): December 31, ------------------------------------------------------------------------------------ 2001 2002 2003 ------------------------ ------------------------ ------------------------ Single family homes (1-4 units) $ 37,542 45.35% $ 36,574 43.72% $ 66,631 45.27% Apartments (over 4 units) 7,337 8.86% 6,572 7.86% 22,649 15.39% Commercial 32,105 38.78% 32,089 38.36% 52,502 35.67% Land 5,806 7.01% 8,415 10.06% 5,392 3.67% ---------- ---------- ---------- ---------- ---------- --------- Total $ 82,790 100.00% $ 83,650 100.00% $147,174 100.00% ========== ========== ========== ========== ========== ========= As of December 31, 2003, the partnership held 81 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 December 31, 2003. PRIORITIES, ASSET CONCENTRATIONS AND MATURITIES OF SECURED LOANS As of December 31, 2003 (in thousands) # of Loans Amount Percent ---------- ----------- ----------- 1st Mortgages 43 $ 84,437 57.37% 2nd Mortgages 35 61,247 41.62% 3rd Mortgages 3 1,490 1.01% ========== =========== =========== Total 81 $147,174 100.00% Maturing in 2004 23 $ 41,774 28.38% Maturing in 2005 18 59,496 40.43% Maturing in 2006 17 31,165 21.18% Maturing after 12/31/06 23 14,739 10.01% ========== =========== =========== Total 81 $147,174 100.00% Average secured loan as a % of secured loan portfolio $ 1,817 1.23% Largest secured loan as a % of secured loan portfolio 16,010 10.88% Smallest secured loan as a % of secured loan portfolio 40 0.03% Average secured loan-to-value at time of loan based on appraisals and prior liens at time of loan 53.97% Largest secured loan as a % of partnership assets 16,010 11.54% 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. 19 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 December 31, 2003 the general partners have determined that the allowance for loan losses of $2,649,000 (1.91% 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 December 31, 2003, 16 loans were delinquent over 90 days amounting to $27,182,000. Additionally, $3,693,000 of these delinquent loans were subject to workout agreements. The partnership also makes loans requiring periodic disbursements of funds. As of December 31, 2003 there were eleven such loans. These loans include ground up construction of buildings and loans for rehabilitation of existing structures. Interest on these loans is computed at simple interest method and only on the amounts disbursed on a daily basis. A summary of the status of the partnership's loans, which are periodically disbursed as of December 31, 2003, is set forth below (in thousands): Complete Construction Rehabilitation ---------------------- ----------------- Disbursed funds $ 13,899 $21,978 Undisbursed funds $ 11,540 $ 3,202 Item 8 - Consolidated Financial Statements and Supplementary Data A - Consolidated Financial Statements The following financial statements of Redwood Mortgage Investors VIII are included in Item 8: o Independent Auditors' Report o Consolidated Balance Sheets - December 31, 2003, and December 31, 2002 o Consolidated Statements of Income for the years ended December 31, 2003, 2002 and 2001 o Consolidated Statements of Changes In Partners' Capital for the years ended December 31, 2003, 2002 and 2001 o Consolidated Statements of Cash Flows for the years ended December 31, 2003, 2002 and 2001 o Notes to Consolidated Financial Statements B - Consolidated Financial Statement Schedules The following consolidated financial statement schedules of Redwood Mortgage Inventors VIII are included in Item 8. o Schedule II - Valuation and Qualifying Accounts o Schedule IV - Loans on Real Estate All other schedules for which provision is made in the applicable accounting regulations of the Securities and Exchange Commission are not required under the related instructions or are inapplicable, and therefore have been omitted. 20 REDWOOD MORTGAGE INVESTORS VIII (A CALIFORNIA LIMITED PARTNERSHIP) CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 2003 AND 2002 AND FOR EACH OF THE THREE YEARS IN THE PERIOD ENDED DECEMBER 31, 2003 21 TABLE OF CONTENTS Page No. Independent Auditors' Report 23 Consolidated Balance Sheets 24 Consolidated Statements of Income 25 Consolidated Statements of Changes in Partners' Capital 26 Consolidated Statements of Cash Flows 28 Notes to Consolidated Financial Statements 29 Supplemental Schedules Schedule II - Valuation and Qualifying Accounts 44 Schedule IV - Mortgage Loans on Real Estate 45 Rule 12-29 Loans on Real Estate 22 ARMANINO McKENNA LLP CERTIFIED PUBLIC ACCOUNTANTS 12667 Alcosta Blvd., Suite 500 San Ramon, CA 94583 (925) 790-2600 INDEPENDENT AUDITORS' REPORT To the Partners Redwood Mortgage Investors VIII Redwood City, California We have audited the accompanying consolidated balance sheets of Redwood Mortgage Investors VIII (a California limited partnership) as of December 31, 2003 and 2002 and the related consolidated statements of income, changes in partners' capital and cash flows for each of the three years in the period ended December 31, 2003. These consolidated financial statements are the responsibility of the Partnership's management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits. We conducted our audits in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Redwood Mortgage Investors VIII as of December 31, 2003 and 2002 and the results of its operations and cash flows for each of the three years in the period ended December 31, 2003, in conformity with accounting principles generally accepted in the United States of America. Our audits were conducted for the purpose of forming an opinion on the basic consolidated financial statements taken as a whole. Schedule II and IV are presented for purposes of additional analysis and are not a required part of the basic consolidated financial statements. Such information has been subjected to the auditing procedures applied in the audits of the basic consolidated financial statements and, in our opinion, is fairly stated in all material respects in relation to the basic consolidated financial statements taken as a whole. ARMANINO McKENNA LLP San Ramon, California February 13, 2004 23 REDWOOD MORTGAGE INVESTORS VIII (A California Limited Partnership) CONSOLIDATED BALANCE SHEETS DECEMBER 31, 2003 AND 2002 (in thousands) ASSETS 2003 2002 ----------- ---------- Cash and cash equivalents $ 8,921 $ 7,188 ----------- ---------- Loans Loans secured by deeds of trust 147,174 83,650 Loans, unsecured 34 - Allowance for loan losses (2,649) (3,021) ----------- ---------- Net loans 144,559 80,629 ----------- ---------- Interest and other receivables Accrued interest and late fees 4,735 3,913 Advances on loans 416 279 Other receivables - 888 ----------- ---------- Total interest and other receivables 5,151 5,080 ----------- ---------- Other assets Loan origination fees, net 44 22 Real estate held for sale, net 3,979 9,286 ----------- ---------- Total other assets 4,023 9,308 ----------- ---------- Total assets $ 162,654 $ 102,205 =========== ========== LIABILITIES AND PARTNERS' CAPITAL Liabilities Line of credit $ 22,000 $ - Accounts payable 224 449 Payable to affiliate 448 294 Deferred interest - 112 Note payable - 1,782 ----------- ---------- Total liabilities 22,672 2,637 ----------- ---------- Minority interest - 1,213 ----------- ---------- Investors in applicant status 1,210 2,578 ----------- ---------- Partners' capital Limited partners' capital, subject to redemption, net of unallocated syndication costs of $875 and $592 for 2003 and 2002, respectively; and net of formation loan receivable of $7,550 and $5,258 for 2003 and 2002, respectively 138,649 95,690 General partners' capital, net of unallocated syndication costs of $9 and $6 for 2003 and 2002, respectively 123 87 ----------- ---------- Total partners' capital 138,772 95,777 ----------- ---------- Total liabilities and partners' capital $ 162,654 $ 102,205 =========== ========== The accompanying notes are an integral part of these consolidated financial statements. 24 REDWOOD MORTGAGE INVESTORS VIII (A California Limited Partnership) CONSOLIDATED STATEMENTS OF INCOME FOR THE YEARS ENDED DECEMBER 31, 2003, 2002 AND 2001 (in thousands, except for per limited partner amounts) 2003 2002 2001 ------------ ----------- ---------- Revenues Interest on loans $ 12,496 $ 11,416 $ 8,920 Late fees 201 114 99 Other 262 161 69 ----------- ----------- ---------- 12,958 11,691 9,088 ----------- ----------- ---------- Expenses Mortgage servicing fees 1,057 1,098 552 Interest expense 71 516 972 Amortization of loan origination fees 23 12 14 Provision for losses on loans 782 780 957 Provision for losses on real estate - 500 - Asset management fees 468 325 158 Clerical costs from Redwood Mortgage Corp. 290 266 241 Professional services 111 66 13 Broker expense 181 444 - Amortization of discount on imputed interest 195 154 53 Other 228 44 35 ----------- ----------- ---------- 3,406 4,205 2,995 ----------- ----------- ---------- Income before minority interest 9,552 7,486 6,093 Minority interest share of subsidiary loss 42 - - ----------- ----------- ---------- Net income $ 9,594 $ 7,486 $ 6,093 =========== =========== ========== Net income General partners (1%) $ 96 $ 75 $ 61 Limited partners (99%) 9,498 7,411 6,032 ----------- ----------- ---------- $ 9,594 $ 7,486 $ 6,093 =========== =========== ========== Net income per $1,000 invested by limited partners for entire period Where income is reinvested and compounded $ 78 $ 87 $ 90 Where partner receives income in monthly distributions $ 75 $ 84 $ 86 The accompanying notes are an integral part of these consolidated financial statements. 