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ALERUS FINANCIAL CORP - Quarter Report: 2021 September (Form 10-Q)

Table of Contents

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, DC 20549

FORM 10-Q

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

For the quarterly period ended September 30, 2021

   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 October 31, 2021 was 17,208,077.

Table of Contents

Alerus Financial Corporation and Subsidiaries

Table of Contents

Page

Part 1:

FINANCIAL INFORMATION

Item 1.

Consolidated Financial Statements

1

Consolidated Balance Sheets as of September 30, 2021 and December 31, 2020

1

Consolidated Statements of Income for the three and nine months ended September 30, 2021 and 2020

2

Consolidated Statements of Comprehensive Income for the three and nine months ended September 30, 2021 and 2020

3

Consolidated Statements of Changes in Stockholders’ Equity for the three and nine months ended September 30, 2021 and 2020

4

Consolidated Statements of Cash Flows for the nine months ended September 30, 2021 and 2020

5

Notes to Consolidated Financial Statements

7

Item 2.

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

36

Item 3.

Quantitative and Qualitative Disclosures About Market Risk

60

Item 4.

Controls and Procedures

62

Part 2:

OTHER INFORMATION

Item 1.

Legal Proceedings

63

Item 1A.

Risk Factors

63

Item 2.

Unregistered Sales of Equity Securities and Use of Proceeds

63

Item 3.

Defaults Upon Senior Securities

64

Item 4.

Mine Safety Disclosures

64

Item 5.

Other Information

64

Item 6.

Exhibits

65

Signatures

66

Table of Contents

PART 1. FINANCIAL INFORMATION

Item 1 - Consolidated Financial Statements

Alerus Financial Corporation and Subsidiaries

Consolidated Balance Sheets

    

September 30, 

    

December 31, 

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

    

2021

    

2020

Assets

 

(Unaudited)

 

(Audited)

Cash and cash equivalents

$

159,454

$

172,962

Investment securities

 

  

 

  

Available-for-sale, at fair value

 

655,282

 

592,342

Held-to-maturity, at carrying value

 

362,586

 

Loans held for sale

 

60,912

 

122,440

Loans

 

1,800,386

 

1,979,375

Allowance for loan losses

 

(32,066)

 

(34,246)

Net loans

 

1,768,320

 

1,945,129

Land, premises and equipment, net

 

18,403

 

20,289

Operating lease right-of-use assets

 

3,821

 

6,918

Accrued interest receivable

 

8,836

 

9,662

Bank-owned life insurance

 

32,954

 

32,363

Goodwill

 

30,201

 

30,201

Other intangible assets

 

22,593

 

25,919

Servicing rights

 

1,776

 

1,987

Deferred income taxes, net

 

11,609

 

9,409

Other assets

 

38,422

 

44,150

Total assets

$

3,175,169

$

3,013,771

Liabilities and Stockholders’ Equity

 

  

 

  

Deposits

 

  

 

  

Noninterest-bearing

$

797,062

$

754,716

Interest-bearing

 

1,916,026

 

1,817,277

Total deposits

 

2,713,088

 

2,571,993

Long-term debt

 

58,963

 

58,735

Operating lease liabilities

 

4,428

 

7,861

Accrued expenses and other liabilities

 

45,495

 

45,019

Total liabilities

 

2,821,974

 

2,683,608

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: 17,208,077 and 17,125,270 issued and outstanding

 

17,208

 

17,125

Additional paid-in capital

 

91,783

 

90,237

Retained earnings

 

243,638

 

212,163

Accumulated other comprehensive income (loss)

 

566

 

10,638

Total stockholders’ equity

 

353,195

 

330,163

Total liabilities and stockholders’ equity

$

3,175,169

$

3,013,771

See accompanying notes to consolidated financial statements (unaudited)

1

Table of Contents

Alerus Financial Corporation and Subsidiaries

Consolidated Statements of Income (Unaudited)

Three months ended

Nine months ended

September 30, 

September 30, 

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

    

2021

    

2020

    

2021

    

2020

Interest Income

Loans, including fees

$

18,888

$

21,962

$

58,779

$

63,876

Investment securities

 

  

 

  

 

  

 

  

Taxable

 

3,249

 

1,973

 

8,547

 

5,497

Exempt from federal income taxes

 

225

 

238

 

694

 

712

Other

 

185

 

116

 

432

 

816

Total interest income

 

22,547

 

24,289

68,452

 

70,901

Interest Expense

 

  

 

  

 

  

 

  

Deposits

 

880

 

1,683

 

2,781

 

7,633

Long-term debt

 

535

 

841

 

1,361

 

2,575

Total interest expense

 

1,415

 

2,524

 

4,142

 

10,208

Net interest income

 

21,132

 

21,765

 

64,310

 

60,693

Provision for loan losses

 

(2,000)

 

3,500

 

(2,000)

 

9,500

Net interest income after provision for loan losses

 

23,132

 

18,265

 

66,310

 

51,193

Noninterest Income

 

  

 

  

 

  

 

  

Retirement and benefit services

 

18,031

 

15,104

 

53,157

 

45,034

Wealth management

 

5,295

 

4,486

 

15,419

 

12,644

Mortgage banking

 

11,116

 

22,269

 

40,535

 

44,860

Service charges on deposit accounts

 

357

 

355

 

1,025

 

1,075

Net gains (losses) on investment securities

 

11

 

1,428

 

125

 

2,722

Other

 

1,230

 

1,614

 

3,408

 

4,340

Total noninterest income

 

36,040

 

45,256

 

113,669

 

110,675

Noninterest Expense

 

  

 

  

 

  

 

  

Compensation

 

23,291

 

22,740

 

71,298

 

62,684

Employee taxes and benefits

 

5,058

 

5,033

 

16,443

 

15,088

Occupancy and equipment expense

 

2,063

 

2,511

 

6,212

 

7,615

Business services, software and technology expense

 

5,332

 

4,378

 

15,266

 

13,501

Intangible amortization expense

 

1,088

 

990

 

3,327

 

2,971

Professional fees and assessments

 

1,503

 

1,070

 

4,484

 

3,303

Marketing and business development

 

865

 

929

 

2,310

 

2,088

Supplies and postage

 

549

 

248

 

1,583

 

1,630

Travel

 

174

 

26

 

236

 

338

Mortgage and lending expenses

 

1,231

 

1,434

 

3,762

 

3,916

Other

 

887

 

855

 

2,712

 

3,540

Total noninterest expense

 

42,041

 

40,214

 

127,633

 

116,674

Income before income taxes

 

17,131

 

23,307

 

52,346

 

45,194

Income tax expense

 

4,064

 

5,648

 

12,370

 

10,698

Net income

$

13,067

$

17,659

$

39,976

$

34,496

Per Common Share Data

Basic earnings per common share

$

0.75

$

1.01

$

2.29

$

1.98

Diluted earnings per common share

$

0.74

$

0.99

$

2.26

$

1.94

Dividends declared per common share

$

0.16

$

0.15

$

0.47

$

0.45

Average common shares outstanding

 

17,205

 

17,121

 

17,182

 

17,101

Diluted average common shares outstanding

 

17,499

 

17,453

 

17,488

 

17,435

See accompanying notes to consolidated financial statements (unaudited)

2

Table of Contents

Alerus Financial Corporation and Subsidiaries

Consolidated Statements of Comprehensive Income (Unaudited)

Three months ended

Nine months ended

September 30, 

September 30, 

(dollars in thousands)

    

2021

    

2020

    

2021

    

2020

Net Income

$

13,067

$

17,659

$

39,976

$

34,496

Other Comprehensive Income (Loss), Net of Tax

 

  

 

  

 

  

 

  

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

 

(2,496)

 

2,459

 

(13,101)

 

14,212

Accretion of (gains) losses on debt securities reclassified to held-to-maturity

(106)

(221)

Reclassification adjustment for losses (gains) realized in income

 

(11)

 

(1,428)

 

(125)

 

(2,722)

Total other comprehensive income (loss), before tax

 

(2,613)

 

1,031

 

(13,447)

 

11,490

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

 

(656)

 

259

 

(3,375)

 

2,883

Other comprehensive income (loss), net of tax

 

(1,957)

 

772

 

(10,072)

 

8,607

Total comprehensive income

$

11,110

$

18,431

$

29,904

$

43,103

See accompanying notes to consolidated financial statements (unaudited)

3

Table of Contents

Alerus Financial Corporation and Subsidiaries

Consolidated Statements of Changes in Stockholders’ Equity (Unaudited)

Three months ended September 30, 2021

Accumulated

Additional

Other

Common

Paid-in

Retained

Comprehensive

(dollars and shares in thousands)

    

Stock

    

Capital

    

Earnings

    

Income (Loss)

    

Total

Balance as of June 30, 2021

$

17,198

$

91,273

$

233,397

$

2,523

$

344,391

Net income

 

 

 

13,067

 

 

13,067

Other comprehensive income (loss)

 

 

 

 

(1,957)

 

(1,957)

Common stock repurchased

 

(2)

 

(23)

 

(50)

 

 

(75)

Common stock dividends

 

 

 

(2,776)

 

 

(2,776)

Stock-based compensation expense

 

 

545

 

 

 

545

Vesting of restricted stock

 

12

(12)

 

 

 

Balance as of September 30, 2021

$

17,208

$

91,783

$

243,638

$

566

$

353,195

Nine months ended September 30, 2021

Accumulated

Additional

Other

Common

Paid-in

Retained

Comprehensive

(dollars in thousands)

    

Stock

    

Capital

    

Earnings

    

Income (Loss)

    

Total

Balance as of December 31, 2020

$

17,125

$

90,237

$

212,163

$

10,638

$

330,163

Net income

 

 

 

39,976

 

 

39,976

Other comprehensive income (loss)

 

 

 

 

(10,072)

 

(10,072)

Common stock repurchased

 

(18)

 

(157)

 

(346)

 

 

(521)

Common stock dividends

 

 

 

(8,155)

 

 

(8,155)

Share‑based compensation expense

 

8

 

1,796

 

 

 

1,804

Vesting of restricted stock

 

93

 

(93)

 

 

 

Balance as of September 30, 2021

$

17,208

$

91,783

$

243,638

$

566

$

353,195

Three months ended September 30, 2020

Accumulated

Additional

Other

Common

Paid-in

Retained

Comprehensive

(dollars in thousands)

    

Stock

    

Capital

    

Earnings

    

Income (Loss)

    

Total

Balance as of June 30, 2020

$

17,120

$

89,313

$

189,528

$

9,771

$

305,732

Net income

 

 

 

17,659

 

 

17,659

Other comprehensive income (loss)

 

 

 

 

772

 

772

Common stock repurchased

 

 

(29)

 

(7)

 

 

(36)

Common stock dividends

 

 

 

(2,599)

 

 

(2,599)

Stock-based compensation expense

 

 

475

 

 

 

475

Vesting of restricted stock

 

2

 

(2)

 

 

 

Balance as of September 30, 2020

$

17,122

$

89,757

$

204,581

$

10,543

$

322,003

Nine months ended September 30, 2020

Accumulated

Additional

Other

Common

Paid-in

Retained

Comprehensive

(dollars in thousands)

    

Stock

    

Capital

    

Earnings

    

Income (Loss)

    

Total

Balance as of December 31, 2019

$

17,050

$

88,650

$

178,092

$

1,936

$

285,728

Net income

 

 

 

34,496

 

 

34,496

Other comprehensive income (loss)

 

 

 

 

8,607

 

8,607

Common stock repurchased

 

(15)

 

(140)

 

(217)

 

 

(372)

Common stock dividends

 

 

 

(7,790)

 

 

(7,790)

Share‑based compensation expense

 

14

 

1,320

 

 

 

1,334

Vesting of restricted stock

 

73

 

(73)

 

 

 

Balance as of September 30, 2020

$

17,122

$

89,757

$

204,581

$

10,543

$

322,003

See accompanying notes to consolidated financial statements (unaudited)

4

Table of Contents

Alerus Financial Corporation and Subsidiaries

Consolidated Statements of Cash Flows (Unaudited)

Nine months ended

September 30, 

(dollars in thousands)

    

2021

    

2020

Operating Activities

 

  

 

  

Net income

$

39,976

$

34,496

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

 

  

 

  

Deferred income taxes

 

1,176

 

(3,620)

Provision for loan losses

 

(2,000)

 

9,500

Depreciation and amortization

 

6,726

 

6,657

Amortization and accretion of premiums/discounts on investment securities

 

2,506

 

1,140

Amortization of operating lease right-of-use assets

(40)

(18)

Stock-based compensation

 

1,804

 

1,334

Increase in value of bank-owned life insurance

 

(591)

 

(595)

Realized loss (gain) on sale of fixed assets

(62)

 

Realized loss (gain) on derivative instruments

 

6,612

 

(3,282)

Realized loss (gain) on loans sold

 

(39,940)

 

(37,220)

Realized loss (gain) on sale of foreclosed assets

 

(203)

 

(26)

Realized loss (gain) on sale of investment securities

 

(125)

 

(2,722)

Realized loss (gain) on servicing rights

 

(369)

 

574

Net change in:

 

 

Loans held for sale

 

101,482

 

(27,325)

Accrued interest receivable

 

826

 

(1,648)

Other assets

 

(1,951)

 

(2,842)

Accrued expenses and other liabilities

 

1,913

 

5,754

Net cash provided (used) by operating activities

 

117,740

 

(19,843)

Investing Activities

 

  

 

  

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

 

13,189

 

74,630

Proceeds from maturities of investment securities available-for-sale

 

91,240

 

39,208

Purchases of investment securities available-for-sale

 

(331,785)

 

(285,830)

Proceeds from sales or calls of investment securities held-to-maturity

1,763

Proceeds from maturities of investment securities held-to-maturity

2,681

Purchases of investment securities held-to-maturity

(218,443)

Net (increase) decrease in equity securities

2,808

Net (increase) decrease in loans

 

177,675

 

(339,758)

Purchases of premises and equipment

 

(845)

 

(2,761)

Proceeds from sales of foreclosed assets

 

539

 

555

Net cash provided (used) by investing activities

 

(263,986)

 

(511,148)

Financing Activities

 

  

 

  

Net increase (decrease) in deposits

 

141,095

 

491,054

Repayments of long-term debt

 

(49,861)

 

(156)

Proceeds from the issuance of subordinated debt

50,000

Cash dividends paid on common stock

 

(7,975)

 

(7,790)

Repurchase of common stock

 

(521)

 

(372)

Net cash provided (used) by financing activities

 

132,738

 

482,736

Net change in cash and cash equivalents

 

(13,508)

 

(48,255)

Cash and cash equivalents at beginning of period

 

172,962

 

144,006

Cash and cash equivalents at end of period

$

159,454

$

95,751

See accompanying notes to consolidated financial statements (unaudited)

5

Table of Contents

Nine months ended

September 30, 

Supplemental Cash Flow Disclosures

    

2021

    

2020

Cash paid for:

 

  

 

  

Interest

$

3,498

$

9,838

Income taxes

 

12,075

 

11,041

Non-cash information

 

  

 

  

Loan collateral transferred to foreclosed assets

 

1,135

 

531

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

 

(9,851)

 

8,607

Accretion of unrealized (gain) loss on investment securities held-to-maturity

(221)

Investment securities transferred to held-to-maturity

149,191

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

1,531

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

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, 2020, included in the Company’s Annual Report on Form 10-K filed with the SEC on March 12, 2021.

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.

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.

7

Table of Contents

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

As of September 30, 2021, the Coronavirus Disease, or COVID-19, pandemic is ongoing. During 2020, the COVID-19 pandemic created disruption in global supply chains, increased rates of unemployment and adversely impacted many industries, including industries related to the collateral underlying certain of our loans, and many of these effects are continuing. In 2021, the U.S. economy has, with certain setbacks, begun reopening and wider distribution of vaccines has encouraged greater economic activity. Nonetheless, the economic recovery could remain uneven, particularly given uncertainty with respect to the distribution and acceptance of the vaccines and their effectiveness with respect to new variants of the virus. 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.

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.

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.

Investment Securities

Held-to-maturity securities consist of debt securities, primarily obligations of state and political agencies. Held-to-maturity securities are carried at amortized cost based on the Company’s intent and ability to hold these securities to maturity. Interest earned on held-to-maturity debt securities is included in interest income. Amortization or accretion of premiums and discounts is also recognized in interest income using the effective interest method over the contractual life of the security and is adjusted to reflect actual prepayments. Transfers of debt securities from available-for-sale to held-to-maturity are made at fair value at the date of transfer. Unrealized holding gains and losses at the date of transfer are included in other comprehensive income and in the carrying value of the held-to-maturity security are amortized over the remaining life of the security.

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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, 2021, and those which are not yet effective and have been evaluated or are currently being evaluated by management as of September 30, 2021.

