Alerus Financial 10Q 2022 Q1 Quarterly report

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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, DC 20549

FORM 10-Q

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

For the quarterly period ended March 31, 2022

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

Commission File Number: 001-39036

ALERUS FINANCIAL CORPORATION

(Exact name of registrant as specified in its charter)

Delaware	45-0375407
(State or other jurisdiction of incorporation or	(I.R.S. Employer Identification No.)
organization)

401 Demers Avenue
Grand Forks, ND	58201
(Address of principal executive offices)	(Zip Code)

(701) 795-3200

(Registrant’s telephone number, including area code)

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


Title of each class	Trading symbol	Name of each exchange on which registered
Common Stock, par value $1.00 per share	ALRS	The Nasdaq Stock Market LLC

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

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

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

Large accelerated filer ◻

Accelerated filer ⌧

Non-accelerated filer ◻

Smaller reporting company ☐

Emerging growth company ☒

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

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

The number of shares of the registrant’s common stock outstanding at April 30, 2022 was 17,288,575.

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Alerus Financial Corporation and Subsidiaries

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		Page
Part 1:	FINANCIAL INFORMATION
Item 1.	Consolidated Financial Statements	1
	Consolidated Balance Sheets as of March 31, 2022 and December 31, 2021	1
	Consolidated Statements of Income for the three months ended March 31, 2022 and 2021	2
	Consolidated Statements of Comprehensive Income for the three months ended March 31, 2022 and 2021	3
	Consolidated Statements of Changes in Stockholders’ Equity for the three months ended March 31, 2022 and 2021	4
	Consolidated Statements of Cash Flows for the three months ended March 31, 2022 and 2021	5
	Notes to Consolidated Financial Statements	7
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	34
Item 3.	Quantitative and Qualitative Disclosures About Market Risk	54
Item 4.	Controls and Procedures	56

Part 2:	OTHER INFORMATION
Item 1.	Legal Proceedings	56
Item 1A.	Risk Factors	56
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	56
Item 3.	Defaults Upon Senior Securities	57
Item 4.	Mine Safety Disclosures	57
Item 5.	Other Information	57
Item 6.	Exhibits	58

Signatures		59

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PART 1. FINANCIAL INFORMATION

Item 1 - Consolidated Financial Statements

Alerus Financial Corporation and Subsidiaries

Consolidated Balance Sheets


	March 31,		December 31,
(dollars in thousands, except share and per share data)	2022		2021
Assets	(Unaudited)		(Audited)
Cash and cash equivalents	$	132,832	$	242,311
Investment securities
Available-for-sale, at fair value		866,333		853,649
Held-to-maturity, at carrying value		340,150		352,061
Loans held for sale		21,864		46,490
Loans		1,818,042		1,758,020
Allowance for loan losses		(31,713)		(31,572)
Net loans		1,786,329		1,726,448
Land, premises and equipment, net		17,619		18,370
Operating lease right-of-use assets		3,360		3,727
Accrued interest receivable		8,516		8,537
Bank-owned life insurance		33,358		33,156
Goodwill		31,490		31,490
Other intangible assets		19,197		20,250
Servicing rights		1,771		1,880
Deferred income taxes, net		23,517		11,614
Other assets		49,863		42,708
Total assets	$	3,336,199	$	3,392,691
Liabilities and Stockholders’ Equity
Deposits
Noninterest-bearing	$	831,558	$	938,840
Interest-bearing		2,060,709		1,981,711
Total deposits		2,892,267		2,920,551
Long-term debt		58,902		58,933
Operating lease liabilities		3,850		4,275
Accrued expenses and other liabilities		52,675		49,529
Total liabilities		3,007,694		3,033,288
Stockholders’ equity
Preferred stock, $1 par value, 2,000,000 shares authorized: 0 issued and outstanding		—		—
Common stock, $1 par value, 30,000,000 shares authorized: 17,288,575 and 17,212,588 issued and outstanding		17,289		17,213
Additional paid-in capital		92,573		92,878
Retained earnings		260,967		253,567
Accumulated other comprehensive income (loss)		(42,324)		(4,255)
Total stockholders’ equity		328,505		359,403
Total liabilities and stockholders’ equity	$	3,336,199	$	3,392,691

See accompanying notes to consolidated financial statements (unaudited)

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Alerus Financial Corporation and Subsidiaries

Consolidated Statements of Income (Unaudited)


	Three months ended
	March 31,
(dollars and shares in thousands, except per share data)	2022		2021
Interest Income
Loans, including fees	$	17,292	$	20,567
Investment securities
Taxable		5,440		2,401
Exempt from federal income taxes		216		236
Other		116		117
Total interest income		23,064		23,321
Interest Expense
Deposits		829		995
Long-term debt		562		288
Total interest expense		1,391		1,283
Net interest income		21,673		22,038
Provision for loan losses		—		—
Net interest income after provision for loan losses		21,673		22,038
Noninterest Income
Retirement and benefit services		17,646		17,255
Wealth management		5,326		4,986
Mortgage banking		4,931		17,132
Service charges on deposit accounts		363		338
Net gains (losses) on investment securities		—		114
Other		1,204		1,056
Total noninterest income		29,470		40,881
Noninterest Expense
Compensation		19,051		23,698
Employee taxes and benefits		6,162		5,813
Occupancy and equipment expense		2,051		2,231
Business services, software and technology expense		4,924		4,976
Intangible amortization expense		1,053		1,151
Professional fees and assessments		1,541		1,472
Marketing and business development		600		676
Supplies and postage		646		531
Travel		179		26
Mortgage and lending expenses		686		1,332
Other		1,178		1,136
Total noninterest expense		38,071		43,042
Income before income taxes		13,072		19,877
Income tax expense		2,888		4,662
Net income	$	10,184	$	15,215
Per Common Share Data
Basic earnings per common share	$	0.58	$	0.87
Diluted earnings per common share	$	0.57	$	0.86
Dividends declared per common share	$	0.16	$	0.15
Average common shares outstanding		17,244		17,145
Diluted average common shares outstanding		17,500		17,465

See accompanying notes to consolidated financial statements (unaudited)

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Alerus Financial Corporation and Subsidiaries

Consolidated Statements of Comprehensive Income (Unaudited)


	Three months ended
	March 31,
(dollars in thousands)	2022		2021
Net Income	$	10,184	$	15,215
Other Comprehensive Income (Loss), Net of Tax
Unrealized gains (losses) on available-for-sale securities		(46,708)		(18,036)
Accretion of (gains) losses on debt securities reclassified to held-to-maturity		(4,118)		—
Reclassification adjustment for losses (gains) realized in income		—		(114)
Total other comprehensive income (loss), before tax		(50,826)		(18,150)
Income tax expense (benefit) related to items of other comprehensive income		(12,757)		(4,556)
Other comprehensive income (loss), net of tax		(38,069)		(13,594)
Total comprehensive income (loss)	$	(27,885)	$	1,621

See accompanying notes to consolidated financial statements (unaudited)

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Alerus Financial Corporation and Subsidiaries

Consolidated Statements of Changes in Stockholders’ Equity (Unaudited)


	Three months ended March 31, 2022
							Accumulated
			Additional				Other
	Common		Paid-in		Retained		Comprehensive
(dollars in thousands)	Stock		Capital		Earnings		Income (Loss)		Total
Balance as of December 31, 2021	$	17,213	$	92,878	$	253,567	$	(4,255)	$	359,403
Net income		—		—		10,184		—		10,184
Other comprehensive income (loss)		—		—		—		(38,069)		(38,069)
Common stock repurchased		(20)		(587)		—		—		(607)
Common stock dividends		—		—		(2,784)		—		(2,784)
Share‑based compensation expense		—		378		—		—		378
Vesting of restricted stock		96		(96)		—		—		—
Balance as of March 31, 2022	$	17,289	$	92,573	$	260,967	$	(42,324)	$	328,505


	Three months ended March 31, 2021
							Accumulated
			Additional				Other
	Common		Paid-in		Retained		Comprehensive
(dollars in thousands)	Stock		Capital		Earnings		Income (Loss)		Total
Balance as of December 31, 2020	$	17,125	$	90,237	$	212,163	$	10,638	$	330,163
Net income		—		—		15,215		—		15,215
Other comprehensive income (loss)		—		—		—		(13,594)		(13,594)
Common stock repurchased		(16)		(134)		(296)		—		(446)
Common stock dividends		—		—		(2,602)		—		(2,602)
Share‑based compensation expense		—		498		—		—		498
Vesting of restricted stock		81		(81)		—		—		—
Balance as of March 31, 2021	$	17,190	$	90,520	$	224,480	$	(2,956)	$	329,234

See accompanying notes to consolidated financial statements (unaudited)

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Alerus Financial Corporation and Subsidiaries

Consolidated Statements of Cash Flows (Unaudited)


	Three months ended
	March 31,
(dollars in thousands)	2022		2021
Operating Activities
Net income	$	10,184	$	15,215
Adjustments to reconcile net income to net cash provided (used) by operating activities
Deferred income taxes		854		264
Depreciation and amortization		2,083		2,345
Amortization and accretion of premiums/discounts on investment securities		1,010		794
Amortization of operating lease right-of-use assets		(19)		(8)
Stock-based compensation		378		498
Increase in value of bank-owned life insurance		(202)		(193)
Realized loss (gain) on sale of fixed assets		—		(27)
Realized loss (gain) on derivative instruments		2		(713)
Realized loss (gain) on loans sold		(3,097)		(14,201)
Realized loss (gain) on sale of foreclosed assets		(8)		(23)
Realized loss (gain) on sale of investment securities		—		(114)
Realized loss (gain) on servicing rights		(51)		(165)
Net change in:
Loans held for sale		27,638		57,823
Accrued interest receivable		21		391
Other assets		(4,818)		(2,050)
Accrued expenses and other liabilities		872		(4,995)
Net cash provided (used) by operating activities		34,847		54,841
Investing Activities
Proceeds from sales or calls of investment securities available-for-sale		—		13,189
Proceeds from maturities of investment securities available-for-sale		31,665		27,307
Purchases of investment securities available-for-sale		(95,640)		(262,081)
Proceeds from sales or calls of investment securities held-to-maturity		515		—
Proceeds from maturities of investment securities held-to-maturity		10,851		—
Net (increase) decrease in loans		(59,910)		41,391
Purchases of premises and equipment		(130)		(277)
Proceeds from sales of foreclosed assets		57		101
Net cash provided (used) by investing activities		(112,592)		(180,370)
Financing Activities
Net increase (decrease) in deposits		(28,284)		145,580
Repayments of long-term debt		(59)		(49,748)
Proceeds from the issuance of subordinated debt		—		50,000
Cash dividends paid on common stock		(2,784)		(2,602)
Repurchase of common stock		(607)		(446)
Net cash provided (used) by financing activities		(31,734)		142,784
Net change in cash and cash equivalents		(109,479)		17,255
Cash and cash equivalents at beginning of period		242,311		172,962
Cash and cash equivalents at end of period	$	132,832	$	190,217

See accompanying notes to consolidated financial statements (unaudited)

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	Three months ended
	March 31,
Supplemental Cash Flow Disclosures	2022		2021
Cash paid for:
Interest	$	926	$	1,405
Income taxes		12		736
Non-cash information
Loan collateral transferred to foreclosed assets		29		154
Unrealized gain (loss) on investment securities available-for-sale		(33,951)		(13,594)
Accretion of unrealized (gain) loss on investment securities held-to-maturity		(4,118)		—

See accompanying notes to consolidated financial statements (unaudited)

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Alerus Financial Corporation and Subsidiaries

Notes to Consolidated Financial Statements (Unaudited)

NOTE 1 Significant Accounting Policies

Organization

Alerus Financial Corporation, or the Company, is a financial holding company organized under the laws of the state of Delaware. The Company and its subsidiaries operate as a diversified financial services company headquartered in Grand Forks, North Dakota. Through its subsidiary, Alerus Financial, National Association, or the Bank, the Company provides financial solutions to businesses and consumers through 4 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, 2021, included in the Company’s Annual Report on Form 10-K filed with the SEC on March 11, 2022.

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 loan losses, valuation of reporting units for the purpose of testing goodwill and other intangible assets for impairment, valuation of deferred tax assets, and fair values of financial instruments.

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Reclassifications

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

Other Information

As of March 31, 2022, the Coronavirus Disease, or COVID-19, pandemic was ongoing. During 2020, the COVID-19 pandemic created disruption in global supply chains, increased rates of unemployment and adversely impacted many industries, including industries related to the collateral underlying certain of our loans, and many of these effects are continuing. Beginning in 2021 and continuing into 2022, the U.S. economy, with certain setbacks, started reopening and wider distribution of vaccines encouraged greater economic activity. Nonetheless, the economic recovery could remain uneven, particularly given uncertainty with respect to the continued distribution and acceptance of the vaccines and their effectiveness with respect to new variants of the virus. Management believes the Company is taking appropriate actions to mitigate, to the extent possible, the negative impact. However, the full impact of COVID-19 is currently unknown and cannot be reasonably estimated as the events are continuing to unfold.

Emerging Growth Company

The Company qualifies as an “emerging growth company” under the Jumpstart Our Business Startups Act of 2012, or the JOBS Act, and may take advantage of certain exemptions from various reporting requirements that are applicable to public companies that are not emerging growth companies, including, but not limited to, not being required to comply with the auditor attestation requirements of Section 404 of the Sarbanes-Oxley Act, reduced disclosure obligations regarding executive compensation in periodic reports and proxy statements, and exemptions from the requirements of holding a nonbinding advisory vote on executive compensation and shareholder approval of any golden parachute payments not previously approved. In addition, even if the Company complies with the greater obligations of public companies that are not emerging growth companies, the Company may avail itself of the reduced requirements applicable to emerging growth companies from time to time in the future, so long as the Company is an emerging growth company. The Company will continue to be an emerging growth company until the earliest to occur of: (1) the end of the fiscal year following the fifth anniversary of the date of the first sale of common equity securities under the Company’s Registration Statement on Form S-1, which was declared effective by the SEC on September 12, 2019; (2) the last day of the fiscal year in which the Company has $1.07 billion or more in annual revenues; (3) the date on which the Company is deemed to be a “large accelerated filer” under the Securities Exchange Act of 1934, as amended, or the “Exchange Act”; or (4) the date on which the Company has, during the previous three-year period, issued publicly or privately, more than $1.0 billion in non-convertible debt securities.

