Annual Statements Open main menu

ALERUS FINANCIAL CORP - Quarter Report: 2020 March (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 March 31, 2020

 

   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 May 8, 2020 was 17,105,668.

 

 

 

 

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 (Unaudited) as of March 31, 2020 and December 31, 2019

1

 

Consolidated Statements of Income (Unaudited) for the three months ended March 31, 2020 and 2019

2

 

Consolidated Statements of Comprehensive Income (Unaudited) for the three months ended March 31, 2020 and 2019

3

 

Consolidated Statements of Changes in Shareholders’ Equity (Unaudited) for the three months ended March 31, 2020 and 2019

4

 

Consolidated Statements of Cash Flows (Unaudited) for the three months ended March 31, 2020 and 2019

5

 

Notes to Consolidated Financial Statements (Unaudited)

7

Item 2. 

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

35

Item 3. 

Quantitative and Qualitative Disclosures About Market Risk

57

Item 4. 

Controls and Procedures

59

 

 

 

Part 2 

OTHER INFORMATION

 

Item 1. 

Legal Proceedings

59

Item 1A. 

Risk Factors

60

Item 2. 

Unregistered Sales of Equity Securities and Use of Proceeds

61

Item 3. 

Defaults Upon Senior Securities

61

Item 4. 

Mine Safety Disclosures

62

Item 5. 

Other Information

62

Item 6. 

Exhibits

63

 

 

 

Signatures 

 

64

 

 

 

Table of Contents

PART 1. FINANCIAL INFORMATION

Item 1 - Financial Statements

Alerus Financial Corporation and Subsidiaries

Consolidated Balance Sheets (Unaudited)

 

 

 

 

 

 

 

 

 

    

March 31, 

    

December 31, 

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

    

2020

    

2019

Assets

 

 

 

 

 

  

Cash and cash equivalents

 

$

198,489

 

$

144,006

Investment securities, at fair value

 

 

  

 

 

  

Available-for-sale

 

 

354,149

 

 

310,350

Equity

 

 

 —

 

 

2,808

Loans held for sale

 

 

72,258

 

 

46,846

Loans

 

 

1,758,277

 

 

1,721,279

Allowance for loan losses

 

 

(27,019)

 

 

(23,924)

Net loans

 

 

1,731,258

 

 

1,697,355

Land, premises and equipment, net

 

 

20,372

 

 

20,629

Operating lease right-of-use assets

 

 

7,965

 

 

8,343

Accrued interest receivable

 

 

7,425

 

 

7,551

Bank-owned life insurance

 

 

31,763

 

 

31,566

Goodwill

 

 

27,329

 

 

27,329

Other intangible assets

 

 

17,401

 

 

18,391

Servicing rights

 

 

3,277

 

 

3,845

Deferred income taxes, net

 

 

6,185

 

 

7,891

Other assets

 

 

34,207

 

 

29,968

Total assets

 

$

2,512,078

 

$

2,356,878

Liabilities and Stockholders’ Equity

 

 

  

 

 

  

Deposits

 

 

  

 

 

  

Noninterest-bearing

 

$

608,559

 

$

577,704

Interest-bearing

 

 

1,512,955

 

 

1,393,612

Total deposits

 

 

2,121,514

 

 

1,971,316

Long-term debt

 

 

58,762

 

 

58,769

Operating lease liabilities

 

 

8,480

 

 

8,864

Accrued expenses and other liabilities

 

 

29,714

 

 

32,201

Total liabilities

 

 

2,218,470

 

 

2,071,150

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: 17,105,668 and 17,049,551 issued and outstanding

 

 

17,106

 

 

17,050

Additional paid-in capital

 

 

88,703

 

 

88,650

Retained earnings

 

 

180,650

 

 

178,092

Accumulated other comprehensive income (loss)

 

 

7,149

 

 

1,936

Total stockholders’ equity

 

 

293,608

 

 

285,728

Total liabilities and stockholders’ equity

 

$

2,512,078

 

$

2,356,878

 

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

 

 

March 31, 

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

    

2020

    

2019

Interest Income

 

 

 

 

 

 

Loans, including fees

 

$

20,542

 

$

21,573

Investment securities

 

 

  

 

 

  

Taxable

 

 

1,759

 

 

1,309

Exempt from federal income taxes

 

 

235

 

 

244

Other

 

 

570

 

 

184

Total interest income

 

 

23,106

 

 

23,310

Interest Expense

 

 

  

 

 

  

Deposits

 

 

3,392

 

 

2,748

Short-term borrowings

 

 

 —

 

 

531

Long-term debt

 

 

877

 

 

911

Total interest expense

 

 

4,269

 

 

4,190

Net interest income

 

 

18,837

 

 

19,120

Provision for loan losses

 

 

2,500

 

 

2,220

Net interest income after provision for loan losses

 

 

16,337

 

 

16,900

Noninterest Income

 

 

  

 

 

  

Retirement and benefit services

 

 

16,220

 

 

15,059

Wealth management

 

 

4,046

 

 

3,611

Mortgage banking

 

 

5,045

 

 

4,569

Service charges on deposit accounts

 

 

423

 

 

444

Net gains (losses) on investment securities

 

 

 —

 

 

127

Other

 

 

1,455

 

 

1,264

Total noninterest income

 

 

27,189

 

 

25,074

Noninterest Expense

 

 

  

 

 

  

Compensation

 

 

18,731

 

 

16,813

Employee taxes and benefits

 

 

5,308

 

 

5,428

Occupancy and equipment expense

 

 

2,755

 

 

2,745

Business services, software and technology expense

 

 

4,444

 

 

3,798

Intangible amortization expense

 

 

990

 

 

1,051

Professional fees and assessments

 

 

1,040

 

 

1,066

Marketing and business development

 

 

610

 

 

427

Supplies and postage

 

 

703

 

 

733

Travel

 

 

261

 

 

502

Mortgage and lending expenses

 

 

1,043

 

 

446

Other

 

 

841

 

 

505

Total noninterest expense

 

 

36,726

 

 

33,514

Income before income taxes

 

 

6,800

 

 

8,460

Income tax expense

 

 

1,437

 

 

2,024

Net income

 

$

5,363

 

$

6,436

Per Common Share Data

 

 

 

 

 

 

Basic earnings per common share

 

$

0.31

 

$

0.47

Diluted earnings per common share

 

$

0.30

 

$

0.46

Dividends declared per common share

 

$

0.15

 

$

0.14

Average common shares outstanding

 

 

17,070

 

 

13,781

Diluted average common shares outstanding

 

 

17,405

 

 

14,078

 

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

 

 

March 31, 

(dollars in thousands)

    

2020

    

2019

Net Income

 

$

5,363

 

$

6,436

Other Comprehensive Income (Loss), Net of Tax

 

 

  

 

 

  

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

 

 

6,959

 

 

3,150

Reclassification adjustment for losses (gains) realized in income

 

 

 —

 

 

(113)

Total other comprehensive income (loss), before tax

 

 

6,959

 

 

3,037

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

 

 

1,746

 

 

762

Other comprehensive income (loss), net of tax

 

 

5,213

 

 

2,275

Total comprehensive income

 

$

10,576

 

$

8,711

 

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 March 31, 2020

 

 

 

 

 

 

 

 

 

 

 

Accumulated

 

 

 

 

 

 

 

 

 

 

 

Additional

 

 

 

 

Other

 

ESOP-

 

 

 

 

 

Common

 

Paid-in

 

Retained

 

Comprehensive

 

Owned

 

 

 

(dollars and shares in thousands)

    

Stock

    

Capital

    

Earnings

    

Income (Loss)

    

Shares

    

Total

Balance as of December 31, 2019

 

$

17,050

 

$

88,650

 

$

178,092

 

$

1,936

 

$

 —

 

$

285,728

Net income

 

 

 —

 

 

 —

 

 

5,363

 

 

 —

 

 

 —

 

 

5,363

Other comprehensive income (loss)

 

 

 —

 

 

 —

 

 

 —

 

 

5,213

 

 

 —

 

 

5,213

Common stock repurchased

 

 

(15)

 

 

(111)

 

 

(210)

 

 

 —

 

 

 —

 

 

(336)

Common stock dividends

 

 

 —

 

 

 —

 

 

(2,595)

 

 

 —

 

 

 —

 

 

(2,595)

Share‑based compensation expense

 

 

 —

 

 

235

 

 

 —

 

 

 —

 

 

 —

 

 

235

Vesting of restricted stock

 

 

71

 

 

(71)

 

 

 —

 

 

 —

 

 

 —

 

 

 —

Balance as of March 31, 2020

 

$

17,106

 

$

88,703

 

$

180,650

 

$

7,149

 

$

 —

 

$

293,608

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Three months ended March 31, 2019

 

 

 

 

 

 

 

 

 

 

 

Accumulated

 

 

 

 

 

 

 

 

 

 

 

Additional

 

 

 

 

Other

 

ESOP-

 

 

 

 

 

Common

 

Paid-in

 

Retained

 

Comprehensive

 

Owned

 

 

 

(dollars and shares 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

 

 

 

 

 

 

6,436

 

 

 

 

 

 

6,436

Other comprehensive income (loss)

 

 

 

 

 

 

 —

 

 

2,275

 

 

 

 

2,275

Common stock repurchased

 

 

(4)

 

 

(14)

 

 

(71)

 

 

 

 

 

 

(89)

Common stock dividends

 

 

 

 

 

 

(1,973)

 

 

 

 

 

 

(1,973)

Net change in fair value of ESOP shares

 

 

 

 

 

 

 

 

 

 

 —

 

 

 —

Share‑based compensation expense

 

 

 —

 

 

346

 

 

 

 

 

 

 

 

346

Vesting of restricted stock

 

 

30

 

 

(30)

 

 

 

 

 

 

 

 

 —

Balance as of March 31, 2019

 

$

13,801

 

$

28,045

 

$

163,429

 

$

(1,326)

 

$

(34,494)

 

$

169,455

 

See accompanying notes to consolidated financial statements (unaudited)

4

Table of Contents

Alerus Financial Corporation and Subsidiaries

Consolidated Statements of Cash Flows (Unaudited)

 

 

 

 

 

 

 

 

 

 

Three months ended

 

 

March 31, 

(dollars in thousands)

    

2020

    

2019

Operating Activities

 

 

  

 

 

  

Net income

 

$

5,363

 

$

6,436

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

 

 

  

 

 

  

Deferred income taxes

 

 

(40)

 

 

480

Provision for loan losses

 

 

2,500

 

 

2,220

Depreciation and amortization

 

 

2,075

 

 

2,054

Amortization and accretion of premiums/discounts on investment securities

 

 

305

 

 

280

Amortization of operating lease right-of-use assets

 

 

(6)

 

 

 6

Stock-based compensation

 

 

235

 

 

346

Increase in value of bank-owned life insurance

 

 

(197)

 

 

(196)

Realized loss (gain) on forward sale derivatives

 

 

 —

 

 

(11)

Realized loss (gain) on rate lock commitments

 

 

 —

 

 

12

Realized loss (gain) on sale of foreclosed assets

 

 

(63)

 

 

(57)

Realized loss (gain) on sale of investment securities

 

 

 —

 

 

(113)

Realized loss (gain) on servicing rights

 

 

381

 

 

(67)

Net change in:

 

 

 

 

 

 

Securities held for trading

 

 

 —

 

 

1,539

Loans held for sale

 

 

(25,412)

 

 

(13,069)

Accrued interest receivable

 

 

126

 

 

(332)

Other assets

 

 

(4,038)

 

 

2,657

Accrued expenses and other liabilities

 

 

(2,395)

 

 

(3,584)

Net cash provided (used) by operating activities

 

 

(21,166)

 

 

(1,399)

Investing Activities

 

 

  

 

 

  

Proceeds from sales or calls of investment securities available-for-sale

 

 

4,000

 

 

4,763

Proceeds from maturities of investment securities available-for-sale

 

 

9,003

 

 

10,282

Purchases of investment securities available-for-sale

 

 

(50,148)

 

 

(17,901)

Net (increase) decrease in equity securities

 

 

2,808

 

 

248

Net (increase) decrease in loans

 

 

(36,637)

 

 

(10,368)

Proceeds from sale of fixed assets

 

 

 —

 

 

 —

Purchases of premises and equipment

 

 

(689)

 

 

(1,366)

Proceeds from sales of foreclosed assets

 

 

96

 

 

254

Net cash provided (used) by investing activities

 

 

(71,567)

 

 

(14,088)

Financing Activities

 

 

  

 

 

  

Net increase (decrease) in deposits

 

 

150,198

 

 

103,201

Net increase (decrease) in short-term borrowings

 

 

 —

 

 

(81,410)

Repayments of long-term debt

 

 

(51)

 

 

(45)

Cash dividends paid on common stock

 

 

(2,595)

 

 

(1,973)

Repurchase of common stock

 

 

(336)

 

 

(89)

Net cash provided (used) by financing activities

 

 

147,216

 

 

19,684

Net change in cash and cash equivalents

 

 

54,483

 

 

4,197

Cash and cash equivalents at beginning of period

 

 

144,006

 

 

40,651

Cash and cash equivalents at end of period

 

$

198,489

 

$

44,848

 

See accompanying notes to consolidated financial statements (unaudited)

5

Table of Contents

 

 

 

 

 

 

 

 

 

Three months ended

 

 

March 31, 

Supplemental Cash Flow Disclosures

    

2020

    

2019

Cash paid for:

 

 

  

 

 

  

Interest

 

$

4,128

 

$

3,290

Income taxes

 

 

 —

 

 

103

Non-cash information

 

 

  

 

 

  

Loan collateral transferred to foreclosed assets

 

 

234

 

 

142

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

 

 

5,213

 

 

2,275

Initial recognition of operating lease right-of-use assets

 

 

 —

 

 

10,000

Initial recognition of operating lease liabilities

 

 

 —

 

 

10,521

Right-of-use assets obtained in exchange for new operating leases.

 

 

183

 

 

 —

 

See accompanying notes to consolidated financial statements (unaudited)

 

 

6

Table of Contents

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, or the Company, and its subsidiaries is a diversified financial services company headquartered in Grand Forks, North Dakota. Through its subsidiary, Alerus Financial, National Association, or 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, or 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, or 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. The Company has also evaluated all subsequent events for potential recognition and disclosure through the date of the filing of this Quarterly Report on Form 10-Q. 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, 2019, included in the Company’s Annual Report on Form 10-K filed with the SEC on March 26, 2020.

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, or 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.

7

Table of Contents

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.

Reclassifications

Certain items previously reported have been reclassified to conform to the current period’s reporting format. Such reclassifications did not affect net income or stockholders’ equity.

Other Information

On March 11, 2020, the World Health Organization declared the spread of Coronavirus Disease 2019, or COVID-19, a worldwide pandemic. The COVID-19 pandemic is having significant effects on global markets, supply chains, businesses, and communities. Specific to the Company, COVID-19 is expected to impact various parts of its 2020 operations and financial results, including, but not limited to, additional loan loss reserves, costs for emergency preparedness, or potential shortages of personnel. Management believes the Company is taking appropriate actions to mitigate, to the extent possible, the negative impact. However, the full impact of COVID-19 is currently unknown and cannot be reasonably estimated as the events are continuing to unfold as the year progresses.

In March 2020, various regulatory agencies, including the Board of Governors of the Federal Reserve System and the Federal Deposit Insurance Corporation, or the agencies, issued an interagency statement on loan modifications and reporting for financial institutions working with customers affected by COVID-19. The interagency statement was effective immediately and impacted accounting loan modifications. Under Accounting Standards Codification 310-40, “Receivables – Troubled Debt Restructurings by Creditors,” or ASC 310-40, a restructuring of debt constitutes a troubled debt restructuring, or TDR, if the creditor for economic or legal reasons related to the debtor’s financial difficulties, grants a concession to the debtor that it would not otherwise consider. The agencies confirmed with the staff of the Financial Accounting Standards Boards, or FASB, that short-term modifications made on a good faith basis in response to COVID-19 to borrowers who were current prior to any relief, are not to be considered TDRs. This includes short-term (e.g., six months) modifications such as payment deferrals, fee waivers, extensions of repayment terms, or other delays in payment that are insignificant. Borrowers considered current are those that are less than 30 days past due on their contractual payments at the time a modification program is implemented. This interagency guidance is expected to have a material impact on the Company’s financial statements for disclosure of the impact to date.

Emerging Growth Company

The Company qualifies as an “emerging growth company” under the Jumpstart Our Business Startups Act of 2012, or 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, or 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.

8

Table of Contents

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, or ASUs, are divided into pronouncements which have been adopted by the Company since January 1, 2020, and those which are not yet effective and have been evaluated or are currently being evaluated by management as of March 31, 2020.

Adopted Pronouncements

In January 2017, the FASB issued ASU No. 2017-04, Simplifying the Test for Goodwill Impairment. This ASU removes Step 2 of the goodwill impairment test, which requires a hypothetical purchase price allocation. Under the amended guidance, a goodwill impairment charge will now be recognized for the amount by which the carrying value of a reporting unit exceeds its estimated fair value, not to exceed the carrying amount of goodwill. For public business entities that are US Securities and Exchange Commission filers, ASU 2017-04, is effective for interim and annual reporting periods beginning after December 15, 2019. The Company adopted ASU 2017-04 effective January 1, 2020, the new guidance did not have an impact on the Company’s consolidated financial statements.

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. The Company adopted ASU 2018-13 effective January 1, 2020, the revised disclosure requirements did not have a material impact on the Company’s consolidated financial statements.

In August 2018, the FASB issued ASU 2018-15, Intangibles – Goodwill and Other – Internal Use Software (Subtopic 350-40) – Customer’s Accounting for Implementation Costs Incurred in a Cloud Computing Arrangement That is a Service Contract. ASU 2018-15 aligns the requirements for capitalizing implementation costs incurred in a hosting arrangement that is a service contract with the requirements for capitalizing implementation costs incurred to develop or obtain internal-use software (and hosting arrangements that include an internal-use software license). The accounting for the service element of a hosting arrangement that is a service contract is not affected by these amendments. ASU 2018-15 was effective for the Company on January 1, 2020, and did not have a material impact on the Company’s consolidated financial statements.

