The following discussion and analysis of our financial condition and results of
operations should be read in conjunction with the “Selected Financial Data” and
our audited consolidated financial statements and related notes included
elsewhere in this report. In addition to historical information, this discussion
and analysis contains forward-looking statements that involve risks,
uncertainties and assumptions. Certain risks, uncertainties and other factors,
including but not limited to those set forth under “Cautionary Note Regarding
Forward-Looking Statements,” “Risk Factors” and elsewhere in this report, may
cause actual results to differ materially from those projected in the
forward-looking statements. We assume no obligation to update any of these
forward-looking statements.
Overview
We are a diversified financial services company headquartered in Grand Forks,
North Dakota. Through our subsidiary, Alerus Financial, National Association, we
provide innovative and comprehensive financial solutions to businesses and
consumers through four distinct business lines-banking, retirement and benefit
services, wealth management and mortgage. These solutions are delivered through
a relationship-oriented primary point of contact along with responsive and
client-friendly technology.
Our primary banking market areas are the states of North Dakota, Minnesota,
specifically, the Twin Cities MSA, and Arizona, specifically, the Phoenix MSA.
In addition to our offices located in our banking markets, our retirement and
benefit services business administers plans in all 50 states through offices
located in Michigan, Minnesota and Colorado.
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 believe our
client-first and advice-based philosophy, diversified business model and history
of high performance and growth distinguishes us from other financial service
providers. 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.
As of December 31, 2020, we had $3.0 billion of total assets, $2.0 billion of
total loans, $2.6 billion of total deposits, $330.2 million of stockholders’
equity, $34.2 billion of AUA/AUM in our retirement and benefit services segment,
and $3.3 billion of AUA/AUM in our wealth management segment. For the year ended
December 31, 2020, we had $1.8 billion of mortgage originations.
Recent Developments
Impact of COVID-19
The progression of the COVID-19 pandemic in the United States has not had an
adverse impact on our financial condition and results of operations as of and
for the year ending December 31, 2020, but it is expected to have a complex and
significant impact on the economy, the banking industry and our Company in
future fiscal periods, all subject to a high degree of uncertainty.
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Effects on Our Market Areas. Our primary banking market areas are the states of
North Dakota, Minnesota, and Arizona. Our retirement and benefit services
segment 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 two retirement and benefits services offices in
Minnesota, one in Michigan and one in Colorado.
In Minnesota, at the start of the pandemic, the Governor ordered individuals to
stay at home and non-essential businesses to cease all activities, in each case
subject to limited exceptions. This order went into effect on March 2, 2020, and
was in effect until May 18, 2020. The state has now implemented a four phase
stay safe plan to reopen businesses in the area. Similarly, in Arizona, the
Governor ordered individuals to stay at home and non-essential businesses to
cease all activities, in each case subject to limited exceptions. This order
went into effect on March 31, 2020, and expired on May 15, 2020, and the
Governor announced new guidance for protecting businesses and their customers as
they reopen. The state has implemented a four phase reopening plan that requires
benchmarks be met for a certain period of time before transitioning from one
phase to another. In North Dakota, the Governor did not issue an order requiring
individuals to stay at home, but placed certain restrictions on bars,
restaurants and gyms. These orders have been lifted and North Dakota is now
working toward a “Smart Restart” program to encourage businesses to open safely
and take precautions to slow the spread of COVID-19. In response to these
orders, the Bank has been serving its customers through its drive-up windows at
various branch locations and through online and mobile banking. The Bank is also
permitting certain visits to its branches on a limited basis and by appointment
only. In Minnesota and Arizona, the Bank is offering appointments to clients to
meet with safeguards in place that materially comply with the CDC guidance. In
North Dakota, offices have re-opened for business with safeguards in place that
materially comply with CDC guidance.
Each state experienced a dramatic and sudden increase in unemployment levels as
a result of the curtailment of business activities. According to data released
by the U.S. Department of Labor, initial claims for unemployment insurance
initially spiked in each of the states in our banking markets. We expect claims
for unemployment insurance to remain at elevated levels for the foreseeable
future until restrictions are lifted and the pandemic’s effects have subsided.