Adopted Pronouncements

In January 2020, the FASB issued ASU 2020-01, Investments – Equity Securities (Topic 321), Investments – Equity Method and Joint Ventures (Topic 323), and Derivatives and Hedging (Topic 815) – Clarifying the Interactions between Topic 321, Topic 323, and Topic 815. The ASU is based on a consensus of the Emerging Issues Task Force and is expected to increase comparability in accounting for these transactions. ASU 2016-01 made targeted improvements to accounting for financial instruments, including providing an entity the ability to measure certain equity securities without a readily determinable fair value at cost, less any impairment, plus or minus changes resulting from observable price changes in orderly transactions for the identical or a similar investment of the same issuer. Among other topics, the amendments clarify that an entity should consider observable transactions that require it to either apply or discontinue the equity method of accounting. For public business entities, the amendments in the ASU are effective for fiscal years beginning after December 15, 2020, and interim periods within those fiscal years. Early adoptions are permitted. The Company adopted ASU 2020-01 as of January 1, 2021 the implementation had no impact on its consolidated financial statements.

In March 2020, the FASB issued ASU 2020-04, Reference Rate Reform (Topic 848): Facilitation of the Effects of Reference Rate Reform on Financial Reporting. These amendments provide temporary optional guidance to ease the potential burden in accounting for reference rate reform. The ASU provides optional expedients and exceptions for applying GAAP to contract modifications and hedging relationships, subject to meeting certain criteria, that reference LIBOR or another reference rate expected to be discontinued. It is intended to help stakeholders during the global market-wide reference rate transition period. The guidance is effective for all entities as of March 12, 2020 through December 31, 2022. In January 2021, the FASB issued ASU 2021-01, Reference Rate Reform (Topic 848) in response to concerns about structural risks in accounting for reference rate reform. The ASU clarifies certain optional expedients and exceptions in Topic 848 for contract modifications and hedge accounting to apply to derivatives that are affected by the discontinuing transition. The Company adopted ASU 2020-04, as of March 2020 and is putting a transition plan together but does not expect adoption to 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. 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 on its 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.

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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. The Company will consider these clarifications and improvements in determining the appropriate adoption of ASU 2019-04.

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.

In March 2020, the FASB issued ASU 2020-03, Codification Improvements to Financial Instruments. This ASU represents changes to clarify or improve the Accounting Standards Codification, or ASC, related to seven topics. The amendments make the ASC easier to understand and easier to apply by eliminating inconsistencies and providing clarifications. Issues 1, 2, 3, 4, and 5 are conforming amendments and for public business entities effective upon the issuance of the standard. Issues 6 and 7 are amendments that affect the guidance in ASU 2016-13. The Company will consider these clarifications and improvements in determining the appropriate adoption of ASU 2016-13.

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 and the amortized cost, net unrealized gains, carrying value, gross unrealized gains and losses and fair value of for held-to-maturity as of September 30, 2021 and December 31, 2020:

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September 30, 2021

Amortized

Unrealized

Unrealized

Fair

(dollars in thousands)

    

Cost

Gains

Losses

    

Value

Available-for-sale

U.S. Treasury and agencies

$

5,382

$

87

$

$

5,469

Mortgage backed securities

 

  

 

 

 

Residential agency

 

523,743

 

2,219

 

(7,490)

 

518,472

Commercial

 

91,336

 

3,582

 

 

94,918

Asset backed securities

 

61

 

3

 

 

64

Corporate bonds

 

35,038

 

1,321

 

 

36,359

Total available-for-sale investment securities

655,560

7,212

(7,490)

655,282

Held-to-maturity

Obligations of state and political agencies

145,172

 

1,530

 

(29)

 

146,673

Mortgage backed securities

Residential agency

217,414

 

55

 

(602)

 

216,867

Total held-to-maturity investment securities

362,586

1,585

(631)

363,540

Total investment securities

$

1,018,146

$

8,797

$

(8,121)

$

1,018,822

December 31, 2020

Amortized

Unrealized

Unrealized

Fair

(dollars in thousands)

    

Cost

Gains

Losses

    

Value

Available-for-sale

U.S. Treasury and agencies

$

5,926

$

$

(19)

$

5,907

Obligations of state and political agencies

 

148,491

 

5,282

 

 

153,773

Mortgage backed securities

 

  

 

 

 

  

Residential agency

 

303,760

 

3,395

 

(436)

 

306,719

Commercial

 

89,300

 

5,678

 

 

94,978

Asset backed securities

 

109

 

6

 

 

115

Corporate bonds

 

30,552

 

388

 

(90)

 

30,850

Total available-for-sale investment securities

$

578,138

$

14,749

$

(545)

$

592,342

On April 1, 2021, the Company transferred its debt securities consisting of obligations of state and political agencies with a fair value of $149.2 million and a net unrealized gain of $1.3 million from available-for-sale to held-to-maturity.

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Gross unrealized losses on investment securities and the fair value of the related securities aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position as of September 30, 2021 and December 31, 2020, were as follows:

September 30, 2021

Less than 12 Months

Over 12 Months

Total

Unrealized

Fair

Unrealized

Fair

Unrealized

Fair

(dollars in thousands)

    

Losses

    

Value

    

Losses

    

Value

    

Losses

    

Value

Available-for-sale

U.S. Treasury and agencies

$

$

$

$

$

$

Mortgage backed securities

 

  

 

  

 

  

 

  

 

  

 

  

Residential agency

 

(7,416)

 

340,254

 

(74)

 

9,057

 

(7,490)

 

349,311

Commercial

 

 

 

 

 

 

Asset backed securities

 

 

 

 

2

 

 

2

Corporate bonds

 

 

 

 

 

 

Total available-for-sale investment securities

(7,416)

340,254

(74)

9,059

(7,490)

349,313

Held-to-maturity

Obligations of state and political agencies

(29)

22,550

(29)

22,550

Mortgage backed securities

Residential agency

(602)

80,145

(602)

80,145

Total held-to-maturity investment securities

(631)

102,695

(631)

102,695

Total investment securities

$

(8,047)

$

442,949

(74)

9,059

(8,121)

452,008

December 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

Available-for-sale

U.S. Treasury and agencies

$

(10)

$

4,509

$

(9)

$

1,309

$

(19)

$

5,818

Obligations of state and political agencies

 

 

 

 

 

 

Mortgage backed securities

 

  

 

  

 

  

 

  

 

  

 

  

Residential agency

 

(432)

 

68,494

 

(4)

 

2,356

 

(436)

 

70,850

Commercial

 

 

 

 

 

 

Asset backed securities

 

 

 

 

2

 

 

2

Corporate bonds

 

(90)

 

16,454

 

 

 

(90)

 

16,454

Total available-for-sale investment securities

$

(532)

$

89,457

$

(13)

$

3,667

$

(545)

$

93,124

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 and nine months ended September 30, 2021 and 2020, the Company did not recognize OTTI losses on its investment securities.

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The following table presents amortized cost and fair value of available-for-sale and held-to-maturity investment securities as of September 30, 2021, by contractual maturity:

Held-to-maturity

Available-for-sale

Carrying

Fair

Amortized

Fair

(dollars in thousands)

    

Value

Value

Cost

    

Value

Due within one year or less

$

4,690

$

4,690

$

$

Due after one year through five years

 

34,282

 

34,359

 

3,270

 

3,376

Due after five years through ten years

 

75,197

 

76,120

 

83,891

 

87,330

Due after 10 years

 

248,417

 

248,371

 

568,399

 

564,576

Total investment securities

$

362,586

$

363,540

$

655,560

$

655,282

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 a total carrying value of $165.5 million and $160.8 million were pledged as of September 30, 2021 and December 31, 2020, 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 and nine months ended September 30, 2021 and 2020, are displayed in the table below:

Three months ended

Nine months ended

September 30, 

September 30, 

(dollars in thousands)

    

2021

    

2020

    

2021

    

2020

Proceeds

$

$

35,125

$

13,189

$

74,630

Realized gains

 

 

1,428

 

114

 

2,722

Realized losses

 

 

 

 

Proceeds from the sale or call of held-to-maturity investment securities, for the three and nine months ended September 30, 2021 and 2020, are displayed in the table below:

Three months ended

Nine months ended

September 30, 

September 30, 

(dollars in thousands)

    

2021

    

2020

    

2021

    

2020

Proceeds

$

348

$

$

1,763

$

Realized gains

 

11

 

 

11

 

Realized losses

 

 

 

 

During the three and nine months ended September 30, 2021, the Company sold one held-to-maturity security with an amortized cost of $330 thousand. Proceeds from the sale totaled $348 thousand, resulting in realized gains of $11 thousand. For this sale of a held-to-maturity security, the Company received evidence of a significant deterioration of the issuer’s creditworthiness. There were no sales of held-to-maturity securities during the three and nine months ended September 30, 2020.

As of September 30, 2021 and December 31, 2020, the carrying value of the Company’s Federal Reserve stock and Federal Home Loan Bank of Des Moines, or FHLB, stock was as follows:

September 30, 

December 31, 

(dollars in thousands)

    

2021

    

2020

Federal Reserve

$

2,675

$

2,675

FHLB

 

3,827

 

3,090

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

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securities to be long-term investments. Accordingly, when evaluating these securities for impairment, management considers the ultimate recoverability of the par value rather than recognizing temporary declines in value.

Visa Class B Restricted Shares

In 2008, the Company received Visa Class B restricted shares as part of Visa’s initial public offering. These shares are transferable only under limited circumstances until they can be converted into the publicly traded Class A common shares. This conversion will not occur until the settlement of certain litigation which will be indemnified by Visa members, including the Company. Visa funded an escrow account from its initial public offering to settle these litigation claims. Should this escrow account be insufficient to cover these litigation claims, Visa is entitled to fund additional amounts to the escrow account by reducing each member bank’s Class B conversion ratio to unrestricted Class A shares. As of September 30, 2021, 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 owned as of September, 2021 and December 31, 2020, are carried at a zero cost basis.

NOTE 4 Loans and Allowance for Loan Losses

The following table presents total loans outstanding, by portfolio segment, as of September 30, 2021 and December 31, 2020:

    

September 30, 

    

December 31, 

(dollars in thousands)

    

2021

    

2020

Commercial

Commercial and industrial (1)

$

506,599

$

691,858

Real estate construction

 

37,751

 

44,451

Commercial real estate

 

573,518

 

563,007

Total commercial

 

1,117,868

 

1,299,316

Consumer

 

  

 

  

Residential real estate first mortgage

 

501,339

 

463,370

Residential real estate junior lien

 

130,243

 

143,416

Other revolving and installment

 

50,936

 

73,273

Total consumer

 

682,518

 

680,059

Total loans

$

1,800,386

$

1,979,375

(1)Included Paycheck Protection Program, or PPP, loans of $103.5 million at September 30, 2021 and $268.4 million at December 31, 2020.

Total loans included net deferred loan fees and costs of $2.4 million and $4.7 million at September 30, 2021 and December 31, 2020, respectively. Deferred loan fees on PPP loans were $2.9 million at September 30, 2021 and $4.3 million at December 31, 2020.

Management monitors the credit quality of its loan portfolio on an ongoing basis. Measurements 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. Loan modifications made in accordance with the Interagency Statement on Loan Modifications and Reporting for Financial Institutions as issued on April 7, 2020, are included as accruing current.

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The following tables present a past due aging analysis of total loans outstanding, by portfolio segment, as of September 30, 2021 and December 31, 2020:

September 30, 2021

90 Days

Accruing

30 - 89 Days

or More

Total

(dollars in thousands)

    

Current

    

Past Due

    

Past Due

    

Nonaccrual

    

Loans

Commercial

 

  

 

  

 

  

 

  

 

  

Commercial and industrial

$

504,309

$

657

$

$

1,633

$

506,599

Real estate construction

 

37,751

 

 

 

 

37,751

Commercial real estate

 

569,209

 

 

 

4,309

 

573,518

Total commercial

 

1,111,269

 

657

 

 

5,942

 

1,117,868

Consumer

 

  

 

  

 

  

 

  

 

  

Residential real estate first mortgage

 

500,350

 

876

 

 

113

 

501,339

Residential real estate junior lien

 

129,521

 

552

 

 

170

 

130,243

Other revolving and installment

 

50,735

 

197

 

 

4

 

50,936

Total consumer

 

680,606

 

1,625

 

 

287

 

682,518

Total loans

$

1,791,875

$

2,282

$

$

6,229

$

1,800,386

December 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

$

689,340

$

500

$

30

$

1,988

$

691,858

Real estate construction

 

44,451

 

 

 

 

44,451

Commercial real estate

 

558,127

 

2,449

 

 

2,431

 

563,007

Total commercial

 

1,291,918

 

2,949

 

30

 

4,419

 

1,299,316

Consumer

 

  

 

  

 

  

 

  

 

  

Residential real estate first mortgage

 

461,179

 

1,752

 

 

439

 

463,370

Residential real estate junior lien

 

143,060

 

191

 

 

165

 

143,416

Other revolving and installment

 

73,128

 

118

 

 

27

 

73,273

Total consumer

 

677,367

 

2,061

 

 

631

 

680,059

Total loans

$

1,969,285

$

5,010

$

30

$

5,050

$

1,979,375

The Company’s consumer loan portfolio is primarily comprised of secured 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.

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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.

The tables below present total loans outstanding, by loan portfolio segment, and risk category as of September 30, 2021 and December 31, 2020:

September 30, 2021

Criticized

Special

(dollars in thousands)

    

Pass

    

Mention

    

Substandard

    

Doubtful

    

Total

Commercial

 

  

 

  

 

  

 

  

 

  

Commercial and industrial

$

498,201

$

1,777

$

6,374

$

247

$

506,599

Real estate construction

 

37,751

 

 

 

 

37,751

Commercial real estate

 

553,492

 

2,316

 

17,710

 

 

573,518

Total commercial

1,089,444

4,093

24,084

247

1,117,868

Consumer

 

  

 

  

 

  

 

  

 

  

Residential real estate first mortgage

 

499,497

 

 

1,842

 

 

501,339

Residential real estate junior lien

 

129,303

 

 

940

 

 

130,243

Other revolving and installment

 

50,932

 

 

4

 

 

50,936

Total consumer

 

679,732

 

 

2,786

 

 

682,518

Total loans

$

1,769,176

$

4,093

$

26,870

$

247

$

1,800,386

December 31, 2020

Criticized

Special

(dollars in thousands)

    

Pass

    

Mention

    

Substandard

    

Doubtful

    

Total

Commercial

 

  

 

  

 

  

 

  

 

  

Commercial and industrial

$

669,602

$

5,415

$

16,841

$

$

691,858

Real estate construction

 

44,451

 

 

 

 

44,451

Commercial real estate

 

533,733

 

6,686

 

22,588

 

 

563,007

Total commercial

1,247,786

12,101

39,429

1,299,316

Consumer

 

  

 

  

 

  

 

  

 

  

Residential real estate first mortgage

 

461,221

 

1,406

 

743

 

 

463,370

Residential real estate junior lien

 

140,461

 

1,819

 

1,136

 

 

143,416

Other revolving and installment

 

73,236

 

 

37

 

 

73,273

Total consumer

 

674,918

 

3,225

 

1,916

 

 

680,059

Total loans

$

1,922,704

$

15,326

$

41,345

$

$

1,979,375

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.

