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, 2023
☐ 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, 2023 was 19,776,006.
Alerus Financial Corporation and Subsidiaries
Page
Part 1:
FINANCIAL INFORMATION
Item 1.
Consolidated Financial Statements
1
Consolidated Balance Sheets as of September 30, 2023 and December 31, 2022
Consolidated Statements of Income for the three and nine months ended September 30, 2023 and 2022
2
Consolidated Statements of Comprehensive Income for the three and nine months ended September 30, 2023 and 2022
3
Consolidated Statements of Changes in Stockholders’ Equity for the three and nine months ended September 30, 2023 and 2022
4
Consolidated Statements of Cash Flows for the nine months ended September 30, 2023 and 2022
6
Notes to Consolidated Financial Statements
8
Item 2.
Management’s Discussion and Analysis of Financial Condition and Results of Operations
45
Item 3.
Quantitative and Qualitative Disclosures About Market Risk
69
Item 4.
Controls and Procedures
71
Part 2:
OTHER INFORMATION
Legal Proceedings
Item 1A.
Risk Factors
Unregistered Sales of Equity Securities, Use of Proceeds, and Issuer Purchases of Equity Securities
Defaults Upon Senior Securities
72
Mine Safety Disclosures
Item 5.
Other Information
Item 6.
Exhibits
73
Signatures
74
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)
2023
2022
Assets
(Unaudited)
(Audited)
Cash and cash equivalents
$
64,724
58,242
Investment securities
Available-for-sale, at fair value
640,001
717,324
Held-to-maturity, at carrying value (allowance for credit losses on investments of $218 September 30, 2023)
303,268
321,902
Loans held for sale
16,346
9,488
Loans
2,606,430
2,443,994
Allowance for credit losses on loans
(36,290)
(31,146)
Net loans
2,570,140
2,412,848
Land, premises and equipment, net
17,182
17,288
Operating lease right-of-use assets
5,986
5,419
Accrued interest receivable
15,561
12,869
Bank-owned life insurance
33,012
33,991
Goodwill
46,783
47,087
Other intangible assets
18,482
22,455
Servicing rights
2,214
2,643
Deferred income taxes, net
47,978
42,369
Other assets
87,461
75,712
Total assets
3,869,138
3,779,637
Liabilities and Stockholders’ Equity
Deposits
Noninterest-bearing
717,990
860,987
Interest-bearing
2,154,194
2,054,497
Total deposits
2,872,184
2,915,484
Short-term borrowings
515,470
378,080
Long-term debt
58,928
58,843
Operating lease liabilities
6,286
5,902
Accrued expenses and other liabilities
66,868
64,456
Total liabilities
3,519,736
3,422,765
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: 19,847,706 and 19,991,681 issued and outstanding
19,848
19,992
Additional paid-in capital
151,875
155,095
Retained earnings
291,162
280,426
Accumulated other comprehensive income (loss)
(113,483)
(98,641)
Total stockholders’ equity
349,402
356,872
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
34,986
25,379
99,187
60,659
Taxable
6,146
5,939
18,222
17,447
Exempt from federal income taxes
182
209
558
638
Other
724
748
2,221
1,021
Total interest income
42,038
32,275
120,188
79,765
Interest Expense
14,436
1,852
36,218
3,494
6,528
1,516
15,684
1,794
679
591
1,999
1,712
Total interest expense
21,643
3,959
53,901
7,000
Net interest income
20,395
28,316
66,287
72,765
Provision for credit losses
550
Net interest income after provision for credit losses
65,737
Noninterest Income
Retirement and benefit services
18,605
16,597
49,977
50,536
Wealth management
5,271
4,852
15,915
15,726
Mortgage banking
2,510
3,782
7,132
14,751
Service charges on deposit accounts
328
377
940
1,152
1,693
1,402
5,475
3,541
Total noninterest income
28,407
27,010
79,439
85,706
Noninterest Expense
Compensation
19,071
21,168
57,076
61,467
Employee taxes and benefits
4,895
5,079
15,472
17,028
Occupancy and equipment expense
1,883
1,925
5,619
5,713
Business services, software and technology expense
4,774
5,373
15,367
15,082
Intangible amortization expense
1,324
3,972
3,430
Professional fees and assessments
1,716
3,126
4,397
6,913
Marketing and business development
692
890
2,026
2,304
Supplies and postage
410
588
1,275
1,806
Travel
322
291
876
826
Mortgage and lending expenses
689
409
1,401
1,577
1,484
2,594
4,022
4,676
Total noninterest expense
37,260
42,767
111,503
120,822
Income before income taxes
11,542
12,559
33,673
37,649
Income tax expense
2,381
2,940
7,222
8,553
Net income
9,161
9,619
26,451
29,096
Per Common Share Data
Basic earnings per common share
0.46
0.48
1.31
1.58
Diluted earnings per common share
0.45
0.47
1.30
1.56
Dividends declared per common share
0.19
0.18
0.56
0.52
Average common shares outstanding
19,872
19,987
19,977
18,186
Diluted average common shares outstanding
20,095
20,230
20,193
18,431
Consolidated Statements of Comprehensive Income (Unaudited)
(dollars in thousands)
Net Income
Other Comprehensive Income (Loss), Net of Tax
Net change in unrealized gains (losses) on available-for-sale securities
(19,074)
(43,305)
(23,782)
(131,424)
Accretion of losses on debt securities reclassified to held-to-maturity
(80)
(91)
(251)
(290)
Net change in unrealized gain (losses) on cash flow hedging derivatives
1,216
Reclassification adjustment for losses (gains) realized in income
(205)
Net change in unrealized gain (losses) on other derivatives
1,132
3,206
Total other comprehensive income (loss), before tax
(17,011)
(43,396)
(19,816)
(131,714)
Income tax expense (benefit) related to items of other comprehensive income (loss)
(4,270)
(10,892)
(4,974)
(33,060)
Other comprehensive income (loss), net of tax
(12,741)
(32,504)
(14,842)
(98,654)
Total comprehensive income (loss)
(3,580)
(22,885)
11,609
(69,558)
Consolidated Statements of Changes in Stockholders’ Equity (Unaudited)
Three months ended September 30, 2023
Accumulated
Additional
Common
Paid-in
Retained
Comprehensive
(dollars and shares in thousands)
Stock
Capital
Earnings
Income (Loss)
Total
Balance as of June 30, 2023
19,915
152,673
285,839
(100,742)
357,685
Other comprehensive income (loss)
Common stock repurchased
(70)
(1,172)
(1,242)
Common stock dividends
(3,838)
Share‑based compensation expense
Vesting of restricted stock
(3)
Balance as of September 30, 2023
Nine months ended September 30, 2023
Balance as of December 31, 2022
Cumulative effect of change in accounting principles, net of tax
(4,452)
Balance as of January 1, 2023
275,974
352,420
(257)
(4,299)
(4,556)
(11,263)
18
1,174
1,192
95
(95)
Three months ended September 30, 2022
Balance as of June 30, 2022
17,306
93,129
267,128
(70,405)
307,158
(3,615)
Stock issuance from the acquisition of Metro Phoenix Bank
2,681
61,149
63,830
351
Balance as of September 30, 2022
154,629
273,132
(102,909)
344,839
Nine months ended September 30, 2022
Balance as of December 31, 2021
17,213
92,878
253,567
(4,255)
359,403
(24)
(673)
(697)
(9,531)
10
1,382
1,392
107
(107)
5
Consolidated Statements of Cash Flows (Unaudited)
Operating Activities
Adjustments to reconcile net income to net cash provided (used) by operating activities
Deferred income taxes
857
(1,215)
Depreciation and amortization
6,378
6,116
Amortization and accretion of premiums/discounts on investment securities
1,652
2,778
Amortization of operating lease right-of-use assets
1,756
(65)
Originations on loans held for sale
(239,004)
(353,547)
Proceeds on loans held for sale
238,028
383,740
(Increase) in value of bank-owned life insurance
(653)
(621)
Realized loss (gain) on sale of fixed assets
(71)
(33)
Realized loss (gain) on derivative instruments
531
1,031
Realized loss (gain) on loans sold
(5,922)
(10,062)
Realized loss (gain) on sale of foreclosed assets
(27)
(9)
Realized loss (gain) on BOLI mortality
(1,196)
Realized loss (gain) on servicing rights
(28)
(683)
Net change in:
(2,692)
(1,628)
4,784
(13,903)
(1,986)
12,348
Net cash provided (used) by operating activities
30,600
54,735
Investing Activities
Proceeds from maturities of investment securities available-for-sale
46,655
88,417
Purchases of investment securities available-for-sale
(96,968)
Proceeds from calls of investment securities held-to-maturity
242
827
Proceeds from maturities and paydowns of investment securities held-to-maturity
17,125
23,422
Net (increase) decrease in loans
(161,606)
(290,565)
Net (increase) decrease in FHLB stock
(5,953)
Net cash received (paid) for business combinations
101,585
Proceeds from BOLI mortality claim
2,828
Purchases of premises and equipment
(1,731)
(1,081)
Proceeds from sales of foreclosed assets
51
143
Net cash provided (used) by investing activities
(102,389)
(174,220)
Financing Activities
Net increase (decrease) in deposits
(43,300)
(312,425)
Net increase (decrease) in short-term borrowings
137,390
253,830
Repayments of long-term debt
(182)
Cash dividends paid on common stock
(9,185)
Repurchase of common stock
Net cash provided (used) by financing activities
78,271
(68,659)
Net change in cash and cash equivalents
6,482
(188,144)
Cash and cash equivalents at beginning of period
242,311
Cash and cash equivalents at end of period
54,167
Supplemental Cash Flow Disclosures
Interest paid
50,969
7,269
Income taxes paid
6,637
8,713
Cash dividends declared, not paid
3,838
3,615
Supplemental Disclosures of Noncash Investing and Financing Activities
Loan collateral transferred to foreclosed assets
153
Right-of-use assets obtained in exchange for new operating lease liabilities, net
1,938
1,452
Change in fair value hedges presented within residential real estate loans and other assets
7
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, 2022, included in the Company’s Annual Report on Form 10-K filed with the SEC on March 13, 2023.
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 as of 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 credit 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.
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 $1.235 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. The last year the Company qualifies as an emerging growth company is 2024.
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.
Allowance for credit losses
Investment securities available-for-sale. For available-for-sale investment securities in an unrealized loss position, the Company evaluates the securities to determine whether the decline in fair value below the amortized cost basis, or impairment, is due to credit-related factors or noncredit-related factors. Any impairment that is not credit related is recognized in other comprehensive income (loss), net of applicable taxes. Credit-related impairment is recognized as an allowance for credit losses, or ACL, related to investment securities available-for-sale on the balance sheet, limited to the amount by which the amortized cost basis exceeds the fair value, with a corresponding adjustment to earnings. Both the ACL and the adjustment to net income may be reversed if conditions change. However, if the Company intends to sell an impaired available-for-sale investment security or is required to sell such a security before recovering its amortized cost basis, the entire impairment amount must be recognized in earnings with a corresponding adjustment to the security’s amortized cost basis. Because the security’s amortized cost basis is adjusted to fair value, there is no ACL in this situation.
In evaluating available-for-sale securities in unrealized loss positions for impairment and the criteria regarding its intent or requirement to sell such securities, the Company considers the extent to which fair value is less than amortized cost, whether the securities are issued by the federal government or its agencies, whether downgrades by bond rating agencies have occurred, and the results of reviews of the issuers’ financial condition, among other factors.
