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

Table of Contents

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, DC 20549

FORM 10-Q

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

For the quarterly period ended March 31, 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 April 30, 2021 was 17,190,481.

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 March 31, 2021 and December 31, 2020

1

Consolidated Statements of Income for the three months ended March 31, 2021 and 2020

2

Consolidated Statements of Comprehensive Income for the three months ended March 31, 2021 and 2020

3

Consolidated Statements of Changes in Stockholders’ Equity for the three months ended March 31, 2021 and 2020

4

Consolidated Statements of Cash Flows for the three months ended March 31, 2021 and 2020

5

Notes to Consolidated Financial Statements

7

Item 2.

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

33

Item 3.

Quantitative and Qualitative Disclosures About Market Risk

55

Item 4.

Controls and Procedures

57

Part 2:

OTHER INFORMATION

Item 1.

Legal Proceedings

58

Item 1A.

Risk Factors

58

Item 2.

Unregistered Sales of Equity Securities and Use of Proceeds

58

Item 3.

Defaults Upon Senior Securities

59

Item 4.

Mine Safety Disclosures

59

Item 5.

Other Information

59

Item 6.

Exhibits

60

Signatures

61

Table of Contents

PART 1. FINANCIAL INFORMATION

Item 1 - Consolidated Financial Statements

Alerus Financial Corporation and Subsidiaries

Consolidated Balance Sheets

    

March 31, 

    

December 31, 

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

    

2021

    

2020

Assets

 

(Unaudited)

 

(Audited)

Cash and cash equivalents

$

190,217

$

172,962

Investment securities, at fair value

 

  

 

  

Available-for-sale

 

795,097

 

592,342

Equity

 

 

Loans held for sale

 

78,665

 

122,440

Loans

 

1,937,345

 

1,979,375

Allowance for loan losses

 

(33,758)

 

(34,246)

Net loans

 

1,903,587

 

1,945,129

Land, premises and equipment, net

 

19,605

 

20,289

Operating lease right-of-use assets

 

6,293

 

6,918

Accrued interest receivable

 

9,271

 

9,662

Bank-owned life insurance

 

32,556

 

32,363

Goodwill

 

30,201

 

30,201

Other intangible assets

 

24,768

 

25,919

Servicing rights

 

1,952

 

1,987

Deferred income taxes, net

 

13,700

 

9,409

Other assets

 

45,844

 

44,150

Total assets

$

3,151,756

$

3,013,771

Liabilities and Stockholders’ Equity

 

  

 

  

Deposits

 

  

 

  

Noninterest-bearing

$

775,434

$

754,716

Interest-bearing

 

1,942,139

 

1,817,277

Total deposits

 

2,717,573

 

2,571,993

Long-term debt

 

59,020

 

58,735

Operating lease liabilities

 

7,140

 

7,861

Accrued expenses and other liabilities

 

38,789

 

45,019

Total liabilities

 

2,822,522

 

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: 17,190,481 and 17,125,270 issued and outstanding

 

17,190

 

17,125

Additional paid-in capital

 

90,520

 

90,237

Retained earnings

 

224,480

 

212,163

Accumulated other comprehensive income (loss)

 

(2,956)

 

10,638

Total stockholders’ equity

 

329,234

 

330,163

Total liabilities and stockholders’ equity

$

3,151,756

$

3,013,771

See accompanying notes to consolidated financial statements (unaudited)

1

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Alerus Financial Corporation and Subsidiaries

Consolidated Statements of Income (Unaudited)

Three months ended

March 31, 

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

    

2021

    

2020

Interest Income

Loans, including fees

$

20,567

$

20,542

Investment securities

 

  

 

  

Taxable

 

2,401

 

1,759

Exempt from federal income taxes

 

236

 

235

Other

 

117

 

570

Total interest income

23,321

 

23,106

Interest Expense

 

  

 

  

Deposits

 

995

 

3,392

Short-term borrowings

 

 

Long-term debt

 

288

 

877

Total interest expense

 

1,283

 

4,269

Net interest income

 

22,038

 

18,837

Provision for loan losses

 

 

2,500

Net interest income after provision for loan losses

 

22,038

 

16,337

Noninterest Income

 

  

 

  

Retirement and benefit services

 

17,255

 

16,220

Wealth management

 

4,986

 

4,046

Mortgage banking

 

17,132

 

5,045

Service charges on deposit accounts

 

338

 

423

Net gains (losses) on investment securities

 

114

 

Other

 

1,056

 

1,455

Total noninterest income

 

40,881

 

27,189

Noninterest Expense

 

  

 

  

Compensation

 

23,698

 

18,731

Employee taxes and benefits

 

5,813

 

5,308

Occupancy and equipment expense

 

2,231

 

2,492

Business services, software and technology expense

 

4,976

 

4,543

Intangible amortization expense

 

1,151

 

990

Professional fees and assessments

 

1,472

 

1,056

Marketing and business development

 

676

 

610

Supplies and postage

 

531

 

707

Travel

 

26

 

261

Mortgage and lending expenses

 

1,332

 

1,141

Other

 

1,136

 

887

Total noninterest expense

 

43,042

 

36,726

Income before income taxes

 

19,877

 

6,800

Income tax expense

 

4,662

 

1,437

Net income

$

15,215

$

5,363

Per Common Share Data

Basic earnings per common share

$

0.87

$

0.31

Diluted earnings per common share

$

0.86

$

0.30

Dividends declared per common share

$

0.15

$

0.15

Average common shares outstanding

 

17,145

 

17,070

Diluted average common shares outstanding

 

17,465

 

17,405

See accompanying notes to consolidated financial statements (unaudited)

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Alerus Financial Corporation and Subsidiaries

Consolidated Statements of Comprehensive Income (Unaudited)

Three months ended

March 31, 

(dollars in thousands)

    

2021

    

2020

Net Income

$

15,215

$

5,363

Other Comprehensive Income (Loss), Net of Tax

 

  

 

  

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

 

(18,036)

 

6,959

Reclassification adjustment for losses (gains) realized in income

 

(114)

 

Total other comprehensive income (loss), before tax

 

(18,150)

 

6,959

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

 

(4,556)

 

1,746

Other comprehensive income (loss), net of tax

 

(13,594)

 

5,213

Total comprehensive income

$

1,621

$

10,576

See accompanying notes to consolidated financial statements (unaudited)

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Alerus Financial Corporation and Subsidiaries

Consolidated Statements of Changes in Stockholders’ Equity (Unaudited)

Three months ended March 31, 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

 

 

 

15,215

 

 

15,215

Other comprehensive income (loss)

 

 

 

 

(13,594)

 

(13,594)

Common stock repurchased

 

(16)

 

(134)

 

(296)

 

 

(446)

Common stock dividends

 

 

 

(2,602)

 

 

(2,602)

Share‑based compensation expense

 

 

498

 

 

 

498

Vesting of restricted stock

 

81

 

(81)

 

 

 

Balance as of March 31, 2021

$

17,190

$

90,520

$

224,480

$

(2,956)

$

329,234

Three months ended March 31, 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

 

 

 

5,363

 

 

5,363

Other comprehensive income (loss)

 

 

 

 

5,213

 

5,213

Common stock repurchased

 

(15)

 

(111)

 

(210)

 

 

(336)

Common stock dividends

 

 

 

(2,595)

 

 

(2,595)

ESOP repurchase obligation termination

 

 

 

 

 

Share‑based compensation expense

 

 

235

 

 

 

235

Vesting of restricted stock

 

71

 

(71)

 

 

 

Balance as of March 31, 2020

$

17,106

$

88,703

$

180,650

$

7,149

$

293,608

See accompanying notes to consolidated financial statements (unaudited)

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Alerus Financial Corporation and Subsidiaries

Consolidated Statements of Cash Flows (Unaudited)

Three months ended

March 31, 

(dollars in thousands)

    

2021

    

2020

Operating Activities

 

  

 

  

Net income

$

15,215

$

5,363

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

 

  

 

  

Deferred income taxes

 

264

 

(40)

Provision for loan losses

 

 

2,500

Depreciation and amortization

 

2,345

 

2,167

Amortization and accretion of premiums/discounts on investment securities

 

794

 

305

Amortization of operating lease right-of-use assets

(8)

(6)

Stock-based compensation

 

498

 

235

Increase in value of bank-owned life insurance

 

(193)

 

(197)

Realized loss (gain) on sale of fixed assets

(27)

 

Realized loss (gain) on derivative instruments

 

(713)

 

881

Realized loss (gain) on loans sold

 

(14,201)

 

(5,654)

Realized loss (gain) on sale of foreclosed assets

 

(23)

 

(63)

Realized loss (gain) on sale of investment securities

 

(114)

 

Realized loss (gain) on servicing rights

 

(165)

 

381

Net change in:

 

 

Loans held for sale

 

57,823

 

(19,846)

Accrued interest receivable

 

391

 

126

Other assets

 

(2,050)

 

(2,239)

Accrued expenses and other liabilities

 

(4,995)

 

(5,079)

Net cash provided (used) by operating activities

 

54,841

 

(21,166)

Investing Activities

 

  

 

  

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

 

13,189

 

4,000

Proceeds from maturities of investment securities available-for-sale

 

27,307

 

9,003

Purchases of investment securities available-for-sale

 

(262,081)

 

(50,148)

Net (increase) decrease in equity securities

 

 

2,808

Net (increase) decrease in loans

 

41,391

 

(36,637)

Purchases of premises and equipment

 

(277)

 

(689)

Proceeds from sales of foreclosed assets

 

101

 

96

Net cash provided (used) by investing activities

 

(180,370)

 

(71,567)

Financing Activities

 

  

 

  

Net increase (decrease) in deposits

 

145,580

 

150,198

Repayments of long-term debt

 

(49,748)

 

(51)

Proceeds from the issuance of Subordinated Debt

50,000

Cash dividends paid on common stock

 

(2,602)

 

(2,595)

Repurchase of common stock

 

(446)

 

(336)

Net cash provided (used) by financing activities

 

142,784

 

147,216

Net change in cash and cash equivalents

 

17,255

 

54,483

Cash and cash equivalents at beginning of period

 

172,962

 

144,006

Cash and cash equivalents at end of period

$

190,217

$

198,489

See accompanying notes to consolidated financial statements (unaudited)

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Three months ended

March 31, 

Supplemental Cash Flow Disclosures

    

2021

    

2020

Cash paid for:

 

  

 

  

Interest

$

1,405

$

3,546

Income taxes

 

736

 

Non-cash information

 

  

 

  

Loan collateral transferred to foreclosed assets

 

154

 

234

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

 

(13,594)

 

5,213

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

183

See accompanying notes to consolidated financial statements (unaudited)

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Alerus Financial Corporation and Subsidiaries

Notes to Consolidated Financial Statements (Unaudited)

NOTE 1 Significant Accounting Policies

Organization

Alerus Financial Corporation, 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.