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

NOTE 2 Recent Accounting Pronouncements

The following FASB Accounting Standards Updates, or ASUs, are divided into pronouncements which have been adopted by the Company since January 1, 2022, and those which are not yet effective and have been evaluated or are currently being evaluated by management as of March 31, 2022.

Adopted Pronouncements

In December 2019, the FASB issued ASU 2019-12, Income Taxes (Topic 740), which simplifies accounting for income taxes by removing certain exceptions to the general principles in Topic 740. The amendments also improve consistent application of and simplify GAAP for the areas of Topic 740 by clarifying and amending existing guidance. This guidance is effective for fiscal years, and interim periods within those fiscal years beginning after December 15,

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2020, for public business entities. For private companies and smaller reporting companies, this guidance is effective for fiscal years, and interim periods within those fiscal years beginning after December 15, 2021. The Company adopted ASU 2019-12, as of January 2022. The new guidance did not have an impact on the Company’s consolidated financial statements.

Pronouncements Not Yet Effective

In June 2016, the FASB issued ASU No. 2016-13, Financial Instruments – Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments. This ASU requires a new impairment model known as the current expected credit loss, or CECL, which significantly changes the way impairment of financial instruments is recognized by requiring immediate recognition of estimated credit losses expected to occur over the remaining life of financial instruments. The main provisions of ASU 2016-13 include (1) replacing the “incurred cost” approach under GAAP with an “expected loss” model for instruments measured at amortized cost, (2) requiring entities to record an allowance for credit losses related to available-for-sale debt securities rather than a direct write-down of the carrying amount of the investments, as is required by the other-than-temporary impairment model under current GAAP, and (3) a simplified accounting model for purchase credit-impaired debt securities and loans. In November 2019, the FASB issued ASU No. 2019-10, Financial Instruments – Credit Losses (Topic 326). This update amends the effective date of ASU No. 2016-13 for certain entities, including private companies and smaller reporting companies, until fiscal years beginning after December 15, 2022, including interim periods within those fiscal periods. Early adoption is permitted. As an emerging growth company, the Company can take advantage of this delay and plans to adopt the standard with the amended effective date. The Company does not plan to early adopt this standard but continues to work on its implementation. The Company continues collecting and retaining loan and credit data and evaluating various loss estimation models. While we currently cannot reasonably estimate the impact of adopting this standard, we expect the impact will be influenced by the composition, characteristics, and quality of our loan portfolio, as well as the general economic conditions and forecasts as of the adoption date.

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

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

In March 2020, the FASB issued ASU 2020-03, Codification Improvements to Financial Instruments. This ASU represents changes to clarify or improve the Accounting Standards Codification, or ASC, related to seven topics. The amendments make the ASC easier to understand and easier to apply by eliminating inconsistencies and providing clarifications. Issues 1, 2, 3, 4, and 5 are conforming amendments and for public business entities effective upon the issuance of the standard. Issues 6 and 7 are amendments that affect the guidance in ASU 2016-13. The Company will consider these clarifications and improvements in determining the appropriate adoption of ASU 2016-13.

NOTE 3 Investment Securities

The following tables present amortized cost, gross unrealized gain and losses, and fair value of the available-for-sale investment securities and the amortized cost, net unrealized gains, carrying value, gross unrealized gains and losses and fair value of for held-to-maturity as of March 31, 2022 and December 31, 2021:

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	March 31, 2022
	Amortized		Unrealized		Unrealized		Fair
(dollars in thousands)	Cost		Gains		Losses		Value
Available-for-sale
U.S. Treasury and agencies	$	4,107	$	60	$	—	$	4,167
Mortgage backed securities
Residential agency		765,363		229		(54,471)		711,121
Commercial		85,123		185		(2,576)		82,732
Asset backed securities		41		1		—		42
Corporate bonds		69,033		531		(1,293)		68,271
Total available-for-sale investment securities		923,667		1,006		(58,340)		866,333
Held-to-maturity
Obligations of state and political agencies		141,373		1		(7,594)		133,780
Mortgage backed securities
Residential agency		198,777		—		(14,731)		184,046
Total held-to-maturity investment securities		340,150		1		(22,325)		317,826
Total investment securities	$	1,263,817	$	1,007	$	(80,665)	$	1,184,159


	December 31, 2021
	Amortized		Unrealized		Unrealized		Fair
(dollars in thousands)	Cost		Gains		Losses		Value
Available-for-sale
U.S. Treasury and agencies	$	5,028	$	75	$	—	$	5,103
Mortgage backed securities
Residential agency		717,781		1,213		(11,837)		707,157
Commercial		88,362		2,674		(123)		90,913
Asset backed securities		52		2		—		54
Corporate bonds		49,035		1,398		(11)		50,422
Total available-for-sale investment securities		860,258		5,362		(11,971)		853,649
Held-to-maturity
Obligations of state and political agencies		144,543		1,110		(349)		145,304
Mortgage backed securities
Residential agency		207,518		—		(3,145)		204,373
Total held-to-maturity investment securities		352,061		1,110		(3,494)		349,677
Total investment securities	$	1,212,319	$	6,472	$	(15,465)	$	1,203,326

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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 March 31, 2022 and December 31, 2021, were as follows:


	March 31, 2022
	Less than 12 Months				Over 12 Months				Total
	Unrealized		Fair		Unrealized		Fair		Unrealized		Fair
(dollars in thousands)	Losses		Value		Losses		Value		Losses		Value
Available-for-sale
U.S. Treasury and agencies	$	—	$	—	$	—	$	—	$	—	$	—
Mortgage backed securities
Residential agency		(30,707)		462,087		(23,764)		219,167		(54,471)		681,254
Commercial		(2,576)		70,176		—		—		(2,576)		70,176
Asset backed securities		—		—		—		2		—		2
Corporate bonds		(1,293)		38,240		—		—		(1,293)		38,240
Total available-for-sale investment securities		(34,576)		570,503		(23,764)		219,169		(58,340)		789,672
Held-to-maturity
Obligations of state and political agencies		(7,594)		131,278		—		—		(7,594)		131,278
Mortgage backed securities
Residential agency		(14,731)		184,046		—		—		(14,731)		184,046
Total held-to-maturity investment securities		(22,325)		315,324		—		—		(22,325)		315,324
Total investment securities	$	(56,901)	$	885,827	$	(23,764)	$	219,169	$	(80,665)	$	1,104,996


	December 31, 2021
	Less than 12 Months				Over 12 Months				Total
	Unrealized		Fair		Unrealized		Fair		Unrealized		Fair
(dollars in thousands)	Losses		Value		Losses		Value		Losses		Value
Available-for-sale
U.S. Treasury and agencies	$	—	$	—	$	—	$	—	$	—	$	—
Mortgage backed securities
Residential agency		(10,156)		554,811		(1,681)		55,082		(11,837)		609,893
Commercial		(123)		17,470		—		—		(123)		17,470
Asset backed securities		—		—		—		2		—		2
Corporate bonds		(11)		5,989		—		—		(11)		5,989
Total available-for-sale investment securities		(10,290)		578,270		(1,681)		55,084		(11,971)		633,354
Held-to-maturity
Obligations of state and political agencies		(349)		53,210		—		—		(349)		53,210
Mortgage backed securities
Residential agency		(3,145)		204,373		—		—		(3,145)		204,373
Total held-to-maturity investment securities		(3,494)		257,583		—		—		(3,494)		257,583
Total investment securities	$	(13,784)	$	835,853	$	(1,681)	$	55,084	$	(15,465)	$	890,937

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

For the three months ended March 31, 2022 and 2021, the Company did not recognize OTTI losses on its investment securities.

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The following table presents amortized cost and fair value of available-for-sale and carrying value and fair value of held-to-maturity investment securities as of March 31, 2022, by contractual maturity:


	Held-to-maturity				Available-for-sale
	Carrying		Fair		Amortized		Fair
(dollars in thousands)	Value		Value		Cost		Value
Due within one year or less	$	7,452	$	7,423	$	1	$	1
Due after one year through five years		35,474		33,923		8,456		8,316
Due after five years through ten years		73,557		69,032		100,021		98,740
Due after 10 years		223,667		207,448		815,189		759,276
Total investment securities	$	340,150	$	317,826	$	923,667	$	866,333

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 $270.0 million and $192.8 million were pledged as of March 31, 2022 and December 31, 2021, respectively, to secure public deposits and for other purposes required or permitted by law.

Proceeds from the sale or call of available-for-sale investment securities, for the three months ended March 31, 2022 and 2021, are displayed in the table below:


	Three months ended
	March 31,
(dollars in thousands)	2022		2021
Proceeds	$	—	$	13,189
Realized gains		—		114
Realized losses		—		—

Proceeds from the call of held-to-maturity investment securities, for the three months ended March 31, 2022 and 2021, are displayed in the table below:


	Three months ended
	March 31,
(dollars in thousands)	2022		2021
Proceeds	$	515	$	—
Realized gains		—		—
Realized losses		—		—

As of March 31, 2022 and December 31, 2021, the carrying value of the Company’s Federal Reserve stock and Federal Home Loan Bank of Des Moines, or FHLB, stock was as follows:


	March 31,		December 31,
(dollars in thousands)	2022		2021
Federal Reserve	$	2,675	$	2,675
FHLB		4,246		3,806

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.

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Visa Class B Restricted Shares

In 2008, the Company received Visa Class B restricted shares as part of Visa’s initial public offering. These shares are transferable only under limited circumstances until they can be converted into the publicly traded Class A common shares. This conversion will not occur until the settlement of certain litigation which will be indemnified by Visa members, including the Company. Visa funded an escrow account from its initial public offering to settle these litigation claims. Should this escrow account be insufficient to cover these litigation claims, Visa is entitled to fund additional amounts to the escrow account by reducing each member bank’s Class B conversion ratio to unrestricted Class A shares. As of March 31, 2022, the conversion ratio was 1.6181. Based on the existing transfer restriction and the uncertainty of the outcome of the Visa litigation mentioned above, the 6,924 Class B shares (11,204 Class A equivalents) that the Company owned as of March 31, 2022 and December 31, 2021, were carried at a 0 cost basis.

NOTE 4 Loans and Allowance for Loan Losses

The following table presents total loans outstanding, by portfolio segment, as of March 31, 2022 and December 31, 2021:


	March 31,		December 31,
(dollars in thousands)	2022		2021
Commercial
Commercial and industrial (1)	$	467,449	$	436,761
Real estate construction		41,604		40,619
Commercial real estate		602,158		598,893
Total commercial		1,111,211		1,076,273
Consumer
Residential real estate first mortgage		522,489		510,716
Residential real estate junior lien		130,604		125,668
Other revolving and installment		53,738		45,363
Total consumer		706,831		681,747
Total loans	$	1,818,042	$	1,758,020

(1)	Included Paycheck Protection Program, or PPP, loans of $13.1 million at March 31, 2022 and $33.6 million at December 31, 2021.

Total loans included net deferred loan fees and costs of $444 thousand and $231 thousand at March 31, 2022 and December 31, 2021, respectively. Deferred loan fees on PPP loans were $333 thousand at March 31, 2022 and $881 thousand at December 31, 2021.

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

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The following tables present a past due aging analysis of total loans outstanding, by portfolio segment, as of March 31, 2022 and December 31, 2021:


	March 31, 2022
					90 Days
	Accruing		30 - 89 Days		or More				Total
(dollars in thousands)	Current		Past Due		Past Due		Nonaccrual		Loans
Commercial
Commercial and industrial	$	465,678	$	218	$	146	$	1,407	$	467,449
Real estate construction		41,604		—		—		—		41,604
Commercial real estate		601,087		442		—		629		602,158
Total commercial		1,108,369		660		146		2,036		1,111,211
Consumer
Residential real estate first mortgage		520,043		687		—		1,759		522,489
Residential real estate junior lien		129,934		445		—		225		130,604
Other revolving and installment		53,518		171		—		49		53,738
Total consumer		703,495		1,303		—		2,033		706,831
Total loans	$	1,811,864	$	1,963	$	146	$	4,069	$	1,818,042


	December 31, 2021
					90 Days
	Accruing		30 - 89 Days		or More				Total
(dollars in thousands)	Current		Past Due		Past Due		Nonaccrual		Loans
Commercial
Commercial and industrial	$	435,135	$	168	$	121	$	1,337	$	436,761
Real estate construction		40,619		—		—		—		40,619
Commercial real estate		598,264		—		—		629		598,893
Total commercial		1,074,018		168		121		1,966		1,076,273
Consumer
Residential real estate first mortgage		508,925		1,770		—		21		510,716
Residential real estate junior lien		125,412		167		—		89		125,668
Other revolving and installment		45,242		121		—		—		45,363
Total consumer		679,579		2,058		—		110		681,747
Total loans	$	1,753,597	$	2,226	$	121	$	2,076	$	1,758,020

Interest income foregone on nonaccrual loans approximated $36 thousand and $80 thousand for the three months ended March 31, 2022 and 2021, respectively.

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

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

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

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

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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 tables below present total loans outstanding, by loan portfolio segment, and risk category as of March 31, 2022 and December 31, 2021:


	March 31, 2022
			Criticized
			Special
(dollars in thousands)	Pass		Mention		Substandard		Doubtful		Total
Commercial
Commercial and industrial	$	463,278	$	—	$	4,171	$	—	$	467,449
Real estate construction		41,604		—		—		—		41,604
Commercial real estate		592,748		—		9,410		—		602,158
Total commercial		1,097,630		—		13,581		—		1,111,211
Consumer
Residential real estate first mortgage		520,438		—		2,051		—		522,489
Residential real estate junior lien		129,830		—		774		—		130,604
Other revolving and installment		53,689		—		49		—		53,738
Total consumer		703,957		—		2,874		—		706,831
Total loans	$	1,801,587	$	—	$	16,455	$	—	$	1,818,042


	December 31, 2021
			Criticized
			Special
(dollars in thousands)	Pass		Mention		Substandard		Doubtful		Total
Commercial
Commercial and industrial	$	430,235	$	480	$	6,046	$	—	$	436,761
Real estate construction		40,619		—		—		—		40,619
Commercial real estate		585,291		—		13,602		—		598,893
Total commercial		1,056,145		480		19,648		—		1,076,273
Consumer
Residential real estate first mortgage		510,375		—		341		—		510,716
Residential real estate junior lien		124,898		—		770		—		125,668
Other revolving and installment		45,363		—		—		—		45,363
Total consumer		680,636		—		1,111		—		681,747
Total loans	$	1,736,781	$	480	$	20,759	$	—	$	1,758,020

The adequacy of the allowance for loan losses is assessed at the end of each quarter. The allowance for loan losses includes a specific component related to loans that are individually evaluated for impairment and a general component related to loans that are segregated into homogeneous pools and collectively evaluated for impairment. The factors applied to these pools are an estimate of probable incurred losses based on management’s evaluation of historical

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net losses from loans with similar characteristics, which are adjusted by management to reflect current events, trends, and conditions. The adjustments include consideration of the following: changes in lending policies and procedures, economic conditions, nature and volume of the portfolio, experience of lending management, volume and severity of past due loans, quality of the loan review system, value of underlying collateral for collateral dependent loans, concentrations, and other external factors.

