(Letterhead of Morrison Foerster LLP)
February 28, 2006
By Telefacsimile and Mail
Rebekah Moore
Staff Accountant
United States Securities and Exchange Commission
450 Fifth Street N.W.
Washington, D.C. 20549
Re: Redwood Mortgage Investors VIII
Form 10-K for the Fiscal Year Ended December 31, 2004 Form 10-Q for the
Fiscal Quarter ended June 30, 2005 File No. 000-27816
Dear Ms. Moore:
On behalf of our client, Redwood Mortgage Investors VIII (the "Company") we
are responding to the comments of the Staff (the "Staff") of the Securities and
Exchange Commission (the "Commission") set forth in your letter of January 23,
2006. The following discussion and answers to your inquiries have been presented
in numbered paragraphs to conform to the numbered paragraphs in your letter. For
the convenience of the Staff, we have set forth the Staff's comments fully
identified in bold and italicized type immediately prior to each response.
1. Please refer to comment 2 in our letter dated December 1, 2005. On page
22 of your Form 10-K for the year ended December 31, 2004, you disclose balances
of loans by property type, i.e. single family homes, apartments, commercial and
land. Each type has a different risk of loss and it is meaningful to investors
to know how you allocate your allowance for loan losses in response to these
risks. Further, disclosure of the amount of recoveries and charge-offs by
property type also lets investors know the results of your risk management
strategies. Please revise your proposed disclosures of the allocation of the
allowance for loan losses and the roll forward of the allowance to provide the
information set forth by the property types presented on page 22 of your 2004
Form 10-K and provide us with your proposed disclosures.
RESPONSE:
As requested by the Staff, the Registrant agrees to disclose, by property
type, its allocation of its allowance for loan losses and the amount of
recoveries and charge-offs. Specifically, the Registrant propose to revise in
future filings (i) the first table that is set forth in note 2 to its financial
statements in its Form 10-K for the year ended December 31, 2004 (at page 37 of
that 10-K) to the table that is set forth in Attachment A to this letter and
(ii) the second table that is set forth in that note 2 to the table that is set
forth in Attachment B to this letter. We note that in future Form 10-Q filings,
such proposed tables would set forth information as of the end of the particular
quarter and as of the end of the previous fiscal year. In future Form 10-K
filings, such tables would set forth information as of the end of each of the
three fiscal years in the period ending as of the date covered by the Form 10-K.
2. Please refer to our previous comment 5 in our letter dated September 29,
2005. You state that you imputed interest expense in accordance with APB 21.
However, it is still unclear why you have recorded interest income in connection
with the interest free loan from your general partner. Please provide additional
detail regarding this transaction to include the specific accounting literature
relied upon in recording these amounts, the dollar amounts for the related
assets and liabilities, and sample journal entries for this transaction.
RESPONSE:
The transaction for which the Registrant has recorded imputed interest
income relates to an interest-free loan that the Registrant has made to one of
its general partners, Redwood Mortgage Corp. (RMC). To understand the accounting
that the Registrant has utilized for this transaction, it is helpful to first
understand the accounting for the transaction by RMC.
RMC's Accounting For The Transaction
RMC received an interest-free loan (the "Formation Loan") from the
Registrant to finance the purchase of the exclusive right to act as the mortgage
loan broker (the "deferred brokerage rights") for the Registrant's loan
portfolio. Note the accounting for RMC's intangible asset, deferred brokerage
rights, had been reviewed by the SEC staff via a comment letter in connection
with the Registrant's 2002 Form S-11 filing.
The Formation Loan from the Registrant to RMC is repayable in ten equal
annual installments, without interest, commencing in the year after the
Formation Loan is completed.
In accordance with Accounting Principles Board Opinion No. 21 "Interest on
Receivables and Payables" (APB No. 21), RMC has imputed interest on the
Formation Loan. As described in paragraph 12. of APB No. 21 "When a note is
exchanged for property, goods, or service in a bargained transaction entered
into at arm's length, there should be a general presumption that the rate of
interest stipulated by the parties to the transaction represents fair and
adequate compensation to the supplier for the use of the related funds. That
presumption, however, must not permit the form of the transaction to prevail
over its economic substance and thus would not apply if (1) interest is not
stated, or (2) the stated interest rate is unreasonable.... In these
circumstances, the note, the sales price, and the cost of the property, goods,
or service exchanged for the note should be recorded at the fair value of the
property, goods, or services...."
To reflect the economic substance of the financing arrangement, and to
ensure fair and adequate compensation was recorded for the use of the funds, RMC
imputed interest on the Formation Loan. RMC calculated the present value of the
Formation Loan by discounting all future payments on the loan at an imputed rate
of interest in accordance with paragraphs 13 and 14 of APB No. 21. As such, the
transaction was recorded as follows assuming the following hypothetical data:
Data:
Amount of Formation Loan $1,000,000
Formation Loan to be repaid in 10 equal
installments with no interest - annual pmt. $100,000
Stated interest rate 0%
Net present value of future loan payments $750,000
First year of imputed interest expense $50,000
First year of amortization of deferred
brokerage rights $35,000
Entries Recorded:
Cash $1,000,000
Formation Loan $1,000,000
(To record receipt of cash and Formation Loan)
Deferred brokerage rights (net of discount) $750,000
Discount on Formation Loan $250,000
Cash $1,000,000
(To record purchase of deferred brokerage rights
and discount on non-interest bearing loan)
Interest expense $50,000
Discount on Formation Loan $50,000
(Record interest expense on Formation Loan in
accordance with amortization schedule using imputed
interest rate over 10 year life of loan)
Amortization expense $35,000
Deferred brokerage rights $35,000
(Record amortization of deferred brokerage
rights over 25 year useful life in proportion
to expected net cash flow over period)
The discount on the Formation Loan is amortized to interest expense over
the 10 year term of the loan, using amortization under the interest method at
the imputed rate of interest. The Deferred Brokerage Rights (reduced by the
difference between its purchase price and the net present value of future
payments to be made on the Formation Loan) are amortized over the 25 year
expected life of the rights in proportion to the expected receipt of cash flows
over this period.