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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 March 31, 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. In 2021, the U.S. economy has, with certain setbacks, begun reopening and wider distribution of vaccines will likely encourage 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.

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 March 31, 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

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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 is 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.

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

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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 as of March 31, 2021 and December 31, 2020:

March 31, 2021

Amortized

Unrealized

Unrealized

Fair

(dollars in thousands)

    

Cost

    

Gains

    

Losses

    

Value

U.S. Treasury and agencies

$

5,704

$

$

(21)

$

5,683

Obligations of state and political agencies

 

147,926

 

2,710

 

(1,445)

 

149,191

Mortgage backed securities

 

  

 

 

 

  

Residential agency

 

529,717

 

2,146

 

(10,268)

 

521,595

Commercial

 

85,060

 

2,650

 

(13)

 

87,697

Asset backed securities

 

91

 

5

 

 

96

Corporate bonds

 

30,545

 

707

 

(417)

 

30,835

Total available-for-sale investment securities

$

799,043

$

8,218

$

(12,164)

$

795,097

December 31, 2020

Amortized

Unrealized

Unrealized

Fair

(dollars in thousands)

    

Cost

    

Gains

    

Losses

    

Value

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

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The following tables present unrealized losses and fair values for available-for-sale investment securities as of March 31, 2021 and December 31, 2020, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position:

March 31, 2021

Less than 12 Months

Over 12 Months

Total

Unrealized

Fair

Unrealized

Fair

Unrealized

Fair

(dollars in thousands)

    

Losses

    

Value

    

Losses

    

Value

    

Losses

    

Value

U.S. Treasury and agencies

$

$

$

(21)

$

5,650

$

(21)

$

5,650

Obligations of state and political agencies

 

(1,445)

 

51,463

 

 

 

(1,445)

 

51,463

Mortgage backed securities

 

  

 

  

 

  

 

  

 

  

 

  

Residential agency

 

(10,268)

 

380,454

 

 

 

(10,268)

 

380,454

Commercial

 

(13)

 

9,026

 

 

 

(13)

 

9,026

Asset backed securities

 

 

 

 

2

 

 

2

Corporate bonds

 

(417)

 

13,583

 

 

 

(417)

 

13,583

Total available-for-sale investment securities

$

(12,143)

$

454,526

$

(21)

$

5,652

$

(12,164)

$

460,178

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

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 months ended March 31, 2021 and 2020, the Company did not recognize OTTI losses on its investment securities.

The following table presents amortized cost and estimated fair value of the available-for-sale investment securities as of March 31, 2021, by contractual maturity:

Amortized

Fair

(dollars in thousands)

    

Cost

    

Value

Due within one year or less

$

5,480

$

5,506

Due after one year through five years

 

32,626

 

33,180

Due after five years through ten years

 

150,987

 

153,408

Due after 10 years

 

609,950

 

603,003

Total available-for-sale investment securities

$

799,043

$

795,097

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.

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Table of Contents

Investment securities with a total carrying value of $177.5 million and $160.8 million were pledged as of March 31, 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 months ended March 31, 2021 and 2020, are displayed in the table below:

Three months ended

March 31, 

(dollars in thousands)

    

2021

    

2020

Proceeds

$

13,189

$

4,000

Realized gains

 

114

 

Realized losses

 

 

As of March 31, 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:

March 31, 

December 31, 

(dollars in thousands)

    

2021

    

2020

Federal Reserve

$

2,675

$

2,675

FHLB

 

3,864

 

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

Visa Class B Restricted Shares

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

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Table of Contents

NOTE 4 Loans and Allowance for Loan Losses

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

    

March 31, 

    

December 31, 

(dollars in thousands)

    

2021

    

2020

Commercial

Commercial and industrial (1)

$

678,029

$

691,858

Real estate construction

 

40,473

 

44,451

Commercial real estate

 

569,451

 

563,007

Total commercial

 

1,287,953

 

1,299,316

Consumer

 

  

 

  

Residential real estate first mortgage

 

454,958

 

463,370

Residential real estate junior lien

 

130,299

 

143,416

Other revolving and installment

 

64,135

 

73,273

Total consumer

 

649,392

 

680,059

Total loans

$

1,937,345

$

1,979,375

(1)Included Paycheck Protection Program, or PPP, loans of $256.8 million at March 31, 2021 and $268.4 million at December 31, 2020.

Total loans included net deferred loan fees and costs of $5.9 million and $4.7 million at March 31, 2021 and December 31, 2020, respectively. Deferred loan fees on PPP loans were $5.7 million at March 31, 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.

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

March 31, 2021

90 Days

Accruing

30 - 89 Days

or More

Total

(dollars in thousands)

    

Current

    

Past Due

    

Past Due

    

Nonaccrual

    

Loans

Commercial

 

  

 

  

 

  

 

  

 

  

Commercial and industrial

$

675,755

$

75

$

$

2,199

$

678,029

Real estate construction

 

40,473

 

 

 

 

40,473

Commercial real estate

 

564,959

 

2,602

 

 

1,890

 

569,451

Total commercial

 

1,281,187

 

2,677

 

 

4,089

 

1,287,953

Consumer

 

  

 

  

 

  

 

  

 

  

Residential real estate first mortgage

 

453,574

 

952

 

 

432

 

454,958

Residential real estate junior lien

 

129,917

 

184

 

 

198

 

130,299

Other revolving and installment

 

63,980

 

118

 

 

37

 

64,135

Total consumer

 

647,471

 

1,254

 

 

667

 

649,392

Total loans

$

1,928,658

$

3,931

$

$

4,756

$

1,937,345

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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.

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.

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Table of Contents

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

March 31, 2021

Criticized

Special

(dollars in thousands)

    

Pass

    

Mention

    

Substandard

    

Doubtful

    

Total

Commercial

 

  

 

  

 

  

 

  

 

  

Commercial and industrial

$

658,607

$

2,725

$

16,516

$

181

$

678,029

Real estate construction

 

40,473

 

 

 

 

40,473

Commercial real estate

 

540,906

 

3,615

 

24,930

 

 

569,451

Total commercial

1,239,986

6,340

41,446

181

1,287,953

Consumer

 

  

 

  

 

  

 

  

 

  

Residential real estate first mortgage

 

448,919

 

3,928

 

2,111

 

 

454,958

Residential real estate junior lien

 

128,788

 

407

 

1,104

 

 

130,299

Other revolving and installment

 

64,098

 

 

37

 

 

64,135

Total consumer

 

641,805

 

4,335

 

3,252

 

 

649,392

Total loans

$

1,881,791

$

10,675

$

44,698

$

181

$

1,937,345

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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Table of Contents

The following tables present, by loan portfolio segment, a summary of the changes in the allowance for loan losses for the three months ended March 31, 2021 and 2020:

Three months ended March 31, 2021

Beginning

Provision for

Loan

Loan

Ending

(dollars in thousands)

    

Balance

    

Loan Losses

    

Charge-offs

    

Recoveries

    

Balance

Commercial

Commercial and industrial

$

10,205

$

316

$

(204)

$

170

$

10,487

Real estate construction

658

(60)

598

Commercial real estate

14,105

277

(536)

3

13,849

Total commercial

24,968

533

(740)

173

24,934

Consumer

Residential real estate first mortgage

5,774

273

6,047

Residential real estate junior lien

1,373

(168)

83

1,288

Other revolving and installment

753

(83)

(44)

40

666

Total consumer

7,900

22

(44)

123

8,001

Unallocated

1,378

(555)

823

Total

$

34,246

$

$

(784)

$

296

$

33,758

Three months ended March 31, 2020

Beginning

Provision for

Loan

Loan

Ending

(dollars in thousands)

    

Balance

    

Loan Losses

    

Charge-offs

    

Recoveries

    

Balance

Commercial

 

  

 

  

 

  

 

  

 

  

Commercial and industrial

$

12,270

$

70

$

(32)

$

593

$

12,901

Real estate construction

 

303

 

31

 

 

 

334

Commercial real estate

 

6,688

 

1,588

 

 

 

8,276

Total commercial

 

19,261

 

1,689

 

(32)

 

593

 

21,511

Consumer

 

 

  

 

  

 

  

 

  

Residential real estate first mortgage

 

1,448

 

761

 

 

 

2,209

Residential real estate junior lien

 

671

 

317

 

 

37

 

1,025

Other revolving and installment

 

352

 

92

 

(67)

 

64

 

441

Total consumer

 

2,471

 

1,170

 

(67)

 

101

 

3,675

Unallocated

 

2,192

 

(359)

 

 

 

1,833

Total

$

23,924

$

2,500

$

(99)

$

694

$

27,019

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

March 31, 2021

Recorded Investment

Allowance for Loan Losses

Individually

Collectively

Individually

Collectively

(dollars in thousands)

    

Evaluated

    

Evaluated

    

Total

    

Evaluated

    

Evaluated

    

Total

Commercial

  

 

  

 

  

Commercial and industrial

$

2,794

$

675,235

$

678,029

$

691

$

9,796

$

10,487

Real estate construction

 

 

40,473

 

40,473

598

598

Commercial real estate

 

4,676

 

564,775

 

569,451

268

13,581

13,849

Total commercial

 

7,470

 

1,280,483

 

1,287,953

959

23,975

24,934

Consumer

 

  

 

  

 

  

Residential real estate first mortgage

 

432

 

454,526

 

454,958

6,047

6,047

Residential real estate junior lien

 

202

 

130,097

 

130,299

27

1,261

1,288

Other revolving and installment

 

37

 

64,098

 

64,135

16

650

666

Total consumer

 

671

 

648,721

 

649,392

43

7,958

8,001

Unallocated

823

Total loans

$

8,141

$

1,929,204

$

1,937,345

$

1,002

$

31,933

$

33,758

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Table of Contents

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

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

March 31, 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

$

1,606

$

1,689

$

691

$

723

$

725

$

336

Commercial real estate

 

