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SLRK > SEC Filings for SLRK > Form 10-K on 21-Mar-2014All Recent SEC Filings

Show all filings for SOLERA NATIONAL BANCORP, INC.

Form 10-K for SOLERA NATIONAL BANCORP, INC.


21-Mar-2014

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

We are a Delaware corporation that was incorporated to organize and serve as the holding company for Solera National Bank, which opened for business in 2007. Solera National Bank is a full-service commercial bank headquartered in Lakewood, Colorado primarily serving the Colorado Front Range. Our main banking office is located at 319 S. Sheridan Blvd., Lakewood, Colorado 80226. Our telephone number is (303) 209-8600.

Earnings are derived primarily from noninterest income earned from gains on the sale of residential mortgage loans and net interest income, which is interest income less interest expense, offset by noninterest expense and provision for loan and lease losses. As the majority of assets are interest-earning and liabilities are interest-bearing, changes in interest rates impact net interest margin. 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. We manage interest-earning assets and interest-bearing liabilities to reduce the impact of interest rate changes on operating results.

We offer a broad range of commercial and consumer banking services to small and medium-sized businesses, licensed professionals and individuals who are particularly responsive to the personalized service that Solera National Bank provides to its customers. We believe that local ownership and control allows the Bank to serve customers efficiently and effectively. Solera National Bank competes on the basis of providing a unique and personalized banking experience combined with a broad range of services, customized and tailored to fit the individual needs of its clients. While the Bank seeks to serve the entire market, it focuses on serving the local Hispanic and other minority populations which it believes are currently underserved.

In December 2012, the Company launched a residential mortgage division with approximately 50 employees in five loan production offices including Boulder, two locations in Colorado Springs, the Denver Tech Center and Durango. As of December 31, 2013, the Bank had 84 full-time equivalent employees compared to 63 full-time equivalent employees as of December 31, 2012.

Since we operate in Colorado, our operating results are significantly influenced by economic conditions in Colorado, particularly the health of the real estate market. Additionally, we are subject to competition from other financial institutions and are impacted by fiscal and regulatory policies of the federal government as well as regulatory oversight by the Office of the Comptroller of the Currency, (the "OCC").


SOLERA NATIONAL BANCORP, INC.

The following discussion focuses on the Company's financial condition and results of operations during the years ended December 31, 2013 and 2012, presented on a consolidated basis.

As of December 31, 2013, on a consolidated basis, the Company had total assets of $169.7 million, net loans of $78.2 million, total deposits of $132.8 million, and stockholders' equity of $17.0 million.

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-8 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, 2013, 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, the loan portfolio continues to increase, 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 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.

Share-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.


SOLERA NATIONAL BANCORP, INC.

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 restricted stock 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, loans held for sale, interest rate lock commitments, forward sales commitments 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.

Comparative Results of Operations for the years ended December 31, 2013 and 2012

Net loss for the twelve months ended December 31, 2013 was $656,000, or $(0.26) per share, compared to net income of $281,000, or $0.11 per share, for the twelve months ended December 31, 2012. The $937,000 decrease was primarily due to the following items, slightly offset by improved performance of our core banking operations:

$442,000 in severance costs during the fourth quarter of 2013 and the retirement of our former CEO in the third quarter of 2013.

$358,000 in restructuring charges incurred during the fourth quarter of 2013 to terminate a facility lease and suspend plans to convert our Boulder loan production office into a full-service banking facility. These strategic decisions were made to reduce future costs by significantly scaling back previous plans to expand the Bank's residential mortgage lending business as the fourth quarter of 2013 saw retail single-family loan originations decline to their lowest level in five years.

$169,000 in charge-offs related to our OREO properties during 2013.

$50,000 in data processing charges incurred to integrate the deposits we acquired during the second quarter of 2013.

When comparing other key metrics from 2013 to 2012, some items are significantly higher due to our residential mortgage department which began operating during the first quarter of 2013. More specifically, noninterest income increased $6.4 million in 2013 compared to 2012 primarily due to the gain on residential mortgage loans sold. Similarly, employee compensation and benefits increased $5.9 million in 2013. Of that, $5.4 million relates to salaries and commissions paid to


SOLERA NATIONAL BANCORP, INC.

employees of our residential mortgage division. These and other changes are described in more detail in the ensuing discussion.

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 presents, for the periods indicated, average assets, liabilities and stockholders' equity, as well as the components of net interest income and the resultant annualized yields / costs expressed in percentages.