25 REDWOOD MORTGAGE INVESTORS VIII (A California Limited Partnership) CONSOLIDATED STATEMENTS OF CHANGES IN PARTNERS' CAPITAL FOR THE YEARS ENDED DECEMBER 31, 2003, 2002 AND 2001 (in thousands) Limited Partners --------------------------------------------------------- Partners Capital Total In Account Unallocated Formation Limited Applicant Limited Syndication Loan, Partners' Status Partners' Costs Gross Capital ----------- ----------- ----------- ----------- ----------- Balances at December 31, 2000 $ 225 $ 56,502 $ (311) $ (3,011) $ 53,180 Contributions on application 19,712 - - - - Formation loan increases - - - (1,462) (1,462) Formation loan payments received - - - 300 300 Interest credited to partners in applicant status 1 - - - - Transfers to partners' capital (19,265) 19,245 - - 19,245 Net income - 6,032 - - 6,032 Syndication costs incurred - - (291) - (291) Allocation of syndication costs - (178) 178 - - Partners' withdrawals - (3,317) - - (3,317) Early withdrawal penalties - (70) 24 46 - ------------ ----------- ----------- ----------- ----------- Balances at December 31, 2001 673 78,214 (400) (4,127) 73,687 Contributions on application 21,563 - - - - Formation loan increases - - - (1,677) (1,677) Formation loan payments received - - - 530 530 Interest credited to partners in applicant status 1 - - - - Transfers to partners' capital (19,659) 19,659 - - 19,659 Net income - 7,411 - - 7,411 Syndication costs incurred - - (377) - (377) Allocation of syndication costs - (178) 178 - - Partners' withdrawals - (3,543) - - (3,543) Early withdrawal penalties - (23) 7 16 - ------------ ----------- ----------- ----------- ----------- Balances at December 31, 2002 2,578 101,540 (592) (5,258) 95,690 Contributions on application 40,030 - - - - Formation loan increases - - - (2,929) (2,929) Formation loan payments received - - - 575 575 Interest credited to partners in applicant status 37 - - - - Interest withdrawn (14) - - - - Transfers to partners' capital (41,421) 41,421 - - 41,421 Net income - 9,498 - - 9,498 Syndication costs incurred - - (478) - (478) Allocation of syndication costs - (178) 178 - - Partners' withdrawals - (5,128) - - (5,128) Early withdrawal penalties - (79) 17 62 - ------------ ----------- ----------- ----------- ----------- Balances at December 31, 2003 $ 1,210 $ 147,074 $ (875) $ (7,550) $ 138,649 ============ =========== =========== =========== =========== The accompanying notes are an integral part of these consolidated financial statements. 26 REDWOOD MORTGAGE INVESTORS VIII (A California Limited Partnership) CONSOLIDATED STATEMENTS OF CHANGES IN PARTNERS' CAPITAL (continued) FOR THE YEARS ENDED DECEMBER 31, 2003, 2002 AND 2001 (in thousands) General Partners ------------------------------------------- Capital Total Account Unallocated General Total General Syndication Partners' Partners' Partners' Costs Capital Capital ----------- ----------- ----------- ----------- Balances at December 31, 2000 $ 51 $ (3) $ 48 $ 53,228 Contributions on application - - - - Formation loan increases - - - (1,462) Formation loan payments received - - - 300 Interest credited to partners in applicant status - - - - Capital contributed 20 - 20 19,265 Net income 61 - 61 6,093 Syndication costs incurred - (3) (3) (294) Allocation of syndication costs (2) 2 - - Partners' withdrawals (59) - (59) (3,376) Early withdrawal penalties - - - - ----------- ----------- ----------- ----------- Balances at December 31, 2001 71 (4) 67 73,754 Contributions on application - - - - Formation loan increases - - - (1,677) Formation loan payments received - - - 530 Interest credited to partners in applicant status - - - - Capital contributed 22 - 22 19,681 Net income 75 - 75 7,486 Syndication costs incurred - (4) (4) (381) Allocation of syndication costs (2) 2 - - Partners' withdrawals (73) - (73) (3,616) Early withdrawal penalties - - - - ----------- ----------- ----------- ----------- Balances at December 31, 2002 93 (6) 87 95,777 Contributions on application - - - - Formation loan increases - - - (2,929) Formation loan payments received - - - 575 Interest credited to partners in applicant status - - - - Interest withdrawn - - - - Capital contributed 40 - 40 41,461 Net income 96 - 96 9,594 Syndication costs incurred - (5) (5) (483) Allocation of syndication costs (2) 2 - - Partners' withdrawals (95) - (95) (5,223) Early withdrawal penalties - - - - ----------- ----------- ----------- ----------- Balances at December 31, 2003 $ 132 $ (9) $ 123 $ 138,772 =========== =========== =========== =========== The accompanying notes are an integral part of these consolidated financial statements. 27 REDWOOD MORTGAGE INVESTORS VIII (A California Limited Partnership) CONSOLIDATED STATEMENTS OF CASH FLOWS FOR THE YEARS ENDED DECEMBER 31, 2003, 2002 AND 2001 (in thousands) 2003 2002 2001 ----------- ----------- ----------- Cash flows from operating activities Net income $ 9,594 $ 7,486 $ 6,093 Adjustments to reconcile net income to net cash provided by operating activities Amortization of loan fees 23 12 14 Imputed interest income (195) (154) (53) Amortization of discount 195 154 53 Provision for loan and real estate losses 782 1,280 957 Realized loss on sale of real estate 127 - - Minority interest share of subsidiary loss (42) - - Change in operating assets and liabilities Unsecured loans - 4 50 Accrued interest and late fees (3,448) (1,253) (2,306) Advances on loans (500) (312) (23) Other receivables 888 (888) - Loan origination fees (45) (28) (7) Accounts payable (225) 375 44 Payable to affiliate 154 185 109 Deferred interest (112) 112 (82) ----------- ----------- ----------- Net cash provided by operating activities 7,196 6,973 4,849 ----------- ----------- ----------- Cash flows from investing activities Loans originated (96,820) (32,601) (47,512) Principal collected on loans 35,097 26,083 33,239 Payments for development of real estate (706) (219) - Proceeds from disposition of real estate 6,036 - - ----------- ----------- ----------- Net cash used in investing activities (56,393) (6,737) (14,273) ----------- ----------- ----------- Cash flows from financing activities Borrowings (repayments) on line of credit, net 22,000 (11,400) (5,000) Repayments on note payable (1,782) (7) - Contributions by partner applicants 40,093 21,586 19,713 Partners' withdrawals (5,223) (3,616) (3,376) Syndication costs paid (483) (381) (294) Formation loan lending (2,929) (1,677) (1,462) Formation loan collections 575 530 300 Distributions to minority interest (1,321) - - ----------- ----------- ----------- Net cash provided by financing activities 50,930 5,035 9,881 ----------- ----------- ----------- Net increase in cash and cash equivalents 1,733 5,271 457 Cash and cash equivalents - beginning of year 7,188 1,917 1,460 ----------- ----------- ----------- Cash and cash equivalents - end of year $ 8,921 $ 7,188 $ 1,917 =========== =========== =========== Supplemental disclosures of cash flow information Cash paid for interest, net $ 71 $ 516 $ 972 The accompanying notes are an integral part of these consolidated financial statements. 28 REDWOOD MORTGAGE INVESTORS VIII (A California Limited Partnership) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 2003, 2002 AND 2001 1. Organizational and General Redwood Mortgage Investors VIII, a California Limited Partnership (the "Partnership"), was organized in 1993. The general partners are Michael R. Burwell, an individual, Gymno Corporation and Redwood Mortgage Corp., both California corporations. The Partnership was organized to engage in business as a mortgage lender for the primary purpose of making loans secured by deeds of trust on California real estate. Loans are being arranged and serviced by Redwood Mortgage Corp., a general partner. At December 31, 2003, the Partnership was in its fifth offering stage, wherein contributed capital totaled $131,269,000 of approved aggregate offerings of $200,000,000. As of December 31, 2003 and 2002, $1,210,000 and $2,578,000, respectively, remained in applicant status, and total Partnership units sold were in the aggregate of $131,269,000 and $91,239,000, respectively. A minimum of $250,000 and a maximum of $15,000,000 in Partnership units were initially offered through qualified broker-dealers. This initial offering closed in October 1996. In December 1996, the Partnership commenced a second offering of an additional $30,000,000, which closed on August 30, 2000. On August 31, 2000, the Partnership commenced a third offering for an additional $30,000,000, which closed in April 2002. On October 31, 2002, the Partnership commenced a fourth offering for