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ALRS Alerus Financial

Filed: 5 Nov 20, 12:40pm

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, DC 20549

FORM 10-Q

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

For the quarterly period ended September 30, 2020

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

Commission File Number: 001-39036

ALERUS FINANCIAL CORPORATION

(Exact name of registrant as specified in its charter)

Delaware

45-0375407

(State or other jurisdiction of incorporation or

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

organization)

401 Demers Avenue

Grand Forks, ND

58201

(Address of principal executive offices)

(Zip Code)

(701) 795-3200

(Registrant’s telephone number, including area code)

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

Title of each class

    

Trading symbol

    

Name of each exchange on which registered

Common Stock, par value $1.00 per share

ALRS

The Nasdaq Stock Market LLC

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ☒ No

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

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

Large accelerated filer 

Accelerated filer 

Non-accelerated filer 

Smaller reporting company 

Emerging growth company 

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

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

The number of shares of the registrant’s common stock outstanding at October 31, 2020 was 17,121,863.



PART 1. FINANCIAL INFORMATION

Item 1 - Consolidated Financial Statements

Alerus Financial Corporation and Subsidiaries

Consolidated Balance Sheets (Unaudited)

    

September 30, 

    

December 31, 

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

    

2020

    

2019

Assets

 

 

  

Cash and cash equivalents

$

95,751

$

144,006

Investment securities, at fair value

 

  

 

  

Available-for-sale

 

495,414

 

310,350

Equity

 

 

2,808

Loans held for sale

 

111,311

 

46,846

Loans

 

2,058,419

 

1,721,279

Allowance for loan losses

 

(31,337)

 

(23,924)

Net loans

 

2,027,082

 

1,697,355

Land, premises and equipment, net

 

20,493

 

20,629

Operating lease right-of-use assets

 

8,168

 

8,343

Accrued interest receivable

 

9,199

 

7,551

Bank-owned life insurance

 

32,161

 

31,566

Goodwill

 

27,329

 

27,329

Other intangible assets

 

15,421

 

18,391

Servicing rights

 

2,579

 

3,845

Deferred income taxes, net

 

8,628

 

7,891

Other assets

 

45,273

 

29,968

Total assets

$

2,898,809

$

2,356,878

Liabilities and Stockholders’ Equity

 

  

 

  

Deposits

 

  

 

  

Noninterest-bearing

$

693,450

$

577,704

Interest-bearing

 

1,768,920

 

1,393,612

Total deposits

 

2,462,370

 

1,971,316

Long-term debt

 

58,745

 

58,769

Operating lease liabilities

 

8,671

 

8,864

Accrued expenses and other liabilities

 

47,020

 

32,201

Total liabilities

 

2,576,806

 

2,071,150

Stockholders’ equity

 

  

 

  

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

Common stock, $1 par value, 30,000,000 shares authorized: 17,121,863 and 17,049,551 issued and outstanding

 

17,122

 

17,050

Additional paid-in capital

 

89,757

 

88,650

Retained earnings

 

204,581

 

178,092

Accumulated other comprehensive income (loss)

 

10,543

 

1,936

Total stockholders’ equity

 

322,003

 

285,728

Total liabilities and stockholders’ equity

$

2,898,809

$

2,356,878

See accompanying notes to consolidated financial statements (unaudited)

1


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)

2


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)

3


Alerus Financial Corporation and Subsidiaries

Consolidated Statements of Changes in Stockholders’ Equity (Unaudited)

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)

4


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)

5


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)

6


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)

7


Alerus Financial Corporation and Subsidiaries

Notes to Consolidated Financial Statements (Unaudited)

NOTE 1 Significant Accounting Policies

Organization

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

Initial Public Offering

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

Basis of Presentation

The accompanying unaudited consolidated financial statements and notes thereto of the Company have been prepared in accordance with the rules and regulations of the Securities and Exchange Commission, or SEC, and conform to practices within the banking industry and include all of the information and disclosures required by generally accepted accounting principles in the United States of America, or GAAP, for interim financial reporting. The accompanying unaudited consolidated financial statements reflect all adjustments (consisting only of normal recurring adjustments) that are necessary for a fair presentation of financial results for the interim periods presented. The results of operations for the interim periods are not necessarily indicative of the results for the full year or any other period. The Company has also evaluated all subsequent events for potential recognition and disclosure through the date of the filing of this Quarterly Report on Form 10-Q. These interim unaudited financial statements should be read in conjunction with the audited consolidated financial statements and the notes thereto as of and for the year ended December 31, 2019, included in the Company’s Annual Report on Form 10-K filed with the SEC on March 26, 2020.

Principles of Consolidation

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

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

Use of Estimates

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

8


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

9


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

NOTE 2 Recent Accounting Pronouncements

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

Adopted Pronouncements

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

In August 2018, the FASB issued ASU No. 2018-13, Disclosure Framework—Changes to the Disclosure Requirements for Fair Value Measurement. This ASU eliminates, adds, and modifies certain disclosure requirements for estimated fair value measurements. Among the changes, entities will no longer be required to disclose the amount of and reasons for 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 is effective for all entities interim and annual reporting periods beginning after December 15, 2019. The Company adopted ASU 2018-13 effective January 1, 2020, and the revised disclosure requirements did not have a material impact on the Company’s consolidated financial statements.

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

10


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

In April 2019, the FASB issued ASU 2019-04, Codification Improvements to Topic 326, Financial Instruments—Credit Losses, Topic 815, Derivatives and Hedging, and Topic 825, Financial Instruments, which affects a variety of topics in the Codification and applies to all reporting entities within the scope of the affected accounting guidance. The Company will consider these clarifications and improvements in determining the appropriate adoption of ASU 2019-04.

In May 2019, the FASB issued ASU 2019-05, Targeted Transition Relief to provide entities with an option to irrevocably elect the fair value option applied on an instrument-by-instrument basis for eligible instruments. In November 2019, the FASB Issued ASU 2019-10, which amends the effective date of this ASU for certain entities, including private companies and smaller reporting companies until after December 15, 2022, including interim periods within those fiscal years. As an emerging growth company, the Company can take advantage of this delay and plans to 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.