The following tables present, by loan portfolio segment, a summary of the changes in the allowance for loan losses for the three months ended March 31, 2022 and 2021:


	Three months ended March 31, 2022
	Beginning		Provision for		Loan		Loan		Ending
(dollars in thousands)	Balance		Loan Losses		Charge-offs		Recoveries		Balance
Commercial
Commercial and industrial	$	8,925	$	771	$	(27)	$	126	$	9,795
Real estate construction		783		27		—		—		810
Commercial real estate		12,376		(441)		—		11		11,946
Total commercial		22,084		357		(27)		137		22,551
Consumer
Residential real estate first mortgage		6,532		129		—		—		6,661
Residential real estate junior lien		1,295		92		—		13		1,400
Other revolving and installment		481		145		(18)		36		644
Total consumer		8,308		366		(18)		49		8,705
Unallocated		1,180		(723)		—		—		457
Total	$	31,572	$	—	$	(45)	$	186	$	31,713


	Three months ended March 31, 2021
	Beginning		Provision for		Loan		Loan		Ending
(dollars in thousands)	Balance		Loan Losses		Charge-offs		Recoveries		Balance
Commercial
Commercial and industrial	$	10,205	$	316	$	(204)	$	170	$	10,487
Real estate construction		658		(60)		—		—		598
Commercial real estate		14,105		277		(536)		3		13,849
Total commercial		24,968		533		(740)		173		24,934
Consumer
Residential real estate first mortgage		5,774		273		—		—		6,047
Residential real estate junior lien		1,373		(168)		—		83		1,288
Other revolving and installment		753		(83)		(44)		40		666
Total consumer		7,900		22		(44)		123		8,001
Unallocated		1,378		(555)		—		—		823
Total	$	34,246	$	—	$	(784)	$	296	$	33,758

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The following tables present the recorded investment in loans and related allowance for loan losses, by loan portfolio segment, disaggregated on the basis of the Company’s impairment methodology, as of March 31, 2022 and December 31, 2021:


	March 31, 2022
	Recorded Investment						Allowance for Loan Losses
	Individually		Collectively				Individually		Collectively
(dollars in thousands)	Evaluated		Evaluated		Total		Evaluated		Evaluated		Total
Commercial
Commercial and industrial	$	1,584	$	465,865	$	467,449	$	339	$	9,456	$	9,795
Real estate construction		—		41,604		41,604		—		810		810
Commercial real estate		806		601,352		602,158		4		11,942		11,946
Total commercial		2,390		1,108,821		1,111,211		343		22,208		22,551
Consumer
Residential real estate first mortgage		1,759		520,730		522,489		—		6,661		6,661
Residential real estate junior lien		226		130,378		130,604		—		1,400		1,400
Other revolving and installment		49		53,689		53,738		18		626		644
Total consumer		2,034		704,797		706,831		18		8,687		8,705
Unallocated		—		—		—		—		—		457
Total loans	$	4,424	$	1,813,618	$	1,818,042	$	361	$	30,895	$	31,713


	December 31, 2021
	Recorded Investment						Allowance for Loan Losses
	Individually		Collectively				Individually		Collectively
(dollars in thousands)	Evaluated		Evaluated		Total		Evaluated		Evaluated		Total
Commercial
Commercial and industrial	$	1,831	$	434,930	$	436,761	$	278	$	8,647	$	8,925
Real estate construction		—		40,619		40,619		—		783		783
Commercial real estate		809		598,084		598,893		5		12,371		12,376
Total commercial		2,640		1,073,633		1,076,273		283		21,801		22,084
Consumer
Residential real estate first mortgage		21		510,695		510,716		—		6,532		6,532
Residential real estate junior lien		91		125,577		125,668		—		1,295		1,295
Other revolving and installment		—		45,363		45,363		—		481		481
Total consumer		112		681,635		681,747		—		8,308		8,308
Unallocated		—		—		—		—		—		1,180
Total loans	$	2,752	$	1,755,268	$	1,758,020	$	283	$	30,109	$	31,572

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


	March 31, 2022						December 31, 2021
	Recorded		Unpaid		Related		Recorded		Unpaid		Related
(dollars in thousands)	Investment		Principal		Allowance		Investment		Principal		Allowance
Impaired loans with a valuation allowance
Commercial and industrial	$	508	$	532	$	339	$	445	$	464	$	278
Commercial real estate		177		199		4		180		203		5
Residential real estate junior lien		—		—		—		—		—		—
Other revolving and installment		40		40		18		—		—		—
Total impaired loans with a valuation allowance		725		771		361		625		667		283
Impaired loans without a valuation allowance
Commercial and industrial		1,076		1,188		—		1,386		1,575		—
Commercial real estate		629		684		—		629		684		—
Residential real estate first mortgage		1,759		1,759		—		21		24		—
Residential real estate junior lien		226		256		—		91		120		—
Other revolving and installment		9		9		—		—		—		—
Total impaired loans without a valuation allowance		3,699		3,896		—		2,127		2,403		—
Total impaired loans
Commercial and industrial		1,584		1,720		339		1,831		2,039		278
Commercial real estate		806		883		4		809		887		5
Residential real estate first mortgage		1,759		1,759		—		21		24		—
Residential real estate junior lien		226		256		—		91		120		—
Other revolving and installment		49		49		18		—		—		—
Total impaired loans	$	4,424	$	4,667	$	361	$	2,752	$	3,070	$	283

The table below presents the average recorded investment in impaired loans and interest income for the three months ended March 31, 2022 and 2021:


	Three Months Ended March 31,
	2022				2021
	Average				Average
	Recorded		Interest		Recorded		Interest
(dollars in thousands)	Investment		Income		Investment		Income
Impaired loans with a valuation allowance
Commercial and industrial	$	528	$	3	$	1,816	$	13
Commercial real estate		180		2		2,793		138
Residential real estate junior lien		—		—		33		—
Other revolving and installment		41		—		38		—
Total impaired loans with a valuation allowance		749		5		4,680		151
Impaired loans without a valuation allowance
Commercial and industrial		1,126		—		1,258		22
Commercial real estate		642		—		2,158		—
Residential real estate first mortgage		1,759		—		435		—
Residential real estate junior lien		230		—		176		—
Other revolving and installment		9		—		—		—
Total impaired loans without a valuation allowance		3,766		—		4,027		22
Total impaired loans
Commercial and industrial		1,654		3		3,074		35
Commercial real estate		822		2		4,951		138
Residential real estate first mortgage		1,759		—		435		—
Residential real estate junior lien		230		—		209		—
Other revolving and installment		50		—		38		—
Total impaired loans	$	4,515	$	5	$	8,707	$	173

Loans with a carrying value of $1.3 billion as of March 31, 2022 and $1.2 billion as of December 31, 2021, were pledged to secure public deposits, and for other purposes required or permitted by law.

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Under certain circumstances, the Company will provide borrowers relief through loan restructurings. A restructuring of debt constitutes a TDR if the Company, for economic or legal reasons related to the borrower’s financial difficulties, grants a concession to the borrower that it would not otherwise consider. TDR concessions can include a reduction of interest rates, an extension of maturity dates, forgiveness of principal or interest due, or acceptance of other assets in full or partial satisfaction of the debt.

During the first quarter of 2022, there were 0 loans modified as a TDR. During the first quarter of 2021, there were 0 loans modified as a TDR.

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

NOTE 5 Goodwill and Other Intangible Assets

The following table summarizes the carrying amount of goodwill, by segment, as of March 31, 2022 and December 31, 2021:


	March 31,		December 31,
(dollars in thousands)	2022		2021
Banking	$	20,131	$	20,131
Retirement and benefit services		11,359		11,359
Total goodwill	$	31,490	$	31,490

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 0 goodwill impairment as of March 31, 2022.

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


	March 31, 2022						December 31, 2021
(dollars in thousands)	Gross Carrying Amount		Accumulated Amortization		Total		Gross Carrying Amount		Accumulated Amortization		Total
Identifiable customer intangibles	$	42,057	$	(22,860)	$	19,197	$	42,057	$	(21,807)	$	20,250
Total intangible assets	$	42,057	$	(22,860)	$	19,197	$	42,057	$	(21,807)	$	20,250

Amortization of intangible assets was $1.1 million and $1.2 million for the three months ended March 31, 2022, and 2021, 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 $325.0 million and $345.8 million as of March 31, 2022 and December 31, 2021, respectively. Servicing loans for others generally consists of collecting mortgage payments, maintaining escrow accounts, disbursing payments to investors and collection and foreclosure processing. Loan servicing income is recorded on an accrual basis and includes servicing fees from investors and certain charges collected from borrowers, such as late payment fees, and is net of fair value adjustments to capitalized mortgage servicing rights.

The following table summarizes the Company’s activity related to servicing rights for the three months ended March 31, 2022 and 2021:

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	Three months ended
	March 31,
(dollars in thousands)	2022		2021
Balance, beginning of period	$	1,880	$	1,987
Additions		4		49
Amortization		(159)		(200)
(Impairment)/Recovery		46		116
Balance, end of period	$	1,771	$	1,952

The following is a summary of key data and assumptions used in the valuation of servicing rights as of March 31, 2022 and December 31, 2021. Increases or decreases in any one of these assumptions would result in lower or higher fair value measurements:


	March 31,			December 31,
(dollars in thousands)	2022			2021
Fair value of servicing rights	$	1,771		$	1,880
Weighted-average remaining term, years		20.7			20.3
Prepayment speeds		8.8	%		14.2	%
Discount rate		10.0	%		9.5	%

NOTE 7 Leases

Substantially all of the leases in which the Company is the lessee are comprised of real estate property for offices and office equipment rentals with terms extending through 2027. Portions of certain properties are subleased for terms extending through 2024. Substantially all of the Company’s leases are classified as operating leases. The Company has 1 existing finance lease for the Company’s headquarters building with a lease term through October 31, 2022.

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


		March 31,		December 31,
(dollars in thousands)		2022		2021
Lease Right-of-Use Assets	Classification
Operating lease right-of-use assets	Operating lease right-of-use assets	$	3,360	$	3,727
Finance lease right-of-use assets	Land, premises and equipment, net		58		87
Total lease right-of-use assets		$	3,418	$	3,814
Lease Liabilities
Operating lease liabilities	Operating lease liabilities	$	3,850	$	4,275
Finance lease liabilities	Long-term debt		143		203
Total lease liabilities		$	3,993	$	4,478

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 1 or more options to renew at the Company’s discretion. If at lease inception, the Company considers the exercising of a renewal option to be reasonably certain, the Company will include the extended term in the calculation of the ROU asset and lease liability. Regarding the discount rate, Topic 842 requires the use of the rate implicit in the lease whenever this rate is readily determinable. As this rate is rarely determinable, the Company utilizes its incremental borrowing rate at lease inception, on a collateralized basis, over a similar term. For the Company’s only finance lease, the Company utilized its incremental borrowing rate at lease inception.

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	March 31,		December 31,
	2022		2021
Weighted-average remaining lease term, years
Operating leases	3.3		3.4
Finance leases	0.5		0.8
Weighted-average discount rate
Operating leases	2.3	%	2.5	%
Finance leases	7.8	%	7.8	%

As the Company elected, for all classes of underlying assets, not to separate lease and non-lease components and instead to account for them as a single lease component, the variable lease cost primarily represents variable payments such as common area maintenance and utilities. Variable lease cost also includes payments for usage or maintenance of those capitalized equipment operating leases.

The following table presents lease costs and other lease information for the three months ending March 31, 2022 and 2021:


	Three months ended
	March 31,
(dollars in thousands)	2022		2021
Lease costs
Operating lease cost	$	411	$	496
Variable lease cost		213		233
Short-term lease cost		45		37
Finance lease cost
Interest on lease liabilities		4		8
Amortization of right-of-use assets		29		29
Sublease income		(57)		(60)
Net lease cost	$	645	$	743
Other information
Cash paid for amounts included in the measurement of lease liabilities operating cash flows from operating leases	$	392	$	487
Right-of-use assets obtained in exchange for new operating lease liabilities	$	—	$	—

Future minimum payments for finance and operating leases with initial or remaining terms of one year or more as of March 31, 2022 were as follows:


	Finance		Operating
(dollars in thousands)	Leases		Leases
Twelve months ended
March 31, 2023	$	146	$	1,597
March 31, 2024		—		1,439
March 31, 2025		—		676
March 31, 2026		—		389
March 31, 2027		—		250
Thereafter		—		238
Total future minimum lease payments	$	146	$	4,589
Amounts representing interest		(3)		(739)
Total operating lease liabilities	$	143	$	3,850

NOTE 8 Deposits

The components of deposits in the consolidated balance sheets as of March 31, 2022 and December 31, 2021 were as follows:

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	March 31,		December 31,
(dollars in thousands)	2022		2021
Noninterest-bearing	$	831,558	$	938,840
Interest-bearing
Interest-bearing demand		760,321		714,669
Savings accounts		99,299		96,825
Money market savings		976,905		937,305
Time deposits		224,184		232,912
Total interest-bearing		2,060,709		1,981,711
Total deposits	$	2,892,267	$	2,920,551

NOTE 9 Long-Term Debt

Long-term debt as of March 31, 2022 and December 31, 2021 consisted of the following:


	March 31, 2022
						Period End
	Face		Carrying			Interest		Maturity
(dollars in thousands)	Value		Value		Interest Rate	Rate		Date	Call Date
Subordinated notes payable	$	50,000	$	50,000	Fixed	3.50	%	3/30/2031	3/31/2026
Junior subordinated debenture (Trust I)		4,124		3,503	Three-month LIBOR + 3.10%	4.07	%	6/26/2033	6/26/2008
Junior subordinated debenture (Trust II)		6,186		5,256	Three-month LIBOR + 1.80%	2.63	%	9/15/2036	9/15/2011
Finance lease liability		2,700		143	Fixed	7.81	%	10/31/2022	N/A
Total long-term debt	$	63,010	$	58,902


	December 31, 2021
						Period End
	Face		Carrying			Interest		Maturity
(dollars in thousands)	Value		Value		Interest Rate	Rate		Date	Call Date
Subordinated notes payable	$	50,000	$	50,000	Fixed	3.50	%	12/30/2025	12/30/2020
Junior subordinated debenture (Trust I)		4,124		3,492	Three-month LIBOR + 3.10%	3.32	%	6/26/2033	6/26/2008
Junior subordinated debenture (Trust II)		6,186		5,238	Three-month LIBOR + 1.80%	2.00	%	9/15/2036	9/15/2011
Finance lease liability		2,700		203	Fixed	7.81	%	10/31/2022	N/A
Total long-term debt	$	63,010	$	58,933

NOTE 10 Financial Instruments with Off-Balance Sheet Risk

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

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A summary of the contractual amounts of the Company’s exposure to off-balance sheet risk as of March 31, 2022 and December 31, 2021, respectively, was as follows:


	March 31,		December 31,
(dollars in thousands)	2022		2021
Commitments to extend credit	$	650,087	$	668,115
Standby letters of credit		10,591		10,529
Total	$	660,678	$	678,644

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

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

The Company utilizes standby letters of credit issued by either the FHLB or the Bank of North Dakota to secure public unit deposits. The Company had a $150 thousand letter of credit with the FHLB as of March 31, 2022 and December 31, 2021. With the Bank of North Dakota, the Company had 0 letters of credit outstanding as of March 31, 2022 and December 31, 2021. Bank of North Dakota potential letters of credit were collateralized by loans pledged to the Bank of North Dakota in the amount of $227.9 million and $229.7 million as of March 31, 2022 and December 31, 2021, respectively.