Pronouncements Not Yet Effective

In June 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, or 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. In November 2019, the FASB issued ASU No. 2019-10, Financial Instruments – Credit Losses (Topic 326). This update amends the effective date of ASU No. 2016-13 for certain entities, including private companies and smaller reporting companies, until fiscal years beginning after December 15, 2022, including interim periods within those fiscal periods. Early adoption is permitted.

9

Table of Contents

As an emerging growth company, the Company can take advantage of this delay and plans to adopt the standard with the amended effective date. The Company does not plan to early adopt this standard but continues to work through implementation. The Company continues collecting and retaining loan and credit data and evaluating various loss estimation models. While we currently cannot reasonably estimate the impact of adopting this standard, we expect the impact will be influenced by the composition, characteristics, and quality of our loan portfolio, as well as the general economic conditions and forecasts as of the adoption date.

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. In November 2019, the FASB Issued ASU 2019-10, which amends the effective date of this ASU for certain entities, including private companies and smaller reporting companies until after December 15, 2022, including interim periods within those fiscal years. As an emerging growth company, the Company can take advantage of this delay and plans to adopt the standard with the amended effective date. This update is not expected to have a significant impact on the Company’s consolidated financial statements.

In December 2019, the FASB issued ASU 2019-12, Income Taxes (Topic 740), which simplifies accounting for income taxes by removing certain exceptions to the general principles in Topic 740. The amendments also improve consistent application of and simplify GAAP for the areas of Topic 740 by clarifying and amending existing guidance. This guidance is effective for fiscal years, and interim periods within those fiscal years beginning after December 15, 2020, for public business entities. For private companies and smaller reporting companies, this guidance is effective for fiscal years, and interim periods within those fiscal years beginning after December 15, 2021. As an emerging growth company, the Company can take advantage of this later effective date. Early adoption of the amendments is permitted, including adoption in any interim period for which financial statements have not yet been issued. Depending on the amendment, adoption may be applied on the retrospective, modified retrospective, or prospective basis. The Company is currently reviewing the provisions of this new pronouncement, but does not expect adoption of this guidance to have a material 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 March 31, 2020 and December 31, 2019:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

March 31, 2020

 

 

Amortized

 

Unrealized

 

Unrealized

 

Fair

(dollars in thousands)

    

Cost

    

Gains

    

Losses

    

Value

U.S. Treasury and agencies

 

$

16,538

 

$

93

 

$

(4)

 

$

16,627

Obligations of state and political agencies

 

 

67,921

 

 

1,212

 

 

(27)

 

 

69,106

Mortgage backed securities

 

 

  

 

 

 

 

 

 

 

 

  

Residential agency

 

 

221,844

 

 

7,483

 

 

(18)

 

 

229,309

Commercial

 

 

29,128

 

 

899

 

 

(117)

 

 

29,910

Asset backed securities

 

 

134

 

 

 7

 

 

 —

 

 

141

Corporate bonds

 

 

9,039

 

 

18

 

 

(1)

 

 

9,056

Total available-for-sale investment securities

 

$

344,604

 

$

9,712

 

$

(167)

 

$

354,149

 

10

Table of Contents

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

December 31, 2019

 

 

Amortized

 

Unrealized

 

Unrealized

 

Fair

(dollars in thousands)

    

Cost

    

Gains

    

Losses

    

Value

U.S. Treasury and agencies

 

$

21,246

 

$

 9

 

$

(15)

 

$

21,240

Obligations of state and political agencies

 

 

68,162

 

 

647

 

 

(161)

 

 

68,648

Mortgage backed securities

 

 

  

 

 

 

 

 

 

 

 

  

Residential agency

 

 

180,411

 

 

2,258

 

 

(131)

 

 

182,538

Commercial

 

 

30,752

 

 

101

 

 

(168)

 

 

30,685

Asset backed securities

 

 

139

 

 

 5

 

 

 —

 

 

144

Corporate bonds

 

 

7,054

 

 

41

 

 

 —

 

 

7,095

Total available-for-sale investment securities

 

$

307,764

 

$

3,061

 

$

(475)

 

$

310,350

 

The following tables present unrealized losses and fair values for available-for-sale investment securities as of March 31, 2020 and December 31, 2019, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

March 31, 2020

 

 

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

 

$

(4)

 

$

1,342

 

$

 —

 

$

 —

 

$

(4)

 

$

1,342

Obligations of state and political agencies

 

 

(27)

 

 

12,420

 

 

 —

 

 

 —

 

 

(27)

 

 

12,420

Mortgage backed securities

 

 

  

 

 

  

 

 

  

 

 

  

 

 

  

 

 

  

Residential agency

 

 

(5)

 

 

2,664

 

 

(13)

 

 

1,691

 

 

(18)

 

 

4,355

Commercial

 

 

 —

 

 

 —

 

 

(117)

 

 

6,932

 

 

(117)

 

 

6,932

Asset backed securities

 

 

 —

 

 

 2

 

 

 —

 

 

 —

 

 

 —

 

 

 2

Corporate bonds

 

 

(1)

 

 

2,009

 

 

 —

 

 

 —

 

 

(1)

 

 

2,009

Total available-for-sale investment securities

 

$

(37)

 

$

18,437

 

$

(130)

 

$

8,623

 

$

(167)

 

$

27,060

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

December 31, 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

 

$

(5)

 

$

1,740

 

$

(10)

 

$

9,990

 

$

(15)

 

$

11,730

Obligations of state and political agencies

 

 

(140)

 

 

11,959

 

 

(21)

 

 

5,798

 

 

(161)

 

 

17,757

Mortgage backed securities

 

 

  

 

 

  

 

 

  

 

 

  

 

 

  

 

 

  

Residential agency

 

 

(52)

 

 

17,131

 

 

(79)

 

 

14,036

 

 

(131)

 

 

31,167

Commercial

 

 

(116)

 

 

15,235

 

 

(52)

 

 

6,195

 

 

(168)

 

 

21,430

Asset backed securities

 

 

 —

 

 

 2

 

 

 —

 

 

 —

 

 

 —

 

 

 2

Corporate bonds

 

 

 —

 

 

 —

 

 

 —

 

 

 —

 

 

 —

 

 

 —

Total available-for-sale investment securities

 

$

(313)

 

$

46,067

 

$

(162)

 

$

36,019

 

$

(475)

 

$

82,086

 

For all of the above investment securities, the unrealized losses were generally due to changes in interest rates and unrealized losses were considered to be temporary as the fair value is expected to recover as the securities approach their maturity dates. The Company evaluates securities for other-than-temporary impairment, or 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 months ended March 31, 2020 and 2019, the Company did not recognize OTTI losses on its investment securities.

11

Table of Contents

The following table presents amortized cost and estimated fair value of the available-for-sale investment securities as of March 31, 2020, by contractual maturity:

 

 

 

 

 

 

 

 

 

Amortized

 

Fair

(dollars in thousands)

    

Cost

    

Value

Due within one year or less

 

$

16,054

 

$

16,149

Due after one year through five years

 

 

25,745

 

 

25,934

Due after five years through ten years

 

 

78,317

 

 

80,298

Due after 10 years

 

 

224,488

 

 

231,768

Total available-for-sale investment securities

 

$

344,604

 

$

354,149

 

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 $125.7 million and $136.2 million were pledged as of March 31, 2020 and December 31, 2019, respectively, to secure public deposits and for other purposes required or permitted by law.

Proceeds from the sale or call of available‑for‑sale investment securities, for the three months ended March 31, 2020 and 2019, are displayed in the table below:

 

 

 

 

 

 

 

 

 

Three months ended

 

 

March 31, 

(dollars in thousands)

    

2020

    

2019

Proceeds

 

$

4,000

 

$

4,763

Realized gains

 

 

 —

 

 

119

Realized losses

 

 

 —

 

 

 6

 

As of March 31, 2020 and December 31, 2019, the carrying value of the Company’s Federal Reserve stock and Federal Home Loan Bank of Des Moines, or FHLB, stock was as follows:

 

 

 

 

 

 

 

 

 

March 31, 

 

December 31, 

(dollars in thousands)

    

2020

    

2019

Federal Reserve

 

$

2,675

 

$

2,675

FHLB

 

 

3,284

 

 

3,080

 

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 March 31, 2020, the conversion ratio was 1.6228. Based on the existing transfer restriction and the uncertainty of the outcome of the Visa litigation mentioned above, the 6,924 Class B shares (11,236 Class A equivalents) that the Company owns as of March 31, 2020 and December 31, 2019, 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 March 31, 2020 and December 31, 2019:

 

 

 

 

 

 

 

 

    

March 31, 

    

December 31, 

(dollars in thousands)

    

2020

    

2019

Commercial

 

 

 

 

 

 

Commercial and industrial

 

$

502,637

 

$

479,144

Real estate construction

 

 

25,487

 

 

26,378

Commercial real estate

 

 

522,106

 

 

494,703

Total commercial

 

 

1,050,230

 

 

1,000,225

Consumer

 

 

  

 

 

  

Residential real estate first mortgage

 

 

457,895

 

 

457,155

Residential real estate junior lien

 

 

170,538

 

 

177,373

Other revolving and installment

 

 

79,614

 

 

86,526

Total consumer

 

 

708,047

 

 

721,054

Total loans

 

$

1,758,277

 

$

1,721,279

 

Total loans included net deferred loan fees and costs of $994 thousand and $1.0 million at March 31, 2020 and December 31, 2019, 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 March 31, 2020 and December 31, 2019:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

March 31, 2020

 

 

 

 

 

 

 

 

90 Days

 

 

 

 

 

 

 

 

Accruing

 

30 - 89 Days

 

or More

 

 

 

 

Total

(dollars in thousands)

    

Current

    

Past Due

    

Past Due

    

Nonaccrual

    

Loans

Commercial

 

 

  

 

 

  

 

 

  

 

 

  

 

 

  

Commercial and industrial

 

$

497,635

 

$

438

 

$

 —

 

$

4,564

 

$

502,637

Real estate construction

 

 

25,487

 

 

 —

 

 

 —

 

 

 —

 

 

25,487

Commercial real estate

 

 

518,064

 

 

2,602

 

 

 —

 

 

1,440

 

 

522,106

Total commercial

 

 

1,041,186

 

 

3,040

 

 

 —

 

 

6,004

 

 

1,050,230

Consumer

 

 

  

 

 

  

 

 

  

 

 

  

 

 

  

Residential real estate first mortgage

 

 

455,580

 

 

1,574

 

 

 —

 

 

741

 

 

457,895

Residential real estate junior lien

 

 

170,099

 

 

237

 

 

11

 

 

191

 

 

170,538

Other revolving and installment

 

 

79,274

 

 

317

 

 

 —

 

 

23

 

 

79,614

Total consumer

 

 

704,953

 

 

2,128

 

 

11

 

 

955

 

 

708,047

Total loans

 

$

1,746,139

 

$

5,168

 

$

11

 

$

6,959

 

$

1,758,277

 

13

Table of Contents

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

December 31, 2019

 

 

 

 

 

 

 

 

90 Days

 

 

 

 

 

 

 

 

Accruing

 

30 - 89 Days

 

or More

 

 

 

 

Total

(dollars in thousands)

    

Current

    

Past Due

    

Past Due

    

Nonaccrual

    

Loans

Commercial

 

 

  

 

 

  

 

 

  

 

 

  

 

 

  

Commercial and industrial

 

$

473,900

 

$

382

 

$

 —

 

$

4,862

 

$

479,144

Real estate construction

 

 

26,251

 

 

127

 

 

 —

 

 

 —

 

 

26,378

Commercial real estate

 

 

492,707

 

 

556

 

 

 —

 

 

1,440

 

 

494,703

Total commercial

 

 

992,858

 

 

1,065

 

 

 —

 

 

6,302

 

 

1,000,225

Consumer

 

 

  

 

 

  

 

 

  

 

 

  

 

 

  

Residential real estate first mortgage

 

 

455,244

 

 

666

 

 

448

 

 

797

 

 

457,155

Residential real estate junior lien

 

 

176,915

 

 

184

 

 

 —

 

 

274

 

 

177,373

Other revolving and installment

 

 

86,172

 

 

348

 

 

 —

 

 

 6

 

 

86,526

Total consumer

 

 

718,331

 

 

1,198

 

 

448

 

 

1,077

 

 

721,054

Total loans

 

$

1,711,189

 

$

2,263

 

$

448

 

$

7,379

 

$

1,721,279

 

The Company’s consumer loan portfolio is primarily comprised of both secured and unsecured loans that 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 March 31, 2020 and December 31, 2019:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

March 31, 2020

 

 

 

 

 

Criticized

 

 

 

 

 

 

 

 

Special

 

 

 

 

 

 

 

 

 

(dollars in thousands)

    

Pass

    

Mention

    

Substandard

    

Doubtful

    

Total

Commercial

 

 

  

 

 

  

 

 

  

 

 

  

 

 

  

Commercial and industrial

 

$

470,867

 

$

10,178

 

$

21,575

 

$

17

 

$

502,637

Real estate construction

 

 

24,941

 

 

279

 

 

267

 

 

 —

 

 

25,487

Commercial real estate

 

 

492,434

 

 

4,422

 

 

25,250

 

 

 —

 

 

522,106

Total commercial

 

 

988,242

 

 

14,879

 

 

47,092

 

 

17

 

 

1,050,230

Consumer

 

 

  

 

 

  

 

 

  

 

 

  

 

 

  

Residential real estate first mortgage

 

 

455,720

 

 

1,434

 

 

741

 

 

 —

 

 

457,895

Residential real estate junior lien

 

 

167,356

 

 

1,952

 

 

1,230

 

 

 —

 

 

170,538

Other revolving and installment

 

 

79,591

 

 

 —

 

 

23

 

 

 —

 

 

79,614

Total consumer

 

 

702,667

 

 

3,386

 

 

1,994

 

 

 —

 

 

708,047

Total loans

 

$

1,690,909

 

$

18,265

 

$

49,086

 

$

17

 

$

1,758,277

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

December 31, 2019

 

 

 

 

 

Criticized

 

 

 

 

 

 

 

 

Special

 

 

 

 

 

 

 

 

 

(dollars in thousands)

    

Pass

    

Mention

    

Substandard

    

Doubtful

    

Total

Commercial

 

 

  

 

 

  

 

 

  

 

 

  

 

 

  

Commercial and industrial

 

$

448,306

 

$

9,585

 

$

21,253

 

$

 —

 

$

479,144

Real estate construction

 

 

25,119

 

 

282

 

 

977

 

 

 —

 

 

26,378

Commercial real estate

 

 

462,294

 

 

2,359

 

 

30,050

 

 

 —

 

 

494,703

Total commercial

 

 

935,719

 

 

12,226

 

 

52,280

 

 

 —

 

 

1,000,225

Consumer

 

 

  

 

 

  

 

 

  

 

 

  

 

 

  

Residential real estate first mortgage

 

 

456,358

 

 

 —

 

 

797

 

 

 —

 

 

457,155

Residential real estate junior lien

 

 

176,122

 

 

 —

 

 

1,251

 

 

 —

 

 

177,373

Other revolving and installment

 

 

86,520

 

 

 —

 

 

 6

 

 

 —

 

 

86,526

Total consumer

 

 

719,000

 

 

 —

 

 

2,054

 

 

 —

 

 

721,054

Total loans

 

$

1,654,719

 

$

12,226

 

$

54,334

 

$

 —

 

$

1,721,279

 

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 months ended March 31, 2020 and 2019:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Three months ended March 31, 2020

 

 

Beginning

 

Provision for

 

Loan

 

Loan

 

Ending

(dollars in thousands)

    

Balance

    

Loan Losses

    

Charge-offs

    

Recoveries

    

Balance

Commercial

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Commercial and industrial

 

$

12,270

 

$

70

 

$

(32)

 

$

593

 

$

12,901

Real estate construction

 

 

303

 

 

31

 

 

 —

 

 

 —

 

 

334

Commercial real estate

 

 

6,688

 

 

1,588

 

 

 —

 

 

 —

 

 

8,276

Total commercial

 

 

19,261

 

 

1,689

 

 

(32)

 

 

593

 

 

21,511

Consumer

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Residential real estate first mortgage

 

 

1,448

 

 

761

 

 

 —

 

 

 —

 

 

2,209

Residential real estate junior lien

 

 

671

 

 

317

 

 

 —

 

 

37

 

 

1,025

Other revolving and installment

 

 

352

 

 

92

 

 

(67)

 

 

64

 

 

441

Total consumer

 

 

2,471

 

 

1,170

 

 

(67)

 

 

101

 

 

3,675

Unallocated

 

 

2,192

 

 

(359)

 

 

 —

 

 

 —

 

 

1,833

Total

 

$

23,924

 

$

2,500

 

$

(99)

 

$

694

 

$

27,019

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Three months ended March 31, 2019

 

 

Beginning

 

Provision for

 

Loan

 

Loan

 

Ending

(dollars in thousands)

    

Balance

    

Loan Losses

    

Charge-offs

    

Recoveries

    

Balance

Commercial

 

 

  

 

 

  

 

 

  

 

 

  

 

 

  

Commercial and industrial

 

$

12,127

 

$

3,407

 

$

(1,785)

 

$

66

 

$

13,815

Real estate construction

 

 

250

 

 

 2

 

 

(1)

 

 

 —

 

 

251

Commercial real estate

 

 

6,279

 

 

(436)

 

 

 —

 

 

 —

 

 

5,843

Total commercial

 

 

18,656

 

 

2,973

 

 

(1,786)

 

 

66

 

 

19,909

Consumer

 

 

  

 

 

  

 

 

  

 

 

  

 

 

  

Residential real estate first mortgage

 

 

1,156

 

 

454

 

 

 —

 

 

 —

 

 

1,610

Residential real estate junior lien

 

 

805

 

 

 7

 

 

(104)

 

 

53

 

 

761

Other revolving and installment

 

 

380

 

 

(46)

 

 

(58)

 

 

73

 

 

349

Total consumer

 

 

2,341

 

 

415

 

 

(162)

 

 

126

 

 

2,720

Unallocated

 

 

1,177

 

 

(1,168)

 

 

 —

 

 

 —

 

 

 9

Total

 

$

22,174

 

$

2,220

 

