Edgar Filing: Solera National Bancorp, Inc.

SLRK-2013.12.31-10K

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-K

(Mark one)



þ	ANNUAL REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the fiscal year ended December 31, 2013



¨	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 if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes ¨ No þ

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes ¨ No þ

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 if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§ 229.405 of this chapter) is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. ¨

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

The aggregate market value of the voting and non-voting common equity held by non-affiliates of the registrant computed by reference to the price at which the common equity was last sold as of June 28, 2013 was $13,751,933.

The number of shares of common stock, par value $0.01 share, of the Registrant outstanding as of March 10, 2014, 2,663,578.

DOCUMENTS INCORPORATED BY REFERENCE: Portions of the Company’s definitive proxy statement for its 2014 Annual Meeting of Stockholders, to be held on May 22, 2014, are incorporated by reference into Part III of this Form 10-K.

SOLERA NATIONAL BANCORP, INC.

ANNUAL REPORT ON FORM 10-K

CONTENTS



PART I		PAGE
ITEM 1.	BUSINESS	4
ITEM 1A.	RISK FACTORS	27
ITEM 1B.	UNRESOLVED STAFF COMMENTS	33
ITEM 2.	PROPERTIES	33
ITEM 3.	LEGAL PROCEEDINGS	33
ITEM 4.	MINE SAFETY DISCLOSURES	33

PART II
ITEM 5.	MARKET FOR REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES	33
ITEM 6.	SELECTED FINANCIAL DATA	35
ITEM 7.	MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS	35
ITEM 7A.	QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK	47
ITEM 8.	FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA	47
ITEM 9.	CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE	47
ITEM 9A.	CONTROLS AND PROCEDURES	47
ITEM 9B.	OTHER INFORMATION	48

PART III
ITEM 10.	DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE	49
ITEM 11.	EXECUTIVE COMPENSATION	49
ITEM 12.	SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS	49
ITEM 13.	CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE	49
ITEM 14.	PRINCIPAL ACCOUNTANT FEES AND SERVICES	49

PART IV
ITEM 15.	EXHIBITS AND FINANCIAL STATEMENT SCHEDULES	50

INDEX TO CONSOLIDATED FINANCIAL STATEMENTS

SOLERA NATIONAL BANCORP, INC.

PART I

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

This Report on Form 10-K 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 Annual 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 the Company 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:


•	we face a potential proxy contest the outcome of which may significantly impact the strategic direction of the Company and the Company's financial performance;


•	our residential mortgage lending division may expose us to increased operating and compliance risks;


•	we may be unable to limit credit risk associated with our loan portfolio, which would affect the Company's profitability;


•	general economic conditions may be less favorable than expected, causing an adverse impact on our financial performance;


•	we operate in an industry that 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 it;


•	the effects of competition from a variety of competitors; and


•	other factors including those disclosed under “Part I - Item 1A. Risk Factors” in this Annual Report on Form 10-K.

Any forward-looking statement made in this Annual Report on Form 10-K or elsewhere speaks only as of the date on which it is made. New risks and uncertainties arise from time to time, and it is impossible for management to predict these events or how they may affect the Company. The Company has no duty to, and does not intend to, update or revise the forward-looking statements in this Annual Report on Form 10-K after the date of this filing, except as may be required by law. In light of these risks and uncertainties, any forward-looking statement made in this Annual Report on Form 10-K or elsewhere might not occur.

SOLERA NATIONAL BANCORP, INC.

Item 1. Business

Overview

Solera National Bancorp, Inc. - The Company, headquartered in Lakewood, Colorado, was organized as a Delaware corporation in 2006 to serve as a bank holding company for the Bank. The Company received approval from the Federal Reserve Bank of Kansas City to operate as a bank holding company for Solera National Bank in July 2007. The Company raised a total of $25.5 million in its initial public offering and used $20.0 million of the proceeds to purchase shares of the Bank’s common stock.

At this time, the Company engages in no material business operations other than owning and managing the Bank. At December 31, 2013, Solera National Bancorp, Inc. had no employees, as all staff are employees of the Bank.

Solera National Bank. - In September 2007, the Bank began banking operations as a federally-chartered national bank, having received all necessary regulatory approvals. The Federal Deposit Insurance Corporation (“FDIC”) insures the Bank’s deposit accounts up to the maximum amount currently allowable under federal law. The Bank is subject to examination and regulation by the Office of the Comptroller of the Currency (“OCC”). The Bank is further subject to regulations by the Federal Reserve Board concerning reserves to be maintained against deposits and certain other matters and is a member of the Federal Reserve Bank (“FRB”).

On June 29, 2012, 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.

Solera National Bank is a full-service commercial bank headquartered in Lakewood, Colorado that offers a broad range of commercial and consumer banking services to small- and medium-sized businesses, licensed professionals and individuals primarily located in the six-county Denver metropolitan area. While the Bank serves the entire community, it has a specialized focus serving the local Hispanic and other minority populations which it believes are currently underserved.

In December 2012, the Company launched a residential mortgage division with five loan production offices in Colorado including Boulder, two locations in Colorado Springs, the Denver Tech Center and Durango. With the addition of more than 50 mortgage professionals, the Bank began offering residential mortgage loans, the vast majority of which are sold on the secondary market. As of December 31, 2013, the Bank had 84 full-time equivalent employees.

Available Information

The Company’s Investor Relations information can be obtained through the Bank’s internet address, www.solerabank.com. The Company makes available on or through its Investor Relations page, without charge, its annual reports on Form 10-K, quarterly reports on Form 10-Q, and current reports on Form 8-K and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934, as amended, as soon as reasonably practicable after such reports are electronically filed with, or furnished to, the Securities and Exchange Commission (“SEC”). The Company’s reports filed with, or furnished to, the SEC are also available at the SEC’s website at www.sec.gov. In addition, the Company makes available, free of charge, its press releases, and charters for the Audit Committee, Compensation Committee and Nomination and Corporate Governance Committee through the Company’s Investor Relations page. Information on our website is not incorporated by reference into this document and should not be considered part of this Report.

Philosophy and Strategy

Solera National Bank operates as a full-service community bank and mortgage banking operation offering a wide array of financial products and services while emphasizing prompt, personalized customer service. The Bank believes that this philosophy, encompassing the service aspects of community banking, distinguishes the Bank from its competitors.

To carry out its philosophy, the Bank’s business strategy involves the following:


•	capitalizing on the diverse community involvement, professional expertise and personal and business contacts of its Directors and executive officers;

SOLERA NATIONAL BANCORP, INC.

•hiring and retaining experienced and qualified banking personnel, several of whom are fluent in Spanish;

•providing personalized customer service with consistent, local decision-making authority;


•	utilizing technology and strategic outsourcing to provide a broad array of convenient products and services;


•	operating from highly visible and accessible banking and loan production offices in close proximity to concentrations of targeted commercial businesses, professionals and individuals; and


•	utilizing an effective business development calling program.

Market Opportunities

Primary Service Area. Solera National Bank’s primary service area for its community banking operation is the six-county Denver metropolitan area. The Bank’s main office is located at 319 South Sheridan Boulevard in Lakewood, Colorado. According to information gathered from SNL Analytics, within a three mile radius of the Bank’s main office, there are approximately 7,250 businesses, 97,000 employees and 198,000 residents. The Bank is targeting these small- to mid-sized businesses, as well as local residents. This location offers the ability to target Hispanic and other minority populations as approximately 52% are Hispanic households within three miles of the Bank’s main office. Most of the Bank’s customers are from our primary service area. The residential mortgage department has offices in Boulder, Colorado Springs, the Denver Tech Center and Durango.

The economic outlook continues to improve at a moderate pace both nationally and locally.

National Economy. Real gross domestic product (GDP) increased at an annual rate of 2.4% in the fourth quarter of 2013 according to the “second” estimate released by the Bureau of Economic Analysis on February 28, 2014. For the year 2013, real GDP increased 1.9%, compared with an increase of 2.8% in 2012. The increase in real GDP in the fourth quarter primarily reflected positive contributions from personal consumption expenditures, exports, nonresidential fixed investment, and private inventory investment that were partly offset by negative contributions from federal government spending, residential fixed investment and state and local government spending.

According to the Federal Open Market Committee (FOMC) minutes released February 19, 2014, growth in economic activity has picked up in recent quarters. Labor market indicators were mixed but on balance showed further improvement. The unemployment rate declined but remains elevated. Household spending and business fixed investment advanced more quickly in recent months, while the recovery in the housing sector slowed somewhat. Fiscal policy is restraining economic growth, although the extent of restraint is diminishing. Inflation has been running below the Committee's longer-run objective, but longer-term inflation expectations have remained stable.

The FOMC continues to add to its holdings of agency mortgage-backed securities but at a slower pace. The Committee continues to anticipate that it likely will be appropriate to maintain the current target range for the federal funds rate well past the time that the unemployment rate declines below 6.5%, especially if projected inflation continues to run below the Committee's 2% longer-run goal.

The Conference Board’s Leading Economic Index increased 0.3% in January 2014 to 99.5. According to economists, the improvement in the index suggests gradually strengthening economic conditions through early 2014, but uncertainties surrounding business spending and the impact of slower growth of U.S. exports may hold back progress.

Colorado Economy. The Leeds Business Confidence Index increased slightly in the first quarter of 2014 to 59.9 from 59.3 in the fourth quarter. Each metric of the survey measured positive (above 50), and the third quarter marked the eighth consecutive quarter of positive expectations.

According to the Colorado Department of Labor and Employment in a report released January 28, 2014, Colorado added 2,200 payroll jobs in December and 43,900 for full year 2013. The state’s unemployment rate fell for the fifth consecutive month to 6.2% in December 2013, the lowest level in six years, and a healthy decline from 7.5% in December 2012.

According to the 2014 Forecast prepared by the Metro Denver Economic Development Corporation (Metro EDC), the total employment growth rate in 2014 is expected to be slightly slower than 2013, however, the state should still add over 59,000 jobs. Broad-based job growth is expected across almost all sectors. The oil and gas industry in Colorado is experiencing exceptional growth that will continue throughout 2014. The construction sector is also posting large job increases, as the demand for residential, commercial, and infrastructure projects picks up.

SOLERA NATIONAL BANCORP, INC.

According to commentary from Wells Fargo Securities in a December 31, 2013 release entitled Colorado 2014 Economic Outlook, Colorado posted the fifth-largest population gain in the country in 2013, with a net gain of 78,909 new residents. Strong population growth has been critical in maintaining the viability of the state’s housing market. Overall, housing permits are up over the past year; however, much of the rise has been in multifamily. Compared to the historical annual average of 35,995 permits seen between 1998 and 2003, single-family permit issuance is running around two-thirds below this number. Even with the historically low level of single-family permits, other housing market metrics show a more encouraging picture. New listings are up 14.2% over the past year and the number of days on the market has fallen to 71 days from an average of 93 days, according to the Colorado Association of Realtors. Colorado home prices have had a strong year, rising 9.1% based on data from CoreLogic.

Denver Metropolitan Area Economy. Metro Denver’s unadjusted unemployment rate stood at 5.8% in December, unchanged from November and down sharply from 7.4% in December 2012. The Metro EDC forecasts that the three sectors that added the most jobs in 2013 - professional and business services, education and health services, and natural resources and construction - are likely to maintain this distinction in 2014. Only the federal government subsector is likely to shed jobs in the coming year.

The expanding employment base provided the basis for an improved commercial real estate market. Vacancy rates decreased and average lease rates increased for all property types, a trend that should continue in 2014. The residential real estate market also remains strong with high levels of sales activity and rising home prices.

According to data compiled by CoStar Realty, the office market vacancy rate fell and the average lease rate increased during the fourth quarter of 2013. The vacancy rate fell 0.1% compared with the third quarter, reaching 11.1%, the lowest rate since the fourth quarter of 2001. The fall in the vacancy rate was accompanied by an increase in the average lease rate, which was up 1.5% over-the-quarter to $21.91 per square foot.

The industrial market vacancy rate fell to its lowest point since the availability of data beginning in the fourth quarter of 1999. The vacancy rate dropped to 3.8% during the fourth quarter, a decrease of 0.4% over-the-quarter and 1.3% compared with the level last year. The average lease rate grew as demand for space increased. The lease rate of $5.05 per square foot was up 2.9% compared with the third quarter and 7.7% above the year-ago level.

Finally, the demand for retail space is growing. The direct vacancy rate fell 0.2% to 6.1% between the third and fourth quarters. The vacancy rate was 0.6% lower than the fourth quarter 2012 rate. The lower vacancy did not push up the average lease rate of $15.21 per square foot, which was unchanged compared with the third quarter rate. However, the lease rate was up 3.5% over-the-year.

Competition. Solera National Bank faces substantial competition in both lending and deposit originations from other commercial banks, savings and loan associations, credit unions, consumer finance companies, pension trusts, mutual funds, insurance companies, mortgage bankers and brokers, brokerage and investment banking firms, asset-based non-bank lenders, and certain other non-financial institutions, including retail stores, that may offer more favorable financing alternatives than the Bank. The Bank generally competes based on customer service, the rates of interest charged on loans and the rates of interest paid for deposits.

According to information disclosed on the FDIC’s website (www.fdic.gov), as of June 30, 2013, the majority of deposits held in traditional banking institutions in the Bank’s primary banking market were attributable to super-regional banks (serving several states) and branch offices of out-of-state banks. The Company believes that banks headquartered outside of its primary service areas often lack the consistency of local leadership necessary to provide efficient service to individuals and small- to medium-sized business customers. Through its local ownership and management, the Company believes Solera National Bank is positioned to efficiently provide these customers with mortgage loan, business loan, deposit and other financial products tailored to fit their specific needs. We believe that we can compete effectively with larger and more established financial institutions through an active business development program and by offering local access, competitive products and services, and more responsive customer service.