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The following tables present, by loan portfolio segment, a summary of the changes in the allowance for loan losses for the three and nine months ended September 30, 2021 and 2020:

Three months ended September 30, 2021

Beginning

Provision for

Loan

Loan

Ending

(dollars in thousands)

    

Balance

    

Loan Losses

    

Charge-offs

    

Recoveries

    

Balance

Commercial

 

  

 

  

 

  

 

  

 

  

Commercial and industrial

$

9,620

$

(825)

$

(747)

$

1,052

$

9,100

Real estate construction

 

587

 

92

 

 

 

679

Commercial real estate

 

12,937

 

(413)

 

 

 

12,524

Total commercial

 

23,144

 

(1,146)

 

(747)

 

1,052

 

22,303

Consumer

 

  

 

  

 

  

 

  

 

  

Residential real estate first mortgage

 

6,176

 

625

 

 

 

6,801

Residential real estate junior lien

 

1,401

 

6

 

 

16

 

1,423

Other revolving and installment

 

574

 

(32)

 

(46)

 

27

 

523

Total consumer

 

8,151

 

599

 

(46)

 

43

 

8,747

Unallocated

 

2,469

 

(1,453)

 

 

 

1,016

Total

$

33,764

$

(2,000)

$

(793)

$

1,095

$

32,066

Nine months ended September 30, 2021

Beginning

Provision for

Loan

Loan

Ending

(dollars in thousands)

    

Balance

    

Loan Losses

    

Charge-offs

    

Recoveries

    

Balance

Commercial

Commercial and industrial

$

10,205

$

(1,378)

$

(1,224)

$

1,497

$

9,100

Real estate construction

658

21

679

Commercial real estate

14,105

(1,049)

(536)

4

12,524

Total commercial

24,968

(2,406)

(1,760)

1,501

22,303

Consumer

Residential real estate first mortgage

5,774

1,027

6,801

Residential real estate junior lien

1,373

(63)

113

1,423

Other revolving and installment

753

(196)

(139)

105

523

Total consumer

7,900

768

(139)

218

8,747

Unallocated

1,378

(362)

1,016

Total

$

34,246

$

(2,000)

$

(1,899)

$

1,719

$

32,066

Three months ended September 30, 2020

Beginning

Provision for

Loan

Loan

Ending

(dollars in thousands)

    

Balance

    

Loan Losses

    

Charge-offs

    

Recoveries

    

Balance

Commercial

Commercial and industrial

$

10,797

$

(846)

$

(10)

$

432

$

10,373

Real estate construction

443

 

40

 

 

483

Commercial real estate

9,948

 

1,828

 

 

95

11,871

Total commercial

21,188

 

1,022

 

(10)

 

527

22,727

Consumer

 

  

 

  

 

  

Residential real estate first mortgage

2,673

 

1,694

 

 

4,367

Residential real estate junior lien

1,102

 

28

 

 

81

1,211

Other revolving and installment

546

 

108

 

(41)

 

24

637

Total consumer

4,321

1,830

(41)

105

6,215

Unallocated

1,747

 

648

2,395

Total

$

27,256

$

3,500

$

(51)

$

632

$

31,337

17

Table of Contents

Nine months ended September 30, 2020

Beginning

Provision for

Loan

Loan

Ending

(dollars in thousands)

    

Balance

    

Loan Losses

    

Charge-offs

    

Recoveries

    

Balance

Commercial

 

  

 

  

 

  

 

  

 

  

Commercial and industrial

$

12,270

$

(498)

$

(2,745)

$

1,346

$

10,373

Real estate construction

 

303

 

180

 

 

 

483

Commercial real estate

 

6,688

 

5,953

 

(865)

 

95

 

11,871

Total commercial

 

19,261

 

5,635

 

(3,610)

 

1,441

 

22,727

Consumer

 

 

  

 

  

 

  

 

  

Residential real estate first mortgage

 

1,448

 

2,914

 

 

5

 

4,367

Residential real estate junior lien

 

671

 

377

 

(12)

 

175

 

1,211

Other revolving and installment

 

352

 

371

 

(194)

 

108

 

637

Total consumer

 

2,471

 

3,662

 

(206)

 

288

 

6,215

Unallocated

 

2,192

 

203

 

 

 

2,395

Total

$

23,924

$

9,500

$

(3,816)

$

1,729

$

31,337

The following tables present the recorded investment in loans and related allowance for loan losses, by loan portfolio segment, disaggregated on the basis of the Company’s impairment methodology, as of September 30, 2021 and December 31, 2020:

September 30, 2021

Recorded Investment

Allowance for Loan Losses

Individually

Collectively

Individually

Collectively

(dollars in thousands)

    

Evaluated

    

Evaluated

    

Total

    

Evaluated

    

Evaluated

    

Total

Commercial

  

 

  

 

  

Commercial and industrial

$

2,161

$

504,438

$

506,599

$

536

$

8,564

$

9,100

Real estate construction

 

 

37,751

 

37,751

679

679

Commercial real estate

 

4,493

 

569,025

 

573,518

11

12,513

12,524

Total commercial

 

6,654

 

1,111,214

 

1,117,868

547

21,756

22,303

Consumer

 

  

 

  

 

  

Residential real estate first mortgage

 

121

 

501,218

 

501,339

6,801

6,801

Residential real estate junior lien

 

172

 

130,071

 

130,243

8

1,415

1,423

Other revolving and installment

 

4

 

50,932

 

50,936

4

519

523

Total consumer

 

297

 

682,221

 

682,518

12

8,735

8,747

Unallocated

1,016

Total loans

$

6,951

$

1,793,435

$

1,800,386

$

559

$

30,491

$

32,066

December 31, 2020

Recorded Investment

Allowance for Loan Losses

Individually

Collectively

Individually

Collectively

(dollars in thousands)

    

Evaluated

    

Evaluated

    

Total

    

Evaluated

    

Evaluated

    

Total

Commercial

  

 

  

 

  

Commercial and industrial

$

2,616

$

689,242

$

691,858

$

336

$

9,869

$

10,205

Real estate construction

 

 

44,451

 

44,451

658

658

Commercial real estate

 

5,224

 

557,783

 

563,007

837

13,268

14,105

Total commercial

 

7,840

 

1,291,476

 

1,299,316

1,173

23,795

24,968

Consumer

 

  

 

  

 

  

Residential real estate first mortgage

 

439

 

462,931

 

463,370

5,774

5,774

Residential real estate junior lien

 

224

143,192

 

143,416

19

1,354

1,373

Other revolving and installment

 

27

 

73,246

 

73,273

13

740

753

Total consumer

 

690

 

679,369

 

680,059

32

7,868

7,900

Unallocated

1,378

Total loans

$

8,530

$

1,970,845

$

1,979,375

$

1,205

$

31,663

$

34,246

18

Table of Contents

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

September 30, 2021

 

December 31, 2020

Recorded

Unpaid

Related

 

Recorded

Unpaid

Related

(dollars in thousands)

    

Investment

    

Principal

    

Allowance

    

Investment

    

Principal

    

Allowance

Impaired loans with a valuation allowance

 

  

 

  

 

  

Commercial and industrial

$

710

$

725

$

536

$

723

$

725

$

336

Commercial real estate

 

777

 

920

 

11

 

3,948

 

3,974

 

837

Residential real estate junior lien

 

8

 

8

8

19

 

20

19

Other revolving and installment

 

4

 

4

 

4

27

 

27

 

13

Total impaired loans with a valuation allowance

1,499

1,657

559

4,717

4,746

1,205

Impaired loans without a valuation allowance

 

  

 

  

 

  

  

 

  

 

  

Commercial and industrial

1,451

1,603

1,893

2,173

Commercial real estate

 

3,716

3,872

 

1,276

 

1,415

 

Residential real estate first mortgage

 

121

 

123

 

439

 

464

 

Residential real estate junior lien

 

164

 

194

 

205

 

306

 

Other revolving and installment

 

 

 

 

 

Total impaired loans without a valuation allowance

5,452

5,792

3,813

4,358

Total impaired loans

 

  

 

  

 

  

  

 

  

 

  

Commercial and industrial

2,161

2,328

536

2,616

2,898

336

Commercial real estate

 

4,493

 

4,792

 

11

 

5,224

 

5,389

 

837

Residential real estate first mortgage

121

123

439

464

Residential real estate junior lien

 

172

 

202

 

8

 

224

 

326

 

19

Other revolving and installment

 

4

 

4

 

4

 

27

 

27

 

13

Total impaired loans

$

6,951

$

7,449

$

559

$

8,530

$

9,104

$

1,205

The table below presents the average recorded investment in impaired loans and interest income for the three and nine months ended September 30, 2021 and 2020:

Three months ended September 30, 

2021

2020

Average

Average

Recorded

Interest

Recorded

Interest

(dollars in thousands)

    

Investment

    

Income

    

Investment

    

Income

Impaired loans with a valuation allowance

Commercial and industrial

$

719

$

3

$

2,541

$

14

Commercial real estate

779

2

197

8

Residential real estate first mortgage

Residential real estate junior lien

8

19

Other revolving and installment

4

Total impaired loans with a valuation allowance

1,510

5

2,757

22

Impaired loans without a valuation allowance

 

Commercial and industrial

2,016

5

1,013

24

Commercial real estate

3,793

1,330

Residential real estate first mortgage

121

459

Residential real estate junior lien

166

211

3

Other revolving and installment

Total impaired loans without a valuation allowance

6,096

5

3,013

27

Total impaired loans

Commercial and industrial

2,735

8

3,554

38

Commercial real estate

4,572

2

1,527

8

Residential real estate first mortgage

121

459

Residential real estate junior lien

174

230

3

Other revolving and installment

4

Total impaired loans

$

7,606

$

10

$

5,770

$

49

19

Table of Contents

Nine Months Ended September 30, 

2021

2020

Average

Average

Recorded

Interest

Recorded

Interest

(dollars in thousands)

    

Investment

    

Income

    

Investment

    

Income

Impaired loans with a valuation allowance

 

  

 

  

 

  

 

  

Commercial and industrial

$

818

$

10

$

3,815

$

14

Commercial real estate

 

782

 

6

 

200

 

8

Residential real estate junior lien

 

11

 

 

20

 

Other revolving and installment

 

3

 

 

 

Total impaired loans with a valuation allowance

1,614

16

4,035

22

Impaired loans without a valuation allowance

  

 

  

 

  

 

  

Commercial and industrial

2,061

15

1,154

26

Commercial real estate

 

3,980

 

 

1,699

 

Residential real estate first mortgage

 

114

 

 

467

 

Residential real estate junior lien

 

190

 

 

217

3

Other revolving and installment

 

 

 

 

Total impaired loans without a valuation allowance

6,345

15

3,537

29

Total impaired loans

 

  

 

  

 

  

 

  

Commercial and industrial

2,879

25

4,969

40

Commercial real estate

 

4,762

 

6

 

1,899

 

8

Residential real estate first mortgage

 

114

 

 

467

 

Residential real estate junior lien

 

201

 

 

237

 

3

Other revolving and installment

 

3

 

 

 

Total impaired loans

$

7,959

$

31

$

7,572

$

51

Loans with a carrying value of $1.2 billion as of September 30, 2021 and December 31, 2020, respectively, 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 a reduction of interest rates, an 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 third quarter of 2021, there were no loans modified as a TDR as a result of changing the terms allowing for interest rate reductions and an extension of the maturity dates. During the third quarter of 2020, there were no loans modified as a TDR.

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

Beginning in 2020, in accordance with the Interagency Statement on Loan Modifications and Reporting for Financial Institutions as issued on April 7, 2020, through September 30, 2021, the Company had entered into modifications on 587 loans representing $154.5 million in principal balances, since the beginning of the COVID-19 pandemic. Of those loans, 8 loans with a total outstanding principal balance of $3.4 million, have been granted additional deferrals, 2 loans with a total outstanding principal balance of $69 thousand remain on the first deferral and the remaining loans have been returned to a normal payment status. These deferrals were generally no more than 90 days in duration and were not considered TDRs.

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Table of Contents

NOTE 5 Goodwill and Other Intangible Assets

The following table summarizes the carrying amount of goodwill, by segment, as of September 30, 2021 and December 31, 2020:

September 30, 

December 31, 

(dollars in thousands)

    

2021

    

2020

Banking

$

20,131

$

20,131

Retirement and benefit services

10,070

10,070

Total goodwill

$

30,201

$

30,201

Goodwill is evaluated for impairment on an annual basis, at a minimum, and more frequently when the economic environment warrants. The Company determined that there was no goodwill impairment as of September 30, 2021.

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

September 30, 2021

December 31, 2020

(dollars in thousands)

    

Gross Carrying Amount

    

Accumulated Amortization

    

Total

    

Gross Carrying Amount

    

Accumulated Amortization

    

Total

Identifiable customer intangibles

$

43,346

$

(20,753)

$

22,593

$

43,346

$

(17,490)

$

25,856

Core deposit intangible assets

3,793

(3,730)

63

Total intangible assets

$

43,346

$

(20,753)

$

22,593

$

47,139

$

(21,220)

$

25,919

Amortization of intangible assets was $1.1 million and $1.0 million for the three months ended September 30, 2021, and 2020, respectively. Amortization of intangible assets was $3.3 million and $3.0 million for the nine months ended September 30, 2021, and 2020, 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 $401.4 million and $445.5 million as of September 30, 2021 and December 31, 2020, respectively. Servicing loans for others generally consists of collecting mortgage payments, maintaining escrow accounts, disbursing payments to investors and collection and foreclosure processing. Loan servicing income is recorded on an accrual basis and includes servicing fees from investors and certain charges collected from borrowers, such as late payment fees, and is net of fair value adjustments to capitalized mortgage servicing rights.

The following table summarizes the Company’s activity related to servicing rights for the three and nine months ended September 30, 2021 and 2020:

    

Three months ended

    

Nine months ended

September 30, 

September 30, 

(dollars in thousands)

    

2021

    

2020

    

2021

    

2020

Balance, beginning of period

$

1,964

$

2,891

$

1,987

$

3,845

Additions

84

42

 

195

 

154

Amortization

(195)

(296)

 

(580)

 

(692)

(Impairment)/Recovery

(77)

(58)

 

174

 

(728)

Balance, end of period

$

1,776

$

2,579

$

1,776

$

2,579

21

Table of Contents

The following is a summary of key data and assumptions used in the valuation of servicing rights as of September 30, 2021 and December 31, 2020. Increases or decreases in any one of these assumptions would result in lower or higher fair value measurements.

    

September 30, 

    

December 31, 

 

(dollars in thousands)

2021

2020

Fair value of servicing rights

$

1,776

$

1,987

Weighted-average remaining term, years

 

20.4

 

20.1

Prepayment speeds

 

15.4

%  

 

17.7

%

Discount rate

 

9.3

%  

 

9.0

%

NOTE 7 Leases

Substantially all of the leases in which the Company is the lessee are comprised of real estate property for offices and office equipment rentals with terms extending through 2027. 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 right-of-use, or ROU, assets and lease liabilities on the consolidated financial statements.

    

    

    

September 30, 

    

December 31, 

(dollars in thousands)

 

 

2021

 

2020

Lease Right-of-Use Assets

Classification

Operating lease right-of-use assets

 

Operating lease right-of-use assets

$

3,821

$

6,918

Finance lease right-of-use assets

 

Land, premises and equipment, net

 

116

 

202

Total lease right-of-use assets

$

3,937

$

7,120

Lease Liabilities

 

  

 

 

  

Operating lease liabilities

 

Operating lease liabilities

$

4,428

$

7,861

Finance lease liabilities

 

Long-term debt

 

261

 

430

Total lease liabilities

$

4,689

$

8,291

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.

September 30, 

December 31, 

 

    

2021

    

2020

Weighted-average remaining lease term, years

Operating leases

 

3.4

5.8

Finance leases

 

1.0

1.8

Weighted-average discount rate

 

  

Operating leases

 

2.6

%

2.9

%

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

22

Table of Contents

payments such as common area maintenance and utilities. Variable lease cost also includes payments for usage or maintenance of those capitalized equipment operating leases.

The following table presents lease costs and other lease information for the three and nine months ending September 30, 2021 and 2020.

    

Three months ended

    

Nine months ended

September 30, 

September 30, 

(dollars in thousands)

    

2021

    

2020

    

2021

2020

Lease costs

 

 

  

Operating lease cost

$

429

$

634

$

1,417

$

1,825

Variable lease cost

192

223

 

583

 

888

Short-term lease cost

89

102

 

172

 

304

Finance lease cost

 

  

 

  

Interest on lease liabilities

7

10

 

22

 

33

Amortization of right-of-use assets

29

29

 

87

 

87

Sublease income

(51)

(57)

 

(163)

 

(175)

Net lease cost

$

695

$

941

$

2,118

$

2,962

Other information

 

  

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

$

411

$

628

$

1,372

$

1,807

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

 

1,531

Future minimum payments for finance and operating leases with initial or remaining terms of one year or more as of September 30, 2021 were as follows:

Finance

Operating

(dollars in thousands)

    

Leases

    

Leases

Twelve months ended

September 30, 2022

$

251

$

1,597

September 30, 2023

 

21

 

1,439

September 30, 2024

 

 

676

September 30, 2025

 

 

389

September 30, 2026

 

 

250

Thereafter

 

 

238

Total future minimum lease payments

$

272

$

4,589

Amounts representing interest

 

(11)

 

(161)

Total operating lease liabilities

$

261

$

4,428

NOTE 8 Deposits

The components of deposits in the consolidated balance sheets as of September 30, 2021 and December 31, 2020 were as follows:

September 30, 

December 31, 

(dollars in thousands)

    

2021

    

2020

Noninterest-bearing

$

797,062

$

754,716

Interest-bearing

 

  

 

  

Interest-bearing demand

 

673,916

 

618,900

Savings accounts

 

92,632

 

79,902

Money market savings

 

924,678

 

909,137

Time deposits

 

224,800

 

209,338

Total interest-bearing

 

1,916,026

 

1,817,277

Total deposits

$

2,713,088

$

2,571,993

23

Table of Contents

NOTE 9 Long-Term Debt

Long-term debt as of September 30, 2021 and December 31, 2020 consisted of the following:

September 30, 2021

Period End

Face

Carrying

Interest

Maturity

(dollars in thousands)

    

Value

    

Value

    

Interest Rate

    

Rate

    

Date

    

Call Date

Subordinated notes payable

$

50,000

$

50,000

Fixed

3.50

%  

3/30/2031

3/31/2026

Junior subordinated debenture (Trust I)

4,124

3,481

 

Three-month LIBOR + 3.10%

3.23

%  

6/26/2033

 

6/26/2008

Junior subordinated debenture (Trust II)

 

6,186

 

5,221

 

Three-month LIBOR + 1.80%

1.92

%  

9/15/2036

 

9/15/2011

Finance lease liability

 

2,700

 

261

 

Fixed

 

7.81

%  

10/31/2022

 

N/A

Total long-term debt

$

63,010

$

58,963

 

  

 

  

 

  

 

  

December 31, 2020

Period End

Face

Carrying

Interest

Maturity

(dollars in thousands)

    

Value

    

Value

    

Interest Rate

    

Rate

    

Date

    

Call Date

Subordinated notes payable

$

50,000

$

49,688

 

Three-month LIBOR + 4.12%

 

4.36

%  

12/30/2025

 

12/30/2020

Junior subordinated debenture (Trust I)

 

4,124

 

3,447

 

Three-month LIBOR + 3.10%

3.35

%  

6/26/2033

 

6/26/2008

Junior subordinated debenture (Trust II)

 

6,186

 

5,170

 

Three-month LIBOR + 1.80%

2.02

%  

9/15/2036

 

9/15/2011

Finance lease liability

 

2,700

 

430

 

Fixed

 

7.81

%  

10/31/2022

 

N/A

Total long-term debt

$

63,010

$

58,735

 

  

 

  

 

  

 

  

NOTE 10 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.