an additional $50,000,000, which closed in October 2003. On October 7, 2003, the Partnership commenced a fifth offering for an additional $75,000,000. As loans are identified, partners are transferred from applicant status to admitted partners participating in loan operations. Sales commissions - formation loans Sales commissions are not paid directly by the Partnership out of the offering proceeds. Instead, the Partnership loans to Redwood Mortgage Corp., one of the general partners, amounts to pay all sales commissions and amounts payable in connection with unsolicited orders. This loan is unsecured and non-interest bearing and is referred to as the "formation loan." The formation loan relating to the initial offering ($15,000,000) totaled $1,075,000, which was 7.2% of limited partners' contributions of $14,932,000. It is being repaid, without interest, in ten annual installments of $107,000, which commenced on January 1, 1997, following the year the initial offering closed. The formation loan relating to the second offering ($30,000,000) totaled $2,272,000, which was 7.6% of limited partners' contributions of $29,993,000. It is being repaid, without interest, in ten equal annual installments of $201,000, which commenced on January 1, 2001, following the year the second offering closed. Additional payments on this loan were also made during the offering period. The formation loan relating to the third offering ($30,000,000) totaled $2,218,000, which was 7.4% of the limited partners' contributions of $29,999,000. It is to be repaid, without interest, in ten annual installments of $178,000, which commenced on January 1, 2003. Additional payments on this loan were also made during the offering stage. The formation loan relating to the fourth offering ($50,000,000) totaled $3,777,000, which was 7.6% of the limited partners contributions of $49,985,000. It is to be repaid, without interest, in ten annual installments of $365,000, which will commence on January 1, 2004. Additional payments on this loan were also made during the offering stage. The formation loan relating to the fifth offering ($75,000,000) totaled $453,000 as of December 31, 2003, which was 7.1% of the limited partners contributions of $6,360,000 through December 31, 2003. An equal annual repayment schedule on this loan, without interest, will commence in the year subsequent to the closing of this offering. 29 REDWOOD MORTGAGE INVESTORS VIII (A California Limited Partnership) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 2003, 2002 AND 2001 1. Organizational and General (continued) Sales commissions - formation loans (continued) For the offerings, sales commissions paid to brokers range from 0% (units sold by general partners) to 9% of gross proceeds. The Partnership anticipates that the sales commissions will approximate 7.6% based on the assumption that 65% of investors will elect to reinvest earnings, thus generating full 9% commissions. The principal balance of the formation loan will increase as additional sales of units are made. The amount of the annual installment payment to be made by Redwood Mortgage Corp., during the offering stage, will be determined at annual installments of one-tenth of the principal balance of the formation loan as of December 31 of each year. The following summarizes formation loan transactions to December 31, 2003 (in thousands): Initial Subsequent Third Fourth Fifth Offering of Offering of Offering of Offering of Offering of $15,000 $30,000 $30,000 $50,000 $75,000 Total ------------ ------------- ------------ ------------ ------------ ------------ Limited Partner contributions $ 14,932 $ 29,993 $ 29,999 $ 49,985 $ 6,360 $ 131,269 ============ ============= ============ ============ ============ ============ Formation loan made $ 1,075 $ 2,272 $ 2,218 $ 3,777 $ 453 $ 9,795 Discount on imputed interest (48) (435) (367) (757) (86) (1,693) ------------ ------------- ------------ ------------ ------------ ------------ Formation loan made, net 1,027 1,837 1,851 3,020 367 8,102 Repayments to date (690) (837) (384) (130) - (2,041) Early withdrawal penalties applied (63) (88) (53) - - (204) ------------ ------------- ------------ ------------ ------------ ------------ Formation loan, net at December 31, 2003 274 912 1,414 2,890 367 5,857 Unamortized discount on imputed interest 48 435 367 757 86 1,693 ------------ ------------- ------------ ------------ ------------ ------------ Balance, December 31, 2003 $ 322 $ 1,347 $ 1,781 $ 3,647 $ 453 $ 7,550 ============ ============= ============ ============ ============ ============ Percent loaned 7.2% 7.6% 7.4% 7.6% 7.1% 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., the deduction from capital will be reduced. Interest has been imputed at the market rate of interest in effect at the date the offerings closed. During 2003, 2002 and 2001 amortization expense of $195,000, $154,000 and $53,000, respectively, was recorded related to the discount on imputed interest. 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 individual partners consistent with the partnership agreement. 30 REDWOOD MORTGAGE INVESTORS VIII (A California Limited Partnership) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 2003, 2002 AND 2001 1. Organizational and General (continued) Syndication costs (continued) Through December 31, 2003, syndication costs of $2,553,000 had been incurred by the Partnership with the following distribution (in thousands): Costs incurred $ 2,553 Early withdrawal penalties applied (88) Allocated to date (1,581) ----------- December 31, 2003 balance $ 884 =========== Syndication costs attributable to the initial offering ($15,000,000) were limited to the lesser of 10% of the gross proceeds or $600,000 with any excess being paid by the general partners. Applicable gross proceeds were $14,932,000. Related expenditures totaled $582,000 ($570,000 syndication costs plus $12,000 organization expense) or 3.9%. Syndication costs attributable to the second offering ($30,000,000) were limited to the lesser of 10% of the gross proceeds or $1,200,000 with any excess being paid by the general partners. Gross proceeds of the second offering were $29,993,000. Syndication costs totaled $598,000 or 2% of contributions. Syndication costs attributable to the third offering ($30,000,000) were limited to the lesser of 10% of the gross proceeds or $1,200,000 with any excess being paid by the general partners. Gross proceeds of the third offering were $29,999,000. Syndication costs totaled $643,000 or 2% of contributions. 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. Gross proceeds of the fourth offering were $49,985,000. Syndication costs totaled $658,000 or 1.3% of contributions. Syndication costs attributable to the fifth offering ($75,000,000) will be limited to the lesser of 10% of the gross proceeds or $3,000,000 with any excess to be paid by the general partners. As of December 31, 2003, the fifth offering had incurred syndication costs of $84,000 (1.3% of contributions). Term of the partnership The Partnership is scheduled to terminate on December 31, 2032, unless sooner terminated as provided in the partnership agreement. 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. 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 presentation. 31 REDWOOD MORTGAGE INVESTORS VIII (A California Limited Partnership) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 2003, 2002 AND 2001 2. Summary of Significant Accounting Policies (continued) Management estimates The preparation of consolidated 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 consolidated 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. Loans, secured by deeds of trust Loans generally are stated at their outstanding unpaid principal balance with interest thereon being accrued by the effective interest method. 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 loan is 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. At December 31, 2003 and 2002, there were no loans categorized as impaired by the Partnership. The average recorded investment in impaired loans was $0 for 2003 and $355,000 for 2002 and 2001. At December 31, 2003 and 2002, the Partnership had sixteen and twenty loans past due 90 days or more totaling $27,182,000 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 is still accruing interest on these loans. As presented in Note 11 to the consolidated financial statements, the average loan to appraised value of security based upon appraised values and prior indebtedness at the time the loans were consummated for loans outstanding at December 31, 2003 and 2002 was 53.97% and 60.61%, respectively. When loans are considered impaired, the allowance for loan losses is updated to reflect the change in the valuation of collateral security. However, a low loan to value ratio has the tendency to minimize reductions for impairment. During 2003, the Partnership restructured three loans into a new loan and restructured two loans into an existing loan, both with lower interest rates. The amount restructured was $15,599,000. During 2002, the Partnership restructured three previously impaired loans into two new loans with a lower interest rate. The amount restructured was $1,090,000. 