2,791

 

2,816

 

268

 

3,948

 

3,974

 

837

Residential real estate junior lien

 

27

 

29

27

19

 

20

19

Other revolving and installment

 

37

 

38

 

16

27

 

27

 

13

Total impaired loans with a valuation allowance

4,461

4,572

1,002

4,717

4,746

1,205

Impaired loans without a valuation allowance

 

  

 

  

 

  

  

 

  

 

  

Commercial and industrial

1,188

1,341

1,893

2,173

Commercial real estate

 

1,885

 

2,029

 

1,276

 

1,415

 

Residential real estate first mortgage

 

432

 

461

 

439

 

464

 

Residential real estate junior lien

 

175

 

199

 

205

 

306

 

Total impaired loans without a valuation allowance

3,680

4,030

3,813

4,358

Total impaired loans

 

  

 

  

 

  

  

 

  

 

  

Commercial and industrial

2,794

3,030

691

2,616

2,898

336

Commercial real estate

 

4,676

 

4,845

 

268

 

5,224

 

5,389

 

837

Residential real estate first mortgage

432

461

439

464

Residential real estate junior lien

 

202

 

228

 

27

 

224

 

326

 

19

Other revolving and installment

 

37

 

38

 

16

 

27

 

27

 

13

Total impaired loans

$

8,141

$

8,602

$

1,002

$

8,530

$

9,104

$

1,205

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The table below presents the average recorded investment in impaired loans and interest income for the three months ended March 31, 2021 and 2020:

Three Months Ended March 31, 

2021

2020

Average

Average

Recorded

Interest

Recorded

Interest

(dollars in thousands)

    

Investment

    

Income

    

Investment

    

Income

Impaired loans with a valuation allowance

 

  

 

  

 

  

 

  

Commercial and industrial

$

1,816

$

13

$

4,979

$

15

Commercial real estate

 

2,793

 

138

 

1,536

 

8

Residential real estate junior lien

 

33

 

 

20

 

Other revolving and installment

 

38

 

 

17

 

Total impaired loans with a valuation allowance

4,680

151

6,552

23

Impaired loans without a valuation allowance

  

 

  

 

  

 

  

Commercial and industrial

1,258

22

545

27

Commercial real estate

 

2,158

 

 

 

Residential real estate first mortgage

 

435

 

 

835

 

Residential real estate junior lien

 

176

 

 

224

3

Other revolving and installment

 

 

 

8

 

Total impaired loans without a valuation allowance

4,027

22

1,612

30

Total impaired loans

 

  

 

  

 

  

 

  

Commercial and industrial

3,074

35

5,524

42

Real estate construction

Commercial real estate

 

4,951

 

138

 

1,536

 

8

Residential real estate first mortgage

 

435

 

 

835

 

Residential real estate junior lien

 

209

 

 

244

 

3

Other revolving and installment

 

38

 

 

25

 

Total impaired loans

$

8,707

$

173

$

8,164

$

53

Loans with a carrying value of $1.2 billion as of March 31, 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 reduction of interest rates, extension of maturity dates, forgiveness of principal or interest due, or acceptance of other assets in full or partial satisfaction of the debt.

During the first quarter of 2021, there were no loans modified as a TDR. Beginning in 2020, in accordance with the Interagency Statement on Loan Modifications and Reporting for Financial Institutions as issued on April 7, 2020, through March 31, 2021, the Company had entered into modifications on 582 loans representing $154.0 million in principal balances, since the beginning of the COVID-19 pandemic. Of those loans, 16 loans with a total outstanding principal balance of $7.6 million, have been granted additional deferral, 6 loans with a total outstanding principal balance of $767 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. During the first 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.

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NOTE 5 Goodwill and Other Intangible Assets

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

March 31, 

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

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

March 31, 2021

December 31, 2020

(dollars in thousands)

    

Gross Carrying Amount

    

Accumulated Amortization

    

Total

    

Gross Carrying Amount

    

Accumulated Amortization

    

Total

Identifiable customer intangibles

$

43,346

$

(18,578)

$

24,768

$

43,346

$

(17,490)

$

25,856

Core deposit intangible assets

3,793

(3,730)

63

Total intangible assets

$

43,346

$

(18,578)

$

24,768

$

47,139

$

(21,220)

$

25,919

Amortization of intangible assets was $1.2 million and $1.0 million for the three months ended March 31, 2021, and 2020, respectively.

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 March 31, 2021.

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 $423.5 million and $445.5 million as of March 31, 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 months ended March 31, 2021 and 2020:

    

Three months ended

March 31, 

(dollars in thousands)

    

2021

    

2020

Balance, beginning of period

$

1,987

$

3,845

Additions

 

49

 

24

Amortization

 

(200)

 

(187)

(Impairment)/Recovery

 

116

 

(405)

Balance, end of period

$

1,952

$

3,277

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

    

March 31, 

    

December 31, 

 

(dollars in thousands)

2021

2020

Fair value of servicing rights

$

1,952

$

1,987

Weighted-average remaining term, years

 

20.4

 

20.1

Prepayment speeds

 

16.1

%  

 

17.7

%

Discount rate

 

9.0

%  

 

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.

    

    

    

March 31, 

    

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

$

6,293

$

6,918

Finance lease right-of-use assets

 

Land, premises and equipment, net

 

173

 

202

Total lease right-of-use assets

$

6,466

$

7,120

Lease Liabilities

 

  

 

 

  

Operating lease liabilities

 

Operating lease liabilities

$

7,140

$

7,861

Finance lease liabilities

 

Long-term debt

 

375

 

430

Total lease liabilities

$

7,515

$

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.

March 31, 

December 31, 

 

    

2021

    

2020

Weighted-average remaining lease term, years

Operating leases

 

5.7

5.8

Finance leases

 

1.6

1.8

Weighted-average discount rate

 

  

Operating leases

 

2.9

%

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

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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 months ending March 31, 2021 and 2020.

    

Three months ended

March 31, 

(dollars in thousands)

    

2021

2020

Lease costs

 

  

Operating lease cost

$

496

$

623

Variable lease cost

 

233

 

197

Short-term lease cost

 

37

 

95

Finance lease cost

 

  

 

  

Interest on lease liabilities

 

8

 

12

Amortization of right-of-use assets

 

29

 

29

Sublease income

 

(60)

 

(66)

Net lease cost

$

743

$

890

Other information

 

  

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

$

487

$

618

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

 

183

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

 

Future minimum payments for finance and operating leases with initial or remaining terms of one year or more as of March 31, 2021 were as follows:

Finance

Operating

(dollars in thousands)

    

Leases

    

Leases

Twelve months ended

March 31, 2022

$

251

$

1,787

March 31, 2023

 

146

 

1,823

March 31, 2024

 

 

1,317

March 31, 2025

 

 

596

March 31, 2026

 

 

552

Thereafter

 

 

1,494

Total future minimum lease payments

$

397

$

7,569

Amounts representing interest

 

(22)

 

(429)

Total operating lease liabilities

$

375

$

7,140

NOTE 8 Deposits

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

March 31, 

December 31, 

(dollars in thousands)

    

2021

    

2020

Noninterest-bearing

$

775,434

$

754,716

Interest-bearing

 

  

 

  

Interest-bearing demand

 

674,466

 

618,900

Savings accounts

 

87,492

 

79,902

Money market savings

 

967,273

 

909,137

Time deposits

 

212,908

 

209,338

Total interest-bearing

 

1,942,139

 

1,817,277

Total deposits

$

2,717,573

$

2,571,993

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NOTE 9 Long-Term Debt

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

March 31, 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

3,458

 

Three-month LIBOR + 3.10%

3.30

%  

6/26/2033

 

6/26/2008

Junior subordinated debenture (Trust II)

 

6,186

 

5,187

 

Three-month LIBOR + 1.80%

1.98

%  

9/15/2036

 

9/15/2011

Finance lease liability

 

2,700

 

375

 

Fixed

 

7.81

%  

10/31/2022

 

N/A

Total long-term debt

$

63,010

$

59,020

 

  

 

  

 

  

 

  

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:

March 31, 

December 31, 

(dollars in thousands)

    

2021

    

2020

Commitments to extend credit

$

593,818

$

611,140

Standby letters of credit

 

6,224

 

6,510

Total

$

600,042

$

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.

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The Company utilizes standby letters of credit issued by either the Federal Home Loan Bank or the Bank of North Dakota to secure public unit deposits. The Company had a $150 thousand letter of credit with the Federal Home Loan Bank as of March 31, 2021 and December 31, 2020. With the Bank of North Dakota, the Company had no letters of credit outstanding as of March 31, 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 $237.6 million and $245.7 million as of March 31, 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 March 31, 2021, 30,499 stock awards and 91,302 restricted stock units had been issued under the plan.

Compensation expense relating to awards under these plans was $498 thousand and $235 thousand for the three months ended March 31, 2021 and 2020, respectively.

The following table presents the activity in the stock plans for the three months ended March 31, 2021 and 2020:

Three months ended March 31, 2021

Three months ended March 31, 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

 

59,374

 

26.36

63,048

 

20.23

Vested

 

(81,092)

 

20.72

(71,339)

 

16.06

Forfeited or cancelled

 

 

(5,068)

 

19.37

Outstanding at end of period

303,312

$

20.49

333,852

$

19.47

As of March 31, 2021, there was $4.1 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 2.93 years.

