10-Q 1 rmi710q3rdqtr2005.txt UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-Q (Mark One) [X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the Quarterly Period Ended September 30, 2005 OR [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from ______________ to ______________ Commission File Number: 000-19992 REDWOOD MORTGAGE INVESTORS VII, a California Limited Partnership (Exact name of registrant as specified in its charter) California 94-3094928 (State or other jurisdiction of incorporation (I.R.S. Employer or organization) Identification No.) 900 Veterans Blvd., Suite 500, Redwood City, CA 94063-1743 (Address of principal executive offices) (Zip Code) (650) 365-5341 (Registrant's telephone number, including area code) NOT APPLICABLE (Former name, former address and former fiscal year, if changed since last report) Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes XX No -------------- ------------- Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). Yes No XX -------------- ------------- Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes No XX -------------- -------------- 1 Part I - Item 1. FINANCIAL STATEMENTS REDWOOD MORTGAGE INVESTORS VII (A California Limited Partnership) BALANCE SHEETS SEPTEMBER 30, 2005 and DECEMBER 31, 2004 (unaudited) ASSETS September 30, December 31, 2005 2004 ---------------- --------------- Cash and cash equivalents $ 658,700 $ 346,393 ---------------- --------------- Loans Loans, secured by deeds of trust 6,318,264 7,388,478 Loans, unsecured, net discount of $91,318 and $107,433 for September 30, 2005 and December 31, 2004, respectively 245,300 238,484 ---------------- --------------- 6,563,564 7,626,962 Allowance for loan losses (746,356) (745,476) ---------------- --------------- Net loans 5,817,208 6,881,486 Interest and other receivables Accrued interest and late fees 157,842 190,105 Advances on loans 256 8,188 ---------------- --------------- Total interest and other receivables 158,098 198,293 ---------------- --------------- Investment in limited liability company 881,617 - Real estate held for sale, net 1,825,548 1,782,182 ---------------- --------------- Total assets $ 9,341,171 $ 9,208,354 ================ =============== LIABILITIES AND PARTNERS' CAPITAL Liabilities Accounts payable $ 3,678 $ 4,951 Payable to affiliate 78,607 74,987 ---------------- --------------- Total liabilities 82,285 79,938 ---------------- --------------- Partners' capital Limited partners' capital, subject to redemption 9,246,913 9,116,443 General partners' capital 11,973 11,973 ---------------- --------------- Total partners' capital 9,258,886 9,128,416 ---------------- --------------- Total liabilities and partners' capital $ 9,341,171 $ 9,208,354 ================ ===============
The accompanying notes are an integral part of these financial statements. 2 REDWOOD MORTGAGE INVESTORS VII (A California Limited Partnership) STATEMENTS OF INCOME FOR THE THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2005 and 2004 (unaudited) THREE MONTHS ENDED NINE MONTHS ENDED SEPTEMBER 30, SEPTEMBER 30, ------------------------------- ------------------------------ 2005 2004 2005 2004 ----------- ----------- ----------- ----------- Revenues Interest on loans $197,654 $198,818 $517,709 $594,290 Interest - interest bearing accounts 770 629 2,005 2,435 Late fees 5,526 7,115 9,274 17,703 Other 641 8,747 2,311 25,939 ----------- ----------- ----------- ----------- 204,591 215,309 531,299 640,367 ----------- ----------- ----------- ----------- Expenses Mortgage servicing fees 22,729 20,457 54,692 60,219 Interest expense - 1,444 - 2,512 Clerical costs through Redwood Mortgage Corp. 3,498 4,337 10,284 13,753 Asset management fees 8,642 8,520 25,824 25,507 Provisions for (recovery of) losses on loans and real estate held for sale 5,372 16,185 (32,493) 42,438 Professional services 13,222 7,293 38,746 37,066 Printing, supplies and postage 1,412 1,378 5,843 5,664 Other 1,141 6,362 5,384 25,334 ----------- ----------- ----------- ----------- 56,016 65,976 108,280 212,493 ----------- ----------- ----------- ----------- Net income $148,575 $149,333 $423,019 $427,874 =========== =========== =========== =========== Net income: to general partners (1%) 1,486 1,493 4,230 4,279 to limited partners (99%) 147,089 147,840 418,789 423,595 ----------- ----------- ----------- ----------- $148,575 $149,333 $423,019 $427,874 =========== =========== =========== =========== Net income per $1,000 invested by limited partners for entire period -where income is compounded and retained $ 16.05 $ 16.35 $ 46.55 $ 47.68 =========== =========== =========== =========== -where partner receives income in monthly distributions $ 15.97 $ 16.26 $ 45.62 $ 46.70 =========== =========== =========== ===========
The accompanying notes are an integral part of these financial statements. 3 REDWOOD MORTGAGE INVESTORS VII (A California Limited Partnership) STATEMENTS OF CASH FLOWS FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2005 and 2004 (unaudited) 2005 2004 -------------- ------------- Cash flows from operating activities Net income $ 423,019 $ 427,874 Adjustments to reconcile net income to net cash provided by operating activities Provisions for (recovery of) losses on loans and real estate (32,493) 42,438 Early withdrawal penalty credited to income (1,844) (1,777) Amortization of discount on unsecured loans (16,115) (16,115) Change in operating assets and liabilities Accrued interest and advances on loans (20,278) (183,164) Accounts payable and other liabilities 2,347 20,215 Prepaid expenses - (1,741) -------------- ------------- Net cash provided by operating activities 354,636 287,730 -------------- ------------- Cash flows from investing activities Principal collected on loans 4,462,402 3,020,006 Loans originated (4,168,416) (3,360,068) Recoveries of (payments for) real estate held for sale (9,994) 17,010 Investment in limited liability company (44,915) - Proceeds from unsecured loans 9,299 11,804 -------------- ------------- Net cash provided by (used in) investing activities 248,376 (311,248) -------------- ------------- Cash flows from financing activities Net increase in line of credit - 500,000 Partners' withdrawals (290,705) (346,415) -------------- ------------- Net cash provided by (used in) financing activities (290,705) 153,585 -------------- ------------- Net increase in cash and cash equivalents 312,307 130,067 Cash and cash equivalents - beginning of period 346,393 321,114 -------------- ------------- Cash and cash equivalents - end of period 658,700 451,181 ============== ============= Cash payments for interest $ - $ 2,512 ============== =============
The accompanying notes are an integral part of these financial statements. 4 REDWOOD MORTGAGE INVESTORS VII (A California Limited Partnership) NOTES TO FINANCIAL STATEMENTS SEPTEMBER 30, 2005 (unaudited) NOTE 1 - GENERAL In the opinion of the management of the Partnership, the accompanying unaudited financial statements contain all adjustments, consisting of normal, recurring adjustments, necessary to present fairly the financial information included therein. These financial statements should be read in conjunction with the audited financial statements included in the Partnership's Form 10-K for the fiscal year ended December 31, 2004 filed with the Securities and Exchange Commission. The results of operations for the nine month period ended September 30, 2005 are not necessarily indicative of the operating results to be expected for the full year. NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES Loans, secured by deeds of trust At September 30, 2005 and December 31, 2004 there were no loans and one loan categorized as impaired by the Partnership totaling $0 and $96,716, respectively. In 2004 it was determined that a reduction in carrying value was no longer required on this loan. The real estate securing this loan appreciated in value over a period of time and the borrower began to pay down the advances and accrued interest. The increase in value had been determined to be other than temporary. As of September 30, 2005, all the advances were paid in full together with a portion of the accrued interest. This loan was evaluated and it was established that the loan was no longer impaired and as of September 30, 2005 it was recategorized and all interest and late charges owed by the borrower were accrued and recognized as income. Thereafter, interest and late charges will be accrued. As of September 30, 2005 the Partnership had a combined total of three loans with outstanding principal balances of $161,486 that were either past due 90 days or more in interest payments and/or past maturity. These three loans included two loans totaling $64,770 that were past maturity and one loan totaling $96,716 that was past due 90 days or more in interest payments. This compares to a combined total of five loans totaling $1,049,730 that were either past due 90 days or more in interest payments and/or past maturity as of December 31, 2004. These five loans included two loans totaling $64,850 that were past maturity and three loans totaling $984,880 that were past due 90 days or more in interest payments. A past maturity loan is a loan in which the principal and/or any accrued interest is due and payable, but the borrower has failed to make such payment of principal and/or accrued interest. In the opinion of management, the delinquent and/or past maturity loans as of September 30, 2005 have sufficient collateral to cover the amount outstanding to the Partnership and are still accruing