32 REDWOOD MORTGAGE INVESTORS VIII (A California Limited Partnership) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 2003, 2002 AND 2001 2. Summary of Significant Accounting Policies (continued) Allowance for loan losses Loans and the related accrued interest, late fees and advances are analyzed on a continuous basis for recoverability. Delinquencies are identified and followed as part of the loan system. Delinquencies are determined based upon contractual terms. 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 values, 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. The composition of the allowance for loan losses as of December 31, 2003 and 2002 was as follows (in thousands): 2003 2002 ----------- ---------- Specified loans $ 49 $ 120 General 2,600 2,901 ----------- ---------- $ 2,649 $ 3,021 =========== ========== Activity in the allowance for loan losses is as follows for the years ended December 31, (in thousands): 2003 2002 2001 ---------- ----------- ---------- Beginning balance $ 3,021 $ 2,247 $ 1,345 Restructured loans - 11 - Additions charged to income 782 780 957 Write-offs (1,154) (17) (55) ---------- ---------- ---------- $ 2,649 $ 3,021 $ 2,247 ========== ========== ========== Cash and cash equivalents The Partnership considers all highly liquid financial instruments with maturities of three months or less at the time of purchase to be cash equivalents. Real estate held for sale 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. The Partnership increased the allowance for losses on real estate held for sale by $500,000 during the year ended December 31, 2002. 33 REDWOOD MORTGAGE INVESTORS VIII (A California Limited Partnership) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 2003, 2002 AND 2001 2. Summary of Significant Accounting Policies (continued) Loan origination fees The Partnership capitalizes fees for obtaining bank financing. The fees are amortized over the life of the financing using the straight-line method. 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 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. Late fee revenue Late fees are generally charged at 6% of the monthly installment payment past due. During 2003, 2002 and 2001, late fee revenue of $201,000, $114,000 and $99,000, respectively, was recorded. The Partnership has a recorded late fee receivable at December 31, 2003 and 2002 of $193,000 and $133,000, respectively. Recently issued accounting pronouncements In November 2002, the Financial Accounting Standards Board (FASB) issued FASB Interpretation 45, "Guarantor's Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others" (FIN 45). FIN 45 requires the recognition of liabilities for guarantees that are issued or modified subsequent to December 31, 2002. The liabilities should reflect the fair value, at inception, of the guarantor's obligations to stand ready to perform, in the event that the specified triggering events or conditions occur. The implementation of FIN 45 did not have any significant effect on the Partnership. In January 2003, FASB issued FASB Interpretation 46 "Consolidation of Variable Interest Entities, an Interpretation of ARB No. 51" (FIN 46). FIN 46 is effective immediately for any variable interest entities created after January 31, 2003 and is effective beginning in the third quarter of 2003 to any variable interest entities created prior to the issuance of the interpretation. FIN 46 provides a new framework to identify variable interest entities and to determine when an entity should include the assets, liabilities, non-controlling interests and the results of activities of a variable interest entity in its financial statements. The implementation of FIN 46 did not have any significant effect on the Partnership. 34 REDWOOD MORTGAGE INVESTORS VIII (A California Limited Partnership) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 2003, 2002 AND 2001 2. Summary of Significant Accounting Policies (continued) Recently issued accounting pronouncements (continued) In December 2003, the American Institute of Certified Public Accountants (AICPA) Accounting Standards Executive Committee (AcSEC) issued Statement of Position 03-03, "Accounting for Certain Loans or Debt Securities Acquired in a Transfer"(SOP 03-3). SOP 03-03 is effective for loans acquired in fiscal years beginning after December 15, 2004, with early adoption encouraged. SOP 03-03 addresses accounting for differences between contractual cash flows and cash flows expected to be collected from an investor's initial investment in loans or debt securities acquired in a transfer if those differences are attributable, at least in part, to credit quality. It includes loans acquired in business combinations and applies to all nongovernmental entities, including not-for-profit organizations. The SOP does not apply to loans originated by the entity. The implementation of SOP 03-03 is not anticipated to have any significant effect on the Partnership. 3. Other Partnership Provisions The Partnership is a California limited partnership. The rights, duties and powers of the general and limited partners of the Partnership are governed by the limited partnership agreement and Sections 15611 et seq. of the California Corporations Code. The general partners are in complete control of the Partnership business, subject to the voting rights of the limited partners on specified matters. Any one of the general partners acting alone has the power and authority to act for and bind the Partnership. A majority of the outstanding limited partnership interests may, without the permission of the general partners, vote to: (i) terminate the Partnership, (ii) amend the limited partnership agreement, (iii) approve or disapprove the sale of all or substantially all of the assets of the Partnership and (iv) remove or replace one or all of the general partners. The approval of all the limited partners is required to elect a new general partner to continue the Partnership business where there is no remaining general partner after a general partner ceases to be a general partner other than by removal. Applicant status Subscription funds received from purchasers of Partnership units are not admitted to the Partnership until appropriate lending opportunities are available. During the period prior to the time of admission, which is anticipated to be between 1 - 90 days, purchasers' subscriptions will remain irrevocable and will earn interest at money market rates, which are lower than the anticipated return on the Partnership's loan portfolio. During 2003, 2002 and 2001, interest totaling $37,000, $1,000 and $1,000, respectively, was credited to partners in applicant status. As loans were made and partners were transferred to regular status to begin sharing in income from loans secured by deeds of trust, the interest credited was either paid to the investors or transferred to partners' capital along with the original investment. Election to receive monthly, quarterly or annual distributions At subscription, investors elect to receive monthly, quarterly or annual distributions of earnings allocations, or to allow earnings to compound. Subject to certain limitations, a compounding investor may subsequently change his election, but an investor's election to have cash distributions is irrevocable. 35 REDWOOD MORTGAGE INVESTORS VIII (A California Limited Partnership) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 2003, 2002 AND 2001 3. Other Partnership Provisions (continued) 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. Liquidity, capital withdrawals and early withdrawals There are substantial restrictions on transferability of Partnership units and accordingly an investment in the Partnership is non-liquid. Limited partners have no right to withdraw from the Partnership or to obtain the return of their capital account for at least one year from the date of purchase of units. In order to provide a certain degree of liquidity to the limited partners after the one-year period, limited partners may withdraw all or part of their capital accounts from the Partnership in four quarterly installments beginning on the last day of the calendar quarter following the quarter in which the notice of withdrawal is given, subject to a 10% early withdrawal penalty. The 10% penalty is applicable to the amount withdrawn as stated in the notice of withdrawal and will be deducted from the capital account. After five years from the date of purchase of the units, limited partners have the right to withdraw from the Partnership on an installment basis. Generally this is done over a five-year period in twenty quarterly installments. Once a limited partner has been in the Partnership for the minimum five-year period, no penalty will be imposed if withdrawal is made in twenty quarterly installments or longer. Notwithstanding the five-year (or longer) withdrawal period, the general partners may liquidate all or part of a limited partner's capital