Policy and Regulatory Developments. Federal, state and local governments and
regulatory authorities have enacted and issued a range of policy responses to
the COVID-19 pandemic, including the following:
The Federal Reserve decreased the range for the Federal Funds Target Rate by
? 0.50% on March 3, 2020, and by another 1.00% on March 16, 2020, reaching a
current range of 0.00-0.25%.
On March 27. 2020, President Trump signed into law the Coronavirus Aid, Relief
and Economic Security Act, or CARES Act, which established a $2.0 trillion
economic stimulus package, including cash payments to individuals, supplemental
unemployment insurance benefits and a $349 billion loan program administered
through the U.S. Small Business Administration, or SBA, referred to as the
Paycheck Protection Program, or PPP. On April 24, 2020, an additional $310
? billion in funding for PPP loans was authorized, with such funds available for
PPP loans beginning on April 27, 2020. In addition, the CARES Act, as extended
by the Coronavirus Response and Relief Supplemental Appropriations Act of 2021
(a part of the Consolidated Appropriations Act, 2021), provides financial
institutions the option to temporarily suspend certain requirements under GAAP
related to TDRs for a limited period of time to account for the effects of
COVID-19. See “Note 6 Loans and Allowance for Loan Losses” for additional
discussion regarding TDRs.
On April 7, 2020, federal banking regulators issued a revised Interagency
Statement on Loan Modifications and Reporting for Financial Institutions,
which, among other things, encouraged financial institutions to work prudently
with borrowers who are or may be unable to meet their contractual payment
? obligations because of the effects of COVID-19, and stated that institutions
generally do not need to categorize COVID-19-related modifications as TDRs and
that the agencies will not direct supervised institutions to automatically
categorize all COVID-19 related loan modifications as TDRs. See “Note 6 Loans
and Allowance for Loan Losses” for additional discussion regarding TDRs.
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On April 9, 2020, the Federal Reserve announced additional measures aimed at
supporting small and midsized businesses, as well as state and local
governments impacted by COVID-19. The Federal Reserve announced the Main Street
Business Lending Program, which established two new loan facilities intended to
? facilitate lending to small and midsized businesses: (1) the Main Street New
Loan Facility, or MSNLF, and (2) the Main Street Expanded Loan Facility, or
MSELF. MSNLF loans are unsecured term loans originated on or after April 8,
2020, while MSELF loans are provided as upsized tranches of existing loans
originated before April 8, 2020. The combined size of the program is $600
billion.
On August 3, 2020, the FFIEC issued a joint statement on Additional Loan
Accommodations Related to COVID-19, which among other things, encouraged
? financial institutions to consider prudent additional loan accommodation
options when borrowers are unable to meet their obligations due to continuing
financial challenges. Accommodation options should be based on prudent risk
management and consumer protection principles.
On December 27, 2020, President Trump signed the Consolidated Appropriations
? Act, 2021, a $900.0 billion COVID-19 relief package that includes an additional
$284.0 billion in PPP funding.
In addition to the policy responses described above, the federal bank
regulatory agencies, along with their state counterparts, have issued a stream
of guidance in response to the COVID-19 pandemic and have taken a number of
unprecedented steps to help banks navigate the pandemic and mitigate its
impact. These include without limitation: requiring banks to focus on business
continuity and pandemic planning; adding pandemic scenarios to stress testing;
encouraging bank use of capital buffers and reserves in lending programs;
permitting certain regulatory reporting extensions; reducing margin
requirements on swaps; permitting certain otherwise prohibited investments in
investment funds; issuing guidance to encourage banks to work with customers
? affected by the pandemic and encourage loan workouts; and providing credit
under the Community Reinvestment Act, or CRA, for certain pandemic-related
loans, investments and public service. Moreover, because of the need for social
distancing measures the agencies have revamped the manner in which they conduct
periodic examinations of their regulated institutions, including making greater
use of off-site reviews. The Federal Reserve also issued guidance encouraging
banking institutions to utilize their discount window for loans and intraday
credit extended by their Reserve Banks to help households and businesses
impacted by the pandemic and announced numerous funding facilities. The FDIC
has also acted to mitigate the deposit insurance assessment effects of
participating in the PPP and the PPPL Facility and Money Market Mutual Fund
Liquidity Facility.