$

(1,948)

 

$

192

 

$

22,638

 

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 March 31, 2020 and December 31, 2019:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

March 31, 2020

 

 

Recorded Investment

 

Allowance for Loan Losses

 

 

Individually

 

Collectively

 

 

 

 

Individually

 

Collectively

 

 

 

 

 

 

(dollars in thousands)

    

Evaluated

    

Evaluated

    

Total

    

Evaluated

    

Evaluated

    

Unallocated

    

Total

Commercial

 

 

  

 

 

  

 

 

  

 

 

 

 

 

 

 

 

 

 

 

 

Commercial and industrial

 

$

5,422

 

$

497,215

 

$

502,637

 

$

2,764

 

$

10,137

 

$

 —

 

$

12,901

Real estate construction

 

 

 —

 

 

25,487

 

 

25,487

 

 

 —

 

 

334

 

 

 —

 

 

334

Commercial real estate

 

 

1,524

 

 

520,582

 

 

522,106

 

 

271

 

 

8,005

 

 

 —

 

 

8,276

Total commercial

 

 

6,946

 

 

1,043,284

 

 

1,050,230

 

 

3,035

 

 

18,476

 

 

 —

 

 

21,511

Consumer

 

 

  

 

 

  

 

 

  

 

 

 

 

 

 

 

 

 

 

 

 

Residential real estate first mortgage

 

 

733

 

 

457,162

 

 

457,895

 

 

 —

 

 

2,209

 

 

 —

 

 

2,209

Residential real estate junior lien

 

 

241

 

 

170,297

 

 

170,538

 

 

20

 

 

1,005

 

 

 —

 

 

1,025

Other revolving and installment

 

 

22

 

 

79,592

 

 

79,614

 

 

11

 

 

430

 

 

 —

 

 

441

Total consumer

 

 

996

 

 

707,051

 

 

708,047

 

 

31

 

 

3,644

 

 

 —

 

 

3,675

Total loans

 

$

7,942

 

$

1,750,335

 

$

1,758,277

 

$

3,066

 

$

22,120

 

$

1,833

 

$

27,019

 

16

Table of Contents

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

December 31, 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

 

$

976

 

$

478,168

 

$

479,144

 

$

189

 

$

12,081

 

$

 —

 

$

12,270

Real estate construction

 

 

 —

 

 

26,378

 

 

26,378

 

 

 —

 

 

303

 

 

 —

 

 

303

Commercial real estate

 

 

5,925

 

 

488,778

 

 

494,703

 

 

2,946

 

 

3,742

 

 

 —

 

 

6,688

Total commercial

 

 

6,901

 

 

993,324

 

 

1,000,225

 

 

3,135

 

 

16,126

 

 

 —

 

 

19,261

Consumer

 

 

  

 

 

  

 

 

  

 

 

 

 

 

 

 

 

 

 

 

 

Residential real estate first mortgage

 

 

782

 

 

456,373

 

 

457,155

 

 

 —

 

 

1,448

 

 

 —

 

 

1,448

Residential real estate junior lien

 

 

266

 

 

177,107

 

 

177,373

 

 

 —

 

 

671

 

 

 —

 

 

671

Other revolving and installment

 

 

 5

 

 

86,521

 

 

86,526

 

 

 3

 

 

349

 

 

 —

 

 

352

Total consumer

 

 

1,053

 

 

720,001

 

 

721,054

 

 

 3

 

 

2,468

 

 

 —

 

 

2,471

Total loans

 

$

7,954

 

$

1,713,325

 

$

1,721,279

 

$

3,138

 

$

18,594

 

$

2,192

 

$

23,924

 

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.

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

March 31, 2020

 

December 31, 2019

 

 

Recorded

 

Unpaid

 

Related

 

Recorded

 

Unpaid

 

Related

(dollars in thousands)

    

Investment

    

Principal

    

Allowance

    

Investment

    

Principal

    

Allowance

Impaired loans with a valuation allowance

 

 

  

 

 

  

 

 

  

 

 

 

 

 

 

 

 

 

Commercial and industrial

 

$

4,891

 

$

5,028

 

$

2,764

 

$

639

 

$

727

 

$

189

Commercial real estate

 

 

1,524

 

 

1,642

 

 

271

 

 

5,718

 

 

5,823

 

 

2,946

Residential real estate junior lien

 

 

20

 

 

20

 

 

20

 

 

 —

 

 

 —

 

 

 —

Other revolving and installment

 

 

17

 

 

17

 

 

11

 

 

 5

 

 

 6

 

 

 3

Total impaired loans with a valuation allowance

 

 

6,452

 

 

6,707

 

 

3,066

 

 

6,362

 

 

6,556

 

 

3,138

Impaired loans without a valuation allowance

 

 

  

 

 

  

 

 

  

 

 

 

 

 

 

 

 

 

Commercial and industrial

 

 

531

 

 

611

 

 

 —

 

 

337

 

 

1,110

 

 

 —

Commercial real estate

 

 

 —

 

 

 —

 

 

 —

 

 

207

 

 

236

 

 

 —

Residential real estate first mortgage

 

 

733

 

 

741

 

 

 —

 

 

782

 

 

797

 

 

 —

Residential real estate junior lien

 

 

221

 

 

325

 

 

 —

 

 

266

 

 

372

 

 

 —

Other revolving and installment

 

 

 5

 

 

 5

 

 

 —

 

 

 —

 

 

 —

 

 

 —

Total impaired loans without a valuation allowance

 

 

1,490

 

 

1,682

 

 

 —

 

 

1,592

 

 

2,515

 

 

 —

Total impaired loans

 

 

  

 

 

  

 

 

  

 

 

 

 

 

 

 

 

 

Commercial and industrial

 

 

5,422

 

 

5,639

 

 

2,764

 

 

976

 

 

1,837

 

 

189

Commercial real estate

 

 

1,524

 

 

1,642

 

 

271

 

 

5,925

 

 

6,059

 

 

2,946

Residential real estate first mortgage

 

 

733

 

 

741

 

 

 —

 

 

782

 

 

797

 

 

 —

Residential real estate junior lien

 

 

241

 

 

345

 

 

20

 

 

266

 

 

372

 

 

 —

Other revolving and installment

 

 

22

 

 

22

 

 

11

 

 

 5

 

 

 6

 

 

 3

Total impaired loans

 

$

7,942

 

$

8,389

 

$

3,066

 

$

7,954

 

$

9,071

 

$

3,138

 

17

Table of Contents

The table below presents the average recorded investment in impaired loans and interest income for the three months ended March 31, 2020 and 2019:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Three Months Ended March 31, 

 

 

2020

 

2019

 

 

Average

 

 

 

 

Average

 

 

 

 

 

Recorded

 

Interest

 

Recorded

 

Interest

(dollars in thousands)

    

Investment

    

Income

    

Investment

    

Income

Impaired loans with a valuation allowance

 

 

  

 

 

  

 

 

  

 

 

  

Commercial and industrial

 

$

4,979

 

$

15

 

$

5,529

 

$

 —

Commercial real estate

 

 

1,536

 

 

 8

 

 

1,533

 

 

 —

Residential real estate junior lien

 

 

20

 

 

 —

 

 

 —

 

 

 —

Other revolving and installment

 

 

17

 

 

 —

 

 

27

 

 

 —

Total impaired loans with a valuation allowance

 

 

6,552

 

 

23

 

 

7,089

 

 

 —

Impaired loans without a valuation allowance

 

 

  

 

 

  

 

 

  

 

 

  

Commercial and industrial

 

 

545

 

 

27

 

 

1,816

 

 

46

Real estate construction

 

 

 —

 

 

 —

 

 

220

 

 

 9

Residential real estate first mortgage

 

 

835

 

 

 —

 

 

 —

 

 

 —

Residential real estate junior lien

 

 

224

 

 

 3

 

 

290

 

 

 4

Other revolving and installment

 

 

 8

 

 

 —

 

 

 —

 

 

 —

Total impaired loans without a valuation allowance

 

 

1,612

 

 

30

 

 

2,326

 

 

59

Total impaired loans

 

 

  

 

 

  

 

 

  

 

 

  

Commercial and industrial

 

 

5,524

 

 

42

 

 

7,345

 

 

46

Real estate construction

 

 

 —

 

 

 —

 

 

220

 

 

 9

Commercial real estate

 

 

1,536

 

 

 8

 

 

1,533

 

 

 —

Residential real estate first mortgage

 

 

835

 

 

 —

 

 

 —

 

 

 —

Residential real estate junior lien

 

 

244

 

 

 3

 

 

290

 

 

 4

Other revolving and installment

 

 

25

 

 

 —

 

 

27

 

 

 —

Total impaired loans

 

$

8,164

 

$

53

 

$

9,415

 

$

59

 

Loans with a carrying value of $1.2 billion as of March 31, 2020 and $1.2 billion as of December 31, 2019,  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 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 2020 there were no loans modified as a TDR.  As of April 21, 2020, we had executed 325 principal and interest deferrals on outstanding loan balances of $97.4 million in connection with the COVID-19 relief provided by the CARES Act. These deferrals were generally no more than 90 days in duration and were not considered TDRs based on the interagency guidance issued in March. During the first quarter of 2019, there was one loan modified as a TDR as a result of extending the amortization period. As of December 31, 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 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.

18

Table of Contents

NOTE 5 Goodwill and Other Intangible Assets

The following table summarizes the carrying amount of goodwill, by segment, as of March 31, 2020 and December 31, 2019:

 

 

 

 

 

 

 

 

 

March 31, 

 

December 31, 

(dollars in thousands)

    

2020

 

2019

Banking

 

$

20,131

 

$

20,131

Retirement and benefit services

 

 

7,198

 

 

7,198

Total goodwill

 

$

27,329

 

$

27,329

 

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

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

March 31, 2020

 

December 31, 2019

(dollars in thousands)

    

Gross Carrying Amount

    

Accumulated Amortization

    

Total

    

Gross Carrying Amount

    

Accumulated Amortization

    

Total

Identifiable customer intangibles

 

$

31,857

 

$

(15,088)

 

$

16,769

 

$

31,857

 

$

(14,287)

 

$

17,570

Core deposit intangible assets

 

 

3,793

 

 

(3,161)

 

 

632

 

 

4,993

 

 

(4,172)

 

 

821

Total intangible assets

 

$

35,650

 

$

(18,249)

 

$

17,401

 

$

36,850

 

$

(18,459)

 

$

18,391

 

Amortization of intangible assets was $1.0 million and $1.1 million for the three months ended March 31, 2020, and 2019, 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 $524.6 million and $541.9 million as of March 31, 2020 and December 31, 2019, 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 months ended March 31, 2020 and 2019:

 

 

 

 

 

 

 

 

    

Three months ended

 

 

March 31, 

(dollars in thousands)

    

2020

    

2019

Balance, beginning of period

 

$

3,845

 

$

4,623

Additions

 

 

24

 

 

67

Amortization

 

 

(187)

 

 

(165)

(Impairment)/Recovery

 

 

(405)

 

 

 5

Balance, end of period

 

$

3,277

 

$

4,530

 

The following is a summary of key data and assumptions used in the valuation of servicing rights as of March 31, 2020 and December 31, 2019. Increases or decreases in any one of these assumptions would result in lower or higher fair value measurements.

 

 

 

 

 

 

 

 

 

    

March 31, 

    

December 31, 

 

(dollars in thousands)

 

2020

 

2019

 

Fair value of servicing rights

 

$

3,277

 

$

3,845

 

Weighted-average remaining term, years

 

 

20.0

 

 

20.1

 

Prepayment speeds

 

 

14.2

%  

 

11.8

%

Discount rate

 

 

9.4

%  

 

9.4

%

 

 

19

Table of Contents

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. The Company has one existing finance lease for the Company’s headquarters building with a lease term through 2022.

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.

 

 

 

 

 

 

 

 

 

 

    

    

    

March 31, 

 

December 31, 

(dollars in thousands)

 

 

 

2020

 

2019

Lease Right-of-Use Assets

 

Classification

 

 

 

 

 

 

Operating lease right-of-use assets

 

Operating lease right-of-use assets

 

$

7,965

 

$

8,343

Finance lease right-of-use assets

 

Land, premises and equipment, net

 

 

289

 

 

318

Total lease right-of-use assets

 

 

 

$

8,254

 

$

8,661

Lease Liabilities

 

  

 

 

 

 

 

  

Operating lease liabilities

 

Operating lease liabilities

 

$

8,480

 

$

8,864

Finance lease liabilities

 

Long-term debt

 

 

589

 

 

640

Total lease liabilities

 

 

 

$

9,069

 

$

9,504

 

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.

 

 

 

 

 

 

 

 

March 31, 

 

December 31, 

 

 

    

2020

 

2019

 

Weighted-average remaining lease term, years

 

 

 

 

 

Operating leases

 

6.1

 

6.2

 

Finance leases

 

2.6

 

2.8

 

Weighted-average discount rate

 

 

 

  

 

Operating leases

 

3.2

%

3.1

%

Finance leases

 

7.8

%

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.

20

Table of Contents

The following table presents lease costs and other lease information for the three months ending March 31, 2020 and 2019.

 

 

 

 

 

 

 

 

    

Three months ended

 

 

March 31, 

(dollars in thousands)

    

2020

 

2019

Lease costs

 

 

 

 

 

  

Operating lease cost

 

$

623

 

$

572

Variable lease cost

 

 

197

 

 

199

Short-term lease cost

 

 

95

 

 

205

Finance lease cost

 

 

  

 

 

  

Interest on lease liabilities

 

 

12

 

 

15

Amortization of right-of-use assets

 

 

29

 

 

29

Sublease income

 

 

(66)

 

 

(71)

Net lease cost

 

$

890

 

$

949

Other information

 

 

 

 

 

  

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

 

$

618

 

$

577

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

 

 

183

 

 

 —

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 March 31, 2020 were as follows:

 

 

 

 

 

 

 

 

 

Finance

 

Operating

(dollars in thousands)

    

Leases

    

Leases

Twelve months ended

 

 

 

 

 

 

March 31, 2021

 

$

251

 

$

2,037

March 31, 2022

 

 

251

 

 

1,630

March 31, 2023

 

 

150

 

 

1,592

March 31, 2024

 

 

 —

 

 

1,441

March 31, 2025

 

 

 —

 

 

761

Thereafter

 

 

 —

 

 

2,083

Total future minimum lease payments

 

$

652

 

$

9,544

Amounts representing interest

 

 

(63)

 

 

(1,064)

Total operating lease liabilities

 

$

589

 

$

8,480

 

 

NOTE 8 Deposits

The components of deposits in the consolidated balance sheets as of March 31, 2020 and December 31, 2019 were as follows:

 

 

 

 

 

 

 

 

 

March 31, 

 

December 31, 

(dollars in thousands)

    

2020

    

2019

Noninterest-bearing

 

$

608,559

 

$

577,704

Interest-bearing

 

 

  

 

 

  

Interest-bearing demand

 

 

477,752

 

 

458,689

Savings accounts

 

 

60,181

 

 

55,777

Money market savings

 

 

773,652

 

 

683,064

Time deposits

 

 

201,370

 

 

196,082

Total interest-bearing

 

 

1,512,955

 

 

1,393,612

Total deposits

 

$

2,121,514

 

$

1,971,316

 

 

NOTE 9 Short‑Term Borrowings

There were no short‑term borrowings outstanding as of March 31, 2020 and December 31, 2019.

21

Table of Contents

The following table presents information related to short-term borrowings for the three months ending March 31, 2020 and 2019:

 

 

 

 

 

 

 

 

 

 

Three months ended

 

 

March 31, 

(dollars in thousands)

    

2020

    

2019

 

Fed funds purchased

 

 

 

 

 

 

 

Balance as of end of period

 

$

 —

 

$

12,050

 

Average daily balance

 

 

 —

 

 

83,331

 

Maximum month-end balance

 

 

 —

 

 

92,371

 

Weighted-average rate

 

 

 

 

 

 

 

During period

 

 

 —

%

 

2.59

%

End of period

 

 

 —

%

 

2.62

%

 

 

 

NOTE 10 Long‑Term Debt

Long‑term debt as of March 31, 2020 and December 31, 2019 consisted of the following:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

March 31, 2020

 

 

 

 

 

 

 

 

 

 

Period End

 

 

 

 

 

 

Face

 

Carrying

 

 

 

Interest

 

Maturity

 

 

(dollars in thousands)

    

Value

    

Value

    

Interest Rate

    

Rate

    

Date

    

Call Date

Subordinated notes payable

 

$

50,000

 

$

49,641

 

Fixed

 

5.75

%  

12/30/2025

 

12/30/2020

Junior subordinated debenture (Trust I)

 

 

4,124

 

 

3,413

 

Three-month LIBOR + 3.10%

 

4.33

%  

6/26/2033

 

6/26/2008

Junior subordinated debenture (Trust II)

 

 

6,186

 

 

5,119

 

Three-month LIBOR + 1.80%

 

2.54

%  

9/15/2036

 

9/15/2011

Finance lease liability

 

 

2,700

 

 

589

 

Fixed

 

7.81

%  

10/31/2022

 

N/A

Total long-term debt

 

$

63,010

 

$

58,762

 

  

 

  

 

  

 

  

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

December 31, 2019

 

 

 

 

 

 

 

 

 

 

Period End

 

 

 

 

 

 

Face

 

Carrying

 

 

 

Interest

 

Maturity

 

 

(dollars in thousands)

    

Value

    

Value

    

Interest Rate

    

Rate

    

Date

    

Call Date

Subordinated notes payable

 

$

50,000

 

$

49,625

 

Fixed

 

5.75

%  

12/30/2025

 

12/30/2020

Junior subordinated debenture (Trust I)

 

 

4,124

 

 

3,402

 

Three-month LIBOR + 3.10%

 

5.05

%  

6/26/2033

 

6/26/2008

Junior subordinated debenture (Trust II)

 

 

6,186

 

 

5,102

 

Three-month LIBOR + 1.80%

 

3.69

%  

9/15/2036

 

9/15/2011

Finance lease liability

 

 

2,700

 

 

640

 

Fixed

 

7.81

%  

10/31/2022

 

N/A

Total long-term debt

 

$

63,010

 

$

58,769

 

  

 

  

 

  

 

  

 

 

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.