interest on these loans. Allowance for loan losses The composition of the allowance for loan losses as of September 30, 2005 and December 31, 2004 was as follows: September 30, December 31, 2005 2004 ---------------- ---------------- Specified loans $ 290,464 $ 290,464 General 226,952 231,443 Unsecured loans 228,940 223,569 ---------------- ---------------- $ 746,356 $ 745,476 ================ ================ 5 REDWOOD MORTGAGE INVESTORS VII (A California Limited Partnership) NOTES TO FINANCIAL STATEMENTS SEPTEMBER 30, 2005 (unaudited) NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued) Allowance for loan losses (continued) Activity in the allowance for loan losses for the nine month period ended September 30, 2005 and the year ended December 31, 2004 was as follows: September 30, December 31, 2005 2004 --------------- --------------- Beginning balance $ 745,476 $ 680,469 Provision for (recoveries of) loan losses (32,493) 65,007 Transfers 33,373 - --------------- --------------- $ 746,356 $ 745,476 =============== =============== Investment in limited liability company Investment in limited liability company ("LLC") is accounted for using the equity method as one of the Partnership's general partners is the managing member of the LLC. In February, 2005 the Partnership acquired an 8% interest in Larkin Property Company, LLC (see note 5). Income taxes No provision for federal and state income taxes (other than an $800 state minimum tax) is made in the financial statements since income taxes are the obligation of the partners if and when income taxes apply. Reclassifications Certain reclassifications, not affecting previously reported net income or total partners' capital, have been made to the previously issued financial statements to conform to the current year classification. Profits and losses Profits and losses are allocated among the limited partners according to their respective capital accounts monthly after 1% of the profits and losses are allocated to the general partners. Management estimates The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions about the reported amounts of assets and liabilities, and disclosures of contingent assets and liabilities, at the dates of the financial statements and the reported amounts of revenues and expenses during the reported periods. Such estimates relate principally to the determination of the allowance for loan losses, including the valuation of impaired loans and the valuation of real estate held for sale. Actual results could differ significantly from these estimates. 6 REDWOOD MORTGAGE INVESTORS VII (A California Limited Partnership) NOTES TO FINANCIAL STATEMENTS SEPTEMBER 30, 2005 (unaudited) NOTE 3 - GENERAL PARTNERS AND RELATED PARTIES The following are commissions and fees, which will be paid to the general partners. Mortgage brokerage commissions For fees in connection with the review, selection, evaluation, negotiation and extension of loans, Redwood Mortgage Corp., an affiliate of the general partners, may collect an amount equivalent to 12% of the loaned amount until six months after the termination date of the offering. Thereafter, loan brokerage commissions (points) will be limited to an amount not to exceed 4% of the total Partnership assets per year. The loan brokerage commissions are paid by the borrowers and thus, are not an expense of the Partnership. Mortgage servicing fees Monthly mortgage servicing fees of up to 1/8 of 1% (1.5% annual) of the unpaid principal are paid to Redwood Mortgage Corp., based on the unpaid principal balance of the loan portfolio, or such lesser amount as is reasonable and customary in the geographic area where the property securing the mortgage is located. Once a loan is categorized as impaired, mortgage servicing fees are no longer accrued. Additional service fees are recorded upon the receipt of any subsequent payments on impaired loans. Asset management fees The general partners receive monthly fees for managing the Partnership's loan portfolio and operations of up to 1/32 of 1% of the "net asset value" (3/8 of 1% annually). Other fees The Partnership Agreement provides for other fees such as reconveyance, mortgage assumption and mortgage extension fees. Such fees are incurred by the borrowers and are paid to parties related to the general partners. Operating expenses Redwood Mortgage Corp., an affiliate of the general partners, is reimbursed by the Partnership for all operating expenses actually incurred by it on behalf of the Partnership, including without limitation, out-of-pocket general and administration expenses of the Partnership, accounting and audit fees, legal fees and expenses, postage and preparation of reports to limited partners. Redwood Mortgage Corp. waived reimbursement of approximately $755 in operating expenses during the second quarter of 2005. NOTE 4 - REAL ESTATE HELD FOR SALE In 1993 the Partnership, together with two other affiliates, acquired through foreclosure a parcel of land located in East Palo Alto, CA, which is on the market for sale. The general partners believe that this property is worth considerably more than its carrying value, but it may take a considerable amount of additional time to sell the property and realize its full potential. The property is unique in that it may only be utilized for commercial or industrial uses. Until recently, land sales activity has been slow. Interest in land sales for commercial sites has been improving. As of September 30, 2005 the Partnership's investment in this property was $62,720. 7 REDWOOD MORTGAGE INVESTORS VII (A California Limited Partnership) NOTES TO FINANCIAL STATEMENTS SEPTEMBER 30, 2005 (unaudited) NOTE 4 - REAL ESTATE HELD FOR SALE (continued) In December 2004, the Partnership acquired undeveloped parcels of land through a deed in lieu of foreclosure. The land is located in Stanislaus County, California. It is comprised of three separate lots, which total approximately 14 acres. The parcels are currently for sale. As of September 30, 2005 the Partnership's investment in this property totaled $1,762,828, including accrued interest and advances, as of the date of the acquisition. Management believes that the full value of this investment will be recovered from the eventual sale of the property based upon its current estimate of the fair value of the property. This property is jointly owned by two other affiliated partnerships. As such, during the quarter ended September 30, 2005, the Partnership transferred the entire reserve against real estate of $33,373 to the allowance for loan losses. In February, 2005 the Partnership acquired another property through foreclosure (see Note 5). The following schedule reflects the costs of real estate acquired through foreclosure and the recorded reductions to estimated fair values, including estimated costs to sell as of September 30, 2005 and December 31, 2004: September 30, December 31, 2005 2004 ---------------- --------------- Costs of properties $ 1,825,548 $ 1,815,555 Reduction in value - (33,373) ---------------- --------------- Real estate held for sale, net $ 1,825,548 $ 1,782,182 ================ =============== NOTE 5 - INVESTMENT IN LIMITED LIABILITY COMPANY In February, 2005, the Partnership acquired a multi-unit property through foreclosure. This property is located in an upscale neighborhood in San Francisco. At the time the Partnership took ownership of the property, the Partnership's investment totaled $836,702 including accrued interest and advances. This property is jointly owned by three other affiliated Partnerships. Upon acquisition the Partnership transferred its interest (principally land and building) to a limited liability company ("LLC"), Larkin Property Company, LLC ("Larkin"), which is 8% owned by the Partnership, and 92% owned by three other affiliates. No allowance for loss has been set aside as management believes that the fair value of the property exceeds the combined Partnerships' investment in the property. The Partnership intends to undertake additional improvements to the property. As of September 30, 2005 the Partnership has capitalized approximately $44,915 in costs related to this property. NOTE 6 - BANK LINE OF CREDIT The Partnership has a bank line of credit secured by its loan portfolio of up to $2,500,000 at .25% over prime. There were no balances outstanding as of September 30, 2005 and December 31, 2004 and the interest rate was 7.00% (6.75% prime plus .25%) at September 30, 2005. This line of credit expires December 2007 and requires the Partnership to meet certain financial covenants. To the best of its knowledge, the Partnership was in compliance with all loan covenants for the nine month period ended September 30, 2005 and for the year ended December 31, 2004. The Partnership anticipates that the line of credit will be renewed at its maturity. In the event that a renewal is not forthcoming, the Partnership has the option to convert the line of credit to a three year term loan beginning December 2007. 