UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, DC 20549

FORM 10-Q

☒QUARTERLY REPORT PURSUANT TO SECTION13 OR 15(d)OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended September 30, ~~2019~~2020

☐TRANSITION REPORT PURSUANT TO SECTION13 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~~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
~~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~~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~~12b-2 of the Act). Yes ☐ No ☒⌧

The number of shares of the registrant’s common stock outstanding at ~~November 7, 2019~~October 31, 2020 was ~~17,049,439.~~17,121,863.

Table of Contents

Alerus Financial Corporation and Subsidiaries

Table of Contents

			Page
Part 1:	FINANCIAL INFORMATION
Item 1.	Consolidated Financial Statements	1
	Consolidated Balance Sheets (Unaudited) as of September 30, ~~2019 (Unaudited)~~2020 and December 31, ~~2018~~2019	1
	Consolidated Statements of Income (Unaudited) for the three and nine months ended September 30, ~~2019~~2020 and ~~2018~~2019	2
	Consolidated Statements of Comprehensive Income (Unaudited) for the three and nine months ended September 30, ~~2019~~2020 and ~~2018~~2019	3
	Consolidated Statements of Changes in ~~Shareholders’~~Stockholders’ Equity (Unaudited) for the three and nine months ended September 30, ~~2019~~2020 and ~~2018~~2019	4
	Consolidated Statements of Cash Flows (Unaudited) for the nine months ended September 30, ~~2019~~2020 and ~~2018~~2019	5 6
	Notes to Consolidated Financial Statements (Unaudited)	7 8
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	39 37
Item 3.	Quantitative and Qualitative Disclosures About Market Risk	61 63
Item 4.	Controls and Procedures	63 65

Part 2:	OTHER INFORMATION
Item 1.	Legal Proceedings	63 66
Item 1A.	Risk Factors	63 66
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	63 69
Item 3.	Defaults Upon Senior Securities	64 70
Item 4.	Mine Safety Disclosures	64 70
Item 5.	Other Information	64 70
Item 6.	Exhibits	65 71

Signatures		66 72

Table of Contents

PART 1. FINANCIAL INFORMATION

Item 1 - Consolidated Financial Statements

Alerus Financial Corporation and Subsidiaries

Consolidated Balance Sheets (Unaudited)


	September 30,		December 31,
(dollars and shares in thousands, except per share data)	2019		2018

					September 30,		December 31,
(dollars in thousands, except share and per share data)					2020		2019
Assets
Cash and cash equivalents	$	61,174	$	40,651	$	95,751	$	144,006
Investment securities, at fair value
Trading		—		1,539
Available-for-sale		278,716		250,174		495,414		310,350
Equity		2,675		3,165		—		2,808
Loans held for sale		66,021		14,486		111,311		46,846
Loans held for branch sale		—		32,031
Loans		1,686,087		1,701,850		2,058,419		1,721,279
Allowance for loan losses		(22,984)		(22,174)		(31,337)		(23,924)
Net loans		1,663,103		1,679,676		2,027,082		1,697,355
Land, premises and equipment, net		21,150		21,743		20,493		20,629
Operating lease right-of-use assets		8,877		—		8,168		8,343
Accrued interest receivable		7,412		7,645		9,199		7,551
Bank-owned life insurance		31,364		30,763		32,161		31,566
Goodwill		27,329		27,329		27,329		27,329
Other intangible assets		19,382		22,473		15,421		18,391
Servicing rights		4,146		4,623		2,579		3,845
Deferred income taxes, net		7,695		10,085		8,628		7,891
Other assets		29,267		32,687		45,273		29,968
Total assets	$	2,228,311	$	2,179,070	$	2,898,809	$	2,356,878
Liabilities and Stockholders’ Equity
Deposits
Noninterest-bearing	$	537,951	$	550,640	$	693,450	$	577,704
Interest-bearing		1,295,162		1,224,456		1,768,920		1,393,612
Total deposits		1,833,113		1,775,096		2,462,370		1,971,316
Deposits held for sale		—		24,197
Short-term borrowings		—		93,460
Long-term debt		58,775		58,824		58,745		58,769
Operating lease liabilities		9,401		—		8,671		8,864
Accrued expenses and other liabilities		45,619		30,539		47,020		32,201
Total liabilities		1,946,908		1,982,116		2,576,806		2,071,150
Commitments and contingent liabilities ESOP-owned shares		—		34,494
Stockholders’ equity
Preferred stock, $1 par value, 2,000,000 shares authorized: 0 issued and outstanding		—		—		—		—
Common stock, $1 par value, 30,000,000 shares authorized: 17,049,493 and 13,775,327 issued and outstanding		17,049		13,775
Common stock, $1 par value, 30,000,000 shares authorized: 17,121,863 and 17,049,551 issued and outstanding						17,122		17,050
Additional paid-in capital		88,230		27,743		89,757		88,650
Retained earnings		173,039		159,037		204,581		178,092
Accumulated other comprehensive income (loss)		3,085		(3,601)		10,543		1,936
Total stockholders’ equity		281,403		196,954		322,003		285,728
Less ESOP-owned shares		—		(34,494)
Total stockholders’ equity net ESOP-owned shares		281,403		162,460
Total liabilities and stockholders’ equity	$	2,228,311	$	2,179,070	$	2,898,809	$	2,356,878

See accompanying notes to consolidated financial statements (unaudited)

Table of Contents

Alerus Financial Corporation and Subsidiaries

Consolidated Statements of Income (Unaudited)


	Three months ended				Nine months ended
	September 30,				September 30,
(dollars and shares in thousands, except per share data)	2020		2019		2020		2019
Interest Income
Loans, including fees	$	21,962	$	21,886	$	63,876	$	65,171
Investment securities
Taxable		1,973		1,374		5,497		4,021
Exempt from federal income taxes		238		163		712		618
Other		116		202		816		603
Total interest income		24,289		23,625		70,901		70,413
Interest Expense
Deposits		1,683		3,506		7,633		9,802
Short-term borrowings		—		539		—		1,805
Long-term debt		841		899		2,575		2,714
Total interest expense		2,524		4,944		10,208		14,321
Net interest income		21,765		18,681		60,693		56,092
Provision for loan losses		3,500		1,498		9,500		5,515
Net interest income after provision for loan losses		18,265		17,183		51,193		50,577
Noninterest Income
Retirement and benefit services		15,104		15,307		45,034		46,142
Wealth management		4,486		3,896		12,644		11,385
Mortgage banking		22,269		8,135		44,860		19,739
Service charges on deposit accounts		355		447		1,075		1,321
Net gains (losses) on investment securities		1,428		48		2,722		357
Other		1,614		1,747		4,340		5,694
Total noninterest income		45,256		29,580		110,675		84,638
Noninterest Expense
Compensation		22,740		20,041		62,684		54,997
Employee taxes and benefits		5,033		4,600		15,088		15,188
Occupancy and equipment expense		2,768		2,700		8,392		8,086
Business services, software and technology expense		4,420		4,224		13,384		12,044
Intangible amortization expense		990		990		2,971		3,091
Professional fees and assessments		1,031		1,051		3,231		3,146
Marketing and business development		929		890		2,088		2,024
Supplies and postage		247		631		1,625		2,027
Travel		26		435		338		1,335
Mortgage and lending expenses		1,231		751		3,466		1,966
Other		799		1,014		3,407		2,198
Total noninterest expense		40,214		37,327		116,674		106,102
Income before income taxes		23,307		9,436		45,194		29,113
Income tax expense		5,648		2,332		10,698		7,225
Net income	$	17,659	$	7,104	$	34,496	$	21,888
Per Common Share Data
Basic earnings per common share	$	1.01	$	0.49	$	1.98	$	1.53
Diluted earnings per common share	$	0.99	$	0.48	$	1.94	$	1.49
Dividends declared per common share	$	0.15	$	0.14	$	0.45	$	0.42
Average common shares outstanding		17,121		14,274		17,101		13,957
Diluted average common shares outstanding		17,453		14,626		17,435		14,317

See accompanying notes to consolidated financial statements (unaudited)

Table of Contents

Alerus Financial Corporation and Subsidiaries

Consolidated Statements of Comprehensive Income (Unaudited)


	Three months ended				Nine months ended
	September 30,				September 30,
(dollars in thousands)	2020		2019		2020		2019
Net Income	$	17,659	$	7,104	$	34,496	$	21,888
Other Comprehensive Income (Loss), Net of Tax
Unrealized gains (losses) on available-for-sale securities		2,459		2,187		14,212		9,307
Reclassification adjustment for losses (gains) realized in income		(1,428)		(49)		(2,722)		(379)
Total other comprehensive income (loss), before tax		1,031		2,138		11,490		8,928
Income tax expense (benefit) related to items of other comprehensive income		259		538		2,883		2,242
Other comprehensive income (loss), net of tax		772		1,600		8,607		6,686
Total comprehensive income	$	18,431	$	8,704	$	43,103	$	28,574

See accompanying notes to consolidated financial statements (unaudited)

Table of Contents

Alerus Financial Corporation and Subsidiaries

Consolidated Statements of ~~Income~~Changes in Stockholders’ Equity (Unaudited)

Three months ended

Nine months ended

September 30,

September 30,
(dollars and shares in thousands, except per share data)

2019

2018

2019

2018
Interest Income

Loans, including fees

$
21,886

$
20,576

$
65,171

$
59,594
Investment securities








Taxable

1,374

1,129

4,021

3,475
Exempt from federal income taxes

163

301

618

927
Other

202

191

603

475
Total interest income

23,625

22,197

70,413

64,471
Interest Expense








Deposits

3,506

1,790

9,802

4,481
Short-term borrowings

539

575

1,805

1,331
Long-term debt

899

903

2,714

2,688
Total interest expense

4,944

3,268

14,321

8,500
Net interest income

18,681

18,929

56,092

55,971
Provision for loan losses

1,498

1,530

5,515

7,080
Net interest income after provision for loan losses

17,183

17,399

50,577

48,891
Noninterest Income








Retirement and benefit services

15,307

15,536

46,142

46,873
Wealth management

3,896

3,685

11,385

10,948
Mortgage banking

8,135

5,318

19,739

13,551
Service charges on deposit accounts

447

442

1,321

1,333
Net gains (losses) on investment securities

48

13

357

119
Other

1,747

1,264

5,694

3,784
Total noninterest income

29,580

26,258

84,638

76,608
Noninterest Expense








Compensation

20,041

17,873

54,997

50,906
Employee benefits

4,600

4,314

15,188

13,606
Occupancy and equipment expense

2,700

2,698

8,086

8,215
Business services, software and technology expense

4,224

3,731

12,044

10,467
Intangible amortization expense

990

1,196

3,091

3,588
Professional fees and assessments

1,051

1,628

3,146

3,734
Marketing and business development

890

856

2,024

2,439
Supplies and postage

631

611

2,027

1,902
Travel

435

382

1,335

1,252
Mortgage and lending expenses

751

437

1,966

1,597
Other

1,014

610

2,198

2,708
Total noninterest expense

37,327

34,336

106,102

100,414
Income before income taxes

9,436

9,321

29,113

25,085
Income tax expense

2,332

1,951

7,225

5,252
Net income

$
7,104

$
7,370

$
21,888

$
19,833
Per Common Share Data

Basic earnings per common share

$
0.49

$
0.53

$
1.53

$
1.44
Diluted earnings per common share

$
0.48

$
0.52

$
1.49

$
1.41
Dividends declared per common share

$
0.14

$
0.13

$
0.42

$
0.39
Average common shares outstanding

14,274

13,777

13,957

13,759
Diluted average common shares outstanding

14,626

14,071

14,317

14,060


	Three months ended September 30, 2020
							Accumulated
			Additional				Other		ESOP-
	Common		Paid-in		Retained		Comprehensive		Owned
(dollars and shares in thousands)	Stock		Capital		Earnings		Income (Loss)		Shares		Total
Balance as of June 30, 2020	$	17,120	$	89,313	$	189,528	$	9,771	$	—	$	305,732
Net income		—		—		17,659		—		—		17,659
Other comprehensive income (loss)		—		—		—		772		—		772
Common stock repurchased		—		(29)		(7)		—		—		(36)
Common stock dividends		—		—		(2,599)		—		—		(2,599)
Stock-based compensation expense		—		475		—		—		—		475
Vesting of restricted stock		2		(2)		—		—		—		—
Balance as of September 30, 2020	$	17,122	$	89,757	$	204,581	$	10,543	$	—	$	322,003


	Nine months ended September 30, 2020
							Accumulated
			Additional				Other		ESOP-
	Common		Paid-in		Retained		Comprehensive		Owned
(dollars and shares in thousands)	Stock		Capital		Earnings		Income (Loss)		Shares		Total
Balance as of December 31, 2019	$	17,050	$	88,650	$	178,092	$	1,936	$	—	$	285,728
Net income		—		—		34,496		—		—		34,496
Other comprehensive income (loss)		—		—		—		8,607		—		8,607
Common stock repurchased		(15)		(140)		(217)		—		—		(372)
Common stock dividends		—		—		(7,790)		—		—		(7,790)
Share‑based compensation expense		14		1,320		—		—		—		1,334
Vesting of restricted stock		73		(73)		—		—		—		—
Balance as of September 30, 2020	$	17,122	$	89,757	$	204,581	$	10,543	$	—	$	322,003


	Three months ended September 30, 2019
							Accumulated
			Additional				Other		ESOP-
	Common		Paid-in		Retained		Comprehensive		Owned
(dollars in thousands)	Stock		Capital		Earnings		Income (Loss)		Shares		Total
Balance as of June 30, 2019	$	13,816	$	28,676	$	169,788	$	1,485	$	(34,494)	$	179,271
Net income		—		—		7,104		—		—		7,104
Other comprehensive income (loss)		—		—		—		1,600		—		1,600
Common stock repurchased		(77)		(275)		(1,489)		—		—		(1,841)
Common stock dividends		—		—		(2,364)		—		—		(2,364)
ESOP repurchase obligation termination		—		—		—		—		34,494		34,494
Initial public offering of 3,289,000 shares of common stock net of issuance costs		3,289		59,515		—		—		—		62,804
Stock-based compensation expense		—		335		—		—		—		335
Vesting of restricted stock		21		(21)		—		—		—		—
Balance as of September 30, 2019	$	17,049	$	88,230	$	173,039	$	3,085	$	—	$	281,403

See accompanying notes to consolidated financial statements (unaudited)

Table of Contents


	Nine months ended September 30, 2019
							Accumulated
			Additional				Other		ESOP-
	Common		Paid-in		Retained		Comprehensive		Owned
(dollars in thousands)	Stock		Capital		Earnings		Income (Loss)		Shares		Total
Balance as of December 31, 2018	$	13,775	$	27,743	$	159,037	$	(3,601)	$	(34,494)	$	162,460
Net income		—		—		21,888		—		—		21,888
Other comprehensive income (loss)		—		—		—		6,686		—		6,686
Common stock repurchased		(82)		(291)		(1,574)		—		—		(1,947)
Common stock dividends		—		—		(6,312)		—		—		(6,312)
ESOP repurchase obligation termination		—		—		—		—		34,494		34,494
Initial public offering of 3,289,000 shares of common stock net of issuance costs		3,289		59,515								62,804
Share‑based compensation expense		13		1,317		—		—		—		1,330
Vesting of restricted stock		54		(54)		—		—		—		—
Balance as of September 30, 2019	$	17,049	$	88,230	$	173,039	$	3,085	$	—	$	281,403

See accompanying notes to consolidated financial statements (unaudited)

Table of Contents

Alerus Financial Corporation and Subsidiaries

Consolidated Statements of Cash Flows (Unaudited)


	Nine months ended
	September 30,
(dollars in thousands)	2020		2019
Operating Activities
Net income	$	34,496	$	21,888
Adjustments to reconcile net income to net cash provided (used) by operating activities
Deferred income taxes		(3,620)		149
Provision for loan losses		9,500		5,515
Depreciation and amortization		6,657		6,500
Amortization and accretion of premiums/discounts on investment securities		1,140		832
Amortization of operating lease right-of-use assets		(18)		3
Stock-based compensation		1,334		1,330
Increase in value of bank-owned life insurance		(595)		(601)
Realized loss (gain) on sale of branch		—		(1,544)
Realized loss (gain) on sale of fixed assets		—		(541)
Realized loss (gain) on derivative instruments		(3,282)		(3,086)
Realized loss (gain) on loans sold		(37,220)		(12,885)
Realized loss (gain) on sale of foreclosed assets		(26)		(120)
Realized loss (gain) on sale of investment securities		(2,722)		(379)
Realized loss (gain) on servicing rights		574		(213)
Net change in:
Securities held for trading		—		1,539
Loans held for sale		(27,325)		(38,294)
Accrued interest receivable		(1,648)		151
Other assets		(2,842)		6,122
Accrued expenses and other liabilities		5,754		15,566
Net cash provided (used) by operating activities		(19,843)		1,932
Investing Activities
Proceeds from sales or calls of investment securities available-for-sale		74,630		32,565
Proceeds from maturities of investment securities available-for-sale		39,208		27,818
Purchases of investment securities available-for-sale		(285,830)		(80,450)
Net (increase) decrease in equity securities		2,808		490
Net (increase) decrease in loans		(339,758)		14,213
Proceeds from sale of branch		—		10,379
Proceeds from sale of fixed assets		—		875
Purchases of premises and equipment		(2,761)		(2,450)
Proceeds from sales of foreclosed assets		555		1,006
Net cash provided (used) by investing activities		(511,148)		4,446
Financing Activities
Net increase (decrease) in deposits		491,054		53,241
Net increase (decrease) in short-term borrowings		—		(93,460)
Repayments of long-term debt		(156)		(181)
Cash dividends paid on common stock		(7,790)		(6,312)
Repurchase of common stock		(372)		(1,947)
Proceeds from the issuance of common stock in initial public offering net of issuance costs		—		62,804
Net cash provided (used) by financing activities		482,736		14,145
Net change in cash and cash equivalents		(48,255)		20,523
Cash and cash equivalents at beginning of period		144,006		40,651
Cash and cash equivalents at end of period	$	95,751	$	61,174

See accompanying notes to consolidated financial statements (unaudited)

Table of Contents


	Nine months ended
	September 30,
Supplemental Cash Flow Disclosures	2020		2019
Cash paid for:
Interest	$	9,838	$	13,162
Income taxes		11,041		5,550
Non-cash information
Loan collateral transferred to foreclosed assets		531		766
Unrealized gain (loss) on investment securities available-for-sale		8,607		6,686
Initial recognition of operating lease right-of-use assets		—		10,475
Initial recognition of operating lease liabilities		—		10,996
Right-of-use assets obtained in exchange for new operating leases		1,531		—
ESOP repurchase obligation termination		—		34,494

See accompanying notes to consolidated financial statements (unaudited)

Table of Contents

Alerus Financial Corporation and Subsidiaries

~~Consolidated Statements of Comprehensive Income (Unaudited)~~

Three months ended

Nine months ended

September 30,

September 30,
(dollars in thousands)

2019

2018

2019

2018
Net Income

$
7,104

$
7,370

$
21,888

$
19,833
Other Comprehensive Income, Net of Tax








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

2,187

(1,351)

9,307

(5,978)
Reclassification adjustment for losses (gains) realized in income

(49)

(13)

(379)

(135)
Total other comprehensive income (loss), before tax

2,138

(1,364)

8,928

(6,113)
Income tax expense (benefit) related to items of other comprehensive income

538

(342)

2,242

(1,534)
Other comprehensive income (loss), net of tax

1,600

(1,022)

6,686

(4,579)
Total comprehensive income

$
8,704

$
6,348

$
28,574

$
15,254

~~See accompanying notes to consolidated financial statements (unaudited)~~

~~Table of Contents~~

~~Alerus Financial Corporation and Subsidiaries~~

~~Consolidated Statements of Changes in Stockholders’ Equity (Unaudited)~~

Three months ended September 30, 2019

Accumulated

Additional

Other

ESOP-

Common

Paid-in

Retained

Comprehensive

Owned

(dollars in thousands)

Stock

Capital

Earnings

Income (Loss)

Shares

Total
Balance as of June 30, 2019

$
13,816

$
28,676

$
169,788

$
1,485

$
(34,494)

$
179,271
Net income

—

—

7,104

—

—

7,104
Other comprehensive income (loss)

—

—

—

1,600

—

1,600
Common stock repurchased

(77)

(275)

(1,489)

—

—

(1,841)
Common stock dividends

—

—

(2,364)

—

—

(2,364)
ESOP repurchase obligation termination

—

—

—

—

34,494

34,494
Initial public offering of 3,289,000 shares of common stock net of issuance costs

3,289

59,515

—

—

—

62,804
Stock-based compensation expense

—

335

—

—

—

335
Vesting of restricted stock

21

(21)

—

—

—

—
Balance as of September 30, 2019

$
17,049

$
88,230

$
173,039

$
3,085

$
—

$
281,403

Nine months ended September 30, 2019

Accumulated

Additional

Other

ESOP-

Common

Paid-in

Retained

Comprehensive

Owned

(dollars in thousands)

Stock

Capital

Earnings

Income (Loss)

Shares

Total
Balance as of December 31, 2018

$
13,775

$
27,743

$
159,037

$
(3,601)

$
(34,494)

$
162,460
Net income

—

—

21,888

—

—

21,888
Other comprehensive income (loss)

—

—

—

6,686

—

6,686
Common stock repurchased

(82)

(291)

(1,574)

—

—

(1,947)
Common stock dividends

—

—

(6,312)

—

—

(6,312)
ESOP repurchase obligation termination

—

—

—

—

34,494

34,494
Initial public offering of 3,289,000 shares of common stock net of issuance costs

3,289

59,515

—

—

—

62,804
Stock-based compensation expense

13

1,317

—

—

—

1,330
Vesting of restricted stock

54

(54)

—

—

—

—
Balance as of September 30, 2019

$
17,049

$
88,230

$
173,039

$
3,085

$
—

$
281,403

Three months ended September 30, 2018

Accumulated

Additional

Other

ESOP-

Common

Paid-in

Retained

Comprehensive

Owned

(dollars in thousands)

Stock

Capital

Earnings

Income (Loss)

Shares

Total
Balance as of June 30, 2018

$
13,778

$
26,664

$
149,541

$
(4,617)

$
(31,491)

$
153,875
Net income

—

—

7,370

—

—

7,370
Other comprehensive income (loss)

—

—

—

(1,022)

—

(1,022)
Common stock repurchased

(2)

(6)

(32)

—

—

(40)
Common stock dividends

—

—

(1,829)

—

—

(1,829)
Net change in fair value of ESOP shares

—

—

—

—

(3,003)

(3,003)
Stock-based compensation expense

—

237

—

—

—

237
Vesting of restricted stock

—

—

—

—

—

—
Balance as of September 30, 2018

$
13,776

$
26,895

$
155,050

$
(5,639)

$
(34,494)

$
155,588

Nine months ended September 30, 2018

Accumulated

Additional

Other

ESOP-

Common

Paid-in

Retained

Comprehensive

Owned

(dollars in thousands)

Stock

Capital

Earnings

Income (Loss)

Shares

Total
Balance as of December 31, 2017

$
13,699

$
26,040

$
140,986

$
(1,131)

$
(31,491)

$
148,103
Net income

—

—

19,833

—

—

19,833
Adjustment for adoption of ASU 2016-01

—

—

(71)

71

—

—
Other comprehensive income (loss)

—

—

—

(4,579)

—

(4,579)
Common stock repurchased

(11)

(39)

(212)

—

—

(262)
Common stock dividends

—

—

(5,486)

—

—

(5,486)
Net change in fair value of ESOP shares

—

—

—

—

(3,003)

(3,003)
Stock-based compensation expense

11

971

—

—

—

982
Vesting of restricted stock

77

(77)

—

—

—

—
Balance as of September 30, 2018

$
13,776

$
26,895

$
155,050

$
(5,639)

$
(34,494)

$
155,588

~~See accompanying notes to consolidated financial statements (unaudited)~~

~~Table of Contents~~

~~Alerus Financial Corporation and Subsidiaries~~

~~Consolidated Statements of Cash Flows (Unaudited)~~

Nine months ended

September 30,
(dollars in thousands)

2019

2018
Operating Activities




Net income

$
21,888

$
19,833
Adjustments to reconcile net income to net cash provided (used) by operating activities




Deferred income taxes

149

(1,907)
Provision for loan losses

5,515

7,080
Depreciation and amortization

6,503

6,591
Amortization and accretion of premiums/discounts on investment securities

832

1,227
Stock-based compensation

1,330

982
Increase in value of bank-owned life insurance

(601)

(602)
Realized loss (gain) on sale of branch

(1,544)

—
Realized loss (gain) on sale of fixed assets

(541)

—
Realized loss (gain) on forward sale derivatives

(7)

—
Realized loss (gain) on rate lock commitments

12

(24)
Realized loss (gain) on sale of foreclosed assets

(120)

187
Realized loss (gain) on sale of investment securities

(379)

(135)
Realized loss (gain) on servicing rights

(213)

(497)
Net change in:

Securities held for trading

1,539

51
Loans held for sale

(51,535)

(9,734)
Accrued interest receivable

151

(993)
Other assets

3,287

6,707
Accrued expenses and other liabilities

15,666

(1,417)
Net cash provided (used) by operating activities

1,932

27,349
Investing Activities




Proceeds from sales of investment securities available-for-sale

32,565

2,466
Proceeds from maturities of investment securities available-for-sale

27,818

26,120
Purchases of investment securities available-for-sale

(80,450)

(10,493)
Net (increase) decrease in equity securities

490

2,698
Net (increase) decrease in loans

14,213

(153,475)
Proceeds from sale of branch

10,379

—
Proceeds from sale of fixed assets

875

—
Purchases of premises and equipment

(2,450)

(2,314)
Proceeds from sales of foreclosed assets

1,006

687
Net cash provided (used) by investing activities

4,446

(134,311)
Financing Activities




Net increase (decrease) in deposits

53,241

(17,253)
Net increase (decrease) in short-term borrowings

(93,460)

43,930
Repayments of long-term debt

(181)

(128)
Cash dividends paid on common stock

(6,312)

(5,486)
Repurchase of common stock

(1,947)

(262)
Proceeds from the issuance of common stock in initial public offering net of issuance costs

62,804

—
Net cash provided (used) by financing activities

14,145

20,801
Net change in cash and cash equivalents

20,523

(86,161)
Cash and cash equivalents at beginning of period

40,651

121,998
Cash and cash equivalents at end of period

$
61,174

$
35,837

~~See accompanying notes to consolidated financial statements (unaudited)~~

~~Table of Contents~~

Nine months ended

September 30,
Supplemental Cash Flow Disclosures

2019

2018
Cash paid for:




Interest

$
13,162

$
7,692
Income taxes

5,550

3,030
Non-cash information




Loan collateral transferred to foreclosed assets

766

661
Unrealized gain (loss) on investment securities available-for-sale

6,686

(4,579)
Initial recognition of operating lease right-of-use assets

10,475

—
Initial recognition of operating lease liabilities

10,996

—
Change in fair value of ESOP shares

—

(3,003)
ESOP repurchase obligation termination

34,494

—

~~See accompanying notes to consolidated financial statements (unaudited)~~

~~Table of Contents~~

~~Alerus Financial Corporation and Subsidiaries~~

Notes to Consolidated Financial Statements (Unaudited)

NOTE 1 Significant Accounting Policies

Organization

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

Initial Public Offering

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

Basis of Presentation

The accompanying unaudited consolidated financial statements and notes thereto of the Company have been prepared in accordance with the rules and regulations of the Securities and Exchange Commission, ~~(“SEC”)~~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, ~~(“GAAP”)~~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, ~~2018,~~2019, included in the Company’s ~~prospectus~~Annual Report on Form 10-K filed with the SEC on ~~September 13, 2019, pursuant to Rule 424(b)(4) under the Securities Act of 1933.~~March 26, 2020.

Principles of Consolidation

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

In the normal course of business, the Company may enter into a transaction with a variable interest entity, ~~(“VIE”).~~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.

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

Reclassifications

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

Other Information

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

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

Emerging Growth Company

The Company qualifies as an “emerging growth company” under the Jumpstart Our Business Startups Act of 2012, ~~(the “JOBS Act”),~~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, ~~(the~~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. Management cannot predict if investors will find the Company’s common stock less attractive because it will rely on these exemptions. If some investors find the Company’s common stock less attractive as a result, there may be a less active trading market for its common stock and the Company’s stock price may be more volatile.

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

NOTE 2 Recent Accounting Pronouncements

The following FASB Accounting Standards Updates, ~~(“ASUs”)~~or ASUs, are divided into pronouncements which have been adopted by the Company since January 1, ~~2019,~~2020, and those which are not yet effective and have been evaluated or are currently being evaluated by management as of September 30, ~~2019.~~2020.