Accrued interest receivable is excluded from the estimate of credit losses.
Investment securities held-to-maturity. Management measures expected credit losses on held-to-maturity investment securities on a collective basis by major security type. The Company evaluates held-to-maturity investment
9
securities by credit rating and an external study, updated annually, that includes historical information such as probability of default and loss going back several years. Accrued interest receivable on held-to-maturity investment securities is excluded from the estimate of credit losses.
Loans held for investment. Under the current expected credit loss, or CECL, accounting standard the ACL is a valuation estimated at each balance sheet date and deducted from the amortized cost basis of loans held for investment to present the net amount expected to be collected.
The Company estimates the ACL based on the underlying assets’ amortized cost basis, which is the amount at which the financing receivable is originated or acquired, adjusted for collection of cash and charge-offs, as well as applicable accretion or amortization of premium, discount and net deferred fees or costs. In the event that collection of principal becomes uncertain, the Company has policies in place to reverse accrued interest in a timely manner. Therefore, the Company has made the policy election to exclude accrued interest from the measurement of ACL.
Expected credit losses are reflected in the ACL through a charge to provision for credit losses when the Company deems all or a portion of the financial asset will be uncollectible; the appropriate amount is written off and the ACL is reduced by the same amount. The Company applies judgement to determine when a financial asset is deemed uncollectible; however, generally, an asset will be considered uncollectible no later than when all efforts of collection have been exhausted. Subsequent recoveries, if any, are credited to the ACL when received.
Upon the adoption of the CECL accounting standard, the Company elected to maintain pools of loans that were previously accounted for under ASC 310-30 and will continue to account for these pools as a unit of account. Upon the adoption of the CECL accounting standard, the ACL was determined for each pool and added to the pools’ carrying amount to establish a new amortized cost basis. Loans that do not share similar risk characteristics are evaluated on an individual basis.
Management estimates the ACL using relevant information, from internal and external sources, relating to past events, current conditions, and reasonable supportable forecasts. Historical loss experience provides the basis for estimation of expected credit losses. Adjustments to historical loss information are made for differences in the current loan-specific risk characteristics such as different underwriting standards, portfolio mix, delinquency level, or life of the loan, as well as changes in environmental conditions, levels of economic activity, unemployment rates, property values and other relevant factors. The calculation also contemplates that the Company may not be able to make or obtain such forecasts for the entire life of the financial assets and requires a reversion to historical loss information.
Ongoing impacts of the CECL accounting standard will be dependent upon changes in economic conditions and forecasts, originated and acquired loan portfolio composition, credit performance trends, portfolio duration and other forecasts.
Loans that do not share risk characteristics are evaluated on an individual basis. Loans evaluated individually are not also included in the collective evaluation. The ACL on individually evaluated loans is recognized on the basis of the present value of expected future cash flows discounted at the effective interest rate, the fair value of collateral adjusted of estimated costs to sell, or observable market price as of the relevant date.
Reserve for off-balance sheet credit exposures. In estimating expected credit losses for off-balance sheet credit exposures, the Company is required to estimate expected credit losses over the contractual period in which it is exposed to credit risk via a present contractual obligation to extend credit, unless that obligation is unconditionally cancellable by the issuer. To be considered unconditionally cancellable for accounting purposes, the Company must have the ability to, at any time, with or without cause, refuse to extend credit under the commitment. Off-balance sheet credit exposure segments share the same risk characteristics as portfolio loans. The Company incorporates a probability of funding and utilizes the ACL loss rates to calculate the reserve. The reserve for off-balance sheet credit exposure is carried on the balance sheet in accrued expenses and other liabilities rather than as a component of the allowance. The reserve for off-balance sheet credit exposure is adjusted as a provision for off-balance sheet credit exposure reported as a component of the provision for credit loss expense in the accompanying unaudited Consolidated Statements of Income.
NOTE 2 Recent Accounting Pronouncements
The following Financial Accounting Standards Board, or FASB, Accounting Standards Updates, or ASUs, are divided into pronouncements which have been adopted by the Company since January 1, 2023, and those which are not yet effective and have been evaluated or are currently being evaluated by management as of September 30, 2023.
Adopted Pronouncements
On January 1, 2023, the Company adopted ASU No. 2016-13, Financial Instruments – Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments. The measurement of expected credit losses under the CECL accounting standard is applicable to financial assets measured at amortized cost, including loan receivables. It also applies to off-balance sheet credit exposures not accounted for as insurance (loan commitments, standby letters of credit, financial guarantees, and other similar agreements). In addition, ASC 326 made changes to the accounting for held-to-maturity debt securities. One such change is to require credit losses to be presented as an allowance, rather than as a write-down.
The Company adopted ASC 326 using the modified retrospective method for all financial assets measured at amortized cost, off-balance sheet credit exposures, and held-to-maturity securities. Results for reporting periods beginning after December 31, 2022, are presented under ASC 326, while prior period amounts continue to be reported in accordance with previously applicable GAAP. The Company recorded a net decrease to retained earnings of $4.5 million as of January 1, 2023, for the cumulative effect of adopting ASC 326.
The Company adopted ASC 326 using the prospective transition approach for financial assets purchased with credit deterioration previously classified as purchased credit impaired and accounted for under ASC 310-30. In accordance with the standard, management did not reassess whether purchased credit impaired, or PCI, assets met the criteria of purchased credit deteriorated, or PCD, assets as of the date of adoption.
11
The following table illustrates the impact of ASC 326:
January 1, 2023
As reported
Pre-tax impact of
under
Pre-ASC 326
ASC 326
Assets:
Adoption
Investments
Held-to-maturity
Obligations of state and political agencies
110
Mortgage backed securities
Residential agency
62
Total allowance for held-to-maturity investment securities
172
Commercial
Commercial and industrial
8,296
9,158
(862)
Real estate construction
3,964
1,446
2,518
Commercial real estate
12,264
12,688
(424)
Total commercial
24,524
23,292
1,232
Consumer
Residential real estate first mortgage
7,849
5,769
2,080
Residential real estate junior lien
1,222
1,289
(67)
Other revolving and installment
424
528
(104)
Total consumer
9,495
7,586
1,909
Unallocated
984
268
716
Total allowance for loans
35,003
31,146
3,857
Allowance for credit losses on loans and investments securities
35,175
4,029
Liabilities:
Allowance for credit losses on unfunded commitments
5,159
3,244
1,915
In March 2022, the FASB issued ASU No. 2022-01, Derivatives and Hedging (Topic 815): Fair Value Hedging – Portfolio Layer Method, which clarifies the guidance on fair value hedge accounting of interest rate risk portfolios of financial assets. ASU 2022-01 updates guidance in Topic 815, to expand the scope of the current last-of-layer method to allow multiple hedged layers to be designated for a single closed portfolio of financial assets or one or more beneficial interests secured by a portfolio of financial instruments on a prospective basis. Additionally, ASU 2022-01 clarifies that basis adjustments related to existing portfolio layer hedge relationships should not be considered when measuring credit losses on the financial assets included in the closed portfolio. Further, ASU 2022-01 clarifies that any reversal of fair value hedge basis adjustments associated with an actual breach should be recognized in interest income immediately. ASU 2022-01 was effective for fiscal years beginning after December 15, 2022, with early adoption permitted. The Company adopted ASU 2022-01 effective January 1, 2023, and entered into a fair value hedge agreement on February 10, 2023 and adopted the portfolio layer method of accounting for this transaction. This adoption had no impact on our consolidated financial statements as the Company did not have any hedged assets using the last-of-layer hedge accounting method.
In March 2022, the FASB issued ASU No. 2022-02, Financial Instruments – Credit Losses Troubled Debt Restructurings and Vintage Disclosures. The amendments in this update eliminate the accounting guidance for Troubled Debt Restructurings, or TDRs, by creditors in Subtopic 310-40. Receivables – Troubled Debt Restructurings by Creditors, while enhancing the disclosure requirements for certain loan refinancings and restructurings by creditors when a borrower is experiencing financial difficulty. For public business entities, this amendment also has vintage disclosures that require that an entity disclose current-period gross write-offs by year of origination for financing receivables and net investments in leases within the scope of Subtopic 326-20 Financial Instruments – Credit Losses – Measured at Amortized Cost. For entities that had not yet adopted the amendment in ASU 2016-13, the effective date for the amendments in this update are same as the effective date for ASU 2016-13. The Company adopted this ASU on January 1, 2023, and had no loans experience financial difficulty in the current period.
12
NOTE 3 Investment Securities
The following tables present amortized cost, gross unrealized gains and losses, allowance for credit losses, and fair value of the available-for-sale investment securities and the amortized cost, gross unrealized gains and losses and fair value of held-to-maturity securities as of September 30, 2023 and December 31, 2022:
September 30, 2023
Amortized
Unrealized
Allowance for
Fair
Cost
Gains
Losses
Credit Losses
Value
Available-for-sale
U.S. Treasury and agencies
2,679
(23)
2,665
656,845
(135,222)
521,623
66,980
(8,295)
58,685
Asset backed securities
27
Corporate bonds
69,495
(12,494)
57,001
Total available-for-sale investment securities
796,026
(156,034)
130,088
(18,651)
115
111,437
173,398
(36,596)
103
136,802
Total held-to-maturity investment securities
303,486
(55,247)
218
248,239
Total investment securities
1,099,512
(211,281)
888,240
December 31, 2022
3,518
19
(17)
N/A
3,520
705,845
(118,168)
587,679
70,669
(7,111)
63,558
34
69,501
(6,968)
62,533
849,567
21
(132,264)
137,787
(17,736)
120,051
184,115
(33,254)
150,861
(50,990)
270,912
1,171,469
(183,254)
988,236
The adequacy of the allowance for credit losses on investment securities is assessed at the end of each quarter. The Company does not believe that the available-for-sale debt securities that were in an unrealized loss position as of September 30, 2023, represent a credit loss impairment. As of September 30, 2023, and December 31, 2022, the gross unrealized loss positions were primarily related to mortgage-backed securities issued by U.S. government agencies or U.S. government-sponsored enterprises. These securities carry the explicit and/or implicit guarantee of the U.S. government, are widely recognized as “risk free,” and have a long history of zero credit loss. Total gross unrealized losses were attributable to changes in interest rates, relative to when the investment securities were purchased, and not due to the credit quality of the investment securities. The Company does not intend to sell the investment securities that were in an unrealized loss position and it is not more likely than not that the Company will be required to sell the investment securities before recovery of their amortized cost basis, which may be at maturity.
The allowance for credit losses on held-to-maturity debt securities is estimated using relevant information, from internal and external sources, relating to past events, current conditions, and reasonable supportable forecasts. Using a probability of default and loss on given default analysis an allowance for credit losses was established in the amount of $218 thousand as of September 30, 2023.
13
Accrued interest receivable on available-for-sale investment securities and held-to-maturity investment securities is recorded in accrued interest receivable and is excluded from the estimate of credit losses. As of September 30, 2023, the accrued interest receivable on available-for-sale investment securities and held-to-maturity investment securities totaled $2.4 million and $1.0 million, respectively. As of December 31, 2022, the accrued interest receivable on available-for-sale investment securities and held-to-maturity investment securities totaled $1.9 million and $1.5 million, respectively.