Business Strategy

Operating Strategy. In order to achieve the level of prompt, responsive service necessary to attract customers and to continue to develop the Bank’s image as a local bank with a community focus, we have employed the following operating strategies:

SOLERA NATIONAL BANCORP, INC.


•	Experienced senior management. Our senior management possesses extensive experience in the banking industry, as well as substantial business and banking contacts in our primary service area.


•	Quality employees. We have hired, and will continue to hire, highly-trained and seasoned staff. Ongoing training provides the staff with extensive knowledge of the Bank’s products and services enabling our employees to answer questions and resolve customer issues quickly. We have hired staff fluent in Spanish to serve diverse banking customers, including the Hispanic community.

•

Community-oriented Board of Directors. The Bank’s directors are experienced local business and community leaders. All of our Directors are currently or have been residents of the Bank’s primary service area, and most have significant business ties to the Bank’s primary service area, enabling them to be sensitive and responsive to the needs of the community. Additionally, the Board of Directors encompasses a wide variety of business experience and community involvement.

•

Well situated sites. The main banking office, located at 319 South Sheridan Boulevard in Lakewood, Colorado, occupies a highly visible location at a major traffic intersection. This site gives the Bank highly visible presence in a market that is dominated by branch offices of banks headquartered out of the area. Each of the mortgage loan production offices are located in attractive markets with excellent access to a broad customer base.


•	Financial education and information resource center. The Bank serves as a financial and information center for the community, sponsoring professionals to conduct seminars and workshops on a variety of subjects of interest.


•	Officer call program. We have implemented an active call program to promote our philosophy. The purpose of this call program is to visit prospective customers and to describe the Bank’s products, services and philosophy and attend various business and community functions. All of the Bank’s officers have extensive contacts in the Denver metropolitan market area.


•	Marketing and advertising. We utilize many tools and resources to promote banking and mortgage products and services including our website, email communications, social media, sponsorship of community events and support of local non-profit organizations. In 2013, we updated the Bank’s image and created a new logo with a bold, bright look.

Growth Strategies. We have implemented the following growth strategies:


•	Capitalize on community orientation. Management is capitalizing on the Bank’s position as an independent, community bank to attract individuals, professionals and local business customers that may be underserved by larger banking institutions in its market area. As discussed previously, this includes tailoring services to the needs of the local community, particularly the Hispanic population.

•

Capitalize on cross-sell opportunities between the community banking department and residential mortgage lending department. Management may consider converting one or more of its residential mortgage loan production offices into deposit-taking locations which should increase the number of customer relationships and core deposits. In the interim, we will fully develop a cross-selling program with the goal of generating profitable deposit and loan relationships.


•	Emphasize local decision-making. We believe we are able to differentiate ourselves from the national and regional banks operating in our markets by offering local decision-making by experienced bankers. This helps the Bank attract local businesses and service-minded customers.


•	Attract experienced lending officers. Solera National Bank has hired experienced, well-trained commercial bankers and residential mortgage loan officers. By hiring experienced lending officers, the Bank is able to grow more rapidly than it would if it hired inexperienced lending officers.


•	Offer fee-generating products and services. The Bank’s range of services, pricing strategies, interest rates paid and charged, and hours of operation are structured to attract its target customers and increase its market share. Solera National Bank strives to offer the small business person, professional, entrepreneur, home

SOLERA NATIONAL BANCORP, INC.

buyer and consumer, competitively priced products and services while utilizing technology and strategic outsourcing to increase fee revenue. Our mortgage banking department has significantly enhanced our noninterest income.


•	Small business lending. The Bank provides financing for small- to medium-sized businesses for business acquisition, debt refinancing, working capital, real estate and equipment, etc. The Bank has hired commercial bankers with extensive knowledge of small-business lending to provide adequate funding for the needs of these potential customers.

Lending Services

Lending Policy. The Bank offers a full range of lending products including residential mortgage loans for purchase and refinance customers, commercial loans to small- to medium-sized businesses and professionals, and consumer loans to individuals. The Bank understands that it is competing for these loans with competitors who are well-established and typically have greater resources and lending limits. A timely response to credit requests often provides the Bank with a competitive advantage.

The Bank’s loan approval policy provides for two levels of lending authority. When the amount of total loans to a single borrower exceeds the Bank President’s or Chief Credit Officer’s lending authority, the Board of Directors Credit Committee determines whether to approve the loan request. In addition, all mortgage loans are carefully underwritten to ensure compliance with residential mortgage rules and regulations and with our secondary market investors’ policies.

Lending Limits. The Bank’s lending activities are subject to a variety of lending limits. In general, the Bank may loan to any one borrower a maximum amount equal to 15% of the Bank’s capital and surplus, or 25% if the amount that exceeds 15% is fully secured by financial instruments. The amount of these lending limits increase or decrease as the Bank’s capital increases or decreases as a result of its earnings or losses, among other reasons.

Credit Risks. The principal economic risk associated with each category of loans that the Bank expects to make is the creditworthiness of the borrower. Borrower creditworthiness is affected by general economic conditions and the strength of the relevant business market segment which impacts a borrower’s ability to repay. The larger, well-established financial institutions in the Bank’s primary service area are likely to make proportionately more loans to medium- and large-sized businesses than the Bank will make. The majority of the Bank’s commercial loans are made to small- and medium-sized businesses that may be less able to withstand competitive, economic and financial pressures than larger borrowers.

Real Estate Loans. The Bank makes commercial real estate loans, construction and development loans, and residential real estate loans. The following is a description of each of the major categories of real estate loans that the Bank makes and the risks associated with each category of loan.

•

Commercial real estate loans. Commercial real estate loan terms generally are limited to ten years or less, although payments may be structured on a longer amortization basis. Interest rates may be fixed or adjustable, although rates typically will not be fixed for a period exceeding 60 months. The Bank generally charges an origination fee for its services. The Bank also generally requires personal guarantees from the principal owners of the business or property supported by a review by Bank management of the principal owners’ personal financial statements. For analytical purposes, we categorize our commercial real estate loans into those that are owner occupied and those that are non-owner occupied. Generally, non-owner occupied loans have more inherent risk as the borrower’s ability to repay is dependent upon the tenant’s ability to pay. Risks associated with commercial real estate loans include fluctuations in the value of real estate, new job creation trends, tenant vacancy rates and the quality of the borrowers’ management. The Bank limits its risk by analyzing borrowers’ cash flow and collateral value on an ongoing basis.

•

Construction and development loans. The Bank generally makes owner-occupied construction loans with a pre-approved take-out loan and considers non-owner occupied construction loans on a case-by-case basis. Construction and development loans are generally made with a term of twelve to eighteen months and interest is paid monthly. The ratio of the loan principal to the value of the collateral as established by independent appraisal typically will not exceed industry standards. Loan proceeds are disbursed based on the percentage of completion and only after the project has been inspected by an experienced construction lender or third-party inspector. Risks associated with construction loans include fluctuations in the value of real estate and new job creation trends.

SOLERA NATIONAL BANCORP, INC.

•

Residential real estate loans (portfolio). The Bank makes residential real estate loans consisting of residential first or second mortgage loans, home equity loans and lines of credit, and home improvement loans and lending for the purchase or refinance of one-to-four family properties. The amortization of second mortgages generally does not exceed 15 years and the rates are generally not fixed for over 60 months. The amortization of first mortgages will not exceed 30 years and the rates are generally adjustable to limit the Bank's interest rate exposure. All loans are made with the ratio of the loan principal to the value of collateral as established by independent appraisal generally not exceeding 80%, unless the borrower has private mortgage insurance. The Bank expects that these loan-to-value ratios will be sufficient to compensate for fluctuations in real estate market value and to minimize losses that could result from a downturn in the residential real estate market.

•

Residential real estate loans (held for sale). Beginning in December 2012, the Bank began offering traditional residential mortgage loans. These loans are generally conventional, conforming loans for the purchase or refinance of a one-to-four family property. These loans are recorded as loans held for sale on the Bank’s Consolidated Balance Sheets as they will be sold to investors on the secondary market, which significantly reduces our credit risk. The Bank enters into an interest rate lock commitment with the customer and simultaneously enters into a forward sales commitment with the secondary market investor which locks the pricing on the subsequent sale of the loan thereby significantly limiting the Bank’s exposure to interest rate risk.

Commercial and Industrial Loans. We target small- to medium-sized commercial and industrial businesses. The terms of these loans vary by purpose and by type of underlying collateral, if any. The commercial loans are primarily underwritten on the basis of the borrower’s ability to service the loan from cash flow. The Bank typically makes equipment loans for a term of seven years or less at fixed or variable rates, with the loan fully amortized over the term. Loans to support working capital typically have terms not exceeding one year and will usually be secured by accounts receivable, inventory or personal guarantees of the principals of the business. For loans secured by accounts receivable or inventory, principal is repaid as the assets securing the loan are converted into cash, and for loans secured with other types of collateral, principal is amortized during the term of the loan with remaining principal due at maturity. The quality of the commercial borrower’s management and its ability both to properly evaluate changes in the supply and demand characteristics affecting its markets for products and services, and to effectively respond to such changes, are significant factors in determining a commercial borrower’s creditworthiness.

The Bank also offers a number of Small Business Administration (“SBA”) guaranteed loan programs to assist small businesses. The 504 program provides small businesses needing “brick and mortar” financing with long-term, fixed-rate financing to acquire major fixed assets for expansion or modernization. The 7(a) program helps start-up and existing small businesses obtain financing when they might not be eligible for business loans through traditional lending channels.

Consumer Loans. The Bank offers a variety of loans to individuals for personal, family and household purposes, including secured and unsecured installment and term loans. The loan officer reviews the borrower’s past credit history, past income level, debt history and cash flow to determine the impact of all these factors on the ability of the borrower to make future payments as agreed. The principal competitors for consumer loans are the established banks, credit unions and finance companies in the Bank’s market.

SOLERA NATIONAL BANCORP, INC.

Composition of portfolio - The following table sets forth the composition of the Bank’s loan portfolio according to the loan’s purpose:



	December 31,
($ in thousands)	2013			2012
Commercial real estate (“CRE”)	$	47,063		$	38,230
Commercial and industrial	11,730			9,383
Residential real estate	17,889			10,608
Construction and land development	2,044			791
Consumer	514			620
GROSS LOANS	79,240			59,632
Net deferred loan expenses / (fees)	46			175
Allowance for loan and lease losses	(1,116		)	(1,063		)
LOANS, NET	$	78,170		$	58,744

Average loan size of portfolio - The following table sets forth the number of loans of the Bank, and the average size of each loan, within each category of the loan portfolio.



	December 31,
	2013			2012
($ in thousands)	# of Loans	Average Loan Size		# of Loans	Average Loan Size
Commercial real estate	89	$	529	75	$	510
Commercial and industrial	77	152		59	159
Residential real estate	88	203		48	221
Construction and development	8	255		2	396
Consumer	54	9		32	19
GROSS LOANS	316	$	251	216	$	276

Re-pricing of portfolio - The following table summarizes the maturities for fixed rate loans and the re-pricing intervals for adjustable rate loans. A portion of the adjustable rate loans have floors which will keep those loans from re-pricing until interest rates move above those floors.



($ in thousands)	December 31, 2013						December 31, 2012
	Principal Balance						Principal Balance
Interval	Fixed Rate		Adjustable Rate ⁽¹⁾		Total		Fixed Rate		Adjustable Rate ⁽²⁾		Total
< 3 months	$	1,256	$	20,957	$	22,213	$	1,855	$	13,520	$	15,375
> 3 to 12 months	7,494		447		7,941		1,539		802		2,341
> 1 to 3 years	9,175		2,797		11,972		7,607		14,970		22,577
> 3 to 5 years	10,102		10,605		20,707		4,866		3,765		8,631
over 5 years	12,672		3,735		16,407		10,708		—		10,708
Gross Loans Receivable	$	40,699	$	38,541	$	79,240	$	26,575	$	33,057	$	59,632

⁽¹⁾Of the $38.5 million adjustable rate loans, $33.6 million mature after December 31, 2014.

⁽²⁾ Of the $33.1 million adjustable rate loans, $31.0 million mature after December 31, 2013.

SOLERA NATIONAL BANCORP, INC.

Contractual maturity of portfolio - The following tables set forth information at December 31, 2013 and 2012, regarding the dollar amount of loans maturing in the Bank’s portfolio based on the contractual terms to maturity. The table does not give effect to potential prepayments.



($ in thousands)	December 31, 2013
	<1 Year		1 - 5 Years		5 – 15 Years		Over 15 Years		Total Loans
Commercial real estate	$	7,143	$	11,637	$	28,136	$	147	$	47,063
Commercial and industrial	3,099		4,336		3,401		894		11,730
Residential real estate	47		1,819		168		15,855		17,889
Construction and land development	2,044		—		—		—		2,044
Consumer	11		475		13		15		514
Gross Loans Receivable	$	12,344	$	18,267	$	31,718	$	16,911	$	79,240



($ in thousands)	December 31, 2012
	<1 Year		1 - 5 Years		5 – 15 Years		Over 15 Years		Total Loans
Commercial real estate	$	2,383	$	8,618	$	27,079	$	150	$	38,230
Commercial and industrial	1,529		3,999		3,362		493		9,383
Residential real estate	900		470		1,173		8,065		10,608
Construction and land development	628		163		—		—		791
Consumer	10		499		3		108		620
Gross Loans Receivable	$	5,450	$	13,749	$	31,617	$	8,816	$	59,632

Asset Quality

General - Management, along with the Bank’s Directors credit committee, currently consisting of the Bank’s President & Chief Executive Officer, the Bank’s Chief Credit Officer, and three independent board members, approve loans above established levels, monitor the credit quality of the Bank’s assets, review classified and other identified loans and review management’s recommendation for the proper level of allowances to allocate against the Bank’s loan portfolio, in each case subject to guidelines approved by the Bank’s Board of Directors.

