slra_10q.htm


UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

FORM 10-Q
(Mark one)
 
þ
QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended June 30, 2012

¨
TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

Commission File Number 000-53181
 
SOLERA NATIONAL BANCORP, INC.
(Exact name of registrant as specified in its charter)

Delaware
 
02-0774841
(State or other jurisdiction
of incorporation or organization)
 
(IRS Employer
Identification No.)
 
319 S. Sheridan Blvd.
Lakewood, CO 80226
303-209-8600
(Address and telephone number of principal executive offices and principal place of business)

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 þ  No ¨
 
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    
Yes þ  No ¨
 
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company.
 
Large accelerated filer o Accelerated filer o
Non-accelerated filer o Smaller reporting company þ
 
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). 
Yes ¨  No þ

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the last practicable date:  As of August 8, 2012, 2,553,671 shares of the registrant’s common stock, $0.01 par value, were issued and outstanding.
 


 
 

 
FORM 10-Q
SOLERA NATIONAL BANCORP, INC.

INDEX
 
       
PAGE
 
           
INTRODUCTORY NOTE.  CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING INFORMATION AND RISK FACTORS     3  
         
PART I - FINANCIAL INFORMATION     4  
         
ITEM 1.
FINANCIAL STATEMENTS (unaudited)
    4  
 
Balance Sheets as of June 30, 2012 and December 31, 2011
    4  
 
Statements of Operations and Comprehensive Income (Loss) for the Three and Six Months Ended June 30, 2012 and 2011
    5  
 
Statements of Changes in Stockholders’ Equity for the Six Months Ended June 30, 2012 and 2011
    6  
 
Statements of Cash Flows for the Six Months Ended June 30, 2012 and 2011
    7  
 
Unaudited Condensed Notes to Consolidated Financial Statements
    9  
ITEM 2.
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
    34  
ITEM 3.
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
    50  
ITEM 4.
CONTROLS AND PROCEDURES
    50  
         
PART II - OTHER INFORMATION     51  
         
ITEM 1.
LEGAL PROCEEDINGS
    51  
ITEM 1A.
RISK FACTORS
    51  
ITEM 2.
UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
    51  
ITEM 3.
DEFAULTS UPON SENIOR SECURITIES
    51  
ITEM 4.
MINE SAFETY DISCLOSURE
    51  
ITEM 5.
OTHER INFORMATION
    51  
ITEM 6.
EXHIBITS
    51  
SIGNATURES     52  
EXHIBIT INDEX     53  
 
 
2

 
 
INTRODUCTORY NOTE.  CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING INFORMATION AND RISK FACTORS

This Quarterly Report on Form 10-Q contains “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995 about Solera National Bancorp, Inc. (the “Company”) and our subsidiary, Solera National Bank (the “Bank,” collectively with the Company, sometimes referred to as “we,” “us” and “our”) that are subject to risks and uncertainties.  Forward-looking statements include information concerning future financial performance, business strategy, projected plans and objectives.  Statements preceded by, followed by or that otherwise include the words “anticipates,” “believes,” “estimates,” “expects,” “intends,” “plans,” “may increase,” “may fluctuate” and similar expressions of future or conditional verbs such as “will,” “should,” “would,” and “could” are generally forward-looking in nature and not historical facts.  Actual results may differ materially from those projected, implied, anticipated or expected in the forward-looking statements.  Readers of this quarterly report should not rely solely on the forward-looking statements and should consider all uncertainties and risks throughout this report. The statements are representative only as of the date they are made, and Solera National Bancorp, Inc. undertakes no obligation to update any forward-looking statement.

These forward-looking statements, implicitly and explicitly, include the assumptions underlying the statements and other information with respect to the Company's beliefs, plans, objectives, goals, expectations, anticipations, estimates, financial condition, results of operations, future performance and business, including management's expectations and estimates with respect to revenues, expenses, return on equity, return on assets, efficiency ratio, asset quality and other financial data and capital and performance ratios.

Although the Company believes that the expectations reflected in the forward-looking statements are reasonable, these statements involve risks and uncertainties that are subject to change based on various important factors, some of which are beyond the control of the Company. The following factors, among others, could cause the Company's results or financial performance to differ materially from its goals, plans, objectives, intentions, expectations and other forward-looking statements:

management of Solera National Bank may be unable to limit credit risk associated with our loan portfolio, which would affect the Company’s profitability;
 
general economic conditions in the U.S. and within our market area may be less favorable than expected, causing an adverse impact on our financial performance;
 
the Company is subject to extensive regulatory oversight, which could restrain our growth and profitability;
 
interest rate volatility could adversely impact our business;
 
the Company may not be able to raise additional capital on terms favorable to us;
 
the Company continues to hold other real estate owned which may be vulnerable to declines in real estate values;
 
the recently proposed Basel capital standards may negatively impact our capital ratios, profitability and ability to lend;
 
the liquidity of our common stock is affected by its limited trading market; and
 
the Company faces competition from a variety of competitors.

For a discussion of these and other risks and uncertainties that could cause actual results to differ from those contained in the forward-looking statements, see “Risk Factors” in Item 1A of the Company’s 2011 Annual Report filed on Form 10-K with the SEC, which is available on the SEC’s website at www.sec.gov.  All forward-looking statements are qualified in their entirety by this cautionary statement, and the Company undertakes no obligation to revise or update this Quarterly Report on Form 10-Q to reflect events or circumstances after the date hereof.  New factors emerge from time to time, and we cannot predict which factors, if any, will arise.  In addition, the Company cannot assess the impact of each factor on the Company’s business or the extent to which any factor, or combination of factors, may cause actual results to differ materially from those contained in any forward-looking statements.
 
 
3

 
 
PART I - FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS (unaudited)

Solera National Bancorp, Inc.

Balance Sheets as of June 30, 2012 and December 31, 2011
(unaudited)
 
($ in thousands, except share data)
 
June 30,
   
December 31,
 
   
2012
   
2011
 
ASSETS
             
Cash and cash equivalents
  $ 849     $ 1,800  
Interest-bearing deposits with banks
    357       1,357  
Investment securities, available-for-sale
    89,141       83,195  
Gross loans
    58,537       55,645  
Net deferred expenses/(fees)
    94       (77 )
Allowance for loan and lease losses
    (1,009 )     (1,067 )
Net loans
    57,622       54,501  
Federal Home Loan Bank (FHLB) and Federal Reserve Bank stocks
    1,164       1,134  
Bank-owned life insurance
    2,027       -  
Other real estate owned
    1,776       1,776  
Premises and equipment, net
    550       599  
Accrued interest receivable
    718       584  
Other assets
    348       420  
Total assets
  $ 154,552     $ 145,366  
                 
LIABILITIES AND STOCKHOLDERS’ EQUITY
                 
Deposits
               
Noninterest-bearing demand
  $ 3,312     $ 3,550  
Interest-bearing demand
    8,950       9,355  
Savings and money market
    56,740       58,854  
Time deposits
    56,199       47,225  
Total deposits
    125,201       118,984  
                 
Securities sold under agreements to repurchase and federal funds purchased
    814       253  
Accrued interest payable
    63       56  
Accounts payable and other liabilities
    336       534  
FHLB advances
    8,500       6,500  
Total liabilities
  $ 134,914     $ 126,327  
                 
COMMITMENTS AND CONTINGENCIES (see Notes 10 and 12)
               
                 
STOCKHOLDERS’ EQUITY
               
Common stock, $0.01 par value; 5,000,000 shares authorized; 2,553,671 shares issued and outstanding
  $ 26     $ 26  
Additional paid-in capital
    26,172       26,146  
Accumulated deficit
    (7,546 )     (7,640 )
Accumulated other comprehensive income
    986       507  
Total stockholders’ equity
  $ 19,638     $ 19,039  
Total liabilities and stockholders’ equity
  $ 154,552     $ 145,366  

See Notes to Consolidated Financial Statements.
 
 
4

 
 
Solera National Bancorp, Inc.

Statements of Operations and Comprehensive Income (Loss) for
the Three and Six Months Ended June 30, 2012 and 2011
(unaudited)
 
($ in thousands, except share data)
 
For the Three Months
Ended June 30,
   
For the Six Months
Ended June 30,
 
   
2012
   
2011
   
2012
   
2011
 
INTEREST INCOME:
                       
Interest and fees on loans
  $ 787     $ 847     $ 1,575     $ 1,671  
Interest on investment securities
    540       646       1,043       1,319  
Dividends on FHLB and FRB stocks
    10       8       18       17  
Other interest income
    3       2       5       3  
Total interest income
    1,340       1,503       2,641       3,010  
INTEREST EXPENSE:
                               
Deposits
    279       354       579       723  
FHLB advances
    33       49       64       106  
Other borrowings
    2       3       3       7  
Total interest expense
    314       406       646       836  
NET INTEREST INCOME BEFORE PROVISION
    1,026       1,097       1,995       2,174  
Provision for loan and lease losses
    -       120       -       120  
NET INTEREST INCOME AFTER PROVISION
    1,026       977       1,995       2,054  
NONINTEREST INCOME:
                               
Service charges and fees
    19       18       34       35  
Other income
    20       1       29       2  
Gain on loans sold
    25       -       25       -  
Gain on sale of available-for-sale securities
    166       225       280       223  
Total noninterest income
    230       244       368       260  
NONINTEREST EXPENSE:
                               
  Salaries and employee benefits
    587       612       1,154       1,317  
  Occupancy
    120       127       247       260  
  Professional fees
    78       99       222       225  
  Other general and administrative
    338       283       646       595  
Total noninterest expense
    1,123       1,121       2,269       2,397  
INCOME (LOSS) BEFORE INCOME TAXES
    133       100       94       (83 )
Provision for income taxes
    -       -       -       -  
NET INCOME (LOSS)
  $ 133     $ 100     $ 94     $ (83 )
                                 
OTHER COMPREHENSIVE INCOME, NET OF TAX:
                               
Change in net unrealized gains on securities
    209       1,023       759       1,096  
Less: Reclassification adjustment for net gains included in net income (loss)
    (166 )     (225     (280     (223
OTHER COMPREHENSIVE INCOME
  $ 43     $ 798     $ 479     $ 873  
                                 
COMPREHENSIVE INCOME
  $ 176     $ 898     $ 573     $ 790  
                                 
NET INCOME (LOSS) AVAILABLE TO COMMON STOCKHOLDERS
  $ 133     $ 100     $ 94     $ (83 )
                                 
INCOME (LOSS) PER COMMON SHARE
                               
Basic
  $ 0.05     $ 0.04     $ 0.04     $ (0.03 )
Weighted-average common shares outstanding - basic
    2,553,671       2,553,671       2,553,671       2,553,671  
Diluted
  $ 0.05     $ 0.04     $ 0.04     $ (0.03 )
Weighted-average common shares outstanding - diluted
    2,558,283       2,553,671       2,558,283       2,553,671  

See Notes to Consolidated Financial Statements.
 
 
5

 

Solera National Bancorp, Inc.

Statements of Changes in Stockholders’ Equity for
the Six Months Ended June 30, 2012 and 2011
(unaudited)

($ in thousands, except share data)
 
Shares
Outstanding
   
Common Stock
   
Additional
Paid-in Capital
   
Accumulated Deficit
   
Accumulated Other
Comprehensive
Income
   
Total
 
                                     
Balance at December 31, 2010
    2,553,671     $ 26     $ 25,980     $ (7,882 )   $ 201     $ 18,325  
Stock-based compensation
    -       -       115       -       -       115  
Comprehensive income:
                                               
   Net loss
    -       -       -       (83 )     -       (83 )
   Other comprehensive income
    -       -       -       -       873       873  
Total comprehensive income
                                            790  
Balance at June 30, 2011
    2,553,671     $ 26     $ 26,095     $ (7,965 )   $ 1,074     $ 19,230  

Balance at December 31, 2011
    2,553,671     $ 26     $ 26,146     $ (7,640 )   $ 507     $ 19,039  
Stock-based compensation
    -       -       26       -       -       26  
Comprehensive income:
                                               
   Net income
    -       -       -       94       -       94  
   Other comprehensive income
    -       -       -       -       479       479  
Total comprehensive income
                                            573  
Balance at June 30, 2012
    2,553,671     $ 26     $ 26,172     $ (7,546 )   $ 986     $ 19,638  

See Notes to Consolidated Financial Statements.
 
 
6

 

Solera National Bancorp, Inc.

Statements of Cash Flows for the
Six Months Ended June 30, 2012 and 2011
(unaudited)
 
   
For the Six Months
 
   
Ended June 30,
 
($ in thousands)  
2012
   
2011
 
             
CASH FLOWS FROM OPERATING ACTIVITIES
           
Net income (loss)
  $ 94     $ (83 )
Adjustments to reconcile net income (loss) to net cash provided by operating activities:
               
   Depreciation and amortization
    61       76  
   Provision for loan and lease losses
    -       120  
   Net accretion of deferred loan fees/expenses
    (6 )     (12 )
   Net amortization of premiums on investment securities
    728       308  
   Gain on sale of available-for-sale investment securities
    (280 )     (223 )
   Federal Home Loan Bank stock dividend
    (2 )     (2 )
   Recognition of stock-based compensation on stock options
    26       115  
   Increase in bank-owned life insurance cash surrender value
    (27 )     -  
Changes in operating assets and liabilities:
               
   Accrued interest receivable
    (134 )     116  
   Other assets
    72       41  
   Prepaid FDIC premiums
    -       111  
   Accrued interest payable
    7       (27 )
   Accounts payable and other liabilities
    (174 )     -  
   Deferred loan fees/expenses, net
    (165 )     (8 )
Net cash provided by operating activities
  $ 200     $ 532  
                 
CASH FLOWS FROM INVESTING ACTIVITIES
               
Purchase of investment securities, available-for-sale
  $ (32,369 )   $ (27,307 )
Proceeds from sales of investment securities, available-for-sale
    19,444       25,058  
Proceeds from maturities/calls/pay downs of investment securities, available-for-sale
    7,010       5,060  
Loan originations funded, net
    (2,950 )     (58 )
(Purchase) / redemption of Federal Reserve Bank stock
    (28 )     53  
Purchase of bank-owned life insurance
    (2,000 )     -  
Purchase of premises and equipment
    (12 )     (2 )
Proceeds from sale of foreclosed properties
    -       1,838  
Purchase of interest-bearing deposits with banks
    -       (1,000 )
Maturity of interest-bearing deposits with banks
    1,000       160  
Net cash (used in) / provided by investing activities
  $ (9,905 )   $ 3,802  
                 
CASH FLOWS FROM FINANCING ACTIVITIES
               
Net increase in deposits
  $ 6,217     $ 2,538  
Net increase in securities sold under agreements to repurchase and federal funds purchased
    561       137  
Increase / (decrease) in FHLB advances
    2,000       (3,500 )
Principal payments on capital lease
    (24 )     (22 )
Net cash provided by / (used in) financing activities
  $ 8,754     $ (847 )
                 
Net (decrease) / increase in cash and cash equivalents
  $ (951 )   $ 3,487  
                 
CASH AND CASH EQUIVALENTS
               
Beginning of period
    1,800       936  
End of period
  $ 849     $ 4,423  
(continued)
               
 
 
7

 
 
Solera National Bancorp, Inc.