The following table presents investment securities available-for-sale in an unrealized loss position for which an allowance for credit losses has not been recorded as of September 30, 2023:
Less than 12 Months
Over 12 Months
389
577
(135,213)
484,451
485,028
58,684
26
584
(156,025)
600,544
601,128
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 December 31, 2022, were as follows:
509
(10,457)
79,693
(107,711)
507,418
587,111
(4,835)
50,437
(2,276)
13,120
63,557
32
48,048
(2,516)
14,484
62,532
(19,761)
178,719
(112,503)
535,024
713,743
(3,336)
18,788
(14,400)
98,762
117,550
(47,654)
249,623
268,411
(23,097)
197,507
(160,157)
784,647
982,154
Unrealized losses on available-for-sale investment securities have not been recognized into income because the issuers’ bonds are of high credit quality. Furthermore, the Company does not intend to sell, and it is likely that management will not be required to sell, the securities prior to their anticipated recovery, and the decline in fair value is largely due to changes in interest rates. The issuers continue to make timely principal and interest payments on their bonds. The Company expects that it could see a continued increase in unrealized losses if the Federal Reserve continues to raise interest rates.
14
The following table presents amortized cost and fair value of available-for-sale investment securities and the carrying value and fair value of held-to-maturity investment securities as of September 30, 2023, by contractual maturity:
Carrying
Due within one year or less
5,981
5,875
Due after one year through five years
51,009
45,878
17,119
15,706
Due after five years through ten years
60,325
49,427
80,670
66,779
Due after 10 years
12,773
10,257
41,392
35,893
139,181
118,378
Mortgage-backed securities
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 $381.4 million and $260.7 million were pledged as of September 30, 2023 and December 31, 2022, respectively, to secure public deposits and for other purposes required or permitted by law.
The company had no sales or calls of available-for-sale investment securities, for the three and nine months ended September 30, 2023 and 2022.
Proceeds from the call of held-to-maturity investment securities, for the three and nine months ended September 30, 2023 and 2022, are displayed in the table below:
Proceeds
116
101
Realized gains
Realized losses
As of September 30, 2023 and December 31, 2022, 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
4,623
4,595
FHLB
25,316
19,362
These securities can only be redeemed or sold at their par value and only to the respective issuing institution or to another member institution. The Company records these non-marketable equity securities as a component of other assets and periodically evaluates these securities for impairment. Management considers these non-marketable equity securities to be long-term investments. Accordingly, when evaluating these securities for impairment, management considers the ultimate recoverability of the par value rather than recognizing temporary declines in value.
Visa Class B Restricted Shares
In 2008, the Company received Visa Class B restricted shares as part of Visa’s initial public offering. These shares are transferable only under limited circumstances until they can be converted into the publicly traded Class A common shares. This conversion will not occur until the settlement of certain litigation which will be indemnified by Visa members, including the Company. Visa funded an escrow account from its initial public offering to settle these
15
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, 2023, the conversion ratio was 1.5902. Based on the existing transfer restriction and the uncertainty of the outcome of the Visa litigation mentioned above, the 6,924 Class B shares (11,010 Class A equivalents) that the Company owned as of September 30, 2023 and December 31, 2022, were carried at a zero cost basis.
NOTE 4 Loans and Allowance for Credit Losses
The following table presents total loans outstanding, by portfolio segment, as of September 30, 2023 and December 31, 2022:
582,387
583,876
97,742
97,810
1,025,014
881,670
1,705,143
1,563,356
717,793
679,551
152,677
150,479
30,817
50,608
901,287
880,638
Total loans
Total loans included net deferred loan fees and costs of $0.5 million and $0.9 million at September 30, 2023 and December 31, 2022, respectively. Unearned discounts associated with the acquisition of Metro Phoenix Bank totaled $5.2 million as of September 30, 2023.
Accrued interest receivable on loans is recorded within accrued interest receivable, and totaled $11.5 million at September 30, 2023 and $9.2 million at December 31, 2022.
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.
The following tables present a past due aging analysis of total loans outstanding, by portfolio segment, as of September 30, 2023 and December 31, 2022:
90 Days
Accruing
30 - 89 Days
or More
Current
Past Due
Nonaccrual
572,898
2,929
6,560
97,627
1,024,118
896
1,694,643
7,571
716,799
108
886
151,593
538
546
30,635
178
899,027
824
1,436
2,593,670
3,753
9,007
16
580,288
2,426
1,162
97,370
440
879,830
368
1,472
1,557,488
2,794
3,074
677,471
1,545
535
149,918
184
50,360
247
877,749
2,169
720
2,435,237
4,963
3,794
In calculating expected credit losses, the Company includes loans on nonaccrual status and loans 90 days or more past due and still accruing. The following table presents the amortized cost basis on nonaccrual status loans and loans 90 days or more past due and still accruing as of September 30, 2023 and December 31, 2022:
As of September 30, 2023
with no Allowance
for Credit Losses
880
46
926
1,041
576
1,214
1,934
Loans with a carrying value of $1.9 billion as of September 30, 2023 and $1.5 billion as of December 31, 2022, were pledged to secure public deposits, and for other purposes required or permitted by law.
17
A loan for which the terms have been modified resulting in a concession represents a loan experiencing financial difficulty. Loans experiencing financial difficulty can include modifications for an interest rate reduction below current market rates, a forgiveness of principal balance, an extension of the loan term, an-other than significant payment delay, or some combination of similar types of modifications. During the three and nine months ended September 30, 2023, the Company did not provide any modifications to loans under these circumstances that were experiencing financial difficulty.
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 performs detailed internal and external reviews of risk rated loans over a certain threshold to identify credit risks and to assess the overall collectability of the portfolio. These risk ratings are also subject to examination by the Company’s regulators. During the internal reviews, management monitors and analyzes the financial condition of borrowers and guarantors, trends in the industries in which the borrowers operate and the estimated fair values of collateral securing the loans. These credit quality indicators are used to assign a risk rating to each individual loan.
The Company’s ratings are aligned to pass and criticized categories. The criticized category includes special mention, substandard, and doubtful risk ratings. The risk ratings are defined as follows:
Pass: A pass loan is a credit with no existing or known potential weaknesses deserving of management’s close attention.
Special Mention: Loans classified as special mention have a potential weakness that deserves management’s close attention. If left uncorrected, this potential weakness may result in deterioration of the repayment prospects for the loan or of the Company’s credit position at some future date. Special mention loans are not adversely classified and do not expose the Company to sufficient risk to warrant adverse classification.
Substandard: Loans classified as substandard are not adequately protected by the current net worth and paying capacity of the borrower or of the collateral pledged, if any. Loans classified as substandard have a well-defined weakness or weaknesses that jeopardize the repayment of the debt. Well-defined weaknesses include a borrower’s lack of marketability, inadequate cash flow or collateral support, failure to complete construction on time, or the failure to fulfill economic expectations. They are characterized by the distinct possibility that the Company will sustain some loss if the deficiencies are not corrected.
Doubtful: Loans classified as doubtful have all the weaknesses inherent in those classified as substandard, with the added characteristic that the weaknesses make collection or repayment in full, on the basis of currently existing facts, conditions, and values, highly questionable and improbable.
Loss: Loans classified as loss are considered uncollectible and charged off immediately.
The following table sets forth the amortized cost basis of loans by credit quality indicator and vintage based on the most recent analysis performed, as of September 30, 2023:
Revolving
Term Loans Amortized Cost Basis by Origination Year
Loans Amortized
2021
2020
2019
Prior
Cost Basis
Pass
104,091
107,346
75,494
67,184
37,877
50,189
108,524
550,705
Special mention
273
Substandard
117
5,052
8,064
104
15,481
31,409
Doubtful
Subtotal
104,208
112,398
75,871
75,248
37,981
52,403
124,278
14,284
39,029
18,594
144
9,506
1,054
82,611
15,131
54,160
151,721
277,347
140,323
158,590
108,798
164,538
16,765
1,018,082
97
4,157
1,792
6,932
277,444
141,209
112,955
166,330
58,972
203,782
222,783
109,029
33,356
89,480
284
717,686
89,587
17,021
16,755
6,452
4,908
1,779
6,299
97,541
150,755
331
1,591
1,922
6,630
99,132
5,786
6,936
1,319
2,000
1,442
8,175
Total Loans
351,875
651,195
464,965
345,014
193,316
313,002
231,289
2,550,656
15,404
5,149
1,263
4,261
4,444
17,072
40,370
351,992
671,475
466,228
353,078
197,577
317,446
248,634
The following table sets forth the risk category of loans by class of loans and credit quality indicator used on the most recent analysis performed as of December 31, 2022:
Criticized
Special
Mention
558,694
21,969
3,213
97,548
262
873,270
8,400
1,529,512
11,875
678,743
63
745
149,847
632
50,607
879,197
1,378
2,408,709
22,032
13,253
The adequacy of the allowance for credit losses on loans is assessed at the end of each quarter. The allowance for credit losses is estimated using relevant information, from internal and external sources, relating to past events, current conditions, and reasonable supportable forecasts. Historical data is evaluated in multiple components of the expected credit loss, including the reasonable and supportable forecast of each loan segment. Historical experience is used to infer probability of default and loss given the reasonable and supportable forecast period. Qualitative reserves reflect management’s overall estimate of the extent to which current expected credit losses on collectively evaluated loans will differ from historical loss experience. The analysis takes into consideration other analytics performed within the organization, such as enterprise and concentration management, along with other credit-related analytics as deemed appropriate.
The following tables present, by loan portfolio segment, a summary of the changes in the allowance for credit losses on loans for the three and nine months ended September 30, 2023 and 2022:
Beginning
Provision for
Loan
Ending
Balance
Charge-offs
Recoveries
7,813
442
(134)
456
8,577
3,646
1,063
4,709
12,965
(270)
12,706
24,424
1,235
467
25,992
7,901
(389)
254
7,757
1,351
(14)
1,337
293
(58)
(8)
24
251
9,545
(461)
278
9,345
1,727
(774)
953
35,696
(151)
36,290
20
of ASC 326
Credit Losses(1)
(275)
(394)
950
408
878
(339)
256
140
(77)
52
(188)
(36)
(387)
(122)
359
(31)
460
(516)
1,343
Loan Losses
10,333
(845)
(672)
105
8,921
378
76
1,332
10,834
1,335
12,270
22,045
868
282
22,523
6,175
(584)
5,591
1,467
(109)
1,365
634
(75)
53
537
8,276
(768)
60
7,493
1,052
(100)
952
31,373
(747)
342
30,968
8,925
1,011
(1,336)
321
783
473
12,376
(229)
123
22,084
1,255
520
6,532
(941)
1,295
221
481
65
(130)
121
8,308
(1,027)
1,180
(228)
31,572
(1,466)
862
The following table presents, by loan portfolio segment, a summary of charge-offs, by vintage, for the nine months ended September 30, 2023:
Gross Charge-offs for nine months ended September 30, 2023
39
28
394
77
36
80
122
37
38
149
516
The following tables present the amortized cost and related allowance for credit losses on loans, by portfolio segment, as of September 30, 2023 and December 31, 2022:
Amortized Cost
Allowance for Credit Losses on Loans
Individually
Collectively
Evaluated for
Impairment
6,559
575,828
1,352
7,225
7,570
1,697,573
24,640
716,907
547
152,130
30,813
1,437
899,850
2,597,423
33,985
Recorded Investment
Allowance for Loan Losses
Evaluated
1,313
582,563
275
8,883
1,349
880,198
582
12,106
3,047
1,560,309
954
22,338
679,016
150,295
879,918
3,767
2,440,227
29,924
22
The following table presents the amortized cost basis of collateral dependent loans, by the primary collateral type, which are individually evaluated to determine expected credit losses, and the related ACL allocated to these loans, as of September 30, 2023:
Primary Type of Collateral
Real estate
Equipment
572
932
936
1,504
1,508
Pre-ASC 326 Adoption impaired loan disclosures
The table below summarizes key information on impaired loans as of December 31, 2022:
Recorded
Unpaid
Related
Investment
Principal
Allowance
Impaired loans with a valuation allowance
675
711
900
Total impaired loans with a valuation allowance
1,833
2,051
Impaired loans without a valuation allowance
767
660
573
Total impaired loans without a valuation allowance
2,219
Total impaired loans
1,478
1,560
4,270
23
The table below presents the average recorded investment in impaired loans and interest income for the three and nine months ended September 30, 2022:
Three months ended September 30,
Average
Interest
Income
722
1,371
801
2,032
189
4,401
2,093
5,123
Nine Months Ended September 30,
833
1,291
805
2,108
193
4,408
2,124
29
5,241
NOTE 5 Goodwill and Other Intangible Assets
The following table summarizes the carrying amount of goodwill, by segment, as of September 30, 2023 and December 31, 2022:
Banking
35,260
11,523
11,827
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, 2023.
