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ALERUS FINANCIAL CORP - Quarter Report: 2019 September (Form 10-Q)

Table of Contents

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, DC 20549

 

FORM 10-Q

 

   QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the quarterly period ended September 30, 2019

 

   TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

Commission File Number: 001-39036

 

ALERUS FINANCIAL CORPORATION

(Exact name of registrant as specified in its charter)

 

Delaware

45-0375407

(State or other jurisdiction of incorporation or

(I.R.S. Employer Identification No.)

organization)

 

 

 

401 Demers Avenue

 

Grand Forks, ND

58201

(Address of principal executive offices)

(Zip Code)

 

(701) 795‑3200

(Registrant’s telephone number, including area code)

 

Securities registered pursuant to section 12(b) of the Act:

 

 

 

 

 

 

Title of each class

    

Trading symbol

    

Name of each exchange on which registered

Common Stock, par value $1.00 per share

 

ALRS

 

The Nasdaq Stock Market LLC

 

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 ☐ No 

 

Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). Yes      No ☐

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, smaller reporting company or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company” and “emerging growth company” in Rule 12b‑2 of the Exchange Act.

 

Large accelerated filer ☐

Accelerated filer ☐

Non-accelerated filer ☒

Smaller reporting company ☐

Emerging growth company ☒

 

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act.

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b‑2 of the Act). Yes   No ☒

 

The number of shares of the registrant’s common stock outstanding at November 7, 2019 was 17,049,439.

 

 

 

 

Table of Contents

Alerus Financial Corporation and Subsidiaries

 

Table of Contents

 

 

Page

Part 1 

FINANCIAL INFORMATION

 

Item 1. 

Consolidated Financial Statements

1

 

Consolidated Balance Sheets as of September 30, 2019 (Unaudited) and December 31, 2018

1

 

Consolidated Statements of Income (Unaudited) for the three and nine months ended September 30, 2019 and 2018

2

 

Consolidated Statements of Comprehensive Income (Unaudited) for the three and nine months ended September 30, 2019 and 2018

3

 

Consolidated Statements of Changes in Shareholders’ Equity (Unaudited) for the three and nine months ended September 30, 2019 and 2018

4

 

Consolidated Statements of Cash Flows (Unaudited) for the nine months ended September 30, 2019 and 2018

5

 

Notes to Consolidated Financial Statements (Unaudited)

7

Item 2. 

Management’s Discussion and Analysis of Financial Condition and Results of Operations

39

Item 3. 

Quantitative and Qualitative Disclosures About Market Risk

61

Item 4. 

Controls and Procedures

63

 

 

 

Part 2 

OTHER INFORMATION

 

Item 1. 

Legal Proceedings

63

Item 1A. 

Risk Factors

63

Item 2. 

Unregistered Sales of Equity Securities and Use of Proceeds

63

Item 3. 

Defaults Upon Senior Securities

64

Item 4. 

Mine Safety Disclosures

64

Item 5. 

Other Information

64

Item 6. 

Exhibits

65

 

 

 

Signatures 

 

66

 

 

 

Table of Contents

PART 1. FINANCIAL INFORMATION

Item 1 - Financial Statements

Alerus Financial Corporation and Subsidiaries

Consolidated Balance Sheets (Unaudited)

 

 

 

 

 

 

 

 

 

    

September 30, 

    

December 31, 

(dollars and shares in thousands, except per share data)

    

2019

    

2018

Assets

 

 

  

 

 

  

Cash and cash equivalents

 

$

61,174

 

$

40,651

Investment securities, at fair value

 

 

  

 

 

  

Trading

 

 

 —

 

 

1,539

Available-for-sale

 

 

278,716

 

 

250,174

Equity

 

 

2,675

 

 

3,165

Loans held for sale

 

 

66,021

 

 

14,486

Loans held for branch sale

 

 

 —

 

 

32,031

Loans

 

 

1,686,087

 

 

1,701,850

Allowance for loan losses

 

 

(22,984)

 

 

(22,174)

Net loans

 

 

1,663,103

 

 

1,679,676

Land, premises and equipment, net

 

 

21,150

 

 

21,743

Operating lease right-of-use assets

 

 

8,877

 

 

 —

Accrued interest receivable

 

 

7,412

 

 

7,645

Bank-owned life insurance

 

 

31,364

 

 

30,763

Goodwill

 

 

27,329

 

 

27,329

Other intangible assets

 

 

19,382

 

 

22,473

Servicing rights

 

 

4,146

 

 

4,623

Deferred income taxes, net

 

 

7,695

 

 

10,085

Other assets

 

 

29,267

 

 

32,687

Total assets

 

$

2,228,311

 

$

2,179,070

Liabilities and Stockholders’ Equity

 

 

  

 

 

  

Deposits

 

 

  

 

 

  

Noninterest-bearing

 

$

537,951

 

$

550,640

Interest-bearing

 

 

1,295,162

 

 

1,224,456

Total deposits

 

 

1,833,113

 

 

1,775,096

Deposits held for sale

 

 

 —

 

 

24,197

Short-term borrowings

 

 

 —

 

 

93,460

Long-term debt

 

 

58,775

 

 

58,824

Operating lease liabilities

 

 

9,401

 

 

 —

Accrued expenses and other liabilities

 

 

45,619

 

 

30,539

Total liabilities

 

 

1,946,908

 

 

1,982,116

Commitments and contingent liabilities ESOP-owned shares

 

 

 —

 

 

34,494

Stockholders’ equity

 

 

  

 

 

  

Preferred stock, $1 par value, 2,000,000 shares authorized: 0 issued and outstanding

 

 

 —

 

 

 —

Common stock, $1 par value, 30,000,000 shares authorized: 17,049,493 and 13,775,327 issued and outstanding

 

 

17,049

 

 

13,775

Additional paid-in capital

 

 

88,230

 

 

27,743

Retained earnings

 

 

173,039

 

 

159,037

Accumulated other comprehensive income (loss)

 

 

3,085

 

 

(3,601)

Total stockholders’ equity

 

 

281,403

 

 

196,954

Less ESOP-owned shares

 

 

 —

 

 

(34,494)

Total stockholders’ equity net ESOP-owned shares

 

 

281,403

 

 

162,460

Total liabilities and stockholders’ equity

 

$

2,228,311

 

$

2,179,070

 

See accompanying notes to consolidated financial statements (unaudited)

1

Table of Contents

Alerus Financial Corporation and Subsidiaries

Consolidated Statements of Income (Unaudited)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Three months ended

 

Nine months ended

 

 

September 30, 

 

September 30, 

(dollars and shares in thousands, except per share data)

    

2019

    

2018

    

2019

    

2018

Interest Income

 

 

 

 

 

 

 

 

 

 

 

 

Loans, including fees

 

$

21,886

 

$

20,576

 

$

65,171

 

$

59,594

Investment securities

 

 

  

 

 

  

 

 

  

 

 

  

Taxable

 

 

1,374

 

 

1,129

 

 

4,021

 

 

3,475

Exempt from federal income taxes

 

 

163

 

 

301

 

 

618

 

 

927

Other

 

 

202

 

 

191

 

 

603

 

 

475

Total interest income

 

 

23,625

 

 

22,197

 

 

70,413

 

 

64,471

Interest Expense

 

 

  

 

 

  

 

 

  

 

 

  

Deposits

 

 

3,506

 

 

1,790

 

 

9,802

 

 

4,481

Short-term borrowings

 

 

539

 

 

575

 

 

1,805

 

 

1,331

Long-term debt

 

 

899

 

 

903

 

 

2,714

 

 

2,688

Total interest expense

 

 

4,944

 

 

3,268

 

 

14,321

 

 

8,500

Net interest income

 

 

18,681

 

 

18,929

 

 

56,092

 

 

55,971

Provision for loan losses

 

 

1,498

 

 

1,530

 

 

5,515

 

 

7,080

Net interest income after provision for loan losses

 

 

17,183

 

 

17,399

 

 

50,577

 

 

48,891

Noninterest Income

 

 

  

 

 

  

 

 

  

 

 

  

Retirement and benefit services

 

 

15,307

 

 

15,536

 

 

46,142

 

 

46,873

Wealth management

 

 

3,896

 

 

3,685

 

 

11,385

 

 

10,948

Mortgage banking

 

 

8,135

 

 

5,318

 

 

19,739

 

 

13,551

Service charges on deposit accounts

 

 

447

 

 

442

 

 

1,321

 

 

1,333

Net gains (losses) on investment securities

 

 

48

 

 

13

 

 

357

 

 

119

Other

 

 

1,747

 

 

1,264

 

 

5,694

 

 

3,784

Total noninterest income

 

 

29,580

 

 

26,258

 

 

84,638

 

 

76,608

Noninterest Expense

 

 

  

 

 

  

 

 

  

 

 

  

Compensation

 

 

20,041

 

 

17,873

 

 

54,997

 

 

50,906

Employee benefits

 

 

4,600

 

 

4,314

 

 

15,188

 

 

13,606

Occupancy and equipment expense

 

 

2,700

 

 

2,698

 

 

8,086

 

 

8,215

Business services, software and technology expense

 

 

4,224

 

 

3,731

 

 

12,044

 

 

10,467

Intangible amortization expense

 

 

990

 

 

1,196

 

 

3,091

 

 

3,588

Professional fees and assessments

 

 

1,051

 

 

1,628

 

 

3,146

 

 

3,734

Marketing and business development

 

 

890

 

 

856

 

 

2,024

 

 

2,439

Supplies and postage

 

 

631

 

 

611

 

 

2,027

 

 

1,902

Travel

 

 

435

 

 

382

 

 

1,335

 

 

1,252

Mortgage and lending expenses

 

 

751

 

 

437

 

 

1,966

 

 

1,597

Other

 

 

1,014

 

 

610

 

 

2,198

 

 

2,708

Total noninterest expense

 

 

37,327

 

 

34,336

 

 

106,102

 

 

100,414

Income before income taxes

 

 

9,436

 

 

9,321

 

 

29,113

 

 

25,085

Income tax expense

 

 

2,332

 

 

1,951

 

 

7,225

 

 

5,252

Net income

 

$

7,104

 

$

7,370

 

$

21,888

 

$

19,833

Per Common Share Data

 

 

 

 

 

 

 

 

 

 

 

 

Basic earnings per common share

 

$

0.49

 

$

0.53

 

$

1.53

 

$

1.44

Diluted earnings per common share

 

$

0.48

 

$

0.52

 

$

1.49

 

$

1.41

Dividends declared per common share

 

$

0.14

 

$

0.13

 

$

0.42

 

$

0.39

Average common shares outstanding

 

 

14,274

 

 

13,777

 

 

13,957

 

 

13,759

Diluted average common shares outstanding

 

 

14,626

 

 

14,071

 

 

14,317

 

 

14,060

 

See accompanying notes to consolidated financial statements (unaudited)

2

Table of Contents

Alerus Financial Corporation and Subsidiaries

Consolidated Statements of Comprehensive Income (Unaudited)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Three months ended

 

Nine months ended

 

 

September 30, 

 

September 30, 

(dollars in thousands)

    

2019

    

2018

    

2019

    

2018

Net Income

 

$

7,104

 

$

7,370

 

$

21,888

 

$

19,833

Other Comprehensive Income, Net of Tax

 

 

  

 

 

  

 

 

  

 

 

  

Unrealized gains (losses) on available-for-sale securities

 

 

2,187

 

 

(1,351)

 

 

9,307

 

 

(5,978)

Reclassification adjustment for losses (gains) realized in income

 

 

(49)

 

 

(13)

 

 

(379)

 

 

(135)

Total other comprehensive income (loss), before tax

 

 

2,138

 

 

(1,364)

 

 

8,928

 

 

(6,113)

Income tax expense (benefit) related to items of other comprehensive income

 

 

538

 

 

(342)

 

 

2,242

 

 

(1,534)

Other comprehensive income (loss), net of tax

 

 

1,600

 

 

(1,022)

 

 

6,686

 

 

(4,579)

Total comprehensive income

 

$

8,704

 

$

6,348

 

$

28,574

 

$

15,254

 

See accompanying notes to consolidated financial statements (unaudited)

3

Table of Contents

Alerus Financial Corporation and Subsidiaries

Consolidated Statements of Changes in Stockholders’ Equity (Unaudited)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Three months ended September 30, 2019

 

 

 

 

 

 

 

 

 

 

 

Accumulated

 

 

 

 

 

 

 

 

 

 

 

Additional

 

 

 

 

Other

 

ESOP-

 

 

 

 

 

Common

 

Paid-in

 

Retained

 

Comprehensive

 

Owned

 

 

 

(dollars in thousands)

    

Stock

    

Capital

    

Earnings

    

Income (Loss)

    

Shares

    

Total

Balance as of June 30, 2019

 

$

13,816

 

$

28,676

 

$

169,788

 

$

1,485

 

$

(34,494)

 

$

179,271

Net income

 

 

 —

 

 

 —

 

 

7,104

 

 

 —

 

 

 —

 

 

7,104

Other comprehensive income (loss)

 

 

 —

 

 

 —

 

 

 —

 

 

1,600

 

 

 —

 

 

1,600

Common stock repurchased

 

 

(77)

 

 

(275)

 

 

(1,489)

 

 

 —

 

 

 —

 

 

(1,841)

Common stock dividends

 

 

 —

 

 

 —

 

 

(2,364)

 

 

 —

 

 

 —

 

 

(2,364)

ESOP repurchase obligation termination

 

 

 —

 

 

 —

 

 

 —

 

 

 —

 

 

34,494

 

 

34,494

Initial public offering of 3,289,000 shares of common stock net of issuance costs

 

 

3,289

 

 

59,515

 

 

 —

 

 

 —

 

 

 —

 

 

62,804

Stock-based compensation expense

 

 

 —

 

 

335

 

 

 —

 

 

 —

 

 

 —

 

 

335

Vesting of restricted stock

 

 

21

 

 

(21)

 

 

 —

 

 

 —

 

 

 —

 

 

 —

Balance as of September 30, 2019

 

$

17,049

 

$

88,230

 

$

173,039

 

$

3,085

 

$

 —

 

$

281,403

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Nine months ended September 30, 2019

 

 

 

 

 

 

 

 

 

 

 

Accumulated

 

 

 

 

 

 

 

 

 

 

 

Additional

 

 

 

 

Other

 

ESOP-

 

 

 

 

 

Common

 

Paid-in

 

Retained

 

Comprehensive

 

Owned

 

 

 

(dollars in thousands)

    

Stock

    

Capital

    

Earnings

    

Income (Loss)

    

Shares

    

Total

Balance as of December 31, 2018

 

$

13,775

 

$

27,743

 

$

159,037

 

$

(3,601)

 

$

(34,494)

 

$

162,460

Net income

 

 

 —

 

 

 —

 

 

21,888

 

 

 —

 

 

 —

 

 

21,888

Other comprehensive income (loss)

 

 

 —

 

 

 —

 

 

 —

 

 

6,686

 

 

 —

 

 

6,686

Common stock repurchased

 

 

(82)

 

 

(291)

 

 

(1,574)

 

 

 —

 

 

 —

 

 

(1,947)

Common stock dividends

 

 

 —

 

 

 —

 

 

(6,312)

 

 

 —

 

 

 —

 

 

(6,312)

ESOP repurchase obligation termination

 

 

 —

 

 

 —

 

 

 —

 

 

 —

 

 

34,494

 

 

34,494

Initial public offering of 3,289,000 shares of common stock net of issuance costs

 

 

3,289

 

 

59,515

 

 

 —

 

 

 —

 

 

 —

 

 

62,804

Stock-based compensation expense

 

 

13

 

 

1,317

 

 

 —

 

 

 —

 

 

 —

 

 

1,330

Vesting of restricted stock

 

 

54

 

 

(54)

 

 

 —

 

 

 —

 

 

 —

 

 

 —

Balance as of September 30, 2019

 

$

17,049

 

$

88,230

 

$

173,039

 

$

3,085

 

$

 —

 

$

281,403

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Three months ended September 30, 2018

 

 

 

 

 

 

 

 

 

 

 

Accumulated

 

 

 

 

 

 

 

 

 

 

 

Additional

 

 

 

 

Other

 

ESOP-

 

 

 

 

 

Common

 

Paid-in

 

Retained

 

Comprehensive

 

Owned

 

 

 

(dollars in thousands)

    

Stock

    

Capital

    

Earnings

    

Income (Loss)

    

Shares

    

Total

Balance as of June 30, 2018

 

$

13,778

 

$

26,664

 

$

149,541

 

$

(4,617)

 

$

(31,491)

 

$

153,875

Net income

 

 

 

 

 

 

7,370

 

 

 

 

 

 

7,370

Other comprehensive income (loss)

 

 

 

 

 

 

 —

 

 

(1,022)

 

 

 

 

(1,022)

Common stock repurchased

 

 

(2)

 

 

(6)

 

 

(32)

 

 

 

 

 

 

(40)

Common stock dividends

 

 

 —

 

 

 —

 

 

(1,829)

 

 

 

 

 

 

(1,829)

Net change in fair value of ESOP shares

 

 

 —

 

 

 —

 

 

 

 

 

 

(3,003)

 

 

(3,003)

Stock-based compensation expense

 

 

 —

 

 

237

 

 

 

 

 

 

 

 

237

Vesting of restricted stock

 

 

 —

 

 

 —

 

 

 

 

 

 

 

 

 —

Balance as of September 30, 2018

 

$

13,776

 

$

26,895

 

$

155,050

 

$

(5,639)

 

$

(34,494)

 

$

155,588

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Nine months ended September 30, 2018

 

 

 

 

 

 

 

 

 

 

 

Accumulated

 

 

 

 

 

 

 

 

 

 

 

Additional

 

 

 

 

Other

 

ESOP-

 

 

 

 

 

Common

 

Paid-in

 

Retained

 

Comprehensive

 

Owned

 

 

 

(dollars in thousands)

    

Stock

    

Capital

    

Earnings

    

Income (Loss)

    

Shares

    

Total

Balance as of December 31, 2017

 

$

13,699

 

$

26,040

 

$

140,986

 

$

(1,131)

 

$

(31,491)

 

$

148,103

Net income

 

 

 

 

 

 

19,833

 

 

 

 

 

 

19,833

Adjustment for adoption of ASU 2016-01

 

 

 

 

 

 

(71)

 

 

71

 

 

 

 

 —

Other comprehensive income (loss)

 

 

 

 

 

 

 —

 

 

(4,579)

 

 

 

 

(4,579)

Common stock repurchased

 

 

(11)

 

 

(39)

 

 

(212)

 

 

 

 

 

 

(262)

Common stock dividends

 

 

 

 

 

 

(5,486)

 

 

 

 

 

 

(5,486)

Net change in fair value of ESOP shares

 

 

 

 

 

 

 

 

 

 

(3,003)

 

 

(3,003)

Stock-based compensation expense

 

 

11

 

 

971

 

 

 

 

 

 

 

 

982

Vesting of restricted stock

 

 

77

 

 

(77)

 

 

 

 

 

 

 

 

 —

Balance as of September 30, 2018

 

$

13,776

 

$

26,895

 

$

155,050

 

$

(5,639)

 

$

(34,494)

 

$

155,588

 

See accompanying notes to consolidated financial statements (unaudited)

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Alerus Financial Corporation and Subsidiaries

Consolidated Statements of Cash Flows (Unaudited)

 

 

 

 

 

 

 

 

 

Nine months ended

 

 

September 30, 

(dollars in thousands)

    

2019

    

2018

Operating Activities

 

 

  

 

 

  

Net income

 

$

21,888

 

$

19,833

Adjustments to reconcile net income to net cash provided (used) by operating activities

 

 

  

 

 

  

Deferred income taxes

 

 

149

 

 

(1,907)

Provision for loan losses

 

 

5,515

 

 

7,080

Depreciation and amortization

 

 

6,503

 

 

6,591

Amortization and accretion of premiums/discounts on investment securities

 

 

832

 

 

1,227

Stock-based compensation

 

 

1,330

 

 

982

Increase in value of bank-owned life insurance

 

 

(601)

 

 

(602)

Realized loss (gain) on sale of branch

 

 

(1,544)

 

 

 —

Realized loss (gain) on sale of fixed assets

 

 

(541)

 

 

 —

Realized loss (gain) on forward sale derivatives

 

 

(7)

 

 

 —

Realized loss (gain) on rate lock commitments

 

 

12

 

 

(24)

Realized loss (gain) on sale of foreclosed assets

 

 

(120)

 

 

187

Realized loss (gain) on sale of investment securities

 

 

(379)

 

 

(135)

Realized loss (gain) on servicing rights

 

 

(213)

 

 

(497)

Net change in:

 

 

 

 

 

 

Securities held for trading

 

 

1,539

 

 

51

Loans held for sale

 

 

(51,535)

 

 

(9,734)

Accrued interest receivable

 

 

151

 

 

(993)

Other assets

 

 

3,287

 

 

6,707

Accrued expenses and other liabilities

 

 

15,666

 

 

(1,417)

Net cash provided (used) by operating activities

 

 

1,932

 

 

27,349

Investing Activities

 

 

  

 

 

  

Proceeds from sales of investment securities available-for-sale

 

 

32,565

 

 

2,466

Proceeds from maturities of investment securities available-for-sale

 

 

27,818

 

 

26,120

Purchases of investment securities available-for-sale

 

 

(80,450)

 

 

(10,493)

Net (increase) decrease in equity securities

 

 

490

 

 

2,698

Net (increase) decrease in loans

 

 

14,213

 

 

(153,475)

Proceeds from sale of branch

 

 

10,379

 

 

 —

Proceeds from sale of fixed assets

 

 

875

 

 

 —

Purchases of premises and equipment

 

 

(2,450)

 

 

(2,314)

Proceeds from sales of foreclosed assets

 

 

1,006

 

 

687

Net cash provided (used) by investing activities

 

 

4,446

 

 

(134,311)

Financing Activities

 

 

  

 

 

  

Net increase (decrease) in deposits

 

 

53,241

 

 

(17,253)

Net increase (decrease) in short-term borrowings

 

 

(93,460)

 

 

43,930

Repayments of long-term debt

 

 

(181)

 

 

(128)

Cash dividends paid on common stock

 

 

(6,312)

 

 

(5,486)

Repurchase of common stock

 

 

(1,947)

 

 

(262)

Proceeds from the issuance of common stock in initial public offering net of issuance costs

 

 

62,804

 

 

 —

Net cash provided (used) by financing activities

 

 

14,145

 

 

20,801

Net change in cash and cash equivalents

 

 

20,523

 

 

(86,161)

Cash and cash equivalents at beginning of period

 

 

40,651

 

 

121,998

Cash and cash equivalents at end of period

 

$

61,174

 

$

35,837

 

See accompanying notes to consolidated financial statements (unaudited)

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Table of Contents

 

 

 

 

 

 

 

 

 

Nine months ended

 

 

September 30, 

Supplemental Cash Flow Disclosures

 

2019

    

2018

Cash paid for:

 

 

  

 

 

  

Interest

 

$

13,162

 

$

7,692

Income taxes

 

 

5,550

 

 

3,030

Non-cash information

 

 

  

 

 

  

Loan collateral transferred to foreclosed assets

 

 

766

 

 

661

Unrealized gain (loss) on investment securities available-for-sale

 

 

6,686

 

 

(4,579)

Initial recognition of operating lease right-of-use assets

 

 

10,475

 

 

 —

Initial recognition of operating lease liabilities

 

 

10,996

 

 

 —

Change in fair value of ESOP shares

 

 

 —

 

 

(3,003)

ESOP repurchase obligation termination

 

 

34,494

 

 

 —

 

 

See accompanying notes to consolidated financial statements (unaudited)

 

 

 

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Alerus Financial Corporation and Subsidiaries

Notes to Consolidated Financial Statements (Unaudited)

NOTE 1 Significant Accounting Policies

Organization

Alerus Financial Corporation is a financial holding company organized under the laws of the state of Delaware. Alerus Financial Corporation (the “Company”) and its subsidiaries is a diversified financial services company headquartered in Grand Forks, North Dakota. Through its subsidiary, Alerus Financial, National Association (the “Bank”), the Company provides innovative and comprehensive financial solutions to businesses and consumers through four distinct business lines—banking, retirement and benefit services, wealth management and mortgage.

Initial Public Offering

On September 17, 2019, the Company sold 2,860,000 shares of common stock in its initial public offering. On September 25, 2019, the Company sold an additional 429,000 shares of common stock pursuant to the exercise in full, by the underwriters, of their option to purchase additional shares. The aggregate offering price for the shares sold by the Company was $69.1 million, and after deducting $4.7 million of underwriting discounts and $1.6 million of offering expenses paid to third parties, the Company received total net proceeds of $62.8 million.

Basis of Presentation

The accompanying unaudited consolidated financial statements and notes thereto of the Company have been prepared in accordance with the rules and regulations of the Securities and Exchange Commission (“SEC”) and conform to practices within the banking industry and include all of the information and disclosures required by generally accepted accounting principles in the United States of America (“GAAP”) for interim financial reporting. The accompanying unaudited consolidated financial statements reflect all adjustments (consisting only of normal recurring adjustments) that are necessary for a fair presentation of financial results for the interim periods presented. The results of operations for the interim periods are not necessarily indicative of the results for the full year or any other period. These interim unaudited financial statements should be read in conjunction with the audited consolidated financial statements and the notes thereto as of and for the year ended December 31, 2018, included in the Company’s prospectus filed with the SEC on September 13, 2019, pursuant to Rule 424(b)(4) under the Securities Act of 1933.

Principles of Consolidation

The accompanying unaudited consolidated financial statements include the accounts of the Company and its wholly owned subsidiaries. The Company’s principal operating subsidiary is the Bank.

In the normal course of business, the Company may enter into a transaction with a variable interest entity (“VIE”). VIE’s are legal entities whose investors lack the ability to make decisions about the entity’s activities, or whose equity investors do not have the right to receive the residual returns of the entity. The applicable accounting guidance requires the Company to perform ongoing quantitative and qualitative analysis to determine whether it must consolidate any VIE. The Company does not have any ownership interest in, or exert any control, over any VIE, and thus no VIE’s are included in the consolidated financial statements.

Use of Estimates

The preparation of consolidated financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenue and expenses during the reporting period. Actual results could differ from those estimates.

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Material estimates that are particularly susceptible to significant change in the near term include the valuation of investment securities, determination of the allowance for loan losses, valuation of reporting units for the purpose of testing goodwill and other intangible assets for impairment, valuation of deferred tax assets, and fair values of financial instruments.

Emerging Growth Company

The Company qualifies as an “emerging growth company” under the Jumpstart Our Business Startups Act of 2012 (the “JOBS Act”), and may take advantage of certain exemptions from various reporting requirements that are applicable to public companies that are not emerging growth companies, including, but not limited to, not being required to comply with the auditor attestation requirements of Section 404 of the Sarbanes-Oxley Act, reduced disclosure obligations regarding executive compensation in periodic reports and proxy statements, and exemptions from the requirements of holding a nonbinding advisory vote on executive compensation and shareholder approval of any golden parachute payments not previously approved. In addition, even if the Company complies with the greater obligations of public companies that are not emerging growth companies, the Company may avail itself of the reduced requirements applicable to emerging growth companies from time to time in the future, so long as the Company is an emerging growth company. The Company will continue to be an emerging growth company until the earliest to occur of: (1) the end of the fiscal year following the fifth anniversary of the date of the first sale of common equity securities under the Company’s Registration Statement on Form S-1, which was declared effective by the SEC on September 12, 2019; (2) the last day of the fiscal year in which the Company has $1.07 billion or more in annual revenues; (3) the date on which the Company is deemed to be a “large accelerated filer” under the Securities Exchange Act of 1934, as amended (the “Exchange Act”); or (4) the date on which the Company has, during the previous three-year period, issued publicly or privately, more than $1.0 billion in non-convertible debt securities. Management cannot predict if investors will find the Company’s common stock less attractive because it will rely on these exemptions. If some investors find the Company’s common stock less attractive as a result, there may be a less active trading market for its common stock and the Company’s stock price may be more volatile.