A summary of the contractual amounts of the Company’s exposure to off-balance sheet risk was as follows:

September 30, 

December 31, 

(dollars in thousands)

    

2021

    

2020

Commitments to extend credit

$

622,465

$

611,140

Standby letters of credit

 

11,028

 

6,510

Total

$

633,493

$

617,650

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.

24

Table of Contents

The Company utilizes standby letters of credit issued by either the FHLB or the Bank of North Dakota to secure public unit deposits. The Company had a $150 thousand letter of credit with the FHLB as of September 30, 2021 and December 31, 2020. With the Bank of North Dakota, the Company had no letters of credit outstanding as of September 30, 2021 and December 31, 2020. Bank of North Dakota letters of credit were collateralized by loans pledged to the Bank of North Dakota in the amount of $230.2 million and $245.7 million as of September 30, 2021 and December 31, 2020, respectively.

NOTE 11 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 awards 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 authorizes the issuance of up to 1,100,000 shares of common stock. As of September 30, 2021, 37,789 stock awards and 91,302 restricted stock units had been issued under the plan.

Compensation expense relating to awards under these plans was $545 thousand and $475 thousand for the three months ended September 30, 2021 and 2020, respectively. Compensation expense relating to awards under these plans was $1.8 million and $1.3 million for the nine months ended September 30, 2021 and 2020, respectively.

The following table presents the activity in the stock plans for the nine months ended September 30, 2021 and 2020:

Nine months ended September 30, 2021

Nine months ended September 30, 2020

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

 

325,030

 

$

19.48

347,211

 

$

18.64

Granted

 

66,664

 

26.63

77,846

 

19.53

Vested

 

(101,108)

 

20.46

(87,939)

 

16.24

Forfeited or cancelled

 

 

(7,590)

 

19.75

Outstanding at end of period

290,586

$

20.77

329,528

$

19.46

As of September 30, 2021, there was $2.5 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 3.31 years.

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NOTE 12 Income Taxes

The components of income tax expense (benefit) for the three and nine months ended September 30, 2021 and 2020 were as follows:

Three months ended September 30, 

2021

2020

    

    

Percent of

  

  

    

Percent of

  

(dollars in thousands)

Amount

Pretax Income

  

Amount

Pretax Income

  

Taxes at statutory federal income tax rate

$

3,598

 

21.0

%

$

4,894

 

21.0

Tax effect of:

 

 

Tax exempt income

(134)

 

(0.8)

%

(134)

 

(0.6)

Other

600

 

3.5

%

888

 

3.8

Applicable income taxes

$

4,064

23.7

%

$

5,648

24.2

Nine months ended September 30, 

2021

2020

    

    

Percent of

  

  

    

Percent of

 

(dollars in thousands)

Amount

Pretax Income

  

Amount

Pretax Income

 

Taxes at statutory federal income tax rate

$

10,993

 

21.0

$

9,491

 

21.0

%

Tax effect of:

 

  

 

  

 

  

 

  

Tax exempt income

 

(434)

 

(0.8)

 

(382)

 

(0.8)

%

Other

1,811

3.5

1,589

3.5

%

Applicable income taxes

$

12,370

 

23.7

$

10,698

 

23.7

%

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

NOTE 13 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.

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

Three months ended September 30, 2021

Retirement and

Wealth

Corporate

(dollars in thousands)

    

Banking

    

Benefit Services

    

Management

    

Mortgage

    

Administration

    

Consolidated

Net interest income

$

21,168

$

$

$

499

$

(535)

$

21,132

Provision for loan losses

 

(2,000)

 

 

 

 

 

(2,000)

Noninterest income

 

1,576

 

18,031

 

5,295

 

11,116

 

22

 

36,040

Noninterest expense

 

11,403

 

10,320

 

2,219

 

8,464

 

9,635

 

42,041

Net income before taxes

$

13,341

$

7,711

$

3,076

$

3,151

$

(10,148)

$

17,131

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Table of Contents

    

Nine months ended September 30, 2021

Retirement and

Wealth

Corporate

(dollars in thousands)

    

Banking

    

Benefit Services

    

Management

    

Mortgage

    

Administration

    

Consolidated

Net interest income

$

64,236

$

$

$

1,435

$

(1,361)

$

64,310

Provision for loan losses

(2,000)

(2,000)

Noninterest income

4,564

53,157

15,419

40,535

(6)

113,669

Noninterest expense

33,401

 

30,420

 

6,682

 

29,978

27,152

127,633

Net income before taxes

$

37,399

$

22,737

$

8,737

$

11,992

$

(28,519)

$

52,346

Three months ended September 30, 2020

Retirement and

Wealth

Corporate

(dollars in thousands)

    

Banking

    

Benefit Services

    

Management

    

Mortgage

    

Administration

    

Consolidated

Net interest income

$

21,994

$

$

$

613

$

(842)

$

21,765

Provision for loan losses

3,500

3,500

Noninterest income

3,398

15,104

4,486

22,269

(1)

45,256

Noninterest expense

10,876

 

8,347

 

2,110

 

9,769

9,112

40,214

Net income before taxes

$

11,016

$

6,757

$

2,376

$

13,113

$

(9,955)

$

23,307

    

Nine months ended September 30, 2020

Retirement and

Wealth

Corporate

(dollars in thousands)

    

Banking

    

Benefit Services

    

Management

    

Mortgage

    

Administration

    

Consolidated

Net interest income

$

61,857

$

$

$

1,411

$

(2,575)

$

60,693

Provision for loan losses

 

9,500

 

 

 

 

 

9,500

Noninterest income

 

8,129

 

45,034

 

12,644

 

44,860

 

8

 

110,675

Noninterest expense

 

34,887

 

25,472

 

6,254

 

23,228

 

26,833

 

116,674

Net income before taxes

$

25,599

$

19,562

$

6,390

$

23,043

$

(29,400)

$

45,194

Banking

The Banking division offers a complete line of loan, deposit, cash management, and treasury services through fourteen 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; and payroll and HRIS services for employers. In addition, the division operates within each of the banking markets, as well as in Lansing, Michigan and Littleton, Colorado.

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.

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Table of Contents

NOTE 14 Earnings Per Share

The calculation of basic and diluted earnings per share using the two-class method for the three and nine months ending September 30, 2021 and 2020 are presented below:

Three months ended

Nine months ended

September 30, 

September 30, 

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

    

2021

    

2020

    

2021

    

2020

Net income

$

13,067

$

17,659

$

39,976

$

34,496

Dividends and undistributed earnings allocated to participating securities

196

315

628

600

Net income available to common shareholders

$

12,871

$

17,344

$

39,348

$

33,896

Weighted-average common shares outstanding for basic earnings per share

17,205

17,121

17,182

 

17,101

Dilutive effect of stock-based awards

294

 

332

 

306

 

334

Weighted-average common shares outstanding for diluted earnings per share

17,499

17,453

17,488

17,435

Earnings per common share:

Basic earnings per common share

$

0.75

$

1.01

$

2.29

$

1.98

Diluted earnings per common share

$

0.74

$

0.99

$

2.26

$

1.94

NOTE 15 Derivative Instruments

The Company enters into interest rate swaps to facilitate client transactions and meet their financing needs. Upon entering into these instruments to meet client needs, the Company enters into offsetting positions with U.S. financial institutions in order to minimize risk to the Company. These swaps are derivatives but are not designated as hedging instruments.

The Company did not have any derivatives designated as hedging instruments as of September 30, 2021 and December 31, 2020. The following table presents the amounts recorded in the Company’s consolidated balance sheets, for derivatives not designated as hedging instruments, as of September 30, 2021 and December 31, 2020:

September 30, 2021

December 31, 2020

Fair

Notional

Fair

Notional

(dollars in thousands)

    

    

Value

    

Amount

    

Value

    

Amount

Asset Derivatives

 

Consolidated Balance Sheet Location

 

  

 

  

 

  

 

  

Interest rate swaps

 

Other assets

$

1,060

$

45,171

$

569

$

44,597

Interest rate lock commitments

 

Other assets

2,813

107,769

10,124

270,103

Forward loan sales commitments

 

Other assets

 

602

 

18,877

 

2,664

 

86,990

TBA mortgage backed securities

 

Other assets

 

405

 

189,470

 

 

Total asset derivatives

 

  

$

4,880

$

361,287

$

13,357

$

401,690

Liability Derivatives

 

  

 

  

 

  

 

  

 

  

Interest rate swaps

 

Accrued expenses and other liabilities

$

1,062

$

45,171

$

572

$

44,597

TBA mortgage backed securities

 

Accrued expenses and other liabilities

2,339

307,000

Total liability derivatives

 

  

$

1,062

$

45,171

$

2,911

$

351,597

The gain (loss) recognized on derivative instruments for the three and nine months ended September 30, 2021 and 2020 was as follows:

28

Table of Contents

Three months ended

Nine months ended

Consolidated Statements

September 30, 

September 30, 

September 30, 

September 30, 

(dollars in thousands)

    

of Income Location

    

2021

    

2020

    

2021

    

2020

Interest rate swaps

 

Other noninterest income

$

1

$

(3)

$

2

$

(3)

Interest rate lock commitments

 

Mortgage banking

(1,793)

5,650

(7,298)

11,229

Forward loan sales commitments

 

Mortgage banking

(499)

369

(2,061)

1,152

TBA mortgage backed securities

 

Mortgage banking

(690)

(3,747)

 

4,865

 

(9,099)

Total gain/(loss) from derivative instruments

 

$

(2,981)

$

2,269

$

(4,492)

$

3,279

The Company has third party agreements that require a minimum dollar transfer amount upon a margin call. This requirement is dependent on certain specified credit measures. The amount of collateral posted with third parties at September 30, 2021 and December 31, 2020 was $2.1 million and $2.7 million, respectively. The amount of collateral posted with third parties was deemed to be sufficient as of those dates to collateralize both the fair market value change as well as any additional amounts that may be required as a result of a change in the specified credit measures.

NOTE 16 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 September 30, 2021 and December 31, 2020, each of the Company and the Bank had met all of the capital adequacy requirements to which it was subject.

The following table presents the Company’s and the Bank’s actual capital amounts and ratios as of September 30, 2021 and December 31, 2020:

September 30, 2021

 

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

$

302,306

 

14.52

%  

$

93,671

 

4.50

%  

$

N/A

 

N/A

Bank

 

286,436

 

13.77

%  

 

93,579

 

4.50

%  

 

135,170

 

6.50

%

Tier 1 capital to risk weighted assets

 

  

 

 

 

  

 

  

 

 

.

 

  

Consolidated

 

310,698

 

14.93

%  

 

124,895

 

6.00

%  

 

N/A

 

N/A

Bank

 

286,436

 

13.77

%  

 

124,772

 

6.00

%  

 

166,363

 

8.00

%

Total capital to risk weighted assets

 

  

 

  

 

 

  

 

  

 

 

  

 

  

Consolidated

 

386,793

 

18.58

%  

 

166,526

 

8.00

%  

 

N/A

 

N/A

Bank

 

312,505

 

15.03

%  

 

166,363

 

8.00

%  

 

207,954

 

10.00

%

Tier 1 capital to average assets

 

  

 

  

 

 

  

 

  

 

 

  

 

  

Consolidated

 

310,698

 

9.88

%  

 

125,777

 

4.00

%  

 

N/A

 

N/A

Bank

 

286,436

 

9.11

%  

 

125,708

 

4.00

%  

 

157,135

 

5.00

%

29

Table of Contents

December 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

$

265,490

 

12.75

%  

$

93,723

 

4.50

%  

$

N/A

 

N/A

Bank

 

251,806

 

12.10

%  

 

93,632

 

4.50

%  

 

135,246

 

6.50

%

Tier 1 capital to risk weighted assets

 

  

 

 

 

  

 

  

 

 

.

 

  

Consolidated

 

273,797

 

13.15

%  

 

124,964

 

6.00

%  

 

N/A

 

N/A

Bank

 

251,806

 

12.10

%  

 

124,843

 

6.00

%  

 

166,457

 

8.00

%

Total capital to risk weighted assets

 

  

 

  

 

 

  

 

  

 

 

  

 

  

Consolidated

 

349,620

 

16.79

%  

 

166,618

 

8.00

%  

 

N/A

 

N/A

Bank

 

277,916

 

13.36

%  

 

166,457

 

8.00

%  

 

208,071

 

10.00

%

Tier 1 capital to average assets

 

  

 

  

 

 

  

 

  

 

 

  

 

  

Consolidated

 

273,797

 

9.24

%  

 

118,587

 

4.00

%  

 

N/A

 

N/A

Bank

 

251,806

 

8.50

%  

 

118,511

 

4.00

%  

 

148,139

 

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 September 30, 2021, 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 September 30, 2021, and December 31, 2020, the Company was in compliance with the aforementioned guidelines.

NOTE 17 Stock Repurchase Program

On February 18, 2021, the Board of Directors of the Company approved a stock repurchase program, or the Program, which authorizes the Company to repurchase up to 770,000 shares of its common stock subject to certain limitations and conditions. The Program was effective immediately and will continue for a period of 36 months. The Program does not obligate the Company to repurchase any shares of its common stock and there is no assurance that the Company will do so. For the nine months ended September 30, 2021, there were no shares repurchased under the Program. The Company also repurchases shares to pay withholding taxes on the vesting of restricted stock awards and units.

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 measurement fall within different levels of the hierarchy, the categorization is based on the lowest level input that is

30

Table of Contents

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 September 30, 2021 and December 31, 2020:

    

September 30, 2021

(dollars in thousands)

    

Level 1

    

Level 2

    

Level 3

    

Total

Available-for-sale

 

  

 

  

 

  

 

  

U.S. treasury and government agencies

$

$

5,469

$

$

5,469

Mortgage backed securities

 

  

 

  

 

  

 

  

Residential agency

 

 

518,472

 

 

518,472

Commercial

 

 

94,918

 

 

94,918

Asset backed securities

 

 

64

 

 

64

Corporate bonds

 

 

36,359

 

 

36,359

Total available-for-sale investment securities

$

$

655,282

$

$

655,282

Other assets

 

  

 

  

 

  

 

  

Derivatives

$

$

4,880

$

$

4,880

Other liabilities

 

  

 

  

 

  

 

  

Derivatives

$

$

1,062

$

$

1,062

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Table of Contents

December 31, 2020

(dollars in thousands)

    

Level 1

    

Level 2

    

Level 3

    

Total

Available-for-sale

 

  

 

  

 

  

 

  

U.S. treasury and government agencies

$

$

5,907

$

$

5,907

Obligations of state and political agencies

 

 

153,773

 

 

153,773

Mortgage backed securities

 

  

 

  

 

  

 

  

Residential agency

 

 

306,719

 

 

306,719

Commercial

 

 

94,978

 

 

94,978

Asset backed securities

 

 

115

 

 

115

Corporate bonds

 

 

30,850

 

 

30,850

Total available-for-sale investment securities

$

$

592,342

$

$

592,342

Other assets

 

  

 

  

 

  

 

  

Derivatives

$

$

13,357

$

$

13,357

Other liabilities

 

  

 

  

 

  

 

  

Derivatives

$

$

2,911

$

$

2,911

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, Available-for-Sale

Generally, debt securities are valued using pricing for similar securities, recently executed transactions, and other pricing models utilizing observable inputs and therefore are classified as Level 2.

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.

Net impairment related to nonrecurring estimated fair value measurements of certain assets as of September 30, 2021 and December 31, 2020 consisted of the following:

September 30, 2021

(dollars in thousands)

    

Level 2

    

Level 3

    

Total

    

Impairment

Loans held for sale

$

60,912

$

$

60,912

$

Impaired loans

 

 

6,392

 

6,392

 

559

Foreclosed assets

 

 

862

 

862

 

Servicing rights

 

 

1,776

 

1,776

 

December 31, 2020

(dollars in thousands)

    

Level 2

    

Level 3

    

Total

    

Impairment

Loans held for sale

$

122,440

$

$

122,440

$

Impaired loans

 

 

7,325

 

7,325

 

1,205

Foreclosed assets

 

 

63

 

63

 

Servicing rights

 

 

1,987

 

1,987

 

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Table of Contents

Loans Held for Sale

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

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.

The valuation techniques and significant unobservable inputs used to measure Level 3 estimated fair values as of September 30, 2021, and December 31, 2020, were as follows:

September 30, 2021

(dollars in thousands)

Weighted

Asset Type

    

Valuation Technique

    

Unobservable Input

Fair Value

    

Range

    

Average

  

Impaired loans

 

Appraisal value

 

Property specific adjustment

$

6,392

 

N/A

N/A

 

Foreclosed assets

 

Appraisal value

 

Property specific adjustment

 

862

 

N/A

 

N/A

 

Servicing rights

 

Discounted cash flows

 

Prepayment speed assumptions

 

1,776

 

184-392

 

257

 

 

  

 

Discount rate

 

  

 

9.3

%  

9.3

December 31, 2020

(dollars in thousands)

Weighted

 

Asset Type

    

Valuation Technique

    

Unobservable Input

Fair Value

    

Range

    

Average

 

Impaired loans

 

Appraisal value

 

Property specific adjustment

$

7,325

 

N/A

 

N/A

Foreclosed assets

 

Appraisal value

 

Property specific adjustment

 

63

 

N/A

 

N/A

Servicing rights

 

Discounted cash flows

 

Prepayment speed assumptions

 

1,987

 

191-403

 

285

 

  

 

Discount rate

 

  

 

9.0

%  

9.0

%

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

The following disclosures represent financial instruments in which the ending balances, as of September 30, 2021 and December 31, 2020, 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.