The gross carrying amount and accumulated amortization for each type of identifiable intangible asset, as of September 30, 2023 and December 31, 2022, were as follows:
Gross Carrying Amount
Accumulated Amortization
Identifiable customer intangibles
41,423
(28,951)
12,472
(25,927)
15,496
Core deposit intangible assets
7,592
(1,582)
6,010
(633)
6,959
Total intangible assets
49,015
(30,533)
(26,560)
Amortization of intangible assets was $1.3 million for both the three months ended September 30, 2023 and 2022. Amortization of intangible assets was $4.0 million and $3.4 million for the nine months ended September 30, 2023 and 2022, 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 $373.8 million and $357.2 million as of September 30, 2023 and December 31, 2022, 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, 2023 and 2022:
Balance, beginning of period
2,351
2,064
1,880
Additions
604
622
Amortization
(140)
(110)
(458)
(367)
Fair value adjustments
222
645
Balance, end of period
2,780
25
The following is a summary of key data and assumptions used in the valuation of servicing rights as of September 30, 2023 and December 31, 2022. 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
18.8
20.5
Prepayment speeds
5.9
%
6.9
Discount rate
11.1
10.5
NOTE 7 Leases
Substantially all of the leases in which the Company is the lessee are comprised of real property for offices and office equipment rentals with terms extending through 2037. Portions of certain properties are subleased for terms extending through 2024. Substantially all of the Company’s leases are classified as operating leases. The Company has no existing finance leases.
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 as of September 30, 2023 and December 31, 2022:
Lease Right-of-Use Assets
Classification
Lease Liabilities
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. The Company utilizes its incremental borrowing rate at lease inception, on a collateralized basis, over a similar term for the discount rate. 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
7.2
5.0
Weighted-average discount rate
3.9
3.1
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 ended September 30, 2023 and 2022:
Lease costs
Operating lease cost
503
425
1,438
1,250
Variable lease cost
219
187
918
Short-term lease cost
188
128
276
Finance lease cost
Interest on lease liabilities
Amortization of right-of-use assets
87
Sublease income
(50)
(63)
(169)
(179)
Net lease cost
718
768
2,315
1,991
Other information
Cash paid for amounts included in the measurement of lease liabilities operating cash flows from operating leases
499
400
1,184
Right-of-use assets obtained in exchange for new operating lease liabilities
(1,240)
1,065
Future minimum payments for finance and operating leases with initial or remaining terms of one year or more as of September 30, 2023 were as follows:
Operating
Leases
Twelve months ended
September 30, 2024
1,667
September 30, 2025
1,278
September 30, 2026
1,064
September 30, 2027
September 30, 2028
311
Thereafter
1,830
Total future minimum lease payments
6,666
Amounts representing interest
(380)
Total operating lease liabilities
NOTE 8 Deposits
The components of deposits in the consolidated balance sheets as of September 30, 2023 and December 31, 2022 were as follows:
Interest-bearing demand
759,812
706,275
Savings accounts
88,341
99,882
Money market savings
959,106
1,035,981
Time deposits
346,935
212,359
Total interest-bearing
Certificates of deposit in excess of $250,000 totaled $98.7 million and $51.1 million at September 30, 2023 and December 31, 2022, respectively.
NOTE 9 Short-Term Borrowings
Short-term borrowings at September 30, 2023 and December 31, 2022 consisted of the following:
Fed funds purchased
315,470
153,080
FHLB short-term advances
200,000
225,000
The following table presents information related to short-term borrowings for the three and nine months ended September 30, 2023 and 2022:
Balance as of end of period
53,830
Average daily balance
312,121
84,149
Maximum month-end balance
78,015
Weighted-average rate
During period
5.50
3.71
End of period
5.53
3.25
173,913
168,750
5.46
1.71
3.20
320,861
55,527
492,060
117,350
5.23
2.47
84,982
60,073
5.22
NOTE 10 Long-Term Debt
Long-term debt as of September 30, 2023 and December 31, 2022 consisted of the following:
Period End
Face
Maturity
Interest Rate
Rate
Date
Call Date
Subordinated notes payable
50,000
Fixed
3.50
3/30/2031
3/31/2026
Junior subordinated debenture (Trust I)
4,124
3,571
Three-month CME SOFR + 0.26% + 3.10%
8.76
6/26/2033
6/26/2008
Junior subordinated debenture (Trust II)
6,186
5,357
Three-month CME SOFR + 0.26% + 1.80%
7.47
9/15/2036
9/15/2011
Total long-term debt
60,310
3,537
Three-month LIBOR + 3.10%
7.82
5,306
Three-month LIBOR + 1.80%
6.57
NOTE 11 Financial Instruments with Off-Balance Sheet Risk
In the normal course of business, the Company has outstanding commitments 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 Company 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 Company 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 as of September 30, 2023 and December 31, 2022, respectively, was as follows:
Commitments to extend credit
786,233
806,431
Standby letters of credit
9,734
13,089
795,967
819,520
The Company had an allowance for loan losses on unfunded commitments of $3.2 million as of December 31, 2022. Upon the adoption of the CECL accounting standard, the Company recorded an additional $1.9 million reserve for unfunded commitments. For the nine months ending September 30, 2023, the Company recorded an additional $304 thousand in provision for credit losses on unfunded commitments for a total of $5.2 million of allowance for credit losses on unfunded commitments as of September 30, 2023.
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 no letters of credit outstanding with the FHLB as of September 30, 2023 or December 31, 2022. With the Bank of North Dakota, the Company had a no letters of credit outstanding as of September 30, 2023 and December 31, 2022. Letters of credit with the Bank of North Dakota were collateralized by loans pledged to the Bank of North Dakota in the amount of $400.3 million and $215.5 million as of September 30, 2023 and December 31, 2022, respectively.
NOTE 12 Share-Based Compensation
On May 6, 2019, the Company’s stockholders approved the Alerus Financial Corporation 2019 Equity Incentive Plan. This plan gives 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 and 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, 2023, 781,839 shares of common stock are still available for issuance under the plan.
The compensation expense relating to awards under these plans was $377 thousand and $351 thousand for the three months ended September 30, 2023 and 2022. The compensation expense relating to awards under these plans was $1.2 million and $1.4 million for the nine months ended September 30, 2023 and 2022, respectively.
The following table presents the activity in the stock plans for the nine months ended September 30, 2023 and 2022:
Nine months ended September 30,
Weighted-
Average Grant
Awards
Date Fair Value
Restricted Stock and Restricted Stock Unit Awards
Outstanding at beginning of period
238,929
23.66
260,850
21.04
Granted
115,174
20.00
102,265
25.44
Vested
(93,767)
21.34
(107,370)
19.19
Forfeited or cancelled
(26,840)
21.33
(10,624)
23.71
Outstanding at end of period
233,496
23.05
245,121
23.57
As of September 30, 2023, there was $3.0 million of unrecognized compensation expense related to non-vested awards granted under the plans. The expense is expected to be recognized over a weighted-average period of 2.4 years.
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NOTE 13 Income Taxes
The components of income tax expense (benefit) for the three and nine months ended September 30, 2023 and 2022 were as follows:
Percent of
Amount
Pretax Income
Taxes at statutory federal income tax rate
2,424
21.0
2,637
Tax effect of:
Tax exempt income
(189)
(1.6)
(133)
(1.1)
State income taxes, net of federal benefits
4.3
406
3.2
Nondeductible items and other
(353)
(3.1)
0.2
Applicable income taxes
20.6
23.3
7,071
7,906
(489)
(1.5)
(372)
(1.0)
1,445
1,515
4.0
(805)
(2.4)
(496)
(1.3)
21.4
22.7
It is the opinion of management that the Company has no significant uncertain tax positions that would be subject to change upon examination.
NOTE 14 Tax Credit Investments
The Company invests in qualified affordable housing projects for the purpose of community reinvestment and obtaining tax credits. The Company’s tax credit investments are limited to existing lending relationships with well-known developers and projects within the Company’s market area.
The following table presents a summary of the Company’s investments in qualified affordable housing project tax credits as of September 30, 2023 and December 31, 2022:
Unfunded Commitment
Accounting Method
Low income housing tax credit
Proportional amortization
17,906
12,719
15,559
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The following table presents a summary of the amortization expense and tax benefit recognized for the Company’s qualified affordable housing projects for the three and nine months ended September 30, 2023 and 2022:
Tax Benefit
Expense (1)
Recognized (2)
245
(435)
109
(146)
884
(1,171)
220
(303)
NOTE 15 Segment Reporting
Operating segments are components of an enterprise, which are evaluated regularly by the “chief operating decision maker” in deciding how to allocate resources and assess performance. The Company’s chief operating decision maker is the President and Chief Executive Officer of the Company. Reportable segments are determined 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 credit 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
Net interest income (loss)
20,818
255
(678)
Noninterest income (loss)
2,150
(129)
Intercompany revenue (expense)
(9,371)
4,264
4,624
483
Noninterest expense
10,728
9,354
2,722
3,245
11,211
Net income (loss) before taxes
2,869
13,515
7,173
(12,018)
67,650
635
(1,998)
Noninterest income
6,308
(15,351)
4,200
994
3,221
36,231
24,954
6,335
9,912
34,071
21,826
31,959
13,780
(1,151)
(32,741)
28,512
393
(589)
1,723
56
(4,562)
1,868
(170)
1,386
15,428
7,998
1,406
5,869
12,066
10,245
10,467
3,276
(308)
(11,121)
72,816
1,660
(1,711)
4,602
91
(8,664)
2,695
(1,028)
3,214
3,783
39,639
23,855
4,034
17,926
35,368
29,115
29,376
10,664
1,699
(33,205)
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; recordkeeping, and administration services to other types of retirement plans; investment fiduciary services to retirement plans; health savings accounts, flex spending accounts, and COBRA recordkeeping and administration services. 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.