Adopted Pronouncements

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

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

~~In March~~ 2017, the FASB issued ASU No. ~~2017‑08, Premium Amortization on Purchased Callable Debt Securities.~~2017-04, Simplifying the Test for Goodwill Impairment. This ASU ~~shortens~~removes Step 2 of the ~~amortization period~~goodwill impairment test, which requires a hypothetical purchase price allocation. Under the amended guidance, a goodwill impairment charge will now be recognized for the ~~premium on certain purchased callable debt securities to~~amount by which the earliest call date. Currently, entities generally amortize the premium as an adjustment of yield over the contractual life of the security. ASU 2017‑08 does not change the accounting for purchased callable debt securities held at a discount as the discount will continue to be accreted to maturity. ASU 2017‑08 is effective for public business entities for the interim and annual reporting periods beginning after December 15, 2018. Early adoption is permitted. The guidance calls for a modified retrospective transition approach under which a cumulative‑effect adjustment will be made to retained earnings as of the beginning of the first reporting period in which ASU 2017‑08 is adopted. The Company elected to early adopt this standard as of January 1, 2019, and has evaluated the provisions of ASU 2017‑08 and determined there is no impact on its consolidated financial statements.

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

~~In September 2018, the FASB issued ASU No. 2018‑07, Compensation (Topic 718): Improvements to Nonemployee Share‑Based Payment Accounting. This ASU has been issued as part~~carrying value of a ~~simplification initiative which will expand the scope of Topic 718~~reporting unit exceeds its estimated fair value, not to include share‑based payment transactions for the acquiring of goods and services from non‑employees and expands the scope through the amendments to address and improve aspects of the accounting for non‑employee share‑based payment transactions. The amendments will be effective for public business entities for interim and annual reporting periods beginning after December 15, 2018. The Company elected to early adopt ASU 2018‑07 effective January 1, 2019, and has evaluated the provisions of ASU 2018‑07 and determined there was no significant impact on its consolidated financial statements.

~~Pronouncements Not Yet Effective~~

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

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~~U.S.~~ US Securities and Exchange Commission filers, ASU ~~2016‑13~~2017-04, is effective for interim and annual reporting periods beginning after December 15, 2019. For all other public business entities ASU 2016‑13 is effective for interim and annual reporting periods beginning after December 15, 2020. As an emerging growth company, ASU 2016‑13 is effective for interim and annual reporting periods beginning after December 15, 2021, although early adoption is permitted. The Company ~~is currently evaluating~~adopted ASU 2017-04 effective January 1, 2020, and the ~~potential~~new guidance did not have an impact ~~of ASU 2016‑13~~ on ~~its~~the Company’s consolidated financial statements. On July 17, 2019, the FASB voted to issue a proposal for public comment that would potentially result in a postponement of the required implementation date for ASU 2016‑13, and on October 16, 2019, the FASB approved delaying the implementation of this ASU for private companies and smaller reporting companies until 2023. As an emerging growth company, the Company can take advantage of this delay. Management will continue to monitor any new developments regarding this possible delay.

In August 2018, the FASB issued ASU No. ~~2018‑13,~~2018-13, Disclosure Framework—Changes to the Disclosure Requirements for Fair Value Measurement. This ASU eliminates, adds, and modifies certain disclosure requirements for estimated fair value measurements. Among the changes, entities will no longer be required to disclose the amount of and reasons for ~~transfer~~transfers between Level 1 and Level 2 of the estimated fair value hierarchy, but will be required to disclose the range and weighted-average used to develop significant unobservable inputs for Level 3 estimated fair value measurements. ASU ~~2018‑13~~2018-13 is effective for all entities interim and annual reporting periods beginning after December 15, 2019. ~~Early adoption is permitted. Entities are also allowed to elect for early adoption of~~The Company adopted ASU 2018-13 effective January 1, 2020, and the ~~eliminated or modified disclosure requirements and delay adoption of the new disclosure requirements until their effective date. The~~ revised disclosure requirements ~~will~~did not have a material impact on the Company’s consolidated financial statements.

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

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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,~~2019-04, Codification Improvements to Topic 326, Financial Instruments—Credit Losses, Topic 815, Derivatives and Hedging, and Topic 825, Financial Instruments, which affects a variety of topics in the Codification and applies to all reporting entities within the scope of the affected accounting guidance. ~~This update is not expected to have a significant impact on~~The Company will consider these clarifications and improvements in determining the ~~Company’s consolidated financial statements.~~appropriate adoption of ASU 2019-04.

In May 2019, the FASB issued ASU ~~2019‑05,~~2019-05, Targeted Transition Relief to provide entities with an option to irrevocably elect the fair value option applied on an instrument-by-instrument basis for eligible instruments. ~~As an emerging growth company, these ASUs are~~In November 2019, the FASB Issued ASU 2019-10, which amends the effective date of this ASU for ~~fiscal years beginning~~certain entities, including private companies and smaller reporting companies until after December 15, ~~2021,~~2022, including interim periods within those fiscal years. As an emerging growth company, the Company can take advantage of this delay and plans to adopt the standard with the amended effective date. This update is not expected to have a significant impact on the Company’s consolidated financial statements.

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

In January 2020, the FASB issued ASU 2020-01, Investments – Equity Securities (Topic 321), Investments – Equity Method and Joint Ventures (Topic 323), and Derivatives and Hedging (Topic 815) – Clarifying the Interactions between Topic 321, Topic 323, and Topic 815. The ASU is based on a consensus of the Emerging Issues Task Force and is expected to increase comparability in accounting for these transactions. ASU 2016-01 made targeted improvements to accounting for financial instruments, including providing an entity the ability to measure certain equity securities without a readily determinable fair value at cost, less any impairment, plus or minus changes resulting from observable price changes in orderly transactions for the identical or a similar investment of the same issuer. Among other topics, the amendments clarify that an entity should consider observable transactions that require it to either apply or discontinue the equity method of accounting. For public business entities, the amendments in the ASU are effective for fiscal years beginning after December 15, 2020, and interim periods within those fiscal years. Early adoptions is permitted. The Company does not expect the adoption of ASU 2020-01 to have a material impact on its 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.

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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. The Company is assessing ASU 2020-04 and its impact on the Company’s transition away from LIBOR for its loan and other financial instruments.

NOTE 3 Investment Securities

The following tables present amortized cost, gross unrealized gain and losses, and fair value of the available-for-sale investment securities as of September 30, ~~2019~~2020 and December 31, ~~2018:~~2019:


	September 30, 2019
	Amortized		Unrealized		Unrealized		Fair

									September 30, 2020
									Amortized		Unrealized		Unrealized		Fair
(dollars in thousands)	Cost		Gains		Losses		Value		Cost		Gains		Losses		Value
U.S. Treasury and agencies	$	21,607	$	29	$	(34)	$	21,602	$	16,075	$	34	$	(17)	$	16,092
Obligations of state and political agencies		47,227		703		(74)		47,856		142,308		4,908		—		147,216
Mortgage backed securities
Residential agency		165,995		3,467		(125)		169,337		203,812		7,933		(45)		211,700
Commercial		32,546		139		(33)		32,652		86,502		1,092		(52)		87,542
Asset backed securities		152		5		—		157		123		8		—		131
Corporate bonds		7,069		43		—		7,112		32,518		244		(29)		32,733
Total available-for-sale investment securities	$	274,596	$	4,386	$	(266)	$	278,716	$	481,338	$	14,219	$	(143)	$	495,414

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	December 31, 2018
	Amortized		Unrealized		Unrealized		Fair

									December 31, 2019
									Amortized		Unrealized		Unrealized		Fair
(dollars in thousands)	Cost		Gains		Losses		Value		Cost		Gains		Losses		Value
U.S. Treasury and agencies	$	19,364	$	—	$	(222)	$	19,142	$	21,246	$	9	$	(15)	$	21,240
Obligations of state and political agencies		67,662		171		(1,446)		66,387		68,162		647		(161)		68,648
Mortgage backed securities
Residential agency		129,906		210		(3,118)		126,998		180,411		2,258		(131)		182,538
Commercial		29,050		20		(303)		28,767		30,752		101		(168)		30,685
Asset backed securities		398		5		(4)		399		139		5		—		144
Corporate bonds		8,602		—		(121)		8,481		7,054		41		—		7,095
Total available-for-sale investment securities	$	254,982	$	406	$	(5,214)	$	250,174	$	307,764	$	3,061	$	(475)	$	310,350

The following tables present unrealized losses and fair values for available-for-sale investment securities as of September 30, ~~2019~~2020 and December 31, ~~2018,~~2019, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position:


	September 30, 2019
	Less than 12 Months				Over 12 Months				Total
	Unrealized		Fair		Unrealized		Fair		Unrealized		Fair

													September 30, 2020
													Less than 12 Months				Over 12 Months				Total
													Unrealized		Fair		Unrealized		Fair		Unrealized		Fair
(dollars in thousands)	Losses		Value		Losses		Value		Losses		Value		Losses		Value		Losses		Value		Losses		Value
U.S. Treasury and agencies	$	(3)	$	1,757	$	(31)	$	9,969	$	(34)	$	11,726	$	(9)	$	4,694	$	(8)	$	1,309	$	(17)	$	6,003
Obligations of state and political agencies		(23)		5,965		(51)		5,999		(74)		11,964		—		590		—		—		—		590
Mortgage backed securities
Residential agency		(44)		10,020		(81)		17,138		(125)		27,158		(45)		15,481		—		—		(45)		15,481
Commercial		(18)		9,215		(15)		3,126		(33)		12,341		(48)		25,292		(4)		2,603		(52)		27,895
Asset backed securities		—		2		—		—		—		2		—		—		—		2		—		2
Corporate bonds		—		—		—		—		—		—		(29)		5,971		—		—		(29)		5,971
Total available-for-sale investment securities	$	(88)	$	26,959	$	(178)	$	36,232	$	(266)	$	63,191	$	(131)	$	52,028	$	(12)	$	3,914	$	(143)	$	55,942

December 31, 2018

Less than 12 Months

Over 12 Months

Total

Unrealized

Fair

Unrealized

Fair

Unrealized

Fair
(dollars in thousands)

Losses

Value

Losses

Value

Losses

Value
U.S. Treasury and agencies

$
(8)

$
5,288

$
(214)

$
11,598

$
(222)

$
16,886
Obligations of state and political agencies

—

389

(1,446)

55,770

(1,446)

56,159
Mortgage backed securities












Residential agency

(44)

7,352

(3,074)

112,293

(3,118)

119,645
Commercial

(39)

7,844

(264)

9,741

(303)

17,585
Asset backed securities

—

2

(4)

155

(4)

157
Corporate bonds

—

—

(121)

8,481

(121)

8,481
Total available-for-sale investment securities

$
(91)

$
20,875

$
(5,123)

$
198,038

$
(5,214)

$
218,913

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	December 31, 2019
	Less than 12 Months				Over 12 Months				Total
	Unrealized		Fair		Unrealized		Fair		Unrealized		Fair
(dollars in thousands)	Losses		Value		Losses		Value		Losses		Value
U.S. Treasury and agencies	$	(5)	$	1,740	$	(10)	$	9,990	$	(15)	$	11,730
Obligations of state and political agencies		(140)		11,959		(21)		5,798		(161)		17,757
Mortgage backed securities
Residential agency		(52)		17,131		(79)		14,036		(131)		31,167
Commercial		(116)		15,235		(52)		6,195		(168)		21,430
Asset backed securities		—		2		—		—		—		2
Corporate bonds		—		—		—		—		—		—
Total available-for-sale investment securities	$	(313)	$	46,067	$	(162)	$	36,019	$	(475)	$	82,086

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

For the three and nine months ended September 30, ~~2019~~2020 and ~~2018,~~2019, the Company did not recognize OTTI losses on its investment securities.

~~Table of Contents~~

The following table presents amortized cost and estimated fair value of the available-for-sale investment securities as of September 30, ~~2019,~~2020, by contractual maturity:


	Amortized		Fair

					Amortized		Fair
(dollars in thousands)	Cost		Value		Cost		Value
Due within one year or less	$	3,016	$	3,026	$	16,132	$	16,211
Due after one year through five years		35,948		35,989		26,821		27,459
Due after five years through ten years		78,983		80,405		145,310		150,121
Due after 10 years		156,649		159,296		293,075		301,623
Total available-for-sale investment securities	$	274,596	$	278,716	$	481,338	$	495,414

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

Investment securities with a total carrying value of ~~$141.1~~$115.4 million and ~~$149.0~~$136.2 million were pledged as of September 30, ~~2019~~2020 and December 31, ~~2018,~~2019, respectively, to secure public deposits and for other purposes required or permitted by law.

Proceeds from the sale or call of ~~available‑for‑sale~~available-for-sale investment securities, for the three and nine months ended September 30, ~~2019~~2020 and ~~2018,~~2019, are displayed in the table below:


	Three months ended				Nine months ended
	September 30,				September 30,

									Three months ended				Nine months ended
									September 30,				September 30,
(dollars in thousands)	2019		2018		2019		2018		2020		2019		2020		2019
Proceeds	$	10,934	$	2,021	$	32,565	$	2,466	$	35,125	$	10,934	$	74,630	$	32,565
Realized gains		59		—		357		105		1,428		59		2,722		357
Realized losses		11		—		22		5		—		(11)		—		(22)

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As of September 30, ~~2019~~2020 and December 31, ~~2018,~~2019, the carrying value of the Company’s Federal Reserve stock and Federal Home Loan Bank of Des Moines, ~~(“FHLB”)~~or FHLB, stock was as follows:


	September 30,		December 31,

					September 30,		December 31,
(dollars in thousands)	2019		2018		2020		2019
Federal Reserve	$	2,675	$	2,675	$	2,675	$	2,675
FHLB		3,121		6,875		3,169		3,080

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

Visa Class B Restricted Shares

In 2008, the Company received Visa Class B restricted shares as part of Visa’s initial public offering. These shares are transferable only under limited circumstances until they can be converted into the publicly traded Class A common shares. This conversion will not occur until the settlement of certain litigation which will be indemnified by Visa members, including the Company. Visa funded an escrow account from its initial public offering to settle these litigation claims. Should this escrow account be insufficient to cover these litigation claims, Visa is entitled to fund additional amounts to the escrow account by reducing each member bank’s Class B conversion ratio to unrestricted Class A shares. As of September 30, ~~2019,~~2020, the conversion ratio was ~~1.6298.~~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 ~~(11,285~~(11,236 Class A equivalents) that the Company ~~owns~~owned as of September 30, ~~2019~~2020 and December 31, ~~2018,~~2019, are carried at a zero cost basis.

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NOTE 4 Loans and Allowance for Loan Losses

The following table presents total loans outstanding, by portfolio segment, as of September 30, ~~2019~~2020 and December 31, ~~2018:~~2019:


	September 30,		December 31,

					September 30,		December 31,
(dollars in thousands)	2019		2018		2020		2019
Commercial
Commercial and industrial(1)	$	485,183	$	510,706	$	789,036	$	479,144
Real estate construction		21,674		18,965		33,169		26,378
Commercial real estate		444,600		439,963		535,216		494,703
Total commercial		951,457		969,634		1,357,421		1,000,225
Consumer
Residential real estate first mortgage		459,763		448,143		469,050		457,155
Residential real estate junior lien		182,516		188,855		152,487		177,373
Other revolving and installment		92,351		95,218		79,461		86,526
Total consumer		734,630		732,216		700,998		721,054
Total loans	$	1,686,087	$	1,701,850	$	2,058,419	$	1,721,279

(1)	Included Paycheck Protection Program, or PPP, loans of $348.9 million at September 30, 2020.

Total loans ~~include~~included net deferred loan fees and costs of ~~$1.1~~$7.8 million and ~~$1.7~~$1.0 million at September 30, ~~2019~~2020 and December 31, ~~2018,~~2019, respectively. Deferred loan fees on PPP loans were $7.4 million at September 30, 2020.

Management monitors the credit quality of its loan portfolio on an ongoing basis. ~~Measurement~~Measurements of delinquency and past due status are based on the contractual terms of each loan. Past due loans are reviewed regularly to identify loans for nonaccrual status. Loan modifications made in accordance with the Interagency Statement on Loan Modifications and Reporting for Financial Institutions as issued on April 7, 2020, are included as accruing current.

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The following tables present a past due aging analysis of total loans outstanding, by portfolio segment, as of September 30, ~~2019~~2020 and December 31, ~~2018:~~2019:


	September 30, 2019
					90 Days
	Accruing		30 - 89 Days		or More				Total

											September 30, 2020
															90 Days
											Accruing		30 - 89 Days		or More				Total
(dollars in thousands)	Current		Past Due		Past Due		Nonperforming		Loans		Current		Past Due		Past Due		Nonaccrual		Loans
Commercial
Commercial and industrial	$	481,480	$	1,561	$	45	$	2,097	$	485,183	$	784,282	$	1,914	$	—	$	2,840	$	789,036
Real estate construction		21,224		450		—		—		21,674		32,384		785		—		—		33,169
Commercial real estate		443,129		—		—		1,471		444,600		530,984		2,903		—		1,329		535,216
Total commercial		945,833		2,011		45		3,568		951,457		1,347,650		5,602		—		4,169		1,357,421
Consumer
Residential real estate first mortgage		456,981		2,105		—		677		459,763		466,551		2,042		—		457		469,050
Residential real estate junior lien		181,646		14		—		856		182,516		152,111		207		—		169		152,487
Other revolving and installment		92,176		169		—		6		92,351		79,221		240		—		—		79,461
Total consumer		730,803		2,288		—		1,539		734,630		697,883		2,489		—		626		700,998
Total loans	$	1,676,636	$	4,299	$	45	$	5,107	$	1,686,087	$	2,045,533	$	8,091	$	—	$	4,795	$	2,058,419

~~Table of Contents~~


	December 31, 2018
					90 Days
	Accruing		30 - 89 Days		or More				Total

											December 31, 2019
															90 Days
											Accruing		30 - 89 Days		or More				Total
(dollars in thousands)	Current		Past Due		Past Due		Nonperforming		Loans		Current		Past Due		Past Due		Nonaccrual		Loans
Commercial
Commercial and industrial	$	504,313	$	2,815	$	—	$	3,578	$	510,706	$	473,900	$	382	$	—	$	4,862	$	479,144
Real estate construction		18,965		—		—		—		18,965		26,251		127		—		—		26,378
Commercial real estate		438,446		—		—		1,517		439,963		492,707		556		—		1,440		494,703
Total commercial		961,724		2,815		—		5,095		969,634		992,858		1,065		—		6,302		1,000,225
Consumer
Residential real estate first mortgage		444,470		2,411		—		1,262		448,143		455,244		666		448		797		457,155
Residential real estate junior lien		187,502		769		—		584		188,855		176,915		184		—		274		177,373
Other revolving and installment		94,615		581		—		22		95,218		86,172		348		—		6		86,526
Total consumer		726,587		3,761		—		1,868		732,216		718,331		1,198		448		1,077		721,054
Total loans	$	1,688,311	$	6,576	$	—	$	6,963	$	1,701,850	$	1,711,189	$	2,263	$	448	$	7,379	$	1,721,279

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

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

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

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

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

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Substandard: Loans classified as substandard are not adequately protected by the current net worth and paying capacity of the borrower or of the collateral pledged, if any. Loans classified as substandard have a ~~well‑defined~~well-defined weakness or weaknesses that jeopardize the repayment of the debt. ~~Well‑defined~~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.

~~Table of Contents~~

The tables below present total loans outstanding, by loan portfolio segment, and risk category as of September 30, ~~2019~~2020 and December 31, ~~2018:~~2019:


	September 30, 2019
			Criticized
			Special

											September 30, 2020
													Criticized
													Special
(dollars in thousands)	Pass		Mention		Substandard		Doubtful		Total		Pass		Mention		Substandard		Doubtful		Total
Commercial
Commercial and industrial	$	453,707	$	10,439	$	20,781	$	256	$	485,183	$	759,808	$	8,706	$	20,522	$	—	$	789,036
Real estate construction		20,396		284		994		—		21,674		32,140		783		246		—		33,169
Commercial real estate		420,060		673		23,867		—		444,600		501,913		7,265		26,038		—		535,216
Total commercial	$	894,163	$	11,396	$	45,642	$	256	$	951,457		1,293,861		16,754		46,806		—		1,357,421
Consumer
Residential real estate first mortgage		459,086		—		677		—		459,763		467,168		1,413		469		—		469,050
Residential real estate junior lien		180,344		—		2,172		—		182,516		149,290		2,005		1,192		—		152,487
Other revolving and installment		92,345		—		6		—		92,351		79,461		—		—		—		79,461
Total consumer		731,775		—		2,855		—		734,630		695,919		3,418		1,661		—		700,998
Total loans	$	1,625,938	$	11,396	$	48,497	$	256	$	1,686,087	$	1,989,780	$	20,172	$	48,467	$	—	$	2,058,419


	December 31, 2018
			Criticized
			Special

											December 31, 2019
													Criticized
													Special
(dollars in thousands)	Pass		Mention		Substandard		Doubtful		Total		Pass		Mention		Substandard		Doubtful		Total
Commercial
Commercial and industrial	$	459,565	$	12,055	$	37,523	$	1,563	$	510,706	$	448,306	$	9,585	$	21,253	$	—	$	479,144
Real estate construction		17,910		—		1,055		—		18,965		25,119		282		977		—		26,378
Commercial real estate		407,178		6,304		26,481		—		439,963		462,294		2,359		30,050		—		494,703
Total commercial	$	884,653	$	18,359	$	65,059	$	1,563	$	969,634		935,719		12,226		52,280		—		1,000,225
Consumer
Residential real estate first mortgage		448,124		—		19		—		448,143		456,358		—		797		—		457,155
Residential real estate junior lien		186,370		—		2,485		—		188,855		176,122		—		1,251		—		177,373
Other revolving and installment		95,218		—		—		—		95,218		86,520		—		6		—		86,526
Total consumer		729,712		—		2,504		—		732,216		719,000		—		2,054		—		721,054
Total loans	$	1,614,365	$	18,359	$	67,563	$	1,563	$	1,701,850	$	1,654,719	$	12,226	$	54,334	$	—	$	1,721,279

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

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The following tables present, by loan portfolio segment, a summary of the changes in the allowance for loan losses for the three and nine months ended September 30, ~~2019~~2020 and ~~2018:~~2019:


	Three months ended September 30, 2019
	Beginning		Provision for		Loan		Loan		Ending

											Three months ended September 30, 2020
											Beginning		Provision for		Loan		Loan		Ending
(dollars in thousands)	Balance		Loan Losses		Charge-offs		Recoveries		Balance		Balance		Loan Losses		Charge-offs		Recoveries		Balance
Commercial
Commercial and industrial	$	11,694	$	(962)	$	(324)	$	538	$	10,946	$	10,797	$	(846)	$	(10)	$	432	$	10,373
Real estate construction		323		25		—		—		348		443		40		—		—		483
Commercial real estate		5,765		(4)		—		—		5,761		9,948		1,828		—		95		11,871
Total commercial		17,782		(941)		(324)		538		17,055		21,188		1,022		(10)		527		22,727
Consumer
Residential real estate first mortgage		1,155		(139)		—		—		1,016		2,673		1,694		—		—		4,367
Residential real estate junior lien		710		157		(20)		49		896		1,102		28		—		81		1,211
Other revolving and installment		380		1		(31)		28		378		546		108		(41)		24		637
Total consumer		2,245		19		(51)		77		2,290		4,321		1,830		(41)		105		6,215
Unallocated		1,219		2,420		—		—		3,639		1,747		648		—		—		2,395
Total	$	21,246	$	1,498	$	(375)	$	615	$	22,984	$	27,256	$	3,500	$	(51)	$	632	$	31,337


	Nine months ended September 30, 2019
	Beginning		Provision for		Loan		Loan		Ending

											Nine months ended September 30, 2020
											Beginning		Provision for		Loan		Loan		Ending
(dollars in thousands)	Balance		Loan Losses		Charge-offs		Recoveries		Balance		Balance		Loan Losses		Charge-offs		Recoveries		Balance
Commercial
Commercial and industrial	$	12,127	$	3,263	$	(5,275)	$	831	$	10,946	$	12,270	$	(498)	$	(2,745)	$	1,346	$	10,373
Real estate construction		250		97		(1)		2		348		303		180		—		—		483
Commercial real estate		6,279		(668)		—		150		5,761		6,688		5,953		(865)		95		11,871
Total commercial		18,656		2,692		(5,276)		983		17,055		19,261		5,635		(3,610)		1,441		22,727
Consumer
Residential real estate first mortgage		1,156		(140)		—		—		1,016		1,448		2,914		—		5		4,367
Residential real estate junior lien		805		113		(154)		132		896		671		377		(12)		175		1,211
Other revolving and installment		380		388		(513)		123		378		352		371		(194)		108		637
Total consumer		2,341		361		(667)		255		2,290		2,471		3,662		(206)		288		6,215
Unallocated		1,177		2,462		—		—		3,639		2,192		203		—		—		2,395
Total	$	22,174	$	5,515	$	(5,943)	$	1,238	$	22,984	$	23,924	$	9,500	$	(3,816)	$	1,729	$	31,337


	Three months ended September 30, 2018
	Beginning		Provision for		Loan		Loan		Ending

											Three months ended September 30, 2019
											Beginning		Provision for		Loan		Loan		Ending
(dollars in thousands)	Balance		Loan Losses		Charge-offs		Recoveries		Balance		Balance		Loan Losses		Charge-offs		Recoveries		Balance
Commercial
Commercial and industrial	$	10,024	$	1,452	$	(424)	$	126	$	11,178	$	11,694	$	(962)	$	(324)	$	538	$	10,946
Real estate construction		395		(109)		—		—		286		323		25		—		—		348
Commercial real estate		6,478		(72)		—		20		6,426		5,765		(4)		—		—		5,761
Total commercial		16,897		1,271		(424)		146		17,890		17,782		(941)		(324)		538		17,055
Consumer
Residential real estate first mortgage		1,486		(142)		—		—		1,344		1,155		(139)		—		—		1,016
Residential real estate junior lien		830		20		(47)		11		814		710		157		(20)		49		896
Other revolving and installment		483		31		(99)		26		441		380		1		(31)		28		378
Total consumer		2,799		(91)		(146)		37		2,599		2,245		19		(51)		77		2,290
Unallocated		173		350		—		—		523		1,219		2,420		—		—		3,639
Total	$	19,869	$	1,530	$	(570)	$	183	$	21,012	$	21,246	$	1,498	$	(375)	$	615	$	22,984

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	Nine months ended September 30, 2018
	Beginning		Provision for		Loan		Loan		Ending

											Nine months ended September 30, 2019
											Beginning		Provision for		Loan		Loan		Ending
(dollars in thousands)	Balance		Loan Losses		Charge-offs		Recoveries		Balance		Balance		Loan Losses		Charge-offs		Recoveries		Balance
Commercial
Commercial and industrial	$	7,589	$	6,158	$	(3,078)	$	509	$	11,178	$	12,127	$	3,263	$	(5,275)	$	831	$	10,946
Real estate construction		343		1		(60)		2		286		250		97		(1)		2		348
Commercial real estate		4,909		1,458		—		59		6,426		6,279		(668)		—		150		5,761
Total commercial		12,841		7,617		(3,138)		570		17,890		18,656		2,692		(5,276)		983		17,055
Consumer
Residential real estate first mortgage		1,411		(38)		(29)		—		1,344		1,156		(140)		—		—		1,016
Residential real estate junior lien		902		(145)		(133)		190		814		805		113		(154)		132		896
Other revolving and installment		499		34		(236)		144		441		380		388		(513)		123		378
Total consumer		2,812		(149)		(398)		334		2,599		2,341		361		(667)		255		2,290
Unallocated		911		(388)		—		—		523		1,177		2,462		—		—		3,639
Total	$	16,564	$	7,080	$	(3,536)	$	904	$	21,012	$	22,174	$	5,515	$	(5,943)	$	1,238	$	22,984

The following tables present the recorded investment in loans and related allowance for loan losses, by loan portfolio segment, disaggregated on the basis of the Company’s impairment methodology, as of September 30, ~~2019~~2020 and December 31, ~~2018:~~2019:


	September 30, 2019
	Recorded Investment						Allowance for Loan Losses
	Individually		Collectively				Individually		Collectively

															September 30, 2020
															Recorded Investment						Allowance for Loan Losses
															Individually		Collectively				Individually		Collectively
(dollars in thousands)	Evaluated		Evaluated		Total		Evaluated		Evaluated		Unallocated		Total		Evaluated		Evaluated		Total		Evaluated		Evaluated		Unallocated		Total
Commercial
Commercial and industrial	$	2,513	$	482,670	$	485,183	$	1,429	$	9,517	$	—	$	10,946	$	3,497	$	785,539	$	789,036	$	379	$	9,994	$	—	$	10,373
Real estate construction		—		21,674		21,674		—		348		—		348		—		33,169		33,169		—		483		—		483
Commercial real estate		1,480		443,120		444,600		352		5,409		—		5,761		1,525		533,691		535,216		9		11,862		—		11,871
Total commercial		3,993		947,464		951,457		1,781		15,274		—		17,055		5,022		1,352,399		1,357,421		388		22,339		—		22,727
Consumer
Residential real estate first mortgage		355		459,408		459,763		—		1,016		—		1,016		457		468,593		469,050		—		4,367		—		4,367
Residential real estate junior lien		804		181,712		182,516		324		572		—		896		229		152,258		152,487		19		1,192		—		1,211
Other revolving and installment		5		92,346		92,351		2		376		—		378		—		79,461		79,461		—		637		—		637
Total consumer		1,164		733,466		734,630		326		1,964		—		2,290		686		700,312		700,998		19		6,196		—		6,215
Total loans	$	5,157	$	1,680,930	$	1,686,087	$	2,107	$	17,238	$	3,639	$	22,984	$	5,708	$	2,052,711	$	2,058,419	$	407	$	28,535	$	2,395	$	31,337