Effect on our Business. We currently expect that the COVID-19 pandemic and the
specific developments referred to above will continue to have a significant
impact on our business. In particular, we anticipate that a significant portion
of the Bank’s borrowers in the retail, restaurant, and hospitality industries
will continue to endure significant economic distress, which could cause them to
draw on their existing lines of credit and could adversely affect their ability
and willingness to repay existing indebtedness, and is expected to adversely
impact of the value of collateral. These developments, together with economic
conditions generally, are also expected to impact our commercial real estate
portfolio, particularly with respect to real estate with exposure to the retail,
office and hospitality industries, our consumer loan business and loan
portfolio, and the value of certain collateral securing our loans. In addition,
we expect to see decreases in our total AUA/AUM and a decrease in mortgage loan
originations. As a result, we anticipate that our financial condition, capital
levels and results of operations will be significantly and adversely affected,
as described in this Management’s Discussion and Analysis of Financial Condition
and Results of Operations.
Our Response. We took numerous steps in response to the COVID-19 pandemic,
including the following:
First and foremost, we have prioritized the safety, health and well-being of
our employees, clients and communities. We have implemented a work from home
policy and certain of our offices remain closed. We continue to effectively
? serve our clients in all markets; virtually, digitally, via drive-thru and
in-person as conditions allow. Our work place strategy includes various phases
of expanding service to clients, reopening offices, and determining long-term
work arrangements for employees. This approach allows us
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to incrementally expand in-person services to clients and provides flexibility
between markets based on local conditions, guidelines, and restrictions.
We offered payment deferrals and interest only payment options for consumer,
small business, and commercial customers for initial terms of up to 90 days. We
offered payment extensions for mortgage customers for initial terms of up to 90
days. As of December 31, 2020, we had entered into principal and interest
? deferrals on 577 loans, representing $153.6 million in principal balances. Of
those loans, 18 loans with a total outstanding principal balance of $8.4
million have been granted second deferrals, 21 loans with a total outstanding
principal balance of $3.7 million remain on the first deferral and the
remaining loans have been returned to normal payment status.
The Business Continuity Planning COVID-19 Response team and Alerus leadership
team meet regularly to manage the Company’s response to the pandemic and the
effect on our business. In addition, a cross functional task force team meets
? regularly to address specific issues such as employee and client
communications, facilities, reopening offices, and long-term work arrangements.
The Risk Committee of the Board meets regularly with management to receive
updates on the Company’s response and discuss the effect on our business.
We participated as a lender in the SBA’s PPP. We have assisted 1,632 borrowers
receive approval for funding of $363.6 million in PPP loans. As of December 31,
? 2020, we had submitted, to the SBA, 711 forgiveness applications totaling
$179.9 million and have received approval and forgiveness on 432 applications
totaling $84.1 million.
Net Interest Income
Net interest income represents interest income less interest expense. We
generate interest income on interest-earning assets, primarily loans and
available-for-sale securities. We incur interest expense on interest-bearing
liabilities, primarily interest-bearing deposits and borrowings. To evaluate net
interest income, we measure and monitor: (i) yields on loans, available-for-sale
securities and other interest-earning assets; (ii) the costs of deposits and
other funding sources; (iii) the rates incurred on borrowings and other
interest-bearing liabilities; and (iv) the regulatory risk weighting associated
with the assets. Interest income is primarily impacted by loan growth and loan
repayments, along with changes in interest rates on the loans. Interest expense
is primarily impacted by changes in deposit balances along with the volume and
type of interest-bearing liabilities. Net interest income is primarily impacted
by changes in market interest rates, the slope of the yield curve, and interest
we earn on interest-earning assets or pay on interest-bearing liabilities.
Noninterest Income
Noninterest income primarily consists of the following:
Our retirement and benefit services business, which includes retirement plan
administration, retirement plan investment advisory, HSA, ESOP, payroll and
other benefit services, is our Company’s largest source of noninterest income.
? Over half of our retirement and benefit services fees are transaction or
participant based fees and are impacted by the number of plans and
participants. The remainder of noninterest income is based on the market value
of the related AUA and AUM and impacted by the level of contributions,
withdrawals, new business, lost business and fluctuation in market values.
Wealth management includes personal trust, investment and brokerage services.