22

Table of Contents

As of March 31, 2020 and December 31, 2019, the following financial instruments whose contract amount represents credit risk were approximately as follows:

 

 

 

 

 

 

 

 

 

March 31, 

    

December 31, 

(dollars in thousands)

    

2020

    

2019

Commitments to extend credit

 

$

524,069

 

$

586,365

Standby letters of credit

 

 

3,276

 

 

8,516

Total

 

$

527,345

 

$

594,881

 

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.

The Company utilizes standby letters of credit issued by either the Federal Home Loan Bank or the Bank of North Dakota to secure public unit deposits. The Company had a $150 thousand letter of credit with the Federal Home Loan Bank as of March 31, 2020 and December 31, 2019.  With the Bank of North Dakota, the Company had $25.0 million of letters of credit outstanding as of March 31, 2020 and $20.0 million as of December 31, 2019. Bank of North Dakota letters of credit were collateralized by loans pledged to the Bank of North Dakota in the amount of $250.3 million and $242.0 million as of March 31, 2020 and December 31, 2019, respectively.

NOTE 12 Share-Based Compensation

The Company has granted equity awards pursuant to the Alerus Financial Corporation 2009 Stock Plan. The awards were 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 has expired.

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 March 31, 2020, 13,444 restricted stock awards and 49,604 restricted stock units had been issued under the plan.

Compensation expense relating to awards under these plans was $253 thousand and $346 thousand for the three months ending March 31, 2020 and 2019, respectively.

23

Table of Contents

The following table presents the activity in the stock plans for the three months ended March 31, 2020 and 2019:

 

 

 

 

 

 

 

 

 

 

 

 

 

Three months ended March 31, 2020

 

Three months ended March 31, 2019

 

 

 

 

Weighted-

 

 

 

Weighted-

 

 

 

    

Average Grant

 

 

 

Average Grant

 

    

Awards

    

Date Fair Value

    

Awards

    

Date Fair Value

Restricted Stock and Restricted Stock Unit Awards

 

 

 

 

 

 

 

 

 

 

Outstanding at beginning of period

 

347,211

 

$

18.64

 

337,014

 

$

18.36

Granted

 

63,048

 

 

20.23

 

70,617

 

 

19.87

Vested

 

(71,339)

 

 

16.06

 

(29,837)

 

 

19.96

Forfeited or cancelled

 

(5,068)

 

 

19.37

 

(753)

 

 

21.76

Outstanding at end of period

 

333,852

 

$

19.47

 

377,041

 

$

18.51

 

As of March 31, 2020, there was $3.7 million of unrecognized compensation expense related to non-vested awards granted under the plans. The expense is expected to be recognized over a weighted-average period of 3.65 years.

 

NOTE 13 Income Taxes

The components of income tax expense (benefit) for the three months ended March 31, 2020 and 2019 are as follows:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Three months ended March 31, 

 

 

 

2020

 

 

2019

 

 

    

 

 

    

Percent of

  

  

 

 

    

Percent of

 

(dollars in thousands)

 

Amount

 

Pretax Income

  

 

Amount

 

Pretax Income

 

Taxes at statutory federal income tax rate

 

$

1,428

 

21.0

 

$

1,777

 

21.0

%

Tax effect of:

 

 

  

 

  

 

 

 

  

 

  

 

Tax exempt interest income

 

 

(121)

 

(1.8)

 

 

(73)

 

(0.9)

%

Other

 

 

130

 

1.9

 

 

320

 

3.8

%

Applicable income taxes

 

$

1,437

 

21.1

 

$

2,024

 

23.9

%

 

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

NOTE 14 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.

The financial information presented for each segment includes 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.

24

Table of Contents

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

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

    

Three months ended March 31, 2020

 

 

 

 

 

Retirement and

 

Wealth

 

 

 

 

Corporate

 

 

 

(dollars in thousands)

    

Banking

    

Benefit Services

    

Management

    

Mortgage

    

Administration

    

Consolidated

Net interest income

 

$

19,446

 

$

 —

 

$

 —

 

$

268

 

$

(877)

 

$

18,837

Provision for loan losses

 

 

2,500

 

 

 —

 

 

 —

 

 

 —

 

 

 —

 

 

2,500

Noninterest income

 

 

1,874

 

 

16,220

 

 

4,046

 

 

5,045

 

 

 4

 

 

27,189

Noninterest expense

 

 

12,652

 

 

7,932

 

 

1,515

 

 

5,439

 

 

9,188

 

 

36,726

Net income before taxes

 

$

6,168

 

$

8,288

 

$

2,531

 

$

(126)

 

$

(10,061)

 

$

6,800

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

    

Three months ended March 31, 2019

 

 

 

 

 

Retirement and

 

Wealth

 

 

 

 

Corporate

 

 

 

(dollars in thousands)

    

Banking

    

Benefit Services

    

Management

    

Mortgage

    

Administration

    

Consolidated

Net interest income

 

$

19,900

 

$

 —

 

$

 —

 

$

129

 

$

(909)

 

$

19,120

Provision for loan losses

 

 

2,220

 

 

 —

 

 

 —

 

 

 —

 

 

 —

 

 

2,220

Noninterest income

 

 

1,831

 

 

15,059

 

 

3,611

 

 

4,569

 

 

 4

 

 

25,074

Noninterest expense

 

 

9,992

 

 

8,990

 

 

1,924

 

 

3,962

 

 

8,646

 

 

33,514

Net income before taxes

 

$

9,519

 

$

6,069

 

$

1,687

 

$

736

 

$

(9,551)

 

$

8,460

Banking

The Banking division offers a complete line of loan, deposit, cash management, and treasury services through fifteen offices  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.

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; payroll and HIRS services for employers. In addition, the division operates within each of the banking markets as well as in Albert Lea, Minnesota, Lansing, Michigan, Bedford, New Hampshire, and 13 satellite offices.

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.

25

Table of Contents

NOTE 15 Earnings Per Share

Beginning in the third quarter of 2019, the Company 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 months ending March 31, 2020 is presented below:

 

 

 

 

 

 

Three months ended

 

 

March 31, 

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

    

2020

Net income

 

$

5,363

Dividends and undistributed earnings allocated to participating securities

 

 

82

Net income available to common shareholders

 

$

5,281

Weighted-average common shares outstanding for basic earnings per share

 

 

17,070

Dilutive effect of stock-based awards

 

 

335

Weighted-average common shares outstanding for diluted earnings per share

 

 

17,405

Earnings per common share:

 

 

 

Basic earnings per common share

 

$

0.31

Diluted earnings per common share

 

$

0.30

 

For the three months ended March 31, 2019, 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 months ended March 31, 2020.

The calculation of basic and diluted earnings per share using the treasury stock method for the three months ending March 31, 2019 is presented below:

 

 

 

 

 

 

Three months ended

 

 

March 31, 

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

    

2019

Basic:

 

 

 

Net income attributable to common shareholders

 

$

6,436

Weighted-average common shares outstanding

 

 

13,781

Basic earnings per common share

 

$

0.47

Diluted:

 

 

 

Net income attributable to common shareholders

 

$

6,436

Weighted-average common shares outstanding

 

 

13,781

Add: Dilutive effect of stock-based awards

 

 

297

Weighted-average common shares outstanding for diluted EPS

 

 

14,078

Diluted earnings per common share

 

$

0.46

 

 

 

26

Table of Contents

NOTE 16 Derivative Instruments

The Company did not have any derivatives designated as hedging instruments, as of March 31, 2020 and December 31, 2019. The following table presents the amounts recorded in the Company’s consolidated balance sheets, for derivatives not designated as hedging instruments, as of March 31, 2020 and December 31, 2019:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

March 31, 2020

 

December 31, 2019

 

 

 

 

Fair

 

Notional

 

Fair

 

Notional

(dollars in thousands)

    

 

    

Value

    

Amount

    

Value

    

Amount

Asset Derivatives

 

Consolidated Balance Sheet Location

 

 

  

 

 

  

 

 

  

 

 

  

Interest rate lock commitments

 

Other assets

 

$

2,543

 

$

147,414

 

$

1,228

 

$

45,715

Forward loan sales commitments

 

Other assets

 

 

1,059

 

 

35,011

 

 

393

 

 

12,784

TBA mortgage backed securities

 

Other assets

 

 

 —

 

 

 —

 

 

 —

 

 

 —

Total asset derivatives

 

  

 

$

3,602

 

$

182,425

 

$

1,621

 

$

58,499

Liability Derivatives

 

  

 

 

  

 

 

  

 

 

  

 

 

  

Interest rate lock commitments

 

Accrued expenses and other liabilities

 

$

 —

 

$

 —

 

$

 —

 

$

 —

Forward loan sales commitments

 

Accrued expenses and other liabilities

 

 

 —

 

 

 —

 

 

 —

 

 

 —

TBA mortgage backed securities

 

Accrued expenses and other liabilities

 

 

2,884

 

 

193,500

 

 

109

 

 

68,500

Total liability derivatives

 

  

 

$

2,884

 

$

193,500

 

$

109

 

$

68,500

 

The gain (loss) recognized on derivative instruments for the three months ended March 31, 2020 and 2019 was as follows:

 

 

 

 

 

 

 

 

 

 

 

 

 

Three months ended

 

 

Consolidated Statements of

 

March 31, 

 

March 31, 

(dollars in thousands)

    

Income Location

    

2020

    

2019

Interest rate lock commitments

 

Mortgage banking

 

$

1,227

 

$

1,789

Forward loan sales commitments

 

Mortgage banking

 

 

666

 

 

246

TBA mortgage backed securities

 

Mortgage banking

 

 

(3,423)

 

 

(454)

Total gain/(loss) from derivative instruments

 

 

 

$

(1,530)

 

$

1,581

 

 

NOTE 17 Regulatory Matters

The Company and the Bank are 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 consolidated financial statements.

Quantitative measures established by regulation to ensure capital adequacy require the Company and 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 at March 31, 2020 and December 31, 2019,  each of the Company and the Bank had met all of the capital adequacy requirements to which it is subject.

27

Table of Contents

The following table presents the Company’s and  the Bank’s actual capital amounts and ratios as of March 31, 2020 and December 31, 2019:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

March 31, 2020

 

 

 

 

 

 

 

 

 

 

 

 

 

 

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

 

$

243,448

 

12.36

%  

$

88,643

 

4.50

%  

$

N/A

 

N/A

 

Bank

 

 

232,162

 

11.80

%  

 

88,567

 

4.50

%  

 

127,930

 

6.50

%

Tier 1 capital to risk weighted assets

 

 

  

 

 

 

 

  

 

  

 

 

.

 

  

 

Consolidated

 

 

251,671

 

12.78

%  

 

118,190

 

6.00

%  

 

N/A

 

N/A

 

Bank

 

 

232,162

 

11.80

%  

 

118,089

 

6.00

%  

 

157,452

 

8.00

%

Total capital to risk weighted assets

 

 

  

 

  

 

 

  

 

  

 

 

  

 

  

 

Consolidated

 

 

325,964

 

16.55

%  

 

157,587

 

8.00

%  

 

N/A

 

N/A

 

Bank

 

 

256,793

 

13.05

%  

 

157,452

 

8.00

%  

 

196,815

 

10.00

%

Tier 1 capital to average assets

 

 

  

 

  

 

 

  

 

  

 

 

  

 

  

 

Consolidated

 

 

251,671

 

10.62

%  

 

94,826

 

4.00

%  

 

N/A

 

N/A

 

Bank

 

 

232,162

 

9.80

%  

 

94,752

 

4.00

%  

 

118,440

 

5.00

%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

December 31, 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

 

$

239,672

 

12.48

%  

$

86,452

 

4.50

%  

$

N/A

 

N/A

 

Bank

 

 

228,512

 

11.91

%  

 

86,362

 

4.50

%  

 

124,745

 

6.50

%

Tier 1 capital to risk weighted assets

 

 

  

 

 

 

 

  

 

  

 

 

.

 

  

 

Consolidated

 

 

247,866

 

12.90

%  

 

115,270

 

6.00

%  

 

N/A

 

N/A

 

Bank

 

 

228,512

 

11.91

%  

 

115,149

 

6.00

%  

 

153,532

 

8.00

%

Total capital to risk weighted assets

 

 

  

 

  

 

 

  

 

  

 

 

  

 

  

 

Consolidated

 

 

321,415

 

16.73

%  

 

153,693

 

8.00

%  

 

N/A

 

N/A

 

Bank

 

 

252,436

 

13.15

%  

 

153,532

 

8.00

%  

 

191,915

 

10.00

%

Tier 1 capital to average assets

 

 

  

 

  

 

 

  

 

  

 

 

  

 

  

 

Consolidated

 

 

247,866

 

11.05

%  

 

91,504

 

4.00

%  

 

N/A

 

N/A

 

Bank

 

 

228,512

 

10.20

%  

 

89,615

 

4.00

%  

 

112,018

 

5.00

%

 

The Bank is subject to certain restrictions on the amount of dividends that it may pay without prior regulatory approval. The Company and the Bank are subject to the rules of the Basel III regulatory capital framework and related Dodd-Frank Wall Street Reform and Consumer Protection Act rules. The rules included the implementation of a 2.5 percent capital conservation buffer that is added to the minimum requirements for capital adequacy purposes. A banking organization with a conservation buffer of less than the required amount will be subject to the limitations on capital distributions, including dividend payments and certain discretionary bonus payments to executive officers. At March 31, 2020, the ratios for the Company and the Bank were sufficient to meet the conservation buffer. In addition, the Company must adhere to various U.S. Department of Housing and Urban Development, or 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 March 31, 2020, and December 31, 2019, the Company was in compliance with HUD guidelines.

NOTE 18 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

28

Table of Contents

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.

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 March 31, 2020 and December 31, 2019:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

    

March 31, 2020

(dollars in thousands)

    

Level 1

    

Level 2

    

Level 3

    

Total

Available-for-sale and equity securities

 

 

  

 

 

  

 

 

  

 

 

  

U.S. treasury and government agencies

 

$

 —

 

$

16,627

 

$

 —

 

$

16,627

Obligations of state and political agencies

 

 

 —

 

 

69,106

 

 

 —

 

 

69,106

Mortgage backed securities

 

 

  

 

 

  

 

 

  

 

 

  

Residential agency

 

 

 —

 

 

229,309

 

 

 —

 

 

229,309

Commercial

 

 

 —

 

 

29,910

 

 

 —

 

 

29,910

Asset backed securities

 

 

 —

 

 

141

 

 

 —

 

 

141

Corporate bonds

 

 

 —

 

 

9,056

 

 

 —

 

 

9,056

Total available-for-sale securities

 

$

 —

 

$

354,149

 

$

 —

 

$

354,149

Other assets

 

 

  

 

 

  

 

 

  

 

 

  

Derivatives

 

$

 —

 

$

3,602

 

$

 —

 

$

3,602

Other liabilities

 

 

  

 

 

  

 

 

  

 

 

  

Derivatives

 

$

 —

 

$

2,884

 

$

 —

 

$

2,884

 

29

Table of Contents

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

December 31, 2019

(dollars in thousands)

    

Level 1

    

Level 2

    

Level 3

    

Total

Available-for-sale and equity securities

 

 

  

 

 

  

 

 

  

 

 

  

U.S. treasury and government agencies

 

$

 —

 

$

21,240

 

$

 —

 

$

21,240

Obligations of state and political agencies

 

 

 —

 

 

68,648

 

 

 —

 

 

68,648

Mortgage backed securities

 

 

  

 

 

  

 

 

  

 

 

  

Residential agency

 

 

 —

 

 

182,538

 

 

 —

 

 

182,538

Commercial

 

 

 —

 

 

30,685

 

 

 —

 

 

30,685

Asset backed securities

 

 

 —

 

 

144

 

 

 —

 

 

144

Corporate bonds

 

 

 —

 

 

7,095

 

 

 —

 

 

7,095

Equity securities

 

 

2,808

 

 

 —

 

 

 —

 

 

2,808

Total available-for-sale and equity securities

 

$

2,808

 

$

310,350

 

$

 —

 

$

313,158

Other assets

 

 

  

 

 

  

 

 

  

 

 

  

Derivatives

 

$

 —

 

$

1,621

 

$

 —

 

$

1,621

Other liabilities

 

 

  

 

 

  

 

 

  

 

 

  

Derivatives

 

$

 —

 

$

109

 

$

 —

 

$

109

 

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.

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.

30

Table of Contents

Net impairment related to nonrecurring estimated fair value measurements of certain assets as of March 31, 2020 and December 31, 2019 consisted of the following:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

March 31, 2020

(dollars in thousands)

    

Level 2

    

Level 3

    

Total

    

Impairment

Loans held for sale

 

$

72,258

 

$

 —

 

$

72,258

 

$

 —

Impaired loans

 

 

 —

 

 

4,876

 

 

4,876

 

 

3,066

Foreclosed assets

 

 

 —

 

 

209

 

 

209

 

 

 —

Servicing rights

 

 

 —

 

 

3,277

 

 

3,277

 

 

 —

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

December 31, 2019

(dollars in thousands)

    

Level 2

    

Level 3

    

Total

    

Impairment

Loans held for sale

 

$

46,846

 

$

 —

 

$

46,846

 

$

 —

Impaired loans

 

 

 —

 

 

4,816

 

 

4,816

 

 

3,138

Foreclosed assets

 

 

 —

 

 

 8

 

 

 8

 

 

 —

Servicing rights

 

 

 —

 

 

3,845

 

 

3,845

 

 

 —

 

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.

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

31

Table of Contents

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.