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Table of Contents

NOTE 12 Income Taxes

The components of income tax expense (benefit) for the three months ended March 31, 2021 and 2020 are as follows:

Three months ended March 31, 

2021

2020

    

    

Percent of

  

  

    

Percent of

 

(dollars in thousands)

Amount

Pretax Income

  

Amount

Pretax Income

 

Taxes at statutory federal income tax rate

$

4,174

 

21.0

$

1,428

 

21.0

%

Tax effect of:

 

  

 

  

 

  

 

  

Tax exempt income

 

(153)

 

(0.8)

 

(121)

 

(1.8)

%

Other

641

3.2

130

1.9

%

Applicable income taxes

$

4,662

 

23.4

$

1,437

 

21.1

%

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 March 31, 2021

Retirement and

Wealth

Corporate

(dollars in thousands)

    

Banking

    

Benefit Services

    

Management

    

Mortgage

    

Administration

    

Consolidated

Net interest income

$

21,880

$

$

$

446

$

(288)

$

22,038

Provision for loan losses

Noninterest income

1,522

17,255

4,986

17,132

(14)

40,881

Noninterest expense

11,084

 

10,112

 

2,335

 

10,853

8,658

43,042

Net income before taxes

$

12,318

$

7,143

$

2,651

$

6,725

$

(8,960)

$

19,877

    

Three months ended March 31, 2020

Retirement and

Wealth

Corporate

(dollars in thousands)

    

Banking

    

Benefit Services

    

Management

    

Mortgage

    

Administration

    

Consolidated

Net interest income

$

19,446

$

$

$

268

$

(877)

$

18,837

Provision for loan losses

 

2,500

 

 

 

 

 

2,500

Noninterest income

 

1,874

 

16,220

 

4,046

 

5,045

 

4

 

27,189

Noninterest expense

 

12,653

 

7,931

 

1,515

 

5,439

 

9,188

 

36,726

Net income before taxes

$

6,167

$

8,289

$

2,531

$

(126)

$

(10,061)

$

6,800

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.

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Table of Contents

Retirement and Benefit Services

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

NOTE 14 Earnings Per Share

The calculation of basic and diluted earnings per share using the two-class method for the three months ending March 31, 2021 and 2020 are presented below:

Three months ended

March 31, 

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

    

2021

    

2020

Net income

$

15,215

$

5,363

Dividends and undistributed earnings allocated to participating securities

254

82

Net income available to common shareholders

$

14,961

$

5,281

Weighted-average common shares outstanding for basic earnings per share

17,145

 

17,070

Dilutive effect of stock-based awards

 

320

 

335

Weighted-average common shares outstanding for diluted earnings per share

17,465

17,405

Earnings per common share:

Basic earnings per common share

$

0.87

$

0.31

Diluted earnings per common share

$

0.86

$

0.30

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 March 31, 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 March 31, 2021 and December 31, 2020:

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March 31, 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

$

1,616

$

45,845

$

569

$

44,597

Interest rate lock commitments

 

Other assets

4,033

260,318

10,124

270,103

Forward loan sales commitments

 

Other assets

 

1,028

 

34,280

 

2,664

 

86,990

TBA mortgage backed securities

 

Other assets

 

6,251

 

309,000

 

 

Total asset derivatives

 

  

$

12,928

$

649,443

$

13,357

$

401,690

Liability Derivatives

 

  

 

  

 

  

 

  

 

  

Interest rate swaps

 

Accrued expenses and other liabilities

$

1,616

$

45,845

$

572

$

44,597

TBA mortgage backed securities

 

Accrued expenses and other liabilities

2,339

307,000

Total liability derivatives

 

  

$

1,616

$

45,845

$

2,911

$

351,597

The gain (loss) recognized on derivative instruments for the three months ended March 31, 2021 and 2020 was as follows:

Three months ended

Consolidated Statements of

March 31, 

March 31, 

(dollars in thousands)

    

of Income Location

    

2021

    

2020

Interest rate swaps

 

Other noninterest income

$

2

$

Interest rate lock commitments

 

Mortgage banking

(6,245)

1,227

Forward loan sales commitments

 

Mortgage banking

(1,635)

666

TBA mortgage backed securities

 

Mortgage banking

 

8,961

 

(3,423)

Total gain/(loss) from derivative instruments

 

$

1,083

$

(1,530)

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 March 31, 2021 and December 31, 2020, respectively was $2.3 million and $2.7 million. 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 March 31, 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.

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

March 31, 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

$

279,434

 

13.48

%  

$

93,307

 

4.50

%  

$

N/A

 

N/A

Bank

 

265,300

 

12.80

%  

 

93,244

 

4.50

%  

 

134,685

 

6.50

%

Tier 1 capital to risk weighted assets

 

  

 

 

 

  

 

  

 

 

.

 

  

Consolidated

 

287,770

 

13.88

%  

 

124,410

 

6.00

%  

 

N/A

 

N/A

Bank

 

265,300

 

12.80

%  

 

124,325

 

6.00

%  

 

165,766

 

8.00

%

Total capital to risk weighted assets

 

  

 

  

 

 

  

 

  

 

 

  

 

  

Consolidated

 

363,785

 

17.54

%  

 

165,880

 

8.00

%  

 

N/A

 

N/A

Bank

 

291,298

 

14.06

%  

 

165,766

 

8.00

%  

 

207,208

 

10.00

%

Tier 1 capital to average assets

 

  

 

  

 

 

  

 

  

 

 

  

 

  

Consolidated

 

287,770

 

9.59

%  

 

120,012

 

4.00

%  

 

N/A

 

N/A

Bank

 

265,300

 

8.85

%  

 

119,947

 

4.00

%  

 

149,934

 

5.00

%

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 March 31, 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 March 31, 2021, and December 31, 2020, the Company was in compliance with HUD guidelines.

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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. As of March 31, 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 significant to the estimated fair value measurement. Assets and liabilities valued at estimated fair value are categorized based on the following inputs to the valuation techniques as follows:

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

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

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

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

Recurring Basis

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

The following tables present the balances of the assets and liabilities measured at estimated fair value on a recurring basis as of March 31, 2021 and December 31, 2020:

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March 31, 2021

(dollars in thousands)

    

Level 1

    

Level 2

    

Level 3

    

Total

Available-for-sale and securities

 

  

 

  

 

  

 

  

U.S. treasury and government agencies

$

$

5,683

$

$

5,683

Obligations of state and political agencies

 

 

149,191

 

 

149,191

Mortgage backed securities

 

  

 

  

 

  

 

  

Residential agency

 

 

521,595

 

 

521,595

Commercial

 

 

87,697

 

 

87,697

Asset backed securities

 

 

96

 

 

96

Corporate bonds

 

 

30,835

 

 

30,835

Total available-for-sale securities

$

$

795,097

$

$

795,097

Other assets

 

  

 

  

 

  

 

  

Derivatives

$

$

12,928

$

$

12,928

Other liabilities

 

  

 

  

 

  

 

  

Derivatives

$

$

1,616

$

$

1,616

December 31, 2020

(dollars in thousands)

    

Level 1

    

Level 2

    

Level 3

    

Total

Available-for-sale and equity securities

 

  

 

  

 

  

 

  

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

Equity securities

 

 

 

 

Total available-for-sale and equity 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

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

Derivatives

All of the Company’s derivatives are traded in over-the-counter markets where quoted market prices are not readily available. For these derivatives, estimated fair value is measured using internally developed models that use

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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 March 31, 2021 and December 31, 2020 consisted of the following:

March 31, 2021

(dollars in thousands)

    

Level 2

    

Level 3

    

Total

    

Impairment

Loans held for sale

$

78,665

$

$

78,665

$

Impaired loans

 

 

7,139

 

7,139

 

1,002

Foreclosed assets

 

 

139

 

139

 

Servicing rights

 

 

1,952

 

1,952

 

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

 

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 March 31, 2021, and December 31, 2020, were as follows:

March 31, 2021

(dollars in thousands)

Weighted

Asset Type

    

Valuation Technique

    

Unobservable Input

Fair Value

    

Range

    

Average

  

Impaired loans

 

Appraisal value

 

Property specific adjustment

$

7,139

 

N/A

N/A

 

Foreclosed assets

 

Appraisal value

 

Property specific adjustment

 

139

 

N/A

 

N/A

 

Servicing rights

 

Discounted cash flows

 

Prepayment speed assumptions

 

1,952

 

175-298

 

269

 

 

  

 

Discount rate

 

  

 

9.0

%  

9.0

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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 March 31, 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.

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.

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Off-Balance Sheet Credit-Related Commitments

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

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

March 31, 2021

Carrying

Estimated Fair Value

(dollars in thousands)

    

Amount

    

Level 1

    

Level 2

    

Level 3

    

Total

Financial Assets

 

  

 

  

 

  

 

  

 

  

Cash and cash equivalents

$

190,217

$

190,217

$

$

$

190,217

Loans

 

1,903,587

 

 

 

1,952,366

 

1,952,366

Accrued interest receivable

 

9,271

 

9,271

 

 

 

9,271

Bank-owned life insurance

 

32,556

 

 

32,556

 

 

32,556

Financial Liabilities

 

  

 

  

 

  

 

  

 

  

Noninterest-bearing deposits

$

775,434

$

$

775,434

$

$

775,434

Interest-bearing deposits

 

1,729,231

 

 

1,729,231

 

 

1,729,231

Time deposits

 

212,908

 

 

 

213,673

 

213,673

Long-term debt

 

59,020

 

 

56,634

 

 

56,634

Accrued interest payable

 

533

 

533

 

 

 

533

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 Paycheck Protection Program, or 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 March 31, 2021, the Company assisted 2,289 new and existing clients secure a total of approximately $447.2 million of PPP financing. Net processing fees in the amount of $14.9 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 months ended March 31, 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, 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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changes to U.S. tax laws, regulations and guidance;
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 March 31, 2021, the 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. In 2021, the U.S. economy has, with certain setbacks,

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begun reopening and wider distribution of vaccines will likely encourage 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 months ended March 31, 2021. 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 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.

Each state has experienced a dramatic and sudden increase in unemployment levels as a result of the curtailment of business activities. According to data released by the U.S. Department of Labor, initial claims for unemployment insurance have spiked in recent months in each of the states in our banking markets, a trend we expect to continue for the foreseeable future until restrictions are lifted.

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 new $1.9 trillion COVID-19 relief bill. The Plan includes 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.

We currently expect that the COVID-19 pandemic and the specific developments referred to above will continue to have a significant impact on our business. In particular, we anticipate that a significant portion of the Bank’s borrowers in the retail, restaurant, and hospitality industries will continue to endure significant economic distress, which could cause them to draw on their existing lines of credit and could adversely affect their ability and willingness to repay existing indebtedness, and is expected to adversely impact the value of collateral. These developments, together with economic conditions generally, are also expected to impact our commercial real estate portfolio, particularly with respect to real estate with exposure to the retail, restaurant and hospitality industries, our consumer loan business and loan portfolio, and the value of certain collateral securing our loans. In addition, we expect to see decreases in our total assets under administration and assets under management and a decrease in mortgage loan originations. Although a recovery is partially underway, it continues to be gradual, uneven and characterized by meaningful dispersion across sectors and regions, and could be hindered by persistent or resurgent infection rates. As a result, we anticipate that our financial condition, capital levels and results of operations will be significantly and adversely affected, as described in this Management’s Discussion and Analysis of Financial Condition and Results of Operations. During this time, we have remained focused on the health and well-being of our workforce and meeting our clients’ needs.