Section 107 of the JOBS Act provides that an emerging growth company can take advantage of the extended transition period provided in Section 7(a)(2)(B) of the Securities Act of 1933 for complying with new or revised accounting standards. As an emerging growth company, the Company can delay the adoption of certain accounting standards until those standards would otherwise apply to private companies. The Company elected to take advantage of the benefits of this extended transition period.

 

NOTE 2 Recent Accounting Pronouncements

The following FASB Accounting Standards Updates (“ASUs”) are divided into pronouncements which have been adopted by the Company since January 1, 2019, and those which are not yet effective and have been evaluated or are currently being evaluated by management as of September 30, 2019.

Adopted Pronouncements

In February 2016, the FASB issued ASU No. 2016‑02, “Leases.” Under the new guidance, lessees will be required to recognize the following for all leases (with the exception of short‑term leases): 1) a lease liability, which is the present value of a lessee’s obligation to make lease payments, and 2) a right‑of‑use asset, which is an asset that represents the lessee’s right to use, or control the use of, a specified asset for the lease term. Lessor accounting under the new guidance remains largely unchanged as it is substantially equivalent to existing guidance for sales‑type leases, direct financing leases, and operating leases. Leveraged leases have been eliminated, although lessors can continue to account for existing leveraged leases using the current accounting guidance. Other limited changes were made to align lessor accounting with the lessee accounting model and the new revenue recognition standard. All entities will classify leases to determine how to recognize lease‑related revenue and expense. Quantitative and qualitative disclosures will be required by lessees and lessors to meet the objective of enabling users of financial statements to assess the amount, timing, and uncertainty of cash flows arising from leases. The intention is to require enough information to supplement the amounts recorded in the financial statements so that users can understand more about the nature of an entity’s leasing activities. ASU No. 2016‑02 is effective for interim and annual reporting periods beginning after December 15, 2018.

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All entities are required to use a modified retrospective approach for leases that exist or are entered into after the beginning of the earliest comparative period in the financial statements. As the Company elected the transition option provided in ASU No. 2018‑11, the modified retrospective approach was applied on January 1, 2019. The Company also elected certain relief options offered in ASU 2016‑02 including the package of practical expedients, the option not to separate lease and non‑lease components and instead to account for them as a single lease component, and the option not to recognize right‑of‑use assets and lease liabilities that arise from short‑term leases (i.e., leases with terms of twelve months or less). The Company did not elect the hindsight practical expedient, which allows entities to use hindsight when determining lease term and impairment of right‑of‑use assets. The Company has several lease agreements, such as branch locations, which are considered operating leases, and therefore, were not previously recognized on the Company’s consolidated balance sheets. The new guidance requires these lease agreements to be recognized on the consolidated balance sheets as a right‑of‑use asset and a corresponding lease liability. The new guidance did not have a material impact on the consolidated statements of income or the consolidated statements of cash flows. See “NOTE 7 Leases” for more information.

In March 2017, the FASB issued ASU No. 2017‑08, Premium Amortization on Purchased Callable Debt Securities. This ASU shortens the amortization period for the premium on certain purchased callable debt securities to the earliest call date. Currently, entities generally amortize the premium as an adjustment of yield over the contractual life of the security. ASU 2017‑08 does not change the accounting for purchased callable debt securities held at a discount as the discount will continue to be accreted to maturity. ASU 2017‑08 is effective for public business entities for the interim and annual reporting periods beginning after December 15, 2018. Early adoption is permitted. The guidance calls for a modified retrospective transition approach under which a cumulative‑effect adjustment will be made to retained earnings as of the beginning of the first reporting period in which ASU 2017‑08 is adopted. The Company elected to early adopt this standard as of January 1, 2019, and has evaluated the provisions of ASU 2017‑08 and determined there is no impact on its consolidated financial statements.

In August 2017, the FASB issued ASU No. 2017‑12, “Targeted Improvements to Accounting for Hedging Activities.” This ASU’s objectives are to (1) improve the transparency and understandability of information conveyed to financial statement users about an entity’s risk management activities by better aligning the entity’s financial reporting for hedging relationships with those risk management activities; and (2) reduce the complexity of and simplify the application of hedge accounting by preparers. ASU No. 2017‑12 is effective for interim and annual reporting periods beginning after December 15, 2018. The Company currently does not designate any derivative financial instruments as formal hedging relationships, and therefore, does not currently utilize hedge accounting. As such, ASU No. 2017‑12 did not impact the Company’s consolidated financial statements.

In September 2018, the FASB issued ASU No. 2018‑07, Compensation (Topic 718): Improvements to Nonemployee Share‑Based Payment Accounting. This ASU has been issued as part of a simplification initiative which will expand the scope of Topic 718 to include share‑based payment transactions for the acquiring of goods and services from non‑employees and expands the scope through the amendments to address and improve aspects of the accounting for non‑employee share‑based payment transactions. The amendments will be effective for public business entities for interim and annual reporting periods beginning after December 15, 2018. The Company elected to early adopt ASU 2018‑07 effective January 1, 2019, and has evaluated the provisions of ASU 2018‑07 and determined there was no significant impact on its consolidated financial statements.

Pronouncements Not Yet Effective

In September 2016, the FASB issued ASU No. 2016‑13, Financial Instruments—Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments. This ASU requires a new impairment model known as the current expected credit loss (“CECL”) which significantly changes the way impairment of financial instruments is recognized by requiring immediate recognition of estimated credit losses expected to occur over the remaining life of financial instruments. The main provisions of ASU 2016‑13 include (1) replacing the “incurred cost” approach under GAAP with an “expected loss” model for instruments measured at amortized cost, (2) requiring entities to record an allowance for credit losses related to available‑for‑sale debt securities rather than a direct write‑down of the carrying amount of the investments, as is required by the other‑than‑temporary impairment model under current GAAP, and (3) a simplified accounting model for purchase credit‑impaired debt securities and loans. For public business entities that are

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U.S. Securities and Exchange Commission filers, ASU 2016‑13 is effective for interim and annual reporting periods beginning after December 15, 2019. For all other public business entities ASU 2016‑13 is effective for interim and annual reporting periods beginning after December 15, 2020. As an emerging growth company, ASU 2016‑13 is effective for interim and annual reporting periods beginning after December 15, 2021, although early adoption is permitted. The Company is currently evaluating the potential impact of ASU 2016‑13 on its consolidated financial statements. On July 17, 2019, the FASB voted to issue a proposal for public comment that would potentially result in a postponement of the required implementation date for ASU 2016‑13, and on October 16, 2019, the FASB approved delaying the implementation of this ASU for private companies and smaller reporting companies until 2023. As an emerging growth company, the Company can take advantage of this delay. Management will continue to monitor any new developments regarding this possible delay.

In August 2018, the FASB issued ASU No. 2018‑13, Disclosure Framework—Changes to the Disclosure Requirements for Fair Value Measurement. This ASU eliminates, adds, and modifies certain disclosure requirements for estimated fair value measurements. Among the changes, entities will no longer be required to disclose the amount of and reasons for transfer between Level 1 and Level 2 of the estimated fair value hierarchy, but will be required to disclose the range and weighted-average used to develop significant unobservable inputs for Level 3 estimated fair value measurements. ASU 2018‑13 is effective for all entities interim and annual reporting periods beginning after December 15, 2019. Early adoption is permitted. Entities are also allowed to elect for early adoption of the eliminated or modified disclosure requirements and delay adoption of the new disclosure requirements until their effective date. The revised disclosure requirements will not have a material impact on the Company’s consolidated financial statements.

In April 2019, the FASB issued ASU 2019‑04, Codification Improvements to Topic 326, Financial Instruments—Credit Losses, Topic 815, Derivatives and Hedging, and Topic 825, Financial Instruments, which affects a variety of topics in the Codification and applies to all reporting entities within the scope of the affected accounting guidance. This update is not expected to have a significant impact on the Company’s consolidated financial statements.

In May 2019, the FASB issued ASU 2019‑05, Targeted Transition Relief to provide entities with an option to irrevocably elect the fair value option applied on an instrument-by-instrument basis for eligible instruments. As an emerging growth company, these ASUs are effective for fiscal years beginning after December 15, 2021, including interim periods within those fiscal years. This update is not expected to have a significant impact on the Company’s consolidated financial statements.

 

 

NOTE 3 Investment Securities

The following tables present amortized cost, gross unrealized gain and losses, and fair value of the available-for-sale investment securities as of September 30, 2019 and December 31, 2018:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

September 30, 2019

 

 

Amortized

 

Unrealized

 

Unrealized

 

Fair

(dollars in thousands)

    

Cost

    

Gains

    

Losses

    

Value

U.S. Treasury and agencies

 

$

21,607

 

$

29

 

$

(34)

 

$

21,602

Obligations of state and political agencies

 

 

47,227

 

 

703

 

 

(74)

 

 

47,856

Mortgage backed securities

 

 

  

 

 

 

 

 

 

 

 

  

Residential agency

 

 

165,995

 

 

3,467

 

 

(125)

 

 

169,337

Commercial

 

 

32,546

 

 

139

 

 

(33)

 

 

32,652

Asset backed securities

 

 

152

 

 

 5

 

 

 —

 

 

157

Corporate bonds

 

 

7,069

 

 

43

 

 

 —

 

 

7,112

Total available-for-sale investment securities

 

$

274,596

 

$

4,386

 

$

(266)

 

$

278,716

 

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Table of Contents

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

December 31, 2018

 

 

Amortized

 

Unrealized

 

Unrealized

 

Fair

(dollars in thousands)

 

Cost

    

Gains

    

Losses

    

Value

U.S. Treasury and agencies

 

$

19,364

 

$

 —

 

$

(222)

 

$

19,142

Obligations of state and political agencies

 

 

67,662

 

 

171

 

 

(1,446)

 

 

66,387

Mortgage backed securities

 

 

  

 

 

  

 

 

  

 

 

  

Residential agency

 

 

129,906

 

 

210

 

 

(3,118)

 

 

126,998

Commercial

 

 

29,050

 

 

20

 

 

(303)

 

 

28,767

Asset backed securities

 

 

398

 

 

 5

 

 

(4)

 

 

399

Corporate bonds

 

 

8,602

 

 

 —

 

 

(121)

 

 

8,481

Total available-for-sale investment securities

 

$

254,982

 

$

406

 

$

(5,214)

 

$

250,174

 

The following tables present unrealized losses and fair values for available-for-sale investment securities as of September 30, 2019 and December 31, 2018, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

September 30, 2019

 

 

Less than 12 Months

 

Over 12 Months

 

Total

 

 

Unrealized

 

Fair

 

Unrealized

 

Fair

 

Unrealized

 

Fair

(dollars in thousands)

    

Losses

    

Value

  

Losses

    

Value

  

Losses

    

Value

U.S. Treasury and agencies

 

$

(3)

 

$

1,757

 

$

(31)

 

$

9,969

 

$

(34)

 

$

11,726

Obligations of state and political agencies

 

 

(23)

 

 

5,965

 

 

(51)

 

 

5,999

 

 

(74)

 

 

11,964

Mortgage backed securities

 

 

  

 

 

  

 

 

  

 

 

  

 

 

  

 

 

  

Residential agency

 

 

(44)

 

 

10,020

 

 

(81)

 

 

17,138

 

 

(125)

 

 

27,158

Commercial

 

 

(18)

 

 

9,215

 

 

(15)

 

 

3,126

 

 

(33)

 

 

12,341

Asset backed securities

 

 

 —

 

 

 2

 

 

 —

 

 

 —

 

 

 —

 

 

 2

Corporate bonds

 

 

 —

 

 

 —

 

 

 —

 

 

 —

 

 

 —

 

 

 —

Total available-for-sale investment securities

 

$

(88)

 

$

26,959

 

$

(178)

 

$

36,232

 

$

(266)

 

$

63,191

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

December 31, 2018

 

 

Less than 12 Months

 

Over 12 Months

 

Total

 

 

Unrealized

 

Fair

 

Unrealized

 

Fair

 

Unrealized

 

Fair

(dollars in thousands)

    

Losses

    

Value

  

Losses

    

Value

  

Losses

    

Value

U.S. Treasury and agencies

 

$

(8)

 

$

5,288

 

$

(214)

 

$

11,598

 

$

(222)

 

$

16,886

Obligations of state and political agencies

 

 

 —

 

 

389

 

 

(1,446)

 

 

55,770

 

 

(1,446)

 

 

56,159

Mortgage backed securities

 

 

  

 

 

  

 

 

  

 

 

  

 

 

  

 

 

  

Residential agency

 

 

(44)

 

 

7,352

 

 

(3,074)

 

 

112,293

 

 

(3,118)

 

 

119,645

Commercial

 

 

(39)

 

 

7,844

 

 

(264)

 

 

9,741

 

 

(303)

 

 

17,585

Asset backed securities

 

 

 —

 

 

 2

 

 

(4)

 

 

155

 

 

(4)

 

 

157

Corporate bonds

 

 

 —

 

 

 —

 

 

(121)

 

 

8,481

 

 

(121)

 

 

8,481

Total available-for-sale investment securities

 

$

(91)

 

$

20,875

 

$

(5,123)

 

$

198,038

 

$

(5,214)

 

$

218,913

 

For all of the above investment securities, the unrealized losses are generally due to changes in interest rates and unrealized losses are considered to be temporary as the fair value is expected to recover as the securities approach maturity date. The Company evaluates securities for other-than-temporary impairment (“OTTI”) on a quarterly basis, at a minimum, and more frequently when economic or market concerns warrant such evaluation. In estimating OTTI losses, consideration is given to the severity and duration of the impairment; the financial condition and near-term prospects of the issuer, which for debt securities, considers external credit ratings and recent downgrades; and the intent and ability of the Company to hold the security for a period of time sufficient for a recovery in value.

For the three and nine months ended September 30, 2019 and 2018, the Company did not recognize OTTI losses on its investment securities.

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The following table presents amortized cost and estimated fair value of the available-for-sale investment securities as of September 30, 2019, by contractual maturity:

 

 

 

 

 

 

 

 

 

Amortized

 

Fair

(dollars in thousands)

    

Cost

    

Value

Due within one year or less

 

$

3,016

 

$

3,026

Due after one year through five years

 

 

35,948

 

 

35,989

Due after five years through ten years

 

 

78,983

 

 

80,405

Due after 10 years

 

 

156,649

 

 

159,296

Total available-for-sale investment securities

 

$

274,596

 

$

278,716

 

Expected maturities will differ from contractual maturities because issuers may have the right to call or prepay obligations with or without call or prepayment penalties.

Investment securities with carrying value of $141.1 million and $149.0 million were pledged as of September 30, 2019 and December 31, 2018, respectively, to secure public deposits and for other purposes required or permitted by law.

Proceeds from the sale of available‑for‑sale investment securities, for the three and nine months ended September 30, 2019 and 2018, are displayed in the table below:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Three months ended

 

Nine months ended

 

 

September 30, 

 

September 30, 

(dollars in thousands)

    

2019

    

2018

    

2019

    

2018

Proceeds

 

$

10,934

 

$

2,021

 

$

32,565

 

$

2,466

Realized gains

 

 

59

 

 

 —

 

 

357

 

 

105

Realized losses

 

 

11

 

 

 —

 

 

22

 

 

 5

 

As of September 30, 2019 and December 31, 2018, the carrying value of the Company’s Federal Reserve stock and Federal Home Loan Bank of Des Moines (“FHLB”) stock was as follows:

 

 

 

 

 

 

 

 

 

September 30, 

 

December 31, 

(dollars in thousands)

    

2019

    

2018

Federal Reserve

 

$

2,675

 

$

2,675

FHLB

 

 

3,121

 

 

6,875

 

These securities can only be redeemed or sold at their par value and only to the respective issuing institution or to another member institution. The Company records these non-marketable equity securities as a component of other assets and periodically evaluates these securities for impairment. Management considers these non-marketable equity securities to be long-term investments. Accordingly, when evaluating these securities for impairment, management considers the ultimate recoverability of the par value rather than recognizing temporary declines in value.

Visa Class B Restricted Shares

In 2008, the Company received Visa Class B restricted shares as part of Visa’s initial public offering. These shares are transferable only under limited circumstances until they can be converted into the publicly traded Class A common shares. This conversion will not occur until the settlement of certain litigation which will be indemnified by Visa members, including the Company. Visa funded an escrow account from its initial public offering to settle these litigation claims. Should this escrow account be insufficient to cover these litigation claims, Visa is entitled to fund additional amounts to the escrow account by reducing each member bank’s Class B conversion ratio to unrestricted Class A shares. As of September 30, 2019, the conversion ratio was 1.6298. Based on the existing transfer restriction and the uncertainty of the outcome of the Visa litigation mentioned above, the 6,924 Class B shares (11,285 Class A equivalents) that the Company owns as of September 30, 2019 and December 31, 2018, are carried at a zero cost basis.

 

12

Table of Contents

NOTE 4 Loans and Allowance for Loan Losses

The following table presents total loans outstanding, by portfolio segment, as of September 30, 2019 and December 31, 2018:

 

 

 

 

 

 

 

 

    

September 30, 

    

December 31, 

(dollars in thousands)

    

2019

    

2018

Commercial

 

 

 

 

 

 

Commercial and industrial

 

$

485,183

 

$

510,706

Real estate construction

 

 

21,674

 

 

18,965

Commercial real estate

 

 

444,600

 

 

439,963

Total commercial

 

 

951,457

 

 

969,634

Consumer

 

 

  

 

 

  

Residential real estate first mortgage

 

 

459,763

 

 

448,143

Residential real estate junior lien

 

 

182,516

 

 

188,855

Other revolving and installment

 

 

92,351

 

 

95,218

Total consumer

 

 

734,630

 

 

732,216

Total loans

 

$

1,686,087

 

$

1,701,850

 

Total loans include net deferred loan fees and costs of $1.1 million and $1.7 million at September 30, 2019 and December 31, 2018, respectively.

Management monitors the credit quality of its loan portfolio on an ongoing basis. Measurement of delinquency and past due status are based on the contractual terms of each loan. Past due loans are reviewed regularly to identify loans for nonaccrual status.

The following tables present a past due aging analysis of total loans outstanding, by portfolio segment, as of September 30, 2019 and December 31, 2018:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

September 30, 2019

 

 

 

 

 

 

 

 

90 Days

 

 

 

 

 

 

 

 

Accruing

 

30 - 89 Days

 

or More

 

 

 

 

Total

(dollars in thousands)

    

Current

    

Past Due

    

Past Due

    

Nonperforming

    

Loans

Commercial

 

 

  

 

 

  

 

 

  

 

 

  

 

 

  

Commercial and industrial

 

$

481,480

 

$

1,561

 

$

45

 

$

2,097

 

$

485,183

Real estate construction

 

 

21,224

 

 

450

 

 

 —

 

 

 —

 

 

21,674

Commercial real estate

 

 

443,129

 

 

 —

 

 

 —

 

 

1,471

 

 

444,600

Total commercial

 

 

945,833

 

 

2,011

 

 

45

 

 

3,568

 

 

951,457

Consumer

 

 

  

 

 

  

 

 

  

 

 

  

 

 

  

Residential real estate first mortgage

 

 

456,981

 

 

2,105

 

 

 —

 

 

677

 

 

459,763

Residential real estate junior lien

 

 

181,646

 

 

14

 

 

 —

 

 

856

 

 

182,516

Other revolving and installment

 

 

92,176

 

 

169

 

 

 —

 

 

 6

 

 

92,351

Total consumer

 

 

730,803

 

 

2,288

 

 

 —

 

 

1,539

 

 

734,630

Total loans

 

$

1,676,636

 

$

4,299

 

$

45

 

$

5,107

 

$

1,686,087

 

13

Table of Contents

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

December 31, 2018

 

 

 

 

 

 

 

 

90 Days

 

 

 

 

 

 

 

 

Accruing

 

30 - 89 Days

 

or More

 

 

 

 

Total

(dollars in thousands)

    

Current

    

Past Due

    

Past Due

    

Nonperforming

    

Loans

Commercial

 

 

  

 

 

  

 

 

  

 

 

  

 

 

  

Commercial and industrial

 

$

504,313

 

$

2,815

 

$

 —

 

$

3,578

 

$

510,706

Real estate construction

 

 

18,965

 

 

 —

 

 

 —

 

 

 —

 

 

18,965

Commercial real estate

 

 

438,446

 

 

 —

 

 

 —

 

 

1,517

 

 

439,963

Total commercial

 

 

961,724

 

 

2,815

 

 

 —

 

 

5,095

 

 

969,634

Consumer

 

 

  

 

 

  

 

 

  

 

 

  

 

 

  

Residential real estate first mortgage

 

 

444,470

 

 

2,411

 

 

 —

 

 

1,262

 

 

448,143

Residential real estate junior lien

 

 

187,502

 

 

769

 

 

 —

 

 

584

 

 

188,855

Other revolving and installment

 

 

94,615

 

 

581

 

 

 —

 

 

22

 

 

95,218

Total consumer

 

 

726,587

 

 

3,761

 

 

 —

 

 

1,868

 

 

732,216

Total loans

 

$

1,688,311

 

$

6,576

 

$

 —

 

$

6,963

 

$

1,701,850

 

The Company’s consumer loan portfolio is primarily comprised of both secured and unsecured loans that are relatively small and are evaluated at origination on a centralized basis against standardized underwriting criteria. The Company generally does not risk rate consumer loans unless a default event such as bankruptcy or extended nonperformance takes place. Credit quality for the consumer loan portfolio is measured by delinquency rates, nonaccrual amounts and actual losses incurred.

The Company assigns a risk rating to all commercial loans, except pools of homogeneous loans, and periodically performs detailed internal and external reviews of risk rated loans over a certain threshold to identify credit risks and to assess the overall collectability of the portfolio. These risk ratings are also subject to examination by the Company’s regulators. During the internal reviews, management monitors and analyzes the financial condition of borrowers and guarantors, trends in the industries in which the borrowers operate and the estimated fair values of collateral securing the loans. These credit quality indicators are used to assign a risk rating to each individual loan.

The Company’s ratings are aligned to pass and criticized categories. The criticized category includes special mention, substandard, and doubtful risk ratings. The risk ratings are defined as follows:

Pass:  A pass loan is a credit with no existing or known potential weaknesses deserving of management’s close attention.

Special Mention:  Loans classified as special mention have a potential weakness that deserves management’s close attention. If left uncorrected, this potential weakness may result in deterioration of the repayment prospects for the loan or of the Company’s credit position at some future date. Special mention loans are not adversely classified and do not expose the Company to sufficient risk to warrant adverse classification.

Substandard:  Loans classified as substandard are not adequately protected by the current net worth and paying capacity of the borrower or of the collateral pledged, if any. Loans classified as substandard have a well‑defined weakness or weaknesses that jeopardize the repayment of the debt. Well‑defined weaknesses include a borrower’s lack of marketability, inadequate cash flow or collateral support, failure to complete construction on time, or the failure to fulfill economic expectations. They are characterized by the distinct possibility that the Company will sustain some loss if the deficiencies are not corrected.

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

Loss:  Loans classified as loss are considered uncollectible and charged off immediately.

14

Table of Contents

The tables below present total loans outstanding, by loan portfolio segment, and risk category as of September 30, 2019 and December 31, 2018:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

September 30, 2019

 

 

 

 

 

Criticized

 

 

 

 

 

 

 

 

Special

 

 

 

 

 

 

 

 

 

(dollars in thousands)

    

Pass

    

Mention

    

Substandard

    

Doubtful

    

Total

Commercial

 

 

  

 

 

  

 

 

  

 

 

  

 

 

  

Commercial and industrial

 

$

453,707

 

$

10,439

 

$

20,781

 

$

256

 

$

485,183

Real estate construction

 

 

20,396

 

 

284

 

 

994

 

 

 —

 

 

21,674

Commercial real estate

 

 

420,060

 

 

673

 

 

23,867

 

 

 —

 

 

444,600

Total commercial

 

$

894,163

 

$

11,396

 

$

45,642

 

$

256

 

$

951,457

Consumer

 

 

  

 

 

  

 

 

  

 

 

  

 

 

  

Residential real estate first mortgage

 

 

459,086

 

 

 —

 

 

677

 

 

 —

 

 

459,763

Residential real estate junior lien

 

 

180,344

 

 

 —

 

 

2,172

 

 

 —

 

 

182,516

Other revolving and installment

 

 

92,345

 

 

 —

 

 

 6

 

 

 —

 

 

92,351

Total consumer

 

 

731,775

 

 

 —

 

 

2,855

 

 

 —

 

 

734,630

Total loans

 

$

1,625,938

 

$

11,396

 

$

48,497

 

$

256

 

$

1,686,087

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

December 31, 2018

 

 

 

 

 

Criticized

 

 

 

 

 

 

 

 

Special

 

 

 

 

 

 

 

 

 

(dollars in thousands)

    

Pass

    

Mention

    

Substandard

    

Doubtful

    

Total

Commercial

 

 

  

 

 

  

 

 

  

 

 

  

 

 

  

Commercial and industrial

 

$

459,565

 

$

12,055

 

$

37,523

 

$

1,563

 

$

510,706

Real estate construction

 

 

17,910

 

 

 —

 

 

1,055

 

 

 —

 

 

18,965

Commercial real estate

 

 

407,178

 

 

6,304

 

 

26,481

 

 

 —

 

 

439,963

Total commercial

 

$

884,653

 

$

18,359

 

$

65,059

 

$

1,563

 

$

969,634

Consumer

 

 

  

 

 

  

 

 

  

 

 

  

 

 

  

Residential real estate first mortgage

 

 

448,124

 

 

 —

 

 

19

 

 

 —

 

 

448,143

Residential real estate junior lien

 

 

186,370

 

 

 —

 

 

2,485

 

 

 —

 

 

188,855

Other revolving and installment

 

 

95,218

 

 

 —

 

 

 —

 

 

 —

 

 

95,218

Total consumer

 

 

729,712

 

 

 —

 

 

2,504

 

 

 —

 

 

732,216

Total loans

 

$

1,614,365

 

$

18,359

 

$

67,563

 

$

1,563

 

$

1,701,850

 

The adequacy of the allowance for loan losses is assessed at the end of each quarter. The allowance for loan losses includes a specific component related to loans that are individually evaluated for impairment and a general component related to loans that are segregated into homogeneous pools and collectively evaluated for impairment.  The factors applied to these pools are an estimate of probable incurred losses based on management’s evaluation of historical net losses from loans with similar characteristics, which are adjusted by management to reflect current events, trends, and conditions. The adjustments include consideration of the following:  changes in lending policies and procedures, economic conditions, nature and volume of the portfolio, experience of lending management, volume and severity of past due loans, quality of the loan review system, value of underlying collateral for collateral dependent loans, concentrations, and other external factors.