The valuation techniques and significant unobservable inputs used to measure Level 3 estimated fair values as of March 31, 2020, and December 31, 2019, were as follows:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

March 31, 2020

 

(dollars in thousands)

 

 

 

 

 

 

 

 

 

Weighted

 

Asset Type

    

Valuation Technique

    

Unobservable Input

Fair Value

    

Range

    

Average

  

Impaired loans

 

Appraisal value

 

Property specific adjustment

$

4,876

 

N/A

 

N/A

 

Foreclosed assets

 

Appraisal value

 

Property specific adjustment

 

209

 

N/A

 

N/A

 

Servicing rights

 

Discounted cash flows

 

Prepayment speed assumptions

 

3,277

 

158-471

 

237

 

 

 

  

 

Discount rate

 

  

 

9.4

%  

9.4

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

December 31, 2019

 

(dollars in thousands)

 

 

 

 

 

 

 

 

 

Weighted

 

Asset Type

    

Valuation Technique

    

Unobservable Input

Fair Value

    

Range

    

Average

 

Impaired loans

 

Appraisal value

 

Property specific adjustment

$

4,816

 

N/A

 

N/A

 

Foreclosed assets

 

Appraisal value

 

Property specific adjustment

 

 8

 

N/A

 

N/A

 

Servicing rights

 

Discounted cash flows

 

Prepayment speed assumptions

 

3,845

 

123-267

 

194

 

 

 

  

 

Discount rate

 

  

 

9.4

%  

9.4

%

 

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 March 31, 2020 and December 31, 2019, 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.

32

Table of Contents

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.

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.

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:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

March 31, 2020

 

 

Carrying

 

Estimated Fair Value

(dollars in thousands)

    

Amount

    

Level 1

    

Level 2

    

Level 3

    

Total

Financial Assets

 

 

  

 

 

  

 

 

  

 

 

  

 

 

  

Cash and cash equivalents

 

$

198,489

 

$

198,489

 

$

 —

 

$

 —

 

$

198,489

Loans

 

 

1,731,258

 

 

 —

 

 

 —

 

 

1,761,783

 

 

1,761,783

Accrued interest receivable

 

 

7,425

 

 

7,425

 

 

 —

 

 

 —

 

 

7,425

Bank-owned life insurance

 

 

31,763

 

 

 —

 

 

31,763

 

 

 —

 

 

31,763

Financial Liabilities

 

 

  

 

 

  

 

 

  

 

 

  

 

 

  

Noninterest-bearing deposits

 

$

608,559

 

$

 —

 

$

608,559

 

$

 —

 

$

608,559

Interest-bearing deposits

 

 

1,311,585

 

 

 —

 

 

1,311,585

 

 

 —

 

 

1,311,585

Time deposits

 

 

201,370

 

 

 —

 

 

 —

 

 

202,892

 

 

202,892

Long-term debt

 

 

58,762

 

 

 —

 

 

57,941

 

 

 —

 

 

57,941

Accrued interest payable

 

 

1,760

 

 

1,760

 

 

 —

 

 

 —

 

 

1,760

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

December 31, 2019

 

 

Carrying

 

Estimated Fair Value

(dollars in thousands)

    

Amount

    

Level 1

    

Level 2

    

Level 3

    

Total

Financial Assets

 

 

  

 

 

  

 

 

  

 

 

  

 

 

  

Cash and cash equivalents

 

$

144,006

 

$

144,006

 

$

 —

 

$

 —

 

$

144,006

Loans

 

 

1,697,355

 

 

 —

 

 

 —

 

 

1,693,824

 

 

1,693,824

Accrued interest receivable

 

 

7,551

 

 

7,551

 

 

 —

 

 

 —

 

 

7,551

Bank-owned life insurance

 

 

31,566

 

 

 —

 

 

31,566

 

 

 —

 

 

31,566

Financial Liabilities

 

 

  

 

 

  

 

 

  

 

 

  

 

 

  

Noninterest-bearing deposits

 

$

577,704

 

$

 —

 

$

577,704

 

$

 —

 

$

577,704

Interest-bearing deposits

 

 

1,197,530

 

 

 —

 

 

1,197,530

 

 

 —

 

 

1,197,530

Time deposits

 

 

196,082

 

 

 —

 

 

 —

 

 

196,182

 

 

196,182

Long-term debt

 

 

58,769

 

 

 —

 

 

58,239

 

 

 —

 

 

58,239

Accrued interest payable

 

 

1,038

 

 

1,038

 

 

 —

 

 

 —

 

 

1,038

 

33

Table of Contents

 

 

NOTE 19 Subsequent Events

On March 27, 2020, President Trump signed into Law the Coronavirus Aid Relief and Economic Security Act, or CARES Act, which establishes a $2.0 trillion economic stimulus package, including cash payments to individuals, supplemental unemployment insurance benefits and a $349 billion loan program administered through the U.S. Small Business Administration, or SBA, referred to as the paycheck protection program, or PPP. Under the PPP, small businesses, sole proprietorships, independent contractors, and self-employed individuals may apply for loans from existing SBA lenders and other approved regulated lenders that enroll in the program, subject to numerous limitations and eligibility criteria. The Bank is participating as a lender in the PPP. In addition, the CARES Act provides financial institutions the option to temporarily suspend certain requirements under GAAP related to TDRs for a limited period of time to account for the effects of COVID-19. See “Note 4 Loans and Allowance for Loan Losses” for additional discussion regarding TDRs.

On April 2, 2020, the SBA issued an interim final rule, announcing the implementation of sections 1102 and 1106 of the CARES Act. Section 1102 of the CARES Act temporarily added a new program, the PPP, to the SBA’s 7(a) Loan Program. Section 1106 of the CARES Act provides for forgiveness of up to the full principal amount of qualifying loans guaranteed under the PPP. The PPP and loan forgiveness are intended to provide economic relief to small businesses nationwide adversely impacted by COVID-19.

As an SBA-Certified Preferred lender we were delegated the authority as part of the CARES Act to make PPP SBA-guaranteed financing available to eligible borrowers. As of April 21, 2020, we had assisted over 900 new and existing clients secure approximately $300 million of PPP financing. The SBA will pay a processing fee based on the balance of the financing outstanding at the time of final disbursement. The processing fees will be as follows: five percent for loans of not more than $350 thousand, three percent for loans of more than $350 thousand and less than $2 million, and one percent for loans of at least $2 million. We currently expect to receive approximately $8.9 million in net processing fees which will be deferred and recognized as interest income on a level yield method over the life of the respective loans.

On April 7, 2020, the Board of Governors of the Federal Reserve System, or FRB, authorized each of the Federal Reserve Banks to establish the Payment Protection Program Lending Facility, or PPPL Facility, pursuant to section 13(3) of the Federal Reserve Act. Under the PPPL Facility, each of the Federal Reserve Banks will extend non-recourse loans to eligible financial institutions to fund loans guaranteed by the SBA under the PPP established by the CARES Act.

On April 15, 2020, we executed a PPPL Facility Agreement with the Federal Reserve Bank of Minneapolis. The PPP loans guaranteed by the SBA are eligible to serve as collateral for the PPPL Facility. The PPPL Facility will provide us with additional liquidity to facilitate lending to small businesses under the PPP.

 

 

34

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 months ended March  31, 2020 and 2019.  Annualized results for this interim period may not be indicative of results for the full year or future periods. 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 Annual Report on Form 10-K for the year ended December 31, 2019, filed with the Securities and Exchange Commission on March 26, 2020.

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:

·

the effects of the COVID-19 pandemic, including its potential effects on the economic environment, our clients and our operations, as well as any changes to federal, state, or local government laws, regulations, or orders in connections with the pandemic;

·

our ability to successfully manage credit risk and maintain an adequate level of allowance for loan losses;

·

new or revised accounting standards, including as a result of the future implementation of the new Current Expected Credit Loss standard;

·

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;

35

Table of Contents

·

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;

·

our ability to manage mortgage pipeline risk;

·

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;

·

severe weather, natural disasters, widespread disease or pandemics, such as the COVID-19 pandemic, acts of war or terrorism, or other adverse external events;

·

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.

36

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, or 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, or GAAP.  The preparation of our consolidated financial statements requires management to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses. These estimates are based upon historical experience and on various other assumptions that management believes are reasonable under current circumstances. These estimates form the basis for making judgments about the carrying value of certain assets and liabilities that are not readily available from other sources. Actual results may differ from these estimates under different assumptions or conditions. The estimates and judgments that management believes have the most effect on the Company’s reported financial position and results of operations are set forth in Note 1 – Significant Accounting Policies of the Notes to the Consolidated Statements,  included in our Annual Report on Form 10-K for the year ended December 31, 2019. There have been no significant changes in critical accounting policies or the assumptions and judgments utilized in applying these policies since December 31, 2019.

The JOBS Act permits the Company an extended transition period for complying with new or revised accounting standards affecting public companies. The Company has elected to take advantage of this extended transition period, which means that the financial statements included in this report, as well as any financial statements filed in the future, will not be subject to all new or revised accounting standards generally applicable to public companies for the transition period for so long as the Company remains an emerging growth company or until the Company affirmatively and irrevocably opts out of the extended transition period under the JOBS Act.

Recent Developments

Impact of COVID-19.

The progression of the COVID-19 pandemic in the United States began to have an adverse impact on our financial condition and results of operations as of and for the three months ended March 31, 2020, and is expected to have a complex and significant adverse impact on the economy, the banking industry and our company in future fiscal periods, all subject to a high degree of uncertainty.

Effects on Our Market Areas. Our primary banking market areas are the states of North Dakota, Minnesota, and Arizona. Our retirement and benefit services business serves clients in all 50 states. We offer retirement and benefit services at all of our banking offices located in our three primary market areas. In addition, we operate two retirement and benefits services offices in Minnesota, two in Michigan and one in New Hampshire.

37

Table of Contents

 In Minnesota, the Governor recently ordered individuals to stay at home and non-essential businesses to cease all activities, in each case subject to limited exceptions. This order went into effect on March 28, 2020, and is currently effective through May 4, 2020. Similarly, in Arizona, the Governor recently ordered individuals to stay at home and non-essential businesses to cease all activities, in each case subject to limited exceptions. This order went into effect on March 31, 2020, and is currently effective through April 30, 2020. In North Dakota, the Governor has not issued an order requiring individuals to stay at home, but has recently placed certain restrictions on bars, restaurants and gyms. In response to these orders, the Bank has been serving its customers through its drive-up windows at various branch locations and through online and mobile banking. The Bank is also permitting certain visits to its branches on a limited basis and by appointment only.

Each state has experienced a dramatic and sudden increase in unemployment levels as a result of the curtailment of business activities. According to data released by the U.S. Department of Labor, initial claims for unemployment insurance have spiked in recent weeks in each of the states in our banking markets, a trend we expect to continue for the foreseeable future until the stay-at-home orders are lifted. To date, many of the public health and economic effects of COVID-19 have been concentrated in the largest U.S. cities, such as New York, but we anticipate that similar effects will occur on a more delayed basis in smaller cities and communities, where many our banking operations are focused.

Policy and Regulatory Developments. Federal, state and local governments and regulatory authorities have enacted and issued a range of policy responses to the COVID-19 pandemic, including the following:

·

The Federal Reserve decreased the range for the Federal Funds Target Rate by 0.50% on March 3, 2020, and by another 1.0% on March 16, 2020, reaching a current range of 0.0 – 0.25%.

·

On March 27, 2020, President Trump signed into law the Coronavirus Aid, Relief and Economic Security Act, or CARES Act, which established a $2.0 trillion economic stimulus package, including cash payments to individuals, supplemental unemployment insurance benefits and a $349 billion loan program administered through the U.S. Small Business Administration, or SBA, referred to as the paycheck protection program, or PPP. Under the PPP, small businesses, sole proprietorships, independent contractors and self-employed individuals may apply for loans from existing SBA lenders and other approved regulated lenders that enroll in the program, subject to numerous limitations and eligibility criteria. The Bank is participating as a lender in the PPP.  On or about April 16, 2020, the SBA notified lenders that the $349 billion earmarked for the PPP was exhausted. On April 24, 2020, an additional $310 billion in funding for PPP loans was authorized, with such funds available for PPP loans beginning on April 27, 2020. In addition, the CARES Act provides financial institutions the option to temporarily suspend certain requirements under GAAP related to TDRs for a limited period of time to account for the effects of COVID-19. See “NOTE 4 Loans and Allowance for Loan Losses” for additional discussion regarding TDRs.

·

On April 7, 2020, federal banking regulators issued a revised Interagency Statement on Loan Modifications and Reporting for Financial Institutions, which, among other things, encouraged financial institutions to work prudently with borrowers who are or may be unable to meet their contractual payment obligations because of the effects of COVID-19, and stated that institutions generally do not need to categorize COVID-19-related modifications as TDRs and that the agencies will not direct supervised institutions to automatically categorize all COVID-19 related loan modifications as TDRs. See “NOTE 4 Loans and Allowance for Loan Losses” for additional discussion regarding TDRs.

·

On April 9, 2020, the Federal Reserve announced additional measures aimed at supporting small and midsized business, as well as state and local governments impacted by COVID-19. The Federal Reserve announced the Main Street Business Lending Program, which establishes two new loan facilities intended to facilitate lending to small and midsized businesses: (1) the Main Street New Loan Facility, or MSNLF, and (2) the Main Street Expanded Loan Facility, or MSELF. MSNLF loans are unsecured term loans originated on or after April 8, 2020, while MSELF loans are provided as upsized tranches of existing loans originated before April 8, 2020. The combined size of the program will be up to $600 billion. The program

38

Table of Contents

is designed for businesses with up to 10,000 employees or $2.5 billion in 2019 revenues. To obtain a loan, borrowers must confirm that they are seeking financial support because of COVID-19 and that they will not use proceeds from the loan to pay off debt. The Federal Reserve also stated that it would provide additional funding to banks offering PPP loans to struggling small businesses. Lenders participating in the PPP will be able to exclude loans financed by the facility from their leverage ratio. In addition, the Federal Reserve created a Municipal Liquidity Facility to support state and local governments with up to $500 billion in lending, with the Treasury Department backing $35 billion for the facility using funds appropriated by the CARES Act. The facility will make short-term financing available to cities with a population of more than one million or counties with a population of greater than two million. The Federal Reserve expanded both the size and scope its Primary and Secondary Market Corporate Credit Facilities to support up to $750 billion in credit to corporate debt issuers. This will allow companies that were investment grade before the onset of COVID-19 but then subsequently downgraded after March 22, 2020 to gain access to the facility. Finally, the Federal Reserve announced that its Term Asset-Backed Securities Loan Facility will be scaled up in scope to include the triple A-rated tranche of commercial mortgage-backed securities and newly issued collateralized loan obligations. The size of the facility is $100 billion.

Effects on Our Business. We currently expect that the COVID-19 pandemic and the specific developments referred to above will have a significant impact on our business. In particular, we anticipate that a significant portion of the Bank’s borrowers in the retail, restaurants, and hospitality industries will continue to endure significant economic distress, which has caused, and will continue to cause, them to draw on their existing lines of credit and could adversely affect their ability and willingness to repay existing indebtedness, and is expected to adversely impact the value of collateral. These developments, together with economic conditions generally, are also expected to impact our commercial real estate portfolio, particularly with respect to real estate with exposure to these industries, our consumer loan business and loan portfolio, and the value of certain collateral securing our loans. In addition, we expect to see decreases in our total assets under administration and assets under management and a decrease in mortgage loan originations. As a result, we anticipate that our financial condition, capital levels and results of operations will be significantly adversely affected, as described in this Management’s Discussion and Analysis of Financial Condition and Results of Operations.

Our Response. We have taken numerous steps in response to the COVID-19 pandemic, including the following:

·

In response to the COVID-19 pandemic and business disruption, first and foremost, we have prioritized the safety, health and well-being of our employees, clients and communities. We have implemented a work from home policy and have closed our offices. We continue to serve clients through our drive-up locations and digital platforms.

·

We are offering payment deferrals and interest only payment options for consumer, small business, and commercial customers for up to 90 days. We are offering payment extensions for mortgage customers for up to 90 days.

·

The Business Continuity Planning COVID-19 Response team and Alerus leadership teams meet regularly to manage the Company’s response to the pandemic and the effect on our business. In addition, cross functional task force teams meet as needed to address specific issues such as employee and client communications, facilities, and branch services. The Risk Committee of the Board meets regularly with management to receive updates on the Company’s response and discuss the effect on our business.

·

We are participating in the SBA’s PPP.  As of April 21, 2020, we had assisted over 900 borrowers receive approval for funding of approximately $300 million in PPP loans.  We expect to continue participation should additional funding for the program be made available.

·

In addition, as disclosed in our Annual Report on Form 10-K for the year ended December 31, 2019, we will not be permitted to make capital distributions (including dividends and repurchases of stock) or pay discretionary bonuses to executive officers without restriction if we do not maintain 2.5% in Common Equity Tier 1 Capital attributable to a capital conservation buffer.

39

Table of Contents

Shareholder Dividend

On February 19, 2020, the Company’s Board of Directors declared a quarterly cash dividend of $0.15 per share. This dividend was paid out on April  10, 2020, to stockholders of record at the close of business on March 20, 2020. It is the expectation and current intent of the Board of Directors to continue with a quarterly cash dividend.