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Investment Securities, Held-to-Maturity

The fair values of debt securities held-to-maturity are based on quoted market prices for the same or similar securities, recently executed transactions and pricing models.

Loans

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

Bank-Owned Life Insurance

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

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:

September 30, 2021

Carrying

Estimated Fair Value

(dollars in thousands)

    

Amount

    

Level 1

    

Level 2

    

Level 3

    

Total

Financial Assets

 

  

 

  

 

  

 

  

 

  

Cash and cash equivalents

$

159,454

$

159,454

$

$

$

159,454

Investment securities held-to-maturity

362,586

363,540

363,540

Loans

 

1,768,320

 

 

 

1,814,289

 

1,814,289

Accrued interest receivable

 

8,836

 

8,836

 

 

 

8,836

Bank-owned life insurance

 

32,954

 

 

32,954

 

 

32,954

Financial Liabilities

 

  

 

  

 

  

 

  

 

  

Noninterest-bearing deposits

$

797,062

$

$

797,062

$

$

797,062

Interest-bearing deposits

 

1,691,226

 

 

1,691,226

 

 

1,691,226

Time deposits

 

224,800

 

 

 

225,353

 

225,353

Long-term debt

 

58,963

 

 

58,319

 

 

58,319

Accrued interest payable

 

1,298

 

1,298

 

 

 

1,298

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December 31, 2020

Carrying

Estimated Fair Value

(dollars in thousands)

    

Amount

    

Level 1

    

Level 2

    

Level 3

    

Total

Financial Assets

 

  

 

  

 

  

 

  

 

  

Cash and cash equivalents

$

172,962

$

172,962

$

$

$

172,962

Loans

 

1,945,129

 

 

 

1,992,394

 

1,992,394

Accrued interest receivable

 

9,662

 

9,662

 

 

 

9,662

Bank-owned life insurance

 

32,363

 

 

32,363

 

 

32,363

Financial Liabilities

 

  

 

  

 

  

 

  

 

  

Noninterest-bearing deposits

$

754,716

$

$

754,716

$

$

754,716

Interest-bearing deposits

 

1,607,939

 

 

1,607,939

 

 

1,607,939

Time deposits

 

209,338

 

 

 

210,637

 

210,637

Long-term debt

 

58,735

 

 

56,131

 

 

56,131

Accrued interest payable

 

654

 

654

 

 

 

654

NOTE 19 COVID-19 Pandemic Response

As discussed in “Note 1 Significant Accounting Policies,” the full extent of the impact of COVID-19 on the U.S. economy generally and the Company is uncertain. In the second quarter of 2020, the Company became a lender under the PPP which was administered through the U.S. Small Business Administration, or SBA, an agency of the U.S Department of the Treasury, which works with financial institutions in providing loans to small businesses. The PPP, which is meant to aid small businesses during the COVID-19 pandemic, was created under the Coronavirus Aid Relief, and Economic Security, or CARES, Act, which was signed into law on March 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.

As of September 30, 2021, the Company had assisted 2,454 new and existing clients secure a total of approximately $474.2 million of PPP financing. Net processing fees in the amount of $15.7 million are being deferred and recognized as interest income on a level yield method over the life of the respective loans. See “Note 4 Loans and Allowance for Loan Losses” for additional discussion on the remaining deferred costs associated with PPP financing.

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

General

The following discussion explains our financial condition and results of operations as of and for the three and nine months ended September 30, 2021 and 2020. 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, 2020, filed with the Securities and Exchange Commission on March 12, 2021.

Forward-Looking Statements

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

Forward-looking statements are neither historical facts nor assurances of future performance. Instead, they are based only on our current beliefs, expectations and assumptions regarding the future of our business, future plans and strategies, projections, anticipated events and trends, the economy and other future conditions. Because forward-looking statements relate to the future, they are subject to inherent uncertainties, risks and changes in circumstances that are difficult to predict and many of which are outside of our control. Our actual results and financial condition may differ materially from those indicated in the forward-looking statements. Therefore, you should not rely on any of these forward-looking statements. Important factors that could cause our actual results and financial condition to differ materially from those indicated in the forward-looking statements include, among others, the following:

our ability to successfully manage credit risk and maintain an adequate level of allowance for loan losses;
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;
the impact of economic or market conditions on our fee-based services;
our ability to implement our organic and acquisition growth strategies;
potential impairment to the goodwill we recorded in connections with our past acquisitions;

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our ability to continue to grow our retirement and benefit services business;
our ability to continue to originate a sufficient volume of residential mortgages;
the occurrence of fraudulent activity, breaches or failures of our information security controls or cybersecurity-related incidents;
interruptions involving our information technology and telecommunications systems or third-party servicers;
developments and uncertainty related to the future use and availability of some reference rates, such as the London Interbank Offered Rate, as well as other alternative reference rates;
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;
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 ability to successfully manage liquidity risk;
concentrations of large depositors;
our dependence on dividends from the Bank;
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;
the extensive regulatory framework that applies to us;
the impact of recent and future legislative and regulatory changes;
the effects of the COVID-19 pandemic, including its effects on the economic environment, our clients and our operations, including due to supply chain disruptions, as well as any changes to federal, state, or local government laws, regulations, or orders in connection with the pandemic;
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;
rapid technological change in the financial services industry;
increased competition in the financial services industry;
our ability to manage mortgage pipeline risk;

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Table of Contents

changes to U.S. or state tax laws, regulations and guidance, including recent proposals to increase the federal corporate tax rate;
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.

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 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, 2020. There have been no significant changes in critical accounting policies, or the assumptions and judgments utilized in applying these policies since December 31, 2020.

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

As of September 30, 2021, the COVID-19 pandemic remains ongoing. During 2020, the COVID-19 pandemic created disruption in global supply chains, increased rates of unemployment and adversely impacted many industries,

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including industries related to the collateral underlying certain of our loans, and many of these effects are continuing. In 2021, the U.S. economy has, with certain setbacks, begun reopening and wider distribution of vaccines has encouraged increased economic activity. The progression of the COVID-19 pandemic in the United States has not had an adverse impact on our financial condition and results of operations as of and for the three and nine months ended September 30, 2021. Nonetheless, the economic recovery could remain gradual and uneven and could be hindered by persistent or resurgent infection rates, particularly given uncertainty with respect to the distribution and acceptance of the vaccines and their effectiveness with respect to the new variants of the virus.

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 one retirement and benefit services office in Minnesota, one in Michigan and one in Colorado.

Each of our market areas continues to have different responses to the COVID-19 pandemic due to the availability of the COVID-19 vaccines and varying infection rates. Based on the current environment, it is unclear how the states in our market areas will continue to change policies in response to the COVID-19 pandemic and whether any such changes will negatively impact our customers and regional economies.

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. Most recently, these have included the following:

On March 11, 2021, President Biden signed into law the American Rescue Plan Act of 2021, or the Plan, a $1.9 trillion COVID-19 relief bill. The Plan included a variety of economic assistance programs for Americans, such as the payment of an additional stimulus, extension of job benefits, additional funding for COVID-19 testing and vaccine distribution, an infusion of cash in state and local governments, and an array of tax benefits among other economic incentives.
On March 30, 2021, President Biden signed into law the PPP Extension Act of 2021, which provided an extension to May 31, 2021, for qualifying businesses to apply for a PPP loan and provided an additional 30 days for the SBA to process pending PPP loan applications.

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

Workforce. We’ve adopted a hybrid approach to our work environment, allowing many of our employees to work from home long-term. We implemented our phased return to office plan, reopening our offices and returning those employees who will work from an Alerus office.
Client Service. We offered payment deferrals and interest only payment options for consumer, small business, and commercial customers for initial terms of up to 90 days. We offered payment extensions for mortgage customers for initial terms of up to 90 days. As of September 30, 2021, we had executed 587 loan deferrals representing $154.5 million. Of those loans, 8 loans with a total outstanding principal balance of $3.4 million have been granted additional deferrals, 2 loans with a total outstanding principal balance of $69 thousand remain on the first deferral and the remaining loans have been returned to a normal payment status.
We participated in the SBA’s PPP. As of September 30, 2021, we had assisted 2,454 borrowers receive approval for funding of $474.2 million in PPP loans. As of September 30, 2021, our borrowers had received approval for forgiveness on 1,937 loans totaling $376.7 million from the SBA. We have submitted to the SBA an additional 12 forgiveness applications totaling $3.3 million.

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Table of Contents

Shareholder Dividend and Stock Repurchases

On July 26, 2021, the Board of Directors of the Company declared a quarterly cash dividend of $0.16 per common share. This dividend was paid on October 8, 2021, to stockholders of record as of the close of business on September 17, 2021.

On February 18, 2021, the Board of Directors of the Company approved a stock repurchase program, or the Program, which authorizes the Company to repurchase up to 770,000 shares of its common stock, subject to certain limitations and conditions. The Program was effective immediately and will continue for a period of 36 months. The Program does not obligate the Company to repurchase any shares of its common stock and there is no assurance that the Company will do so. As of September 30, 2021, no shares had been repurchased under the Program. The Company also repurchases shares to pay withholding taxes on the vesting of restricted stock awards and units.

Operating Results Overview

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

Three months ended

Nine months ended

September 30, 

June 30, 

September 30, 

September 30, 

September 30, 

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

    

2021

    

2021

    

2020

    

2021

    

2020

    

Performance Ratios

 

 

 

 

 

Return on average total assets

 

1.62

%  

 

1.50

%  

 

2.42

%  

 

1.71

%  

 

1.71

%  

Return on average common equity

 

14.68

%  

 

13.82

%  

 

22.31

%  

 

15.61

%  

 

15.17

%  

Return on average tangible common equity (1)

 

18.13

%  

 

17.36

%  

 

26.67

%  

 

19.44

%  

 

18.70

%  

Noninterest income as a % of revenue

 

63.04

%  

 

63.48

%  

 

67.53

%  

 

63.87

%  

 

64.58

%  

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

 

2.78

%  

 

2.88

%  

 

3.17

%  

 

2.92

%  

 

3.22

%  

Efficiency ratio (1)

 

71.49

%  

 

71.46

%  

 

58.42

%  

 

69.69

%  

 

66.22

%  

Average equity to average assets

 

11.07

%  

 

10.88

%  

 

10.83

%  

10.97

%  

11.29

%  

Net charge-offs/(recoveries) to average loans

(0.06)

%  

 

%  

 

(0.11)

%  

 

0.01

%  

 

0.15

%  

Dividend payout ratio

 

21.62

%  

24.24

%  

15.15

%  

20.80

%  

23.20

%  

Per Common Share

 

 

 

 

 

Earnings per common share - basic

$

0.75

$

0.67

$

1.01

$

2.29

$

1.98

Earnings per common share - diluted

$

0.74

$

0.66

$

0.99

$

2.26

$

1.94

Dividends declared per common share

$

0.16

$

0.16

$

0.15

$

0.47

$

0.45

Tangible book value per common share (1)

$

17.46

$

16.89

$

16.31

Average common shares outstanding - basic

 

17,205

 

17,194

 

17,121

 

17,182

 

17,101

Average common shares outstanding - diluted

 

17,499

 

17,497

 

17,453

 

17,488

 

17,435

Other Data

 

 

 

 

Retirement and benefit services assets under administration/management

$

36,202,553

$

36,964,961

$

30,470,645

Wealth management assets under administration/management

3,865,062

3,538,959

3,043,173

Mortgage originations

415,792

545,437

511,605

$

1,479,243

$

1,171,811

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

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Table of Contents

Selected Financial Data

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

Three months ended

Nine months ended

September 30, 

June 30, 

September 30, 

September 30, 

September 30, 

(dollars in thousands)

    

2021

    

2021

    

2020

    

2021

    

2020

Selected Average Balance Sheet Data

 

 

 

 

 

Loans

$

1,820,871

$

1,887,986

$

2,034,778

$

1,884,308

$

1,917,894

Investment securities

 

869,421

 

800,812

 

443,705

 

778,307

 

383,591

Assets

 

3,190,877

 

3,119,740

 

2,908,144

 

3,119,819

 

2,690,182

Deposits

 

2,720,047

 

2,677,258

 

2,454,865

 

2,671,344

 

2,270,781

Short-term borrowings

 

10

 

 

 

3

 

107

Long-term debt

 

58,968

 

58,996

 

58,739

 

48,002

 

58,747

Stockholders’ equity

 

353,196

 

339,439

 

314,921

 

342,344

 

303,825

September 30, 

June 30, 

December 31, 

September 30, 

(dollars in thousands)

    

2021

    

2021

    

2020

    

2020

Selected Period End Balance Sheet Data

Loans

$

1,800,386

$

1,835,312

$

1,979,375

$

2,058,419

Allowance for loan losses

 

(32,066)

 

(33,764)

 

(34,246)

 

(31,337)

Investment securities

 

1,017,868

 

797,862

 

592,342

 

495,414

Assets

 

3,175,169

 

3,157,229

 

3,013,771

 

2,898,809

Deposits

 

2,713,088

 

2,710,940

 

2,571,993

 

2,462,370

Long-term debt

 

58,963

 

58,992

 

58,735

 

58,745

Total stockholders’ equity

 

353,195

 

344,391

 

330,163

 

322,003

Three months ended

Nine months ended

September 30, 

June 30, 

September 30, 

September 30, 

September 30, 

(dollars in thousands)

    

2021

    

2021

    

2020

    

2021

    

2020

Selected Income Statement Data

Net interest income

$

21,132

$

21,140

$

21,765

$

64,310

$

60,693

Provision for loan losses

 

(2,000)

 

 

3,500

 

(2,000)

 

9,500

Noninterest income

 

36,040

 

36,748

 

45,256

 

113,669

 

110,675

Noninterest expense

 

42,041

 

42,550

 

40,214

 

127,633

 

116,674

Income before income taxes

 

17,131

 

15,338

 

23,307

 

52,346

 

45,194

Income tax expense

 

4,064

 

3,644

 

5,648

 

12,370

 

10,698

Net income

$

13,067

$

11,694

$

17,659

$

39,976

$

34,496

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 book value per common 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.

    

September 30, 

June 30, 

December 31, 

September 30, 

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

    

2021

    

2021

    

2020

    

2020

    

Tangible common equity to tangible assets

 

  

 

Total common stockholders’ equity

$

353,195

$

344,391

$

330,163

$

322,003

Less: Goodwill

 

30,201

 

30,201

 

30,201

 

27,329

Less: Other intangible assets

 

22,593

 

23,680

 

25,919

 

15,421

Tangible common equity (a)

 

300,401

 

290,510

 

274,043

 

279,253

Total assets

 

3,175,169

 

3,157,229

 

3,013,771

 

2,898,809

Less: Goodwill

 

30,201

 

30,201

 

30,201

 

27,329

Less: Other intangible assets

 

22,593

 

23,680

 

25,919

 

15,421

Tangible assets (b)

 

3,122,375

 

3,103,348

 

2,957,651

 

2,856,059

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

 

9.62

%  

 

9.36

%  

 

9.27

%  

 

9.78

%  

Tangible book value per common share

Total common stockholders’ equity

$

353,195

$

344,391

$

330,163

$

322,003

Less: Goodwill

30,201

30,201

30,201

27,329

Less: Other intangible assets

22,593

23,680

25,919

15,421

Tangible common equity (c)

300,401

290,510

274,043

279,253

Total common shares issued and outstanding (d)

17,208

17,198

 

17,125

 

17,122

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

$

17.46

$

16.89

$

16.00

$

16.31

Three months ended

Nine months ended

September 30, 

June 30, 

September 30, 

September 30, 

September 30, 

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

    

2021

    

2021

    

2020

    

2021

    

2020

    

Return on average tangible common equity

Net income

$

13,067

$

11,694

$

17,659

$

39,976

$

34,496

Add: Intangible amortization expense (net of tax)

 

860

 

860

 

782

 

2,628

 

2,347

Net income, excluding intangible amortization (e)

 

13,927

 

12,554

 

18,441

 

42,604

 

36,843

Average total equity

 

353,196

 

339,439

 

314,921

 

342,344

 

303,825

Less: Average goodwill

 

30,201

 

30,201

 

27,329

 

30,201

 

27,329

Less: Average other intangible assets (net of tax)

 

18,272

 

19,123

 

12,565

 

19,124

 

13,343

Average tangible common equity (f)

 

304,723

 

290,115

 

275,027

 

293,019

 

263,153

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

 

18.13

%  

 

17.36

%  

 

26.67

%  

 

19.44

%  

 

18.70

%  

Net interest margin (tax-equivalent)

 

 

 

 

 

Net interest income

$

21,132

$

21,140

$

21,765

$

64,310

$

60,693

Tax-equivalent adjustment

 

115

 

135

 

116

 

392

 

325

Tax-equivalent net interest income (g)

 

21,247

 

21,275

 

21,881

 

64,702

 

61,018

Average earning assets (h)

 

3,035,798

 

2,958,468

 

2,744,758

 

2,958,742

 

2,534,038

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

 

2.78

%  

 

2.88

%  

 

3.17

%  

 

2.92

%  

 

3.22

%  

Efficiency ratio

 

 

 

 

 

Noninterest expense

$

42,041

$

42,550

$

40,214

$

127,633

$

116,674

Less: Intangible amortization expense

 

1,088

 

1,088

 

990

 

3,327

 

2,971

Adjusted noninterest expense (i)

 

40,953

 

41,462

 

39,224

 

124,306

 

113,703

Net interest income

 

21,132

 

21,140

 

21,765

 

64,310

 

60,693

Noninterest income

 

36,040

 

36,748

 

45,256

 

113,669

 

110,675

Tax-equivalent adjustment

 

115

 

135

 

116

 

392

 

325

Total tax-equivalent revenue (j)

 

57,287

 

58,023

 

67,137

 

178,371

 

171,693

Efficiency ratio (i)/(j)

 

71.49

%  

 

71.46

%  

 

58.42

%  

 

69.69

%  

 

66.22

%  

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Table of Contents

Discussion and Analysis of Results of Operations

Net Income

Net income for the three months ended September 30, 2021 was $13.1 million, or $0.74 per diluted common share, a $4.6 million decrease as compared to $17.7 million, or $0.99 per diluted common share, for the three months ended September 30, 2020. This decrease in net income was primarily due to a decrease of $9.2 million in noninterest income as well as a $1.8 million increase in noninterest expense, partially offset by a $5.5 million decrease in the provision expense. The decrease in noninterest income was primarily attributable to a $11.2 million decrease in mortgage banking revenue, a result of a $95.8 million decrease in mortgage originations. The decrease in the provision for loan losses was driven by net recoveries and continuous improvements of credit quality indicators and economic conditions.

