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SLRK > SEC Filings for SLRK > Form 10-K on 21-Mar-2013All Recent SEC Filings

Show all filings for SOLERA NATIONAL BANCORP, INC. | Request a Trial to NEW EDGAR Online Pro

Form 10-K for SOLERA NATIONAL BANCORP, INC.


21-Mar-2013

Annual Report


ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The purpose of the following discussion is to address information relating to the financial condition and results of operations of the Company that may not be readily apparent from the financial statements and notes included in this Report. This discussion should be read in conjunction with the information provided in the Company's financial statements and the notes thereto. The financial information provided below has been rounded in order to simplify its presentation. However, the ratios and percentages provided below are calculated using the detailed financial information contained in the financial statements, the notes thereto and the other financial data included elsewhere in this Report.

General

The Company is a Delaware corporation that was incorporated in 2006 to organize and serve as the holding company for Solera National Bank, a national bank that opened for business on September 10, 2007. Solera National Bank is a full-service commercial bank headquartered in Lakewood, Colorado serving the Denver metropolitan area. The Company's main banking office is located at 319 South Sheridan Boulevard, Lakewood, Colorado 80226. The Bank's telephone number is (303) 209-8600.

The Bank offers a broad range of commercial and consumer banking services to small- and medium-sized businesses, licensed professionals and individuals who management believes are particularly responsive to the personalized service that Solera National Bank provides to its customers. Management believes that local ownership and control allows the Bank to serve customers more efficiently and effectively and aids in the Company's growth and success. Solera National Bank competes on the basis of providing a personalized banking experience combined with a full range of services, customized and tailored to fit the individual needs of its clients. While Solera National Bank serves the entire community, it has a specialized focus serving the local Hispanic population, along with other minority and disadvantaged communities due to the significant growth in these markets and its belief that these populations are currently underserved. In December 2012, the Company launched a residential mortgage division with five loan production offices in Colorado including Boulder, two locations in Colorado Springs, the Denver Tech Center and Durango. With the addition of more than 50 mortgage professionals, the Bank now offers residential mortgage loans, the vast majority of which will be sold on the secondary market. We expect that the residential mortgage lending division will generate the majority of our noninterest income and noninterest expenses over the near term, and employ the majority of our employees.

The following discussion focuses on the Company's financial condition and results of operations during the years ended December 31, 2012 and 2011, presented on a consolidated basis.

As of December 31, 2012, on a consolidated basis, the Company had total assets of $153.9 million, net loans of $58.7 million, total deposits of $124.7 million and stockholders' equity of $19.9 million.


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Critical accounting policies

This discussion and analysis of the Company's financial condition and results of operations is based upon the Company's financial statements, which have been prepared in accordance with United States generally accepted accounting principles. The preparation of these consolidated financial statements requires management to make estimates and judgments that affect the reported amounts of assets and liabilities, revenues and expenses, and related disclosures of contingent assets and liabilities at the date of the financial statements. Actual results may differ from these estimates under different assumptions or conditions. The following is a summarized description of the Company's significant accounting policies used in the preparation of the accompanying consolidated financial statements. Please see Note 1 of the Notes to Consolidated Financial Statements contained in "Item 8. Financial Statements and Supplementary Data" beginning on page F-7 of this Annual Report on Form 10-K for a more complete description of our significant accounting policies.

Allowance for loan and lease losses

Implicit in the Company's lending activities is the fact that loan losses will be experienced and that the risk of loss will vary with the type of loan being made and the creditworthiness of the borrower over the term of the loan. The allowance for loan and lease losses represents the Company's recognition of the risks of extending credit and its evaluation of the loan portfolio. The allowance for loan and lease losses is maintained at a level considered adequate to provide for probable loan losses based on management's assessment of various factors affecting the loan portfolio.