Statements of Cash Flows for the
Six Months Ended June 30, 2012 and 2011, (continued)
(unaudited)
 
    For the Six Months
Ended June 30,
 
($ in thousands)   2012     2011  
             
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION            
Cash paid during the period for:
           
Interest
  $ 639     $ 863  
Income taxes paid
  $ -     $ -  
Non-cash investing transactions:
               
Unrealized gain on investment securities, available-for-sale   $ 479     $ 873  
 
See Notes to Consolidated Financial Statements.
 
 
8

 

SOLERA NATIONAL BANCORP, INC.
 
UNAUDITED CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE 1 - SUMMARY OF ORGANIZATION

Solera National Bancorp, Inc. (the “Company”), is a Delaware corporation that was incorporated in 2006 to organize and serve as the holding company for Solera National Bank (the “Bank”), a national bank that opened for business on September 10, 2007.  Solera National Bank is a full-service community, commercial bank headquartered in Lakewood, Colorado primarily serving the six-county Denver metropolitan area.

NOTE 2 - BASIS OF PRESENTATION

The accompanying unaudited condensed consolidated financial statements contain all adjustments (consisting only of normal recurring adjustments) which, in the opinion of management, are necessary to present fairly the financial position of the Company as of June 30, 2012, and the results of its operations for the three and six months ended June 30, 2012 and 2011.  Cash flows are presented for the six months ended June 30, 2012 and 2011.  Certain reclassifications have been made to the consolidated financial statements and related notes of prior periods to conform to the current presentation.  These reclassifications had no impact on stockholders’ equity or net income (loss) for the periods.  Additionally, certain information and footnote disclosures normally included in financial statements have been condensed or omitted pursuant to rules and regulations of the U.S. Securities and Exchange Commission.  The Company believes that the disclosures in the unaudited condensed consolidated financial statements are adequate to make the information presented not misleading.  However, these unaudited condensed consolidated financial statements should be read in conjunction with the consolidated financial statements and footnotes thereto included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2011.

The attainment of sustained profitable operations are dependent on future events, including the successful execution of the Company’s business plan and achieving a level of revenue adequate to support the Company’s cost structure.

Critical Accounting Policies

The following is a description of the Company’s significant accounting policies used in the preparation of the accompanying consolidated financial statements.
 
Provision and allowance for loan and lease losses:  Implicit in the Company’s lending activities is the fact that loan and lease losses will be experienced and that the risk of loss will vary with the type of loans being made and the creditworthiness of the borrowers over the terms of the loans.  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 evaluation of the allowance is inherently subjective as it requires estimates that are susceptible to significant revision as more information becomes available.  The allowance for loan and lease losses is maintained at a level considered adequate to provide for probable loan and lease losses based on management’s assessment of various factors affecting the loan portfolio, including a review of problem loans, business conditions, historical loss experience, evaluation of the quality of the underlying collateral, and holding and disposal costs.  In addition, because the Bank has limited history on which to base future loan and lease losses, a comparison of peer group allowance ratios to gross loans is made with the intention of maintaining similar levels until the Bank has sufficient historical data to see trends in our own loss history.  The allowance for loan and lease losses is increased by provisions charged to expense and reduced by loans and leases charged-off, net of recoveries.  Loan and lease losses are charged against the allowance for loan and lease losses when management believes the balance is uncollectible.
 
 
9

 

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.  To determine this component of the calculation, impaired loans and leases are individually evaluated by either discounting the expected future cash flows or determining the fair value of the collateral, if repayment is expected solely from collateral.  The fair value of the collateral is determined using internal analyses as well as third-party information, such as appraisals.  That value, less estimated costs to sell, is compared to the recorded investment in the loan and any shortfall is charged-off.  Unsecured loans and loans that are not collateral-dependent are evaluated by calculating the discounted cash flow of the payments expected over the life of the loan using the loan’s effective interest rate and giving consideration to currently existing factors that would impact the amount or timing of the cash flows.  The shortfall between the recorded investment in the loan and the discounted cash flows, or the fair value of the collateral less estimated costs to sell, represents the first component of the allowance for loan and lease losses.

The second component of the allowance for loan and lease losses represents contingent losses – the estimated probable losses inherent within the portfolio due to uncertainties.  To determine this component, management calculates a weighted-average loss rate based on actual loss rates over the last two to three years for all banks in Colorado and for similarly-sized commercial banks with two or fewer locations in a metropolitan area.  Management then adjusts the loss rate for environmental factors which 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 levels and trends in non-performing and past due loans; and 4) 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 qualitative factors also consider the risk elements within each segment of the loan portfolio.  The primary risk comes from the difference between the expected and actual cash flows of the borrower and is influenced by the type of collateral securing the loans.  For real estate secured loans, conditions in the real estate markets as well as the general economy influence real estate values and may impact the Company’s ability to recover its investment due to declines in the fair value of the underlying collateral.  The risks in non-real estate secured loans include general economic conditions as well as interest rate changes.  Classified and criticized loans, which are closely monitored by management, are taken out of their original category for calculating their contingent loss rate and are assigned a loss rate ranging between 2.50% and 17.50% of the loan’s principal balance.  The aggregate of above described segments represents the contingent losses in the portfolio.

The recorded allowance for loan and lease losses is the aggregate of the impaired loan and lease component and the contingent loss component.  We aggregate our loans into portfolio segments including:  Commercial Real Estate Secured; Residential Real Estate Secured; Commercial and Industrial; and Consumer.  These segments are based upon the loan’s categorization in the Consolidated Report of Condition and Income, as set forth by banking regulators, (the “Call Report”).  Our methodology for estimating the allowance has not changed during the current or prior reporting period and is consistent across all portfolio segments and classes of loans. 

At June 30, 2012, the Company had an allowance for loan and lease losses of $1.0 million.  We believe that this is adequate to cover probable losses based on 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 and lease losses may be needed if the economy declines, asset quality deteriorates, or the loss experience changes.

 
10

 

Loans receivable:  Loans receivable that the Company has the intent and ability to hold for the foreseeable future or until maturity or payoff are reported at their outstanding unpaid principal balances net of any deferred fees or costs, and reduced by any charge-offs and the allowance for loan and lease losses.

Credit and loan decisions are made by management and the Board of Directors’ Credit Committee in conformity with established loan policies.  The Company’s practice is to charge-off any loan or portion of a loan when the loan is determined to be uncollectible due to the borrower’s failure to meet repayment terms, the borrower’s deteriorated financial condition, the depreciation of the underlying collateral, the loan’s classification as a loss, or for other reasons.

The Company considers a loan to be impaired when it is probable that the Company will be unable to collect all amounts due (principal and interest) according to the contractual terms of the loan agreement.  Measurement of impairment is based on the expected future cash flows of an impaired loan, which are to be discounted at the loan’s effective interest rate, or measured by reference to an observable market value, if one exists, or the fair value of the collateral for a collateral-dependent loan.  The Company selects the measurement method on a loan-by-loan basis except that collateral-dependent loans for which foreclosure is probable are measured at the fair value of the collateral.  The Company recognizes interest income on impaired loans based on its existing methods of recognizing interest income on nonaccrual loans (see Interest and fees on loans, below).

Interest and fees on loans:  Interest income is recognized daily in accordance with the terms of the note based on the outstanding principal balance.  Loans on which the accrual of interest has been discontinued are designated as nonaccrual loans.  The accrual of interest on loans is discontinued when principal or interest is 90 days past due based on contractual terms of the loan or when, in the opinion of management, there is reasonable doubt as to collectability.  When loans are placed on nonaccrual status, all interest previously accrued but not collected is reversed against current period interest income.  Income on nonaccrual loans is subsequently recognized only to the extent that cash is received and the Bank's recorded investment in the loan (the customer's balance less any partial charge-offs) is deemed collectible.  Interest accruals are resumed on such loans only when they are brought current with respect to interest and principal and when, in the judgment of management, the loans are estimated to be fully collectible as to all interest and the Bank's recorded investment.

Generally, for all classes of loans, loans are considered past due when contractual payments are delinquent by 30 days or more.

Loan origination fees and certain direct origination costs are capitalized and recognized as an adjustment of the yield of the related loan using the effective interest method and without anticipating prepayments.

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 in which the recipient is required to provide services in exchange for the award, generally the vesting period.
 
 
11

 

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.  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 the yield curve.  Fair value is the exchange price that would be received for an asset or paid to transfer a liability (exit price) in the most advantageous market for the asset or liability in an orderly transaction between market participants.  The fair value hierarchy requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value.  Current accounting standards describe three levels of inputs that may be used to measure fair values:

Level 1 –
inputs are unadjusted quoted prices in active markets for identical assets or liabilities that the Company has the ability to access at the measurement date.

Level 2 –
inputs are other than quoted prices included in Level 1 that are observable for the asset or liability either directly or indirectly, such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or model-based valuation techniques for which all significant assumptions are observable in the market.

Level 3 –
valuation is generated from model-based techniques that use at least one significant assumption not observable in the market.  These unobservable assumptions reflect estimates of assumptions that market participants would use in pricing the asset or liability.  Valuation techniques include use of option pricing models, discounted cash flow models and similar techniques.

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).  If it is more likely than not that sale of the security will be required prior to recovery of its amortized cost, the entire impairment is recognized in earnings equal to the difference between the amortized cost basis and the fair value.  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.

Income (loss) per common share:  Basic earnings per common share is based on the weighted-average number of common shares outstanding during the period.  Diluted earnings per share is similar to basic earnings per share except that the weighted-average number of common shares outstanding is increased by the number of additional common shares that would have been outstanding if the dilutive potential common shares had been issued.  As of June 30, 2012, there were 4,612 dilutive stock options outstanding that increased the weighted-average diluted shares outstanding.  Since the vast majority of the Company’s stock options were out of the money during 2011, there were no dilutive potential common shares at June 30, 2011.

Recent Accounting Pronouncements

In May 2011, the Financial Accounting Standards Board, (“FASB”), issued an accounting standards update intended to improve the comparability of fair value accounting and reporting requirements between United States Generally Accepted Accounting Principles (U.S. GAAP) and International Financial Reporting Standards (IFRS).  Additional disclosures required by the update are incorporated in Note 11 and include: (i) disclosure of quantitative information regarding the unobservable inputs used in any  Level 3 measurement  including an explanation of the valuation techniques used and the sensitivity to changes in the values assigned to unobservable inputs; (ii) categorization by level for the fair value of financial instruments; and (iii) instances where the fair values disclosed for non-financial assets were based on a highest and best use assumption when in fact the assets are not being utilized in that capacity.  The amendments in the update are effective for the Company’s interim and annual reports beginning with the first quarter 2012.  The provisions of this update did not have a material impact on the Company’s financial position, results of operations or cash flows but did cause changes to the Company’s fair value disclosure (see Note 11).
 
 
12

 

In June 2011, the FASB issued an accounting standards update to increase the prominence of items included in Other Comprehensive Income and facilitate the convergence of U.S. GAAP with IFRS.  The update prohibits continued exclusive presentation of Other Comprehensive Income in the statement of stockholders’ equity.  The update requires that all non-owner changes in stockholders’ equity be presented in either a single continuous statement of comprehensive income or in two separate but continuous statements.  The amendments in the update are effective for the Company’s interim and annual reports beginning with the first quarter 2012.  The provisions of this update did not have a material impact on the Company’s financial position, results of operations or cash flows but did cause changes to the presentation of the Company’s Statements of Operations.

During the first and second quarters of 2012, the FASB issued other accounting standards updates which may impact the banking community or other entities but do not, and are not expected to, have a material impact on our financial position, results of operations or cash flows.

NOTE 3 - INVESTMENTS

The amortized costs and estimated fair values of investment securities as of June 30, 2012 and December 31, 2011 are as follows:

($ in thousands)
June 30, 2012
 
     
Gross
 
Gross
     
 
Amortized
 
Unrealized
 
Unrealized
 
Estimated
 
 
Cost
 
Gains
 
Losses
 
Fair Value
 
Securities available-for-sale:
                       
Corporate
  $ 16,207     $ 327     $ (255 )   $ 16,279  
State and municipal
    16,143       296       (32 )     16,407  
Residential agency mortgage-backed securities (“MBS”)
    55,805       701       (51 )     56,455  
Total securities available-for-sale
  $ 88,155     $ 1,324     $ (338 )   $ 89,141  


($ in thousands)
December 31, 2011
 
     
Gross
 
Gross
     
 
Amortized
 
Unrealized
 
Unrealized
 
Estimated
 
 
Cost
 
Gains
 
Losses
 
Fair Value
 
Securities available-for-sale:
                       
Corporate
  $ 15,117     $ 161     $ (460 )   $ 14,818  
State and municipal
    3,691       198       (4 )     3,885  
Residential agency MBS
    63,880       747       (135 )     64,492  
Total securities available-for-sale
  $ 82,688     $ 1,106     $ (599 )   $ 83,195  

The amortized cost and estimated fair value of investment securities by contractual maturity at June 30, 2012 and December 31, 2011 are shown below.  The timing of principal payments received differs from the contractual maturity because borrowers may be required to make contractual principal payments and often have the right to call or prepay obligations with or without call or prepayment penalties.  As a result, the timing with which principal payments are received on mortgage-backed securities (“MBS”) is not represented in the tables below.  For instance, we received $7.0 million in proceeds from the maturity/call/prepayment of securities during the six months ended June 30, 2012 (see our Consolidated Statements of Cash Flows on page 7) versus no dollars contractually maturing within one year as of December 31, 2011, as set forth in the table below.
 
 
13

 
 
($ in thousands)
 
June 30, 2012
   
December 31, 2011
 
         
 
   
 
 
Securities available-for-sale:  
Amortized
Cost
   
Estimated Fair
Value
   
Amortized
Cost
   
Estimated Fair
Value
 
Due within one year
  $ 499     $ 519     $ -     $ -  
Due after one year through five years
    6,887       7,017       8,540       8,583  
Due after five years through ten years
    23,661       23,889       13,799       13,720  
Due after ten years
    57,108       57,716       60,349       60,892  
Total securities available-for-sale
  $ 88,155     $ 89,141     $ 82,688     $ 83,195  

The following tables show the estimated fair value and gross unrealized losses, aggregated by investment category and length of time the individual securities have been in a continuous loss position as of June 30, 2012 and December 31, 2011.