	December 31, 2018
	Recorded Investment						Allowance for Loan Losses
	Individually		Collectively				Individually		Collectively

															December 31, 2019
															Recorded Investment						Allowance for Loan Losses
															Individually		Collectively				Individually		Collectively
(dollars in thousands)	Evaluated		Evaluated		Total		Evaluated		Evaluated		Unallocated		Total		Evaluated		Evaluated		Total		Evaluated		Evaluated		Unallocated		Total
Commercial
Commercial and industrial	$	3,945	$	506,761	$	510,706	$	2,059	$	10,068	$	—	$	12,127	$	976	$	478,168	$	479,144	$	189	$	12,081	$	—	$	12,270
Real estate construction		—		18,965		18,965		—		250		—		250		—		26,378		26,378		—		303		—		303
Commercial real estate		1,684		438,279		439,963		455		5,824		—		6,279		5,925		488,778		494,703		2,946		3,742		—		6,688
Total commercial		5,629		964,005		969,634		2,514		16,142		—		18,656		6,901		993,324		1,000,225		3,135		16,126		—		19,261
Consumer
Residential real estate first mortgage		352		447,791		448,143		—		1,156		—		1,156		782		456,373		457,155		—		1,448		—		1,448
Residential real estate junior lien		559		188,296		188,855		4		801		—		805		266		177,107		177,373		—		671		—		671
Other revolving and installment		20		95,198		95,218		20		360		—		380		5		86,521		86,526		3		349		—		352
Total consumer		931		731,285		732,216		24		2,317		—		2,341		1,053		720,001		721,054		3		2,468		—		2,471
Total loans	$	6,560	$	1,695,290	$	1,701,850	$	2,538	$	18,459	$	1,177	$	22,174	$	7,954	$	1,713,325	$	1,721,279	$	3,138	$	18,594	$	2,192	$	23,924

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


	September 30, 2019						December 31, 2018
	Recorded		Unpaid		Related		Recorded		Unpaid		Related

													September 30, 2020						December 31, 2019
													Recorded		Unpaid		Related		Recorded		Unpaid		Related
(dollars in thousands)	Investment		Principal		Allowance		Investment		Principal		Allowance		Investment		Principal		Allowance		Investment		Principal		Allowance
Impaired loans with a valuation allowance
Commercial and industrial	$	1,757	$	1,900	$	1,429	$	2,660	$	2,752	$	2,059	$	2,523	$	2,609	$	379	$	639	$	727	$	189
Commercial real estate		1,480		1,595		352		1,499		1,517		455		196		196		9		5,718		5,823		2,946
Residential real estate first mortgage		—		—		—		—		—		—
Residential real estate junior lien		536		619		324		4		4		4		19		20		19		—		—		—
Other revolving and installment		4		4		2		19		20		20		—		—		—		5		6		3
Total impaired loans with a valuation allowance		3,777		4,118		2,107		4,182		4,293		2,538		2,738		2,825		407		6,362		6,556		3,138
Impaired loans without a valuation allowance
Commercial and industrial		756		1,077		—		1,285		1,422		—		974		1,159		—		337		1,110		—
Commercial real estate		—		—		—		185		218		—		1,329		1,448		—		207		236		—
Residential real estate first mortgage		355		367		—		352		504		—		457		469		—		782		797		—
Residential real estate junior lien		268		290		—		555		697		—		210		256		—		266		372		—
Other revolving and installment		1		1		—		1		2		—		—		—		—		—		—		—
Total impaired loans without a valuation allowance		1,380		1,735		—		2,378		2,843		—		2,970		3,332		—		1,592		2,515		—
Total impaired loans
Commercial and industrial		2,513		2,977		1,429		3,945		4,174		2,059		3,497		3,768		379		976		1,837		189
Commercial real estate		1,480		1,595		352		1,684		1,735		455		1,525		1,644		9		5,925		6,059		2,946
Residential real estate first mortgage		355		367		—		352		504		—		457		469		—		782		797		—
Residential real estate junior lien		804		909		324		559		701		4		229		276		19		266		372		—
Other revolving and installment		5		5		2		20		22		20		—		—		—		5		6		3
Total impaired loans	$	5,157	$	5,853	$	2,107	$	6,560	$	7,136	$	2,538	$	5,708	$	6,157	$	407	$	7,954	$	9,071	$	3,138

The table below presents the average recorded investment in impaired loans and interest income for the three and nine months ended September 30, ~~2019~~2020 and ~~2018:~~2019:

Three months ended September 30,

2019

2018

Average

Average

Recorded

Interest

Recorded

Interest
(dollars in thousands)

Investment

Income

Investment

Income
Impaired loans with a valuation allowance

Commercial and industrial

$
1,964

$
4

$
1,961

$
9
Commercial real estate

1,623

2

1,767

2
Residential real estate first mortgage

—

—

—

—
Residential real estate junior lien

619

1

63

1
Other revolving and installment

5

—

39

—
Total impaired loans with a valuation allowance

4,211

7

3,830

12
Impaired loans without a valuation allowance

Commercial and industrial

1,206

7

1,073

—
Commercial real estate

—

—

842

—
Residential real estate first mortgage

183

—

525

—
Residential real estate junior lien

297

—

394

—
Other revolving and installment

2

—

3

—
Total impaired loans without a valuation allowance

1,688

7

2,837

—
Total impaired loans

Commercial and industrial

3,170

11

3,034

9
Commercial real estate

1,623

2

2,609

2
Residential real estate first mortgage

183

—

525

—
Residential real estate junior lien

916

1

457

1
Other revolving and installment

7

—

42

—
Total impaired loans

$
5,899

$
14

$
6,667

$
12


	Three months ended September 30,
	2020				2019
	Average				Average
	Recorded		Interest		Recorded		Interest
(dollars in thousands)	Investment		Income		Investment		Income
Impaired loans with a valuation allowance
Commercial and industrial	$	2,541	$	14	$	1,964	$	4
Commercial real estate		197		8		1,623		2
Residential real estate first mortgage		—		—		—		—
Residential real estate junior lien		19		—		619		1
Other revolving and installment		—		—		5		—
Total impaired loans with a valuation allowance		2,757		22		4,211		7
Impaired loans without a valuation allowance
Commercial and industrial		1,013		24		1,206		7
Commercial real estate		1,330		—		—		—
Residential real estate first mortgage		459		—		183		—
Residential real estate junior lien		211		3		297		—
Other revolving and installment		—		—		2		—
Total impaired loans without a valuation allowance		3,013		27		1,688		7
Total impaired loans
Commercial and industrial		3,554		38		3,170		11
Commercial real estate		1,527		8		1,623		2
Residential real estate first mortgage		459		—		183		—
Residential real estate junior lien		230		3		916		1
Other revolving and installment		—		—		7		—
Total impaired loans	$	5,770	$	49	$	5,899	$	14

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	Nine Months Ended September 30,
	2019				2018
	Average				Average
	Recorded		Interest		Recorded		Interest

									Nine Months Ended September 30,
									2020				2019
									Average				Average
									Recorded		Interest		Recorded		Interest
(dollars in thousands)	Investment		Income		Investment		Income		Investment		Income		Investment		Income
Impaired loans with a valuation allowance
Commercial and industrial	$	2,473	$	12	$	2,026	$	27	$	3,815	$	14	$	2,473	$	12
Commercial real estate		1,668		6		1,793		7		200		8		1,668		6
Residential real estate first mortgage		—		—		—		—
Residential real estate junior lien		621		3		63		2		20		—		621		3
Other revolving and installment		5		—		43		—		—		—		5		—
Total impaired loans with a valuation allowance		4,767		21		3,925		36		4,035		22		4,767		21
Impaired loans without a valuation allowance
Commercial and industrial		2,979		23		1,130		—		1,154		26		2,979		23
Real estate construction										—		—		—		—
Commercial real estate		—		—		747		—		1,699		—		—		—
Residential real estate first mortgage		92		—		539		—		467		—		92		—
Residential real estate junior lien		302		—		403		1		217		3		302		—
Other revolving and installment		4		—		3		—		—		—		4		—
Total impaired loans without a valuation allowance		3,377		23		2,822		1		3,537		29		3,377		23
Total impaired loans
Commercial and industrial		5,452		35		3,156		27		4,969		40		5,452		35
Real estate construction										—		—		—		—
Commercial real estate		1,668		6		2,540		7		1,899		8		1,668		6
Residential real estate first mortgage		92		—		539		—		467		—		92		—
Residential real estate junior lien		923		3		466		3		237		3		923		3
Other revolving and installment		9		—		46		—		—		—		9		—
Total impaired loans	$	8,144	$	44	$	6,747	$	37	$	7,572	$	51	$	8,144	$	44

Loans with a carrying value of ~~$1.1~~$1.2 billion as of September 30, ~~2019~~2020 and December 31, ~~2018,~~2019, 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 ~~troubled debt restructuring (“TDR”)~~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 third quarter of 2020, there were no loans modified as a TDR. As of September 30, 2020, the Company had entered into modifications on 552 loans representing $151.4 million in principal balances, since the beginning of the pandemic. Of those loans, 27 loans with a total outstanding principal balance of $16.9 million, have been granted second deferral, 56 loans with a total outstanding principal balance of $12.0 million 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 in accordance with the Interagency Statement on Loan Modifications and Reporting for Financial Institutions as issued on April 7, 2020. During the first quarter of 2019, there was one loan ~~that was~~ modified as a ~~troubled debt restructuring~~TDR as a result of extending the amortization period. As of September 30, 2019, the carrying value of the restructured loan was $0.2 million. The loan is currently performing according to the modified terms and there was no specific reserve for the loan losses allocated to the loan modified as troubled debt restructuring. During the first quarter of 2018, there was one loan modified as a troubled debt restructuring as a result of adjusting the interest rate below current market levels. The balance at the time of restructuring was $1.0 million. As of December 31, ~~2018,~~2019, the carrying value of the restructured loan was $0.2 million. The loan is currently performing according to the modified terms and there was no specific reserve for loan losses allocated to the loan modified as troubled debt restructuring.

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

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NOTE 5 Goodwill and Other Intangible Assets

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

The following table summarizes the carrying amount of goodwill, by segment, as of September 30, ~~2019~~2020 and December 31, ~~2018:~~2019:



			September 30,		December 31,
(dollars in thousands)	Goodwill		2020		2019
Banking	$	20,131	$	20,131	$	20,131
Retirement and benefit services		7,198		7,198		7,198
Total goodwill	$	27,329	$	27,329	$	27,329

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


	September 30, 2019						December 31, 2018

													September 30, 2020						December 31, 2019
(dollars in thousands)	Gross Carrying Amount		Accumulated Amortization		Total		Gross Carrying Amount		Accumulated Amortization		Total		Gross Carrying Amount		Accumulated Amortization		Total		Gross Carrying Amount		Accumulated Amortization		Total
Identifiable customer intangibles	$	55,744	$	(37,374)	$	18,370	$	55,744	$	(34,972)	$	20,772	$	31,857	$	(16,689)	$	15,168	$	31,857	$	(14,287)	$	17,570
Core deposit intangible assets		7,216		(6,204)		1,012		7,216		(5,515)		1,701		3,793		(3,540)		253		4,993		(4,172)		821
Total intangible assets	$	62,960	$	(43,578)	$	19,382	$	62,960	$	(40,487)	$	22,473	$	35,650	$	(20,229)	$	15,421	$	36,850	$	(18,459)	$	18,391

Amortization of intangible assets was $1.0 million for each of the three months ended September 30, 2020, and 2019, respectively. Amortization of intangible assets was $3.0 and $3.1 million for the ~~three and~~ nine months ended September 30, ~~2019, respectively,~~2020, and ~~$1.2 million and $3.6 million for the comparable periods in 2018,~~2019, 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 September 30, 2020.

NOTE 6 Loan Servicing

Loans serviced for others are not included in the accompanying consolidated balance sheets. The unpaid principal balances of loans serviced for others totaled ~~$560.9~~$476.3 million and ~~$591.6~~$541.9 million as of September 30, ~~2019~~2020 and December 31, ~~2018,~~2019, respectively. Servicing loans for others generally consists of collecting mortgage payments, maintaining escrow accounts, disbursing payments to investors and collection and foreclosure processing. Loan servicing income is recorded on an accrual basis and includes servicing fees from investors and certain charges collected from borrowers, such as late payment fees, and is net of fair value adjustments to capitalized mortgage servicing rights.

The following table summarizes the Company’s activity related to servicing rights for the three and nine months ended September 30, ~~2019~~2020 and ~~2018:~~2019:


	Three months ended				Nine months ended
	September 30,				September 30,

									Three months ended				Nine months ended
									September 30,				September 30,
(dollars in thousands)	2019		2018		2019		2018		2020		2019		2020		2019
Balance, beginning of period	$	4,300	$	4,676	$	4,623	$	4,686	$	2,891	$	4,300	$	3,845	$	4,623
Additions		179		152		279		431		42		179		154		279
Amortization		(287)		(165)		(690)		(512)		(296)		(287)		(692)		(690)
(Impairment)/Recovery		(46)		8		(66)		66		(58)		(46)		(728)		(66)
Balance, end of period	$	4,146	$	4,671	$	4,146	$	4,671	$	2,579	$	4,146	$	2,579	$	4,146

2021

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The following is a summary of key data and assumptions used in the valuation of servicing rights as of September 30, ~~2019~~2020 and December 31, ~~2018.~~2019. Increases or decreases in any one of these assumptions would result in lower or higher fair value measurements.


	September 30,			December 31,

							September 30,			December 31,
(dollars in thousands)	2019			2018			2020			2019
Fair value of servicing rights	$	4,146		$	4,623		$	2,579		$	3,845
Weighted-average remaining term, years		20.5			20.8			20.0			20.1
Prepayment speeds		11.6	%		7.8	%		23.8	%		11.8	%
Discount rate		9.5	%		10.5	%		9.0	%		9.4	%

NOTE 7 Leases

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

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


		September 30,

					September 30,		December 31,
(dollars in thousands)		2019			2020		2019
Lease Right-of-Use Assets	Classification			Classification
Operating lease right-of-use assets	Operating lease right-of-use assets	$	8,877	Operating lease right-of-use assets	$	8,168	$	8,343
Finance lease right-of-use assets	Land, premises and equipment, net		347	Land, premises and equipment, net		231		318
Total lease right-of-use assets		$	9,224		$	8,399	$	8,661
Lease Liabilities
Operating lease liabilities	Operating lease liabilities	$	9,401	Operating lease liabilities	$	8,671	$	8,864
Finance lease liabilities	Long-term debt		690	Long-term debt		484		640
Total lease liabilities		$	10,091		$	9,155	$	9,504

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

~~Table of Contents~~


	~~September 30,~~
	~~2019~~
~~Weighted-average remaining lease term, years~~
~~Operating leases~~		~~6.5~~
~~Finance leases~~		~~3.1~~
~~Weighted-average discount rate~~
~~Operating leases~~		~~3.2~~	%
~~Finance leases~~		~~7.8~~	%


	September 30,		December 31,
	2020		2019
Weighted-average remaining lease term, years
Operating leases	5.5		6.2
Finance leases	0.8		2.8
Weighted-average discount rate
Operating leases	2.8	%	3.1	%
Finance leases	7.8	%	7.8	%

As the Company elected, for all classes of underlying assets, not to separate lease and ~~non‑lease~~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 and nine months ending September 30, 2020 and 2019.


	Three months ended		Nine months ended

					Three months ended				Nine months ended
					September 30,				September 30,
(dollars in thousands)	September 30, 2019		September 30, 2019		2020		2019		2020		2019
Lease costs
Operating lease cost	$	602	$	1,772	$	634	$	602	$	1,825	$	1,772
Variable lease cost		222		633		223		222		888		633
Short-term lease cost		122		416		102		122		304		416
Finance lease cost
Interest on lease liabilities		14		45		10		14		33		45
Amortization of right-of-use assets		29		87		29		29		87		87
Sublease income		(65)		(202)		(57)		(65)		(175)		(202)
Net lease cost	$	924	$	2,751	$	941	$	924	$	2,962	$	2,751
Other information
Cash paid for amounts included in the measurement of lease liabilities Operating cash flows from operating leases		600		1,774
Cash paid for amounts included in the measurement of lease liabilities operating cash flows from operating leases					$	628	$	600	$	1,807	$	1,774
Right-of-use assets obtained in exchange for new operating lease liabilities		—		—		—		—		1,531		—
Right-of-use assets obtained in exchange for new finance lease liabilities		—		—		—		—		—		—

Future minimum payments for finance and operating leases with initial or remaining terms of one year or more as of September 30, ~~2019~~2020 were as follows:


	September 30, 2019
	Finance		Operating

					Finance		Operating
(dollars in thousands)	Leases		Leases		Leases		Leases
2020	$	251	$	2,291
2021		251		1,676
2022		251		1,579
2023		20		1,506
2024		—		1,061
Twelve months ended
September 30, 2021					$	251	$	2,179
September 30, 2022						251		2,095
September 30, 2023						21		1,832
September 30, 2024						—		1,065
September 30, 2025						—		707
Thereafter		—		2,460		—		1,753
Total future minimum lease payments	$	773	$	10,573	$	523	$	9,631
Amounts representing interest		(83)		(1,172)		(39)		(960)
Total operating lease liabilities	$	690	$	9,401	$	484	$	8,671

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NOTE 8 Deposits

The components of deposits in the consolidated balance sheets as of September 30, ~~2019~~2020 and December 31, ~~2018~~2019 were as follows:


	September 30,		December 31,

					September 30,		December 31,
(dollars in thousands)	2019		2018		2020		2019
Noninterest-bearing demand	$	537,951	$	550,640
Noninterest-bearing					$	693,450	$	577,704
Interest-bearing
Interest-bearing demand		424,249		401,078		590,366		458,689
Savings accounts		55,513		53,971		78,659		55,777
Money market savings		622,647		598,820		892,473		683,064
Time deposits		192,753		170,587		207,422		196,082
Total interest-bearing		1,295,162		1,224,456		1,768,920		1,393,612
Total deposits	$	1,833,113	$	1,775,096	$	2,462,370	$	1,971,316

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NOTE 9 ~~Short‑Term~~Short-Term Borrowings

There were no ~~short‑term~~short-term borrowings outstanding as of September 30, ~~2019. Short-term borrowing as of~~2020 and December 31, ~~2018, were $93.5 million and consisted of Fed funds purchased.~~2019.

The following table presents information related to short-term borrowings for the three and nine months ending September 30, ~~2019~~2020 and ~~September 30, 2018:~~2019:


	Three months ended
	September 30,

							Three months ended
							September 30,
(dollars in thousands)	2019			2018			2020			2019
Fed funds purchased
Balance as of end of period	$	—		$	73,930		$	—		$	—
Average daily balance		61,386			103,171			—			61,386
Maximum month-end balance		124,250			94,410			—			124,250
Weighted-average rate
During period		2.40	%		2.21	%		—	%		2.40	%
End of period		2.30	%		2.30	%		—	%		2.30	%
FHLB Short-term advances
Balance as of end of period	$	—		$	—		$	—		$	—
Average daily balance		25,815			—			—			25,815
Maximum month-end balance		—			—			—			—
Weighted-average rate
During period		2.58	%		—	%		—	%		2.58	%
End of period		—	%		—	%		—	%		—	%


	Nine months ended
	September 30,
(dollars in thousands)	2020			2019
Fed funds purchased
Balance as of end of period	$	—		$	—
Average daily balance		107			82,504
Maximum month-end balance		—			139,605
Weighted-average rate
During period		—	%		2.54	%
End of period		—	%		2.30	%
FHLB Short-term advances
Balance as of end of period	$	—		$	—
Average daily balance		—			12,985
Maximum month-end balance		—			135,000
Weighted-average rate
During period		—	%		2.44	%
End of period		—	%		—	%

2324

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Nine months ended

September 30,

(dollars in thousands)

2019

2018

Fed funds purchased

Balance as of end of period

$
—

$
73,930

Average daily balance

82,504

87,391

Maximum month-end balance

139,605

112,260

Weighted-average rate

During period

2.54
%

0.36
%
End of period

2.30
%

2.30
%
FHLB Short-term advances

Balance as of end of period

$
—

$
—

Average daily balance

12,985

110

Maximum month-end balance

135,000

—

Weighted-average rate

During period

2.44
%

2.43
%
End of period

—
%

—
%

NOTE 10 ~~Long‑Term~~Long-Term Debt

~~Long‑term~~Long-term debt as of September 30, ~~2019~~2020 and December 31, ~~2018~~2019 consisted of the following:


	September 30, 2019
						Period End
	Face		Carrying			Interest		Maturity

										September 30, 2020
															Period End
										Face		Carrying			Interest		Maturity
(dollars in thousands)	Value		Value		Interest Rate	Rate		Date	Call Date	Value		Value		Interest Rate	Rate		Date	Call Date
Subordinated notes payable	$	50,000	$	49,609	Fixed	5.75	%	12/30/2025	12/30/2020	$	50,000	$	49,672	Fixed	5.75	%	12/30/2025	12/30/2020
Junior subordinated debenture (Trust I)		4,000		3,390	Three-month LIBOR + 3.10%	5.21	%	6/26/2033	6/26/2008		4,124		3,436	Three-month LIBOR + 3.10%	3.33	%	6/26/2033	6/26/2008
Junior subordinated debenture (Trust II)		6,000		5,086	Three-month LIBOR + 1.80%	3.92	%	9/15/2036	9/15/2011		6,186		5,153	Three-month LIBOR + 1.80%	2.05	%	9/15/2036	9/15/2011
Finance lease liability		2,700		690	Fixed	7.81	%	10/31/2022	N/A		2,700		484	Fixed	7.81	%	10/31/2022	N/A
Total long-term debt	$	62,700	$	58,775						$	63,010	$	58,745


	December 31, 2018
						Period End
	Face		Carrying			Interest		Maturity

										December 31, 2019
															Period End
										Face		Carrying			Interest		Maturity
(dollars in thousands)	Value		Value		Interest Rate	Rate		Date	Call Date	Value		Value		Interest Rate	Rate		Date	Call Date
Subordinated notes payable	$	50,000	$	49,562	Fixed	5.75	%	12/30/2025	12/30/2020	$	50,000	$	49,625	Fixed	5.75	%	12/30/2025	12/30/2020
Junior subordinated debenture (Trust I)		4,000		3,357	Three-month LIBOR + 3.10%	5.92	%	6/26/2033	6/26/2008		4,124		3,402	Three-month LIBOR + 3.10%	5.05	%	6/26/2033	6/26/2008
Junior subordinated debenture (Trust II)		6,000		5,035	Three-month LIBOR + 1.80%	4.59	%	9/15/2036	9/15/2011		6,186		5,102	Three-month LIBOR + 1.80%	3.69	%	9/15/2036	9/15/2011
Obligations under capital lease		2,700		870	Fixed	7.81	%	10/31/2022	N/A
Finance lease liability											2,700		640	Fixed	7.81	%	10/31/2022	N/A
Total long-term debt	$	62,700	$	58,824						$	63,010	$	58,769

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

~~Table of Contents~~

NOTE 11 Financial Instruments with ~~Off‑Balance~~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.

AsA summary of ~~September 30, 2019 and December 31, 2018,~~ the ~~following financial instruments whose contract amount represents credit~~contractual amounts of the Company’s exposure to off-balance sheet risk ~~were approximately~~is as follows:


	September 30,		December 31,

					September 30,		December 31,
(dollars in thousands)	2019		2018		2020		2019
Commitments to extend credit	$	570,220	$	529,890	$	596,642	$	586,365
Standby letters of credit		8,023		8,852		7,073		8,516
Total	$	578,243	$	538,742	$	603,715	$	594,881

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

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

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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 September 30, 2020 and December 31, 2019. With the Bank of North Dakota, the Company had $19.0 million of letters of credit outstanding as of September 30, 2020 and $20.0 million as of December 31, 2019. Bank of North Dakota letters of credit were collateralized by loans pledged to the Bank of North Dakota in the amount of $239.3 million and $242.0 million as of September 30, 2020 and December 31, 2019, respectively.

NOTE 12 Share-Based Compensation

The Company has granted equity awards pursuant to the Alerus Financial Corporation 2009 Stock Plan. The awards ~~can be~~were in the form of restricted stock or restricted stock units and are considered to represent an element of employee compensation. Compensation expense for the ~~award~~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 ~~have~~has expired. ~~Compensation expense relating to awards under this plan was $1.2 million and $702 thousand for the nine months ending September 30, 2019 and September 30, 2018, respectively.~~

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

Nine months ended September 30, 2019

Nine months ended September 30, 2018

Weighted-

Weighted-




Average Grant


Average Grant


Awards

Date Fair Value

Awards

Date Fair Value
Restricted Stock Awards

Outstanding at beginning of period

337,014

$
18.36

336,397

$
15.38
Granted

70,617

19.87

76,031

22.67
Vested

(53,882)

18.69

(76,753)

10.56
Forfeited or cancelled

(6,138)

17.34

—

—
Outstanding at end of period

347,611

$
18.64

335,675

$
18.13

~~Table of Contents~~

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

On May 6, 2019, the Company’s stockholders approved the Alerus Financial Corporation 2019 Equity Incentive Plan. This plan allows the compensation committee the ability to grant a wide variety of equity awards, including stock options, stock appreciation rights, restricted stock, restricted stock units and cash incentive awards in such forms and amounts as it deems appropriate to accomplish the goals of the plan. Any shares subject to an award that is cancelled, forfeited, or expires prior to exercise or realization, either in full or in part, shall again become available for issuance under the plan. However, shares subject to an award shall not again be made available for issuance or delivery under the plan if such shares are (a) tendered in payment of the exercise price of a stock option, (b) delivered to, or withheld by, the Company to satisfy any tax withholding obligation, or (c) covered by a ~~stock‑settled~~stock-settled stock appreciation right or other awards that were not issued upon the settlement of the award. Shares vest, become exercisable and contain such other terms and conditions as determined by the compensation committee and set forth in individual agreements with the participant receiving the award. The plan ~~is authorized to issue~~authorizes the issuance of up to ~~1,100,000.~~1,100,000 shares of common stock. As of September 30, ~~2019, no~~2020, 28,242 stock awards and 49,604 restricted stock units had been issued under the ~~plan~~plan.

~~For~~Compensation expense relating to awards under these plans was $475 thousand and $335 thousand for the three months ended September 30, 2020 and 2019, respectively. Compensation expense relating to awards under these plans was $1.3 million and $1.2 million for the nine months ended September 30, 2020 and 2019, respectively.

The following table presents the ~~Company issued 13,144 shares of common~~activity in the stock ~~pursuant to the Alerus Financial Corporation Stock Grant Plan for Non‑Employee Directors. Compensation expense relating to stock awards under this plan~~plans for the nine months ~~ending~~ended September 30, ~~2019~~2020 and ~~2018,~~2019:


	Nine months ended September 30, 2020			Nine months ended September 30, 2019
		Weighted-			Weighted-
		Average Grant			Average Grant
	Awards	Date Fair Value		Awards	Date Fair Value
Restricted Stock and Restricted Stock Unit Awards
Outstanding at beginning of period	347,211	$	18.64	337,014	$	18.36
Granted	77,846		19.53	70,617		19.87
Vested	(87,939)		16.24	(53,882)		18.69
Forfeited or cancelled	(7,590)		19.75	(6,138)		17.34
Outstanding at end of period	329,528	$	19.46	347,611	$	18.64

As of September 30, 2020, there was ~~$251 thousand and $2~~45 ~~thousand respectively.~~$3.2 million of unrecognized compensation expense related to non-vested awards granted under the plans. The expense is expected to be recognized over a weighted-average period of 3.47 years.