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

Workforce. We continue to prioritize the safety, health and well-being of our employees, clients and communities. We have implemented a work from home policy and certain of our offices remain closed. We

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continue to effectively serve our clients in all markets; virtually, digitally, via drive-thru and in-person as conditions allow. Our work place strategy includes various phases of expanding service to clients, reopening offices, and determining long-term work arrangements for employees. This approach allows us to incrementally expand in-person services to clients and provides flexibility between markets based on local conditions, guidelines, and restrictions.
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 March 31, 2021, we had executed 582 loan deferrals representing $154.0 million. Of those loans, 16 loans with a total outstanding principal balance of $7.6 million have been granted second deferrals, 6 loans with a total outstanding principal balance of $767 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 March 31, 2021, we had assisted 2,289 borrowers receive approval for funding of $447.2 million in PPP loans. As of March 31, 2021, we had received approval for forgiveness on 1,101 loans totaling $194.2 million from the SBA. We have submitted, to the SBA an additional 75 forgiveness applications totaling $61.9 million.

Shareholder Dividend and Stock Repurchases

On February 22, 2021, the Company’s Board of Directors declared a quarterly cash dividend of $0.15 per common share. This dividend was paid out on April 9, 2021, to stockholders of record at the close of business on March 19, 2021.

Although the Board of Directors is closely monitoring the impacts of the COVID-19 pandemic, it is the current expectation and intent of the Board of Directors to continue with a quarterly cash dividend.

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 March 31, 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.

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Operating Results Overview

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

Three months ended

March 31, 

December 31, 

March 31, 

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

    

2021

    

2020

    

2020

    

Performance Ratios

 

 

 

Return on average total assets

 

2.02

%  

 

1.34

%  

 

0.89

%  

Return on average common equity

 

18.46

%  

 

12.30

%  

 

7.32

%  

Return on average tangible common equity (1)

 

23.03

%  

 

15.13

%  

 

9.76

%  

Noninterest income as a % of revenue

 

64.97

%  

 

62.57

%  

 

59.07

%  

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

 

3.12

%  

 

3.23

%  

 

3.35

%  

Efficiency ratio (1)

 

66.43

%  

 

74.44

%  

 

77.47

%  

Average equity to average assets

 

10.97

%  

 

10.87

%  

 

12.18

%  

Net charge-offs/(recoveries) to average loans

(0.12)

%  

 

(0.30)

%  

 

(0.14)

%  

Dividend payout ratio

 

17.44

%  

26.32

%  

50.00

%  

Per Common Share

 

 

 

Earnings per common share - basic

$

0.87

$

0.58

$

0.31

Earnings per common share - diluted

$

0.86

$

0.57

$

0.30

Dividends declared per common share

$

0.15

$

0.15

$

0.15

Tangible book value per common share (1)

$

15.95

$

16.00

$

14.55

Average common shares outstanding - basic

 

17,145

 

17,122

 

17,070

Average common shares outstanding - diluted

 

17,465

 

17,450

 

17,405

Other Data

 

 

Retirement and benefit services assets under administration/management

$

34,774,650

$

34,199,954

$

27,718,026

Wealth management assets under administration/management

3,357,530

3,338,594

2,746,052

Mortgage originations

518,014

607,166

228,568

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

Selected Financial Data

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

Three months ended

March 31, 

December 31, 

March 31, 

(dollars in thousands)

    

2021

    

2020

    

2020

Selected Average Balance Sheet Data

 

 

 

Loans

$

1,945,437

$

2,027,903

$

1,731,593

Investment securities

 

662,413

 

549,198

 

337,160

Assets

 

3,047,261

 

3,028,184

 

2,419,665

Deposits

 

2,615,579

 

2,582,048

 

2,026,261

Long-term debt

 

25,677

 

58,726

 

58,755

Stockholders’ equity

 

334,188

 

329,210

 

294,727

March 31, 

December 31, 

March 31, 

(dollars in thousands)

    

2021

    

2020

    

2020

Selected Period End Balance Sheet Data

Loans

$

1,937,345

$

1,979,375

$

1,758,277

Allowance for loan losses

 

(33,758)

 

(34,246)

 

(27,019)

Investment securities

 

795,097

 

592,342

 

354,149

Assets

 

3,151,756

 

3,013,771

 

2,512,078

Deposits

 

2,717,573

 

2,571,993

 

2,121,514

Long-term debt

 

59,020

 

58,735

 

58,762

Total stockholders’ equity

 

329,234

 

330,163

 

293,608

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Three months ended

March 31, 

December 31, 

March 31, 

(dollars in thousands)

    

2021

    

2020

    

2020

Selected Income Statement Data

Net interest income

$

22,038

$

23,153

$

18,837

Provision for loan losses

 

 

1,400

 

2,500

Noninterest income

 

40,881

 

38,696

 

27,189

Noninterest expense

 

43,042

 

47,125

 

36,726

Income before income taxes

 

19,877

 

13,324

 

6,800

Income tax expense

 

4,662

 

3,144

 

1,437

Net income

$

15,215

$

10,180

$

5,363

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.

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

    

March 31, 

December 31, 

March 31, 

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

    

2021

    

2020

    

2020

    

Tangible common equity to tangible assets

 

  

Total common stockholders’ equity

$

329,234

$

330,163

$

293,608

Less: Goodwill

 

30,201

 

30,201

 

27,329

Less: Other intangible assets

 

24,768

 

25,919

 

17,401

Tangible common equity (a)

 

274,265

 

274,043

 

248,878

Total assets

 

3,151,756

 

3,013,771

 

2,512,078

Less: Goodwill

 

30,201

 

30,201

 

27,329

Less: Other intangible assets

 

24,768

 

25,919

 

17,401

Tangible assets (b)

 

3,096,787

 

2,957,651

 

2,467,348

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

 

8.86

%  

 

9.27

%  

 

10.09

%  

Tangible book value per common share

Total common stockholders’ equity

$

329,234

$

330,163

$

293,608

Less: Goodwill

30,201

30,201

27,329

Less: Other intangible assets

24,768

25,919

17,401

Tangible common equity (c)

274,265

274,043

248,878

Total common shares issued and outstanding (d)

17,190

17,125

 

17,106

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

$

15.95

$

16.00

$

14.55

Three months ended

March 31, 

December 31, 

March 31, 

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

    

2021

    

2020

    

2020

    

Return on average tangible common equity

Net income

$

15,215

$

10,180

$

5,363

Add: Intangible amortization expense (net of tax)

 

909

 

782

 

782

Net income, excluding intangible amortization (e)

 

16,124

 

10,962

 

6,145

Average total equity

 

334,188

 

329,210

 

294,727

Less: Average goodwill

 

30,201

 

27,766

 

27,329

Less: Average other intangible assets (net of tax)

 

19,995

 

13,206

 

14,128

Average tangible common equity (f)

 

283,992

 

288,238

 

253,270

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

 

23.03

%  

 

15.13

%  

 

9.76

%  

Net interest margin (tax-equivalent)

 

 

 

Net interest income

$

22,038

$

23,153

$

18,837

Tax-equivalent adjustment

 

143

 

131

 

100

Tax-equivalent net interest income (g)

 

22,181

 

23,284

 

18,937

Average earning assets (h)

 

2,880,255

 

2,869,767

 

2,271,004

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

 

3.12

%  

 

3.23

%  

 

3.35

%  

Efficiency ratio

 

 

 

Noninterest expense

$

43,042

$

47,125

$

36,726

Less: Intangible amortization expense

 

1,151

 

990

 

990

Adjusted noninterest expense (i)

 

41,891

 

46,135

 

35,736

Net interest income

 

22,038

 

23,153

 

18,837

Noninterest income

 

40,881

 

38,696

 

27,189

Tax-equivalent adjustment

 

143

 

131

 

100

Total tax-equivalent revenue (j)

 

63,062

 

61,980

 

46,126

Efficiency ratio (i)/(j)

 

66.43

%  

 

74.44

%  

 

77.47

%  

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Discussion and Analysis of Results of Operations

Net Income

Net income for the three months ended March 31, 2021 was $15.2 million, or $0.86 per diluted common share, a $9.9 million increase as compared to $5.4 million, or $0.30 per diluted common share, for the three months ended March 31, 2020. This increase in net income was primarily due to increases of $13.7 million in noninterest income, $3.2 million in net interest income, and a $2.5 million decrease in provision expense, partially offset by increases of $6.3 million in noninterest expense and $3.2 million in income tax expense. The increase in noninterest income was primarily due to a $12.1 million increase in mortgage banking revenue as a result of increased mortgage originations. The increase in noninterest expense was primarily attributable to an increase in compensation expense related to the increase in mortgage originations.

Net Interest Income

Net interest income is the difference between interest income and yield-related fees earned on assets and interest expense paid on liabilities. Net interest margin is the difference between the yield on interest earning assets and the cost of interest-bearing liabilities as a percentage of interest earning assets. Net interest margin is presented on a tax-equivalent basis, which means that tax-free interest income has been adjusted to a pre-tax-equivalent income, assuming a federal income tax rate of 21% for the three months ended March 31, 2021 and 2020.

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

Net interest income for the three months ended March 31, 2021 was $22.0 million, an increase of $3.2 million from $18.8 million for the three months ended March 31, 2020. The three months ended March 31, 2021 included a $3.0 million decrease in interest expense compared to the same period in 2020 and a $215 thousand increase in interest income. The decrease in interest expense was primarily driven by a decrease of $2.4 million in deposit interest expense and a decrease of $589 thousand in interest expense on long-term debt. The decrease in deposit interest expense for the three months ended March 31, 2021, compared to the same period 2020 was driven primarily by a 72 basis point reduction in the average rate paid on interest-bearing deposits, partially offset by a $421.9 million increase in the average balance of interest-bearing deposits. The decrease in interest expense on long-term debt for the three months ended March 31, 2021, was primarily due to a $33.1 million decrease in the average balance in long-term debt. The increase in interest income was primarily driven by a $643 thousand increase in interest income from investment securities as a result of a $325.3 million increase in the average balance of investment securities.