11


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, 2020 and December 31, 2019:

September 30, 2020

Amortized

Unrealized

Unrealized

Fair

(dollars in thousands)

    

Cost

    

Gains

    

Losses

    

Value

U.S. Treasury and agencies

$

16,075

$

34

$

(17)

$

16,092

Obligations of state and political agencies

 

142,308

 

4,908

 

 

147,216

Mortgage backed securities

 

  

 

 

 

  

Residential agency

 

203,812

 

7,933

 

(45)

 

211,700

Commercial

 

86,502

 

1,092

 

(52)

 

87,542

Asset backed securities

 

123

 

8

 

 

131

Corporate bonds

 

32,518

 

244

 

(29)

 

32,733

Total available-for-sale investment securities

$

481,338

$

14,219

$

(143)

$

495,414

December 31, 2019

Amortized

Unrealized

Unrealized

Fair

(dollars in thousands)

    

Cost

    

Gains

    

Losses

    

Value

U.S. Treasury and agencies

$

21,246

$

9

$

(15)

$

21,240

Obligations of state and political agencies

 

68,162

 

647

 

(161)

 

68,648

Mortgage backed securities

 

  

 

 

 

  

Residential agency

 

180,411

 

2,258

 

(131)

 

182,538

Commercial

 

30,752

 

101

 

(168)

 

30,685

Asset backed securities

 

139

 

5

 

 

144

Corporate bonds

 

7,054

 

41

 

 

7,095

Total available-for-sale investment securities

$

307,764

$

3,061

$

(475)

$

310,350

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

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

U.S. Treasury and agencies

$

(9)

$

4,694

$

(8)

$

1,309

$

(17)

$

6,003

Obligations of state and political agencies

 

 

590

 

 

 

 

590

Mortgage backed securities

 

  

 

  

 

  

 

  

 

  

 

  

Residential agency

 

(45)

 

15,481

 

 

 

(45)

 

15,481

Commercial

 

(48)

 

25,292

 

(4)

 

2,603

 

(52)

 

27,895

Asset backed securities

 

 

 

 

2

 

 

2

Corporate bonds

 

(29)

 

5,971

 

 

 

(29)

 

5,971

Total available-for-sale investment securities

$

(131)

$

52,028

$

(12)

$

3,914

$

(143)

$

55,942

12


December 31, 2019

Less than 12 Months

Over 12 Months

Total

Unrealized

Fair

Unrealized

Fair

Unrealized

Fair

(dollars in thousands)

    

Losses

    

Value

    

Losses

    

Value

    

Losses

    

Value

U.S. Treasury and agencies

$

(5)

$

1,740

$

(10)

$

9,990

$

(15)

$

11,730

Obligations of state and political agencies

 

(140)

 

11,959

 

(21)

 

5,798

 

(161)

 

17,757

Mortgage backed securities

 

  

 

  

 

  

 

  

 

  

 

  

Residential agency

 

(52)

 

17,131

 

(79)

 

14,036

 

(131)

 

31,167

Commercial

 

(116)

 

15,235

 

(52)

 

6,195

 

(168)

 

21,430

Asset backed securities

 

 

2

 

 

 

 

2

Corporate bonds

 

 

 

 

 

 

Total available-for-sale investment securities

$

(313)

$

46,067

$

(162)

$

36,019

$

(475)

$

82,086

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

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

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

Amortized

Fair

(dollars in thousands)

    

Cost

    

Value

Due within one year or less

$

16,132

$

16,211

Due after one year through five years

 

26,821

 

27,459

Due after five years through ten years

 

145,310

 

150,121

Due after 10 years

 

293,075

 

301,623

Total available-for-sale investment securities

$

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 $115.4 million and $136.2 million were pledged as of September 30, 2020 and December 31, 2019, respectively, to secure public deposits and for other purposes required or permitted by law.

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

Three months ended

Nine months ended

September 30, 

September 30, 

(dollars in thousands)

    

2020

    

2019

    

2020

    

2019

Proceeds

$

35,125

$

10,934

$

74,630

$

32,565

Realized gains

 

1,428

 

59

 

2,722

 

357

Realized losses

 

 

(11)

 

 

(22)

13


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

September 30, 

December 31, 

(dollars in thousands)

    

2020

    

2019

Federal Reserve

$

2,675

$

2,675

FHLB

 

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, 2020, the conversion ratio was 1.6228. Based on the existing transfer restriction and the uncertainty of the outcome of the Visa litigation mentioned above, the 6,924 Class B shares (11,236 Class A equivalents) that the Company owned as of September 30, 2020 and December 31, 2019, are carried at a zero cost basis.

NOTE 4 Loans and Allowance for Loan Losses

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

    

September 30, 

    

December 31, 

(dollars in thousands)

    

2020

    

2019

Commercial

Commercial and industrial (1)

$

789,036

$

479,144

Real estate construction

 

33,169

 

26,378

Commercial real estate

 

535,216

 

494,703

Total commercial

 

1,357,421

 

1,000,225

Consumer

 

  

 

  

Residential real estate first mortgage

 

469,050

 

457,155

Residential real estate junior lien

 

152,487

 

177,373

Other revolving and installment

 

79,461

 

86,526

Total consumer

 

700,998

 

721,054

Total loans

$

2,058,419

$

1,721,279


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

Total loans included net deferred loan fees and costs of $7.8 million and $1.0 million at September 30, 2020 and December 31, 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. 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.

14


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

September 30, 2020

90 Days

Accruing

30 - 89 Days

or More

Total

(dollars in thousands)

    

Current

    

Past Due

    

Past Due

    

Nonaccrual

    

Loans

Commercial

 

  

 

  

 

  

 

  

 

  

Commercial and industrial

$

784,282

$

1,914

$

$

2,840

$

789,036

Real estate construction

 

32,384

 

785

 

 

 

33,169

Commercial real estate

 

530,984

 

2,903

 

 

1,329

 

535,216

Total commercial

 

1,347,650

 

5,602

 

 

4,169

 

1,357,421

Consumer

 

  

 

  

 

  

 

  

 

  

Residential real estate first mortgage

 

466,551

 

2,042

 

 

457

 

469,050

Residential real estate junior lien

 

152,111

 

207

 

 

169

 

152,487

Other revolving and installment

 

79,221

 

240

 

 

 

79,461

Total consumer

 

697,883

 

2,489

 

 

626

 

700,998

Total loans

$

2,045,533

$

8,091

$

$

4,795

$

2,058,419

December 31, 2019

90 Days

Accruing

30 - 89 Days

or More

Total

(dollars in thousands)

    

Current

    

Past Due

    

Past Due

    

Nonaccrual

    

Loans

Commercial

 

  

 

  

 

  

 

  

 

  

Commercial and industrial

$

473,900

$

382

$

$

4,862

$

479,144

Real estate construction

 

26,251

 

127

 

 

 

26,378

Commercial real estate

 

492,707

 

556

 

 

1,440

 

494,703

Total commercial

 

992,858

 

1,065

 

 

6,302

 

1,000,225

Consumer

 

  

 

  

 

  

 

  

 

  

Residential real estate first mortgage

 

455,244

 

666

 

448

 

797

 

457,155

Residential real estate junior lien

 

176,915

 

184

 

 

274

 

177,373

Other revolving and installment

 

86,172

 

348

 

 

6

 

86,526

Total consumer

 

718,331

 

1,198

 

448

 

1,077

 

721,054

Total loans

$

1,711,189

$

2,263

$

448

$

7,379

$

1,721,279

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

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

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

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

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

15


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

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

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

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

September 30, 2020

Criticized

Special

(dollars in thousands)

    

Pass

    

Mention

    

Substandard

    

Doubtful

    

Total

Commercial

 

  

 

  

 

  

 

  

 

  

Commercial and industrial

$

759,808

$

8,706

$

20,522

$

$

789,036

Real estate construction

 

32,140

 

783

 

246

 

 

33,169

Commercial real estate

 

501,913

 

7,265

 

26,038

 

 