8 REDWOOD MORTGAGE INVESTORS VII (A California Limited Partnership) NOTES TO FINANCIAL STATEMENTS SEPTEMBER 30, 2005 (unaudited) NOTE 7 - NON-CASH TRANSACTIONS During the nine month period ended September 30, 2005 the Partnership foreclosed on a property (see Note 5), which resulted in an increase in investment in limited liability company of $836,702, a decrease in loans receivable of $776,228, a decrease in accrued interest of $51,598, a decrease in advances of $5,876, and a decrease in late charge receivable of $3,000. NOTE 8 - FAIR VALUE OF FINANCIAL INSTRUMENTS The following methods and assumptions were used to estimate the fair value of financial instruments: Secured loans had a carrying value of $6,318,264 and $7,388,478 at September 30, 2005 and December 31, 2004, respectively. The fair value of these loans of $6,429,255 and $7,531,668, respectively, was estimated based upon projected cash flows discounted at the estimated current interest rates at which similar loans would be made. The applicable amount of the allowance for loan losses along with accrued interest and advances related thereto should also be considered in evaluating the fair value versus the carrying value. NOTE 9 - ASSET CONCENTRATIONS AND CHARACTERISTICS Most loans are secured by recorded deeds of trust. At September 30, 2005 and December 31, 2004 there were 26 and 28 secured loans outstanding, respectively, with the following characteristics: September 30, December 31, 2005 2004 ---------------- ---------------- Number of secured loans outstanding 26 28 Total secured loans outstanding $ 6,318,264 $ 7,388,478 Average secured loan outstanding $ 243,010 $ 263,874 Average secured loan as percent of total secured loans 3.85% 3.57% Average secured loan as percent of partners' capital 2.63% 2.89% Largest secured loan outstanding $ 686,400 $ 800,000 Largest secured loan as percent of total secured loans 10.86% 10.83% Largest secured loan as percent of partners' capital 7.42% 8.76% Largest secured loan as percent of total assets 7.35% 8.69% Number of counties where security is located (all California) 13 13 Largest percentage of loans in one county 24.19% 24.64% Average secured loan to appraised value of security based on appraised values and prior liens at time loan was consummated 71.29% 71.30% Number of secured loans in foreclosure status None 1 Amount of secured loans in foreclosure status None $ 776,228
Over time, loans may exceed 10% of the secured loan portfolio or Partnership assets as the loan portfolio and assets of the Partnership decrease due to limited partner withdrawals and/or loan payoffs. 9 REDWOOD MORTGAGE INVESTORS VII (A California Limited Partnership) NOTES TO FINANCIAL STATEMENTS SEPTEMBER 30, 2005 (unaudited) NOTE 9 - ASSET CONCENTRATIONS AND CHARACTERISTICS (continued) The following categories of secured loans were held at September 30, 2005 and December 31, 2004: September 30, December 31, 2005 2004 ---------------- ---------------- First trust deeds $ 4,756,452 $ 5,937,736 Second trust deeds 1,337,246 1,450,742 Third trust deeds 224,566 - ---------------- ---------------- Total loans 6,318,264 7,388,478 Prior liens due other lenders at time of loan 5,148,635 1,944,172 ---------------- ---------------- Total debt $ 11,466,899 $ 9,332,650 ================ ================ Appraised property value at time of loan $ 16,085,038 $ 13,089,113 ---------------- ---------------- Total secured loans as percent of appraisals based on appraised values and prior liens at time loan was consummated 71.29% 71.30% ---------------- ---------------- Secured loans by type of property Owner occupied homes $ 2,866,033 $ 2,532,045 Non-owner occupied homes 250,000 1,961,474 Apartments 666,716 971,864 Commercial 2,100,349 1,923,095 Land 435,166 - ---------------- ---------------- $ 6,318,264 $ 7,388,478 ================ ================
Scheduled maturity dates of secured loans as of September 30, 2005 are as follows: Year Ending December 31, ------------------------------ 2005 $ 64,770 2006 916,716 2007 1,681,919 2008 - 2009 1,806,127 Thereafter 1,848,732 ---------------- Total $ 6,318,264 ================ The scheduled maturities for 2005 above include approximately $64,770 in two loans, which were past maturity at September 30, 2005. Interest payments on both of these loans were current as of September 30, 2005. 10 REDWOOD MORTGAGE INVESTORS VII (A California Limited Partnership) NOTES TO FINANCIAL STATEMENTS SEPTEMBER 30, 2005 (unaudited) NOTE 9 - ASSET CONCENTRATIONS AND CHARACTERISTICS (continued) At times, the Partnership's cash deposits exceed federally insured limits. Management believes deposits are maintained in financially secure financial institutions. The Partnership has a substantial amount of its loan receivable balance due on two loans from one borrower. This borrower accounted for approximately 19.73% of the loan balance and approximately 16.26% of interest revenue for the nine month period ended September 30, 2005. The value of collateral securing these loans was less than the principal balance due under the loans. Redwood Mortgage Corp. has provided an indemnity to the Partnership whereby it has agreed to indemnify and hold harmless, the Partnership from any expenses or losses incurred by the Partnership by reason of the Partnership's inability to collect all principal due under the loans after the Partnership has exhausted all reserves set aside for these loans and all remedies available to it including foreclosure of the underlying collateral. Real estate values in the San Francisco Bay Area have appreciated considerably over the years and a recent appraisal of these two properties by an independent party revealed a loan-to-value ratio of 68%. This revised valuation, backed by the indemnity, enhances the Partnership's portfolio. Therefore, these loans are not considered impaired. Neither of these loans is past due 90 days or more on interest payments nor are they past maturity. NOTE 10 - COMMITMENTS AND CONTINGENCIES Workout agreements The Partnership has negotiated a contractual workout agreement with one borrower who is delinquent in making payments. Under the terms of the workout agreement the Partnership is not obligated to make any additional monetary advances for the maintenance or repair of the collateral securing the loan as of September 30, 2005. As of September 30, 2005 the Partnership had one loan under workout agreement totaling $96,716. Construction loans The Partnership makes construction and rehabilitation loans which are not fully disbursed at loan inception. The Partnership approves the borrowers up to a maximum loan balance; however, disbursements are made periodically during completion phases of the construction or rehabilitation or at such other times as required under the loan documents. At September 30, 2005, there was $52,334 in undisbursed loan funds pertaining to one loan. The Partnership does not maintain a separate cash reserve to hold the undisbursed obligations, which are intended to be funded. Legal proceedings The Partnership is involved in various legal actions arising in the normal course of business. In the opinion of management, such matters will not have a material effect upon the financial position of the Partnership. 11 Part I - Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION OF THE PARTNERSHIP Critical Accounting Policies. In preparing the financial statements, management is required to make estimates based on the information available that affect the reported amounts of assets and liabilities as of the balance sheet dates and income and expenses during the reporting periods. Such estimates relate principally to the determination of (1) the allowance for loan losses (i.e. the amount of allowance established against loans receivable as an estimate of potential loan losses) including the accrued interest and advances that are estimated to be unrecoverable based on estimates of amounts to be collected plus estimates of the value of the property as collateral and (2) the valuation of real estate acquired through foreclosure. At September 30, 2005, the partnership owned five pieces of real property. Loans and the related accrued interest, late fees and advances are analyzed on a regular basis for recoverability. Delinquencies are identified and followed as part of the loan system. A provision is made for loan losses to adjust the allowance for loan losses to an amount considered by management to be adequate, with due consideration to collateral value, to provide for unrecoverable loans and receivables, including impaired loans, other loans, accrued interest, late fees and advances on loans and other accounts receivable (unsecured). The Partnership charges off uncollectible loans and related receivables directly to the allowance account once it is determined that the full amount is not collectible. If the probable ultimate recovery of the carrying amount of a loan, with due consideration for the fair value of collateral, is less than amounts due according to the contractual terms of the loan agreement and the shortfall in the amounts due are not insignificant, the carrying amount of the investment shall be reduced to the present value of future cash flows discounted at the loan's effective interest rate. If a loan is collateral dependent, it is valued at the estimated fair value of the related collateral. If events and or changes in circumstances cause management to have serious doubts about the further collectibility of the contractual payments, a loan may be categorized as impaired and interest is no longer accrued. Any subsequent payments on impaired loans are applied to reduce the outstanding loan balances including accrued interest and advances. Recent trends in the economy have been taken into consideration in the aforementioned process of arriving at the allowance for loan losses. Actual results could vary from the aforementioned provisions for losses. Real estate held for sale includes real estate acquired through foreclosure and is stated at the lower of the recorded investment in the loan, plus any senior indebtedness, or at the property's estimated fair value, less