15

Table of Contents

The following tables present, by loan portfolio segment, a summary of the changes in the allowance for loan losses for the three and nine months ended September 30, 2019 and 2018:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Three months ended September 30, 2019

 

 

Beginning

 

Provision for

 

Loan

 

Loan

 

Ending

(dollars in thousands)

    

Balance

    

Loan Losses

    

Charge-offs

    

Recoveries

    

Balance

Commercial

 

 

  

 

 

  

 

 

  

 

 

  

 

 

  

Commercial and industrial

 

$

11,694

 

$

(962)

 

$

(324)

 

$

538

 

$

10,946

Real estate construction

 

 

323

 

 

25

 

 

 —

 

 

 —

 

 

348

Commercial real estate

 

 

5,765

 

 

(4)

 

 

 —

 

 

 —

 

 

5,761

Total commercial

 

 

17,782

 

 

(941)

 

 

(324)

 

 

538

 

 

17,055

Consumer

 

 

  

 

 

  

 

 

  

 

 

  

 

 

  

Residential real estate first mortgage

 

 

1,155

 

 

(139)

 

 

 —

 

 

 —

 

 

1,016

Residential real estate junior lien

 

 

710

 

 

157

 

 

(20)

 

 

49

 

 

896

Other revolving and installment

 

 

380

 

 

 1

 

 

(31)

 

 

28

 

 

378

Total consumer

 

 

2,245

 

 

19

 

 

(51)

 

 

77

 

 

2,290

Unallocated

 

 

1,219

 

 

2,420

 

 

 —

 

 

 —

 

 

3,639

Total

 

$

21,246

 

$

1,498

 

$

(375)

 

$

615

 

$

22,984

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Nine months ended September 30, 2019

 

 

Beginning

 

Provision for

 

Loan

 

Loan

 

Ending

(dollars in thousands)

    

Balance

    

Loan Losses

    

Charge-offs

    

Recoveries

    

Balance

Commercial

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Commercial and industrial

 

$

12,127

 

$

3,263

 

$

(5,275)

 

$

831

 

$

10,946

Real estate construction

 

 

250

 

 

97

 

 

(1)

 

 

 2

 

 

348

Commercial real estate

 

 

6,279

 

 

(668)

 

 

 —

 

 

150

 

 

5,761

Total commercial

 

 

18,656

 

 

2,692

 

 

(5,276)

 

 

983

 

 

17,055

Consumer

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Residential real estate first mortgage

 

 

1,156

 

 

(140)

 

 

 —

 

 

 —

 

 

1,016

Residential real estate junior lien

 

 

805

 

 

113

 

 

(154)

 

 

132

 

 

896

Other revolving and installment

 

 

380

 

 

388

 

 

(513)

 

 

123

 

 

378

Total consumer

 

 

2,341

 

 

361

 

 

(667)

 

 

255

 

 

2,290

Unallocated

 

 

1,177

 

 

2,462

 

 

 —

 

 

 —

 

 

3,639

Total

 

$

22,174

 

$

5,515

 

$

(5,943)

 

$

1,238

 

$

22,984

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Three months ended September 30, 2018

 

 

Beginning

 

Provision for

 

Loan

 

Loan

 

Ending

(dollars in thousands)

    

Balance

    

Loan Losses

    

Charge-offs

    

Recoveries

    

Balance

Commercial

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Commercial and industrial

 

$

10,024

 

$

1,452

 

$

(424)

 

$

126

 

$

11,178

Real estate construction

 

 

395

 

 

(109)

 

 

 —

 

 

 —

 

 

286

Commercial real estate

 

 

6,478

 

 

(72)

 

 

 —

 

 

20

 

 

6,426

Total commercial

 

 

16,897

 

 

1,271

 

 

(424)

 

 

146

 

 

17,890

Consumer

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Residential real estate first mortgage

 

 

1,486

 

 

(142)

 

 

 —

 

 

 —

 

 

1,344

Residential real estate junior lien

 

 

830

 

 

20

 

 

(47)

 

 

11

 

 

814

Other revolving and installment

 

 

483

 

 

31

 

 

(99)

 

 

26

 

 

441

Total consumer

 

 

2,799

 

 

(91)

 

 

(146)

 

 

37

 

 

2,599

Unallocated

 

 

173

 

 

350

 

 

 —

 

 

 —

 

 

523

Total

 

$

19,869

 

$

1,530

 

$

(570)

 

$

183

 

$

21,012

 

16

Table of Contents

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Nine months ended September 30, 2018

 

 

Beginning

 

Provision for

 

Loan

 

Loan

 

Ending

(dollars in thousands)

    

Balance

    

Loan Losses

    

Charge-offs

    

Recoveries

    

Balance

Commercial

 

 

  

 

 

  

 

 

  

 

 

  

 

 

  

Commercial and industrial

 

$

7,589

 

$

6,158

 

$

(3,078)

 

$

509

 

$

11,178

Real estate construction

 

 

343

 

 

 1

 

 

(60)

 

 

 2

 

 

286

Commercial real estate

 

 

4,909

 

 

1,458

 

 

 —

 

 

59

 

 

6,426

Total commercial

 

 

12,841

 

 

7,617

 

 

(3,138)

 

 

570

 

 

17,890

Consumer

 

 

  

 

 

  

 

 

  

 

 

  

 

 

  

Residential real estate first mortgage

 

 

1,411

 

 

(38)

 

 

(29)

 

 

 —

 

 

1,344

Residential real estate junior lien

 

 

902

 

 

(145)

 

 

(133)

 

 

190

 

 

814

Other revolving and installment

 

 

499

 

 

34

 

 

(236)

 

 

144

 

 

441

Total consumer

 

 

2,812

 

 

(149)

 

 

(398)

 

 

334

 

 

2,599

Unallocated

 

 

911

 

 

(388)

 

 

 —

 

 

 —

 

 

523

Total

 

$

16,564

 

$

7,080

 

$

(3,536)

 

$

904

 

$

21,012

 

The following tables present the recorded investment in loans and related allowance for loan losses, by loan portfolio segment, disaggregated on the basis of the Company’s impairment methodology, as of September 30, 2019 and December 31, 2018:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

September 30, 2019

 

 

Recorded Investment

 

Allowance for Loan Losses

 

 

Individually

 

Collectively

 

 

 

 

Individually

 

Collectively

 

 

 

 

 

 

(dollars in thousands)

    

Evaluated

    

Evaluated

    

Total

    

Evaluated

    

Evaluated

    

Unallocated

    

Total

Commercial

 

 

  

 

 

  

 

 

  

 

 

 

 

 

 

 

 

 

 

 

 

Commercial and industrial

 

$

2,513

 

$

482,670

 

$

485,183

 

$

1,429

 

$

9,517

 

$

 —

 

$

10,946

Real estate construction

 

 

 —

 

 

21,674

 

 

21,674

 

 

 —

 

 

348

 

 

 —

 

 

348

Commercial real estate

 

 

1,480

 

 

443,120

 

 

444,600

 

 

352

 

 

5,409

 

 

 —

 

 

5,761

Total commercial

 

 

3,993

 

 

947,464

 

 

951,457

 

 

1,781

 

 

15,274

 

 

 —

 

 

17,055

Consumer

 

 

  

 

 

  

 

 

  

 

 

 

 

 

 

 

 

 

 

 

 

Residential real estate first mortgage

 

 

355

 

 

459,408

 

 

459,763

 

 

 —

 

 

1,016

 

 

 —

 

 

1,016

Residential real estate junior lien

 

 

804

 

 

181,712

 

 

182,516

 

 

324

 

 

572

 

 

 —

 

 

896

Other revolving and installment

 

 

 5

 

 

92,346

 

 

92,351

 

 

 2

 

 

376

 

 

 —

 

 

378

Total consumer

 

 

1,164

 

 

733,466

 

 

734,630

 

 

326

 

 

1,964

 

 

 —

 

 

2,290

Total loans

 

$

5,157

 

$

1,680,930

 

$

1,686,087

 

$

2,107

 

$

17,238

 

$

3,639

 

$

22,984

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

December 31, 2018

 

 

Recorded Investment

 

Allowance for Loan Losses

 

 

Individually

 

Collectively

 

 

 

 

Individually

 

Collectively

 

 

 

 

 

 

(dollars in thousands)

    

Evaluated

    

Evaluated

    

Total

    

Evaluated

    

Evaluated

    

Unallocated

    

Total

Commercial

 

 

  

 

 

  

 

 

  

 

 

 

 

 

 

 

 

 

 

 

 

Commercial and industrial

 

$

3,945

 

$

506,761

 

$

510,706

 

$

2,059

 

$

10,068

 

$

 —

 

$

12,127

Real estate construction

 

 

 —

 

 

18,965

 

 

18,965

 

 

 —

 

 

250

 

 

 —

 

 

250

Commercial real estate

 

 

1,684

 

 

438,279

 

 

439,963

 

 

455

 

 

5,824

 

 

 —

 

 

6,279

Total commercial

 

 

5,629

 

 

964,005

 

 

969,634

 

 

2,514

 

 

16,142

 

 

 —

 

 

18,656

Consumer

 

 

  

 

 

  

 

 

  

 

 

 

 

 

 

 

 

 

 

 

 

Residential real estate first mortgage

 

 

352

 

 

447,791

 

 

448,143

 

 

 —

 

 

1,156

 

 

 —

 

 

1,156

Residential real estate junior lien

 

 

559

 

 

188,296

 

 

188,855

 

 

 4

 

 

801

 

 

 —

 

 

805

Other revolving and installment

 

 

20

 

 

95,198

 

 

95,218

 

 

20

 

 

360

 

 

 —

 

 

380

Total consumer

 

 

931

 

 

731,285

 

 

732,216

 

 

24

 

 

2,317

 

 

 —

 

 

2,341

Total loans

 

$

6,560

 

$

1,695,290

 

$

1,701,850

 

$

2,538

 

$

18,459

 

$

1,177

 

$

22,174

 

17

Table of Contents

The tables below summarize key information on impaired loans. These impaired loans may have estimated losses which are included in the allowance for loan losses.

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

September 30, 2019

 

December 31, 2018

 

 

Recorded

 

Unpaid

 

Related

 

Recorded

 

Unpaid

 

Related

(dollars in thousands)

    

Investment

    

Principal

    

Allowance

    

Investment

    

Principal

    

Allowance

Impaired loans with a valuation allowance

 

 

  

 

 

  

 

 

  

 

 

 

 

 

 

 

 

 

Commercial and industrial

 

$

1,757

 

$

1,900

 

$

1,429

 

$

2,660

 

$

2,752

 

$

2,059

Commercial real estate

 

 

1,480

 

 

1,595

 

 

352

 

 

1,499

 

 

1,517

 

 

455

Residential real estate first mortgage

 

 

 —

 

 

 —

 

 

 —

 

 

 —

 

 

 —

 

 

 —

Residential real estate junior lien

 

 

536

 

 

619

 

 

324

 

 

 4

 

 

 4

 

 

 4

Other revolving and installment

 

 

 4

 

 

 4

 

 

 2

 

 

19

 

 

20

 

 

20

Total impaired loans with a valuation allowance

 

 

3,777

 

 

4,118

 

 

2,107

 

 

4,182

 

 

4,293

 

 

2,538

Impaired loans without a valuation allowance

 

 

  

 

 

  

 

 

  

 

 

 

 

 

 

 

 

 

Commercial and industrial

 

 

756

 

 

1,077

 

 

 —

 

 

1,285

 

 

1,422

 

 

 —

Commercial real estate

 

 

 —

 

 

 —

 

 

 —

 

 

185

 

 

218

 

 

 —

Residential real estate first mortgage

 

 

355

 

 

367

 

 

 —

 

 

352

 

 

504

 

 

 —

Residential real estate junior lien

 

 

268

 

 

290

 

 

 —

 

 

555

 

 

697

 

 

 —

Other revolving and installment

 

 

 1

 

 

 1

 

 

 —

 

 

 1

 

 

 2

 

 

 —

Total impaired loans without a valuation allowance

 

 

1,380

 

 

1,735

 

 

 —

 

 

2,378

 

 

2,843

 

 

 —

Total impaired loans

 

 

  

 

 

  

 

 

  

 

 

 

 

 

 

 

 

 

Commercial and industrial

 

 

2,513

 

 

2,977

 

 

1,429

 

 

3,945

 

 

4,174

 

 

2,059

Commercial real estate

 

 

1,480

 

 

1,595

 

 

352

 

 

1,684

 

 

1,735

 

 

455

Residential real estate first mortgage

 

 

355

 

 

367

 

 

 —

 

 

352

 

 

504

 

 

 —

Residential real estate junior lien

 

 

804

 

 

909

 

 

324

 

 

559

 

 

701

 

 

 4

Other revolving and installment

 

 

 5

 

 

 5

 

 

 2

 

 

20

 

 

22

 

 

20

Total impaired loans

 

$

5,157

 

$

5,853

 

$

2,107

 

$

6,560

 

$

7,136

 

$

2,538

 

The table below presents the average recorded investment in impaired loans and interest income for the three and nine months ended September 30, 2019 and 2018:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Three months ended September 30, 

 

 

2019

 

2018

 

 

Average

 

 

 

 

Average

 

 

 

 

 

Recorded

 

Interest

 

Recorded

 

Interest

(dollars in thousands)

    

Investment

    

Income

    

Investment

    

Income

Impaired loans with a valuation allowance

 

 

 

 

 

 

 

 

 

 

 

 

Commercial and industrial

 

$

1,964

 

$

 4

 

$

1,961

 

$

 9

Commercial real estate

 

 

1,623

 

 

 2

 

 

1,767

 

 

 2

Residential real estate first mortgage

 

 

 —

 

 

 —

 

 

 —

 

 

 —

Residential real estate junior lien

 

 

619

 

 

 1

 

 

63

 

 

 1

Other revolving and installment

 

 

 5

 

 

 —

 

 

39

 

 

 —

Total impaired loans with a valuation allowance

 

 

4,211

 

 

 7

 

 

3,830

 

 

12

Impaired loans without a valuation allowance

 

 

 

 

 

 

 

 

 

 

 

 

Commercial and industrial

 

 

1,206

 

 

 7

 

 

1,073

 

 

 —

Commercial real estate

 

 

 —

 

 

 —

 

 

842

 

 

 —

Residential real estate first mortgage

 

 

183

 

 

 —

 

 

525

 

 

 —

Residential real estate junior lien

 

 

297

 

 

 —

 

 

394

 

 

 —

Other revolving and installment

 

 

 2

 

 

 —

 

 

 3

 

 

 —

Total impaired loans without a valuation allowance

 

 

1,688

 

 

 7

 

 

2,837

 

 

 —

Total impaired loans

 

 

 

 

 

 

 

 

 

 

 

 

Commercial and industrial

 

 

3,170

 

 

11

 

 

3,034

 

 

 9

Commercial real estate

 

 

1,623

 

 

 2

 

 

2,609

 

 

 2

Residential real estate first mortgage

 

 

183

 

 

 —

 

 

525

 

 

 —

Residential real estate junior lien

 

 

916

 

 

 1

 

 

457

 

 

 1

Other revolving and installment

 

 

 7

 

 

 —

 

 

42

 

 

 —

Total impaired loans

 

$

5,899

 

$

14

 

$

6,667

 

$

12

 

18

Table of Contents

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Nine Months Ended September 30, 

 

 

2019

 

2018

 

 

Average

 

 

 

 

Average

 

 

 

 

 

Recorded

 

Interest

 

Recorded

 

Interest

(dollars in thousands)

 

Investment

    

Income

  

Investment

    

Income

Impaired loans with a valuation allowance

 

 

  

 

 

  

 

 

  

 

 

  

Commercial and industrial

 

$

2,473

 

$

12

 

$

2,026

 

$

27

Commercial real estate

 

 

1,668

 

 

 6

 

 

1,793

 

 

 7

Residential real estate first mortgage

 

 

 —

 

 

 —

 

 

 —

 

 

 —

Residential real estate junior lien

 

 

621

 

 

 3

 

 

63

 

 

 2

Other revolving and installment

 

 

 5

 

 

 —

 

 

43

 

 

 —

Total impaired loans with a valuation allowance

 

 

4,767

 

 

21

 

 

3,925

 

 

36

Impaired loans without a valuation allowance

 

 

  

 

 

  

 

 

  

 

 

  

Commercial and industrial

 

 

2,979

 

 

23

 

 

1,130

 

 

 —

Commercial real estate

 

 

 —

 

 

 —

 

 

747

 

 

 —

Residential real estate first mortgage

 

 

92

 

 

 —

 

 

539

 

 

 —

Residential real estate junior lien

 

 

302

 

 

 —

 

 

403

 

 

 1

Other revolving and installment

 

 

 4

 

 

 —

 

 

 3

 

 

 —

Total impaired loans without a valuation allowance

 

 

3,377

 

 

23

 

 

2,822

 

 

 1

Total impaired loans

 

 

  

 

 

  

 

 

  

 

 

  

Commercial and industrial

 

 

5,452

 

 

35

 

 

3,156

 

 

27

Commercial real estate

 

 

1,668

 

 

 6

 

 

2,540

 

 

 7

Residential real estate first mortgage

 

 

92

 

 

 —

 

 

539

 

 

 —

Residential real estate junior lien

 

 

923

 

 

 3

 

 

466

 

 

 3

Other revolving and installment

 

 

 9

 

 

 —

 

 

46

 

 

 —

Total impaired loans

 

$

8,144

 

$

44

 

$

6,747

 

$

37

 

Loans with a carrying value of $1.1 billion as of September 30, 2019 and December 31, 2018, were pledged to secure public deposits, and for other purposes required or permitted by law.

Under certain circumstances, the Company will provide borrowers relief through loan restructurings. A restructuring of debt constitutes a troubled debt restructuring (“TDR”) if the Company, for economic or legal reasons related to the borrower’s financial difficulties, grants a concession to the borrower that it would not otherwise consider. TDR concessions can include reduction of interest rates, extension of maturity dates, forgiveness of principal or interest due, or acceptance of other assets in full or partial satisfaction of the debt.

During the first quarter of 2019 there was one loan that was modified as a troubled debt restructuring as a result of extending the amortization period. As of September 30, 2019, the carrying value of the restructured loan was $0.2 million. The loan is currently performing according to the modified terms and there was no specific reserve for the loan losses allocated to the loan modified as troubled debt restructuring. During the first quarter of 2018, there was one loan modified as a troubled debt restructuring as a result of adjusting the interest rate below current market levels. The balance at the time of restructuring was $1.0 million. As of December 31, 2018, the carrying value of the restructured loan was $0.2 million. The loan is currently performing according to the modified terms and there was no specific reserve for loan losses allocated to the loan modified as troubled debt restructuring.

The Company does not have material commitments to lend additional funds to borrowers with loans whose terms have been modified in troubled debt restructurings or whose loans are on nonaccrual.

 

 

19

Table of Contents

NOTE 5 Goodwill and Other Intangible Assets

As of September 30, 2019 and December 31, 2018, goodwill totaled $27.3 million.

The following table summarizes the carrying amount of goodwill, by segment, as of September 30, 2019 and December 31, 2018:

 

 

 

 

(dollars in thousands)

    

Goodwill

Banking

 

$

20,131

Retirement and benefit services

 

 

7,198

Total goodwill

 

$

27,329

 

The gross carrying amount and accumulated amortization for each type of identifiable intangible asset are as follows:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

September 30, 2019

 

December 31, 2018

(dollars in thousands)

    

Gross Carrying Amount

    

Accumulated Amortization

    

Total

    

Gross Carrying Amount

    

Accumulated Amortization

    

Total

Identifiable customer intangibles

 

$

55,744

 

$

(37,374)

 

$

18,370

 

$

55,744

 

$

(34,972)

 

$

20,772

Core deposit intangible assets

 

 

7,216

 

 

(6,204)

 

 

1,012

 

 

7,216

 

 

(5,515)

 

 

1,701

Total intangible assets

 

$

62,960

 

$

(43,578)

 

$

19,382

 

$

62,960

 

$

(40,487)

 

$

22,473

 

Amortization of intangible assets was $1.0 million and $3.1 million for the three and nine months ended September 30, 2019, respectively, and $1.2 million and $3.6 million for the comparable periods in 2018, respectively.

 

 

NOTE 6 Loan Servicing

Loans serviced for others are not included in the accompanying consolidated balance sheets. The unpaid principal balances of loans serviced for others totaled $560.9 million and $591.6 million as of September 30, 2019 and December 31, 2018, respectively. Servicing loans for others generally consists of collecting mortgage payments, maintaining escrow accounts, disbursing payments to investors and collection and foreclosure processing. Loan servicing income is recorded on an accrual basis and includes servicing fees from investors and certain charges collected from borrowers, such as late payment fees, and is net of fair value adjustments to capitalized mortgage servicing rights.

The following table summarizes the Company’s activity related to servicing rights for the three and nine months ended September 30, 2019 and 2018:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

    

Three months ended

    

Nine months ended

 

 

September 30, 

 

September 30, 

(dollars in thousands)

    

2019

 

2018

 

2019

    

2018

Balance, beginning of period

 

$

4,300

 

$

4,676

 

$

4,623

 

$

4,686

Additions

 

 

179

 

 

152

 

 

279

 

 

431

Amortization

 

 

(287)

 

 

(165)

 

 

(690)

 

 

(512)

(Impairment)/Recovery

 

 

(46)

 

 

 8

 

 

(66)

 

 

66

Balance, end of period

 

$

4,146

 

$

4,671

 

$

4,146

 

$

4,671

 

20

Table of Contents

The following is a summary of key data and assumptions used in the valuation of servicing rights as of September 30, 2019 and December 31, 2018. Increases or decreases in any one of these assumptions would result in lower or higher fair value measurements.

 

 

 

 

 

 

 

 

 

    

September 30, 

    

December 31, 

 

(dollars in thousands)

 

2019

 

2018

 

Fair value of servicing rights

 

$

4,146

 

$

4,623

 

Weighted-average remaining term, years

 

 

20.5

 

 

20.8

 

Prepayment speeds

 

 

11.6

%  

 

7.8

%

Discount rate

 

 

9.5

%  

 

10.5

%

 

 

NOTE 7 Leases

Substantially all of the leases in which the Company is the lessee are comprised of real estate property for branches, and office equipment rentals with terms extending through 2032. Portions of certain properties are subleased for terms extending through 2024. Substantially all of the Company’s leases are classified as operating leases, and therefore, were previously not recognized on the Company’s consolidated financial statements. With the adoption of Topic 842, operating lease agreements are required to be recognized on the consolidated financial statements as a right‑of‑use (“ROU”) asset and a corresponding lease liability. The Company has one existing finance lease (previously referred to as a capital lease) for a portion of the Company’s headquarters building with a lease term through 2022. As this lease was previously required to be recorded on the Company’s consolidated financial statements, Topic 842 did not materially impact the accounting for this lease.

The Company elected not to include short‑term leases (i.e., leases with initial terms of twelve months or less), or equipment leases (deemed immaterial) on the consolidated financial statements. The following table presents the classification of the Company’s ROU assets and lease liabilities on the consolidated financial statements.

 

 

 

 

 

 

 

    

    

    

September 30, 

(dollars in thousands)

 

 

 

2019

Lease Right-of-Use Assets

 

Classification

 

 

 

Operating lease right-of-use assets

 

Operating lease right-of-use assets

 

$

8,877

Finance lease right-of-use assets

 

Land, premises and equipment, net

 

 

347

Total lease right-of-use assets

 

 

 

$

9,224

Lease Liabilities

 

  

 

 

  

Operating lease liabilities

 

Operating lease liabilities

 

$

9,401

Finance lease liabilities

 

Long-term debt

 

 

690

Total lease liabilities

 

 

 

$

10,091

 

The calculated amount of the ROU assets and lease liabilities in the table above are impacted by the length of the lease term and the discount rate used to present value the minimum lease payments. The Company’s lease agreements often include one or more options to renew at the Company’s discretion. If at lease inception, the Company considers the exercising of a renewal option to be reasonably certain, the Company will include the extended term in the calculation of the ROU asset and lease liability. Regarding the discount rate, Topic 842 requires the use of the rate implicit in the lease whenever this rate is readily determinable. As this rate is rarely determinable, the Company utilizes its incremental borrowing rate at lease inception, on a collateralized basis, over a similar term. For operating leases existing prior to January 1, 2019, the rate for the remaining lease term as of January 1, 2019 was used. For the Company’s only finance lease, the Company utilized its incremental borrowing rate at lease inception.

21

Table of Contents

 

 

 

 

 

September 30, 

 

 

2019

 

Weighted-average remaining lease term, years

 

 

 

Operating leases

 

6.5

 

Finance leases

 

3.1

 

Weighted-average discount rate

 

  

 

Operating leases

 

3.2

%

Finance leases

 

7.8

%

 

As the Company elected, for all classes of underlying assets, not to separate lease and non‑lease components and instead to account for them as a single lease component, the variable lease cost primarily represents variable payments such as common area maintenance and utilities. Variable lease cost also includes payments for usage or maintenance of those capitalized equipment operating leases.

The following table presents lease costs and other lease information for the three and nine months ending September 30, 2019.

 

 

 

 

 

 

 

 

    

Three months ended

    

Nine months ended

(dollars in thousands)

    

September 30, 2019

 

September 30, 2019

Lease costs

 

 

 

 

 

  

Operating lease cost

 

$

602

 

$

1,772

Variable lease cost

 

 

222

 

 

633

Short-term lease cost

 

 

122

 

 

416

Finance lease cost

 

 

 

 

 

  

Interest on lease liabilities

 

 

14

 

 

45

Amortization of right-of-use assets

 

 

29

 

 

87

Sublease income

 

 

(65)

 

 

(202)

Net lease cost

 

$

924

 

$

2,751

Other information

 

 

 

 

 

  

Cash paid for amounts included in the measurement of lease liabilities Operating cash flows from operating leases

 

 

600

 

 

1,774

Right-of-use assets obtained in exchange for new operating lease liabilities

 

 

 —

 

 

 —

Right-of-use assets obtained in exchange for new finance lease liabilities

 

 

 —

 

 

 —

 

Future minimum payments for finance and operating leases with initial or remaining terms of one year or more as of September 30, 2019 were as follows:

 

 

 

 

 

 

 

 

 

September 30, 2019

 

 

Finance

 

Operating

(dollars in thousands)

    

Leases

    

Leases

2020

 

$

251

 

$

2,291

2021

 

 

251

 

 

1,676

2022

 

 

251

 

 

1,579

2023

 

 

20

 

 

1,506

2024

 

 

 —

 

 

1,061

Thereafter

 

 

 —

 

 

2,460

Total future minimum lease payments

 

$

773

 

$

10,573

Amounts representing interest

 

 

(83)

 

 

(1,172)

Total operating lease liabilities

 

$

690

 

$

9,401

 

 

22

Table of Contents

NOTE 8 Deposits

The components of deposits in the consolidated balance sheets as of September 30, 2019 and December 31, 2018 were as follows:

 

 

 

 

 

 

 

 

 

September 30, 

 

December 31, 

(dollars in thousands)

    

2019

    

2018

Noninterest-bearing demand

 

$

537,951

 

$

550,640

Interest-bearing

 

 

  

 

 

  

Interest-bearing demand

 

 

424,249

 

 

401,078

Savings accounts

 

 

55,513

 

 

53,971

Money market savings

 

 

622,647

 

 

598,820

Time deposits

 

 

192,753

 

 

170,587

Total interest-bearing

 

 

1,295,162

 

 

1,224,456

Total deposits

 

$

1,833,113

 

$

1,775,096

 

 

NOTE 9 Short‑Term Borrowings

There were no short‑term borrowings outstanding as of September 30, 2019. Short-term borrowing as of December 31, 2018, were $93.5 million and consisted of Fed funds purchased.

