Table of Contents
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
FORM 10-Q
☒ QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 2021
☐ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
Commission File Number: 001-39036
ALERUS FINANCIAL CORPORATION
(Exact name of registrant as specified in its charter)
Delaware
45-0375407
(State or other jurisdiction of incorporation or
(I.R.S. Employer Identification No.)
organization)
401 Demers Avenue
Grand Forks, ND
58201
(Address of principal executive offices)
(Zip Code)
(701) 795-3200
(Registrant’s telephone number, including area code)
Securities registered pursuant to section 12(b) of the Act:
Title of each class
Trading symbol
Name of each exchange on which registered
Common Stock, par value $1.00 per share
ALRS
The Nasdaq Stock Market LLC
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ☒ No ◻
Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). Yes ☒ No ◻
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, smaller reporting company or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company” and “emerging growth company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer ◻
Accelerated filer ⌧
Non-accelerated filer ◻
Smaller reporting company ☐
Emerging growth company ☒
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). Yes ☐ No ⌧
The number of shares of the registrant’s common stock outstanding at October 31, 2021 was 17,208,077.
Alerus Financial Corporation and Subsidiaries
Page
Part 1:
FINANCIAL INFORMATION
Item 1.
Consolidated Financial Statements
1
Consolidated Balance Sheets as of September 30, 2021 and December 31, 2020
Consolidated Statements of Income for the three and nine months ended September 30, 2021 and 2020
2
Consolidated Statements of Comprehensive Income for the three and nine months ended September 30, 2021 and 2020
3
Consolidated Statements of Changes in Stockholders’ Equity for the three and nine months ended September 30, 2021 and 2020
4
Consolidated Statements of Cash Flows for the nine months ended September 30, 2021 and 2020
5
Notes to Consolidated Financial Statements
7
Item 2.
Management’s Discussion and Analysis of Financial Condition and Results of Operations
36
Item 3.
Quantitative and Qualitative Disclosures About Market Risk
60
Item 4.
Controls and Procedures
62
Part 2:
OTHER INFORMATION
Legal Proceedings
63
Item 1A.
Risk Factors
Unregistered Sales of Equity Securities and Use of Proceeds
Defaults Upon Senior Securities
64
Mine Safety Disclosures
Item 5.
Other Information
Item 6.
Exhibits
65
Signatures
66
PART 1. FINANCIAL INFORMATION
Item 1 - Consolidated Financial Statements
Consolidated Balance Sheets
September 30,
December 31,
(dollars in thousands, except share and per share data)
2021
2020
Assets
(Unaudited)
(Audited)
Cash and cash equivalents
$
159,454
172,962
Investment securities
Available-for-sale, at fair value
655,282
592,342
Held-to-maturity, at carrying value
362,586
—
Loans held for sale
60,912
122,440
Loans
1,800,386
1,979,375
Allowance for loan losses
(32,066)
(34,246)
Net loans
1,768,320
1,945,129
Land, premises and equipment, net
18,403
20,289
Operating lease right-of-use assets
3,821
6,918
Accrued interest receivable
8,836
9,662
Bank-owned life insurance
32,954
32,363
Goodwill
30,201
Other intangible assets
22,593
25,919
Servicing rights
1,776
1,987
Deferred income taxes, net
11,609
9,409
Other assets
38,422
44,150
Total assets
3,175,169
3,013,771
Liabilities and Stockholders’ Equity
Deposits
Noninterest-bearing
797,062
754,716
Interest-bearing
1,916,026
1,817,277
Total deposits
2,713,088
2,571,993
Long-term debt
58,963
58,735
Operating lease liabilities
4,428
7,861
Accrued expenses and other liabilities
45,495
45,019
Total liabilities
2,821,974
2,683,608
Stockholders’ equity
Preferred stock, $1 par value, 2,000,000 shares authorized: 0 issued and outstanding
Common stock, $1 par value, 30,000,000 shares authorized: 17,208,077 and 17,125,270 issued and outstanding
17,208
17,125
Additional paid-in capital
91,783
90,237
Retained earnings
243,638
212,163
Accumulated other comprehensive income (loss)
566
10,638
Total stockholders’ equity
353,195
330,163
Total liabilities and stockholders’ equity
See accompanying notes to consolidated financial statements (unaudited)
Consolidated Statements of Income (Unaudited)
Three months ended
Nine months ended
(dollars and shares in thousands, except per share data)
Interest Income
Loans, including fees
18,888
21,962
58,779
63,876
Taxable
3,249
1,973
8,547
5,497
Exempt from federal income taxes
225
238
694
712
Other
185
116
432
816
Total interest income
22,547
24,289
68,452
70,901
Interest Expense
880
1,683
2,781
7,633
535
841
1,361
2,575
Total interest expense
1,415
2,524
4,142
10,208
Net interest income
21,132
21,765
64,310
60,693
Provision for loan losses
(2,000)
3,500
9,500
Net interest income after provision for loan losses
23,132
18,265
66,310
51,193
Noninterest Income
Retirement and benefit services
18,031
15,104
53,157
45,034
Wealth management
5,295
4,486
15,419
12,644
Mortgage banking
11,116
22,269
40,535
44,860
Service charges on deposit accounts
357
355
1,025
1,075
Net gains (losses) on investment securities
11
1,428
125
2,722
1,230
1,614
3,408
4,340
Total noninterest income
36,040
45,256
113,669
110,675
Noninterest Expense
Compensation
23,291
22,740
71,298
62,684
Employee taxes and benefits
5,058
5,033
16,443
15,088
Occupancy and equipment expense
2,063
2,511
6,212
7,615
Business services, software and technology expense
5,332
4,378
15,266
13,501
Intangible amortization expense
1,088
990
3,327
2,971
Professional fees and assessments
1,503
1,070
4,484
3,303
Marketing and business development
865
929
2,310
2,088
Supplies and postage
549
248
1,583
1,630
Travel
174
26
236
338
Mortgage and lending expenses
1,231
1,434
3,762
3,916
887
855
2,712
3,540
Total noninterest expense
42,041
40,214
127,633
116,674
Income before income taxes
17,131
23,307
52,346
45,194
Income tax expense
4,064
5,648
12,370
10,698
Net income
13,067
17,659
39,976
34,496
Per Common Share Data
Basic earnings per common share
0.75
1.01
2.29
1.98
Diluted earnings per common share
0.74
0.99
2.26
1.94
Dividends declared per common share
0.16
0.15
0.47
0.45
Average common shares outstanding
17,205
17,121
17,182
17,101
Diluted average common shares outstanding
17,499
17,453
17,488
17,435
Consolidated Statements of Comprehensive Income (Unaudited)
(dollars in thousands)
Net Income
Other Comprehensive Income (Loss), Net of Tax
Unrealized gains (losses) on available-for-sale securities
(2,496)
2,459
(13,101)
14,212
Accretion of (gains) losses on debt securities reclassified to held-to-maturity
(106)
(221)
Reclassification adjustment for losses (gains) realized in income
(11)
(1,428)
(125)
(2,722)
Total other comprehensive income (loss), before tax
(2,613)
1,031
(13,447)
11,490
Income tax expense (benefit) related to items of other comprehensive income
(656)
259
(3,375)
2,883
Other comprehensive income (loss), net of tax
(1,957)
772
(10,072)
8,607
Total comprehensive income
11,110
18,431
29,904
43,103
Consolidated Statements of Changes in Stockholders’ Equity (Unaudited)
Three months ended September 30, 2021
Accumulated
Additional
Common
Paid-in
Retained
Comprehensive
(dollars and shares in thousands)
Stock
Capital
Earnings
Income (Loss)
Total
Balance as of June 30, 2021
17,198
91,273
233,397
2,523
344,391
Other comprehensive income (loss)
Common stock repurchased
(2)
(23)
(50)
(75)
Common stock dividends
(2,776)
Stock-based compensation expense
545
Vesting of restricted stock
12
(12)
Balance as of September 30, 2021
Nine months ended September 30, 2021
Balance as of December 31, 2020
(18)
(157)
(346)
(521)
(8,155)
Share‑based compensation expense
8
1,796
1,804
93
(93)
Three months ended September 30, 2020
Balance as of June 30, 2020
17,120
89,313
189,528
9,771
305,732
(29)
(7)
(36)
(2,599)
475
Balance as of September 30, 2020
17,122
89,757
204,581
10,543
322,003
Nine months ended September 30, 2020
Balance as of December 31, 2019
17,050
88,650
178,092
1,936
285,728
(15)
(140)
(217)
(372)
(7,790)
14
1,320
1,334
73
(73)
Consolidated Statements of Cash Flows (Unaudited)
Operating Activities
Adjustments to reconcile net income to net cash provided (used) by operating activities
Deferred income taxes
1,176
(3,620)
Depreciation and amortization
6,726
6,657
Amortization and accretion of premiums/discounts on investment securities
2,506
1,140
Amortization of operating lease right-of-use assets
(40)
Stock-based compensation
Increase in value of bank-owned life insurance
(591)
(595)
Realized loss (gain) on sale of fixed assets
(62)
Realized loss (gain) on derivative instruments
6,612
(3,282)
Realized loss (gain) on loans sold
(39,940)
(37,220)
Realized loss (gain) on sale of foreclosed assets
(203)
(26)
Realized loss (gain) on sale of investment securities
Realized loss (gain) on servicing rights
(369)
574
Net change in:
101,482
(27,325)
826
(1,648)
(1,951)
(2,842)
1,913
5,754
Net cash provided (used) by operating activities
117,740
(19,843)
Investing Activities
Proceeds from sales or calls of investment securities available-for-sale
13,189
74,630
Proceeds from maturities of investment securities available-for-sale
91,240
39,208
Purchases of investment securities available-for-sale
(331,785)
(285,830)
Proceeds from sales or calls of investment securities held-to-maturity
1,763
Proceeds from maturities of investment securities held-to-maturity
2,681
Purchases of investment securities held-to-maturity
(218,443)
Net (increase) decrease in equity securities
2,808
Net (increase) decrease in loans
177,675
(339,758)
Purchases of premises and equipment
(845)
(2,761)
Proceeds from sales of foreclosed assets
539
555
Net cash provided (used) by investing activities
(263,986)
(511,148)
Financing Activities
Net increase (decrease) in deposits
141,095
491,054
Repayments of long-term debt
(49,861)
(156)
Proceeds from the issuance of subordinated debt
50,000
Cash dividends paid on common stock
(7,975)
Repurchase of common stock
Net cash provided (used) by financing activities
132,738
482,736
Net change in cash and cash equivalents
(13,508)
(48,255)
Cash and cash equivalents at beginning of period
144,006
Cash and cash equivalents at end of period
95,751
Supplemental Cash Flow Disclosures
Cash paid for:
Interest
3,498
9,838
Income taxes
12,075
11,041
Non-cash information
Loan collateral transferred to foreclosed assets
1,135
531
Unrealized gain (loss) on investment securities available-for-sale
(9,851)
Accretion of unrealized (gain) loss on investment securities held-to-maturity
Investment securities transferred to held-to-maturity
149,191
Right-of-use assets obtained in exchange for new operating leases
1,531
6
Notes to Consolidated Financial Statements (Unaudited)
NOTE 1 Significant Accounting Policies
Organization
Alerus Financial Corporation, or the Company, is a financial holding company organized under the laws of the state of Delaware. The Company and its subsidiaries operate as a diversified financial services company headquartered in Grand Forks, North Dakota. Through its subsidiary, Alerus Financial, National Association, or the Bank, the Company provides financial solutions to businesses and consumers through four distinct business lines—banking, retirement and benefit services, wealth management, and mortgage.
Basis of Presentation
The accompanying unaudited consolidated financial statements and notes thereto of the Company have been prepared in accordance with the rules and regulations of the Securities and Exchange Commission, or SEC, and conform to practices within the banking industry and include all of the information and disclosures required by generally accepted accounting principles in the United States of America, or GAAP, for interim financial reporting. The accompanying unaudited consolidated financial statements reflect all adjustments (consisting only of normal recurring adjustments) that are necessary for a fair presentation of financial results for the interim periods presented. The results of operations for the interim periods are not necessarily indicative of the results for the full year or any other period. The Company has also evaluated all subsequent events for potential recognition and disclosure through the date of the filing of this Quarterly Report on Form 10-Q. These interim unaudited financial statements should be read in conjunction with the audited consolidated financial statements and the notes thereto as of and for the year ended December 31, 2020, included in the Company’s Annual Report on Form 10-K filed with the SEC on March 12, 2021.
Principles of Consolidation
The accompanying unaudited consolidated financial statements include the accounts of the Company and its wholly owned subsidiaries. The Company’s principal operating subsidiary is the Bank.
In the normal course of business, the Company may enter into a transaction with a variable interest entity, or VIE. VIE’s are legal entities whose investors lack the ability to make decisions about the entity’s activities, or whose equity investors do not have the right to receive the residual returns of the entity. The applicable accounting guidance requires the Company to perform ongoing quantitative and qualitative analysis to determine whether it must consolidate any VIE. The Company does not have any ownership interest in, or exert any control, over any VIE, and thus no VIE’s are included in the consolidated financial statements.
Use of Estimates
The preparation of consolidated financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenue and expenses during the reporting period. Actual results could differ from those estimates.
Material estimates that are particularly susceptible to significant change in the near term include the valuation of investment securities, determination of the allowance for loan losses, valuation of reporting units for the purpose of testing goodwill and other intangible assets for impairment, valuation of deferred tax assets, and fair values of financial instruments.
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.
As of September 30, 2021, the Coronavirus Disease, or COVID-19, pandemic is ongoing. During 2020, the COVID-19 pandemic created disruption in global supply chains, increased rates of unemployment and adversely impacted many industries, including industries related to the collateral underlying certain of our loans, and many of these effects are continuing. In 2021, the U.S. economy has, with certain setbacks, begun reopening and wider distribution of vaccines has encouraged greater economic activity. Nonetheless, the economic recovery could remain uneven, particularly given uncertainty with respect to the distribution and acceptance of the vaccines and their effectiveness with respect to new variants of the virus. Management believes the Company is taking appropriate actions to mitigate, to the extent possible, the negative impact. However, the full impact of COVID-19 is currently unknown and cannot be reasonably estimated as the events are continuing to unfold as the year progresses.