NOTE 11 Share-Based Compensation

Before May 6, 2016, the Company granted equity awards pursuant to the Alerus Financial Corporation 2009 Stock Plan. The awards were in the form of restricted stock or restricted stock units and represent an element of employee compensation. The Related compensation expense for the awards is based on the fair value of Alerus Financial Corporation common stock at the time of grant. The value of awards that are expected to vest is amortized as an expense over the applicable vesting periods. The ability to grant awards under this plan has expired.

On May 6, 2019, the Company’s stockholders approved the Alerus Financial Corporation 2019 Equity Incentive Plan. This plan 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 March 31, 2022, 948,428 shares of common stock are still available for issuance under the plan.

The compensation expense relating to awards under these plans was $378 thousand and $498 thousand for the three months ended March 31, 2022 and 2021, respectively.

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The following table presents the activity in the stock plans for the three months ended March 31, 2022 and 2021:


	Three months ended March 31,
	2022			2021
		Weighted-			Weighted-
		Average Grant			Average Grant
	Awards	Date Fair Value		Awards	Date Fair Value
Restricted Stock and Restricted Stock Unit Awards
Outstanding at beginning of period	260,850	$	21.04	325,030	$	19.48
Granted	70,850		28.39	59,374		26.36
Vested	(96,618)		18.66	(81,092)		20.72
Forfeited or cancelled	(2,209)		22.75	—		—
Outstanding at end of period	232,873	$	23.33	303,312	$	20.49

As of March 31, 2022, there was $3.1 million of unrecognized compensation expense related to non-vested awards granted under the plans. The expense is expected to be recognized over a weighted-average period of 2.9 years.

NOTE 12 Income Taxes

The components of income tax expense (benefit) for the three months ended March 31, 2022 and 2021 were as follows:


	Three months ended March 31,
	2022				2021
			Percent of				Percent of
(dollars in thousands)	Amount		Pretax Income		Amount		Pretax Income
Taxes at statutory federal income tax rate	$	2,745	21.0	%	$	4,174	21.0	%
Tax effect of:
Tax exempt income		(117)	(0.9)	%		(153)	(0.8)	%
State income taxes, net of federal benefits		579	4.4			854	4.3
Nondeductible items and other		(319)	(2.4)			(213)	(1.1)
Applicable income taxes	$	2,888	22.1	%	$	4,662	23.4	%

It is the opinion of management that the Company has 0 significant uncertain tax positions that would be subject to change upon examination.

NOTE 13 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 credit investments as of March 31, 2022 and December 31, 2021:


		March 31, 2022				December 31, 2021
(dollars in thousands)		Investment		Unfunded Commitment		Investment		Unfunded Commitment
Investment	Accounting Method
Low income housing tax credit	Proportional amortization	$	12,906	$	11,686	$	7,906	$	6,999
Total		$	12,906	$	11,686	$	7,906	$	6,999

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NOTE 14 Segment Reporting

The Company determines reportable segments based on the services offered, the significance of the services offered, the significance of those services to the Company’s financial statements, and management’s regular review of the operating results of those services. The Company operates through 4 operating segments: Banking, Retirement and Benefit Services, Wealth Management, and Mortgage.

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

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


	Three months ended March 31, 2022
			Retirement and		Wealth				Corporate
(dollars in thousands)	Banking		Benefit Services		Management		Mortgage		Administration		Consolidated
Net interest income	$	21,525	$	—	$	—	$	709	$	(561)	$	21,673
Provision for loan losses		—		—		—		—		—		—
Noninterest income		1,538		17,646		5,326		4,931		29		29,470
Noninterest expense		12,694		8,432		1,838		5,020		10,087		38,071
Net income before taxes	$	10,369	$	9,214	$	3,488	$	620	$	(10,619)	$	13,072


	Three months ended March 31, 2021
			Retirement and		Wealth				Corporate
(dollars in thousands)	Banking		Benefit Services		Management		Mortgage		Administration		Consolidated
Net interest income	$	21,880	$	—	$	—	$	446	$	(288)	$	22,038
Provision for loan losses		—		—		—		—		—		—
Noninterest income		1,522		17,255		4,986		17,132		(14)		40,881
Noninterest expense		11,084		10,112		2,335		10,853		8,658		43,042
Net income before taxes	$	12,318	$	7,143	$	2,651	$	6,725	$	(8,960)	$	19,877

Banking

The Banking division offers a complete line of loan, deposit, cash management, and treasury services through 14 offices in North Dakota, Minnesota, and Arizona. These products and services are supported through web and mobile based applications. The majority of the Company’s assets and liabilities are in the Banking segment’s balance sheet.

Retirement and Benefit Services

Retirement and Benefit Services provides the following services nationally: recordkeeping and administration services to qualified retirement plans; ESOP trustee, recordkeeping, and administration; investment fiduciary services to retirement plans; health savings accounts, flex spending accounts, COBRA recordkeeping and administration services, and payroll to employers; and payroll and HRIS services for employers. In addition, the division operates within each of the banking markets, as well as in Lansing, Michigan and Littleton, Colorado.

Wealth Management

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

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Mortgage

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

NOTE 15 Earnings Per Share

The calculation of basic and diluted earnings per share using the two-class method for the three months ending March 31, 2022 and 2021 are presented below:


	Three months ended
	March 31,
(dollars and shares in thousands, except per share data)	2022		2021
Net income	$	10,184	$	15,215
Dividends and undistributed earnings allocated to participating securities		125		254
Net income available to common shareholders	$	10,059	$	14,961
Weighted-average common shares outstanding for basic earnings per share		17,244		17,145
Dilutive effect of stock-based awards		256		320
Weighted-average common shares outstanding for diluted earnings per share		17,500		17,465
Earnings per common share:
Basic earnings per common share	$	0.58	$	0.87
Diluted earnings per common share	$	0.57	$	0.86

NOTE 16 Derivative Instruments

The Company enters into interest rate swaps to facilitate client transactions and meet their financing needs. Upon entering into these instruments to meet client needs, the Company enters into offsetting positions with U.S. financial institutions in order to minimize risk to the Company. These swaps are derivatives but are not designated as hedging instruments.

The Company did not have any derivatives designated as hedging instruments as of March 31, 2022 and December 31, 2021. The following table presents the amounts recorded in the Company’s consolidated balance sheets, for derivatives not designated as hedging instruments, as of March 31, 2022 and December 31, 2021:


		March 31, 2022				December 31, 2021
		Fair		Notional		Fair		Notional
(dollars in thousands)		Value		Amount		Value		Amount
Asset Derivatives	Consolidated Balance Sheet Location
Interest rate swaps	Other assets	$	3,642	$	44,480	$	1,366	$	44,826
Interest rate lock commitments	Other assets		882		53,070		1,507		52,316
Forward loan sales commitments	Other assets		—		—		490		13,418
TBA mortgage backed securities	Other assets		1,230		80,466		34		97,000
Total asset derivatives		$	5,754	$	178,016	$	3,397	$	207,560
Liability Derivatives
Interest rate swaps	Accrued expenses and other liabilities	$	3,644	$	44,480	$	1,368	$	44,826
TBA mortgage backed securities	Accrued expenses and other liabilities		—		—		—		—
Total liability derivatives		$	3,644	$	44,480	$	1,368	$	44,826

The gain (loss) recognized on derivative instruments for the three months ended March 31, 2022 and 2021 was as follows:

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		Three months ended
	Consolidated Statements	March 31,		March 31,
(dollars in thousands)	of Income Location	2022		2021
Interest rate swaps	Other noninterest income	$	—	$	2
Interest rate lock commitments	Mortgage banking		(710)		(6,245)
Forward loan sales commitments	Mortgage banking		(490)		(1,635)
TBA mortgage backed securities	Mortgage banking		2,503		8,961
Total gain/(loss) from derivative instruments		$	1,303	$	1,083

The Company has third party agreements that require a minimum dollar transfer amount upon a margin call. This requirement is dependent on certain specified credit measures. The amount of collateral posted with third parties at March 31, 2022 and December 31, 2021 was $19 thousand and $19 thousand, respectively. The amount of collateral posted with third parties was deemed to be sufficient as of those dates to collateralize both the fair market value change as well as any additional amounts that may be required as a result of a change in the specified credit measures.

NOTE 17 Regulatory Matters

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

Quantitative measures established by regulation to ensure capital adequacy require the Company and the Bank to maintain minimum amounts and ratios (set forth in the following table) of common equity tier 1, tier 1, and total capital (as defined in the regulations) to risk weighted assets (as defined) and of tier 1 capital (as defined) to average assets (as defined). Management believes at March 31, 2022 and December 31, 2021, 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 March 31, 2022 and December 31, 2021:


	March 31, 2022
										Minimum to be
						Requirements				Well Capitalized
						for Capital				Under Prompt
	Actual				Adequacy Purposes				Corrective Action
(dollars in thousands)	Amount		Ratio		Amount		Ratio		Amount		Ratio
Common equity tier 1 capital to risk weighted assets
Consolidated	$	322,985	14.27	%	$	101,863	4.50	%	$	N/A	N/A
Bank		305,828	13.52	%		101,817	4.50	%		147,070	6.50	%
Tier 1 capital to risk weighted assets										.
Consolidated		331,743	14.66	%		135,817	6.00	%		N/A	N/A
Bank		305,828	13.52	%		135,757	6.00	%		181,009	8.00	%
Total capital to risk weighted assets
Consolidated		410,081	18.12	%		181,090	8.00	%		N/A	N/A
Bank		334,153	14.77	%		181,009	8.00	%		226,261	10.00	%
Tier 1 capital to average assets
Consolidated		331,743	10.30	%		128,837	4.00	%		N/A	N/A
Bank		305,828	9.50	%		128,768	4.00	%		160,960	5.00	%

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	December 31, 2021
										Minimum to be
						Requirements				Well Capitalized
						for Capital				Under Prompt
	Actual				Adequacy Purposes				Corrective Action
(dollars in thousands)	Amount		Ratio		Amount		Ratio		Amount		Ratio
Common equity tier 1 capital to risk weighted assets
Consolidated	$	314,628	14.65	%	$	96,647	4.50	%	$	N/A	N/A
Bank		297,453	13.87	%		96,538	4.50	%		139,444	6.50	%
Tier 1 capital to risk weighted assets										.
Consolidated		323,358	15.06	%		128,862	6.00	%		N/A	N/A
Bank		297,453	13.87	%		128,718	6.00	%		171,624	8.00	%
Total capital to risk weighted assets
Consolidated		400,263	18.64	%		171,816	8.00	%		N/A	N/A
Bank		324,328	15.12	%		171,624	8.00	%		214,530	10.00	%
Tier 1 capital to average assets
Consolidated		323,358	9.79	%		132,112	4.00	%		N/A	N/A
Bank		297,453	9.01	%		132,039	4.00	%		165,049	5.00	%

The Bank is subject to certain restrictions on the amount of dividends that it may pay without prior regulatory approval. The Company and the Bank are subject to the rules of the Basel III regulatory capital framework and related Dodd-Frank Wall Street Reform and Consumer Protection Act rules. The rules included the implementation of a 2.5 percent capital conservation buffer that is added to the minimum requirements for capital adequacy purposes. A banking organization with a conservation buffer of less than the required amount will be subject to the limitations on capital distributions, including dividend payments and certain discretionary bonus payments to executive officers. As of March 31, 2022, the ratios for the Company and the Bank were sufficient to meet the conservation buffer. In addition, the Company must adhere to various U.S. Department of Housing and Urban Development, or HUD, regulatory guidelines including required minimum capital and liquidity to maintain their Federal Housing Administration approval status. Failure to comply with the HUD guidelines could result in withdrawal of this certification. As of March 31, 2022, and December 31, 2021, the Company was in compliance with the aforementioned guidelines.

NOTE 18 Stock Repurchase Program

On February 18, 2021, the Board of Directors of the Company approved a stock repurchase program, or the Program, which authorizes the Company to repurchase up to 770,000 shares of its common stock subject to certain limitations and conditions. The Program was effective immediately and will continue for a period of 36 months. The Program does not obligate the Company to repurchase any shares of its common stock and there is no assurance that the Company will do so. For the three months ended March 31, 2022, there were 0 shares repurchased under the Program. The Company also repurchases shares to pay withholding taxes on the vesting of restricted stock awards and units.

NOTE 19 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.