The following table presents information related to short-term borrowings for the three and nine months ending September 30, 2019 and September 30, 2018:

 

 

 

 

 

 

 

 

 

 

Three months ended

 

 

 

September 30, 

 

(dollars in thousands)

    

2019

 

2018

 

Fed funds purchased

 

 

 

 

 

 

 

Balance as of end of period

 

$

 —

 

$

73,930

 

Average daily balance

 

 

61,386

 

 

103,171

 

Maximum month-end balance

 

 

124,250

 

 

94,410

 

Weighted-average rate

 

 

 

 

 

 

 

During period

 

 

2.40

%

 

2.21

%

End of period

 

 

2.30

%

 

2.30

%

FHLB Short-term advances

 

 

 

 

 

 

 

Balance as of end of period

 

$

 —

 

$

 —

 

Average daily balance

 

 

25,815

 

 

 —

 

Maximum month-end balance

 

 

 —

 

 

 —

 

Weighted-average rate

 

 

 

 

 

 

 

During period

 

 

2.58

%

 

 —

%

End of period

 

 

 —

%

 

 —

%

 

23

Table of Contents

 

 

 

 

 

 

 

 

 

 

Nine months ended

 

 

 

September 30, 

 

(dollars in thousands)

    

2019

 

2018

 

Fed funds purchased

 

 

 

 

 

 

 

Balance as of end of period

 

$

 —

 

$

73,930

 

Average daily balance

 

 

82,504

 

 

87,391

 

Maximum month-end balance

 

 

139,605

 

 

112,260

 

Weighted-average rate

 

 

 

 

 

 

 

During period

 

 

2.54

%

 

0.36

%

End of period

 

 

2.30

%

 

2.30

%

FHLB Short-term advances

 

 

 

 

 

 

 

Balance as of end of period

 

$

 —

 

$

 —

 

Average daily balance

 

 

12,985

 

 

110

 

Maximum month-end balance

 

 

135,000

 

 

 —

 

Weighted-average rate

 

 

 

 

 

 

 

During period

 

 

2.44

%

 

2.43

%

End of period

 

 

 —

%

 

 —

%

 

 

 

NOTE 10 Long‑Term Debt

Long‑term debt as of September 30, 2019 and December 31, 2018 consisted of the following:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

September 30, 2019

 

 

 

 

 

 

 

 

 

 

Period End

 

 

 

 

 

 

Face

 

Carrying

 

 

 

Interest

 

Maturity

 

 

(dollars in thousands)

    

Value

    

Value

    

Interest Rate

    

Rate

    

Date

    

Call Date

Subordinated notes payable

 

$

50,000

 

$

49,609

 

Fixed

 

5.75

%  

12/30/2025

 

12/30/2020

Junior subordinated debenture (Trust I)

 

 

4,000

 

 

3,390

 

Three-month LIBOR + 3.10%

 

5.21

%  

6/26/2033

 

6/26/2008

Junior subordinated debenture (Trust II)

 

 

6,000

 

 

5,086

 

Three-month LIBOR + 1.80%

 

3.92

%  

9/15/2036

 

9/15/2011

Finance lease liability

 

 

2,700

 

 

690

 

Fixed

 

7.81

%  

10/31/2022

 

N/A

Total long-term debt

 

$

62,700

 

$

58,775

 

  

 

  

 

  

 

  

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

December 31, 2018

 

 

 

 

 

 

 

 

 

 

Period End

 

 

 

 

 

 

Face

 

Carrying

 

 

 

Interest

 

Maturity

 

 

(dollars in thousands)

    

Value

    

Value

    

Interest Rate

    

Rate

    

Date

    

Call Date

Subordinated notes payable

 

$

50,000

 

$

49,562

 

Fixed

 

5.75

%  

12/30/2025

 

12/30/2020

Junior subordinated debenture (Trust I)

 

 

4,000

 

 

3,357

 

Three-month LIBOR + 3.10%

 

5.92

%  

6/26/2033

 

6/26/2008

Junior subordinated debenture (Trust II)

 

 

6,000

 

 

5,035

 

Three-month LIBOR + 1.80%

 

4.59

%  

9/15/2036

 

9/15/2011

Obligations under capital lease

 

 

2,700

 

 

870

 

Fixed

 

7.81

%  

10/31/2022

 

N/A

Total long-term debt

 

$

62,700

 

$

58,824

 

  

 

  

 

  

 

  

 

The Company had a $150 thousand letter of credit with the Federal Home Loan Bank as of September 30, 2019 and December 31, 2018. Bank of North Dakota letters of credit are collateralized by loans pledged to the Bank of North Dakota in the amount of $244.8 million and $260.6 million as of September 30, 2019 and December 31, 2018, respectively. There were no outstanding letters of credit with the Bank of North Dakota as of September 30, 2019 and December 31, 2018, respectively.

 

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Table of Contents

NOTE 11 Financial Instruments with Off‑Balance Sheet Risk

In the normal course of business, the Bank has outstanding commitment and contingent liabilities, such as commitments to extend credit and standby letters of credit, which are not included in the accompanying consolidated financial statements. The Bank’s exposure to credit loss in the event of nonperformance by the other party to the financial instruments for commitments to extend credit and standby letters of credit is represented by the contractual or notional amount of those instruments. The Bank uses the same credit policies in making such commitments as it does for instruments that are included in the statements of financial condition.

As of September 30, 2019 and December 31, 2018, the following financial instruments whose contract amount represents credit risk were approximately as follows:

 

 

 

 

 

 

 

 

 

September 30, 

    

December 31, 

(dollars in thousands)

    

2019

    

2018

Commitments to extend credit

 

$

570,220

 

$

529,890

Standby letters of credit

 

 

8,023

 

 

8,852

Total

 

$

578,243

 

$

538,742

 

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

The Company was not required to perform on any financial guarantees and did not incur any losses on its commitments during the past two years.

 

NOTE 12 Share-Based Compensation

The Company has granted equity awards pursuant to the Alerus Financial Corporation 2009 Stock Plan. The awards can be in the form of restricted stock or restricted stock units and are considered to represent an element of employee compensation. Compensation expense for the award is based on the fair value of Alerus Financial Corporation common stock at the time of grant. The value of awards that are expected to vest, are amortized into expense over the vesting periods. The ability to grant awards under this plan have expired. Compensation expense relating to awards under this plan was $1.2 million and $702 thousand for the nine months ending September 30, 2019 and September 30, 2018, respectively.

The following table presents the activity in the stock plan for the nine months ended September 30, 2019 and 2018:

 

 

 

 

 

 

 

 

 

 

 

 

 

Nine months ended September 30, 2019

 

Nine months ended September 30, 2018

 

 

 

 

Weighted-

 

 

 

Weighted-

 

    

 

    

Average Grant

 

 

    

Average Grant

 

    

Awards

    

Date Fair Value

    

Awards

    

Date Fair Value

Restricted Stock Awards

 

 

 

 

 

 

 

 

 

 

Outstanding at beginning of period

 

337,014

 

$

18.36

 

336,397

 

$

15.38

Granted

 

70,617

 

 

19.87

 

76,031

 

 

22.67

Vested

 

(53,882)

 

 

18.69

 

(76,753)

 

 

10.56

Forfeited or cancelled

 

(6,138)

 

 

17.34

 

 —

 

 

 —

Outstanding at end of period

 

347,611

 

$

18.64

 

335,675

 

$

18.13

 

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Table of Contents

As of September 30, 2019, there was $3.6 million of unrecognized compensation expense related to non-vested restricted stock awards granted under the plan. The expense is expected to be recognized over a weighted-average period of 3.29 years.

On May 6, 2019, the Company’s stockholders approved the Alerus Financial Corporation 2019 Equity Incentive Plan. This plan allows the compensation committee the ability to grant a wide variety of equity awards, including stock options, stock appreciation rights, restricted stock, restricted stock units and cash incentive awards in such forms and amounts as it deems appropriate to accomplish the goals of the plan. Any shares subject to an award that is cancelled, forfeited, or expires prior to exercise or realization, either in full or in part, shall again become available for issuance under the plan. However, shares subject to an award shall not again be made available for issuance or delivery under the plan if such shares are (a) tendered in payment of the exercise price of a stock option, (b) delivered to, or withheld by, the Company to satisfy any tax withholding obligation, or (c) covered by a stock‑settled stock appreciation right or other awards that were not issued upon the settlement of the award. Shares vest, become exercisable and contain such other terms and conditions as determined by the compensation committee and set forth in individual agreements with the participant receiving the award. The plan is authorized to issue up to 1,100,000. As of September 30, 2019, no awards had been issued under the plan

For the nine months ended September 30, 2019, the Company issued 13,144 shares of common stock pursuant to the Alerus Financial Corporation Stock Grant Plan for Non‑Employee Directors. Compensation expense relating to stock awards under this plan for the nine months ending September 30, 2019 and 2018, was $251 thousand and $245 thousand respectively.

 

NOTE 13 Noninterest Income

All of the Company’s revenue from contracts with customers, within the scope of ASC 606, is recognized in noninterest income. The material groups of noninterest income are defined as follows:

Retirement and benefit services:  Retirement and benefit services income is primarily comprised of fees earned from the administration of retirement plans, record‑keeping, compliance services, payroll processing, health savings accounts, and flexible benefit plans. Fees are earned based on a combination of the market value of assets under administration and transaction based fees for services provided. Fees that are determined based on the market value of the assets under administration are generally billed monthly or quarterly in arrears and recognized monthly as the Company’s performance obligations are met. Other transaction based fees are recognized monthly as the performance obligation is satisfied.

Wealth management:  Wealth management income is earned from a variety of sources including trust administration and other related fiduciary services, custody, investment management and advisory services, and brokerage. Fees are based on the market value of the assets under management and are generally billed monthly in arrears and recognized monthly as the Company’s performance obligations are met. Commissions on transactions are recognized on a trade‑date basis as the performance obligation is satisfied at the point in time in which the trade is processed. Other related services are based on a fixed fee schedule and the revenue is recognized when the services are rendered, which is when the Company has satisfied its performance obligation.

Service charges on deposit accounts:  Service charges on deposit accounts primarily consist of account analysis fees, monthly maintenance fees, overdraft fees, and other deposit account related fees. Overdraft fees and certain service charges are fixed and the performance obligation is typically satisfied at the time of the related transaction. The consideration for analysis fees and monthly maintenance fees are variable as the fee can be reduced if the customer meets certain qualifying metrics. The Company’s performance obligations are satisfied at the time of the transaction or over the course of a month.

Other noninterest income:  Other noninterest income components include debit card interchange fees, bank‑owned life insurance income and miscellaneous transactional fees. Income earned from these revenue streams is generally recognized concurrently with the satisfaction of the performance obligation.

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Table of Contents

The following table presents the Company’s noninterest income for the three and nine months ended September 30, 2019 and 2018.

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Three months ended

 

Nine months ended

 

 

September 30, 

 

September 30, 

(dollars in thousands)

    

2019

    

2018

    

2019

    

2018

Retirement and benefits

 

$

15,307

 

$

15,536

 

$

46,142

 

$

46,873

Wealth management

 

 

3,896

 

 

3,685

 

 

11,385

 

 

10,948

Mortgage banking (1)

 

 

8,135

 

 

5,318

 

 

19,739

 

 

13,551

Service charges on deposit accounts

 

 

447

 

 

442

 

 

1,321

 

 

1,333

Net gains (losses) on investment securities (1)

 

 

48

 

 

13

 

 

357

 

 

119

Other

 

 

 

 

 

 

 

 

  

 

 

  

Interchange fees

 

 

506

 

 

509

 

 

1,480

 

 

1,519

Bank-owned life insurance income (1)

 

 

205

 

 

202

 

 

601

 

 

602

Misc. transactional fees

 

 

312

 

 

272

 

 

881

 

 

784

Other noninterest income

 

 

724

 

 

281

 

 

2,732

 

 

879

Total noninterest income

 

$

29,580

 

$

26,258

 

$

84,638

 

$

76,608


(1)

Not within scope of ASC 606.

 

NOTE 14 Income Taxes

The components of income tax expense (benefit) for the three and nine months ended September 30, 2019 and 2018 are as follows:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Three months ended September 30, 

 

 

 

2019

 

 

2018

 

 

    

 

 

 

Percent of

 

    

 

 

 

Percent of

 

(dollars in thousands)

 

Amount

 

Pretax Income

 

 

Amount

 

Pretax Income

 

Taxes at statutory federal income tax rate

 

$

1,982

 

21.0

%

 

$

1,957

 

21.0

%

Tax effect of:

 

 

 

 

 

 

 

 

 

 

 

 

Tax exempt income

 

 

(107)

 

(1.1)

 

 

 

(132)

 

(1.4)

 

Other

 

 

457

 

4.8

 

 

 

126

 

1.3

 

Applicable income taxes

 

$

2,332

 

24.7

%

 

$

1,951

 

20.9

%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Nine months ended September 30, 

 

 

 

2019

 

 

2018

 

 

    

 

 

    

Percent of

 

    

 

 

    

Percent of

 

(dollars in thousands)

 

Amount

 

Pretax Income

  

 

Amount

 

Pretax Income

 

Taxes at statutory federal income tax rate

 

$

6,114

 

21.0

 

$

5,268

 

21.0

%

Tax effect of:

 

 

  

 

  

 

 

 

  

 

  

 

Tax exempt income

 

 

(329)

 

(1.1)

 

 

 

(402)

 

(1.6)

 

Other

 

 

1,440

 

4.9

 

 

 

386

 

1.5

 

Applicable income taxes

 

$

7,225

 

24.8

 

$

5,252

 

20.9

%

 

It is the opinion of management that the Company has no significant uncertain tax positions that would be subject to change upon examination.

 

NOTE 15 Segment Reporting

The Company determines reportable segments based on the services offered, the significance of the services offered, the significance of those services to the Company’s financial statements, and management’s regular review of the operating results of those services. The Company operates through four operating segments: Banking, Retirement and Benefit Services, Wealth Management, and Mortgage.

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Table of Contents

The financial information presented on each segment sets forth net interest income, provision for loan losses, direct noninterest income, and direct noninterest expense, before indirect allocations. Corporate Administration includes the indirect overhead and is set forth in the table below. The segment net income before taxes represents direct revenue and expense before indirect allocations and income taxes.

The following table presents key metrics related to the Company’s segments for the periods presented:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Three months ended September 30, 2019

 

    

 

 

    

Retirement and

    

Wealth

    

 

 

    

Corporate

    

 

 

(dollars in thousands)

 

Banking

 

Benefit Services

 

Management

 

Mortgage

 

Administration

 

Consolidated

Net interest income

 

$

19,193

 

$

 —

 

$

 —

 

$

384

 

$

(896)

 

$

18,681

Provision for loan losses

 

 

1,498

 

 

 —

 

 

 —

 

 

 —

 

 

 —

 

 

1,498

Noninterest income

 

 

1,695

 

 

15,307

 

 

3,896

 

 

8,135

 

 

547

 

 

29,580

Noninterest expense

 

 

10,800

 

 

8,551

 

 

1,835

 

 

7,256

 

 

8,885

 

 

37,327

Net income before taxes

 

$

8,590

 

$

6,756

 

$

2,061

 

$

1,263

 

$

(9,234)

 

$

9,436

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Nine months ended September 30, 2019

 

    

 

 

    

Retirement and

    

Wealth

    

 

 

    

Corporate

    

 

 

(dollars in thousands)

 

Banking

 

Benefit Services

 

Management

 

Mortgage

 

Administration

 

Consolidated

Net interest income

 

$

57,987

 

$

 —

 

$

 —

 

$

818

 

$

(2,713)

 

$

56,092

Provision for loan losses

 

 

5,515

 

 

 —

 

 

 —

 

 

 —

 

 

 —

 

 

5,515

Noninterest income

 

 

5,273

 

 

46,142

 

 

11,385

 

 

19,739

 

 

2,099

 

 

84,638

Noninterest expense

 

 

30,880

 

 

26,142

 

 

5,936

 

 

17,184

 

 

25,960

 

 

106,102

Net income before taxes

 

$

26,865

 

$

20,000

 

$

5,449

 

$

3,373

 

$

(26,574)

 

$

29,113

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Three months ended September 30, 2018

 

    

 

 

    

Retirement and

    

Wealth

    

 

 

    

Corporate

    

 

 

(dollars in thousands)

 

Banking

 

Benefit Services

 

Management

 

Mortgage

 

Administration

 

Consolidated

Net interest income

 

$

19,568

 

$

 —

 

$

17

 

$

248

 

$

(904)

 

$

18,929

Provision for loan losses

 

 

1,521

 

 

 —

 

 

 —

 

 

 9

 

 

 —

 

 

1,530

Noninterest income

 

 

1,710

 

 

15,536

 

 

3,685

 

 

5,318

 

 

 9

 

 

26,258

Noninterest expense

 

 

10,042

 

 

8,948

 

 

1,709

 

 

5,319

 

 

8,318

 

 

34,336

Net income before taxes

 

$

9,715

 

$

6,588

 

$

1,993

 

$

238

 

$

(9,213)

 

$

9,321

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Nine months ended September 30, 2018

 

    

 

 

    

Retirement and

    

Wealth

    

 

 

    

Corporate

    

 

 

(dollars in thousands)

 

Banking

 

Benefit Services

 

Management

 

Mortgage

 

Administration

 

Consolidated

Net interest income

 

$

57,960

 

$

 —

 

$

47

 

$

653

 

$

(2,689)

 

$

55,971

Provision for loan losses

 

 

7,071

 

 

 —

 

 

 —

 

 

 9

 

 

 —

 

 

7,080

Noninterest income

 

 

5,159

 

 

46,873

 

 

10,948

 

 

13,551

 

 

77

 

 

76,608

Noninterest expense

 

 

29,416

 

 

27,338

 

 

5,702

 

 

14,273

 

 

23,685

 

 

100,414

Net income before taxes

 

$

26,632

 

$

19,535

 

$

5,293

 

$

(78)

 

$

(26,297)

 

$

25,085

Banking

The Banking division offers a complete line of loan, deposit, cash management, and treasury services through locations in North Dakota, Minnesota, and Arizona. These products and services are supported through web and mobile based applications. The majority of the Company’s assets and liabilities are in the Banking segment’s balance sheet.

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Table of Contents

Retirement and Benefit Services

Retirement and Benefit Services provides the following services nationally: recordkeeping and administration services to qualified retirement plans; ESOP trustee, recordkeeping, and administration; investment fiduciary services to retirement plans; health savings accounts, flex spending accounts, Cobra recordkeeping and administration services, and payroll to employers.

Wealth Management

The Wealth Management division provides advisory and planning services, investment management, and trust and fiduciary services to clients across the Company’s footprint.

Mortgage

The mortgage division offers first and second mortgage loans through a centralized mortgage unit in Minneapolis, Minnesota as well as through the Banking office locations.

 

NOTE 16 Earnings Per Share

Beginning in the third quarter of 2019, the Company has elected to prospectively use the two-class method in calculating earnings per share due to the restricted stock awards and restricted stock units qualifying as participating securities. Under the two-class method, earnings available to common shareholders for the period are allocated between common shareholders and participating securities according to dividends declared (or accumulated) and participating rights in undistributed earnings. Average shares of common stock for diluted net income per common share include shares to be issued upon the vesting of restricted stock awards and restricted stock units granted under the Company's share-based compensation plans.

The calculation of basic and diluted earnings per share using the two-class method for the three and nine months ending September 30, 2019 is presented below:

 

 

 

 

 

 

 

 

 

Three months ended

 

Nine months ended

 

 

September 30, 

 

September 30, 

(dollars and shares in thousands, except per share data)

    

2019

    

2019

Net income

 

$

7,104

 

$

21,888

Dividends and undistributed earnings allocated to participating securities

 

 

154

 

 

514

Net income available to common shareholders

 

$

6,950

 

$

21,374

Weighted-average common shares outstanding for basic earnings per share

 

 

14,274

 

 

13,957

Dilutive effect of stock-based awards

 

 

352

 

 

360

Weighted-average common shares outstanding for diluted earnings per share

 

 

14,626

 

 

14,317

Earnings per common share:

 

 

 

 

 

 

Basic earnings per common share

 

$

0.49

 

$

1.53

Diluted earnings per common share

 

$

0.48

 

$

1.49

For the three and nine months ended September 30, 2018, the basic and diluted earnings per share were calculated using the treasury stock method, as presented in the table below. The Company determined that the impact to diluted earnings per share would be immaterial if calculated under the two-class method for the three and nine months ended September 30, 2018.

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Table of Contents

The calculation of basic and diluted earnings per share using the treasury stock method for the three and nine months ending September 30, 2018 is presented below:

 

 

 

 

 

 

 

 

 

Three months ended

 

Nine months ended

 

 

September 30, 

 

September 30, 

(dollars and shares in thousands, except per share data)

    

2018

    

2018

Basic:

 

 

 

 

 

 

Net income attributable to common shareholders

 

$

7,370

 

$

19,833

Weighted-average common shares outstanding

 

 

13,777

 

 

13,759

Basic earnings per common share

 

$

0.53

 

$

1.44

Diluted:

 

 

 

 

 

 

Net income attributable to common shareholders

 

 

7,370

 

 

19,833

Weighted-average common shares outstanding

 

 

13,777

 

 

13,759

Add: Dilutive effect of stock-based awards

 

 

294

 

 

301

Weighted-average common shares outstanding for diluted EPS

 

 

14,071

 

 

14,060

Diluted earnings per common share

 

$

0.52

 

$

1.41

 

 

 

NOTE 17 Derivative Instruments

The Company did not have any derivatives designated as hedging instruments, as of September 30, 2019 and December 31, 2018. The following table presents the amounts recorded in the Company’s consolidated balance sheets, for derivatives not designated as hedging instruments, as of September 30, 2019 and December 31, 2018:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

September 30, 2019

 

December 31, 2018

 

 

 

 

Fair

 

Notional

 

Fair

 

Notional

(dollars in thousands)

    

 

    

Value

    

Amount

    

Value

    

Amount

Asset Derivatives

 

Consolidated Balance Sheet Location

 

 

  

 

 

  

 

 

  

 

 

  

Interest rate lock commitments

 

Other assets

 

$

2,036

 

$

89,608

 

$

12

 

$

33,858

Forward loan sales commitments

 

Other assets

 

 

447

 

 

17,662

 

 

 —

 

 

 —

TBA mortgage backed securities

 

Other assets

 

 

 —

 

 

 —

 

 

 —

 

 

 —

Total asset derivatives

 

  

 

$

2,483

 

$

107,270

 

$

12

 

$

33,858

Liability Derivatives

 

  

 

 

  

 

 

  

 

 

  

 

 

  

Interest rate lock commitments

 

Accrued expenses and other liabilities

 

$

 —

 

$

 —

 

$

 —

 

$

 —

Forward loan sales commitments

 

Accrued expenses and other liabilities

 

 

 —

 

 

 —

 

 

 7

 

 

2,956

TBA mortgage backed securities

 

Accrued expenses and other liabilities

 

 

104

 

 

148,500

 

 

 —

 

 

 —

Total liability derivatives

 

  

 

$

104

 

$

148,500

 

$

 7

 

$

2,956

 

The gain (loss) recognized on derivative instruments for the three and nine months ended September 30, 2019 and 2018 was as follows:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Gain/(loss)

 

 

 

 

Three months ended

    

Nine months ended

 

 

 

 

September 30, 

 

September 30, 

 

September 30, 

 

September 30, 

(dollars in thousands)

    

Consolidated Statements of Income Location

    

2019

    

2018

    

2019

    

2018

Interest rate lock commitments

 

Mortgage banking

 

$

(257)

 

$

(29)

 

$

2,024

 

$

(11)

Forward loan sales commitments

 

Mortgage banking

 

 

(199)

 

 

46

 

 

454

 

 

24

TBA mortgage backed securities

 

Mortgage banking

 

 

680

 

 

 —

 

 

(104)

 

 

 —

Total gain/(loss) from derivative instruments

 

$

224

 

$

17

 

$

2,374

 

$

13

 

 

30

Table of Contents

NOTE 18 Regulatory Matters

The Bank is subject to various regulatory capital requirements administered by the federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory and possibly additional discretionary actions by regulators that, if undertaken, could have a direct material effect on the Company’s and the Bank’s consolidated financial statements.

Quantitative measures established by regulation to ensure capital adequacy require the Bank to maintain minimum amounts and ratios (set forth in the following table) of common equity tier 1, tier 1, and total capital (as defined in the regulations) to risk weighted assets (as defined) and of tier 1 capital (as defined) to average assets (as defined). Management believes as of September 30, 2019 and December 31, 2018, the Bank had met all of the capital adequacy requirements to which it is subject and would be considered well capitalized under the regulatory framework for prompt corrective action.

The following table presents the Company’s and  the Bank’s actual capital amounts and ratios as of September 30, 2019 and December 31, 2018:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

September 30, 2019

 

 

 

 

 

 

 

 

 

 

 

 

Minimum to be

 

 

 

 

 

 

 

 

Requirements

 

Well Capitalized

 

 

 

 

 

 

 

 

for Capital

 

Under Prompt

 

 

 

Actual

 

Adequacy Purposes

 

Corrective Action

 

(dollars in thousands)

    

Amount

    

Ratio

    

Amount

    

Ratio

    

Amount

    

Ratio

 

Common equity tier 1 capital to risk weighted assets

 

 

  

 

  

 

  

 

  

 

  

 

  

 

Consolidated

 

$

233,030

 

12.38

%  

84,705

 

4.50

%  

N/A

 

N/A

 

Bank

 

 

222,600

 

11.84

%  

84,594

 

4.50

%  

122,192

 

6.50

%

Tier 1 capital to risk weighted assets

 

 

  

 

 

 

  

 

  

 

.

 

  

 

Consolidated

 

 

241,197

 

12.81

%  

112,940

 

6.00

%  

N/A

 

N/A

 

Bank

 

 

222,600

 

11.84

%  

112,792

 

6.00

%  

150,390

 

8.00

%

Total capital to risk weighted assets

 

 

  

 

  

 

  

 

  

 

  

 

  

 

Consolidated

 

 

313,700

 

16.67

%  

150,587

 

8.00

%  

N/A

 

N/A

 

Bank

 

 

245,585

 

13.06

%  

150,390

 

8.00

%  

187,987

 

10.00

%

Tier 1 capital to average assets

 

 

  

 

  

 

  

 

  

 

  

 

  

 

Consolidated

 

 

241,197

 

11.33

%  

85,152

 

4.00

%  

N/A

 

N/A

 

Bank

 

 

222,600

 

10.47

%  

85,009

 

4.00

%  

106,261

 

5.00

%

 

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Table of Contents

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

December 31, 2018

 

 

 

 

 

 

 

 

 

 

 

 

Minimum to be

 

 

 

 

 

 

 

 

Requirements

 

Well Capitalized

 

 

 

 

 

 

 

 

for Capital

 

Under Prompt

 

 

 

Actual

 

Adequacy Purposes

 

Corrective Action

 

(dollars in thousands)

    

Amount

    

Ratio

    

Amount

    

Ratio

    

Amount

    

Ratio

 

Common equity tier 1 capital to risk weighted assets

 

 

  

 

  

 

  

 

  

 

  

 

  

 

Consolidated

 

$

151,745

 

8.43

%  

N/A

 

N/A

 

N/A

 

N/A

 

Bank

 

 

204,680

 

11.39

%  

80,866

 

4.50

%  

116,806

 

6.50

%

Tier 1 capital to risk weighted assets

 

 

  

 

  

 

  

 

  

 

  

 

  

 

Consolidated

 

 

159,774

 

8.87

%  

N/A

 

N/A

 

N/A

 

N/A

 

Bank

 

 

204,680

 

11.39

%  

107,821

 

6.00

%  

143,761

 

8.00

%

Total capital to risk weighted assets

 

 

  

 

  

 

  

 

  

 

  

 

  

 

Consolidated

 

 

231,510

 

12.86

%  

N/A

 

N/A

 

N/A

 

N/A

 

Bank

 

 

226,854

 

12.62

%  

143,806

 

8.00

%  

179,758

 

10.00

%

Tier 1 capital to average assets

 

 

  

 

  

 

  

 

  

 

  

 

  

 

Consolidated

 

 

159,774

 

7.51

%  

N/A

 

N/A

 

N/A

 

N/A

 

Bank

 

 

204,680

 

9.63

%  

85,018

 

4.00

%  

106,272

 

5.00

%

 

The Bank is subject to certain restrictions on the amount of dividends that it may pay without prior regulatory approval. In addition, the Company must adhere to various U.S. Department of Housing and Urban Development (“HUD”) regulatory guidelines including required minimum capital and liquidity to maintain their Federal Housing Administration approval status. Failure to comply with the HUD guidelines could result in withdrawal of this certification. As of September 30, 2019, and December 31, 2018, the Company was in compliance with HUD guidelines.

 

NOTE 19 Fair Value of Assets and Liabilities

The Company categorizes its assets and liabilities measured at estimated fair value into a three level hierarchy based on the priority of the inputs to the valuation technique used to determine estimated fair value. The estimated fair value hierarchy gives the highest priority to quoted prices in active markets for identical assets or liabilities (Level 1) and the lowest priority to unobservable inputs (Level 3). If the inputs used in the determination of the estimated fair value measurement fall within different levels of the hierarchy, the categorization is based on the lowest level input that is significant to the estimated fair value measurement. Assets and liabilities valued at estimated fair value are categorized based on the following inputs to the valuation techniques as follows:

Level 1—Inputs that utilize quoted prices (unadjusted) in active markets for identical assets or liabilities that an entity has the ability to access.