~~NOTE 13 Noninterest Income~~

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

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

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

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

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

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

Three months ended

Nine months ended

September 30,

September 30,
(dollars in thousands)

2019

2018

2019

2018
Retirement and benefits

$
15,307

$
15,536

$
46,142

$
46,873
Wealth management

3,896

3,685

11,385

10,948
Mortgage banking (1)

8,135

5,318

19,739

13,551
Service charges on deposit accounts

447

442

1,321

1,333
Net gains (losses) on investment securities (1)

48

13

357

119
Other




Interchange fees

506

509

1,480

1,519
Bank-owned life insurance income (1)

205

202

601

602
Misc. transactional fees

312

272

881

784
Other noninterest income

724

281

2,732

879
Total noninterest income

$
29,580

$
26,258

$
84,638

$
76,608

~~(1)~~

~~Not within scope of ASC 606.~~

NOTE 1413 Income Taxes

The components of income tax expense (benefit) for the three and nine months ended September 30, ~~2019~~2020 and ~~2018~~2019 are as follows:


	Three months ended September 30,
	2019				2018
			Percent of				Percent of

									Three months ended September 30,
									2020				2019
											Percent of				Percent of
(dollars in thousands)	Amount		Pretax Income		Amount		Pretax Income		Amount		Pretax Income		Amount		Pretax Income
Taxes at statutory federal income tax rate	$	1,982	21.0	%	$	1,957	21.0	%	$	4,894	21.0	%	$	1,982	21.0	%
Tax effect of:
Tax exempt income		(107)	(1.1)			(132)	(1.4)			(134)	(0.6)	%		(107)	(1.1)	%
Other		457	4.8			126	1.3			888	3.8	%		457	4.8	%
Applicable income taxes	$	2,332	24.7	%	$	1,951	20.9	%	$	5,648	24.2	%	$	2,332	24.7	%


	Nine months ended September 30,
	2019				2018
			Percent of				Percent of

									Nine months ended September 30,
									2020				2019
											Percent of				Percent of
(dollars in thousands)	Amount		Pretax Income		Amount		Pretax Income		Amount		Pretax Income		Amount		Pretax Income
Taxes at statutory federal income tax rate	$	6,114	21.0	%	$	5,268	21.0	%	$	9,491	21.0	%	$	6,114	21.0	%
Tax effect of:
Tax exempt income		(329)	(1.1)			(402)	(1.6)			(382)	(0.8)	%		(329)	(1.1)	%
Other		1,440	4.9			386	1.5			1,589	3.5	%		1,440	4.9	%
Applicable income taxes	$	7,225	24.8	%	$	5,252	20.9	%	$	10,698	23.7	%	$	7,225	24.8	%

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

NOTE 1514 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.

~~Table of Contents~~

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

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


	Three months ended September 30, 2019
				Retirement and		Wealth				Corporate

														Three months ended September 30, 2020
																Retirement and			Wealth				Corporate
(dollars in thousands)		Banking		Benefit Services		Management		Mortgage		Administration		Consolidated		Banking		Benefit Services			Management		Mortgage		Administration		Consolidated
Net interest income		$	19,193	$	—	$	—	$	384	$	(896)	$	18,681	$	21,994	$	—		$	—	$	613	$	(842)	$	21,765
Provision for loan losses			1,498		—		—		—		—		1,498		3,500		—	��		—		—		—		3,500
Noninterest income			1,695		15,307		3,896		8,135		547		29,580		3,398		15,104			4,486		22,269		(1)		45,256
Noninterest expense			10,800		8,551		1,835		7,256		8,885		37,327		10,876		8,347			2,110		9,769		9,112		40,214
Net income before taxes		$	8,590	$	6,756	$	2,061	$	1,263	$	(9,234)	$	9,436	$	11,016	$	6,757		$	2,376	$	13,113	$	(9,955)	$	23,307

Table of Contents


	Nine months ended September 30, 2020
			Retirement and		Wealth				Corporate
(dollars in thousands)	Banking		Benefit Services		Management		Mortgage		Administration		Consolidated
Net interest income	$	61,857	$	—	$	—	$	1,411	$	(2,575)	$	60,693
Provision for loan losses		9,500		—		—		—		—		9,500
Noninterest income		8,129		45,034		12,644		44,860		8		110,675
Noninterest expense		34,887		25,472		6,254		23,228		26,833		116,674
Net income before taxes	$	25,599	$	19,562	$	6,390	$	23,043	$	(29,400)	$	45,194


	Nine months ended September 30, 2019
				Retirement and		Wealth				Corporate

														Three months ended September 30, 2019
																Retirement and		Wealth				Corporate
(dollars in thousands)		Banking		Benefit Services		Management		Mortgage		Administration		Consolidated		Banking		Benefit Services		Management		Mortgage		Administration		Consolidated
Net interest income		$	57,987	$	—	$	—	$	818	$	(2,713)	$	56,092	$	19,193	$	—	$	—	$	384	$	(896)	$	18,681
Provision for loan losses			5,515		—		—		—		—		5,515		1,498		—		—		—		—		1,498
Noninterest income			5,273		46,142		11,385		19,739		2,099		84,638		1,695		15,307		3,896		8,135		547		29,580
Noninterest expense			30,880		26,142		5,936		17,184		25,960		106,102		10,800		8,551		1,835		7,256		8,885		37,327
Net income before taxes		$	26,865	$	20,000	$	5,449	$	3,373	$	(26,574)	$	29,113	$	8,590	$	6,756	$	2,061	$	1,263	$	(9,234)	$	9,436

Three months ended September 30, 2018




Retirement and

Wealth



Corporate


(dollars in thousands)

Banking

Benefit Services

Management

Mortgage

Administration

Consolidated
Net interest income

$
19,568

$
—

$
17

$
248

$
(904)

$
18,929
Provision for loan losses

1,521

—

—

9

—

1,530
Noninterest income

1,710

15,536

3,685

5,318

9

26,258
Noninterest expense

10,042

8,948

1,709

5,319

8,318

34,336
Net income before taxes

$
9,715

$
6,588

$
1,993

$
238

$
(9,213)

$
9,321


	Nine months ended September 30, 2018
				Retirement and		Wealth				Corporate

														Nine months ended September 30, 2019
																Retirement and		Wealth				Corporate
(dollars in thousands)		Banking		Benefit Services		Management		Mortgage		Administration		Consolidated		Banking		Benefit Services		Management		Mortgage		Administration		Consolidated
Net interest income		$	57,960	$	—	$	47	$	653	$	(2,689)	$	55,971	$	57,987	$	—	$	—	$	818	$	(2,713)	$	56,092
Provision for loan losses			7,071		—		—		9		—		7,080		5,515		—		—		—		—		5,515
Noninterest income			5,159		46,873		10,948		13,551		77		76,608		5,273		46,142		11,385		19,739		2,099		84,638
Noninterest expense			29,416		27,338		5,702		14,273		23,685		100,414		30,880		26,142		5,936		17,184		25,960		106,102
Net income before taxes		$	26,632	$	19,535	$	5,293	$	(78)	$	(26,297)	$	25,085	$	26,865	$	20,000	$	5,449	$	3,373	$	(26,574)	$	29,113

Banking

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

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

Wealth Management

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

Mortgage

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

Table of Contents

NOTE 1615 Earnings Per Share

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

The calculation of basic and diluted earnings per share using the two-class method for the three and nine months ending September 30, 2020 and 2019 isare presented below:


	Three months ended		Nine months ended
	September 30,		September 30,

					Three months ended				Nine months ended
					September 30,				September 30,
(dollars and shares in thousands, except per share data)	2019		2019		2020		2019		2020		2019
Net income	$	7,104	$	21,888	$	17,659	$	7,104	$	34,496	$	21,888
Dividends and undistributed earnings allocated to participating securities		154		514		315		154		600		514
Net income available to common shareholders	$	6,950	$	21,374	$	17,344	$	6,950	$	33,896	$	21,374
Weighted-average common shares outstanding for basic earnings per share		14,274		13,957		17,121		14,274		17,101		13,957
Dilutive effect of stock-based awards		352		360		332		352		334		360
Weighted-average common shares outstanding for diluted earnings per share		14,626		14,317		17,453		14,626		17,435		14,317
Earnings per common share:
Basic earnings per common share	$	0.49	$	1.53	$	1.01	$	0.49	$	1.98	$	1.53
Diluted earnings per common share	$	0.48	$	1.49	$	0.99	$	0.48	$	1.94	$	1.49

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

~~Table of Contents~~

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

Three months ended

Nine months ended

September 30,

September 30,
(dollars and shares in thousands, except per share data)

2018

2018
Basic:

Net income attributable to common shareholders

$
7,370

$
19,833
Weighted-average common shares outstanding

13,777

13,759
Basic earnings per common share

$
0.53

$
1.44
Diluted:

Net income attributable to common shareholders

7,370

19,833
Weighted-average common shares outstanding

13,777

13,759
Add: Dilutive effect of stock-based awards

294

301
Weighted-average common shares outstanding for diluted EPS

14,071

14,060
Diluted earnings per common share

$
0.52

$
1.41

NOTE 1716 Derivative Instruments

The Company did not have any derivatives designated as hedging instruments, as of September 30, ~~2019~~2020 and December 31, ~~2018.~~2019. The following table presents the amounts recorded in the Company’s consolidated balance sheets, for derivatives not designated as hedging instruments, as of September 30, ~~2019~~2020 and December 31, ~~2018:~~2019:


		September 30, 2019				December 31, 2018
		Fair		Notional		Fair		Notional

											September 30, 2020				December 31, 2019
											Fair		Notional		Fair		Notional
(dollars in thousands)		Value		Amount		Value		Amount			Value		Amount		Value		Amount
Asset Derivatives	Consolidated Balance Sheet Location									Consolidated Balance Sheet Location
Interest rate lock commitments	Other assets	$	2,036	$	89,608	$	12	$	33,858	Accrued interest and Other assets	$	13,133	$	401,313	$	1,228	$	45,715
Forward loan sales commitments	Other assets		447		17,662		—		—	Accrued interest and Other assets		1,545		54,310		393		12,784
TBA mortgage backed securities	Other assets		—		—		—		—
Total asset derivatives		$	2,483	$	107,270	$	12	$	33,858		$	14,678	$	455,623	$	1,621	$	58,499
Liability Derivatives
Interest rate lock commitments	Accrued expenses and other liabilities	$	—	$	—	$	—	$	—
Forward loan sales commitments	Accrued expenses and other liabilities		—		—		7		2,956
TBA mortgage backed securities	Accrued expenses and other liabilities		104		148,500		—		—	Accrued expenses and other liabilities	$	1,960	$	380,063	$	109	$	68,500
Total liability derivatives		$	104	$	148,500	$	7	$	2,956		$	1,960	$	380,063	$	109	$	68,500

Table of Contents

The gain (loss) recognized on derivative instruments for the three and nine months ended September 30, ~~2019~~2020 and ~~2018~~2019 was as follows:


			Gain/(loss)
			Three months ended				Nine months ended
			September 30,		September 30,		September 30,		September 30,

												Three months ended				Nine months ended
											Consolidated Statements of	September 30,		September 30,		September 30,		September 30,
(dollars in thousands)		Consolidated Statements of Income Location	2019		2018		2019		2018		of Income Location	2020		2019		2020		2019
Interest rate lock commitments		Mortgage banking	$	(257)	$	(29)	$	2,024	$	(11)	Mortgage banking/Other noninterest income	$	5,647	$	(257)	$	11,226	$	2,024
Forward loan sales commitments		Mortgage banking		(199)		46		454		24	Mortgage banking		369		(199)		1,152		454
TBA mortgage backed securities		Mortgage banking		680		—		(104)		—	Mortgage banking		(3,747)		680		(9,099)		(104)
Total gain/(loss) from derivative instruments	Total gain/(loss) from derivative instruments		$	224	$	17	$	2,374	$	13		$	2,269	$	224	$	3,279	$	2,374

The Company has third party agreements that require a minimum dollar transfer amount upon a margin call. This requirement is dependent on certain specified credit measures. The amount of collateral posted with third parties at September 30, 2020 and December 31, 2019, respectively was $5.1 million and $853 thousand. 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.

~~Table of Contents~~

NOTE 1817 Regulatory Matters

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

Quantitative measures established by regulation to ensure capital adequacy require the 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 ~~as of~~at September 30, ~~2019~~2020 and December 31, ~~2018,~~2019, each of the Company and the Bank had met all of the capital adequacy requirements to which it ~~is subject and would be considered well capitalized under the regulatory framework for prompt corrective action.~~was subject.

The following table presents the Company’s and the Bank’s actual capital amounts and ratios as of September 30, ~~2019~~2020 and December 31, ~~2018:~~2019:


	September 30, 2019
								Minimum to be
					Requirements			Well Capitalized
					for Capital			Under Prompt
	Actual				Adequacy Purposes			Corrective Action

											September 30, 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		Amount		Ratio		Amount		Ratio		Amount		Ratio
Common equity tier 1 capital to risk weighted assets
Consolidated	$	233,030	12.38	%	84,705	4.50	%	N/A	N/A		$	270,679	13.08	%	$	93,151	4.50	%	$	N/A	N/A
Bank		222,600	11.84	%	84,594	4.50	%	122,192	6.50	%		257,835	12.47	%		93,076	4.50	%		134,443	6.50	%
Tier 1 capital to risk weighted assets								.												.
Consolidated		241,197	12.81	%	112,940	6.00	%	N/A	N/A			278,959	13.48	%		124,202	6.00	%		N/A	N/A
Bank		222,600	11.84	%	112,792	6.00	%	150,390	8.00	%		257,835	12.47	%		124,102	6.00	%		165,469	8.00	%
Total capital to risk weighted assets
Consolidated		313,700	16.67	%	150,587	8.00	%	N/A	N/A			354,573	17.13	%		165,603	8.00	%		N/A	N/A
Bank		245,585	13.06	%	150,390	8.00	%	187,987	10.00	%		283,758	13.72	%		165,469	8.00	%		206,836	10.00	%
Tier 1 capital to average assets
Consolidated		241,197	11.33	%	85,152	4.00	%	N/A	N/A			278,959	9.76	%		114,293	4.00	%		N/A	N/A
Bank		222,600	10.47	%	85,009	4.00	%	106,261	5.00	%		257,835	9.03	%		114,207	4.00	%		142,759	5.00	%

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Table of Contents


	December 31, 2018
								Minimum to be
					Requirements			Well Capitalized
					for Capital			Under Prompt
	Actual				Adequacy Purposes			Corrective Action

											December 31, 2019
																				Minimum to be
																Requirements				Well Capitalized
																for Capital				Under Prompt
											Actual				Adequacy Purposes				Corrective Action
(dollars in thousands)	Amount		Ratio		Amount	Ratio		Amount	Ratio		Amount		Ratio		Amount		Ratio		Amount		Ratio
Common equity tier 1 capital to risk weighted assets
Consolidated	$	151,745	8.43	%	N/A	N/A		N/A	N/A		$	239,672	12.48	%	$	86,452	4.50	%	$	N/A	N/A
Bank		204,680	11.39	%	80,866	4.50	%	116,806	6.50	%		228,512	11.91	%		86,362	4.50	%		124,745	6.50	%
Tier 1 capital to risk weighted assets																				.
Consolidated		159,774	8.87	%	N/A	N/A		N/A	N/A			247,866	12.90	%		115,270	6.00	%		N/A	N/A
Bank		204,680	11.39	%	107,821	6.00	%	143,761	8.00	%		228,512	11.91	%		115,149	6.00	%		153,532	8.00	%
Total capital to risk weighted assets
Consolidated		231,510	12.86	%	N/A	N/A		N/A	N/A			321,415	16.73	%		153,693	8.00	%		N/A	N/A
Bank		226,854	12.62	%	143,806	8.00	%	179,758	10.00	%		252,436	13.15	%		153,532	8.00	%		191,915	10.00	%
Tier 1 capital to average assets
Consolidated		159,774	7.51	%	N/A	N/A		N/A	N/A			247,866	11.05	%		91,504	4.00	%		N/A	N/A
Bank		204,680	9.63	%	85,018	4.00	%	106,272	5.00	%		228,512	10.20	%		89,615	4.00	%		112,018	5.00	%

The Bank is subject to certain restrictions on the amount of dividends that it may pay without prior regulatory approval. The Company and the Bank are subject to the rules of the Basel III regulatory capital framework and related Dodd-Frank Wall Street Reform and Consumer Protection Act rules. The rules included the implementation of a 2.5 percent capital conservation buffer that is added to the minimum requirements for capital adequacy purposes. A banking organization with a conservation buffer of less than the required amount will be subject to the limitations on capital distributions, including dividend payments and certain discretionary bonus payments to executive officers. At September 30, 2020, the ratios for the Company and the Bank were sufficient to meet the conservation buffer. In addition, the Company must adhere to various U.S. Department of Housing and Urban Development, ~~(“HUD”)~~or HUD, regulatory guidelines including required minimum capital and liquidity to maintain their Federal Housing Administration approval status. Failure to comply with the HUD guidelines could result in withdrawal of this certification. As of September 30, ~~2019,~~2020, and December 31, ~~2018,~~2019, the Company was in compliance with HUD guidelines.

NOTE 1918 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~~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.

3231

Table of Contents

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~~instrument-by-instrument basis. The Company adopted the policy to value certain financial instruments at estimated fair value. The Company has not elected to measure any existing financial instruments at estimated fair value; however, it may elect to measure newly acquired financial instruments at estimated fair value in the future.

Recurring Basis

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

The following tables present the balances of the assets and liabilities measured at estimated fair value on a recurring basis as of September 30, ~~2019~~2020 and December 31, ~~2018:~~2019:


	September 30, 2019

									September 30, 2020
(dollars in thousands)	Level 1		Level 2		Level 3		Total		Level 1		Level 2		Level 3		Total
Trading securities
U.S. treasury and government agencies	$	—	$	—	$	—	$	—
Available-for-sale and equity securities
Available-for-sale and securities
U.S. treasury and government agencies	$	—	$	21,602	$	—	$	21,602	$	—	$	16,092	$	—	$	16,092
Obligations of state and political agencies		—		47,856		—		47,856		—		147,216		—		147,216
Mortgage backed securities
Residential agency		—		169,337		—		169,337		—		211,700		—		211,700
Commercial		—		32,652		—		32,652		—		87,542		—		87,542
Asset backed securities		—		157		—		157		—		131		—		131
Corporate bonds		—		7,112		—		7,112		—		32,733		—		32,733
Equity securities		2,675		—		—		2,675
Total available-for-sale and equity securities	$	2,675	$	278,716	$	—	$	281,391
Total available-for-sale securities									$	—	$	495,414	$	—	$	495,414
Other assets
Derivatives	$	—	$	2,483	$	—	$	2,483	$	—	$	14,678	$	—	$	14,678
Other liabilities
Derivatives	$	—	$	104	$	—	$	104	$	—	$	1,960	$	—	$	1,960


	December 31, 2018

									December 31, 2019
(dollars in thousands)	Level 1		Level 2		Level 3		Total		Level 1		Level 2		Level 3		Total
Trading securities
U.S. treasury and government agencies	$	—	$	1,539	$	—	$	1,539
Available-for-sale and equity securities
U.S. treasury and government agencies	$	—	$	19,142	$	—	$	19,142	$	—	$	21,240	$	—	$	21,240
Obligations of state and political agencies		—		66,387		—		66,387		—		68,648		—		68,648
Mortgage backed securities
Residential agency		—		126,998		—		126,998		—		182,538		—		182,538
Commercial		—		28,767		—		28,767		—		30,685		—		30,685
Asset backed securities		—		399		—		399		—		144		—		144
Corporate bonds		—		8,481		—		8,481		—		7,095		—		7,095
Equity securities		3,165		—		—		3,165		2,808		—		—		2,808
Total available-for-sale and equity securities	$	3,165	$	250,174	$	—	$	253,339	$	2,808	$	310,350	$	—	$	313,158
Other assets
Derivatives	$	—	$	12	$	—	$	12	$	—	$	1,621	$	—	$	1,621
Other liabilities
Derivatives	$	—	$	7	$	—	$	7	$	—	$	109	$	—	$	109

~~Table of Contents~~

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

Investment Securities

When available, the Company uses quoted market prices to determine the estimated fair value of investment securities; such items are classified in Level 1 of the estimated fair value hierarchy. For the Company’s investment securities for which quoted prices are not available for identical investment securities in an active market, the Company determines estimated fair value utilizing vendors who apply matrix pricing for similar bonds for which no prices are observable or may compile prices from various sources. These models are primarily ~~industry‑standard~~industry-standard models that

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

Nonrecurring Basis

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

Net impairment related to nonrecurring estimated fair value measurements of certain assets as of September 30, ~~2019~~2020 and December 31, ~~2018~~2019 consisted of the following:


	September 30, 2019

									September 30, 2020
(dollars in thousands)	Level 2		Level 3		Total		Impairment		Level 2		Level 3		Total		Impairment
Loans held for sale	$	66,021	$	—	$	66,021	$	—	$	111,311	$	—	$	111,311	$	—
Loans held for branch sale		—		—		—		—
Impaired loans		—		3,050		3,050		2,107		—		5,301		5,301		407
Foreclosed assets		—		84		84		—		—		10		10		—
Servicing rights		—		4,146		4,146		—		—		2,579		2,579		—


	December 31, 2018

									December 31, 2019
(dollars in thousands)	Level 2		Level 3		Total		Impairment		Level 2		Level 3		Total		Impairment
Loans held for sale	$	14,486	$	—	$	14,486	$	—	$	46,846	$	—	$	46,846	$	—
Loans held for branch sale		—		32,031		32,031		—
Impaired loans		—		4,022		4,022		2,538		—		4,816		4,816		3,138
Foreclosed assets		—		204		204		245		—		8		8		—
Servicing rights		—		4,623		4,623		—		—		3,845		3,845		—

~~Table of Contents~~

Loans Held for Sale

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

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

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

~~Impaired Loans~~

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

~~Foreclosed Assets~~

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

~~Servicing Rights~~

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

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The valuation techniques and significant unobservable inputs used to measure Level 3 estimated fair values as of September 30, ~~2019,~~2020, and December 31, ~~2018,~~2019, were as follows:

September 30, 2019

September 30, 2020

(dollars in thousands)

Weighted

Weighted

Asset Type

Valuation Technique

Unobservable Input

Fair Value

Range

Average

Valuation Technique

Unobservable Input

Fair Value

Range

Average

Impaired loans

Appraisal value

Property specific adjustment

3,050

N/A

Appraisal value

Property specific adjustment

5,301

N/A

Foreclosed assets

Appraisal value

Property specific adjustment

N/A

Appraisal value

Property specific adjustment

N/A

Servicing rights

Discounted cash flows

Prepayment speed assumptions

4,146

154-270

194

Discounted cash flows

Prepayment speed assumptions

2,579

315-485

396

Discount rate

9.5

Discount rate

9.0

December 31, 2018

December 31, 2019

(dollars in thousands)

Weighted

Weighted

Asset Type

Valuation Technique

Unobservable Input

Fair Value

Range

Average

Valuation Technique

Unobservable Input

Fair Value

Range

Average

Loans held for branch sale

Discounted cash flows

Sales agreement

32,031

N/A

Impaired loans

Appraisal value

Property specific adjustment

4,022

N/A

Appraisal value

Property specific adjustment

4,816

N/A

Foreclosed assets

Appraisal value

Property specific adjustment

204

N/A

Appraisal value

Property specific adjustment

N/A

Servicing rights

Discounted cash flows

Prepayment speed assumptions

4,623

104 - 211

130

Discounted cash flows

Prepayment speed assumptions

3,845

123-267

194

Discount rate

10.5

Discount rate

9.4

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

The following disclosures represent financial instruments in which the ending balances, as of September 30, ~~2019~~2020 and December 31, ~~2018,~~2019, were not carried at estimated fair value in their entirety on the consolidated balance sheets.

Cash and Cash Equivalents and Accrued Interest

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

Loans

For ~~variable‑rate~~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~~Bank-Owned Life Insurance

~~Bank‑owned~~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.

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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~~fixed-rate certificates of deposit are estimated using a discounted cash flow calculation that applies current incremental interest rates being offered on certificates of deposit to a schedule of aggregated expected monthly maturities of the outstanding certificates of deposit.

~~Deposits Held for Sale~~

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

~~Short‑Term~~Short-Term Borrowings and ~~Long‑Term~~Long-Term Debt

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

~~Off‑Balance~~Off-Balance Sheet ~~Credit‑Related~~Credit-Related Commitments

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

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


	September 30, 2019
	Carrying		Estimated Fair Value

											September 30, 2020
											Carrying		Estimated Fair Value
(dollars in thousands)	Amount		Level 1		Level 2		Level 3		Total		Amount		Level 1		Level 2		Level 3		Total
Financial Assets
Cash and cash equivalents	$	61,174	$	61,174	$	—	$	—	$	61,174	$	95,751	$	95,751	$	—	$	—	$	95,751
Loans		1,663,103		—		—		1,658,151		1,658,151		2,027,082		—		—		2,075,044		2,075,044
Accrued interest receivable		7,412		7,412		—		—		7,412		9,199		9,199		—		—		9,199
Bank-owned life insurance		31,364		—		31,364		—		31,364		32,161		—		32,161		—		32,161
Financial Liabilities
Noninterest-bearing transaction	$	537,951	$	—	$	537,951	$	—	$	537,951
Interest-bearing transaction		1,102,409		—		1,102,409		—		1,102,409
Noninterest-bearing deposits											$	693,450	$	—	$	693,450	$	—	$	693,450
Interest-bearing deposits												1,561,498		—		1,561,498		—		1,561,498
Time deposits		192,753		—		—		192,869		192,869		207,422		—		—		208,990		208,990
Short-term borrowings		—		—		—		—		—
Long-term debt		58,775		—		58,285		—		58,285		58,745		—		56,219		—		56,219
Accrued interest payable		1,879		1,879		—		—		1,879		1,408		1,408		—		—		1,408


	December 31, 2019
	Carrying		Estimated Fair Value
(dollars in thousands)	Amount		Level 1		Level 2		Level 3		Total
Financial Assets
Cash and cash equivalents	$	144,006	$	144,006	$	—	$	—	$	144,006
Loans		1,697,355		—		—		1,693,824		1,693,824
Accrued interest receivable		7,551		7,551		—		—		7,551
Bank-owned life insurance		31,566		—		31,566		—		31,566
Financial Liabilities
Noninterest-bearing deposits	$	577,704	$	—	$	577,704	$	—	$	577,704
Interest-bearing deposits		1,197,530		—		1,197,530		—		1,197,530
Time deposits		196,082		—		—		196,182		196,182
Long-term debt		58,769		—		58,239		—		58,239
Accrued interest payable		1,038		1,038		—		—		1,038

NOTE 19 COVID-19 Pandemic Response

On March 27, 2020, President Trump signed into Law the Coronavirus Aid Relief and Economic Security Act, or CARES Act, which established a $2.0 trillion economic stimulus package, including cash payments to individuals,

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December 31, 2018

Carrying

Estimated Fair Value
(dollars in thousands)

Amount

Level 1

Level 2

Level 3

Total
Financial Assets










Cash and cash equivalents

$
40,651

$
40,651

$
—

$
—

$
40,651
Loans

1,679,676

—

—

1,663,401

1,663,401
Accrued interest receivable

7,645

7,645

—

—

7,645
Bank-owned life insurance

30,763

—

30,763

—

30,763
Financial Liabilities










Noninterest-bearing transaction

$
550,640

$
—

$
550,640

$
—

$
550,640
Interest-bearing transaction

1,053,869

—

1,053,869

—

1,053,869
Time deposits

170,587

—

—

172,616

172,616
Deposits held for sale

24,197

—

—

22,019

22,019
Short-term borrowings

93,460

93,460

—

—

93,460
Long-term debt

58,824

—

59,988

—

59,988
Accrued interest payable

720

720

—

—

720

~~NOTE 20 Branch Sale~~supplemental unemployment insurance benefits and a $349 billion loan program administered through the U.S. Small Business Administration, or SBA, referred to as the PPP. Under the PPP, small businesses, sole proprietorships, independent contractors, and self-employed individuals were able to apply for loans from existing SBA lenders and other approved regulated lenders that enrolled in the program, subject to numerous limitations and eligibility criteria. The Bank participated as a lender in the PPP. In addition, the CARES Act provides financial institutions the option to temporarily suspend certain requirements under GAAP related to TDRs for a limited period of time to account for the effects of COVID-19. See “Note 4 Loans and Allowance for Loan Losses” for additional discussion regarding TDRs.

On ~~January 15, 2019,~~April 2, 2020, the ~~Bank announced~~SBA issued an ~~agreement to sell~~interim final rule, announcing the ~~Bank’s branch offices located in Duluth, Minnesota, including loans~~implementation of sections 1102 and ~~deposits attributable to those offices, to another financial institution. The Bank decided to exit~~1106 of the ~~Duluth market to reallocate resources~~CARES Act. Section 1102 of the CARES Act temporarily added a new program, the PPP, to the ~~Minneapolis-St. Paul-Bloomington metropolitan statistical area, which is~~SBA’s 7(a) Loan Program. Section 1106 of the CARES Act provides for forgiveness of up to the full principal amount of qualifying loans guaranteed under the PPP. The PPP and loan forgiveness are intended to provide economic relief to small businesses nationwide adversely impacted by COVID-19.

As an SBA-Certified Preferred lender, we were delegated the authority as part of the CARES Act to make PPP SBA-guaranteed financing available to eligible borrowers. As of September 30, 2020, we had assisted 1,632 new and existing clients secure approximately $363.6 million of PPP financing. The SBA pays a ~~higher growth market in~~processing fee based on the ~~state,~~balance of the financing outstanding at the time of final disbursement. The processing fees were as follows: five percent for loans of not more than $350 thousand, three percent for loans of more than $350 thousand and its’ other core markets in the Phoenix-Mesa-Scottsdale metropolitan statistical area, and in Fargo and Grand Forks, North Dakota. The loans and deposits were classified as held for sale in the consolidated financial statements as of December 31, 2018. The transaction closed on April 26, 2019. The loans and deposits associated with this transaction totaled approximately $28.3less than $2 million, and ~~$19.4 million, respectively, as~~one percent for loans of ~~the closing date. A pre‑tax gain on the sale was recognized~~at least $2 million. Net processing fees in the amount of ~~$1.5 million.~~$11.0 million are being deferred and recognized as interest income on a level yield method over the life of the respective loans.