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

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

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

Recurring Basis

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

The following tables present the balances of the assets and liabilities measured at estimated fair value on a recurring basis as of March 31, 2022 and December 31, 2021:


	March 31, 2022
(dollars in thousands)	Level 1		Level 2		Level 3		Total
Available-for-sale
U.S. treasury and government agencies	$	—	$	4,167	$	—	$	4,167
Mortgage backed securities
Residential agency		—		711,121		—		711,121
Commercial		—		82,732		—		82,732
Asset backed securities		—		42		—		42
Corporate bonds		—		68,271		—		68,271
Total available-for-sale investment securities	$	—	$	866,333	$	—	$	866,333
Other assets
Derivatives	$	—	$	5,754	$	—	$	5,754
Other liabilities
Derivatives	$	—	$	3,644	$	—	$	3,644


	December 31, 2021
(dollars in thousands)	Level 1		Level 2		Level 3		Total
Available-for-sale
U.S. treasury and government agencies	$	—	$	5,103	$	—	$	5,103
Mortgage backed securities
Residential agency		—		707,157		—		707,157
Commercial		—		90,913		—		90,913
Asset backed securities		—		54		—		54
Corporate bonds		—		50,422		—		50,422
Total available-for-sale investment securities	$	—	$	853,649	$	—	$	853,649
Other assets
Derivatives	$	—	$	3,397	$	—	$	3,397
Other liabilities
Derivatives	$	—	$	1,368	$	—	$	1,368

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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.

Derivatives

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

Nonrecurring Basis

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

Net impairment related to nonrecurring estimated fair value measurements of certain assets as of March 31, 2022 and December 31, 2021 consisted of the following:


	March 31, 2022
(dollars in thousands)	Level 2		Level 3		Total		Impairment
Loans held for sale	$	21,864	$	—	$	21,864	$	—
Impaired loans		—		4,063		4,063		361
Foreclosed assets		—		865		865		—
Servicing rights		—		1,771		1,771		—


	December 31, 2021
(dollars in thousands)	Level 2		Level 3		Total		Impairment
Loans held for sale	$	46,490	$	—	$	46,490	$	—
Impaired loans		—		2,469		2,469		283
Foreclosed assets		—		885		885		—
Servicing rights		—		1,880		1,880		—

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.

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The valuation techniques and significant unobservable inputs used to measure Level 3 estimated fair values as of March 31, 2022, and December 31, 2021, were as follows:


			March 31, 2022
(dollars in thousands)							Weighted
Asset Type	Valuation Technique	Unobservable Input	Fair Value		Range		Average
Impaired loans	Appraisal value	Property specific adjustment	$	4,063	N/A		N/A
Foreclosed assets	Appraisal value	Property specific adjustment		865	N/A		N/A
Servicing rights	Discounted cash flows	Prepayment speed assumptions		1,771	126-174		147
		Discount rate			10.0	%	10.0	%


			December 31, 2021
(dollars in thousands)							Weighted
Asset Type	Valuation Technique	Unobservable Input	Fair Value		Range		Average
Impaired loans	Appraisal value	Property specific adjustment	$	2,469	N/A		N/A
Foreclosed assets	Appraisal value	Property specific adjustment		885	N/A		N/A
Servicing rights	Discounted cash flows	Prepayment speed assumptions		1,880	161-327		237
		Discount rate			9.5	%	9.5	%

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

The following disclosures represent financial instruments in which the ending balances, as of March 31, 2022 and December 31, 2021, 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.

Loans

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

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Bank-Owned Life Insurance

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

Deposits

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

Short-Term Borrowings and Long-Term Debt

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

Off-Balance Sheet Credit-Related Commitments

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

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


	March 31, 2022
	Carrying		Estimated��Fair Value
(dollars in thousands)	Amount		Level 1		Level 2		Level 3		Total
Financial Assets
Cash and cash equivalents	$	132,832	$	132,832	$	—	$	—	$	132,832
Investment securities held-to-maturity		340,150		—		317,826		—		317,826
Loans, net		1,786,329		—		—		1,800,339		1,800,339
Accrued interest receivable		8,516		8,516		—		—		8,516
Bank-owned life insurance		33,358		—		33,358		—		33,358
Financial Liabilities
Noninterest-bearing deposits	$	831,558	$	—	$	831,558	$	—	$	831,558
Interest-bearing deposits		1,836,525		—		1,836,525		—		1,836,525
Time deposits		224,184		—		—		223,127		223,127
Long-term debt		58,902		—		61,651		—		61,651
Accrued interest payable		2,139		2,139		—		—		2,139

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	December 31, 2021
	Carrying		Estimated Fair Value
(dollars in thousands)	Amount		Level 1		Level 2		Level 3		Total
Financial Assets
Cash and cash equivalents	$	242,311	$	242,311	$	—	$	—	$	242,311
Investment securities held-to-maturity		352,061		—		349,677		—		349,677
Loans, net		1,726,448		—		—		1,760,784		1,760,784
Accrued interest receivable		8,537		8,537		—		—		8,537
Bank-owned life insurance		33,156		—		33,156		—		33,156
Financial Liabilities
Noninterest-bearing deposits	$	938,840	$	—	$	938,840	$	—	$	938,840
Interest-bearing deposits		1,748,799		—		1,748,799		—		1,748,799
Time deposits		232,912		—		—		232,970		232,970
Long-term debt		58,933		—		57,772		—		57,772
Accrued interest payable		1,674		1,674		—		—		1,674

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

General

The following discussion explains our financial condition and results of operations as of and for the three months ended March 31, 2022 and 2021. 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, 2021, filed with the Securities and Exchange Commission on March 11, 2022.

Forward-Looking Statements

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

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

●

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

●

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

●

business and economic conditions generally and in the financial services industry, nationally and within our market areas, including rising rates of inflation;

●

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

●

concentrations within our loan portfolio;

●

the level of nonperforming assets on our balance sheet;

●

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

●

our ability to implement our organic and acquisition growth strategies;

●

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

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●

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

●

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

●

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

●

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

●

developments and uncertainty related to the future use and availability of some reference rates, such as the London Interbank Offered Rate, as well as other alternative reference rates;

●

potential losses incurred in connection with mortgage loan repurchases;

●

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

●

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

●

any material weaknesses in our internal control over financial reporting;

●

our ability to successfully manage liquidity risk, especially in light of recent excess liquidity at the Bank;

●

concentrations of large depositors;

●

our dependence on dividends from the Bank;

●

the effectiveness of our risk management framework;

●

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

●

the extensive regulatory framework that applies to us;

●

the impact of recent and future legislative and regulatory changes;

●

the effects of the COVID-19 pandemic, including its effects on the economic environment, our clients and our operations, including due to supply chain disruptions, as well as any changes to federal, state, or local government laws, regulations, or orders in connection with the pandemic;

●

interest rate risks associated with our business, including the effects of anticipated rate increases by the Federal Reserve;

●

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

●

governmental monetary, trade and fiscal policies;

●

rapid technological change in the financial services industry;

●

increased competition in the financial services industry from non-banks such as credit unions and Fintech companies;

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●

our ability to manage mortgage pipeline risk;

●

changes to U.S. or state tax laws, regulations and guidance, including recent proposals to increase the federal corporate tax rate;

●

talent and labor shortages and employee turnover;

●

possible federal mask and vaccine mandates;

●

the impact of inflation and anticipated interest rate increases;

●

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

●

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

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

Overview

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

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

Critical Accounting Policies

Our consolidated financial statements are prepared based on the application of accounting policies generally accepted in the United States, or GAAP. The preparation of our consolidated financial statements requires management to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses. These estimates are based upon historical experience and on various other assumptions that management believes are reasonable under current circumstances. These estimates form the basis for making judgments about the carrying value of certain assets and liabilities that are not readily available from other sources. Actual results may differ from these estimates under different assumptions or conditions. The estimates and judgments that management believes have the most effect on the Company’s reported financial position and results of operations are set forth in Note 1 – Significant Accounting Policies of the Notes to the Consolidated Statements, included in our Annual Report on Form 10-K for the year ended December 31, 2021. There have been no significant changes in critical accounting policies, or the assumptions and judgments utilized in applying these policies since December 31, 2021.

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

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transition period for so long as the Company remains an emerging growth company or until the Company affirmatively and irrevocably opts out of the extended transition period under the JOBS Act.

Recent Developments

Impact of COVID-19

As of March 31, 2022, the COVID-19 pandemic remained ongoing. The progression of the COVID-19 pandemic in the United States did not have an adverse impact on our financial condition and results of operations as of and for the three months ended March 31, 2022. Nonetheless, the economic recovery could remain gradual and uneven and could be hindered by persistent or resurgent infection rates, particularly given uncertainty with respect to the distribution and acceptance of the vaccines and their effectiveness with respect to the new variants of the virus.

Effects on Our Market Areas. Our primary banking market areas are the states of North Dakota, Minnesota and Arizona. Our retirement and benefit services business serves clients in all 50 states. We offer retirement and benefit services at all of our banking offices located in our three primary market areas. In addition, we operate one retirement and benefit services office in Minnesota, one in Michigan and one in Colorado.

Each of our market areas continues to have different responses to the COVID-19 pandemic due to the availability of the COVID-19 vaccines and varying infection rates. Based on the current environment, it is unclear how the states in our market areas will continue to change policies in response to the COVID-19 pandemic and whether any such changes will negatively impact our customers and regional economies.

Operating Results Overview

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


	Three months ended
	March 31,			December 31,			March 31,
(dollars and shares in thousands, except per share data)	2022			2021			2021
Performance Ratios
Return on average total assets		1.26	%		1.50	%		2.02	%
Return on average common equity		11.78	%		14.13	%		18.46	%
Return on average tangible common equity (1)		14.72	%		17.36	%		23.03	%
Noninterest income as a % of revenue		57.62	%		59.67	%		64.97	%
Net interest margin (taxable-equivalent basis)		2.83	%		2.84	%		3.12	%
Efficiency ratio (1)		72.25	%		71.06	%		66.43	%
Average equity to average assets		10.67	%		10.65	%		10.97	%
Net charge-offs/(recoveries) to average loans		(0.03)	%		(0.22)	%		0.10	%
Dividend payout ratio		28.07	%		22.22	%		17.44	%
Per Common Share
Earnings per common share - basic	$	0.58		$	0.73		$	0.87
Earnings per common share - diluted	$	0.57		$	0.72		$	0.86
Dividends declared per common share	$	0.16		$	0.16		$	0.15
Book value per common share	$	19.00		$	20.88		$	19.15
Tangible book value per common share (1)	$	16.07		$	17.87		$	15.95
Average common shares outstanding - basic		17,244			17,210			17,145
Average common shares outstanding - diluted		17,500			17,480			17,465
Other Data
Retirement and benefit services assets under administration/management	$	35,333,131		$	36,732,938		$	34,774,650
Wealth management assets under administration/management	$	4,584,856		$	4,039,931		$	3,357,530
Mortgage originations	$	186,762		$	356,821		$	518,014

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

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Selected Financial Data

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


	Three months ended
	March 31,		December 31,		March 31,
(dollars in thousands)	2022		2021		2021
Selected Average Balance Sheet Data
Loans	$	1,768,226	$	1,782,657	$	1,945,437
Investment securities		1,216,256		1,119,370		662,413
Assets		3,286,809		3,353,900		3,047,261
Deposits		2,816,828		2,870,631		2,615,579
Long-term debt		58,908		58,938		25,677
Stockholders’ equity		350,545		357,084		334,188


	March 31,		December 31,		March 31,
(dollars in thousands)	2022		2021		2021
Selected Period End Balance Sheet Data
Loans	$	1,818,042	$	1,758,020	$	1,937,345
Allowance for loan losses		(31,713)		(31,572)		(33,758)
Investment securities		1,206,483		1,205,710		795,097
Assets		3,336,199		3,392,691		3,151,756
Deposits		2,892,267		2,920,551		2,717,573
Long-term debt		58,902		58,933		59,020
Total stockholders’ equity		328,505		359,403		329,234


	Three months ended
	March 31,		December 31,		March 31,
(dollars in thousands)	2022		2021		2021
Selected Income Statement Data
Net interest income	$	21,673	$	22,789	$	22,038
Provision for loan losses		—		(1,500)		—
Noninterest income		29,470		33,718		40,881
Noninterest expense		38,071		41,276		43,042
Income before income taxes		13,072		16,731		19,877
Income tax expense		2,888		4,026		4,662
Net income	$	10,184	$	12,705	$	15,215

Non-GAAP to GAAP Reconciliations and Calculation of Non-GAAP Financial Measures

In addition to the results presented in accordance with GAAP, we routinely supplement our evaluation with an analysis of certain non-GAAP financial measures. These non-GAAP financial measures include the ratio of tangible common equity to tangible assets, tangible book value per common share, return on average tangible common equity, net interest margin (tax-equivalent), and the efficiency ratio. Management uses these non-GAAP financial measures in its analysis of its performance, and believes financial analysts and others frequently use these measures, and other similar measures, to evaluate capital adequacy. Management calculates: (i) tangible common equity as total common stockholders' equity less goodwill and other intangible assets; (ii) tangible book value per common share as tangible common equity divided by shares of common stock outstanding; (iii) tangible assets as total assets, less goodwill and other intangible assets; (iv) return on average tangible common equity as net income adjusted for intangible amortization net of tax, divided by average tangible common equity; and (v) efficiency ratio as noninterest expense less intangible amortization expense, divided by net interest income plus noninterest income plus a tax-equivalent adjustment.