Loan Delinquencies - If a borrower fails to make a required payment on a loan, the Bank will attempt to cure the deficiency by contacting the borrower and seeking payment. Contact is generally made following the fifth day after a payment is due, at which time a late payment fee is assessed. In most cases, delinquencies are cured promptly. While the Bank generally prefers to work with borrowers to resolve such problems, if a payment becomes 60 - 90 days delinquent, the Bank may institute foreclosure or other remedies, as necessary, to minimize any potential loss.

Nonperforming Assets - At December 31, 2013 and 2012, the Bank had $1.7 million and $1.8 million, respectively, in nonperforming assets. Nonperforming assets are defined as nonperforming loans and real estate acquired by foreclosure or deed-in-lieu thereof. Non-performing loans are defined as nonaccrual loans, loans 90 days or more past due but still accruing interest and loans that have been restructured resulting in a reduction or deferral of interest or principal. A loan is impaired when, based on current information and events, it is probable the Bank will be unable to collect all amounts due according to the contractual terms of the loan agreement. Troubled debt restructurings (“TDRs”) are defined as loans where the borrower is experiencing financial difficulties and for which the Bank has agreed to modify by accepting repayment terms below current market terms such as, but not limited to, the rate of interest charged, amortization of principal longer than normal for the type of collateral or acceptance of a different type or lower amount of collateral than typically accepted. Loans are placed on nonaccrual status when, in the judgment of management, the probability of collection of interest is deemed to be insufficient to warrant further accrual. When any such loan is placed on nonaccrual status, previously accrued but unpaid interest will be deducted from current period interest income. There were no nonaccrual loans at December 31, 2013 and $13,000 in nonaccrual loans at December 31, 2012.

SOLERA NATIONAL BANCORP, INC.

The following table summarizes information regarding non-performing assets:



	December 31,
($ in thousands)	2013			2012
Nonaccrual loans and leases	$	—		$	13
Other impaired loans	—			—
Total nonperforming loans	—			13
Other real estate owned	1,746			1,776
Substandard, nonaccrual assets	—			—
Total nonperforming assets	$	1,746		$	1,789
Nonperforming loans	$	—		$	13
Allocated allowance for loan and lease losses to nonperforming loans	—			—
Net investment in nonperforming loans	$	—		$	13
Accruing loans past due 90 days or more	$	—		$	—
Loans past due 30-89 days	$	—		$	147
Loans charged-off, year-to-date	$	7		$	88
Recoveries, year-to-date	(60		)	(84		)
Net (recoveries) charge-offs, year-to-date	$	(53	)	$	4
Allowance for loan and lease losses	$	1,116		$	1,063

Allowance for loan and lease losses to gross loans	1.41		%	1.78		%
Allowance for loan and lease losses to nonaccrual loans	NM⁽¹⁾			NM⁽¹⁾
Allowance for loan and lease losses to nonperforming loans	NM⁽¹⁾			NM⁽¹⁾
Nonaccrual loans to loans, net of deferred fees/expenses	—		%	0.02		%
Loans 30-89 days past due to loans, net of deferred fees/expenses	—		%	0.25		%
Nonperforming assets to total assets	1.03		%	1.16		%

⁽¹⁾Not meaningful given the insignificant, or $0, balance in nonaccrual and nonperforming loans.

Classified Assets - Federal regulations require that each insured financial institution classify its assets on a regular basis. In addition, in connection with examinations of insured institutions, federal 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 declined 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 December 31, 2013 and 2012, the Bank had $3.2 million and $4.6 million, respectively, in loans classified as substandard and no loans classified as doubtful or loss. Additionally, at December 31, 2013, the Bank had $1.1 million in substandard assets representing the amortized cost of two corporate bond positions in Dell, Inc. The corporate credit rating on Dell, Inc. was lowered during the third quarter 2013 to below investment grade due to the company's proposed leveraged buy-out which was consummated in the fourth quarter of 2013. Management does not believe these investments are other than temporarily impaired and management intends to hold these investments until recovery of value, which may be until maturity. These bonds are not on nonaccrual status as the Bank continues to receive the interest payments as contractually due. Additionally, the unrealized loss on these securities has declined in recent months and, as of December 31, 2013 the market price exceeds 100% of par value.

Allowance for Loan and Lease Losses - The Bank maintains an allowance for estimated loan losses 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

SOLERA NATIONAL BANCORP, INC.

regulatory environment, among others. In addition, because the Bank has 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 until the Bank has sufficient historical data to see trends in our own loss history. Provisions for loan 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 following table sets forth the allowance for loan and lease losses activity for 2013 and 2012:



($ in thousands)	2013			2012
Balance at beginning of year	$	1,063		$	1,067
Provision charged to expense	—			—
Loans charged-off:
Commercial real estate	(7		)	—
Commercial and industrial	—			(85		)
Residential real estate	—			—
Construction and land development	—			—
Consumer	—			(3		)
Total loans charged-off	(7		)	(88		)
Recoveries on loans previously charged-off:
Commercial real estate	—			—
Commercial and industrial	7			14
Residential real estate	53			70
Construction and land development	—			—
Consumer	—			—
Total recoveries	60			84
Balance at end of year	$	1,116		$	1,063
Net charge-offs (recoveries) to average gross loans	(0.08		)%	0.01		%

As a result of management’s evaluation of all the aforementioned factors, the allowance for loan and lease losses decreased 37 basis points from 1.78% of gross loans at December 31, 2012 to 1.41% of gross loans at December 31, 2013.

The following tables allocate the allowance for loan and lease losses based on management’s judgment of inherent losses by loan category. It is based on management’s assessment as of a given point in time of the risk characteristics for each of the components of the total loan portfolio and is subject to change as and when the risk factors of each such component changes. Such allocation is not indicative of either the specific amounts or the loan categories in which future charge-offs may be taken, nor should it be taken as an indicator of future loss trends. By presenting such allocation, management does not mean to imply that the allocation is exact or that the allowance for loan and lease losses has been precisely determined from such allocation.

SOLERA NATIONAL BANCORP, INC.



($ in thousands)	December 31, 2013
	Amount		Percentage of loans in each category to total loans		Percentage of year-end allowance		Percentage of reserves to total loans by category
Commercial real estate	$	841	59.4	%	75.4	%	1.79	%
Commercial and industrial	123		14.8		11.0		1.05
Residential real estate	129		22.6		11.5		0.72
Construction and development	20		2.6		1.8		0.98
Consumer	3		0.6		0.3		0.58
Total allowance for loan and lease losses	$	1,116	100.0	%	100.0	%	1.41	%



($ in thousands)	December 31, 2012
	Amount		Percentage of loans in each category to total loans		Percentage of year-end allowance		Percentage of reserves to total loans by category
Commercial real estate	$	836	64.1	%	78.7	%	2.19	%
Commercial and industrial	59		15.7		5.5		0.63
Residential real estate	41		17.8		3.8		0.39
Construction and development	124		1.4		11.7		15.68
Consumer	3		1.0		0.3		0.48
Total allowance for loan and lease losses	$	1,063	100.0	%	100.0	%	1.78	%

The allowance for loan and lease losses reflects management’s judgment of the level of allowance adequate to absorb estimated credit losses in the Bank’s loan portfolio. The Board of Directors of the Bank approved a policy formulated by management for a systematic analysis of the adequacy of the allowance. The policy requires management to perform, on a quarterly basis, an in-depth analysis of the allowance which is reviewed by the Directors’ credit committee and then is presented to and approved by the Bank’s Board of Directors.

The Bank’s external asset review system and loss allowance methodology are designed to provide for timely identification of problem assets and recognition of losses. The current monitoring process includes segmenting the loan portfolio into pools of loans that share similar credit characteristics. The loan portfolio is further segmented into risk grades for criticized loans. These specific pools of loans are analyzed for purposes of calculating the contingent losses inherent within the portfolio.

The portion of the allowance for loan and lease losses related to contingent losses is derived by analyzing the historical loss experience of the Bank’s peer groups and asset quality within each loan portfolio segment, along with assessing qualitative environmental factors, and correlating it with the delinquency and classification status for each portfolio segment. Loans that are categorized as “substandard” or “doubtful” are reviewed in more individual detail to determine if the loan is impaired. Those deemed not to be impaired are assigned a loss factor based on their risk grade.

Loss factors for each risk graded loan segment are based on experience of peer institutions and national and regional averages published by the OCC and FDIC. Given that the Bank has limited historical trends, peer group statistics are used to validate the loss factors applied to the Bank’s various loan segments. In addition, the following qualitative environmental elements are considered in determining the loss factors used in calculating the contingent losses: the levels of and trends in past due loans, the trend in volume and terms of loans, the effects of changes in credit concentrations, the effects of changes in risk selection and underwriting standards, and other changes in lending policies, procedures and practices, the experience, ability and depth of management and other relevant staff, national and local economic trends and conditions, and industry conditions.

Classified assets are reviewed on a monthly basis. This evaluation of individual loans is documented in the internal asset review report relating to the specific loan. As part of that review, potential impairment is also considered.

SOLERA NATIONAL BANCORP, INC.

Any deficiencies outlined by the impairment analysis are accounted for in the specific valuation allowance for the loan or are immediately charged-off to bring the loan to its net realizable value. A loan is determined to be impaired if management determines the recovery of the Bank’s gross investment is not probable. A specific valuation allowance is applied if the amount of loss can be reasonably determined. To determine impairment, management assesses the fair value of the loan based on the present value of expected future cash flows discounted at the loan’s effective interest rate or at the loan’s observable market price or the fair value of the collateral, if the loan is collateral dependent.

The allowance requirements for any loan segment could be different in the future as the quantitative and qualitative factors change. Consequently, provision levels may also be influenced by changes in the quantitative and qualitative factors quarter over quarter. In addition, the OCC, as an integral part of their examination process, periodically reviews the Bank’s valuation allowance. This governing agency may require increases to the allowance based on their judgments of the information available to them at the time of their examination.

Management believes that the Bank’s overall asset quality is sound, as supported by the Bank’s internal risk rating process.

Investments

In addition to loans, the Bank makes other investments primarily in obligations guaranteed as to principal and interest by the United States or by quasi-government agencies and other taxable securities. No investment in any of those instruments exceeds any applicable limitation imposed by law or regulation. The asset-liability management committee reviews the investment portfolio on an ongoing basis in order to ensure that the investments conform to the Bank’s policy as set by its Board of Directors.

At the date of purchase, the Bank must classify the securities into one of two categories: held-to-maturity, or available-for-sale. Since its inception, the Bank has not had any held-to-maturity investments; however, investments that management has the positive intent and ability to hold to maturity would be classified as held-to-maturity and recorded at amortized cost. Investments to be held for an indefinite amount of time, but not necessarily to maturity, are classified as available-for-sale and carried at fair value with unrealized gains or losses reported as a separate component of stockholders’ equity in accumulated other comprehensive income, net of applicable income taxes. Since the initial classification of its investment securities, the Bank has not transferred any investment securities between categories.

Declines in fair value of held-to-maturity and available-for-sale securities below their cost that are deemed to be other than temporary are reflected in earnings as realized losses. The Bank has not recognized any other than temporary impairment in 2012 or 2013.

Gains and losses on the sale of securities are recorded on the trade date and are determined using the specific identification method. Purchase premiums and discounts are recognized in interest income using the interest method over the estimated lives of the securities.

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 December 31, 2013 and 2012.



	December 31, 2013
($ 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	$	5,544	$	(223	)	10	$	3,488	$	(121	)	6	$	9,032	$	(344	)	16
State and municipal	15,482		(932		)	33	719		(54		)	2	16,201		(986		)	35
Residential agency MBS/CMOs	19,505		(311		)	23	8,121		(204		)	10	27,626		(515		)	33
Total temporarily-impaired	$	40,531	$	(1,466	)	66	$	12,328	$	(379	)	18	$	52,859	$	(1,845	)	84

SOLERA NATIONAL BANCORP, INC.



	December 31, 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	$	1,436	$	(8	)	2	$	3,353	$	(147	)	6	$	4,789	$	(155	)	8
State and municipal	4,512		(47		)	9	—		—			—	4,512		(47		)	9
Residential agency MBS/CMOs	17,267		(164		)	16	1,134		(5		)	2	18,401		(169		)	18
Total temporarily-impaired	$	23,215	$	(219	)	27	$	4,487	$	(152	)	8	$	27,702	$	(371	)	35

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 December 31, 2013 and 2012. 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 prepay obligations without a prepayment penalty. 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 $14.7 million in proceeds from the maturity/prepayment of securities during 2013 (see our Consolidated Statements of Cash Flows on page F-6) versus the $1.0 million contractually maturing within one year at December 31, 2012 as set forth in the table below.



	December 31, 2013
($ in thousands)	Within One Year				After One Year but within Five Years				After Five Years but within Ten Years				After Ten Years
	Amount		Yield		Amount		Yield		Amount		Yield		Amount		Yield
Securities available-for-sale
Corporate	$	—	—	%	$	4,854	2.47	%	$	8,125	2.39	%	$	—	—	%
State and municipal	—		—		1,703		4.99		14,633		3.22		1,904		3.47
Residential agency MBS	—		—		—		—		1,581		2.01		37,039		2.47
Total	$	—	—	%	$	6,557	3.12	%	$	24,339	2.87	%	$	38,943	2.52	%



	December 31, 2012
($ in thousands)	Within One Year				After One Year but within Five Years				After Five Years but within Ten Years				After Ten Years
	Amount		Yield		Amount		Yield		Amount		Yield		Amount		Yield
Securities available-for-sale
Corporate	$	1,023	5.63	%	$	4,532	2.69	%	$	8,895	3.08	%	$	—	—	%
State and municipal	—		—		1,923		5.06		13,636		3.30		6,558		3.20
Residential agency MBS	—		—		—		—		711		2.67		47,432		1.79
Total	$	1,023	5.63	%	$	6,455	3.40	%	$	23,242	3.19	%	$	53,990	1.96	%

At December 31, 2013 and 2012, we held $2.3 million and $1.2 million, respectively, of other equity securities consisting of Federal Home Loan Bank (“FHLB”) and Federal Reserve Bank stocks with no maturity date, which are not reflected in the above tables.