 ($ in thousands)                              2013                                           2012
                             Average                                        Average
                             Balance        Interest      Yield / Cost      Balance        Interest      Yield / Cost
Assets:
Interest-earning assets:
Gross loans, net of
unearned fees (1) (2)      $   68,683     $    3,577           5.21 %     $   58,309     $    3,272           5.61 %
Loans held for sale            10,875            402           3.70                -              -              -
Investment securities (3)      77,353          1,761           2.28           84,920          2,013           2.37
FHLB and FRB stocks             2,099             67           3.19            1,162             40           3.43
Federal funds sold                720              2           0.24              773              2           0.22
Interest-bearing deposits
with banks                        257              7           2.94              356              8           2.19
Total interest-earning
assets                        159,987     $    5,816           3.64 %        145,520     $    5,335           3.67 %
Noninterest-earning assets      8,358                                          5,941
Total assets               $  168,345                                     $  151,461
Liabilities and Stockholders' Equity:
Interest-bearing
liabilities:
Money market and savings
deposits                   $   52,544     $      241           0.46 %     $   57,052     $      350           0.61 %
Interest-bearing checking
accounts                        9,297             68           0.73            8,621             73           0.84
Time deposits                  60,267            748           1.24           53,999            717           1.33
Other borrowings                  110              -           0.48              524              5           0.95
Short-term FHLB advances       13,113             27           0.21                -              -              -
Long-term FHLB advances         7,947            133           1.68            8,025            131           1.63
Total interest-bearing
liabilities                   143,278     $    1,217           0.85 %        128,221     $    1,276           1.00 %
Noninterest-bearing
checking accounts               5,212                                          3,187
Noninterest-bearing
liabilities                       686                                            439
Stockholders' equity           19,169                                         19,614
Total liabilities and
stockholders' equity       $  168,345                                     $  151,461
Net interest income                       $    4,599                                     $    4,059
Net interest spread                                            2.79 %                                         2.67 %
Net interest margin                                            2.88 %                                         2.79 %

(1) The loan average balances and rates include nonaccrual loans.


SOLERA NATIONAL BANCORP, INC.

(2) Net loan origination costs of $58,000 and $3,000 for the twelve months ended December 31, 2013 and 2012, respectively, are included in the yield computation.
(3) Yields on investment securities have not been adjusted to a tax-equivalent basis since the Company does not own any tax-free securities.

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.

Table 2
                                          Year-ended December 31, 2013
($ in thousands)                                 compared to the
                                          Year-ended December 31, 2012
                                      Net Change         Rate        Volume
Interest income:
Gross loans, net of unearned fees    $     305       $    (207 )    $  512
Loans held for sale                        402               -         402
Investment securities                     (252 )           (77 )      (175 )
FHLB and FRB stocks                         27              (3 )        30
Federal funds sold                           -               -           -
Interest-bearing deposits with banks        (1 )            (1 )         -
Total interest income                $     481       $    (288 )    $  769
Interest expense:
Money market and savings deposits    $    (109 )     $     (83 )    $  (26 )
Interest-bearing checking accounts          (5 )           (11 )         6
Time deposits                               31             (40 )        71
Other borrowings                            (5 )            (2 )        (3 )
Short-term FHLB advances                    27               -          27
Long-term FHLB advances                      2               3          (1 )
Total interest expense               $     (59 )     $    (133 )    $   74
Net interest income                  $     540       $    (155 )    $  695

For the twelve months ended December 31, 2013, the Company's net interest income increased $540,000, or 13%, compared to the twelve months ended December 31, 2012 contributing to a nine basis point increase in net interest margin which was 2.88% for the twelve months ended December 31, 2013. Most notable was the $402,000 increase in interest income from loans held for sale due to new residential mortgage banking operations and the $305,000 increase in interest income on loans primarily due to the $10.4 million increase in average loan balance for the twelve months ended December 31, 2013 compared to the same period in the prior year. These increases were partially offset by an unfavorable decrease in interest income on investment securities, which decreased $252,000, primarily due to a decrease in average balances (down $7.6 million) but also partially due to a decrease in yield (down 9 basis points). The average yield on loans decreased 40 basis points from a year ago as the Bank continues to be impacted by low interest rates and strong competition for well-qualified borrowers that demand competitive rates. The $27,000 increase in interest and dividends on bank stocks primarily relates to increased ownership of FHLB stock which correlates to increased business activity as we utilize overnight borrowings from the FHLB primarily to fund residential mortgage loans held for sale.