 
June 30, 2012
 
($ in thousands)
Less than 12 months
   
12 months or more
   
Total
 
Description of securities:
Estimated Fair Value
 
Unrealized
Losses
   
# of
Securities
   
Estimated Fair Value
 
Unrealized
Losses
   
# of
Securities
   
Estimated Fair Value
 
Unrealized
 Losses
   
# of
Securities
 
Corporate
  $ 2,547     $ (96 )     5     $ 4,341     $ (159 )     7     $ 6,888     $ (255 )     12  
State and municipal
    3,951       (32 )     8       -       -       -       3,951       (32 )     8  
Residential agency MBS
    9,488       (45 )     11       931       (6 )     1       10,419       (51 )     12  
Total temporarily-impaired
  $ 15,986     $ (173 )     24     $ 5,272     $ (165 )     8     $ 21,258     $ (338 )     32  


 
December 31, 2011
 
($ in thousands)
Less than 12 months
   
12 months or more
   
Total
 
Description of securities:
Estimated Fair Value
 
Unrealized
Losses
   
# of
Securities
   
Estimated Fair Value
 
Unrealized
Losses
   
# of
Securities
   
Estimated Fair Value
 
Unrealized
Losses
   
# of
Securities
 
Corporate
  $ 4,033     $ (180 )     8     $ 4,220     $ (280 )     7     $ 8,253     $ (460 )     15  
State and municipal
    502       (4 )     1       -       -       -       502       (4 )     1  
Residential agency MBS
    18,266       (135 )     20       -       -       -       18,266       (135 )     20  
Total temporarily-impaired
  $ 22,801     $ (319 )     29     $ 4,220     $ (280 )     7     $ 27,021     $ (599 )     36  

 
14

 

Management evaluates investment securities for other-than-temporary impairment taking into consideration the extent and length of time the fair value has been less than cost, the financial condition of the issuer, whether the Company has the intent to retain the security and 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.  As of June 30, 2012, no declines were deemed to be other than temporary.  The seven corporate securities that were in a continuous loss position for 12 months or longer at June 30, 2012 fluctuated in value primarily as a result of changes in market interest rates and the widening of spreads due to an increase in the perceived risk of these bonds largely due to the problems with European banks rather than due to a material deterioration in credit quality.  Further, the amount of unrealized loss on these seven corporate bonds has improved by approximately $121,000 since December 31, 2011.  The one residential agency MBS in a continuous loss position for 12 months or longer at June 30, 2012 was primarily due to an expected acceleration in prepayment speeds given the bond’s relatively high coupon.  The Company has determined there is no credit impairment since the bond carries the implicit guarantee of the U.S. government.  Further, the Company has the intent to hold the securities in an unrealized loss position as of June 30, 2012 and does not anticipate that these securities will be required to be sold before recovery of value, which may be upon maturity.  Accordingly, the securities detailed in the table above, are not other than temporarily impaired.  Similarly, management’s evaluation of the securities in an unrealized loss position at December 31, 2011, determined these securities were not other than temporarily impaired.

The Company recorded a net unrealized gain in the investment portfolio of $986,000 at June 30, 2012, a 94% increase over the $507,000 net unrealized gain at December 31, 2011.

Sales of available-for-sale securities were as follows:
 
($ in thousands)  
Three Months Ended June 30,
   
Six Months Ended June 30,
 
   
2012
   
2011
   
2012
   
2011
 
                         
Proceeds
  $ 11,961     $ 13,708     $ 19,444     $ 25,058  
Gross gains
  $ 166     $ 206     $ 280     $ 352  
Gross losses
  $ -     $ (48 )   $ -     $ (129 )

Realized gains and losses on sales are computed on a specific identification basis based on amortized cost on the date of sale.  During the first quarter 2011, the Company recognized $67,000 of loss on available-for-sale securities related to other than temporary impairment on five securities that management had the intent to sell before recovery of value.  Those five securities were sold during the second quarter for a net loss of $48,000, a $19,000 improvement from their March 31, 2011 estimated fair values.

Securities with carrying values of $24.0 million at June 30, 2012 and $20.4 million at December 31, 2011, were pledged as collateral to secure public deposits, borrowings from the FHLB, repurchase agreements and for other purposes as required or permitted by law.
 
 
15

 

NOTE 4 - LOANS

The following table sets forth the composition of the loan portfolio according to the loan’s purpose, which may differ from the categorization of the loan in subsequent tables which categorize the loan according to its underlying collateral:
 
($ in thousands)
 
June 30,
2012
   
December 31,
2011
 
Commercial real estate (“CRE”)
  $ 38,163     $ 37,862  
Commercial and industrial
    7,832       5,971  
Residential real estate
    11,083       10,460  
Construction and land development
    1,405       1,307  
Consumer
    54       45  
GROSS LOANS
    58,537       55,645  
Net deferred loan expenses / (fees)
    94       (77 )
Allowance for loan and lease losses
    (1,009 )     (1,067 )
LOANS, NET
  $ 57,622     $ 54,501  
 
During the first six months of 2012, the Bank purchased ten loans with principal balances totaling approximately $2.3 million.  No loans were purchased during the first or second quarter of 2011.  During the second quarter 2012, the Bank sold the guaranteed portion of an SBA 7A note and recognized a $25,000 gain on sale.  No loans were sold during the first quarter of 2012 or during the first or second quarters of 2011.

In the ordinary course of business, and only if consistent with permissible exceptions to Section 402 of the Sarbanes- Oxley Act of 2002, the Bank may make loans to directors, executive officers, principal stockholders (holders of more than five percent of the outstanding common shares) and the businesses with which they are associated.  In the Company’s opinion, all loans and loan commitments to such parties are made on substantially the same terms, including interest rates and collateral, as those prevailing at the time for comparable transactions with other persons. There were approximately $223,000 and $481,000 in loans receivable from related parties at June 30, 2012 and December 31, 2011, respectively.

The Company’s loan portfolio generally consists of loans to borrowers within Colorado.  Although the Company seeks to avoid concentrations of loans to a single industry or based upon a single class of collateral, the Company’s loan portfolio consists primarily of real estate loans secured by real estate located in Colorado, making the value of the portfolio more susceptible to declines in real estate values and other changes in economic conditions in Colorado.  No single borrower can be approved for a loan over the Bank’s current legal lending limit of approximately $2.6 million.  This regulatory requirement helps to ensure the Bank’s exposure to one individual customer is limited.
 
 
16

 

NOTE 5 - ALLOWANCE FOR LOAN AND LEASE LOSSES
 
Activity in the allowance for loan and lease losses for the three and six months ended June 30, 2012 and 2011 is summarized as follows:
 
($ in thousands)
 
Three Months Ended
June 30,
   
Six Months Ended
June 30,
 
   
2012
   
2011
   
2012
   
2011
 
                         
Balance, beginning of period
  $ 1,077     $ 1,175     $ 1,067     $ 1,175  
Charge-offs
    (85 )     (11 )     (88     (11 )    
Recoveries
    17       -       30       -  
Provision for loan and lease losses
    -       120       -       120  
Balance, end of period
  $ 1,009     $ 1,284     $ 1,009     $ 1,284  

The following allowance for loan and lease loss disclosures are broken out by portfolio segment.  Portfolio segment is defined, under current U.S. GAAP, as the level of aggregation used by the Company to calculate its allowance for loan and lease losses.  Our portfolio segments are based on how loans are categorized on the Call Report, which is primarily based on the collateral securing the loan.  We have four main portfolio segments as follows:
 
Commercial Real Estate (CRE) Secured – loans secured by nonfarm, nonresidential properties
Residential Real Estate Secured – loans secured by 1-4 family residential properties or land
Commercial and Industrial – loans to businesses not secured by real estate, and
Consumer – loans to individuals not secured by real estate.
 
The portfolio segment categorization of loans differs from the categorization shown in Note 4 – Loans.  Portfolio segment categorization is based on the Call Report and the loan’s underlying collateral while the loan categorization in Note 4 – Loans is based on the loan’s purpose as determined during the underwriting process.

The tables below provide a rollforward, by portfolio segment, of the allowance for loan and lease losses for the three and six months ended June 30, 2012 and 2011, respectively.

Rollforward of Allowance for Loan and Lease Losses by Portfolio Segment
 
Three Months Ended June 30, 2012
 
($ in thousands)
Commercial Real
 Estate Secured
 
Residential Real
Estate Secured
 
Commercial and
Industrial
 
Consumer
 
Total
 
                     
Balance at March 31, 2012
  $ 699     $ 247     $ 130     $ 1     $ 1,077  
Charge-offs
    -       -       (85 )     -       (85 )
Recoveries
    -       17       -       -       17  
Provision for loan and lease losses
    (34 )     (17 )     51       -       -  
Balance at June 30, 2012
  $ 665     $ 247     $ 96     $ 1     $ 1,009  

 
17

 

Rollforward of Allowance for Loan and Lease Losses by Portfolio Segment
Six Months Ended June 30, 2012
($ in thousands)
Commercial Real
Estate Secured
 
Residential Real
Estate Secured
 
Commercial and
Industrial
 
Consumer
 
Total
                                         
Balance at December 31, 2011
  $ 726     $ 244     $ 97     $ -     $ 1,067  
Charge-offs
    -               (85 )     (3 )     (88 )
Recoveries
    -       30       -       -       30  
Provision for loan and lease losses
    (61 )     (27 )     84       4       -  
Balance at June 30, 2012
  $ 665     $ 247     $ 96     $ 1     $ 1,009  

The components of the provision for loan and lease losses have changed during the three and six months ended June 30, 2012 primarily due to the need to replenish the allowance for commercial and industrial loans after the $85,000 charge-off which didn’t require provision expense during these periods due to improving asset quality in both commercial and residential real estate secured loans.

Rollforward of Allowance for Loan and Lease Losses by Portfolio Segment
 
Three Months Ended June 30, 2011
 
($ in thousands)
Commercial Real
 Estate Secured
 
Residential Real
Estate Secured
 
Commercial and
Industrial
 
Consumer
 
Total
 
                                         
Balance at March 31, 2011
  $ 581     $ 338     $ 255     $ 1     $ 1,175  
Charge-offs
    (11 )     -       -       -       (11 )
Recoveries
    -       -       -       -       -  
Provision for loan and lease losses
    153       94       (127 )     -       120  
Balance at June 30, 2011
  $ 723     $ 432     $ 128     $ 1     $ 1,284  


Rollforward of Allowance for Loan and Lease Losses by Portfolio Segment
 
Six Months Ended June 30, 2011
 
($ in thousands)
Commercial Real
 Estate Secured
 
Residential Real
Estate Secured
 
Commercial and
Industrial
 
Consumer
 
Total
 
                                         
Balance at December 31, 2010
  $ 524     $ 314     $ 336     $ 1     $ 1,175  
Charge-offs
    (11 )     -       -       -       (11 )
Recoveries
    -       -       -       -       -  
Provision for loan and lease losses
    210       118       (208 )     -       120  
Balance at June 30, 2011
  $ 723     $ 432     $ 128     $ 1     $ 1,284  
 
 
18

 
 
The following tables present the ending balance in loans and allowance for loan and lease losses, broken down by portfolio segment as of June 30, 2012 and December 31, 2011.  The tables also identify the recorded investment in loans and the related allowance that correspond to individual versus collective impairment evaluation as derived from the Company’s methodology of estimating the allowance for loan and lease losses (see additional discussion about our allowance methodology under Note 2:  Critical Accounting Policies, Provision and allowance for loan and lease losses).

Ending Balances in Loans and Allowance for Loan and Lease Losses by Portfolio Segment
 
June 30, 2012
 
($ in thousands)
 
Commercial Real
 Estate Secured
   
Residential Real
 Estate Secured
   
Commercial and Industrial
   
Consumer
   
Total
 
Loans
                             
Individually evaluated for impairment
  $ 214     $ -     $ 93     $ -     $ 307  
Collectively evaluated for impairment
    34,501       16,313       7,362       54       58,230  
Total
  $ 34,715     $ 16,313     $ 7,455     $ 54     $ 58,537  
Allowance for loan losses
                                       
Individually evaluated for impairment
  $ -     $ -     $ -     $ -     $ -  
Collectively evaluated for impairment
    665       247       96       1       1,009  
Total
  $ 665     $ 247     $ 96     $ 1     $ 1,009  
 
Ending Balances in Loans and Allowance for Loan and Lease Losses by Portfolio Segment
 
December 31, 2011
 
($ in thousands)
 
Commercial Real
 Estate Secured
   
Residential Real
 Estate Secured
   
Commercial and Industrial
   
Consumer
   
Total
 
Loans
                             
Individually evaluated for impairment
  $ 274     $ -     $ 336     $ -     $ 610  
Collectively evaluated for impairment
    35,159       14,586       5,245       45       55,035  
Total
  $ 35,433     $ 14,586     $ 5,581     $ 45     $ 55,645  
Allowance for loan losses
                                       
Individually evaluated for impairment
  $ -     $ -     $ -     $ -     $ -  
Collectively evaluated for impairment
    726       244       97       -       1,067  
Total
  $ 726     $ 244     $ 97     $ -     $ 1,067  
 
 
19

 
 
The remaining tables in the allowance for loan and lease losses footnote provide detail about loans according to their class, rather than their segment, as reflected above.  The class level provides more detail than the portfolio segment level.  The following tables contain reconciliation information between the portfolio segment levels and class levels:

Reconciliation between Portfolio Segment and Class
 
June 30, 2012 (Principal Balance)
 
($ in thousands)
 
Portfolio Segment
 
Class
 
Commercial Real
 Estate Secured
   
Residential Real
 Estate Secured
   
Commercial and
Industrial
   
Consumer
   
Total
 
                                         
CRE – owner occupied
  $ 18,104     $ -     $ -     $ -     $ 18,104  
CRE – non-owner occupied
    15,883       -       -       -       15,883  
Commercial and industrial
    -       -       7,455       -       7,455  
Residential real estate
    -       15,636       -       -       15,636  
Construction and land development
    728       677       -       -       1,405  
Consumer
    -       -       -       54       54  
Total
  $ 34,715     $ 16,313     $ 7,455     $ 54     $ 58,537  
 
Reconciliation between Portfolio Segment and Class
 
December 31, 2011 (Principal Balance)
 
($ in thousands)
 
Portfolio Segment
 
Class
 
Commercial Real
 Estate Secured
   
Residential Real
 Estate Secured
   
Commercial and
Industrial
   
Consumer
   
Total
 
                                         
CRE – owner occupied
  $ 16,337     $ -     $ -     $ -     $ 16,337  
CRE – non-owner occupied
    18,367       -       -       -       18,367  
Commercial and industrial
    -       -       5,581       -       5,581  
Residential real estate
    -       14,008       -       -       14,008  
Construction and land development
    729       578       -       -       1,307  
Consumer
    -       -       -       45       45  
Total
  $ 35,433     $ 14,586     $ 5,581     $ 45     $ 55,645  

 
20

 

Impaired Loans
The following tables provide detail of impaired loans broken out according to class as of June 30, 2012 and December 31, 2011.  The class level represents a slightly more detailed level than the portfolio segment level.  There were two impaired loans, totaling $307,000, as of June 30, 2012 compared to three impaired loans totaling $610,000 as of December 31, 2011.  The recorded investment represents the customer balance less any partial charge-offs and excludes any accrued interest receivable since the majority of the loans are on nonaccrual status and therefore do not have interest accruing.  The unpaid principal balance represents the unpaid principal prior to any partial charge-off.