Operating Results Overview

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

 

 

 

 

 

 

 

 

 

 

 

 

 

Three months ended

 

 

 

March 31, 

 

December 31, 

 

March 31, 

 

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

    

2020

 

2019

 

2019

 

Performance Ratios

 

 

 

 

 

 

 

 

 

 

Return on average total assets

 

 

0.89

%  

 

1.33

%  

 

1.20

%  

Return on average common equity

 

 

7.32

%  

 

10.65

%  

 

13.06

%  

Return on average tangible common equity (1)

 

 

9.76

%  

 

13.78

%  

 

18.99

%  

Noninterest income as a % of revenue

 

 

59.07

%  

 

61.56

%  

 

56.74

%  

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

 

 

3.35

%  

 

3.45

%  

 

3.86

%  

Efficiency ratio (1)

 

 

77.47

%  

 

73.68

%  

 

73.30

%  

Net charge-offs/(recoveries) to average loans

 

 

(0.14)

%  

 

0.20

%  

 

0.41

%  

Dividend payout ratio

 

 

50.00

%  

 

34.88

%  

 

30.43

%  

Per Common Share

 

 

 

 

 

 

 

 

 

 

Earnings per common share - basic

 

$

0.31

 

$

0.44

 

$

0.47

 

Earnings per common share - diluted

 

$

0.30

 

$

0.43

 

$

0.46

 

Dividends declared per common share

 

$

0.15

 

$

0.15

 

$

0.14

 

Tangible book value per common share (1)

 

$

14.55

 

$

14.08

 

$

11.25

 

Average common shares outstanding - basic

 

 

17,070

 

 

17,049

 

 

13,781

 

Average common shares outstanding - diluted

 

 

17,405

 

 

17,397

 

 

14,078

 

Other Data

 

 

 

 

 

 

 

 

 

 

Retirement and benefit services assets under administration/management

 

$

27,718,026

 

$

31,904,648

 

$

29,760,820

 

Wealth management assets under administration/management

 

 

2,746,052

 

 

3,103,056

 

 

2,721,328

 

Mortgage originations

 

 

228,568

 

 

261,263

 

 

125,536

 


(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

 

 

March 31, 

 

December 31, 

 

March 31, 

(dollars in thousands)

    

2020

 

2019

 

2019

Selected Average Balance Sheet Data

 

 

 

 

 

 

 

 

 

Loans

 

$

1,731,593

 

$

1,681,311

 

$

1,731,708

Investment securities

 

 

337,160

 

 

296,773

 

 

254,613

Assets

 

 

2,419,665

 

 

2,289,520

 

 

2,179,982

Deposits

 

 

2,026,261

 

 

1,896,804

 

 

1,799,004

Short-term borrowings

 

 

 —

 

 

 —

 

 

83,331

Long-term debt

 

 

58,755

 

 

58,760

 

 

58,811

Stockholders’ equity

 

 

294,727

 

 

285,017

 

 

199,854

 

40

Table of Contents

 

 

 

 

 

 

 

 

 

 

 

 

March 31, 

 

December 31, 

 

March 31, 

(dollars in thousands)

    

2020

 

2019

 

2019

Selected Period End Balance Sheet Data

 

 

 

 

 

 

 

 

 

Loans

 

$

1,758,277

 

$

1,721,279

 

$

1,713,792

Allowance for loan losses

 

 

(27,019)

 

 

(23,924)

 

 

(22,638)

Investment securities

 

 

354,149

 

 

313,158

 

 

258,817

Assets

 

 

2,512,078

 

 

2,356,878

 

 

2,213,758

Deposits

 

 

2,121,514

 

 

1,971,316

 

 

1,882,270

Long-term debt

 

 

58,762

 

 

58,769

 

 

58,823

Total stockholders’ equity

 

 

293,608

 

 

285,728

 

 

203,949

 

 

 

 

 

 

 

 

 

 

 

 

 

Three months ended

 

 

March 31, 

 

December 31, 

 

March 31, 

(dollars in thousands)

    

2020

 

2019

 

2019

Selected Income Statement Data

 

 

 

 

 

 

 

 

 

Net interest income

 

$

18,837

 

$

18,459

 

$

19,120

Provision for loan losses

 

 

2,500

 

 

1,797

 

 

2,220

Noninterest income

 

 

27,189

 

 

29,556

 

 

25,074

Noninterest expense

 

 

36,726

 

 

36,435

 

 

33,514

Income before income taxes

 

 

6,800

 

 

9,783

 

 

8,460

Income tax expense

 

 

1,437

 

 

2,131

 

 

2,024

Net income

 

$

5,363

 

$

7,652

 

$

6,436

 

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 book value per common 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 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.

41

Table of Contents

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.

 

 

 

 

 

 

 

 

 

 

 

 

    

March 31, 

 

December 31, 

 

March 31, 

 

 

    

2020

    

2019

    

2019

    

Tangible common equity to tangible assets

 

 

  

 

 

 

 

 

 

 

Total common stockholders’ equity

 

$

293,608

 

$

285,728

 

$

203,949

 

Less: Goodwill

 

 

27,329

 

 

27,329

 

 

27,329

 

Less: Other intangible assets

 

 

17,401

 

 

18,391

 

 

21,422

 

Tangible common equity (a)

 

 

248,878

 

 

240,008

 

 

155,198

 

Total assets

 

 

2,512,078

 

 

2,356,878

 

 

2,213,758

 

Less: Goodwill

 

 

27,329

 

 

27,329

 

 

27,329

 

Less: Other intangible assets

 

 

17,401

 

 

18,391

 

 

21,422

 

Tangible assets (b)

 

 

2,467,348

 

 

2,311,158

 

 

2,165,007

 

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

 

 

10.09

%  

 

10.38

%  

 

7.17

%  

Tangible book value per common share

 

 

 

 

 

 

 

 

 

 

Total common stockholders’ equity

 

$

293,608

 

$

285,728

 

$

203,949

 

Less: Goodwill

 

 

27,329

 

 

27,329

 

 

27,329

 

Less: Other intangible assets

 

 

17,401

 

 

18,391

 

 

21,422

 

Tangible common equity (c)

 

 

248,878

 

 

240,008

 

 

155,198

 

Total common shares issued and outstanding (d)

 

 

17,106

 

 

17,050

 

 

13,801

 

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

 

$

14.55

 

$

14.08

 

$

11.25

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Three months ended

 

 

 

March 31, 

 

December 31, 

 

March 31, 

 

 

    

2020

    

2019

    

2019

    

Return on average tangible common equity

 

 

 

 

 

 

 

 

 

 

Net income

 

$

5,363

 

$

7,652

 

$

6,436

 

Add: Intangible amortization expense (net of tax)

 

 

782

 

 

782

 

 

830

 

Net income, excluding intangible amortization (e)

 

 

6,145

 

 

8,434

 

 

7,266

 

Average total equity

 

 

294,727

 

 

285,017

 

 

199,854

 

Less: Average goodwill

 

 

27,329

 

 

27,329

 

 

27,329

 

Less: Average other intangible assets (net of tax)

 

 

14,128

 

 

14,912

 

 

17,329

 

Average tangible common equity (f)

 

 

253,270

 

 

242,776

 

 

155,196

 

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

 

 

9.76

%  

 

13.78

%  

 

18.99

%  

Net interest margin (tax-equivalent)

 

 

 

 

 

 

 

 

 

 

Net interest income

 

$

18,837

 

$

18,459

 

$

19,120

 

Tax-equivalent adjustment

 

 

100

 

 

89

 

 

92

 

Tax-equivalent net interest income (g)

 

 

18,937

 

 

18,548

 

 

19,212

 

Average earning assets (h)

 

 

2,271,004

 

 

2,135,682

 

 

2,019,666

 

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

 

 

3.35

%  

 

3.45

%  

 

3.86

%  

Efficiency ratio

 

 

 

 

 

 

 

 

 

 

Noninterest expense

 

$

36,726

 

$

36,435

 

$

33,514

 

Less: Intangible amortization expense

 

 

990

 

 

990

 

 

1,051

 

Adjusted noninterest expense (i)

 

 

35,736

 

 

35,445

 

 

32,463

 

Net interest income

 

 

18,837

 

 

18,459

 

 

19,120

 

Noninterest income

 

 

27,189

 

 

29,556

 

 

25,074

 

Tax-equivalent adjustment

 

 

100

 

 

89

 

 

92

 

Total tax-equivalent revenue (j)

 

 

46,126

 

 

48,104

 

 

44,286

 

Efficiency ratio (i)/(j)

 

 

77.47

%  

 

73.68

%  

 

73.30

%  

 

42

Table of Contents

Discussion and Analysis of Results of Operations

Net Income

Net income for the three months ended March 31, 2020 was $5.4 million, or $0.30 per diluted common share, compared to $6.4 million, or $0.46 per diluted common share, for the three months ended March 31, 2019. The decrease of $1.1 million in net income was primarily due to an increase of $3.2 million in noninterest expense, a $283 thousand decrease in net interest income and a $280 thousand increase in provision for loan losses partially offset by an increase of $2.1 million in noninterest income. The increase in noninterest expense was primarily attributable to increases in compensation expense, business services, software and technology expense, and mortgage and lending expense. The increase in noninterest income was primarily attributable to organic growth in retirement and benefit services, mortgage banking, and wealth management.

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 months ended March 31, 2020 and 2019.

Net interest income for the three months ended March 31, 2020 was  $18.8 million, a decrease of $283 thousand from $19.1 million for the three months ended March 31, 2019. The three months ended March 31, 2020 included a $204 thousand decrease in interest income and a $79 thousand increase in interest expense, compared to the same period in 2019. The decrease in interest income was primarily driven by a decrease of $1.0 million in interest and fees on loans, whereas the increase in interest expense was primarily driven by an increase of $644 thousand in deposit interest expense partially offset by a $531 thousand decrease in interest expense on short-term borrowings. The decrease in interest and fees on loans for the three months ended March 31, 2020, compared to the same period 2019 was driven primarily by a 31 basis point reduction in average yield earned on loans. The increase in deposit interest expense for the three months ended March 31, 2020, was primarily due to a $172.5 million increase in average interest-bearing deposit balances and a 7 basis point increase in average rates paid on interest-bearings deposits.

Our net interest margin (on a fully tax-equivalent, or FTE, basis) for the three months ended March 31, 2020 was 3.35%, compared to 3.86% for the same period in 2019.  The decrease in net interest margin from the first quarter of 2019 was due to a 59 basis point lower average earning asset yield and a $172.5 million increase in the average balance of interest-bearing deposits. In addition, the average yield on loans fell from 5.03% in the first quarter of 2019 to 4.72% in the first quarter of 2020 and the average rate on total interest-bearing liabilities decreased 6 basis points to 1.13% in the first quarter of 2020.

In response to the COVID-19 pandemic, the Federal Reserve decreased the targeted federal funds rate by a total of 150 basis points in March 2020. This decrease impacts the comparability of net interest income between 2019 and 2020. We anticipate that our interest income will be significantly adversely affected in future periods as a result of the COVID-19 pandemic, including as a result of decreases in the size of our loan portfolio and the effects of lower interest rates.

As a result of the recent reductions in the target federal funds interest rate, as well as the impact of the COVID-19 pandemic and related future loan charge-offs that we expect to incur, we expect that our net interest income and net interest margin FTE will decrease significantly in future periods. These decreases will be offset by the processing fees received from PPP financing. The processing fees will be deferred and recognized as an adjustment to interest income over the life of the loans.

43

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 months ended March 31, 2020 and 2019. 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 March 31, 

 

 

 

2020

 

2019

 

 

   

 

 

   

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

 

$

163,351

 

$

502

 

1.24

%

$

11,237

 

$

69

 

2.49

%

Investment securities (1)

 

 

337,160

 

 

2,056

 

2.45

%

 

254,613

 

 

1,617

 

2.58

%

Loans held for sale

 

 

33,138

 

 

254

 

3.08

%

 

12,968

 

 

106

 

3.31

%

Loans

 

 

  

 

 

  

 

  

 

 

  

 

 

  

 

  

 

Commercial:

 

 

  

 

 

 

 

  

 

 

  

 

 

 

 

  

 

Commercial and industrial

 

 

479,291

 

 

6,272

 

5.26

%

 

485,419

 

 

6,612

 

5.52

%

Real estate construction

 

 

26,723

 

 

334

 

5.03

%

 

31,164

 

 

436

 

5.67

%

Commercial real estate

 

 

508,164

 

 

5,823

 

4.61

%

 

479,839

 

 

5,824

 

4.92

%

Total commercial

 

 

1,014,178

 

 

12,429

 

4.93

%

 

996,422

 

 

12,872

 

5.24

%

Consumer

 

 

  

 

 

  

 

  

 

 

  

 

 

  

 

  

 

Residential real estate first mortgage

 

 

460,726

 

 

4,699

 

4.10

%

 

449,763

 

 

4,806

 

4.33

%

Residential real estate junior lien

 

 

173,436

 

 

2,228

 

5.17

%

 

189,108

 

 

2,727

 

5.85

%

Other revolving and installment

 

 

83,253

 

 

970

 

4.69

%

 

96,415

 

 

1,089

 

4.58

%

Total consumer

 

 

717,415

 

 

7,897

 

4.43

%

 

735,286

 

 

8,622

 

4.76

%

Total loans (1)

 

 

1,731,593

 

 

20,326

 

4.72

%

 

1,731,708

 

 

21,494

 

5.03

%

Federal Reserve/FHLB Stock

 

 

5,762

 

 

68

 

4.75

%

 

9,140

 

 

116

 

5.15

%

Total interest earning assets

 

 

2,271,004

 

 

23,206

 

4.11

%

 

2,019,666

 

 

23,402

 

4.70

%

Noninterest earning assets

 

 

148,661

 

 

 

 

 

 

 

160,316

 

 

 

 

 

 

Total assets

 

$

2,419,665

 

 

  

 

  

 

$

2,179,982

 

 

  

 

  

 

Interest-Bearing Liabilities

 

 

  

 

 

  

 

  

 

 

  

 

 

  

 

  

 

Interest-bearing demand deposits

 

$

459,028

 

$

528

 

0.46

%

$

419,325

 

$

407

 

0.39

%

Money market and savings deposits

 

 

803,838

 

 

2,078

 

1.04

%

 

684,487

 

 

1,700

 

1.01

%

Time deposits

 

 

199,088

 

 

786

 

1.59

%

 

185,619

 

 

641

 

1.40

%

Short-term borrowings

 

 

 —

 

 

 —

 

 —

%

 

83,331

 

 

531

 

2.59

%

Long-term debt

 

 

58,755

 

 

877

 

6.00

%

 

58,811

 

 

911

 

6.28

%

Total interest-bearing liabilities 

 

 

1,520,709

 

 

4,269

 

1.13

%

 

1,431,573

 

 

4,190

 

1.19

%

Noninterest-Bearing Liabilities and Stockholders' Equity

 

 

 

 

 

  

 

  

 

 

 

 

 

  

 

  

 

Noninterest-bearing deposits

 

 

564,307

 

 

  

 

  

 

 

509,573

 

 

 

 

 

 

Other noninterest-bearing liabilities

 

 

39,922

 

 

  

 

  

 

 

38,982

 

 

  

 

  

 

Stockholders’ equity

 

 

294,727

 

 

  

 

  

 

 

199,854

 

 

  

 

  

 

Total liabilities and stockholders’ equity

 

$

2,419,665

 

 

  

 

  

 

$

2,179,982

 

 

  

 

  

 

Net interest income

 

 

  

 

$

18,937

 

  

 

 

  

 

$

19,212

 

  

 

Net interest rate spread

 

 

  

 

 

  

 

2.98

%

 

  

 

 

  

 

3.51

%

Net interest margin on FTE basis (2)

 

 

  

 

 

  

 

3.35

%

 

  

 

 

  

 

3.86

%


(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.”

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

44

Table of Contents

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 March 31, 2020

 

 

Compared with

 

 

Three months ended March 31, 2019

 

 

Change due to:

 

Interest

(tax-equivalent basis, dollars in thousands)

    

Volume

    

Rate

    

Variance

Interest earning assets

 

 

  

 

 

  

 

 

  

Interest-bearing deposits with banks

 

$

942

 

$

(509)

 

$

433

Investment securities

 

 

530

 

 

(91)

 

 

439

Loans held for sale

 

 

166

 

 

(18)

 

 

148

Loans

 

 

  

 

 

  

 

 

  

Commercial:

 

 

  

 

 

  

 

 

  

Commercial and industrial

 

 

(84)

 

 

(256)

 

 

(340)

Real estate construction

 

 

(63)

 

 

(39)

 

 

(102)

Commercial real estate

 

 

346

 

 

(347)

 

 

(1)

Total commercial

 

 

199

 

 

(642)

 

 

(443)

Consumer

 

 

  

 

 

  

 

 

  

Residential real estate first mortgage

 

 

118

 

 

(225)

 

 

(107)

Residential real estate junior lien

 

 

(228)

 

 

(271)

 

 

(499)

Other revolving and installment

 

 

(150)

 

 

31

 

 

(119)

Total consumer

 

 

(260)

 

 

(465)

 

 

(725)

Total loans

 

 

(61)

 

 

(1,107)

 

 

(1,168)

Federal Reserve/FHLB Stock

 

 

(43)

 

 

(5)

 

 

(48)

Total interest income

 

 

1,534

 

 

(1,730)

 

 

(196)

Interest-bearing liabilities

 

 

  

 

 

  

 

 

  

Interest-bearing demand deposits

 

 

38

 

 

83

 

 

121

Money market and savings deposits

 

 

300

 

 

78

 

 

378

Time deposits

 

 

47

 

 

98

 

 

145

Short-term borrowings

 

 

(537)

 

 

 6

 

 

(531)

Long-term debt

 

 

(1)

 

 

(33)

 

 

(34)

Total interest expense

 

 

(153)

 

 

232

 

 

79

Change in net interest income

 

$

1,687

 

$

(1,962)

 

$

(275)

 

Provision for Loan Losses

The provision for loan losses is based upon our allowance methodology and is a charge to income that, in our judgment, is required to maintain an adequate allowance for incurred loan losses at each period-end. In assessing the adequacy of the allowance, management considers the size and quality of the loan portfolio measured against prevailing economic conditions, regulatory guidelines, and historical loan loss experience. However, there is no assurance that loan credit losses will not exceed the allowance, and any growth in the loan portfolio and the uncertainty of the general economy may require additional provisions in future periods.

We recorded a provision for loan losses of $2.5 million for the three months ended March 31, 2020, a $280 thousand increase compared to the $2.2 recorded for the three months ended March 31, 2019. The increase in provision expense was primarily due to allocations of reserves for the economic uncertainties related to COVID-19. We expect the provision for loan losses could increase in future periods based on our belief that the credit quality of our loan portfolio may decline, and loan defaults may increase, as a result of COVID-19.

Noninterest Income

Our noninterest income is generated from four primary sources:  (1) retirement and benefit services;  (2) wealth management; (3) mortgage banking; and (4) other general banking services.

45

Table of Contents

The following table presents our noninterest income for the three months ended March 31, 2020 and 2019.