Level 2—Inputs that include quoted prices for similar assets and liabilities in active markets and inputs that are observable for the asset or liability, either directly or indirectly, for substantially the full term of the financial instrument. Estimated fair values for these instruments are estimated using pricing models, quoted prices of investment securities with similar characteristics, or discounted cash flows.

Level 3—Inputs that are unobservable inputs for the asset or liability, which are typically based on an entity’s own assumptions, as there is little, if any, related market activity. Subsequent to initial recognition, the Company may re‑measure the carrying value of assets and liabilities measured on a nonrecurring basis to estimated fair value. Adjustments to estimated fair value usually result when certain assets are impaired. Such assets are written down from their carrying amounts to their estimated fair value.

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Professional standards allow entities the irrevocable option to elect to measure certain financial instruments and other items at estimated fair value for the initial and subsequent measurement on an instrument‑by‑instrument basis. The Company adopted the policy to value certain financial instruments at estimated fair value. The Company has not elected to measure any existing financial instruments at estimated fair value; however, it may elect to measure newly acquired financial instruments at estimated fair value in the future.

Recurring Basis

The Company uses estimated fair value measurements to record estimated fair value adjustments to certain assets and liabilities and to determine estimated fair value disclosures.

The following tables present the balances of the assets and liabilities measured at estimated fair value on a recurring basis as of September 30, 2019 and December 31, 2018:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

    

September 30, 2019

(dollars in thousands)

    

Level 1

    

Level 2

    

Level 3

    

Total

Trading securities

 

 

  

 

 

  

 

 

  

 

 

  

U.S. treasury and government agencies

 

$

 —

 

$

 —

 

$

 —

 

$

 —

Available-for-sale and equity securities

 

 

  

 

 

  

 

 

  

 

 

  

U.S. treasury and government agencies

 

$

 —

 

$

21,602

 

$

 —

 

$

21,602

Obligations of state and political agencies

 

 

 —

 

 

47,856

 

 

 —

 

 

47,856

Mortgage backed securities

 

 

  

 

 

  

 

 

  

 

 

  

Residential agency

 

 

 —

 

 

169,337

 

 

 —

 

 

169,337

Commercial

 

 

 —

 

 

32,652

 

 

 —

 

 

32,652

Asset backed securities

 

 

 —

 

 

157

 

 

 —

 

 

157

Corporate bonds

 

 

 —

 

 

7,112

 

 

 —

 

 

7,112

Equity securities

 

 

2,675

 

 

 —

 

 

 —

 

 

2,675

Total available-for-sale and equity securities

 

$

2,675

 

$

278,716

 

$

 —

 

$

281,391

Other assets

 

 

  

 

 

  

 

 

  

 

 

  

Derivatives

 

$

 —

 

$

2,483

 

$

 —

 

$

2,483

Other liabilities

 

 

  

 

 

  

 

 

  

 

 

  

Derivatives

 

$

 —

 

$

104

 

$

 —

 

$

104

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

    

December 31, 2018

(dollars in thousands)

    

Level 1

    

Level 2

    

Level 3

    

Total

Trading securities

 

 

  

 

 

  

 

 

  

 

 

  

U.S. treasury and government agencies

 

$

 —

 

$

1,539

 

$

 —

 

$

1,539

Available-for-sale and equity securities

 

 

  

 

 

  

 

 

  

 

 

  

U.S. treasury and government agencies

 

$

 —

 

$

19,142

 

$

 —

 

$

19,142

Obligations of state and political agencies

 

 

 —

 

 

66,387

 

 

 —

 

 

66,387

Mortgage backed securities

 

 

  

 

 

  

 

 

  

 

 

  

Residential agency

 

 

 —

 

 

126,998

 

 

 —

 

 

126,998

Commercial

 

 

 —

 

 

28,767

 

 

 —

 

 

28,767

Asset backed securities

 

 

 —

 

 

399

 

 

 —

 

 

399

Corporate bonds

 

 

 —

 

 

8,481

 

 

 —

 

 

8,481

Equity securities

 

 

3,165

 

 

 —

 

 

 —

 

 

3,165

Total available-for-sale and equity securities

 

$

3,165

 

$

250,174

 

$

 —

 

$

253,339

Other assets

 

 

  

 

 

  

 

 

  

 

 

  

Derivatives

 

$

 —

 

$

12

 

$

 —

 

$

12

Other liabilities

 

 

  

 

 

  

 

 

  

 

 

  

Derivatives

 

$

 —

 

$

 7

 

$

 —

 

$

 7

 

33

Table of Contents

The following is a description of the valuation methodologies used for instruments measured at estimated fair value on a recurring basis, as well as the general classification of such instruments pursuant to the valuation hierarchy.

Investment Securities

When available, the Company uses quoted market prices to determine the estimated fair value of investment securities; such items are classified in Level 1 of the estimated fair value hierarchy. For the Company’s investment securities for which quoted prices are not available for identical investment securities in an active market, the Company determines estimated fair value utilizing vendors who apply matrix pricing for similar bonds for which no prices are observable or may compile prices from various sources. These models are primarily industry‑standard models that consider various assumptions, including time value, yield curve, volatility factors, prepayment speeds, default rates, loss severity, current market, and contractual prices for the underlying financial instruments, as well as other relevant economic measures. Substantially all of these assumptions are observable in the marketplace, can be derived from observable data, or are supported by observable levels at which transactions are executed in the marketplace. Estimated fair values from these models are verified, where possible, against quoted prices for recent trading activity of assets with similar characteristics to the security being valued. Such methods are generally classified as Level 2. However, when prices from independent sources vary, cannot be obtained, or cannot be corroborated, a security is generally classified as Level 3.

Derivatives

All of the Company’s derivatives are traded in over‑the‑counter markets where quoted market prices are not readily available. For these derivatives, estimated fair value is measured using internally developed models that use primarily market observable inputs, such as yield curves and option volatilities, and accordingly, classify as Level 2. Examples of Level 2 derivatives are basic interest rate swaps and forward contracts. Any remaining derivative estimated fair value measurements using significant assumptions that are unobservable are classified as Level 3. Level 3 derivatives include interest rate lock commitments written for residential mortgage loans that are held for sale.

Nonrecurring Basis

Certain assets are measured at estimated fair value on a nonrecurring basis. These assets are not measured at estimated fair value on an ongoing basis; however, they are subject to estimated fair value adjustments in certain circumstances, such as when there is evidence of impairment or a change in the amount of previously recognized impairment.

Net impairment related to nonrecurring estimated fair value measurements of certain assets as of September 30, 2019 and December 31, 2018 consisted of the following:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

September 30, 2019

(dollars in thousands)

    

Level 2

    

Level 3

    

Total

    

Impairment

Loans held for sale

 

$

66,021

 

$

 —

 

$

66,021

 

$

 —

Loans held for branch sale

 

 

 —

 

 

 —

 

 

 —

 

 

 —

Impaired loans

 

 

 —

 

 

3,050

 

 

3,050

 

 

2,107

Foreclosed assets

 

 

 —

 

 

84

 

 

84

 

 

 —

Servicing rights

 

 

 —

 

 

4,146

 

 

4,146

 

 

 —

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

December 31, 2018

(dollars in thousands)

 

Level 2

    

Level 3

    

Total

    

Impairment

Loans held for sale

 

$

14,486

 

$

 —

 

$

14,486

 

$

 —

Loans held for branch sale

 

 

 —

 

 

32,031

 

 

32,031

 

 

 —

Impaired loans

 

 

 —

 

 

4,022

 

 

4,022

 

 

2,538

Foreclosed assets

 

 

 —

 

 

204

 

 

204

 

 

245

Servicing rights

 

 

 —

 

 

4,623

 

 

4,623

 

 

 —

 

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Table of Contents

Loans Held for Sale

Loans originated and held for sale are carried at the lower of cost or estimated fair value. The Company obtains quotes or bids on these loans directly from purchasing financial institutions. Typically these quotes include a premium on the sale and thus these quotes indicate estimated fair value of the held for sale loans is greater than cost.

On January 15, 2019, the Bank entered into an agreement with a third party to sell the loans of two branch locations in Duluth, Minnesota, and on April 26, 2019, the Bank completed the sale. As of December 31, 2018, the loans were held for branch sale and totaled $32.0 million. The estimated fair value in the table above was based on the agreed upon purchase price in the sales contract. The measurements were classified as Level 3.

Impairment losses for loans held for sale that are carried at the lower of cost or estimated fair value, represent additional net write‑downs during the period to record these loans at the lower of cost or estimated fair value, subsequent to their initial classification as loans held for sale.

Impaired Loans

In accordance with the provisions of the loan impairment guidance, loans for which it is probable that payment of interest and principal will not be made in accordance with the contractual terms are measured for impairment. Allowable methods for estimating fair value include using the estimated fair value of the collateral for collateral dependent loans or, where a loan is determined not to be collateral dependent, using a discounted cash flow method. The estimated fair value method requires obtaining a current independent appraisal of the collateral and applying a discount factor, if necessary, to the appraised value and including costs to the sell. Because many of these inputs are not observable, the measurements are classified as Level 3.

Foreclosed Assets

Foreclosed assets are recorded at estimated fair value based on property appraisals, less estimated selling costs, at the date of the transfer with any impairment amount charged to the allowance for loan losses. Subsequent to the transfer, foreclosed assets are carried at the lower of cost or estimated fair value, less estimated selling costs with changes in the estimated fair value or any impairment amount recorded in other noninterest expense. Fair value measurements may be based upon appraisals, third‑party price opinions, or internally developed pricing methods. These measurements are classified as Level 3.

Servicing Rights

Servicing rights do not trade in an active market with readily observable prices. Accordingly, the estimated fair value of servicing rights is determined using a valuation model that calculates the present value of estimated future net servicing income. The model incorporates assumptions that market participants use in estimating future net servicing income, including estimates of prepayment speeds, discount rate, cost to service, escrow account earnings, contractual servicing fee income, ancillary income, and late fees. Servicing rights are carried at lower of cost or market value, and therefore can be subject to estimated fair value measurements on a nonrecurring basis. Estimated fair value measurements of servicing rights use significant unobservable inputs and accordingly, are classified as Level 3. The Company obtains the estimated fair value of servicing rights from an independent third party pricing service and records the unadjusted estimated fair values in the financial statements.

35

Table of Contents

The valuation techniques and significant unobservable inputs used to measure Level 3 estimated fair values as of September 30, 2019, and December 31, 2018, were as follows:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

September 30, 2019

 

(dollars in thousands)

 

 

 

 

 

 

 

 

 

Weighted

 

Asset Type

    

Valuation Technique

    

Unobservable Input

    

Fair Value

    

Range

    

Average

  

Impaired loans

 

Appraisal value

 

Property specific adjustment

 

3,050

 

N/A

 

N/A

 

Foreclosed assets

 

Appraisal value

 

Property specific adjustment

 

84

 

N/A

 

N/A

 

Servicing rights

 

Discounted cash flows

 

Prepayment speed assumptions

 

4,146

 

154-270

 

194

 

 

 

  

 

Discount rate

 

  

 

9.5

%  

9.5

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

December 31, 2018

 

(dollars in thousands)

 

 

 

 

 

 

 

 

 

Weighted

 

Asset Type

    

Valuation Technique

    

Unobservable Input

    

Fair Value

    

Range

    

Average

 

Loans held for branch sale

 

Discounted cash flows

 

Sales agreement

 

32,031

 

N/A

 

N/A

 

Impaired loans

 

Appraisal value

 

Property specific adjustment

 

4,022

 

N/A

 

N/A

 

Foreclosed assets

 

Appraisal value

 

Property specific adjustment

 

204

 

N/A

 

N/A

 

Servicing rights

 

Discounted cash flows

 

Prepayment speed assumptions

 

4,623

 

104 - 211

 

130

 

 

 

  

 

Discount rate

 

  

 

10.5

%  

10.5

%

 

Disclosure of estimated fair value information about financial instruments, for which it is practicable to estimate that value, is required whether or not recognized in the consolidated balance sheets. In cases in which quoted market prices are not available, estimated fair values are based on estimates using present value or other valuation techniques. Those techniques are significantly affected by the assumptions used, including the discount rate and estimate of future cash flows. In that regard, the derived estimated fair value estimates cannot be substantiated by comparison to independent markets and, in many cases could not be realized in immediate settlement of the instruments. Certain financial instruments, with an estimated fair value that is not practicable to estimate and all non‑financial instruments, are excluded from the disclosure requirements. Accordingly, the aggregate estimated fair value amounts presented do not necessarily represent the underlying value of the Company.

The following disclosures represent financial instruments in which the ending balances, as of September 30, 2019 and December 31, 2018, were not carried at estimated fair value in their entirety on the consolidated balance sheets.

Cash and Cash Equivalents and Accrued Interest

The carrying amounts reported in the consolidated balance sheets approximate those assets and liabilities estimated fair values.

Loans

For variable‑rate loans that reprice frequently and with no significant change in credit risk, estimated fair values are based on carrying values. The estimated fair values of other loans are estimated using discounted cash flow analysis, using interest rates currently being offered for loans with similar terms to borrowers of similar credit quality.

Bank‑Owned Life Insurance

Bank‑owned life insurance is carried at the amount due upon surrender of the policy, which is also the estimated fair value. This amount was provided by the insurance companies based on the terms of the underlying insurance contract.

36

Table of Contents

Deposits

The estimated fair values of demand deposits are, by definition, equal to the amount payable on demand at the consolidated balance sheet date. The estimated fair values of fixed‑rate certificates of deposit are estimated using a discounted cash flow calculation that applies current incremental interest rates being offered on certificates of deposit to a schedule of aggregated expected monthly maturities of the outstanding certificates of deposit.

Deposits Held for Sale

On January 15, 2019, the Bank entered into an agreement with a third party to sell the deposits of two branch locations in Duluth, Minnesota, and on April 26, 2019, the Bank completed the sale. As of December 31, 2018, the deposits were held for sale and totaled $24.2 million. The estimated fair value in the table below was based on the carrying value of the deposits, less the premium the Bank received, in accordance with the purchase agreement.

Short‑Term Borrowings and Long‑Term Debt

For variable‑rate borrowings that reprice frequently, estimated fair values are based on carrying values. The estimated fair value of fixed‑rate borrowings are estimated using discounted cash flow analysis, based on the Company’s current incremental borrowing rates for similar types of borrowing arrangements.

Off‑Balance Sheet Credit‑Related Commitments

Off‑balance sheet credit related commitments are generally of short‑term nature. The contract amount of such commitments approximates their estimated fair value since the commitments are comprised primarily of unfunded loan commitments which are generally priced at market at the time of funding.

The estimated fair values, and related carrying or notional amounts, of the Company’s financial instruments are as follows:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

September 30, 2019

 

 

Carrying

 

Estimated Fair Value

(dollars in thousands)

    

Amount

    

Level 1

    

Level 2

    

Level 3

    

Total

Financial Assets

 

 

  

 

 

  

 

 

  

 

 

  

 

 

  

Cash and cash equivalents

 

$

61,174

 

$

61,174

 

$

 —

 

$

 —

 

$

61,174

Loans

 

 

1,663,103

 

 

 —

 

 

 —

 

 

1,658,151

 

 

1,658,151

Accrued interest receivable

 

 

7,412

 

 

7,412

 

 

 —

 

 

 —

 

 

7,412

Bank-owned life insurance

 

 

31,364

 

 

 —

 

 

31,364

 

 

 —

 

 

31,364

Financial Liabilities

 

 

  

 

 

  

 

 

  

 

 

  

 

 

  

Noninterest-bearing transaction

 

$

537,951

 

$

 —

 

$

537,951

 

$

 —

 

$

537,951

Interest-bearing transaction

 

 

1,102,409

 

 

 —

 

 

1,102,409

 

 

 —

 

 

1,102,409

Time deposits

 

 

192,753

 

 

 —

 

 

 —

 

 

192,869

 

 

192,869

Short-term borrowings

 

 

 —

 

 

 —

 

 

 —

 

 

 —

 

 

 —

Long-term debt

 

 

58,775

 

 

 —

 

 

58,285

 

 

 —

 

 

58,285

Accrued interest payable

 

 

1,879

 

 

1,879

 

 

 —

 

 

 —

 

 

1,879

 

37

Table of Contents

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

December 31, 2018

 

 

Carrying

 

Estimated Fair Value

(dollars in thousands)

    

Amount

    

Level 1

    

Level 2

    

Level 3

    

Total

Financial Assets

 

 

  

 

 

  

 

 

  

 

 

  

 

 

  

Cash and cash equivalents

 

$

40,651

 

$

40,651

 

$

 —

 

$

 —

 

$

40,651

Loans

 

 

1,679,676

 

 

 —

 

 

 —

 

 

1,663,401

 

 

1,663,401

Accrued interest receivable

 

 

7,645

 

 

7,645

 

 

 —

 

 

 —

 

 

7,645

Bank-owned life insurance

 

 

30,763

 

 

 —

 

 

30,763

 

 

 —

 

 

30,763

Financial Liabilities

 

 

  

 

 

  

 

 

  

 

 

  

 

 

  

Noninterest-bearing transaction

 

$

550,640

 

$

 —

 

$

550,640

 

$

 —

 

$

550,640

Interest-bearing transaction

 

 

1,053,869

 

 

 —

 

 

1,053,869

 

 

 —

 

 

1,053,869

Time deposits

 

 

170,587

 

 

 —

 

 

 —

 

 

172,616

 

 

172,616

Deposits held for sale

 

 

24,197

 

 

 —

 

 

 —

 

 

22,019

 

 

22,019

Short-term borrowings

 

 

93,460

 

 

93,460

 

 

 —

 

 

 —

 

 

93,460

Long-term debt

 

 

58,824

 

 

 —

 

 

59,988

 

 

 —

 

 

59,988

Accrued interest payable

 

 

720

 

 

720

 

 

 —

 

 

 —

 

 

720

 

 

NOTE 20 Branch Sale

On January 15, 2019, the Bank announced an agreement to sell the Bank’s branch offices located in Duluth, Minnesota, including loans and deposits attributable to those offices, to another financial institution. The Bank decided to exit the Duluth market to reallocate resources to the Minneapolis-St. Paul-Bloomington metropolitan statistical area, which is a higher growth market in the state, and its’ other core markets in the Phoenix-Mesa-Scottsdale metropolitan statistical area, and in Fargo and Grand Forks, North Dakota. The loans and deposits were classified as held for sale in the consolidated financial statements as of December 31, 2018. The transaction closed on April 26, 2019. The loans and deposits associated with this transaction totaled approximately $28.3 million and $19.4 million, respectively, as of the closing date. A pre‑tax gain on the sale was recognized in the amount of $1.5 million.

 

 

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Table of Contents

Item 2 – Management’s Discussion and Analysis of Financial Condition and Results of Operations

General

The following discussion explains our financial condition and results of operations as of and for the three and nine months ended September  30, 2019 and 2018. The following discussion and analysis should be read in conjunction with the consolidated financial statements and related notes presented elsewhere in this report and the Company’s prospectus filed with the SEC on September 13, 2019, pursuant to Rule 424(b)(4) under the Securities Act of 1933, which contains audited financial statements of the Company as of and for the year ended December 31, 2018. Annualized results for these interim periods may not be indicative of results for the full year or future periods.

Forward-Looking Statements

This Quarterly Report on Form 10-Q contains “forward-looking statements” within the meaning of the safe harbor provisions of the U.S. Private Securities Litigation Reform Act of 1995. Forward-looking statements include, without limitation, statements concerning plans, estimates, calculations, forecasts and projections with respect to the anticipated future performance of Alerus Financial Corporation. These statements are often, but not always, identified by words such as “may”, “might”, “should”, “could”, “predict”, “potential”, “believe”, “expect”, “continue”, “will”, “anticipate”, “seek”, “estimate”, “intend”, “plan”, “projection”, “would”, “annualized”, “target” and “outlook”, or the negative version of those words or other comparable words of a future or forward-looking nature. Examples of forward-looking statements include, among others, statements we make regarding our projected growth, anticipated future financial performance, financial condition, credit quality and management’s long-term performance goals and the future plans and prospects of Alerus Financial Corporation.

Forward-looking statements are neither historical facts nor assurances of future performance. Instead, they are based only on our current beliefs, expectations and assumptions regarding the future of our business, future plans and strategies, projections, anticipated events and trends, the economy and other future conditions. Because forward-looking statements relate to the future, they are subject to inherent uncertainties, risks and changes in circumstances that are difficult to predict and many of which are outside of our control. Our actual results and financial condition may differ materially from those indicated in the forward-looking statements. Therefore, you should not rely on any of these forward-looking statements. Important factors that could cause our actual results and financial condition to differ materially from those indicated in the forward-looking statements include, among others, the following: our ability to successfully manage credit risk and maintain an adequate level of allowance for loan losses; business and economic conditions generally and in the financial services industry, nationally and within our market areas; the overall health of the local and national real estate market; concentrations within our loan portfolio; the level of nonperforming assets on our balance sheet; our ability to implement our organic and acquisition growth strategies; the impact of economic or market conditions on our fee-based services; our ability to continue to grow our retirement and benefit services business; our ability to continue to originate a sufficient volume of residential mortgages; the occurrence of fraudulent activity, breaches or failures of our information security controls or cybersecurity-related incidents; interruptions involving our information technology and telecommunications systems or third-party servicers; potential losses incurred in connection with mortgage loan repurchases; the composition of our executive management team and our ability to attract and retain key personnel; rapid technological change in the financial services industry; increased competition in the financial services industry; our ability to successfully manage liquidity risk; the effectiveness of our risk management framework; the commencement and outcome of litigation and other legal proceedings and regulatory actions against us or to which we may become subject; potential impairment to the goodwill we recorded in connection with our past acquisitions; the extensive regulatory framework that applies to us; the impact of recent and future legislative and regulatory changes; interest rate risks associated with our business; fluctuations in the values of the securities held in our securities portfolio; governmental monetary, trade and fiscal policies; any material weaknesses in our internal control over financial reporting; our success at managing the risks involved in the foregoing items; and any other risks described in the “Risk Factors” section of this report and in other reports filed by Alerus Financial Corporation with the Securities and Exchange Commission.

39

Table of Contents

Any forward-looking statement made by us in this report is based only on information currently available to us and speaks only as of the date on which it is made. We undertake no obligation to publicly update any forward-looking statement, whether written or oral, that may be made from time to time, whether as a result of new information, future developments or otherwise.

Overview

We are a diversified financial services company headquartered in Grand Forks, North Dakota. Through our subsidiary, Alerus Financial, National Association (the “Bank”), we provide innovative and comprehensive financial solutions to businesses and consumers through four distinct business lines—banking, retirement and benefit services, wealth management and mortgage. These solutions are delivered through a relationship‑oriented primary point of contact along with responsive and client‑friendly technology.

Our business model produces strong financial performance and a diversified revenue stream, which has helped us establish a brand and culture yielding both a loyal client base and passionate and dedicated employees. We generate a majority of our overall revenue from noninterest income, which is driven primarily by our retirement and benefit services, wealth management and mortgage business lines. The remainder of our revenue consists of net interest income, which we derive from offering our traditional banking products and services.

Critical Accounting Policies

Our consolidated financial statements are prepared based on the application of accounting policies generally accepted in the United States (“GAAP”). Our critical accounting policies require reliance on estimates and assumptions, which are based upon historical experience and on various other assumptions that management believes are reasonable under current circumstances, but may prove to be inaccurate or can be subject to variations. Changes in underlying factors, assumptions, or estimates could have a material impact on our future financial condition and results of operations.

The most critical of these significant accounting policies are set forth in Note 1 – Significant Accounting Policies of the Notes to the Consolidated Statements in our consolidated financial statements as of and for the periods ended December 31, 2018, 2017, and 2016 included in our prospectus filed with the SEC on September 13, 2019, pursuant to Rule 424(b)(4) under the Securities Act of 1933. There have been no significant changes in critical accounting policies or the assumptions and judgments utilized in applying these policies since December 31, 2018.

Recent Developments

On September 17, 2019, we sold 2,860,000 shares of common stock in our initial public offering. On September 25, 2019,  we sold an additional 429,000 shares of common stock pursuant to the exercise in full by the underwriters of their option to purchase additional shares. The aggregate offering price for the shares sold by us was $69.1 million, and after deducting $4.7 million of underwriting discounts and $1.6 million of offering expenses paid to third parties, we received total net proceeds of $62.8 million. All of the shares were sold pursuant to our Registration Statement on Form S-1, as amended (File No. 333-233339), which was declared effective by the SEC on September 12, 2019.

On August  28, 2019, the Company’s Board of Directors declared a quarterly cash dividend of $0.14 per share. This dividend was paid out on October 11, 2019, to stockholders of record at the close of business on September 20, 2019.

40

Table of Contents

Operating Results Overview

The following table summarizes key financial results as of and for the periods indicated:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Three months ended

 

Nine months ended

 

 

 

September 30, 

 

June 30, 

 

September 30, 

 

September 30, 

 

September 30, 

 

(dollars and shares in thousands, except per share data)

    

2019

    

2019

    

2018

    

2019

    

2018

    

Performance Ratios

 

 

  

 

 

 

 

 

  

 

 

  

 

 

  

 

Return on average total assets

 

 

1.29

%  

 

1.52

%  

 

1.36

%  

 

1.34

%  

 

1.25

%  

Return on average common equity

 

 

12.42

%  

 

15.82

%  

 

15.45

%  

 

13.74

%  

 

14.35

%  

Return on average tangible common equity (1)

 

 

17.01

%  

 

21.93

%  

 

23.08

%  

 

19.24

%  

 

22.05

%  

Noninterest income as a % of revenue

 

 

61.29

%  

 

62.11

%  

 

58.11

%  

 

60.14

%  

 

57.78

%  

Net interest margin (taxable-equivalent basis) (1)

 

 

3.69

%  

 

3.62

%  

 

3.80

%  

 

3.72

%  

 

3.85

%  

Efficiency ratio (1)

 

 

75.17

%  

 

70.74

%  

 

73.16

%  

 

73.06

%  

 

72.84

%  

Net charge-offs/(recoveries) to average loans

 

 

(0.01)

%  

 

0.18

%  

 

0.02

%  

 

0.27

%  

 

0.16

%  

Dividend payout ratio

 

 

29.17

%  

 

23.73

%  

 

25.00

%  

 

28.19

%  

 

27.66

%  

Per Common Share

 

 

  

 

 

 

 

 

  

 

 

  

 

 

  

 

Earnings per common share - basic

 

$

0.49

 

$

0.60

 

$

0.53

 

$

1.53

 

$

1.44

 

Earnings per common share - diluted

 

$

0.48

 

$

0.59

 

$

0.52

 

$

1.49

 

$

1.41

 

Dividends declared per common share

 

$

0.14

 

$

0.14

 

$

0.13

 

$

0.42

 

$

0.39

 

Tangible book value per common share (1)

 

$

13.77

 

$

12.02

 

$

10.11

 

$

13.77

 

$

10.11

 

Average common shares outstanding - basic

 

 

14,274

 

 

13,810

 

 

13,777

 

 

13,957

 

 

13,759

 

Average common shares outstanding - diluted

 

 

14,626

 

 

14,100

 

 

14,071

 

 

14,317

 

 

14,060

 

Other Data

 

 

  

 

 

 

 

 

 

 

 

 

 

 

 

 

Assets under administration

 

$

27,702,273

 

$

27,854,052

 

$

28,533,616

 

$

27,702,273

 

$

28,533,616

 

Assets under management

 

 

5,724,412

 

 

5,260,233

 

 

4,854,106

 

 

5,724,412

 

 

4,854,106

 

Mortgage originations

 

 

313,527

 

 

246,115

 

 

222,330

 

 

685,178

 

 

609,941

 


(1)

Represents a non-GAAP financial measure. See “Non-GAAP to GAAP Reconciliations and Calculation of Non-GAAP Financial Measures.”