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NOTE 16 Earnings Per Share
The calculation of basic and diluted earnings per share using the two-class method for the three and nine months ended September 30, 2023 and 2022 are presented below:
Dividends and undistributed earnings allocated to participating securities
67
90
186
312
Net income available to common shareholders
9,094
9,529
26,265
28,784
Weighted-average common shares outstanding for basic earnings per share
Dilutive effect of stock-based awards
223
243
216
Weighted-average common shares outstanding for diluted earnings per share
Earnings per common share:
NOTE 17 Derivative Instruments
The company uses a variety of derivative instruments to mitigate exposure to both market and credit risks inherent in its business activities. The Company manages these risks as part of its overall asset and liability management process and through its policies and procedures. Derivatives represent contracts between parties that usually require little or no initial net investment and result in one party delivering cash or another type of asset to the other party based on a notional amount and an underlying as specified in the contract.
Derivatives are often measured in terms of notional amount, but this amount is generally not exchanged, and it is not recorded on the Company’s consolidated balance sheet. The notional amount is the basis to which the underlying is applied to determine required payments under the derivative contract. The underlying is a referenced interest rate, security price, credit spread, or other index. Residential and commercial real estate loan commitments associated with loans to be sold also qualify as derivative instruments.
Derivatives Designated as Hedging Instruments
The Company uses derivative instruments to hedge its exposure to economic risks, including interest rate, liquidity and credit risk. Certain hedging relationships are formally designated and qualify for hedge accounting under GAAP. On the date the Company enters into a derivative contract designated as a hedging instrument, the derivative is designated as either a fair value hedge, cash flow hedge, or a net investment hedge. When a derivative is designated as a fair value, cash flow, or net investment hedge, the Company performs an assessment, at inception and, at a minimum, quarterly thereafter, to determine the effectiveness of the derivative in offsetting changes in the value or cash flows of the hedged item(s). As of September 30, 2023, the Company only uses fair value and cash flow hedges.
Fair value hedges: These derivatives are interest rate swaps the Company uses to hedge the change in fair value related to interest rate changes of its underlying mortgage-backed investment securities and mortgage loan pools. The interest rate swaps are carried on the Company’s Consolidated Balance Sheet at their fair value in other assets (when the fair value is positive) or in accrued expenses and other liabilities (when the fair value is negative). The changes in fair value of the interest rate swaps are recorded in interest income. The unrealized gains or losses due to changes in fair value of the interest rate swaps due to changes in benchmark interest rates are recorded as an adjustment to the hedged instruments and offset in the same interest income line items.
Cash flow hedges: These derivatives are interest rate swaps the Company uses to hedge the variability of expected future cash flows due to market interest changes. The interest rate swap is carried on the Company’s consolidated balance sheet at its fair value in other assets (when the fair value is positive) or in accrued expenses and
other liabilities (when the fair value is negative). Changes in fair value of derivatives designated as cash flow hedges are recorded in other comprehensive income (loss) until the cash flows of the hedged items are realized. If a derivative designated as a cash flow hedge is terminated or ceases to be highly effective, the gain or loss in other comprehensive income (loss) is amortized to earnings over the period the forecasted hedged transactions impact earnings. If a hedged forecasted transaction is no longer probable, hedge accounting is ceased and any gain or loss included in other comprehensive income (loss) is reported in earnings immediately, unless the forecasted transaction is at least reasonably possible of occurring, whereby the amounts remain within accumulated other comprehensive income (loss). There were no cash flow hedges at December 31, 2022. The Company estimates that an additional $1.0 million will be reclassified as a decrease to interest expense over the next 12 months. All cash flow hedges were highly effective for the three months ended September 30, 2023. As of September 30, 2023, the maximum length of time over which forecasted transactions are hedged is 15 months.
Derivatives Not Designated as Hedging Instruments
Interest rate swaps: The Company periodically enters into commercial loan interest rate swap agreements in order to provide commercial loan customers with the ability to convert from variable to fixed interest rates. These derivative contracts relate to transactions in which the Company enters into an interest rate swap with a customer, while simultaneously entering into an offsetting interest rate swap with an institutional counterparty.
Interest rate lock commitments, forward loan sales commitments and to be announced (TBA) mortgage backed securities: The Company enters into forward delivery contracts to sell mortgage loans at specific prices and dates in order to hedge the interest rate risk in its portfolio of mortgage loans held for sale and its residential mortgage interest rate lock commitments.
The following table presents the total notional amounts and gross fair values of the Company’s derivatives as of September 30, 2023 and December 31, 2022:
Notional
Designated as hedging instruments:
Consolidated Balance Sheet Location
Fair value hedges:
Interest rate swaps
3,899
600,000
Cash flow hedges:
Total derivatives designated as hedging instruments
4,910
800,000
Not designated as hedging instruments:
Asset Derivatives
6,819
67,716
6,277
43,430
Interest rate lock commitments
23,352
10,462
Forward loan sales commitments
3,467
To-be-announced mortgage backed securities
155
41,250
Total asset derivatives not designated as hedging instruments
7,283
135,785
6,405
54,243
Liability Derivatives
6,820
25,750
Total liability derivatives not designated as hedging instruments
6,303
69,180
35
The following table shows the effective portion of the gains (losses) recognized in other comprehensive income (loss) and the gains (losses), before tax, reclassified from other comprehensive income (loss) into earnings for the periods indicated:
Gains (Losses)
Recognized in
Reclassified
from Other
(Loss)
into Earnings
Derivatives designated as hedging instruments
205
The following table shows the effect of fair value and cash flow hedge accounting on derivatives designated as hedging instruments in the Consolidated Statements of Income:
Location and Amount of Gains (Losses) Recognized in Income
Loans,
including
securities -
Short-term
fees
borrowings
Total amounts in the Consolidated Statements of Income
606
1,229
The following table shows the notional amount, carrying amount and associated cumulative basis adjustments related to the application of hedge accounting that is included in the carrying amount of hedged assets and liabilities in fair value hedging relationships at September 30, 2023:
Cumulative Fair
Value Hedging
Adjustment in the
Carrying Amount
Carrying Amount of
of Hedged Assets/
Hedged Assets/
Liabilities
Residential agency (1)
196,793
(3,207)
Mortgage loan pools (2)
400,000
399,284
(716)
596,077
(3,923)
The gain (loss) recognized on derivatives not designated as hedging relationships for the three and nine months ended September 30, 2023 and 2022 was as follows:
Derivatives not designated as hedging instruments
Consolidated Statements of Income Location
Other noninterest income
(342)
(1,724)
(1,871)
(532)
55
(480)
1,317
350
5,066
Total gain (loss) from derivatives not designated as hedging instruments
(938)
613
2,717
The Company has third party agreements that require a minimum dollar transfer amount upon a margin call. These requirements are dependent on certain specified credit measures. The amount of collateral posted with third parties was $290 thousand at September 30, 2023 and $309 thousand at December 31, 2022. 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.
The following table presents the Company’s derivative positions and the potential effect of netting arrangements on its financial position as of the dates indicated:
Gross Amount
Not Offset in the
Balance Sheets
Net Amount
Recognized in the
Offset in the
Presented in the
Cash Collateral
Pledged (Received)
Derivative assets:
Interest rate swaps - Company (1)
(10,150)
(5,240)
Interest rate swaps - customer (1)
11,884
1,734
Derivative liabilities:
290
6,530
(6,030)
309
(283)
5,994
NOTE 18 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, 2023 and December 31, 2022, 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, 2023 and December 31, 2022:
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
402,118
13.01
139,056
4.50
Bank
391,239
12.68
138,838
200,544
6.50
Tier 1 capital to risk weighted assets
.
411,046
13.30
185,408
6.00
185,117
246,823
8.00
Total capital to risk weighted assets
497,554
16.10
247,210
427,747
13.86
308,529
10.00
Tier 1 capital to average assets
11.14
147,625
4.00
10.72
146,043
182,554
5.00
389,335
13.39
130,862
370,749
12.76
130,791
188,920
398,179
13.69
174,482
174,388
232,517
479,325
16.48
232,643
401,895
13.83
290,646
11.25
141,514
10.48
141,440
176,800
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 include 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. As of September 30, 2023, the capital 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, 2023 and December 31, 2022, the Company was in compliance with the aforementioned guidelines.
NOTE 19 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, until
February 28, 2024. 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, 2023, the Company repurchased 238,474 shares of common stock under the Program. The Company also repurchases shares to pay withholding taxes on the vesting of restricted stock awards and units.
NOTE 20 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.
40
The following tables present the balances of the assets and liabilities measured at estimated fair value on a recurring basis as of September 30, 2023 and December 31, 2022:
Level 1
Level 2
Level 3
U.S. treasury and government agencies
Derivatives
12,193
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.
41
Net impairment related to nonrecurring estimated fair value measurements of certain assets as of September 30, 2023 and December 31, 2022 consisted of the following:
Individually evaluated
2,390
288
2,813
Foreclosed assets
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, 2023 and December 31, 2022, were as follows:
Weighted
Asset Type
Valuation Technique
Unobservable Input
Fair Value
Range
Appraisal value
Property specific adjustment
Discounted cash flows
Prepayment speed assumptions
84-125
103-137
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
42
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, 2023 and December 31, 2022, 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 values 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.
43
The estimated fair values, and related carrying or notional amounts, of the Company’s financial instruments at the dates indicated are as follows:
Estimated Fair Value
Financial Assets
Investment securities held-to-maturity
Loans, net
2,451,993
Financial Liabilities
Noninterest-bearing deposits
Interest-bearing deposits
1,807,259
343,600
55,076
Accrued interest payable
5,358
2,311,956
1,842,138
208,550
56,116
44
Item 2 – Management’s Discussion and Analysis of Financial Condition and Results of Operations
General
The following discussion explains the Company’s financial condition and results of operations as of and for the three and nine months ended September 30, 2023 and 2022. 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, 2022, filed with the Securities and Exchange Commission on March 13, 2023.
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 the Company make regarding the Company’s 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 the Company’s current beliefs, expectations and assumptions regarding the Company’s 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 the Company’s control. The Company’s actual results and financial condition may differ materially from those indicated in forward-looking statements. Therefore, you should not rely on any of these forward-looking statements. Important factors that could cause the Company’s actual results and financial condition to differ materially from those indicated in forward-looking statements include, among others, the following:
Any forward-looking statement made by the Company in this report is based only on information currently available to the Company and speaks only as of the date on which it is made. The Company undertakes 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
The Company is a diversified financial services company headquartered in Grand Forks, North Dakota. Through the Company’s 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. These solutions are delivered through a relationship-oriented primary point of contact along with responsive and client-friendly technology.
The Company’s business model produces strong financial performance and a diversified revenue stream, which has helped the Company establish a brand and culture yielding both a loyal client base and passionate and dedicated employees. The Company generates a majority of overall revenue from noninterest income, which is driven primarily by the Company’s retirement and benefit services, wealth management and mortgage business lines. The remainder of the Company’s revenue consists of net interest income, which the Company derives from offering traditional banking products and services.
Critical Accounting Policies
The Company’s consolidated financial statements are prepared based on the application of accounting policies generally accepted in the United States, or GAAP. The preparation of the Company’s 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 the Company’s Annual Report on Form 10-K for the year ended December 31, 2022.