535,216

Total commercial

1,293,861

16,754

46,806

1,357,421

Consumer

 

  

 

  

 

  

 

  

 

  

Residential real estate first mortgage

 

467,168

 

1,413

 

469

 

 

469,050

Residential real estate junior lien

 

149,290

 

2,005

 

1,192

 

 

152,487

Other revolving and installment

 

79,461

 

 

 

 

79,461

Total consumer

 

695,919

 

3,418

 

1,661

 

 

700,998

Total loans

$

1,989,780

$

20,172

$

48,467

$

$

2,058,419

December 31, 2019

Criticized

Special

(dollars in thousands)

    

Pass

    

Mention

    

Substandard

    

Doubtful

    

Total

Commercial

 

  

 

  

 

  

 

  

 

  

Commercial and industrial

$

448,306

$

9,585

$

21,253

$

$

479,144

Real estate construction

 

25,119

 

282

 

977

 

 

26,378

Commercial real estate

 

462,294

 

2,359

 

30,050

 

 

494,703

Total commercial

935,719

12,226

52,280

1,000,225

Consumer

 

  

 

  

 

  

 

  

 

  

Residential real estate first mortgage

 

456,358

 

 

797

 

 

457,155

Residential real estate junior lien

 

176,122

 

 

1,251

 

 

177,373

Other revolving and installment

 

86,520

 

 

6

 

 

86,526

Total consumer

 

719,000

 

 

2,054

 

 

721,054

Total loans

$

1,654,719

$

12,226

$

54,334

$

$

1,721,279

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

16


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, 2020 and 2019:

Three months ended September 30, 2020

Beginning

Provision for

Loan

Loan

Ending

(dollars in thousands)

    

Balance

    

Loan Losses

    

Charge-offs

    

Recoveries

    

Balance

Commercial

 

  

 

  

 

  

 

  

 

  

Commercial and industrial

$

10,797

$

(846)

$

(10)

$

432

$

10,373

Real estate construction

 

443

 

40

 

 

 

483

Commercial real estate

 

9,948

 

1,828

 

 

95

 

11,871

Total commercial

 

21,188

 

1,022

 

(10)

 

527

 

22,727

Consumer

 

  

 

  

 

  

 

  

 

  

Residential real estate first mortgage

 

2,673

 

1,694

 

 

 

4,367

Residential real estate junior lien

 

1,102

 

28

 

 

81

 

1,211

Other revolving and installment

 

546

 

108

 

(41)

 

24

 

637

Total consumer

 

4,321

 

1,830

 

(41)

 

105

 

6,215

Unallocated

 

1,747

 

648

 

 

 

2,395

Total

$

27,256

$

3,500

$

(51)

$

632

$

31,337

Nine months ended September 30, 2020

Beginning

Provision for

Loan

Loan

Ending

(dollars in thousands)

    

Balance

    

Loan Losses

    

Charge-offs

    

Recoveries

    

Balance

Commercial

Commercial and industrial

$

12,270

$

(498)

$

(2,745)

$

1,346

$

10,373

Real estate construction

303

180

483

Commercial real estate

6,688

5,953

(865)

95

11,871

Total commercial

19,261

5,635

(3,610)

1,441

22,727

Consumer

Residential real estate first mortgage

1,448

2,914

5

4,367

Residential real estate junior lien

671

377

(12)

175

1,211

Other revolving and installment

352

371

(194)

108

637

Total consumer

2,471

3,662

(206)

288

6,215

Unallocated

2,192

203

2,395

Total

$

23,924

$

9,500

$

(3,816)

$

1,729

$

31,337

Three months ended September 30, 2019

Beginning

Provision for

Loan

Loan

Ending

(dollars in thousands)

    

Balance

    

Loan Losses

    

Charge-offs

    

Recoveries

    

Balance

Commercial

Commercial and industrial

$

11,694

$

(962)

$

(324)

$

538

$

10,946

Real estate construction

323

25

348

Commercial real estate

5,765

(4)

5,761

Total commercial

17,782

(941)

(324)

538

17,055

Consumer

Residential real estate first mortgage

1,155

(139)

1,016

Residential real estate junior lien

710

157

(20)

49

896

Other revolving and installment

380

1

(31)

28

378

Total consumer

2,245

19

(51)

77

2,290

Unallocated

1,219

2,420

3,639

Total

$

21,246

$

1,498

$

(375)

$

615

$

22,984

17


Nine months ended September 30, 2019

Beginning

Provision for

Loan

Loan

Ending

(dollars in thousands)

    

Balance

    

Loan Losses

    

Charge-offs

    

Recoveries

    

Balance

Commercial

 

  

 

  

 

  

 

  

 

  

Commercial and industrial

$

12,127

$

3,263

$

(5,275)

$

831

$

10,946

Real estate construction

 

250

 

97

 

(1)

 

2

 

348

Commercial real estate

 

6,279

 

(668)

 

 

150

 

5,761

Total commercial

 

18,656

 

2,692

 

(5,276)

 

983

 

17,055

Consumer

 

  

 

  

 

  

 

  

 

  

Residential real estate first mortgage

 

1,156

 

(140)

 

 

 

1,016

Residential real estate junior lien

 

805

 

113

 

(154)

 

132

 

896

Other revolving and installment

 

380

 

388

 

(513)

 

123

 

378

Total consumer

 

2,341

 

361

 

(667)

 

255

 

2,290

Unallocated

 

1,177

 

2,462

 

 

 

3,639

Total

$

22,174

$

5,515

$

(5,943)

$

1,238

$

22,984

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, 2020 and December 31, 2019:

September 30, 2020

Recorded Investment

Allowance for Loan Losses

Individually

Collectively

Individually

Collectively

(dollars in thousands)

    

Evaluated

    

Evaluated

    

Total

    

Evaluated

    

Evaluated

    

Unallocated

    

Total

Commercial

  

 

  

 

  

Commercial and industrial

$

3,497

$

785,539

$

789,036

$

379

$

9,994

$

$

10,373

Real estate construction

 

 

33,169

 

33,169

483

483

Commercial real estate

 

1,525

 

533,691

 

535,216

9

11,862

11,871

Total commercial

 

5,022

 

1,352,399

 

1,357,421

388

22,339

22,727

Consumer

 

  

 

  

 

  

Residential real estate first mortgage

 

457

 

468,593

 

469,050

4,367

4,367

Residential real estate junior lien

 

229

 

152,258

 

152,487

19

1,192

1,211

Other revolving and installment

 

 

79,461

 

79,461

637

637

Total consumer

 

686

 

700,312

 

700,998

19

6,196

6,215

Total loans

$

5,708

$

2,052,711

$

2,058,419

$

407

$

28,535

$

2,395

$

31,337

December 31, 2019

Recorded Investment

Allowance for Loan Losses

Individually

Collectively

Individually

Collectively

(dollars in thousands)

    

Evaluated

    

Evaluated

    

Total

    

Evaluated

    

Evaluated

    

Unallocated

    

Total

Commercial

  

 

  

 

  

Commercial and industrial

$

976

$

478,168

$

479,144

$

189

$

12,081

$

$

12,270

Real estate construction

 