Selected Financial Data

The following tables summarize selected financial data as of and for the periods indicated:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Three months ended

 

Nine months ended

 

 

September 30, 

 

June 30, 

 

September 30, 

 

September 30, 

 

September 30, 

(dollars in thousands)

    

2019

    

2019

    

2018

    

2019

    

2018

Selected Average Balance Sheet Data

 

 

  

 

 

 

 

 

  

 

 

  

 

 

  

Loans

 

$

1,691,542

 

$

1,724,081

 

$

1,699,048

 

$

1,715,629

 

$

1,661,493

Investment securities

 

 

257,561

 

 

255,502

 

 

248,568

 

 

255,903

 

 

256,331

Assets

 

 

2,176,862

 

 

2,200,797

 

 

2,144,841

 

 

2,185,868

 

 

2,115,708

Deposits

 

 

1,763,217

 

 

1,777,003

 

 

1,764,939

 

 

1,779,610

 

 

1,755,473

Short-term borrowings

 

 

87,201

 

 

115,892

 

 

103,171

 

 

95,489

 

 

87,501

Long-term debt

 

 

58,776

 

 

58,808

 

 

58,812

 

 

58,798

 

 

58,812

Stockholders’ equity

 

 

226,931

 

 

211,655

 

 

189,311

 

 

212,911

 

 

184,733

 

 

 

 

 

 

 

 

 

 

 

 

 

September 30, 

 

June 30, 

 

September 30, 

(dollars in thousands)

    

2019

    

2019

    

2018

Selected Period End Balance Sheet Data

 

 

 

 

 

 

 

 

 

Loans

 

$

1,686,087

 

$

1,713,452

 

$

1,724,656

Allowance for loan losses

 

 

(22,984)

 

 

(21,246)

 

 

(21,012)

Investment securities

 

 

281,391

 

 

256,252

 

 

246,387

Assets

 

 

2,228,311

 

 

2,207,129

 

 

2,171,821

Deposits

 

 

1,833,113

 

 

1,753,365

 

 

1,817,709

Long-term debt

 

 

58,775

 

 

58,808

 

 

58,824

Total stockholders’ equity

 

 

281,403

 

 

213,765

 

 

190,082

 

41

Table of Contents

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Three months ended

 

Nine months ended

 

 

September 30, 

 

June 30, 

 

September 30, 

 

September 30, 

 

September 30, 

(dollars in thousands)

    

2019

    

2019

    

2018

    

2019

    

2018

Selected Income Statement Data

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net interest income

 

$

18,681

 

$

18,291

 

$

18,929

 

$

56,092

 

$

55,971

Provision for loan losses

 

 

1,498

 

 

1,797

 

 

1,530

 

 

5,515

 

 

7,080

Noninterest income

 

 

29,580

 

 

29,984

 

 

26,258

 

 

84,638

 

 

76,608

Noninterest expense

 

 

37,327

 

 

35,261

 

 

34,336

 

 

106,102

 

 

100,414

Income before income taxes

 

 

9,436

 

 

11,217

 

 

9,321

 

 

29,113

 

 

25,085

Income tax expense

 

 

2,332

 

 

2,869

 

 

1,951

 

 

7,225

 

 

5,252

Net income

 

$

7,104

 

$

8,348

 

$

7,370

 

$

21,888

 

$

19,833

 

Non-GAAP to GAAP Reconciliations and Calculation of Non-GAAP Financial Measures

In addition to the results presented in accordance with GAAP, we routinely supplement our evaluation with an analysis of certain non-GAAP financial measures. These non-GAAP financial measures include the ratio of tangible common equity to tangible assets, tangible common equity per share, return on average tangible common equity, net interest margin (tax-equivalent), and the efficiency ratio. Management uses these non-GAAP financial measures in its analysis of its performance, and believes financial analysts and others frequently use these measures, and other similar measures, to evaluate capital adequacy. Management calculates: (i) tangible common equity as total common stockholders' equity, including ESOP-owned shares, less goodwill and other intangible assets; (ii) tangible common equity per share as tangible common equity divided by shares of common stock outstanding; (iii) tangible assets as total assets, less goodwill and other intangible assets; (iv) return on average tangible common equity as net income adjusted for intangible amortization net of tax, divided by average tangible common equity; (v) net interest margin (tax-equivalent) as net interest income plus a tax-equivalent adjustment, divided by average earning assets; and (vi) efficiency ratio as noninterest expense less intangible amortization expense, divided by net interest income plus noninterest income plus a tax-equivalent adjustment.

The following tables present these non-GAAP financial measures along with the most directly comparable financial measures calculated in accordance with GAAP for the periods indicated.

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

    

September 30,

 

June 30, 

 

December 31, 

 

September 30, 

 

 

    

2019

    

2019

    

2018

    

2018

 

Tangible common equity to tangible assets

 

 

  

 

 

 

 

 

 

  

 

 

 

Total common stockholders’ equity

 

$

281,403

 

$

213,765

 

$

196,954

 

$

190,082

 

Less: Goodwill

 

 

27,329

 

 

27,329

 

 

27,329

 

 

27,329

 

Less: Other intangible assets

 

 

19,382

 

 

20,372

 

 

22,473

 

 

23,523

 

Tangible common equity (a)

 

 

234,692

 

 

166,064

 

 

147,152

 

 

139,230

 

Total assets

 

 

2,228,311

 

 

2,207,129

 

 

2,179,070

 

 

2,171,821

 

Less: Goodwill

 

 

27,329

 

 

27,329

 

 

27,329

 

 

27,329

 

Less: Other intangible assets

 

 

19,382

 

 

20,372

 

 

22,473

 

 

23,523

 

Tangible assets (b)

 

 

2,181,600

 

 

2,159,428

 

 

2,129,268

 

 

2,120,969

 

Tangible common equity to tangible assets (a)/(b)

 

 

10.76

%  

 

7.69

%

$

6.91

%  

 

6.56

%

Tangible book value per common share

 

 

 

 

 

 

 

 

 

 

 

 

 

Total common stockholders’ equity

 

$

281,403

 

$

213,765

 

$

196,954

 

$

190,082

 

Less: Goodwill

 

 

27,329

 

 

27,329

 

 

27,329

 

 

27,329

 

Less: Other intangible assets

 

 

19,382

 

 

20,372

 

 

22,473

 

 

23,523

 

Tangible common equity (c)

 

 

234,692

 

 

166,064

 

 

147,152

 

 

139,230

 

Total common shares issued and outstanding (d)

 

 

17,049

 

 

13,816

 

 

13,775

 

 

13,776

 

Tangible book value per common share (c)/(d)

 

$

13.77

 

$

12.02

 

$

10.68

 

$

10.11

 

42

Table of Contents

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Three months ended

 

Nine months ended

 

 

 

September 30, 

 

June 30, 

 

September 30, 

 

September 30, 

 

September 30, 

 

 

    

2019

    

2019

    

2018

    

2019

    

2018

 

Return on average tangible common equity

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net income

 

$

7,104

 

$

8,348

 

$

7,370

 

$

21,888

 

$

19,833

 

Add: Intangible amortization expense (net of tax)

 

 

782

 

 

830

 

 

945

 

 

2,442

 

 

2,835

 

Net income, excluding intangible amortization (e)

 

 

7,886

 

 

9,178

 

 

8,315

 

 

24,330

 

 

22,668

 

Average total equity

 

 

226,931

 

 

211,655

 

 

189,311

 

 

212,911

 

 

184,733

 

Less: Average goodwill

 

 

27,329

 

 

27,329

 

 

27,329

 

 

27,329

 

 

27,329

 

Less: Average other intangible assets (net of tax)

 

 

15,697

 

 

16,498

 

 

19,045

 

 

16,502

 

 

19,982

 

Average tangible common equity (f)

 

 

183,905

 

 

167,828

 

 

142,937

 

 

169,080

 

 

137,422

 

Return on average tangible common equity (e)/(f)

 

 

17.01

%  

 

21.93

%  

 

23.08

%  

 

19.24

%  

 

22.05

%  

Net interest margin (tax-equivalent)

 

 

  

 

 

 

 

 

 

 

 

  

 

 

  

 

Net interest income

 

$

18,681

 

$

18,291

 

$

18,929

 

$

56,092

 

$

55,971

 

Tax-equivalent adjustment

 

 

81

 

 

84

 

 

114

 

 

257

 

 

348

 

Tax-equivalent net interest income (g)

 

 

18,762

 

 

18,375

 

 

19,043

 

 

56,349

 

 

56,319

 

Average earning assets (h)

 

 

2,017,198

 

 

2,037,605

 

 

1,987,267

 

 

2,024,814

 

 

1,955,253

 

Net interest margin (tax-equivalent) (g)/(h)

 

 

3.69

%  

 

3.62

%  

 

3.80

%  

 

3.72

%  

 

3.85

%  

Efficiency ratio

 

 

  

 

 

 

 

 

 

 

 

  

 

 

  

 

Noninterest expense

 

$

37,327

 

$

35,261

 

$

34,336

 

$

106,102

 

$

100,414

 

Less: Intangible amortization expense

 

 

990

 

 

1,050

 

 

1,196

 

 

3,091

 

 

3,588

 

Adjusted noninterest expense (i)

 

 

36,337

 

 

34,211

 

 

33,140

 

 

103,011

 

 

96,826

 

Net interest income

 

 

18,681

 

 

18,291

 

 

18,929

 

 

56,092

 

 

55,971

 

Noninterest income

 

 

29,580

 

 

29,984

 

 

26,258

 

 

84,638

 

 

76,608

 

Tax-equivalent adjustment

 

 

81

 

 

84

 

 

114

 

 

257

 

 

348

 

Total tax-equivalent revenue (j)

 

 

48,342

 

 

48,359

 

 

45,301

 

 

140,987

 

 

132,927

 

Efficiency ratio (i)/(j)

 

 

75.17

%  

 

70.74

%  

 

73.16

%  

 

73.06

%  

 

72.84

%  

 

Discussion and Analysis of Results of Operations

Net Income

Net income for the three months ended September 30, 2019 was $7.1 million, or $0.48 per diluted common share, compared to $7.4 million, or $0.52 per diluted common share, for the three months ended September 30, 2018. The decrease of $266 thousand in net income was primarily due to an increase of $3.3 million in noninterest income, offset by increases of $3.0 million in noninterest expense and $381 thousand in income tax expense and a $248 thousand decrease in net interest income.

Net income for the nine months ended September 30, 2019 was  $21.9 million, or $1.49 per diluted common share, compared to $19.8 million, or $1.41 per diluted common share, for the nine months ended September 30, 2018. The increase of $2.1 million in net income in the first nine months of 2019 primarily reflects an increase of $8.0 million in noninterest income and a $1.6 million decrease in provision for loan losses partially offset by an increase of $5.7 million in noninterest expense and an increase in income tax expense of $2.0 million.

Net Interest Income

Net interest income is the difference between interest income and yield‑related fees earned on assets and interest expense paid on liabilities. Net interest margin is the difference between the yield on interest earning assets and the cost of interest-bearing liabilities as a percentage of interest earning assets. Net interest margin is presented on a tax-equivalent basis, which means that tax-free interest income has been adjusted to a pre-tax-equivalent income, assuming a federal income tax rate of 21% for the three and nine months ended September 30, 2019 and 2018.

Net interest income was  $18.7 million and $18.9 million for the three months ended September 30, 2019 and 2018, respectively. The three months ended September 30, 2019 included a $1.4 million increase in interest income offset by a $1.7 million increase in interest expense, compared to the same period in 2018. The increase in interest income was primarily driven by an increase of $1.3 million in interest and fees on loans, whereas the increase in interest expense was primarily driven by an increase of $1.7 million in deposit interest expense. The change in interest and fees

43

Table of Contents

on loans for the three months ended September 30, 2019, compared to the same period 2018 was driven by a combination of growth in total loans and by higher interest rates. The increase in deposit interest expense during the three months ended September 30, 2019, was primarily due to higher average rates paid on deposits as a result of the increase in the target federal funds rate, as well as an increase in total deposits compared to the same period in 2018.

Net interest income was  $56.1 million and $56.0 million for the nine months ended September 30, 2019 and 2018, respectively. The nine months ended September 30, 2019 included a $5.9 million increase in interest income offset by a $5.8 million increase in interest expense, compared to the same period in 2018. The increase in interest income was primarily driven by an increase of $5.6 million in interest and fees on loans, whereas the increase in interest expense was primarily driven by an increase of $5.3 million in deposit interest expense and an increase of $500 thousand in interest expense on other borrowed funds. The change in interest and fees on loans for the nine months ended September 30, 2019 compared to the same period 2018 was driven by a combination of growth in total loans and by higher interest rates. The increase in deposit interest expense during the nine months ended September 30, 2019 was driven by a combination of growth in total deposits and higher average rates paid on deposits as a result of the increase in the target federal fund rate, compared to the same period in 2018.

Our net interest margin (on a fully tax-equivalent, or FTE, basis) for the three months ended September 30, 2019 was 3.69%, compared to 3.80% for the same period in 2018. The decrease of 11 basis points was primarily a result of an increased cost of funds compared to the same period in 2018. For the three months ended September 30, 2019 and 2018, the average yield on total loans was 5.06% and 4.77%, respectively. For the three months ended September 30, 2019 and 2018, the cost of interest-bearing liabilities was 1.39% and 0.94%, respectively.

Our net interest margin (FTE) for the nine months ended September 30, 2019 was 3.72%, compared to 3.85% for the same period in 2018. The decrease of 13 basis points was primarily a result of an increased cost of funds compared to the same period in 2018. For the nine months ended September 30, 2019 and 2018, the average yield on total loans was 5.03% and 4.77%, respectively. For the nine months ended September 30, 2019 and 2018, the cost of interest-bearing liabilities was 1.33% and 0.83%, respectively.

44

Table of Contents

The following tables present average balance sheet information,  interest income, interest expense and the corresponding average yields on assets, and average yields earned and rates paid for the three and nine months ended September 30, 2019 and 2018. We derived these yields and rates by dividing income or expense by the average balance of the corresponding assets or liabilities. We derived average balances from the daily balances throughout the periods indicated. Average loan balances include loans that have been placed on nonaccrual, while interest previously accrued on these loans is reversed against interest income. In these tables, adjustments are made to the yields on tax‑exempt assets in order to present tax‑exempt income and fully taxable income on a comparable basis.

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Three months ended September 30, 

 

 

 

2019

 

2018

 

 

 

 

 

 

Interest

 

Average

 

 

 

 

Interest

 

Average

 

 

 

Average

 

Income/

 

Yield/

 

Average

 

Income/

 

Yield/

 

(dollars in thousands)

    

Balance

    

Expense

    

Rate

    

Balance

    

Expense

    

Rate

 

Interest Earning Assets

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Interest-bearing deposits with banks

 

$

12,998

 

$

83

 

2.53

%  

$

7,260

 

$

43

 

2.35

%

Investment securities (1)

 

 

257,561

 

 

1,580

 

2.43

%  

 

248,568

 

 

1,510

 

2.41

%

Loans held for sale

 

 

45,794

 

 

359

 

3.11

%  

 

22,438

 

 

182

 

3.22

%

Loans

 

 

  

 

 

  

 

  

 

 

  

 

 

  

 

  

 

Commercial:

 

 

  

 

 

 

 

  

 

 

  

 

 

 

 

  

 

Commercial and industrial

 

 

494,081

 

 

6,830

 

5.48

%  

 

524,601

 

 

6,867

 

5.19

%

Real estate construction

 

 

25,137

 

 

352

 

5.56

%  

 

23,999

 

 

326

 

5.39

%

Commercial real estate

 

 

439,751

 

 

5,866

 

5.29

%  

 

435,950

 

 

5,133

 

4.67

%

Total commercial

 

 

958,969

 

 

13,048

 

5.40

%  

 

984,550

 

 

12,326

 

4.97

%

Consumer

 

 

  

 

 

  

 

  

 

 

  

 

 

  

 

  

 

Residential real estate first mortgage

 

 

454,971

 

 

4,789

 

4.18

%  

 

434,691

 

 

4,530

 

4.13

%

Residential real estate junior lien

 

 

184,124

 

 

2,611

 

5.63

%  

 

188,897

 

 

2,563

 

5.38

%

Other revolving and installment

 

 

93,478

 

 

1,117

 

4.74

%  

 

90,910

 

 

1,009

 

4.40

%

Total consumer

 

 

732,573

 

 

8,517

 

4.61

%  

 

714,498

 

 

8,102

 

4.50

%

Total loans (1)

 

 

1,691,542

 

 

21,565

 

5.06

%  

 

1,699,048

 

 

20,428

 

4.77

%

Federal Reserve/FHLB Stock

 

 

9,303

 

 

119

 

5.07

%  

 

9,953

 

 

148

 

5.90

%

Total interest earning assets

 

 

2,017,198

 

 

23,706

 

4.66

%  

 

1,987,267

 

 

22,311

 

4.45

%

Noninterest earning assets

 

 

159,664

 

 

 

 

 

 

 

157,574

 

 

 

 

 

 

Total assets

 

$

2,176,862

 

 

  

 

  

 

$

2,144,841

 

 

  

 

  

 

Interest-Bearing Liabilities

 

 

  

 

 

  

 

  

 

 

  

 

 

  

 

  

 

Interest-bearing demand deposits

 

$

424,896

 

$

522

 

0.49

%  

$

393,390

 

$

231

 

0.23

%

Money market and savings deposits

 

 

649,190

 

 

2,162

 

1.32

%  

 

619,386

 

 

1,042

 

0.67

%

Time deposits

 

 

187,023

 

 

822

 

1.74

%  

 

207,009

 

 

517

 

0.99

%

Short-term borrowings

 

 

87,201

 

 

539

 

2.46

%  

 

103,171

 

 

575

 

2.21

%

Long-term debt

 

 

58,776

 

 

899

 

6.07

%  

 

58,812

 

 

903

 

6.09

%

Total interest-bearing liabilities

 

 

1,407,086

 

 

4,944

 

1.39

%  

 

1,381,768

 

 

3,268

 

0.94

%

Noninterest-Bearing Liabilities and Stockholders' Equity

 

 

 

 

 

 

 

  

 

 

 

 

 

  

 

  

 

Noninterest-bearing deposits

 

 

502,108

 

 

 

 

  

 

 

545,154

 

 

  

 

  

 

Other noninterest-bearing liabilities

 

 

40,737

 

 

 

 

  

 

 

28,608

 

 

  

 

  

 

Stockholders’ equity

 

 

226,931

 

 

 

 

  

 

 

189,311

 

 

  

 

  

 

Total liabilities and stockholders’ equity

 

$

2,176,862

 

 

 

 

  

 

$

2,144,841

 

 

  

 

  

 

Net interest rate spread

 

 

 

 

 

 

 

3.27

%  

 

  

 

 

  

 

3.51

%

Net interest rate margin (2)

 

 

 

 

 

 

 

3.69

%  

 

  

 

 

  

 

3.80

%

 

45

Table of Contents

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Nine months ended September 30, 

 

 

 

2019

 

2018

 

 

    

 

 

    

Interest

    

Average

    

 

 

    

Interest

    

Average

 

 

 

Average

 

Income/

 

Yield/

 

Average

 

Income/

 

Yield/

 

(dollars in thousands)

 

Balance

 

Expense

 

Rate

 

Balance

 

Expense

 

Rate

 

Interest Earning Assets

 

 

  

 

 

  

 

  

 

 

  

 

 

  

 

  

 

Interest-bearing deposits with banks

 

$

12,910

 

$

231

 

2.39

%  

$

7,905

 

$

121

 

2.05

%

Investment securities (1)

 

 

255,903

 

 

4,803

 

2.51

%  

 

256,331

 

 

4,648

 

2.42

%

Loans held for sale

 

 

30,734

 

 

745

 

3.24

%  

 

20,217

 

 

459

 

3.04

%

Loans

 

 

  

 

 

  

 

  

 

 

  

 

 

  

 

  

 

Commercial:

 

 

  

 

 

 

 

  

 

 

  

 

 

 

 

  

 

Commercial and industrial

 

 

509,806

 

 

20,966

 

5.50

%  

 

514,940

 

 

19,549

 

5.08

%

Real estate construction

 

 

23,532

 

 

975

 

5.54

%  

 

24,533

 

 

1,000

 

5.45

%

Commercial real estate

 

 

444,964

 

 

16,768

 

5.04

%  

 

441,209

 

 

15,665

 

4.75

%

Total commercial

 

 

978,302

 

 

38,709

 

5.29

%  

 

980,682

 

 

36,214

 

4.94

%

Consumer

 

 

  

 

 

  

 

  

 

 

  

 

 

  

 

  

 

Residential real estate first mortgage

 

 

455,898

 

 

14,496

 

4.25

%  

 

402,644

 

 

12,528

 

4.16

%

Residential real estate junior lien

 

 

186,744

 

 

8,028

 

5.75

%  

 

191,348

 

 

7,665

 

5.36

%

Other revolving and installment

 

 

94,685

 

 

3,286

 

4.64

%  

 

86,819

 

 

2,830

 

4.36

%

Total consumer

 

 

737,327

 

 

25,810

 

4.68

%  

 

680,811

 

 

23,023

 

4.52

%

Total loans (1)

 

 

1,715,629

 

 

64,519

 

5.03

%  

 

1,661,493

 

 

59,237

 

4.77

%

Federal Reserve/FHLB Stock

 

 

9,638

 

 

372

 

5.16

%  

 

9,307

 

 

354

 

5.09

%

Total interest earning assets

 

 

2,024,814

 

 

70,670

 

4.67

%  

 

1,955,253

 

 

64,819

 

4.43

%

Noninterest earning assets

 

 

161,054

 

 

 

 

 

 

 

160,455

 

 

 

 

 

 

Total assets

 

$

2,185,868

 

 

  

 

  

 

$

2,115,708

 

 

  

 

  

 

Interest-Bearing Liabilities

 

 

  

 

 

  

 

  

 

 

  

 

 

  

 

  

 

Interest-bearing demand deposits

 

$

423,181

 

$

1,415

 

0.45

%  

$

405,837

 

$

699

 

0.23

%

Money market and savings deposits

 

 

675,921

 

 

6,217

 

1.23

%  

 

618,700

 

 

2,552

 

0.55

%

Time deposits

 

 

183,686

 

 

2,170

 

1.58

%  

 

199,928

 

 

1,230

 

0.82

%

Short-term borrowings

 

 

95,489

 

 

1,805

 

2.53

%  

 

87,501

 

 

1,331

 

2.03

%

Long-term debt

 

 

58,798

 

 

2,714

 

6.17

%  

 

58,812

 

 

2,688

 

6.11

%

Total interest-bearing liabilities 

 

 

1,437,075

 

 

14,321

 

1.33

%  

 

1,370,778

 

 

8,500

 

0.83

%

Noninterest-Bearing Liabilities and Stockholders' Equity

 

 

 

 

 

  

 

  

 

 

 

 

 

  

 

  

 

Noninterest-bearing deposits

 

 

496,822

 

 

  

 

  

 

 

531,008

 

 

 

 

 

 

Other noninterest-bearing liabilities

 

 

39,060

 

 

  

 

  

 

 

29,189

 

 

  

 

  

 

Stockholders’ equity

 

 

212,911

 

 

  

 

  

 

 

184,733

 

 

  

 

  

 

Total liabilities and stockholders’ equity

 

$

2,185,868

 

 

  

 

  

 

$

2,115,708

 

 

  

 

  

 

Net interest rate spread

 

 

  

 

 

  

 

3.34

%  

 

  

 

 

  

 

3.60

%

Net interest rate margin (2)

 

 

  

 

 

  

 

3.72

%  

 

  

 

 

  

 

3.85

%


(1)

Taxable equivalent adjustment was calculated utilizing a marginal income tax rate of 21.0 percent.

(2)

Represents a non-GAAP financial measure. See “Non-GAAP to GAAP Reconciliations and Calculation of Non-GAAP Financial Measures.”

46

Table of Contents

Interest Rates and Operating Interest Differential

Increases and decreases in interest income and interest expense result from changes in average balances (volume) of interest earning assets and interest-bearing liabilities, as well as changes in average interest rates. The following table shows the effect that these factors had on the interest earned on our interest earning assets and the interest incurred on our interest-bearing liabilities. The effect of changes in volume is determined by multiplying the change in volume by the previous period’s average rate. Similarly, the effect of rate changes is calculated by multiplying the change in average rate by the previous period’s volume.

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Three Months Ended September 30, 2019

 

Nine months ended September 30, 2019

 

 

Compared with

 

Compared with

 

 

Three Months Ended September 30, 2018

 

Nine months ended September 30, 2018

 

    

Change due to:

    

Interest

    

Change due to:

    

Interest

(tax-equivalent basis, dollars in thousands)

    

Volume

    

Rate

    

Variance

    

Volume

    

Rate

    

Variance

Interest earning assets

 

 

 

 

 

 

 

 

 

 

 

  

 

 

  

 

 

  

Interest-bearing deposits with banks

 

$

34

 

$

 6

 

$

40

 

$

77

 

$

33

 

$

110

Investment securities

 

 

55

 

 

15

 

 

70

 

 

(8)

 

 

163

 

 

155

Loans held for sale

 

 

190

 

 

(13)

 

 

177

 

 

239

 

 

47

 

 

286

Loans

 

 

  

 

 

  

 

 

  

 

 

  

 

 

  

 

 

  

Commercial:

 

 

  

 

 

  

 

 

  

 

 

  

 

 

  

 

 

  

Commercial and industrial

 

 

(399)

 

 

362

 

 

(37)

 

 

(195)

 

 

1,612

 

 

1,417

Real estate construction

 

 

15

 

 

11

 

 

26

 

 

(41)

 

 

16

 

 

(25)

Commercial real estate

 

 

45

 

 

688

 

 

733

 

 

133

 

 

970

 

 

1,103

Total commercial

 

 

(339)

 

 

1,061

 

 

722

 

 

(103)

 

 

2,598

 

 

2,495

Consumer

 

 

`

 

 

  

 

 

  

 

 

  

 

 

  

 

 

  

Residential real estate first mortgage

 

 

211

 

 

48

 

 

259

 

 

1,657

 

 

311

 

 

1,968

Residential real estate junior lien

 

 

(65)

 

 

113

 

 

48

 

 

(185)

 

 

548

 

 

363

Other revolving and installment

 

 

28

 

 

80

 

 

108

 

 

257

 

 

199

 

 

456

Total consumer

 

 

174

 

 

241

 

 

415

 

 

1,729

 

 

1,058

 

 

2,787

Total loans

 

 

(165)

 

 

1,302

 

 

1,137

 

 

1,626

 

 

3,656

 

 

5,282

Federal Reserve/FHLB Stock

 

 

(10)

 

 

(19)

 

 

(29)

 

 

13

 

 

 5

 

 

18

Total interest income

 

 

104

 

 

1,291

 

 

1,395

 

 

1,947

 

 

3,904

 

 

5,851

Interest-bearing liabilities

 

 

  

 

 

  

 

 

  

 

 

  

 

 

  

 

 

  

Interest-bearing demand deposits

 

 

18

 

 

273

 

 

291

 

 

30

 

 

686

 

 

716

Money market and savings deposits

 

 

50

 

 

1,070

 

 

1,120

 

 

235

 

 

3,430

 

 

3,665

Time deposits

 

 

(50)

 

 

355

 

 

305

 

 

(100)

 

 

1,040

 

 

940

Short-term borrowings

 

 

(89)

 

 

53

 

 

(36)

 

 

121

 

 

353

 

 

474

Long-term debt

 

 

(1)

 

 

(3)

 

 

(4)

 

 

(1)

 

 

27

 

 

26

Total interest expense

 

 

(72)

 

 

1,748

 

 

1,676

 

 

285

 

 

5,536

 

 

5,821

Change in net interest income

 

$

176

 

$

(457)

 

$

(281)

 

$

1,662

 

$

(1,632)

 

$

30

 

Provision for Loan Losses

The provision for loan losses reflects our judgment of the expense necessary to achieve the appropriate amount of the allowance for loan losses.  We maintain the allowance for loan losses at levels we believe adequate to cover our estimate of probable credit losses as of the end of the reporting period.  The allowance for loan losses is determined through detailed quarterly analysis of the loan portfolio.  The allowance for loan losses is based on our loss experience and changes in the economic environment, as well as an ongoing assessment of credit quality.  Additional factors that are considered in determining the amount of the allowance for loan losses are the level of net charge-offs, nonperforming assets, risk-rating migration, as well as changes in our portfolio size and composition.