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

On April 15, 2020, we executed a PPPL Facility Agreement with the Federal Reserve Bank of Minneapolis. The PPP loans guaranteed by the SBA are eligible to serve as collateral for the PPPL Facility. The PPPL Facility provided us with additional liquidity, if necessary, to facilitate lending to small businesses under the PPP. As of September 30, 2020, we have not had a need to utilize the PPPL Facility.

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

General

The following discussion explains our financial condition and results of operations as of and for the three and nine months ended September 30, ~~2019~~2020 and ~~2018.~~2019. Annualized results for this interim period may not be indicative of results for the full year or future periods. The following discussion and analysis should be read in conjunction with the consolidated financial statements and related notes presented elsewhere in this report and the Company’s ~~prospectus filed with the SEC~~Annual Report on ~~September 13, 2019, pursuant to Rule 424(b)(4) under the Securities Act of 1933, which contains audited financial statements of the Company as of and~~Form 10-K for the year ended December 31, ~~2018. Annualized results for these interim periods may not be indicative of results for~~2019, filed with the ~~full year or future periods.~~Securities and Exchange Commission on March 26, 2020.

Forward-Looking Statements

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

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

●

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;

●

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

●

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

●

business and economic conditions generally and in the financial services industry, nationally and within our market areas;

●

the overall health of the local and national real estate market;

●

concentrations within our loan portfolio;

●

the level of nonperforming assets on our balance sheet;

●

our ability to implement our organic and acquisition growth strategies;

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●

the impact of economic or market conditions on our fee-based services;

●

our ability to continue to grow our retirement and benefit services business;

●

our ability to continue to originate a sufficient volume of residential mortgages;

●

our ability to manage mortgage pipeline risk;

●

the occurrence of fraudulent activity, breaches or failures of our information security controls or cybersecurity-related incidents;

●

interruptions involving our information technology and telecommunications systems or third-party servicers;

●

potential losses incurred in connection with mortgage loan repurchases;

●

the composition of our executive management team and our ability to attract and retain key personnel;

●

rapid technological change in the financial services industry;

●

increased competition in the financial services industry;

●

our ability to successfully manage liquidity risk;

●

the effectiveness of our risk management framework;

●

the commencement and outcome of litigation and other legal proceedings and regulatory actions against us or to which we may become subject;

●

potential impairment to the goodwill we recorded in connection with our past acquisitions;

●

the extensive regulatory framework that applies to us;

●

the impact of recent and future legislative and regulatory changes;

●

interest rate risks associated with our business;

●

fluctuations in the values of the securities held in our securities portfolio;

●

governmental monetary, trade and fiscal policies;

●

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

●

any material weaknesses in our internal control over financial reporting;

●

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;

●

our success at managing the risks involved in the foregoing items; and

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●

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, ~~(the “Bank”),~~or the Bank, we provide ~~innovative and comprehensive~~ financial solutions to businesses and consumers through four distinct business lines—banking, retirement and benefit services, wealth management and mortgage. These solutions are delivered through a ~~relationship‑oriented~~relationship-oriented primary point of contact along with responsive and ~~client‑friendly~~client-friendly technology.

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

Critical Accounting Policies

Our consolidated financial statements are prepared based on the application of accounting policies generally accepted in the United States, ~~(“GAAP”). Our critical accounting policies require reliance on~~or GAAP. The preparation of our consolidated financial statements requires management to make estimates and ~~assumptions, which~~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, but~~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 ~~prove to be inaccurate or can be subject to variations. Changes in underlying factors,~~differ from these estimates under different assumptions or conditions. The estimates ~~could~~and judgments that management believes have ~~a material impact~~the most effect on ~~our future~~the Company’s reported financial ~~condition~~position and results of ~~operations.~~

~~The most critical of these significant accounting policies~~operations are set forth in Note 1 – Significant Accounting Policies of the Notes to the Consolidated Statements, included in our ~~consolidated financial statements as of and~~Annual Report on Form 10-K for the ~~periods~~year ended December 31, ~~2018, 2017, and 2016 included in our prospectus filed with the SEC on September 13, 2019, pursuant to Rule 424(b)(4) under the Securities Act of 1933.~~2019. There have been no significant changes in critical accounting policies or the assumptions and judgments utilized in applying these policies since December 31, ~~2018.~~2019.

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

Recent Developments

OnImpact of COVID-19

The progression of the COVID-19 pandemic in the United States has not had an adverse impact on our financial condition and results of operations as of and for the three and nine months ended September ~~17, 2019, we sold 2,860,000 shares~~30, 2020, but it is expected to have a complex and significant impact on the economy, the banking industry and our Company in future fiscal periods, all subject to a high degree of ~~common stock~~uncertainty.

Effects on Our Market Areas. Our primary banking market areas are the states of North Dakota, Minnesota, and Arizona. Our retirement and benefit services business serves clients in all 50 states. We offer retirement and benefit

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services at all of our banking offices located in our three primary market areas. In addition, we operate two retirement and benefits services offices in Minnesota, two in Michigan and one in New Hampshire.

In Minnesota, the Governor ordered individuals to stay at home and non-essential businesses to cease all activities, in each case subject to limited exceptions. This order went into effect on March 28, 2020, and was in effect until May 18, 2020. The state has now implemented a four phase stay safe plan to reopen businesses in the area. Similarly, in Arizona, the Governor ordered individuals to stay at home and non-essential businesses to cease all activities, in each case subject to limited exceptions. This order went into effect on March 31, 2020, and expired on May 15, 2020, and the Governor announced new guidance for protecting businesses and their customers as they reopen. The state has implemented a four phase reopening plan that requires benchmarks be met for a certain period of time before transitioning from one phase to another. In North Dakota, the Governor did not issue an order requiring individuals to stay at home, but placed certain restrictions on bars, restaurants and gyms. These orders have been lifted and North Dakota is now working toward a “Smart Restart” program to encourage businesses to open safely and take precautions to slow the spread of COVID-19. In response to these orders, the Bank has been serving its customers through its drive-up windows at various branch locations and through online and mobile banking. The Bank is also permitting certain visits to its branches on a limited basis and by appointment only. In Minnesota and Arizona, the Bank is offering appointments to our customers to meet us with safeguards in place that materially comply with CDC guidance. In North Dakota, certain offices have re-opened for business with safeguards in place that materially comply with CDC guidance.

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. To date, many of the public ~~offering. On September 25, 2019,~~health and economic effects of COVID-19 have been concentrated in the largest U.S. cities, such as New York, but we ~~sold an additional 429,000 shares~~are beginning to see similar effects in smaller cities and communities, where many of ~~common stock pursuant~~our banking operations are focused.

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

●

The Federal Reserve decreased the range for the Federal Funds Target Rate by 0.50% on March 3, 2020, and by another 1.00% on March 16, 2020, reaching a current range of 0.00 – 0.25%.

●

On March 27, 2020, President Trump signed into law the Coronavirus Aid, Relief and Economic Security Act, or CARES Act, which established a $2.0 trillion economic stimulus package, including cash payments to individuals, supplemental unemployment insurance benefits and a $349 billion loan program administered through the U.S. Small Business Administration, or SBA, referred to as the paycheck protection program, or PPP. On April 24, 2020, an additional $310 billion in funding for PPP loans was authorized, with such funds available for PPP loans beginning on April 27, 2020. In addition, the CARES Act provides financial institutions the option to temporarily suspend certain requirements under GAAP related to TDRs for a limited period of time to account for the effects of COVID-19. See “NOTE 4 Loans and Allowance for Loan Losses” for additional discussion regarding TDRs.

●

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

●

On April 9, 2020, the Federal Reserve announced additional measures aimed at supporting small and midsized business, as well as state and local governments impacted by COVID-19. The Federal Reserve announced the Main Street Business Lending Program, which established two new loan facilities intended to facilitate lending to small and midsized businesses: (1) the Main Street New Loan Facility, or MSNLF,

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and (2) the Main Street Expanded Loan Facility, or MSELF. MSNLF loans are unsecured term loans originated on or after April 8, 2020, while MSELF loans are provided as upsized tranches of existing loans originated before April 8, 2020. The combined size of the program is $600 billion.

●

On August 3, 2020, the FFIEC issued a joint statement on Additional Loan Accommodations Related to COVID-19, which, among other things, encouraged financial institutions to consider prudent additional loan accommodation options when borrowers are unable to meet their obligations due to continuing financial challenges. Accommodation options should be based on prudent risk management and consumer protection principles.

●

In addition to the policy responses described above, the federal bank regulatory agencies, along with their state counterparts, have issued a stream of guidance in response to the COVID-19 pandemic and have taken a number of unprecedented steps to help banks navigate the pandemic and mitigate its impact. These include, without limitation: requiring banks to focus on business continuity and pandemic planning; adding pandemic scenarios to stress testing; encouraging bank use of capital buffers and reserves in lending programs; permitting certain regulatory reporting extensions; reducing margin requirements on swaps; permitting certain otherwise prohibited investments in investment funds; issuing guidance to encourage banks to work with customers affected by the pandemic and encourage loan workouts; and providing credit under the Community Reinvestment Act, or CRA, for certain pandemic-related loans, investments and public service. Moreover, because of the need for social distancing measures, the agencies have revamped the manner in which they conduct periodic examinations of their regulated institutions, including making greater use of off-site reviews. The Federal Reserve also issued guidance encouraging banking institutions to utilize their discount window for loans and intraday credit extended by their Reserve Banks to help households and businesses impacted by the pandemic and announced numerous funding facilities. The FDIC has also acted to mitigate the deposit insurance assessment effects of participating in the PPP and the PPPL Facility and Money Market Mutual Fund Liquidity Facility.

Effects on Our Business. We currently expect that the COVID-19 pandemic and the specific developments referred to purchase additional shares. The aggregate offering price for the shares sold by us was $69.1 million, and after deducting $4.7 million of underwriting discounts and $1.6 million of offering expenses paidabove will continue to ~~third parties,~~have a significant impact on our business. In particular, we ~~received total net proceeds of $62.8 million. All~~anticipate that a significant portion of the ~~shares were sold pursuant~~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 ~~Registration Statement on Form S-1,~~commercial real estate portfolio, particularly with respect to real estate with exposure to these industries, our consumer loan business and loan portfolio, and the value of certain collateral securing our loans. In addition, we expect to see decreases in our total assets under administration and assets under management and a decrease in mortgage loan originations. As a result, we anticipate that our financial condition, capital levels and results of operations will be significantly and adversely affected, as ~~amended (File No. 333-233339), which was declared effective by~~described in this Management’s Discussion and Analysis of Financial Condition and Results of Operations.

Our Response. We have taken numerous steps in response to the ~~SEC on September 12, 2019.~~COVID-19 pandemic, including the following:

●

First and foremost, we have prioritized the safety, health and well-being of our employees, clients and communities. We have implemented a work from home policy and certain of our offices remain closed. We 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.

●

We offered payment deferrals and interest only payment options for consumer, small business, and commercial customers for initial terms of up to 90 days. We offered payment extensions for mortgage customers for initial terms of up to 90 days. As of September 30, 2020, we had executed 552 loan deferrals representing $151.4 million. Of those loans, 27 loans with a total outstanding principal balance of $16.9

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million have been granted second deferrals, 56 loans with a total outstanding principal balance of $12.0 million remain on the first deferral and the remaining loans have been returned to a normal payment status.

●

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

●

We participated in the SBA’s PPP. As of September 30, 2020, we had assisted 1,632 borrowers receive approval for funding of $363.6 million in PPP loans. As of October 22, 2020, we had submitted to the SBA 79 forgiveness applications totaling $51.7 million. We have not yet received any decisions from the SBA on the applications submitted, and no forgiveness has been granted as of that date.

●

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

Shareholder Dividend and Stock Repurchases

On ~~August 28, 2019,~~July 23, 2020, the Company’s Board of Directors declared a quarterly cash dividend of ~~$0.14~~$0.15 per common share. This dividend was paid out on October ~~11, 2019,~~9, 2020, to stockholders of record at the close of business on September ~~20, 2019.~~18, 2020.

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.

We currently do not have an authorized stock repurchase program, but the Company does repurchase shares to pay withholding taxes on the vesting of restricted stock awards and units.

4042

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Operating Results Overview

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


	Three months ended									Nine months ended
	September 30,			June 30,			September 30,			September 30,			September 30,

																Three months ended									Nine months ended
																September 30,			June 30,			September 30,			September 30,			September 30,
(dollars and shares in thousands, except per share data)	2019			2019			2018			2019			2018			2020			2020			2019			2020			2019
Performance Ratios
Return on average total assets		1.29	%		1.52	%		1.36	%		1.34	%		1.25	%		2.42	%		1.68	%		1.29	%		1.71	%		1.34	%
Return on average common equity		12.42	%		15.82	%		15.45	%		13.74	%		14.35	%		22.31	%		15.30	%		12.42	%		15.17	%		13.74	%
Return on average tangible common equity (1)		17.01	%		21.93	%		23.08	%		19.24	%		22.05	%		26.67	%		18.88	%		17.01	%		18.70	%		19.24	%
Noninterest income as a % of revenue		61.29	%		62.11	%		58.11	%		60.14	%		57.78	%		67.53	%		65.55	%		61.29	%		64.58	%		60.14	%
Net interest margin (taxable-equivalent basis) (1)		3.69	%		3.62	%		3.80	%		3.72	%		3.85	%		3.17	%		3.14	%		3.69	%		3.22	%		3.72	%
Efficiency ratio (1)		75.17	%		70.74	%		73.16	%		73.06	%		72.84	%		58.42	%		66.31	%		75.17	%		66.22	%		73.06	%
Net charge-offs/(recoveries) to average loans		(0.01)	%		0.18	%		0.02	%		0.27	%		0.16	%		(0.11)	%		0.66	%		(0.06)	%		0.15	%		0.37	%
Dividend payout ratio		29.17	%		23.73	%		25.00	%		28.19	%		27.66	%		15.15	%		23.08	%		29.17	%		23.20	%		28.19	%
Per Common Share
Earnings per common share - basic	$	0.49		$	0.60		$	0.53		$	1.53		$	1.44		$	1.01		$	0.66		$	0.49		$	1.98		$	1.53
Earnings per common share - diluted	$	0.48		$	0.59		$	0.52		$	1.49		$	1.41		$	0.99		$	0.65		$	0.48		$	1.94		$	1.49
Dividends declared per common share	$	0.14		$	0.14		$	0.13		$	0.42		$	0.39		$	0.15		$	0.15		$	0.14		$	0.45		$	0.42
Tangible book value per common share (1)	$	13.77		$	12.02		$	10.11		$	13.77		$	10.11		$	16.31		$	15.30		$	13.77
Average common shares outstanding - basic		14,274			13,810			13,777			13,957			13,759			17,121			17,111			14,274			17,101			13,957
Average common shares outstanding - diluted		14,626			14,100			14,071			14,317			14,060			17,453			17,445			14,626			17,435			14,317
Other Data
Assets under administration	$	27,702,273		$	27,854,052		$	28,533,616		$	27,702,273		$	28,533,616
Assets under management		5,724,412			5,260,233			4,854,106			5,724,412			4,854,106
Retirement and benefit services assets under administration/management																$	30,470,645		$	30,093,095		$	30,661,226
Wealth management assets under administration/management																	3,043,173			2,957,213			2,765,459
Mortgage originations		313,527			246,115			222,330			685,178			609,941			511,605			431,638			313,527		$	1,171,811		$	685,178

(1)

~~(1)~~

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

Selected Financial Data

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


	Three months ended						Nine months ended
	September 30,		June 30,		September 30,		September 30,		September 30,

											Three months ended						Nine months ended
											September 30,		June 30,		September 30,		September 30,		September 30,
(dollars in thousands)	2019		2019		2018		2019		2018		2020		2020		2019		2020		2019
Selected Average Balance Sheet Data
Loans	$	1,691,542	$	1,724,081	$	1,699,048	$	1,715,629	$	1,661,493	$	2,034,778	$	1,986,028	$	1,691,542	$	1,917,894	$	1,715,629
Investment securities		257,561		255,502		248,568		255,903		256,331		443,705		369,247		257,561		383,591		255,903
Assets		2,176,862		2,200,797		2,144,841		2,185,868		2,115,708		2,908,144		2,740,330		2,176,862		2,690,182		2,185,868
Deposits		1,763,217		1,777,003		1,764,939		1,779,610		1,755,473		2,454,865		2,329,192		1,763,217		2,270,781		1,779,610
Short-term borrowings		87,201		115,892		103,171		95,489		87,501		—		321		87,201		107		95,489
Long-term debt		58,776		58,808		58,812		58,798		58,812		58,739		58,747		58,776		58,747		58,798
Stockholders’ equity		226,931		211,655		189,311		212,911		184,733		314,921		301,719		226,931		303,825		212,911

September 30,

June 30,

September 30,
(dollars in thousands)

2019

2019

2018
Selected Period End Balance Sheet Data

Loans

$
1,686,087

$
1,713,452

$
1,724,656
Allowance for loan losses

(22,984)

(21,246)

(21,012)
Investment securities

281,391

256,252

246,387
Assets

2,228,311

2,207,129

2,171,821
Deposits

1,833,113

1,753,365

1,817,709
Long-term debt

58,775

58,808

58,824
Total stockholders’ equity

281,403

213,765

190,082

4143

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Three months ended

Nine months ended

September 30,

June 30,

September 30,

September 30,

September 30,
(dollars in thousands)

2019

2019

2018

2019

2018
Selected Income Statement Data

Net interest income

$
18,681

$
18,291

$
18,929

$
56,092

$
55,971
Provision for loan losses

1,498

1,797

1,530

5,515

7,080
Noninterest income

29,580

29,984

26,258

84,638

76,608
Noninterest expense

37,327

35,261

34,336

106,102

100,414
Income before income taxes

9,436

11,217

9,321

29,113

25,085
Income tax expense

2,332

2,869

1,951

7,225

5,252
Net income

$
7,104

$
8,348

$
7,370

$
21,888

$
19,833


	September 30,		June 30,		December 31,		September 30,
(dollars in thousands)	2020		2020		2019		2019
Selected Period End Balance Sheet Data
Loans	$	2,058,419	$	2,034,197	$	1,721,279	$	1,686,087
Allowance for loan losses		(31,337)		(27,256)		(23,924)		(22,984)
Investment securities		495,414		393,727		313,158		281,391
Assets		2,898,809		2,875,457		2,356,878		2,228,311
Deposits		2,462,370		2,453,153		1,971,316		1,833,113
Long-term debt		58,745		58,754		58,769		58,775
Total stockholders’ equity		322,003		305,732		285,728		281,403


	Three months ended						Nine months ended
	September 30,		June 30,		September 30,		September 30,		September 30,
(dollars in thousands)	2020		2020		2019		2020		2019
Selected Income Statement Data
Net interest income	$	21,765	$	20,091	$	18,681	$	60,693	$	56,092
Provision for loan losses		3,500		3,500		1,498		9,500		5,515
Noninterest income		45,256		38,230		29,580		110,675		84,638
Noninterest expense		40,214		39,734		37,327		116,674		106,102
Income before income taxes		23,307		15,087		9,436		45,194		29,113
Income tax expense		5,648		3,613		2,332		10,698		7,225
Net income	$	17,659	$	11,474	$	7,104	$	34,496	$	21,888

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

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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.


	September 30,			June 30,			December 31,			September 30,
	2019			2019			2018			2018

													September 30,			June 30,			December 31,			September 30,
													2020			2020			2019			2019
Tangible common equity to tangible assets
Total common stockholders’ equity	$	281,403		$	213,765		$	196,954		$	190,082		$	322,003		$	305,732		$	285,728		$	281,403
Less: Goodwill		27,329			27,329			27,329			27,329			27,329			27,329			27,329			27,329
Less: Other intangible assets		19,382			20,372			22,473			23,523			15,421			16,411			18,391			19,382
Tangible common equity (a)		234,692			166,064			147,152			139,230			279,253			261,992			240,008			234,692
Total assets		2,228,311			2,207,129			2,179,070			2,171,821			2,898,809			2,875,457			2,356,878			2,228,311
Less: Goodwill		27,329			27,329			27,329			27,329			27,329			27,329			27,329			27,329
Less: Other intangible assets		19,382			20,372			22,473			23,523			15,421			16,411			18,391			19,382
Tangible assets (b)		2,181,600			2,159,428			2,129,268			2,120,969			2,856,059			2,831,717			2,311,158			2,181,600
Tangible common equity to tangible assets (a)/(b)		10.76	%		7.69	%	$	6.91	%		6.56	%		9.78	%		9.25	%		10.38	%		10.76	%
Tangible book value per common share
Total common stockholders’ equity	$	281,403		$	213,765		$	196,954		$	190,082		$	322,003		$	305,732		$	285,728		$	281,403
Less: Goodwill		27,329			27,329			27,329			27,329			27,329			27,329			27,329			27,329
Less: Other intangible assets		19,382			20,372			22,473			23,523			15,421			16,411			18,391			19,382
Tangible common equity (c)		234,692			166,064			147,152			139,230			279,253			261,992			240,008			234,692
Total common shares issued and outstanding (d)		17,049			13,816			13,775			13,776			17,122			17,120			17,050			17,049
Tangible book value per common share (c)/(d)	$	13.77		$	12.02		$	10.68		$	10.11		$	16.31		$	15.30		$	14.08		$	13.77


	Three months ended									Nine months ended
	September 30,			June 30,			September 30,			September 30,			September 30,
	2020			2020			2019			2020			2019
Return on average tangible common equity
Net income	$	17,659		$	11,474		$	7,104		$	34,496		$	21,888
Add: Intangible amortization expense (net of tax)		782			783			782			2,347			2,442
Net income, excluding intangible amortization (e)		18,441			12,257			7,886			36,843			24,330
Average total equity		314,921			301,719			226,931			303,825			212,911
Less: Average goodwill		27,329			27,329			27,329			27,329			27,329
Less: Average other intangible assets (net of tax)		12,565			13,345			15,697			13,343			16,502
Average tangible common equity (f)		275,027			261,045			183,905			263,153			169,080
Return on average tangible common equity (e)/(f)		26.67	%		18.88	%		17.01	%		18.70	%		19.24	%
Net interest margin (tax-equivalent)
Net interest income	$	21,765		$	20,091		$	18,681		$	60,693		$	56,092
Tax-equivalent adjustment		116			109			81			325			257
Tax-equivalent net interest income (g)		21,881			20,200			18,762			61,018			56,349
Average earning assets (h)		2,744,758			2,584,037			2,017,198			2,534,038			2,024,814
Net interest margin (tax-equivalent) (g)/(h)		3.17	%		3.14	%		3.69	%		3.22	%		3.72	%
Efficiency ratio
Noninterest expense	$	40,214		$	39,734		$	37,327		$	116,674		$	106,102
Less: Intangible amortization expense		990			991			990			2,971			3,091
Adjusted noninterest expense (i)		39,224			38,743			36,337			113,703			103,011
Net interest income		21,765			20,091			18,681			60,693			56,092
Noninterest income		45,256			38,230			29,580			110,675			84,638
Tax-equivalent adjustment		116			109			81			325			257
Total tax-equivalent revenue (j)		67,137			58,430			48,342			171,693			140,987
Efficiency ratio (i)/(j)		58.42	%		66.31	%		75.17	%		66.22	%		73.06	%

4245

Table of Contents

Three months ended

Nine months ended

September 30,

June 30,

September 30,

September 30,

September 30,


2019

2019

2018

2019

2018

Return on average tangible common equity

Net income

$
7,104

$
8,348

$
7,370

$
21,888

$
19,833

Add: Intangible amortization expense (net of tax)

782

830

945

2,442

2,835

Net income, excluding intangible amortization (e)

7,886

9,178

8,315

24,330

22,668

Average total equity

226,931

211,655

189,311

212,911

184,733

Less: Average goodwill

27,329

27,329

27,329

27,329

27,329

Less: Average other intangible assets (net of tax)

15,697

16,498

19,045

16,502

19,982

Average tangible common equity (f)

183,905

167,828

142,937

169,080

137,422

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

17.01
%

21.93
%

23.08
%

19.24
%

22.05
%
Net interest margin (tax-equivalent)







Net interest income

$
18,681

$
18,291

$
18,929

$
56,092

$
55,971

Tax-equivalent adjustment

81

84

114

257

348

Tax-equivalent net interest income (g)

18,762

18,375

19,043

56,349

56,319

Average earning assets (h)

2,017,198

2,037,605

1,987,267

2,024,814

1,955,253

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

3.69
%

3.62
%

3.80
%

3.72
%

3.85
%
Efficiency ratio







Noninterest expense

$
37,327

$
35,261

$
34,336

$
106,102

$
100,414

Less: Intangible amortization expense

990

1,050

1,196

3,091

3,588

Adjusted noninterest expense (i)

36,337

34,211

33,140

103,011

96,826

Net interest income

18,681

18,291

18,929

56,092

55,971

Noninterest income

29,580

29,984

26,258

84,638

76,608

Tax-equivalent adjustment

81

84

114

257

348

Total tax-equivalent revenue (j)

48,342

48,359

45,301

140,987

132,927

Efficiency ratio (i)/(j)

75.17
%

70.74
%

73.16
%

73.06
%

72.84
%

Discussion and Analysis of Results of Operations

Net Income

Net income for the three months ended September 30, ~~2019~~2020 was $17.7 million, or $0.99 per diluted common share, a $10.6 million increase as compared to $7.1 million, or $0.48 ~~per diluted common share, compared to $7.4 million, or $0.52~~ per diluted common share, for the three months ended September 30, ~~2018. The decrease of $266 thousand~~2019. This increase in net income was primarily due to ana $15.7 million increase ~~of $3.3 million~~ in noninterest income and a $3.1 million increase in net interest income, partially offset by increases of ~~$3.0~~$2.9 million in noninterest expense, $2.0 million in provision expense, and ~~$381 thousand~~$3.3 million in income tax expense. The increase in noninterest income was primarily due to a $14.1 million increase in mortgage banking revenue due to an increase in mortgage originations. The increase in noninterest expense ~~and a $248 thousand decrease~~was primarily attributable to an increase in ~~net interest income.~~compensation expense related to the increase in mortgage originations.

Net income for the nine months ended September 30, ~~2019~~2020 was ~~$21.9~~$34.5 million, or ~~$1.49~~$1.94 per diluted common share, compared to ~~$19.8~~$21.9 million, or ~~$1.41~~$1.49 per diluted common share, for the nine months ended September 30, ~~2018.~~2019. The increase of ~~$2.1~~$12.6 million ~~in net income in the first nine months~~was due to increases of ~~2019 primarily reflects an increase of $8.0~~$26.0 million in noninterest income and ~~a $1.6~~$4.6 million ~~decrease~~ in ~~provision for loan losses~~net interest income, partially offset by ~~an increase~~increases of ~~$5.7~~$10.6 million in noninterest expense and $3.5 million in income tax expense. The increase in noninterest income was primarily due to a $25.1 million increase in mortgage banking revenue as a result of a $486.6 million increase in mortgage originations. The increase in noninterest expense was primarily attributable to an increase in ~~income tax~~compensation expense ~~of $2.0 million.~~related to the increase in mortgage originations.

Net Interest Income

Net interest income is the difference between interest income and ~~yield‑related~~yield-related fees earned on assets and interest expense paid on liabilities. Net interest margin is the difference between the yield on interest earning assets and the cost of interest-bearing liabilities as a percentage of interest earning assets. Net interest margin is presented on a tax-equivalent basis, which means that tax-free interest income has been adjusted to a pre-tax-equivalent income, assuming a federal income tax rate of 21% for the three and nine months ended September 30, 2020 and 2019.

In response to the COVID-19 pandemic, the Federal Reserve decreased the targeted federal funds rate by a total of 150 basis points in March 2020. This decrease impacts the comparability of net interest income between 2019 and ~~2018.~~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 September 30, 2020 was ~~$18.7~~$21.8 million, ~~and $18.9~~an increase of $3.1 million from $18.7 million for the three months ended September 30, ~~2019 and 2018, respectively.~~2019. The three months ended September 30, ~~2019~~2020 included a ~~$1.4~~$2.4 million ~~increase in interest income offset by a $1.7 million increase~~decrease in interest expense compared to the same period in ~~2018.~~2019 and a $664 thousand increase in interest income. The decrease in interest expense was primarily driven by a decrease of $1.8 million in deposit interest expense and a decrease of $539 thousand in interest expense on short-term borrowings. The decrease in deposit interest expense for the three months ended September 30, 2020, compared to the same period 2019 was driven primarily by a 72 basis point reduction in the average rate paid on interest-bearing deposits, partially offset by a $495.2 million increase in the average balance of interest-bearing deposits. The decrease in interest expense on short-term borrowings for the three months ended September 30, 2020, was primarily due to an $87.2 million decrease in the average balance in short-term borrowings. The increase in interest income was primarily driven by ~~an increase of $1.3 million in interest and fees on loans, whereas the~~a $674 thousand increase in interest ~~expense was primarily driven by an~~income from investment securities as a result of a $186.1 million increase in the average balance of ~~$1.7 million in deposit~~investment securities.