 

26,378

 

26,378

303

303

Commercial real estate

 

5,925

 

488,778

 

494,703

2,946

3,742

6,688

Total commercial

 

6,901

 

993,324

 

1,000,225

3,135

16,126

19,261

Consumer

 

  

 

  

 

  

Residential real estate first mortgage

 

782

 

456,373

 

457,155

1,448

1,448

Residential real estate junior lien

 

266

177,107

 

177,373

671

671

Other revolving and installment

 

5

 

86,521

 

86,526

3

349

352

Total consumer

 

1,053

 

720,001

 

721,054

3

2,468

2,471

Total loans

$

7,954

$

1,713,325

$

1,721,279

$

3,138

$

18,594

$

2,192

$

23,924

18


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, 2020

 

December 31, 2019

Recorded

Unpaid

Related

 

Recorded

Unpaid

Related

(dollars in thousands)

    

Investment

    

Principal

    

Allowance

    

Investment

    

Principal

    

Allowance

Impaired loans with a valuation allowance

 

  

 

  

 

  

Commercial and industrial

$

2,523

$

2,609

$

379

$

639

$

727

$

189

Commercial real estate

 

196

 

196

 

9

 

5,718

 

5,823

 

2,946

Residential real estate junior lien

 

19

 

20

19

 

 

Other revolving and installment

 

 

 

5

 

6

 

3

Total impaired loans with a valuation allowance

2,738

2,825

407

6,362

6,556

3,138

Impaired loans without a valuation allowance

 

  

 

  

 

  

Commercial and industrial

974

1,159

337

1,110

Commercial real estate

 

1,329

 

1,448

 

207

 

236

 

Residential real estate first mortgage

 

457

 

469

 

782

 

797

 

Residential real estate junior lien

 

210

 

256

 

266

 

372

 

Other revolving and installment

 

 

 

 

 

Total impaired loans without a valuation allowance

2,970

3,332

1,592

2,515

Total impaired loans

 

  

 

  

 

  

Commercial and industrial

3,497

3,768

379

976

1,837

189

Commercial real estate

 

1,525

 

1,644

 

9

 

5,925

 

6,059

 

2,946

Residential real estate first mortgage

457

469

782

797

Residential real estate junior lien

 

229

 

276

 

19

 

266

 

372

 

Other revolving and installment

 

 

 

 

5

 

6

 

3

Total impaired loans

$

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, 2020 and 2019:

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

19


Nine 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

$

3,815

$

14

$

2,473

$

12

Commercial real estate

 

200

 

8

 

1,668

 

6

Residential real estate junior lien

 

20

 

 

621

 

3

Other revolving and installment

 

 

 

5

 

Total impaired loans with a valuation allowance

4,035

22

4,767

21

Impaired loans without a valuation allowance

  

 

  

 

  

 

  

Commercial and industrial

1,154

26

2,979

23

Real estate construction

Commercial real estate

 

1,699

 

 

 

Residential real estate first mortgage

 

467

 

 

92

 

Residential real estate junior lien

 

217

 

3

 

302

Other revolving and installment

 

 

 

4

 

Total impaired loans without a valuation allowance

3,537

29

3,377

23

Total impaired loans

 

  

 

  

 

  

 

  

Commercial and industrial

4,969

40

5,452

35

Real estate construction

Commercial real estate

 

1,899

 

8

 

1,668

 

6

Residential real estate first mortgage

 

467

 

 

92

 

Residential real estate junior lien

 

237

 

3

 

923

 

3

Other revolving and installment

 

 

 

9

 

Total impaired loans

$

7,572

$

51

$

8,144

$

44

Loans with a carrying value of $1.2 billion as of September 30, 2020 and December 31, 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 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 modified as a TDR as a result of extending the amortization period. As of December 31, 2019, the carrying value of the restructured loan was $0.2 million. The loan is currently performing according to the modified terms and there was no specific reserve for loan losses allocated to the loan modified as troubled debt restructuring.

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

20


NOTE 5 Goodwill and Other Intangible Assets

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

September 30, 

December 31, 

(dollars in thousands)

    

2020

    

2019

Banking

$

20,131

$

20,131

Retirement and benefit services

7,198

7,198

Total goodwill

$

27,329

$

27,329

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

September 30, 2020

December 31, 2019

(dollars in thousands)

    

Gross Carrying Amount

    

Accumulated Amortization

    

Total

    

Gross Carrying Amount

    

Accumulated Amortization

    

Total

Identifiable customer intangibles

$

31,857

$

(16,689)

$

15,168

$

31,857

$

(14,287)

$

17,570

Core deposit intangible assets

3,793

(3,540)

253

4,993

(4,172)

821

Total intangible assets

$

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 nine months ended September 30, 2020, and 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 $476.3 million and $541.9 million as of September 30, 2020 and December 31, 2019, respectively. Servicing loans for others generally consists of collecting mortgage payments, maintaining escrow accounts, disbursing payments to investors and collection and foreclosure processing. Loan servicing income is recorded on an accrual basis and includes servicing fees from investors and certain charges collected from borrowers, such as late payment fees, and is net of fair value adjustments to capitalized mortgage servicing rights.

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

    

Three months ended

    

Nine months ended

September 30, 

September 30, 

(dollars in thousands)

    

2020

    

2019

    

2020

    

2019

Balance, beginning of period

$

2,891

$

4,300

$

3,845

$

4,623

Additions

42

179

 

154

 

279

Amortization

(296)

(287)

 

(692)

 

(690)

(Impairment)/Recovery

(58)

(46)

 

(728)

 

(66)

Balance, end of period

$

2,579

$

4,146

$

2,579

$

4,146

21


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

    

September 30, 

    

December 31, 

 

(dollars in thousands)

2020

2019

Fair value of servicing rights

$

2,579

$

3,845

Weighted-average remaining term, years

 

20.0

 

20.1

Prepayment speeds

 

23.8

%  

 

11.8

%

Discount rate

 

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 offices and office equipment rentals with terms extending through 2027. Portions of certain properties are subleased for terms extending through 2024. Substantially all of the Company’s leases are classified as operating leases, and therefore, were previously not recognized on the Company’s consolidated financial statements. The Company has one existing finance lease for the Company’s headquarters building with a lease term through 2022.

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

    

    

    

September 30, 

    

December 31, 

(dollars in thousands)

 

 

2020

 

2019

Lease Right-of-Use Assets

Classification

Operating lease right-of-use assets

 

Operating lease right-of-use assets

$

8,168

$

8,343

Finance lease right-of-use assets

 

Land, premises and equipment, net

 

231

 

318

Total lease right-of-use assets

$

8,399

$

8,661

Lease Liabilities

 

  

 

 

  

Operating lease liabilities

 

Operating lease liabilities

$

8,671

$

8,864

Finance lease liabilities

 

Long-term debt

 

484

 

640

Total lease liabilities

$

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.