estimated costs to sell. The Partnership periodically compares the carrying value of real estate to expected undiscounted future cash flows for the purpose of assessing the recoverability of the recorded amounts. If the carrying value exceeds future undiscounted cash flows, the assets are reduced to estimated fair value. Forward Looking Statements. Certain statements in this Report on Form 10-Q which are not historical facts may be considered forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities and Exchange Act of 1934, as amended, including statements regarding the Partnership's expectations, hopes, intentions, beliefs and strategies regarding the future. Forward-looking statements include statements regarding future loan payoffs, future interest rates and economic conditions and their effect on the Partnership and its assets, future sales of properties held by the Partnership and the proceeds from such sales, trends in the California real estate market, estimates as to the allowance for loan losses, estimates of future limited partner withdrawals and 2005 annualized yield estimates. Actual results may be materially different from what is projected by such forward-looking statements. Factors that might cause such a difference include unexpected changes in economic conditions and interest rates, the impact of competition and competitive pricing and downturns in the real estate markets in which the Partnership has made loans. All forward-looking statements and reasons why results may differ included in this Form 10-Q are made as of the date hereof, and we assume no obligation to update any such forward-looking statement or reason why actual results may differ. 12 Related Parties. The general partners of the Partnership are Gymno Corporation and Michael R. Burwell. Most Partnership business is conducted through Redwood Mortgage Corp., an affiliate of the general partner, which arranges, services, and maintains the loan portfolio for the benefit of the Partnership. Michael R. Burwell is President and Chief Financial Officer of Gymno Corporation and Redwood Mortgage Corp. The fees received by the affiliate to the general partners are paid pursuant to the Partnership Agreement and are determined at the sole discretion of the affiliate to the general partner. In the past, the affiliate to the general partners has elected not to take the maximum compensation. The following is a list of various Partnership activities for which related parties are compensated. o Mortgage Brokerage Commissions For fees in connection with the review, selection, evaluation, negotiation and extension of loans, Redwood Mortgage Corp. may collect an amount equivalent to 12% of the loaned amount until 6 months after the termination date of the offering. Thereafter, the loan brokerage commissions (points) will be limited to an amount not to exceed 4% of the total Partnership assets per year. The loan brokerage commissions are paid by the borrowers, and thus, are not an expense of the Partnership. Loan brokerage commissions paid by the borrowers were $103,848 and $59,128 for the nine month periods ended September 30, 2005 and 2004, and $50,198 and $9,600 for the three month periods ended September 30, 2005 and 2004, respectively. o Mortgage Servicing Fees Monthly mortgage servicing fees of up to 1/8 of 1% (1.5% on an annual basis) of the unpaid principal of the Partnership's loans is paid to Redwood Mortgage Corp., or such lesser amount as is reasonable and customary in the geographic area where the property securing the mortgage is located. Mortgage servicing fees of $54,692 and $60,219 were incurred for the nine month periods ended September 30, 2005 and 2004, and $22,729 and $20,457 were incurred for the three month periods ended September 30, 2005 and 2004, respectively. o Asset Management Fees The general partners receive monthly fees for managing the Partnership's portfolio and operations up to 1/32 of 1% of the `net asset value' (3/8 of 1% on an annual basis). Management fees to the general partners of $25,824 and $25,507 were incurred by the Partnership for the nine month periods ended September 30, 2005 and 2004, and $8,642 and $8,520 were incurred for the three month periods ended September 30, 2005 and 2004, respectively. o Other Fees The Partnership Agreement provides that the general partners may receive other fees such as processing and escrow, reconveyance, mortgage assumption and mortgage extension fees. Such fees are incurred by the borrowers and are paid to the general partners. Such fees aggregated $7,629 and $6,606 for the nine month periods ended September 30, 2005 and 2004, and $3,474 and $906 for the three month periods ended September 30, 2005 and 2004, respectively. o Income and Losses All income and losses are credited or charged to partners in relation to their respective Partnership interests. The allocation to the general partners (combined) shall be a total of 1%, which was $4,230 and $4,279 for the nine month periods ended September 30, 2005 and 2004, and $1,486 and $1,493 for the three month periods ended September 30, 2005 and 2004, respectively. o Operating Expenses An affiliate of the Partnership, Redwood Mortgage Corp., is reimbursed by the Partnership for all operating expenses actually incurred by it on behalf of the Partnership, including without limitation, out-of-pocket general and administration expenses of the Partnership, accounting and audit fees, legal fees and expenses, postage and preparation of reports to limited partners. Such reimbursements are reflected as expenses in the statements of income. Operating expenses totaling $10,284 and $13,753 for the nine month periods ended September 30, 2005 and 2004, and $3,498 and $4,337 for the three month periods ended September 30, 2005 and 2004, respectively, were reimbursed to Redwood Mortgage Corp. In June, 2005, Redwood Mortgage Corp waived approximately $755 of this cost. o Contributed Capital The general partners jointly and severally contributed 1/10 of 1% in cash contributions as proceeds from the offerings were received from the limited partners. As of September 30, 2005 and 2004, a general partner, Gymno Corporation, had contributed $11,973 as capital in accordance with Section 4.02(a) of the Partnership Agreement. 13 Results of Operations - For the nine and three months ended September 30, 2005 and 2004 Changes in the Partnership's operating results for the nine and three month periods ended September 30, 2005 versus 2004 are discussed below: Changes during the Changes during the nine months ended three months ended September 30, 2005 September 30, 2005 versus 2004 versus 2004 ---------------------- ---------------------- Net income increase/(decrease) $ (4,855) $ (758) =============== ============== Revenue Interest on loans $ (76,581) $ (1,164) Interest - interest bearing accounts (430) 141 Late fees (8,429) (1,589) Other (23,628) (8,106) --------------- --------------- $ (109,068) $ (10,718) --------------- --------------- Expenses Mortgage servicing fees $ (5,527) $ 2,272 Interest expense (2,512) (1,444) Clerical costs through Redwood Mortgage Corp. (3,469) (839) Asset management fees 317 122 Provisions for (recovery of) losses on loans and real estate held for sale (74,931) (10,813) Professional services 1,680 5,929 Printing, supplies and postage 179 34 Other (19,950) (5,221) --------------- --------------- $ (104,213) $ (9,960) --------------- --------------- Net income increase/(decrease) $ (4,855) $ (758) =============== ===============
The decrease in interest on loans of $76,581 (12.89%) for the nine month period and $1,164 (0.59%) for the three month period ended September 30, 2005 as compared to the same periods in 2004 was primarily due to a decrease in the loan portfolio outstanding to $6,318,264 as of September 30, 2005 from $8,620,888 as of September 30, 2004. Average loan portfolio balance for the nine month period ended September 30, 2005 and 2004 was $6,512,678 and $7,993,287, respectively. The decrease in interest is also attributed to a decrease in the average interest rate, which stood at 9.24% as of September 30, 2005 as compared to 9.66% as of September 30, 2004. The decrease in interest on loans of $1,164 during the third quarter of 2005 as compared to the same period in 2004 was mitigated, as to the continuing nine month downward trend, by accrual of interest totaling $42,472 on a loan that was previously considered to be impaired. There is a strong likelihood that during the fourth quarter of 2005 two loans with principal balances totaling approximately $1,450,000 will be paid off. Should this occur, interest income may be significantly reduced until the funds can be placed into new mortgage loans. The decrease in other income of $23,628 (91.09%) for the nine month period and $8,106 (92.67%) for the three month period ended September 30, 2005 as compared to the same periods in 2004 was primarily due to the Partnership no longer receiving non-refundable option payments on a property sold in October, 2004. During the first nine months of 2004 these option payments totaled $23,143. The property against which the payments were being made was sold in October, 2004. The decrease in late charges of $8,429 (47.61%) for the nine month period and $1,589 (22.33%) for the three month period ended September 30, 2005 as compared to the same periods in 2004 was primarily due to a reduction in delinquent loans. 