We recorded a provision for loan losses of $1.5 million for both the three months ended September 30, 2019 and 2018. For the nine months ended September 30, 2019 we recorded a provision for loan losses of $5.5 million compared to $7.1 million for the nine months ended September 30, 2018. The decrease in provision for loan losses was primarily due to a decrease in criticized assets as well as a decrease in the total loans outstanding.

47

Table of Contents

Noninterest Income

Our noninterest income is generated from four primary sources:  (1) retirement and employee benefits;  (2) wealth management, comprised of trust services, investment products and services, and asset management services; (3) mortgage banking; and (4) other general banking services related to loans, deposits and other core client activities typically provided through the branch network and electronic banking channels.

The following table presents our noninterest income for the three and nine months ended September 30, 2019 and 2018.

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Three months ended

 

Nine months ended

 

 

 

September 30, 

 

September 30, 

 

(dollars in thousands)

    

2019

    

2018

 

2019

    

2018

 

Retirement and benefit services

 

$

15,307

 

$

15,536

 

$

46,142

 

$

46,873

 

Wealth management

 

 

3,896

 

 

3,685

 

 

11,385

 

 

10,948

 

Mortgage banking

 

 

8,135

 

 

5,318

 

 

19,739

 

 

13,551

 

Service charges on deposit accounts

 

 

447

 

 

442

 

 

1,321

 

 

1,333

 

Net gains (losses) on investment securities

 

 

48

 

 

13

 

 

357

 

 

119

 

Other

 

 

1,747

 

 

1,264

 

 

5,694

 

 

3,784

 

Total noninterest income

 

$

29,580

 

$

26,258

 

$

84,638

 

$

76,608

 

Noninterest income as a % of revenue

 

 

61.29

%  

 

58.11

%  

 

60.14

%  

 

57.78

%  

Total noninterest income for the three months ended September 30, 2019 was $29.6 million, an increase of $3.3 million compared to $26.3 million for the three months ended September 30, 2018. The increase in noninterest income was primarily due to an increase in mortgage division revenue driven by a $91.2 million increase in mortgage originations, along with the transition to mandatory delivery of mortgage loans to the secondary market. Other noninterest income increased $483 thousand, as we realized a $542 thousand gain on the sale of a parcel of land in Grand Forks, North Dakota. This increase was partially offset by a decrease in retirement and benefits revenue of $229 thousand due to a decrease in asset based fees, partially offset by an increase in transaction fees.

Total noninterest income for the nine months ended September 30, 2019 was $84.6 million an increase of  $8.0 million,  compared to $76.6 million for the nine months ended September 30, 2018. The increase in noninterest income was primarily due to an increase in mortgage division revenue of $6.2 million,  driven by the transition to mandatory delivery of mortgage loans to the secondary market in addition to an increase of $75.2 million in mortgage originations. Other noninterest income increased $1.9 million as we realized a $1.5 million gain on the sale of our Duluth, Minnesota branch as well as a $542 thousand gain on the sale of a parcel of land in Grand Forks, North Dakota. These increases  were partially offset by a decrease in retirement and benefits revenue of $731 thousand due to a decrease in asset based fees, partially offset by an increase in transaction fees.

Noninterest income as a percent of total operating revenue, which consists of net interest income plus noninterest income, was 61.3% for the three months ending September 30, 2019, compared to 58.1% for the three months ending September 30, 2018. The increase was due to noninterest income increasing by 12.7%  while net interest income decreased 1.3%.

Noninterest income as a percent of total operating revenue was 60.1% for the nine months ending September 30, 2019, compared to 57.8% for the nine months ending September 30, 2018. The increase was due to noninterest income increasing by 10.5%  while net interest income only increased by 0.2%.

See “NOTE 15 Segment Reporting” for additional discussion regarding our business lines.

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Table of Contents

Noninterest Expense

The following table presents noninterest expense for the three and nine months ended September 30, 2019 and 2018.

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Three months ended

 

Nine months ended

 

 

September 30, 

 

September 30, 

(dollars in thousands)

    

2019

    

2018

 

2019

    

2018

Compensation

 

$

20,041

 

$

17,873

 

$

54,997

 

$

50,906

Employee benefits

 

 

4,600

 

 

4,314

 

 

15,188

 

 

13,606

Occupancy and equipment expense

 

 

2,700

 

 

2,698

 

 

8,086

 

 

8,215

Business services, software and technology expense

 

 

4,224

 

 

3,731

 

 

12,044

 

 

10,467

Intangible amortization expense

 

 

990

 

 

1,196

 

 

3,091

 

 

3,588

Professional fees and assessments

 

 

1,051

 

 

1,628

 

 

3,146

 

 

3,734

Marketing and business development

 

 

890

 

 

856

 

 

2,024

 

 

2,439

Supplies and postage

 

 

631

 

 

611

 

 

2,027

 

 

1,902

Travel

 

 

435

 

 

382

 

 

1,335

 

 

1,252

Mortgage and lending expenses

 

 

751

 

 

437

 

 

1,966

 

 

1,597

Other

 

 

1,014

 

 

610

 

 

2,198

 

 

2,708

Total noninterest expense

 

$

37,327

 

$

34,336

 

$

106,102

 

$

100,414

 

Total noninterest expense for the three months ended September 30, 2019 was $37.3 million, an increase of  $3.0 million compared to $34.3 million for the three months ended September 30, 2018. The increase in noninterest expense was primarily due to an increase in compensation and employee benefits of $2.5 million, an increase in business services, software and technology expense of $493 thousand, an increase of $314 thousand in mortgage and lending expenses, and an increase of $404 thousand in other expenses. The increase in compensation and employee benefits between periods was primarily the result of additional investments in talent, with an increase of eight, on average, full‑time equivalent employees along with annual merit pay increases. The increase in technology related expenses was due to the continued investments related to our new client relationship manager software and digital delivery of solutions to clients. These increases were partially offset by decreases of $577 thousand in professional fees and assessments and $206 thousand in intangible amortization expense.

Total noninterest expense for the nine months ended September 30, 2019 was $106.1 million, an increase of $5.7 million compared to $100.4 million for the nine months ended September 30, 2018. The increase in noninterest expense was primarily due to an increase in compensation and employee benefits of $5.7 million, an increase in business services, software and technology expense of $1.6 million, and an increase of $369 thousand in mortgage and lending expenses. The increase in compensation and employee benefits between periods was the result of an increase of fourteen, on average, full‑time equivalent employees, along with an increased cost of health insurance benefits. The increase in technology related expenses was due to the continued investments related to our new client relationship manager software and digital delivery of solutions to clients. These increases were partially offset by decreases of $588 thousand in professional fees and assessments, $510 thousand in other expenses, $497 thousand in intangible amortization expense, and $415 thousand in marketing and business development.

Income Tax Expense

Income tax expense is an estimate based on the amount we expect to owe the respective taxing authorities, plus the impact of deferred tax items. Accrued taxes represent the net estimated amount due, or to be received from, taxing authorities. In estimating accrued taxes, management assesses the relative merits and risks of the appropriate tax treatment of transactions, taking into account statutory, judicial, and regulatory guidance in the context of our tax position. If the final resolution of taxes payable differs from our estimates due to regulatory determination or legislative or judicial actions, adjustments to tax expense may be required.

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Table of Contents

For the three months ended September 30, 2019, we recognized income tax expense of $2.3 million on $9.4 million of pre‑tax income, resulting in an effective tax rate of 24.7%, compared to income tax expense of $2.0 million on $9.3 million of pre‑tax income, resulting in an effective tax rate of 20.9%, for the three months ended September 30, 2018. The increase in the effective tax rate was primarily due to a reduction in tax exempt income and net operating loss deductions for the three months ended September 30, 2019 as compared to the same period in 2018.

For the nine months ended September 30, 2019, we recognized income tax expense of $7.2 million on $29.1 million of pre‑tax income, resulting in an effective tax rate of 24.8%, compared to income tax expense of $5.3 million on $25.1 million of pre‑tax income, resulting in an effective tax rate of 20.9%, for the nine months ended September 30, 2018. The increase in the effective tax rate was primarily due to a reduction in excess tax benefits from stock‑based compensation and a reduction in tax exempt income for the nine months ended September 30, 2019, as compared to the same period in 2018.

Financial Condition

Overview

Total assets were $2.2 billion as of September 30, 2019, an increase of $49.2 million, or 2.3%, as compared to December 31, 2018. The increase in total assets was primarily due to increases of $51.5 million in loans held for sale, $28.5 million in available-for-sale investment securities, $20.5 million in cash and cash equivalents, and the recognition of $8.9 million in operating lease right-of-use assets. These increases were offset by a reduction of $32.0 million in loans held for branch sale, and $15.8 million in loans.  

Loans

The loan portfolio represents a broad range of borrowers comprised of commercial and industrial, commercial real estate, residential real estate, and consumer financing loans. The goal of the overall portfolio mix is to retain balance with approximately one third of the portfolio in each of the commercial and industrial, commercial real estate, and residential real estate categories.

Commercial and industrial loans include financing for commercial purposes in various lines of businesses, including manufacturing, service industry and professional service areas. Commercial and industrial loans are generally secured with the assets of the company and/or the personal guarantee of the business owners.

Commercial real estate loans consist of term loans secured by a mortgage lien on the real property, such as office and industrial buildings, retail shopping centers and apartment buildings, as well as commercial real estate construction loans that are offered to builders and developers.

Residential real estate loans represent loans to consumers for the purchase or refinance of a residence. These loans are generally financed over a 15‑ to 30‑year term and, in most cases, are extended to borrowers to finance their primary residence with both fixed‑rate and adjustable‑rate terms. Real estate construction loans are also offered to consumers who wish to build their own homes and are often structured to be converted to permanent loans at the end of the construction phase, which is typically twelve months. Residential real estate loans also include home equity loans and lines of credit that are secured by a first‑ or second‑lien on the borrower’s residence. Home equity lines of credit consist mainly of revolving lines of credit secured by residential real estate.

Consumer loans include loans made to individuals not secured by real estate, including loans secured by automobiles or watercraft, and personal unsecured loans.

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Table of Contents

The following table presents the composition of total loans outstanding by portfolio segment as of September 30, 2019 and December 31, 2018:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

September 30, 2019

 

 

December 31, 2018

 

 

 

 

 

 

 

 

 

 

Percent of

 

 

 

 

 

Percent of

 

 

Change

 

(dollars in thousands)

    

Balance

    

Portfolio

 

    

Balance

    

Portfolio

    

    

 

Amount

    

Percent

 

Commercial

 

 

  

 

  

 

 

 

  

 

  

 

 

 

 

 

 

 

Commercial and industrial

 

$

485,183

 

28.7

%  

 

$

510,706

 

30.0

%  

 

$

(25,523)

 

(5.0)

%

Real estate construction

 

 

21,674

 

1.3

%  

 

 

18,965

 

1.1

%  

 

 

2,709

 

14.3

%

Commercial real estate

 

 

444,600

 

26.4

%  

 

 

439,963

 

25.9

%  

 

 

4,637

 

1.1

%

Total commercial

 

 

951,457

 

56.4

%  

 

 

969,634

 

57.0

%  

 

 

(18,177)

 

(1.9)

%

Consumer

 

 

  

 

  

 

 

 

  

 

  

 

 

 

 

 

 

 

Residential real estate first mortgage

 

 

459,763

 

27.3

%  

 

 

448,143

 

26.3

%  

 

 

11,620

 

2.6

%

Residential real estate junior lien

 

 

182,516

 

10.8

%  

 

 

188,855

 

11.1

%  

 

 

(6,339)

 

(3.4)

%

Other revolving and installment

 

 

92,351

 

5.5

%  

 

 

95,218

 

5.6

%  

 

 

(2,867)

 

(3.0)

%

Total consumer

 

 

734,630

 

43.6

%  

 

 

732,216

 

43.0

%  

 

 

2,414

 

0.3

%

Total loans

 

$

1,686,087

 

100.0

%  

 

$

1,701,850

 

100.0

%  

 

$

(15,763)

 

(0.9)

%

 

Total loans outstanding of $1.69 billion as of September 30, 2019, decreased $15.8 million, or 0.9%, from December 31, 2018. The decrease in total loans was primarily due to a decrease in our commercial and industrial loans of $25.5 million, and residential real estate junior liens of $6.3 million. These decreases were offset by increases of $11.6 million in residential real estate first mortgages and $4.6 million in commercial real estate loans.

The following table presents the maturities and type of interest rates for the loan portfolio as of September 30, 2019.  

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

September 30, 2019

 

 

 

 

 

After one

 

 

 

 

 

 

 

 

One year

 

but within

 

After

 

 

 

(dollars in thousands)

    

or less

    

five years

    

five years

    

Total

Commercial

 

 

  

 

 

  

 

 

  

 

 

  

Commercial and industrial

 

$

189,754

 

$

219,468

 

$

75,961

 

$

485,183

Real estate construction

 

 

6,381

 

 

10,201

 

 

5,092

 

 

21,674

Commercial real estate

 

 

44,431

 

 

222,814

 

 

177,355

 

 

444,600

Total commercial

 

 

240,566

 

 

452,483

 

 

258,408

 

 

951,457

Consumer

 

 

  

 

 

  

 

 

  

 

 

  

Residential real estate first mortgage

 

 

20,339

 

 

18,739

 

 

420,685

 

 

459,763

Residential real estate junior lien

 

 

21,234

 

 

86,632

 

 

74,650

 

 

182,516

Other revolving and installment

 

 

16,162

 

 

59,335

 

 

16,854

 

 

92,351

Total consumer

 

 

57,735

 

 

164,706

 

 

512,189

 

 

734,630

Total loans

 

$

298,301

 

$

617,189

 

$

770,597

 

$

1,686,087

Sensitivity of loans to changes in interest rates

 

 

  

 

 

  

 

 

  

 

 

  

Fixed interest rates

 

 

  

 

$

475,519

 

$

515,514

 

 

  

Floating interest rates

 

 

  

 

 

141,670

 

 

255,083

 

 

  

Total

 

 

  

 

$

617,189

 

$

770,597

 

 

  

 

As of September 30, 2019, 63.8% of the loan portfolio bore interest at fixed rates and 36.2% at floating rates. The expected life of our loan portfolio will differ from contractual maturities because borrowers may have the right to curtail or prepay their loans with or without penalties. Consequently, the table above includes information limited to contractual maturities of the underlying loans.

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Table of Contents

Asset Quality

Our strategy for credit risk management includes well‑defined, centralized credit policies; uniform underwriting criteria; and ongoing risk monitoring and review processes for all commercial and consumer credit exposures. The strategy also emphasizes diversification on a geographic, industry, and client level; regular credit examinations; and management reviews of loans experiencing deterioration of credit quality. We strive to identify potential problem loans early, take necessary charge‑offs promptly, and maintain adequate reserve levels for probable loan losses inherent in the portfolio. Management performs ongoing, internal reviews of any problem credits and continually assesses the adequacy of the allowance. We utilize an internal lending division, Special Credit Services, to develop and implement strategies for the management of individual nonperforming loans.

Credit Quality Indicators

Loans are assigned a risk rating and grouped into categories based on relevant information about the ability of borrowers to service their debt such as: current financial information, historical payment experience, credit documentation, public information, and current economic trends, among other factors. The risk ratings are aligned to pass and criticized categories.  The criticized category includes special mention, substandard, and doubtful risk ratings.  See “NOTE 4 Loans and Allowance for Loan Losses” to the consolidated financial statements for a definition of each of the risk rating.

The table below presents criticized loans outstanding by loan portfolio segment as of September 30, 2019 and December 31, 2018:

 

 

 

 

 

 

 

 

 

 

September 30, 

 

December 31, 

 

(dollars in thousands)

    

2019

    

2018

    

Commercial

 

 

  

 

 

 

 

Commercial and industrial

 

$

31,476

 

$

51,141

 

Real estate construction

 

 

1,278

 

 

1,055

 

Commercial real estate

 

 

24,540

 

 

32,785

 

Total commercial

 

 

57,294

 

 

84,981

 

Consumer

 

 

  

 

 

 

 

Residential real estate first mortgage

 

 

677

 

 

19

 

Residential real estate junior lien

 

 

2,172

 

 

2,485

 

Other revolving and installment

 

 

 6

 

 

 —

 

Total consumer

 

 

2,855

 

 

2,504

 

Total loans

 

$

60,149

 

$

87,485

 

Criticized loans as a percent of total loans

 

 

3.57

%

 

5.14

%

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Table of Contents

 

The following table presents information regarding nonperforming assets as of September 31, 2019 and December 31, 2018:

 

 

 

 

 

 

 

 

 

 

 

September 30, 

 

December 31, 

 

(dollars in thousands)

    

2019

    

2018

 

Nonaccrual loans

 

$

5,107

 

$

6,963

 

Accruing loans 90+ days past due

 

 

45

 

 

 —

 

Total nonperforming loans

 

 

5,152

 

 

6,963

 

OREO and repossessed assets

 

 

84

 

 

204

 

Total nonperforming assets

 

$

5,236

 

$

7,167

 

Nonperforming loans to total loans

 

 

0.31

%

 

0.41

%

Nonperforming assets to total assets

 

 

0.23

%

 

0.33

%

Allowance for loan losses to nonperforming loans

 

 

446

%

 

318

%

Allowance for Loan Losses

The allowance for loan losses is maintained at a level management believes is sufficient to absorb incurred losses in the loan portfolio given the conditions at the time. Management determines the adequacy of the allowance based on periodic evaluations of the loan portfolio and other factors. These evaluations are inherently subjective as they require management to make material estimates, all of which may be susceptible to significant change. The allowance is increased by provisions charged to expense and decreased by actual charge‑offs, net of recoveries.

The allowance for loan losses represents management’s assessment of probable credit losses inherent in the loan portfolio. The allowance for loan losses consists of specific components, based on individual evaluation of certain loans, and general components for homogeneous pools of loans with similar risk characteristics.

Impaired loans include loans placed on nonaccrual status and TDRs. Loans are considered impaired when, based on current information and events, it is probable that all amounts due, in accordance with the original contractual terms of the loan agreement, will not be collected. When determining if all amounts due in accordance with the original contractual terms of the loan agreement will be collected, the borrower’s overall financial condition, resources and payment record, support from guarantors, and the realizable value of any collateral, are taken into consideration. Loans that experience insignificant payment delays and payment shortfalls generally are not classified as impaired. Management determines the significance of payment delays and payment shortfalls on a case‑by‑case basis, taking into consideration all of the circumstances surrounding the loan and the borrower, including the length of the delay, the reasons for the delay, the borrower’s prior payment record, and the amount of the shortfall in relation to the principal and interest owed.

All impaired loans are individually evaluated for impairment. If a loan is impaired, a portion of the allowance is allocated so that the loan is reported, net, at the discounted expected future cash flows or at the fair value of collateral if repayment is collateral dependent.

The allowance for non‑impaired loans is based on historical losses adjusted for current qualitative factors. The historical loss experience is determined by portfolio segment and is based on the actual loss history over the most recent five years. This actual loss experience is adjusted for economic factors based on the risks present for each portfolio segment. These economic factors include consideration of the following: levels of and trends in delinquencies and impaired loans; levels of and trends in charge‑offs and recoveries; trends in volume and terms of loans; effects of any changes in risk selection and underwriting standards; other changes in lending policies, procedures, and practices; experience, ability, and depth of lending management and other relevant staff; national and local economic trends and conditions; industry conditions; and effects of changes in credit concentrations. These factors are inherently subjective and are driven by the repayment risk associated with each portfolio segment. These portfolio segments include commercial and industrial, real estate construction, commercial real estate, residential real estate first mortgage, residential real estate junior liens, and other revolving and installment.

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Table of Contents

In the ordinary course of business, we enter into commitments to extend credit, including commitments under credit arrangements, commercial letters of credit, and standby letters of credit. Such financial instruments are recorded when they are funded. A reserve for unfunded commitments is established using historical loss data and utilization assumptions. This reserve is located under accrued expenses and other liabilities on the Consolidated Balance Sheets. The reserve for unfunded commitments was $980 thousand as of September 30, 2019, compared to $1.4 million as of December 31, 2018.

The following table presents, by loan type, the changes in the allowance for loan losses for the periods presented.

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Three months ended

 

Nine months ended

 

 

 

September 30, 

 

September 30, 

 

(dollars in thousands)

    

2019

    

2018

    

2019

    

2018

 

Balance—beginning of period

 

$

21,246

 

$

19,869

 

$

22,174

 

$

16,564

 

Commercial loan charge-offs

 

 

  

 

 

  

 

 

  

 

 

  

 

Commercial and Industrial

 

 

(324)

 

 

(424)

 

 

(5,275)

 

 

(3,078)

 

Real estate construction

 

 

 —

 

 

 —

 

 

(1)

 

 

(60)

 

Commercial real estate

 

 

 —

 

 

 —

 

 

 —

 

 

 —

 

Total commercial loan charge-offs

 

 

(324)

 

 

(424)

 

 

(5,276)

 

 

(3,138)

 

Consumer loan charge-offs

 

 

  

 

 

  

 

 

  

 

 

  

 

Residential real estate first mortgage

 

 

 —

 

 

 —

 

 

 —

 

 

(29)

 

Residential real estate junior lien

 

 

(20)

 

 

(47)

 

 

(154)

 

 

(133)

 

Other revolving and installment

 

 

(31)

 

 

(99)

 

 

(513)

 

 

(236)

 

Total consumer loan charge-offs

 

 

(51)

 

 

(146)

 

 

(667)

 

 

(398)

 

Total loan charge-offs

 

 

(375)

 

 

(570)

 

 

(5,943)

 

 

(3,536)

 

Commercial loan recoveries

 

 

  

 

 

  

 

 

  

 

 

  

 

Commercial and Industrial

 

 

538

 

 

126

 

 

831

 

 

509

 

Real estate construction

 

 

 —

 

 

 —

 

 

 2

 

 

 2

 

Commercial real estate

 

 

 —

 

 

20

 

 

150

 

 

59

 

Total commercial recoveries

 

 

538

 

 

146

 

 

983

 

 

570

 

Consumer loan recoveries

 

 

  

 

 

  

 

 

  

 

 

  

 

Residential real estate first mortgage

 

 

 —

 

 

 —

 

 

 —

 

 

 —

 

Residential real estate junior lien

 

 

49

 

 

11

 

 

132

 

 

190

 

Other revolving and installment

 

 

28

 

 

26

 

 

123

 

 

144

 

Total consumer loan recoveries

 

 

77

 

 

37

 

 

255

 

 

334

 

Total loan recoveries

 

 

615

 

 

183

 

 

1,238

 

 

904

 

Net loan charge-offs (recoveries)

 

 

(240)

 

 

387

 

 

4,705

 

 

2,632

 

Commercial loan provision

 

 

  

 

 

  

 

 

  

 

 

  

 

Commercial and Industrial

 

 

(962)

 

 

1,452

 

 

3,263

 

 

6,158

 

Real estate construction

 

 

25

 

 

(109)

 

 

97

 

 

 1

 

Commercial real estate

 

 

(4)

 

 

(72)

 

 

(668)

 

 

1,458

 

Total commercial loan provision

 

 

(941)

 

 

1,271

 

 

2,692

 

 

7,617

 

Consumer loan provision

 

 

  

 

 

  

 

 

  

 

 

  

 

Residential real estate first mortgage

 

 

(139)

 

 

(142)

 

 

(140)

 

 

(38)

 

Residential real estate junior lien

 

 

157

 

 

20

 

 

113

 

 

(145)

 

Other revolving and installment

 

 

 1

 

 

31

 

 

388

 

 

34

 

Total consumer loan provision

 

 

19

 

 

(91)

 

 

361

 

 

(149)

 

Unallocated provision expense

 

 

2,420

 

 

350

 

 

2,462

 

 

(388)

 

Total loan loss provision

 

 

1,498

 

 

1,530

 

 

5,515

 

 

7,080

 

Balance—end of period

 

$

22,984

 

$

21,012

 

$

22,984

 

$

21,012

 

Total loans

 

$

1,686,087

 

$

1,724,656

 

$

1,686,087

 

$

1,724,656

 

Average total loans

 

 

1,691,542

 

 

1,699,048

 

 

1,715,629

 

 

1,661,493

 

Allowance for loan losses as a percentage of total loans

 

 

1.36

%  

 

1.22

%  

 

1.36

%  

 

1.22

%

Net charge-offs/(recoveries) to average total loans

 

 

(0.01)

%  

 

0.02

%  

 

0.27

%  

 

0.16

%

 

The allowance for loan losses was $23.0 million as of September 30, 2019, compared to $22.2 million as of December 31, 2018. The $810 thousand increase in the allowance for loan losses was due to additional provision for loan losses of $5.5 million, partially offset by net loan charge‑offs of $4.7 million. The level of nonperforming loans to total loans as of September 30, 2019 was 0.31%, compared to 0.41% as of December 31, 2018. The allowance for loan losses to total loans was 1.36% as of September 30, 2019, compared to 1.30% as of December 31, 2018.

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The following table presents the allocation of the allowance for loan losses as of the dates presented.

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

September 30, 2019

 

December 31, 2018

 

 

 

 

 

Percentage

 

 

 

 

 

Percentage

 

 

 

Allocated

 

of loans to

 

 

Allocated

 

of loans to

 

(dollars in thousands)

    

Allowance

    

total loans

 

    

Allowance

    

total loans

 

Commercial and industrial

 

$

10,946

 

28.7

%

 

$

12,127

 

30.0

%

Real estate construction

 

 

348

 

1.3

%

 

 

250

 

1.1

%

Commercial real estate

 

 

5,761

 

26.4

%

 

 

6,279

 

25.9

%

Residential real estate first mortgage

 

 

1,016

 

27.3

%

 

 

1,156

 

26.3

%

Residential real estate junior lien

 

 

896

 

10.8

%

 

 

805

 

11.1

%

Other revolving and installment

 

 

378

 

5.5

%

 

 

380

 

5.6

%

Unallocated

 

 

3,639

 

 —

%

 

 

1,177

 

 —

%

Total loans

 

$

22,984

 

100.0

%

 

$

22,174

 

100.0

%

 

Loans Held for Sale

Loans held for sale represent loans to consumers for the purchase or refinance of a residence that we have originated and intend to sell into the secondary market. Loans held for sale were $66.0 million as of September 30, 2019, an increase of $51.5 million, as compared to December 31, 2018. The increase in loans held for sale was primarily due to seasonally higher mortgage loan originations which were $313.5 million for the three months ended September 30, 2019 compared to $169.8 million for the three months ended December 31, 2018.

Loans Held for Branch Sale

On January 15, 2019, we entered into an agreement to sell the loans of two branch locations in Duluth, Minnesota. These loans were classified as loans held for branch sale in our consolidated balance sheets as of December 31, 2018. As of December 31, 2018, loans held for branch sale totaled $32.0 million. The sale was completed on April 26, 2019, and as of September 30, 2019, there were no loans held for branch sale.

Investment Securities

The composition of our investment securities portfolio reflects our investment strategy of maintaining an appropriate level of liquidity for normal operations while providing an additional source of revenue. The investment portfolio also provides a balance to interest rate risk and credit risk in other categories of the balance sheet, while providing a vehicle for the investment of available funds, furnishing liquidity, and supplying securities to pledge as collateral.