Emerging Growth Company
The Company qualifies as an “emerging growth company” under the Jumpstart Our Business Startups Act of 2012, or the JOBS Act, and may take advantage of certain exemptions from various reporting requirements that are applicable to public companies that are not emerging growth companies, including, but not limited to, not being required to comply with the auditor attestation requirements of Section 404 of the Sarbanes-Oxley Act, reduced disclosure obligations regarding executive compensation in periodic reports and proxy statements, and exemptions from the requirements of holding a nonbinding advisory vote on executive compensation and shareholder approval of any golden parachute payments not previously approved. In addition, even if the Company complies with the greater obligations of public companies that are not emerging growth companies, the Company may avail itself of the reduced requirements applicable to emerging growth companies from time to time in the future, so long as the Company is an emerging growth company. The Company will continue to be an emerging growth company until the earliest to occur of: (1) the end of the fiscal year following the fifth anniversary of the date of the first sale of common equity securities under the Company’s Registration Statement on Form S-1, which was declared effective by the SEC on September 12, 2019; (2) the last day of the fiscal year in which the Company has $1.07 billion or more in annual revenues; (3) the date on which the Company is deemed to be a “large accelerated filer” under the Securities Exchange Act of 1934, as amended, or the “Exchange Act”; or (4) the date on which the Company has, during the previous three-year period, issued publicly or privately, more than $1.0 billion in non-convertible debt securities.
Section 107 of the JOBS Act provides that an emerging growth company can take advantage of the extended transition period provided in Section 7(a)(2)(B) of the Securities Act of 1933 for complying with new or revised accounting standards. As an emerging growth company, the Company can delay the adoption of certain accounting standards until those standards would otherwise apply to private companies. The Company elected to take advantage of the benefits of this extended transition period.
Investment Securities
Held-to-maturity securities consist of debt securities, primarily obligations of state and political agencies. Held-to-maturity securities are carried at amortized cost based on the Company’s intent and ability to hold these securities to maturity. Interest earned on held-to-maturity debt securities is included in interest income. Amortization or accretion of premiums and discounts is also recognized in interest income using the effective interest method over the contractual life of the security and is adjusted to reflect actual prepayments. Transfers of debt securities from available-for-sale to held-to-maturity are made at fair value at the date of transfer. Unrealized holding gains and losses at the date of transfer are included in other comprehensive income and in the carrying value of the held-to-maturity security are amortized over the remaining life of the security.
NOTE 2 Recent Accounting Pronouncements
The following FASB Accounting Standards Updates, or ASUs, are divided into pronouncements which have been adopted by the Company since January 1, 2021, and those which are not yet effective and have been evaluated or are currently being evaluated by management as of September 30, 2021.
Adopted Pronouncements
In January 2020, the FASB issued ASU 2020-01, Investments – Equity Securities (Topic 321), Investments – Equity Method and Joint Ventures (Topic 323), and Derivatives and Hedging (Topic 815) – Clarifying the Interactions between Topic 321, Topic 323, and Topic 815. The ASU is based on a consensus of the Emerging Issues Task Force and is expected to increase comparability in accounting for these transactions. ASU 2016-01 made targeted improvements to accounting for financial instruments, including providing an entity the ability to measure certain equity securities without a readily determinable fair value at cost, less any impairment, plus or minus changes resulting from observable price changes in orderly transactions for the identical or a similar investment of the same issuer. Among other topics, the amendments clarify that an entity should consider observable transactions that require it to either apply or discontinue the equity method of accounting. For public business entities, the amendments in the ASU are effective for fiscal years beginning after December 15, 2020, and interim periods within those fiscal years. Early adoptions are permitted. The Company adopted ASU 2020-01 as of January 1, 2021 the implementation had no impact on its consolidated financial statements.
In March 2020, the FASB issued ASU 2020-04, Reference Rate Reform (Topic 848): Facilitation of the Effects of Reference Rate Reform on Financial Reporting. These amendments provide temporary optional guidance to ease the potential burden in accounting for reference rate reform. The ASU provides optional expedients and exceptions for applying GAAP to contract modifications and hedging relationships, subject to meeting certain criteria, that reference LIBOR or another reference rate expected to be discontinued. It is intended to help stakeholders during the global market-wide reference rate transition period. The guidance is effective for all entities as of March 12, 2020 through December 31, 2022. In January 2021, the FASB issued ASU 2021-01, Reference Rate Reform (Topic 848) in response to concerns about structural risks in accounting for reference rate reform. The ASU clarifies certain optional expedients and exceptions in Topic 848 for contract modifications and hedge accounting to apply to derivatives that are affected by the discontinuing transition. The Company adopted ASU 2020-04, as of March 2020 and is putting a transition plan together but does not expect adoption to have a material impact on the Company’s consolidated financial statements.
Pronouncements Not Yet Effective
In June 2016, the FASB issued ASU No. 2016-13, Financial Instruments – Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments. This ASU requires a new impairment model known as the current expected credit loss, or CECL, which significantly changes the way impairment of financial instruments is recognized by requiring immediate recognition of estimated credit losses expected to occur over the remaining life of financial instruments. The main provisions of ASU 2016-13 include (1) replacing the “incurred cost” approach under GAAP with an “expected loss” model for instruments measured at amortized cost, (2) requiring entities to record an allowance for credit losses related to available-for-sale debt securities rather than a direct write-down of the carrying amount of the investments, as is required by the other-than-temporary impairment model under current GAAP, and (3) a simplified accounting model for purchase credit-impaired debt securities and loans. In November 2019, the FASB issued ASU No. 2019-10, Financial Instruments – Credit Losses (Topic 326). This update amends the effective date of ASU No. 2016-13 for certain entities, including private companies and smaller reporting companies, until fiscal years beginning after December 15, 2022, including interim periods within those fiscal periods. Early adoption is permitted. As an emerging growth company, the Company can take advantage of this delay and plans to adopt the standard with the amended effective date. The Company does not plan to early adopt this standard but continues to work on its implementation. The Company continues collecting and retaining loan and credit data and evaluating various loss estimation models. While we currently cannot reasonably estimate the impact of adopting this standard, we expect the impact will be influenced by the composition, characteristics, and quality of our loan portfolio, as well as the general economic conditions and forecasts as of the adoption date.
9
In April 2019, the FASB issued ASU 2019-04, Codification Improvements to Topic 326, Financial Instruments—Credit Losses, Topic 815, Derivatives and Hedging, and Topic 825, Financial Instruments, which affects a variety of topics in the Codification and applies to all reporting entities within the scope of the affected accounting guidance. The Company will consider these clarifications and improvements in determining the appropriate adoption of ASU 2019-04.
In May 2019, the FASB issued ASU 2019-05, Targeted Transition Relief to provide entities with an option to irrevocably elect the fair value option applied on an instrument-by-instrument basis for eligible instruments. In November 2019, the FASB Issued ASU 2019-10, which amends the effective date of this ASU for certain entities, including private companies and smaller reporting companies until after December 15, 2022, including interim periods within those fiscal years. As an emerging growth company, the Company can take advantage of this delay and plans to adopt the standard with the amended effective date. This update is not expected to have a significant impact on the Company’s consolidated financial statements.
In December 2019, the FASB issued ASU 2019-12, Income Taxes (Topic 740), which simplifies accounting for income taxes by removing certain exceptions to the general principles in Topic 740. The amendments also improve consistent application of and simplify GAAP for the areas of Topic 740 by clarifying and amending existing guidance. This guidance is effective for fiscal years, and interim periods within those fiscal years beginning after December 15, 2020, for public business entities. For private companies and smaller reporting companies, this guidance is effective for fiscal years, and interim periods within those fiscal years beginning after December 15, 2021. As an emerging growth company, the Company can take advantage of this later effective date. Early adoption of the amendments is permitted, including adoption in any interim period for which financial statements have not yet been issued. Depending on the amendment, adoption may be applied on the retrospective, modified retrospective, or prospective basis. The Company is currently reviewing the provisions of this new pronouncement but does not expect adoption of this guidance to have a material impact on the Company’s consolidated financial statements.
In March 2020, the FASB issued ASU 2020-03, Codification Improvements to Financial Instruments. This ASU represents changes to clarify or improve the Accounting Standards Codification, or ASC, related to seven topics. The amendments make the ASC easier to understand and easier to apply by eliminating inconsistencies and providing clarifications. Issues 1, 2, 3, 4, and 5 are conforming amendments and for public business entities effective upon the issuance of the standard. Issues 6 and 7 are amendments that affect the guidance in ASU 2016-13. The Company will consider these clarifications and improvements in determining the appropriate adoption of ASU 2016-13.
NOTE 3 Investment Securities
The following tables present amortized cost, gross unrealized gain and losses, and fair value of the available-for-sale investment securities and the amortized cost, net unrealized gains, carrying value, gross unrealized gains and losses and fair value of for held-to-maturity as of September 30, 2021 and December 31, 2020:
10
September 30, 2021
Amortized
Unrealized
Fair
Cost
Gains
Losses
Value
Available-for-sale
U.S. Treasury and agencies
5,382
87
5,469
Mortgage backed securities
Residential agency
523,743
2,219
(7,490)
518,472
Commercial
91,336
3,582
94,918
Asset backed securities
61
Corporate bonds
35,038
1,321
36,359
Total available-for-sale investment securities
655,560
7,212
Held-to-maturity
Obligations of state and political agencies
145,172
1,530
146,673
217,414
55
(602)
216,867
Total held-to-maturity investment securities
1,585
(631)
363,540
Total investment securities
1,018,146
8,797
(8,121)
1,018,822
December 31, 2020
5,926
(19)
5,907
148,491
5,282
153,773
303,760
3,395
(436)
306,719
89,300
5,678
94,978
109
115
30,552
388
(90)
30,850
578,138
14,749
(545)
On April 1, 2021, the Company transferred its debt securities consisting of obligations of state and political agencies with a fair value of $149.2 million and a net unrealized gain of $1.3 million from available-for-sale to held-to-maturity.
Gross unrealized losses on investment securities and the fair value of the related securities aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position as of September 30, 2021 and December 31, 2020, were as follows:
Less than 12 Months
Over 12 Months
(7,416)
340,254
(74)
9,057
349,311
9,059
349,313
22,550
80,145
102,695
(8,047)
442,949
452,008
(10)
4,509
(9)
1,309
5,818
(432)
68,494
(4)
2,356
70,850
16,454
(532)
89,457
(13)
3,667
93,124
For all of the above investment securities, the unrealized losses were generally due to changes in interest rates and unrealized losses were considered to be temporary as the fair value is expected to recover as the securities approach their maturity dates. The Company evaluates securities for other-than-temporary impairment, or OTTI, on a quarterly basis, at a minimum, and more frequently when economic or market concerns warrant such evaluation. In estimating OTTI losses, consideration is given to the severity and duration of the impairment; the financial condition and near-term prospects of the issuer, which for debt securities, considers external credit ratings and recent downgrades; and the intent and ability of the Company to hold the security for a period of time sufficient for a recovery in value.
For the three and nine months ended September 30, 2021 and 2020, the Company did not recognize OTTI losses on its investment securities.
The following table presents amortized cost and fair value of available-for-sale and held-to-maturity investment securities as of September 30, 2021, by contractual maturity:
Carrying
Due within one year or less
4,690
Due after one year through five years
34,282
34,359
3,270
3,376
Due after five years through ten years
75,197
76,120
83,891
87,330
Due after 10 years
248,417
248,371
568,399
564,576
Expected maturities will differ from contractual maturities because issuers may have the right to call or prepay obligations with or without call or prepayment penalties.
Investment securities with a total carrying value of $165.5 million and $160.8 million were pledged as of September 30, 2021 and December 31, 2020, respectively, to secure public deposits and for other purposes required or permitted by law.
Proceeds from the sale or call of available-for-sale investment securities, for the three and nine months ended September 30, 2021 and 2020, are displayed in the table below:
Proceeds
35,125
Realized gains
114
Realized losses
Proceeds from the sale or call of held-to-maturity investment securities, for the three and nine months ended September 30, 2021 and 2020, are displayed in the table below:
348
During the three and nine months ended September 30, 2021, the Company sold one held-to-maturity security with an amortized cost of $330 thousand. Proceeds from the sale totaled $348 thousand, resulting in realized gains of $11 thousand. For this sale of a held-to-maturity security, the Company received evidence of a significant deterioration of the issuer’s creditworthiness. There were no sales of held-to-maturity securities during the three and nine months ended September 30, 2020.
As of September 30, 2021 and December 31, 2020, the carrying value of the Company’s Federal Reserve stock and Federal Home Loan Bank of Des Moines, or FHLB, stock was as follows:
Federal Reserve
2,675
FHLB
3,827
3,090
These securities can only be redeemed or sold at their par value and only to the respective issuing institution or to another member institution. The Company records these non-marketable equity securities as a component of other assets and periodically evaluates these securities for impairment. Management considers these non-marketable equity
13
securities to be long-term investments. Accordingly, when evaluating these securities for impairment, management considers the ultimate recoverability of the par value rather than recognizing temporary declines in value.
Visa Class B Restricted Shares
In 2008, the Company received Visa Class B restricted shares as part of Visa’s initial public offering. These shares are transferable only under limited circumstances until they can be converted into the publicly traded Class A common shares. This conversion will not occur until the settlement of certain litigation which will be indemnified by Visa members, including the Company. Visa funded an escrow account from its initial public offering to settle these litigation claims. Should this escrow account be insufficient to cover these litigation claims, Visa is entitled to fund additional amounts to the escrow account by reducing each member bank’s Class B conversion ratio to unrestricted Class A shares. As of September 30, 2021, the conversion ratio was 1.6228. Based on the existing transfer restriction and the uncertainty of the outcome of the Visa litigation mentioned above, the 6,924 Class B shares (11,236 Class A equivalents) that the Company owned as of September, 2021 and December 31, 2020, are carried at a zero cost basis.
NOTE 4 Loans and Allowance for Loan Losses
The following table presents total loans outstanding, by portfolio segment, as of September 30, 2021 and December 31, 2020:
Commercial and industrial (1)
506,599
691,858
Real estate construction
37,751
44,451
Commercial real estate
573,518
563,007
Total commercial
1,117,868
1,299,316
Consumer
Residential real estate first mortgage
501,339
463,370
Residential real estate junior lien
130,243
143,416
Other revolving and installment
50,936
73,273
Total consumer
682,518
680,059
Total loans
Total loans included net deferred loan fees and costs of $2.4 million and $4.7 million at September 30, 2021 and December 31, 2020, respectively. Deferred loan fees on PPP loans were $2.9 million at September 30, 2021 and $4.3 million at December 31, 2020.
Management monitors the credit quality of its loan portfolio on an ongoing basis. Measurements of delinquency and past due status are based on the contractual terms of each loan. Past due loans are reviewed regularly to identify loans for nonaccrual status. Loan modifications made in accordance with the Interagency Statement on Loan Modifications and Reporting for Financial Institutions as issued on April 7, 2020, are included as accruing current.