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On January 1, 2023, the Company adopted ASU 2016-13, Financial Instruments – Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments, which created material changes to the Company’s existing critical accounting policy that existed at December 31, 2022. Effective January 1, 2023, through March 31, 2023, the significant accounting policy which the Company believes to be critical in preparing the Company’s consolidated financial is the determination of the allowance for credit losses.
Management considers the policies related to the allowance for credit losses critical to the financial statement presentation. The allowance for credit losses is established through the provision for credit losses charged to current earnings. The Company’s methodologies for estimating the allowance for credit losses consider available relevant information about the collectability of cash flows, including information about past events, current conditions, and reasonable and supportable forecasts. Refer to Note 1 – Significant Accounting Policies in the accompanying notes to the consolidated financial statements for further discussion on the methodology in establishing the allowance for credit losses.
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
Shareholder Dividend
On August 24, 2023, the Board of Directors of the Company declared a quarterly cash dividend of $0.19 per common share. This dividend was paid on October 13, 2023, to stockholders of record at the close of business on September 15, 2023.
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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
0.95
0.96
1.02
0.93
1.13
Return on average common equity
10.05
10.14
10.25
9.79
11.27
Return on average tangible common equity (1)
13.51
13.71
13.89
13.27
14.59
Noninterest income as a % of revenue
58.21
53.69
48.82
54.51
54.08
Net interest margin (taxable-equivalent basis)
2.27
2.52
3.21
2.50
3.02
Efficiency ratio (1)
73.37
72.79
74.76
73.57
73.94
Average equity to average assets
9.47
9.52
9.95
9.51
10.06
Net charge-offs/(recoveries) to average loans
(0.09)
(0.07)
0.07
(0.04)
0.04
Dividend payout ratio
42.22
38.30
43.08
33.33
Per Common Share
Earnings per common share - basic
Earnings per common share - diluted
Book value per common share
17.60
17.96
17.25
Tangible book value per common share (1)
14.32
14.60
13.76
Average common shares outstanding - basic
20,033
Average common shares outstanding - diluted
20,241
Other Data
Retirement and benefit services assets under administration/management
34,552,569
35,052,652
30,545,694
Wealth management assets under administration/management
3,724,091
3,857,710
3,435,786
Mortgage originations
109,637
111,261
229,901
298,626
686,060
Selected Financial Data
The following tables summarize selected financial data as of and for the periods indicated:
Selected Average Balance Sheet Data
2,544,836
2,482,413
2,262,361
2,495,122
1,958,216
971,913
1,007,792
1,116,458
1,004,436
1,165,414
3,821,601
3,785,487
3,743,154
3,799,645
3,431,212
2,844,758
2,940,216
2,995,071
2,905,675
2,851,425
360,033
58,914
58,886
58,875
361,735
360,216
372,274
361,260
345,192
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Selected Period End Balance Sheet Data
2,533,522
2,318,231
(35,696)
(30,968)
943,269
985,870
1,039,226
1,055,520
3,832,978
3,691,253
2,852,855
2,961,811
58,900
58,836
Selected Income Statement Data
22,234
25,778
36,373
11,639
2,535
9,104
Non-GAAP to GAAP Reconciliations and Calculation of Non-GAAP Financial Measures
In addition to the results presented in accordance with GAAP, the Company routinely supplements its 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, as adjusted. 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; and (v) efficiency ratio, as adjusted, as noninterest expense less intangible amortization expense, divided by net interest income plus noninterest income plus a tax-equivalent adjustment.
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The following tables present these non-GAAP financial measures along with the most directly comparable financial measures calculated in accordance with GAAP as of and for the periods indicated:
Tangible common equity to tangible assets
Total common stockholders’ equity
Less: Goodwill
46,060
Less: Other intangible assets
19,806
23,779
Tangible common equity (a)
284,137
290,792
287,330
275,000
Tangible assets (b)
3,803,873
3,766,085
3,710,095
3,621,414
Tangible common equity to tangible assets (a)/(b)
7.72
7.74
7.59
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)
14.37
Return on average tangible common equity
Add: Intangible amortization expense (net of tax)
1,046
3,138
2,710
Net income, excluding intangible amortization (e)
10,207
10,150
10,665
29,589
31,806
Average total equity
Less: Average goodwill
46,882
48,141
47,018
37,101
Less: Average other intangible assets (net of tax)
15,109
16,153
19,466
16,149
16,605
Average tangible common equity (f)
299,744
296,976
304,667
298,093
291,486
Return on average tangible common equity (e)/(f)
Efficiency ratio
Less: Intangible amortization expense
Adjusted noninterest expense (g)
35,936
35,049
41,443
107,531
117,392
Tax-equivalent adjustment
180
112
444
306
Total tax-equivalent revenue (h)
48,982
48,152
55,438
146,170
158,777
Efficiency ratio (g)/(h)
Discussion and Analysis of Results of Operations
Net income for the three months ended September 30, 2023, was $9.2 million, or $0.45 per diluted common share, a $0.5 million, or 4.8%, decrease compared to $9.6 million, or $0.47 per diluted common share, for the three months ended September 30, 2022. Earnings for the third quarter of 2023 compared to the third quarter of 2022
decreased primarily due to a $7.9 million decrease in net interest income. This negative result was partially offset by a $1.4 million increase in noninterest income and a $5.5 million decrease in noninterest expense.
Net income for the nine months ended September 30, 2023, was $26.5 million, or $1.30 per diluted common share, a $2.6 million, or 9.1%, decrease compared to $29.1 million, or $1.56 per diluted common share, for the nine months ended September 30, 2022. Earnings for the nine months ended September 30, 2023 compared to the nine months ended September 30, 2022 decreased primarily due to a $6.5 million decrease in net interest income, a $550 thousand increase in provision for credit losses, and a $6.3 million decrease in noninterest income. These negative results were partially offset by a $9.3 million decrease in noninterest expense.
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, 2023 and 2022.
Net interest income for the three months ended September 30, 2023, was $20.4 million, a decrease of $7.9 million, or 28.0%, compared to $28.3 million for the three months ended September 30, 2022. Net interest income for the third quarter of 2023 decreased compared to the third quarter of 2022 primarily due to the increasing cost of interest-bearing liabilities as interest expense increased $17.7 million mainly driven by an increase of 252 basis points in the average rate paid on interest-bearing liabilities. In addition, the average balance of interest-bearing liabilities increased $310.5 million. This was partially offset by a $9.8 million increase in interest income, as interest earning assets increased $73.1 million while the interest earning asset yield increased 101 basis points. The increase in interest earning assets was due to organic growth. The increase in interest-bearing liabilities was due to a decrease in deposits which were replaced with wholesale borrowings and a shift from noninterest-bearing deposits to interest-bearing deposits.
Net interest income for the nine months ended September 30, 2023, was $66.3 million, a decrease of $6.5 million, or 8.9%, compared to $72.8 million for the nine months ended September 30, 2022. Net interest income for the nine months ended September 30, 2023, decreased compared to the nine months ended September 30, 2022, primarily due to a 231 basis point increase in the average rate paid on interest-bearing liabilities in addition to an increase of $446.6 million in the average balance of interest-bearing liabilities. This was partially offset by increases of 121 basis points in the average rate paid on interest earning assets and the average balance of interest earning assets. The average balance of interest earning assets increased $335.1 million. The increase in interest earning assets was due to a combination of organic growth and the acquisition of Metro Phoenix Bank. The increase in interest-bearing liabilities was due to the acquisition of Metro Phoenix Bank and a decrease in noninterest-bearing liabilities.
Net interest margin (on a FTE basis) for the three months ended September 30, 2023, was 2.27%, compared to 3.21% for the same period in 2022.
Net interest margin (on a FTE basis) for the nine months ended September 30, 2023, was 2.50%, compared to 3.02% for the same period in 2022.
As a result of the recent and expected increases in the target federal funds interest rate, the Company anticipates that net interest income and net interest margin (on a FTE basis) will remain under pressure in future periods.
The following table presents average balance sheet information, interest income, interest expense and the corresponding average yields on assets, average yields earned, and rates paid for the three and nine months ended September 30, 2023 and 2022. The Company derived these yields and rates by dividing income or expense by the average balance of the corresponding assets or liabilities. The Company 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
29,450
229
3.09
72,157
2.02
Investment securities (1)
6,377
2.60
6,204
2.20
Fed funds sold
21,893
131
2.37
16,518
231
5.55
27,032
4.14
Commercial:
555,649
9,258
6.61
566,987
7,729
5.41
88,450
1,900
8.52
70,545
996
5.60
998,636
13,219
5.25
807,505
8,279
4.07
1,642,735
24,377
5.89
1,445,037
17,004
4.67
714,874
7,007
3.89
624,826
5,580
3.54
154,939
3,004
7.69
140,664
1,918
32,288
497
6.11
51,834
651
4.98
902,101
10,508
4.62
817,324
8,149
3.96
Total loans (1)
34,885
5.44
25,153
4.41
Federal Reserve/FHLB Stock
28,761
495
6.83
18,449
249
5.35
Total interest earning assets
3,591,478
42,217
4.66
3,518,350
32,387
3.65
Noninterest earning assets
230,123
224,804
Interest-Bearing Liabilities
Interest-bearing demand deposits
751,455
2,534
1.34
659,696
211
0.13
Money market and savings deposits
1,073,297
8,650
1,180,576
1,202
0.40
327,264
3,252
3.94
234,459
439
0.74
4,327
787
2,201
5.02
729
4.57
3.98
Total interest-bearing liabilities
2,696,964
3.18
2,386,473
0.66
Noninterest-Bearing Liabilities and Stockholders' Equity
692,742
920,340
Other noninterest-bearing liabilities
70,160
64,067
20,574
28,428
Net interest rate spread
1.48
2.99
Net interest margin on FTE basis (1)
35,892
927
3.45
68,811
0.86
18,928
18,255
2.09
7,378
13,822
5.29
27,864
3.31
553,460
27,037
6.53
488,771
17,797
4.87
93,098
5,197
7.46
52,212
1,839
4.71
956,018
36,485
5.10
670,854
19,378
3.86
1,602,576
68,719
5.73
1,211,837
39,014
4.30
700,734
19,942
3.80
561,261
14,472
153,664
8,565
7.45
132,968
4,829
4.86
38,148
1,708
5.99
52,150
1,791
4.59
892,546
30,215
4.53
746,379
21,092
3.78
98,934
5.30
60,106
4.10
25,403
1,294
6.81
11,877
448
5.04
3,574,675
120,630
4.51
3,239,560
80,071
3.30
224,970
191,652
757,995
1.16
692,310
637
0.12
1,127,630
22,915
2.72
1,089,137
1,943
0.24
276,797
6,744
3.26
224,603
914
0.54
12,556
1,027
3,128
4.92
4.54
2,627,151
2.74
2,180,525
0.43
743,253
845,375
67,981
60,120
66,729
73,071
1.77
2.87
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 interest earning assets and the interest incurred on interest-bearing liabilities. The effect of changes in volume is determined by multiplying the change in
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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, 2023
Compared with
Three Months Ended September 30, 2022
Change due to:
(tax-equivalent basis, dollars in thousands)
Volume
Variance
Interest earning assets
(217)
78
(139)
(212)
697
485
(802)
975
173
3,189
673
(131)
59
(51)
(348)
206
(142)
(155)
1,684
1,529
2,356
6,884
9,240
253
904
1,440
3,358
1,961
2,979
4,940
8,233
8,874
17,107
2,059
5,314
7,373
12,029
17,676
29,705
803
624
1,427
3,599
1,871
5,470
195
891
1,086
752
2,984
3,736
(245)
(154)
(481)
398
(83)
753
1,606
2,359
3,870
5,253
9,123
2,812
6,920
9,732
15,899
22,929
38,828
139
246
510
336
846
1,691
8,139
9,830
13,202
27,357
40,559
Interest-bearing liabilities
2,293
2,323
5,863
5,922
(108)
7,556
7,448
20,903
20,972
2,640
5,830
2,132
1,408
3,540
4,902
6,627
11,529
1,450
319
2,042
2,361
88
287
2,250
15,434
17,684
5,560
41,341
46,901
Change in net interest income
(559)
(7,295)
(7,854)
7,642
(13,984)
(6,342)
Provision for Credit Losses
The Company recorded no provision for credit loss expense for the three months ending September 30, 2023 and September 30, 2022.