Net interest ~~expense. The change in interest and fees~~

~~Table of Contents~~

~~on loans~~income for the ~~three~~nine months ended September 30, ~~2019, compared to the same period 2018~~2020 was driven by a combination of growth in total loans and by higher interest rates. The increase in deposit interest expense during the three months ended September 30, 2019, was primarily due to higher average rates paid on deposits as a result of the increase in the target federal funds rate, as well as$60.7 million, an increase ~~in total deposits compared to the same period in 2018.~~

~~Net interest income was~~of $4.6 million from $56.1 ~~million and $56.0~~ million for the nine months ended September 30, ~~2019 and 2018, respectively.~~2019. The ~~nine months ended September 30, 2019 included~~increase in net interest income was primarily driven by a ~~$5.9~~decrease of $4.1 million in interest expense as well as a $488 thousand increase in interest ~~income offset by a $5.8 million increase~~income. The decrease in interest expense ~~compared to the same period~~was driven by a $2.2 million decrease in ~~2018.~~deposit interest expense. The increase in interest income was primarily driven by ana $1.6 million increase in interest income from investment securities, partially offset by a $1.3 million decrease in interest and fees on loans. The decrease in interest expense on deposits was due to a 39 basis point reduction in the average rate paid on interest-bearing deposits, partially offset by a $336.0 million increase in the average balance of ~~$5.6 million~~interest-bearing deposits. The increase in interest income from investment securities was

Table of Contents

primarily due to a $127.7 increase in the average balance of investment securities. The decrease in interest and fees on loans ~~whereas the increase in interest expense~~ was primarily driven by an increase of $5.3 million in deposit interest expense and an increase of $500 thousand in interest expense on other borrowed funds. The change in interest and fees on loans for the nine months ended September 30, 2019 compared to the same period 2018 was driven by a combination of growth in total loans and by higher interest rates. The increase in deposit interest expense during the nine months ended September 30, 2019 was driven by a combination of growth in total deposits and higher average rates paid on deposits as a result of the increase66 basis point decrease in the ~~target federal fund rate, compared to the same period in 2018.~~average yield on total loans.

Our net interest margin (on a fully tax-equivalent, or FTE, basis) for the three months ended September 30, ~~2019~~2020 was ~~3.69%~~3.17%, compared to ~~3.80%~~3.69% for the same period in ~~2018.~~2019. The decrease in net interest margin from the third quarter of 112019 was due to a 112 basis ~~points~~point lower average earning asset yield, partially offset by an 84 basis point decrease in the average rate paid on interest-bearing liabilities. The decrease in the average earning asset yield was primarily ~~a result of~~due to an ~~increased cost of funds compared to the same period~~86 basis point decrease in ~~2018. For the three months ended September 30, 2019 and 2018,~~ the average yield on total ~~loans~~loans. The decline in loan yield was ~~5.06% and 4.77%, respectively. For~~primarily due to the ~~three months ended September 30, 2019 and 2018,~~addition of PPP loan balances which averaged $348.1 million during the ~~cost~~quarter with a yield of 3.64%. The decrease in the average rate paid on total interest-bearing liabilities was ~~1.39%~~primarily due to a 100 basis point decrease in the average rate paid on money market and ~~0.94%, respectively.~~savings deposits.

Our net interest margin (FTE) for the nine months ended September 30, ~~2019~~2020 was ~~3.72%~~3.22%, compared to ~~3.85%~~3.72% for the same period in ~~2018.~~2019. The decrease ~~of 13 basis points~~in net interest margin was primarily attributable to a ~~result of an increased cost of funds compared~~92 basis point decrease on the average earning asset yield, partially offset by a 52 basis point decrease in the average rate on interest-bearing liabilities. The decrease in the average earning asset yield was primarily due to a 66 basis point reduction in the ~~same period~~average yield on total loans. The decline in ~~2018. For~~loan yield was primarily due to PPP loan balances which averaged $207.8 million for the nine months ended September 30, ~~2019 and 2018, the~~2020 with a yield of 3.37%.The decrease in average ~~yield~~rate on ~~total loans was 5.03% and 4.77%, respectively. For the nine months ended September 30, 2019 and 2018, the cost of~~ interest-bearing liabilities was ~~1.33%~~the result of a 57 basis point decrease in the average rate on money market and ~~0.83%, respectively.~~savings deposits and a $95.4 million decrease in the average balance on short-term borrowings.

As a result of the recent reductions in the target federal funds interest rate, as well as the impact of the COVID-19 pandemic and related future loan charge-offs that we expect to incur, we 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.

4447

Table of Contents

The following tables present average balance sheet information, interest income, interest expense and the corresponding average yields on assets, and average yields earned and rates paid for the three and nine months ended September 30, ~~2019~~2020 and ~~2018.~~2019. We derived these yields and rates by dividing income or expense by the average balance of the corresponding assets or liabilities. We derived average balances from the daily balances throughout the periods indicated. Average loan balances include loans that have been placed on nonaccrual, while interest previously accrued on these loans is reversed against interest income. In these tables, adjustments are made to the yields on ~~tax‑exempt~~tax-exempt assets in order to present ~~tax‑exempt~~tax-exempt income and fully taxable income on a comparable basis.

Three months ended September 30,

2019

2018

Interest

Average

Interest

Average

Average

Income/

Yield/

Average

Income/

Yield/

(dollars in thousands)

Balance

Expense

Rate

Balance

Expense

Rate

Interest Earning Assets

Interest-bearing deposits with banks

$
12,998

$
83

2.53
%
$
7,260

$
43

2.35
%
Investment securities (1)

257,561

1,580

2.43
%

248,568

1,510

2.41
%
Loans held for sale

45,794

359

3.11
%

22,438

182

3.22
%
Loans













Commercial:









Commercial and industrial

494,081

6,830

5.48
%

524,601

6,867

5.19
%
Real estate construction

25,137

352

5.56
%

23,999

326

5.39
%
Commercial real estate

439,751

5,866

5.29
%

435,950

5,133

4.67
%
Total commercial

958,969

13,048

5.40
%

984,550

12,326

4.97
%
Consumer













Residential real estate first mortgage

454,971

4,789

4.18
%

434,691

4,530

4.13
%
Residential real estate junior lien

184,124

2,611

5.63
%

188,897

2,563

5.38
%
Other revolving and installment

93,478

1,117

4.74
%

90,910

1,009

4.40
%
Total consumer

732,573

8,517

4.61
%

714,498

8,102

4.50
%
Total loans (1)

1,691,542

21,565

5.06
%

1,699,048

20,428

4.77
%
Federal Reserve/FHLB Stock

9,303

119

5.07
%

9,953

148

5.90
%
Total interest earning assets

2,017,198

23,706

4.66
%

1,987,267

22,311

4.45
%
Noninterest earning assets

159,664

157,574

Total assets

$
2,176,862





$
2,144,841





Interest-Bearing Liabilities













Interest-bearing demand deposits

$
424,896

$
522

0.49
%
$
393,390

$
231

0.23
%
Money market and savings deposits

649,190

2,162

1.32
%

619,386

1,042

0.67
%
Time deposits

187,023

822

1.74
%

207,009

517

0.99
%
Short-term borrowings

87,201

539

2.46
%

103,171

575

2.21
%
Long-term debt

58,776

899

6.07
%

58,812

903

6.09
%
Total interest-bearing liabilities

1,407,086

4,944

1.39
%

1,381,768

3,268

0.94
%
Noninterest-Bearing Liabilities and Stockholders' Equity







Noninterest-bearing deposits

502,108



545,154





Other noninterest-bearing liabilities

40,737



28,608





Stockholders’ equity

226,931



189,311





Total liabilities and stockholders’ equity

$
2,176,862



$
2,144,841





Net interest rate spread

3.27
%





3.51
%
Net interest rate margin (2)

3.69
%





3.80
%

~~Table of Contents~~


	Nine months ended September 30,
	2019						2018
			Interest		Average				Interest		Average
	Average		Income/		Yield/		Average		Income/		Yield/

													Three months ended September 30,
													2020						2019
															Interest		Average				Interest		Average
													Average		Income/		Yield/		Average		Income/		Yield/
(dollars in thousands)	Balance		Expense		Rate		Balance		Expense		Rate		Balance		Expense		Rate		Balance		Expense		Rate
Interest Earning Assets
Interest-bearing deposits with banks	$	12,910	$	231	2.39	%	$	7,905	$	121	2.05	%	$	169,770	$	51	0.12	%	$	12,998	$	83	2.53	%
Investment securities (1)		255,903		4,803	2.51	%		256,331		4,648	2.42	%		443,705		2,274	2.04	%		257,561		1,580	2.43	%
Loans held for sale		30,734		745	3.24	%		20,217		459	3.04	%		90,634		555	2.44	%		45,794		359	3.11	%
Loans
Commercial:
Commercial and industrial		509,806		20,966	5.50	%		514,940		19,549	5.08	%		782,853		8,543	4.34	%		494,081		6,830	5.48	%
Real estate construction		23,532		975	5.54	%		24,533		1,000	5.45	%		32,747		368	4.47	%		25,137		352	5.56	%
Commercial real estate		444,964		16,768	5.04	%		441,209		15,665	4.75	%		525,514		5,315	4.02	%		439,751		5,866	5.29	%
Total commercial		978,302		38,709	5.29	%		980,682		36,214	4.94	%		1,341,114		14,226	4.22	%		958,969		13,048	5.40	%
Consumer
Residential real estate first mortgage		455,898		14,496	4.25	%		402,644		12,528	4.16	%		460,995		4,588	3.96	%		454,971		4,789	4.18	%
Residential real estate junior lien		186,744		8,028	5.75	%		191,348		7,665	5.36	%		153,326		1,749	4.54	%		184,124		2,611	5.63	%
Other revolving and installment		94,685		3,286	4.64	%		86,819		2,830	4.36	%		79,343		897	4.50	%		93,478		1,117	4.74	%
Total consumer		737,327		25,810	4.68	%		680,811		23,023	4.52	%		693,664		7,234	4.15	%		732,573		8,517	4.61	%
Total loans (1)		1,715,629		64,519	5.03	%		1,661,493		59,237	4.77	%		2,034,778		21,460	4.20	%		1,691,542		21,565	5.06	%
Federal Reserve/FHLB Stock		9,638		372	5.16	%		9,307		354	5.09	%		5,871		65	4.40	%		9,303		119	5.07	%
Total interest earning assets		2,024,814		70,670	4.67	%		1,955,253		64,819	4.43	%		2,744,758		24,405	3.54	%		2,017,198		23,706	4.66	%
Noninterest earning assets		161,054						160,455						163,386						159,664
Total assets	$	2,185,868					$	2,115,708					$	2,908,144					$	2,176,862
Interest-Bearing Liabilities
Interest-bearing demand deposits	$	423,181	$	1,415	0.45	%	$	405,837	$	699	0.23	%	$	589,633	$	395	0.27	%	$	424,896	$	522	0.49	%
Money market and savings deposits		675,921		6,217	1.23	%		618,700		2,552	0.55	%		961,669		781	0.32	%		649,190		2,162	1.32	%
Time deposits		183,686		2,170	1.58	%		199,928		1,230	0.82	%		204,969		507	0.98	%		187,023		822	1.74	%
Short-term borrowings		95,489		1,805	2.53	%		87,501		1,331	2.03	%		—		—	—	%		87,201		539	2.46	%
Long-term debt		58,798		2,714	6.17	%		58,812		2,688	6.11	%		58,739		841	5.70	%		58,776		899	6.07	%
Total interest-bearing liabilities		1,437,075		14,321	1.33	%		1,370,778		8,500	0.83	%		1,815,010		2,524	0.55	%		1,407,086		4,944	1.39	%
Noninterest-Bearing Liabilities and Stockholders' Equity
Noninterest-bearing deposits		496,822						531,008						698,594						502,108
Other noninterest-bearing liabilities		39,060						29,189						79,619						40,737
Stockholders’ equity		212,911						184,733						314,921						226,931
Total liabilities and stockholders’ equity	$	2,185,868					$	2,115,708					$	2,908,144					$	2,176,862
Net interest income															$	21,881					$	18,762
Net interest rate spread					3.34	%					3.60	%					2.99	%					3.27	%
Net interest rate margin (2)					3.72	%					3.85	%
Net interest margin on FTE basis (2)																	3.17	%					3.69	%

(1)

~~(1)~~

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

(2)

~~(2)~~

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

4648

Table of Contents


	Nine months ended September 30,
	2020						2019
			Interest		Average				Interest		Average
	Average		Income/		Yield/		Average		Income/		Yield/
(dollars in thousands)	Balance		Expense		Rate		Balance		Expense		Rate
Interest Earning Assets
Interest-bearing deposits with banks	$	162,134	$	615	0.51	%	$	12,910	$	231	2.39	%
Investment securities (1)		383,591		6,398	2.23	%		255,903		4,803	2.51	%
Loans held for sale		64,555		1,274	2.64	%		30,734		745	3.24	%
Loans
Commercial:
Commercial and industrial		667,742		22,397	4.48	%		509,806		20,966	5.50	%
Real estate construction		30,385		1,055	4.64	%		23,532		975	5.54	%
Commercial real estate		515,761		16,646	4.31	%		444,964		16,768	5.04	%
Total commercial		1,213,888		40,098	4.41	%		978,302		38,709	5.29	%
Consumer
Residential real estate first mortgage		460,505		13,968	4.05	%		455,898		14,496	4.25	%
Residential real estate junior lien		163,332		5,921	4.84	%		186,744		8,028	5.75	%
Other revolving and installment		80,169		2,751	4.58	%		94,685		3,286	4.64	%
Total consumer		704,006		22,640	4.30	%		737,327		25,810	4.68	%
Total loans (1)		1,917,894		62,738	4.37	%		1,715,629		64,519	5.03	%
Federal Reserve/FHLB Stock		5,864		201	4.58	%		9,638		372	5.16	%
Total interest earning assets		2,534,038		71,226	3.75	%		2,024,814		70,670	4.67	%
Noninterest earning assets		156,144						161,054
Total assets	$	2,690,182					$	2,185,868
Interest-Bearing Liabilities
Interest-bearing demand deposits	$	528,024	$	1,328	0.34	%	$	423,181	$	1,415	0.45	%
Money market and savings deposits		889,039		4,363	0.66	%		675,921		6,217	1.23	%
Time deposits		201,747		1,942	1.29	%		183,686		2,170	1.58	%
Short-term borrowings		107		—	—	%		95,489		1,805	2.53	%
Long-term debt		58,747		2,575	5.85	%		58,798		2,714	6.17	%
Total interest-bearing liabilities		1,677,664		10,208	0.81	%		1,437,075		14,321	1.33	%
Noninterest-Bearing Liabilities and Stockholders' Equity
Noninterest-bearing deposits		651,971						496,822
Other noninterest-bearing liabilities		56,722						39,060
Stockholders’ equity		303,825						212,911
Total liabilities and stockholders’ equity	$	2,690,182					$	2,185,868
Net interest income			$	61,018					$	56,349
Net interest rate spread					2.94	%					3.34	%
Net interest margin on FTE basis (2)					3.22	%					3.72	%

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

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

Interest Rates and Operating Interest Differential

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

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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 September 30, 2019						Nine months ended September 30, 2019
	Compared with						Compared with
	Three Months Ended September 30, 2018						Nine months ended September 30, 2018
	Change due to:				Interest		Change due to:				Interest

													Three Months Ended September 30, 2020						Nine months ended September 30, 2020
													Compared with						Compared with
													Three Months Ended September 30, 2019						Nine months ended September 30, 2019
													Change due to:				Interest		Change due to:				Interest
(tax-equivalent basis, dollars in thousands)	Volume		Rate		Variance		Volume		Rate		Variance		Volume		Rate		Variance		Volume		Rate		Variance
Interest earning assets
Interest-bearing deposits with banks	$	34	$	6	$	40	$	77	$	33	$	110	$	997	$	(1,029)	$	(32)	$	2,670	$	(2,286)	$	384
Investment securities		55		15		70		(8)		163		155		1,137		(443)		694		2,399		(804)		1,595
Loans held for sale		190		(13)		177		239		47		286		351		(155)		196		820		(291)		529
Loans
Commercial:
Commercial and industrial		(399)		362		(37)		(195)		1,612		1,417		3,978		(2,265)		1,713		6,503		(5,072)		1,431
Real estate construction		15		11		26		(41)		16		(25)		106		(90)		16		284		(204)		80
Commercial real estate		45		688		733		133		970		1,103		1,140		(1,691)		(551)		2,671		(2,793)		(122)
Total commercial		(339)		1,061		722		(103)		2,598		2,495		5,224		(4,046)		1,178		9,458		(8,069)		1,389
Consumer		`
Residential real estate first mortgage		211		48		259		1,657		311		1,968		63		(264)		(201)		147		(675)		(528)
Residential real estate junior lien		(65)		113		48		(185)		548		363		(436)		(426)		(862)		(1,008)		(1,099)		(2,107)
Other revolving and installment		28		80		108		257		199		456		(168)		(52)		(220)		(504)		(31)		(535)
Total consumer		174		241		415		1,729		1,058		2,787		(541)		(742)		(1,283)		(1,365)		(1,805)		(3,170)
Total loans		(165)		1,302		1,137		1,626		3,656		5,282		4,683		(4,788)		(105)		8,093		(9,874)		(1,781)
Federal Reserve/FHLB Stock		(10)		(19)		(29)		13		5		18		(44)		(10)		(54)		(146)		(25)		(171)
Total interest income		104		1,291		1,395		1,947		3,904		5,851		7,124		(6,425)		699		13,836		(13,280)		556
Interest-bearing liabilities
Interest-bearing demand deposits		18		273		291		30		686		716		203		(330)		(127)		353		(440)		(87)
Money market and savings deposits		50		1,070		1,120		235		3,430		3,665		1,037		(2,418)		(1,381)		1,962		(3,816)		(1,854)
Time deposits		(50)		355		305		(100)		1,040		940		78		(393)		(315)		214		(442)		(228)
Short-term borrowings		(89)		53		(36)		121		353		474		(539)		—		(539)		(1,807)		2		(1,805)
Long-term debt		(1)		(3)		(4)		(1)		27		26		(1)		(57)		(58)		(2)		(137)		(139)
Total interest expense		(72)		1,748		1,676		285		5,536		5,821		778		(3,198)		(2,420)		720		(4,833)		(4,113)
Change in net interest income	$	176	$	(457)	$	(281)	$	1,662	$	(1,632)	$	30	$	6,346	$	(3,227)	$	3,119	$	13,116	$	(8,447)	$	4,669

Provision for Loan Losses

The provision for loan losses ~~reflects~~is based upon our allowance methodology and is a charge to income that, in our judgment, ofis required to maintain an adequate allowance for incurred loan losses at each period-end. In assessing the ~~expense necessary to achieve the appropriate amount~~adequacy of the allowance, ~~for loan losses. We maintain~~management considers the allowance for loan losses at levels we believe adequate to cover our estimate of probable credit losses as of the end of the reporting period. The allowance for loan losses is determined through detailed quarterly analysissize and quality of the loan ~~portfolio. The~~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, ~~for loan losses is based on our loss experience~~ and ~~changes~~any growth in the ~~economic environment, as well as an ongoing assessment of credit quality. Additional factors that are considered in determining~~loan portfolio and the ~~amount~~uncertainty of the ~~allowance for loan losses are the level of net charge-offs, nonperforming assets, risk-rating migration, as well as changes~~general economy may require additional provisions in ~~our portfolio size and composition.~~future periods.

We recorded a provision for loan losses of ~~$1.5~~$3.5 million for ~~both~~ the three months ended September 30, ~~2019 and 2018. For~~2020, a $2.0 million increase compared to the ~~nine~~$1.5 recorded for the three months ended September 30, ~~2019 we~~2019. The increase in provision expense was primarily due to allocations of reserves for the economic uncertainties related to COVID-19. We expect the provision for loan losses could increase in future periods based on our belief that the credit quality of our loan portfolio may decline, and loan defaults may increase, as a result of COVID-19.

We recorded a provision for loan losses of ~~$5.5 million compared to $7.1~~$9.5 million for the nine months ended September 30, ~~2018.~~2020, a $4.0 million increase compared to the $5.5 million for the nine months ended September 30, 2019. The ~~decrease~~increase in provision ~~for loan losses~~expense was primarily due to ~~a decrease in criticized assets as well as a decrease in~~allocations of reserves for the ~~total loans outstanding.~~

economic uncertainties related to COVID-19.

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Noninterest Income

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

The following table presents our noninterest income for the three and nine months ended September 30, ~~2019~~2020 and ~~2018.~~2019.


	Three months ended						Nine months ended
	September 30,						September 30,

													Three months ended						Nine months ended
													September 30,						September 30,
(dollars in thousands)	2019			2018			2019			2018			2020			2019			2020			2019
Retirement and benefit services	$	15,307		$	15,536		$	46,142		$	46,873		$	15,104		$	15,307		$	45,034		$	46,142
Wealth management		3,896			3,685			11,385			10,948			4,486			3,896			12,644			11,385
Mortgage banking		8,135			5,318			19,739			13,551			22,269			8,135			44,860			19,739
Service charges on deposit accounts		447			442			1,321			1,333			355			447			1,075			1,321
Net gains (losses) on investment securities		48			13			357			119			1,428			48			2,722			357
Other		1,747			1,264			5,694			3,784			1,614			1,747			4,340			5,694
Total noninterest income	$	29,580		$	26,258		$	84,638		$	76,608		$	45,256		$	29,580		$	110,675		$	84,638
Noninterest income as a % of revenue		61.29	%		58.11	%		60.14	%		57.78	%		67.53	%		61.29	%		64.58	%		60.14	%

Total noninterest income for the three months ended September 30, ~~2019~~2020 was ~~$29.6~~$45.3 million, an increase of ~~$3.3~~$15.7 million, or 53.0%, compared to ~~$26.3~~$29.6 million for the three months ended September 30, ~~2018.~~2019. The increase in noninterest income was primarily due to an increase of $14.1 million in mortgage ~~division~~banking revenue, ~~driven~~a $1.4 million increase in net gains and losses on investment securities, and a $590 thousand increase in wealth management revenue, partially offset by a ~~$91.2~~$203 thousand decrease in retirement and benefit services revenue. Mortgage banking revenue increased primarily due to a $198.1 million increase in mortgage originations along with ~~the transition to mandatory delivery of mortgage loans to the secondary market. Other noninterest income increased $483 thousand, as we realized~~ a ~~$542 thousand~~75 basis point increase in the gain on sale margin. Wealth management revenue increased as a result of an increase in the ~~sale~~average balance of ~~a parcel of land in Grand Forks, North Dakota. This increase was partially offset by a~~assets under administration/management. The decrease in retirement and ~~benefits~~benefit services revenue ~~of $229 thousand~~was primarily due to a $347 thousand decrease in asset based ~~fees, partially offset by an increase in transaction~~ fees.

Total noninterest income for the nine months ended September 30, ~~2019~~2020 was ~~$84.6~~$110.7 million, an increase of ~~$8.0~~$26.0 million or 30.8%, compared to ~~$76.6~~$84.6 million for the nine months ended September 30, ~~2018.~~2019. The increase in noninterest income was primarily ~~due to an increase in mortgage division revenue of $6.2 million,~~ driven by ~~the transition to mandatory delivery of mortgage loans to the secondary market in addition to~~ an increase of ~~$75.2~~$25.1 million in mortgage ~~originations.~~banking revenue and a $2.4 million increase in net gains and losses on investment securities, partially offset by a $1.4 million decrease in other noninterest income. Mortgage banking revenue increased as mortgage originations increased from $685.2 million for the nine months ended September 30, 2019 to $1.17 billion for the nine months ended September 30, 2020, along with a 35 basis point increase in the gain on sale margin. Other noninterest income ~~increased $1.9~~decreased $1.4 million ~~as we realized~~for the nine months ended September 30 of 2020 due to a $1.5 million gain on the sale of a branch that occurred in 2019.

We anticipate that our ~~Duluth, Minnesota branch as well~~noninterest income will be significantly adversely affected in future periods as a ~~$542 thousand gain on~~result of the ~~sale of a parcel of land~~COVID-19 pandemic and the related decline in ~~Grand Forks, North Dakota. These increases were partially offset by a decrease~~global economic conditions and significant volatility in the global stock markets. We expect retirement and ~~benefits revenue of $731 thousand due to a decrease in~~benefit services asset based revenue will be adversely affected by reduced assets under administration and assets under management, waived transaction and participant related fees, ~~partially offset by an increase~~and a decline in ESOP transaction fees. We expect wealth management asset based revenue will be adversely affected by reduced assets under administration and assets under management and we also expect increased unemployment and recessionary concerns will adversely affect mortgage originations and mortgage banking revenue in future periods.

Noninterest income as a ~~percent~~percentage of total operating revenue, which consists of net interest income plus noninterest income, was 67.5% for the three months ended September 30, 2020, compared to 61.3% for the three months ~~ending~~ended September 30, ~~2019, compared to 58.1% for the three months ending September 30, 2018.~~2019. The increase was due to noninterest income increasing by ~~12.7%~~53.0% while net interest income ~~decreased 1.3%~~increased by only 16.5%.

Noninterest income as a ~~percent~~percentage of total operating revenue was 64.6% for the nine months ended September 30, 2020, compared to 60.1% for the nine months ~~ending~~ended September 30, ~~2019, compared to 57.8% for the nine months ending September 30, 2018.~~2019. The increase was due to noninterest income increasing by ~~10.5%~~30.8% while net interest income ~~only~~ increased by ~~0.2%~~only 8.2%.

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See “NOTE 1514 Segment Reporting” for additional discussion regarding our business lines.

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Noninterest Expense

The following table presents noninterest expense for the three and nine months ended September 30, ~~2019~~2020 and ~~2018.~~

2019.


	Three months ended				Nine months ended
	September 30,				September 30,

									Three months ended				Nine months ended
									September 30,				September 30,
(dollars in thousands)	2019		2018		2019		2018		2020		2019		2020		2019
Compensation	$	20,041	$	17,873	$	54,997	$	50,906	$	22,740	$	20,041	$	62,684	$	54,997
Employee benefits		4,600		4,314		15,188		13,606
Employee taxes and benefits										5,033		4,600		15,088		15,188
Occupancy and equipment expense		2,700		2,698		8,086		8,215		2,768		2,700		8,392		8,086
Business services, software and technology expense		4,224		3,731		12,044		10,467		4,420		4,224		13,384		12,044
Intangible amortization expense		990		1,196		3,091		3,588		990		990		2,971		3,091
Professional fees and assessments		1,051		1,628		3,146		3,734		1,031		1,051		3,231		3,146
Marketing and business development		890		856		2,024		2,439		929		890		2,088		2,024
Supplies and postage		631		611		2,027		1,902		247		631		1,625		2,027
Travel		435		382		1,335		1,252		26		435		338		1,335
Mortgage and lending expenses		751		437		1,966		1,597		1,231		751		3,466		1,966
Other		1,014		610		2,198		2,708		799		1,014		3,407		2,198
Total noninterest expense	$	37,327	$	34,336	$	106,102	$	100,414	$	40,214	$	37,327	$	116,674	$	106,102

Total noninterest expense for the three months ended September 30, ~~2019~~2020 was ~~$37.3~~$40.2 million, an increase of ~~$3.0~~$2.9 million, or 7.7%, compared to ~~$34.3~~$37.3 million for the three months ended September 30, ~~2018.~~2019. The increase in noninterest expense was ~~primarily due to an increase~~driven by increases of $2.7 million in compensation expense, $480 thousand in mortgage and lending expenses, $433 thousand in employee taxes and benefits, and $196 thousand in business services, software and technology expense, partially offset by a $409 thousand decrease in travel and a $384 thousand decrease in supplies and postage. Increases in compensation, employee taxes and benefits and mortgage and lending expenses were a direct result of ~~$2.5 million, an~~increases in mortgage originations. The increase in business services, software and technology ~~expense~~expenses was a result of ~~$493 thousand,~~ an increase ~~of $314 thousand~~ in ~~mortgage~~information technology service expenses related to our “One Alerus” initiative and ~~lending expenses, and an increase of $404 thousand~~additional equipment purchases. The decrease in ~~other expenses. The increase in compensation and employee benefits between periods~~travel was ~~primarily the~~a direct result of ~~additional investments~~COVID-19 and the decrease in ~~talent, with an increase of eight, on average, full‑time equivalent employees along with annual merit pay increases. The increase in technology related expenses~~supplies and postage was due to ~~the continued investments related~~a transition to E-statements for our ~~new client relationship manager software~~retirement and digital delivery of solutions to clients. These increases were partially offset by decreases of $577 thousand in professional fees and assessments and $206 thousand in intangible amortization expense.benefit services segment.