Our Company earns trust, investment, and IRA fees from managing assets,
including corporate trusts, personal trusts, and separately managed accounts.
? Trust and investment management fees are primarily based on a tiered scale
relative to the market value of the AUM. Trust and investment management fees
are primarily impacted by rates charged and increases and decreases in AUM. AUM
is primarily impacted by opening and closing of client advisory and trust
accounts, contributions and withdrawals, and the fluctuation in market values.
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Mortgage noninterest income consists of gains on originating and selling
? mortgages and origination fees. Mortgage gains are primarily impacted by the
level of originations, amount of loans sold, the type of loans sold and market
conditions.
Service charges on deposit accounts are comprised of income generated through
deposit account related service charges such as: electronic transfer fees,
? treasury management fees, bill pay fees, and other banking fees. Banking fees
are primarily impacted by the level of business activities and cash movement
activities of our clients.
Other noninterest income consists of debit card interchange income, income
earned on the growth of the cash surrender value of life insurance policies we
? hold on certain key employees, loan servicing income net of the related
amortization, and any other income which does not fit within one of the
specific noninterest income lines described above. Other noninterest income is
generally impacted by business activities and level of transactions.
Noninterest Expense
Noninterest expense is comprised primarily of the following:
Compensation and employee taxes and benefits-include all forms of personnel
related expenses including salary, commissions, incentive compensation, payroll
? related taxes, stock-based compensation, benefit plans, health insurance,
401(k) plan match costs, ESOP and other benefit related expenses. Compensation
and employee benefit costs are primarily impacted by changes in headcount and
fluctuations in benefits costs.
Occupancy and equipment-costs related to owning and leasing our office space,
depreciation charges for the furniture, fixtures and equipment, amortization of
? leasehold improvements, utilities and other occupancy-related expenses.
Occupancy and equipment costs are primarily impacted by the number and size of
the locations we occupy.
Business services, software and technology-costs related to contracts with core
system and third-party data processing providers, software and information
technology services to support office activities and internal networks. We
? believe our technology spending enhances the efficiency of our employees and
enables us to provide outstanding service to our clients. Technology and
information system costs are primarily impacted by the number of locations we
occupy, the number of employees, clients and volume of transactions we have and
the level of service we require from our third-party technology vendors.
Intangible amortization expense is the result of acquisitions of fee income and
banking companies. Identified intangible assets with definite lives consist of
? client relationship intangibles and are amortized on a straight-line basis over
the period representing the estimated remaining lives of the assets. The amount
of expense is impacted by the timing of acquisitions and the estimated
remaining lives of the assets.
Professional fees and assessments-costs related to legal, accounting, tax,
consulting, personnel recruiting, directors fees, insurance and other
? outsourcing arrangements. Professional services costs are primarily impacted by
corporate activities requiring specialized services. FDIC insurance expense is
also included in this line and represents the assessments that we pay to the
FDIC for deposit insurance.
Other operational expenses-includes costs related to marketing, donations,
promotions, and expenses associated with office supplies, postage, travel
expenses, meals and entertainment, dues and memberships, costs to maintain or
? prepare other real estate owned, or OREO, for sale, and other general corporate
expenses that do not fit within one of the specific noninterest expense lines
described above. Other operational expenses are generally impacted by our
business activities and needs.
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Operating Segments
We measure the overall profitability of business operations based on income
before income tax. We allocate costs to our segments, which consist primarily of
compensation and overhead expense directly attributable to the products and
services within banking, retirement and benefit services, wealth management, and
mortgage. We measure the profitability of each segment based on the direct
allocations of expense as we believe it better approximates the contribution
generated by our reportable operating segments. All indirect overhead
allocations and income tax expense is allocated to corporate administration. A
description of each segment is provided in Note 22 (Segment Reporting) of the
Company’s audited consolidated financial statements included elsewhere in this
report.
Critical Accounting Policies
As a result of the complex and dynamic nature of our business, management must
exercise judgment in selecting and applying the most appropriate accounting
policies for its various areas of operations. The policy decision process not
only ensures compliance with current GAAP, but also reflects management’s
discretion with regard to choosing the most suitable methodology for reporting
our financial performance. It is management’s opinion that the accounting
estimates covering certain aspects of the business have more significance than
others due to the relative importance of those areas to overall performance, or
the level of subjectivity in the selection process. These estimates affect the
reported amounts of assets and liabilities as well as disclosures of revenues
and expenses during the reporting period. Actual results could differ from these
estimates. The most critical of the accounting policies are discussed below.