The Company has established a formal process for determining an adequate allowance for loan and lease losses. The allowance for loan and lease losses calculation has two components. The first component represents the allowance for loan and lease losses for impaired loans; that is loans where the Company believes collection of the contractual principal and interest payments is not probable. The second component represents contingent losses - the estimated probable losses inherent within the portfolio due to uncertainties. Factors considered by management to estimate inherent losses include, but are not limited to, 1) historical and current trends in downgraded loans; 2) the level of the allowance in relation to total loans; 3) the level of the allowance in relation to the Bank's peer group; 4) the levels and trends in non-performing and past due loans; and 5) management's assessment of economic conditions and certain qualitative factors as defined by bank regulatory guidance, including but not limited to, changes in the size, composition and concentrations of the loan portfolio, changes in the legal and regulatory environment, and changes in lending management. The recorded allowance for loan and lease losses is the aggregate of the impaired loans component and the contingent loss component.

At December 31, 2012, the Company had an allowance for loan and lease losses of $1.1 million. Management believes that this allowance for loan and lease losses is adequate to cover probable losses based on all currently available evidence. Future additions to the allowance for loan and lease losses may be required based on management's continuing evaluation of the inherent risks in the portfolio. Additional provisions for loan losses may need to be recorded if the economy declines, asset quality deteriorates, or the loss experience changes. Also, federal regulators, when reviewing the Bank's loan portfolio in the future, may require the Bank to increase the allowance for loan and lease losses. Any increase in the allowance for loan and lease losses would likely have an adverse effect on earnings. An analysis of the allowance for loan and lease losses as well as its allocation among certain categories of the loan portfolio can be found in Part I - Item 1. Business - Asset Quality, above.

Stock-based compensation

The Company grants stock options as incentive compensation to employees and directors. The cost of employee/director services received in exchange for an award of equity instruments is based on the grant-date fair value of the award, which is determined using a Black-Scholes-Merton model. This cost, net of estimated forfeitures, is expensed to salaries and employee benefits over the period which the recipient is required to provide services in exchange for the award, generally the vesting period.


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Additionally, the Company may grant restricted stock awards. These stock awards may vest based on a performance or service condition. For awards that vest based on a service condition, the compensation expense is recognized over the service period based on the grant-date fair value of the award (as determined by the quoted market price on the date of grant). For awards that vest based on a performance condition, the expense is recognized based on the number of awards that are expected to vest based on then-current projections. Should these expectations change in future periods, additional expense could be recorded or expense previously recorded could be reversed. Prior to the vesting of stock awards, each grantee shall have the rights of a stockholder with respect to voting and dividend rights of the granted stock.

Estimation of fair value

The estimation of fair value is significant to a number of the Company's assets, including available-for-sale investment securities and other real estate owned. These are all recorded at either fair value or at the lower of cost or fair value. Furthermore, accounting principles generally accepted in the United States require disclosure of the fair value of financial instruments as a part of the notes to the consolidated financial statements. Fair values are volatile and may be influenced by a number of factors, including market interest rates, prepayment speeds, discount rates and the shape of yield curves.

Impairment of investment securities

Investment securities are evaluated for impairment on at least a quarterly basis and more frequently when economic or market conditions warrant such an evaluation to determine whether a decline in their value below amortized cost is other-than-temporary. Securities are evaluated for impairment utilizing criteria such as the magnitude and duration of the decline, current market conditions, payment history, the credit worthiness of the obligor, the intent of the Company to retain the security or whether it is more likely than not that the Company will be required to sell the security before recovery of the value, as well as other qualitative factors. If a decline in value below amortized cost is determined to be other-than-temporary, which does not necessarily indicate that the decline is permanent, but indicates that the prospects for a near-term recovery of value is not favorable, the security is reviewed in more detail in order to determine the portion of the impairment that relates to credit (resulting in a charge to earnings) versus the portion of the impairment that is noncredit related (resulting in a charge to accumulated other comprehensive income). A credit loss is determined by comparing the amortized cost basis to the present value of cash flows expected to be collected, computed using the original yield as the discount rate.

New accounting pronouncements

See Note 1 of the Notes to Consolidated Financial Statements contained in "Item
8. Financial Statements and Supplementary Data" for information on recent accounting pronouncements and their impact, if any, on our consolidated financial statements.