account in four quarterly installments beginning on the last day of the calendar quarter following the quarter in which the notice of withdrawal is given. This withdrawal is subject to a 10% early withdrawal penalty applicable to any sums withdrawn prior to the time when such sums could have been withdrawn without penalty. The Partnership will not establish a reserve from which to fund withdrawals and, accordingly, the Partnership's capacity to return a limited partner's capital is restricted to the availability of Partnership cash flow. Furthermore, no more than 20% of the total limited partners' capital accounts outstanding at the beginning of any year, shall be liquidated during any calendar year. Guaranteed interest rate for offering period For the first three offerings, the general partners guaranteed an earnings rate equal to the greater of actual earnings from mortgage operations or 2% above The Weighted Average Cost of Funds Index for the Eleventh District Savings Institutions (Savings & Loan & Thrift Institutions) as computed by the Federal Home Loan Bank of San Francisco on a monthly basis, up to a maximum interest rate of 12%. The interest rate was guaranteed during the period commencing with the day a limited partner was admitted to the Partnership and ended three months after the initial through third offering termination date, which in all cases was August 2002. Through August 2002, actual earnings exceeded the guaranteed amount for each month. 36 REDWOOD MORTGAGE INVESTORS VIII (A California Limited Partnership) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 2003, 2002 AND 2001 4. 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, the Partnership may collect an amount equivalent to 12% of the loaned amount until 6 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. In 2003, 2002 and 2001, loan brokerage commissions paid by the borrowers were $2,621,000, $996,000 and $1,156,000, respectively. 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. Mortgage servicing fees of $1,057 000, $1,098,000 and $552,000 were incurred for 2003, 2002 and 2001, respectively. The Partnership has a payable to Redwood Mortgage Corp. for servicing fees of $448,000 and $294,000 at December 31, 2003 and 2002, respectively. Asset management fee The general partners receive monthly fees for managing the Partnership's loan portfolio and operations up to 1/32 of 1% of the "net asset value" (3/8 of 1% annual). Asset management fees of $468,000, $325,000 and $158,000 were incurred for 2003, 2002 and 2001, respectively. 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 Redwood Mortgage Corp., a general partner, is reimbursed by the Partnership for all operating expenses 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. During 2003, 2002 and 2001, operating expenses totaling $290,000, $266,000 and $241,000, respectively, were reimbursed to Redwood Mortgage Corp. Contributed capital The general partners jointly or severally are to contribute 1/10 of 1% of limited partners' contributions in cash contributions as proceeds from the offerings are received from the limited partners. As of December 31, 2003 and 2002, Gymno Corporation, a general partner, had capital in accordance with Section 4.02(a) of the Partnership Agreement. 37 REDWOOD MORTGAGE INVESTORS VIII (A California Limited Partnership) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 2003, 2002 AND 2001 5. Real Estate Held for Sale During 2002, the Partnership contributed its interests in two foreclosed real properties into two limited liability companies ("LLCs"). The following schedule reflects the cost of the LLCs' properties and recorded reductions to estimated fair values at December 31, (in thousands): 2003 2002 ----------- ----------- Costs of properties $ 4,479 $ 9,786 Reduction in value (500) (500) ----------- ----------- Real estate held for sale, net $ 3,979 $ 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, liabilities and operating results of Russian have been consolidated into the accompanying consolidated financial statements of the Partnership. Costs related to the sale of this property are being capitalized; thus, there was no income or expense recognized by Russian during 2003 and 2002. As of December 31, 2003 and 2002, the Partnership had advanced approximately $94,000 and $37,000, respectively, to Russian for sales costs. At December 31, 2003 and 2002, the Partnership's total investment in Russian was $3,979,000 and $3,913,000, net of a valuation allowance of $500,000. 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 7). 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. The assets, liabilities and operating results of Stockton have been consolidated into the accompanying consolidated financial statements of the Partnership. Development costs were capitalized during construction; thus, there was no income or expense recognized by Stockton during 2002 and a portion of 2003. As of December 31, 2003 and 2002, advances of approximately $132,000 and $238,000 were made for construction and other related development costs and $48,000 and $87,000 of interest expense was capitalized, respectively. At December 31, 2002, the Partnership's total investment in Stockton was $5,373,000. As of December 31, 2003, the property had been sold and a net loss of $127,000 was incurred, of which $42,000 was allocated to the minority interest. 6. Bank Line of Credit The Partnership has a $22,000,000 bank line of credit through November 25, 2005, with borrowings at prime and secured by its loan portfolio. The outstanding balances were $22,000,000 and $0 at December 31, 2003 and 2002, respectively. The interest rate was 4.00% at December 31, 2003. The line of credit requires the Partnership to comply with certain financial covenants. The Partnership was in compliance with these covenants at December 31, 2003 and 2002. 38 REDWOOD MORTGAGE INVESTORS VIII (A California Limited Partnership) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 2003, 2002 AND 2001 7. Note Payable During 2002, the Partnership assumed a bank loan of $1,789,000 in connection with the foreclosure on a property (see Note 5). The loan was secured by the property and bore interest at 5.68%. As of December 31, 2003, this loan has been paid in full upon the sale of the related property. 8. Income Taxes The following reflects a reconciliation of partners' capital reflected in the consolidated financial statements to the tax basis of Partnership capital (in thousands): 2003 2002 ----------- ----------- Partners' capital per consolidated financial statements $ 138,772 $ 95,777 Non-allocated syndication costs 884 598 Allowance for loan losses and real estate held for sale 3,149 3,521 Formation loans receivable 7,550 5,258 ----------- ----------- Partners' capital - tax basis $ 150,355 $ 105,154 =========== =========== In 2003 and 2002, approximately 47% of taxable income was allocated to tax-exempt organizations (i.e., retirement plans). 9. Fair Value of Financial Instruments The following methods and assumptions were used to estimate the fair value of financial instruments: (a) Cash and Cash Equivalents. The carrying amount equals fair value. All amounts, including interest bearing, are subject to immediate withdrawal. (b) Secured loans carrying value was $147,174,000 and $83,650,000 at December 31, 2003 and 2002, respectively. The fair value of these loans of $148,748,000 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. Non-cash Transactions During 2003, the Partnership restructured three loans that resulted in an increase to loans receivable of $2,989,000 and a decrease to accrued interest and advances of $2,626,000 and $363,000, respectively. During 2003, a previously secured loan became unsecured which resulted in a decrease to loans receivable of $34,000 and an increase to unsecured loans of $34,000. 39 REDWOOD MORTGAGE INVESTORS VIII (A California Limited Partnership) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 2003, 2002 AND 2001 10. Non-cash Transactions (continued) During 2002, the Partnership foreclosed on two properties (see Note 5), which resulted in an increase in real estate held for sale and notes payable of $8,354,000 and $1,789,000, respectively and a decrease in loans receivable, accrued interest and advances of $5,986,000, $383,000 and $196,000, respectively. During 2002, the Partnership restructured three loans that resulted in an increase to loans receivable and the allowance for loan losses of $345,000 and $11,000, respectively and a decrease to accrued interest and advances of $302,000 and $32,000, respectively. 