The following tables present a past due aging analysis of total loans outstanding, by portfolio segment, as of September 30, 2021 and December 31, 2020:
90 Days
Accruing
30 - 89 Days
or More
Current
Past Due
Nonaccrual
Commercial and industrial
504,309
657
1,633
569,209
4,309
1,111,269
5,942
500,350
876
113
129,521
552
170
50,735
197
680,606
1,625
287
1,791,875
2,282
6,229
689,340
500
30
1,988
558,127
2,449
2,431
1,291,918
2,949
4,419
461,179
1,752
439
143,060
191
165
73,128
118
27
677,367
2,061
631
1,969,285
5,010
5,050
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, 2021 and December 31, 2020:
Criticized
Special
Pass
Mention
Substandard
Doubtful
498,201
1,777
6,374
247
553,492
2,316
17,710
1,089,444
4,093
24,084
499,497
1,842
129,303
940
50,932
679,732
2,786
1,769,176
26,870
669,602
5,415
16,841
533,733
6,686
22,588
1,247,786
12,101
39,429
461,221
1,406
743
140,461
1,819
1,136
73,236
37
674,918
3,225
1,916
1,922,704
15,326
41,345
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, 2021 and 2020:
Beginning
Provision for
Loan
Ending
Balance
Loan Losses
Charge-offs
Recoveries
9,620
(825)
(747)
1,052
9,100
587
92
679
12,937
(413)
12,524
23,144
(1,146)
22,303
6,176
625
6,801
1,401
1,423
(32)
(46)
523
8,151
599
43
8,747
Unallocated
2,469
(1,453)
1,016
33,764
(793)
1,095
32,066
10,205
(1,378)
(1,224)
1,497
658
21
14,105
(1,049)
(536)
24,968
(2,406)
(1,760)
1,501
5,774
1,027
1,373
(63)
753
(196)
(139)
105
7,900
768
218
1,378
(362)
34,246
(1,899)
1,719
10,797
(846)
10,373
443
40
483
9,948
1,828
95
11,871
21,188
1,022
527
22,727
2,673
1,694
4,367
1,102
28
81
1,211
546
108
(41)
24
637
4,321
1,830
6,215
1,747
648
2,395
27,256
(51)
632
31,337
17
12,270
(498)
(2,745)
1,346
303
180
6,688
5,953
(865)
19,261
5,635
(3,610)
1,441
1,448
2,914
671
377
175
352
371
(194)
2,471
3,662
(206)
288
2,192
203
23,924
(3,816)
1,729
The following tables present the recorded investment in loans and related allowance for loan losses, by loan portfolio segment, disaggregated on the basis of the Company’s impairment methodology, as of September 30, 2021 and December 31, 2020:
Recorded Investment
Allowance for Loan Losses
Individually
Collectively
Evaluated
2,161
504,438
536
8,564
4,493
569,025
12,513
6,654
1,111,214
547
21,756
121
501,218
172
130,071
519
297
682,221
8,735
6,951
1,793,435
559
30,491
2,616
689,242
336
9,869
5,224
557,783
837
13,268
7,840
1,291,476
1,173
23,795
462,931
224
143,192
19
1,354
73,246
740
690
679,369
32
7,868
8,530
1,970,845
1,205
31,663
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.
Recorded
Unpaid
Related
Investment
Principal
Allowance
Impaired loans with a valuation allowance
710
725
723
777
920
3,948
3,974
20
Total impaired loans with a valuation allowance
1,499
1,657
4,717
4,746
Impaired loans without a valuation allowance
1,451
1,603
1,893
2,173
3,716
3,872
1,276
123
464
164
194
205
306
Total impaired loans without a valuation allowance
5,452
5,792
3,813
4,358
Total impaired loans
2,328
2,898
4,792
5,389
202
326
7,449
9,104
The table below presents the average recorded investment in impaired loans and interest income for the three and nine months ended September 30, 2021 and 2020:
Three months ended September 30,
Average
Income
719
2,541
779
1,510
2,757
22
2,016
1,013
3,793
1,330
459
166
211
6,096
3,013
2,735
3,554
38
4,572
1,527
230
7,606
5,770
49
Nine Months Ended September 30,
818
3,815
782
200
4,035
1,154
3,980
1,699
467
190
217
6,345
3,537
29
2,879
25
4,969
4,762
1,899
201
237
7,959
31
7,572
51
Loans with a carrying value of $1.2 billion as of September 30, 2021 and December 31, 2020, respectively, were pledged to secure public deposits, and for other purposes required or permitted by law.
Under certain circumstances, the Company will provide borrowers relief through loan restructurings. A restructuring of debt constitutes a TDR if the Company, for economic or legal reasons related to the borrower’s financial difficulties, grants a concession to the borrower that it would not otherwise consider. TDR concessions can include a reduction of interest rates, an extension of maturity dates, forgiveness of principal or interest due, or acceptance of other assets in full or partial satisfaction of the debt.
During the third quarter of 2021, there were no loans modified as a TDR as a result of changing the terms allowing for interest rate reductions and an extension of the maturity dates. During the third quarter of 2020, there were no loans modified as a TDR.
The Company does not have material commitments to lend additional funds to borrowers with loans whose terms have been modified in TDRs or whose loans are on nonaccrual.
Beginning in 2020, in accordance with the Interagency Statement on Loan Modifications and Reporting for Financial Institutions as issued on April 7, 2020, through September 30, 2021, the Company had entered into modifications on 587 loans representing $154.5 million in principal balances, since the beginning of the COVID-19 pandemic. Of those loans, 8 loans with a total outstanding principal balance of $3.4 million, have been granted additional deferrals, 2 loans with a total outstanding principal balance of $69 thousand remain on the first deferral and the remaining loans have been returned to a normal payment status. These deferrals were generally no more than 90 days in duration and were not considered TDRs.
NOTE 5 Goodwill and Other Intangible Assets
The following table summarizes the carrying amount of goodwill, by segment, as of September 30, 2021 and December 31, 2020:
Banking
20,131
10,070
Total goodwill
Goodwill is evaluated for impairment on an annual basis, at a minimum, and more frequently when the economic environment warrants. The Company determined that there was no goodwill impairment as of September 30, 2021.
The gross carrying amount and accumulated amortization for each type of identifiable intangible asset are as follows:
Gross Carrying Amount
Accumulated Amortization
Identifiable customer intangibles
43,346
(20,753)
(17,490)
25,856
Core deposit intangible assets
(3,730)
Total intangible assets
47,139
(21,220)
Amortization of intangible assets was $1.1 million and $1.0 million for the three months ended September 30, 2021, and 2020, respectively. Amortization of intangible assets was $3.3 million and $3.0 million for the nine months ended September 30, 2021, and 2020, respectively.
NOTE 6 Loan Servicing
Loans serviced for others are not included in the accompanying consolidated balance sheets. The unpaid principal balances of loans serviced for others totaled $401.4 million and $445.5 million as of September 30, 2021 and December 31, 2020, respectively. Servicing loans for others generally consists of collecting mortgage payments, maintaining escrow accounts, disbursing payments to investors and collection and foreclosure processing. Loan servicing income is recorded on an accrual basis and includes servicing fees from investors and certain charges collected from borrowers, such as late payment fees, and is net of fair value adjustments to capitalized mortgage servicing rights.
The following table summarizes the Company’s activity related to servicing rights for the three and nine months ended September 30, 2021 and 2020:
Balance, beginning of period
1,964
2,891
3,845
Additions
84
42
195
154
Amortization
(195)
(296)
(580)
(692)
(Impairment)/Recovery
(77)
(58)
(728)
Balance, end of period
2,579
The following is a summary of key data and assumptions used in the valuation of servicing rights as of September 30, 2021 and December 31, 2020. Increases or decreases in any one of these assumptions would result in lower or higher fair value measurements.
Fair value of servicing rights
Weighted-average remaining term, years
20.4
20.1
Prepayment speeds
15.4
%
17.7
Discount rate
9.3
9.0
NOTE 7 Leases
Substantially all of the leases in which the Company is the lessee are comprised of real estate property for offices and office equipment rentals with terms extending through 2027. Portions of certain properties are subleased for terms extending through 2024. Substantially all of the Company’s leases are classified as operating leases, and therefore, were previously not recognized on the Company’s consolidated financial statements. The Company has one existing finance lease for the Company’s headquarters building with a lease term through 2022.
The Company elected not to include short-term leases (i.e., leases with initial terms of twelve months or less), or equipment leases (deemed immaterial) on the consolidated financial statements. The following table presents the classification of the Company’s right-of-use, or ROU, assets and lease liabilities on the consolidated financial statements.
Lease Right-of-Use Assets
Classification
Finance lease right-of-use assets
Total lease right-of-use assets
3,937
7,120
Lease Liabilities
Finance lease liabilities
261
430
Total lease liabilities
4,689
8,291
The calculated amount of the ROU assets and lease liabilities in the table above are impacted by the length of the lease term and the discount rate used to present value the minimum lease payments. The Company’s lease agreements often include one or more options to renew at the Company’s discretion. If at lease inception, the Company considers the exercising of a renewal option to be reasonably certain, the Company will include the extended term in the calculation of the ROU asset and lease liability. Regarding the discount rate, Topic 842 requires the use of the rate implicit in the lease whenever this rate is readily determinable. As this rate is rarely determinable, the Company utilizes its incremental borrowing rate at lease inception, on a collateralized basis, over a similar term. For operating leases existing prior to January 1, 2019, the rate for the remaining lease term as of January 1, 2019 was used. For the Company’s only finance lease, the Company utilized its incremental borrowing rate at lease inception.
Weighted-average remaining lease term, years
Operating leases
3.4
5.8
Finance leases
1.0
1.8
Weighted-average discount rate
2.6
2.9
7.8
As the Company elected, for all classes of underlying assets, not to separate lease and non-lease components and instead to account for them as a single lease component, the variable lease cost primarily represents variable
payments such as common area maintenance and utilities. Variable lease cost also includes payments for usage or maintenance of those capitalized equipment operating leases.
The following table presents lease costs and other lease information for the three and nine months ending September 30, 2021 and 2020.
Lease costs
Operating lease cost
429
634
1,417
1,825
Variable lease cost
192
223
583
888
Short-term lease cost
89
102
304
Finance lease cost
Interest on lease liabilities
33
Amortization of right-of-use assets
Sublease income
(57)
(163)
(175)
Net lease cost
695
941
2,118
2,962
Other information
Cash paid for amounts included in the measurement of lease liabilities operating cash flows from operating leases
411
628
1,372
1,807
Right-of-use assets obtained in exchange for new operating lease liabilities
Future minimum payments for finance and operating leases with initial or remaining terms of one year or more as of September 30, 2021 were as follows:
Finance
Operating
Leases
Twelve months ended
September 30, 2022
251
1,597
September 30, 2023
1,439
September 30, 2024
676
September 30, 2025
389
September 30, 2026
250
Thereafter
Total future minimum lease payments
272
4,589
Amounts representing interest
(161)
Total operating lease liabilities
NOTE 8 Deposits
The components of deposits in the consolidated balance sheets as of September 30, 2021 and December 31, 2020 were as follows:
Interest-bearing demand
673,916
618,900
Savings accounts
92,632
79,902
Money market savings
924,678
909,137
Time deposits
224,800
209,338
Total interest-bearing
23
NOTE 9 Long-Term Debt
Long-term debt as of September 30, 2021 and December 31, 2020 consisted of the following:
Period End
Face
Maturity
Interest Rate
Rate
Date
Call Date
Subordinated notes payable
Fixed
3.50
3/30/2031
3/31/2026
Junior subordinated debenture (Trust I)
4,124
3,481
Three-month LIBOR + 3.10%
3.23
6/26/2033
6/26/2008
Junior subordinated debenture (Trust II)
6,186
5,221
Three-month LIBOR + 1.80%
1.92
9/15/2036
9/15/2011
Finance lease liability
2,700
7.81
10/31/2022
N/A
Total long-term debt
63,010
49,688
Three-month LIBOR + 4.12%
4.36
12/30/2025
12/30/2020
3,447
3.35
5,170
2.02
NOTE 10 Financial Instruments with Off-Balance Sheet Risk
In the normal course of business, the Bank has outstanding commitment and contingent liabilities, such as commitments to extend credit and standby letters of credit, which are not included in the accompanying consolidated financial statements. The Bank’s exposure to credit loss in the event of nonperformance by the other party to the financial instruments for commitments to extend credit and standby letters of credit is represented by the contractual or notional amount of those instruments. The Bank uses the same credit policies in making such commitments as it does for instruments that are included in the statements of financial condition.
A summary of the contractual amounts of the Company’s exposure to off-balance sheet risk was as follows:
Commitments to extend credit
622,465
611,140
Standby letters of credit
11,028
6,510
633,493
617,650
Commitments to extend credit are agreements to lend to a client as long as there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Since many of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. The Company evaluates each client’s creditworthiness on a case by case basis. The amount of collateral obtained, if deemed necessary by the Company upon extension of credit, is based on management’s credit evaluation. Collateral held varies but may include accounts receivable, inventory, property and equipment, and income producing commercial properties.
The Company was not required to perform on any financial guarantees and did not incur any losses on its commitments during the past two years.
The Company utilizes standby letters of credit issued by either the FHLB or the Bank of North Dakota to secure public unit deposits. The Company had a $150 thousand letter of credit with the FHLB as of September 30, 2021 and December 31, 2020. With the Bank of North Dakota, the Company had no letters of credit outstanding as of September 30, 2021 and December 31, 2020. Bank of North Dakota letters of credit were collateralized by loans pledged to the Bank of North Dakota in the amount of $230.2 million and $245.7 million as of September 30, 2021 and December 31, 2020, respectively.
NOTE 11 Share-Based Compensation
The Company has granted equity awards pursuant to the Alerus Financial Corporation 2009 Stock Plan. The awards were in the form of restricted stock or restricted stock units and are considered to represent an element of employee compensation. Compensation expense for the awards is based on the fair value of Alerus Financial Corporation common stock at the time of grant. The value of awards that are expected to vest are amortized into expense over the vesting periods. The ability to grant awards under this plan has expired.