14 The decrease in mortgage servicing fees of $5,527 (9.18%) for the nine month period ended September 30, as compared to the same period in 2004, was primarily due to a decrease in the loan portfolio balance to $6,318,264 as of September 30, 2005 from a portfolio balance of $8,620,888 as of September 30, 2004. The average loan portfolio balance for the nine month periods ended September 30, 2005 and 2004 was $6,512,678 and $7,993,287, respectively. The increase in mortgage servicing fees of $2,272 (11.11%) for the three month period ended September 30, 2005 as compared to the same period in 2004 was due to the accrual of servicing fees of $8,014 on a loan that was previously considered to be impaired. Mortgage servicing fees on impaired loans are due as borrower payments are received. The servicing fees on the previously impaired loan also reduced the decrease in servicing fees for the nine month period ended September 30, 2005. The decrease in provisions for losses on loans and real estate held for sale of $74,931 (176.57%) for the nine month period and $10,813 (66.81%) for the three month period ended September 30, 2005 as compared to the same periods in 2004 is due to management's determination that the allowance for loan losses of $746,356 as of September 30, 2005 was adequate to offset potential losses on loans. There were no filed notices of default as of September 30, 2005 and none are expected in the foreseeable future. The increase in professional fees of $1,680 (4.53%) for the nine month period and $5,929 (81.30%) for the three month period ended September 30, 2005 as compared to the same periods in 2004 is due to an increase in fees and timing of billings in 2005 compared to 2004. The decrease in interest expense of $2,512 (100%) for the nine month period and $1,444 (100%) for the three month period ended September 30, 2005 as compared to the same periods in 2004, is due to non-usage of the line of credit facility during the first nine months of 2005 compared to an average usage of $236,667 during the corresponding period of 2004. The decrease in other expenses of $19,950 (78.75%) for the nine month period and $5,221 (82.07%) for the three month period ended September 30, 2005 as compared to the same periods in 2004 was primarily due to a reduction in upkeep costs for the real estate held for sale properties. The Partnership spent $2,745 and $21,772 during the nine month periods ended September 30, 2005 and 2004, and $1,116 and $6,286 during the three month periods ended September 30, 2005 and 2004. The decrease in clerical costs of $3,469 (25.22%) for the nine month period and $839 (19.35%) for the three month period ended September 30, 2005 as compared to the same periods in 2004 is primarily due to lower servicing costs. The decrease of $3,469 for the nine months ended September 30, 2005 would have been only $2,714 had Redwood Mortgage Corp. not waived $755 in such costs in June 2005. Partnership capital increased by $130,470 during the first nine months of 2005 as the aggregate of earnings distributions and capital liquidations was less than the net income level of the Partnership. For the nine month period ended September 30, 2005 limited partners' net income was $418,789 as compared to earnings distributions of $135,245 and capital liquidations of $153,218, which totaled $288,463, as compared to limited partners' net income of $423,595 as compared to earnings distributions of $145,076 and capital liquidations of $198,838, which totaled $343,914 for the corresponding period in 2004. During the third quarter of 2005 limited partners' net income was $147,089 as compared to earnings distributions of $44,961 and capital liquidations of $36,198, which totaled $81,159, as compared to limited partners' net income of $147,840 as compared to earnings distributions of $49,828 and capital liquidations of $51,018, which totaled $100,846 for the corresponding period in 2004. Earnings and capital liquidations are a factor of limited partner elections and currently limited partners seeking liquidations of earnings or their capital account continues to decline. Limited partner income, which has continued to be higher than earnings distributions and capital liquidations for the past several quarters, has grown the limited partners' capital. At September 30, 2005 there were no outstanding loans with filed notices of default. 15 Redwood Mortgage Corp., an affiliate of the general partners, received mortgage brokerage commissions from loan borrowers of $103,848 and $50,198 for the nine and three month periods ended September 30, 2005 as compared to $59,128 and $9,600 for the same periods in 2004. The increase of $44,720 for the nine month period and $40,598 for the three month period ended September 30, 2005 as compared to the same periods in 2004 is due to more loans that were funded totaling $4,168,416 and $3,360,068, respectively. Allowance for Losses. The general partners regularly review the loan portfolio, examining the status of delinquencies, the underlying collateral securing these loans, borrowers' payment records, etc. Based upon this information and other data, the allowance for loan losses is increased or decreased. Borrower foreclosures are a normal aspect of Partnership operations. The Partnership is not a credit based lender and hence while it reviews the credit history and income of borrowers, and if applicable, the income from income producing properties, the general partners expect that we will on occasion take back real estate security. During 2002 and 2003, the California economy stabilized. During 2004 and continuing in 2005 the economy and the Northern California Real Estate Market has strengthened. At September 30, 2005 the Partnership had one loan past due 90 days or more in interest payments totaling $96,716 with no loans in foreclosure. In addition, two loans with total principal balance of $64,770 were current in interest payments but were past maturity as of September 30, 2005, for a combined total of three loans past due 90 days or more in interest payments and/or past maturity totaling $161,486. Periodically, the Partnership enters into workout agreements with borrowers who are past maturity or delinquent in their regular payments. The Partnership has one loan totaling $96,716 in a workout agreement with the borrower. Typically, a workout agreement allows the borrower to extend the maturity date of the balloon payment and/or allows the borrower to make current monthly payments while deferring for periods of time, past due payments and balloon payments and allows time to pay the loan in full. Workout agreements and foreclosures generally exist within our loan portfolio to greater or lesser degrees, depending primarily on the health of the economy. The number of foreclosures and workout agreements will generally rise during difficult economic times and conversely fall during good economic times. The number and amount of workout agreements existing at September 30, 2005, in management's opinion, does not have a material effect on our results of operations or liquidity. Workout agreements are considered when management arrives at an appropriate allowance for loan losses, and based on our experience; they are reflective of our loan marketplace segment. In the remainder of 2005, we may initiate foreclosure by filing notices of default on delinquent borrowers or borrowers who become delinquent during the year. Borrower foreclosures are a normal aspect of Partnership operations and the general partners anticipate that they will not have a material effect on liquidity. As a prudent guard against potential losses, the general partners have made provisions for losses on loans and real estate held for sale through foreclosure of $746,356 at September 30, 2005. These provisions for losses were made to guard against collection losses. The total provision for losses as of September 30, 2005 is considered by the general partners to be adequate. Because of the number of variables involved, the magnitude of the swings possible and the general partners' inability to control many of these factors, actual results may and do sometimes differ significantly from estimates made by the general partners. Total provision for losses on loans and real estate held for sale of $746,356 as of September 30, 2005 is considered to be reasonable. As of September 30, 2005, the Partnership had an average loan to value ratio computed based on appraised values and prior liens as of the date the loan was made of 71.29%. This percentage does not account for any increases or decreases in property values since the date the loan was made, nor does it include any reductions in principal through amortization of payments after the loan was made. This low loan to value ratio will assist the Partnership in weathering loan delinquencies and foreclosures should they eventuate. 16 PORTFOLIO REVIEW - For the nine months ended September 30, 2005 and 2004 Loan Portfolio The Partnership's loan portfolio consists primarily of short-term (one to five years), fixed rate loans secured by real estate. As of September 30, 2005 and 2004 the Partnership's loans secured by real property collateral in five San Francisco Bay Area counties (San Francisco, San Mateo, Santa Clara, Alameda, and Contra Costa) represented $4,718,050 (74.67%) and $5,417,331 (62.84%) of the outstanding secured loan portfolio. The remainder of the portfolio represented loans secured by real estate located primarily in Northern California. As of September 30, 2005 and 2004, the Partnership held 26 and 29 loans respectively in the following categories: September 30, 2005 September 30, 2004 ------------------------------- ------------------------------ Single Family Homes (1-4 units) $ 3,116,033 49% $ 3,716,448 43% Commercial 2,100,349 33% 2,598,804 30% Apartments (5+ units) 666,716 11% 1,012,221 12% Land 435,166 7% 1,293,415 15% -------------- ------------- -------------- ------------- Total $ 6,318,264 100% $ 8,620,888 100% ============== ============= ============== =============