 
Impaired Loans by Class as of June 30, 2012
 
($ in thousands)
 
Recorded
 Investment
   
Unpaid Principal Balance
   
Related
Allowance
   
Average Recorded Investment YTD
   
Interest Income Recognized YTD
 
Impaired loans with no related allowance
                         
CRE – owner occupied
  $ -     $ -     $ -     $ -     $ -  
CRE – non-owner occupied
    214       434       -       243       -  
Commercial and industrial
    93       93       -       309       2  
Residential real estate
    -       -       -       -       -  
Construction and land development
    -       -       -       -       -  
Consumer
    -       -       -       -       -  
Total
  $ 307     $ 527     $ -     $ 552     $ 2  
                                         
Impaired loans with a related allowance
                                 
CRE – owner occupied
  $ -     $ -     $ -     $ -     $ -  
CRE – non-owner occupied
    -       -       -       -       -  
Commercial and industrial
    -       -       -       -       -  
Residential real estate
    -       -       -       -       -  
Construction and land development
    -       -       -       -       -  
Consumer
    -       -       -       -       -  
Total
  $ -     $ -     $ -     $ -     $ -  
                                         
Total impaired loans
                                       
CRE – owner occupied
  $ -     $ -     $ -     $ -     $ -  
CRE – non-owner occupied
    214       434       -       243       -  
Commercial and industrial
    93       93       -       309       2  
Residential real estate
    -       -       -       -       -  
Construction and land development
    -       -       -       -       -  
Consumer
    -       -       -       -       -  
Total
  $ 307     $ 527     $ -     $ 552     $ 2  

 
21

 
 
 
Impaired Loans by Class as of December 31, 2011
 
($ in thousands)
 
Recorded
Investment
   
Unpaid Principal Balance
   
Related
 Allowance
   
Average Recorded Investment YTD
   
Interest Income Recognized YTD
 
Impaired loans with no related allowance
                         
CRE – owner occupied
  $ -     $ -     $ -     $ -     $ -  
CRE – non-owner occupied
    274       494       -       345       -  
Commercial and industrial
    336       336       -       517       15  
Residential real estate
    -       -       -       -       -  
Construction and land development
    -       -       -       -       -  
Consumer
    -       -       -       -       -  
Total
  $ 610     $ 830     $ -     $ 862     $ 15  
                                         
Impaired loans with a related allowance
                                 
CRE – owner occupied
  $ -     $ -     $ -     $ -     $ -  
CRE – non-owner occupied
    -       -       -       -       -  
Commercial and industrial
    -       -       -       -       -  
Residential real estate
    -       -       -       -       -  
Construction and land development
    -       -       -       -       -  
Consumer
    -       -       -       -       -  
Total
  $ -     $ -     $ -     $ -     $ -  
                                         
Total impaired loans
                                       
CRE – owner occupied
  $ -     $ -     $ -     $ -     $ -  
CRE – non-owner occupied
    274       494       -       345       -  
Commercial and industrial
    336       336       -       517       15  
Residential real estate
    -       -       -       -       -  
Construction and land development
    -       -       -       -       -  
Consumer
    -       -       -       -       -  
Total
  $ 610     $ 830     $ -     $ 862     $ 15  

As of both June 30, 2012 and December 31, 2011, the impaired loans without a valuation allowance did not have a related allowance because they have either been partially charged-off, bringing them to their net realizable value, or are well-secured.

Troubled debt restructurings (TDRs) are included in impaired loans above.  No loans were modified as TDRs during the three or six months ended June 30, 2012.  The Company has not committed additional funds to any of the borrowers whose loans are classified as a TDR.  A TDR is considered to be in payment default once it is 90 days past due under the modified terms or when the loan is determined to be uncollectible and is classified as loss and charged-off.  One loan, totaling $85,000, that was restructured during the last 12 months subsequently defaulted and was charged-off during the second quarter 2012.
 
 
22

 

Age Analysis of Loans
 
The following tables summarize, by class, our past due and nonaccrual loans as of the dates indicated.

   
Age Analysis of Loans by Class as of June 30, 2012
 
($ in thousands)
 
30-59 Days
Past Due
   
60-89 Days
Past Due
   
Past Due 90 Days or More and Still Accruing
   
Nonaccrual
   
Total Past Due and Nonaccrual
   
Current
   
Total
 
CRE – owner occupied
  $ -     $ -     $ -     $ -     $ -     $ 18,104     $ 18,104  
CRE – non-owner occupied
    -       -       -       214       214       15,669       15,883  
Commercial and industrial
    -       170       -       93       263       7,192       7,455  
Residential real estate
    -       -       -       -       -       15,636       15,636  
Construction and land development
    -       -       -       -       -       1,405       1,405  
Consumer
    -       -       -       -       -       54       54  
Total
  $ -     $ 170     $ -     $ 307     $ 477     $ 58,060     $ 58,537  


   
Age Analysis of Loans by Class as of December 31, 2011
 
($ in thousands)
 
30-59 Days
Past Due
   
60-89 Days
Past Due
   
Past Due 90 Days or More and Still Accruing
   
Nonaccrual
   
Total Past Due and Nonaccrual
   
Current
   
Total
 
CRE – owner occupied
  $ -     $ 1,040     $ -     $ -     $ 1,040     $ 15,297     $ 16,337  
CRE – non-owner occupied
    -       -       -       274       274       18,093       18,367  
Commercial and industrial
    -       -       -       336       336       5,245       5,581  
Residential real estate
    139       170       -       -       309       13,699       14,008  
Construction and land development
    -       -       -       -       -       1,307       1,307  
Consumer
    -       -       -       -       -       45       45  
Total
  $ 139     $ 1,210     $ -     $ 610     $ 1,959     $ 53,686     $ 55,645  
 
 
23

 
 
Credit Quality Information
The Company uses the following definitions for risk ratings, which are consistent with the definitions used in supervisory guidance and are the same for all classes of loans:

 
Special Mention:
Loans in this category have potential weaknesses that deserve management’s close attention.  If left uncorrected, these potential weaknesses may result in deterioration of the repayment at some future date.

 
Substandard:
Loans in this category are inadequately protected by the current sound worth and paying capacity of the borrower or of the collateral pledged, if any.  These loans have well-defined weaknesses that jeopardize the liquidation of the debt and have the distinct possibility that the Bank will sustain some loss if the deficiencies are not corrected.

 
Doubtful:
Loans in this category have all the weaknesses inherent in those classified as substandard, above, with the added characteristic that the weaknesses make the collection or liquidation in full, on the basis of currently existing facts, conditions and values, highly questionable and improbable.

 
Loss:
Loans in this category are deemed not collectible and are charged-off.

Loans not meeting any of the definitions above are considered to be pass rated loans.

As of June 30, 2012, and based on the most recent analysis performed during the month of June 2012, the recorded investment in each risk category of loans by class of loan is as follows:

   
Credit Quality of Loans by Class as of June 30, 2012
 
($ in thousands)
 
Pass
   
Special Mention
   
Substandard
   
Doubtful
   
Total
 
CRE – owner occupied
  $ 15,144     $ 1,448     $ 1,512     $ -     $ 18,104  
CRE – non-owner occupied
    14,568       1,101       214       -       15,883  
Commercial and industrial
    7,106       170       179       -       7,455  
Residential real estate
    14,988       -       648       -       15,636  
Construction and land development
    531       -       874       -       1,405  
Consumer
    39       15       -               54  
Total
  $ 52,376     $ 2,734     $ 3,427     $ -     $ 58,537  

 
24

 

As of December 31, 2011, and based on the most recent analysis performed during the month of December 2011, the recorded investment in each risk category of loans by class of loan is as follows:

   
Credit Quality of Loans by Class as of December 31, 2011
 
($ in thousands)
 
Pass
   
Special Mention
   
Substandard
   
Doubtful
   
Total
 
CRE – owner occupied
  $ 14,068     $ 1,135     $ 1,134     $ -     $ 16,337  
CRE – non-owner occupied
    15,395       1,796       1,176       -       18,367  
Commercial and industrial
    5,021       -       560       -       5,581  
Residential real estate
    13,344       -       664       -       14,008  
Construction and land development
    232       -       1,075       -       1,307  
Consumer
    45       -       -       -       45  
Total
  $ 48,105     $ 2,931     $ 4,609     $ -     $ 55,645  

NOTE 6 - BANK-OWNED LIFE INSURANCE

During the first quarter of 2012, the Company invested $2.0 million in bank-owned life insurance on certain key employees.  Bank-owned life insurance is recorded at the amount that can be realized under the insurance contract at the balance sheet date, which is the cash surrender value.  Increases in the cash surrender value are recognized as other noninterest income.

NOTE 7 - DEPOSITS

Deposits are summarized as follows:

($ in thousands)
 
June 30, 2012
   
December 31, 2011
 
   
Amount
   
% of Total
   
Amount
   
% of Total
 
Noninterest-bearing demand
  $ 3,312       3 %   $ 3,550       3 %
Interest-bearing demand
    8,950       7       9,355       8  
Money market accounts
    10,295       8       9,781       8  
Savings accounts
    46,445       37       49,073       41  
Time deposits, less than $100,000
    4,496       4       5,193       4  
Time deposits, $100,000 or more
    51,703       41       42,032       36  
Total deposits
  $ 125,201       100 %   $ 118,984       100 %

In the ordinary course of business, certain officers, directors, stockholders, and employees of the Bank have deposits with the Bank.  In the Bank’s opinion, all deposit relationships with such parties are made on substantially the same terms including interest rates and maturities, as those prevailing at the time for comparable transactions with other persons.  The balances of related party deposits were approximately $3.6 million and $4.3 million at June 30, 2012 and December 31, 2011, respectively.
 
 
25

 

NOTE 8 - STOCK-BASED COMPENSATION

Under the terms of the Company’s Stock Incentive Plan, (the “Plan”), employees may be granted both nonqualified and incentive stock options and directors and other consultants, who are not also officers or employees, may only be granted nonqualified stock options.  The Board reserved approximately 510,700 shares of common stock for issuance under the Plan.  Of that, approximately 482,600 are issued and outstanding, leaving approximately 28,100 available for future grants as of June 30, 2012.  The Plan provides for options to purchase shares of common stock at a price not less than 100% of the fair market value of the stock on the date of grant.  Stock options expire no later than ten years from the date of the grant and generally vest over four years.  The Plan provides for accelerated vesting if there is a change of control, as defined in the Plan.  The Company recognized stock-based compensation cost of approximately $13,000 and $54,000 during the three months ended June 30, 2012 and 2011, respectively and $26,000 and $115,000 during the six months ended June 30, 2012 and 2011, respectively.  No tax benefit related to stock-based compensation will be recognized until the Company demonstrates an ability to maintain profitability.

The fair value of each option grant is estimated on the date of grant using the Black-Scholes-Merton option pricing model.  The Company granted 4,500 options during the second quarter 2012 as incentive compensation to employees.

During the three months ended June 30, 2012, 1,198 options were forfeited and no vested options expired unexercised.  During the second quarter 2011, no options were forfeited and 1,000 vested options expired unexercised.  No options were exercised during the three or six months ended June 30, 2012 or 2011.  The Company recognized expense for approximately 13,000 options, representing a pro-rata amount of the options earned during the second quarter of 2012 that are expected to vest.  As of June 30, 2012, there was approximately $97,000 of total unrecognized compensation cost related to the outstanding stock options that will be recognized over a weighted-average period of 1.9 years.

The following is a summary of the Company’s outstanding stock options and related activity for the six months ended June 30, 2012:

   
Options
   
Weighted-Average Grant Date Fair Value
   
Weighted-Average Exercise Price
 
Outstanding at December 31, 2011
    400,312     $ 1.93     $ 7.62  
Granted
    93,250       0.63       3.38  
Exercised
    -       -       -  
Forfeited
    (4,948 )         0.60       3.15  
Expired
    (6,042 )          1.83       8.14  
Outstanding at June 30, 2012
    482,572     $ 1.69     $ 6.84  

The following is a summary of the Company’s outstanding stock options and related activity for the six months ended June 30, 2011:

   
Options
   
Weighted-Average Grant Date Fair Value
   
Weighted-Average Exercise Price
 
Outstanding at December 31, 2010
    367,790     $ 2.43     $ 8.31  
Granted
    44,000       0.64       3.00  
Exercised
    -       -       -  
Forfeited
    (14,020 )           2.29       8.90  
Expired
    (1,000 )           1.32       5.90  
Outstanding at June 30, 2011
    396,770     $ 2.24     $ 8.66  
 
 
26

 

NOTE 9 - NONINTEREST EXPENSE

The following table details the items comprising other general and administrative expenses:

($ in thousands)
 
Three Months Ended
June 30,
   
Six Months Ended
June 30,
 
Other general and administrative expenses:
 
2012
   
2011
   
2012
   
2011
 
Data processing
  $ 84     $ 77     $ 159     $ 155  
FDIC assessment
    50       38       96       117  
Regulatory and reporting fees
    41       48       73       82  
Marketing and promotions
    29       25       48       41  
Directors’ fees
    23       22       42       45  
Loan and collection expenses
    21       16       52       35  
OREO expense
    11       -       33       -  
Insurance
    12       6       24       12  
Telephone/communication
    12       12       24       23  
Travel and entertainment
    11       5       23       15  
Dues and memberships
    10       7       15       13  
Printing, stationery and supplies
    8       7       13       14  
ATM and debit card fees
    4       3       8       7  
Postage and shipping
    4       3       7       7  
Training and education
    2       3       5       7  
Franchise taxes
    3       3       5       7  
Miscellaneous
    13       8       19       15  
Total
  $ 338     $ 283     $ 646     $ 595  

NOTE 10 - COMMITMENTS AND CONTINGENCIES

The Company is a party to credit related financial instruments with off-balance-sheet risk in the normal course of business to meet the financing needs of its customers.  These financial instruments consist of commitments to extend credit.  Such commitments involve, to varying degrees, elements of credit and interest rate risk in excess of the amount recognized in the consolidated balance sheets.  The Company’s exposure to credit loss is represented by the contractual amount of these commitments.  The Company follows the same credit policies in making commitments as it does for on-balance-sheet instruments.
 