11. Asset Concentrations and Characteristics Most loans are secured by recorded deeds of trust. At December 31, 2003 and 2002, there were 81 and 70 secured loans outstanding, respectively, with the following characteristics (dollars in thousands): 2003 2002 ---------- ---------- Number of secured loans outstanding 81 70 Total secured loans outstanding $ 147,174 $ 83,650 Average secured loan outstanding $ 1,817 $ 1,195 Average secured loan as percent of total 1.23% 1.43% Average secured loan as percent of partners' capital 1.31% 1.25% Largest secured loan outstanding $ 16,010 $ 4,943 Largest secured loan as percent of total 10.88% 5.91% Largest secured loan as percent of partners' capital 11.54% 5.16% Number of counties where security is located (all California) 20 15 Largest percentage of secured loans in one county 26.47% 27.22% Average secured loan to appraised value of security based on appraised values and prior liens at time loan was consummated 53.97% 60.61% Number of secured loans in foreclosure status 3 6 Amount of secured loans in foreclosure $ 2,931 $ 4,029 40 REDWOOD MORTGAGE INVESTORS VIII (A California Limited Partnership) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 2003, 2002 AND 2001 11. Asset Concentrations and Characteristics (continued) The following secured loan categories were held at December 31, 2003 and 2002 (in thousands): 2003 2002 ----------- ---------- First trust deeds $ 84,437 $ 46,117 Second trust deeds 61,247 30,930 Third trust deeds 1,490 6,603 ----------- ---------- Total loans 147,174 83,650 Prior liens due other lenders at time of loan 116,870 79,846 ----------- ---------- Total debt $ 264,044 $163,496 =========== ========== Appraised property value at time of loan $ 489,219 $269,773 Total loans as a percent of appraisals 53.97% 60.61% Loans by type of property Owner occupied homes $ 13,656 $ 12,854 Non-owner occupied homes 52,975 23,720 Apartments 22,649 6,572 Commercial 52,502 32,089 Land 5,392 8,415 ----------- ---------- $ 147,174 $ 83,650 =========== ========== The interest rates on the loans range from 7.50% to 18.00% at December 31, 2003. Scheduled maturity dates of secured loans as of December 31, 2003 are as follows (in thousands): Year Ending December 31, 2004 $ 41,774 2005 59,496 2006 31,165 2007 8,138 2008 3,390 Thereafter 3,211 ----------- $ 147,174 =========== The scheduled maturities for 2004 include nine loans totaling $10,767,000 (7.3%), which are past maturity at December 31, 2003. Interest payments on eight of these loans were delinquent and are included in total of loans 90 days or more delinquent presented in Note 2. Cash deposits per bank at December 31, 2003, exceeded federal insurance limits (up to $100,000 per bank) by approximately $9,446,000. 41 REDWOOD MORTGAGE INVESTORS VIII (A California Limited Partnership) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 2003, 2002 AND 2001 12. Commitments and Contingencies Construction loans The Partnership has construction loans on projects, which are at various stages of completion. The Partnership has approved the borrowers up to a maximum loan balance; however, disbursements are made during completion phases throughout the construction process. At December 31, 2003, there was $14,742,000 of undistributed construction loans. Workout agreements The Partnership has negotiated various workout agreements with borrowers. The Partnership is not obligated to fund additional money as of December 31, 2003. There are six loans totaling $4,227,000 in workout agreements as of December 31, 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. 13. Selected Financial Information (Unaudited) Calendar Quarter (in thousands) ------------------------------------------------ First Second Third Fourth Annual --------- ---------- --------- --------- --------- Revenues 2003 $ 2,789 $ 3,072 $ 3,225 $ 3,872 $12,958 2002 $ 2,591 $ 2,515 $ 3,165 $ 3,420 $11,691 2001 $ 2,151 $ 2,195 $ 2,265 $ 2,477 $ 9,088 Expenses 2003 $ 659 $ 711 $ 722 $ 1,272 $ 3,364 2002 $ 788 $ 665 $ 1,311 $ 1,441 $ 4,205 2001 $ 802 $ 711 $ 676 $ 806 $ 2,995 Net income allocated to general partners 2003 $ 21 $ 24 $ 25 $ 26 $ 96 2002 $ 18 $ 18 $ 19 $ 20 $ 75 2001 $ 13 $ 14 $ 15 $ 19 $ 61 Net income allocated to limited partners 2003 $ 2,109 $ 2,337 $ 2,478 $ 2,574 $ 9,498 2002 $ 1,784 $ 1,831 $ 1,836 $ 1,960 $ 7,411 2001 $ 1,335 $ 1,469 $ 1,573 $ 1,655 $ 6,032 42 REDWOOD MORTGAGE INVESTORS VIII (A California Limited Partnership) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 2003, 2002 AND 2001 13. Selected Financial Information (Unaudited) (continued) Calendar Quarter (in thousands) ---------------------------------------------- First Second Third Fourth Annual --------- --------- --------- -------- --------- Net income per $1,000 invested where income is reinvested 2003 $ 20 $ 19 $ 18 $ 21 $ 78 2002 $ 21 $ 21 $ 21 $ 24 $ 87 2001 $ 22 $ 22 $ 22 $ 24 $ 90 where income is withdrawn 2003 $ 20 $ 19 $ 18 $ 18 $ 75 2002 $ 21 $ 21 $ 21 $ 21 $ 84 2002 $ 22 $ 22 $ 20 $ 20 $ 86 14. Subsequent Events Subsequent to December 31, 2003 and through the date of this report, the Partnership has received $3,928,000 of new investor money for the current offering and had admitted $3,067,000 of partners in applicant status into the Partnership. 43 REDWOOD MORTGAGE INVESTORS VIII (A California Limited Partnership) SCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS December 31, 2003 (in thousands) Col. C Additions ---------------------------- Col. B Col. E Balance at Charged to Charged to Balance at Col. A Beginning Costs & Other Col. D End of Description of Period Expenses Accounts Deductions Period - ---------------------------------- ------------ ----------- ----------- ------------ ----------- Year Ended December 31, 2003 Deducted from asset accounts Allowance for loan losses $ 3,021 $ 782 $ - $ (1,154) (a) $ 2,649 Cumulative write-down of real estate held for sale (REO) 500 - - - 500 ------------ ----------- ------------ ------------- ------------ $ 3,521 $ 782 $ - $ (1,154) (a) $ 3,149 ============ =========== ============ ============= ============ Note (a) - Represents write-offs of loans. 44 REDWOOD MORTGAGE INVESTORS VIII (A California Limited Partnership) SCHEDULE IV - mortgage loans on real estate rule 12-29 loans on real estate December 31, 2003 (in thousands) Col. F Col. G Col. H Col. C Col. D Face Carrying Pr. Col. J Col. B Final Periodic Col. E Amt. Of Amount. Amount Col. I Geog. Col. A Interest Maturity Payment Prior Mortgage Mortgage Subj. to Type of County Desc. Rate Date Terms Liens Orig. Amt. Investment Delinquency Lien Location - ----------------------------------------------------------------------------------------------------------------------------- Comm. 11.75% 12/01/09 $ 3 $ - $ 148 $ 148 $ - 1st Yuba Comm. 14.00% 04/01/06 12 - 700 290 - 1st San Francisco Res. 13.50% 07/01/00 7 - 579 579 579 1st San Francisco Comm. 11.00% 10/01/07 6 - 650 626 - 1st San Francisco Res. 18.00% 03/01/00 11 580 951 762 762 2nd San Francisco Res. 12.00% 05/01/03 12 363 1,210 1,210 1,210 1st Marin Land 11.00% 01/01/01 13 363 1,800 1,392 1,392 2nd Stanislaus Land 11.00% 07/01/01 24 358 2,600 2,537 2,537 2nd Stanislaus Apts. 12.50% 11/15/02 4 47 39 298 298 2nd Contra Costa Land 11.00% 11/01/00 2 2,968 222 - - 3rd Stanislaus Comm. 11.50% 02/01/05 4 493 400 396 396 2nd San Francisco Land 11.50% 07/01/01 5 2,600 476 476 476 2nd Stanislaus Comm. 10.50% 06/01/06 7 - 775 759 - 1st San Mateo Apts. 12.00% 07/01/06 40 - 4,000 6,483 - 1st San Francisco Comm. 12.00% 05/01/07 9 2,916 799 789 - 2nd Santa Clara Res. 12.00% 03/01/01 13 - 1,325 1,325 1,325 1st Marin Res. 12.00% 05/01/03 - - 4,117 - - 3rd Santa Clara Apts. 11.50% 06/01/06 2 - 182 178 - 1st Merced Res. 13.25% 12/01/02 20 582 2,188 2,188 2,188 2nd Santa Clara Res. 13.25% 01/01/03 20 - 3,516 3,991 3,991 1st Napa Comm. 11.50% 08/01/06 4 - 350 282 - 1st San Mateo Res. 11.50% 12/01/06 1 167 70 69 - 2nd Stanislaus Res. 10.25% 12/01/04 3 978 300 300 - 2nd San Francisco Land 9.50% 02/01/04 8 - 987 987 - 1st Santa Clara Res. 11.00% 02/01/04 6 65 708 708 - 2nd Lake Comm. 11.00% 03/01/07 16 - 1,600 1,589 1,589 1st Alameda Res. 10.00% 12/01/02 3 - 318 316 316 1st San Mateo Comm. 7.50% 02/28/07 5 - 770 770 - 1st Santa Clara Comm. 7.50% 02/28/07 2 - 320 320 - 1st Alameda Res. 10.25% 04/01/05 14 - 1,650 2,300 - 1st Napa Comm. 13.00% 06/01/05 41 10,000 4,550 6,020 6,020 2nd Santa Clara Comm. 10.50% 08/01/04 32 - 3,600 3,600 - 1st Santa Clara Res. 10.25% 08/01/04 4 1,647 263 236 - 2nd Santa Clara Res. 10.50% 08/01/07 18 3,500 2,000 1,986 - 2nd San Francisco Res. 10.50% 09/01/07 2 1,468 805 270 - 3rd Santa Clara Res. 11.50% 09/01/05 12 - 1,300 1,300 1,300 1st Alameda Res. 10.50% 09/01/05 2 710 269 269 - 2nd San Mateo Res. 10.50% 10/01/05 16 - 1,781 1,781 1,781 1st San Mateo Comm. 10.50% 10/01/07 4 - 441 438 - 1st San Mateo 45 SCHEDULE IV (continued) Col. F Col. G Col. H Col. C Col. D Face Carrying Pr. Col. J Col. B Final Periodic Col. E Amt. Of Amount. Amount Col. I Geog. Col. A Interest Maturity Payment Prior Mortgage Mortgage Subj. to Type of County Desc. Rate Date Terms Liens Orig. Amt. Investment Delinquency Lien Location - --------------------------------------------------------------------------------------------------------------------------- Res. 10.50% 10/01/07 2 245 159 205 - 2nd San Mateo Comm. 11.25% 12/01/07 9 718 900 896 - 1st & 3rd El Dorado Res. 10.00% 11/01/05 11 500 1,320 1,320 1,320 2nd Napa Comm. 10.00% 12/01/07 2 1,802 250 249 - 2nd Sonoma Res. 12.75% 07/01/04 1 749 650 384 - 2nd Santa Clara Comm. 10.00% 01/01/08 13 - 1,500 1,500 - 1st River Side Comm. 13.00% 