As of September 30, 2005, the Partnership held 26 loans secured by deeds of trust. The following table sets forth the priorities, asset concentrations and maturities of the loans held by the Partnership as of September 30, 2005: PRIORITIES, ASSET CONCENTRATIONS AND MATURITIES OF LOANS As of September 30, 2005 # of Loans Amount Percent ------------- --------------- ------------- 1st Mortgages 16 $ 4,756,452 75% 2nd Mortgages 8 1,337,246 21% 3rd Mortgages 2 224,566 4% ============= =============== ============= Total 26 $ 6,318,264 100% Maturing 12/31/05 and prior 2 $ 64,770 1% Maturing prior to 12/31/06 3 916,716 14% Maturing prior to 12/31/07 3 1,681,919 27% Maturing after 12/31/07 18 3,654,859 58% ============= =============== ============= Total 26 $ 6,318,264 100% Average Secured Loan $ 243,010 4% Largest Secured Loan 686,400 11% Smallest Secured Loan 11,541 0.18% Average Loan-to-Value based upon appraisals and prior liens at time loan was consummated 71.29%
The Partnership's largest loan in the principal amount of $686,400 represents 10.86% of outstanding secured loans and 7.35% of Partnership assets. Over time, loans may increase above 10% of the secured loan portfolio or Partnership assets as the loan portfolio and assets of the Partnership decrease due to limited partner withdrawals and/or loan payoffs. 17 Liquidity and Capital Resources. The Partnership relies upon loan payoffs and borrowers' mortgage payments for the source of funds for loans. Recently, mortgage interest rates have decreased somewhat from those available at the inception of the Partnership. If interest rates were to increase substantially, the yield of the Partnership's loans may provide lower yields than other comparable debt-related investments. Additionally, since the Partnership has made primarily fixed rate loans, if interest rates were to rise, the likely result would be a slower prepayment rate for the Partnership. This could cause a lower degree of liquidity as well as a slowdown in the ability of the Partnership to invest in loans at the then current interest rates. Conversely, in the event interest rates were to decline, the Partnership could experience significant borrower prepayments, which, if the Partnership can only obtain the then existing lower rates of interest may cause a dilution of the Partnership's yield on loans, thereby lowering the Partnership's overall yield to the limited partners. Cash is constantly being generated from borrower interest payments, late charges, amortization of loan principal and loan payoffs. Currently, cash flow exceeds Partnership expenses, earnings and limited partner capital payout requirements. Excess cash flow will be invested in new loan opportunities, when available, and in other Partnership business. During the fourth quarter of 2005 it is anticipated that two loans with outstanding principal balances of approximately $1,450,000 will be paid off. Alone, payoff of these two loans represents 23% of the Partnership's loan portfolio at September 30, 2005. The Partnership will endeavor to place cash proceeds into suitable mortgage loan investments. However, it is unlikely that the cash will immediately be placed in new loans. As a result, interest income may decline until suitable replacement loans are funded. At the time of subscription to the Partnership, limited partners made a decision to either take distributions of earnings monthly, quarterly or annually or to compound earnings in their capital account. For the nine and three month periods ended September 30, 2005 and 2004, the Partnership made distributions of earnings to limited partners of $135,245 and $145,076 for the nine months, and $44,961 and $49,828 for the three months, respectively. Distribution of earnings to limited partners, which were not withdrawn for the nine and three month periods ended September 30, 2005 and 2004 were $283,544 and $278,519 for the nine months, and $102,128 and $98,012 for the three months, respectively. As of September 30, 2005 and 2004, limited partners electing to withdraw earnings represented 35% and 34% of the limited partners' capital. The Partnership also allows the limited partners to withdraw their capital account subject to certain limitations. For the nine and three month periods ended September 30, 2005 and 2004, $23,045 and $22,213 for the nine months, and $5,489 and $8,950 for the three months, respectively, were liquidated subject to the 10% penalty for early withdrawal. These withdrawals are within the normally anticipated range that the general partners would expect in their experience in this and other Partnerships. The general partners expect that a small percentage of limited partners will elect to liquidate their capital accounts over one year with a 10% early withdrawal penalty. In originally conceiving the Partnership, the general partners wanted to provide limited partners needing their capital returned a degree of liquidity. Generally, limited partners electing to withdraw over one year need to liquidate their investment to raise cash. The trend the Partnership is experiencing in withdrawals by limited partners electing a one year liquidation program is that such withdrawals represent a small percentage of limited partner capital as of September 30, 2005 and 2004. Additionally, for the nine and three month periods ended September 30, 2005 and 2004, $130,173 and $176,625 for the nine months, and $30,708 and $42,068 for the three months, respectively, were liquidated by limited partners who have elected a liquidation program over a period of five years or longer. This ability to withdraw after five years by limited partners has the effect of providing limited partner liquidity. The general partners expect a portion of the limited partners to take advantage of this provision. This has the anticipated effect of the Partnership growing, primarily through reinvestment of earnings in years one through five. The general partners expect to see increasing numbers of limited partner withdrawals in years five through eleven, after which time the bulk of those limited partners who have sought withdrawal have been liquidated. After year eleven, liquidation generally subsides. 18 In some cases in order to satisfy Broker Dealers and other reporting requirements, the general partners have valued the limited partners' interest in the Partnership on a basis which utilizes a per Unit system of calculation, rather than based upon the investors' capital account. This information has been reported in this manner in order to allow the Partnership to integrate with certain software used by the Broker Dealers and other reporting entities. In those cases, the Partnership will report to Broker Dealers, Trust Companies and others a "reporting" number of Units based upon a $1.00 per Unit calculation. The number of reporting Units provided will be calculated based upon the limited partner's capital account value divided by $1.00. Each investor's capital account balance is set forth periodically on the Partnership account statement provided to investors. The reporting Units are solely for Broker Dealers requiring such information for their software programs and do not reflect actual Units owned by a limited partner or the limited partners' right or interest in cash flow or any other economic benefit in the Partnership. Each investor's capital account balance is set forth periodically on the Partnership account statement provided to investors. The amount of Partnership earnings each investor is entitled to receive is determined by the ratio that each investor's capital account bears to the total amount of all investor capital accounts then outstanding. The capital account balance of each investor should be included on any NASD member client account statement in providing a per Unit estimated value of the client's investment in the Partnership in accordance with NASD Rule 2340. While the general partners have set an estimated value for the Partnership Units, such determination may not be representative of the ultimate price realized by an investor for such Units upon sale. No public trading market exists for the Partnership's Units and none is likely to develop. Thus, there is no certainty that the Units can be sold at a price equal to the stated value of the capital account. Furthermore, the ability of an investor to liquidate his or her investment is limited subject to certain liquidation rights provided by the Partnership, which may include early withdrawal penalties. Current Economic Conditions. From July 1, 2004 through September 30, 2005, the Federal Reserve increased the Federal Funds Rate to 3.75% from 1%. The recent upward movement in the Federal Funds Rate during 2004 and 2005 has raised short-term rates; and while long-term interest rates have risen, they have not increased at a pace comparable to the rise in short-term rates. In the future the general partners anticipate that interest rates will likely change from their current levels. The general partners cannot, at this time, predict at what levels interest rates will be in the future. The general partners anticipate that new loans will be placed during 2005 at rates slightly above those that prevailed in 2004. The recent increases