Our net interest margin (on a fully tax-equivalent, or FTE, basis) for the three months ended March 31, 2021 was 3.12%, compared to 3.35% for the same period in 2020. The decrease in net interest margin from the first quarter of 2020 was due to an 81 basis point lower average earning asset yield, partially offset by an 86 basis point decrease in the average rate paid on interest-bearing liabilities. The decrease in the average earning asset yield was primarily due to decreases of 112 basis points on interest-bearing deposits with banks and 80 basis points on the average rate on investment securities. These decreases were largely driven by the low interest rate environment as well as a shift to a more liquid balance sheet mix as the average balance in interest-bearing deposits with banks increased $21.0 million and the average balance in investment securities increased $325.3 million. The decrease in the average rate paid on total interest-bearing liabilities was primarily due to an 86 basis point decrease in the average rate paid on money market and savings deposits.

As a result of the reductions in the target federal funds interest rate, as well as the impact of the COVID-19 pandemic and related future loan charge-offs that we expect to incur, we anticipate that our net interest income and net interest margin FTE will decrease in future periods. These decreases 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.

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The following tables present average balance sheet information, interest income, interest expense and the corresponding average yields on assets, and average yields earned and rates paid for the three months ended March 31, 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 March 31, 

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

$

184,376

$

53

0.12

%

$

163,351

$

502

1.24

%

Investment securities (1)

 

662,413

 

2,700

1.65

%

 

337,160

 

2,056

2.45

%

Loans held for sale

 

82,249

 

432

2.13

%

 

33,138

 

254

3.08

%

Loans

 

  

 

  

  

 

  

 

  

  

Commercial:

 

  

 

  

 

  

 

  

Commercial and industrial

 

674,935

 

7,863

4.72

%

 

479,291

 

6,272

5.26

%

Real estate construction

 

45,264

 

471

4.22

%

 

26,723

 

334

5.03

%

Commercial real estate

 

560,986

 

5,243

3.79

%

 

508,164

 

5,823

4.61

%

Total commercial

 

1,281,185

 

13,577

4.30

%

 

1,014,178

 

12,429

4.93

%

Consumer

 

  

 

  

  

 

  

 

  

  

Residential real estate first mortgage

 

457,882

 

4,247

3.76

%

 

460,726

 

4,699

4.10

%

Residential real estate junior lien

 

137,745

 

1,650

4.86

%

 

173,436

 

2,228

5.17

%

Other revolving and installment

 

68,625

 

741

4.38

%

 

83,253

 

970

4.69

%

Total consumer

 

664,252

 

6,638

4.05

%

 

717,415

 

7,897

4.43

%

Total loans (1)

 

1,945,437

 

20,215

4.21

%

 

1,731,593

 

20,326

4.72

%

Federal Reserve/FHLB Stock

 

5,780

 

64

4.49

%

 

5,762

 

68

4.75

%

Total interest earning assets

 

2,880,255

 

23,464

3.30

%

 

2,271,004

 

23,206

4.11

%

Noninterest earning assets

167,006

148,661

Total assets

$

3,047,261

 

  

  

$

2,419,665

 

  

  

Interest-Bearing Liabilities

 

  

 

  

  

 

  

 

  

  

Interest-bearing demand deposits

$

642,832

$

247

0.16

%

$

459,028

$

528

0.46

%

Money market and savings deposits

 

1,030,348

 

403

0.16

%

 

803,838

 

2,078

1.04

%

Time deposits

 

210,719

 

345

0.66

%

 

199,088

 

786

1.59

%

Long-term debt

 

25,677

 

288

4.55

%

 

58,755

 

877

6.00

%

Total interest-bearing liabilities 

 

1,909,576

 

1,283

0.27

%

 

1,520,709

 

4,269

1.13

%

Noninterest-Bearing Liabilities and Stockholders' Equity

 

 

  

  

 

 

  

  

Noninterest-bearing deposits

731,680

 

  

  

 

564,307

Other noninterest-bearing liabilities

 

71,817

 

  

  

 

39,922

 

  

  

Stockholders’ equity

 

334,188

 

  

  

 

294,727

 

  

  

Total liabilities and stockholders’ equity

$

3,047,261

 

  

  

$

2,419,665

 

  

  

Net interest income

 

  

$

22,181

  

 

  

$

18,937

  

Net interest rate spread

 

  

 

  

3.03

%

 

  

 

  

2.98

%

Net interest margin on FTE basis (1)

 

  

 

  

3.12

%

 

  

 

  

3.35

%

(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

42

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

Three months ended March 31, 2021

Compared with

Three months ended March 31, 2020

Change due to:

Interest

(tax-equivalent basis, dollars in thousands)

    

Volume

    

Rate

    

Variance

Interest earning assets

 

  

 

  

 

  

Interest-bearing deposits with banks

$

64

$

(513)

$

(449)

Investment securities

 

1,965

 

(1,321)

 

644

Loans held for sale

 

373

 

(195)

 

178

Loans

 

  

 

  

 

  

Commercial:

 

  

 

  

 

  

Commercial and industrial

 

2,537

 

(946)

 

1,591

Real estate construction

 

230

 

(93)

 

137

Commercial real estate

 

600

 

(1,180)

 

(580)

Total commercial

 

3,367

 

(2,219)

 

1,148

Consumer

 

  

 

  

 

  

Residential real estate first mortgage

 

(29)

 

(423)

 

(452)

Residential real estate junior lien

 

(455)

 

(123)

 

(578)

Other revolving and installment

 

(169)

 

(60)

 

(229)

Total consumer

 

(653)

 

(606)

 

(1,259)

Total loans

 

2,714

 

(2,825)

 

(111)

Federal Reserve/FHLB Stock

 

 

(4)

 

(4)

Total interest income

 

5,116

 

(4,858)

 

258

Interest-bearing liabilities

 

  

 

  

 

  

Interest-bearing demand deposits

 

208

 

(489)

 

(281)

Money market and savings deposits

 

581

 

(2,256)

 

(1,675)

Time deposits

 

46

 

(487)

 

(441)

Short-term borrowings

 

 

 

Long-term debt

 

(489)

 

(100)

 

(589)

Total interest expense

 

346

 

(3,332)

 

(2,986)

Change in net interest income

$

4,770

$

(1,526)

$

3,244

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 no provision for loan losses for the three months ended March 31, 2021, a $2.5 million decrease compared to the provision for the three months ended March 31, 2020. Management believes that no additional provision is necessary at this time due to declining loan balances and strong credit quality indicators.

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 months ended March 31, 2021 and 2020.

Three months ended

March 31, 

(dollars in thousands)

    

2021

    

2020

    

Retirement and benefit services

$

17,255

$

16,220

Wealth management

 

4,986

 

4,046

Mortgage banking

 

17,132

 

5,045

Service charges on deposit accounts

 

338

 

423

Net gains (losses) on investment securities

 

114

 

Other

 

1,056

 

1,455

Total noninterest income

$

40,881

$

27,189

Noninterest income as a % of revenue

64.97

%  

59.07

%  

Total noninterest income for the three months ended March 31, 2021 was $40.9 million, an increase of $13.7 million, or 50.4%, compared to $27.2 million for the three months ended March 31, 2020. The increase in noninterest income was primarily driven by increases of $12.1 million in mortgage banking revenue, $1.0 million in retirement and benefit services revenue and $940 thousand in wealth management revenue, partially offset by a decrease of $399 thousand in other noninterest income. The increase in mortgage banking revenue was primarily driven by an increase of $289.4 million in mortgage originations as well as a $1.6 million increase in the change in the fair value of the secondary market hedge. The increase in retirement and benefit services revenue was primarily attributed to the acquisition of Retirement Planning Services Inc. Wealth management revenue increased primarily due to an increase of $611.5 million of assets under administration/management.

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 65.0% for the three months ended March 31, 2021, compared to 59.1% for the three months ended March 31, 2020. The increase was due to noninterest income increasing by 50.4% while net interest income increased by only 17.0%.

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

Noninterest Expense

The following table presents noninterest expense for the three months ended March 31, 2021 and 2020.

Three months ended

March 31, 

(dollars in thousands)

    

2021

    

2020

Compensation

$

23,698

$

18,731

Employee taxes and benefits

 

5,813

 

5,308

Occupancy and equipment expense

 

2,231

 

2,492

Business services, software and technology expense

 

4,976

 

4,543

Intangible amortization expense

 

1,151

 

990

Professional fees and assessments

1,472

 

1,056

Marketing and business development

676

 

610

Supplies and postage

531

 

707

Travel

26

 

261

Mortgage and lending expenses

1,332

 

1,141

Other

 

1,136

 

887

Total noninterest expense

$

43,042

$

36,726

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Total noninterest expense for the three months ended March 31, 2021 was $43.0 million, an increase of $6.3 million, or 17.2%, compared to $36.7 million for the three months ended March 31, 2020. The increase in noninterest expense was driven by increases of $5.0 million in compensation expense, $505 thousand in employee taxes and benefits, $433 thousand in business services, software and technology expense, $416 thousand in professional fees and assessments and $249 thousand in other noninterest expense, partially offset by decreases $235 thousand in travel and $261 thousand in occupancy and equipment expense. The increases in compensation expense as well as employee taxes and benefits are due to increases in mortgage originations and the related compensation and incentives. The increase in business services, software and technology expense was primarily due to our continued focus on internal core processing technology.

Income Tax Expense

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

For the three months ended March 31, 2021, we recognized income tax expense of $4.7 million on $19.9 million of pre-tax income, resulting in an effective tax rate of 23.4%, compared to income tax expense of $1.4 million on $6.8 million of pre-tax income for the three months ended March 31, 2020, resulting in an effective tax rate of 21.1%.

Financial Condition

Overview

Total assets were $3.2 billion as of March 31, 2021, an increase of $138.0 million, or 4.6%, as compared to December 31, 2020. The increase in total assets was primarily due to increases of $202.8 million in available-for-sale investment securities and $17.3 million in cash and cash equivalents, partially offset by decreases of $43.8 million in loans held for sale and $42.0 million in loans held for investment.

Loans

The loan portfolio represents a broad range of borrowers comprised of commercial and industrial, commercial real estate, residential real estate, and consumer financing loans. The goal of the overall portfolio mix is to diversify with approximately one third of the portfolio in each of the commercial and industrial, commercial real estate, and residential real estate categories. As of March 31, 2021, the portfolio mix was 35.0% commercial and industrial, 29.4% commercial real estate, 30.2% residential real estate and 5.4% in other categories. Commercial and industrial loans included $256.8 million of PPP loans as of March 31, 2021.