On May 6, 2019, the Company’s stockholders approved the Alerus Financial Corporation 2019 Equity Incentive Plan. This plan allows the compensation committee the ability to grant a wide variety of equity awards, including stock options, stock appreciation rights, restricted stock, restricted stock units and cash incentive awards in such forms and amounts as it deems appropriate to accomplish the goals of the plan. Any shares subject to an award that is cancelled, forfeited, or expires prior to exercise or realization, either in full or in part, shall again become available for issuance under the plan. However, shares subject to an award shall not again be made available for issuance or delivery under the plan if such shares are (a) tendered in payment of the exercise price of a stock option, (b) delivered to, or withheld by, the Company to satisfy any tax withholding obligation, or (c) covered by a stock-settled stock appreciation right or other awards that were not issued upon the settlement of the award. Shares vest, become exercisable and contain such other terms and conditions as determined by the compensation committee and set forth in individual agreements with the participant receiving the award. The plan authorizes the issuance of up to 1,100,000 shares of common stock. As of September 30, 2021, 37,789 stock awards and 91,302 restricted stock units had been issued under the plan.
Compensation expense relating to awards under these plans was $545 thousand and $475 thousand for the three months ended September 30, 2021 and 2020, respectively. Compensation expense relating to awards under these plans was $1.8 million and $1.3 million for the nine months ended September 30, 2021 and 2020, respectively.
The following table presents the activity in the stock plans for the nine months ended September 30, 2021 and 2020:
Weighted-
Average Grant
Awards
Date Fair Value
Restricted Stock and Restricted Stock Unit Awards
Outstanding at beginning of period
325,030
19.48
347,211
18.64
Granted
66,664
26.63
77,846
19.53
Vested
(101,108)
20.46
(87,939)
16.24
Forfeited or cancelled
(7,590)
19.75
Outstanding at end of period
290,586
20.77
329,528
19.46
As of September 30, 2021, there was $2.5 million of unrecognized compensation expense related to non-vested awards granted under the plans. The expense is expected to be recognized over a weighted-average period of 3.31 years.
NOTE 12 Income Taxes
The components of income tax expense (benefit) for the three and nine months ended September 30, 2021 and 2020 were as follows:
Percent of
Amount
Pretax Income
Taxes at statutory federal income tax rate
3,598
21.0
4,894
Tax effect of:
Tax exempt income
(134)
(0.8)
(0.6)
600
3.5
3.8
Applicable income taxes
23.7
24.2
Nine months ended September 30,
10,993
9,491
(434)
(382)
1,811
1,589
It is the opinion of management that the Company has no significant uncertain tax positions that would be subject to change upon examination.
NOTE 13 Segment Reporting
The Company determines reportable segments based on the services offered, the significance of the services offered, the significance of those services to the Company’s financial statements, and management’s regular review of the operating results of those services. The Company operates through four operating segments: Banking, Retirement and Benefit Services, Wealth Management, and Mortgage.
The financial information presented for each segment includes net interest income, provision for loan losses, direct noninterest income, and direct noninterest expense, before indirect allocations. Corporate Administration includes the indirect overhead and is set forth in the table below. The segment net income before taxes represents direct revenue and expense before indirect allocations and income taxes.
The following table presents key metrics related to the Company’s segments for the periods presented:
Retirement and
Wealth
Corporate
Benefit Services
Management
Mortgage
Administration
Consolidated
21,168
499
(535)
Noninterest income
1,576
Noninterest expense
11,403
10,320
8,464
9,635
Net income before taxes
13,341
7,711
3,076
3,151
(10,148)
64,236
1,435
(1,361)
4,564
(6)
33,401
30,420
6,682
29,978
27,152
37,399
22,737
8,737
11,992
(28,519)
21,994
613
(842)
3,398
(1)
10,876
8,347
2,110
9,769
9,112
11,016
6,757
2,376
13,113
(9,955)
61,857
1,411
(2,575)
8,129
34,887
25,472
6,254
23,228
26,833
25,599
19,562
6,390
23,043
(29,400)
The Banking division offers a complete line of loan, deposit, cash management, and treasury services through fourteen offices in North Dakota, Minnesota, and Arizona. These products and services are supported through web and mobile based applications. The majority of the Company’s assets and liabilities are in the Banking segment’s balance sheet.
Retirement and Benefit Services
Retirement and Benefit Services provides the following services nationally: recordkeeping and administration services to qualified retirement plans; ESOP trustee, recordkeeping, and administration; investment fiduciary services to retirement plans; health savings accounts, flex spending accounts, COBRA recordkeeping and administration services, and payroll to employers; and payroll and HRIS services for employers. In addition, the division operates within each of the banking markets, as well as in Lansing, Michigan and Littleton, Colorado.
Wealth Management
The Wealth Management division provides advisory and planning services, investment management, and trust and fiduciary services to clients across the Company’s footprint.
The Mortgage division offers first and second mortgage loans through a centralized mortgage unit in Minneapolis, Minnesota, as well as through the Banking office locations.
NOTE 14 Earnings Per Share
The calculation of basic and diluted earnings per share using the two-class method for the three and nine months ending September 30, 2021 and 2020 are presented below:
Dividends and undistributed earnings allocated to participating securities
196
315
Net income available to common shareholders
12,871
17,344
39,348
33,896
Weighted-average common shares outstanding for basic earnings per share
Dilutive effect of stock-based awards
294
332
334
Weighted-average common shares outstanding for diluted earnings per share
Earnings per common share:
NOTE 15 Derivative Instruments
The Company enters into interest rate swaps to facilitate client transactions and meet their financing needs. Upon entering into these instruments to meet client needs, the Company enters into offsetting positions with U.S. financial institutions in order to minimize risk to the Company. These swaps are derivatives but are not designated as hedging instruments.
The Company did not have any derivatives designated as hedging instruments as of September 30, 2021 and December 31, 2020. The following table presents the amounts recorded in the Company’s consolidated balance sheets, for derivatives not designated as hedging instruments, as of September 30, 2021 and December 31, 2020:
Notional
Asset Derivatives
Consolidated Balance Sheet Location
Interest rate swaps
1,060
45,171
569
44,597
Interest rate lock commitments
2,813
107,769
10,124
270,103
Forward loan sales commitments
602
18,877
2,664
86,990
TBA mortgage backed securities
405
189,470
Total asset derivatives
4,880
361,287
13,357
401,690
Liability Derivatives
1,062
572
2,339
307,000
Total liability derivatives
2,911
351,597
The gain (loss) recognized on derivative instruments for the three and nine months ended September 30, 2021 and 2020 was as follows:
Consolidated Statements
of Income Location
Other noninterest income
(3)
(1,793)
5,650
(7,298)
11,229
(499)
369
(2,061)
1,152
(690)
(3,747)
4,865
(9,099)
Total gain/(loss) from derivative instruments
(2,981)
2,269
(4,492)
3,279
The Company has third party agreements that require a minimum dollar transfer amount upon a margin call. This requirement is dependent on certain specified credit measures. The amount of collateral posted with third parties at September 30, 2021 and December 31, 2020 was $2.1 million and $2.7 million, respectively. The amount of collateral posted with third parties was deemed to be sufficient as of those dates to collateralize both the fair market value change as well as any additional amounts that may be required as a result of a change in the specified credit measures.
NOTE 16 Regulatory Matters
The Company and the Bank are subject to various regulatory capital requirements administered by the federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory and possibly additional discretionary actions by regulators that, if undertaken, could have a direct material effect on the Company’s consolidated financial statements.
Quantitative measures established by regulation to ensure capital adequacy require the Company and the Bank to maintain minimum amounts and ratios (set forth in the following table) of common equity tier 1, tier 1, and total capital (as defined in the regulations) to risk weighted assets (as defined) and of tier 1 capital (as defined) to average assets (as defined). Management believes at September 30, 2021 and December 31, 2020, each of the Company and the Bank had met all of the capital adequacy requirements to which it was subject.
The following table presents the Company’s and the Bank’s actual capital amounts and ratios as of September 30, 2021 and December 31, 2020:
Minimum to be
Requirements
Well Capitalized
for Capital
Under Prompt
Actual
Adequacy Purposes
Corrective Action
Ratio
Common equity tier 1 capital to risk weighted assets
302,306
14.52
93,671
4.50
Bank
286,436
13.77
93,579
135,170
6.50
Tier 1 capital to risk weighted assets
.
310,698
14.93
124,895
6.00
124,772
166,363
8.00
Total capital to risk weighted assets
386,793
18.58
166,526
312,505
15.03
207,954
10.00
Tier 1 capital to average assets
9.88
125,777
4.00
9.11
125,708
157,135
5.00
265,490
12.75
93,723
251,806
12.10
93,632
135,246
273,797
13.15
124,964
124,843
166,457
349,620
16.79
166,618
277,916
13.36
208,071
9.24
118,587
8.50
118,511
148,139
The Bank is subject to certain restrictions on the amount of dividends that it may pay without prior regulatory approval. The Company and the Bank are subject to the rules of the Basel III regulatory capital framework and related Dodd-Frank Wall Street Reform and Consumer Protection Act rules. The rules included the implementation of a 2.5 percent capital conservation buffer that is added to the minimum requirements for capital adequacy purposes. A banking organization with a conservation buffer of less than the required amount will be subject to the limitations on capital distributions, including dividend payments and certain discretionary bonus payments to executive officers. At September 30, 2021, the ratios for the Company and the Bank were sufficient to meet the conservation buffer. In addition, the Company must adhere to various U.S. Department of Housing and Urban Development, or HUD, regulatory guidelines including required minimum capital and liquidity to maintain their Federal Housing Administration approval status. Failure to comply with the HUD guidelines could result in withdrawal of this certification. As of September 30, 2021, and December 31, 2020, the Company was in compliance with the aforementioned guidelines.
NOTE 17 Stock Repurchase Program
On February 18, 2021, the Board of Directors of the Company approved a stock repurchase program, or the Program, which authorizes the Company to repurchase up to 770,000 shares of its common stock subject to certain limitations and conditions. The Program was effective immediately and will continue for a period of 36 months. The Program does not obligate the Company to repurchase any shares of its common stock and there is no assurance that the Company will do so. For the nine months ended September 30, 2021, there were no shares repurchased under the Program. The Company also repurchases shares to pay withholding taxes on the vesting of restricted stock awards and units.
NOTE 18 Fair Value of Assets and Liabilities
The Company categorizes its assets and liabilities measured at estimated fair value into a three level hierarchy based on the priority of the inputs to the valuation technique used to determine estimated fair value. The estimated fair value hierarchy gives the highest priority to quoted prices in active markets for identical assets or liabilities (Level 1) and the lowest priority to unobservable inputs (Level 3). If the inputs used in the determination of the estimated fair value measurement fall within different levels of the hierarchy, the categorization is based on the lowest level input that is
significant to the estimated fair value measurement. Assets and liabilities valued at estimated fair value are categorized based on the following inputs to the valuation techniques as follows:
Level 1—Inputs that utilize quoted prices (unadjusted) in active markets for identical assets or liabilities that an entity has the ability to access.
Level 2—Inputs that include quoted prices for similar assets and liabilities in active markets and inputs that are observable for the asset or liability, either directly or indirectly, for substantially the full term of the financial instrument. Estimated fair values for these instruments are estimated using pricing models, quoted prices of investment securities with similar characteristics, or discounted cash flows.
Level 3—Inputs that are unobservable inputs for the asset or liability, which are typically based on an entity’s own assumptions, as there is little, if any, related market activity. Subsequent to initial recognition, the Company may re-measure the carrying value of assets and liabilities measured on a nonrecurring basis to estimated fair value. Adjustments to estimated fair value usually result when certain assets are impaired. Such assets are written down from their carrying amounts to their estimated fair value.
Professional standards allow entities the irrevocable option to elect to measure certain financial instruments and other items at estimated fair value for the initial and subsequent measurement on an instrument-by-instrument basis. The Company adopted the policy to value certain financial instruments at estimated fair value. The Company has not elected to measure any existing financial instruments at estimated fair value; however, it may elect to measure newly acquired financial instruments at estimated fair value in the future.
Recurring Basis
The Company uses estimated fair value measurements to record estimated fair value adjustments to certain assets and liabilities and to determine estimated fair value disclosures.
The following tables present the balances of the assets and liabilities measured at estimated fair value on a recurring basis as of September 30, 2021 and December 31, 2020:
Level 1
Level 2
Level 3
U.S. treasury and government agencies
Derivatives
Other liabilities
The following is a description of the valuation methodologies used for instruments measured at estimated fair value on a recurring basis, as well as the general classification of such instruments pursuant to the valuation hierarchy.
Investment Securities, Available-for-Sale
Generally, debt securities are valued using pricing for similar securities, recently executed transactions, and other pricing models utilizing observable inputs and therefore are classified as Level 2.
All of the Company’s derivatives are traded in over-the-counter markets where quoted market prices are not readily available. For these derivatives, estimated fair value is measured using internally developed models that use primarily market observable inputs, such as yield curves and option volatilities, and accordingly, classify as Level 2. Examples of Level 2 derivatives are basic interest rate swaps and forward contracts.
Nonrecurring Basis
Certain assets are measured at estimated fair value on a nonrecurring basis. These assets are not measured at estimated fair value on an ongoing basis; however, they are subject to estimated fair value adjustments in certain circumstances, such as when there is evidence of impairment or a change in the amount of previously recognized impairment.
Net impairment related to nonrecurring estimated fair value measurements of certain assets as of September 30, 2021 and December 31, 2020 consisted of the following:
Impairment
Impaired loans
6,392
Foreclosed assets
862
7,325
Loans Held for Sale
Loans originated and held for sale are carried at the lower of cost or estimated fair value. The Company obtains quotes or bids on these loans directly from purchasing financial institutions. Typically, these quotes include a premium on the sale and thus these quotes indicate estimated fair value of the held for sale loans is greater than cost.
Impairment losses for loans held for sale that are carried at the lower of cost or estimated fair value, represent additional net write-downs during the period to record these loans at the lower of cost or estimated fair value, subsequent to their initial classification as loans held for sale.
The valuation techniques and significant unobservable inputs used to measure Level 3 estimated fair values as of September 30, 2021, and December 31, 2020, were as follows:
Weighted
Asset Type
Valuation Technique
Unobservable Input
Fair Value
Range
Appraisal value
Property specific adjustment
Discounted cash flows
Prepayment speed assumptions
184-392
257
191-403
285
Disclosure of estimated fair value information about financial instruments, for which it is practicable to estimate that value, is required whether or not recognized in the consolidated balance sheets. In cases in which quoted market prices are not available, estimated fair values are based on estimates using present value or other valuation techniques. Those techniques are significantly affected by the assumptions used, including the discount rate and estimate of future cash flows. In that regard, the derived estimated fair value estimates cannot be substantiated by comparison to independent markets and, in many cases could not be realized in immediate settlement of the instruments. Certain financial instruments, with an estimated fair value that is not practicable to estimate and all non-financial instruments, are excluded from the disclosure requirements. Accordingly, the aggregate estimated fair value amounts presented do not necessarily represent the underlying value of the Company.