 
27

 

At June 30, 2012 and December 31, 2011, $7.5 million and $6.3 million, respectively, in unfunded commitments were outstanding whose contract amounts represent credit risk.

Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract.  Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee.  Since many of the commitments are expected to expire without being drawn upon, the commitments do not necessarily represent future cash requirements.  The Company evaluates each customer’s creditworthiness on a case-by-case basis.  The amount of collateral obtained is based on management’s credit evaluation.  Collateral held varies, but may include accounts receivable, inventory, property, plant and equipment and income producing commercial properties.

NOTE 11 - FAIR VALUE

The Company carries its available-for-sale securities at fair value.  Fair value measurement is obtained from independent pricing services which utilize observable data that may include dealer quotes, market spreads, cash flows, the U.S. Treasury yield curve, live trading levels, trade execution data, market consensus prepayment speeds, credit information and the bonds’ terms and conditions, among other things.  As of June 30, 2012 and December 31, 2011, all of the Company’s available-for-sale securities were valued using Level 2 inputs.

Impaired loans are evaluated and valued at the time the loan is identified as impaired, at the lower of cost or fair value.  Fair value is measured based on the value of the collateral securing these loans or the present value of expected cash flows and is classified as Level 3 in the fair value hierarchy.  Collateral may be real estate and/or business assets including equipment, inventory and/or accounts receivable and is determined based on appraisals performed by qualified licensed appraisers hired by the Company.  Appraised and reported values may be adjusted based on management's historical knowledge, changes in market conditions from the time of valuation, and/or management's expertise and knowledge of the client and client's business.  Such discounts are typically significant and result in a Level 3 classification of the inputs for determining fair value.  Impaired loans are reviewed and evaluated on at least a quarterly basis for additional impairment and adjusted accordingly.

Other real estate owned is valued at the time the loan is foreclosed upon and the asset is transferred to other real estate owned.  The value is based primarily on third party appraisals, less costs to sell.  The appraisals may be adjusted based on management's historical knowledge, changes in market conditions from the time of valuation, and/or management's expertise and knowledge of the client and client's business.  Such discounts are typically significant and result in a Level 3 classification of the inputs for determining fair value.  Other real estate owned is reviewed and evaluated on at least an annual basis for additional impairment and adjusted accordingly.
 
 
28

 

Assets and Liabilities Measured on a Recurring Basis
 
Assets and liabilities measured at fair value on a recurring basis are summarized below:

($ in thousands)
 
Quoted Prices in Active Markets for Identical Assets
(Level 1)
   
Significant Other Observable Inputs
(Level 2)
   
Significant
Unobservable Inputs
(Level 3)
   
Total
 
Assets at June 30, 2012
                       
Investment securities, available-for-sale:
                       
Corporate
  $ -     $ 16,279     $ -     $ 16,279  
State and municipal
    -       16,407       -       16,407  
Residential agency MBS
    -       56,455       -       56,455  
Total
  $ -     $ 89,141     $ -     $ 89,141  
Assets at December 31, 2011
                               
Investment securities, available-for-sale:
                               
Corporate
  $ -     $ 14,818     $ -     $ 14,818  
State and municipal
    -       3,885       -       3,885  
Residential agency MBS
    -       64,492       -       64,492  
Total
  $ -     $ 83,195     $ -     $ 83,195  

There were no transfers in or out of the levels during the periods presented.
 
 
29

 

Assets and Liabilities Measured on a Nonrecurring Basis
 
Assets and liabilities measured at fair value on a nonrecurring basis are summarized below:

($ in thousands)
 
Quoted Prices in Active Markets for Identical Assets
(Level 1)
   
Significant Other Observable Inputs
(Level 2)
   
Significant Unobservable Inputs
(Level 3)
   
Total
 
Assets at June 30, 2012
                       
Impaired loans (Financial)
  $ -     $ -     $ 251     $ 251  
Other real estate owned (Non-financial)
  $ -     $ -     $ 1,989     $ 1,989  
Assets at December 31, 2011
                               
Impaired loans (Financial)
  $ -     $ -     $ 311     $ 311  
Other real estate owned (Non-financial)
  $ -     $ -     $ 1,989     $ 1,989  

Impaired loans, which are measured for impairment using either the fair value of collateral or present value of expected cash flows, had carrying amounts at June 30, 2012 totaling $307,000 after partial charge-offs of $220,000, which were recorded in 2011.  In addition, these loans have $37,000 of estimated selling costs which reduced the carrying value.  Of the $307,000 of impaired loans at June 30, 2012, $214,000 were carried at fair value adjusted for the aforementioned charge-offs and estimated selling costs.  The remaining $93,000 was carried at cost at June 30, 2012, as the fair value of collateral or expected cash flows on these loans exceeded the book value.

Impaired loans at December 31, 2011 had carrying amounts totaling $610,000 after partial charge-offs of $220,000.  These impaired loans had no specific valuation allowance at December 31, 2011.  In addition, impaired loans had $37,000 of estimated selling costs which reduced the carrying value.  Of the $610,000 of impaired loans at December 31, 2011, $274,000 were carried at fair value adjusted for the aforementioned charge-offs and estimated selling costs.  The remaining $336,000 were carried at cost at December 31, 2011, as the fair value of collateral or expected cash flows on these loans exceeded the book value.

Other real estate owned (OREO) is real property taken by the Company either through foreclosure or through deed in lieu of foreclosure.  The fair value of OREO is based on property appraisals adjusted at management’s discretion to reflect further decline in fair value since the time the appraisal analysis was completed, if warranted.  Therefore, the inputs used to determine the fair value of OREO fall within Level 3.  OREO had a carrying amount of $1.8 million at both June 30, 2012 and December 31, 2011, based on the current appraisals less reasonable costs to sell of approximately $253,000 for the Company’s two OREO properties.  This value included partial charge-offs of $40,000 which were recorded during 2011.

The following table provides information describing the valuation process used to determine recurring and nonrecurring fair value measurements categorized within Level 3 of the fair value hierarchy:

Asset Type
 
Valuation Method
 
Unobservable Inputs
 
Range
             
Impaired Loans
 
Property appraisals
 
Management discount for property type and/or recent market volatility
 
0% - 20% discount
             
   
Discounted cash flow
 
Estimated loss probability based on management’s knowledge of client or client’s business
 
0% - 50% discount
             
OREO
 
Property appraisals
 
Management discount for property type, recent market volatility, and/or management’s knowledge of the property
 
0% - 20% discount
 
 
30

 

Fair Value of Financial Instruments

Disclosure of fair value information about financial instruments, whether or not recognized in the consolidated balance sheets, for which it is practicable to estimate such value is required by U.S. GAAP.  Fair value estimates are made at a specific point in time based on relevant market information and information about the financial instrument.  Because no market value exists for a significant portion of the financial instruments, fair value estimates are based on judgments regarding future expected loss experience, current economic conditions, risk characteristics of various financial instruments, and other factors.  These estimates are subjective in nature, involve uncertainties and matters of judgment, and therefore cannot be determined with precision.  Changes in assumptions could significantly affect the estimates.

Fair value information is not required to be disclosed for certain financial instruments and all nonfinancial instruments.  Accordingly, the aggregate fair value amounts presented may not necessarily represent the underlying fair value of the financial instruments held by the Company.  Fair value estimates are based on financial instruments both on and off the balance sheet without attempting to estimate the value of anticipated future business and the value of assets and liabilities that are not considered financial instruments.  Additionally, tax consequences related to the realization of the unrealized gains and losses can have a potential effect on fair value estimates and have not been considered in many of the estimates.

The following methods and assumptions were used to estimate the fair value of significant financial instruments:

Cash and cash equivalents:  The carrying amounts of cash and due from banks approximate their fair values.

Interest-bearing deposits with banks:  The carrying amount of interest-bearing deposits with banks approximates fair values due to the relatively stable level of short-term interest rates.

Investment securities:  Fair value measurement is obtained from independent pricing services which utilize observable data that may include dealer quotes, market spreads, cash flows, the U.S. Treasury yield curve, live trading levels, trade execution data, market consensus prepayment speeds, credit information and the bonds’ terms and conditions, among other things.

Loans, net:  The fair value of fixed rate loans is estimated by discounting the future cash flows using interest rates currently being offered for loans with similar terms to borrowers of similar credit quality.  For variable rate loans that reprice frequently and with no significant change in credit risk, fair values are estimated to be equivalent to carrying values.  Variable rate loans that are currently priced at their contractual floor or ceiling, and thus similar to fixed rate loans, are reviewed to determine the interest rate that would be currently offered on similar credits.  If the current floor/ceiling rate is equivalent to current market rates, fair value is estimated to be equivalent to carrying value.  If the current market rates differ from the loan’s current rate, the contractual cash flows are discounted using the current market rate to derive the loan’s estimated fair value.  Both the estimated fair value and the carrying value have been reduced by specific and general reserves for loan losses.

Investment in FHLB and Federal Reserve Bank stocks:  It is not practical to determine the fair value of bank stocks due to the restrictions placed on the transferability of FHLB stock and Federal Reserve Bank stock.

Bank-owned life insurance:  The carrying amount of bank-owned life insurance is based on the cash surrender value of the policies which is a reasonable estimate of fair value.

Accrued interest receivable:  The carrying value of interest receivable approximates fair value due to the short period of time between accrual and receipt of payment.

Deposits:  The fair value of noninterest-bearing demand deposits, interest-bearing demand deposits and savings and money market accounts is determined to be the amount payable on demand at the reporting date.  The fair value of fixed rate time deposits is estimated using a discounted cash flow calculation that applies interest rates currently being offered for deposits of similar remaining maturities.  Carrying value is assumed to approximate fair value for all variable rate time deposits.
 
 
31

 

Securities sold under agreements to repurchase:  The carrying amount of securities sold under agreements to repurchase approximates fair value due to the short-term nature of these agreements, which generally mature within one to four days from the transaction date.

Federal funds purchased: The carrying amount of federal funds purchased approximates fair value due to their short-term nature.

Federal Home Loan Bank advances:  Fair value of the Federal Home Loan Bank advances is estimated using a discounted cash flow model based on current market rates for similar types of borrowing arrangements including similar remaining maturities.

Accrued interest payable:  The carrying value of interest payable approximates fair value due to the short period of time between accrual and payment.

Loan commitments:  The fair values of commitments are estimated using the fees currently charged to enter into similar agreements, taking into account the remaining terms of the agreements and the present creditworthiness of the counterparties.  The difference between the carrying value of commitments to fund loans or standby letters of credit and their fair values are not significant and, therefore, are not included in the following table.

The carrying amounts and estimated fair values of financial instruments are summarized as follows:
 
($ in thousands)
 
Carrying
   
Fair Value Measurements at June 30, 2012
 
Financial Assets:
 
Value
   
Level 1
   
Level 2
   
Level 3
   
Total
 
Cash and cash equivalents
  $ 849     $ 849     $ -     $ -     $ 849  
Interest-bearing deposits with banks
    357       -       357       -       357  
Investment securities
    89,141       -       89,141       -       89,141  
Loans, net
    57,622       -       -       57,836       57,836  
FHLB and FRB stocks
    1,164       -       -    
NA
   
NA
 
Bank-owned life insurance
    2,027       -       -       2,027       2,027  
Accrued interest receivable
    718       -       519       199       718  
                                         
Financial Liabilities:
                                       
Deposits, demand, savings and money market
  $ 69,002     $ -     $ 69,002     $ -     $ 69,002  
Time deposits
    56,199       -       57,036       -       57,036  
Securities sold under agreements to repurchase
    254       -       254       -       254  
Federal funds purchased
    560       560       -       -       560  
FHLB advances
    8,500       -       8,716       -       8,716  
Accrued interest payable
    63       -       63       -       63  

 
32

 


($ in thousands)
 
Carrying
   
Fair Value Measurements at December 31, 2011
 
Financial Assets:
 
Value
   
Level 1
   
Level 2
   
Level 3
   
Total
 
Cash and cash equivalents
  $ 1,800     $ 1,800     $ -     $ -     $ 1,800  
Interest-bearing deposits with banks
    1,357       -       1,357       -       1,357  
Investment securities
    83,195       -       83,195       -       83,195  
Loans, net
    54,501       -       -       54,788       54,788  
FHLB and FRB stocks
    1,134       -       -    
NA
   
NA
 
Accrued interest receivable
    584       -       423       161       584  
                                         
Financial Liabilities:
                                       
Deposits, demand, savings and money market
  $ 71,759     $ -     $ 71,759     $ -     $ 71,759  
Time deposits
    47,225       -       47,917       -       47,917  
Securities sold under agreements to repurchase
    253       -       253       -       253  
FHLB advances
    6,500       -       6,692       -       6,692  
Accrued interest payable
    56       -       56               56  

NOTE 12 – LEGAL CONTINGENCIES

In the ordinary course of our business, we are party to various legal actions, which we believe are incidental to the operation of our business. Although the ultimate outcome and amount of liability associated with these legal actions, if any, cannot presently be ascertained with certainty, in the opinion of management, based upon information currently available to us, any resulting liability is not likely to have a materially adverse effect on the Company’s consolidated financial position, results of operations or cash flows.

NOTE 13 – TERMINATION OF CONSENT ORDER

On June 29, 2012, the Office of the Comptroller of the Currency, (the “OCC”), terminated the Amended Consent Order, (the “Consent Order”), by and between the OCC and Solera National Bank which was entered into on December 16, 2010.  The Consent Order replaced and superseded the consent order entered into on March 18, 2010 by the Bank.  As such, the Bank is no longer subject to any formal or informal regulatory agreement.
 
 
33

 

ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The following discussion and analysis presents the Company’s consolidated financial condition as of June 30, 2012 and results of operations for the three and six months ended June 30, 2012 and 2011.  The discussion should be read in conjunction with the financial statements and the notes related thereto which appear elsewhere in this Quarterly Report on Form 10-Q.

Executive Overview

We are a Delaware corporation that was incorporated 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 primarily serving the six-county Denver metropolitan area.  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 net interest income, which is interest income less interest expense, and noninterest income earned from gains on sales of investment securities, increased cash surrender value on bank-owned life insurance policies, and banking service fees, offset by noninterest expense and provision for loan losses. As the majority of assets are interest-earning and liabilities are interest-bearing, changes in interest rates impact net interest margin.  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.  Since opening the bank in September of 2007, management has successfully executed its strategy of delivering prudent and controlled growth to efficiently leverage the Company’s capital and expense base with the goal of achieving sustained profitability. 

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”).
 
On June 29, 2012, the OCC terminated the Bank's Consent Order; as such, the Bank is no longer subject to any formal or informal regulatory agreement.
 