Investment securities-Investment securities can be classified as trading,
available-for-sale, and equity. The appropriate classification is based
partially on our ability to hold the securities to maturity and largely on
management’s intentions with respect to either holding or selling the
securities. The classification of investment securities is significant since it
directly impacts the accounting for unrealized gains and losses on securities.
Unrealized gains and losses on available-for-sale securities are recorded in
accumulated other comprehensive income or loss, as a separate component of
stockholders’ equity, and do not affect earnings until realized. The fair values
of investment securities are generally determined by reference to quoted market
prices, where available. If quoted market prices are not available, fair values
are based on quoted market prices of comparable instruments, or a discounted
cash flow model using market estimates of interest rates and volatility.
Investment securities with significant declines in fair value are evaluated to
determine whether they should be considered other-than-temporarily impaired. An
unrealized loss is generally deemed to be other-than-temporary and a credit loss
is deemed to exist if the present value of the expected future cash flows is
less than the amortized cost basis of the debt security. The credit loss
component of an other-than-temporary impairment write-down is recorded in
current earnings, while the remaining portion of the impairment loss is
recognized in other comprehensive income (loss), provided we do not intend to
sell the underlying debt security, and it is not likely that we will be required
to sell the debt security prior to recovery of the full value of its amortized
cost basis.
Allowance for loan losses-The allowance for loan losses reflects management’s
best estimate of probable loan losses in our loan portfolio. Determination of
the allowance for loan losses is inherently subjective. It requires significant
estimates, including the amounts and timing of expected future cash flows on
impaired loans, appraisal values of underlying collateral for collateralized
loans, and the amount of estimated losses on pools of homogeneous loans which is
based on historical loss experience, expected duration and consideration of
current economic trends, all of which may be susceptible to significant change.
Intangible assets-As a result of acquisitions, we carry goodwill and
identifiable intangible assets. Goodwill represents the cost of acquired
companies in excess of the fair value of net assets at the acquisition date.
Goodwill is evaluated at least annually or when business conditions suggest
impairment may have occurred. Should impairment occur, goodwill will be reduced
to its revised carrying value through a charge to earnings. Core deposits and
other identifiable intangible assets are amortized to expense over their
estimated useful lives. The determination of whether or not impairment exists is
based upon discounted cash flow modeling techniques that require management to
make estimates regarding the amount and timing of expected future cash flows. It
also requires them to select a discount rate that reflects the current return
requirements of the market in relation to present risk-free interest rates,
required equity market premiums, and company-specific performance and risk
metrics, all of which are susceptible to change based on changes in economic and
market conditions and other factors. Future events or changes in the estimates
used to
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determine the carrying value of goodwill and identifiable intangible assets
could have a material impact on our results of operations.
Income taxes-Income tax expense or benefit is the total of the current year
income tax due or refundable and the change in deferred tax assets and
liabilities. Deferred tax assets and liabilities are the expected future tax
amounts for the temporary differences between carrying amounts and tax bases of
assets and liabilities, computed using enacted tax rates. A valuation allowance,
if needed, reduces deferred tax assets to the amount expected to be realized. A
tax position is recognized as a benefit only if it is “more likely than not”
that the tax position would be sustained in a tax examination, with a tax
examination being presumed to occur. The amount recognized is the largest amount
of tax benefit that is greater than 50% likely of being realized on examination.
For tax positions not meeting the “more likely than not” test, no tax benefit is
recorded. Interest and penalties related to income tax matters are recognized in
income tax expense.
On December 22, 2017, the U.S government enacted Public Law 115-97, commonly
known as, the Tax Cuts and Jobs Act, a comprehensive tax legislation, which
reduced the federal income tax rate for C corporations from 35% to 21%,
effective January 1, 2018. As a result of the reduction in the U.S corporate
income tax rate from 35% to 21%, we re-measured our deferred tax assets and
recognized $4.8 million of tax expense in the Consolidated Statement of Income
for the year ended December 31, 2017. See Note 21 (Income Taxes) of the
Company’s audited consolidated financial statements included elsewhere in this
report.