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 components and instead to account for them as a single lease component, the variable lease cost primarily represents variable

22


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

September 30, 

September 30, 

(dollars in thousands)

    

2020

    

2019

    

2020

2019

Lease costs

 

 

  

Operating lease cost

$

634

$

602

$

1,825

$

1,772

Variable lease cost

223

222

 

888

 

633

Short-term lease cost

102

122

 

304

 

416

Finance lease cost

 

  

 

  

Interest on lease liabilities

10

14

 

33

 

45

Amortization of right-of-use assets

29

29

 

87

 

87

Sublease income

(57)

(65)

 

(175)

 

(202)

Net lease cost

$

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

$

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, 2020 were as follows:

Finance

Operating

(dollars in thousands)

    

Leases

    

Leases

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

 

 

1,753

Total future minimum lease payments

$

523

$

9,631

Amounts representing interest

 

(39)

 

(960)

Total operating lease liabilities

$

484

$

8,671

NOTE 8 Deposits

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

September 30, 

December 31, 

(dollars in thousands)

    

2020

    

2019

Noninterest-bearing

$

693,450

$

577,704

Interest-bearing

 

  

 

  

Interest-bearing demand

 

590,366

 

458,689

Savings accounts

 

78,659

 

55,777

Money market savings

 

892,473

 

683,064

Time deposits

 

207,422

 

196,082

Total interest-bearing

 

1,768,920

 

1,393,612

Total deposits

$

2,462,370

$

1,971,316

23


NOTE 9 Short-Term Borrowings

There were no short-term borrowings outstanding as of September 30, 2020 and December 31, 2019.

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

Three months ended

September 30, 

(dollars in thousands)

    

2020

    

2019

Fed funds purchased

 

Balance as of end of period

$

$

Average daily balance

61,386

Maximum month-end balance

124,250

Weighted-average rate

During period

%

2.40

%

End of period

%

2.30

%

FHLB Short-term advances

Balance as of end of period

$

$

Average daily balance

25,815

Maximum month-end balance

Weighted-average rate

During period

%

2.58

%

End of period

%

%

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

%

%

24


NOTE 10 Long-Term Debt

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

September 30, 2020

Period End

Face

Carrying

Interest

Maturity

(dollars in thousands)

    

Value

    

Value

    

Interest Rate

    

Rate

    

Date

    

Call Date

Subordinated notes payable

$

50,000

$

49,672

 

Fixed

 

5.75

%  

12/30/2025

 

12/30/2020

Junior subordinated debenture (Trust I)

 

4,124

 

3,436

 

Three-month LIBOR + 3.10%

3.33

%  

6/26/2033

 

6/26/2008

Junior subordinated debenture (Trust II)

 

6,186

 

5,153

 

Three-month LIBOR + 1.80%

2.05

%  

9/15/2036

 

9/15/2011

Finance lease liability

 

2,700

 

484

 

Fixed

 

7.81

%  

10/31/2022

 

N/A

Total long-term debt

$

63,010

$

58,745

 

  

 

  

 

  

 

  

December 31, 2019

Period End

Face

Carrying

Interest

Maturity

(dollars in thousands)

    

Value

    

Value

    

Interest Rate

    

Rate

    

Date

    

Call Date

Subordinated notes payable

$

50,000

$

49,625

 

Fixed

 

5.75

%  

12/30/2025

 

12/30/2020

Junior subordinated debenture (Trust I)

 

4,124

 

3,402

 

Three-month LIBOR + 3.10%

5.05

%  

6/26/2033

 

6/26/2008

Junior subordinated debenture (Trust II)

 

6,186

 

5,102

 

Three-month LIBOR + 1.80%

3.69

%  

9/15/2036

 

9/15/2011

Finance lease liability

 

2,700

 

640

 

Fixed

 

7.81

%  

10/31/2022

 

N/A

Total long-term debt

$

63,010

$

58,769

 

  

 

  

 

  

 

  

NOTE 11 Financial Instruments with Off-Balance Sheet Risk

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

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

September 30, 

December 31, 

(dollars in thousands)

    

2020

    

2019

Commitments to extend credit

$

596,642

$

586,365

Standby letters of credit

 

7,073

 

8,516

Total

$

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.

25


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 were in the form of restricted stock or restricted stock units and are considered to represent an element of employee compensation. Compensation expense for the awards is based on the fair value of Alerus Financial Corporation common stock at the time of grant. The value of awards that are expected to vest are amortized into expense over the vesting periods. The ability to grant awards under this plan has expired.

On May 6, 2019, the Company’s stockholders approved the Alerus Financial Corporation 2019 Equity Incentive Plan. This plan allows the compensation committee the ability to grant a wide variety of equity awards, including stock options, stock appreciation rights, restricted stock, restricted stock units and cash incentive awards in such forms and amounts as it deems appropriate to accomplish the goals of the plan. Any shares subject to an award that is cancelled, forfeited, or expires prior to exercise or realization, either in full or in part, shall again become available for issuance under the plan. However, shares subject to an award shall not again be made available for issuance or delivery under the plan if such shares are (a) tendered in payment of the exercise price of a stock option, (b) delivered to, or withheld by, the Company to satisfy any tax withholding obligation, or (c) covered by a stock-settled stock appreciation right or other awards that were not issued upon the settlement of the award. Shares vest, become exercisable and contain such other terms and conditions as determined by the compensation committee and set forth in individual agreements with the participant receiving the award. The plan authorizes the issuance of up to 1,100,000 shares of common stock. As of September 30, 2020, 28,242 stock awards and 49,604 restricted stock units had been issued under the plan.

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 activity in the stock plans for the nine months ended September 30, 2020 and 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 $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.

26


NOTE 13 Income Taxes

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

Three months ended September 30, 

2020

2019

    

    

Percent of

  

  

    

Percent of

  

(dollars in thousands)

Amount

Pretax Income

  

Amount

Pretax Income

  

Taxes at statutory federal income tax rate

$

4,894

 

21.0

%

$

1,982

 

21.0

Tax effect of:

 

 

Tax exempt income

(134)

 

(0.6)

%

(107)

 

(1.1)

Other

888

 

3.8

%

457

 

4.8

Applicable income taxes

$

5,648

24.2

%

$

2,332

24.7

Nine months ended September 30, 

2020

2019

    

    

Percent of

  

  

    

Percent of

 

(dollars in thousands)

Amount

Pretax Income

  

Amount

Pretax Income

 

Taxes at statutory federal income tax rate

$

9,491

 

21.0

$

6,114

 

21.0

%

Tax effect of:

 

  

 

  

 

  

 

  

Tax exempt income

 

(382)

 

(0.8)

 

(329)

 

(1.1)

%

Other

1,589

3.5

1,440

4.9

%

Applicable income taxes

$

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 14 Segment Reporting

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

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

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

Three months ended September 30, 2020

Retirement and

Wealth

Corporate

(dollars in thousands)

    

Banking

    

Benefit Services

    

Management

    

Mortgage

    

Administration

    

Consolidated

Net interest income

$

21,994

$

$

$

613

$

(842)

$

21,765

Provision for loan losses

 

3,500

 

��

 

 

 

 

3,500

Noninterest income

 

3,398

 

15,104

 

4,486

 

22,269

 