in short term interest rates, and to a lesser extent long term interest rates, have encouraged those borrowers with interest rates above the current going rates to refinance their indebtedness to lock in these historically low interest rates should they increase in the future. Demand for loans from qualified borrowers continues to be strong and as loan repayments occur, the general partners expect to replace the paid off loans with loans at interest rates attainable in the then existing interest rate environment. At this time, the general partners believe that the average loan portfolio interest rate will remain relatively stable over the remainder of 2005. Based upon the rates payable in connection with the existing loans, anticipated interest rates to be charged by the Partnership, and the general partners' experience, the general partners anticipate that the Partnership's annualized yield will range between 5.75% and 6.50% in 2005. During the third quarter of 2005, the United States economy as a whole performed well. Early estimates of a 3.8% third quarter Real Gross Domestic Product shows a continuation of the previous nine consecutive quarters of expansion in excess of 3% (BEA 11/05). The United States unemployment rate for October, 2005 was 5% and has hovered close to that level throughout the second and third quarters of 2005. Regionally, the San Francisco Bay Area demonstrated a very similar unemployment rate with an unemployment rate of 4.9% for the month ended August, 2005. The San Francisco Bay area unemployment rate has been declining from 5.3% in January, 2005 to the current 4.9% (United States Department of Labor 11/05). The rate of inflation concerns many with energy costs having risen significantly over the last year. The consumer price index spiked upward 1.2% in September, 2005 and was 4.7% higher than in September, 2004 (United States Department of Labor 11/05). It remains to be seen whether increased energy costs will ripple through the economy and drive inflation upward, which could push interest rates higher. These statistics indicate an economy that is continuing to grow, which is good for both mortgage lenders and the real estate industry as a whole. The Partnership makes loans primarily in Northern California. As such the regional real estate market is of primary concern to the Partnership. As of September 30, 2005 and 2004, approximately 74.67% ($4,718,050) and 62.84% ($5,417,331) of the loans held by the Partnership were in five San Francisco Bay Area Counties, respectively. The remainder of the loans held was secured primarily by Northern California real estate outside of the San Francisco Bay Area. 19 California residential real estate continued to appreciate in value during the third quarter of 2005. In the San Francisco Bay Area, as of September 2005 single family home median sales prices increased by 19.4%, 22.1%, 15.7% 10.3%, 21.0% and 18.5% to $616,000, $580,000, $899,000, $757,500, $816,500, and $705,000 for the Alameda, Contra Costa, Marin, San Francisco, San Mateo and Santa Clara counties from September 2004, respectively (DataQuick Information Systems). The total sales volumes and the number of homes sold have been declining. Sales volumes for the nine months ended September 2005 as compared to September 2004 were typically 5% lower. Mortgage interest rates for both fixed and adjustable rate loans have been rising, decreasing housing affordability. During the week of October 14, 2005, 30 year fixed rate mortgages increased above a 6% interest rate for the first time since March 2005 (Freddie Mac). Rising interest rates will likely slow down the rate of housing appreciation we have seen over the last two years. A strong residential real estate marketplace increases lending opportunities and assists in providing adequate equity to help repay mortgage debt should borrowers become delinquent in their payments. Commercial real estate in the San Francisco Bay Area continued its rebound. Occupancy is increasing and rents are either stagnant or increasing in most markets throughout the San Francisco Bay Area. Grubb and Ellis reports that class A space in San Francisco average rents are $32.60 up 3.6% from the second quarter and that vacancy is at 17.6%t down from 18.5% in the second quarter and 21.2% in the third quarter of 2004. The San Francisco leasing market has absorbed an estimated 1.9 million square feet net during 2005. Sales of commercial office buildings are brisk with record per square foot prices being attained and 2005 being on track to be a record volume sales year. A healthy commercial real estate market increases lending opportunities and assists in providing adequate equity to repay mortgage debt should borrowers become delinquent in their payments. For Partnership loans outstanding as of September 30, 2005, the Partnership had an average loan-to-value ratio of 71.29%, computed based on appraised values and senior liens as of the date the loan was made. This percentage does not account for any increases or decreases in property values since the date the loan was made, nor does it include any reductions in principal on senior indebtedness through amortization of payments after the loan was made. This low loan-to-value ratio will assist the Partnership in weathering loan delinquencies and foreclosures should they eventuate. Contractual Obligations Table. A summary of the contractual obligations of the Partnership as of September 30, 2005 is set forth below: Contractual Obligation Total Less than 1 Year 1-3 Years 3-5 Years ---------------------------- ----------------- ------------------ ----------------- ---------------- Line of credit - - - - Rehabilitation loans $ 52,334 $ 52,334 - - ----------------- ----------------- ----------------- ---------------- Total $ 52,334 $ 52,334 - - ================= ================= ================= ================
20 Part I - Item 3. Quantitative and Qualitative Disclosures About Market Risk The following table contains information about the cash held in money market accounts, loans held in the Partnership's portfolio and loans to the partnership pursuant to its line of credit as of September 30, 2005. The presentation, for each category of information, aggregates the assets and liabilities by their maturity dates for maturities occurring in each of the years 2005 through 2009 and separately aggregates the information for all maturities arising after 2009. The carrying values of these assets and liabilities approximate their fair market values as of September 30, 2005: 2005 2006 2007 2008 2009 Thereafter Total ---------------------------------------------------------------------------------------------- Interest earning assets: Money market accounts $ 642,888 $ 642,888 Average interest rate 0.68% 0.68% Unsecured loans $ 245,300 $ 245,300 Average interest rate 0% 0% Loans secured by deeds of trust $ 64,770 916,716 1,681,919 - 1,806,127 1,848,732 $6,318,264 Average interest rate 10.00% 8.91% 9.13% - 9.16% 9.25% 9.15% Interest bearing liabilities: Line of credit $ - $ - Interest rate 7.00% 7.00%
Market Risk. The Partnership's line of credit bears interest at a variable rate, tied to the prime rate. As a result, the Partnership's primary market risk exposure with respect to its obligations is to changes in interest rates, which will affect the interest cost of outstanding amounts on the line of credit. The Partnership may also suffer market risk tied to general trends affecting real estate values that may impact the Partnership's security for its loans. The Partnership's primary market risk in terms of its profitability is the exposure to fluctuations in earnings resulting from fluctuations in general interest rates. The majority of the Partnership's mortgage loans earn interest at fixed rates. Changes in interest rates may also affect the value of the Partnership's investment in mortgage loans and the rates at which the Partnership reinvests funds obtained from loan repayments and new capital contributions from limited partners. If interest rates increase, the interest rates the Partnership obtains from reinvested funds will generally increase, but the value of the Partnership's existing loans at fixed rates will generally tend to decrease. The risk is mitigated by the fact that the Partnership does not intend to sell its loan portfolio, rather such loans are held until they are paid off. If interest rates decrease, the amounts becoming available to the Partnership for investment due to repayment of Partnership loans may be reinvested at lower rates than the Partnership had been able to obtain in prior investments, or than the rates on the repaid loans. In addition, interest rate decreases may encourage borrowers to refinance their loans with the Partnership at a time where the Partnership is unable to reinvest in loans of comparable value. The Partnership does not hedge or otherwise seek to manage interest rate risk. The Partnership does not enter into risk sensitive instruments for trading purposes. ASSET QUALITY A consequence of lending activities is that occasionally losses will be experienced and that the amount of such losses will vary from time to time, depending upon the risk characteristics of the loan portfolio as affected by economic conditions and the financial experiences of borrowers. Many of these factors are beyond the control of the general partners. There is no precise method of predicting specific losses or amounts that ultimately may be charged off on particular segments of the loan portfolio, especially in light of the current economic environment. 