SOLERA NATIONAL BANCORP, INC.

Deposit Services

The Bank offers a variety of deposit products at competitive interest rates. The Bank utilizes traditional marketing methods to attract new clients and deposits, including various forms of advertising and significant involvement in the local communities. The majority of depositors are residents of, and businesses and their employees located in, the Bank’s primary service areas and the state of Colorado. The Bank attracts these deposits through personal solicitation by its officers, customer referrals and various marketing efforts. The Bank does not operate a money desk or otherwise solicit brokered deposits. However, the Bank obtains time deposits from national listing services on occasion for liquidity and interest rate risk purposes.

The following table sets forth the composition of the Bank’s deposits by type at December 31, 2013 and 2012:



($ in thousands)	2013				2012
	Amount		% of Total		Amount		% of Total
Noninterest-bearing demand	$	6,362	5	%	$	3,387	3	%
Interest-bearing demand	10,559		8	%	8,218		7	%
Money market accounts	14,929		11	%	10,511		8	%
Savings accounts	36,256		28	%	44,847		36	%
Time deposits, less than $100,000	4,485		3	%	4,559		3	%
Time deposits, $100,000 or more	60,253		45	%	53,210		43	%
Total deposits	$	132,844	100	%	$	124,732	100	%

The following table presents average deposits by type and the related average interest rate paid by deposit type for the years ended December 31, 2013 and 2012:



($ in thousands)	2013				2012
	Average Balance		Average Rate		Average Balance		Average Rate
Noninterest-bearing demand	$	5,212	—	%	$	3,187	—	%
Interest-bearing demand	9,297		0.73		8,621		0.84
Money market accounts	12,667		0.43		10,459		0.60
Savings accounts	39,877		0.47		46,593		0.62
Time deposits	60,267		1.24		53,999		1.33
Total deposits	$	127,320	0.81	%	$	122,859	0.93	%

The following table sets forth the amount and maturities of the time deposits at December 31, 2013:



($ in thousands)	Time Deposits $100,000 or greater		Time Deposits less than $100,000		Total Time Deposits
Due in three months or less	$	5,653	$	464	$	6,117
Due in over three months through six months	5,212		329		5,541
Due in over six months through twelve months	7,640		1,288		8,928
Due in over twelve months	41,748		2,404		44,152
Total	$	60,253	$	4,485	$	64,738

Included in time deposits $100,000 or greater at December 31, 2013 are approximately $47.1 million of time deposits between $100,000 and $250,000. These time deposits are fully insured by the FDIC.

SOLERA NATIONAL BANCORP, INC.

The following table sets forth the amount and maturities of the time deposits at December 31, 2012.



($ in thousands)	Time Deposits $100,000 or greater		Time Deposits less than $100,000		Total Time Deposits
Due in three months or less	$	5,129	$	360	$	5,489
Due in over three months through six months	5,114		466		5,580
Due in over six months through twelve months	6,935		1,112		8,047
Due in over twelve months	36,032		2,621		38,653
Total	$	53,210	$	4,559	$	57,769

Included in time deposits $100,000 or greater at December 31, 2012 are approximately $40.0 million of time deposits between $100,000 and $250,000. These time deposits are fully insured by the FDIC.

Supervision and Regulation

The following is not intended to be a complete discussion but is intended to be a summary of some of the more significant provisions of laws and regulations which are applicable to the Company and the Bank. This regulatory framework is intended to protect depositors, federal deposit insurance funds and the banking system as a whole, and not to protect security holders. To the extent that the information describes statutory and regulatory provisions, it is qualified in its entirety by reference to those provisions. Additionally, such statutes, regulations and policies are continually under review by Congress and state legislatures, and federal and state regulatory agencies. A change in statutes, regulations or regulatory policies applicable to the Company or the Bank, including changes in interpretations, could have a material effect on the Bank’s business.

General. Banking is a complex, highly regulated industry. Consequently, the growth and earnings performance of the Company and the Bank can be affected, not only by management decisions and general and local economic conditions, but also by the statutes administered by, and the regulations and policies of, various governmental regulatory authorities. These authorities include, but are not limited to, the Consumer Financial Protection Bureau ("CFPB"), the Federal Reserve, the FDIC, the OCC, the Internal Revenue Service and state taxing authorities. The effect of these statutes, regulations and policies and any changes to any of them can be significant and cannot be predicted.

The primary goals of the Bank regulators are to maintain a safe and sound banking system and to facilitate the conduct of sound monetary policy. In furtherance of these goals, Congress had created several largely autonomous regulatory agencies and enacted numerous laws that govern banks, bank holding companies and the banking industry. In 2010, the Dodd-Frank act established the CFPB. The CFPB was largely established due to the financial crisis of 2007. The CFPB consolidates most Federal consumer financial protection authority in one place.

The system of supervision and regulation applicable to the Company and the Bank establishes a comprehensive framework for their respective operations and is intended primarily for the protection of the FDIC’s deposit insurance funds, the Bank’s depositors and the public, rather than the stockholders and creditors. The following is an attempt to summarize some of the relevant laws, rules and regulations governing banks and bank holding companies, but does not purport to be a complete summary of all applicable laws, rules and regulations governing banks and bank holding companies. The descriptions are qualified in their entirety by reference to the specific statutes and regulations discussed.

Regulatory Reform. As mentioned above, on July 21, 2010, the President signed the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”), which comprehensively reforms the regulation of financial institutions, products and services. Many of the provisions of the Dodd-Frank Act noted in this section are also discussed in other sections below. Furthermore, many of the provisions of the Dodd-Frank Act required study or rulemaking by other agencies, a process which has taken several years to fully implement.

Among other things, the Dodd-Frank Act permanently raised deposit insurance levels to $250,000, retroactive to January 1, 2008, and provided unlimited deposit insurance coverage for noninterest-bearing transaction accounts through December 31, 2012. The definition of noninterest-bearing accounts also includes the interest on lawyer trust accounts. Pursuant to modifications under the Dodd-Frank Act, deposit insurance assessments effective April 1, 2011, are based on an insured depository institution’s assets rather than its insured deposits and the minimum reserve ratio of the FDIC’s

SOLERA NATIONAL BANCORP, INC.

Deposit Insurance Fund was raised to 1.35%. The payment of interest on business demand deposit accounts is permitted by the Dodd-Frank Act. The Dodd-Frank Act authorized the Federal Reserve Board to regulate interchange fees for debit card transactions and established new minimum mortgage underwriting standards for residential mortgages. Further, the Dodd-Frank Act bars banking organizations, such as the Company, from engaging in proprietary trading and from sponsoring and investing in hedge funds and private equity funds, except as permitted under certain limited circumstances. The Dodd-Frank Act empowered the newly established Financial Stability Oversight Council to designate certain activities as posing a risk to the U.S. financial system and to recommend new or heightened standards and safeguards for financial institutions engaging in such activities.

Solera National Bancorp, Inc.

General. As a result of holding all of the capital stock of Solera National Bank, the Company is a bank holding company registered with, and subject to regulation by, the Federal Reserve under the Bank Holding Company Act of 1956, as amended. The Bank Holding Company Act and other federal laws subject bank holding companies to particular restrictions on the types of activities in which they may engage, and to a range of supervisory requirements and activities, including regulatory enforcement actions for violations of laws and regulations.

In accordance with Federal Reserve policy, the Company is expected to act as a source of financial strength to the Bank and commit resources to support the Bank. This support may be required under circumstances when the Company might not be inclined to do so absent this Federal Reserve policy. As discussed below, the Company could be required to guarantee the capital plan of the Bank if it becomes undercapitalized for purposes of banking regulations.

Certain Acquisitions. The Bank Holding Company Act requires every bank holding company to obtain the prior approval of the Federal Reserve before (i) acquiring more than five percent of the voting stock of any bank or other bank holding company, (ii) acquiring all or substantially all of the assets of any bank or bank holding company, or (iii) merging or consolidating with any other bank holding company.

Additionally, the Bank Holding Company Act provides that the Federal Reserve may not approve any of these transactions if it would result in or tend to create a monopoly or substantially lessen competition or otherwise function as a restraint of trade, unless the anti-competitive effects of the proposed transaction are clearly outweighed by the public interest in meeting the convenience and needs of the community to be served. The Federal Reserve is also required to consider the financial and managerial resources and future prospects of bank holding companies and banks concerned and the convenience and needs of the community to be served. The Federal Reserve’s consideration of financial resources generally focuses on capital adequacy, which is discussed below. As a result of the Patriot Act, which is discussed below, the Federal Reserve is also required to consider the record of a bank holding company and its subsidiary bank(s) in combating money laundering activities in its evaluation of bank holding company merger or acquisition transactions.

Under the Bank Holding Company Act, if adequately capitalized and adequately managed, any bank holding company incorporated in Delaware may purchase a bank located outside of Delaware. Conversely, an adequately capitalized and adequately managed bank holding company incorporated outside of Delaware may purchase a bank located inside Delaware. In each case, however, restrictions currently exist on the acquisition of a bank that has only been in existence for a limited amount of time or will result in specified concentrations of deposits.

Change in Bank Control. Subject to various exceptions, the Bank Holding Company Act and the Change in Bank Control Act of 1978, together with related regulations, require Federal Reserve approval prior to any person or company acquiring “control” of a bank holding company. Control is conclusively presumed to exist if an individual or company acquires 25% or more of any class of voting securities of the bank holding company. With respect to Solera National Bancorp, Inc., rebuttable control is presumed to exist if a person or company acquires 10% or more, but less than 25%, of any class of voting securities.

Permitted Activities. Generally, bank holding companies are prohibited under the Bank Holding Company Act, from engaging in or acquiring direct or indirect control of more than 5% of the voting shares of any company engaged in any activity other than (i) banking or managing or controlling banks or (ii) an activity that the Federal Reserve determines to be so closely related to banking as to be a proper incident to the business of banking.

Activities that the Federal Reserve has found to be so closely related to banking as to be a proper incident to the business of banking include:


•	factoring accounts receivable;

SOLERA NATIONAL BANCORP, INC.


•	making, acquiring, brokering or servicing loans and usual related activities;


•	leasing personal or real property;


•	operating a non-bank depository institution, such as a savings association;


•	trust company functions;


•	financial and investment advisory activities;


•	conducting discount securities brokerage activities;


•	underwriting and dealing in government obligations and money market instruments;


•	providing specified management consulting and counseling activities;


•	performing selected data processing services and support services;


•	acting as agent or broker in selling credit life insurance and other types of insurance in connection with credit transactions; and


•	performing selected insurance underwriting activities.

Despite prior approval, the Federal Reserve has the authority to require a bank holding company to terminate an activity or terminate control of or liquidate or divest certain subsidiaries or affiliates when the Federal Reserve believes the activity or the control of the subsidiary or affiliate constitutes a significant risk to the financial safety, soundness or stability of any of its banking subsidiaries. A bank holding company that qualifies and elects to become a financial holding company is permitted to engage in additional activities that are financial in nature or incidental or complementary to financial activity. The Bank Holding Company Act expressly lists the following activities as financial in nature:


•	lending, exchanging, transferring, investing for others, or safeguarding money or securities;


•	insuring, guaranteeing or indemnifying against loss or harm, or providing and issuing annuities, and acting as principal, agent or broker for these purposes, in any state;


•	providing financial, investment or advisory services;


•	issuing or selling instruments representing interests in pools of assets permissible for a bank to hold directly;


•	underwriting, dealing in or making a market in securities;


•	other activities that the Federal Reserve may determine to be so closely related to banking or managing or controlling banks as to be a proper incident to managing or controlling banks;


•	foreign activities permitted outside of the United States if the Federal Reserve has determined them to be usual in connection with banking operations abroad;


•	merchant banking through securities or insurance affiliates; and


•	insurance company portfolio investments.

To qualify to become a financial holding company, Solera National Bank and any other depository institution subsidiary that the Company may own at the time must be well capitalized and well managed and must have a Community Reinvestment Act rating of at least satisfactory. Additionally, the Company would be required to file an election with the Federal Reserve to become a financial holding company and to provide the Federal Reserve with 30 days written notice prior to engaging in a permitted financial activity. A bank holding company that falls out of compliance with these requirements may be required to cease engaging in some of its activities. The Federal Reserve serves as the primary “umbrella” regulator of financial holding companies, with supervisory authority over each parent company and limited authority over its subsidiaries. Expanded financial activities of financial holding companies generally will be regulated according to the type of such financial activity: banking activities by banking regulators, securities activities by securities regulators and insurance activities by insurance regulators. The Company currently has no plans to make a financial holding company election.

Sound Banking Practice. Bank holding companies are not permitted to engage in unsound banking practices. For example, the Federal Reserve’s Regulation Y requires a holding company to give the Federal Reserve prior notice of any redemption or repurchase of its own equity securities, if the consideration to be paid, together with the consideration paid for any repurchases in the preceding year, is equal to 10% or more of the company’s consolidated net worth. The Federal Reserve may oppose the transaction if it believes that the transaction would constitute an unsafe or unsound practice or would violate any law or regulation. As another example, a holding company could not impair its subsidiary bank’s soundness by causing it to make funds available to non-banking subsidiaries or their customers if the Federal Reserve believed it not prudent to do so.

The Financial Institutions Reform, Recovery and Enforcement Act of 1989, or FIRREA, expanded the Federal Reserve’s authority to prohibit activities of bank holding companies and their non-banking subsidiaries which represent unsafe and unsound banking practices or which constitute violations of laws or regulations. FIRREA increased the amount of civil money penalties which the Federal Reserve can assess for activities conducted on a knowing and reckless basis, if

SOLERA NATIONAL BANCORP, INC.

those activities caused a substantial loss to a depository institution. The penalties can be as high as $1 million for each day the activity continues, up to a maximum of $5 million. FIRREA also expanded the scope of individuals and entities against which such penalties may be assessed.