Fair value measurements-Fair value is the price that would be received to sell
an asset, or paid to transfer a liability, in the principal or most advantageous
market for an asset or liability in an orderly transaction between market
participants at the measurement date. The degree of management judgment involved
in determining the fair value of a financial instrument is dependent upon the
availability of quoted market prices, or observable market inputs. For financial
instruments that are traded actively and have quoted market prices or observable
market inputs, there is minimal subjectivity involved in measuring fair value.
However, when quoted market prices or observable market inputs are not fully
available, significant management judgement may be necessary to estimate fair
value. In developing our fair value measurements, we maximize the use of
observable inputs and minimize the use of unobservable inputs.
Financial assets that are recorded at fair value on a recurring basis include
investment securities and derivative financial instruments. As of December 31,
2020 and 2019, $605.7 million or 20.1% and $314.8 million or 13.4%,
respectively, of our total assets consisted of financial assets recorded at fair
value on a recurring basis and most of these financial assets consisted of
available-for-sale investment securities. The fair value of financial assets on
a recurring basis are classified in either Levels 1 or 2 of the fair value
hierarchy. Financial liabilities that are recorded at fair value on a recurring
basis are comprised of derivative financial instruments. As of December 31, 2020
and 2019, $2.9 million and $109 thousand, respectively represented less than 1%
of our total liabilities in those years and were classified as Level 2 of the
fair value hierarchy. We have no fair value assets or liabilities classified in
Level 3 of the fair value hierarchy.
A further discussion regarding the fair value of assets and liabilities, and the
classification of Level 1, 2, and 3 hierarchies, is disclosed in Note 27 (Fair
Value of Assets and Liabilities) of the Company’s audited consolidated financial
statements included elsewhere in this report.
A summary of the accounting policies used by management is disclosed in Note 1
(Significant Accounting Policies) of the Company’s audited consolidated
financial statements included elsewhere in this report.
Selected Financial Data
The following consolidated selected financial data is derived from the Company’s
audited consolidated financial statements as of and for the five years ended
December 31, 2020.
The consolidated selected financial data presented below contains financial
measures that are not presented in accordance with accounting principles
generally accepted in the United States and have not been audited. See “Non-GAAP
to GAAP Reconciliations and Calculation of Non-GAAP Financial Measures” below.
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As of and for the year ended December 31,
(dollars and shares in thousands,
except per share data) 2020 2019 2018 2017 2016
Selected Income Statement Data
Net interest income $ 83,846$ 74,551$ 75,224$ 67,670$ 62,940
Provision for loan losses 10,900 7,312 8,610 3,280 3,060
Noninterest income 149,371 114,194 102,749 103,045 105,089
Noninterest expense 163,799 142,537 136,325 134,920 143,792
Income before income taxes 58,518 38,896 33,038 32,515 21,177
Income tax expense 13,843 9,356 7,172 17,514 7,141
Net income (1) 44,675 29,540 25,866 15,001 14,036
Less: preferred stock dividends – – – – 25
Net income attributable to common
stockholders $ 44,675$ 29,540$ 25,866$ 15,001$ 14,011
Per Common Share Data
Earnings – basic $ 2.57$ 1.96$ 1.88$ 1.10$ 1.04
Earnings – diluted $ 2.52$ 1.91$ 1.84$ 1.07$ 1.00
Dividends declared $ 0.60$ 0.57$ 0.53$ 0.48$ 0.44
Tangible book value per common
share (1)(2) $ 16.00$ 14.08$ 10.68$ 9.14$ 7.99
Average shares outstanding – basic 17,106 14,736 13,763 13,653 13,495
Average shares outstanding –
diluted 17,438 15,093 14,063 14,007 14,000
Selected Performance Ratios
Return on average total assets (1) 1.61 % 1.34 % 1.21 % 0.75 % 0.72 %