Results of operations for the years ended December 31, 2012 and 2011

During the year ended December 31, 2012, the Company recorded net income of $281,000 an improvement of $39,000, or 16%, from net income of $242,000 for the year ended December 31, 2011. The improvement in earnings was primarily attributable to the $128,000 increase in noninterest income and the $155,000 decrease in provision for loan and lease losses due to stabilizing loan quality, partially offset by a $151,000 net increase in total noninterest expense. See "Non interest expense" below for further details. Additionally, the Company experienced a 24 basis point decrease in net interest margin from 3.03% in 2011 to 2.79% in 2012, which contributed to a $93,000 decrease in net interest income.

The Company recorded return on average assets of 0.19% in 2012, compared with 0.17% in 2011 and return on average equity of 1.43% in 2012, compared with 1.29% in 2011.


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Net interest income and net interest margin

Net interest income is the difference between interest and fee income, principally from loan and investment security portfolios, and interest expense, principally on customer deposits and borrowings. Net interest income is our primary source of revenues. Changes in net interest income result from changes in volume, spread and margin. Volume refers to the average dollar level of interest-earning assets and interest-bearing liabilities. Spread refers to the difference between the average yield on interest-earning assets and the average cost of interest-bearing liabilities. Margin refers to net interest income divided by average interest-earning assets, and is influenced by the level and relative mix of interest-earning assets and interest-bearing liabilities.

The following table sets forth, for the periods indicated, information related to the Company's average balance sheet and its average yields on assets and average costs of liabilities. These yields are derived by dividing the annual income or expense by the average balance of the corresponding asset or liability.

($ in thousands)                                2012                                            2011
                              Average        Interest/        Average         Average        Interest/        Average
                              Balance        Dividend        Yield/Rate       Balance        Dividend       Yield/Rate
ASSETS
Federal funds sold and
other
short-term investments       $    1,129     $        10             0.84 %   $    1,619     $         7            0.45 %
Investment securities            84,920           2,013             2.37         77,302           2,407            3.11
Gross loans, net of
unearned fees                    58,309           3,272             5.61         57,208           3,300            5.77
FHLB and Federal Reserve
Bank stock                        1,162              40             3.43          1,139              35            3.06
TOTAL EARNING ASSETS            145,520     $     5,335             3.67 %      137,268     $     5,749            4.19 %
Non-earning assets                5,941                                           2,484
TOTAL ASSETS                 $  151,461                                      $  139,752

LIABILITIES
Interest-bearing deposits
Interest-bearing demand      $    8,621     $        73             0.84 %   $   10,948     $       119            1.08 %
Savings and money market         57,052             350             0.61         61,239             645            1.05
Time deposits                    53,999             717             1.33         39,011             625            1.60
TOTAL
INTEREST-BEARING DEPOSITS    $  119,672     $     1,140             0.95 %   $  111,198     $     1,389            1.25 %
Securities sold under
agreements to repurchase            515               3             0.67            573               6            1.03
FHLB borrowings                   8,025             131             1.63          6,320             197            3.12
Other borrowings                      9               2            16.20             54               5            9.42
TOTAL INTEREST-BEARING
LIABILITIES                  $  128,221     $     1,276             1.00 %   $  118,145     $     1,597            1.35 %
Noninterest-bearing demand
deposits                          3,187                                           2,489
Other liabilities                   439                                             399
TOTAL LIABILITIES               131,847                                         121,033
STOCKHOLDERS' EQUITY             19,614                                          18,719
TOTAL LIABILITIES
AND STOCKHOLDERS' EQUITY     $  151,461                                      $  139,752
NET INTEREST INCOME /
MARGIN                                      $     4,059             2.79 %                  $     4,152            3.03 %
NET INTEREST SPREAD                                                 2.67 %                                         2.84 %


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The following table presents the dollar amount of changes in interest income and interest expense for the major categories of interest-earning assets and interest-bearing liabilities. The information details the changes attributable to a change in volume (i.e. change in average balance multiplied by the prior-period average rate) and changes attributable to a change in rate (i.e. change in average rate multiplied by the prior-period average balance). There is a component that is attributable to both a change in volume and a change in rate. This component has been allocated proportionately to the rate and volume columns.