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


	March 31,			December 31,			March 31,
(dollars and shares in thousands, except per share data)	2022			2021			2021
Tangible common equity to tangible assets
Total common stockholders’ equity	$	328,505		$	359,403		$	329,234
Less: Goodwill		31,490			31,490			30,201
Less: Other intangible assets		19,197			20,250			24,768
Tangible common equity (a)		277,818			307,663			274,265
Total assets		3,336,199			3,392,691			3,151,756
Less: Goodwill		31,490			31,490			30,201
Less: Other intangible assets		19,197			20,250			24,768
Tangible assets (b)		3,285,512			3,340,951			3,096,787
Tangible common equity to tangible assets (a)/(b)		8.46	%		9.21	%		8.86	%
Tangible book value per common share
Total common stockholders’ equity	$	328,505		$	359,403		$	329,234
Less: Goodwill		31,490			31,490			30,201
Less: Other intangible assets		19,197			20,250			24,768
Tangible common equity (c)		277,818			307,663			274,265
Total common shares issued and outstanding (d)		17,289			17,213			17,190
Tangible book value per common share (c)/(d)	$	16.07		$	17.87		$	15.95


	Three months ended
	March 31,			December 31,			March 31,
(dollars and shares in thousands, except per share data)	2022			2021			2021
Return on average tangible common equity
Net income	$	10,184		$	12,705		$	15,215
Add: Intangible amortization expense (net of tax)		832			832			909
Net income, excluding intangible amortization (e)		11,016			13,537			16,124
Average total equity		350,545			357,084			334,188
Less: Average goodwill		31,490			30,930			30,201
Less: Average other intangible assets (net of tax)		15,569			16,843			19,995
Average tangible common equity (f)		303,486			309,311			283,992
Return on average tangible common equity (e)/(f)		14.72	%		17.36	%		23.03	%
Efficiency ratio
Noninterest expense	$	38,071		$	41,276		$	43,042
Less: Intangible amortization expense		1,053			1,053			1,151
Adjusted noninterest expense (g)		37,018			40,223			41,891
Net interest income		21,673			22,789			22,038
Noninterest income		29,470			33,718			40,881
Tax-equivalent adjustment		94			99			143
Total tax-equivalent revenue (h)		51,237			56,606			63,062
Efficiency ratio (g)/(h)		72.25	%		71.06	%		66.43	%

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Discussion and Analysis of Results of Operations

Net Income

Net income for the three months ended March 31, 2022 was $10.2 million, or $0.57 per diluted common share, a $5.0 million decrease as compared to $15.2 million, or $0.86 per diluted common share, for the three months ended March 31, 2021. The decrease in net income was primarily attributable to decreases of $11.4 million in noninterest income and $365 thousand in net interest income, partially offset by decreases of $5.0 million in noninterest expense and $1.8 million in income tax 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 months ended March 31, 2022 and 2021.

Net interest income for the three months ended March 31, 2022 was $21.7 million, a decrease of $365 thousand from $22.0 million for the three months ended March 31, 2021. The decrease in net interest income was primarily a result of a $3.3 million decrease in interest income from loans, partially offset by a $3.0 million increase in interest income from investment securities. The decrease in interest income earned on loans was primarily the result of a $177.2 million decrease in average loans. This was offset by a $553.8 million increase in average investment securities, as we’ve continued to update our balance sheet mix.

Our net interest margin (on a fully tax-equivalent, or FTE, basis) for the three months ended March 31, 2022 was 2.83%, compared to 3.12% for the same period in 2021. This decrease was primarily due to a 29 basis point decrease in the overall yield of our interest earning assets, the largest component of which was a 27 basis point decrease in our loan yield. The loan yield decrease was primarily driven by a $240.3 million decrease in our average commercial and industrial loans, of which, $231.5 million were PPP loans. Excluding PPP loans, average loans would have increased $54.3 million.

As a result of the expected increases in the target federal funds interest rate, we anticipate that our net interest income and net interest margin (on a FTE basis) will remain under pressure in future periods.

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The following tables present average balance sheet information, interest income, interest expense and the corresponding average yields on assets, average yields earned, and rates paid for the three months ended March 31, 2022 and 2021. We derived these yields and rates by dividing income or expense by the average balance of the corresponding assets or liabilities. We derived average balances from the daily balances throughout the periods indicated. Average loan balances include loans that have been placed on nonaccrual, while interest previously accrued on these loans is reversed against interest income. In these tables, adjustments are made to the yields on tax-exempt assets in order to present tax-exempt income and fully taxable income on a comparable basis.


	Three months ended March 31,
	2022						2021
			Interest		Average				Interest		Average
	Average		Income/		Yield/		Average		Income/		Yield/
(dollars in thousands)	Balance		Expense		Rate		Balance		Expense		Rate
Interest Earning Assets
Interest-bearing deposits with banks	$	105,726	$	46	0.18	%	$	184,376	$	53	0.12	%
Investment securities ⁽¹⁾		1,216,256		5,713	1.90	%		662,413		2,700	1.65	%
Loans held for sale		24,656		156	2.57	%		82,249		432	2.13	%
Loans
Commercial:
Commercial and industrial		434,656		5,016	4.68	%		674,935		7,863	4.72	%
Real estate construction		41,139		395	3.89	%		45,264		471	4.22	%
Commercial real estate		601,024		5,399	3.64	%		560,986		5,243	3.79	%
Total commercial		1,076,819		10,810	4.07	%		1,281,185		13,577	4.30	%
Consumer
Residential real estate first mortgage		514,724		4,433	3.49	%		457,882		4,247	3.76	%
Residential real estate junior lien		125,997		1,382	4.45	%		137,745		1,650	4.86	%
Other revolving and installment		50,686		548	4.38	%		68,625		741	4.38	%
Total consumer		691,407		6,363	3.73	%		664,252		6,638	4.05	%
Total loans ⁽¹⁾		1,768,226		17,173	3.94	%		1,945,437		20,215	4.21	%
Federal Reserve/FHLB Stock		6,486		70	4.38	%		5,780		64	4.49	%
Total interest earning assets		3,121,350		23,158	3.01	%		2,880,255		23,464	3.30	%
Noninterest earning assets		165,459						167,006
Total assets	$	3,286,809					$	3,047,261
Interest-Bearing Liabilities
Interest-bearing demand deposits	$	714,472	$	215	0.12	%	$	642,832	$	247	0.16	%
Money market and savings deposits		1,043,430		367	0.14	%		1,030,348		403	0.16	%
Time deposits		227,485		247	0.44	%		210,719		345	0.66	%
Fed funds purchased		—		—	—	%		—		—	—	%
Long-term debt		58,908		562	3.87	%		25,677		288	4.55	%
Total interest-bearing liabilities		2,044,295		1,391	0.28	%		1,909,576		1,283	0.27	%
Noninterest-Bearing Liabilities and Stockholders' Equity
Noninterest-bearing deposits		831,441						731,680
Other noninterest-bearing liabilities		60,528						71,817
Stockholders’ equity		350,545						334,188
Total liabilities and stockholders’ equity	$	3,286,809					$	3,047,261
Net interest income			$	21,767					$	22,181
Net interest rate spread					2.73	%					3.03	%
Net interest margin on FTE basis (1)					2.83	%					3.12	%

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

Interest Rates and Operating Interest Differential

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

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


	Three months ended March 31, 2022
	Compared with
	Three months ended March 31, 2021
	Change due to:				Interest
(tax-equivalent basis, dollars in thousands)	Volume		Rate		Variance
Interest earning assets
Interest-bearing deposits with banks	$	(23)	$	16	$	(7)
Investment securities		2,253		760		3,013
Loans held for sale		(302)		26		(276)
Loans
Commercial:
Commercial and industrial		(2,796)		(51)		(2,847)
Real estate construction		(43)		(33)		(76)
Commercial real estate		374		(218)		156
Total commercial		(2,465)		(302)		(2,767)
Consumer
Residential real estate first mortgage		527		(341)		186
Residential real estate junior lien		(141)		(127)		(268)
Other revolving and installment		(194)		1		(193)
Total consumer		192		(467)		(275)
Total loans		(2,273)		(769)		(3,042)
Federal Reserve/FHLB Stock		8		(2)		6
Total interest income		(337)		31		(306)
Interest-bearing liabilities
Interest-bearing demand deposits		28		(60)		(32)
Money market and savings deposits		5		(41)		(36)
Time deposits		27		(125)		(98)
Short-term borrowings		—		—		—
Long-term debt		373		(99)		274
Total interest expense		433		(325)		108
Change in net interest income	$	(770)	$	356	$	(414)

Provision for Loan Losses

The provision for loan losses is based upon our allowance methodology and is a charge to income that, in our judgment, is required to maintain an adequate allowance for incurred loan losses at each period-end. In assessing the adequacy of the allowance, management considers the size and quality of the loan portfolio measured against prevailing economic conditions, regulatory guidelines, and historical loan loss experience. However, there is no assurance that loan credit losses will not exceed the allowance, and any growth in the loan portfolio and the uncertainty of the general economy may require additional provisions in future periods.

There was no provision expense recorded for the first quarter of 2022, no change from the first quarter of 2021. Management saw modest net recoveries in the first quarter of 2022, which supported the decision that no additional provision expense should be recognized.

Noninterest Income

Our noninterest income is generated from four primary sources: (1) retirement and benefit services; (2) wealth management; (3) mortgage banking; and (4) other general banking services.

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The following table presents our noninterest income for the three months ended March 31, 2022 and 2021:


	Three months ended
	March 31,
(dollars in thousands)	2022			2021
Retirement and benefit services	$	17,646		$	17,255
Wealth management		5,326			4,986
Mortgage banking		4,931			17,132
Service charges on deposit accounts		363			338
Net gains (losses) on investment securities		—			114
Other		1,204			1,056
Total noninterest income	$	29,470		$	40,881
Noninterest income as a % of revenue		57.62	%		64.97	%

Total noninterest income for the three months ended March 31, 2022, was $29.5 million, a decrease of $11.4 million, or 27.9%, compared to $40.9 million for the three months ended March 31, 2021. The year over year decrease in noninterest income was primarily attributable to a $12.2 million decrease in mortgage banking revenue, a result of a $331.3 million, or 63.9%, decrease in mortgage originations compared to March 31, 2021. Partially offsetting this decrease were increases of $391 thousand of retirement and benefit services revenue, $340 thousand of wealth management revenue and $148 thousand in other noninterest income. Retirement and benefit services revenue increased primarily due to a $588 thousand increase in non-asset based fees, specifically including a $280 thousand increase in record keepings fees and $252 thousand in health and welfare income. Wealth management revenue increased as a result of $280 thousand in fee revenue earned from blueprint accounts and $209 thousand in fee revenue earned from dimension accounts.

We anticipate that our noninterest income will be significantly adversely affected in future periods as a result of increasing interest rates and inflationary pressure, which will adversely affect mortgage originations and mortgage banking revenue.

Noninterest income as a percentage of total operating revenue, which consists of net interest income plus noninterest income, was 57.6% for the three months ended March 31, 2022, compared to 65.0% for the three months ended March 31, 2021.

See “NOTE 13 Segment Reporting” for additional discussion regarding our business lines.

Noninterest Expense

The following table presents noninterest expense for the three months ended March 31, 2022 and 2021.


	Three months ended
	March 31,
(dollars in thousands)	2022		2021
Compensation	$	19,051	$	23,698
Employee taxes and benefits		6,162		5,813
Occupancy and equipment expense		2,051		2,231
Business services, software and technology expense		4,924		4,976
Intangible amortization expense		1,053		1,151
Professional fees and assessments		1,541		1,472
Marketing and business development		600		676
Supplies and postage		646		531
Travel		179		26
Mortgage and lending expenses		686		1,332
Other		1,178		1,136
Total noninterest expense	$	38,071	$	43,042

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Total noninterest expense for the three months ended March 31, 2022 was $38.1 million, a decrease of $5.0 million, or 11.5%, compared to $43.0 million for the three months ended March 31, 2021. The year over year decrease in noninterest expense was primarily attributable to decreases of $4.6 million in compensation expense and $646 thousand in mortgage and lending expense. Partially offsetting these decreases were increases of $349 thousand in employee and benefits expense, $153 thousand in travel expense, and $115 thousand in supplies and postage. The decreases in compensation expense and mortgage and lending expense were a result of the decrease in mortgage originations as previously stated. Employee taxes and benefits expense increased primarily due to an increase in group insurance. Travel expenses have increased as the effect of the COVID-19 pandemic subsides, and our employees have started to resume serving clients face-to-face.

Income Tax Expense

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

For the three months ended March 31, 2022, we recognized income tax expense of $2.9 million on $13.1 million of pre-tax income, resulting in an effective tax rate of 22.1%, compared to income tax expense of $4.7 million on $19.9 million of pre-tax income for the three months ended March 31, 2021, resulting in an effective tax rate of 23.4%.

Financial Condition

Overview

Total assets were $3.3 billion as of March 31, 2022, a decrease of $56.5 million, or 1.7%, as compared to December 31, 2021. The overall change in assets included decreases of $109.5 million in cash and cash equivalents, $11.9 million in investment securities held-to-maturity, and $24.6 million in loans held for sale. Partially offsetting these decreases, was a $60.0 million increase in loans held for investment and a $12.7 million increase in investments available-for-sale. If PPP loans were excluded, loans held for investment would have increased $80.5 million, or 4.7%, from December 31, 2021.

Loans

The loan portfolio represents a broad range of borrowers comprised of commercial and industrial, commercial real estate, residential real estate, and consumer loans. The goal of the overall portfolio mix is to diversify with approximately one third of the portfolio in each of the commercial and industrial, commercial real estate, and residential real estate categories. As of March 31, 2022, the portfolio mix was 25.7% commercial and industrial, 33.1% commercial real estate, 35.9% residential real estate and 5.3% in other categories.

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The following table presents the composition of total loans outstanding by portfolio segment as of March 31, 2022 and December 31, 2021:


	March 31, 2022				December 31, 2021
			Percent of				Percent of		Change
(dollars in thousands)	Balance		Portfolio		Balance		Portfolio			Amount	Percent
Commercial
Commercial and industrial (1)	$	467,449	25.7	%	$	436,761	24.8	%	$	30,688	7.0	%
Real estate construction		41,604	2.3	%		40,619	2.3	%		985	2.4	%
Commercial real estate		602,158	33.1	%		598,893	34.1	%		3,265	0.5	%
Total commercial		1,111,211	61.1	%		1,076,273	61.2	%		34,938	3.2	%
Consumer
Residential real estate first mortgage		522,489	28.7	%		510,716	29.1	%		11,773	2.3	%
Residential real estate junior lien		130,604	7.2	%		125,668	7.1	%		4,936	3.9	%
Other revolving and installment		53,738	3.0	%		45,363	2.6	%		8,375	18.5	%
Total consumer		706,831	38.9	%		681,747	38.8	%		25,084	3.7	%
Total loans	$	1,818,042	100.0	%	$	1,758,020	100.0	%	$	60,022	3.4	%

(1)	Included PPP loans of $13.1 million at March 31, 2022 and $33.6 million at December 31, 2021.

Total loans outstanding were $1.8 billion as of March 31, 2022, an increase of $60.0 million, or 3.4%, from December 31, 2021. This increase was primarily a result of increases of $30.7 million in commercial and industrial loans, $3.3 million in commercial real estate loans, $16.7 million in residential loans, and $9.4 million in other loan categories. If PPP loans were excluded, commercial and industrial loans would have increased $51.1 million, or 12.7%, from December 31, 2021, primarily as a result of increased credit line utilization.