02/01/05 16 - 1,500 600 - 1st Calaveras Comm. 9.50% 02/01/06 11 - 1,388 1,388 - 1st Santa Clara Res. 10.00% 03/01/08 13 1,699 1,450 1,444 - 2nd El Dorado Comm. 1.00% 12/31/04 87 - 10,440 10,440 - 1st San Francisco Comm. 10.00% 03/01/08 1 546 137 136 - 2nd San Mateo Apts. 10.00% 10/14/05 79 13,768 9,420 4,372 - 2nd Alameda Comm. 9.75% 05/01/13 4 - 420 418 - 1st San Francisco Res. 11.50% 12/01/04 41 - 7,700 5,345 - 1st San Mateo Comm. 10.00% 04/01/05 47 - 5,293 5,816 - 1st Los Angeles Apts. 10.00% 05/01/05 3 - 396 396 - 1st Alameda Res. 11.50% 11/01/04 3 1,734 395 324 - 3rd San Mateo Comm. 10.00% 06/01/06 14 5,500 1,625 1,625 - 2nd Napa Apts. 10.00% 06/01/05 16 2,147 1,950 1,949 - 2nd Contra Costa Apts. 13.00% 01/02/06 29 14,800 2,660 2,660 - 2nd Santa Clara Comm. 12.00% 07/01/06 25 - 2,500 2,500 - 1st Sacramento Apts. 10.00% 05/01/04 19 15,440 2,250 2,250 - 2nd San Mateo Res. 11.00% 07/01/05 9 - 6,074 1,067 - 1st Fresno Res. 10.00% 08/01/13 2 - 230 229 - 1st San Joaquin Res. 9.00% 07/01/06 28 - 3,707 2,699 - 1st Alameda Comm. 11.00% 07/01/06 33 - 3,570 3,570 - 1st Alameda Res. 11.00% 08/01/10 10 940 3,185 1,389 - 2nd Marin Res. 9.00% 02/01/06 4 893 500 500 - 2nd Sonoma Res. 8.75% 09/01/05 103 - 15,600 8,700 - 1st Alameda Res. 9.50% 09/01/04 16 680 2,000 2,000 - 2nd Santa Clara Res. 8.50% 10/01/08 1 - 180 180 - 1st Contra Costa Res. 9.00% 11/01/09 2 - 300 300 - 1st Stanislaus Apts. 9.50% 01/01/09 4 - 413 413 - 1st San Joaquin Comm. 9.50% 12/01/05 22 - 2,750 2,750 - 1st San Francisco Res. 9.25% 12/01/08 1 376 130 130 - 2nd Santa Clara Res. 8.75% 11/01/05 6 - 800 800 - 1st San Francisco Apts. 9.50% 11/01/05 29 3,115 3,650 3,650 - 2nd River Side Res. 8.50% 12/01/04 - 505 40 40 - 2nd Santa Clara Res. 8.50% 12/01/04 3 1,131 400 400 - 2nd Contra Costa Res. 11.50% 01/01/06 13 445 4,483 2,107 - 2nd Santa Clara Comm. 9.00% 01/01/06 25 - 3,375 3,375 - 1st San Joaquin Res. 10.00% 12/25/05 133 13,575 16,010 16,010 - 2nd Alameda Res. 8.50% 01/01/06 8 - 1,070 1,070 - 1st Placer Comm. 9.50% 01/01/06 13 - 1,610 1,610 - 1st Napa -------------------------------------------------------------- Total $ 1,318 $ 111,113 $ 173,139 $147,174 $ 27,480 ============================================================== 46 REDWOOD MORTGAGE INVESTORS VIII (A California Limited Partnership) SCHEDULE IV - mortgage loans on real estate rule 12-29 loans on real estate (continued) (in thousands) Reconciliation of carrying amount (cost) of loans at close of periods Year ended December 31, ---------------------------------------------- 2003 2002 2001 ------------ ------------ ------------ Balance at beginning of year $ 83,650 $ 82,790 $ 68,571 Additions during period: New loans 96,820 32,601 47,512 Other 2,989 1,060 - ------------ ------------ ------------ Total additions 99,809 33,661 47,512 ------------ ------------ ------------ Deductions during period: Collections of principal 35,097 26,083 33,239 Foreclosures - 5,986 - Cost of loans sold - - - Amortization of premium - - - Other 1,188 732 54 ------------ ------------ ------------ Total deductions 36,285 32,801 33,293 ------------ ------------ ------------ Balance at close of year $ 147,174 $ 83,650 $ 82,790 ============ ============ ============ 47 Item 9 - Changes in and Disagreements with Accountants on Accounting and Financial Disclosure There were no disagreements with the partnership's independent public accountants during the years ended December 31, 2003 and 2002. Item 9a. - Controls and Procedures 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 as of the end of the period covered by this report pursuant to the Securities and Exchange Act of 1934. Based upon that evaluation, the general partners concluded that the partnership's disclosure controls and procedures were effective. There were no significant changes in the partnership's internal control over financial reporting during the partnership's fourth fiscal quarter and through the date of this report that have materially affected, or are likely to materially affect, the partnership's internal control over financial reporting. Part III Item 10 - Directors and Executive Officers of the Registrant The partnership has no Officers or Directors. Rather, the activities of the partnership are managed by three general partners, one of whom is an individual, Michael R. Burwell. The other two general partners are Gymno Corporation and Redwood Mortgage Corp. Both are California corporations, formed in 1986 and 1978, respectively. Mr. Burwell is one of the two shareholders of Gymno Corporation, a California corporation, on an equal (50-50) basis. Redwood Mortgage Corp. is a subsidiary of The Redwood Group Ltd., whose principal stockholders are the Burwell Trusts, the other shareholder of Gymno Corporation. The General Partners. Michael R. Burwell. Michael R. Burwell, age 46, General Partner, past member of Board of Trustees and Treasurer, Mortgage Brokers Institute (1984-1986); President, Director, Chief Financial Officer, Redwood Mortgage Corp. (1979-present); Director, Secretary and Treasurer A & B Financial Services, Inc. (1980-present); President, Director, Chief Financial Officer and Secretary (since 1986) of Gymno Corporation; President, Director, Secretary and Treasurer of The Redwood Group, Ltd. (1979-present). Mr. Burwell is licensed as a real estate sales person. Gymno Corporation. Gymno Corporation, General Partner, is a California corporation formed in 1986 for the purpose of acting as a general partner of this partnership and of other limited partnerships formed by the individual general partners. The shares in Gymno Corporation are held equally by Michael R. Burwell and the estate of D. Russell Burwell. Upon the completion of the administration of D. Russell Burwell's estate, Michael R. Burwell will have a controlling interest in Gymno Corporation. Michael R. Burwell is a director of Gymno and the director position held by D. Russell Burwell is currently vacant. Michael R. Burwell is its President, Chief Financial Officer and Secretary. Redwood Mortgage Corp. Redwood Mortgage Corp. is a licensed real estate broker incorporated in 1978 under the laws of the State of California, and is engaged primarily in the business of arranging and servicing mortgage loans. Redwood Mortgage Corp. will act as the loan broker and servicing agent in connection with loans, as it has done on behalf of several other limited partnerships formed by the general partners. 48 Financial Oversight by General Partners. The partnership does not have a board of directors or an audit committee. Accordingly, the general partners serve the equivalent function of an audit committee for, among other things, the following purposes: appointment, compensation, review and oversight of the work of our independent public accountants, and establishing the enforcing of the Code of Ethics. However, since the partnership does not have an audit committee and the general partners are not independent of the partnership, the partnership does not have an "audit committee financial expert." Code of Ethics. The general partners have adopted a Code of Ethics applicable to the general partners and to any agents, employees or independent contractors engaged by the general partners to perform the functions of a principal financial officer, principal accounting officer or controller of the partnership, if any. You may obtain a copy of this Code of Ethics, without charge, upon request by calling our Investor Services Department at (650) 365-5341. Item 11 - Executive Compensation COMPENSATION OF THE GENERAL PARTNERS AND AFFILIATES BY PARTNERSHIP As indicated above in Item 10, 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 (S-11) dated October 7, 2003, page 5, 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 year ended December 31, 2003. All such compensation is in compliance with the guidelines and limitations set forth in the prospectus. Entity Receiving Compensation Description of Compensation and Services Rendered Amount - -------------------------------------------------------------------------------------------------------- I. Redwood Mortgage Corp. Mortgage Servicing Fee for servicing loans...............$1,057,000 (General Partner) General Partners &/or Affiliates Asset Management Fee for managing assets...................$468,000 General Partners 1% interest in profits......................................$96,000 Less allocation of syndication costs.........................$2,000 ------------- $94,000 General Partners &/or Affiliates Portion of early withdrawal penalties applied to reduce Formation Loan.......................................$62,000 49 II. FEES PAID BY BORROWERS ON MORTGAGE LOANS PLACED WITH THE PARTNERSHIP BY COMPANIES RELATED TO THE GENERAL PARTNERS (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..............................$2,621,000 Redwood Mortgage Corp. Processing and Escrow Fees for services in borrowers connection with notary, document preparation, credit investigation, and escrow fees payable by the and not by the partnership...........................................