(1)

 

45,256

Noninterest expense

 

10,876

 

8,347

 

2,110

 

9,769

 

9,112

 

40,214

Net income before taxes

$

11,016

$

6,757

$

2,376

$

13,113

$

(9,955)

$

23,307

27


    

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

Three months ended September 30, 2019

Retirement and

Wealth

Corporate

(dollars in thousands)

    

Banking

    

Benefit Services

    

Management

    

Mortgage

    

Administration

    

Consolidated

Net interest income

$

19,193

$

$

$

384

$

(896)

$

18,681

Provision for loan losses

1,498

1,498

Noninterest income

1,695

15,307

3,896

8,135

547

29,580

Noninterest expense

10,800

8,551

1,835

7,256

8,885

37,327

Net income before taxes

$

8,590

$

6,756

$

2,061

$

1,263

$

(9,234)

$

9,436

    

Nine months ended September 30, 2019

Retirement and

Wealth

Corporate

(dollars in thousands)

    

Banking

    

Benefit Services

    

Management

    

Mortgage

    

Administration

    

Consolidated

Net interest income

$

57,987

$

$

$

818

$

(2,713)

$

56,092

Provision for loan losses

 

5,515

 

 

 

 

 

5,515

Noninterest income

 

5,273

 

46,142

 

11,385

 

19,739

 

2,099

 

84,638

Noninterest expense

 

30,880

 

26,142

 

5,936

 

17,184

 

25,960

 

106,102

Net income before taxes

$

26,865

$

20,000

$

5,449

$

3,373

$

(26,574)

$

29,113

Banking

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

Retirement and Benefit Services

Retirement and Benefit Services provides the following services nationally: recordkeeping and administration services to qualified retirement plans; ESOP trustee, recordkeeping, and administration; investment fiduciary services to retirement plans; health savings accounts, flex spending accounts, COBRA recordkeeping and administration services, and payroll to employers; 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 division offers first and second mortgage loans through a centralized mortgage unit in Minneapolis, Minnesota as well as through the Banking office locations.

28


NOTE 15 Earnings Per Share

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

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

Three months ended

Nine months ended

September 30, 

September 30, 

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

    

2020

    

2019

    

2020

    

2019

Net income

$

17,659

$

7,104

$

34,496

$

21,888

Dividends and undistributed earnings allocated to participating securities

315

154

600

514

Net income available to common shareholders

$

17,344

$

6,950

$

33,896

$

21,374

Weighted-average common shares outstanding for basic earnings per share

17,121

14,274

17,101

 

13,957

Dilutive effect of stock-based awards

332

 

352

 

334

 

360

Weighted-average common shares outstanding for diluted earnings per share

17,453

14,626

17,435

14,317

Earnings per common share:

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

NOTE 16 Derivative Instruments

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

September 30, 2020

December 31, 2019

Fair

Notional

Fair

Notional

(dollars in thousands)

    

    

Value

    

Amount

    

Value

    

Amount

Asset Derivatives

 

Consolidated Balance Sheet Location

 

  

 

  

 

  

 

  

Interest rate lock commitments

 

Accrued interest and Other assets

$

13,133

$

401,313

$

1,228

$

45,715

Forward loan sales commitments

 

Accrued interest and Other assets

 

1,545

 

54,310

 

393

 

12,784

Total asset derivatives

 

  

$

14,678

$

455,623

$

1,621

$

58,499

Liability Derivatives

 

  

 

  

 

  

 

  

 

  

TBA mortgage backed securities

 

Accrued expenses and other liabilities

$

1,960

$

380,063

$

109

$

68,500

Total liability derivatives

 

  

$

1,960

$

380,063

$

109

$

68,500

29


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

Three months ended

Nine months ended

Consolidated Statements of

September 30, 

September 30, 

September 30, 

September 30, 

(dollars in thousands)

    

of Income Location

    

2020

    

2019

    

2020

    

2019

Interest rate lock commitments

 

Mortgage banking/Other noninterest income

$

5,647

$

(257)

$

11,226

$

2,024

Forward loan sales commitments

 

Mortgage banking

369

(199)

1,152

454

TBA mortgage backed securities

 

Mortgage banking

(3,747)

680

 

(9,099)

 

(104)

Total gain/(loss) from derivative instruments

 

$

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.

NOTE 17 Regulatory Matters

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

Quantitative measures established by regulation to ensure capital adequacy require the Company and the Bank to maintain minimum amounts and ratios (set forth in the following table) of common equity tier 1, tier 1, and total capital (as defined in the regulations) to risk weighted assets (as defined) and of tier 1 capital (as defined) to average assets (as defined). Management believes at September 30, 2020 and December 31, 2019, each of the Company and the Bank had met all of the capital adequacy requirements to which it was subject.

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

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

 

Common equity tier 1 capital to risk weighted assets

 

  

 

  

 

  

 

  

 

  

 

  

Consolidated

$

270,679

 

13.08

%  

$

93,151

 

4.50

%  

$

N/A

 

N/A

Bank

 

257,835

 

12.47

%  

 

93,076

 

4.50

%  

 

134,443

 

6.50

%

Tier 1 capital to risk weighted assets

 

  

 

 

 

  

 

  

 

 

.

 

  

Consolidated

 

278,959

 

13.48

%  

 

124,202

 

6.00

%  

 

N/A

 

N/A

Bank

 

257,835

 

12.47

%  

 

124,102

 

6.00

%  

 

165,469

 

8.00

%

Total capital to risk weighted assets

 

  

 

  

 

 

  

 

  

 

 

  

 

  

Consolidated

 

354,573

 

17.13

%  

 

165,603

 

8.00

%  

 

N/A

 

N/A

Bank

 

283,758

 

13.72

%  

 

165,469

 

8.00

%  

 

206,836

 

10.00

%

Tier 1 capital to average assets

 

  

 

  

 

 

  

 

  

 

 

  

 

  

Consolidated

 

278,959

 

9.76

%  

 

114,293

 

4.00

%  

 

N/A

 

N/A

Bank

 

257,835

 

9.03

%  

 

114,207

 

4.00

%  

 

142,759

 

5.00

%

30


December 31, 2019

 

Minimum to be

Requirements

Well Capitalized

 

for Capital

Under Prompt

 

Actual

Adequacy Purposes

Corrective Action

 

(dollars in thousands)

    

Amount

    

Ratio

    

Amount

    

Ratio

    

Amount

    

Ratio

 

Common equity tier 1 capital to risk weighted assets

 

  

 

  

 

  

 

  

 

  

 

  

Consolidated

$

239,672

 

12.48

%  

$

86,452

 

4.50

%  

$

N/A

 

N/A

Bank

 

228,512

 

11.91

%  

 

86,362

 

4.50

%  

 

124,745

 

6.50

%

Tier 1 capital to risk weighted assets

 

  

 

 

 

  

 

  

 

 

.