The following disclosures represent financial instruments in which the ending balances, as of September 30, 2021 and December 31, 2020, were not carried at estimated fair value in their entirety on the consolidated balance sheets.
Cash and Cash Equivalents and Accrued Interest
The carrying amounts reported in the consolidated balance sheets approximate those assets and liabilities estimated fair values.
Investment Securities, Held-to-Maturity
The fair values of debt securities held-to-maturity are based on quoted market prices for the same or similar securities, recently executed transactions and pricing models.
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.
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:
Estimated Fair Value
Financial Assets
Investment securities held-to-maturity
1,814,289
Financial Liabilities
Noninterest-bearing deposits
Interest-bearing deposits
1,691,226
225,353
58,319
Accrued interest payable
1,298
34
1,992,394
1,607,939
210,637
56,131
654
NOTE 19 COVID-19 Pandemic Response
As discussed in “Note 1 Significant Accounting Policies,” the full extent of the impact of COVID-19 on the U.S. economy generally and the Company is uncertain. In the second quarter of 2020, the Company became a lender under the PPP which was administered through the U.S. Small Business Administration, or SBA, an agency of the U.S Department of the Treasury, which works with financial institutions in providing loans to small businesses. The PPP, which is meant to aid small businesses during the COVID-19 pandemic, was created under the Coronavirus Aid Relief, and Economic Security, or CARES, Act, which was signed into law on March 27, 2020. In addition, the CARES Act provides financial institutions the option to temporarily suspend certain requirements under GAAP related to TDRs for a limited period of time to account for the effects of COVID-19. See “Note 4 Loans and Allowance for Loan Losses” for additional discussion regarding TDRs.
As of September 30, 2021, the Company had assisted 2,454 new and existing clients secure a total of approximately $474.2 million of PPP financing. Net processing fees in the amount of $15.7 million are being deferred and recognized as interest income on a level yield method over the life of the respective loans. See “Note 4 Loans and Allowance for Loan Losses” for additional discussion on the remaining deferred costs associated with PPP financing.
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Item 2 – Management’s Discussion and Analysis of Financial Condition and Results of Operations
General
The following discussion explains our financial condition and results of operations as of and for the three and nine months ended September 30, 2021 and 2020. Annualized results for this interim period may not be indicative of results for the full year or future periods. The following discussion and analysis should be read in conjunction with the consolidated financial statements and related notes presented elsewhere in this report and the Company’s Annual Report on Form 10-K for the year ended December 31, 2020, filed with the Securities and Exchange Commission on March 12, 2021.
Forward-Looking Statements
This Quarterly Report on Form 10-Q contains “forward-looking statements” within the meaning of the safe harbor provisions of the U.S. Private Securities Litigation Reform Act of 1995. Forward-looking statements include, without limitation, statements concerning plans, estimates, calculations, forecasts and projections with respect to the anticipated future performance of Alerus Financial Corporation. These statements are often, but not always, identified by words such as “may”, “might”, “should”, “could”, “predict”, “potential”, “believe”, “expect”, “continue”, “will”, “anticipate”, “seek”, “estimate”, “intend”, “plan”, “projection”, “would”, “annualized”, “target” and “outlook”, or the negative version of those words or other comparable words of a future or forward-looking nature. Examples of forward-looking statements include, among others, statements we make regarding our projected growth, anticipated future financial performance, financial condition, credit quality and management’s long-term performance goals and the future plans and prospects of Alerus Financial Corporation.
Forward-looking statements are neither historical facts nor assurances of future performance. Instead, they are based only on our current beliefs, expectations and assumptions regarding the future of our business, future plans and strategies, projections, anticipated events and trends, the economy and other future conditions. Because forward-looking statements relate to the future, they are subject to inherent uncertainties, risks and changes in circumstances that are difficult to predict and many of which are outside of our control. Our actual results and financial condition may differ materially from those indicated in the forward-looking statements. Therefore, you should not rely on any of these forward-looking statements. Important factors that could cause our actual results and financial condition to differ materially from those indicated in the forward-looking statements include, among others, the following:
Any forward-looking statement made by us in this report is based only on information currently available to us and speaks only as of the date on which it is made. We undertake no obligation to publicly update any forward-looking statement, whether written or oral, that may be made from time to time, whether as a result of new information, future developments or otherwise.
Overview
We are a diversified financial services company headquartered in Grand Forks, North Dakota. Through our subsidiary, Alerus Financial, National Association, or the Bank, we provide financial solutions to businesses and consumers through four distinct business lines—banking, retirement and benefit services, wealth management and mortgage. These solutions are delivered through a relationship-oriented primary point of contact along with responsive and client-friendly technology.
Our business model produces strong financial performance and a diversified revenue stream, which has helped us establish a brand and culture yielding both a loyal client base and passionate and dedicated employees. We generate a majority of our overall revenue from noninterest income, which is driven primarily by our retirement and benefit services, wealth management and mortgage business lines. The remainder of our revenue consists of net interest income, which we derive from offering our traditional banking products and services.
Critical Accounting Policies
Our consolidated financial statements are prepared based on the application of accounting policies generally accepted in the United States, or GAAP. The preparation of our consolidated financial statements requires management to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses. These estimates are based upon historical experience and on various other assumptions that management believes are reasonable under current circumstances. These estimates form the basis for making judgments about the carrying value of certain assets and liabilities that are not readily available from other sources. Actual results may differ from these estimates under different assumptions or conditions. The estimates and judgments that management believes have the most effect on the Company’s reported financial position and results of operations are set forth in Note 1 – Significant Accounting Policies of the Notes to the Consolidated Statements, included in our Annual Report on Form 10-K for the year ended December 31, 2020. There have been no significant changes in critical accounting policies, or the assumptions and judgments utilized in applying these policies since December 31, 2020.
The JOBS Act permits the Company an extended transition period for complying with new or revised accounting standards affecting public companies. The Company has elected to take advantage of this extended transition period, which means that the financial statements included in this report, as well as any financial statements filed in the future, will not be subject to all new or revised accounting standards generally applicable to public companies for the transition period for so long as the Company remains an emerging growth company or until the Company affirmatively and irrevocably opts out of the extended transition period under the JOBS Act.
Recent Developments
Impact of COVID-19
As of September 30, 2021, the COVID-19 pandemic remains ongoing. During 2020, the COVID-19 pandemic created disruption in global supply chains, increased rates of unemployment and adversely impacted many industries,
including industries related to the collateral underlying certain of our loans, and many of these effects are continuing. In 2021, the U.S. economy has, with certain setbacks, begun reopening and wider distribution of vaccines has encouraged increased economic activity. The progression of the COVID-19 pandemic in the United States has not had an adverse impact on our financial condition and results of operations as of and for the three and nine months ended September 30, 2021. Nonetheless, the economic recovery could remain gradual and uneven and could be hindered by persistent or resurgent infection rates, particularly given uncertainty with respect to the distribution and acceptance of the vaccines and their effectiveness with respect to the new variants of the virus.
Effects on Our Market Areas. Our primary banking market areas are the states of North Dakota, Minnesota and Arizona. Our retirement and benefit services business serves clients in all 50 states. We offer retirement and benefit services at all of our banking offices located in our three primary market areas. In addition, we operate one retirement and benefit services office in Minnesota, one in Michigan and one in Colorado.
Each of our market areas continues to have different responses to the COVID-19 pandemic due to the availability of the COVID-19 vaccines and varying infection rates. Based on the current environment, it is unclear how the states in our market areas will continue to change policies in response to the COVID-19 pandemic and whether any such changes will negatively impact our customers and regional economies.
Policy and Regulatory Developments. Federal, state and local governments and regulatory authorities have enacted and issued a range of policy responses to the COVID-19 pandemic. Most recently, these have included the following:
Our Response. We have taken numerous steps in response to the COVID-19 pandemic, including the following:
39
Shareholder Dividend and Stock Repurchases
On July 26, 2021, the Board of Directors of the Company declared a quarterly cash dividend of $0.16 per common share. This dividend was paid on October 8, 2021, to stockholders of record as of the close of business on September 17, 2021.
On February 18, 2021, the Board of Directors of the Company approved a stock repurchase program, or the Program, which authorizes the Company to repurchase up to 770,000 shares of its common stock, subject to certain limitations and conditions. The Program was effective immediately and will continue for a period of 36 months. The Program does not obligate the Company to repurchase any shares of its common stock and there is no assurance that the Company will do so. As of September 30, 2021, no shares had been repurchased under the Program. The Company also repurchases shares to pay withholding taxes on the vesting of restricted stock awards and units.
Operating Results Overview
The following table summarizes key financial results as of and for the periods indicated:
June 30,
Performance Ratios
Return on average total assets
1.62
1.50
2.42
1.71
Return on average common equity
14.68
13.82
22.31
15.61
15.17
Return on average tangible common equity (1)
18.13
17.36
26.67
19.44
18.70
Noninterest income as a % of revenue
63.04
63.48
67.53
63.87
64.58
Net interest margin (taxable-equivalent basis) (1)
2.78
2.88
3.17
2.92
3.22
Efficiency ratio (1)
71.49
71.46
58.42
69.69
66.22
Average equity to average assets
11.07
10.88
10.83
10.97
11.29
Net charge-offs/(recoveries) to average loans
(0.06)
(0.11)
0.01
Dividend payout ratio
21.62
24.24
15.15
20.80
23.20
Per Common Share
Earnings per common share - basic
0.67
Earnings per common share - diluted
0.66
Tangible book value per common share (1)
17.46
16.89
16.31
Average common shares outstanding - basic
17,194
Average common shares outstanding - diluted
17,497
Other Data
Retirement and benefit services assets under administration/management
36,202,553
36,964,961
30,470,645
Wealth management assets under administration/management
3,865,062
3,538,959
3,043,173
Mortgage originations
415,792
545,437
511,605
1,479,243
1,171,811
Selected Financial Data
The following tables summarize selected financial data as of and for the periods indicated:
Selected Average Balance Sheet Data
1,820,871
1,887,986
2,034,778
1,884,308
1,917,894
869,421
800,812
443,705
778,307
383,591
3,190,877
3,119,740
2,908,144
3,119,819
2,690,182
2,720,047
2,677,258
2,454,865
2,671,344
2,270,781
Short-term borrowings
107
58,968
58,996
58,739
48,002
58,747
353,196
339,439
314,921
342,344
303,825
Selected Period End Balance Sheet Data
1,835,312
2,058,419
(33,764)
(31,337)
1,017,868
797,862
495,414
3,157,229
2,898,809
2,710,940
2,462,370
58,992
58,745
Selected Income Statement Data
21,140
36,748
42,550
15,338
3,644
11,694
Non-GAAP to GAAP Reconciliations and Calculation of Non-GAAP Financial Measures
In addition to the results presented in accordance with GAAP, we routinely supplement our evaluation with an analysis of certain non-GAAP financial measures. These non-GAAP financial measures include the ratio of tangible common equity to tangible assets, tangible book value per common share, return on average tangible common equity, net interest margin (tax-equivalent), and the efficiency ratio. Management uses these non-GAAP financial measures in its analysis of its performance, and believes financial analysts and others frequently use these measures, and other similar measures, to evaluate capital adequacy. Management calculates: (i) tangible common equity as total common stockholders' equity less goodwill and other intangible assets; (ii) tangible book value per common share as tangible common equity divided by shares of common stock outstanding; (iii) tangible assets as total assets, less goodwill and other intangible assets; (iv) return on average tangible common equity as net income adjusted for intangible amortization net of tax, divided by average tangible common equity; (v) net interest margin (tax-equivalent) as net interest income plus a tax-equivalent adjustment, divided by average earning assets; and (vi) efficiency ratio as noninterest expense less intangible amortization expense, divided by net interest income plus noninterest income plus a tax-equivalent adjustment.
41
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.
Tangible common equity to tangible assets
Total common stockholders’ equity
Less: Goodwill
27,329
Less: Other intangible assets
23,680
15,421
Tangible common equity (a)
300,401
290,510
274,043
279,253
Tangible assets (b)
3,122,375
3,103,348
2,957,651
2,856,059
Tangible common equity to tangible assets (a)/(b)
9.62
9.36
9.27
9.78
Tangible book value per common share
Tangible common equity (c)
Total common shares issued and outstanding (d)
Tangible book value per common share (c)/(d)
16.00
Return on average tangible common equity
Add: Intangible amortization expense (net of tax)
860
2,628
2,347
Net income, excluding intangible amortization (e)
13,927
12,554
18,441
42,604
36,843
Average total equity
Less: Average goodwill
Less: Average other intangible assets (net of tax)
18,272
19,123
12,565
19,124
13,343
Average tangible common equity (f)
304,723
290,115
275,027
293,019
263,153
Return on average tangible common equity (e)/(f)
Net interest margin (tax-equivalent)
Tax-equivalent adjustment
135
392
325
Tax-equivalent net interest income (g)
21,247
21,275
21,881
64,702
61,018
Average earning assets (h)
3,035,798
2,958,468
2,744,758
2,958,742
2,534,038
Net interest margin (tax-equivalent) (g)/(h)
Efficiency ratio
Less: Intangible amortization expense
Adjusted noninterest expense (i)
40,953
41,462
39,224
124,306
113,703
Total tax-equivalent revenue (j)
57,287
58,023
67,137
178,371
171,693
Efficiency ratio (i)/(j)
Discussion and Analysis of Results of Operations
Net income for the three months ended September 30, 2021 was $13.1 million, or $0.74 per diluted common share, a $4.6 million decrease as compared to $17.7 million, or $0.99 per diluted common share, for the three months ended September 30, 2020. This decrease in net income was primarily due to a decrease of $9.2 million in noninterest income as well as a $1.8 million increase in noninterest expense, partially offset by a $5.5 million decrease in the provision expense. The decrease in noninterest income was primarily attributable to a $11.2 million decrease in mortgage banking revenue, a result of a $95.8 million decrease in mortgage originations. The decrease in the provision for loan losses was driven by net recoveries and continuous improvements of credit quality indicators and economic conditions.
Net income for the nine months ended September 30, 2021 was $40.0 million, or $2.26 per diluted common share, a $5.5 million increase as compared to $34.5 million, or $1.94 per diluted common share for the nine months ended September 30, 2020. The increase in net income was primarily due to a $11.5 million decrease in provision expense, a $3.6 million increase in net interest income and a $3.0 million increase in noninterest income, partially offset by a $11.0 million increase in noninterest expense. The decrease in provision expense was primarily due to a reduction in net charge-offs, improved economic conditions and credit quality indicators. The increase in noninterest expense was primarily due to an $8.6 million increase in compensation expense which was due to a combination of increased mortgage incentives as a result of the $307.4 million increase in mortgage originations, along with an increase in compensation from the acquisition of RPS.