Anti-tying Restrictions. Bank holding companies and affiliates are prohibited from tying the provision of services, such as extensions of credit, to other services offered by a holding company or its affiliates.

Dividends. Consistent with its policy that bank holding companies should serve as a source of financial strength for their subsidiary banks, the Federal Reserve has stated that, as a matter of prudence, a bank holding company, generally should not maintain a rate of distributions to stockholders unless its available net income has been sufficient to fully fund the distributions, and the prospective rate of earnings retention appears consistent with the bank holding company’s capital needs, asset quality and overall financial condition. In addition, the Company is subject to certain restrictions on the making of distributions as a result of the requirement that the Bank maintain an adequate level of capital as described below. As a Delaware corporation, the Company is restricted under the Delaware General Corporation Law from paying dividends under certain conditions.

Solera National Bank

Solera National Bank is subject to the supervision, examination and reporting requirements of the National Bank Act and the regulations of the OCC and CFPB. The OCC regularly examines the Bank’s operations and has the authority to approve or disapprove mergers, the establishment of branches and similar corporate actions. The OCC also has the power to prevent the continuance or development of unsafe or unsound banking practices or other violations of law. Solera National Bank is also subject to numerous state and federal statutes and regulations that affect its business, activities and operations. The Bank’s deposits are insured by the FDIC to the maximum extent provided by law.

Branching and Interstate Banking. National banks are required by the National Bank Act to adhere to branching laws applicable to state banks in the states in which they are located. Under current Colorado law, banks are permitted to establish branch offices throughout Colorado with prior regulatory approval. In addition, with prior regulatory approval, banks are permitted to acquire branches of existing banks located in Colorado. Finally, banks generally may branch across state lines by merging with banks or by purchasing a branch of another bank in other states if allowed by the applicable states’ laws. If the resulting bank is a Colorado state bank, the merger is subject to Colorado state law. If the resulting bank is an out-of-state bank, the merger will be subject to the laws of that state. Colorado law, with limited exceptions, currently permits branching across state lines through interstate mergers if the bank located in Colorado has been in existence for at least five years. Under the Federal Deposit Insurance Act, states may “opt-in” and allow out-of-state banks to branch into their state by establishing a new start-up branch in the state. Colorado law currently does not permit de novo branching into the state of Colorado.

Deposit Insurance Assessments. Banks must pay assessments to the FDIC for federal deposit insurance protection. The FDIC has adopted a risk-based assessment system as required by the Federal Deposit Insurance Corporation Improvement Act, or FDICIA. Under this system, FDIC-insured depository institutions pay insurance premiums at rates based on their risk classification. Institutions assigned to higher risk classifications (that is, institutions that pose a higher risk of loss to their respective deposit insurance funds) pay assessments at higher rates than institutions that pose a lower risk. An institution’s risk classification is assigned based on its capital levels and the level of supervisory concern the institution poses to the regulators. Pursuant to the Dodd-Frank Act, the FDIC amended the deposit insurance assessment during 2011 by changing the calculation of deposit assessments. Effective April 1, 2011, the deposit insurance premiums are based on assets rather than insurable deposits and the assessment rate is influenced by Tier 1 capital levels, and the Bank’s CAMELS ratings. Assessments may change if there are any future special assessments by the FDIC. Additionally, if the risk category of the Bank changes adversely, our FDIC insurance premiums could increase.

In late 2009, the FDIC issued a final rule that mandated that insured depository institutions prepay their quarterly risk-based assessments to the FDIC for the fourth quarter of 2009 and for all of 2010, 2011, and 2012. The amount of the Bank’s prepaid deposit premium was $0 as of December 31, 2012.

The FDIC has the power to adjust deposit insurance assessment rates at any time or to make special assessments that could result in higher assessment rates that could have a material adverse effect on earnings. The FDIC may terminate its insurance of deposits if it finds that the institution has engaged in unsafe and unsound practices, is in an unsafe or unsound condition to continue operations, or has violated any applicable law, regulation, rule, order, or condition imposed by the FDIC. The Bank’s deposit insurance assessments may increase or decrease depending on the risk assessment classification to which the Bank is assigned by the FDIC. We cannot predict whether the FDIC will increase deposit

SOLERA NATIONAL BANCORP, INC.

insurance assessment levels in the future. Any increase in insurance assessments could have an adverse effect on the Bank’s earnings.

Expanded Financial Activities. The Gramm-Leach-Bliley Financial Services Modernization Act of 1999 expands the types of activities in which a holding company or national bank may engage. Subject to various limitations, the act generally permits holding companies to elect to become financial holding companies and, along with national banks, conduct certain expanded financial activities related to insurance and securities, including securities underwriting, dealing and market making; sponsoring mutual funds and investment companies; insurance underwriting and agency activities; merchant banking activities; and activities that the Board of Governors of the Federal Reserve has determined to be closely related to banking. Banks with financial subsidiaries must establish certain firewalls and safety and soundness controls, and must deduct their equity investment in such subsidiaries from their equity capital calculations. Expanded financial activities of financial holding companies and banks will generally be regulated according to the type of such financial activity: banking activities by banking regulators, securities activities by securities regulators, and insurance activities by insurance regulators.

Community Reinvestment Act. The Community Reinvestment Act requires that, in connection with examinations of financial institutions within its jurisdiction, the FDIC shall evaluate the record of each financial institution in meeting the credit needs of its assessment area, including low- and moderate-income neighborhoods. These facts are also considered in evaluating mergers, acquisitions, and applications to open a branch or facility. Failure to adequately meet these criteria could impose additional requirements and limitations on the Bank. Because the Bank’s aggregate assets are currently less than $250 million, under the Community Reinvestment Act, it is subject to a Community Reinvestment Act examination only once every 48 months. We received a satisfactory rating on our first examination in 2010, which is the only examination we have been subject to to-date. Additionally, the Bank must publicly disclose the terms of various Community Reinvestment Act-related agreements.

Other Regulations. Interest and other charges collected or contracted for by the Bank are subject to state usury laws and federal laws concerning interest rates. The Bank’s loan operations are also subject to federal laws applicable to credit transactions, such as:


•	the federal Truth-In-Lending Act, governing disclosures of credit terms to consumer borrowers;


•	the Home Mortgage Disclosure Act of 1975, requiring financial institutions to provide information to enable the public and public officials to determine whether a financial institution is fulfilling its obligation to help meet the housing needs of the community it serves;


•	the Equal Credit Opportunity Act, prohibiting discrimination on the basis of race, creed or other prohibited factors in extending credit;


•	the Fair Credit Reporting Act of 1978, governing the use and provision of information to credit reporting agencies;


•	the Fair Debt Collection Act, governing the manner in which consumer debts may be collected by collection agencies; and


•	the rules and regulations of the various federal and state agencies charged with the responsibility of implementing these federal and state laws.

The loan and deposit operations of Solera National Bank are subject to:


•	the Truth-in-Savings Act, requiring clear and uniform disclosures of rates of interest and fees;


•	the Right to Financial Privacy Act, which imposes a duty to maintain confidentiality of consumer financial records and prescribes procedures for complying with administrative subpoenas of financial records;


•	the Electronic Funds Transfer Act, which govern automatic deposits to and withdrawals from deposit accounts and customers’ rights and liabilities arising from the use of automated teller machines and other electronic banking services;


•	the Ability to Repay and Qualified Mortgage (ATR/QM) rule, that applies to all closed-end residential mortgage loans; and


•	other rules and regulations of the various federal and state agencies charged with the responsibility of implementing these federal and state laws.

Dividends. Solera National Bank is required by federal law to obtain prior approval of the OCC for payments of dividends if the total of all dividends declared by its Board of Directors in any year will exceed its net profits earned during

SOLERA NATIONAL BANCORP, INC.

the current year combined with its retained net profits of the immediately preceding two years, less any required transfers to surplus. In addition, Solera National Bank is unable to pay dividends unless and until it has positive retained earnings.

In addition, under the FDICIA, Solera National Bank may not pay any dividend if the payment of the dividend would cause the Bank to become undercapitalized or in the event the Bank is “undercapitalized.” The OCC may further restrict the payment of dividends by requiring that a financial institution maintain a higher level of capital than would otherwise be required to be “adequately capitalized” for regulatory purposes. Moreover, if, in the opinion of the OCC, Solera National Bank is engaged in an unsound practice (which could include the payment of dividends), the OCC may require, generally after notice and hearing, that Solera National Bank cease such practice. The OCC has indicated that paying dividends that deplete a depository institution’s capital base to an inadequate level would be an unsafe banking practice. Moreover, the OCC has also issued policy statements providing that insured depository institutions generally should pay dividends only out of current operating earnings.

Capital Adequacy. The Federal Reserve monitors the capital adequacy of bank holding companies, such as Solera National Bancorp, and the OCC monitors the capital adequacy of Solera National Bank. The federal bank regulators use a combination of risk-based guidelines and leverage ratios to evaluate capital adequacy and consider these capital levels when taking action on various types of applications and when conducting supervisory activities related to safety and soundness. The risk-based guidelines apply on a consolidated basis to bank holding companies with consolidated assets of $500 million or more and, generally, on a bank-only basis for bank holding companies with less than $500 million in consolidated assets. Each insured depository subsidiary of a bank holding company with less than $500 million in consolidated assets is expected to be “well-capitalized.”

The risk-based capital standards are designed to make regulatory capital requirements more sensitive to differences in risk profiles among banks and their holding companies, to account for off-balance-sheet exposure, and to minimize disincentives for holding liquid assets. Assets and off-balance-sheet items, such as letters of credit and unfunded loan commitments, are assigned to broad risk categories, each with appropriate risk weights. The resulting capital ratios represent capital as a percentage of total risk-weighted assets and off-balance-sheet items. The minimum guideline for the ratio of total capital to risk-weighted assets is 8%. Total capital consists of two components, Tier 1 Capital and Tier 2 Capital. Tier 1 Capital generally consists of common stock, minority interests in the equity accounts of consolidated subsidiaries, noncumulative perpetual preferred stock, and a limited amount of qualifying cumulative perpetual preferred stock, less goodwill and other specified intangible assets. Tier 1 Capital must equal at least 4% of risk-weighted assets. Tier 2 Capital generally consists of subordinated debt, preferred stock (other than that which is included in Tier 1 Capital), and a limited amount of loan loss reserves. The total amount of Tier 2 Capital is limited to 100% of Tier 1 Capital.

In addition, the Federal Reserve has established minimum leverage ratio guidelines for bank holding companies with assets of $500 million or more. These guidelines provide for a minimum ratio of Tier 1 Capital to average assets, less goodwill and other specified intangible assets, of 3% for bank holding companies that meet specified criteria, including having the highest regulatory rating and implementing the Federal Reserve’s risk-based capital measure for market risk. All other bank holding companies with assets of $500 million or more generally are required to maintain a leverage ratio of at least 4%. The guidelines also provide that bank holding companies of such size experiencing internal growth or making acquisitions will be expected to maintain strong capital positions substantially above the minimum supervisory levels without reliance on intangible assets. The Federal Reserve considers the leverage ratio and other indicators of capital strength in evaluating proposals for expansion or new activities. The Federal Reserve and the FDIC have adopted amendments to their risk-based capital regulations to provide for the consideration of interest rate risk in the agencies’ determination of a banking institution’s capital adequacy.

On July 9, 2013, bank regulators approved the final rule to implement the Basel III regulatory capital reforms. The final rule becomes effective for the Bank beginning on January 1, 2015, as we are considered a non-advanced approaches bank. The final rule minimizes the impact on smaller, less complex financial institutions, although it does increase both the quantity and quality of capital required to be held in order to meet the minimum capital requirements.

Bank holding companies with assets under $500 million are exempt from the capital adequacy guidelines if they meet certain qualitative requirements. However, a bank holding company does not qualify for the exemption if it, or its nonbanking subsidiary, as applicable, (i) is engaged in significant nonbanking activities, (ii) conducts significant off-balance-sheet activities, or (iii) has a material amount of registered debt or equity securities (other than trust preferred securities). Certain transition rules apply to trust preferred securities, but these transition rules do not apply to Solera National Bancorp because the Company did not issue trust preferred securities before September 28, 2005. To continue to qualify for the exemption from the capital adequacy guidelines, small bank holding companies (i) must be well-capitalized,

SOLERA NATIONAL BANCORP, INC.

(ii) are subject to debt retirement requirements, and (iii) are subject to certain debt-to-equity ratios, generally including a restriction on paying dividends if the bank holding company’s debt to equity ratio is not one-to-one or less.

Failure to meet capital guidelines could subject a bank or bank holding company to a variety of enforcement remedies, including issuance of a capital directive, the termination of deposit insurance by the FDIC, a prohibition on accepting brokered deposits, and other restrictions on its business.

Concentrated Commercial Real Estate Lending Regulations. The OCC, along with the Federal Reserve and the FDIC, has promulgated guidance governing financial institutions with concentrations in commercial real estate lending. The guidance provides that a bank has a concentration in commercial real estate lending if (i) total reported loans for construction, development, and other land represent 100% or more of total risk-based capital or (ii) total reported loans secured by multifamily and non-owner occupied, non-farm non-residential properties and loans for construction, development, and other land represent 300% or more of total risk-based capital and the outstanding balance of such loans has increased 50% or more during the prior 36 months. At December 31, 2013, Solera National Bank’s ratios were 6% and 88%, respectively, well below the regulatory guideline for highly concentrated loans in commercial real estate. If a concentration is present, management must employ heightened risk management practices including board and management oversight and strategic planning, development of underwriting standards, risk assessment and monitoring through market analysis and stress testing, and increasing capital requirements.