($ in thousands)                                             Year-ended December 31, 2012
                                                                    compared to the
                                                             Year-ended December 31, 2011
                                                      Net Change           Rate          Volume
Interest income:
Gross loans, net of unearned fees                     $       (28 )     $      (96 )   $       68
Investment securities                                        (394 )           (671 )          277
FHLB and Federal Reserve Bank stocks                            5                4              1
Federal funds sold and other short-term investments             3                3              -
Total interest income                                 $      (414 )     $     (760 )   $      346

Interest expense:
Interest-bearing demand                               $       (46 )     $      (24 )   $      (22 )
Savings and money market                                     (295 )           (253 )          (42 )
Time deposits                                                  92              (74 )          166
Securities sold under agreements to repurchase                 (3 )             (3 )            -
FHLB borrowings                                               (66 )           (152 )           86
Other borrowings                                               (3 )             26            (29 )
Total interest expense                                $      (321 )     $     (480 )   $      159

Net interest income                                   $       (93 )     $     (280 )   $      187

The Company's net interest margin declined 24 basis points from 3.03% in 2011 to 2.79% in 2012. The decrease was primarily due to the rate on interest-bearing assets declining by more than the rate on interest-bearing liabilities, combined with unfavorable shifts in volume including an increase in higher-costing time deposits and the increase in the average balance of lower-yielding investment securities outpacing the increase in higher-yielding loans.

The $760,000 unfavorable rate decrease on interest-earning assets was primarily attributable to the reinvestment of principal payments received on mortgage-backed securities and from sale of investment securities at near historically low rates. The impact of this decline was mitigated by the decrease in interest expense on interest-bearing liabilities. The cost of money market, savings and time deposits decreased year-over-year due to a lower interest rate environment as well as the implementation of a tiered rate structure on savings accounts during the second quarter of 2012. This, in conjunction with the restructuring of $3.5 million in fixed-rate FHLB advances during the fourth quarter 2011, enabled the Bank to save 35 basis points on the cost of interest-bearing liabilities during 2012 as compared 2011.

The Federal Reserve Board influences the level and direction of interest rates. The Bank's loan portfolio is significantly affected by changes in the prime interest rate. The prime interest rate, which is the rate offered on loans to borrowers with strong credit, has remained at 3.25% since December 2008 and, thus, has had no impact on the change in loan yields during this time period. The federal funds rate, which is the cost of immediately available, overnight funds, has behaved in a similar manner, changing insignificantly since the end of 2008. However, other treasury rates have hit historic lows in recent months. Our Bank's loan portfolio has been impacted some by these low rates, as reflected in the 16 basis point decrease in loan yield from 2011 to 2012 but our investment portfolio has seen sharp declines, as mentioned above, given this interest rate environment.


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Total interest and dividend income was $5.3 million for 2012, consisting primarily of interest and fees on loans of $3.3 million and interest on investment securities of $2.0 million. Average gross loans, net of unearned fees, increased $1.1 million to $58.3 million from 2011. Average investment securities increased $7.6 million to $84.9 million during 2012.

Total interest expense was $1.3 million, a decrease of $321,000 from $1.6 million in 2011. Net interest income was $4.1 million in 2012, a decrease of $93,000, or 2%, from 2011. On an annual basis, the Company's net interest spread, (the yield earned on interest-earning assets less the cost of interest-bearing liabilities) declined17 basis points from 2.84% in2011 to 2.67% in2012.

Net interest income is expected to be enhanced in 2013 due to interest earned on residential mortgage loans held for sale.

Provision and allowance for loan and lease losses

The provision for loan and lease losses is the annual cost of providing an allowance or reserve for estimated probable losses on loans and leases. The provision decreased $155,000 in 2012to $0 due to improved loan quality. Impaired loans totaled $13,000 at December 31, 2012 versus $610,000 at December 31, 2011. The allowance for loan and lease losses reflects management's judgment of the level of allowance adequate to absorb estimated credit losses in the Bank's loan portfolio.