Comparative Results of Operations for the Three Months Ended June 30, 2012 and 2011

The following discussion focuses on the Company’s financial condition and results of operations for the three months ended June 30, 2012 compared to the financial condition and results of operations for the three months ended June 30, 2011.

Net income for the quarter ended June 30, 2012 was $133,000, or $0.05 per share, compared with net income of $100,000, or $0.04 per share, for the second quarter of 2011.  The $33,000 increase was primarily the result of a $120,000 decrease in provision for loan and lease losses as a result of stabilizing asset quality which resulted in no provision expense during the second quarter 2012.  This was partially offset by a $71,000 decrease in net interest income primarily due to lower yields on our investment securities, along with a $14,000 decrease in noninterest income primarily due to lower gains from the sale of investment securities.  These and other changes are explained in more detail in the ensuing discussion.

As of June 30, 2012, the Company had total assets of $154.6 million, an increase of $9.2 million, or 6%, from December 31, 2011.  Net loans increased 6%, from $54.5 million at December 31, 2011 to $57.6 million at June 30, 2012.  Similarly, the Company’s total deposits increased 5% to $125.2 million as of June 30, 2012.
 
 
34

 

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.

Table 1
 
($ in thousands)
Three Months Ended
June 30, 2012
   
Three Months Ended
June 30, 2011
 
 
Average Balance
   
Interest
   
Yield / Cost
   
Average Balance
   
Interest
   
Yield / Cost
 
Assets:
                                   
Interest-earning assets:
                                   
Gross loans, net of unearned fees
  $ 56,309     $ 787       5.62 %   $ 58,154     $ 847       5.84 %
Investment securities**
    86,102       540       2.52       75,115       646       3.45  
FHLB and FRB stocks
    1,156       10       3.43       1,116       8       2.94  
Federal funds sold
    730       1       0.22       1,431       1       0.22  
Interest-bearing deposits with banks
    357       2       2.12       1,054       1       0.42  
Total interest-earning assets
    144,654     $ 1,340       3.72 %     136,870     $ 1,503       4.41 %
Noninterest-earning assets
    6,067                       2,144                  
Total assets
  $ 150,721                     $ 139,014                  
                                                 
Liabilities and Stockholders' Equity:
                                         
Interest-bearing liabilities:
                                               
Money market and savings deposits
  $ 56,875     $ 85       0.60 %   $ 63,148     $ 175       1.11 %
Interest-bearing checking accounts
    8,905       18       0.82       11,623       34       1.16  
Time deposits
    52,782       176       1.34       37,555       145       1.55  
Securities sold under agreements to repurchase and federal funds purchased
    568       1       0.73       728       2       1.14  
FHLB advances
    8,526       33       1.56       4,624       49       4.25  
Other borrowings
    11       1       12.81       60       1       9.38  
Total interest-bearing liabilities
    127,667     $ 314       0.99 %     117,738     $ 406       1.38 %
Noninterest-bearing checking accounts
    3,137                       2,249                  
Noninterest-bearing liabilities
    366                       388                  
Stockholders' equity
    19,551                       18,639                  
Total liabilities and stockholders' equity
  $ 150,721                     $ 139,014                  
                                                 
Net interest income
          $ 1,026                     $ 1,097          
                                                 
Net interest spread
            2.73
%
                  3.03
%
     
                                                 
Net interest margin
            2.85 %                   3.22
%
     
 
**Yields on investment securities have not been adjusted to a tax-equivalent basis.
 
 
35

 

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
 
($ in thousands)
 
Three Months Ended June 30, 2012
Compared to Three Months Ended June 30, 2011
 
   
Net Change
   
Rate
   
Volume
 
Interest income:
                 
Gross loans, net of unearned fees
  $ (60 )   $ (36 )   $ (24 )
Investment securities
    (106 )     (225 )     119  
FHLB and FRB stocks
    2       2       -  
Federal funds sold
    -       -       -  
Interest-bearing deposits with banks
    1       1       -  
Total interest income
  $ (163 )   $ (258 )   $ 95  
                         
Interest expense:
                       
Money market and savings deposits
  $ (90 )   $ (75 )   $ (15 )
Interest-bearing checking accounts
    (16 )     (9 )     (7 )
Time deposits
    31       (17 )     48  
Securities sold under agreements to repurchase and federal funds purchased
    (1 )     -       (1 )
FHLB advances
    (16 )     (151 )     135  
Other borrowings
    -       1       (1 )
Total interest expense
  $ (92 )   $ (251 )   $ 159  
                         
Net interest income
  $ (71 )   $ (7 )   $ (64 )

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 principal source of earnings.  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.
 
 
36

 

For the three months ended June 30, 2012, the Company’s net interest income decreased $71,000, or 6%, compared to the three months ended June 30, 2011.  The Company experienced a 37 basis point decrease in net interest margin declining from 3.22% for the second quarter 2011 to 2.85% for the second quarter 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 an unfavorable shift in volume from higher-yielding loans to lower-yielding investment securities.

Most notable was the unfavorable decrease in yield on the Company’s investment securities, down 93 basis points from the prior year which was primarily attributable to the sale of longer-maturity, higher-yielding investments, along with principal payments received on mortgage-backed securities, which were reinvested in bonds that are earning at historically low rates.  This unfavorable decrease in rate was partially offset by a favorable decrease in the cost of interest-bearing liabilities, which declined 39 basis points from the comparable period in the prior year.  Contributing most significantly to the decline in interest-bearing liability costs was the $90,000 decrease in interest expense related to money market and savings deposits which is a result of management’s decision to lower promotional rates further and implement a tiered rate structure during the second quarter of 2012 where rates paid on smaller balance accounts were reduced more dramatically.  Additionally, the Company realized a $151,000 favorable decrease on the rate of FHLB advances due to the restructuring of $3.5 million in fixed-rate advances during the fourth quarter 2011 that reduced the effective interest rate from 4.37% to 2.14% and extended the average maturity of those borrowings.

The combination of the aforementioned factors resulted in further compression in the Company’s net interest spread (the yield earned on interest-earning assets less the cost of interest-bearing liabilities) which declined 30 basis points from 3.03% for the quarter ended June 30, 2011 to 2.73% for the quarter ended June 30, 2012.

Provision 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.  For additional information concerning this determination, see the section of this discussion and analysis captioned Financial Condition, Allowance for Loan and Lease Losses.

During the second quarter of 2012, we did not recognize any provision for loan and lease losses reflecting improving asset quality.  See additional discussion below under Financial Condition, Loan Portfolio.

Noninterest Income

Noninterest income for the quarter ended June 30, 2012 was $230,000, a decrease of $14,000 from $244,000 for the second quarter 2011.  The Company sold securities for gains of $166,000 during the second quarter 2012 as compared to $225,000 during the second quarter 2011.  Gains on the sale of securities are not part of the Bank’s expected ongoing operations and should not be considered recurring.  Additionally, the Company recognized $20,000 of other income during the second quarter 2012, compared to $1,000 during the second quarter 2011 primarily due to increases in the cash surrender value of bank-owned life insurance which the Company purchased during the first quarter 2012.  Finally, the Company recognized $25,000 related to the sale of the guaranteed portion of an SBA 7(a) loan during the second quarter of 2012.

Service charges on deposits remained relatively unchanged from second quarter 2011 increasing $1,000 during second quarter 2012.
 
 
37

 

Noninterest Expense

Our total noninterest expense for the quarter ended June 30, 2012 was $1.1 million, which was unchanged from the quarter ended June 30, 2011.  Professional fees decreased $21,000, or 21%, primarily due to a shift in timing of internal audit fees which, during 2011, were incurred primarily during the second quarter but in 2012 many of these costs were incurred during the first quarter.  Additionally, salaries and benefits decreased $25,000, or 4%, partially due to reduced expense associated with stock options as many of the Company’s options are now fully vested and partially due to an increase in deferred expenses on loan originations which directly correlates to more loans closed during the second quarter of 2012 compared to the same period of 2011.  These cost savings were offset by the $55,000 increase in other general and administrative costs as detailed in Table 3, below:

Table 3
 
($ in thousands)
 
Three Months Ended
June 30,
   
Increase/
 
Other general and administrative expenses:
 
2012
   
2011
   
(Decrease)
 
Data processing
  $ 84     $ 77     $ 7  
FDIC assessment
    50       38       12  
Regulatory and reporting fees
    41       48       (7 )
Marketing and promotions
    29       25       4  
Directors’ fees
    23       22       1  
Loan and collection expenses
    21       16       5  
OREO expense
    11       -       11  
Insurance
    12       6       6  
Telephone/communication
    12       12       -  
Travel and entertainment
    11       5       6  
Dues and memberships
    10       7       3  
Printing, stationery and supplies
    8       7       1  
ATM and debit card fees
    4       3       1  
Postage and shipping
    4       3       1  
Training and education
    2       3       (1 )
Franchise taxes
    3       3       -  
Miscellaneous
    13       8       5  
Total
  $ 338     $ 283     $ 55  

FDIC assessments increased $12,000 due to higher average assets, and OREO expenses increased $11,000.  We expect OREO expense to continue to impact our 2012 operating results as we incur costs such as taxes, insurance, repairs and maintenance, among others, on these properties.  The $7,000 increase in data processing was primarily volume related.  The Company experienced a $6,000 increase in insurance expenses from enhanced coverage obtained during the third quarter 2011.  Finally, the $6,000 increase in travel and entertainment expense correlates to increased loan demand.  As reflected in the table above, all other costs remained fairly consistent with the second quarter 2011.
 
 
38

 

Income Taxes

No federal or state tax expense has been recorded for the three months ended June 30, 2012 and 2011, based upon significant operating loss carry-forwards that can be used to offset approximately $3.4 million of taxable income for federal tax purposes.  Since it is uncertain that the Company will achieve sustained profitability, the deferred tax benefit accumulated to date has a full valuation allowance so that the net deferred tax benefit at June 30, 2012 and December 31, 2011 is $0.

Comparative Results of Operations for the Six Months Ended June 30, 2012 and 2011

The following discussion focuses on the Company’s financial condition and results of operations for the six months ended June 30, 2012 compared to the financial condition and results of operations for the six months ended June 30, 2011.  The Company’s principal operations for each of these periods consisted of the operations of Solera National Bank.

The Company recorded net income of $94,000, or $0.04 per share, for the six months ended June 30, 2012 compared with a net loss of $83,000, or ($0.03) per share, for the six months ended June 30, 2011.  The most notable items contributing to the increase in net income were a $108,000 increase in noninterest income, a $128,000 favorable decline in noninterest expense partially offset by a $59,000 decline in net interest income after the provision for loan and lease losses.  These variances are discussed in more detail in the ensuing narrative.

The following table presents, for the periods indicated, average assets, liabilities and stockholders’ equity, as well as the net interest income from average interest-earning assets and average interest-bearing liabilities and the resultant annualized yields expressed in percentages.

Table 4
 
($ in thousands)
Six Months Ended
June 30, 2012
   
Six Months Ended
June 30, 2011
 
 
Average Balance
   
Interest
   
Yield / Cost
   
Average Balance
   
Interest
   
Yield / Cost
 
Assets:
                                   
Interest-earning assets:
                                   
Gross loans, net of unearned fees
  $ 55,425     $ 1,575       5.71 %   $ 58,168     $ 1,671       5.79 %
Investment securities**
    84,609       1,043       2.48       74,530       1,319       3.57  
FHLB and FRB stocks
    1,148       18       3.15       1,137       17       3.04  
Federal funds sold
    677       1       0.22       1,023       1       0.22  
Interest-bearing deposits with banks
    385       4       2.04       728       2       0.46  
Total interest-earning assets
    142,244     $ 2,641       3.73 %     135,586     $ 3,010       4.48 %
Noninterest-earning assets
    5,421                       2,676                  
Total assets
  $ 147,665                     $ 138,262                  
                                                 
Liabilities and Stockholders' Equity:
                                         
Interest-bearing liabilities:
                                               
Money market and savings deposits
  $ 57,768     $ 195       0.68 %   $ 61,757     $ 354       1.16 %
Interest-bearing checking accounts
    8,937       37       0.84       11,524       67       1.18  
Time deposits
    49,989       347       1.39       37,745       302       1.61  
Securities sold under agreements to repurchase and federal funds purchased
    539       2       0.75       664       4       1.13  
FHLB advances
    7,513       64       1.71       5,523       106       3.89  
Other borrowings
    19       1       10.07       66       3       9.47  
Total interest-bearing liabilities
    124,765     $ 646       1.04 %     117,279     $ 836       1.44 %
Noninterest-bearing checking accounts
    3,178                       2,276                  
Noninterest-bearing liabilities
    409                       364                  
Stockholders' equity
    19,313                       18,343                  
Total liabilities and stockholders' equity
  $ 147,665                     $ 138,262                  
                                                 
Net interest income
          $ 1,995                     $ 2,174          
                                                 
Net interest spread
            2.69 %                   3.04 %      
                                                 
Net interest margin
            2.82
%
                  3.23 %      
 
**  Yields on investment securities have not been adjusted to a tax-equivalent basis.
 
 
39

 

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 5
 
($ in thousands)
 
Six Months Ended June 30, 2012
Compared to Six Months Ended June 30, 2011
 
   
Net Change
   
Rate
   
Volume
 
Interest income:
                 
Gross loans, net of unearned fees
  $ (96 )   $ (18 )   $ (78 )
Investment securities
    (276 )     (498 )     222  
FHLB and FRB stocks
    1       1       -  
Federal funds sold
    -       -       -  
Interest-bearing deposits with banks
    2       2       -  
Total interest income
  $ (369 )   $ (513 )   $ 144  
                         
Interest expense:
                       
Money market and savings deposits
  $ (159 )   $ (138 )   $ (21 )
Interest-bearing checking accounts
    (30 )     (17 )     (13 )
Time deposits
    45       (31 )     76  
Securities sold under agreements to repurchase and federal funds purchased
    (2 )     -       (2 )
FHLB advances
    (42 )     (119 )     77  
Other borrowings
    (2 )     -       (2 )
Total interest expense
  $ (190 )   $ (305 )   $ 115  
                         
Net interest income
  $ (179 )   $ (208 )   $ 29  

Net Interest Income and Net Interest Margin

Net interest income is the difference between interest income, principally from loan and investment security portfolios, and interest expense, principally on customer deposits and borrowings.  Net interest income is our principal source of earnings.  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.
 
 
40

 
 
The Federal Reserve Board influences the general market rates of short-term interest, including the deposit and loan rates offered by the Bank.  The Bank’s loan portfolio is significantly affected by changes in the prime interest rate.  The prime interest rate 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 less impacted by these low rates but our investment portfolio has seen sharp declines given this economic environment.