Net income for the nine months ended September 30, 2021 was $40.0 million, or $2.26 per diluted common share, a $5.5 million increase as compared to $34.5 million, or $1.94 per diluted common share for the nine months ended September 30, 2020. The increase in net income was primarily due to a $11.5 million decrease in provision expense, a $3.6 million increase in net interest income and a $3.0 million increase in noninterest income, partially offset by a $11.0 million increase in noninterest expense. The decrease in provision expense was primarily due to a reduction in net charge-offs, improved economic conditions and credit quality indicators. The increase in noninterest expense was primarily due to an $8.6 million increase in compensation expense which was due to a combination of increased mortgage incentives as a result of the $307.4 million increase in mortgage originations, along with an increase in compensation from the acquisition of RPS.

Net Interest Income

Net interest income is the difference between interest income and yield-related fees earned on assets and interest expense paid on liabilities. Net interest margin is the difference between the yield on interest earning assets and the cost of interest-bearing liabilities as a percentage of interest earning assets. Net interest margin is presented on a tax-equivalent basis, which means that tax-free interest income has been adjusted to a pre-tax-equivalent income, assuming a federal income tax rate of 21% for the three and nine months ended September 30, 2021 and 2020.

Net interest income for the three months ended September 30, 2021 was $21.1 million, a decrease of $633 thousand from $21.8 million for the three months ended September 30, 2020. The decrease included a $1.7 million decrease in interest income, offset by a $1.1 million decrease in interest expense. The decrease in interest income was primarily a result of a $3.1 million decrease in interest income from loans due to a decrease of $213.9 million in average loans driven primarily by PPP loan forgiveness. Partially offsetting this decrease was a $1.3 million increase in interest income from investment securities as a result of a $425.7 million increase in average balances. The decrease in interest expense was primarily due to a 27 basis point decrease in the cost of interest-bearing liabilities.

Net interest income for the nine months ended September 30, 2021 was $64.3 million, a $3.6 million increase, or 6.0%, from $60.7 million for the nine months ended September 30, 2020. The change in net interest income was due to a $6.1 million decrease in interest expense, partially offset by a $2.4 million decrease of interest income. The decrease in interest expense was primarily driven by a $4.9 million decrease in interest expense paid on deposits and a $1.2 million decrease in interest expense paid on long-term debt. The decrease in interest income was primarily due to a $5.1 million decrease on interest income from loans partially offset by a $3.0 million increase in interest income from investment securities.

Our net interest margin (on a fully tax-equivalent, or FTE, basis) for the three months ended September 30, 2021 was 2.78%, compared to 3.17% for the same period in 2020. The decrease in net interest margin from the third quarter of 2020 was driven by a 58 basis point lower average earning asset yield, offset by a 27 basis point decrease in the average rate paid on interest-bearing liabilities. The decrease in the average earning asset yield was primarily due to a change in balance sheet mix as the average balance in investment securities increased $425.7 million along with a $112.0 million increase in interest-bearing deposits with banks.

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Table of Contents

Our net interest margin (on a FTE basis) for the nine months ended September 30, 2021 was 2.92%, compared to 3.22% for the same period in 2020. The change in net interest margin was primarily due to a 64 basis point decrease in average earning asset yield, partially offset by a 53 basis point decrease in the average rate paid on interest-bearing liabilities. Also contributing to the decrease in net interest margin was the change in balance sheet mix as we had increases of $57.5 million in interest-bearing deposits with banks and $394.7 million in investment securities.

As a result of the reductions in the target federal funds interest rate, as well as the impact of the COVID-19 pandemic, we anticipate that our net interest income and net interest margin (on a FTE basis) will remain under pressure in future periods. Any decrease in net interest income or net interest margin will be partially offset by the processing fees received from PPP financing, which fees are being deferred and recognized as an adjustment to interest income over the life of the loans.

44

Table of Contents

The following tables present average balance sheet information, interest income, interest expense and the corresponding average yields on assets, and average yields earned, and rates paid for the three and nine months ended September 30, 2021 and 2020. We derived these yields and rates by dividing income or expense by the average balance of the corresponding assets or liabilities. We derived average balances from the daily balances throughout the periods indicated. Average loan balances include loans that have been placed on nonaccrual, while interest previously accrued on these loans is reversed against interest income. In these tables, adjustments are made to the yields on tax-exempt assets in order to present tax-exempt income and fully taxable income on a comparable basis.

Three months ended September 30, 

2021

2020

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

$

281,768

$

114

 

0.16

%  

$

169,770

$

51

 

0.12

%  

Investment securities (1)

 

869,421

 

3,534

 

1.61

%  

 

443,705

 

2,274

 

2.04

%  

Loans held for sale

 

57,233

 

346

 

2.40

%  

 

90,634

 

555

 

2.44

%  

Loans

 

  

 

  

 

  

 

  

 

  

 

  

Commercial:

 

  

 

 

  

 

  

 

 

  

Commercial and industrial

 

544,811

 

6,803

 

4.95

%  

 

782,853

 

8,543

 

4.34

%  

Real estate construction

 

37,743

 

380

 

3.99

%  

 

32,747

 

368

 

4.47

%  

Commercial real estate

 

567,696

 

5,245

 

3.67

%  

 

525,514

 

5,315

 

4.02

%  

Total commercial

 

1,150,250

 

12,428

 

4.29

%  

 

1,341,114

 

14,226

 

4.22

%  

Consumer

 

  

 

  

 

  

 

  

 

  

 

  

Residential real estate first mortgage

 

487,699

 

4,077

 

3.32

%  

 

460,995

 

4,588

 

3.96

%  

Residential real estate junior lien

 

129,239

 

1,490

 

4.57

%  

 

153,326

 

1,749

 

4.54

%  

Other revolving and installment

 

53,683

 

602

 

4.45

%  

 

79,343

 

897

 

4.50

%  

Total consumer

 

670,621

 

6,169

 

3.65

%  

 

693,664

 

7,234

 

4.15

%  

Total loans (1)

 

1,820,871

 

18,597

 

4.05

%  

 

2,034,778

 

21,460

 

4.20

%  

Federal Reserve/FHLB Stock

 

6,505

 

71

 

4.33

%  

 

5,871

 

65

 

4.40

%  

Total interest earning assets

 

3,035,798

22,662

 

2.96

%  

 

2,744,758

 

24,405

 

3.54

%  

Noninterest earning assets

155,079

163,386

Total assets

$

3,190,877

  

 

  

$

2,908,144

 

  

 

  

Interest-Bearing Liabilities

 

  

 

  

 

  

 

  

 

  

 

  

Interest-bearing demand deposits

$

692,873

$

240

 

0.14

%  

$

589,633

$

395

 

0.27

%  

Money market and savings deposits

 

1,009,564

 

365

 

0.14

%  

 

961,669

 

781

 

0.32

%  

Time deposits

 

217,756

 

275

 

0.50

%  

 

204,969

 

507

 

0.98

%  

Short-term borrowings

 

10

 

 

%  

 

 

 

%  

Long-term debt

 

58,968

 

535

 

3.60

%  

 

58,739

 

841

 

5.70

%  

Total interest-bearing liabilities

 

1,979,171

 

1,415

 

0.28

%  

 

1,815,010

 

2,524

 

0.55

%  

Noninterest-Bearing Liabilities and Stockholders' Equity

 

 

  

 

 

  

 

  

Noninterest-bearing deposits

 

799,854

 

  

 

698,594

 

  

 

  

Other noninterest-bearing liabilities

 

58,656

 

  

 

79,619

 

  

 

  

Stockholders’ equity

 

353,196

 

  

 

314,921

 

  

 

  

Total liabilities and stockholders’ equity

$

3,190,877

 

  

$

2,908,144

 

  

 

  

Net interest income

$

21,247

 

  

 

  

$

21,881

 

  

Net interest rate spread

 

 

2.68

%  

 

  

 

  

 

2.99

%  

Net interest margin on FTE basis (1)

 

 

2.78

%  

 

  

 

  

 

3.17

%  

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

45

Table of Contents

Nine months ended September 30, 

2021

2020

   

   

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

$

219,636

$

227

0.14

%

$

162,134

$

615

0.51

%

Investment securities (1)

 

778,307

 

9,425

1.62

%

 

383,591

 

6,398

2.23

%

Loans held for sale

 

70,218

 

1,180

2.25

%

 

64,555

 

1,274

2.64

%

Loans

 

  

 

  

  

 

  

 

  

  

Commercial:

 

  

 

  

 

  

 

  

Commercial and industrial

 

615,310

 

21,780

4.73

%

 

667,742

 

22,397

4.48

%

Real estate construction

 

41,812

 

1,304

4.17

%

 

30,385

 

1,055

4.64

%

Commercial real estate

 

565,861

 

15,744

3.72

%

 

515,761

 

16,646

4.31

%

Total commercial

 

1,222,983

 

38,828

4.24

%

 

1,213,888

 

40,098

4.41

%

Consumer

 

  

 

  

  

 

  

 

  

  

Residential real estate first mortgage

 

468,395

 

12,371

3.53

%

 

460,505

 

13,968

4.05

%

Residential real estate junior lien

 

132,145

 

4,619

4.67

%

 

163,332

 

5,921

4.84

%

Other revolving and installment

 

60,785

 

1,989

4.37

%

 

80,169

 

2,751

4.58

%

Total consumer

 

661,325

 

18,979

3.84

%

 

704,006

 

22,640

4.30

%

Total loans (1)

 

1,884,308

 

57,807

4.10

%

 

1,917,894

 

62,738

4.37

%

Federal Reserve/FHLB Stock

 

6,273

 

205

4.37

%

 

5,864

 

201

4.58

%

Total interest earning assets

 

2,958,742

 

68,844

3.11

%

 

2,534,038

 

71,226

3.75

%

Noninterest earning assets

161,077

156,144

Total assets

$

3,119,819

 

  

  

$

2,690,182

 

  

  

Interest-Bearing Liabilities

 

  

 

  

  

 

  

 

  

  

Interest-bearing demand deposits

$

678,015

$

740

0.15

%

$

528,024

$

1,328

0.34

%

Money market and savings deposits

 

1,018,347

 

1,131

0.15

%

 

889,039

 

4,363

0.66

%

Time deposits

 

212,297

 

910

0.57

%

 

201,747

 

1,942

1.29

%

Short-term borrowings

 

3

 

%

 

107

 

%

Long-term debt

 

48,002

 

1,361

3.79

%

 

58,747

 

2,575

5.85

%

Total interest-bearing liabilities 

 

1,956,664

 

4,142

0.28

%

 

1,677,664

 

10,208

0.81

%

Noninterest-Bearing Liabilities and Stockholders' Equity

 

 

  

  

 

 

  

  

Noninterest-bearing deposits

762,685

 

  

  

 

651,971

Other noninterest-bearing liabilities

 

58,126

 

  

  

 

56,722

 

  

  

Stockholders’ equity

 

342,344

 

  

  

 

303,825

 

  

  

Total liabilities and stockholders’ equity

$

3,119,819

 

  

  

$

2,690,182

 

  

  

Net interest income

 

  

$

64,702

  

 

  

$

61,018

  

Net interest rate spread

 

  

 

  

2.83

%

 

  

 

  

2.94

%

Net interest margin on FTE basis (1)

 

  

 

  

2.92

%

 

  

 

  

3.22

%

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

Interest Rates and Operating Interest Differential

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

46

Table of Contents

change in volume by the previous period’s average rate. Similarly, the effect of rate changes is calculated by multiplying the change in average rate by the previous period’s volume.

Three Months Ended September 30, 2021

Nine months ended September 30, 2021

Compared with

Compared with

Three Months Ended September 30, 2020

Nine months ended September 30, 2020

Change due to:

Interest

Change due to:

Interest

(tax-equivalent basis, dollars in thousands)

    

Volume

    

Rate

    

Variance

    

Volume

    

Rate

    

Variance

Interest earning assets

 

  

 

  

 

  

Interest-bearing deposits with banks

$

34

$

29

$

63

$

219

$

(607)

$

(388)

Investment securities

 

2,189

 

(929)

 

1,260

 

6,584

 

(3,557)

 

3,027

Loans held for sale

 

(205)

 

(4)

 

(209)

 

112

 

(206)

 

(94)

Loans

 

  

 

  

 

  

 

  

 

  

 

  

Commercial:

 

  

 

  

 

  

 

  

 

  

 

  

Commercial and industrial

 

(2,604)

 

864

 

(1,740)

 

(1,757)

 

1,140

 

(617)

Real estate construction

 

56

 

(44)

 

12

 

397

 

(148)

 

249

Commercial real estate

 

427

 

(497)

 

(70)

 

1,615

 

(2,517)

 

(902)

Total commercial

 

(2,121)

 

323

 

(1,798)

 

255

 

(1,525)

 

(1,270)

Consumer

 

 

  

 

  

 

  

 

  

 

  

Residential real estate first mortgage

 

267

 

(778)

 

(511)

 

239

 

(1,836)

 

(1,597)

Residential real estate junior lien

 

(276)

 

17

 

(259)

 

(1,129)

 

(173)

 

(1,302)

Other revolving and installment

 

(291)

 

(4)

 

(295)

 

(664)

 

(98)

 

(762)

Total consumer

 

(300)

 

(765)

 

(1,065)

 

(1,554)

 

(2,107)

 

(3,661)

Total loans

 

(2,421)

 

(442)

 

(2,863)

 

(1,299)

 

(3,632)

 

(4,931)

Federal Reserve/FHLB Stock

 

7

 

(1)

 

6

 

14

 

(10)

 

4

Total interest income

 

(396)

 

(1,347)

 

(1,743)

 

5,630

 

(8,012)

 

(2,382)

Interest-bearing liabilities

 

  

 

  

 

  

 

  

 

  

 

  

Interest-bearing demand deposits

 

70

 

(225)

 

(155)

 

381

 

(969)

 

(588)

Money market and savings deposits

 

39

 

(455)

 

(416)

 

638

 

(3,870)

 

(3,232)

Time deposits

 

32

 

(264)

 

(232)

 

102

 

(1,134)

 

(1,032)

Short-term borrowings

 

 

 

 

 

 

Long-term debt

 

3

 

(309)

 

(306)

 

(470)

 

(744)

 

(1,214)

Total interest expense

 

144

 

(1,253)

 

(1,109)

 

651

 

(6,717)

 

(6,066)

Change in net interest income

$

(540)

$

(94)

$

(634)

$

4,979

$

(1,295)

$

3,684

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 $2.0 million reversal of the provision for loan losses for the three and nine months ended September 30, 2021, a $5.5 million decrease compared to the provision for the three months ended September 30, 2020 and an $11.5 million decrease compared to the provision for the nine months ended September 30, 2020. Management believes that a negative adjustment to the provision in the third quarter of 2021 was prudent and was driven by net recoveries in four of the last five quarters and continuous improvements of credit quality indicators and economic conditions.

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.

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The following table presents our noninterest income for the three and nine months ended September 30, 2021 and 2020.