 

  

Consolidated

 

247,866

 

12.90

%  

 

115,270

 

6.00

%  

 

N/A

 

N/A

Bank

 

228,512

 

11.91

%  

 

115,149

 

6.00

%  

 

153,532

 

8.00

%

Total capital to risk weighted assets

 

  

 

  

 

 

  

 

  

 

 

  

 

  

Consolidated

 

321,415

 

16.73

%  

 

153,693

 

8.00

%  

 

N/A

 

N/A

Bank

 

252,436

 

13.15

%  

 

153,532

 

8.00

%  

 

191,915

 

10.00

%

Tier 1 capital to average assets

 

  

 

  

 

 

  

 

  

 

 

  

 

  

Consolidated

 

247,866

 

11.05

%  

 

91,504

 

4.00

%  

 

N/A

 

N/A

Bank

 

228,512

 

10.20

%  

 

89,615

 

4.00

%  

 

112,018

 

5.00

%

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

NOTE 18 Fair Value of Assets and Liabilities

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

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

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

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

31


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

Recurring Basis

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

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

    

September 30, 2020

(dollars in thousands)

    

Level 1

    

Level 2

    

Level 3

    

Total

Available-for-sale and securities

 

  

 

  

 

  

 

  

U.S. treasury and government agencies

$

$

16,092

$

$

16,092

Obligations of state and political agencies

 

 

147,216

 

 

147,216

Mortgage backed securities

 

  

 

  

 

  

 

  

Residential agency

 

 

211,700

 

 

211,700

Commercial

 

 

87,542

 

 

87,542

Asset backed securities

 

 

131

 

 

131

Corporate bonds

 

 

32,733

 

 

32,733

Total available-for-sale securities

$

$

495,414

$

$

495,414

Other assets

 

  

 

  

 

  

 

  

Derivatives

$

$

14,678

$

$

14,678

Other liabilities

 

  

 

  

 

  

 

  

Derivatives

$

$

1,960

$

$

1,960

December 31, 2019

(dollars in thousands)

    

Level 1

    

Level 2

    

Level 3

    

Total

Available-for-sale and equity securities

 

  

 

  

 

  

 

  

U.S. treasury and government agencies

$

$

21,240

$

$

21,240

Obligations of state and political agencies

 

 

68,648

 

 

68,648

Mortgage backed securities

 

  

 

  

 

  

 

  

Residential agency

 

 

182,538

 

 

182,538

Commercial

 

 

30,685

 

 

30,685

Asset backed securities

 

 

144

 

 

144

Corporate bonds

 

 

7,095

 

 

7,095

Equity securities

 

2,808

 

 

 

2,808

Total available-for-sale and equity securities

$

2,808

$

310,350

$

$

313,158

Other assets

 

  

 

  

 

  

 

  

Derivatives

$

$

1,621

$

$

1,621

Other liabilities

 

  

 

  

 

  

 

  

Derivatives

$

$

109

$

$

109

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

Investment Securities

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

32


consider various assumptions, including time value, yield curve, volatility factors, prepayment speeds, default rates, loss severity, current market, and contractual prices for the underlying financial instruments, as well as other relevant economic measures. Substantially all of these assumptions are observable in the marketplace, can be derived from observable data, or are supported by observable levels at which transactions are executed in the marketplace. Estimated fair values from these models are verified, where possible, against quoted prices for recent trading activity of assets with similar characteristics to the security being valued. Such methods are generally classified as Level 2. However, when prices from independent sources vary, cannot be obtained, or cannot be corroborated, a security is generally classified as Level 3.

Derivatives

All of the Company’s derivatives are traded in over-the-counter markets where quoted market prices are not readily available. For these derivatives, estimated fair value is measured using internally developed models that use primarily market observable inputs, such as yield curves and option volatilities, and accordingly, classify as Level 2. Examples of Level 2 derivatives are basic interest rate swaps and forward contracts.

Nonrecurring Basis

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

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

September 30, 2020

(dollars in thousands)

    

Level 2

    

Level 3

    

Total

    

Impairment

Loans held for sale

$

111,311

$

$

111,311

$

Impaired loans

 

 

5,301

 

5,301

 

407

Foreclosed assets

 

 

10

 

10

 

Servicing rights

 

 

2,579

 

2,579

 

December 31, 2019

(dollars in thousands)

    

Level 2

    

Level 3

    

Total

    

Impairment

Loans held for sale

$

46,846

$

$

46,846

$

Impaired loans

 

 

4,816

 

4,816

 

3,138

Foreclosed assets

 

 

8

 

8

 

Servicing rights

 

 

3,845

 

3,845

 

Loans Held for Sale

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

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

33


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

September 30, 2020

(dollars in thousands)

Weighted

Asset Type

    

Valuation Technique

    

Unobservable Input

Fair Value

    

Range

    

Average

  

Impaired loans

 

Appraisal value

 

Property specific adjustment

$

5,301

 

N/A

N/A

 

Foreclosed assets

 

Appraisal value

 

Property specific adjustment

 

10

 

N/A

 

N/A

 

Servicing rights

 

Discounted cash flows

 

Prepayment speed assumptions

 

2,579

 

315-485

 

396

 

 

  

 

Discount rate

 

  

 

9.0

%  

9.0

December 31, 2019

(dollars in thousands)

Weighted

 

Asset Type

    

Valuation Technique

    

Unobservable Input

Fair Value

    

Range

    

Average

 

Impaired loans

 

Appraisal value

 

Property specific adjustment

$

4,816

 

N/A

 

N/A

Foreclosed assets

 

Appraisal value

 

Property specific adjustment

 

8

 

N/A

 

N/A

Servicing rights

 

Discounted cash flows

 

Prepayment speed assumptions

 

3,845

 

123-267

 

194

 

  

 

Discount rate

 

  

 

9.4

%  

9.4

%

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

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

Cash and Cash Equivalents and Accrued Interest

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

Loans

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

Bank-Owned Life Insurance

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

34


Deposits

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

Short-Term Borrowings and Long-Term Debt

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

Off-Balance Sheet Credit-Related Commitments

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

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

September 30, 2020

Carrying

Estimated Fair Value

(dollars in thousands)

    

Amount

    

Level 1

    

Level 2

    

Level 3

    

Total

Financial Assets

 

  

 

  

 

  

 

  

 

  

Cash and cash equivalents

$

95,751

$

95,751

$

$

$

95,751

Loans

 

2,027,082

 

 

 

2,075,044

 

2,075,044

Accrued interest receivable

 

9,199

 

9,199

 

 

 

9,199

Bank-owned life insurance

 

32,161

 

 

32,161

 

 

32,161

Financial Liabilities

 

  

 

  

 

  

 

  

 

  

Noninterest-bearing deposits

$

693,450

$

$

693,450

$

$

693,450

Interest-bearing deposits

 

1,561,498

 

 

1,561,498

 

 

1,561,498

Time deposits

 

207,422

 

 

 

208,990

 

208,990

Long-term debt

 

58,745

 

 

56,219

 

 

56,219

Accrued interest payable

 

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,

35


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

As an SBA-Certified Preferred lender, we were delegated the authority as part of the CARES Act to make PPP SBA-guaranteed financing available to eligible borrowers. As of September 30, 2020, we had assisted 1,632 new and existing clients secure approximately $363.6 million of PPP financing. The SBA pays a processing fee based on the 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 less than $2 million, and one percent for loans of at least $2 million. Net processing fees in the amount of $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.