We anticipate that loan growth will slow down in the future for our commercial and industrial, commercial real estate, residential real estate, and consumer loan portfolios as a result of the increasing interest rate environment and competition in our market areas.

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The following table presents the maturities and types of interest rates for the loan portfolio as of March 31, 2022:


	March 31, 2022
			After one		After five
	One year		but within		but within		After
(dollars in thousands)	or less		five years		fifteen years		fifteen years		Total
Commercial
Commercial and industrial	$	132,727	$	244,050	$	80,684	$	9,988	$	467,449
Real estate construction		20,617		17,294		3,693		—		41,604
Commercial real estate		24,079		228,237		322,616		27,226		602,158
Total commercial		177,423		489,581		406,993		37,214		1,111,211
Consumer
Residential real estate first mortgage		3,630		16,123		45,092		457,644		522,489
Residential real estate junior lien		8,490		28,263		30,813		63,038		130,604
Other revolving and installment		10,613		41,431		1,694		—		53,738
Total consumer		22,733		85,817		77,599		520,682		706,831
Total loans	$	200,156	$	575,398	$	484,592	$	557,896	$	1,818,042
Loans with fixed interest rates:
Commercial
Commercial and industrial	$	14,756	$	200,338	$	62,273	$	9,274	$	286,641
Real estate construction		20,617		9,094		1,977		—		31,688
Commercial real estate		17,272		173,837		171,363		10,681		373,153
Total commercial		52,645		383,269		235,613		19,955		691,482
Consumer
Residential real estate first mortgage		3,467		13,047		41,761		309,951		368,226
Residential real estate junior lien		3,441		6,748		10,973		3,265		24,427
Other revolving and installment		1,675		28,319		1,694		—		31,688
Total consumer		8,583		48,114		54,428		313,216		424,341
Total loans with fixed interest rates	$	61,228	$	431,383	$	290,041	$	333,171	$	1,115,823
Loans with floating interest rates:
Commercial
Commercial and industrial	$	117,971	$	43,712	$	18,411	$	714	$	180,808
Real estate construction		—		8,200		1,716		—		9,916
Commercial real estate		6,807		54,400		151,253		16,545		229,005
Total commercial		124,778		106,312		171,380		17,259		419,729
Consumer
Residential real estate first mortgage		163		3,076		3,331		147,693		154,263
Residential real estate junior lien		5,049		21,515		19,840		59,773		106,177
Other revolving and installment		8,938		13,112		—		—		22,050
Total consumer		14,150		37,703		23,171		207,466		282,490
Total loans with floating interest rates	$	138,928	$	144,015	$	194,551	$	224,725	$	702,219

The expected life of our loan portfolio will differ from contractual maturities because borrowers may have the right to curtail or prepay their loans with or without penalties. Consequently, the table above includes information limited to contractual maturities of the underlying loans.

Asset Quality

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

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Credit Quality Indicators

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

The table below presents criticized loans outstanding by loan portfolio segment as of March 31, 2022 and December 31, 2021:


	March 31,			December 31,
(dollars in thousands)	2022			2021
Commercial
Commercial and industrial	$	4,171		$	6,526
Real estate construction		—			—
Commercial real estate		9,410			13,602
Total commercial		13,581			20,128
Consumer
Residential real estate first mortgage		2,051			341
Residential real estate junior lien		774			770
Other revolving and installment		49			—
Total consumer		2,874			1,111
Total loans	$	16,455		$	21,239
Criticized loans as a percent of total loans		0.91	%		1.21	%

The following table presents information regarding nonperforming assets as of March 31, 2022 and December 31, 2021:


	March 31,			December 31,
(dollars in thousands)	2022			2021
Nonaccrual loans	$	4,069		$	2,076
Accruing loans 90+ days past due		146			121
Total nonperforming loans		4,215			2,197
OREO and repossessed assets		865			885
Total nonperforming assets		5,080			3,082
Total restructured accruing loans		355			676
Total nonperforming assets and restructured accruing loans	$	5,435		$	3,758
Nonperforming loans to total loans		0.23	%		0.12	%
Nonperforming assets to total assets		0.15	%		0.09	%
Allowance for loan losses to nonperforming loans		752	%		1,437	%

Interest income lost on nonaccrual loans approximated $29 thousand and $80 thousand for the three months ended March 31, 2022 and 2021, respectively. There was no interest income included in net interest income related to nonaccrual loans for the three months ended March 31, 2022 and 2021.

Allowance for Loan Losses

The allowance for loan losses represents management’s estimate of incurred credit losses inherent in the loan portfolio as of the balance sheet date. The allowance for loan losses is maintained at a level management believes is sufficient to absorb incurred losses in the loan portfolio given the conditions at the time. Management determines the adequacy of the allowance based on periodic evaluations of the loan portfolio, after consideration of risk characteristics of the loans and prevailing and anticipated economic and other conditions. A risk system, consisting of multiple grading categories for each portfolio class, is utilized as an analytical tool to assess risk and appropriate reserves. In addition to the risk system, management further evaluates risk characteristics of the loan portfolio under current and anticipated

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economic conditions and considers such factors as the financial condition of the borrower, past and expected loss experience, and other factors which management feels deserve recognition in establishing an appropriate reserve. These estimates are reviewed at least quarterly, and, as adjustments become necessary, they are recognized in the periods in which they become known. These evaluations are inherently subjective as they require management to make material estimates, all of which may be susceptible to significant change.

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


	Three months ended
	March 31,
(dollars in thousands)	2022			2021
Balance—beginning of period	$	31,572		$	34,246
Commercial loan charge-offs
Commercial and Industrial		(27)			(204)
Real estate construction		—			—
Commercial real estate		—			(536)
Total commercial loan charge-offs		(27)			(740)
Consumer loan charge-offs
Residential real estate first mortgage		—			—
Residential real estate junior lien		—			—
Other revolving and installment		(18)			(44)
Total consumer loan charge-offs		(18)			(44)
Total loan charge-offs		(45)			(784)
Commercial loan recoveries
Commercial and Industrial		126			170
Real estate construction		—			—
Commercial real estate		11			3
Total commercial recoveries		137			173
Consumer loan recoveries
Residential real estate first mortgage		—			—
Residential real estate junior lien		13			83
Other revolving and installment		36			40
Total consumer loan recoveries		49			123
Total loan recoveries		186			296
Net loan charge-offs (recoveries)		(141)			488
Commercial loan provision
Commercial and Industrial		771			316
Real estate construction		27			(60)
Commercial real estate		(441)			277
Total commercial loan provision		357			533
Consumer loan provision
Residential real estate first mortgage		129			273
Residential real estate junior lien		92			(168)
Other revolving and installment		145			(83)
Total consumer loan provision		366			22
Unallocated provision expense		(723)			(555)
Total loan loss provision		—			—
Balance—end of period	$	31,713		$	33,758
Total loans	$	1,818,042		$	1,937,345
Average total loans		1,768,226			1,945,437
Allowance for loan losses to total loans		1.74	%		1.74	%
Net charge-offs/(recoveries) to average total loans (annualized)		(0.03)	%		0.10	%

The allowance for loan losses was $31.7 million as of March 31, 2022, compared to $31.6 million as of December 31, 2021. The $141 thousand increase was the result of $141 thousand net recoveries and no additional provision expense. As of March 31, 2022, the allowance for loan losses represented 1.74% of total loans.

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


	March 31, 2022				December 31, 2021
			Percentage				Percentage
	Allocated		of loans to		Allocated		of loans to
(dollars in thousands)	Allowance		total loans		Allowance		total loans
Commercial and industrial	$	9,795	25.7	%	$	8,925	24.8	%
Real estate construction		810	2.3	%		783	2.3	%
Commercial real estate		11,946	33.1	%		12,376	34.1	%
Residential real estate first mortgage		6,661	28.7	%		6,532	29.1	%
Residential real estate junior lien		1,400	7.2	%		1,295	7.1	%
Other revolving and installment		644	3.0	%		481	2.6	%
Unallocated		457	—	%		1,180	—	%
Total loans	$	31,713	100.0	%	$	31,572	100.0	%

In the ordinary course of business, we enter into commitments to extend credit, including commitments under credit arrangements, commercial letters of credit, and standby letters of credit. Such financial instruments are recorded when they are funded. A reserve for unfunded commitments is established using historical loss data and utilization assumptions. This reserve is located in accrued expenses and other liabilities on the Consolidated Balance Sheets. The reserve for unfunded commitments was $2.1 million as of March 31, 2022.

Loans Held for Sale

Loans held for sale represent loans to consumers for the purchase or refinance of a residence that we have originated and intend to sell into the secondary market. Loans held for sale were $21.9 million as of March 31, 2022, a decrease of $24.6 million, or 53.0%, as compared to December 31, 2021. The decrease in loans held for sale was primarily the result of a $170.1 million decrease in mortgage originations, as compared to the three months ending December 31, 2021.

Investment Securities

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

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The following table presents the fair value composition of our investment securities portfolio as of March 31, 2022 and December 31, 2021:


	March 31, 2022				December 31, 2021
			Percent of				Percent of
(dollars in thousands)	Balance		Portfolio		Balance		Portfolio
Available-for-sale
U.S. Treasury and agencies	$	4,167	0.3	%	$	5,103	0.4	%
Mortgage backed securities
Residential agency		711,121	58.9	%		707,157	58.7	%
Commercial		82,732	6.9	%		90,913	7.5	%
Asset backed securities		42	—	%		54	—	%
Corporate bonds		68,271	5.7	%		50,422	4.2	%
Total available-for-sale investment securities		866,333	71.8	%		853,649	70.8	%
Held-to-maturity
Obligations of state and political agencies		141,373	11.7	%		144,543	12.0	%
Mortgage backed securities
Residential agency		198,777	16.5	%		207,518	17.2	%
Total held-to-maturity investment securities		340,150	28.2	%		352,061	29.2	%
Total investment securities	$	1,206,483	100.0	%	$	1,205,710	100.0	%

The investment securities presented in the following table are reported at fair value and by contractual maturity as of March 31, 2022. Actual timing may differ from contractual maturities if borrowers have the right to call or prepay obligations with or without call or prepayment penalties. Additionally, residential mortgage backed securities and collateralized mortgage obligations receive monthly principal payments, which are not reflected below. The yields below are calculated on a tax-equivalent basis.


	Maturity as of March 31, 2022
	One year or less				One to five years				Five to ten years				After ten years
	Fair		Average		Fair		Average		Fair		Average		Fair		Average
(dollars in thousands)	Value		Yield		Value		Yield		Value		Yield		Value		Yield
Available-for-sale
U.S. Treasury and agencies	$	—	—	%	$	—	—	%	$	1,147	0.92	%	$	3,020	0.71	%
Mortgage backed securities
Residential agency		1	3.60	%		3,060	2.52	%		11,468	2.34	%		696,592	1.75	%
Commercial		—	—	%		5,256	2.88	%		25,838	2.79	%		51,638	2.56	%
Asset backed securities		—	—	%		—	—	%		16	5.17	%		26	5.29	%
Corporate bonds		—	—	%		—	—	%		60,271	3.85	%		8,000	3.75	%
Total available-for-sale investment securities		1	3.60	%		8,316	2.75	%		98,740	3.36	%		759,276	1.82	%
Held-to-maturity
Obligations of state and political agencies		7,423	1.14	%		33,923	0.95	%		69,032	1.84	%		23,402	2.24	%
Mortgage backed securities
Residential agency		—	—	%		—	—	%		—	—	%		184,046	1.88	%
Total held-to-maturity investment securities		7,423	1.14	%		33,923	0.95	%		69,032	1.84	%		207,448	1.92	%
Total investment securities	$	7,424	1.14	%	$	42,239	1.30	%	$	167,772	2.74	%	$	966,724	1.84	%

Deposits

Total deposits were $2.9 billion as of March 31, 2022, a decrease of $28.3 million, or 1.0%, from December 31, 2021. Interest-bearing deposits increased $79.0 million while noninterest-bearing deposits decreased $107.3 million. The increase in interest-bearing deposits included increases of $45.7 million in interest-bearing demand deposits, $39.6 million in money market accounts, and a $2.5 million increase in savings accounts, partially offset by an $8.7 million decrease in time deposits. Synergistic deposits decreased $26.1 million from December 31, 2021. Excluding synergistic deposits, commercial transaction deposits decreased $16.7 million, or 1.3%, partially offset by a $21.7 million increase in consumer transaction deposits.

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The following table presents the composition of our deposit portfolio as of March 31, 2022 and December 31, 2021:


	March 31, 2022				December 31, 2021
			Percent of				Percent of		Change
(dollars in thousands)	Balance		Portfolio		Balance		Portfolio		Amount		Percent
Noninterest-bearing demand	$	831,558	28.7	%	$	938,840	32.1	%	$	(107,282)	(11.4)	%
Interest-bearing demand		760,321	26.3	%		714,669	24.5	%		45,652	6.4	%
Money market and savings		1,076,204	37.2	%		1,034,130	35.4	%		42,074	4.1	%
Time deposits		224,184	7.8	%		232,912	8.0	%		(8,728)	(3.7)	%
Total deposits	$	2,892,267	100.0	%	$	2,920,551	100.0	%	$	(28,284)	(1.0)	%

The following table presents the average balances and rates of our deposit portfolio for the three months ended March 31, 2022 and 2021:


	Three months ended March 31,
	2022				2021
	Average		Average		Average		Average
(dollars in thousands)	Balance		Rate		Balance		Rate
Noninterest-bearing demand	$	831,441	—	%	$	731,680	—	%
Interest-bearing demand		714,472	0.12	%		642,832	0.16	%
Money market and savings		1,043,430	0.14	%		1,030,348	0.16	%
Time deposits		227,485	0.44	%		210,719	0.66	%
Total deposits	$	2,816,828	0.12	%	$	2,615,579	0.15	%

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 March 31, 2022:


	March 31,
(dollars in thousands)	2022
Maturing in:
3 months or less	$	—
3 months to 6 months		50,471
6 months to 1 year		31,799
1 year or greater		829
Total	$	83,099

Borrowings

Borrowings as of March 31, 2022 and December 31, 2021 were as follows:


	March 31, 2022				December 31, 2021
			Percent of				Percent of
(dollars in thousands)	Balance		Portfolio		Balance		Portfolio
Subordinated notes		50,000	84.9	%		50,000	84.9	%
Junior subordinated debentures		8,759	14.9	%		8,730	14.8	%
Finance lease liability		143	0.2	%		203	0.3	%
Total borrowed funds	$	58,902	100.0	%	$	58,933	100.0	%

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 $30.9 million, or 8.6%, to $328.5 million as of March 31, 2022, compared to $359.4 million as of December 31, 2021, primarily due to a $38.1 million decrease in other comprehensive income, due

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to rising interest rates that resulted in a lower fair value on our investment securities available-for-sale. Tangible common equity to tangible assets, a non-GAAP financial measure, decreased to 8.46% as of March 31, 2022, from 9.21% as of December 31, 2021.