Although we experienced decreases in yields on our interest-earning assets, we were also able to reduce rates on our interest-bearing liabilities which enabled us to improve our net interest spread to 2.79% for the twelve months ended December 31, 2013 from 2.67% for the same period of the prior year. Overall, the cost of interest-bearing liabilities decreased 15 basis points from the prior year. Contributing most significantly to this decline was the $109,000 decrease in interest expense related to money market and savings deposits as a result of lowering deposit rates across all balance tiers. The volume of short-term


SOLERA NATIONAL BANCORP, INC.

FHLB advances increased significantly during 2013, primarily to support the Company's increase in loans held for sale, as mentioned above. Additionally, the Bank had an increase in time deposits, which, on average, increased $6.3 million to further support the increase in loans.

Provision and Allowance for Loan and Lease Losses

We determine a provision for loan and lease losses that we consider sufficient to maintain an allowance to absorb probable losses inherent in our portfolio as of the balance sheet date. During both 2013 and 2012, we did not recognize any provision for loan and lease losses reflecting improved asset quality. There were no impaired loans as of December 31, 2013 compared to $13,000 as of December 31, 2012. See additional discussion below under Financial Condition, Loans.

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 for the twelve months ended December 31, 2013 was $7.4 million, an increase of $6.4 million from $1.0 million for the twelve months ended December 31, 2012. The most notable increase in noninterest income was due to the $6.6 million of gain on residential mortgage loans sold to secondary market investors. Additionally, the Company recognized $135,000 of gains on the sale of the guaranteed portion of SBA 7(a) loans. The Company sold securities for gains of $387,000 during 2013 compared to $730,000 in 2012.

The following table summarizes the Bank's residential mortgage loan activity during the first twelve months of 2013. It should be noted the Bank's mortgage department was formed during the fourth quarter of 2012 so no material activity existed before the first quarter of 2013.

($ in thousands)                       Q1 2013    Q2 2013    Q3 2014    Q4 2013    YTD 2013
Gain on Loans Sold                    $  1,414   $  2,487   $  1,563   $  1,151   $   6,615
Average Service Release Premium           2.37 %     2.65 %     2.36 %     2.57 %      2.51 %
Residential Mortgage Loans Originated $ 52,137   $ 86,091   $ 62,265   $ 37,857   $ 238,350
Residential Mortgage Loans Sold       $ 33,096   $ 88,125   $ 69,699   $ 39,659   $ 230,579
Purpose of Loan: (1)
Purchase                                    72 %       64 %       81 %       77 %        70 %
Refinance                                   28 %       36 %       19 %       23 %        30 %


(1) indicates the percentage of loans originated during the period

Refinancing activity slowed significantly during the third and fourth quarters of 2013 due to the rise in longer-term interest rates. Additionally, a seasonal slow-down in originations for home purchases occurred during the fourth quarter. We expect originations for home purchases to remain lower, primarily due to seasonal trends, during the first quarter of 2014. Additionally, we expect refinancing activity to be significantly lower in 2014 as most economic forecasts expect longer-term interest rates to remain stable or increase slightly throughout 2014. Given the lower volumes experienced in the second half of 2013 and the forecast for 2014, management has taken action during the first quarter of 2014 to right-size the mortgage department.

Noninterest Expense

Our total noninterest expense for the twelve months ended December 31, 2013 was $12.7 million, which was $7.8 million, or 162%, higher than the $4.8 million for the twelve months ended December 31, 2012. The reasons for this increase are discussed in more detail below.

Employee Compensation and Benefits
Employee compensation and benefit expense increased $5.9 million due to an additional 61 employees, from an average of 25 full-time equivalent employees during 2012 to an average of 86 for 2013. The majority of these


SOLERA NATIONAL BANCORP, INC.

new employees related to the residential mortgage department. Total employee compensation and benefits for the mortgage department was $5.4 million. This included nonrecurring items of $164,000 for severance costs and $55,000 for the accelerated vesting of restricted stock awards. Many of the mortgage department's employees have commission-based pay that increases or decreases based on the volume of loans closed.

For the community banking department, employee compensation and benefits increased $496,000, which partially related to an increase in the number of employees (from 25 at December 31, 2012 to 32 at December 31, 2013) and partially related to the approximately $278,000 incurred in conjunction with the retirement of our former CEO and severance associated with other employees during the year.

Occupancy
Occupancy expense increased $533,000 due to the addition of five locations associated with residential mortgage operations. During the fourth quarter of 2013, the Bank terminated an office building lease agreement which was expected to commence during the first quarter of 2014. This space was expected to replace our corporate offices, provide space for commercial bankers and mortgage loan officers, as well as back-office operations. For now, our corporate offices are being leased on a month-to-month basis. Occupancy expense is expected to . . .

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