Three months ended

Nine months ended

September 30, 

September 30, 

(dollars in thousands)

    

2021

    

2020

    

2021

    

2020

    

Retirement and benefit services

$

18,031

$

15,104

$

53,157

$

45,034

Wealth management

 

5,295

 

4,486

 

15,419

 

12,644

Mortgage banking

 

11,116

 

22,269

 

40,535

 

44,860

Service charges on deposit accounts

 

357

 

355

 

1,025

 

1,075

Net gains (losses) on investment securities

 

11

 

1,428

 

125

 

2,722

Other

 

1,230

 

1,614

 

3,408

 

4,340

Total noninterest income

$

36,040

$

45,256

$

113,669

$

110,675

Noninterest income as a % of revenue

63.04

%  

67.53

%  

63.87

%  

64.58

%  

Total noninterest income for the three months ended September 30, 2021, was $36.0 million, a decrease of $9.2 million, or 20.4%, compared to $45.3 million for the three months ended September 30, 2020. The decrease in noninterest income was primarily driven by decreases of $11.2 million in mortgage banking revenue and $1.4 million in net gains on investment securities. These decreases were partially offset by a $2.9 million increase in retirement and benefit services revenue and a $809 thousand increase in wealth management revenue. The decrease in mortgage banking revenue was primarily due to a $7.8 million decrease in the change in fair value of the secondary market hedge driven by a reduction in the hedged pipeline. The increase in retirement and benefit services revenue was primarily due to $1.8 million in revenue attributable to the acquisition of RPS and $892 thousand in document restatement fees. Wealth management revenue increased primarily due to organic growth and market increases in assets under administration/management.

Total noninterest income for the nine months ended September 30, 2021, was $113.7 million, an increase of $3.0 million, or 2.7%, compared to $110.7 million for the nine months ended September 30, 2020. The change in noninterest income was primarily driven by increases of $8.1 million in retirement and benefit services revenue and $2.8 million in wealth management revenue, partially offset by a $4.3 million decrease in mortgage banking revenue and a $2.6 million decrease in net gains on investment securities. The increase in retirement and benefit services revenue was primarily a result of a $4.5 million in revenue attributable to the acquisition of RPS and a $1.7 million increase in document restatement fees as well as organic growth from an increase in assets under administration/management. Wealth management revenue increased due to increases in assets under administration/management as a result of reasons previously discussed. The decrease in mortgage banking revenue was the result of a $17.7 million decrease in the change in fair value of the secondary market hedge, partially offset by an increase of $307.4 million in mortgage originations and an 11 basis point increase in the gain on sale margin.

We anticipate that our noninterest income will be significantly adversely affected in future periods as a result of increasing interest rates and inflationary pressure, which will adversely affect mortgage originations and mortgage banking revenue.

Noninterest income as a percentage of total operating revenue, which consists of net interest income plus noninterest income, was 63.0% for the three months ended September 30, 2021, compared to 67.5% for the three months ended September 30, 2020 and was 63.9% for the nine months ended September 30, 2021, compared to 64.6% for the nine months ended September 30, 2020.

See “NOTE 13 Segment Reporting” for additional discussion regarding our business lines.

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Table of Contents

Noninterest Expense

The following table presents noninterest expense for the three and nine months ended September 30, 2021 and 2020.

Three months ended

Nine months ended

September 30, 

September 30, 

(dollars in thousands)

    

2021

    

2020

    

2021

    

2020

Compensation

$

23,291

$

22,740

$

71,298

$

62,684

Employee taxes and benefits

 

5,058

 

5,033

 

16,443

 

15,088

Occupancy and equipment expense

 

2,063

 

2,511

 

6,212

 

7,615

Business services, software and technology expense

 

5,332

 

4,378

 

15,266

 

13,501

Intangible amortization expense

 

1,088

 

990

 

3,327

 

2,971

Professional fees and assessments

1,503

 

1,070

 

4,484

 

3,303

Marketing and business development

865

 

929

 

2,310

 

2,088

Supplies and postage

549

 

248

 

1,583

 

1,630

Travel

174

 

26

 

236

 

338

Mortgage and lending expenses

1,231

 

1,434

 

3,762

 

3,916

Other

 

887

 

855

 

2,712

 

3,540

Total noninterest expense

$

42,041

$

40,214

$

127,633

$

116,674

Total noninterest expense for the three months ended September 30, 2021 was $42.0 million, an increase of $1.8 million, or 4.5%, compared to $40.2 million for the three months ended September 30, 2020. The increase in noninterest expense was driven by increases of $954 thousand in business services, software and technology expense, $551 thousand in compensation expense and $433 thousand in professional fees and assessments. These increases were partially offset by decreases of $448 thousand in occupancy and equipment expense as well as a $203 thousand decrease in mortgage and lending expenses. Business services, software and technology expense increased due to non-recurring expenses related to investments in automated processing and integration expenses associated with the acquisition of RPS. The increase in compensation expense was a result of the acquisition of RPS, as the number of full-time employees increased from 790 employees in the third quarter of 2020 to 825 employees in the third quarter of 2021 and partially offset by decreased mortgage incentives due to a $95.8 million decrease in mortgage originations. The increase in professional fees and assessments was primarily a result of increased legal fees. The decrease in occupancy and equipment expense was due to the closure of certain offices in 2021 due to our ongoing hybrid work environment. The decrease in mortgage and lending expenses was due to decreased mortgage originations. Occupancy and equipment expense decreased due to the closure of certain offices in 2021 due to our transition to a hybrid work environment.

Total noninterest expense for the nine months ended September 30, 2021 was $127.6 million, an increase of $11.0 million or 9.4%, compared to $116.7 million for the nine months ended September 30, 2020. The increase in noninterest expense was primarily driven by increases of $8.6 million in compensation expense, $1.8 million in business services, software and technology expense and $1.4 million in employee taxes and benefits, partially offset by decreases of $1.4 million in occupancy and equipment expense and $828 thousand in other noninterest expense. The changes in business services, software and technology expense, compensation, employee and benefits, and occupancy and equipment expenses were similar to the changes stated previously. The decrease in other noninterest expense was primarily driven by a $758 thousand decrease in the provision for unfunded commitments. Unfunded commitments decreased 4.3% from the third quarter of 2020.

Income Tax Expense

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

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For the three months ended September 30, 2021, we recognized income tax expense of $4.1 million on $17.1 million of pre-tax income, resulting in an effective tax rate of 23.7%, compared to income tax expense of $5.6 million on $23.3 million of pre-tax income for the three months ended September 30, 2020, resulting in an effective tax rate of 24.2%.

For the nine months ended September 30, 2021, we recognized income tax expense of $12.4 million on $52.3 million of pre-tax income, resulting in an effective tax rate of 23.7%, compared to income tax expense of $10.7 million on $45.2 million of pre-tax income for the nine months ended September 30, 2020, resulting in an effective tax rate of 23.7%.

Financial Condition

Overview

Total assets were $3.2 billion as of September 30, 2021, an increase of $161.4 million, or 5.4%, as compared to December 31, 2020. The overall increase in total assets was primarily due to increases of $425.5 million in investment securities, partially offset by decreases of $179.0 million in loans held for investment and $61.5 million in loans held for sale. The decrease in loans held for investment was primarily due to PPP loan balances decreasing by $164.9 million from December 31, 2020.

Loans

The loan portfolio represents a broad range of borrowers comprised of commercial and industrial, commercial real estate, residential real estate, and consumer 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 September 30, 2021, the portfolio mix was 28.1% commercial and industrial, 32.0% commercial real estate, 35.0% residential real estate and 4.9% in other categories. Commercial and industrial loans included $103.5 million of PPP loans as of September 30, 2021.

The following table presents the composition of total loans outstanding by portfolio segment as of September 30, 2021 and December 31, 2020:

September 30, 2021

December 31, 2020

Percent of

Percent of

Change

(dollars in thousands)

Balance

    

Portfolio

    

Balance

    

Portfolio

    

    

Amount

    

Percent

    

Commercial

    

 

 

 

 

 

Commercial and industrial (1)

 

$

506,599

28.1

%  

$

691,858

35.0

%  

$

(185,259)

(26.8)

%  

Real estate construction

 

37,751

2.1

%  

 

44,451

2.2

%  

 

(6,700)

(15.1)

%  

Commercial real estate

 

573,518

32.0

%  

 

563,007

28.5

%  

 

10,511

1.9

%  

Total commercial

 

1,117,868

62.2

%  

 

1,299,316

65.7

%  

 

(181,448)

(14.0)

%  

Consumer

 

 

 

Residential real estate first mortgage

 

501,339

27.8

%  

 

463,370

23.4

%  

 

37,969

8.2

%  

Residential real estate junior lien

 

130,243

7.2

%  

 

143,416

7.2

%  

 

(13,173)

(9.2)

%  

Other revolving and installment

 

50,936

2.8

%  

 

73,273

3.7

%  

 

(22,337)

(30.5)

%  

Total consumer

 

682,518

37.8

%  

 

680,059

34.3

%  

 

2,459

0.4

%  

Total loans

$

1,800,386

100.0

%  

$

1,979,375

100.0

%  

$

(178,989)

(9.0)

%  

(1)Included PPP loans of $103.5 million at September 30, 2021 and $268.4 million at December 31, 2020.

Total loans outstanding were $1.80 billion as of September 30, 2021, a decrease of $179.0 million, or 9.0%, from December 31, 2020. The decrease was primarily due to decreases of $185.3 million in commercial and industrial loans and $6.7 million in real estate construction loans, partially offset by increases of $10.5 million in the commercial real estate loan portfolio and $2.5 million in the consumer loan portfolio. Excluding PPP loans, the commercial portfolio decreased by $16.5 million, or 1.6%, from December 31, 2020.

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Consistent with regulatory guidance urging banks to work with borrowers during the COVID-19 pandemic and as outlined in the CARES Act, the Company offered a payment deferral program for its lending clients that were adversely affected by COVID-19. These deferrals were generally no more than 90 days in duration. As of September 30, 2021, the Company had executed 587 of these deferrals representing $154.5 million. Of those loans, 8 loans with a total outstanding principal balance of $3.4 million have been granted second deferrals, 2 loans with a total outstanding principal balance of $69 thousand remain on the first deferral and the remaining loans have been returned to a normal payment status. In accordance with the Interagency Statement on Loan Modifications and Reporting for Financial institutions as issued on April 7, 2020, these short-term deferrals were 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, commercial real estate, residential real estate, and consumer loan portfolios as a result of higher levels of liquidity and competition in our market areas.

The following table presents the maturities and types of interest rates for the loan portfolio as of September 30, 2021.

September 30, 2021

After one

One year

but within

After

(dollars in thousands)

    

or less

    

five years

    

five years

    

Total

Commercial

 

  

 

  

 

  

 

  

Commercial and industrial

$

124,595

$

317,946

$

64,058

$

506,599

Real estate construction

 

8,284

 

28,833

 

634

 

37,751

Commercial real estate

 

39,765

 

230,117

 

303,636

 

573,518

Total commercial

 

172,644

 

576,896

 

368,328

 

1,117,868

Consumer

 

  

 

  

 

  

 

  

Residential real estate first mortgage

 

10,188

 

16,085

 

475,066

 

501,339

Residential real estate junior lien

 

10,543

 

32,009

 

87,691

 

130,243

Other revolving and installment

 

7,543

 

40,413

 

2,980

 

50,936

Total consumer

 

28,274

 

88,507

 

565,737

 

682,518

Total loans

$

200,918

$

665,403

$

934,065

$

1,800,386

Sensitivity of loans to changes in interest rates

 

  

 

  

 

  

 

  

Fixed interest rates

 

  

$

526,838

$

510,687

 

  

Floating interest rates

 

  

 

138,565

 

423,378

 

  

Total

 

  

$

665,403

$

934,065

 

  

As of September 30, 2021, 62.8% of the loan portfolio bore interest at fixed rates and 37.2% at floating rates. The expected life of our loan portfolio will differ from contractual maturities because borrowers may have the right to curtail or prepay their loans with or without penalties. Consequently, the table above includes information limited to contractual maturities of the underlying loans.

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.

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Table of Contents

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 categories include special mention, substandard, and doubtful risk ratings. See “NOTE 4 Loans and Allowance for Loan Losses” to the consolidated financial statements for a definition of each of the risk ratings.

The table below presents criticized loans outstanding by loan portfolio segment as of September 30, 2021 and December 31, 2020:

September 30, 

December 31, 

(dollars in thousands)

    

2021

    

2020

    

Commercial

 

  

Commercial and industrial

$

8,398

$

22,256

Real estate construction

 

Commercial real estate

 

20,026

29,274

Total commercial

 

28,424

51,530

Consumer

 

  

Residential real estate first mortgage

 

1,842

2,149

Residential real estate junior lien

 

940

2,955

Other revolving and installment

4

37

Total consumer

 

2,786

5,141

Total loans

$

31,210

$

56,671

Criticized loans as a percent of total loans

1.73

%

2.86

%

The following table presents information regarding nonperforming assets as of September 30, 2021 and December 31, 2020:

September 30, 

December 31, 

(dollars in thousands)

    

2021

    

2020

    

Nonaccrual loans

 

$

6,229

 

$

5,050

 

Accruing loans 90+ days past due

 

 

30

 

Total nonperforming loans

6,229

5,080

OREO and repossessed assets

 

862

 

63

Total nonperforming assets

7,091

5,143

Total restructured accruing loans

714

3,427

Total nonperforming assets and restructured accruing loans

$

7,805

$

8,570

Nonperforming loans to total loans

 

0.35

%

 

0.26

%

Nonperforming assets to total assets

 

0.22

%

 

0.17

%

Allowance for loan losses to nonperforming loans

 

515

%

 

674

%

Interest income lost on nonaccrual loans approximated $85 thousand and $159 thousand for the three months ended September 30, 2021, and 2020, respectively. There was no interest income included in net interest income related to nonaccrual loans for the three months ended September 30, 2021 and 2020.

Interest income lost on nonaccrual loans approximated $197 thousand and $473 thousand for the nine months ended September 30, 2021, and 2020, respectively. There was no interest income included in net interest income related to nonaccrual loans for the nine months ended September 30, 2021 and 2020.

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

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Table of Contents

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.

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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

Nine months ended

September 30, 

September 30, 

(dollars in thousands)

    

2021

    

2020

    

2021

    

2020

    

Balance—beginning of period

$

33,764

$

27,256

$

34,246

$

23,924

Commercial loan charge-offs

 

  

 

  

 

  

 

  

Commercial and Industrial

 

(747)

 

(10)

 

(1,224)

 

(2,745)

Real estate construction

 

 

 

 

Commercial real estate

 

 

 

(536)

 

(865)

Total commercial loan charge-offs

 

(747)

 

(10)

 

(1,760)

 

(3,610)

Consumer loan charge-offs

 

  

 

  

 

  

 

  

Residential real estate first mortgage

 

 

 

 

Residential real estate junior lien

 

 

 

 

(12)

Other revolving and installment

 

(46)

 

(41)

 

(139)

 

(194)

Total consumer loan charge-offs

 

(46)

 

(41)

 

(139)

 

(206)

Total loan charge-offs

 

(793)

 

(51)

 

(1,899)

 

(3,816)

Commercial loan recoveries

 

  

 

  

 

  

 

  

Commercial and Industrial

 

1,052

 

432

 

1,497

 

1,346

Real estate construction

 

 

 

 

Commercial real estate

 

 

95

 

4

 

95

Total commercial recoveries

 

1,052

 

527

 

1,501

 

1,441

Consumer loan recoveries

 

  

 

  

 

  

 

  

Residential real estate first mortgage

 

 

 

 

5

Residential real estate junior lien

 

16

 

81

 

113

 

175

Other revolving and installment

 

27

 

24

 

105

 

108

Total consumer loan recoveries

 

43

 

105

 

218

 

288

Total loan recoveries

 

1,095

 

632

 

1,719

 

1,729

Net loan charge-offs (recoveries)

 

(302)

 

(581)

 

180

 

2,087

Commercial loan provision

 

  

 

  

 

  

 

  

Commercial and Industrial

 

(825)

 

(846)

 

(1,378)

 

(498)

Real estate construction

 

92

 

40

 

21

 

180

Commercial real estate

 

(413)

 

1,828

 

(1,049)

 

5,953

Total commercial loan provision

 

(1,146)

 

1,022

 

(2,406)

 

5,635

Consumer loan provision

 

  

 

  

 

  

 

  

Residential real estate first mortgage

 

625

 

1,694

 

1,027

 

2,914

Residential real estate junior lien

 

6

 

28

 

(63)

 

377

Other revolving and installment

 

(32)

 

108

 

(196)

 

371

Total consumer loan provision

 

599

 

1,830

 

768

 

3,662

Unallocated provision expense

 

(1,453)

 

648

 

(362)

 

203

Total loan loss provision

 

(2,000)

 

3,500

 

(2,000)

 

9,500

Balance—end of period

$

32,066

$

31,337

$

32,066

$

31,337

Total loans

$

1,800,386

$

2,058,419

$

1,800,386

$

2,058,419

Average total loans

1,820,871

2,034,778

1,884,308

1,917,894

Allowance for loan losses to total loans

 

1.78

%  

 

1.52

%  

 

1.78

%  

 

1.52

%  

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

 

(0.06)

%  

 

(0.11)

%  

 

0.01

%  

 

0.15

%  

The allowance for loan losses was $32.1 million as of September 30, 2021, compared to $34.2 million as of December 31, 2020. The $2.2 million decrease in the allowance for loan losses was primarily due to a $2.0 million reversal of the provision for loan losses expense in the third quarter of 2021. As of September 30, 2021, the allowance for loan losses represented 1.78% of total loans. Excluding PPP loans, the ratio of allowance for loan losses to total loans was 1.89% at September 30, 2021, compared to 2.00% as of December 31, 2020.