 

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Table of Contents

The following table presents the fair value composition of our investment securities portfolio as of September 30, 2019 and December 31, 2018:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

    

September 30, 2019

 

 

December 31, 2018

 

 

 

 

 

 

 

 

 

 

Percent of

 

 

 

 

 

Percent of

 

 

Change

 

(dollars in thousands)

    

Balance

    

Portfolio

 

    

Balance

    

Portfolio

    

    

Amount

    

Percent

 

Trading

 

$

 —

 

 -

%  

 

$

1,539

 

0.6

%  

 

$

(1,539)

 

(100.0)

%  

Available-for-sale

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

U.S. Treasury and agencies

 

 

21,602

 

7.7

%  

 

 

19,142

 

7.5

%  

 

 

2,460

 

12.9

%  

Obligations of state and political agencies

 

 

47,856

 

17.0

%  

 

 

66,387

 

26.0

%  

 

 

(18,531)

 

(27.9)

%  

Mortgage backed securities

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Residential Agency

 

 

169,337

 

60.1

%  

 

 

126,998

 

50.0

%  

 

 

42,339

 

33.3

%  

Commercial

 

 

32,652

 

11.6

%  

 

 

28,767

 

11.3

%  

 

 

3,885

 

13.5

%  

Asset backed securities

 

 

157

 

0.1

%  

 

 

399

 

0.2

%  

 

 

(242)

 

(60.7)

%  

Corporate bonds

 

 

7,112

 

2.5

%  

 

 

8,481

 

3.3

%  

 

 

(1,369)

 

(16.1)

%  

Total available-for-sale

 

 

278,716

 

99.0

%  

 

 

250,174

 

98.3

%  

 

 

28,542

 

11.4

%  

Equity

 

 

2,675

 

1.0

%  

 

 

3,165

 

1.1

%  

 

 

(490)

 

(15.5)

%  

Total investment securities

 

$

281,391

 

100.0

%  

 

$

254,878

 

100.0

%  

 

$

26,513

 

10.4

%  

The securities available‑for‑sale presented in the following table are reported at fair value and by contractual maturity as of September 30, 2019. Actual timing may differ from contractual maturities if borrowers have the right to call or prepay obligations with or without call or prepayment penalties. Additionally, residential mortgage backed securities and collateralized mortgage obligations receive monthly principal payments, which are not reflected below. The yields below are calculated on a tax-equivalent basis.

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Maturity as of September 30, 2019

 

 

 

One year or less

 

One to five years

 

Five to ten years

 

After ten years

 

 

    

Fair

    

Average

    

Fair

    

Average

    

Fair

    

Average

    

Fair

    

Average

 

(dollars in thousands)

 

Value

 

Yield

 

Value

 

Yield

 

Value

 

Yield

 

Value

 

Yield

 

Available-for-sale

 

 

  

 

  

 

 

  

 

  

 

 

  

 

  

 

 

  

 

  

 

U.S. Treasury and agencies

 

$

 —

 

 —

%  

$

9,969

 

1.52

%  

$

5,841

 

3.36

%  

$

5,792

 

3.00

%

Obligations of state and political agencies

 

 

977

 

1.00

%  

 

15,030

 

1.53

%  

 

14,666

 

2.12

%  

 

17,183

 

2.68

%

Mortgage backed securities

 

 

  

 

  

 

 

  

 

 

 

 

  

 

  

 

 

  

 

  

 

Residential Agency

 

 

17

 

 —

%  

 

3,783

 

2.37

%  

 

51,512

 

2.55

%  

 

114,025

 

2.79

%

Commercial

 

 

 —

 

 —

%  

 

2,127

 

3.06

%  

 

8,386

 

2.39

%  

 

22,139

 

2.65

%

Asset backed securities

 

 

 —

 

4.90

%  

 

 —

 

 —

%  

 

 —

 

 —

%  

 

157

 

5.64

%

Corporate bonds

 

 

2,032

 

 —

%  

 

5,080

 

2.58

%  

 

 —

 

 —

%  

 

 —

 

 —

%

Total available-for-sale

 

$

3,026

 

1.03

%  

$

35,989

 

1.89

%  

$

80,405

 

2.51

%  

$

159,296

 

2.77

%

Cash and Cash Equivalents

Cash and cash equivalents increased $20.5 million to $61.2 million as of September 30, 2019 compared to December 31, 2018. This increase was primarily due to cash flows from financing activities and investing activities totaling $14.1 million and $4.4 million, respectively. The increase in cash flows provided by financing activities was primarily driven by $62.8 million in proceeds received from the issuance of common stock related to our initial public offering and a $53.2 million increase in deposits, partially offset by $93.5 million reduction in short-term borrowings. Cash flows provided by investing activities primarily consisted of a $60.4 million increase in proceeds from the sales and maturities of investment securities, $14.2 million in proceeds from a decrease in loans and $10.4 million in proceeds from the sale of our Duluth branch, partially offset by $80.5 million in purchases of investments securities available-for-sale. 

Deposits

Total deposits as of September 30, 2019 were $1.8 billion and increased $58.0 million, or 3.3%,  as compared to December 31, 2018. The increase in total deposits was due to an increase in interest-bearing deposits of $70.7 million

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partially offset by a decrease in noninterest-bearing accounts of $12.7 million. Total deposits represented 94.2% of total liabilities as of September 30, 2019. The increase in interest-bearing deposits was fairly evenly split amongst interest-bearing demand, money market and savings, and time deposits.

The following table presents the composition of our deposit portfolio as of September 30, 2019 and December 31, 2018:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

    

September 30, 2019

 

 

December 31, 2018

 

 

 

 

 

 

 

 

 

 

 

 

Percent of

 

 

 

 

 

Percent of

 

 

Change

 

(dollars in thousands)

    

Balance

    

Portfolio

 

    

Balance

    

Portfolio

 

    

 

Amount

    

Percent

 

Noninterest-bearing demand

 

$

537,951

 

29.3

%  

 

$

550,640

 

31.0

%  

 

$

(12,689)

 

(2.3)

%  

Interest-bearing demand

 

 

424,249

 

23.1

%  

 

 

401,078

 

22.6

%  

 

 

23,171

 

5.8

%  

Money market and savings

 

 

678,160

 

37.1

%  

 

 

652,791

 

36.8

%  

 

 

25,369

 

3.9

%  

Time deposits

 

 

192,753

 

10.5

%  

 

 

170,587

 

9.6

%  

 

 

22,166

 

13.0

%  

Total deposits

 

$

1,833,113

 

100.0

%  

 

$

1,775,096

 

100.0

%  

 

$

58,017

 

3.3

%  

The following table presents the average balances and rates of our deposit portfolio for the three months ended September 30, 2019 and 2018:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Three months ended

 

Three months ended

 

 

 

September 30, 2019

 

September 30, 2018

 

 

 

Average

 

Average

 

Average

 

Average

 

(dollars in thousands)

 

Balance

 

Rate

 

Balance

 

Rate

 

Noninterest-bearing demand

 

$

502,108

 

 -

%

$

545,154

 

 -

%

Interest-bearing demand

 

 

424,896

 

0.49

%

 

393,390

 

0.23

%

Money market and savings

 

 

649,190

 

1.32

%

 

619,386

 

0.67

%

Time deposits

 

 

187,023

 

1.74

%

 

207,009

 

0.99

%

Total deposits

 

$

1,763,217

 

0.79

%

$

1,764,939

 

0.40

%

The following table presents the contractual maturity of time deposits, including certificate of deposit account registry services and IRA deposits of $100 thousand and over, that were outstanding, as of the dates presented:

 

 

 

 

 

 

 

 

 

September 30, 

 

December 31, 

(dollars in thousands)

    

2019

    

2018

Maturing in:

 

 

  

 

 

  

3 months or less

 

$

46,870

 

$

24,856

3 months to 6 months

 

 

32,389

 

 

37,129

6 months to 1 year

 

 

10,854

 

 

8,260

1 year or greater

 

 

15,657

 

 

13,767

Total

 

$

105,770

 

$

84,012

Deposits Held for Sale

On January 15, 2019, we entered into an agreement to sell our branch offices located in Duluth, Minnesota, including deposits attributable to those offices. These deposits were classified as held for sale in our consolidated balance sheets. As of December 31, 2018, deposits held for sale totaled $24.2 million. The sale was completed on April 26, 2019, and as of September 30, 2019, there were no deposits held for sale.

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Table of Contents

Borrowings

Borrowings as of September 30, 2019 and December 31, 2018 were as follows:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

September 30, 2019

 

 

December 31, 2018

 

 

 

 

 

 

 

 

 

 

 

 

Percent of

 

 

 

 

 

Percent of

 

 

Change

 

(dollars in thousands)

    

Balance

    

Portfolio

 

    

Balance

    

Portfolio

 

    

 

Amount

    

Percent

 

Fed funds purchased

 

$

 —

 

0.0

%

 

$

93,460

 

61.4

%

 

$

(93,460)

 

(100.0)

%

FHLB Short-term advances

 

 

 —

 

0.0

%

 

 

 —

 

0.0

%

 

 

 —

 

 —

%

Subordinated notes

 

 

49,609

 

84.4

%

 

 

49,562

 

32.5

%

 

 

47

 

0.1

%

Junior subordinated debentures

 

 

8,476

 

14.4

%

 

 

8,392

 

5.5

%

 

 

84

 

1.0

%

Finance lease liability

 

 

690

 

1.2

%

 

 

870

 

0.6

%

 

 

(180)

 

(20.7)

%

Total borrowed funds

 

$

58,775

 

100.0

%

 

$

152,284

 

100.0

%

 

$

(93,509)

 

(61.4)

%

 

Capital Resources

Stockholders' equity is influenced primarily by earnings, dividends, the Company's sales and repurchases of its common stock and changes in accumulated other comprehensive income caused primarily by fluctuations in unrealized gains or losses, net of taxes, on available-for-sale securities.

Stockholders' equity increased $84.4 million to $281.4 million as of September  30, 2019, compared to $197.0 million as of December 31, 2018. The increase in stockholders' equity was primarily impacted by $62.8  million of net proceeds received from our initial public offering, $21.9 million of net income for the nine months ended September 30, 2019, and an increase of $6.7 million of accumulated other comprehensive income. These increases were partially offset by dividends paid to common shareholders totaling $6.3 million for the nine months ended September 30, 2019. The increase in accumulated other comprehensive income was entirely from the increase in after-tax market value adjustments on the available-for-sale investment securities portfolio.

 

We strive to maintain an adequate capital base to support our activities in a safe and sound manner while at the same time attempting to maximize stockholder value. Capital adequacy is assessed against the risk inherent in our balance sheet, recognizing that unexpected loss is the common denominator of risk and that common equity has the greatest capacity to absorb unexpected loss.

We are subject to various regulatory capital requirements both at the Company and at the Bank level. Failure to meet minimum capital requirements could result in certain mandatory and possible additional discretionary actions by regulators that, if undertaken, could have an adverse material effect on our financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, specific capital guidelines must be met that involve quantitative measures of assets, liabilities, and certain off-balance sheet items as calculated under regulatory accounting policies. We have consistently maintained regulatory capital ratios at or above the well-capitalized standards.

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Table of Contents

At September 30, 2019 and December 31, 2018, we met all the capital adequacy requirements to which we were subject. The table below presents the Company’s and the Bank’s regulatory capital ratios as of September 30, 2019 and December 31, 2018: 

 

 

 

 

 

 

 

 

 

September 30, 

 

December 31, 

 

Capital Ratios

    

2019

    

2018

    

Alerus Financial Corporation

 

  

 

  

 

Common equity tier 1 capital to risk weighted assets

 

12.38

%

8.43

%

Tier 1 capital to risk weighted assets

 

12.81

%

8.87

%

Total capital to risk weighted assets

 

16.67

%

12.86

%

Tier 1 capital to average assets

 

11.33

%

7.51

%

Tangible common equity to tangible assets (1)

 

10.76

%

6.91

%

 

 

 

 

 

 

Alerus Financial, National Association

 

 

 

 

 

Common equity tier 1 capital to risk weighted assets

 

11.84

%

11.39

%

Tier 1 capital to risk weighted assets

 

11.84

%

11.39

%

Total capital to risk weighted assets

 

13.06

%

12.62

%

Tier 1 capital to average assets

 

10.47

%

9.63

%


(1)

Represents a non-GAAP financial measure. See “Non-GAAP to GAAP Reconciliations and Calculation of Non-GAAP Financial Measures.”

The capital ratios for the Company and the Bank, as of September 30, 2019, as shown in the above tables, indicate levels above the regulatory minimum to be considered “well capitalized”. All regulatory capital ratios increased from their December 31, 2018 levels primarily as a result of net proceeds received from our initial public offering and the increase in retained earnings.

 

Contractual Obligations and Off‑Balance Sheet Arrangements

Contractual Obligations

In the ordinary course of our operations, we enter into certain contractual obligations. The following table presents our contractual obligations by maturity as of September 30, 2019.

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

September 30, 2019

 

    

Less than

    

One to

    

Three to

    

Over

    

 

 

(dollars in thousands)

    

one year

    

three years

    

five years

    

five years

    

Total

Operating lease obligations

 

$

2,291

 

$

3,255

 

$

2,567

 

$

2,460

 

$

10,573

Time deposits

 

 

154,554

 

 

23,665

 

 

7,247

 

 

7,287

 

 

192,753

Subordinated notes payable

 

 

 —

 

 

 —

 

 

 —

 

 

49,609

 

 

49,609

Junior subordinated debenture (Trust I)

 

 

 —

 

 

 —

 

 

 —

 

 

3,390

 

 

3,390

Junior subordinated debenture (Trust II)

 

 

 —

 

 

 —

 

 

 —

 

 

5,086

 

 

5,086

Finance lease liability

 

 

251

 

 

502

 

 

20

 

 

 —

 

 

773

 

Off‑Balance Sheet Arrangements

We are a party to financial instruments with off‑balance sheet risk in the normal course of business to meet the financing needs of our customers. These financial instruments consist primarily of commitments to extend credit and standby letters of credit. Commitments to extend credit are agreements to lend to customers, generally having fixed expiration dates or other termination clauses that may require payment of a fee. These commitments consist principally of unused commercial and consumer credit lines. Standby letters of credit generally are contingent upon the failure of the customer to perform according to the terms of an underlying contract with a third party. The credit risks associated with commitments to extend credit and standby letters of credit are essentially the same as that involved with extending loans to customers and are subject to normal credit policies. Collateral may be required based on management’s assessment of the customer’s creditworthiness. The fair value of these commitments is considered immaterial for disclosure purposes.

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Table of Contents

A summary of the contractual amounts of our exposure to off‑balance sheet agreements as of September 30, 2019 and December 31, 2018, is as follows:

 

 

 

 

 

 

 

 

 

 

September 30, 

    

December 31, 

(dollars in thousands)

    

2019

    

2018

Commitments to extend credit

 

$

570,220

 

$

529,890

Standby letters of credit

 

 

8,023

 

 

8,852

Total

 

$

578,243

 

$

538,742

 

Liquidity

Liquidity management is the process by which we manage the flow of funds necessary to meet our financial commitments on a timely basis and at a reasonable cost and to take advantage of earnings enhancement opportunities. These financial commitments include withdrawals by depositors, credit commitments to borrowers, expenses of our operations, and capital expenditures. Liquidity is monitored and closely managed by our asset and liability committee, or the ALCO, a group of senior officers from the finance, enterprise risk management, deposit, investment, treasury, and lending areas. It is the ALCO’s responsibility to ensure we have the necessary level of funds available for normal operations as well as maintain a contingency funding policy to ensure that potential liquidity stress events are planned for, quickly identified, and management has plans in place to respond. The ALCO has created policies which establish limits and require measurements to monitor liquidity trends, including modeling and management reporting that identifies the amounts and costs of all available funding sources.

As of September 30, 2019, we had on balance sheet liquidity of $192.7 million, compared to $152.1 million as of December 31, 2018. On balance sheet liquidity includes total due from banks, federal funds sold, interest‑bearing deposits with banks, unencumbered securities available‑for‑sale and over collateralized securities pledging position.

The Bank is a member of the FHLB, which provides short‑ and long‑term funding to its members through advances collateralized by real estate related assets and other select collateral, most typically in the form of debt securities. The actual borrowing capacity is contingent on the amount of collateral available to be pledged to the FHLB. As of September 30, 2019, we had no outstanding fed funds purchased from the FHLB. As of September 30, 2019 we had $858.3 million of real estate‑related loans pledged to the FHLB. Based on this collateral we were eligible to borrow up to an additional $545.7 million. In addition, we can borrow up to $87.0 million through the unsecured lines of credit we have established with four other banks.

In addition, because the Bank is “well capitalized,” we can accept wholesale deposits up to 20.0% of total assets based on current policy limits. Management believed that we had adequate resources to fund all of our commitments as of September 30, 2019 and December 31, 2018.

Our primary sources of liquidity include liquid assets, as well as unencumbered securities that can be used to collateralize additional funding. As of September 30, 2019, we had $61.2 million of cash and cash equivalents of which $25.0 million are interest‑earning deposits held at the Federal Reserve, FHLB and other correspondent banks.

Though remote, the possibility of a funding crisis exists at all financial institutions. Accordingly, management has addressed this issue by formulating a liquidity contingency plan, which has been reviewed and approved by both the Bank’s board of directors and the ALCO. The plan addresses the actions that we would take in response to both a short‑term and long‑term funding crisis.

A short‑term funding crisis would most likely result from a shock to the financial system, either internal or external, which disrupts orderly short‑term funding operations. Such a crisis would likely be temporary in nature and would not involve a change in credit ratings. A long‑term funding crisis would most likely be the result of both external and internal factors and would most likely result in drastic credit deterioration. Management believes that both potential circumstances have been fully addressed through detailed action plans and the establishment of trigger points for monitoring such events.

 

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Table of Contents

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Market risk is the risk of loss arising from adverse changes in the fair value of financial instruments due to changes in interest rates. Interest‑rate risk is the risk to earnings and equity value arising from changes in market interest rates and arises in the normal course of business to the extent that there is a divergence between the amount of interest‑earning assets and the amount of interest‑bearing liabilities that are prepaid/withdrawn, re‑price, or mature in specified periods. We seek to achieve consistent growth in net interest income and equity while managing volatility arising from shifts in market interest rates. The ALCO oversees market risk management, monitoring risk measures, limits, and policy guidelines for managing the amount of interest rate risk and its effect on net interest income and capital. The Bank’s board of directors approves policy limits with respect to interest rate risk.

Interest Rate Risk

Interest rate risk management is an active process that encompasses monitoring loan and deposit flows complemented by investment and funding activities. Effective interest rate risk management begins with understanding the dynamic characteristics of assets and liabilities and determining the appropriate interest rate risk position given business activities, management objectives, market expectations and ALCO policy limits and guidelines.

Interest rate risk can come in a variety of forms, including repricing risk, basis risk, yield curve risk and option risk. Repricing risk is the risk of adverse consequences from a change in interest rates that arises because of differences in the timing of when those interest rate changes impact our assets and liabilities. Basis risk is the risk of adverse consequence resulting from unequal change in the spread between two or more rates for different instruments with the same maturity. Yield curve risk is the risk of adverse consequences resulting from unequal changes in the spread between two or more rates for different maturities for the same or different instruments. Option risk in financial instruments arises from embedded options such as options provided to borrowers to make unscheduled loan prepayments, options provided to debt issuers to exercise call options prior to maturity, and depositor options to make withdrawals and early redemptions.

Management regularly reviews our exposure to changes in interest rates. Among the factors considered are changes in the mix of interest‑earning assets and interest‑bearing liabilities, interest rate spreads and repricing periods. The ALCO reviews, on at least a quarterly basis, the interest rate risk position.

The interest‑rate risk position is measured and monitored at the Bank using net interest income simulation models and economic value of equity sensitivity analysis that capture both short‑term and long‑term interest‑rate risk exposure.

Modeling the sensitivity of net interest income and the economic value of equity to changes in market interest rates is highly dependent on numerous assumptions incorporated into the modeling process. The models used for these measurements rely on estimates of the potential impact that changes in interest rates may have on the value and prepayment speeds on all components of our loan portfolio, investment portfolio, as well as embedded options and cash flows of other assets and liabilities. Balance sheet growth assumptions are also included in the simulation modeling process. The analysis provides a framework as to what our overall sensitivity position is as of our most recent reported position and the impact that potential changes in interest rates may have on net interest income and the economic value of our equity.

Net interest income simulation involves forecasting net interest income under a variety of interest rate scenarios including instantaneous shocks.

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The estimated impact on our net interest income as of September 30, 2019 and December 31, 2018, assuming immediate parallel moves in interest rates is presented in the table below.

 

 

 

 

 

 

 

 

 

 

 

 

 

September 30, 2019

 

December 31, 2018

 

 

    

Following

    

Following

    

Following

    

Following

 

 

 

12 months

 

24 months

 

12 months

 

24 months

 

+400 basis points

 

4.4

%  

11.4

%  

0.4

%  

10.7

%

+300 basis points

 

3.4

%  

8.5

%  

0.3

%  

8.7

%

+200 basis points

 

2.3

%  

5.5

%  

0.2

%  

6.6

%

+100 basis points

 

1.3

%  

2.4

%  

0.3

%  

4.8

%

−100 basis points

 

−5.4

%  

−11.4

%  

−5.2

%  

−6.7

%

−200 basis points

 

N/A

%  

N/A

%  

−9.6

%  

−16.4

%

 

Management strategies may impact future reporting periods, as actual results may differ from simulated results due to the timing, magnitude, and frequency of interest rate changes, the difference between actual experience, and the characteristics assumed, as well as changes in market conditions. Market based prepayment speeds are factored into the analysis for loan and securities portfolios. Rate sensitivity for transactional deposit accounts is modeled based on both historical experience and external industry studies.

Management uses economic value of equity sensitivity analysis to understand the impact of interest rate changes on long‑term cash flows, income, and capital. Economic value of equity is based on discounting the cash flows for all balance sheet instruments under different interest rate scenarios. Deposit premiums are based on external industry studies and utilizing historical experience.

The table below presents the change in the economic value of equity as of September 30, 2019 and December 31, 2018, assuming immediate parallel shifts in interest rates.

 

 

 

 

 

 

 

 

    

September 30, 

    

December 31, 

 

 

 

2019

 

2018

 

+400 basis points

 

18.5

%  

4.9

%

+300 basis points

 

16.0

%  

4.8

%

+200 basis points

 

12.5

%  

4.0

%

+100 basis points

 

7.9

%  

2.8

%

−100 basis points

 

−26.5

%  

−15.9

%

−200 basis points

 

N/A

%  

−36.8

%

 

Operational Risk

Operational risk is the risk of loss due to human behavior, inadequate or failed internal systems and controls, and external influences such as market conditions, fraudulent activities, disasters, and security risks. Management continuously strives to strengthen its system of internal controls, enterprise risk management, operating processes and employee awareness to assess the impact on earnings and capital and to improve the oversight of our operational risk.

Compliance Risk

Compliance risk represents the risk of regulatory sanctions, reputational impact or financial loss resulting from failure to comply with rules and regulations issued by the various banking agencies and standards of good banking practice. Activities which may expose us to compliance risk include, but are not limited to, those dealing with the prevention of money laundering, privacy and data protection, community reinvestment initiatives, fair lending challenges resulting from the expansion of our banking center network, employment and tax matters.

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Strategic and/or Reputation Risk

Strategic and/or reputation risk represents the risk of loss due to impairment of reputation, failure to fully develop and execute business plans, failure to assess current and new opportunities in business, markets and products, and any other event not identified in the defined risk types mentioned previously. Mitigation of the various risk elements that represent strategic and/or reputation risk is achieved through initiatives to help management better understand and report on various risks, including those related to the development of new products and business initiatives.

 

ITEM 4. CONTROLS AND PROCEDURES

Evaluation of Disclosure Controls and Procedures

The Company’s management, including our President and Chief Executive Officer and our Chief Financial Officer, have evaluated the effectiveness of our “disclosure controls and procedures” (as defined in Rule 13a‑15(e) under the Securities Exchange Act of 1934, or the “Exchange Act”), as of the end of the period covered by this report. Based on such evaluation, our President and Chief Executive Officer and our Chief Financial Officer have concluded that, as of the end of such period, the Company’s disclosure controls and procedures were effective as of that date to provide reasonable assurance that the information required to be disclosed by the Company in the reports it files or submits under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the rules and forms of the SEC and that information required to be disclosed by the Company in the reports it files or submits under the Exchange Act is accumulated and communicated to the Company’s management, including its President and Chief Executive Officer and its Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure.

Changes in Internal Control over Financial Reporting

There have not been any changes in the Company’s internal control over financial reporting (as such term is defined in Rule 13a‑15(f) under the Exchange Act) during the fiscal quarter to which this report relates that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.

PART II—OTHER INFORMATION

Item 1 – Legal Proceedings

There are no material pending legal proceedings, other than ordinary routine litigation incidental to the business of the Company or its subsidiaries, to which we or any of our subsidiaries is a party or to which our property is the subject. The Company does not know of any proceeding contemplated by a governmental authority against the Company or any of its subsidiaries. 

 

Item 1A – Risk Factors

There have been no material changes from the risk factors previously disclosed in the “Risk Factors” section included in our prospectus filed with the SEC on September 13, 2019, pursuant to Rule 424(b)(4) under the Securities Act of 1933, as amended.

 

Item 2  - Recent Sales of Unregistered Securities

Unregistered Sales of Equity Securities

None.

 

Use of Proceeds from Registered Securities

On September 17, 2019, the Company sold 2,860,000 shares of common stock in its initial public offering. On September 25, 2019, the Company sold 429,000 additional shares of common stock pursuant to the exercise in full by

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the underwriters of their option to purchase additional shares to cover over-allotments. The aggregate offering price for the shares sold by the Company was $69.1 million, and after deducting $6.3 million of underwriting discounts, commissions and offering expenses paid to third parties, the Company received total net proceeds of $62.8 million. All of the shares were sold pursuant to the Company’s Registration Statement on Form S-1, as amended (File No. 333-233339), which was declared effective by the SEC on September 12, 2019, and registered shares of the Company’s common stock with a maximum aggregate offering price of $89.7 million.  Raymond James & Associates, Inc. and D.A. Davidson & Co. served as joint book-running managers in the offering, and Piper Jaffray & Co. served as co-manager. The Company’s common stock is currently traded on the Nasdaq Capital Market under the symbol “ALRS”.

There has been no material change in the planned use of proceeds from the initial public offering as described in the Company’s prospectus filed with the SEC on September 13, 2019, pursuant to Rule 424(b)(4) under the Securities Act of 1933. From the effective date of the registration statement through September 30, 2019, the Company has maintained the net proceeds of the initial public offering on deposit with the Bank. The Bank has used the deposits of the Company to pay down short-term borrowings.

 

Item 3 – Defaults Upon Senior Securities

None.

 

Item 4 – Mine Safety Disclosures

Not Applicable.

 

Item 5 – Other Information

None.

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Item 6 – Exhibits

 

 

 

Exhibit No.

    

Description

31.1

 

Chief Executive Officer’s Certifications required by Rule 13(a)‑14(a) – filed herewith.

 

 

 

31.2

 

Chief Financial Officer’s Certifications required by Rule 13(a)‑14(a) – filed herewith.

 

 

 

32.1

 

Chief Executive Officer Certifications pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 – filed herewith.

 

 

 

32.2

 

Chief Financial Officer Certifications pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 – filed herewith.

101.INS*

 

XBRL Instance Document

 

 

 

101.SCH*

 

XBRL Taxonomy Extension Schema

 

 

 

101.CAL*

 

XBRL Taxonomy Extension Calculation Linkbase

 

 

 

101.DEF*

 

XBRL Taxonomy Extension Definition Linkbase

 

 

 

101.LAB*

 

XBRL Taxonomy Extension Label Linkbase

 

 

 

101.PRE*

 

XBRL Taxonomy Extension Presentation Linkbase

 

 

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SIGNATURES

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

 

 

 

 

ALERUS FINANCIAL CORPORATION

 

 

Date: November 7, 2019

By:

/s/ Randy L. Newman

 

 

Name:    Randy L. Newman

 

 

Title:      Chairman, Chief Executive Officer and President

 

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