Prompt Corrective Action Regulations. Under the prompt corrective action regulations, the FDIC is required and authorized to take supervisory actions against undercapitalized banks. For this purpose, a bank is placed in one of the following five categories based on the Bank’s capital:


•	well-capitalized (at least 5% leverage capital, 6% Tier 1 risk-based capital and 10% total risk-based capital);


•	adequately capitalized (at least 4% leverage capital, 4% Tier 1 risk-based capital and 8% total risk-based capital);


•	undercapitalized (less than 8% total risk-based capital, 4% Tier 1 risk-based capital or 3% leverage capital);


•	significantly undercapitalized (less than 6% total risk-based capital, 3% Tier 1 risk-based capital or 3% leverage capital); and


•	critically undercapitalized (less than 2% tangible capital).

Federal banking regulators are required to take various mandatory supervisory actions and are authorized to take other discretionary actions with respect to institutions in the three undercapitalized categories. The severity of the action depends upon the capital category in which the institution is placed. Generally, subject to a narrow exception, banking regulators must appoint a receiver or conservator for an institution that is “critically undercapitalized.” The federal banking agencies have specified by regulation the relevant capital level for each category. An institution that is categorized as “undercapitalized,” “significantly undercapitalized,” or “critically undercapitalized” is required to submit an acceptable capital restoration plan to its appropriate federal banking agency. A bank holding company must guarantee that a subsidiary depository institution meets its capital restoration plan, subject to various limitations. The controlling holding company’s obligation to fund a capital restoration plan is limited to the lesser of 5% of an “undercapitalized” subsidiary’s assets at the time it became “undercapitalized” or the amount required to meet regulatory capital requirements. An “undercapitalized” institution is also generally prohibited from increasing its average total assets, making acquisitions, establishing any branches or engaging in any new line of business, except under an accepted capital restoration plan or with FDIC approval. The regulations also establish procedures for downgrading an institution to a lower capital category based on supervisory factors other than capital.

Restrictions on Transactions with Affiliates and Loans to Insiders. Solera National Bancorp and Solera National Bank are subject to the provisions of Section 23A of the Federal Reserve Act. These provisions place limits on the amount of:


•	the Bank’s loans or extensions of credit to affiliates;


•	the Bank’s investment in affiliates;


•	assets that the Bank may purchase from affiliates, except for real and personal property exempted by the Federal Reserve;


•	the amount of loans or extensions of credit to third parties collateralized by the securities or obligations of affiliates; and


•	the Bank’s guarantee, acceptance or letter of credit issued on behalf of an affiliate.

SOLERA NATIONAL BANCORP, INC.

The total amount of the above transactions is limited in amount, as to any one affiliate, to 10% of the Bank’s capital and surplus and, as to all affiliates combined, to 20% of its capital and surplus. In addition to the limitation on the amount of these transactions, each of the above transactions must also meet specified collateral requirements. The Bank must also comply with other provisions designed to avoid the taking of low-quality assets.

Solera National Bancorp and Solera National Bank are also subject to the provisions of Section 23B of the Federal Reserve Act which, among other things, prohibit the Bank from engaging in any transaction with an affiliate unless the transaction is on terms substantially the same, or at least as favorable to the Bank or its subsidiaries, as those prevailing at the time for comparable transactions with nonaffiliated companies.

The Bank is also subject to restrictions on extensions of credit to its executive officers, directors, principal stockholders and their related interests. These types of extensions of credit (1) must be made on substantially the same terms, including interest rates and collateral, as those prevailing at the time for comparable transactions with third parties and (2) must not involve more than the normal risk of repayment or present other unfavorable features.

Privacy. Financial institutions are required to disclose their policies for collecting and protecting confidential information. Customers generally may prevent financial institutions from sharing personal financial information with nonaffiliated third parties except for third parties that market the institutions’ own products and services. Additionally, financial institutions generally may not disclose consumer account numbers and other customer information to any nonaffiliated third party for use in telemarketing, direct mail marketing or other marketing through electronic mail to consumers.

Bank Secrecy Act. Congress enacted the Bank Secrecy Act (“BSA”) as a tool for the U.S. government to help identify the source, volume, and movement of currency and other monetary instruments transported or transmitted into and out of the United States or deposited in financial institutions. These records enable law enforcement and regulatory agencies to pursue investigation of criminal, tax, and regulatory violations, if warranted, and provide evidence useful in prosecuting money laundering and other financial crimes. The Money Laundering Control Act augmented the BSA’s effectiveness by directing banks to establish and maintain procedures reasonably designed to ensure and monitor compliance with the reporting and recordkeeping requirements of the BSA. The Annunzio-Wylie Anti-Money Laundering Act (“AML”) further strengthened the sanctions for BSA violation and the role of the U.S. Treasury. In addition, the Suspicious Activity Report (“SAR”) was developed in 1996. All banking organizations are required to file a SAR whenever a known or suspected criminal violation of federal law or a suspicious transaction related to money laundering activity or a violation of the BSA is detected. The Office of Foreign Asset Control (“OFAC”) requirements are separate and distinct from the BSA, but both OFAC and the BSA share a common national security goal. Solera National Bank has BSA, AML, and OFAC compliant policies, procedures and programs.

Anti-terrorism Legislation. In the wake of the tragic events of September 11, 2001, President Bush signed into law the Uniting and Strengthening America by Providing Appropriate Tools Required to Intercept and Obstruct Terrorism Act of 2001. Also known as the “USA Patriot Act,” the law enhances the powers of the federal government and law enforcement organizations to combat terrorism, organized crime and money laundering. The USA Patriot Act significantly amended and expanded the application of the Bank Secrecy Act, including enhanced measures regarding customer identity, suspicious activity reporting rules and enhanced anti-money laundering programs.

Under the USA Patriot Act, financial institutions are subject to prohibitions against specified financial transactions and account relationships as well as enhanced due diligence and “know your customer” standards in their dealings with foreign financial institutions and foreign customers. For example, the enhanced due diligence policies, procedures and controls generally require financial institutions to take reasonable steps:


•	to conduct enhanced scrutiny of account relationships to guard against money laundering and report any suspicious transaction; and


•	to ascertain the identity of the nominal and beneficial owners of, and the source of funds deposited into, each account as needed to guard against money laundering and report any suspicious transactions.

Under the USA Patriot Act, financial institutions must also establish anti-money laundering programs. The USA Patriot Act sets forth minimum standards for these programs, including: (i) the development of internal policies, procedures and controls; (ii) the designation of a compliance officer; (iii) an ongoing employee training program; and (iv) an independent audit function to test the programs.

SOLERA NATIONAL BANCORP, INC.

In addition, the USA Patriot Act requires the bank regulatory agencies to consider the record of a bank in combating money laundering activities in their evaluation of bank merger or acquisition transactions. Regulations proposed by the U.S. Department of the Treasury to effectuate certain provisions of the USA Patriot Act provide that all transaction or other correspondent accounts held by a U.S. financial institution on behalf of any foreign bank must be closed within 90 days after the final regulations are issued, unless the foreign bank has provided the U.S. financial institution with a means of verification that the institution is not a “shell bank.” Proposed regulations interpreting other provisions of the USA Patriot Act are continuing to be issued.

Under the authority of the USA Patriot Act, the Secretary of the Treasury adopted rules on September 26, 2002 increasing the cooperation and information sharing among financial institutions, regulators and law enforcement authorities regarding individuals, entities and organizations engaged in, or reasonably suspected based on credible evidence of engaging in, terrorist acts or money laundering activities. Under these rules, a financial institution is required to:


•	expeditiously search its records to determine whether it maintains or has maintained accounts, or engaged in transactions with individuals or entities, listed in a request submitted by the Financial Crimes Enforcement Network, or FinCEN;


•	notify FinCEN if an account or transaction is identified;


•	designate a contact person to receive information requests;


•	limit use of information provided by FinCEN to: (1) reporting to FinCEN, (2) determining whether to establish or maintain an account or engage in a transaction and (3) assisting the financial institution in complying with the Bank Secrecy Act; and


•	maintain adequate procedures to protect the security and confidentiality of FinCEN requests.

Under the information sharing between the government agencies and financial institution rule, a financial institution may also share information regarding individuals, entities, organizations and countries for purposes of identifying and, where appropriate, reporting activities that it suspects may involve possible terrorist activity or money laundering.

The Secretary of the Treasury also adopted a rule on September 26, 2002 intended to prevent money laundering and terrorist financing through correspondent accounts maintained by U.S. financial institutions on behalf of foreign banks. Under the rule, financial institutions: (i) are prohibited from providing correspondent accounts to foreign shell banks; (ii) are required to obtain a certification from foreign banks for which they maintain a correspondent account stating the foreign bank is not a shell bank and that it will not permit a foreign shell bank to have access to the U.S. account; (iii) must maintain records identifying the owner of the foreign bank for which they may maintain a correspondent account and its agent in the United States designated to accept services of legal process; and (iv) must terminate correspondent accounts of foreign banks that fail to comply with or fail to contest a lawful request of the Secretary of the Treasury or the Attorney General of the United States, after being notified by the Secretary or Attorney General.

Sarbanes-Oxley Act of 2002. The Sarbanes-Oxley Act of 2002 was enacted in response to public concerns regarding corporate accountability in connection with certain accounting scandals. The stated goals of the Sarbanes-Oxley Act are to increase corporate responsibility, to provide for enhanced penalties for accounting and auditing improprieties at publicly traded companies, and to protect investors by improving the accuracy and reliability of corporate disclosures pursuant to the securities laws.

The Sarbanes-Oxley Act includes specific additional disclosure requirements, requires the Securities and Exchange Commission and national securities exchanges to adopt extensive additional disclosure, corporate governance and other related rules, and mandates further studies of certain issues by the Securities and Exchange Commission. The Sarbanes-Oxley Act represents significant federal involvement in matters traditionally left to state regulatory systems, such as the regulation of the accounting profession, and to state corporate law, such as the relationship between a Board of Directors and management and between a Board of Directors and its committees.

The Company has incurred additional expense in complying with the provisions of the Sarbanes-Oxley Act and the regulations that have been promulgated to implement the Sarbanes-Oxley Act, particularly those regulations relating to the establishment of internal controls over financial reporting.

Proposed Legislation and Regulatory Action. New regulations and statutes are regularly proposed that contain wide-ranging proposals for altering the structures, regulations and competitive relationships of financial institutions operating in the United States. The Company cannot predict whether or in what form any proposed regulation or statute will be adopted or the extent to which its business may be affected by any new regulation or statute.

SOLERA NATIONAL BANCORP, INC.

Effect of Governmental Monetary Policies. The commercial banking business is affected not only by general economic conditions but also by the fiscal and monetary policies of the Federal Reserve. Some of the instruments of fiscal and monetary policy available to the Federal Reserve include changes in the discount rate on member bank borrowings, the fluctuating availability of borrowings at the “discount window,” open market operations, the imposition of and changes in reserve requirements against banks’ deposits and assets of foreign branches, the imposition of and changes in reserve requirements against certain borrowings by banks and their affiliates, and the placing of limits on interest rates that banks may pay on time and savings deposits. Such policies influence to a significant extent the overall growth of bank loans, investments, and deposits and the interest rates charged on loans or paid on time and savings deposits. The Company cannot predict the nature of future fiscal and monetary policies and the effect of such policies on the future business and its earnings.

All of the above laws and regulations add to the cost of operating the Company and the Bank.

Item 1A. Risk Factors

The reader should carefully consider the following risk factors and all other information contained in this Report in connection with ownership of or investment in the Company’s securities. These risks and uncertainties are not the only ones faced by the Company or the Bank. Additional risks and uncertainties not presently known to the Company or that the Company currently believes are immaterial also may impair the business of the Company or the Bank. If any of the events described in the following risk factors occur, the Company’s and the Bank’s business, results of operations and financial condition could be materially adversely affected. In addition, the trading price of the Company’s stock could decline due to any of the events described in these risks.

The Company faces a potential proxy contest at the 2014 annual meeting of stockholders. The outcome of this contest could have substantial impact on the strategic direction of the Company and the Company's financial performance.

On February 20, 2014, Michael D. Quagliano, the largest stockholder of the Company, owning approximately 22% of our common stock, filed Amendment No. 2 to Schedule 13D to alert the Company and other stockholders that he is likely to propose a slate of nominees for election as directors at the Company's 2014 Annual Meeting to be held on May 22, 2014. He has subsequently presented the Company with a slate of nominees. Additionally, Mr. Quagliano has proposed an amendment to the bylaws of the Company to reduce the size of the board of directors. In addition, Ms. Kathleen Stout, the former executive vice president of the Company and the former President of its residential mortgage department, also provided the Company with notice of her intent to nominate other persons to the board of directors at our 2014 annual meeting of stockholders.

The Company could incur significant legal fees and proxy solicitation expenses in connection with these matters. Further, the Company could be adversely impacted as a result of its limited resources and significant attention of its management being temporarily diverted from day-to-day business operations. This conflict could also adversely impact the perception of the stability of the Bank by regulators, depositors and our stockholders.

Changes in interest rates can result in volatility of our mortgage banking revenues and earnings.

The Bank's residential mortgage banking activity constitutes a significant portion of its total operations. An increase in mortgage interest rates generally leads to a decrease in demand for mortgage loans, which reduces income from loans originated for sale to secondary market investors thereby adversely impacting our earnings. We experienced this in the second half of 2013. The Bank has developed a stress testing model to measure the correlation between changing interest rates and residential mortgage loan production. The stress testing model, along with our capacity planning model, assists management in making informed and timely decisions regarding appropriate staffing levels in the mortgage operations department. However, there can be no guarantee that we will be able to adjust staffing levels sufficiently to avoid operating losses during periods of low volume production.

SOLERA NATIONAL BANCORP, INC.

Our financial performance may be adversely affected by conditions in the financial markets and economic conditions generally.