The Company recorded a provision for credit loss expense of $550 thousand for the nine months ended September 30, 2023, a $550 thousand increase compared to the nine months ended September 30, 2022. The provision for credit loss expense for the nine months ended September 30, 2023 included $460 thousand in provision for credit loss on loans, $44 thousand in provision for credit loss on unfunded commitments and $46 thousand in provision for credit loss on investment securities held-to-maturity. The CECL accounting standard requires the Company to recognize losses over the expected life of the loan as opposed to the losses expected to already have been incurred. The increase in provision for credit losses is primarily a result of a change in forecasting assumptions brought about by the new methodology.
The Company’s 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.
The following table presents the Company’s noninterest income for the three and nine months ended September 30, 2023 and 2022:
Total noninterest income for the three months ended September 30, 2023 was $28.4 million, a $1.4 million, or 5.2%, increase compared to $27.0 million for the three months ended September 30, 2022. The increase in noninterest income was primarily driven by an increase of $2.0 million in retirement and benefit services due to the divestiture of the ESOP trustee business and increased assets under administration/management. Assets under administration/management were higher due to an increase in overall plans and participants coupled with improved equity and bond markets.
Total noninterest income for the nine months ended September 30, 2023, was $79.4 million, a $6.3 million, or 7.3%, decrease compared to $85.7 million for the nine months ended September 30, 2022. The decrease in noninterest income was primarily driven by a decrease of $7.6 million in mortgage banking revenue as mortgage originations decreased compared to 2022 as higher interest rates dramatically impacted demand.
The Company anticipates that noninterest income will continue to be significantly adversely affected in future periods as a result of increasing interest rates and inflationary pressure, which have begun to and will continue to adversely affect mortgage originations and mortgage banking revenue.
See “NOTE 15 Segment Reporting” of the consolidated financial statements for additional discussion regarding the Company’s business lines.
The following table presents noninterest expense for the three and nine months ended September 30, 2023 and 2022:
Total noninterest expense for the three months ended September 30, 2023, was $37.3 million, a $5.5 million, or 12.9%, decrease compared to $42.8 million for the three months ended September 30, 2022. The year over year decrease was primarily due to a $2.1 million decrease in compensation and $1.4 million decrease in professional fees and
assessments. Compensation decreased primarily due to a decrease in overall headcount and due to lower mortgage related incentive compensation as a result of lower mortgage originations. The decrease in professional fees and assessments was due to merger-related expenses incurred in the third quarter of 2022, in connection with the acquisition of Metro Phoenix Bank.
Total noninterest expense for the nine months ended September 30, 2023, was $111.5 million, a $9.3 million, or 7.7%, decrease compared to $120.8 million for the nine months ended September 30, 2022. The decrease was driven by decreases of $4.4 million in compensation, $1.6 million in employee taxes and benefits, and $2.5 million in professional fees and assessments. The decrease in compensation expense was primarily due to a decrease in overall headcount and due to a lower mortgage related incentive compensation as a result of lower mortgage originations, which was also the primary driver for the decrease in mortgage and lending expenses. The decrease in employee taxes and benefits was primarily due to lower group insurance claims driven by a reduction in headcount along with a decrease in taxes driven by lower compensation expense. The decrease in professional fees and assessments was primarily driven by lower merger and acquisition and recruitment expenses offset by an increase in FDIC assessments.
Income Tax Expense
Income tax expense is an estimate based on the amount the Company expects 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 the Company’s tax position. If the final resolution of taxes payable differs from the Company’s estimates due to regulatory determination or legislative or judicial actions, adjustments to tax expense may be required.
For the three months ended September 30, 2023, the Company recognized income tax expense of $2.4 million on $11.5 million of pre-tax income, resulting in an effective tax rate of 20.6%, compared to income tax expense of $2.9 million on $12.6 million of pre-tax income for the three months ended September 30, 2022, resulting in an effective tax rate of 23.3%.
For the nine months ended September 30, 2023, the Company recognized income tax expense of $7.2 million on $33.7 million of pre-tax income, resulting in an effective tax rate of 21.4%, compared to income tax expense of $8.6 million on $37.6 million of pre-tax income for the nine months ended September 30, 2022, resulting in an effective tax rate of 22.7%.
Financial Condition
Total assets were $3.9 billion as of September 30, 2023, an increase of $89.5 million, or 2.4%, compared to December 31, 2022. The increase was primarily due to a $162.4 million increase in loans, $6.9 million increase in loans held for sale and $6.5 million increase in cash and cash equivalents, offset by a decrease of $96.0 million in investment securities and a $5.1 million increase in the allowance for credit losses.
The loan portfolio represents a broad range of borrowers comprised of commercial and industrial, commercial real estate, residential real estate, and other revolving and installment loans. As of September 30, 2023, the portfolio mix was 22.3% commercial and industrial, 39.3% commercial real estate, 33.4% residential real estate and 5.0% in other categories.
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The following table presents the composition of total loans outstanding by portfolio segment as of September 30, 2023 and December 31, 2022:
Change
Portfolio
Percent
22.3
23.9
(1,489)
(0.3)
3.8
(68)
(0.1)
39.3
36.0
143,344
16.3
65.4
63.9
141,787
9.1
27.5
27.8
38,242
5.6
6.2
2,198
1.5
1.2
2.1
(19,791)
(39.1)
34.6
36.1
20,649
2.3
100.0
162,436
6.6
Total loans outstanding were $2.6 billion as of September 30, 2023, an increase of $162.4 million, or 6.6%, from December 31, 2022. The increase was primarily driven by a $143.3 million increase in commercial real estate and a $38.2 million increase in residential real estate loans, offset by a $19.8 million decrease in other consumer revolving and installment loans.
Despite headwinds from a higher interest rate environment and competition in the Company’s market areas, the Company anticipates continued loan growth for the commercial and industrial and commercial real estate loan portfolios as a result of recently added production talent.
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The following table presents the maturities and types of interest rates for the loan portfolio as of September 30, 2023:
After one
After five
One year
but within
After
or less
five years
fifteen years
168,974
252,223
161,190
25,538
63,442
6,567
2,195
67,108
449,764
445,426
62,716
261,620
765,429
613,183
64,911
5,829
30,107
45,676
636,181
8,708
22,360
34,557
87,052
8,734
19,242
2,841
23,271
71,709
83,074
723,233
284,891
837,138
696,257
788,144
Loans with fixed interest rates:
14,337
217,039
59,857
291,233
5,837
15,930
3,973
25,740
48,842
330,527
284,539
22,740
686,648
69,016
563,496
348,369
1,003,621
4,269
26,273
38,048
419,213
487,803
1,451
6,899
22,487
15,828
46,665
3,231
16,797
22,869
8,951
49,969
63,376
435,041
557,337
Total loans with fixed interest rates
77,967
613,465
411,745
457,781
1,560,958
Loans with floating interest rates:
154,637
35,184
101,333
291,154
19,701
47,512
72,002
18,266
119,237
160,887
39,976
338,366
192,604
201,933
264,814
42,171
701,522
3,834
7,628
216,968
229,990
7,257
15,461
12,070
71,224
106,012
5,503
2,445
7,948
14,320
21,740
19,698
288,192
343,950
Total loans with floating interest rates
206,924
223,673
284,512
330,363
1,045,472
The expected life of the Company’s 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
The Company’s 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. The Company strives to identify potential problem loans early, take necessary charge-offs promptly, and maintain adequate reserve levels for credit losses inherent in the portfolio. Management performs ongoing, internal reviews of any problem credits and continually assesses the adequacy of the allowance. The Company utilized 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 Credit 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, 2023 and December 31, 2022:
31,682
25,182
53,745
33,844
808
2,029
1,441
55,774
35,285
Criticized loans as a percent of total loans
2.14
1.44
The following table presents information regarding nonperforming assets as of September 30, 2023 and December 31, 2022:
Nonaccrual loans
Accruing loans 90+ days past due
Total nonperforming loans
OREO and repossessed assets
Total nonperforming assets
9,010
3,824
Total restructured accruing loans
151
Total nonperforming assets and restructured accruing loans
3,975
Nonperforming loans to total loans
0.35
0.16
Nonperforming assets to total assets
0.23
0.10
Allowance for credit losses on loans to nonperforming loans
403
821
Interest income lost on nonaccrual loans approximated $287 thousand and $172 thousand for the nine months ended September 30, 2023 and 2022, respectively. There was no interest income included in net interest income related to nonaccrual loans for the nine months ended September 30, 2023 and 2022.
The allowance for credit losses is a significant estimate in the Company’s Consolidated Balance Sheet, affecting both earnings and capital. Its methodology influences and is influenced by the Company’s overall credit risk management processes. The allowance for credit losses is managed in accordance with GAAP to provide an adequate reserve for expected credit losses that is reflective of management’s best estimate of what is expected to be collected. All estimates of credit losses should be based on a careful consideration of all significant factors affecting the collectability as of the evaluation date. The allowance for credit losses is established through provision for credit loss expense charged to income.
The Company calculates the allowance for credit losses at each reporting date. The Company recognizes an allowance for the lifetime expected credit losses for the amount the Company does not expect to collect. Subsequent changes in expected credit losses are recognized immediately in earnings. Management determines the adequacy of the allowance based on periodic evaluations of the loan portfolio, after consideration of risk characteristics of the loans and prevailing and anticipated economic and other conditions. A risk system, consisting of multiple grading categories for each portfolio class, is utilized as an analytical tool to assess risk and appropriate reserves. In addition to the risk system, management further evaluates risk characteristics of the loan portfolio under current and anticipated economic conditions and considers such factors as the financial condition of the borrower, expected loss experience, and other relevant information from internal and external sources which management feels deserve recognition in establishing an appropriate reserve. 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 credit losses on loans 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)
(594)
405
(827)
Commercial loan provision
Total commercial loan provision
Consumer loan provision
Total consumer loan provision
Unallocated provision expense
Total provision for credit losses on loans
Balance—end of period
Average total loans
Allowance for credit losses on loans to total loans
1.39
Net charge-offs/(recoveries) to average total loans (annualized)
Effective January 1, 2023, the Company adopted the new CECL accounting standard. The adoption of the CECL accounting standard resulted in the Company’s allowance for credit losses increasing by approximately $5.9 million relative to the allowance held as of December 31, 2022. The adoption of the CECL accounting standard resulted in an additional allowance of $3.9 million in the allowance for credit losses on loans and $1.9 million in additional allowance for credit losses on unfunded commitments. The allowance for credit losses on loans was $36.3 million as of September 30, 2023, compared to $31.1 million as of December 31, 2022. The $5.1 million increase was the result of a $3.9 million increase from the adoption of the CECL accounting standard as well as a $550 thousand provision for credit losses on loans expense. As of September 30, 2023, the allowance for credit losses on loans represented 1.39% of total loans.