 

 

 

 

 

 

 

 

 

 

Three months ended

 

 

 

March 31, 

 

(dollars in thousands)

    

2020

 

2019

 

Retirement and benefit services

 

$

16,220

 

$

15,059

 

Wealth management

 

 

4,046

 

 

3,611

 

Mortgage banking

 

 

5,045

 

 

4,569

 

Service charges on deposit accounts

 

 

423

 

 

444

 

Net gains (losses) on investment securities

 

 

 —

 

 

127

 

Other

 

 

1,455

 

 

1,264

 

Total noninterest income

 

$

27,189

 

$

25,074

 

Noninterest income as a % of revenue

 

 

59.07

%  

 

56.74

%  

 

Total noninterest income for the three months ended March 31, 2020 was $27.2 million, an increase of $2.1 million, or 8.4%, compared to $25.1 million for the three months ended March 31, 2019. The increase in noninterest income was primarily due to an increase in retirement and benefit services revenue of $1.2 million, an increase of $476 thousand in mortgage banking revenue and an increase of $435 thousand in wealth management revenue. The increase in retirement and benefit services revenue was primarily due to non-asset based fees which increased $975 thousand due to the increased numbers of participants and transactions and changes made to our fee schedules. The increase in mortgage banking revenue was primarily due to $103.0 million in additional mortgage originations for the three months ended March 31, 2020, as compared to the same period in 2019. The increase in wealth management revenue was primarily due to an increase in assets under administration and management due to organic client growth and market appreciation.

We anticipate that our noninterest income will be significantly adversely affected in future periods as a result of the COVID-19 pandemic and the related decline in global economic conditions and significant corrections in the global stock markets. We expect retirement and benefit services asset based revenue will be adversely affected by reduced assets under administration and assets under management, waived transaction and participant related fees, and a decline in ESOP transaction fees. We expect wealth management asset based revenue will be adversely affected by reduced assets under administration and assets under management and we also expect increased unemployment and recessionary concerns will adversely affect mortgage originations and mortgage banking revenue in future periods.

Noninterest income as a percentage of total operating revenue, which consists of net interest income plus noninterest income, was 59.1% for the three months ending March 31, 2020,  compared to 56.7% for the three months ending March 31, 2019. The increase was due to noninterest income increasing by 8.4%  while net interest income decreased 1.5%.

See “NOTE 14 Segment Reporting” for additional discussion regarding our business lines.

Noninterest Expense

Total noninterest expense for the three months ended March 31, 2020 was $36.7 million, an increase of  $3.2 million, or 9.6%, compared to $33.5 million for the three months ended March 31, 2019. The increase was primarily attributable to increases of $1.9 million in compensation expense, $646 thousand in business services, software and technology expense, and $597 thousand in mortgage and lending expense. The increases in compensation and mortgage and lending expenses were primarily a result of higher mortgage originations during the period. The increase in business services, software and technology expense was primarily due to the continuing roll-out of our One Alerus initiative.

46

Table of Contents

The following table presents noninterest expense for the three months ended March 31, 2020 and 2019.

 

 

 

 

 

 

 

 

 

Three months ended

 

 

March 31, 

(dollars in thousands)

    

2020

 

2019

Compensation

 

$

18,731

 

$

16,813

Employee taxes and benefits

 

 

5,308

 

 

5,428

Occupancy and equipment expense

 

 

2,755

 

 

2,745

Business services, software and technology expense

 

 

4,444

 

 

3,798

Intangible amortization expense

 

 

990

 

 

1,051

Professional fees and assessments

 

 

1,040

 

 

1,066

Marketing and business development

 

 

610

 

 

427

Supplies and postage

 

 

703

 

 

733

Travel

 

 

261

 

 

502

Mortgage and lending expenses

 

 

1,043

 

 

446

Other

 

 

841

 

 

505

Total noninterest expense

 

$

36,726

 

$

33,514

 

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.

For the three months ended March 31, 2020, we recognized income tax expense of $1.4 million on $6.8 million of pre‑tax income, resulting in an effective tax rate of 21.1%, compared to income tax expense of $2.0 million on $8.5 million of pre‑tax income for the three months ended March 31, 2019, resulting in an effective tax rate of 23.9%. The decrease in the effective tax rate was primarily due to additional tax benefits from share-based compensation for the three months ended March 31, 2020, as compared to the same period in 2019.

Financial Condition

Overview

Total assets were $2.5 billion as of March 31, 2020, an increase of $155.2 million, or 6.6%, as compared to December 31, 2019. The increase in total assets was primarily due to increases of $54.5 million in cash and cash equivalents, $43.8 million in available-for-sale investment securities, $37.0 million in loans held for investment, and $25.4 million in loans held for sale. 

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 diversify with approximately one third of the portfolio in each of the commercial and industrial, commercial real estate, and residential real estate categories. As of March 31, 2020 the portfolio mix was 28.7% commercial and industrial, 29.7% commercial real estate, 35.7% residential real estate and 5.9% other categories.

47

Table of Contents

The following table presents the composition of total loans outstanding by portfolio segment as of March 31, 2020 and December 31, 2019:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

March 31, 2020

 

 

December 31, 2019

 

 

 

 

 

 

 

 

 

 

 

 

Percent of

 

 

 

 

 

Percent of

 

 

Change

 

(dollars in thousands)

 

Balance

    

Portfolio

 

    

Balance

    

Portfolio

    

    

 

Amount

    

Percent

 

Commercial

    

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Commercial and industrial

 

$

502,637

 

28.7

%  

 

$

479,144

 

27.8

%  

 

$

23,493

 

4.9

%

Real estate construction

 

 

25,487

 

1.4

%  

 

 

26,378

 

1.5

%  

 

 

(891)

 

(3.4)

%

Commercial real estate

 

 

522,106

 

29.7

%  

 

 

494,703

 

28.8

%  

 

 

27,403

 

5.5

%

Total commercial

 

 

1,050,230

 

59.8

%  

 

 

1,000,225

 

58.1

%  

 

 

50,005

 

5.0

%

Consumer

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Residential real estate first mortgage

 

 

457,895

 

26.0

%  

 

 

457,155

 

26.6

%  

 

 

740

 

0.2

%

Residential real estate junior lien

 

 

170,538

 

9.7

%  

 

 

177,373

 

10.3

%  

 

 

(6,835)

 

(3.9)

%

Other revolving and installment

 

 

79,614

 

4.5

%  

 

 

86,526

 

5.0

%  

 

 

(6,912)

 

(8.0)

%

Total consumer

 

 

708,047

 

40.2

%  

 

 

721,054

 

41.9

%  

 

 

(13,007)

 

(1.8)

%

Total loans

 

$

1,758,277

 

100.0

%  

 

$

1,721,279

 

100.0

%  

 

$

36,998

 

2.1

%

 

Total loans outstanding of $1.76 billion as of March 31, 2020,  increased $37.0 million, or 2.1%, from December 31, 2019. The increase in total loans was primarily due to increases in our commercial and industrial loans of $23.5 million and commercial real estate of $27.4 million. These increases were partially offset by decreases of $6.8 million in residential real estate junior liens and $6.9 million in other revolving and installment loans.

Consistent with regulatory guidance urging banks to work with borrowers during this unprecedented situation and as outlined in the CARES Act, the Company is executing a payment deferral program for its lending clients that are adversely affected by COVID-19.  These deferrals were generally no more than 90 days in duration. As of April 21,  2020, the Company had executed 325 of these deferrals on outstanding loan balances of $97.4 million. In accordance with interagency guidance issued in March 2020, these short-term deferrals are not considered TDRs. See “NOTE 4 Loans and Allowance for Loan Losses” to the consolidated financial statements for additional information regarding TDRs.

We anticipate that loan growth will slow down in the future for our commercial and industrial loan, commercial real estate loan, residential real estate loan and consumer loan portfolios as a result of COVID-19 and the related decline in economic conditions in our market areas. We are also anticipating that we will see increased line of credit utilization and a reduction in our unused commitments.

48

Table of Contents

The following table presents the maturities and types of interest rates for the loan portfolio as of March 31, 2020.

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

March 31, 2020

 

 

 

 

 

After one

 

 

 

 

 

 

 

 

One year

 

but within

 

After

 

 

 

(dollars in thousands)

    

or less

    

five years

    

five years

    

Total

Commercial

 

 

  

 

 

  

 

 

  

 

 

  

Commercial and industrial

 

$

189,968

 

$

242,414

 

$

70,255

 

$

502,637

Real estate construction

 

 

5,008

 

 

11,209

 

 

9,270

 

 

25,487

Commercial real estate

 

 

53,344

 

 

227,144

 

 

241,618

 

 

522,106

Total commercial

 

 

248,320

 

 

480,767

 

 

321,143

 

 

1,050,230

Consumer

 

 

  

 

 

  

 

 

  

 

 

  

Residential real estate first mortgage

 

 

19,891

 

 

20,323

 

 

417,681

 

 

457,895

Residential real estate junior lien

 

 

21,282

 

 

71,014

 

 

78,242

 

 

170,538

Other revolving and installment

 

 

12,524

 

 

57,603

 

 

9,487

 

 

79,614

Total consumer

 

 

53,697

 

 

148,940

 

 

505,410

 

 

708,047

Total loans

 

$

302,017

 

$

629,707

 

$

826,553

 

$

1,758,277

Sensitivity of loans to changes in interest rates

 

 

  

 

 

  

 

 

  

 

 

  

Fixed interest rates

 

 

  

 

$

484,123

 

$

368,291

 

 

  

Floating interest rates

 

 

  

 

 

145,584

 

 

458,262

 

 

  

Total

 

 

  

 

$

629,707

 

$

826,553

 

 

  

 

As of March 31, 2020,  52.4% of the loan portfolio bore interest at fixed rates and 47.6% 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.

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. 

49

Table of Contents

See “NOTE 4 Loans and Allowance for Loan Losses” to the consolidated financial statements for a definition of each of the risk ratings.

The table below presents criticized loans outstanding by loan portfolio segment as of March 31, 2020 and December 31, 2019:

 

 

 

 

 

 

 

 

 

 

March 31, 

 

December 31, 

 

(dollars in thousands)

    

2020

    

2019

 

Commercial

 

 

  

 

 

 

 

Commercial and industrial

 

$

31,770

 

$

30,838

 

Real estate construction

 

 

546

 

 

1,259

 

Commercial real estate

 

 

29,672

 

 

32,409

 

Total commercial

 

 

61,988

 

 

64,506

 

Consumer

 

 

  

 

 

 

 

Residential real estate first mortgage

 

 

2,175

 

 

797

 

Residential real estate junior lien

 

 

3,182

 

 

1,251

 

Other revolving and installment

 

 

23

 

 

 6

 

Total consumer

 

 

5,380

 

 

2,054

 

Total loans

 

$

67,368

 

$

66,560

 

Criticized loans as a percent of total loans

 

 

3.83

%

 

3.87

%

 

The following table presents information regarding nonperforming assets as of March 31, 2020 and December 31, 2019:

 

 

 

 

 

 

 

 

 

 

March 31, 

 

December 31, 

 

(dollars in thousands)

    

2020

    

2019

 

Nonaccrual loans

 

$

6,959

 

$

7,379

 

Accruing loans 90+ days past due

 

 

11

 

 

448

 

Total nonperforming loans

 

 

6,970

 

 

7,827

 

OREO and repossessed assets

 

 

209

 

 

 8

 

Total nonperforming assets

 

 

7,179

 

 

7,835

 

Total restructured accruing loans

 

 

926

 

 

957

 

Total nonperforming assets and restructured accruing loans

 

$

8,105

 

$

8,792

 

Nonperforming loans to total loans

 

 

0.40

%

 

0.45

%

Nonperforming assets to total assets

 

 

0.29

%

 

0.33

%

Allowance for loan losses to nonperforming loans

 

 

388

%

 

306

%

 

Interest income lost on nonaccrual loans approximated $155 thousand and $127 thousand for the three months ended March 31, 2020 and 2019, respectively. There was no interest income included in net income related to nonaccrual loans for the three months ended March 31, 2020 and 2019.

Allowance for Loan Losses

The allowance for loan losses represents management’s estimate of incurred credit losses inherent in the loan portfolio at the balance sheet date. 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, after consideration of risk characteristics of the loans and prevailing and anticipated economic and other conditions. A risk system, consisting of multiple grading categories for each portfolio class, is utilized as an analytical tool to assess risk and appropriate reserves. In addition to the risk system, management further evaluates risk characteristics of the loan portfolio under current and anticipated economic conditions and considers such factors as the financial condition of the borrower, past and expected loss experience, and other factors which management feels deserve recognition in establishing an appropriate reserve. These estimates are reviewed at least quarterly, and, as adjustments become necessary, they  are recognized in the periods in which they become known. These evaluations are inherently subjective as they require management to make material estimates, all of which may be susceptible to significant change.

50

Table of Contents

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

 

 

 

 

 

 

 

 

 

 

Three months ended

 

 

 

March 31, 

 

(dollars in thousands)

    

2020

    

2019

 

Balance—beginning of period

 

$

23,924

 

$

22,174

 

Commercial loan charge-offs

 

 

  

 

 

  

 

Commercial and Industrial

 

 

(32)

 

 

(1,785)

 

Real estate construction

 

 

 —

 

 

(1)

 

Commercial real estate

 

 

 —

 

 

 —

 

Total commercial loan charge-offs

 

 

(32)

 

 

(1,786)

 

Consumer loan charge-offs

 

 

  

 

 

  

 

Residential real estate first mortgage

 

 

 —

 

 

 —

 

Residential real estate junior lien

 

 

 —

 

 

(104)

 

Other revolving and installment

 

 

(67)

 

 

(58)

 

Total consumer loan charge-offs

 

 

(67)

 

 

(162)

 

Total loan charge-offs

 

 

(99)

 

 

(1,948)

 

Commercial loan recoveries

 

 

  

 

 

  

 

Commercial and Industrial

 

 

593

 

 

66

 

Real estate construction

 

 

 —

 

 

 —

 

Commercial real estate

 

 

 —

 

 

 —

 

Total commercial recoveries

 

 

593

 

 

66

 

Consumer loan recoveries

 

 

  

 

 

  

 

Residential real estate first mortgage

 

 

 —

 

 

 —

 

Residential real estate junior lien

 

 

37

 

 

53

 

Other revolving and installment

 

 

64

 

 

73

 

Total consumer loan recoveries

 

 

101

 

 

126

 

Total loan recoveries

 

 

694

 

 

192

 

Net loan charge-offs (recoveries)

 

 

(595)

 

 

1,756

 

Commercial loan provision

 

 

  

 

 

  

 

Commercial and Industrial

 

 

70

 

 

3,407

 

Real estate construction

 

 

31

 

 

 2

 

Commercial real estate

 

 

1,588

 

 

(436)

 

Total commercial loan provision

 

 

1,689

 

 

2,973

 

Consumer loan provision

 

 

  

 

 

  

 

Residential real estate first mortgage

 

 

761

 

 

454

 

Residential real estate junior lien

 

 

317

 

 

 7

 

Other revolving and installment

 

 

92

 

 

(46)

 

Total consumer loan provision

 

 

1,170

 

 

415

 

Unallocated provision expense

 

 

(359)

 

 

(1,168)

 

Total loan loss provision

 

 

2,500

 

 

2,220

 

Balance—end of period

 

$

27,019

 

$

22,638

 

Total loans

 

$

1,758,277

 

$

1,713,792

 

Average total loans

 

 

1,731,593

 

 

1,731,708

 

Allowance for loan losses as a percentage of total loans

 

 

1.54

%  

 

1.32

%

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

 

 

(0.14)

%  

 

0.41

%

 

The allowance for loan losses was $27.0 million as of March 31, 2020, compared to $23.9 million as of December 31, 2019. The $3.1 million increase in the allowance for loan losses was due to additional provision for loan losses of $2.5 million and net recoveries of $0.6 million. The increase in provision expense was primarily due to allocations of reserves for the economic uncertainties related to COVID-19. The level of nonperforming loans to total loans as of March 31, 2020 was 0.40%, compared to 0.45% as of December 31, 2019. The allowance for loan losses to total loans was 1.54% as of March 31, 2020, compared to 1.39% as of December 31, 2019.

Based on current economic indicators, the Company increased the economic factors within the allowance for loan losses evaluation. We expect that the allowance for loan losses as a percent of total loans may increase in future

51

Table of Contents

periods based on our belief that the credit quality of our loan portfolio may decline, and loan defaults may increase as a result of COVID-19.

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

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

March 31, 2020

 

 

December 31, 2019

 

 

 

 

 

 

Percentage

 

 

 

 

 

Percentage

 

 

 

Allocated

 

of loans to

 

 

Allocated

 

of loans to

 

(dollars in thousands)

    

Allowance

    

total loans

 

 

Allowance

    

total loans

 

Commercial and industrial

 

$

12,901

 

28.7

%

 

$

12,270

 

27.8

%

Real estate construction

 

 

334

 

1.4

%

 

 

303

 

1.5

%

Commercial real estate

 

 

8,276

 

29.7

%

 

 

6,688

 

28.8

%

Residential real estate first mortgage

 

 

2,209

 

26.0

%

 

 

1,448

 

26.6

%

Residential real estate junior lien

 

 

1,025

 

9.7

%

 

 

671

 

10.3

%

Other revolving and installment

 

 

441

 

4.5

%

 

 

352

 

5.0

%

Unallocated

 

 

1,833

 

 —

%

 

 

2,192

 

 —

%

Total loans

 

$

27,019

 

100.0

%

 

$

23,924

 

100.0

%

 

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 in accrued expenses and other liabilities on the Consolidated Balance Sheets. The reserve for unfunded commitments was $1.1 million as of March 31, 2020 and December 31, 2019.

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 $72.3 million as of March 31, 2020, an increase of $25.4 million, as compared to December 31, 2019. The increase in loans held for sale was primarily due to increased mortgage originations during the month of March, investor pipeline capacity and a volatile capital market. Mortgage loan originations totaled $228.6 million for the three months ended March 31, 2020 compared to $261.3 million for the three months ended December 31, 2019.

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.