Net Interest Income
Net interest income is the difference between interest income and yield-related fees earned on assets and interest expense paid on liabilities. Net interest margin is the difference between the yield on interest earning assets and the cost of interest-bearing liabilities as a percentage of interest earning assets. Net interest margin is presented on a tax-equivalent basis, which means that tax-free interest income has been adjusted to a pre-tax-equivalent income, assuming a federal income tax rate of 21% for the three and nine months ended September 30, 2021 and 2020.
Net interest income for the three months ended September 30, 2021 was $21.1 million, a decrease of $633 thousand from $21.8 million for the three months ended September 30, 2020. The decrease included a $1.7 million decrease in interest income, offset by a $1.1 million decrease in interest expense. The decrease in interest income was primarily a result of a $3.1 million decrease in interest income from loans due to a decrease of $213.9 million in average loans driven primarily by PPP loan forgiveness. Partially offsetting this decrease was a $1.3 million increase in interest income from investment securities as a result of a $425.7 million increase in average balances. The decrease in interest expense was primarily due to a 27 basis point decrease in the cost of interest-bearing liabilities.
Net interest income for the nine months ended September 30, 2021 was $64.3 million, a $3.6 million increase, or 6.0%, from $60.7 million for the nine months ended September 30, 2020. The change in net interest income was due to a $6.1 million decrease in interest expense, partially offset by a $2.4 million decrease of interest income. The decrease in interest expense was primarily driven by a $4.9 million decrease in interest expense paid on deposits and a $1.2 million decrease in interest expense paid on long-term debt. The decrease in interest income was primarily due to a $5.1 million decrease on interest income from loans partially offset by a $3.0 million increase in interest income from investment securities.
Our net interest margin (on a fully tax-equivalent, or FTE, basis) for the three months ended September 30, 2021 was 2.78%, compared to 3.17% for the same period in 2020. The decrease in net interest margin from the third quarter of 2020 was driven by a 58 basis point lower average earning asset yield, offset by a 27 basis point decrease in the average rate paid on interest-bearing liabilities. The decrease in the average earning asset yield was primarily due to a change in balance sheet mix as the average balance in investment securities increased $425.7 million along with a $112.0 million increase in interest-bearing deposits with banks.
Our net interest margin (on a FTE basis) for the nine months ended September 30, 2021 was 2.92%, compared to 3.22% for the same period in 2020. The change in net interest margin was primarily due to a 64 basis point decrease in average earning asset yield, partially offset by a 53 basis point decrease in the average rate paid on interest-bearing liabilities. Also contributing to the decrease in net interest margin was the change in balance sheet mix as we had increases of $57.5 million in interest-bearing deposits with banks and $394.7 million in investment securities.
As a result of the reductions in the target federal funds interest rate, as well as the impact of the COVID-19 pandemic, we anticipate that our net interest income and net interest margin (on a FTE basis) will remain under pressure in future periods. Any decrease in net interest income or net interest margin will be partially offset by the processing fees received from PPP financing, which fees are being deferred and recognized as an adjustment to interest income over the life of the loans.
44
The following tables present average balance sheet information, interest income, interest expense and the corresponding average yields on assets, and average yields earned, and rates paid for the three and nine months ended September 30, 2021 and 2020. We derived these yields and rates by dividing income or expense by the average balance of the corresponding assets or liabilities. We derived average balances from the daily balances throughout the periods indicated. Average loan balances include loans that have been placed on nonaccrual, while interest previously accrued on these loans is reversed against interest income. In these tables, adjustments are made to the yields on tax-exempt assets in order to present tax-exempt income and fully taxable income on a comparable basis.
Income/
Yield/
Expense
Interest Earning Assets
Interest-bearing deposits with banks
281,768
169,770
0.12
Investment securities (1)
3,534
1.61
2,274
2.04
57,233
346
2.40
90,634
2.44
Commercial:
544,811
6,803
4.95
782,853
8,543
4.34
37,743
380
3.99
32,747
368
4.47
567,696
5,245
3.67
525,514
5,315
4.02
1,150,250
12,428
4.29
1,341,114
14,226
4.22
487,699
4,077
3.32
460,995
4,588
3.96
129,239
1,490
4.57
153,326
1,749
4.54
53,683
4.45
79,343
897
670,621
6,169
3.65
693,664
7,234
4.15
Total loans (1)
18,597
4.05
21,460
4.20
Federal Reserve/FHLB Stock
6,505
71
4.33
5,871
4.40
Total interest earning assets
22,662
2.96
24,405
3.54
Noninterest earning assets
155,079
163,386
Interest-Bearing Liabilities
Interest-bearing demand deposits
692,873
240
0.14
589,633
395
0.27
Money market and savings deposits
1,009,564
365
961,669
781
0.32
217,756
275
0.50
204,969
507
0.98
3.60
5.70
Total interest-bearing liabilities
1,979,171
0.28
1,815,010
0.55
Noninterest-Bearing Liabilities and Stockholders' Equity
799,854
698,594
Other noninterest-bearing liabilities
58,656
79,619
Net interest rate spread
2.68
2.99
Net interest margin on FTE basis (1)
45
219,636
227
162,134
615
0.51
9,425
6,398
2.23
70,218
1,180
2.25
64,555
1,274
2.64
615,310
21,780
4.73
667,742
22,397
4.48
41,812
1,304
4.17
30,385
1,055
4.64
565,861
15,744
3.72
515,761
16,646
4.31
1,222,983
38,828
4.24
1,213,888
40,098
4.41
468,395
12,371
3.53
460,505
13,968
132,145
4,619
4.67
163,332
5,921
4.84
60,785
1,989
4.37
80,169
2,751
4.58
661,325
18,979
3.84
704,006
22,640
4.30
57,807
4.10
62,738
6,273
5,864
68,844
3.11
71,226
3.75
161,077
156,144
678,015
528,024
1,328
0.34
1,018,347
1,131
889,039
4,363
212,297
910
0.57
201,747
1,942
1.29
3.79
5.85
1,956,664
1,677,664
0.81
762,685
651,971
58,126
56,722
2.83
2.94
Interest Rates and Operating Interest Differential
Increases and decreases in interest income and interest expense result from changes in average balances (volume) of interest earning assets and interest-bearing liabilities, as well as changes in average interest rates. The following table shows the effect that these factors had on the interest earned on our interest earning assets and the interest incurred on our interest-bearing liabilities. The effect of changes in volume is determined by multiplying the
46
change in volume by the previous period’s average rate. Similarly, the effect of rate changes is calculated by multiplying the change in average rate by the previous period’s volume.
Three Months Ended September 30, 2021
Compared with
Three Months Ended September 30, 2020
Change due to:
(tax-equivalent basis, dollars in thousands)
Volume
Variance
Interest earning assets
219
(607)
(388)
2,189
(929)
1,260
6,584
(3,557)
3,027
(205)
(209)
112
(94)
(2,604)
864
(1,740)
(1,757)
(617)
56
(44)
397
(148)
249
427
(497)
(70)
1,615
(2,517)
(902)
(2,121)
323
(1,798)
255
(1,525)
(1,270)
267
(778)
(511)
239
(1,836)
(1,597)
(276)
(259)
(1,129)
(173)
(1,302)
(291)
(295)
(664)
(98)
(762)
(300)
(765)
(1,065)
(1,554)
(2,107)
(3,661)
(2,421)
(442)
(2,863)
(1,299)
(3,632)
(4,931)
(396)
(1,347)
(1,743)
5,630
(8,012)
(2,382)
Interest-bearing liabilities
70
(225)
(155)
381
(969)
(588)
(455)
(416)
638
(3,870)
(3,232)
(264)
(232)
(1,134)
(1,032)
(309)
(306)
(470)
(744)
(1,214)
144
(1,253)
(1,109)
651
(6,717)
(6,066)
Change in net interest income
(540)
(634)
4,979
(1,295)
3,684
Provision for Loan Losses
The provision for loan losses is based upon our allowance methodology and is a charge to income that, in our judgment, is required to maintain an adequate allowance for incurred loan losses at each period-end. In assessing the adequacy of the allowance, management considers the size and quality of the loan portfolio measured against prevailing economic conditions, regulatory guidelines, and historical loan loss experience. However, there is no assurance that loan credit losses will not exceed the allowance, and any growth in the loan portfolio and the uncertainty of the general economy may require additional provisions in future periods.
We recorded a $2.0 million reversal of the provision for loan losses for the three and nine months ended September 30, 2021, a $5.5 million decrease compared to the provision for the three months ended September 30, 2020 and an $11.5 million decrease compared to the provision for the nine months ended September 30, 2020. Management believes that a negative adjustment to the provision in the third quarter of 2021 was prudent and was driven by net recoveries in four of the last five quarters and continuous improvements of credit quality indicators and economic conditions.
Our noninterest income is generated from four primary sources: (1) retirement and benefit services; (2) wealth management; (3) mortgage banking; and (4) other general banking services.
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The following table presents our noninterest income for the three and nine months ended September 30, 2021 and 2020.
Total noninterest income for the three months ended September 30, 2021, was $36.0 million, a decrease of $9.2 million, or 20.4%, compared to $45.3 million for the three months ended September 30, 2020. The decrease in noninterest income was primarily driven by decreases of $11.2 million in mortgage banking revenue and $1.4 million in net gains on investment securities. These decreases were partially offset by a $2.9 million increase in retirement and benefit services revenue and a $809 thousand increase in wealth management revenue. The decrease in mortgage banking revenue was primarily due to a $7.8 million decrease in the change in fair value of the secondary market hedge driven by a reduction in the hedged pipeline. The increase in retirement and benefit services revenue was primarily due to $1.8 million in revenue attributable to the acquisition of RPS and $892 thousand in document restatement fees. Wealth management revenue increased primarily due to organic growth and market increases in assets under administration/management.
Total noninterest income for the nine months ended September 30, 2021, was $113.7 million, an increase of $3.0 million, or 2.7%, compared to $110.7 million for the nine months ended September 30, 2020. The change in noninterest income was primarily driven by increases of $8.1 million in retirement and benefit services revenue and $2.8 million in wealth management revenue, partially offset by a $4.3 million decrease in mortgage banking revenue and a $2.6 million decrease in net gains on investment securities. The increase in retirement and benefit services revenue was primarily a result of a $4.5 million in revenue attributable to the acquisition of RPS and a $1.7 million increase in document restatement fees as well as organic growth from an increase in assets under administration/management. Wealth management revenue increased due to increases in assets under administration/management as a result of reasons previously discussed. The decrease in mortgage banking revenue was the result of a $17.7 million decrease in the change in fair value of the secondary market hedge, partially offset by an increase of $307.4 million in mortgage originations and an 11 basis point increase in the gain on sale margin.
We anticipate that our noninterest income will be significantly adversely affected in future periods as a result of increasing interest rates and inflationary pressure, which will adversely affect mortgage originations and mortgage banking revenue.
Noninterest income as a percentage of total operating revenue, which consists of net interest income plus noninterest income, was 63.0% for the three months ended September 30, 2021, compared to 67.5% for the three months ended September 30, 2020 and was 63.9% for the nine months ended September 30, 2021, compared to 64.6% for the nine months ended September 30, 2020.
See “NOTE 13 Segment Reporting” for additional discussion regarding our business lines.
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The following table presents noninterest expense for the three and nine months ended September 30, 2021 and 2020.
Total noninterest expense for the three months ended September 30, 2021 was $42.0 million, an increase of $1.8 million, or 4.5%, compared to $40.2 million for the three months ended September 30, 2020. The increase in noninterest expense was driven by increases of $954 thousand in business services, software and technology expense, $551 thousand in compensation expense and $433 thousand in professional fees and assessments. These increases were partially offset by decreases of $448 thousand in occupancy and equipment expense as well as a $203 thousand decrease in mortgage and lending expenses. Business services, software and technology expense increased due to non-recurring expenses related to investments in automated processing and integration expenses associated with the acquisition of RPS. The increase in compensation expense was a result of the acquisition of RPS, as the number of full-time employees increased from 790 employees in the third quarter of 2020 to 825 employees in the third quarter of 2021 and partially offset by decreased mortgage incentives due to a $95.8 million decrease in mortgage originations. The increase in professional fees and assessments was primarily a result of increased legal fees. The decrease in occupancy and equipment expense was due to the closure of certain offices in 2021 due to our ongoing hybrid work environment. The decrease in mortgage and lending expenses was due to decreased mortgage originations. Occupancy and equipment expense decreased due to the closure of certain offices in 2021 due to our transition to a hybrid work environment.
Total noninterest expense for the nine months ended September 30, 2021 was $127.6 million, an increase of $11.0 million or 9.4%, compared to $116.7 million for the nine months ended September 30, 2020. The increase in noninterest expense was primarily driven by increases of $8.6 million in compensation expense, $1.8 million in business services, software and technology expense and $1.4 million in employee taxes and benefits, partially offset by decreases of $1.4 million in occupancy and equipment expense and $828 thousand in other noninterest expense. The changes in business services, software and technology expense, compensation, employee and benefits, and occupancy and equipment expenses were similar to the changes stated previously. The decrease in other noninterest expense was primarily driven by a $758 thousand decrease in the provision for unfunded commitments. Unfunded commitments decreased 4.3% from the third quarter of 2020.
Income Tax Expense
Income tax expense is an estimate based on the amount we expect to owe the respective taxing authorities, plus the impact of deferred tax items. Accrued taxes represent the net estimated amount due, or to be received from, taxing authorities. In estimating accrued taxes, management assesses the relative merits and risks of the appropriate tax treatment of transactions, taking into account statutory, judicial, and regulatory guidance in the context of our tax position. If the final resolution of taxes payable differs from our estimates due to regulatory determination or legislative or judicial actions, adjustments to tax expense may be required.
For the three months ended September 30, 2021, we recognized income tax expense of $4.1 million on $17.1 million of pre-tax income, resulting in an effective tax rate of 23.7%, compared to income tax expense of $5.6 million on $23.3 million of pre-tax income for the three months ended September 30, 2020, resulting in an effective tax rate of 24.2%.
For the nine months ended September 30, 2021, we recognized income tax expense of $12.4 million on $52.3 million of pre-tax income, resulting in an effective tax rate of 23.7%, compared to income tax expense of $10.7 million on $45.2 million of pre-tax income for the nine months ended September 30, 2020, resulting in an effective tax rate of 23.7%.