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

March 31, 2021

December 31, 2020

Percent of

Percent of

Change

(dollars in thousands)

Balance

    

Portfolio

    

Balance

    

Portfolio

    

    

Amount

    

Percent

    

Commercial

    

 

 

 

 

 

Commercial and industrial (1)

 

$

678,029

35.0

%  

$

691,858

35.0

%  

$

(13,829)

(2.0)

%  

Real estate construction

 

40,473

2.1

%  

 

44,451

2.2

%  

 

(3,978)

(8.9)

%  

Commercial real estate

 

569,451

29.4

%  

 

563,007

28.5

%  

 

6,444

1.1

%  

Total commercial

 

1,287,953

66.5

%  

 

1,299,316

65.7

%  

 

(11,363)

(0.9)

%  

Consumer

 

 

 

Residential real estate first mortgage

 

454,958

23.5

%  

 

463,370

23.4

%  

 

(8,412)

(1.8)

%  

Residential real estate junior lien

 

130,299

6.7

%  

 

143,416

7.2

%  

 

(13,117)

(9.1)

%  

Other revolving and installment

 

64,135

3.3

%  

 

73,273

3.7

%  

 

(9,138)

(12.5)

%  

Total consumer

 

649,392

33.5

%  

 

680,059

34.3

%  

 

(30,667)

(4.5)

%  

Total loans

$

1,937,345

100.0

%  

$

1,979,375

100.0

%  

$

(42,030)

(2.1)

%  

(1)Included PPP loans of $256.8 million at March 31, 2021 and $268.4 million at December 31, 2020.

Total loans outstanding were $1.94 billion as of March 31, 2021, a decrease of $42.0 million, or 2.1%, from December 31, 2020. The decrease was primarily due to decreases of $13.8 million in commercial and industrial loans, $4.0 million in our real estate construction and $30.7 in our consumer loan portfolio, partially offset by a $6.4 million increase in our commercial real estate loan portfolio.

Consistent with regulatory guidance urging banks to work with borrowers during this unprecedented situation 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 March 31, 2021, the Company had executed 582 of these deferrals representing $154.0 million. Of those loans, 16 loans with a total outstanding principal balance of $7.6 million have been granted second deferrals, 6 loans with a total outstanding principal balance of $767 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 COVID-19 and the related decline in economic conditions in our market areas.

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The following table presents the maturities and types of interest rates for the loan portfolio as of March 31, 2021.

March 31, 2021

After one

One year

but within

After

(dollars in thousands)

    

or less

    

five years

    

five years

    

Total

Commercial

 

  

 

  

 

  

 

  

Commercial and industrial

$

115,225

$

507,779

$

55,025

$

678,029

Real estate construction

 

11,516

 

11,057

 

17,900

 

40,473

Commercial real estate

 

51,003

 

216,172

 

302,276

 

569,451

Total commercial

 

177,744

 

735,008

 

375,201

 

1,287,953

Consumer

 

  

 

  

 

  

 

  

Residential real estate first mortgage

 

19,284

 

15,994

 

419,680

 

454,958

Residential real estate junior lien

 

12,948

 

40,825

 

76,526

 

130,299

Other revolving and installment

 

8,106

 

45,619

 

10,410

 

64,135

Total consumer

 

40,338

 

102,438

 

506,616

 

649,392

Total loans

$

218,082

$

837,446

$

881,817

$

1,937,345

Sensitivity of loans to changes in interest rates

 

  

 

  

 

  

 

  

Fixed interest rates

 

  

$

718,086

$

432,761

 

  

Floating interest rates

 

  

 

119,360

 

449,056

 

  

Total

 

  

$

837,446

$

881,817

 

  

As of March 31, 2021, 63.5% of the loan portfolio bore interest at fixed rates and 36.5% at floating rates. The expected life of our loan portfolio will differ from contractual maturities because borrowers may have the right to curtail or prepay their loans with or without penalties. Consequently, the table above includes information limited to contractual maturities of the underlying loans.

Asset Quality

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

Credit Quality Indicators

Loans are assigned a risk rating and grouped into categories based on relevant information about the ability of borrowers to service their debt such as: current financial information, historical payment experience, credit documentation, public information, and current economic trends, among other factors. The risk ratings are aligned to pass and criticized categories. The criticized categories include special mention, substandard, and doubtful risk ratings.

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Table of Contents

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

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

March 31, 

December 31, 

(dollars in thousands)

    

2021

    

2020

    

Commercial

 

  

Commercial and industrial

$

19,422

$

22,256

Real estate construction

 

Commercial real estate

 

28,545

29,274

Total commercial

 

47,967

51,530

Consumer

 

  

Residential real estate first mortgage

 

6,039

2,149

Residential real estate junior lien

 

1,511

2,955

Other revolving and installment

37

37

Total consumer

 

7,587

5,141

Total loans

$

55,554

$

56,671

Criticized loans as a percent of total loans

2.87

%

2.86

%

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

March 31, 

December 31, 

(dollars in thousands)

    

2021

    

2020

    

Nonaccrual loans

 

$

4,756

 

$

5,050

 

Accruing loans 90+ days past due

 

 

30

 

Total nonperforming loans

4,756

5,080

OREO and repossessed assets

 

139

 

63

Total nonperforming assets

4,895

5,143

Total restructured accruing loans

3,390

3,427

Total nonperforming assets and restructured accruing loans

$

8,285

$

8,570

Nonperforming loans to total loans

 

0.25

%

 

0.26

%

Nonperforming assets to total assets

 

0.16

%

 

0.17

%

Allowance for loan losses to nonperforming loans

 

710

%

 

674

%

The ratio of nonperforming loans to total loans at March 31, 2021 was 0.25%. Nonperforming assets as a percentage of total assets was 0.16% at March 31, 2021.

Interest income lost on nonaccrual loans approximated zero and $155 thousand for the three months ended March 31, 2021 and 2020, respectively. There was no interest income included in net interest income related to nonaccrual loans for the three months ended March 31, 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 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

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Table of Contents

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.

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

Three months ended

March 31, 

(dollars in thousands)

    

2021

    

2020

    

Balance—beginning of period

$

34,246

$

23,924

Commercial loan charge-offs

 

  

 

  

Commercial and Industrial

 

(204)

 

(32)

Real estate construction

 

 

Commercial real estate

 

(536)

 

Total commercial loan charge-offs

 

(740)

 

(32)

Consumer loan charge-offs

 

  

 

  

Residential real estate first mortgage

 

 

Residential real estate junior lien

 

 

Other revolving and installment

 

(44)

 

(67)

Total consumer loan charge-offs

 

(44)

 

(67)

Total loan charge-offs

 

(784)

 

(99)

Commercial loan recoveries

 

  

 

  

Commercial and Industrial

 

170

 

593

Real estate construction

 

 

Commercial real estate

 

3

 

Total commercial recoveries

 

173

 

593

Consumer loan recoveries

 

  

 

  

Residential real estate first mortgage

 

 

Residential real estate junior lien

 

83

 

37

Other revolving and installment

 

40

 

64

Total consumer loan recoveries

 

123

 

101

Total loan recoveries

 

296

 

694

Net loan charge-offs (recoveries)

 

488

 

(595)

Commercial loan provision

 

  

 

  

Commercial and Industrial

 

316

 

70

Real estate construction

 

(60)

 

31

Commercial real estate

 

277

 

1,588

Total commercial loan provision

 

533

 

1,689

Consumer loan provision

 

  

 

  

Residential real estate first mortgage

 

273

 

761

Residential real estate junior lien

 

(168)

 

317

Other revolving and installment

 

(83)

 

92

Total consumer loan provision

 

22

 

1,170

Unallocated provision expense

 

(555)

 

(359)

Total loan loss provision

 

 

2,500

Balance—end of period

$

33,758

$

27,019

Total loans

$

1,937,345

$

1,758,277

Average total loans

1,945,437

1,731,593

Allowance for loan losses to total loans

 

1.74

%  

 

1.54

%  

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

 

0.10

%  

 

(0.14)

%  

The allowance for loan losses was $33.8 million as of March 31, 2021, compared to $34.2 million as of December 31, 2020. The $488 million decrease in the allowance for loan losses was due to net charge-offs in the quarter as there was no additional provision expense taken during the period. As of March 31, 2021, the allowance for loan losses represented 1.74% of total loans. Excluding PPP loans, the ratio of allowance for loan losses to total loans was 2.01% at March 31, 2021, compared to 2.00% as of December 31, 2020.

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Table of Contents

Based on current economic indicators, the Company maintained the economic factors within the allowance for loan losses evaluation. We expect that the allowance for loan losses as a percent of total loans may increase in future periods based on our belief that the credit quality of our loan portfolio may decline, and loan defaults may increase, as a result of COVID-19.

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

March 31, 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

$

10,487

35.0

%

$

10,205

35.0

%

Real estate construction

 

598

2.1

%

 

658

2.2

%

Commercial real estate

 

13,849

29.4

%

 

14,105

28.5

%

Residential real estate first mortgage

 

6,047

23.5

%

 

5,774

23.4

%

Residential real estate junior lien

 

1,288

6.7

%

 

1,373

7.2

%

Other revolving and installment

 

666

3.3

%

 

753

3.7

%

Unallocated

 

823

%

 

1,378

%

Total loans

$

33,758

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 $1.8 million as of March 31, 2021, a decrease of $94 thousand, as compared to December 31, 2020.

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 $78.7 million as of March 31, 2021, a decrease of $43.8 million, as compared to December 31, 2020. The decrease in loans held for sale was primarily due to decreased mortgage originations in the first quarter. Mortgage loan originations totaled $518.0 million for the three months ended March 31, 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.