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Table of Contents

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

September 30, 2021

December 31, 2020

Percentage

Percentage

Allocated

of loans to

Allocated

of loans to

(dollars in thousands)

    

Allowance

    

total loans

    

Allowance

    

total loans

Commercial and industrial

$

9,100

28.1

%

$

10,205

35.0

%

Real estate construction

 

679

2.1

%

 

658

2.2

%

Commercial real estate

 

12,524

32.0

%

 

14,105

28.5

%

Residential real estate first mortgage

 

6,801

27.8

%

 

5,774

23.4

%

Residential real estate junior lien

 

1,423

7.2

%

 

1,373

7.2

%

Other revolving and installment

 

523

2.8

%

 

753

3.7

%

Unallocated

 

1,016

%

 

1,378

%

Total loans

$

32,066

100.0

%

$

34,246

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 $1.9 million as of September 30, 2021.

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 $60.9 million as of September 30, 2021, a decrease of $61.5 million, as compared to December 31, 2020. The decrease in loans held for sale was primarily due to a decrease in mortgage originations. Mortgage loan originations totaled $415.8 million for the three months ended September 30, 2021, compared to $607.2 million for the three months ended December 31, 2020.

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. In the second quarter of 2021, we transferred our investment securities of obligations of state and political agencies from available-for-sale to held-to-maturity to protect capital and reduce volatility in other comprehensive income due to market value changes.

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The following table presents the fair value composition of our investment securities portfolio as of September 30, 2021 and December 31, 2020:

    

September 30, 2021

    

December 31, 2020

    

Percent of

Percent of

Change

(dollars in thousands)

    

Balance

    

Portfolio

    

Balance

    

Portfolio

    

Amount

    

Percent

    

Available-for-sale

 

U.S. Treasury and agencies

5,469

0.5

%  

5,907

1.0

%  

$

(438)

(7.4)

%  

Obligations of state and political agencies

-

%  

153,773

26.0

%  

(153,773)

(100.0)

%  

Mortgage backed securities

Residential Agency

518,472

50.9

%  

306,719

51.8

%  

211,753

69.0

%  

Commercial

94,918

9.3

%  

94,978

16.0

%  

(60)

(0.1)

%  

Asset backed securities

64

-

%  

115

%  

(51)

(44.3)

%  

Corporate bonds

36,359

3.6

%  

30,850

5.2

%  

5,509

17.9

%  

Total available-for-sale investment securities

 

655,282

64.3

%  

 

592,342

100.0

%  

 

62,940

10.6

%  

Held-to-maturity

Obligations of state and political agencies

 

145,172

14.3

%  

 

%  

 

145,172

%  

Mortgage backed securities

Residential Agency

217,414

21.4

%

%

217,414

%  

Total held-to-maturity investment securities

362,586

35.7

%  

%  

145,172

%  

Total investment securities

$

1,017,868

100.0

%  

$

592,342

100.0

%  

$

208,112

35.1

%  

The investment securities presented in the following table are reported at fair value and by contractual maturity as of September 30, 2021. Actual timing may differ from contractual maturities if borrowers have the right to call or prepay obligations with or without call or prepayment penalties. Additionally, residential mortgage backed securities and collateralized mortgage obligations receive monthly principal payments, which are not reflected below. The yields below are calculated on a tax-equivalent basis.

Maturity as of September 30, 2021

 

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

$

 

%  

$

 

%  

$

1,357

 

0.92

%  

$

4,112

 

0.71

%

Mortgage backed securities

 

  

 

  

 

  

 

 

  

 

  

 

  

 

  

Residential Agency

 

 

%  

 

3,376

 

2.54

%  

 

13,787

 

2.06

%  

 

501,309

 

1.28

%

Commercial

 

 

%  

 

 

%  

 

35,827

 

2.80

%  

 

59,091

 

2.56

%

Asset backed securities

 

 

%  

 

 

%  

 

 

%  

 

64

 

5.31

%

Corporate bonds

 

 

%  

 

 

%  

 

36,359

 

4.29

%  

 

 

%

Total available-for-sale investment securities

 

%  

3,376

 

2.54

%  

87,330

 

3.28

%  

564,576

 

1.41

%

Held-to-maturity

Obligations of state and political agencies

4,690

0.26

%  

34,359

0.98

%  

76,120

1.76

%  

31,504

2.20

%

Mortgage backed securities

 

  

 

  

 

  

 

 

  

 

  

 

  

 

  

Residential Agency

 

 

%  

 

 

%  

 

 

%  

 

216,867

 

1.85

%

Total held-to-maturity investment securities

4,690

0.26

%  

34,359

0.98

%  

76,120

1.76

%  

248,371

1.89

%

Total investment securities

$

4,690

0.26

%  

$

37,735

1.12

%  

$

163,450

2.57

%  

$

812,947

1.55

%

Deposits

Total deposits were $2.71 billion as of September 30, 2021, an increase of $141.1 million, or 5.5%, from December 31, 2020. Interest-bearing deposits increased $98.7 million while noninterest-bearing deposits increased $42.3 million. Key drivers included inflows from government stimulus programs and higher depositor balances due to the uncertain economic environment and volatile financial markets. The increase in interest-bearing deposits included increases of $55.0 million in interest-bearing demand deposits, $28.3 million in money market accounts and savings

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accounts and $15.5 million in time deposits. Although overall deposits increased, we saw that within interest-bearing and noninterest-bearing deposits, synergistic deposits decreased $19.6 million from our retirement and benefit services and wealth management segments as participants transitioned balances back into the markets. As of September 30, 2021, the total sourced deposits outside of our branch footprint was $576.0 million. Excluding synergistic deposits, commercial transaction deposits increased $112.5 million, or 10.2%, while consumer transaction deposits increased $31.2 million, or 4.8%, since December 31, 2020.

The following table presents the composition of our deposit portfolio as of September 30, 2021 and December 31, 2020:

    

September 30, 2021

December 31, 2020

Percent of

Percent of

Change

(dollars in thousands)

    

Balance

    

Portfolio

    

Balance

    

Portfolio

    

Amount

    

Percent

    

Noninterest-bearing demand

$

797,062

29.4

%

$

754,716

29.3

%

$

42,346

5.6

%

Interest-bearing demand

 

673,916

24.8

%

 

618,900

24.1

%

 

55,016

8.9

%

Money market and savings

 

1,017,310

37.5

%

 

989,039

38.5

%

 

28,271

2.9

%

Time deposits

 

224,800

8.3

%

 

209,338

8.1

%

 

15,462

7.4

%

Total deposits

$

2,713,088

100.0

%

$

2,571,993

100.0

%

$

141,095

5.5

%

The following table presents the average balances and rates of our deposit portfolio for the three months ended September 30, 2021 and 2020:

Three months ended

Three months ended

September 30, 2021

September 30, 2020

Average

Average

Average

Average

(dollars in thousands)

    

Balance

    

Rate

    

Balance

    

Rate

    

Noninterest-bearing demand

$

799,854

%

$

698,594

%

Interest-bearing demand

692,873

0.14

%

589,633

0.27

%

Money market and savings

1,009,564

0.14

%

961,669

0.32

%

Time deposits

217,756

0.50

%

204,969

0.98

%

Total deposits

$

2,720,047

0.13

%

$

2,454,865

0.27

%

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

September 30, 

(dollars in thousands)

    

2021

Maturing in:

 

  

3 months or less

$

76,902

3 months to 6 months

 

58,486

6 months to 1 year

 

4,375

1 year or greater

 

8,379

Total

$

148,142

Borrowings

Borrowings as of September 30, 2021 and December 31, 2020 were as follows:

September 30, 2021

December 31, 2020

Percent of

Percent of

(dollars in thousands)

    

Balance

    

Portfolio

    

Balance

    

Portfolio

    

Subordinated notes

50,000

84.8

%

49,688

84.6

%

Junior subordinated debentures

 

8,702

14.8

%

8,617

14.7

%

Finance lease liability

261

0.4

%

430

0.7

%

Total borrowed funds

$

58,963

100.0

%

$

58,735

100.0

%

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In the first quarter of 2021, we redeemed our previously issued subordinated debt with an initial fixed rate of 5.75% and issued new subordinated debt to the Bank of North Dakota with an initial fixed rate of 3.50%.

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 $23.0 million to $353.2 million as of September 30, 2021, compared to $330.2 million as of December 31, 2020. The increase in stockholders' equity was primarily driven by $40.0 million in net income, partially offset by $8.2 million in dividends declared on common stock and a $10.1 million decrease in accumulated other comprehensive income. Tangible common equity to tangible assets, a non-GAAP financial measure, increased to 9.62% as of September 30, 2021, from 9.27% as of December 31, 2020. Tangible common equity to tangible assets would have been 9.95% as of September 30, 2021 and 10.19% as of December 31, 2020, if PPP loans were excluded.

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 September 30, 2021 and December 31, 2020, we met all the capital adequacy requirements to which we were subject. The table below presents the Company’s and the Bank’s regulatory capital ratios as of September 30, 2021 and December 31, 2020:

September 30, 

December 31, 

Capital Ratios

    

2021

    

2020

    

Alerus Financial Corporation Consolidated

 

  

 

  

 

Common equity tier 1 capital to risk weighted assets

14.52

%

12.75

%

Tier 1 capital to risk weighted assets

14.93

%

13.15

%

Total capital to risk weighted assets

18.58

%

16.79

%

Tier 1 capital to average assets

9.88

%

9.24

%

Tangible common equity to tangible assets (1)

9.62

%

9.27

%

 

 

Alerus Financial, National Association

 

 

Common equity tier 1 capital to risk weighted assets

13.77

%

12.10

%

Tier 1 capital to risk weighted assets

13.77

%

12.10

%

Total capital to risk weighted assets

15.03

%

13.36

%

Tier 1 capital to average assets

9.11

%

8.50

%

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

The capital ratios for the Company and the Bank, as of September 30, 2021, as shown in the above tables, were at levels above the regulatory minimums to be considered “well capitalized”. See “Note 16 Regulatory Matters” to the consolidated financial statements for additional information.

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Contractual Obligations and Off-Balance Sheet Arrangements

Contractual Obligations

In the ordinary course of our operations, we enter into certain contractual obligations. The following table presents our contractual obligations by maturity as of September 30, 2021.

September 30, 2021

Less than

One to

Three to

Over

(dollars in thousands)

    

one year

    

three years

    

five years

    

five years

    

Total

Operating lease obligations

$

1,597

$

2,115

$

639

$

238

$

4,589

Time deposits

 

200,773

 

14,065

 

7,875

 

2,087

 

224,800

Subordinated notes payable

50,000

50,000

Junior subordinated debenture (Trust I)

 

 

 

 

3,481

 

3,481

Junior subordinated debenture (Trust II)

 

 

 

 

5,221

 

5,221

Finance lease liability

 

251

 

21

 

 

 

272

Total contractual obligations

$

202,621

$

16,201

$

8,514

$

61,027

$

288,363

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 September 30, 2021 and December 31, 2020, was as follows:

September 30, 

December 31, 

(dollars in thousands)

    

2021

    

2020

Commitments to extend credit

$

622,465

$

611,140

Standby letters of credit

 

11,028

 

6,510

Total

$

633,493

$

617,650

Liquidity

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

As of September 30, 2021, we had on balance sheet liquidity of $789.5 million, compared to $511.1 million as of December 31, 2020. On balance sheet liquidity includes cash and cash equivalents, federal funds sold, unencumbered securities available-for-sale, and over collateralized securities pledging positions available-for-sale.

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The Bank is a member of the FHLB, which provides short- and long-term funding to its members through advances collateralized by real estate related assets and other select collateral, most typically in the form of debt securities. The actual borrowing capacity is contingent on the amount of collateral available to be pledged to the FHLB. As of September 30, 2021, we had no outstanding fed funds purchased from the FHLB and $658.2 million of collateral pledged to the FHLB. Based on this collateral, we were eligible to borrow up to $657.9 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, or $635.0 million as of September 30, 2021. Management believed that we had adequate resources to fund all of our commitments as of September 30, 2021 and December 31, 2020.

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. The economic impact of COVID-19 could place increased demand on our liquidity if we experience significant credit deterioration and as we meet borrowers’ needs. 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

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prepayments, options provided to debt issuers to exercise call options prior to maturity, and depositor options to make withdrawals and early redemptions.

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

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

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

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

The estimated impact on our net interest income as of September 30, 2021 and December 31, 2020, assuming immediate parallel moves in interest rates is presented in the table below.

September 30, 2021

December 31, 2020

 

    

Following

    

Following

    

Following

    

Following

 

12 months

24 months

12 months

24 months

 

+400 basis points

 

−2.2

%  

5.9

%  

10.2

%  

7.3

%

+300 basis points

 

−1.5

%  

2.3

%  

7.9

%  

3.2

%

+200 basis points

 

−0.9

%  

−1.3

%  

5.5

%  

−1.0

%

+100 basis points

 

−0.2

%  

−4.9

%  

3.2

%  

−5.3

%

−100 basis points

 

−11.1

%  

−21.0

%  

−4.9

%  

−18.8

%

−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.

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The table below presents the change in the economic value of equity as of September 30, 2021 and December 31, 2020, assuming immediate parallel shifts in interest rates.

September 30, 

December 31, 

 

    

2021

    

2020

 

+400 basis points

 

−21.8

%  

12.1

%

+300 basis points

 

−14.1

%  

12.6

%

+200 basis points

 

−7.0

%  

11.9

%

+100 basis points

 

−1.0

%  

9.5

%

−100 basis points

 

−31.9

%  

−51.0

%

−200 basis points

 

N/A

%  

N/A

%

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.

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PART II—OTHER INFORMATION

Item 1 – Legal Proceedings

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

Item 1A – Risk Factors

There have been no material changes to the risk factors disclosed in the Company’s Annual Report on Form 10-K filed with the SEC on March 12, 2021.

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

Unregistered Sales of Equity Securities

None.

Issuer Repurchases of Equity Securities

The following table presents information related to repurchases of shares of our common stock for each calendar month in the third quarter of 2021.

Total Number of

Maximum Number of

Total Number

Average

Shares Purchased as

Shares that May

of Shares

Price Paid

Part of Publicly

Yet be Purchased

(dollars in thousands, except per share data)

    

Purchased (1)

    

per Share

    

Announced Plans

    

Under the Plan (2)

July

 

1,634

 

$

32.08

 

 

770,000

August

 

786

 

 

28.20

 

 

770,000

September

 

 

 

 

 

770,000

Total

 

2,420

 

$

30.82

 

 

770,000

(1)Shares repurchased by the Company represent shares surrendered by employees to the Company to pay withholding taxes on the vesting of restricted stock awards.
(2)On February 18, 2021, the Board of Directors of the Company approved a stock repurchase program, or the Program, which authorizes the Company to repurchase up to 770,000 shares of its common stock, subject to certain limitations and conditions. The Program was effective immediately and will continue for a period of 36 months. The Program does not obligate the Company to repurchase any shares of its common stock and there is no assurance that the Company will do so.

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 September 30, 2021, the Company has

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maintained the net proceeds of the initial public offering on deposit with the Bank. The Bank has used the deposits of the Company to pay down short-term borrowings.

Item 3 – Defaults Upon Senior Securities

None.

Item 4 – Mine Safety Disclosures

Not Applicable.

Item 5 – Other Information

None.

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Item 6 – Exhibits

Exhibit No.

    

Description

3.1

Third Amended and Restated Certificate of Incorporation of Alerus Financial Corporation (incorporated herein by reference to Exhibit 3.1 on Form S-1 filed on August 16, 2019).

3.2

Second Amended and Restated Bylaws of Alerus Financial Corporation (incorporated herein by reference to Exhibit 3.2 on Form S-1 filed on August 16, 2019).

31.1

Chief Executive Officers Certifications required by Rule 13(a)-14(a) – filed herewith.

31.2

Chief Financial Officers 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

iXBRL Instance Document

101.SCH

iXBRL Taxonomy Extension Schema

101.CAL

iXBRL Taxonomy Extension Calculation Linkbase

101.DEF

iXBRL Taxonomy Extension Definition Linkbase

101.LAB

iXBRL Taxonomy Extension Label Linkbase

101.PRE

iXBRL Taxonomy Extension Presentation Linkbase

104

Cover Page Interactive Data File (formatted Inline XBRL and contained in Exhibits 101)

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SIGNATURES

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

ALERUS FINANCIAL CORPORATION

Date: November 4, 2021

By:

/s/ Randy L. Newman

Name:    Randy L. Newman

Title:      Chairman, Chief Executive Officer and President (Principal Executive Officer)

Date: November 4, 2021

By:

/s/ Katie A. Lorenson

Name:    Katie A. Lorenson

Title:      Executive Vice President and Chief Financial Officer (Principal Financial and Accounting Officer)

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