Information regarding the calculation of the loan and lease loss provision, the factors considered by the Company in establishing the reserves and the quality of the Bank's loan portfolio are included in the section of this Report titled "Part I - Item 1. Business - Asset Quality."

Noninterest income

Noninterest income was $1.0 million for the year ended December 31, 2012, an increase of $128,000, or 14%from $920,000 for the year ended December 31, 2011 consisting of:

A) $730,000 in realized gains, net of losses, from the sales of investment securities, which was a decrease of $141,000 from 2011 primarily due to the Company capitalizing on favorable market conditions during 2011. Gains on the sale of securities are not part of the Bank's expected ongoing operations and should not be considered recurring. Additionally, if interest rates rise, the value of our investment portfolio will likely decrease which would impair our ability to recognize gains from the sale of investment securities in future periods.

B) $149,000 of gains related to the sale of the guaranteed portion of SBA 7(a) loans, which is a new product line the Bank started offering in the second quarter of 2012.

C) $96,000 in other income which consisted of $67,000 in increases in the cash surrender value of bank-owned life insurance, which the Company purchased during the first quarter 2012, and $26,000 of operating income on one of the Bank's OREO properties. Income for OREO properties is not part of the Bank's expected ongoing operations and should not be considered recurring.

D) $73,000 in service charges on deposit accounts, which was a 7%, or $5,000 increase from 2011 primarily due to an increase in the number of accounts.

E) Additionally, the Company experienced a $25,000 loss on the sale of OREO during the third quarter of 2011, which negatively impacted total noninterest income for the year ended December 31, 2011.

We expect noninterest income to increase significantly in 2013 due to gains from the sale of residential mortgage loans to secondary market investors.


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Noninterest expense

Noninterest expense totaled $4.8 million for the year ended December 31, 2012 an increase of $151,000, or 3%, from the prior year which totaled $4.7 million. This was primarily due to a$154,000, or13% year-over-year increase in other general and administrative expenses, as detailed in the following table and discussed below:

    ($ in thousands)                                  Year Ended
                                                     December 31,          Increase/
    Other general and administrative expenses:     2012        2011       (Decrease)

    Data processing                               $   319     $   304     $        15
    FDIC assessments                                  152         212             (60 )
    Other regulatory and reporting fees               131         150             (19 )
    Marketing and promotions                          107          84              23
    Directors fees                                    101          88              13
    Loan and collection expense                        90         104             (14 )
    OREO expense                                       55          21              34
    Telephone                                          48          48               -
    Travel and entertainment                           47          33              14
    Insurance                                          47          32              15
    Dues and memberships                               35          29               6
    Printing, stationery and supplies                  34          32               2
    ATM and debit card fees                            16          14               2
    Franchise taxes                                    15          14               1
    Postage, shipping and courier                      13          13               -
    Customer checks and other customer expenses        11          15              (4 )
    Training and education                              9          15              (6 )
    Operating losses / legal settlements              138          11             127
    Miscellaneous                                      11           6               5
    Total                                         $ 1,379     $ 1,225     $       154

The most significant changes included increases of:

A) $127,000 in operating losses / legal settlements primarily related to legal settlements;

B) $34,000 related to expenses incurred on the Bank's two OREO properties;

C) $23,000 in marketing and promotion expenses partially due to increased business development efforts and partially due to costs incurred to improve our website and on-line banking platform;

D) $15,000 in insurance expenses from enhanced coverage obtained during the third quarter of 2011;

E) $15,000 in data processing due to increased customer volumes;

F) $14,000 in travel and entertainment correlated to an increase in loan demand;

G) $13,000 in directors fees due primarily to an increase in directors credit committee meetings and an increase in the number of board members in 2012.


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We expect OREO expense to continue to impact our 2013 operating results as we incur costs such as taxes, insurance, repairs and maintenance, among others, on these properties. Additionally, management realizes there is some exposure to additional impairment on these properties if there are declines in real estate values.

. . .

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