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Table of Contents

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

    

March 31, 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

5,683

0.7

%  

5,907

1.0

%  

$

(224)

(3.8)

%  

Obligations of state and political agencies

149,191

18.8

%  

153,773

26.0

%  

(4,582)

(3.0)

%  

Mortgage backed securities

Residential Agency

521,595

65.6

%  

306,719

51.8

%  

214,876

70.1

%  

Commercial

87,697

11.0

%  

94,978

16.0

%  

(7,281)

(7.7)

%  

Asset backed securities

96

%  

115

%  

(19)

(16.5)

%  

Corporate bonds

30,835

3.9

%  

30,850

5.2

%  

(15)

%  

Total investment securities

$

795,097

100.0

%  

$

592,342

100.0

%  

$

202,755

34.2

%  

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

$

 

%  

$

 

%  

$

1,476

 

0.92

%  

$

4,207

 

0.71

%

Obligations of state and political agencies

 

4,500

 

1.30

%  

 

30,177

 

1.35

%  

 

73,310

 

1.82

%  

 

41,204

 

2.34

%

Mortgage backed securities

 

  

 

  

 

  

 

 

  

 

  

 

  

 

  

Residential Agency

 

1

 

3.82

%  

 

3,003

 

2.87

%  

 

15,825

 

2.16

%  

 

502,766

 

1.22

%

Commercial

 

 

%  

 

 

%  

 

32,967

 

2.81

%  

 

54,730

 

2.78

%

Asset backed securities

 

 

%  

 

 

%  

 

 

%  

 

96

 

5.22

%

Corporate bonds

 

1,005

 

2.77

%  

 

 

%  

 

29,830

 

4.51

%  

 

 

%

Total available-for-sale

$

5,506

 

1.57

%  

$

33,180

 

1.48

%  

$

153,408

 

2.58

%  

$

603,003

 

1.43

%

Deposits

Total deposits were $2.72 billion as of March 31, 2021, an increase of $145.6 million, or 5.7%, from December 31, 2020. Interest-bearing deposits increased $124.9 million while noninterest-bearing deposits increased $20.7 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 $55.6 million in interest-bearing demand deposits, $58.1 million in money market accounts, $7.6 million in savings accounts and $3.6 million in time deposits, partially offset by a $26.6 million decrease in synergistic deposits, including health savings account deposits from our retirement and benefit services and wealth management segments. As of March 31, 2021, the total sourced deposits outside of our branch footprint was $569.0 million. Excluding synergistic deposits, commercial transaction deposits increased $135.2 million, or 12.2%, while consumer transaction deposits increased $24.3 million, or 3.8%, since December 31, 2020.

We expect that deposit levels will generally decrease in future periods as a result of the distressed economic conditions in our market areas as a result of the COVID-19 pandemic and as clients continue to utilize funds received from PPP loans and government stimulus programs.

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

    

March 31, 2021

December 31, 2020

Percent of

Percent of

Change

(dollars in thousands)

    

Balance

    

Portfolio

    

Balance

    

Portfolio

    

Amount

    

Percent

    

Noninterest-bearing demand

$

775,434

28.5

%

$

754,716

29.3

%

$

20,718

2.7

%

Interest-bearing demand

 

674,466

24.8

%

 

618,900

24.1

%

 

55,566

9.0

%

Money market and savings

 

1,054,765

38.9

%

 

989,039

38.5

%

 

65,726

6.6

%

Time deposits

 

212,908

7.8

%

 

209,338

8.1

%

 

3,570

1.7

%

Total deposits

$

2,717,573

100.0

%

$

2,571,993

100.0

%

$

145,580

5.7

%

The following table presents the average balances and rates of our deposit portfolio for the three months ended March 31, 2021 and 2020:

Three months ended

Three months ended

March 31, 2021

March 31, 2020

Average

Average

Average

Average

(dollars in thousands)

    

Balance

    

Rate

    

Balance

    

Rate

    

Noninterest-bearing demand

$

731,680

%

$

564,307

%

Interest-bearing demand

642,832

0.16

%

459,028

0.46

%

Money market and savings

1,030,348

0.16

%

803,838

1.04

%

Time deposits

210,719

0.66

%

199,088

1.59

%

Total deposits

$

2,615,579

0.15

%

$

2,026,261

0.67

%

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

March 31, 

(dollars in thousands)

    

2021

Maturing in:

 

  

3 months or less

$

66,793

3 months to 6 months

 

51,201

6 months to 1 year

 

6,374

1 year or greater

 

8,828

Total

$

133,196

Borrowings

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

March 31, 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

 

8,645

14.6

%

8,617

14.7

%

Finance lease liability

375

0.6

%

430

0.7

%

Total borrowed funds

$

59,020

100.0

%

$

58,735

100.0

%

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

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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 decreased $929 thousand to $329.2 million as of March 31, 2021, compared to $330.2 million as of December 31, 2020. The decrease in stockholders' equity was primarily driven by decreases of $13.6 million in accumulated other comprehensive income and $2.6 million in dividends declared on common stock, partially offset by $15.2 million in net income. Tangible common equity to tangible assets, a non-GAAP financial measure, decreased to 8.86% as of March 31, 2021, from 9.27% as of December 31, 2020. Tangible common equity to tangible assets would have been 9.66% as of March 31, 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 March 31, 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 March 31, 2021 and December 31, 2019:

March 31, 

December 31, 

Capital Ratios

    

2021

    

2020

    

Alerus Financial Corporation Consolidated

 

  

 

  

 

Common equity tier 1 capital to risk weighted assets

13.48

%

12.75

%

Tier 1 capital to risk weighted assets

13.88

%

13.15

%

Total capital to risk weighted assets

17.54

%

16.79

%

Tier 1 capital to average assets

9.59

%

9.24

%

Tangible common equity to tangible assets (1)

8.86

%

9.27

%

 

 

Alerus Financial, National Association

 

 

Common equity tier 1 capital to risk weighted assets

12.80

%

12.10

%

Tier 1 capital to risk weighted assets

12.80

%

12.10

%

Total capital to risk weighted assets

14.06

%

13.36

%

Tier 1 capital to average assets

8.85

%

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 March 31, 2021, as shown in the above tables, were at levels above the regulatory minimums to be considered “well capitalized”. See “Note 17 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 March 31, 2021.

March 31, 2021

Less than

One to

Three to

Over

(dollars in thousands)

    

one year

    

three years

    

five years

    

five years

    

Total

Operating lease obligations

$

1,787

$

3,140

$

1,148

$

1,494

$

7,569

Time deposits

 

188,169

 

14,792

 

6,497

 

3,450

 

212,908

Subordinated notes payable

50,000

50,000

Junior subordinated debenture (Trust I)

 

 

 

 

3,458

 

3,458

Junior subordinated debenture (Trust II)

 

 

 

 

5,187

 

5,187

Finance lease liability

 

251

 

146

 

 

 

397

Total contractual obligations

$

190,207

$

18,078

$

7,645

$

63,589

$

279,519

Off-Balance Sheet Arrangements

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

A summary of the contractual amounts of our exposure to off-balance sheet agreements as of March 31, 2021 and December 31, 2020, was as follows:

March 31, 

December 31, 

(dollars in thousands)

    

2021

    

2020

Commitments to extend credit

$

593,818

$

611,140

Standby letters of credit

 

6,224

 

6,510

Total

$

600,042

$

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 March 31, 2021, we had on balance sheet liquidity of $708.2 million, compared to $511.1 million as of December 31, 2020. On balance sheet liquidity includes total due from banks, federal funds sold, interest-bearing deposits with banks, unencumbered securities available-for-sale, and over collateralized securities pledging positions.

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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 March 31, 2021, we had no outstanding fed funds purchased from the FHLB and $968.1 million of collateral pledged to the FHLB. Based on this collateral, we were eligible to borrow up to $647.9 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. Management believed that we had adequate resources to fund all of our commitments as of March 31, 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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Table of Contents

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 March 31, 2021 and December 31, 2020, assuming immediate parallel moves in interest rates is presented in the table below.

March 31, 2021

December 31, 2020

 

    

Following

    

Following

    

Following

    

Following

 

12 months

24 months

12 months

24 months

 

+400 basis points

 

2.9

%  

3.2

%  

10.2

%  

7.3

%

+300 basis points

 

2.0

%  

0.1

%  

7.9

%  

3.2

%

+200 basis points

 

1.0

%  

−3.0

%  

5.5

%  

−1.0

%

+100 basis points

 

0.3

%  

−6.0

%  

3.2

%  

−5.3

%

−100 basis points

 

−6.7

%  

−20.9

%  

−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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Table of Contents

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

March 31, 

December 31, 

 

    

2021

    

2020

 

+400 basis points

 

−10.8

%  

12.1

%

+300 basis points

 

−6.6

%  

12.6

%

+200 basis points

 

−2.8

%  

11.9

%

+100 basis points

 

0.6

%  

9.5

%

−100 basis points

 

−31.6

%  

−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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Table of Contents

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 first 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)

January

 

983

 

$

26.68

 

 

770,000

February

 

14,898

 

 

28.18

 

 

770,000

March

 

 

 

 

 

770,000

Total

 

15,881

 

$

28.09

 

 

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 March 31, 2021, the Company has maintained

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Table of Contents

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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Table of Contents

Item 6 – Exhibits

Exhibit No.

    

Description

4.1

Subordinated Note Due March 30, 2021 (incorporated herein by reference to Exhibit 4.1 on Form 8-K filed on March 30, 2021)

10.1

Subordinated Note Purchase Agreement by and between Alerus Financial Corporation and the Bank of North Dakota, dated March 30, 2021 (incorporated herein by reference to Exhibit 10.1 on Form 8-K filed on March 30, 2021)

10.2

Alerus Financial Corporation Long-Term Incentive Plan (incorporated herein by reference to Exhibit 10.1 on Form 8-K filed on February 22, 2021)

10.3

Form of Performance-Based Restricted Stock Unit Award Agreement for Senior Executive Officers (incorporated herein by reference to Exhibit 10.2 on Form 8-K filed on February 22, 2021)

10.4

Form of Performance-Based Restricted Stock Unit Award Agreement for Non-Executive Senior Officers (incorporated herein by reference to Exhibit 10.3 on Form 8-K filed on February 22, 2021)

10.5

Form of Time-Based Restricted Stock Unit Award Agreement for Senior Executive Officers (incorporated herein by reference to Exhibit 10.4 on Form 8-K filed on February 22, 2021)

10.6

Form of Time-Based Restricted Stock Unit Award Agreement for Non-Executive Senior Officers (incorporated herein by reference to Exhibit 10.5 on Form 8-K filed on February 22, 2021)

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: May 6, 2021

By:

/s/ Randy L. Newman

Name:    Randy L. Newman

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

Date: May 6, 2021

By:

/s/ Katie A. Lorenson

Name:    Katie A. Lorenson

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

61