Description

Solera National Bank, SLRK, $7.70

Solera National Bank is a Lakewood, Colorado business-focused single-branch bank primarily serving the Denver metropolitan area. It has recently terminated the regulatory enforcement agreement with the OCC that it has operated under since November, 2014. It has zero NPA’s or REO, trades at just 90% P/TB and has been steadily improving its costs, growing its non-interest-bearing deposits and producing healthy ROA’s and ROE’s of approximately 1.25% and 9% (adjusted for DTA reversal and severance resolution). It is very rare to see such a clean bank that is at the sweet spot of combining growth and improving efficiencies.

This is a thinly traded stock and only suitable for smaller accounts. However, a rights offering contemplated for later in the year has the potential to shake some volume loose and create an opportunistic opening for interested investors.

Although well capitalized, the bank has begun taking steps to raise additional capital, and is targeting to file a registration statement in the third quarter for a proposed rights offering to existing shareholders. The primary shareholder owns 30.8% of the common shares, up from 23% before a proxy battle in 2014, and undoubtedly wishes to preserve his ownership stake.

The loan portfolio is approximately half commercial real estate (CRE) and just over a quarter residential real estate. The remaining quarter is nearly evenly split between consumer and C&I/construction-development.

The primary shareholder is Michael Quagliano, who serves as Chairman of the Board. Compensation for senior management is in line with the bank’s size, with the CFO, Chief Credit Officer and CEO earning total comp of $138k, $143k and $134k respectively.

Prior to this, compensation was out-of-control. As this article details, and keep-in-mind that this was a single-branch de novo, compensation and severance were concerning (http://www.denverpost.com/2014/05/23/soleras-financial-road-not-as-bumpy-as-dissident-shareholder-suggests/):

Its first CEO, Paul Ferguson was paid $195,000 — plus a $20,000 signing bonus. Robert Fenton, its initial chief financial officer and chief operating officer, $175,000. And Mark Martinez, its senior lending officer, $180,000.

With bonuses and options, it was even higher.

Though all three are gone today, the sting remains.

A year after he was hired, Ferguson was handed $187,000 on the way out. Martinez got $82,500 when he left in 2011. Fenton got $87,500 when he parted last year.

There were others.

Ferguson’s replacement, Douglas Crichfield, was paid $195,000. Add options and bonuses: $272,000. When he retired in July 2013, the board handed him $200,000 in severance.

And, until recently, Solera’s outsized board carried 13 directors who collectively pocketed $190,000 last year.

And all that executive compensation came when there were only 15 employees and a single location.

The bank was formed with the intention of targeting the area’s growing Hispanic community, but while its board of directors, which at one point held 23 members, was originally composed of prominent members of the community, the bank made only a handful of loans to Hispanics despite 40% of its deposits coming from that demographic. The bank explained that there was simply very little loan demand from its target community.

Subsequent to the 2014 proxy battle, the six-member board now has one Hispanic board member, and company communications emphasize that the bank is business-focused and has dropped the previous messaging. However, the bank is looking to solidify its original emphasis in other ways, acknowledging the commitment to its roots and purchasing its Lakewood location.

It makes sense to maintain a balance between acknowledging these roots while focusing on good banking. The Latino/Hispanic demographic is a major dynamic within the Colorado banking landscape. According to the previous management as part of their 2014 proxy campaign, Colorado is home to a sweeping demographic shift, with just over one million 2010 Hispanic population. This accounts for 21% of Colorado’s population while representing 42% percent of the overall state population growth between 2000 and 2010. The population in Denver is over 30% Latino or Hispanic. At the time of the 2014 proxy battle, the aforementioned 40% of deposits that came from the Hispanic community, while not nearly as much as one might expect given the bank’s roots and founding board composition, still seems to reflect being tapped into this growing population dynamic.

A good sense of the potential valuation of the bank is reflected in its 2013 acquisition of $6.0M deposits from the Lakewood branch of Liberty Savings, in which Solera paid a 7.8% deposit premium. While I do not believe a sale is imminent—quite the contrary, as the bank has long growth path in front of it, it makes sense to compare this transaction to the bank’s current market value. At a similar 8% deposit premium on year-end $126.3M in deposits and adjusting for the approximately 250k near-the-money options (9% dilution), the bank would be worth $11.75/share. While this may take some time to achieve, given the previous management’s lack of focus on building core deposits, it is clear that the current management is on well on track to transforming the deposit base increasingly into core, non-interest-bearing deposits.

In the meantime, the last vestiges of the 2014 proxy battle were resolved recently when the bank lost a court case regarding the severance pay due to its previous CEO. Clearly, this was an antagonistic process, with no love lost between the outgoing CEO and the current board chairman and controlling shareholder: http://www.denverpost.com/2016/09/27/solera-bank-lawsuit-fired-ceo/.

Of course, we’ve all read worse accounts of adversarial depositions, “offensive coughing” notwithstanding. It is remarkable how the bank historically catered generous contracts and severance to its managers and board members, and good to see that era come to an end.

The bank is clearly well-capitalized, with Tier 1 leverage ratio currently at 14.0%. The bank would still be considered well-capitalized at a ratio closer to 10.0%. At current ROA’s, this would suggest normalized earnings power is considerably stronger given the bank’s transition to a more efficient operation.

Note that earnings have more than turned the corner, with now ten consecutive quarters of positive earnings and a reversal of the DTA:

Here is a timeline of developments at Solera:

Catalyst

Valuation at 90% of tangible book value with rights offering suggested for later in the year.