Total noninterest expense for the nine months ended September 30, ~~2019~~2020 was ~~$106.1~~$116.7 million, an increase of ~~$5.7~~$10.6 million, or 10.0%, compared to ~~$100.4~~$106.1 million for the nine months ended September 30, ~~2018.~~2019. The increase in noninterest expense was ~~primarily~~ due to ~~an increase~~increases of $7.7 million in compensation expense, $1.5 million in mortgage and lending expense, $1.3 in business services, software and technology expense, and $1.2 million in other noninterest expense, partially offset by decreases of $1.0 million in travel and $402 thousand in supplies and postage. The increases in compensation and ~~employee benefits~~mortgage and lending expenses were a result of ~~$5.7 million, an~~increased mortgage originations. The increase in business services, software and technology expense ~~of $1.6 million,~~was due to our continued investment in software and ~~an increase of $369 thousand in mortgage and lending expenses.~~technology related to our “One Alerus” initiative. The increase in ~~compensation and employee benefits between periods~~other noninterest expense was primarily due to a $1.2 million increase in the provision for unfunded commitments. The decrease in travel was a direct result of ~~an increase of fourteen, on average, full‑time equivalent employees, along with an increased cost of health insurance benefits. The increase~~COVID-19 and the decrease in ~~technology related expenses~~supplies and postage was due to ~~the continued investments related~~a transition to E-statements for our ~~new client relationship manager software~~retirement and digital delivery of solutions to clients. These increases were partially offset by decreases of $588 thousand in professional fees and assessments, $510 thousand in other expenses, $497 thousand in intangible amortization expense, and $415 thousand in marketing and business development.benefit services segment.

Income Tax Expense

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

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For the three months ended September 30, ~~2019,~~2020, we recognized income tax expense of $5.6 million on $23.3 million of pre-tax income, resulting in an effective tax rate of 24.2%, compared to income tax expense of $2.3 million on $9.4 million of ~~pre‑~~pre-tax income for the three months ended September 30, 2019, resulting in an effective tax rate of 24.7%.

For the nine months ended September 30, 2020, we recognized income tax expense of $10.7 million on $45.2 million of pre-tax income, resulting in an effective tax rate of ~~24.7%~~23.7%, compared to income tax expense of $2.0 million on $9.3 million of pre‑tax income, resulting in an effective tax rate of 20.9%, for the three months ended September 30, 2018. The increase in the effective tax rate was primarily due to a reduction in tax exempt income and net operating loss deductions for the three months ended September 30, 2019 as compared to the same period in 2018.

~~For the nine months ended September 30, 2019, we recognized~~ income tax expense of $7.2 million on $29.1 million of ~~pre‑tax~~pre-tax income for the nine months ended September, 2019, resulting in an effective tax rate of 24.8%~~, compared to income tax expense of $5.3 million on $25.1 million of pre‑tax income, resulting in an effective tax rate of 20.9%, for the nine months ended September 30, 2018.~~. The ~~increase~~decrease in the effective tax rate was primarily due to ~~a reduction in excess~~additional tax benefits from ~~stock‑based~~share-based compensation ~~and a reduction in tax exempt income~~ for the nine months ended September 30, ~~2019,~~2020, as compared to the same period in ~~2018.~~2019.

Financial Condition

Overview

Total assets were ~~$2.2~~$2.9 billion as of September 30, ~~2019,~~2020, an increase of ~~$49.2~~$541.9 million, or ~~2.3%~~23.0%, as compared to December 31, ~~2018.~~2019. The increase in total assets was primarily due to increases of ~~$51.5~~$337.1 million in loans, $185.1 million in available-for-sale investments, $64.5 million in loans held for sale, ~~$28.5~~and $15.3 million in ~~available-for-sale investment securities, $20.5 million in cash and cash equivalents, and the recognition of $8.9 million in operating lease right-of-use~~other assets. ~~These increases were offset by a reduction of $32.0 million in loans held for branch sale, and $15.8 million in loans.~~

Loans

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

As of September 30, 2020, the portfolio mix was 38.3% commercial and industrial, 26.0% commercial real estate, 30.2% residential real estate and 5.5% in other categories. Commercial and industrial loans ~~include financing for commercial purposes in various lines~~included $348.9 million of ~~businesses, including manufacturing, service industry and professional service areas. Commercial and industrial~~PPP loans ~~are generally secured with the assets~~as of ~~the company and/or the personal guarantee of the business owners.~~

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

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

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

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September 30, 2020.

The following table presents the composition of total loans outstanding by portfolio segment as of September 30, ~~2019~~2020 and December 31, ~~2018:~~2019:



	September 30, 2019				December 31, 2018
			Percent of				Percent of		Change

													September 30, 2020				December 31, 2019
															Percent of				Percent of		Change
(dollars in thousands)	Balance		Portfolio		Balance		Portfolio			Amount	Percent		Balance		Portfolio		Balance		Portfolio			Amount	Percent
Commercial
Commercial and industrial	$	485,183	28.7	%	$	510,706	30.0	%	$	(25,523)	(5.0)	%
Commercial and industrial (1)													$	789,036	38.3	%	$	479,144	27.8	%	$	309,892	64.7	%
Real estate construction		21,674	1.3	%		18,965	1.1	%		2,709	14.3	%		33,169	1.6	%		26,378	1.5	%		6,791	25.7	%
Commercial real estate		444,600	26.4	%		439,963	25.9	%		4,637	1.1	%		535,216	26.0	%		494,703	28.8	%		40,513	8.2	%
Total commercial		951,457	56.4	%		969,634	57.0	%		(18,177)	(1.9)	%		1,357,421	65.9	%		1,000,225	58.1	%		357,196	35.7	%
Consumer
Residential real estate first mortgage		459,763	27.3	%		448,143	26.3	%		11,620	2.6	%		469,050	22.8	%		457,155	26.6	%		11,895	2.6	%
Residential real estate junior lien		182,516	10.8	%		188,855	11.1	%		(6,339)	(3.4)	%		152,487	7.4	%		177,373	10.3	%		(24,886)	(14.0)	%
Other revolving and installment		92,351	5.5	%		95,218	5.6	%		(2,867)	(3.0)	%		79,461	3.9	%		86,526	5.0	%		(7,065)	(8.2)	%
Total consumer		734,630	43.6	%		732,216	43.0	%		2,414	0.3	%		700,998	34.1	%		721,054	41.9	%		(20,056)	(2.8)	%
Total loans	$	1,686,087	100.0	%	$	1,701,850	100.0	%	$	(15,763)	(0.9)	%	$	2,058,419	100.0	%	$	1,721,279	100.0	%	$	337,140	19.6	%

(1)	Included PPP loans of $348.9 million at September 30, 2020.

Total loans outstanding ~~of $1.69~~were $2.06 billion as of September 30, ~~2019, decreased $15.8~~2020, an increase of $337.1 million, or ~~0.9%~~19.6%, from December 31, ~~2018.~~2019. The ~~decrease in total loans~~increase was primarily due to increases of $309.9 million in commercial and industrial loans and $40.5 million in our commercial real estate loan portfolio, partially offset by a $20.1 million decrease in our consumer loan portfolio. The increase in commercial and industrial loans was due to an increase of $348.9 million in net PPP loans, offset by a decrease of $64.6 million, or 7.64% in operating line utilization.

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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 are adversely affected by COVID-19. These deferrals were generally no more than 90 days in duration. As of September 30, 2020, the Company had executed 552 of these deferrals representing $151.4 million. Of those loans, 27 loans with a total outstanding principal balance of $16.9 million have been granted second deferrals, 56 loans with a total outstanding principal balance of $12.0 million 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, ~~loans of $25.5 million, and~~commercial real estate, residential real estate, ~~junior liens~~and consumer loan portfolios as a result of ~~$6.3 million. These decreases were offset by increases of $11.6 million~~COVID-19 and the related decline in ~~residential real estate first mortgages and $4.6 million~~economic conditions in ~~commercial real estate loans.~~our market areas.

The following table presents the maturities and ~~type~~types of interest rates for the loan portfolio as of September 30, ~~2019.~~ 2020.


	September 30, 2019
			After one
	One year		but within		After

									September 30, 2020
											After one
									One year		but within		After
(dollars in thousands)	or less		five years		five years		Total		or less		five years		five years		Total
Commercial
Commercial and industrial	$	189,754	$	219,468	$	75,961	$	485,183	$	133,279	$	594,853	$	60,904	$	789,036
Real estate construction		6,381		10,201		5,092		21,674		3,229		12,393		17,547		33,169
Commercial real estate		44,431		222,814		177,355		444,600		41,059		223,196		270,961		535,216
Total commercial		240,566		452,483		258,408		951,457		177,567		830,442		349,412		1,357,421
Consumer
Residential real estate first mortgage		20,339		18,739		420,685		459,763		17,962		18,645		432,443		469,050
Residential real estate junior lien		21,234		86,632		74,650		182,516		17,021		54,292		81,174		152,487
Other revolving and installment		16,162		59,335		16,854		92,351		10,707		55,260		13,494		79,461
Total consumer		57,735		164,706		512,189		734,630		45,690		128,197		527,111		700,998
Total loans	$	298,301	$	617,189	$	770,597	$	1,686,087	$	223,257	$	958,639	$	876,523	$	2,058,419
Sensitivity of loans to changes in interest rates
Fixed interest rates			$	475,519	$	515,514					$	822,116	$	395,404
Floating interest rates				141,670		255,083						136,523		481,119
Total			$	617,189	$	770,597					$	958,639	$	876,523

As of September 30, ~~2019, 63.8%~~2020, 62.1% of the loan portfolio bore interest at fixed rates and ~~36.2%~~37.9% 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.

~~Table of Contents~~

Asset Quality

Our strategy for credit risk management includes ~~well‑defined,~~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~~charge-offs promptly, and maintain adequate reserve levels for probable loan losses inherent in the portfolio. Management performs ongoing, internal reviews of any problem credits and continually assesses the adequacy of the allowance. We utilize an internal lending division, Special Credit Services, to develop and implement strategies for the management of individual nonperforming loans.

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Credit Quality Indicators

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

The table below presents criticized loans outstanding by loan portfolio segment as of September 30, ~~2019~~2020 and December 31, ~~2018:~~2019:


	September 30,			December 31,

							September 30,			December 31,
(dollars in thousands)	2019			2018			2020			2019
Commercial
Commercial and industrial	$	31,476		$	51,141		$	29,228		$	30,838
Real estate construction		1,278			1,055			1,029			1,259
Commercial real estate		24,540			32,785			33,303			32,409
Total commercial		57,294			84,981			63,560			64,506
Consumer
Residential real estate first mortgage		677			19			1,882			797
Residential real estate junior lien		2,172			2,485			3,197			1,251
Other revolving and installment		6			—			—			6
Total consumer		2,855			2,504			5,079			2,054
Total loans	$	60,149		$	87,485		$	68,639		$	66,560
Criticized loans as a percent of total loans		3.57	%		5.14	%		3.33	%		3.87	%

~~Table of Contents~~

The following table presents information regarding nonperforming assets as of September ~~31, 2019~~30, 2020 and December 31, ~~2018:~~2019:


	September 30,			December 31,
(dollars in thousands)	2020			2019
Nonaccrual loans	$	4,795		$	7,379
Accruing loans 90+ days past due		—			448
Total nonperforming loans		4,795			7,827
OREO and repossessed assets		10			8
Total nonperforming assets		4,805			7,835
Total restructured accruing loans		858			957
Total nonperforming assets and restructured accruing loans	$	5,663		$	8,792
Nonperforming loans to total loans		0.23	%		0.45	%
Nonperforming assets to total assets		0.17	%		0.33	%
Allowance for loan losses to nonperforming loans		654	%		306	%

The ratio of nonperforming loans to total loans at September 30, 2020 was 0.23%. Nonperforming assets as a percentage of total assets was 0.17% at September 30, 2020.

Interest income lost on nonaccrual loans approximated $159 thousand and $130 thousand for the three months ended September 30, 2020 and 2019, respectively. There was no interest income included in net interest income related to nonaccrual loans for the three months ended September 30, 2020 and 2019.

Interest income lost on nonaccrual loans approximated $473 thousand and $277 thousand for the nine months ended September 30, 2020 and 2019, respectively. There was no interest income included in net interest income related to nonaccrual loans for the nine months ended September 30, 2020 and 2019.

September 30,

December 31,

(dollars in thousands)

2019

2018

Nonaccrual loans

$
5,107

$
6,963

Accruing loans 90+ days past due

45

—

Total nonperforming loans

5,152

6,963

OREO and repossessed assets

84

204

Total nonperforming assets

$
5,236

$
7,167

Nonperforming loans to total loans

0.31
%

0.41
%
Nonperforming assets to total assets

0.23
%

0.33
%
Allowance for loan losses to nonperforming loans

446
%

318
%

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

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The following table presents, by loan type, the changes in the allowance ~~is increased by provisions charged to expense and decreased by actual charge‑offs, net of recoveries.~~for loan losses for the periods presented.


	Three months ended						Nine months ended
	September 30,						September 30,
(dollars in thousands)	2020			2019			2020			2019
Balance—beginning of period	$	27,256		$	21,246		$	23,924		$	22,174
Commercial loan charge-offs
Commercial and Industrial		(10)			(324)			(2,745)			(5,275)
Real estate construction		—			—			—			(1)
Commercial real estate		—			—			(865)			—
Total commercial loan charge-offs		(10)			(324)			(3,610)			(5,276)
Consumer loan charge-offs
Residential real estate first mortgage		—			—			—			—
Residential real estate junior lien		—			(20)			(12)			(154)
Other revolving and installment		(41)			(31)			(194)			(513)
Total consumer loan charge-offs		(41)			(51)			(206)			(667)
Total loan charge-offs		(51)			(375)			(3,816)			(5,943)
Commercial loan recoveries
Commercial and Industrial		432			538			1,346			831
Real estate construction		—			—			—			2
Commercial real estate		95			—			95			150
Total commercial recoveries		527			538			1,441			983
Consumer loan recoveries
Residential real estate first mortgage		—			—			5			—
Residential real estate junior lien		81			49			175			132
Other revolving and installment		24			28			108			123
Total consumer loan recoveries		105			77			288			255
Total loan recoveries		632			615			1,729			1,238
Net loan charge-offs (recoveries)		(581)			(240)			2,087			4,705
Commercial loan provision
Commercial and Industrial		(846)			(962)			(498)			3,263
Real estate construction		40			25			180			97
Commercial real estate		1,828			(4)			5,953			(668)
Total commercial loan provision		1,022			(941)			5,635			2,692
Consumer loan provision
Residential real estate first mortgage		1,694			(139)			2,914			(140)
Residential real estate junior lien		28			157			377			113
Other revolving and installment		108			1			371			388
Total consumer loan provision		1,830			19			3,662			361
Unallocated provision expense		648			2,420			203			2,462
Total loan loss provision		3,500			1,498			9,500			5,515
Balance—end of period	$	31,337		$	22,984		$	31,337		$	22,984
Total loans	$	2,058,419		$	1,686,087		$	2,058,419		$	1,686,087
Average total loans		2,034,778			1,691,542			1,917,894			1,715,629
Allowance for loan losses to total loans		1.52	%		1.36	%		1.52	%		1.36	%
Net charge-offs/(recoveries) to average total loans (annualized)		(0.11)	%		(0.06)	%		0.15	%		0.37	%

The allowance for loan losses ~~represents management’s assessment~~was $31.3 million as of ~~probable credit losses inherent~~September 30, 2020, compared to $23.9 million as of December 31, 2019. The $7.4 million increase in the ~~loan portfolio. The~~ allowance for loan losses ~~consists~~was due to additional provision for loan losses of ~~specific components, based on individual evaluation~~$9.5 million, partially offset by net charge-offs of ~~certain loans, and general components for homogeneous pools~~$2.1 million. The increase in provision expense was primarily due to allocations of ~~loans with similar risk characteristics.~~

Impaired loans include loans placed on nonaccrual status and TDRs. Loans are considered impaired when, based on current information and events, it is probable that all amounts due, in accordance with the original contractual terms of the loan agreement, will not be collected. When determining if all amounts due in accordance with the original contractual terms of the loan agreement will be collected, the borrower’s overall financial condition, resources and payment record, support from guarantors, and the realizable value of any collateral, are taken into consideration. Loans that experience insignificant payment delays and payment shortfalls generally are not classified as impaired. Management determines the significance of payment delays and payment shortfalls on a case‑by‑case basis, taking into consideration all of the circumstances surrounding the loan and the borrower, including the length of the delay, the reasonsreserves for the ~~delay, the borrower’s prior payment record, and the amount~~economic uncertainties related to COVID-19. As of ~~the shortfall in relation to the principal and interest owed.~~

~~All impaired loans are individually evaluated for impairment. If a loan is impaired, a portion of~~September 30, 2020, the allowance ~~is allocated so that~~for loan losses represented 1.52% of total loans. Excluding PPP loans, the ~~loan is reported, net, at the discounted expected future cash flows or at the fair value~~ratio of ~~collateral if repayment is collateral dependent.~~

~~The~~ allowance for ~~non‑impaired~~loan losses to total loans ~~is based on historical losses adjusted for current qualitative factors. The historical loss experience is determined by portfolio segment and is based on~~increased 44 basis points to 1.83% at September 30, 2020, compared to 1.39% as of December 31, 2019. For the ~~actual loss history over~~nine months ended September 30, 2020, the ~~most recent five years. This actual loss experience is adjusted for economic factors based on the risks present for each portfolio segment. These economic factors include consideration~~ratio of the following: levels of and trends in delinquencies and impaired loans; levels of and trends in charge‑offs and recoveries; trends in volume and terms of loans; effects of any changes in risk selection and underwriting standards; other changes in lending policies, procedures, and practices; experience, ability, and depth of lending management and other relevant staff; national and local economic trends and conditions; industry conditions; and effects of changes in credit concentrations. These factors are inherently subjective and are driven by the repayment risk associated with each portfolio segment. These portfolio segments include commercial and industrial, real estate construction, commercial real estate, residential real estate first mortgage, residential real estate junior liens, and other revolving and installment.

net charge-offs to average total loans was 0.15%.

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


	September 30, 2020				December 31, 2019
			Percentage				Percentage
	Allocated		of loans to		Allocated		of loans to
(dollars in thousands)	Allowance		total loans		Allowance		total loans
Commercial and industrial	$	10,373	38.3	%	$	12,270	27.8	%
Real estate construction		483	1.6	%		303	1.5	%
Commercial real estate		11,871	26.0	%		6,688	28.8	%
Residential real estate first mortgage		4,367	22.8	%		1,448	26.6	%
Residential real estate junior lien		1,211	7.4	%		671	10.3	%
Other revolving and installment		637	3.9	%		352	5.0	%
Unallocated		2,395	—	%		2,192	—	%
Total loans	$	31,337	100.0	%	$	23,924	100.0	%

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

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

Three months ended

Nine months ended

September 30,

September 30,

(dollars in thousands)

2019

2018

2019

2018

Balance—beginning of period

$
21,246

$
19,869

$
22,174

$
16,564

Commercial loan charge-offs









Commercial and Industrial

(324)

(424)

(5,275)

(3,078)

Real estate construction

—

—

(1)

(60)

Commercial real estate

—

—

—

—

Total commercial loan charge-offs

(324)

(424)

(5,276)

(3,138)

Consumer loan charge-offs









Residential real estate first mortgage

—

—

—

(29)

Residential real estate junior lien

(20)

(47)

(154)

(133)

Other revolving and installment

(31)

(99)

(513)

(236)

Total consumer loan charge-offs

(51)

(146)

(667)

(398)

Total loan charge-offs

(375)

(570)

(5,943)

(3,536)

Commercial loan recoveries









Commercial and Industrial

538

126

831

509

Real estate construction

—

—

2

2

Commercial real estate

—

20

150

59

Total commercial recoveries

538

146

983

570

Consumer loan recoveries









Residential real estate first mortgage

—

—

—

—

Residential real estate junior lien

49

11

132

190

Other revolving and installment

28

26

123

144

Total consumer loan recoveries

77

37

255

334

Total loan recoveries

615

183

1,238

904

Net loan charge-offs (recoveries)

(240)

387

4,705

2,632

Commercial loan provision









Commercial and Industrial

(962)

1,452

3,263

6,158

Real estate construction

25

(109)

97

1

Commercial real estate

(4)

(72)

(668)

1,458

Total commercial loan provision

(941)

1,271

2,692

7,617

Consumer loan provision









Residential real estate first mortgage

(139)

(142)

(140)

(38)

Residential real estate junior lien

157

20

113

(145)

Other revolving and installment

1

31

388

34

Total consumer loan provision

19

(91)

361

(149)

Unallocated provision expense

2,420

350

2,462

(388)

Total loan loss provision

1,498

1,530

5,515

7,080

Balance—end of period

$
22,984

$
21,012

$
22,984

$
21,012

Total loans

$
1,686,087

$
1,724,656

$
1,686,087

$
1,724,656

Average total loans

1,691,542

1,699,048

1,715,629

1,661,493

Allowance for loan losses as a percentage of total loans

1.36
%

1.22
%

1.36
%

1.22
%
Net charge-offs/(recoveries) to average total loans

(0.01)
%

0.02
%

0.27
%

0.16
%

~~The allowance for loan losses was $23.0~~$1.9 million as of September 30, ~~2019,~~2020, an increase of $800 thousand, as compared to ~~$22.2 million as of~~ December 31, 2018. The $810 thousand increase in the allowance for loan losses was due to additional provision for loan losses of $5.5 million, partially offset by net loan charge‑offs of $4.7 million. The level of nonperforming loans to total loans as of September 30, 2019 was 0.31%, compared to 0.41% as of December 31, 2018. The allowance for loan losses to total loans was 1.36% as of September 30, 2019, compared to 1.30% as of December 31, 2018.

~~Table of Contents~~

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

September 30, 2019

December 31, 2018

Percentage

Percentage

Allocated

of loans to

Allocated

of loans to

(dollars in thousands)

Allowance

total loans


Allowance

total loans

Commercial and industrial

$
10,946

28.7
%

$
12,127

30.0
%
Real estate construction

348

1.3
%

250

1.1
%
Commercial real estate

5,761

26.4
%

6,279

25.9
%
Residential real estate first mortgage

1,016

27.3
%

1,156

26.3
%
Residential real estate junior lien

896

10.8
%

805

11.1
%
Other revolving and installment

378

5.5
%

380

5.6
%
Unallocated

3,639

—
%

1,177

—
%
Total loans

$
22,984

100.0
%

$
22,174

100.0
%

2019.

Loans Held for Sale

Loans held for sale represent loans to consumers for the purchase or refinance of a residence that we have originated and intend to sell into the secondary market. Loans held for sale were ~~$66.0~~$111.3 million as of September 30, ~~2019,~~2020, an increase of ~~$51.5~~$64.5 million, as compared to December 31, ~~2018.~~2019. The increase in loans held for sale was primarily due to ~~seasonally higher~~increased mortgage originations through September and investor pipeline capacity. Mortgage loan originations ~~which were $313.5~~totaled $511.6 million for the three months ended September 30, ~~2019~~2020 compared to ~~$169.8~~$261.3 million for the three months ended December 31, ~~2018.~~

~~Loans Held for Branch Sale~~

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

Investment Securities

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

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The following table presents the fair value composition of our investment securities portfolio as of September 30, ~~2019~~2020 and December 31, ~~2018:~~2019:


	September 30, 2019				December 31, 2018
			Percent of				Percent of		Change

													September 30, 2020				December 31, 2019
															Percent of				Percent of		Change
(dollars in thousands)	Balance		Portfolio		Balance		Portfolio		Amount		Percent		Balance		Portfolio		Balance		Portfolio		Amount		Percent
Trading	$	—	-	%	$	1,539	0.6	%	$	(1,539)	(100.0)	%
Available-for-sale
U.S. Treasury and agencies		21,602	7.7	%		19,142	7.5	%		2,460	12.9	%	$	16,092	3.2	%	$	21,240	6.8	%	$	(5,148)	(24.2)	%
Obligations of state and political agencies		47,856	17.0	%		66,387	26.0	%		(18,531)	(27.9)	%		147,216	29.7	%		68,648	21.9	%		78,568	114.5	%
Mortgage backed securities
Residential Agency		169,337	60.1	%		126,998	50.0	%		42,339	33.3	%		211,700	42.8	%		182,538	58.3	%		29,162	16.0	%
Commercial		32,652	11.6	%		28,767	11.3	%		3,885	13.5	%		87,542	17.7	%		30,685	9.8	%		56,857	185.3	%
Asset backed securities		157	0.1	%		399	0.2	%		(242)	(60.7)	%		131	—	%		144	—	%		(13)	(9.0)	%
Corporate bonds		7,112	2.5	%		8,481	3.3	%		(1,369)	(16.1)	%		32,733	6.6	%		7,095	2.3	%		25,638	361.4	%
Total available-for-sale		278,716	99.0	%		250,174	98.3	%		28,542	11.4	%		495,414	100.0	%		310,350	99.1	%		185,064	59.6	%
Equity		2,675	1.0	%		3,165	1.1	%		(490)	(15.5)	%		—	-	%		2,808	0.9	%		(2,808)	(100.0)	%
Total investment securities	$	281,391	100.0	%	$	254,878	100.0	%	$	26,513	10.4	%	$	495,414	100.0	%	$	313,158	100.0	%	$	182,256	58.2	%

The securities ~~available‑for‑sale~~available-for-sale presented in the following table are reported at fair value and by contractual maturity as of September 30, ~~2019.~~2020. Actual timing may differ from contractual maturities if borrowers have the right to call or prepay obligations with or without call or prepayment penalties. Additionally, residential mortgage backed securities and collateralized mortgage obligations receive monthly principal payments, which are not reflected below. The yields below are calculated on a tax-equivalent basis.


	Maturity as of September 30, 2019
	One year or less				One to five years				Five to ten years				After ten years
	Fair		Average		Fair		Average		Fair		Average		Fair		Average

																	Maturity as of September 30, 2020
																	One year or less				One to five years				Five to ten years				After ten years
																	Fair		Average		Fair		Average		Fair		Average		Fair		Average
(dollars in thousands)	Value		Yield		Value		Yield		Value		Yield		Value		Yield		Value		Yield		Value		Yield		Value		Yield		Value		Yield
Available-for-sale
U.S. Treasury and agencies	$	—	—	%	$	9,969	1.52	%	$	5,841	3.36	%	$	5,792	3.00	%	$	10,034	1.52	%	$	—	—	%	$	1,576	0.92	%	$	4,482	0.71	%
Obligations of state and political agencies		977	1.00	%		15,030	1.53	%		14,666	2.12	%		17,183	2.68	%		2,127	1.56	%		23,873	1.46	%		72,932	1.85	%		48,284	2.34	%
Mortgage backed securities
Residential Agency		17	—	%		3,783	2.37	%		51,512	2.55	%		114,025	2.79	%		2	4.36	%		1,447	2.81	%		51,703	2.34	%		158,548	2.21	%
Commercial		—	—	%		2,127	3.06	%		8,386	2.39	%		22,139	2.65	%		—	—	%		2,139	3.30	%		5,225	2.24	%		80,178	1.50	%
Asset backed securities		—	4.90	%		—	—	%		—	—	%		157	5.64	%		—	—	%		—	—	%		—	—	%		131	5.44	%
Corporate bonds		2,032	—	%		5,080	2.58	%		—	—	%		—	—	%		4,048	2.57	%		—	2.63	%		18,685	4.85	%		10,000	3.88	%
Total available-for-sale	$	3,026	1.03	%	$	35,989	1.89	%	$	80,405	2.51	%	$	159,296	2.77	%	$	16,211	1.79	%	$	27,459	1.67	%	$	150,121	2.42	%	$	301,623	2.07	%

~~Cash and Cash Equivalents~~

~~Cash and cash equivalents increased $20.5 million to $61.2 million~~Deposits

Total deposits were $2.46 billion as of September 30, ~~2019 compared to December 31, 2018. This~~2020, an increase was primarily due to cash flows from financing activities and investing activities totaling $14.1 million and $4.4 million, respectively. The increase in cash flows provided by financing activities was primarily driven by $62.8 million in proceeds received from the issuance of common stock related to our initial public offering and a $53.2 million increase in deposits, partially offset by $93.5 million reduction in short-term borrowings. Cash flows provided by investing activities primarily consisted of a $60.4 million increase in proceeds from the sales and maturities of investment securities, $14.2 million in proceeds from a decrease in loans and $10.4 million in proceeds from the sale of our Duluth branch, partially offset by $80.5 million in purchases of investments securities available-for-sale.

~~Deposits~~

~~Total deposits as of September 30, 2019 were $1.8 billion and increased $58.0~~$491.1 million, or ~~3.3%~~24.9%, as compared to December 31, ~~2018.~~2019. Interest-bearing deposits increased $375.3 million while noninterest-bearing deposits increased $115.7 million. The increase in ~~total~~ deposits was primarily due to anhigher customer balances resulting from PPP loans, government stimulus, and the uncertain economic environment. The increase in interest-bearing deposits included a $128.8 million increase in synergistic deposits from our retirement and benefit services and wealth management segments. In addition, health savings account, or HSA, deposits were $131.5 million as of ~~$70.7~~September 30, 2020, an increase of $11.8 million,

~~Table~~ or 9.9%, from December 31, 2019. Noninterest-bearing deposits as a percent of ~~Contents~~

~~partially offset by a decrease in noninterest-bearing accounts~~total deposits was 28.2% and 29.3% as of ~~$12.7 million.~~September 30, 2020 and December 31, 2019, respectively. Total deposits represented ~~94.2%~~95.6% of total liabilities as of September 30, ~~2019. The increase~~2020.

We expect that deposit levels will generally decrease in ~~interest-bearing deposits was fairly evenly split amongst interest-bearing demand, money~~future periods as a result of the distressed economic conditions in our market areas as a result of the COVID-19 pandemic and ~~savings, and time deposits.~~as clients continue to utilize funds received from PPP loans.