The Company’s financial performance generally, and in particular the ability of borrowers to pay interest on and repay principal of outstanding loans and leases and the value of collateral securing those loans and leases, is highly dependent upon the business environment primarily in the Front Range of Colorado, which includes the Denver metropolitan area. A favorable business environment is generally characterized by, among other factors, economic growth, efficient capital markets, low inflation, high business and investor confidence, and strong business earnings. Unfavorable or uncertain economic and market conditions can be caused by: declines in economic growth, housing and real estate values, business activity, or lowered investor or business confidence; limitations on the availability or increases in the cost of credit and capital; increases in inflation or interest rates; natural disasters; or a combination of these or other factors.

Periods of weakened market conditions could materially and adversely affect the credit quality of our loans, and therefore, our results of operations and financial condition. Weakened financial market and economic conditions during 2008-2011 negatively impacted the Company’s operations during that time.

Weakness in the economic environment could reduce our customer base and demand for financial products such as loans.

Our success significantly depends upon the growth in population, income levels, and strength in the housing market. If the communities in which we operate do not grow or if prevailing economic conditions do not continue to improve, our business may be adversely impacted. Borrowers will be less likely to repay their loans as scheduled. Moreover, the value of real estate or other collateral that secures our loans could be further negatively affected. Unlike many larger institutions, we are not able to spread the risks of unfavorable local economic conditions across a large number of diversified economies. Continued economic weakness could, therefore, result in losses that materially and adversely affect our business.

Interest rate volatility could adversely impact our business.

Our results of operations are affected by the monetary and fiscal policies of the federal government and the regulatory policies of governmental authorities. A significant component of our earnings is our net interest income. Net interest income is the difference between income from interest-earning assets, such as loans and investments, and the expense of interest-bearing liabilities, such as deposits and borrowed funds. In particular, changes in relative interest rates may reduce our net interest income as the difference between interest income and interest expense decreases. As a result, we have adopted asset and liability management policies and utilize interest rate risk measurement tools to minimize the potential adverse effects of changes in interest rates on net interest income. However, there can be no assurance that a change in interest rates will not negatively impact our results from operations or financial position. Since market interest rates may change by differing magnitudes and at different times, significant changes in interest rates over an extended period of time could reduce overall net interest income. An increase in interest rates could also have a negative impact on our results of operations by reducing the ability of borrowers to repay their current loan obligations, which could lead to increased loan defaults, foreclosures and write-offs, and necessitate further increases to our allowance for loan and lease losses.

We continue to hold other real estate owned (“OREO”) properties, which has led to increased operating costs and vulnerability to declines in real estate values.

In the ordinary course of our business, we foreclose and take title to the real estate that serves as collateral on defaulted loans. During 2013 and 2012, we incurred expenses related to the operation of two OREO properties we have held since 2010. We expect that our 2014 operating results will be negatively impacted as we continue to incur costs associated with owning and operating these properties. Further, we are subject to potential declines in market values associated with these properties which could lead to write-downs of the property’s value and a corresponding expense to our income statement. During 2013, one of our OREO properties experienced a decline in market value such that the property was considered partially impaired. We cannot predict, with certainty, how long it will take to dispose of these properties, or whether the properties will become further impaired.

The value of our available-for-sale investment securities may be negatively affected by changes in securities markets.

The market for some of the investment securities held in our portfolio has been somewhat volatile over the past several years. Volatile market conditions may detrimentally affect the value of these securities due to the perception of heightened credit and liquidity risks. As interest rates increase, the value of our investments would likely decline. There can be no assurance that declines in market value will not result in other than temporary impairments of these assets, which would lead to accounting charges that could have a material adverse effect on our net income and capital levels.

SOLERA NATIONAL BANCORP, INC.

Departures of key personnel may impair the Bank’s operations and adversely affect the Company’s financial results.

Our success depends, in large part, on our ability to attract and retain key personnel. Competition for qualified personnel can be strong and we may not be able to hire or retain the key personnel that we depend upon for success. The unexpected loss of services of one or more key persons could have a material adverse impact on our business because of their skills, knowledge of the markets in which we operate, years of industry experience and the difficulty of finding qualified replacement personnel in a timely manner. Departures of key personnel may also result in significant charges to earnings as it did in 2013 with the departure of two senior executives.

Solera National Bank faces significant competition from a variety of competitors.

Competition in the banking and financial services industry is strong. In our market, we compete for loans, deposits and other financial products and services with local independent banks, national and super-regional banks, savings institutions, and credit unions, among others. Many of our competitors have competitive advantages, including greater financial resources and higher lending limits, a wider geographic presence, more accessible branch office locations, the ability to offer a wider array of services or more favorable pricing alternatives, as well as lower origination and operating costs. Because we maintain a smaller staff and have fewer financial and other resources than larger institutions with which we compete, we may be limited in our ability to attract customers.

We believe that Solera National Bank has emerged as a viable competitor in the market area in which we operate. However, if we are unable to attract and retain customers, we may be unable to achieve further growth in the loan and core deposit portfolios, and our results of operations and financial condition may be negatively impacted.

Management of the Bank may be unable to adequately measure and limit credit risk associated with our loan portfolio, which would affect our profitability.

As a material part of the Bank’s business plan, we make various types of commercial and consumer loans. The principal economic risk associated with each loan is the creditworthiness of the borrower, which is affected by the strength of the relevant business market segment, local market conditions and general economic conditions. If the Bank is unable to effectively measure and limit the risk of default associated with its loan portfolio, our profitability will likely be adversely impacted.

We are exposed to higher credit risk from commercial real estate, commercial business, and construction lending that is highly dependent on market conditions in the Colorado Front Range.

Commercial real estate, commercial business, and construction lending usually involve higher credit risks than that of single-family residential lending. These types of loans involve larger loan balances to a single borrower or groups of related borrowers. Commercial real estate loans may be affected to a greater extent than residential loans by adverse conditions in real estate markets or the economy because commercial real estate borrowers’ ability to repay their loans depends on successful development of their properties, as well as the factors affecting residential real estate borrowers. Unlike larger banks that are more geographically diversified, we provide services primarily to the Front Range of Colorado. Due to our concentration of operations in the Front Range, we are dependent on the local economic conditions in our market area that could result in higher credit risks to us if the population or income growth along the Colorado Front Range is slower than projected. Our underwriting, review, and monitoring cannot eliminate all of the risks related to commercial real estate, commercial business, and construction lending loans.

Our allowance for loan and lease losses may be insufficient.

We maintain an allowance for loan and lease losses, which is a reserve established through a provision for probable loan and lease losses charged to expense. This allowance represents management’s best estimate of probable losses that may exist within the existing portfolio of loans. The determination of the appropriate level of the allowance for probable loan and lease losses inherently involves a high degree of subjectivity and requires us to make significant estimates and assumptions regarding current credit risks and future trends, all of which may undergo material changes. Changes in economic conditions affecting the value of properties used as collateral for loans, problems affecting the creditworthiness of borrowers, new information regarding existing loans, identification of additional problem loans and other factors, both within and outside our control, may require an increase in the allowance for probable loan and lease losses. In addition, bank regulatory agencies periodically review our allowance for loan and lease losses and may require an increase in the provision for probable loan and lease losses or the recognition of further loan charge-offs, based on judgments different than those of management. If charge-offs in future periods exceed the allowance for probable loan losses, we will need additional provisions to increase the allowance for probable loan losses. Any increases in the allowance for probable loan losses will result in a decrease in net income and could have a material adverse effect on our financial condition and results of operations.

SOLERA NATIONAL BANCORP, INC.

Substantial changes to mortgage banking rules and regulations may expose our mortgage lending department to increased operational and compliance risk.

The CFPB has issued a rule designed to clarify how lenders can avoid legal liability under the Dodd-Frank Act, which would hold lenders accountable for ensuring a borrower’s ability to repay a mortgage. Loans that meet the definition of “qualified mortgage’ will be presumed to have complied with the new ability-to-repay standard. The CFPB’s rule on qualified mortgages and similar rules could limit our ability to make certain types of loans or loans to certain borrowers, or could make it more expensive and time-consuming to make these loans, which could limit our growth or profitability.

We may be required to repurchase residential mortgage loans which may result in losses or reduction in capital.

The Bank, through its residential mortgage department, routinely sells residential mortgage loans to various third party investors. The Bank may be required under repurchase obligations, to repurchase a loan in the event of failure to timely cure a material breach, or to repay the gain on sale if there is an early payment default. If an investor executes its repurchase obligation provision, the Bank would have the option to either include the loan in its loan portfolio and to service the loan during the period held, or to sell the loan. There can be no guarantee that the sale of such a loan would be at or above the carrying value of the loan, which would require immediate loss recognition and reduction of capital.

Funding to provide liquidity may not be available to us on favorable terms, or at all.

Liquidity is the ability to meet cash flow needs on a timely basis at a reasonable cost. The liquidity of Solera National Bank is used to make loans and to repay deposit liabilities as they become due or are demanded by customers. Liquidity policies and limits are established by the Board of Directors. Management regularly monitors the overall liquidity position of the Bank to ensure that various alternative strategies exist to cover unanticipated events that could affect liquidity. Management monitors guidelines to diversify the Bank’s funding sources to avoid concentrations in excess of Board-approved policies. Funding sources include primarily federal funds purchased and deposits. The Bank is also a member of the Federal Home Loan Bank System, which provides funding through collateralized advances to members.

We maintain a portfolio of investment securities that can be used as a secondary source of liquidity. There are other sources of liquidity available to us should they be needed. These sources include sales of loans, and our ability to acquire additional national market, non-core deposits. The Bank can also borrow from the Federal Reserve’s discount window.

There is no assurance that we will be able to obtain such liquidity on terms that are favorable to us, or at all. If we were unable to access any of these funding sources when needed, we might be unable to meet customers’ needs, which could adversely impact our financial condition, results of operations, cash flows and liquidity, and level of regulatory-qualifying capital.

We may not be able to raise additional capital on terms favorable to us.

We are required by regulatory authorities to maintain adequate levels of capital to support our operations. To support our continued growth, or replenish capital as a result of losses, we may need to raise additional capital. Our ability to raise additional capital, if needed, will depend in part on conditions in the capital markets at that time, which are outside our control. Accordingly, we cannot assure you of our ability to raise additional capital, if needed, on terms acceptable to us. If we cannot raise additional capital when needed, our ability to further expand operations through internal growth and acquisitions could be materially impaired. In addition, if we decide to raise additional equity capital, the share ownership of our existing stockholders would likely be diluted.

The liquidity of our common stock is affected by its limited trading market.

The Company’s shares do not, at this time, qualify for listing on any national securities exchange and trading volume is limited. We cannot assure investors that our shares will ever be listed on a national securities exchange. However, our shares are traded over-the-counter (OTCQB) and several broker/dealers make a market in our common stock. Because our shares are not listed on a national securities exchange, we cannot assure you that a broadly followed, established trading market for our common stock will ever develop or be maintained. The absence of an active trading market reduces liquidity, and we believe our low trading volume has had an adverse effect on the market prices of our shares. The trading price of our common stock may also be affected by numerous other factors, including, but not limited to trends in our industry and expectations of future financial performance regardless of our actual operating performance.

SOLERA NATIONAL BANCORP, INC.

Offerings of new products and services may subject us to additional risks.

Customer demands may lead us to offer new products and services which create new risks and uncertainties. We may invest significant time and resources in deploying these offerings, and we may not meet our established timelines or profitability goals associated with the products or services. Furthermore, we may encounter difficulties from competitive alternatives, shifting market preferences or compliance with regulations that impact our offerings. Managing these risks is critical to the development and implementation of new products and services and failure to do so may significantly impact our business, results of operations and financial condition.

The potential for business interruption exists throughout our organization.

We rely on third-party service providers for much of our communication, information, operating and financial control systems technology, including our internet banking services and data processing systems. The failure of these vendors to perform in accordance with the terms of a service agreement for any reason could be disruptive to our operations, which could have a material adverse impact on our business and, in turn, our financial condition and results of operations. Additionally, a breach of the vendor’s technology may also cause reimbursable loss to our consumer and business customers, through no fault of our own. Liability arising from such a security breach or fraud attack could have a material adverse impact on our business and, in turn, our financial condition and results of operations.

Managing reputational risk is important to attracting and maintaining customers, investors and employees.

Threats to the Company's reputation can come from many sources, including but not limited to unethical practices, employee misconduct, failure to deliver minimum standards of service or quality, compliance deficiencies, and questionable or fraudulent activities of our customers. We have policies and procedures in place to protect our reputation and promote ethical conduct, but these policies and procedures may not be fully effective. Negative publicity regarding our business, employees, or customers, with or without merit, may result in the loss of customers, investors and employees, costly litigation, a decline in revenues and increased governmental regulation.

Existing and proposed government regulations that, when adopted, may have an adverse effect on our profitability and growth.

Bank holding companies (BHCs) and national banking associations operate in a highly regulated environment and are subject to supervision, regulation and examination by various federal regulatory agencies, as well as other governmental agencies in the states in which they operate. Federal and state laws and regulations govern numerous matters including changes in the ownership or control of banks and BHCs, maintenance of adequate capital, the financial condition of the Company, permissible types, amounts and terms of extensions of credit and investments, permissible non-banking activities, the level of reserves against deposits and restrictions on dividend payments. The OCC possesses cease and desist powers to prevent or remedy unsafe or unsound practices or violations of law by banks subject to their regulation, and the FRB possesses similar powers with respect to BHCs. These and other restrictions limit the manner in which we may conduct business.

Due to the nature of our business, we may be subject to litigation from time to time, some of which may not be covered by insurance.

As a holding company and through our bank subsidiary, we operate in a highly regulated industry and as a result, are subject to various regulations related to disclosures to our customers, our lending practices, and other fiduciary responsibilities, including those to our stockholders. From time to time, we may become subject to legal actions relating to our operations that could involve claims for substantial monetary damages. During 2012, we were party to two legal matters, which were incidental to the operation of our business. These matters were settled prior to trial and resulted in $135,000 of legal settlement costs incurred by the Bank. Although the Company was confident it could successfully defend against the claims, we agreed to settle to avoid costly litigation and business distraction. Although we maintain insurance, the scope of this coverage may not provide us with full, or even partial, coverage against future legal claims. As a result, a judgment against us in any such litigation could have a material adverse effect on our financial condition and results of operations.