52

Table of Contents

The following table presents the fair value composition of our investment securities portfolio as of March 31, 2020 and December 31, 2019:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

    

March 31, 2020

 

December 31, 2019

 

 

 

 

 

 

 

 

 

Percent of

 

 

 

 

Percent of

 

Change

 

(dollars in thousands)

    

Balance

    

Portfolio

 

Balance

    

Portfolio

    

Amount

    

Percent

 

Available-for-sale

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

U.S. Treasury and agencies

 

$

16,627

 

4.7

%  

$

21,240

 

6.8

%  

$

(4,613)

 

(21.7)

%  

Obligations of state and political agencies

 

 

69,106

 

19.5

%  

 

68,648

 

21.9

%  

 

458

 

0.7

%  

Mortgage backed securities

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Residential Agency

 

 

229,309

 

64.8

%  

 

182,538

 

58.3

%  

 

46,771

 

25.6

%  

Commercial

 

 

29,910

 

8.4

%  

 

30,685

 

9.8

%  

 

(775)

 

(2.5)

%  

Asset backed securities

 

 

141

 

 —

%  

 

144

 

 —

%  

 

(3)

 

(2.1)

%  

Corporate bonds

 

 

9,056

 

2.6

%  

 

7,095

 

2.3

%  

 

1,961

 

27.6

%  

Total available-for-sale

 

 

354,149

 

100.0

%  

 

310,350

 

99.1

%  

 

43,799

 

14.1

%  

Equity

 

 

 —

 

 -

%  

 

2,808

 

0.9

%  

 

(2,808)

 

(100.0)

%  

Total investment securities

 

$

354,149

 

100.0

%  

$

313,158

 

100.0

%  

$

40,991

 

13.1

%  

 

The securities available‑for‑sale presented in the following table are reported at fair value and by contractual maturity as of March 31, 2020. 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 March 31, 2020

 

 

 

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

 

$

10,084

 

1.52

%  

$

 —

 

 —

%  

$

1,671

 

2.37

%  

$

4,872

 

2.19

%

Obligations of state and political agencies

 

 

1,019

 

1.81

%  

 

19,090

 

1.47

%  

 

22,077

 

2.03

%  

 

26,920

 

2.64

%

Mortgage backed securities

 

 

  

 

  

 

 

  

 

 

 

 

  

 

  

 

 

  

 

  

 

Residential Agency

 

 

16

 

3.78

%  

 

3,061

 

2.33

%  

 

47,259

 

2.55

%  

 

178,973

 

2.67

%

Commercial

 

 

 —

 

 —

%  

 

1,755

 

2.94

%  

 

7,291

 

2.37

%  

 

20,864

 

2.40

%

Asset backed securities

 

 

 2

 

5.44

%  

 

 —

 

 —

%  

 

 —

 

 —

%  

 

139

 

5.45

%

Corporate bonds

 

 

5,028

 

2.53

%  

 

2,028

 

2.70

%  

 

2,000

 

3.38

%  

 

 —

 

 —

%

Total available-for-sale

 

$

16,149

 

1.85

%  

$

25,934

 

1.77

%  

$

80,298

 

2.41

%  

$

231,768

 

2.64

%

 

Deposits

Total deposits were $2.1 billion as of March 31, 2020, an increase of  $150.2 million, or 7.6%,  as compared to December 31, 2019. The increase in total deposits was due to an increase in interest-bearing deposits of $119.3 million and a $30.9 million increase in noninterest-bearing deposits.  The increase in interest-bearing deposits was primarily due to a $76.6 million increase in synergistic deposits from our retirement and benefit services and wealth management segments. In addition, health savings account, or HSA, deposits were $124.2 million as of March 31, 2020, an increase of $4.4 million, or 3.7%, from December 31, 2019. Noninterest-bearing deposits as a percent of total deposits was 28.7% and 29.3% as of March 31, 2020 and December 31, 2019, respectively. Total deposits represented 95.6% of total liabilities as of March 31, 2020.

We expect that deposit levels will generally decrease in future periods as a result of the distressed economic conditions in our market areas as a result of the COVID-19 pandemic.

53

Table of Contents

The following table presents the composition of our deposit portfolio as of March 31, 2020 and December 31, 2019:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

    

March 31, 2020

 

December 31, 2019

 

 

 

 

 

 

 

 

 

 

 

Percent of

 

 

 

 

Percent of

 

Change

 

(dollars in thousands)

    

Balance

    

Portfolio

    

Balance

    

Portfolio

  

Amount

    

Percent

 

Noninterest-bearing demand

 

$

608,559

 

28.7

%

$

577,704

 

29.3

%

$

30,855

 

5.3

%

Interest-bearing demand

 

 

477,752

 

22.5

%

 

458,689

 

23.3

%

 

19,063

 

4.2

%

Money market and savings

 

 

833,833

 

39.3

%

 

738,841

 

37.5

%

 

94,992

 

12.9

%

Time deposits

 

 

201,370

 

9.5

%

 

196,082

 

9.9

%

 

5,288

 

2.7

%

Total deposits

 

$

2,121,514

 

100.0

%

$

1,971,316

 

100.0

%

$

150,198

 

7.6

%

 

The following table presents the average balances and rates of our deposit portfolio for the three months ended March 31, 2020 and 2019:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Three months ended

 

Three months ended

 

 

 

March 31, 2020

 

March 31, 2019

 

 

 

Average

 

Average

 

Average

 

Average

 

(dollars in thousands)

    

Balance

    

Rate

    

Balance

    

Rate

    

Noninterest-bearing demand

 

$

564,307

 

 —

%

$

509,573

 

 —

%

Interest-bearing demand

 

 

459,028

 

0.46

%

 

419,325

 

0.39

%

Money market and savings

 

 

803,838

 

1.04

%

 

684,487

 

1.01

%

Time deposits

 

 

199,088

 

1.59

%

 

185,619

 

1.40

%

Total deposits (1)

 

$

2,026,261

 

0.67

%

$

1,799,004

 

0.62

%

 

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:

 

 

 

 

 

 

March 31, 

(dollars in thousands)

    

2020

Maturing in:

 

 

  

3 months or less

 

$

59,634

3 months to 6 months

 

 

36,443

6 months to 1 year

 

 

4,879

1 year or greater

 

 

14,724

Total

 

$

115,680

 

Borrowings

Borrowings as of March 31, 2020 and December 31, 2019 were as follows:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

March 31, 2020

 

December 31, 2019

 

 

 

 

 

 

 

 

 

 

 

Percent of

 

 

 

 

Percent of

 

Change

 

(dollars in thousands)

    

Balance

    

Portfolio

    

Balance

    

Portfolio

    

Amount

    

Percent

    

Subordinated notes

 

$

49,641

 

84.5

%

$

49,625

 

84.4

%

$

16

 

 —

%

Junior subordinated debentures

 

 

8,532

 

14.5

%

 

8,504

 

14.5

%

 

28

 

0.3

%

Finance lease liability

 

 

589

 

1.0

%

 

640

 

1.1

%

 

(51)

 

(7.9)

%

Total borrowed funds

 

$

58,762

 

100.0

%

$

58,769

 

100.0

%

$

(7)

 

 —

%

 

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 $7.9 million to $293.6 million as of March 31, 2020, compared to $285.7 million as of December 31, 2019. The increase in stockholders' equity was primarily impacted by $5.4 million of net income for

54

Table of Contents

the three months ended March 31, 2020, and an increase of $5.2 million of accumulated other comprehensive income. These increases were partially offset by $2.6 million in dividends declared on common stock.

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.

At March 31, 2020 and December 31, 2019, 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 March 31, 2020 and December 31, 2019:

 

 

 

 

 

 

 

 

March 31, 

 

December 31, 

 

Capital Ratios

    

2020

    

2019

 

Alerus Financial Corporation

 

  

 

  

 

Common equity tier 1 capital to risk weighted assets

 

12.36

%

12.48

%

Tier 1 capital to risk weighted assets

 

12.78

%

12.90

%

Total capital to risk weighted assets

 

16.55

%

16.73

%

Tier 1 capital to average assets

 

10.62

%

11.05

%

Tangible common equity to tangible assets (1)

 

10.09

%

10.38

%

 

 

 

 

 

 

Alerus Financial, National Association

 

 

 

 

 

Common equity tier 1 capital to risk weighted assets

 

11.80

%

11.91

%

Tier 1 capital to risk weighted assets

 

11.80

%

11.91

%

Total capital to risk weighted assets

 

13.05

%

13.15

%

Tier 1 capital to average assets

 

9.80

%

10.20

%


(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 March 31, 2020, 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, 2019 levels primarily as a result of the increase in retained earnings. See “Note 17 Regulatory Matters” to the consolidated financial statements for additional information

55

Table of Contents

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 March 31, 2020.

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

March 31, 2020

 

 

Less than

 

One to

 

Three to

 

Over

 

 

 

(dollars in thousands)

    

one year

    

three years

    

five years

    

five years

    

Total

Operating lease obligations

 

$

2,037

 

$

3,222

 

$

2,202

 

$

2,083

 

$

9,544

Time deposits

 

 

166,478

 

 

21,292

 

 

6,932

 

 

6,668

 

 

201,370

Subordinated notes payable

 

 

 —

 

 

 —

 

 

 —

 

 

49,641

 

 

49,641

Junior subordinated debenture (Trust I)

 

 

 —

 

 

 —

 

 

 —

 

 

3,413

 

 

3,413

Junior subordinated debenture (Trust II)

 

 

 —

 

 

 —

 

 

 —

 

 

5,119

 

 

5,119

Finance lease liability

 

 

251

 

 

401

 

 

 —

 

 

 —

 

 

652

Total contractual obligations

 

$

168,766

 

$

24,915

 

$

9,134

 

$

66,924

 

$

269,739

 

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.

A summary of the contractual amounts of our exposure to off‑balance sheet agreements as of March 31, 2020 and December 31, 2019, is as follows:

 

 

 

 

 

 

 

 

 

March 31, 

    

December 31, 

(dollars in thousands)

    

2020

    

2019

Commitments to extend credit

 

$

524,069

 

$

586,365

Standby letters of credit

 

 

3,276

 

 

8,516

Total

 

$

527,345

 

$

594,881

 

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 March 31, 2020, we had on balance sheet liquidity of $364.3 million, compared to $250.7 million as of December 31, 2019. 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.

56

Table of Contents

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 March 31, 2020, we had no outstanding fed funds purchased from the FHLB and $924.8 million of collateral pledged to the FHLB. Based on this collateral, we were eligible to borrow up to $573.3 million from the FHLB. In addition, we can borrow up to $102.0 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 March 31, 2020 and December 31, 2019.

Our primary sources of liquidity include liquid assets, as well as unencumbered securities that can be used to collateralize additional funding.

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.

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.

57

Table of Contents

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.

The estimated impact on our net interest income as of March 31, 2020 and December 31, 2019, assuming immediate parallel moves in interest rates is presented in the table below.

 

 

 

 

 

 

 

 

 

 

 

 

March 31, 2020

 

December 31, 2019

 

 

    

Following

    

Following

    

Following

    

Following

 

 

 

12 months

 

24 months

 

12 months

 

24 months

 

+400 basis points

 

7.4

%  

11.8

%  

5.5

%  

12.2

%

+300 basis points

 

5.2

%  

8.0

%  

4.2

%  

9.0

%

+200 basis points

 

3.0

%  

4.2

%  

2.9

%  

5.7

%

+100 basis points

 

1.0

%  

0.4

%  

1.5

%  

2.4

%

−100 basis points

 

−1.2

%  

−8.6

%  

−5.4

%  

−11.9

%

−200 basis points

 

N/A

%  

N/A

%  

N/A

%  

N/A

%

 

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 March 31, 2020 and December 31, 2019, assuming immediate parallel shifts in interest rates.

 

 

 

 

 

 

 

 

March 31, 

 

December 31, 

 

 

    

2020

    

2019

 

+400 basis points

 

12.1

%  

12.8

%

+300 basis points

 

11.9

%  

11.4

%

+200 basis points

 

10.5

%  

9.2

%

+100 basis points

 

7.5

%  

6.1

%

−100 basis points

 

−38.6

%  

−23.2

%

−200 basis points

 

N/A

%  

N/A

%

 

58

Table of Contents

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.

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. 

59

Table of Contents

Item 1A – Risk Factors

In addition to the risk factors set forth under Part I, Item 1A “Risk Factors” in the Company’s Form 10-K for the fiscal year ended December 31, 2019, the following risk factors apply to the Company:

The outbreak of Coronavirus Disease 2019, or COVID-19, or an outbreak of other highly infectious or contagious diseases, could adversely impact certain industries in which the Company’s customers operate and impair their ability to fulfill their obligations to the Company. Further, the spread of the outbreak could lead to an economic recession or other severe disruptions in the U.S. economy and may disrupt banking and other financial activity in the areas in which the Company operates and could potentially create widespread business continuity issues for the Company.

The spread of COVID-19 has caused severe disruptions in the U.S. economy at large, and for small businesses in particular, which has disrupted the Company’s operations. We are starting to see the impact from COVID-19 on our business, and we believe that it will be significant, adverse and potentially material. Currently, COVID-19 is spreading through the United States and the world. The responses on the part of the U.S. and global governments and populations have created a risk of a recession, reduced economic activity and caused a significant correction in the global stock markets. We expect that we will experience significant disruption across our business due to these effects, leading to decreased earnings and significant slowdowns in our loan collections or loan defaults. We expect retirement and benefit services and wealth management asset based revenue will be adversely affected by reduced assets under administration and assets under management and we also expect increased unemployment and recessionary concerns will adversely affect mortgage originations and mortgage banking revenue in future periods.

COVID-19 may impact the financial ability of businesses and consumers to borrow money, which would negatively impact loan volumes. In addition, certain of our borrowers are in or have exposure to the retail, restaurant, and hospitality industries and/or are located in areas that are quarantined or under stay-at-home orders, and COVID-19 may also have an adverse effect on our commercial real estate and consumer loan portfolios. A prolonged quarantine or stay-at-home order would have a negative adverse impact on these borrowers and their revenue streams, which consequently impacts their ability to meet their financial obligations and could result in loan defaults.

The outbreak of COVID-19 has resulted in a decrease in our customers’ businesses, a decrease in consumer confidence and business generally, an increase in unemployment and a disruption in the services provided by the Company’s vendors. Disruptions to our customers could result in increased risk of delinquencies, defaults, foreclosures and losses on our loans, declines in assets under management and wealth management revenues, negatively impact regional economic conditions, result in declines in local loan demand, liquidity of loan guarantors, loan collateral (particularly in real estate), loan originations and deposit availability and negatively impact the implementation of our growth strategy.

The Company relies upon its third-party vendors to conduct business and to process, record, and monitor transactions. If any of these vendors are unable to continue to provide the Company with these services, it could negatively impact the Company’s ability to serve its customers. Furthermore, the outbreak could negatively impact the ability of the Company’s employees and customers to engage in banking and other financial transactions in the geographic areas in which the Company operates and could create widespread business continuity issues for the Company. The Company also could be adversely affected if key personnel or a significant number of employees were to become unavailable due to the effects and restrictions of a COVID-19 outbreak in our market areas. Although the Company has business continuity plans and other safeguards in place, there is no assurance that such plans and safeguards will be effective.

We believe that the economic impact from COVID-19 will be severe and could have a material and adverse impact on our business and that it could result in significant losses in our loan portfolio, all of which would adversely and materially impact our earnings and capital.

As a participating lender in the U.S. Small Business Administration, or SBA, Paycheck Protection Program, or PPP, the Company and the Bank are subject to additional risks of litigation from the Bank’s customers or other parties

60

Table of Contents

regarding the Bank’s processing of loans for the PPP and risks that the SBA may not fund some of or all PPP loan guarantees.

On March 27, 2020, President Trump signed the Coronavirus Aid, Relieve, and Economic Security Act, or CARES Act, which included a $349 billion loan program administered through the SBA referred to as the PPP. Under the PPP, small businesses and other entities and individuals can apply for loans from existing SBA lenders and other approved regulated lenders that enroll in the program, subject to numerous limitations and eligibility criteria. The Bank is participating as a lender in the PPP. The PPP opened on April 3, 2020; however, because of the short timeframe between the passing of the CARES Act and the opening of the PPP, there is some ambiguity in the laws, rules, and guidance regarding the operation of the PPP, which exposes the Company and the Bank to risks relating to noncompliance with the PPP. On or about April 16, 2020, the SBA notified lenders that the $349 billion earmarked for the PPP was exhausted. On April 24, 2020, an additional $310 billion in funding for PPP loans was authorized, with such funds available for PPP loans beginning on April 27, 2020.

Since the opening of the PPP, several other larger banks have been subject to litigation regarding the process and procedures that such banks used in processing applications for the PPP. If any such litigation is filed against the Company or the Bank and is not resolved in a manner favorable to the Company or the Bank, it may result in significant financial liability or adversely affect the Company’s reputation. In addition, litigation can be costly, regardless of outcome. Any financial liability, litigations costs, or reputational damage caused by the PPP related litigation could have a material adverse impact on our business, financial condition, and results of operations.

The Bank also has credit risk on PPP loans if a determination is made by the SBA that there is a deficiency in the manner in which the loan was originated, funded, or serviced by the Bank, such as an issue with the eligibility of a borrower to receive a PPP loan, which may or may not be related to the ambiguity in the laws, rules, and guidance regarding the operation of the PPP. In the event of a loss resulting from a default on a PPP loan and a determination by the SBA that there is a deficiency in the manner in which the PPP loan was originated, funded, or serviced by the Company, the SBA may deny its liability under the guaranty, reduce the amount of the guaranty, or, if it has already paid under the guaranty, seek recovery of any loss related to the deficiency from the Company.

Item 2 – Unregistered Sales of Equity Securities and Use of Proceeds

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 the underwriters of their option to purchase additional shares to cover over-allotments. 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. 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 March 31, 2020, 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.

61

Table of Contents

Item 4 – Mine Safety Disclosures

Not Applicable.

Item 5 – Other Information

None.

62

Table of Contents

Item 6 – Exhibits

 

 

 

Exhibit No.

    

Description

10.1

 

Form of Performance-Based Restricted Stock Unit Award Agreement under the Alerus Financial Corporation 2019 Equity Incentive Plan (incorporated by reference to Exhibit 10.1 on Form 8-K filed on February 25, 2020).

 

 

 

10.2

 

Executive Severance Agreement by and between Alerus Financial Corporation and Ryan Goldberg, dated March 4, 2020 (incorporated by reference to Exhibit 10.1 on Form 8-K filed on March 10, 2020).

 

 

 

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

 

 

63

Table of Contents

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: May 13, 2020

By:

/s/ Randy L. Newman

 

 

Name:    Randy L. Newman

 

 

Title:      Chairman, Chief Executive Officer and President

 

64