36


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, 2020 and 2019. Annualized results for this interim period may not be indicative of results for the full year or future periods. The following discussion and analysis should be read in conjunction with the consolidated financial statements and related notes presented elsewhere in this report and the Company’s Annual Report on Form 10-K for the year ended December 31, 2019, filed with the Securities and Exchange Commission on March 26, 2020.

Forward-Looking Statements

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

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

the effects of the COVID-19 pandemic, including its 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;

37


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

38


any other risks described in the “Risk Factors” section of this report and in other reports filed by Alerus Financial Corporation with the Securities and Exchange Commission.

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

Overview

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

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

Critical Accounting Policies

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

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

Recent Developments

Impact of COVID-19

The progression of the COVID-19 pandemic in the United States has not had an adverse impact on our financial condition and results of operations as of and for the three and nine months ended September 30, 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 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

39


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 health and economic effects of COVID-19 have been concentrated in the largest U.S. cities, such as New York, but we are beginning to see similar effects in smaller cities and communities, where many of our banking operations are focused.

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

The Federal Reserve decreased the range for the Federal Funds Target Rate by 0.50% on March 3, 2020, and by another 1.00% 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,

40


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 above will continue to have a significant impact on our business. In particular, we anticipate that a significant portion of the Bank’s borrowers in the retail, restaurant, and hospitality industries will continue to endure significant economic distress, which could cause them to draw on their existing lines of credit and could adversely affect their ability and willingness to repay existing indebtedness, and is expected to adversely impact the value of collateral. These developments, together with economic conditions generally, are also expected to impact our commercial real estate portfolio, particularly with respect to real estate with exposure to 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 described in this Management’s Discussion and Analysis of Financial Condition and Results of Operations.

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

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

41


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

42


Operating Results Overview

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

Three months ended

Nine months ended

September 30, 

June 30, 

September 30, 

September 30, 

September 30, 

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

    

2020

    

2020

    

2019

    

2020

    

2019

    

Performance Ratios

 

 

 

 

 

Return on average total assets

 

2.42

%  

 

1.68

%  

 

1.29

%  

 

1.71

%  

 

1.34

%  

Return on average common equity

 

22.31

%  

 

15.30

%  

 

12.42

%  

 

15.17

%  

 

13.74

%  

Return on average tangible common equity (1)

 

26.67

%  

 

18.88

%  

 

17.01

%  

 

18.70

%  

 

19.24

%  

Noninterest income as a % of revenue

 

67.53

%  

 

65.55

%  

 

61.29

%  

 

64.58

%  

 

60.14

%  

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

 

3.17

%  

 

3.14

%  

 

3.69

%  

 

3.22

%  

 

3.72

%  

Efficiency ratio (1)

 

58.42

%  

 

66.31

%  

 

75.17

%  

 

66.22

%  

 

73.06

%  

Net charge-offs/(recoveries) to average loans

(0.11)

%  

 

0.66

%  

 

(0.06)

%  

 

0.15

%  

 

0.37

%  

Dividend payout ratio

 

15.15

%  

23.08

%  

29.17

%  

23.20

%  

28.19

%  

Per Common Share

 

 

 

 

 

Earnings per common share - basic

$

1.01

$

0.66

$

0.49

$

1.98

$

1.53

Earnings per common share - diluted

$

0.99

$

0.65

$

0.48

$

1.94

$

1.49

Dividends declared per common share

$

0.15

$

0.15

$

0.14

$

0.45

$

0.42

Tangible book value per common share (1)

$

16.31

$

15.30

$

13.77

Average common shares outstanding - basic

 

17,121

 

17,111

 

14,274

 

17,101

 

13,957

Average common shares outstanding - diluted

 

17,453

 

17,445

 

14,626

 

17,435

 

14,317

Other Data

 

 

 

 

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

511,605

431,638

313,527

$

1,171,811

$

685,178


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

Selected Financial Data

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

Three months ended

Nine months ended

September 30, 

June 30, 

September 30, 

September 30, 

September 30, 

(dollars in thousands)

    

2020

    

2020

    

2019

    

2020

    

2019

Selected Average Balance Sheet Data

 

 

 

 

 

Loans

$

2,034,778

$

1,986,028

$

1,691,542

$

1,917,894

$

1,715,629

Investment securities

 

443,705

 

369,247

 

257,561

 

383,591

 

255,903

Assets

 

2,908,144

 

2,740,330

 

2,176,862

 

2,690,182

 

2,185,868

Deposits

 

2,454,865

 

2,329,192

 

1,763,217

 

2,270,781

 

1,779,610

Short-term borrowings

 

 

321

 

87,201

 

107

 

95,489

Long-term debt

 

58,739

 

58,747

 

58,776

 

58,747

 

58,798

Stockholders’ equity

 

314,921

 

301,719

 

226,931

 

303,825

 

212,911

43


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

44


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, 

    

2020

    

2020

    

2019

    

2019

    

Tangible common equity to tangible assets

 

  

 

Total common stockholders’ equity

$

322,003

$

305,732

$

285,728

$

281,403

Less: Goodwill

 

27,329

 

27,329

 

27,329

 

27,329

Less: Other intangible assets

 

15,421

 

16,411

 

18,391

 

19,382

Tangible common equity (a)

 

279,253

 

261,992

 

240,008

 

234,692

Total assets

 

2,898,809

 

2,875,457

 

2,356,878

 

2,228,311

Less: Goodwill

 

27,329

 

27,329

 

27,329

 

27,329

Less: Other intangible assets

 

15,421

 

16,411

 

18,391

 

19,382

Tangible assets (b)

 

2,856,059

 

2,831,717

 

2,311,158

 

2,181,600

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

 

9.78

%  

 

9.25

%  

 

10.38

%  

 

10.76

%  

Tangible book value per common share

Total common stockholders’ equity

$

322,003

$

305,732

$

285,728

$

281,403

Less: Goodwill

27,329

27,329

27,329

27,329

Less: Other intangible assets

15,421

16,411

18,391

19,382

Tangible common equity (c)

279,253

261,992

240,008

234,692

Total common shares issued and outstanding (d)

17,122

17,120

 

17,050

 

17,049

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

$

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

%  

45


Discussion and Analysis of Results of Operations

Net Income

Net income for the three months ended September 30, 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, for the three months ended September 30, 2019. This increase in net income was primarily due to a $15.7 million increase in noninterest income and a $3.1 million increase in net interest income, partially offset by increases of $2.9 million in noninterest expense, $2.0 million in provision expense, and $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 was primarily attributable to an increase in compensation expense related to the increase in mortgage originations.

Net income for the nine months ended September 30, 2020 was $34.5 million, or $1.94 per diluted common share, compared to $21.9 million, or $1.49 per diluted common share, for the nine months ended September 30, 2019. The increase of $12.6 million was due to increases of $26.0 million in noninterest income and $4.6 million in net interest income, partially offset by increases of $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 nonintere