As reflected in Table 4 above, the 41 basis point decrease in the Company’s net interest margin, from 3.23% for the six months ended June 30, 2011 to 2.82% for the same period in 2012 is due to the decline in interest income earned on interest-earning assets outpacing the decline in expense on interest-bearing liabilities.  The Bank’s yield on interest-earning assets decreased 75 basis points from 4.48% for the six months ended June 30, 2011 to 3.73% for the six months ended June 30, 2012.  This decline is primarily due to a decrease in the Bank’s yield on investment securities which decreased 109 basis points during this time period.  This decrease is attributable to the sale of longer-maturity, higher-yielding investments, along with principal payments received on mortgage-backed securities, which were reinvested in shorter-term, lower-yielding bonds to help shorten the duration of the investment portfolio.

The rate paid on money market, savings and time deposits all decreased year-over-year due to a decision to lower promotional rates further and implement a tiered rate structure on savings accounts during the second quarter of 2012 where rates paid on smaller balance accounts were significantly reduced.  This, in conjunction with the restructuring of $3.5 million in fixed-rate FHLB advances during the fourth quarter 2011, which produced a $119,000 savings due to lower rates, enabled the Bank to save 40 basis points on the cost of interest-bearing liabilities during the six months ended June 30, 2012 as compared to the same period of 2011.

The Company’s balance sheet is currently marginally asset sensitive, meaning that interest-earning assets generally reprice more quickly than interest-bearing liabilities.  Therefore, the Company could experience expansion in its net interest margin during periods of rising short-term interest rates.

Total interest income was $2.6 million for the six months ended June 30, 2012, consisting primarily of interest on loans of $1.6 million and interest on investment securities of $1.0 million.  Average gross loans, net of unearned fees, declined $2.7 million, from $58.2 million at June 30, 2011 to $55.4 million at June 30, 2012.  Average investment securities increased $10.1 million from $74.5 million at June 30, 2011 to $84.6 million at June 30, 2012.

Total interest expense was $646,000 for the six months ended June 30, 2012, a decrease of $190,000 from $836,000 during the same period of 2011.  Net interest income was $2.0 million for the first six months of 2012, a decrease of $179,000, or 8.2%, from $2.2 million for the same period of 2011.  Our net interest spread decreased 35 basis points from 3.04% for the six months ended June 30, 2011 to 2.69% for the six months ended June 30, 2012.
 
 
41

 

Provision 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.  For additional information concerning this determination, see the section of this discussion and analysis captioned Financial Condition, Allowance for Loan and Lease Losses.
 
During the first six months of 2012, our provision for loan and lease losses was $0 compared to $120,000 for the same time period of 2011.  The amount of the provision reflects the estimated probable losses inherent within the portfolio due to uncertainties in economic conditions which have caused increases in our classified loans.  Impaired loans totaled $307,000 at June 30, 2012 versus $2.3 million at June 30, 2011.  The decrease in provision expense during the first six months of 2012 is primarily a reflection of improving asset quality.  See additional discussion below under Financial Condition,  Nonperforming Loans, Leases and Assets.

Noninterest Income

Noninterest income for the six months ended June 30, 2012 was $368,000, a $108,000, or 42%, increase from $260,000 for the six months ended June 30, 2011.  The increase was due to increased gains on the sales of investment securities.  The Company sold securities for net gains of $280,000 during the first half of 2012 compared to net gains on the sale of investment securities of $223,000 during the first half of 2011.  Gains on the sale of securities are not part of the Bank’s expected ongoing operations and should not be considered recurring.  Additionally, the Company recognized $29,000 of other income during the first six months of 2012, compared to $2,000 during the same period of 2011 due to increases in the cash surrender value of bank-owned life insurance which the Company purchased during the first quarter 2012.  Finally, the Company recognized a $25,000 gain related to the sale of the guaranteed portion of an SBA 7(a) loan during the second quarter of 2012.

Noninterest Expense

Our total noninterest expense was $2.3 million for the six months ended June 30, 2012, a 5%, or $128,000, decrease from $2.4 million for the six months ended June 30, 2011 due to the following:
 
A)  
Decreased salaries and employee benefits expense of $163,000, or 12%, related to the following:  1) costs associated with the separation agreement of an employee recorded during the first quarter of 2011, 2) increased salary expense deferral on loan originations which directly correlates to more loans closed during the first half of 2012 compared to 2011, and 3) reduced stock option expense, as many of the Company’s options are now fully vested.
 
B)  
Decreased occupancy expense of $13,000, or 5%, year-over-year primarily due to a lease extension that was negotiated at a reduced rate.
 
C)  
Decreased professional fees of $3,000, partially offset by a $51,000, or 9%, increase in other general and administrative expenses as detailed in Table 6, below:
 
 
42

 
 
Table 6
 
($ in thousands)
 
Six Months Ended
June 30,
   
Increase/
 
Other general and administrative expenses:
 
2012
   
2011
   
(Decrease)
 
Data processing
  $ 159     $ 155     $ 4  
FDIC assessment
    96       117       (21 )
Regulatory and reporting fees
    73       82       (9 )
Marketing and promotions
    48       41       7  
Directors’ fees
    42       45       (3 )
Loan and collection expenses
    52       35       17  
OREO expense
    33       -       33  
Insurance
    24       12       12  
Telephone/communication
    24       23       1  
Travel and entertainment
    23       15       8  
Dues and memberships
    15       13       2  
Printing, stationery and supplies
    13       14       (1 )
ATM and debit card fees
    8       7       1  
Postage and shipping
    7       7       -  
Training and education
    5       7       (2 )
Franchise taxes
    5       7       (2 )
Miscellaneous
    19       15       4  
Total
  $ 646     $ 595     $ 51  

The most significant changes included an increase of $33,000 related to expenses incurred on the Bank’s two OREO properties and a $17,000 increase in loan and collection expenses related to the collection of problem loans.  We expect OREO expense to continue to impact our 2012 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.

Other significant changes in other general and administrative expenses include a $12,000 increase in insurance expenses from enhanced coverage obtained during the third quarter 2011.  Travel and entertainment increased $8,000 and marketing and promotion costs increased $7,000 – both are correlated to the increase in loan demand.  These increases were partially offset by a $21,000 decrease in FDIC fees due to lower assessments associated with the revised calculation methodology implemented during the second quarter of 2011.

Income Taxes

No federal or state tax expense has been recorded for the six months ended June 30, 2012 and 2011, based upon significant operating loss carry-forwards that can be used to offset approximately $3.4 million of taxable income for federal tax purposes.  Since it is uncertain that the Company will achieve sustained profitability, the deferred tax benefit accumulated to date has a full valuation allowance so that the net deferred tax benefit at June 30, 2012 and December 31, 2011 is $0.
 
 
43

 

Financial Condition

At June 30, 2012, the Company had total assets of $154.6 million, a $9.2 million, or 6%, increase from $145.4 million in total assets at December 31, 2011 primarily due to increases in gross loans, up 5%, investment securities, up 7%, and a $2.0 million new investment in bank-owned life insurance made in the first quarter of 2012.  As of June 30, 2012, stockholders’ equity was $19.6 million, a $599,000 increase versus $19.0 million at December 31, 2011.  The increase was primarily due to the $479,000 increase in other comprehensive income related to changes in the fair value of available-for-sale securities, $94,000 of net income for the six months ended June 30, 2012 and $26,000 of stock-based compensation expense related to the Company’s stock incentive plan.

Key Ratios

Ratio:
 
June 30, 2012
   
December 31, 2011
 
Return on Average Assets
    0.13 %     0.17 %
Return on Average Equity
    0.98 %     1.29 %
Average Equity to Average Assets
    13.08 %     13.39 %

Federal Home Loan Bank (FHLB) and Federal Reserve Bank Stocks

At June 30, 2012, the Bank had a total of $1.2 million invested in FHLB and Federal Reserve Bank stocks carried at cost consisting of $514,000 in Federal Reserve Bank stock and $650,000 in FHLB stock.  These investments allow Solera National Bank to conduct business with these entities.  As of June 30, 2012, the Federal Reserve Bank stock was yielding an average rate of 5.8% and the FHLB stock was yielding an average rate of 1.1%.

Investment Securities

Our investment portfolio serves as a source of interest income, a source of liquidity and a management tool for managing interest rate sensitivity.  We manage our investment portfolio according to a written investment policy approved by our Board of Directors.

At June 30, 2012, Solera National Bank’s securities consisted of available-for-sale securities of $89.1 million.  The following tables set forth the estimated market values and approximate weighted average yields of the debt securities in the investment portfolio by contractual maturity at June 30, 2012 and December 31, 2011:

   
At June 30, 2012
 
($ in thousands)
 
Within One Year
   
After One Year but within Five Years
   
After Five Years but within Ten Years
 
After Ten Years
 
Securities available-for-sale
 
Amount
   
Yield
   
Amount
   
Yield
   
Amount
   
Yield
 
Amount
   
Yield
 
Corporate
  $ 519       5.44 %   $ 4,820       3.03 %   $ 10,940       3.80 %   $ -       - %
State and municipal
    -       -       2,197       4.13       10,923       3.56       3,287       3.19  
Residential agency MBS
    -       -       -       -       2,026       2.25       54,429       2.18  
Total
  $ 519       5.44 %   $ 7,017       3.37 %   $ 23,889       3.56 %   $ 57,716       2.24 %

 
44

 

   
At December 31, 2011
($ in thousands)
  Within One Year     After One Year but within Five Years    
After Five Years but within Ten Years
   
After Ten Years
Securities available-for-sale
 
Amount
   
Yield
   
Amount
   
Yield
   
Amount
   
Yield
   
Amount
   
Yield
Corporate
  $ -       - %   $ 6,794       3.39 %   $ 8,024       4.14 %   $ -       - %
State and municipal
    -       -       1,789       4.33       2,096       4.39       -       -  
Residential agency MBS
    -       -       -       -       3,600       2.86       60,892       2.00  
Total
  $ -       - %   $ 8,583       3.59 %   $ 13,720       3.84 %   $ 60,892       2.00 %

Loan Portfolio

The following table presents the composition of our loan portfolio by category as of the dates indicated:

($ in thousands)
 
June 30, 2012
   
December 31, 2011
 
   
Amount
   
% of Total
   
Amount
   
% of Total
 
Commercial real estate
  $ 38,163       66 %   $ 37,862       68 %
Commercial and industrial
    7,832       13       5,971       11  
Residential real estate
    11,083       19       10,460       19  
Construction and land development
    1,405       2       1,307       2  
Consumer
    54       -       45       -  
GROSS LOANS
    58,537       100 %     55,645       100 %
Deferred loan expenses / (fees), net
    94               (77 )        
Allowance for loan and lease losses
    (1,009 )             (1,067 )        
LOANS, NET
  $ 57,622             $ 54,501          

As of June 30, 2012, gross loans were $58.5 million, an increase of $2.9 million, or 5%, from $54.5 million at December 31, 2011.  Net loans were 37% of total assets at both June 30, 2012 and December 31, 2011.  The Bank closed approximately $5.1 million in new originations during the second quarter 2012 which was offset by approximately $1.6 million in loan pay downs, primarily the result of intense competition for strong borrowers.  For the six months ended June 30, 2012, the Bank closed approximately $6.6 million in new originations offset by approximately $3.7 million in loan pay downs.

Loan concentrations are considered to exist when there are amounts loaned to a multiple number of borrowers engaged in similar activities that would cause them to be similarly impacted by economic or other conditions.  The Company’s loan portfolio generally consists of loans to borrowers within Colorado.  Although the Company seeks to avoid concentrations of loans to a single industry or based upon a single class of collateral, the Company’s loan portfolio consists primarily of real estate loans secured by real estate located in Colorado, making the value of the portfolio more susceptible to declines in real estate values and other changes in economic conditions in Colorado.  No single borrower can be approved for a loan over the Bank’s current legal lending limit of approximately $2.6 million.  This regulatory requirement helps to ensure the Bank’s exposure to one individual customer is limited.

Management may renew loans at maturity when requested by a customer whose financial strength appears to support such a renewal or when such a renewal appears to be in the best interest of Solera National Bank.  Solera National Bank requires payment of accrued interest in such instances and may adjust the rate of interest, require a principal reduction, or modify other terms of the loan at the time of renewal.
 
 
45

 

The following tables set forth information at June 30, 2012 and December 31, 2011, regarding the dollar amount of loans maturing in the Bank’s portfolio based on the contractual terms to maturity.  The tables do not give effect to potential prepayments or contractual principal payments.

 ($ in thousands)
 
June 30, 2012
 
   
<1 Year
   
1 - 5 Years
   
5 – 15 Years
   
Over 15 Years
   
Total Loans
 
Commercial real estate
  $ 3,131     $ 10,977     $ 24,055     $ -     $ 38,163  
Commercial and industrial
    2,575       2,767       1,991       499       7,832  
Residential real estate
    -       2,468       1,186       7,429       11,083  
Construction and land development
    1,259       146       -       -       1,405  
Consumer
    8       37       -       9       54  
   Gross Loans Receivable
  $ 6,973     $ 16,395     $ 27,232     $ 7,937     $ 58,537  

 ($ in thousands)
 
December 31, 2011
 
   
<1 Year
   
1 - 5 Years
   
5 – 15 Years
   
Over 15 Years
   
Total Loans
 
Commercial real estate
  $ 805     $ 13,064     $ 23,993     $ -     $ 37,862  
Commercial and industrial
    2,422       2,787       762       -       5,971  
Residential real estate
    -       2,461       1,200       6,799       10,460  
Construction and land development
    1,150       157       -       -       1,307  
Consumer
    11       24       -       10       45  
   Gross Loans Receivable
  $ 4,388     $ 18,493     $ 25,955     $ 6,809     $ 55,645  

Nonperforming Loans, Leases and Assets

Nonperforming assets consist of loans and leases on nonaccrual status, loans 90 days or more past due and still accruing interest, loans that have been restructured resulting in a reduction or deferral of interest or principal, other real estate owned (OREO), and other repossessed assets.  As of June 30, 2012, there were $2.1 million in nonperforming assets.

 
46

 
 
The following table summarizes information regarding nonperforming assets:

 ($ in thousands)
 
June 30,
 2012
   
December 31,
2011
 
Nonaccrual loans and leases
  $ 307     $ 610  
Other impaired loans
    -       -  
      Total nonperforming loans
    307       610  
Other real estate owned
    1,776       1,776  
Total nonperforming assets
  $ 2,083     $ 2,386  
                 
Nonperforming loans
  $ 307     $ 610  
Allocated allowance for loan and lease losses to nonperforming loans
    -       -  
      Net investment in nonperforming loans
  $ 307     $ 610  
                 
Accruing loans past due 90 days or more
  $ -     $ -  
Loans past due 30-89 days
  $ 170     $ 1,349 (1)
                 
Loans charged-off, year-to-date
  $ 88     $ 276  
Recoveries, year-to-date
    (30 )     (13 )
      Net charge-offs, year-to-date
  $ 58     $ 263  
Allowance for loan and lease losses
  $ 1,009     $ 1,067  
                 
Allowance for loan and lease losses to loans, net of deferred fees/expenses
    1.72 %     1.92 %
Allowance for loan and lease losses to nonaccrual loans
    328.66 %     174.92 %
Allowance for loan and lease losses to nonperforming loans
    328.66 %     174.92 %
Nonaccrual loans to loans, net of deferred fees/expenses
    0.52 %     1.10 %
Loans 30-89 days past due to loans, net of deferred fees/expenses
    0.29 %     2.43 %
Nonperforming assets to total assets
    1.35 %     1.64 %

(1) The $1.3 million of past due loans at December 31, 2011 were brought current as of January 10, 2012.