21 The conclusion that a loan may become uncollectible, in whole or in part, is a matter of judgment. Although institutional lenders are subject to requirements and regulations that, among other things, require them to perform ongoing analyses of their portfolios, loan-to-value ratios, reserves, etc., and to obtain and maintain current information regarding their borrowers and the securing properties, the Partnership is not subject to these regulations and has not adopted certain of these practices. Rather, the general partners, in connection with the periodic closing of the accounting records of the Partnership and the preparation of the financial statements, determine whether the allowance for loan losses is adequate to cover potential loan losses of the Partnership. As of September 30, 2005 the general partners have determined that the allowance for loan losses of $746,356 (8.06% of net assets) is adequate in amount. Because of the number of variables involved, the magnitude of the swings possible and the general partners' inability to control many of these factors, actual results may and do sometimes differ significantly from estimates made by the general partners. As of September 30, 2005, one loan totaling $96,716 was delinquent 90 days or more in interest payments. Management believes that there is sufficient collateral to cover the amount outstanding to the Partnership on this loan. The allowance for loan losses of $746,356 as of September 30, 2005 is considered reasonable to offset potential loss in loan collections in the future. Part I - Item 4. CONTROLS AND PROCEDURES As of September 30, 2005, the Partnership carried out an evaluation, under the supervision and with the participation of the general partners of the effectiveness of the design and operation of the Partnership's disclosure controls and procedures pursuant to Rule 13a-15 of the Securities Exchange Act of 1934, as amended. Based upon that evaluation, the general partners concluded that the Partnership's disclosure controls and procedures are effective in timely alerting the general partners to material information relating to the Partnership that is required to be included in our periodic filings with the Securities and Exchange Commission. There were no significant changes in the Partnership's internal control over financial reporting during the Partnership's third fiscal quarter that have materially affected, or are reasonably likely to materially affect, the Partnership's internal control over financial reporting. 22 PART II - OTHER INFORMATION Item 1. Legal Proceedings The Partnership periodically is a defendant in various legal actions. Please refer to Note 10 of the Financial Statements. Item 2. Unregistered Sales of Equity Securities and Use of Proceeds Not Applicable Item 3. Defaults upon Senior Securities Not Applicable Item 4. Submission of Matters to a Vote of Security Holders Not Applicable Item 5. Other Information Not Applicable Item 6. Exhibits 31.1 Certification of General Partner pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 31.2 Certification of General Partner pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 32.1 Certification of General Partner pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 32.2 Certification of General Partner pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 23 SIGNATURES Pursuant to the requirements of Section 13 or 15 (d) of the Securities Exchange Act of 1934 the registrant has duly caused this report to be signed on its behalf by the undersigned, thereto duly authorized on the 14th day of November 2005. REDWOOD MORTGAGE INVESTORS VII By: /S/ Michael R. Burwell ------------------------------------ Michael R. Burwell, General Partner By: Gymno Corporation, General Partner By: /S/ Michael R. Burwell ---------------------------------------------- Michael R. Burwell, President, Secretary/Treasurer & Chief Financial Officer 24 Exhibit 31.1 GENERAL PARTNER CERTIFICATION I, Michael R. Burwell, General Partner, certify that: 1. I have reviewed this quarterly report on Form 10-Q of Redwood Mortgage Investors VII, a California Limited Partnership (the "Registrant"); 2. Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report; 3. Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of the Registrant as of, and for, the periods presented in this quarterly report; 4. The Registrant's other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the Registrant and we have: (a) designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the Registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this quarterly report is being prepared; (b) evaluated the effectiveness of the Registrant's disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and (c) disclosed in this report any change in the Registrant's internal control over financial reporting that occurred during the Registrant's most recent fiscal quarter (the Registrant's fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the Registrant's internal control over financial reporting; and 5. The Registrant's other certifying officers and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the Registrant's auditors and the audit committee of Registrant's board of directors (or persons performing the equivalent function): (a) all significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the Registrant's ability to record, process, summarize and report financial data; and (b) any fraud, whether or not material, that involves management or other employees who have a significant role in the Registrant's internal control over financial reporting. /s/ Michael R. Burwell ----------------------------------- Michael R. Burwell, General Partner November 14, 2005 25 Exhibit 31.2 PRESIDENT AND CHIEF FINANCIAL OFFICER CERTIFICATION I, Michael R. Burwell, President and Chief Financial Officer of Gymno Corporation, General Partner, certify that: 1. I have reviewed this quarterly report on Form 10-Q of Redwood Mortgage Investors VII, a California Limited Partnership (the "Registrant"); 2. Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report; 3. Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of the Registrant as of, and for, the periods presented in this quarterly report; 4. The Registrant's other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the Registrant and we have: (a) designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the Registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this quarterly report is being prepared; (b) evaluated the effectiveness of the Registrant's disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and (c) disclosed in this report any change in the Registrant's internal control over financial reporting that occurred during the Registrant's most recent fiscal quarter (the Registrant's fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the Registrant's internal control over financial reporting; and 5. The Registrant's other certifying officers and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the Registrant's auditors and the audit committee of Registrant's board of directors (or persons performing the equivalent function): (a) all significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the Registrant's ability to record, process, summarize and report financial data; and (b) any fraud, whether or not material, that involves management or other employees who have a significant role in the Registrant's internal control over financial reporting. /s/ Michael R. Burwell --------------------------------- Michael R. Burwell, President and Chief Financial Officer of Gymno Corporation, General Partner November 14, 2005 26 Exhibit 32.1 CERTIFICATION PURSUANT TO 18 U.S.C SECTION 1350, AS ADOPTED PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002 In connection with the Quarterly Report of Redwood Mortgage Investors VII (the "Partnership") on Form 10-Q for the period ending September 30, 2005 as filed with the Securities and Exchange Commission on the date hereof (the "Report"), pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, I, Michael R. Burwell, General Partner of the Partnership, certify, that to the best of my knowledge: (1) The Report fully complies with the requirements of section 13(a) or 15(d) of the Securities Exchange Act of 1934; and (2) The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Partnership at the dates and for the periods indicated. /s/ Michael R. Burwell ----------------------------------- Michael R. Burwell, General Partner November 14, 2005 27 Exhibit 32.2 CERTIFICATION PURSUANT TO 18 U.S.C. SECTION 1350 AS ADOPTED PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002 In connection with the Quarterly Report of Redwood Mortgage Investors VII (the "Partnership") on Form 10-Q for the period ending September 30, 2005 as filed with the Securities and Exchange Commission on the date hereof (the "Report"), pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, I, Michael R. Burwell, President, Secretary/Treasurer & Chief Financial Officer of Gymno Corporation, General Partner of the Partnership, certify that to the best of my knowledge: (1) The Report fully complies with the requirements of section 13(a) or 15(d) of the Securities Exchange Act of 1934; and (2) The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Partnership at the dates and for the periods indicated. /s/ Michael R. Burwell ----------------------------------- Michael R. Burwell, President, Secretary/Treasurer & Chief Financial Officer of Gymno Corporation, General Partner November 14, 2005 28