Our deposit insurance premiums could increase in the future, which could have an adverse impact to future earnings.

The FDIC insures deposits at FDIC-insured financial institutions, including the Bank. The FDIC charges insured financial institutions premiums to maintain the Deposit Insurance Fund (DIF) at a certain level. If the risk category of the Bank changes adversely, our FDIC insurance premiums could increase. Additionally, the FDIC may further increase or decrease the assessment rate schedule in order to manage the DIF to prescribed statutory target levels. An increase in the Risk Category for the Bank or in the assessment rates could have an adverse effect on the Bank's earnings. The FDIC may terminate deposit insurance if it determines the institution involved has engaged in or is engaging in unsafe or unsound banking practices, is in an unsafe or unsound condition, or has violated applicable laws, regulations or orders.

SOLERA NATIONAL BANCORP, INC.

We face risks associated with acquisitions or mergers.

As our Bank continues to grow, we may pursue, or be a party to, an acquisition or merger opportunity. Mergers and acquisitions bring risks, which may include, among other things:


•	difficulty of integrating the personnel, operations and systems of an acquired entity;


•	possible loss of key employees and customers of the acquired or merged entity;


•	potential disruption of our ongoing business;


•	difficulty in estimating the value of the acquired or merged entity;


•	inability of management to successfully execute the strategy associated with the acquisition or merger; and


•	potential changes in banking or tax laws or regulations that may affect the combined entity.

There can be no assurance that we will successfully overcome all risks associated with an acquisition or merger. We may devote a significant amount of time and effort to addressing these risks which could have a material adverse effect on our business.

We cannot assure that attractive acquisition or expansion opportunities will be made available to us in the future.

Our business strategy includes the continuance of internally-generated growth, as well as opportunistic acquisitions of competitors’ loans and deposits, or branches. We face competition from many types of financial institutions, which could increase prices for potential acquisitions that we believe are attractive. Expansion may also be hindered as a result of regulatory oversight. Regulators will consider among other things, our liquidity, capital, profitability and regulatory compliance in determining whether to approve a proposed acquisition or expansion. Failure to effectively manage our growth could have a material adverse effect on our business, future prospects, financial condition and results of operations and could affect our ability to successfully implement our business strategy.

During 2013, the Bank received approval from the OCC for the expansion of Bank operations to include a full-service branch in our existing Boulder office space, and approval to open a full-service branch in an office building leased in the Cherry Creek neighborhood of Denver. Subsequently, market conditions changed such that expansion was not considered an attractive option for the Company. Termination charges for our planned expansion efforts are included in other general and administrative expenses on our Consolidated Statements of Operations and Comprehensive (Loss) Income.

Our financial statements are based in part on assumptions and estimates, which, if wrong, could cause unexpected losses in the future.

Pursuant to U.S. generally accepted accounting principles, we are required to use certain assumptions and estimates in preparing our financial statements, including in determining the allowance for loan and lease losses and the fair value of certain assets and liabilities, among other items. If assumptions or estimates underlying our financial statements are incorrect, we may experience material losses. For additional information, see “Management’s Discussion and Analysis of Financial Condition and Results of Operations - Critical Accounting Policies.”

Our certificate of incorporation and bylaws, and the employment agreements of our executive officers, contain provisions that could make a takeover more difficult.

Our certificate of incorporation and bylaws include provisions designed to provide our Board of Directors with time to consider whether a hostile takeover offer is in our and our stockholders’ best interests, and could be utilized by our Board of Directors to deter a transaction that would provide stockholders with a premium over the market price of our shares. These provisions include the availability of authorized, but unissued shares for issuance from time to time at the discretion of our Board of Directors; bylaw provisions enabling our Board of Directors to increase the size of the board and to fill the vacancies created by the increase; and bylaw provisions establishing advance notice procedures with regard to business to be presented at a stockholder meeting or director nominations.

In addition, there are “change in control” provisions in the employment agreements of certain executive officers providing for lump-sum cash payments based on the officers' base compensation which may be a financial disincentive to any party desiring to obtain control of the Company.

These provisions may discourage potential acquisition proposals and could delay or prevent a change in control, including under circumstances in which our stockholders might otherwise receive a premium over the market price of our shares. These provisions may also have the effect of making it more difficult for third parties to cause the replacement of our current management and may limit the ability of our stockholders to approve transactions that they may deem to be in their best interests.

SOLERA NATIONAL BANCORP, INC.

Our directors and executive officers could have the ability to influence stockholder actions in a manner that may be adverse to your personal investment objectives.

As of March 10, 2014, our directors and executive officers owned, or had voting rights on 273,525 shares of our common stock, which represents 10.3% of the number of shares outstanding. Additionally, we issued warrants to our initial organizers and stock options to our directors and executive officers. If our executive officers and directors exercised all of their warrants, our directors and executive officers would own shares upon exercise representing as much as 15.9% of our then existing outstanding common stock. Moreover, although all of the stock options are not immediately exercisable by their terms, upon exercise of the stock options granted or vesting of restricted stock granted to our directors and executive officers, our directors and executive officers would own shares upon exercise/vesting representing as much as 24.8% of our then existing outstanding common stock based on number of shares outstanding.

Due to their significant ownership interests, our directors and executive officers will be able to exercise significant control over the management and affairs of Solera National Bancorp and Solera National Bank. For example, our directors and executive officers may be able to influence the outcome of director elections or block significant transactions, such as a merger or acquisition, or any other matter that might otherwise be approved by the non-affiliate stockholders.

Item 1B. Unresolved Staff Comments

None.

Item 2. Properties

The Bank’s main office, which is also the principal executive office of the Company, is located at 319 South Sheridan Boulevard, Lakewood, Colorado 80226. The Bank occupies a 6,218 square foot one-story freestanding building. The Bank also leases 3,518 square feet of space in Lakewood, Colorado that serves as administrative offices for our executive management, accounting and marketing functions. Additionally, the Bank has five residential mortgage loan production offices located in Colorado including, Boulder, two in Colorado Springs, the Denver Tech Center and Durango. The Bank has entered into lease agreements with respect to each of these locations. The aggregate commitments under the leases are set forth in Note 9 to the Consolidated Financial Statements included in this Form 10-K. Management anticipates adding additional leased space in 2014 to accommodate expected growth.

Item 3. Legal Proceedings

On March 12, 2014, Solera National Bancorp, Inc. filed a lawsuit against Mr. Michael D. Quagliano, John Frew, Lars Johnson, Jackson Lounsberry, Carlyle F. Griffin, Drew Quagliano and Melissa Allen (the "defendants") asserting that Mr. Quagliano failed to provide complete and proper notice as required by the Company's bylaws concerning the notice he delivered to the Company on February 20, 2014. The notice contained information concerning Mr. Quagliano's intention to nominate the defendants for election as directors at the Company's 2014 Annual Meeting of Stockholders. The Company seeks a declaratory judgment that the defendants have not complied with the Company's bylaws relating to the nomination of candidates for election as directors, that the defendants cannot stand for election at the meeting and that the election of any defendant as a director at the meeting would be invalid and of no effect. The case was filed in the Jefferson County, Colorado district court.

Item 4. Mine Safety Disclosures

Not applicable.

PART II

Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities

Market Price of Common Stock

The Company’s common stock is traded over the counter under the symbol “SLRK”. Corporate Stock Transfer is the Company’s transfer agent and registrar, and is able to respond to inquiries from stockholders on its website: www.corporatestock.com or at its mailing address: 3200 Cherry Creek Drive South, Suite #430, Denver, CO 80209. The

SOLERA NATIONAL BANCORP, INC.

following table sets forth the high and low sales prices of our stock for the periods indicated below. The table reflects inter-dealer prices, without retail mark-up, mark-down or commission, and may not represent actual transactions.



Year Ended December 31, 2013:	High		Low
First Quarter	$	5.60	$	5.45
Second Quarter	$	9.25	$	5.45
Third Quarter	$	7.80	$	7.15
Fourth Quarter	$	7.25	$	5.62



Year Ended December 31, 2012:	High		Low
First Quarter	$	4.00	$	3.30
Second Quarter	$	4.95	$	4.00
Third Quarter	$	4.75	$	4.35
Fourth Quarter	$	5.00	$	4.75

Holders

As of March 6, 2014, there were approximately 660 holders of record of our common stock.

Dividends

The Company has never declared or paid dividends on its common stock. In addition, the Company expects to retain future earnings, if any, for use in the operation and expansion of the Bank’s business and does not anticipate paying any cash dividends in the foreseeable future. Any determination to pay dividends in the future will be at the discretion of the Board of Directors and will, among other factors, depend upon regulatory requirements and restrictions, the Company’s results of operations, its financial condition and capital requirements. Because, it is a holding company, the Company conducts no material activities at this time other than holding the common stock of the Bank and its ability to pay dividends depends on the receipt of dividends from the Bank. The Board of Directors of the Bank intends to retain earnings to promote growth and build capital and to recover any losses incurred in prior periods. Accordingly, the Company does not expect to receive dividends from the Bank in the foreseeable future. In addition, banks and bank holding companies are both subject to certain regulatory restrictions on the payment of cash dividends. In the case of the holding company, for example, cash to pay dividends to stockholders of the holding company, is substantially dependent on the earnings of the Bank and the payment of dividends by the Bank to the holding company, as the Bank’s sole stockholder. The Bank is currently prohibited by the regulators from paying dividends without regulatory approval until the accumulated deficit has been eliminated. For additional discussion of legal and regulatory restrictions on the payment of dividends, see “Part I - Item 1. Business - Supervision and Regulation.”

Recent Sales of Unregistered Securities

None.

Issuer Purchases of Equity Securities

During 2013, there was no publicly announced plan to repurchase stock.

The following table provides information with respect to purchases made by or on behalf of the Company or any “affiliated purchaser” (as defined in Rule 10b-18(a)(3) under the Exchange Act) of our voting common stock during the fourth quarter of 2013.

SOLERA NATIONAL BANCORP, INC.



	Total Shares Purchased ⁽¹⁾	Average Price Paid per Share
October 1 to October 31, 2013	—	$	—
November 1 to November 30, 2013	—	—
December 1 to December 31, 2013	14,208	$	7.20

⁽¹⁾ These shares relate to the net settlement by employees related to vested, restricted stock awards. Net settlements represent instances where employees elect to satisfy their income tax liability related to the vesting of restricted stock through the surrender of a proportionate number of their vested shares to the Company.

Item 6. Selected Financial Data

As a smaller reporting company, this item is not required.

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

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

General

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

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

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

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

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

SOLERA NATIONAL BANCORP, INC.

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

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

Critical accounting policies

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

Allowance for loan and lease losses

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

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

At December 31, 2013, the Company had an allowance for loan and lease losses of $1.1 million. Management believes that this allowance for loan and lease losses is adequate to cover probable losses based on all currently available evidence. Future additions to the allowance for loan and lease losses may be required based on management’s continuing evaluation of the inherent risks in the portfolio. Additional provisions for loan losses may need to be recorded if the economy declines, the loan portfolio continues to increase, asset quality deteriorates, or the loss experience changes. Also, federal regulators, when reviewing the Bank’s loan portfolio in the future, may require the Bank to increase the allowance for loan and lease losses. Any increase in the allowance for loan and lease losses would have an adverse effect on earnings. An analysis of the allowance for loan and lease losses as well as its allocation among certain categories of the loan portfolio can be found in Part I - Item 1. Business - Asset Quality, above.

Share-based compensation

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

SOLERA NATIONAL BANCORP, INC.

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

Estimation of fair value

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

Impairment of investment securities

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

New accounting pronouncements

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

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

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


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

•

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


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


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

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

SOLERA NATIONAL BANCORP, INC.

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

Net Interest Income and Net Interest Margin

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

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



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

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

SOLERA NATIONAL BANCORP, INC.

⁽²⁾ Net loan origination costs of $58,000 and $3,000 for the twelve months ended December 31, 2013 and 2012, respectively, are included in the yield computation.

⁽³⁾ Yields on investment securities have not been adjusted to a tax-equivalent basis since the Company does not own any tax-free securities.

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

Table 2



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

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

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

SOLERA NATIONAL BANCORP, INC.

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

Provision and Allowance for Loan and Lease Losses

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

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

Noninterest Income

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

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



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

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

Noninterest Expense

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

Employee Compensation and Benefits

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

SOLERA NATIONAL BANCORP, INC.

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

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

Occupancy

Occupancy expense increased $533,000 due to the addition of five locations associated with residential mortgage operations. During the fourth quarter of 2013, the Bank terminated an office building lease agreement which was expected to commence during the first quarter of 2014. This space was expected to replace our corporate offices, provide space for commercial bankers and mortgage loan officers, as well as back-office operations. For now, our corporate offices are being leased on a month-to-month basis. Occupancy expense is expected to increase in 2014 as we add additional leased space to accommodate expected growth. However, the increase is not expected to be significant.

Professional Fees

Professional fees increased $52,000, or 12%, due primarily to the mortgage department, whose total professional fees were $46,000 for 2013. The fees related to costs incurred for internal audits, professional consulting fees and to a lesser extent, legal fees.

Other General and Administrative Expenses:



					Total Company				Increase/(Decrease)
($ in thousands)	2013 Segment Detail				Year Ended December 31,				Community Banking
Other general and administrative expenses:	Community Banking		Mortgage Banking		2013		2012		2013 vs 2012
Data processing	$	385	$	208	$	593	$	319	$	66
Other loan expenses	48		286		334		90		(42		)
Marketing and promotions	122		91		213		107		15
Regulatory and reporting fees	132		1		133		131		1
Directors’ fees