In determining that imputing interest was the appropriate treatment of the
fair value of the Deferred Brokerage Rights and the Formation Loan, RMC
determined that the transaction described did not qualify for the exclusion from
the provisions of APB No. 21 described in paragraph No. 3f "transactions between
parent and subsidiary companies and between subsidiaries of a common parent."
The Registrant and RMC do not have a parent/subsidiary relationship and the
rights of the limited partners to replace RMC as the Registrant's general
partner (i.e. kick-out rights) are substantive. (i.e., a simple majority vote of
the limited partners at any time).
The Registrant's Accounting For The Transaction
From the Registrant's standpoint, the Formation Loan is not simply a note
exchanged for cash. As described above, the Registrant has financed RMC's
purchase of the exclusive right to act as the mortgage loan broker to the
Registrant's loan portfolio. The Registrant recorded the following entries
related to this transaction, using the same hypothetical data described above:
Entries Recorded:
Formation Loan ** $1,000,000
Cash $1,000,000
(To record Formation Loan to RMC)
Deferred costs on interest-free loan $250,000
Discount on Formation Loan $250,000
(To record net present value of future cash payments
on loan at imputed rate of interest)
Discount on Formation Loan $50,000
Interest income $50,000
Amort. of discount on imputed interest $50,000
Deferred costs on interest-free loan $50,000
(Record interest income on Formation Loan in
accordance with amortization schedule using imputed
interest rate over 10 year life of loan)
** - It should be noted that in accordance with comments received from the
SEC in the 1990's, the Formation Loan is reflected as a reduction in Partners'
Capital in the Registrant's financial statements.
The Registrant has capitalized certain costs of making the Formation Loan
as Deferred Costs on Interest-free Loan. These costs are amortized over the term
of the loan in a manner consistent with the amortization method used for the
imputed interest discount.
In making the determination to impute interest, the Registrant considered
the accounting treatment of RMC. The Registrant wanted to ensure consistency of
treatment for the transaction by both parties to the transaction. As RMC was
required to impute interest as described above, the Registrant determined that
it should also impute interest. Consistent treatment of this transaction by both
parties leads to better transparency into the transaction by readers of the
Registrant's offerings. Note that the balance sheet of RMC is included in the
offerings of the Registrant.
Very truly yours,
/s/ Stephen J. Schrader
Stephen J. Schrader
cc: Michael R. Burwell, Redwood Mortgage Investors VIII
Attachment A
Allocation of the Allowance for Loan Losses
(in thousands)
December 31, December 31, December 31
----------------------------- ---------------------------- ----------------------------
2003 2004 2005
----------------------------- ---------------------------- ----------------------------
Percent of
Percent of Percent of loans in
loans in loans in each
each each category
category to category to to total
Amount total loans Amount total loans Amount loans
---------- ------------- ---------- ------------- ----------- ------------
Balance at End of Period
Applicable to:
- ---------------------------------------
Domestic
Real estate - mortgage
Single Family (1-4 units) $1,072 45.27% $ 850 49.12% - -
Apartments 315 15.39 430 18.04 - -
Commercial 880 35.67 1,033 31.83 - -
Land 382 3.67 30 1.01 - -
----------- ------------- ---------- ------------- ----------- ------------
Total $ 2,649 100% $ 2,343 100% $ - -%
=========== ============= ========== ============= =========== ============
Attachment B
Analysis of the Allowance for Loan Losses
(in thousands)
Years Ended December 31
--------------------------------------------------------
2003 2004 2005
---------------- ---------------- ----------------
Balance at beginning of year $ 3,021 $ 2,649 $ 2,343
Charge-offs
Domestic
Real estate - mortgage -
Single Family (1-4 units) (1,068) (842)
Apartments (86) (0)
Commercial (0) (110)
Land (0) (0) -
---------------- ---------------- ----------------
(1,154) (952) -
---------------- ---------------- ----------------
Recoveries
Domestic
Real estate - mortgage -
Single Family (1-4 units) 0 0
Apartments 0 0
Commercial 0 0
Land 0 0
---------------- ---------------- ----------------
0 0 -
---------------- ---------------- ----------------
Net Charge-Offs (1,154) (952) -
---------------- ---------------- ----------------
Additions charge to operations 782 1146 -
---------------- ---------------- ----------------
Transfer to real estate held for sale reserve 0 (500)
---------------- ---------------- ----------------
Balance at end of year $ 2,649 $ 2,343 $ -
================ ================ ================
Ratio of net charge-offs during
the period to average secured loans
outstanding during the period 1.00% 0.60% -%
================ ================ ================