$32,000 Gymno Corporation Reconveyance Fee......................................................$7,033 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 . . . . . . . . . . . . . . . . . . .$290,000 Item 12 - Security Ownership of Certain Beneficial Owners and Management The general partners own a combined total of 1% of the partnership including a 1% portion of income and losses. Item 13 - Certain Relationships and Related Transactions Refer to footnotes 3 and 4 of the Notes to Consolidated Financial Statements in Part II item 8, which describes related party fees and data. Also refer to the Prospectus dated October 7, 2003, (incorporated herein by reference) on page 5 "Compensation of General Partners and Affiliates". Item 14 - Principal Accountant Fees and Services Fees for services performed for the partnership by the principal accountant for 2003 and 2002 are as follows: Audit Fees The aggregate fees billed during the years ended December 31, 2003 and 2002 for professional services rendered for the audit of the partnership's annual financial statements included in the partnership's Annual Report on Form 10-K, review of financial statements included in the partnership's Quarterly Reports on Form 10-Q and for services provided in connection with regulatory filings were $101,302 and $131,066, respectively. Audit Related Fees There were no fees billed during the years ended December 31, 2003 and 2002 for audit-related services. Tax fees The aggregate fees billed for tax services for the years ended December 31, 2003 and 2002, were $5,487 and $6,605, respectively. These fees relate to professional services rendered primarily for tax compliance. All Other Fees There were no other fees billed during the years ended December 31, 2003 and 2002. All audit and non-audit services are approved by the general partner prior to the accountant being engaged by the partnership. 50 Part IV Item 15 - Exhibits, Financial Statements Schedules, and Reports on Form 8-K A. Documents filed as part of this report are incorporated: 1. In Part II, Item 8 under A - Consolidated Financial Statements. 2. The Consolidated Financial Statement Schedules are listed in Part II - Item 8 under B - Consolidated Financial Statement Schedules. 3. Exhibits. Exhibit No. Description of Exhibits - ------------- -------------------------------------------------------------- 3.1 Limited Partnership Agreement 3.2 Form of Certificate of Limited Partnership Interest 3.3 Certificate of Limited Partnership 10.1 Escrow Agreement 10.2 Servicing Agreement 10.3 (a) Form of Note secured by Deed of Trust for Construction Loans, which provides for principal and interest payments. (b) Form of Note secured by Deed of Trust for Commercial and Multi-Family loans which provides for principal and interest payments (c) Form of Note secured by Deed of Trust for Commercial and Multi-Family loans which provides for interest only payments (d) Form of Note secured by Deed of Trust for Single Family Residential Loans, which provides for interest and principal payments. (e) Form of Note secured by Deed of Trust for Single Family Residential loans, which provides for interest only payments. 10.4 (a) Deed of Trust, Assignment of Leases and Rents, Security Agreement and Fixture Filing to accompany Exhibits 10.3 (a), and (c). (b) Deed of Trust, Assignment of Leases and Rents, Security Agreement and Fixture Filing to accompany Exhibit 10.3 (b). (c) Deed of Trust, Assignment of Leases and Rents, Security Agreement and Fixture Filing to accompany Exhibit 10.3 (c). 10.5 Promissory Note for Formation Loan 10.6 Agreement to Seek a Lender All of these exhibits were previously filed as the exhibits to Registrant's Registration Statement on Form S-11 (Registration No. 333-106900 and incorporated by reference herein). B. Reports of Form 8-K. No reports on Form 8-K have been filed during the last quarter of the period covered by this report. C. See A (3) above. D. See A (2) above. Additional reference is made to the prospectus (filed as part of the S-11 registration statement) dated October 7, 2003, supplement No. 1 dated January 30, 2004 (post effective amendment No. 1 to the S-11 registration statement), for financial data related to Gymno Corporation, and Redwood Mortgage Corp., the Corporate General Partners. 51 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 30th day of March, 2004. 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, and Principal Financial Officer By: Redwood Mortgage Corp. By: /S/ Michael R. Burwell ----------------------------------------- Michael R. Burwell, President, Secretary/Treasurer 52 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 30th day of March, 2004. Signature Title Date /S/ Michael R. Burwell - --------------------------- Michael R. Burwell General Partner March 30, 2004 /S/ Michael R. Burwell - --------------------------- Michael R. Burwell President of Gymno Corporation, March 30, 2004 (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 of March 30, 2004 Redwood Mortgage Corp. (Principal Financial and Accounting Officer); Director of Redwood Mortgage Corp. 53 Exhibit 99.1 GENERAL PARTNER CERTIFICATION I, Michael R. Burwell, General Partner of the Partnership, certify that: 1. I have reviewed this annual report on Form 10-K of Redwood Mortgage Investors VIII, a California Limited Partnership (the "Registrant"); 2. Based on my knowledge, this annual 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 annual report; 3. Based on my knowledge, the consolidated financial statements, and other financial information included in this annual 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 annual 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 annual report is being prepared; (b) evaluated the effectiveness of the Registrant's disclosure controls and procedures as of December 31, 2003 (the "Evaluation Date"); and (c) presented in this annual 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 annual 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 March 30, 2004 54 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 Annual Report of Redwood Mortgage Investors VIII (the "Partnership") on Form 10-K for the period ended December 31, 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 March 30, 2004 55 Exhibit 99.2 PRESIDENT AND CHIEF FINANCIAL OFFICER CERTIFICATION I, Michael R. Burwell, President and Chief Financial Officer of Gymno Corporation, General Partner of the partnership, certify that: 1. I have reviewed this annual report on Form 10-K of Redwood Mortgage Investors VIII, a California Limited Partnership (the "Registrant"); 2. Based on my knowledge, this annual 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 annual report; 3. Based on my knowledge, the consolidated financial statements, and other financial information included in this annual 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 annual 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 annual report is being prepared; (b) evaluated the effectiveness of the Registrant's disclosure controls and procedures as of December 31, 2003 (the "Evaluation Date"); and (c) presented in this annual 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 annual 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 March 30, 2004 56 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 Annual Report of Redwood Mortgage Investors VIII (the "Partnership") on Form 10-K for the period ended December 31, 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 and 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. /s/ Michael R. Burwell - ---------------------------------- Michael R. Burwell, President, and Chief Financial Officer of Gymno Corporation, General Partner March 30, 2004 57 Exhibit 99.3 PRESIDENT'S CERTIFICATION I, Michael R. Burwell, president of Redwood Mortgage Corporation, General Partner, certify that: 1. I have reviewed this annual report on Form 10-K of Redwood Mortgage Investors VIII, a California Limited Partnership (the "Registrant"); 2. Based on my knowledge, this annual 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 annual report; 3. Based on my knowledge, the consolidated financial statements, and other financial information included in this annual 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 annual 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 annual report is being prepared; (b) evaluated the effectiveness of the Registrant's disclosure controls and procedures as of December 31, 2003 (the "Evaluation Date"); and (c) presented in this annual 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 annual 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, Redwood Mortgage Corporation, General Partner March 30, 2004 58 Exhibit 99.3 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 Annual Report of Redwood Mortgage Investors VIII (the "Partnership") on Form 10-K for the period ended December 31, 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, Redwood Mortgage Corporation, General Partner, 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, Redwood Mortgage Corporation, General Partner March 30, 2004 59