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The following table presents the composition of our deposit portfolio as of September 30, ~~2019~~2020 and December 31, ~~2018:~~2019:


	September 30, 2019				December 31, 2018
			Percent of				Percent of		Change

													September 30, 2020				December 31, 2019
															Percent of				Percent of		Change
(dollars in thousands)	Balance		Portfolio		Balance		Portfolio			Amount	Percent		Balance		Portfolio		Balance		Portfolio		Amount		Percent
Noninterest-bearing demand	$	537,951	29.3	%	$	550,640	31.0	%	$	(12,689)	(2.3)	%	$	693,450	28.2	%	$	577,704	29.3	%	$	115,746	20.0	%
Interest-bearing demand		424,249	23.1	%		401,078	22.6	%		23,171	5.8	%		590,366	24.0	%		458,689	23.3	%		131,677	28.7	%
Money market and savings		678,160	37.1	%		652,791	36.8	%		25,369	3.9	%		971,132	39.4	%		738,841	37.5	%		232,291	31.4	%
Time deposits		192,753	10.5	%		170,587	9.6	%		22,166	13.0	%		207,422	8.4	%		196,082	9.9	%		11,340	5.8	%
Total deposits	$	1,833,113	100.0	%	$	1,775,096	100.0	%	$	58,017	3.3	%	$	2,462,370	100.0	%	$	1,971,316	100.0	%	$	491,054	24.9	%

The following table presents the average balances and rates of our deposit portfolio for the three months ended September 30, ~~2019~~2020 and ~~2018:~~2019:


	Three months ended				Three months ended
	September 30, 2019				September 30, 2018
	Average		Average		Average		Average

									Three months ended				Three months ended
									September 30, 2020				September 30, 2019
									Average		Average		Average		Average
(dollars in thousands)	Balance		Rate		Balance		Rate		Balance		Rate		Balance		Rate
Noninterest-bearing demand	$	502,108	-	%	$	545,154	-	%	$	698,594	—	%	$	502,108	—	%
Interest-bearing demand		424,896	0.49	%		393,390	0.23	%		589,633	0.27	%		424,896	0.49	%
Money market and savings		649,190	1.32	%		619,386	0.67	%		961,669	0.32	%		649,190	1.32	%
Time deposits		187,023	1.74	%		207,009	0.99	%		204,969	0.98	%		187,023	1.74	%
Total deposits	$	1,763,217	0.79	%	$	1,764,939	0.40	%	$	2,454,865	0.27	%	$	1,763,217	0.79	%

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


	September 30,		December 31,

					September 30,
(dollars in thousands)	2019		2018		2020
Maturing in:
3 months or less	$	46,870	$	24,856	$	52,348
3 months to 6 months		32,389		37,129		47,944
6 months to 1 year		10,854		8,260		12,061
1 year or greater		15,657		13,767		11,281
Total	$	105,770	$	84,012	$	123,634

~~Deposits Held for Sale~~

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

~~Table of Contents~~

Borrowings

Borrowings as of September 30, ~~2019~~2020 and December 31, ~~2018~~2019 were as follows:


	September 30, 2019				December 31, 2018
			Percent of				Percent of		Change

													September 30, 2020				December 31, 2019
															Percent of				Percent of		Change
(dollars in thousands)	Balance		Portfolio		Balance		Portfolio			Amount	Percent		Balance		Portfolio		Balance		Portfolio		Amount		Percent
Fed funds purchased	$	—	0.0	%	$	93,460	61.4	%	$	(93,460)	(100.0)	%
FHLB Short-term advances		—	0.0	%		—	0.0	%		—	—	%
Subordinated notes		49,609	84.4	%		49,562	32.5	%		47	0.1	%	$	49,672	84.6	%	$	49,625	84.4	%	$	47	0.1	%
Junior subordinated debentures		8,476	14.4	%		8,392	5.5	%		84	1.0	%		8,589	14.6	%		8,504	14.5	%		85	1.0	%
Finance lease liability		690	1.2	%		870	0.6	%		(180)	(20.7)	%		484	0.8	%		640	1.1	%		(156)	(24.3)	%
Total borrowed funds	$	58,775	100.0	%	$	152,284	100.0	%	$	(93,509)	(61.4)	%	$	58,745	100.0	%	$	58,769	100.0	%	$	(24)	—	%

Capital Resources

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

Stockholders' equity increased ~~$84.4~~$36.3 million to ~~$281.4~~$322.0 million as of September 30, ~~2019,~~2020, compared to ~~$197.0~~$285.7 million as of December 31, ~~2018.~~2019. The increase in stockholders' equity was primarily ~~impacted~~driven by ~~$62.8~~$34.5 million of net ~~proceeds received from our initial public offering, $21.9 million~~

Table of ~~net~~ Contents

income for the nine months ended September 30, ~~2019,~~2020, and an increase of ~~$6.7~~$8.6 million of accumulated other comprehensive income. These increases were partially offset by $7.8 million in dividends ~~paid~~declared on common stock. Tangible common equity to ~~common shareholders totaling $6.3 million for the nine months ended~~tangible assets, a non-GAAP financial measure, decreased to 9.78% as of September 30, 2020, from 10.38% as of December 31, 2019. ~~The increase in accumulated other comprehensive income was entirely from the increase in after-tax market value adjustments on the available-for-sale investment securities portfolio.~~

Tangible common equity to tangible assets would have been 11.14% as of September 30, 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.

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At September 30, ~~2019~~2020 and December 31, ~~2018,~~2019, we met all the capital adequacy requirements to which we were subject. The table below presents the Company’s and the Bank’s regulatory capital ratios as of September 30, ~~2019~~2020 and December 31, ~~2018:~~

2019:


	September 30,		December 31,

					September 30,		December 31,
Capital Ratios	2019		2018		2020		2019
Alerus Financial Corporation
Common equity tier 1 capital to risk weighted assets	12.38	%	8.43	%	13.08	%	12.48	%
Tier 1 capital to risk weighted assets	12.81	%	8.87	%	13.48	%	12.90	%
Total capital to risk weighted assets	16.67	%	12.86	%	17.13	%	16.73	%
Tier 1 capital to average assets	11.33	%	7.51	%	9.76	%	11.05	%
Tangible common equity to tangible assets (1)	10.76	%	6.91	%	9.78	%	10.38	%


Alerus Financial, National Association
Common equity tier 1 capital to risk weighted assets	11.84	%	11.39	%	12.47	%	11.91	%
Tier 1 capital to risk weighted assets	11.84	%	11.39	%	12.47	%	11.91	%
Total capital to risk weighted assets	13.06	%	12.62	%	13.72	%	13.15	%
Tier 1 capital to average assets	10.47	%	9.63	%	9.03	%	10.20	%

~~(1)~~

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

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

The capital ratios for the Company and the Bank, as of September 30, ~~2019,~~2020, as shown in the above tables, ~~indicate~~were at levels above the regulatory ~~minimum~~minimums to be considered “well capitalized”. ~~All regulatory capital ratios increased from their December 31, 2018 levels primarily as a result~~See “Note 17 Regulatory Matters” to the consolidated financial statements for additional information.

Table of ~~net proceeds received from our initial public offering and the increase in retained earnings.~~Contents

Contractual Obligations and ~~Off‑Balance~~Off-Balance Sheet Arrangements

Contractual Obligations

In the ordinary course of our operations, we enter into certain contractual obligations. The following table presents our contractual obligations by maturity as of September 30, ~~2019.~~2020.


	September 30, 2020
	Less than		One to		Three to		Over
(dollars in thousands)	one year		three years		five years		five years		Total
Operating lease obligations	$	2,179	$	3,927	$	1,772	$	1,753	$	9,631
Time deposits		178,362		17,514		6,220		5,326		207,422
Subordinated notes payable		—		—		—		49,672		49,672
Junior subordinated debenture (Trust I)		—		—		—		3,436		3,436
Junior subordinated debenture (Trust II)		—		—		—		5,153		5,153
Finance lease liability		251		272		—		—		523
Total contractual obligations	$	180,792	$	21,713	$	7,992	$	65,340	$	275,837

September 30, 2019


Less than

One to

Three to

Over


(dollars in thousands)

one year

three years

five years

five years

Total
Operating lease obligations

$
2,291

$
3,255

$
2,567

$
2,460

$
10,573
Time deposits

154,554

23,665

7,247

7,287

192,753
Subordinated notes payable

—

—

—

49,609

49,609
Junior subordinated debenture (Trust I)

—

—

—

3,390

3,390
Junior subordinated debenture (Trust II)

—

—

—

5,086

5,086
Finance lease liability

251

502

20

—

773

~~Off‑Balance~~Off-Balance Sheet Arrangements

We are a party to financial instruments with ~~off‑balance~~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.

~~Table of Contents~~

A summary of the contractual amounts of our exposure to ~~off‑balance~~off-balance sheet agreements as of September 30, ~~2019~~2020 and December 31, ~~2018,~~2019, is as follows:


	September 30,		December 31,

					September 30,		December 31,
(dollars in thousands)	2019		2018		2020		2019
Commitments to extend credit	$	570,220	$	529,890	$	596,642	$	586,365
Standby letters of credit		8,023		8,852		7,073		8,516
Total	$	578,243	$	538,742	$	603,715	$	594,881

Liquidity

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

As of September 30, ~~2019,~~2020, we had on balance sheet liquidity of ~~$192.7~~$311.1 million, compared to ~~$152.1~~$250.7 million as of December 31, ~~2018.~~2019. On balance sheet liquidity includes total due from banks, federal funds sold, ~~interest‑bearing~~interest-bearing deposits with banks, unencumbered securities ~~available‑for‑sale~~available-for-sale, and over collateralized securities pledging ~~position.~~positions.

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The Bank is a member of the FHLB, which provides ~~short‑~~short- and ~~long‑term~~long-term funding to its members through advances collateralized by real estate related assets and other select collateral, most typically in the form of debt securities. The actual borrowing capacity is contingent on the amount of collateral available to be pledged to the FHLB. As of September 30, ~~2019,~~2020, we had no outstanding fed funds purchased from the ~~FHLB. As of September 30, 2019 we had $858.3~~FHLB and $565.3 million of ~~real estate‑related loans~~collateral pledged to the FHLB. Based on this collateral, we were eligible to borrow up to ~~an additional $545.7 million.~~$565.0 million from the FHLB. In addition, we can borrow up to ~~$87.0~~$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 September 30, ~~2019~~2020 and December 31, ~~2018.~~2019.

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

Though remote, the possibility of a funding crisis exists at all financial institutions. 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~~short-term and ~~long‑term~~long-term funding crisis.

A ~~short‑term~~short-term funding crisis would most likely result from a shock to the financial system, either internal or external, which disrupts orderly ~~short‑term~~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~~long-term funding crisis would most likely be the result of both external and internal factors and would most likely result in drastic credit deterioration. Management believes that both potential circumstances have been fully addressed through detailed action plans and the establishment of trigger points for monitoring such events.

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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~~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~~interest-earning assets and the amount of ~~interest‑bearing~~interest-bearing liabilities that are prepaid/withdrawn, ~~re‑price,~~re-price, or mature in specified periods. We seek to achieve consistent growth in net interest income and equity while managing volatility arising from shifts in market interest rates. The ALCO oversees market risk management, monitoring risk measures, limits, and policy guidelines for managing the amount of interest rate risk and its effect on net interest income and capital. The Bank’s board of directors approves policy limits with respect to interest rate risk.

Interest Rate Risk

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

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

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

Management regularly reviews our exposure to changes in interest rates. Among the factors considered are changes in the mix of ~~interest‑earning~~interest-earning assets and ~~interest‑bearing~~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~~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~~short-term and ~~long‑term interest‑rate~~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.

~~Table of Contents~~

The estimated impact on our net interest income as of September 30, ~~2019~~2020 and December 31, ~~2018,~~2019, assuming immediate parallel moves in interest rates is presented in the table below.


	September 30, 2019				December 31, 2018
	Following		Following		Following		Following
	12 months		24 months		12 months		24 months

									September 30, 2020				December 31, 2019
									Following		Following		Following		Following
									12 months		24 months		12 months		24 months
+400 basis points	4.4	%	11.4	%	0.4	%	10.7	%	3.5	%	−1.7	%	5.5	%	12.2	%
+300 basis points	3.4	%	8.5	%	0.3	%	8.7	%	2.6	%	−4.6	%	4.2	%	9.0	%
+200 basis points	2.3	%	5.5	%	0.2	%	6.6	%	1.7	%	−7.6	%	2.9	%	5.7	%
+100 basis points	1.3	%	2.4	%	0.3	%	4.8	%	0.9	%	−10.6	%	1.5	%	2.4	%
−100 basis points	−5.4	%	−11.4	%	−5.2	%	−6.7	%	−2.8	%	−18.6	%	−5.4	%	−11.9	%
−200 basis points	N/A	%	N/A	%	−9.6	%	−16.4	%	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~~long-term cash flows, income, and capital. Economic value of equity is based on discounting the cash flows for all balance sheet instruments under different interest rate scenarios. Deposit premiums are based on external industry studies and utilizing historical experience.

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The table below presents the change in the economic value of equity as of September 30, ~~2019~~2020 and December 31, ~~2018,~~2019, assuming immediate parallel shifts in interest rates.


	September 30,		December 31,
	2019		2018

					September 30,		December 31,
					2020		2019
+400 basis points	18.5	%	4.9	%	11.2	%	12.8	%
+300 basis points	16.0	%	4.8	%	11.7	%	11.4	%
+200 basis points	12.5	%	4.0	%	11.1	%	9.2	%
+100 basis points	7.9	%	2.8	%	8.5	%	6.1	%
−100 basis points	−26.5	%	−15.9	%	−43.1	%	−23.2	%
−200 basis points	N/A	%	−36.8	%	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.

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Strategic and/or Reputation Risk

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

ITEM 4. CONTROLS AND PROCEDURES

Evaluation of Disclosure Controls and Procedures

The Company’s management, including our President and Chief Executive Officer and our Chief Financial Officer, have evaluated the effectiveness of our “disclosure controls and procedures” (as defined in Rule ~~13a‑15(e)~~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)~~13a-15(f) under the Exchange Act) during the fiscal quarter to which this report relates that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.

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PART II—OTHER INFORMATION

Item 1 – Legal Proceedings

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

Item 1A – Risk Factors

~~There have been no material changes from~~In addition to the risk factors ~~previously disclosed~~set forth under Part I, Item 1A “Risk Factors” in the ~~“Risk Factors” section included~~Company’s Form 10-K for the fiscal year ended December 31, 2019, the following risk factors apply to the Company:

The outbreak of Coronavirus Disease 2019, or COVID-19, has led to an economic recession and other severe disruptions to the U.S. economy and has adversely impacted certain industries in which our clients operate and impaired their ability to fulfill their financial obligations to us. As a result, we are starting to see the impact from COVID-19 on our business, and we believe that it will be significant, adverse, and potentially material.

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

The outbreak of COVID-19 has resulted in a decline in our clients’ businesses, a decrease in consumer confidence, an increase in unemployment, and a disruption in the services provided by our vendors. Continued disruptions to our clients’ businesses could result in increased risk of delinquencies, defaults, foreclosures, and losses on our loans and declines in assets under management and wealth management revenues, negatively impact regional economic conditions, result in declines in local loan demand, liquidity of loan guarantors, the value of loan collateral (particularly in real estate), loan originations, and deposit availability and negatively impact the implementation of our growth strategy. Although the U.S. government initially introduced a number of programs designed to soften the impact of COVID-19 on small businesses, the lack of additional programs may cause our borrowers to not be able to satisfy their financial obligations to us.

In addition, COVID-19 has impacted and likely will continue to impact the financial ability of businesses and consumers to borrow money, which would negatively impact loan volumes. Certain of our borrowers are in, or have exposure to, the retail, restaurant, and hospitality industries and are located in areas that are, or were, quarantined or under stay-at-home orders, and COVID-19 may also have an adverse effect on our commercial real estate portfolio, particularly with respect to real estate with exposure to these industries, and consumer loan portfolios. As COVID-19 cases have begun to surge in recent months, any new or prolonged quarantine or stay-at-home orders would have a negative adverse impact on these borrowers and their revenue streams, which consequently impacts their ability to meet their financial obligations to us and could result in loan defaults.

The ultimate extent of the COVID-19 pandemic’s effect on our business will depend on many factors, primarily including the speed and extent of any recovery from the related economic recession. Among other things, this will depend on the duration of the COVID-19 pandemic, particularly in our markets, the development and distribution of vaccines, therapies and other public health initiatives to control the spread of the disease, the nature and size of federal

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economic stimulus and other governmental efforts, and the possibility of additional state lockdown or stay-at-home orders in our markets in response to the recent surge in the number of COVID-19 cases.

As a result of the COVID-19 pandemic we may experience adverse financial consequences due to a number of other factors, including but not limited to:

●

a further and sustained decline in our stock price or the occurrence of what management would deem to be a triggering event that could, under certain circumstances, cause management to perform impairment testing on our goodwill and other intangible assets that could result in an impairment charge being recorded for that period, and adversely impact our results of operations and the ability of the Bank to pay dividends to us;

●

the negative effect on earnings resulting from the Bank modifying loans and agreeing to loan payment deferrals due to the COVID-19 crisis;

●

increased demand on our liquidity as we meet borrowers’ needs, experience significant credit deterioration, and cover expenses related to our business continuity plan;

●

the potential for reduced liquidity and its negative affect on our capital and leverage ratios;

●

the modification of our business practices, including with respect to branch operations, employee travel, employee work locations, participation in meetings, events and conferences, and related changes for our vendors and other business partners;

●

the disruption of our acquisition strategy due to the uncertainties created by the pandemic and challenges to our own business, which could limit or delay our future growth plans;

●

increases in federal and state taxes as a result of the effects of the pandemic and stimulus programs on governmental budgets;

●

an increase in FDIC premiums if the agency experiences additional resolution costs relating to bank failures;

●

increased cyber and payment fraud risk due to increased online and remote activity; and

●

other operational failures due to changes in our normal business practices because of the pandemic and governmental actions to contain it.

Overall, we believe that the economic impact from COVID-19 will be severe and could have a material and adverse impact on our business and result in significant losses in our loan portfolio, all of which would adversely and materially impact our earnings and capital. Even after the COVID-19 pandemic has subsided, we may continue to experience materially adverse impacts to our business as a result of the global economic impact of the COVID-19 pandemic, including the availability of credit, adverse impacts on liquidity and any recession that has occurred or may occur in the future. There are no comparable recent events that provide guidance as to the effect the spread of COVID-19 as a global pandemic may have, and, as a result, the ultimate impact of the pandemic is highly uncertain and subject to change.

The U.S. government and banking regulators, including the Federal Reserve, have taken a number of unprecedented actions in response to the COVID-19 pandemic, which could ultimately have a material adverse effect on our business and results of operations

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supplemental unemployment insurance benefits and a $349 billion loan program administered through the SBA referred to as the PPP. In addition to implementing the programs contemplated by the CARES Act, the federal bank regulatory agencies have issued a steady stream of guidance in response to the COVID-19 pandemic and have taken a number of unprecedented steps to help banks navigate the pandemic and mitigate its impact. These include, without limitation:

●

requiring banks to focus on business continuity and pandemic planning;

●

adding pandemic scenarios to stress testing;

●

encouraging bank use of capital conservation buffers and reserves in lending programs;

●

permitting certain regulatory reporting extensions;

●

reducing margin requirements on swaps;

●

permitting certain otherwise prohibited investments in investment funds;

●

issuing guidance to encourage banks to work with customers affected by the pandemic and encourage loan workouts; and

●

providing credit under the CRA for certain pandemic-related loans, investments, and public service.

The COVID-19 pandemic has significantly affected the financial markets and the Federal Reserve has taken a number of actions in response. In March 2020, the Federal Reserve dramatically reduced the target federal funds rate and announced a $700 billion quantitative easing program in response to the expected economic downturn caused by the COVID-19 pandemic. In addition, the Federal Reserve reduced the interest that it pays on excess reserves. We expect that these reductions in interest rates, especially if prolonged, could adversely affect our net interest income and our net interest margin and our profitability. The Federal Reserve also launched the Main Street Lending Program, which offers deferred interest on four-year loans to small and mid-sized businesses. The full impact of the COVID-19 pandemic on our business activities as a result of new government and regulatory laws, policies, programs, and guidelines, as well as market reactions to such activities, remains uncertain but may ultimately have a material adverse effect on our business and results of operations.

COVID-19 has disrupted banking and other financial activities in the areas in which we operate and could potentially create widespread business continuity issues for us.

The COVID-19 pandemic has negatively impacted the ability of our employees and clients to engage in banking and other financial transactions in the geographic areas in which we operate and could create widespread business continuity issues for us. We also could be adversely affected if key personnel or a significant number of employees were to become unavailable due to the effects and restrictions of an outbreak or escalation of the COVID-19 pandemic in our market areas, including because of illness, quarantines, government actions or other restrictions in connection with the ~~SEC~~COVID-19 pandemic. Although we have business continuity plans and other safeguards in place, there is no assurance that such plans and safeguards will be effective. Further, we rely upon third-party vendors to conduct business and to process, record, and monitor transactions. If any of these vendors are unable to continue to provide us with these services, it could negatively impact our ability to serve our clients.

As a participating lender in the PPP, we are subject to additional risks of litigation from our clients or other parties regarding our processing of loans for the PPP and risks that the SBA may not fund some or all PPP loan guarantees.

The CARES Act included a $349 billion loan program administered through the SBA referred to as the PPP. Under the PPP, small businesses and other entities and individuals could apply for loans from existing SBA lenders and other approved regulated lenders that enrolled in the program, subject to numerous limitations and eligibility criteria. The Bank participated as a lender in the PPP. The PPP opened on ~~September 13, 2019, pursuant~~April 3, 2020; however, because of the short

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timeframe between the passing of the CARES Act and the opening of the PPP, there is some ambiguity in the laws, rules, and guidance regarding the operation of the PPP, which exposes us to ~~Rule 424(b)(4)~~risks relating to noncompliance with the PPP. On April 24, 2020, an additional $310 billion in funding for PPP loans was authorized and such funds became available for PPP loans beginning on April 27, 2020.

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

We also have credit risk on PPP loans if a determination is made by the SBA that there is a deficiency in the manner in which the loan was originated, funded, or serviced by the Bank, such as an issue with the eligibility of a borrower to receive a PPP loan, which may or may not be related to the ambiguity in the laws, rules, and guidance regarding the operation of the PPP. In the event of a loss resulting from a default on a PPP loan and a determination by the SBA that there is a deficiency in the manner in which the PPP loan was originated, funded, or serviced by us, the SBA may deny its liability under the ~~Securities Act~~guaranty, reduce the amount of ~~1933, as amended.~~the guaranty, or if it has already paid under the guaranty, seek recovery of any loss related to the deficiency from us.

Item 2 ~~- Recent Sales of Unregistered Securities~~

– Unregistered Sales of Equity Securities and Use of Proceeds

~~None.~~Unregistered Sales of Equity Securities

The following table presents information related to repurchases of shares of our common stock for each calendar month in the third quarter of 2020.


					Maximum
				Total Number of	Amount That May
	Total Number	Average		Shares Purchased as	Yet be Purchased
	of Shares	Price Paid		Part of Publicly	Under the Plan
(dollars in thousands, except per share data)	Purchased (1)	per Share		Announced Plans	Or program
July	536	$	19.43	—	$	—
August	76		19.86	—		—
September	—		—	—		—
Total	612	$	19.48	—	$	—

(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.

Use of Proceeds from Registered Securities

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

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

There has been no material change in the planned use of proceeds from the initial public offering as described in the Company’s prospectus filed with the SEC on September 13, 2019, pursuant to Rule 424(b)(4) under the Securities Act of 1933. From the effective date of the registration statement through September 30, ~~2019,~~2020, the Company has maintained the net proceeds of the initial public offering on deposit with the Bank. The Bank has used the deposits of the Company to pay down short-term borrowings.

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Item 3 – Defaults Upon Senior Securities

None.

Item 4 – Mine Safety Disclosures

Not Applicable.

Item 5 – Other Information

None.

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Item 6 – Exhibits


Exhibit No.		Description
~~Exhibit No.~~		~~Description~~
31.1		Chief Executive ~~Officer’s~~Officer’s Certifications required by Rule13(a)~~‑14(a)~~-14(a) – filed herewith.

31.2		Chief Financial ~~Officer’s~~Officer’s Certifications required by Rule13(a)~~‑14(a)~~-14(a) – filed herewith.

32.1		Chief Executive Officer Certifications pursuant to 18 U.S.C. Section1350, as adopted pursuant to Section906 of the Sarbanes-Oxley Act of 2002 – filed herewith.

32.2		Chief Financial Officer Certifications pursuant to 18 U.S.C. Section1350, as adopted pursuant to Section906 of the Sarbanes-Oxley Act of 2002 – filed herewith.
101.INS*
101.INS		XBRL Instance Document

101.SCH*101.SCH		XBRL Taxonomy Extension Schema

101.CAL*101.CAL		XBRL Taxonomy Extension Calculation Linkbase

101.DEF*101.DEF		XBRL Taxonomy Extension Definition Linkbase

101.LAB*101.LAB		XBRL Taxonomy Extension Label Linkbase

101.PRE*101.PRE		XBRL Taxonomy Extension Presentation Linkbase

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SIGNATURES

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


			ALERUS FINANCIAL CORPORATION
	~~ALERUS FINANCIAL CORPORATION~~

Date: November ~~7, 2019~~5, 2020	By:	/s/ Randy L. Newman
		Name: Randy L. Newman
		Title: Chairman, Chief Executive Officer and President (Principal Executive Officer)

Date: November 5, 2020	By:	/s/ Katie A. Lorenson
		Name: Katie A. Lorenson
		Title: Executive Vice President and Chief Financial Officer (Principal Financial and Accounting Officer)

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	Three months ended September 30, 2019
							Accumulated
			Additional				Other		ESOP-
	Common		Paid-in		Retained		Comprehensive		Owned
(dollars in thousands)	Stock		Capital		Earnings		Income (Loss)		Shares		Total
Balance as of June 30, 2019	$	13,816	$	28,676	$	169,788	$	1,485	$	(34,494)	$	179,271
Net income		—		—		7,104		—		—		7,104
Other comprehensive income (loss)		—		—		—		1,600		—		1,600
Common stock repurchased		(77)		(275)		(1,489)		—		—		(1,841)
Common stock dividends		—		—		(2,364)		—		—		(2,364)
ESOP repurchase obligation termination		—		—		—		—		34,494		34,494
Initial public offering of 3,289,000 shares of common stock net of issuance costs		3,289		59,515		—		—		—		62,804
Stock-based compensation expense		—		335		—		—		—		335
Vesting of restricted stock		21		(21)		—		—		—		—
Balance as of September 30, 2019	$	17,049	$	88,230	$	173,039	$	3,085	$	—	$	281,403


	Nine months ended
	September 30,
Supplemental Cash Flow Disclosures	2019		2018
Cash paid for:
Interest	$	13,162	$	7,692
Income taxes		5,550		3,030
Non-cash information
Loan collateral transferred to foreclosed assets		766		661
Unrealized gain (loss) on investment securities available-for-sale		6,686		(4,579)
Initial recognition of operating lease right-of-use assets		10,475		—
Initial recognition of operating lease liabilities		10,996		—
Change in fair value of ESOP shares		—		(3,003)
ESOP repurchase obligation termination		34,494		—


	Nine months ended September 30, 2019			Nine months ended September 30, 2018
		Weighted-			Weighted-
		Average Grant			Average Grant
	Awards	Date Fair Value		Awards	Date Fair Value
Restricted Stock Awards
Outstanding at beginning of period	337,014	$	18.36	336,397	$	15.38
Granted	70,617		19.87	76,031		22.67
Vested	(53,882)		18.69	(76,753)		10.56
Forfeited or cancelled	(6,138)		17.34	—		—
Outstanding at end of period	347,611	$	18.64	335,675	$	18.13


	September 30, 2019				December 31, 2018
			Percentage				Percentage
	Allocated		of loans to		Allocated		of loans to
(dollars in thousands)	Allowance		total loans		Allowance		total loans
Commercial and industrial	$	10,946	28.7	%	$	12,127	30.0	%
Real estate construction		348	1.3	%		250	1.1	%
Commercial real estate		5,761	26.4	%		6,279	25.9	%
Residential real estate first mortgage		1,016	27.3	%		1,156	26.3	%
Residential real estate junior lien		896	10.8	%		805	11.1	%
Other revolving and installment		378	5.5	%		380	5.6	%
Unallocated		3,639	—	%		1,177	—	%
Total loans	$	22,984	100.0	%	$	22,174	100.0	%


	September 30, 2019
	Less than		One to		Three to		Over
(dollars in thousands)	one year		three years		five years		five years		Total
Operating lease obligations	$	2,291	$	3,255	$	2,567	$	2,460	$	10,573
Time deposits		154,554		23,665		7,247		7,287		192,753
Subordinated notes payable		—		—		—		49,609		49,609
Junior subordinated debenture (Trust I)		—		—		—		3,390		3,390
Junior subordinated debenture (Trust II)		—		—		—		5,086		5,086
Finance lease liability		251		502		20		—		773