The following table summarizes the activity in the allowance for credit losses on loans for the periods indicated:
Net charge-offs (recoveries):
Commercial net charge-offs (recoveries)
(322)
567
(556)
1,015
(76)
(11)
(101)
(34)
(123)
Total commercial net charge-offs (recoveries)
(333)
390
(590)
816
Consumer net charge-offs (recoveries)
(247)
(7)
(221)
(16)
(15)
Total consumer net charge-offs (recoveries)
(261)
(237)
Total net charge-offs (recoveries)
Provision for credit losses on loans
Net charge-offs (recoveries) to average loans
Commercial net charge-offs (recoveries) to average loans
(0.05)
(0.03)
(0.01)
(0.02)
Total commercial net charge-offs (recoveries) to average loans
0.06
Consumer net charge-offs (recoveries) to average loans
Total consumer net charge-offs (recoveries) to average loans
Total net charge-offs (recoveries) to average loans
Allowance for credit losses on loans to nonaccrual loans
The following table presents the allocation of the allowance for credit losses on loans as of the dates presented:
Percentage
Allocated
of loans to
total loans
In the ordinary course of business, the Company enters 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. An allowance was established for off-balance sheet credit exposures as part of the adoption of the CECL accounting standard and is measured using similar internal and external assumptions.
This allowance is located in accrued expenses and other liabilities on the Consolidated Balance Sheets. The reserve for unfunded commitments was $5.2 million as of September 30, 2023.
Investment Securities
The composition of the Company’s investment securities portfolio reflects the Company’s 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.
The following table presents the fair value composition of the Company’s investment securities portfolio as of September 30, 2023 and December 31, 2022:
0.3
55.3
56.6
6.1
6.0
67.8
69.0
13.8
13.3
18.4
17.7
32.2
31.0
943,487
The investment securities presented in the following table are reported at fair value and by contractual maturity as of September 30, 2023. 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
64
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, 2023
One year or less
One to five years
Five to ten years
After ten years
Yield
4.26
590
5.68
1,685
5.66
3.11
3,248
2.22
5,416
2.77
512,944
1.82
15,316
9,179
2.88
34,190
2.42
5.20
3.83
18,954
2.71
72,194
3.66
548,838
1.87
0.60
1.38
2.04
2.21
2.17
147,059
5,890
0.61
64,832
121,621
695,897
1.93
Deposit inflows and outflows are influenced by prevailing market interest rates, competition, local and economic conditions, and fluctuations in the Company’s customers’ own liquidity needs and may also be influenced by recent developments in the financial services industry, including the large-scale deposit withdrawals over a short period of time at Silicon Valley Bank, Signature Bank, and First Republic Bank that resulted in the failure of those institutions.
Total deposits were $2.9 billion as of September 30, 2023, a decrease of $43.3 million, or 1.5%, from December 31, 2022. Interest-bearing deposits increased $99.7 million while noninterest-bearing deposits decreased $143.0 million. The decrease in total deposits was due to both public unit depositor seasonality and clients using excess liquidity and paying down revolving debt. Noninterest-bearing deposits decreased from 29.5% of total deposits to 25.0% as higher yields on interest-bearing accounts and other investment alternatives, such as U.S. treasuries, attracted funds. Time deposit balances increased as higher short-term CD rates attracted both existing non-maturity deposits as well as new deposits to the Company.
The following table presents the composition of the Company’s deposit portfolio as of September 30, 2023 and December 31, 2022:
Noninterest-bearing demand
25.0
29.5
(142,997)
(16.6)
26.5
24.2
53,537
7.6
Money market and savings
1,047,447
36.4
1,135,863
39.0
(88,416)
(7.8)
12.1
7.3
134,576
63.4
The following table presents the average balances and rates of the Company’s deposit portfolio for the three months ended September 30, 2023 and 2022:
1.97
0.25
The following table presents the contractual maturity of time deposits, including certificate of deposit account registry services and IRA deposits of $250 thousand and over, that were outstanding as of September 30, 2023:
Maturing in:
3 months or less
34,094
3 months to 6 months
42,811
6 months to 1 year
17,753
1 year or greater
4,044
98,702
The Company’s total uninsured deposits, which are amounts of deposit accounts that exceed the FDIC insurance limit, currently $250,000, were approximately $1.0 billion at September 30, 2023 These amounts were estimated based on the same methodologies used for regulatory reporting purposes.
Borrowings
Borrowings as of September 30, 2023 and December 31, 2022 were as follows:
54.9
35.0
FHLB Short-term advances
34.8
51.6
Subordinated notes
8.7
11.4
Junior subordinated debentures
8,928
1.6
8,843
2.0
Total borrowed funds
574,398
436,923
Capital Resources
Stockholders' equity is influenced primarily by earnings, dividends, the Company's sales and repurchases of its common stock and changes in accumulated other comprehensive income caused primarily by fluctuations in unrealized gains or losses, net of taxes, on available-for-sale securities.
Stockholders' equity decreased $7.5 million, or 2.1%, to $349.4 million as of September 30, 2023, compared to $356.9 million as of December 31, 2022. Tangible common equity to tangible assets, a non-GAAP financial measure, decreased to 7.47% as of September 30, 2023, from 7.74% as of December 31, 2022. Common equity tier 1 capital to risk weighted assets decreased to 13.01% as of September 30, 2023, from 13.39% as of December 31, 2022.
The Company strives to maintain an adequate capital base to support the Company’s activities in a safe and sound manner while at the same time attempting to maximize stockholder value. Capital adequacy is assessed against the
66
risk inherent in the Company’s balance sheet, recognizing that unexpected loss is the common denominator of risk, and that common equity has the greatest capacity to absorb unexpected loss.
The Company is 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 the Company’s 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. The Company has consistently maintained regulatory capital ratios at or above the well-capitalized standards.
At September 30, 2023 and December 31, 2022, the Company met all the capital adequacy requirements to which the Company was subject. The table below presents the Company’s and the Bank’s regulatory capital ratios as of September 30, 2023 and December 31, 2022:
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, 2023, as shown in the above table, were at levels above the regulatory minimums to be considered “well capitalized”. See “NOTE 18 Regulatory Matters” to the consolidated financial statements for additional information.
Off-Balance Sheet Arrangements
The Company is a party to financial instruments with off-balance sheet risk in the normal course of business to meet the financing needs of the Company’s 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 the Company’s exposure to off-balance sheet agreements as of September 30, 2023 and December 31, 2022, was as follows:
Liquidity
Liquidity management is the process by which the Company manages the flow of funds necessary to meet the Company’s 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 the Company’s operations, and capital expenditures. Liquidity is monitored and closely managed by the Company’s 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 the Company has 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, 2023, the Company had on balance sheet liquidity of $623.4 million, compared to $778.9 million as of December 31, 2022. 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.
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. Actual borrowing capacity is contingent on the amount of collateral available to be pledged to the FHLB. As of September 30, 2023, the Company had $315.5 million in federal funds purchased and $200.0 million in short-term borrowings from the FHLB. As of September 30, 2023, the Company had $1.5 billion of collateral pledged to the FHLB and based on this collateral, the Company was eligible to borrow up to an additional $477.1 million from the FHLB. In addition, the Company can borrow up to $107.0 million through the unsecured lines of credit the Company has established with four other correspondent banks.
In addition, because the Bank is “well capitalized,” the Company can accept wholesale deposits up to 20.0% of total assets based on current policy limits, or $773.8 million, as of September 30, 2023. Management believed that the Company had adequate resources to fund all of the Company’s commitments as of September 30, 2023 and December 31, 2022.
The Company’s 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 the recent rise in inflation and rising interest rates could place increased demand on the Company’s liquidity if the Company experiences significant credit deterioration and as the Company meets 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 the Company 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
68
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. The Company seeks 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 the Company’s 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 the Company’s 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 the Company’s loan portfolio, investment portfolio, as well as embedded options and cash flows of other assets and liabilities. The balance sheet composition and size are assumed to remain static in the simulation modeling process. The analysis provides a framework as to what the Company’s overall sensitivity position is as of the Company’s most recent reported position and the impact that potential changes in interest rates may have on net interest income and the economic value of the Company’s equity.
Net interest income simulation involves forecasting net interest income under a variety of interest rate scenarios including instantaneous shocks.
The estimated impact on the Company’s net interest income as of September 30, 2023 and December 31, 2022, assuming immediate parallel moves in interest rates, is presented in the table below:
Following
12 months
24 months
+400 basis points
−6.3
−6.7
−25.1
−8.2
+300 basis points
−4.9
−5.5
−18.9
−6.4
+200 basis points
−3.3
−3.7
−12.7
−4.4
+100 basis points
−1.4
−1.3
−6.2
−1.8
−100 basis points
0.6
5.2
0.5
−200 basis points
0.4
−0.9
7.9
−1.7
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 an 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, 2023 and December 31, 2022, assuming immediate parallel shifts in interest rates:
−23.1
−19.5
−18.5
−15.3
−12.3
−10.4
4.1
6.5
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 the Company’s 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 the Company 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 the Company’s 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,
70
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 the President and Chief Executive Officer, the Chief Financial Officer, and the Chief Accounting Officer have evaluated the effectiveness of the Company’s “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, the President and Chief Executive Officer, the Chief Financial Officer and the Chief Accounting 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, its Chief Financial Officer and its Chief Accounting 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 the Company or any of its subsidiaries are 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 13, 2023.
Item 2 – Unregistered Sales of Equity Securities, Use of Proceeds, and Issuer Purchases of Equity Securities
Unregistered Sales of Equity Securities
None.
Issuer Repurchases of Equity Securities
The following table presents information related to repurchases of shares of the Company’s common stock for each calendar month in the third quarter of 2023:
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 1-31, 2023
48,364
17.29
46,464
553,490
August 1-31, 2023
861
18.45
552,629
September 1-30, 2023
21,103
17.92
531,526
70,328
17.49
68,428
Use of Proceeds from Registered Securities
Item 3 – Defaults Upon Senior Securities
Item 4 – Mine Safety Disclosures
Not Applicable.
Item 5 – Other Information
During the fiscal quarter ended September 30, 2023, none of the Company’s directors or executive officers adopted or terminated any contract, instruction or written plan for the purchase or sale of Company securities that was intended to satisfy the affirmative defense conditions of Rule10b5-1(c) or any non-Rule 10b5-1 trading arrangement.
Item 6 – Exhibits
Exhibit No.
Description
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.
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
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 2, 2023
By:
/s/ Katie A. Lorenson
Name: Katie A. Lorenson
Title: President and Chief Executive Officer (Principal Executive Officer)
/s/ Alan A. Villalon
Name: Alan A. Villalon
Title: Executive Vice President and Chief Financial Officer (Principal Financial Officer)