Federal regulations require that each insured financial institution classify its assets on a regular basis.  In addition, in connection with examinations of insured institutions, regulatory examiners have authority to identify problem assets and, if appropriate, classify them.  The Bank has established three classifications for potential problem assets: “substandard,” “doubtful” and “loss.”  Loans classified as “substandard” are those loans with well-defined weaknesses, such that future capacity to repay the loan has been negatively impacted.  Loans classified as “doubtful” are those loans that have characteristics similar to substandard loans, but the weaknesses have moved to the point where complete collection of the obligation from all sources is unlikely and a portion of the principal may be charged-off.  Although loans classified as substandard do not duplicate loans classified as doubtful, both substandard and doubtful loans may include some loans that are past due at least 90 days, are on nonaccrual status or have been restructured.  Loans classified as “loss” are those loans that are in the process of being charged-off.  At June 30, 2012, Solera National Bank had substandard loans totaling $3.4 million, and no loans classified as doubtful or loss.  Of the $3.4 million in substandard loans, only $307,000 was 30 days or more past due.  As of December 31, 2011, the Bank had $4.6 million classified as substandard and no loans classified as doubtful or loss.

 
47

 
 
Allowance for Loan and Lease Losses

Implicit in Solera National Bank’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. To reflect the currently perceived risk of loss associated with the loan portfolio, additions are made to the allowance for loan and lease losses in the form of direct charges against income to ensure that the allowance is available to absorb possible loan losses.  The Bank’s allowance for estimated loan and lease losses is based on a number of quantitative and qualitative factors.  Factors used to assess the adequacy of the allowance for loan and lease losses are established based upon management’s assessment of the credit risk in the portfolio, historical loan loss, changes in the size, composition and concentrations of the loan portfolio, general economic conditions, and changes in the legal and regulatory environment, among others.  In addition, because the Bank has a limited history on which to base future loan losses, a comparison of peer group allowance ratios to gross loans is made with the intention of maintaining similar levels of reserves.

Provisions for loan and lease losses may be provided both on a specific and general basis.  Specific and general valuation allowances are increased by provisions charged to expense and decreased by charge-offs of loans, net of recoveries.  Specific allowances are provided for impaired loans for which the expected loss is measurable.  General valuation allowances are provided based on a formula that incorporates the factors discussed above.  The Bank periodically reviews the assumptions and formula by which additions are made to the specific and general valuation allowances for losses in an effort to refine such allowances in light of the current status of the aforementioned factors.

The amount of the allowance equals the cumulative total of the provisions made from time to time, reduced by loan charge-offs and increased by recoveries of loans previously charged-off.  The allowance was $1.0 million, or 1.72% of outstanding principal as of June 30, 2012.  We did not recognize any provision expense during the three or six months ended June 30, 2012, reflecting improving asset quality.  We recognized provision expense of $120,000 during the second quarter of 2011 reflecting an increase in classified loans.

The following table sets forth the allowance for loan and lease losses activity for the three and six months ended June 30, 2012 and 2011:

 ($ in thousands)
 
Three Months Ended
June 30,
   
Six Months Ended
June 30,
 
   
2012
   
2011
   
2012
   
2011
 
                         
Balance at beginning of period
  $ 1,077     $ 1,175     $ 1,067     $ 1,175  
Provision charged to expense
    -       120       -       120  
Loans charged-off:
                               
Commercial real estate
    -       (11 )     -       (11 )
Commercial and industrial
    (85 )     -       (85 )     -  
Residential real estate
    -       -       -       -  
Construction and land development
    -       -       -       -  
Consumer
    -       -       (3 )     -  
Total loans charged-off
    (85 )     (11 )     (88 )     (11 )
Recoveries on loans previously charged-off:
                               
Commercial real estate
    -       -       -       -  
Commercial and industrial
    -       -       -       -  
Residential real estate
    17       -       30       -  
Construction and land development
    -       -       -       --  
Consumer
    -       -       -       -  
Total recoveries
    17       -       30       -  
Balance at end of period
  $ 1,009     $ 1,284     $ 1,009     $ 1,284  
                                 
Net charge-offs to average gross loans
    0.15 %     0.02 %     0.16 %     0.02 %

Credit and loan decisions are made by management and the Board of Directors’ Credit Committee in conformity with loan policies established by the Board of Directors.  Solera National Bank’s practice is to charge-off any loan or portion of a loan when the loan is determined by management to be uncollectible due to the borrower’s failure to meet repayment terms, the borrower’s deteriorating or deteriorated financial condition, the depreciation of the underlying collateral, the loan’s classification as a loss, or other reasons.
 
 
48

 

Off-Balance-Sheet Arrangements

In the ordinary course of business, the Company enters into various off-balance-sheet commitments and other arrangements to extend credit that are not reflected in the consolidated balance sheets of the Company.  The business purpose of these off-balance-sheet commitments is the routine extension of credit.  The total amounts of off-balance-sheet financial instruments with credit risk were $7.5 million and $6.3 million as of June 30, 2012 and December 31, 2011, respectively.

Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract.  Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee.  Commitments also include revolving lines of credit arrangements and unused commitments for commercial and real estate secured loans.  Since many of the commitments are expected to expire without being drawn upon, the commitments do not necessarily represent future cash requirements.

The Company faces the risk of deteriorating credit quality of borrowers to whom a commitment to extend credit has been made; however, no significant credit losses are expected from these commitments and arrangements.

Borrowings

As of June 30, 2012, the Bank had $8.5 million in fixed-rate borrowings from the Federal Home Loan Bank of Topeka (FHLB) with varying maturity dates between June 2014 and November 2017 and a weighted-average effective interest rate of 1.57%.

The Bank has also established unsecured Federal Funds lines-of-credit totaling $9.1 million with various correspondent banks.  Additionally, the Bank has access to the Federal Discount window.  As of June 30, 2012, the Company had $560,000 outstanding on these lines.

Capital Resources and Capital Adequacy Requirements

The risk-based capital regulations established and administered by the federal banking regulatory agencies are applicable to Solera National Bank.  Risk-based capital guidelines are designed to make regulatory capital requirements more sensitive to differences in risk profiles among banks, to account for off-balance-sheet exposure, and to minimize disincentives for holding liquid assets.  Under the regulations, assets and off-balance-sheet items are assigned to broad risk categories, each with appropriate weights.  The resulting capital ratios represent capital as a percentage of total risk-weighted assets and off-balance-sheet items.  Under the prompt corrective action regulations, to be adequately capitalized a bank must maintain minimum ratios of total capital to risk-weighted assets of 8.0%, Tier 1 capital to risk-weighted assets of 4.0%, and Tier 1 capital to total average assets of 4.0%.  Failure to meet these capital requirements can initiate certain mandatory, and possibly additional discretionary, actions by regulators that, if undertaken, could have a direct material effect on Solera National Bank’s financial statements.

A well-capitalized institution must maintain a minimum ratio of total capital to risk-weighted assets of at least 10.0%, a minimum ratio of Tier 1 capital to risk-weighted assets of at least 6.0%, and a minimum ratio of Tier 1 capital to total average assets of at least 5.0% and must not be subject to any written order, agreement, or directive requiring it to meet or maintain a specific capital level.

The following table summarizes the ratios of the Bank and the regulatory minimum capital requirements at June 30, 2012:

($ in thousands)
 
Risk-based
   
Leverage
 
   
Tier 1
   
Total capital
   
Tier 1
 
Actual regulatory capital
  $ 16,387     $ 17,396     $ 16,387  
Well-capitalized requirement
    5,519       9,199       7,536  
Excess regulatory capital
  $ 10,868     $ 8,197     $ 8,851  
Capital ratios
    17.8 %     18.9 %     10.9 %
Minimum capital requirement
    4.0 %     8.0 %     4.0 %
Well-capitalized requirement
    6.0 %     10.0 %     5.0 %

On June 7, 2012, the Board of Governors of the Federal Reserve System, the FDIC and the OCC  announced proposed changes to the capital requirements of banks, known as Basel III.  The Basel III capital standards substantially increase the complexity of capital calculations and the minimum capital required to be maintained to meet well-capitalized standards,  The potential impact of Basel III on Solera National Bank, includes, but is not limited to, the potential need to increase capital in the future to comply with the new well-capitalized standards which may dilute shareholder value; reduced lending and negative pressure on profitability due to higher capital requirements on loan products; and/or additional constraints on the ability to pay common stock dividends.  The Company is currently evaluating the effects of the proposed Basel III guidelines and will continue to monitor the effective date for implementing these proposed changes.

 
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Liquidity

The primary source of liquidity for the Company is dividends paid by Solera National Bank.  However, Solera National Bank is currently restricted from paying dividends without regulatory approval that will not be granted until the accumulated deficit has been eliminated.

Solera National Bank’s liquidity is monitored by its staff, the Asset Liability Committee and the Board of Directors, who review historical funding requirements, the current liquidity position, sources and stability of funding, marketability of assets, options for attracting additional funds, and anticipated future funding needs, including the level of unfunded commitments.

Solera National Bank’s primary sources of funds are retail and commercial deposits, loan and securities repayments, other short-term borrowings, and other funds provided by operations.  While scheduled loan repayments and maturing investments are relatively predictable, deposit flows and early loan prepayments are more influenced by interest rates, general economic conditions, and competition.  Solera National Bank will maintain investments in liquid assets based upon management’s assessment of (1) the need for funds, (2) expected deposit flows, (3) yields available on short-term liquid assets, and (4) objectives of the asset/liability management program.

Additionally, the Company is a member of the Certificate of Deposit Account Registry Service (“CDARS®”) program.  Through CDARS®, the Bank’s customers can increase their FDIC insurance by up to $50 million through reciprocal deposit accounts.  This is accomplished by the Bank entering into reciprocal depository relationships with other member banks.  The individual customer’s large deposit is broken into amounts below the $250,000 FDIC-insured amount and placed with other banks that are members of the network.  The reciprocal member bank issues deposits in amounts that ensure the entire deposit is eligible for FDIC insurance.  These sources provide secondary liquidity to the Company to service its depositors’ needs.  As of June 30, 2012 and December 31, 2011, the Bank had $10.1 million and $11.3 million, respectively, in CDARS® deposits.

As loan demand increases, greater pressure will be exerted on Solera National Bank’s liquidity.  Solera National Bank does not intend to aggressively pursue lending opportunities if sufficient funding sources (e.g., deposits, Federal Funds, etc.) are not available.  Additionally, management does not anticipate the need to access capital markets to obtain additional liquidity in the near term.  As of June 30, 2012 and December 31, 2011, the loan to deposit ratio was 47%.

The Bank is a member of the FHLB of Topeka, which gives the Bank access to a secured line of credit with approximately $53.8 million of available funding as of June 30, 2012, subject to the availability of sufficient collateral to pledge against such borrowings.  Additionally, the Bank has approved, unsecured federal funds purchase lines totaling $9.1 million with three correspondent banks.  These lines either expire during 2012, or can be terminated at any time; however, it is not anticipated that these lines will be terminated and the Bank expects to be approved for new lines once the existing lines expire.  The Bank also has the ability to borrow at the Federal Reserve Discount Window on a secured basis.

The Company had cash and cash equivalents of $849,000, or 0.5% of total assets, at June 30, 2012.  Additionally, the Company had $89.1 million in available-for-sale investment securities, or 58% of total assets, at June 30, 2012.  Management believes Solera National Bank will have adequate liquidity to meet anticipated future funding needs.

ITEM 3.  QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

As a smaller reporting company, the Company is not required to provide the information required by this Item.

ITEM 4.  CONTROLS AND PROCEDURES

Disclosure Controls and Procedures

Management is responsible for maintaining effective disclosure controls and procedures.  As of the end of the period covered by this Quarterly Report on Form 10-Q, management evaluated the effectiveness and operation of the Company’s disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)).  Based on that evaluation, both the Company’s Principal Executive Officer and Principal Accounting and Chief Financial Officer have concluded that the Company’s disclosure controls and procedures are effective to ensure that the information required to be disclosed by the Company in reports that are filed or submitted under the Exchange Act are recorded, processed, summarized and reported to management within the time periods specified in the Securities and Exchange Commission’s rules and forms and that such information is accumulated and communicated to management as appropriate to allow timely decisions regarding disclosure.

Changes in Internal Control over Financial Reporting

There have been no changes in internal controls over financial reporting during the Company’s last fiscal quarter that have materially affected, or are reasonably likely to materially affect, the Company’s internal controls over financial reporting.
 
 
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PART II - OTHER INFORMATION

ITEM 1. LEGAL PROCEEDINGS
 
Not applicable.
 
ITEM 1A.  RISK FACTORS

As a smaller reporting company, the Company is not required to provide the information required by this Item.

ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS

Not applicable.

ITEM 3. DEFAULTS UPON SENIOR SECURITIES

Not applicable.

ITEM 4. MINE SAFETY DISCLOSURE

Not applicable.

ITEM 5. OTHER INFORMATION

Not applicable.

ITEM 6. EXHIBITS
 
Please see the exhibit index following the signature page of this Report.
 
 
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SOLERA NATIONAL BANCORP, INC.

SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

 
SOLERA NATIONAL BANCORP, INC.
 
 
(Registrant)
 
     
Dated: August 9, 2012
/s/ Douglas Crichfield
 
 
Douglas Crichfield
 
 
President and Chief Executive Officer
 
 
(Principal Executive Officer)
 
     
     
 Dated: August 9, 2012
/s/ Robert J. Fenton
 
 
Robert J. Fenton
 
 
Executive Vice President, Chief Financial Officer
 
 
(Principal Accounting and Financial Officer)
 

 
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EXHIBIT INDEX

Exhibit
   
Number
 
Description of Exhibit
     
 
Certification pursuant to Rule 13a-14(a) of the Securities Exchange Act.
     
 
Certification pursuant to Rule 13a-14(a) of the Securities Exchange Act.
     
 
Certification pursuant to Rule 13a-14(b) of the Securities Exchange Act and 18 U.S.C. §1350.
     
(*)
 
Filed herewith.
 
 
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