Financial Condition
Total assets were $3.2 billion as of September 30, 2021, an increase of $161.4 million, or 5.4%, as compared to December 31, 2020. The overall increase in total assets was primarily due to increases of $425.5 million in investment securities, partially offset by decreases of $179.0 million in loans held for investment and $61.5 million in loans held for sale. The decrease in loans held for investment was primarily due to PPP loan balances decreasing by $164.9 million from December 31, 2020.
The loan portfolio represents a broad range of borrowers comprised of commercial and industrial, commercial real estate, residential real estate, and consumer loans. The goal of the overall portfolio mix is to diversify with approximately one third of the portfolio in each of the commercial and industrial, commercial real estate, and residential real estate categories. As of September 30, 2021, the portfolio mix was 28.1% commercial and industrial, 32.0% commercial real estate, 35.0% residential real estate and 4.9% in other categories. Commercial and industrial loans included $103.5 million of PPP loans as of September 30, 2021.
The following table presents the composition of total loans outstanding by portfolio segment as of September 30, 2021 and December 31, 2020:
Change
Portfolio
Percent
28.1
35.0
(185,259)
(26.8)
2.1
2.2
(6,700)
(15.1)
32.0
28.5
10,511
1.9
62.2
65.7
(181,448)
(14.0)
27.8
23.4
37,969
8.2
7.2
(13,173)
(9.2)
2.8
3.7
(22,337)
(30.5)
37.8
34.3
0.4
100.0
(178,989)
(9.0)
Total loans outstanding were $1.80 billion as of September 30, 2021, a decrease of $179.0 million, or 9.0%, from December 31, 2020. The decrease was primarily due to decreases of $185.3 million in commercial and industrial loans and $6.7 million in real estate construction loans, partially offset by increases of $10.5 million in the commercial real estate loan portfolio and $2.5 million in the consumer loan portfolio. Excluding PPP loans, the commercial portfolio decreased by $16.5 million, or 1.6%, from December 31, 2020.
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Consistent with regulatory guidance urging banks to work with borrowers during the COVID-19 pandemic and as outlined in the CARES Act, the Company offered a payment deferral program for its lending clients that were adversely affected by COVID-19. These deferrals were generally no more than 90 days in duration. As of September 30, 2021, the Company had executed 587 of these deferrals representing $154.5 million. Of those loans, 8 loans with a total outstanding principal balance of $3.4 million have been granted second deferrals, 2 loans with a total outstanding principal balance of $69 thousand remain on the first deferral and the remaining loans have been returned to a normal payment status. In accordance with the Interagency Statement on Loan Modifications and Reporting for Financial institutions as issued on April 7, 2020, these short-term deferrals were not considered TDRs. See “NOTE 4 Loans and Allowance for Loan Losses” to the consolidated financial statements for additional information regarding TDRs.
We anticipate that loan growth will slow down in the future for our commercial and industrial, commercial real estate, residential real estate, and consumer loan portfolios as a result of higher levels of liquidity and competition in our market areas.
The following table presents the maturities and types of interest rates for the loan portfolio as of September 30, 2021.
After one
One year
but within
After
or less
five years
124,595
317,946
64,058
8,284
28,833
39,765
230,117
303,636
172,644
576,896
368,328
10,188
16,085
475,066
32,009
87,691
7,543
40,413
2,980
28,274
88,507
565,737
200,918
665,403
934,065
Sensitivity of loans to changes in interest rates
Fixed interest rates
526,838
510,687
Floating interest rates
138,565
423,378
As of September 30, 2021, 62.8% of the loan portfolio bore interest at fixed rates and 37.2% at floating rates. The expected life of our loan portfolio will differ from contractual maturities because borrowers may have the right to curtail or prepay their loans with or without penalties. Consequently, the table above includes information limited to contractual maturities of the underlying loans.
Asset Quality
Our strategy for credit risk management includes well-defined, centralized credit policies; uniform underwriting criteria; and ongoing risk monitoring and review processes for all commercial and consumer credit exposures. The strategy also emphasizes diversification on a geographic, industry, and client level; regular credit examinations; and management reviews of loans experiencing deterioration of credit quality. We strive to identify potential problem loans early, take necessary charge-offs promptly, and maintain adequate reserve levels for probable loan losses inherent in the portfolio. Management performs ongoing, internal reviews of any problem credits and continually assesses the adequacy of the allowance. We utilize an internal lending division, Special Credit Services, to develop and implement strategies for the management of individual nonperforming loans.
Credit Quality Indicators
Loans are assigned a risk rating and grouped into categories based on relevant information about the ability of borrowers to service their debt such as: current financial information, historical payment experience, credit documentation, public information, and current economic trends, among other factors. The risk ratings are aligned to pass and criticized categories. The criticized categories include special mention, substandard, and doubtful risk ratings. See “NOTE 4 Loans and Allowance for Loan Losses” to the consolidated financial statements for a definition of each of the risk ratings.
The table below presents criticized loans outstanding by loan portfolio segment as of September 30, 2021 and December 31, 2020:
8,398
22,256
20,026
29,274
28,424
51,530
2,149
2,955
5,141
31,210
56,671
Criticized loans as a percent of total loans
1.73
2.86
The following table presents information regarding nonperforming assets as of September 30, 2021 and December 31, 2020:
Nonaccrual loans
Accruing loans 90+ days past due
Total nonperforming loans
5,080
OREO and repossessed assets
Total nonperforming assets
7,091
5,143
Total restructured accruing loans
714
3,427
Total nonperforming assets and restructured accruing loans
7,805
8,570
Nonperforming loans to total loans
0.35
0.26
Nonperforming assets to total assets
0.22
0.17
Allowance for loan losses to nonperforming loans
515
674
Interest income lost on nonaccrual loans approximated $85 thousand and $159 thousand for the three months ended September 30, 2021, and 2020, respectively. There was no interest income included in net interest income related to nonaccrual loans for the three months ended September 30, 2021 and 2020.
Interest income lost on nonaccrual loans approximated $197 thousand and $473 thousand for the nine months ended September 30, 2021, and 2020, respectively. There was no interest income included in net interest income related to nonaccrual loans for the nine months ended September 30, 2021 and 2020.
The allowance for loan losses represents management’s estimate of incurred credit losses inherent in the loan portfolio at the balance sheet date. The allowance for loan losses is maintained at a level management believes is sufficient to absorb incurred losses in the loan portfolio given the conditions at the time. Management determines the
52
adequacy of the allowance based on periodic evaluations of the loan portfolio, after consideration of risk characteristics of the loans and prevailing and anticipated economic and other conditions. A risk system, consisting of multiple grading categories for each portfolio class, is utilized as an analytical tool to assess risk and appropriate reserves. In addition to the risk system, management further evaluates risk characteristics of the loan portfolio under current and anticipated economic conditions and considers such factors as the financial condition of the borrower, past and expected loss experience, and other factors which management feels deserve recognition in establishing an appropriate reserve. These estimates are reviewed at least quarterly, and, as adjustments become necessary, they are recognized in the periods in which they become known. These evaluations are inherently subjective as they require management to make material estimates, all of which may be susceptible to significant change.
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The following table presents, by loan type, the changes in the allowance for loan losses for the periods presented.
Balance—beginning of period
Commercial loan charge-offs
Commercial and Industrial
Total commercial loan charge-offs
Consumer loan charge-offs
Total consumer loan charge-offs
Total loan charge-offs
Commercial loan recoveries
Total commercial recoveries
Consumer loan recoveries
Total consumer loan recoveries
Total loan recoveries
Net loan charge-offs (recoveries)
(302)
(581)
2,087
Commercial loan provision
Total commercial loan provision
Consumer loan provision
Total consumer loan provision
Unallocated provision expense
Total loan loss provision
Balance—end of period
Average total loans
Allowance for loan losses to total loans
1.78
1.52
Net charge-offs/(recoveries) to average total loans (annualized)
The allowance for loan losses was $32.1 million as of September 30, 2021, compared to $34.2 million as of December 31, 2020. The $2.2 million decrease in the allowance for loan losses was primarily due to a $2.0 million reversal of the provision for loan losses expense in the third quarter of 2021. As of September 30, 2021, the allowance for loan losses represented 1.78% of total loans. Excluding PPP loans, the ratio of allowance for loan losses to total loans was 1.89% at September 30, 2021, compared to 2.00% as of December 31, 2020.
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The following table presents the allocation of the allowance for loan losses as of the dates presented.
Percentage
Allocated
of loans to
total loans
In the ordinary course of business, we enter into commitments to extend credit, including commitments under credit arrangements, commercial letters of credit, and standby letters of credit. Such financial instruments are recorded when they are funded. A reserve for unfunded commitments is established using historical loss data and utilization assumptions. This reserve is located in accrued expenses and other liabilities on the Consolidated Balance Sheets. The reserve for unfunded commitments was $1.9 million as of September 30, 2021.
Loans held for sale represent loans to consumers for the purchase or refinance of a residence that we have originated and intend to sell into the secondary market. Loans held for sale were $60.9 million as of September 30, 2021, a decrease of $61.5 million, as compared to December 31, 2020. The decrease in loans held for sale was primarily due to a decrease in mortgage originations. Mortgage loan originations totaled $415.8 million for the three months ended September 30, 2021, compared to $607.2 million for the three months ended December 31, 2020.
The composition of our investment securities portfolio reflects our investment strategy of maintaining an appropriate level of liquidity for normal operations while providing an additional source of revenue. The investment portfolio also provides a balance to interest rate risk and credit risk in other categories of the balance sheet, while providing a vehicle for the investment of available funds, furnishing liquidity, and supplying securities to pledge as collateral. In the second quarter of 2021, we transferred our investment securities of obligations of state and political agencies from available-for-sale to held-to-maturity to protect capital and reduce volatility in other comprehensive income due to market value changes.
The following table presents the fair value composition of our investment securities portfolio as of September 30, 2021 and December 31, 2020:
0.5
(438)
(7.4)
-
26.0
(153,773)
(100.0)
Residential Agency
50.9
51.8
211,753
69.0
16.0
(60)
(0.1)
(44.3)
3.6
5.2
5,509
17.9
64.3
62,940
10.6
14.3
21.4
35.7
208,112
35.1
The investment securities presented in the following table are reported at fair value and by contractual maturity as of September 30, 2021. Actual timing may differ from contractual maturities if borrowers have the right to call or prepay obligations with or without call or prepayment penalties. Additionally, residential mortgage backed securities and collateralized mortgage obligations receive monthly principal payments, which are not reflected below. The yields below are calculated on a tax-equivalent basis.
Maturity as of September 30, 2021
One year or less
One to five years
Five to ten years
After ten years
Yield
1,357
0.92
4,112
0.71
2.54
13,787
2.06
501,309
1.28
35,827
2.80
59,091
2.56
5.31
3.28
1.41
1.76
31,504
2.20
1.85
1.89
37,735
1.12
163,450
2.57
812,947
1.55
Total deposits were $2.71 billion as of September 30, 2021, an increase of $141.1 million, or 5.5%, from December 31, 2020. Interest-bearing deposits increased $98.7 million while noninterest-bearing deposits increased $42.3 million. Key drivers included inflows from government stimulus programs and higher depositor balances due to the uncertain economic environment and volatile financial markets. The increase in interest-bearing deposits included increases of $55.0 million in interest-bearing demand deposits, $28.3 million in money market accounts and savings
accounts and $15.5 million in time deposits. Although overall deposits increased, we saw that within interest-bearing and noninterest-bearing deposits, synergistic deposits decreased $19.6 million from our retirement and benefit services and wealth management segments as participants transitioned balances back into the markets. As of September 30, 2021, the total sourced deposits outside of our branch footprint was $576.0 million. Excluding synergistic deposits, commercial transaction deposits increased $112.5 million, or 10.2%, while consumer transaction deposits increased $31.2 million, or 4.8%, since December 31, 2020.
The following table presents the composition of our deposit portfolio as of September 30, 2021 and December 31, 2020:
Noninterest-bearing demand
29.4
29.3
42,346
5.6
24.8
24.1
55,016
8.9
Money market and savings
1,017,310
37.5
989,039
38.5
28,271
8.3
8.1
15,462
7.4
5.5
The following table presents the average balances and rates of our deposit portfolio for the three months ended September 30, 2021 and 2020:
September 30, 2020
0.13
The following table presents the contractual maturity of time deposits, including certificate of deposit account registry services and IRA deposits of $100 thousand and over, that were outstanding, as of the dates presented:
Maturing in:
3 months or less
76,902
3 months to 6 months
58,486
6 months to 1 year
4,375
1 year or greater
8,379
148,142
Borrowings
Borrowings as of September 30, 2021 and December 31, 2020 were as follows:
Subordinated notes
84.8
84.6
Junior subordinated debentures
8,702
14.8
8,617
14.7
0.7
Total borrowed funds
57
In the first quarter of 2021, we redeemed our previously issued subordinated debt with an initial fixed rate of 5.75% and issued new subordinated debt to the Bank of North Dakota with an initial fixed rate of 3.50%.
Capital Resources
Stockholders' equity is influenced primarily by earnings, dividends, the Company's sales and repurchases of its common stock and changes in accumulated other comprehensive income caused primarily by fluctuations in unrealized gains or losses, net of taxes, on available-for-sale securities.
Stockholders' equity increased $23.0 million to $353.2 million as of September 30, 2021, compared to $330.2 million as of December 31, 2020. The increase in stockholders' equity was primarily driven by $40.0 million in net income, partially offset by $8.2 million in dividends declared on common stock and a $10.1 million decrease in accumulated other comprehensive income. Tangible common equity to tangible assets, a non-GAAP financial measure, increased to 9.62% as of September 30, 2021, from 9.27% as of December 31, 2020. Tangible common equity to tangible assets would have been 9.95% as of September 30, 2021 and 10.19% as of December 31, 2020, if PPP loans were excluded.
We strive to maintain an adequate capital base to support our activities in a safe and sound manner while at the same time attempting to maximize stockholder value. Capital adequacy is assessed against the risk inherent in our balance sheet, recognizing that unexpected loss is the common denominator of risk, and that common equity has the greatest capacity to absorb unexpected loss.
We are subject to various regulatory capital requirements both at the Company and at the Bank level. Failure to meet minimum capital requirements could result in certain mandatory and possible additional discretionary actions by regulators that, if undertaken, could have an adverse material effect on our financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, specific capital guidelines must be met that involve quantitative measures of assets, liabilities, and certain off-balance sheet items as calculated under regulatory accounting policies. We have consistently maintained regulatory capital ratios at or above the well-capitalized standards.