We strive to maintain an adequate capital base to support our activities in a safe and sound manner while at the same time attempting to maximize stockholder value. Capital adequacy is assessed against the risk inherent in our balance sheet, recognizing that unexpected loss is the common denominator of risk, and that common equity has the greatest capacity to absorb unexpected loss.

We are subject to various regulatory capital requirements both at the Company and at the Bank level. Failure to meet minimum capital requirements could result in certain mandatory and possible additional discretionary actions by regulators that, if undertaken, could have an adverse material effect on our financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, specific capital guidelines must be met that involve quantitative measures of assets, liabilities, and certain off-balance sheet items as calculated under regulatory accounting policies. We have consistently maintained regulatory capital ratios at or above the well-capitalized standards.

At March 31, 2022 and December 31, 2021, we met all the capital adequacy requirements to which we were subject. The table below presents the Company’s and the Bank’s regulatory capital ratios as of March 31, 2022 and December 31, 2021:


	March 31,		December 31,
Capital Ratios	2022		2021
Alerus Financial Corporation Consolidated
Common equity tier 1 capital to risk weighted assets	14.27	%	14.65	%
Tier 1 capital to risk weighted assets	14.66	%	15.06	%
Total capital to risk weighted assets	18.12	%	18.64	%
Tier 1 capital to average assets	10.30	%	9.79	%
Tangible common equity to tangible assets (1)	8.46	%	9.21	%

Alerus Financial, National Association
Common equity tier 1 capital to risk weighted assets	13.52	%	13.87	%
Tier 1 capital to risk weighted assets	13.52	%	13.87	%
Total capital to risk weighted assets	14.77	%	15.12	%
Tier 1 capital to average assets	9.50	%	9.01	%

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

The capital ratios for the Company and the Bank, as of March 31, 2022, as shown in the above tables, were at levels above the regulatory minimums to be considered “well capitalized”. See “Note 16 Regulatory Matters” to the consolidated financial statements for additional information.

Off-Balance Sheet Arrangements

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

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A summary of the contractual amounts of our exposure to off-balance sheet agreements as of March 31, 2022 and December 31, 2021, was as follows:


	March 31,		December 31,
(dollars in thousands)	2022		2021
Commitments to extend credit	$	650,087	$	668,115
Standby letters of credit		10,591		10,529
Total	$	660,678	$	678,644

Liquidity

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

As of March 31, 2022, we had on balance sheet liquidity of $998.7 million, compared to $1.1 billion as of December 31, 2021. 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 March 31, 2022, we had no outstanding fed funds purchased from the FHLB and $760.7 million of collateral pledged to the FHLB. Based on this collateral, we were eligible to borrow up to $760.4 million from the FHLB. In addition, we can borrow up to $102.0 million through the unsecured lines of credit we have established with four other banks.

In addition, because the Bank is “well capitalized,” we can accept wholesale deposits up to 20.0% of total assets based on current policy limits, or $667.2 million, as of March 31, 2022. Management believed that we had adequate resources to fund all of our commitments as of March 31, 2022 and December 31, 2021.

Our primary sources of liquidity include liquid assets, as well as unencumbered securities that can be used to collateralize additional funding.

Though remote, the possibility of a funding crisis exists at all financial institutions. The economic impact of COVID-19 could place increased demand on our liquidity if we experience significant credit deterioration and as we meet borrowers’ needs. Accordingly, management has addressed this issue by formulating a liquidity contingency plan, which has been reviewed and approved by both the Bank’s board of directors and the ALCO. The plan addresses the actions that we would take in response to both a short-term and long-term funding crisis.

A short-term funding crisis would most likely result from a shock to the financial system, either internal or external, which disrupts orderly short-term funding operations. Such a crisis would likely be temporary in nature and would not involve a change in credit ratings. A long-term funding crisis would most likely be the result of both external and internal factors and would most likely result in drastic credit deterioration. Management believes that both potential circumstances have been fully addressed through detailed action plans and the establishment of trigger points for monitoring such events.

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ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Market risk is the risk of loss arising from adverse changes in the fair value of financial instruments due to changes in interest rates. Interest-rate risk is the risk to earnings and equity value arising from changes in market interest rates and arises in the normal course of business to the extent that there is a divergence between the amount of interest-earning assets and the amount of interest-bearing liabilities that are prepaid/withdrawn, re-price, or mature in specified periods. We seek to achieve consistent growth in net interest income and equity while managing volatility arising from shifts in market interest rates. The ALCO oversees market risk management, monitoring risk measures, limits, and policy guidelines for managing the amount of interest rate risk and its effect on net interest income and capital. The Bank’s board of directors approves policy limits with respect to interest rate risk.

Interest Rate Risk

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

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

Management regularly reviews our exposure to changes in interest rates. Among the factors considered are changes in the mix of interest-earning assets and interest-bearing liabilities, interest rate spreads and repricing periods. The ALCO reviews, on at least a quarterly basis, the interest rate risk position.

The interest-rate risk position is measured and monitored at the Bank using net interest income simulation models and economic value of equity sensitivity analysis that capture both short-term and long-term interest-rate risk exposure.

Modeling the sensitivity of net interest income and the economic value of equity to changes in market interest rates is highly dependent on numerous assumptions incorporated into the modeling process. The models used for these measurements rely on estimates of the potential impact that changes in interest rates may have on the value and prepayment speeds on all components of our loan portfolio, investment portfolio, as well as embedded options and cash flows of other assets and liabilities. Balance sheet growth assumptions are also included in the simulation modeling process. The analysis provides a framework as to what our overall sensitivity position is as of our most recent reported position and the impact that potential changes in interest rates may have on net interest income and the economic value of our equity.

Net interest income simulation involves forecasting net interest income under a variety of interest rate scenarios including instantaneous shocks.

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The estimated impact on our net interest income as of March 31, 2022 and December 31, 2021, assuming immediate parallel moves in interest rates is presented in the table below:


	March 31, 2022				December 31, 2021
	Following		Following		Following		Following
	12 months		24 months		12 months		24 months
+400 basis points	−6.9	%	2.8	%	−8.2	%	−2.9	%
+300 basis points	−5.3	%	2.9	%	−6.1	%	−2.3	%
+200 basis points	−3.8	%	3.1	%	−4.1	%	−1.8	%
+100 basis points	−2.1	%	3.5	%	−2.0	%	−1.3	%
−100 basis points	−4.5	%	−5.6	%	−10.6	%	−15.7	%
−200 basis points	N/A	%	N/A	%	N/A	%	N/A	%

Management strategies may impact future reporting periods, as actual results may differ from simulated results due to the timing, magnitude, and frequency of interest rate changes, the difference between actual experience, and the characteristics assumed, as well as changes in market conditions. Market-based prepayment speeds are factored into the analysis for loan and securities portfolios. Rate sensitivity for transactional deposit accounts is modeled based on both historical experience and external industry studies.

Management uses 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 March 31, 2022 and December 31, 2021, assuming immediate parallel shifts in interest rates:


	March 31,		December 31,
	2022		2021
+400 basis points	−22.1	%	−26.0	%
+300 basis points	−15.2	%	−16.8	%
+200 basis points	−8.7	%	−8.2	%
+100 basis points	−3.1	%	−1.4	%
−100 basis points	—	%	−31.2	%
−200 basis points	N/A	%	N/A	%

Operational Risk

Operational risk is the risk of loss due to human behavior, inadequate or failed internal systems and controls, and external influences such as market conditions, fraudulent activities, disasters, and security risks. Management continuously strives to strengthen its system of internal controls, enterprise risk management, operating processes and employee awareness to assess the impact on earnings and capital and to improve the oversight of our operational risk.

Compliance Risk

Compliance risk represents the risk of regulatory sanctions, reputational impact or financial loss resulting from failure to comply with rules and regulations issued by the various banking agencies and standards of good banking practice. Activities which may expose us to compliance risk include, but are not limited to, those dealing with the prevention of money laundering, privacy and data protection, community reinvestment initiatives, fair lending challenges resulting from the expansion of our banking center network, employment and tax matters.

Strategic and/or Reputation Risk

Strategic and/or reputation risk represents the risk of loss due to impairment of reputation, failure to fully develop and execute business plans, failure to assess current and new opportunities in business, markets and products, and any other event not identified in the defined risk types mentioned previously. Mitigation of the various risk elements

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that represent strategic and/or reputation risk is achieved through initiatives to help management better understand and report on various risks, including those related to the development of new products and business initiatives.

ITEM 4. CONTROLS AND PROCEDURES

Evaluation of Disclosure Controls and Procedures

The Company’s management, including our President and Chief Executive Officer and our Chief Financial Officer, have evaluated the effectiveness of our “disclosure controls and procedures” (as defined in Rule 13a-15(e) under the Securities Exchange Act of 1934, or the Exchange Act), as of the end of the period covered by this report. Based on such evaluation, our President and Chief Executive Officer and our Chief Financial Officer have concluded that, as of the end of such period, the Company’s disclosure controls and procedures were effective as of that date to provide reasonable assurance that the information required to be disclosed by the Company in the reports it files or submits under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the rules and forms of the SEC and that information required to be disclosed by the Company in the reports it files or submits under the Exchange Act is accumulated and communicated to the Company’s management, including its President and Chief Executive Officer and its Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure.

Changes in Internal Control over Financial Reporting

There have not been any changes in the Company’s internal control over financial reporting (as such term is defined in Rule 13a-15(f) under the Exchange Act) during the fiscal quarter to which this report relates that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.

PART II—OTHER INFORMATION

Item 1 – Legal Proceedings

There are no material pending legal proceedings, other than ordinary routine litigation incidental to the business of the Company or its subsidiaries, to which we or any of our subsidiaries 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 11, 2022.

Item 2 – Unregistered Sales of Equity Securities and Use of Proceeds

Unregistered Sales of Equity Securities

None.

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Issuer Repurchases of Equity Securities

The following table presents information related to repurchases of shares of our common stock for each calendar month in the first quarter of 2022:



				Total Number of	Maximum Number of
	Total Number	Average		Shares Purchased as	Shares that May
	of Shares	Price Paid		Part of Publicly	Yet be Purchased
(dollars in thousands, except per share data)	Purchased (1)	per Share		Announced Plans	Under the Plan (2)
January	240	$	29.28	—	770,000
February	20,391		29.43	—	770,000
March	—		—	—	770,000
Total	20,631	$	29.43	—	770,000

(1)	Shares repurchased by the Company represent shares surrendered by employees to the Company to pay withholding taxes on the vesting of restricted stock awards.

(2)

On February 18, 2021, the Board of Directors of the Company approved a stock repurchase program, or the Program, which authorizes the Company to repurchase up to 770,000 shares of its common stock, subject to certain limitations and conditions. The Program was effective immediately and will continue for a period of 36 months, 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 three months ended March 31, 2022, there were no shares repurchased under the Program.

Use of Proceeds from Registered Securities

On September 17, 2019, the Company sold 2,860,000 shares of common stock in its initial public offering. On September 25, 2019, the Company sold 429,000 additional shares of common stock pursuant to the exercise in full by the underwriters of their option to purchase additional shares to cover over-allotments. All of the shares were sold pursuant to the Company’s Registration Statement on Form S-1, as amended (File No. 333-233339), which was declared effective by the SEC on September 12, 2019. The Company’s common stock is currently traded on the Nasdaq Capital Market under the symbol “ALRS”.

There has been no material change in the planned use of proceeds from the initial public offering as described in the Company’s prospectus filed with the SEC on September 13, 2019, pursuant to Rule 424(b)(4) under the Securities Act of 1933. From the effective date of the registration statement through March 31, 2022, the Company has maintained the net proceeds of the initial public offering on deposit with the Bank. The Bank has used the deposits of the Company to pay down short-term borrowings.

Item 3 – Defaults Upon Senior Securities

None.

Item 4 – Mine Safety Disclosures

Not Applicable.

Item 5 – Other Information

None.

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Item 6 – Exhibits


Exhibit No.		Description

3.1		Third Amended and Restated Certificate of Incorporation of Alerus Financial Corporation (incorporated herein by reference to Exhibit 3.1 on Form S-1 filed on August 16, 2019).

3.2		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).

10.1		Employment Offer Letter between Alerus Financial Corporation and Alan Villalon dated January 11, 2022 (incorporated by reference to Exhibit 10.24 on Form 10-K filed on March 11, 2022).

10.2		Executive Severance Agreement by and between Alerus Financial Corporation and Alan Villalon, dated January 11, 2022 (incorporated by reference to Exhibit 10.25 on Form 10-K filed on March 11, 2022).

31.1		Chief Executive Officer’s Certifications required by Rule 13(a)-14(a) – filed herewith.

31.2		Chief Financial Officer’s Certifications required by Rule 13(a)-14(a) – filed herewith.

32.1		Chief Executive Officer Certifications pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 – filed herewith.

32.2		Chief Financial Officer Certifications pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 – filed herewith.

101.INS		iXBRL Instance Document

101.SCH		iXBRL Taxonomy Extension Schema

101.CAL		iXBRL Taxonomy Extension Calculation Linkbase

101.DEF		iXBRL Taxonomy Extension Definition Linkbase

101.LAB		iXBRL Taxonomy Extension Label Linkbase

101.PRE		iXBRL Taxonomy Extension Presentation Linkbase

104		Cover Page Interactive Data File (formatted Inline XBRL and contained in Exhibits 101)

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SIGNATURES

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


	ALERUS FINANCIAL CORPORATION

Date: May 6, 2022	By:	/s/ Katie A. Lorenson
		Name: Katie A. Lorenson
		Title: President and Chief Executive Officer (Principal Executive Officer)

Date: May 6, 2022	By:	/s/ Alan A. Villalon
		Name: Alan A. Villalon
		Title: Executive Vice President and Chief Financial Officer (Principal Financial Officer)

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Alerus Financial (ALRS) 10-Q2022 Q1 Quarterly report

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