At September 30, 2021 and December 31, 2020, we met all the capital adequacy requirements to which we were subject. The table below presents the Company’s and the Bank’s regulatory capital ratios as of September 30, 2021 and December 31, 2020:
Capital Ratios
Alerus Financial Corporation Consolidated
Tangible common equity to tangible assets (1)
Alerus Financial, National Association
The capital ratios for the Company and the Bank, as of September 30, 2021, as shown in the above tables, were at levels above the regulatory minimums to be considered “well capitalized”. See “Note 16 Regulatory Matters” to the consolidated financial statements for additional information.
58
Contractual Obligations and Off-Balance Sheet Arrangements
Contractual Obligations
In the ordinary course of our operations, we enter into certain contractual obligations. The following table presents our contractual obligations by maturity as of September 30, 2021.
Less than
One to
Three to
Over
one year
three years
Operating lease obligations
2,115
639
200,773
14,065
7,875
Total contractual obligations
202,621
16,201
8,514
61,027
288,363
Off-Balance Sheet Arrangements
We are a party to financial instruments with off-balance sheet risk in the normal course of business to meet the financing needs of our customers. These financial instruments consist primarily of commitments to extend credit and standby letters of credit. Commitments to extend credit are agreements to lend to customers, generally having fixed expiration dates or other termination clauses that may require payment of a fee. These commitments consist principally of unused commercial and consumer credit lines. Standby letters of credit generally are contingent upon the failure of the customer to perform according to the terms of an underlying contract with a third party. The credit risks associated with commitments to extend credit and standby letters of credit are essentially the same as that involved with extending loans to customers and are subject to normal credit policies. Collateral may be required based on management’s assessment of the customer’s creditworthiness. The fair value of these commitments is considered immaterial for disclosure purposes.
A summary of the contractual amounts of our exposure to off-balance sheet agreements as of September 30, 2021 and December 31, 2020, was as follows:
Liquidity
Liquidity management is the process by which we manage the flow of funds necessary to meet our financial commitments on a timely basis and at a reasonable cost and to take advantage of earnings enhancement opportunities. These financial commitments include withdrawals by depositors, credit commitments to borrowers, expenses of our operations, and capital expenditures. Liquidity is monitored and closely managed by our asset and liability committee, or the ALCO, a group of senior officers from the finance, enterprise risk management, deposit, investment, treasury, and lending areas. It is the ALCO’s responsibility to ensure we have the necessary level of funds available for normal operations as well as maintain a contingency funding policy to ensure that potential liquidity stress events are planned for, quickly identified, and management has plans in place to respond. The ALCO has created policies which establish limits and require measurements to monitor liquidity trends, including modeling and management reporting that identifies the amounts and costs of all available funding sources.
As of September 30, 2021, we had on balance sheet liquidity of $789.5 million, compared to $511.1 million as of December 31, 2020. On balance sheet liquidity includes cash and cash equivalents, federal funds sold, unencumbered securities available-for-sale, and over collateralized securities pledging positions available-for-sale.
59
The Bank is a member of the FHLB, which provides short- and long-term funding to its members through advances collateralized by real estate related assets and other select collateral, most typically in the form of debt securities. The actual borrowing capacity is contingent on the amount of collateral available to be pledged to the FHLB. As of September 30, 2021, we had no outstanding fed funds purchased from the FHLB and $658.2 million of collateral pledged to the FHLB. Based on this collateral, we were eligible to borrow up to $657.9 million from the FHLB. In addition, we can borrow up to $102.0 million through the unsecured lines of credit we have established with four other banks.
In addition, because the Bank is “well capitalized,” we can accept wholesale deposits up to 20.0% of total assets based on current policy limits, or $635.0 million as of September 30, 2021. Management believed that we had adequate resources to fund all of our commitments as of September 30, 2021 and December 31, 2020.
Our primary sources of liquidity include liquid assets, as well as unencumbered securities that can be used to collateralize additional funding.
Though remote, the possibility of a funding crisis exists at all financial institutions. The economic impact of COVID-19 could place increased demand on our liquidity if we experience significant credit deterioration and as we meet borrowers’ needs. Accordingly, management has addressed this issue by formulating a liquidity contingency plan, which has been reviewed and approved by both the Bank’s board of directors and the ALCO. The plan addresses the actions that we would take in response to both a short-term and long-term funding crisis.
A short-term funding crisis would most likely result from a shock to the financial system, either internal or external, which disrupts orderly short-term funding operations. Such a crisis would likely be temporary in nature and would not involve a change in credit ratings. A long-term funding crisis would most likely be the result of both external and internal factors and would most likely result in drastic credit deterioration. Management believes that both potential circumstances have been fully addressed through detailed action plans and the establishment of trigger points for monitoring such events.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Market risk is the risk of loss arising from adverse changes in the fair value of financial instruments due to changes in interest rates. Interest-rate risk is the risk to earnings and equity value arising from changes in market interest rates and arises in the normal course of business to the extent that there is a divergence between the amount of interest-earning assets and the amount of interest-bearing liabilities that are prepaid/withdrawn, re-price, or mature in specified periods. We seek to achieve consistent growth in net interest income and equity while managing volatility arising from shifts in market interest rates. The ALCO oversees market risk management, monitoring risk measures, limits, and policy guidelines for managing the amount of interest rate risk and its effect on net interest income and capital. The Bank’s board of directors approves policy limits with respect to interest rate risk.
Interest Rate Risk
Interest rate risk management is an active process that encompasses monitoring loan and deposit flows complemented by investment and funding activities. Effective interest rate risk management begins with understanding the dynamic characteristics of assets and liabilities and determining the appropriate interest rate risk position given business activities, management objectives, market expectations and ALCO policy limits and guidelines.
Interest rate risk can come in a variety of forms, including repricing risk, basis risk, yield curve risk and option risk. Repricing risk is the risk of adverse consequences from a change in interest rates that arises because of differences in the timing of when those interest rate changes impact our assets and liabilities. Basis risk is the risk of adverse consequence resulting from unequal change in the spread between two or more rates for different instruments with the same maturity. Yield curve risk is the risk of adverse consequences resulting from unequal changes in the spread between two or more rates for different maturities for the same or different instruments. Option risk in financial instruments arises from embedded options such as options provided to borrowers to make unscheduled loan
prepayments, options provided to debt issuers to exercise call options prior to maturity, and depositor options to make withdrawals and early redemptions.
Management regularly reviews our exposure to changes in interest rates. Among the factors considered are changes in the mix of interest-earning assets and interest-bearing liabilities, interest rate spreads and repricing periods. The ALCO reviews, on at least a quarterly basis, the interest rate risk position.
The interest-rate risk position is measured and monitored at the Bank using net interest income simulation models and economic value of equity sensitivity analysis that capture both short-term and long-term interest-rate risk exposure.
Modeling the sensitivity of net interest income and the economic value of equity to changes in market interest rates is highly dependent on numerous assumptions incorporated into the modeling process. The models used for these measurements rely on estimates of the potential impact that changes in interest rates may have on the value and prepayment speeds on all components of our loan portfolio, investment portfolio, as well as embedded options and cash flows of other assets and liabilities. Balance sheet growth assumptions are also included in the simulation modeling process. The analysis provides a framework as to what our overall sensitivity position is as of our most recent reported position and the impact that potential changes in interest rates may have on net interest income and the economic value of our equity.
Net interest income simulation involves forecasting net interest income under a variety of interest rate scenarios including instantaneous shocks.
The estimated impact on our net interest income as of September 30, 2021 and December 31, 2020, assuming immediate parallel moves in interest rates is presented in the table below.
Following
12 months
24 months
+400 basis points
−2.2
5.9
10.2
7.3
+300 basis points
−1.5
2.3
7.9
3.2
+200 basis points
−0.9
−1.3
−1.0
+100 basis points
−0.2
−4.9
−5.3
−100 basis points
−11.1
−21.0
−18.8
−200 basis points
Management strategies may impact future reporting periods, as actual results may differ from simulated results due to the timing, magnitude, and frequency of interest rate changes, the difference between actual experience, and the characteristics assumed, as well as changes in market conditions. Market based prepayment speeds are factored into the analysis for loan and securities portfolios. Rate sensitivity for transactional deposit accounts is modeled based on both historical experience and external industry studies.
Management uses economic value of equity sensitivity analysis to understand the impact of interest rate changes on long-term cash flows, income, and capital. Economic value of equity is based on discounting the cash flows for all balance sheet instruments under different interest rate scenarios. Deposit premiums are based on external industry studies and utilizing historical experience.
The table below presents the change in the economic value of equity as of September 30, 2021 and December 31, 2020, assuming immediate parallel shifts in interest rates.
−21.8
12.1
−14.1
12.6
−7.0
11.9
9.5
−31.9
−51.0
Operational Risk
Operational risk is the risk of loss due to human behavior, inadequate or failed internal systems and controls, and external influences such as market conditions, fraudulent activities, disasters, and security risks. Management continuously strives to strengthen its system of internal controls, enterprise risk management, operating processes and employee awareness to assess the impact on earnings and capital and to improve the oversight of our operational risk.
Compliance Risk
Compliance risk represents the risk of regulatory sanctions, reputational impact or financial loss resulting from failure to comply with rules and regulations issued by the various banking agencies and standards of good banking practice. Activities which may expose us to compliance risk include, but are not limited to, those dealing with the prevention of money laundering, privacy and data protection, community reinvestment initiatives, fair lending challenges resulting from the expansion of our banking center network, employment and tax matters.
Strategic and/or Reputation Risk
Strategic and/or reputation risk represents the risk of loss due to impairment of reputation, failure to fully develop and execute business plans, failure to assess current and new opportunities in business, markets and products, and any other event not identified in the defined risk types mentioned previously. Mitigation of the various risk elements that represent strategic and/or reputation risk is achieved through initiatives to help management better understand and report on various risks, including those related to the development of new products and business initiatives.
ITEM 4. CONTROLS AND PROCEDURES
Evaluation of Disclosure Controls and Procedures
The Company’s management, including our President and Chief Executive Officer and our Chief Financial Officer, have evaluated the effectiveness of our “disclosure controls and procedures” (as defined in Rule 13a-15(e) under the Securities Exchange Act of 1934, or the “Exchange Act”), as of the end of the period covered by this report. Based on such evaluation, our President and Chief Executive Officer and our Chief Financial Officer have concluded that, as of the end of such period, the Company’s disclosure controls and procedures were effective as of that date to provide reasonable assurance that the information required to be disclosed by the Company in the reports it files or submits under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the rules and forms of the SEC and that information required to be disclosed by the Company in the reports it files or submits under the Exchange Act is accumulated and communicated to the Company’s management, including its President and Chief Executive Officer and its Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure.
Changes in Internal Control over Financial Reporting
There have not been any changes in the Company’s internal control over financial reporting (as such term is defined in Rule 13a-15(f) under the Exchange Act) during the fiscal quarter to which this report relates that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.
PART II—OTHER INFORMATION
Item 1 – Legal Proceedings
There are no material pending legal proceedings, other than ordinary routine litigation incidental to the business of the Company or its subsidiaries, to which we or any of our subsidiaries is a party or to which our property is the subject. The Company does not know of any proceeding contemplated by a governmental authority against the Company or any of its subsidiaries.
Item 1A – Risk Factors
There have been no material changes to the risk factors disclosed in the Company’s Annual Report on Form 10-K filed with the SEC on March 12, 2021.
Item 2 – Unregistered Sales of Equity Securities and Use of Proceeds
Unregistered Sales of Equity Securities
None.
Issuer Repurchases of Equity Securities
The following table presents information related to repurchases of shares of our common stock for each calendar month in the third quarter of 2021.
Total Number of
Maximum Number of
Total Number
Shares Purchased as
Shares that May
of Shares
Price Paid
Part of Publicly
Yet be Purchased
(dollars in thousands, except per share data)
Purchased (1)
per Share
Announced Plans
Under the Plan (2)
July
1,634
32.08
770,000
August
786
28.20
September
2,420
30.82
Use of Proceeds from Registered Securities
On September 17, 2019, the Company sold 2,860,000 shares of common stock in its initial public offering. On September 25, 2019, the Company sold 429,000 additional shares of common stock pursuant to the exercise in full by the underwriters of their option to purchase additional shares to cover over-allotments. All of the shares were sold pursuant to the Company’s Registration Statement on Form S-1, as amended (File No. 333-233339), which was declared effective by the SEC on September 12, 2019. The Company’s common stock is currently traded on the Nasdaq Capital Market under the symbol “ALRS”.
There has been no material change in the planned use of proceeds from the initial public offering as described in the Company’s prospectus filed with the SEC on September 13, 2019, pursuant to Rule 424(b)(4) under the Securities Act of 1933. From the effective date of the registration statement through September 30, 2021, the Company has
maintained the net proceeds of the initial public offering on deposit with the Bank. The Bank has used the deposits of the Company to pay down short-term borrowings.
Item 3 – Defaults Upon Senior Securities
Item 4 – Mine Safety Disclosures
Not Applicable.
Item 5 – Other Information
Item 6 – Exhibits
Exhibit No.
Description
3.1
Third Amended and Restated Certificate of Incorporation of Alerus Financial Corporation (incorporated herein by reference to Exhibit 3.1 on Form S-1 filed on August 16, 2019).
Second Amended and Restated Bylaws of Alerus Financial Corporation (incorporated herein by reference to Exhibit 3.2 on Form S-1 filed on August 16, 2019).
31.1
Chief Executive Officer’s Certifications required by Rule 13(a)-14(a) – filed herewith.
31.2
Chief Financial Officer’s Certifications required by Rule 13(a)-14(a) – filed herewith.
32.1
Chief Executive Officer Certifications pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 – filed herewith.
32.2
Chief Financial Officer Certifications pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 – filed herewith.
101.INS
iXBRL Instance Document
101.SCH
iXBRL Taxonomy Extension Schema
101.CAL
iXBRL Taxonomy Extension Calculation Linkbase
101.DEF
iXBRL Taxonomy Extension Definition Linkbase
101.LAB
iXBRL Taxonomy Extension Label Linkbase
101.PRE
iXBRL Taxonomy Extension Presentation Linkbase
104
Cover Page Interactive Data File (formatted Inline XBRL and contained in Exhibits 101)
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized
Date: November 4, 2021
By:
/s/ Randy L. Newman
Name: Randy L. Newman
Title: Chairman, Chief Executive Officer and President (Principal Executive Officer)
/s/ Katie A. Lorenson
Name: Katie A. Lorenson
Title: Executive Vice President and Chief Financial Officer (Principal Financial and Accounting Officer)