Return on average common equity
(1) 14.40 % 12.78 % 13.81 % 8.49 % 8.46 %
Return on average tangible common
equity (1)(2) 17.74 % 17.46 % 21.02 % 18.04 % 15.81 %
Noninterest income as a % of
revenue 64.05 % 60.50 % 57.73 % 60.36 % 62.54 %
Net interest margin
(taxable-equivalent basis) (2) 3.22 % 3.65 %
3.84 % 3.74 % 3.62 %
Efficiency ratio (2) 68.40 % 73.22 % 73.80 % 75.36 % 81.12 %
Dividend payout ratio 23.81 % 29.84 % 28.82 % 44.82 % 43.97 %
Average equity to average assets 11.18 % 10.45 % 8.80 % 8.83 % 8.67 %
Selected Balance Sheet Data –
Period Ending
Loans (3) $ 1,979,375$ 1,721,279$ 1,701,850$ 1,574,474$ 1,366,952
Allowance for loan losses (34,246) (23,924) (22,174) (16,564) (15,615)
Investment securities 592,342 313,158
254,878 274,411 278,911
Assets 3,013,771 2,356,878 2,179,070 2,136,081 2,050,045
Deposits (4) 2,571,993 1,971,316 1,775,096 1,834,962 1,785,209
Long-term debt 58,735 58,769 58,824 58,819 58,813
Total stockholders’ equity (5) 330,163 285,728 196,954 179,594 168,251
Asset Quality Ratios
Net charge-offs/(recoveries) to
average loans 0.03 % 0.33 % 0.18 % 0.16 % 0.16 %
Nonperforming loans to total loans 0.26 % 0.45 % 0.41 % 0.37 % 0.56 %
Nonperforming assets to total
assets 0.17 % 0.33 % 0.33 % 0.30 % 0.47 %
Allowance for loan losses to total
loans 1.73 % 1.39 % 1.30 % 1.05 % 1.14 %
Allowance for loan losses to
nonperforming loans 674.13 % 305.66 % 318.45 % 282.04 % 205.03 %
Other Data
Retirement and benefit services
assets under
administration/management $ 34,199,954$ 31,904,648$ 27,812,149$ 29,366,365$ 26,111,299
Wealth management assets under
administration/management 3,338,594 3,103,056 2,626,815 2,701,966 2,298,992
Mortgage originations 1,778,977 946,441 779,708 867,253 1,065,132
Excluding a one-time $4.8 million expense related to the revaluation of our
deferred tax assets in 2017, our net income, ROAA, ROAE, and ROATCE would
(1) have been $19.8 million, 0.99%, 11.21%, and 18.04%, respectively. These
adjusted metrics represent non-GAAP financial measures. See “Non-GAAP to GAAP
Reconciliations and Calculation of Non-GAAP Financial Measures.”
(2) Represents a Non-GAAP financial measure. See “Non-GAAP to GAAP
Reconciliations and Calculation of Non-GAAP Financial Measures.”
(3) Excludes loans held for branch sale at 2018.
(4) Excludes deposits held for sale at 2018.
(5) Includes ESOP-owned shares.
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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 common equity per share, return on average
tangible common equity, net interest margin (tax-equivalent), and the efficiency
ratio. Management uses these non-GAAP financial measures in its analysis of its
performance, and believes financial analysts and others frequently use these
measures, and other similar measures, to evaluate capital adequacy. Management
calculates: (i) tangible common equity as total common stockholders’ equity,
less goodwill and other intangible assets; (ii) tangible common equity per share
as tangible common equity divided by shares of common stock outstanding;
(iii) tangible assets as total assets, less goodwill and other intangible
assets; (iv) return on average tangible common equity as net income adjusted for
intangible amortization net of tax, divided by average tangible common equity;
(v) net interest margin (tax-equivalent) as net interest income plus a
tax-equivalent adjustment, divided by average earning assets; and
(vi) efficiency ratio as noninterest expense less intangible amortization
expense, divided by net interest income plus noninterest income plus a
tax-equivalent adjustment.
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.
December 31, December 31, December 31, December 31, December 31,
2020 2019 2018 2017 2016
Tangible common equity to tangible
assets
Total common stockholders’ equity $ 330,163$ 285,728$ 196,954$ 179,594$ 168,251
Less: Goodwill 30,201 27,329 27,329 27,329 27,329
Less: Other intangible assets 25,919 18,391
22,473 27,111 32,729
Tangible common equity (a) 274,043 240,008 147,152 125,154 108,193
Total assets 3,013,771 2,356,878 2,179,070 2,136,081 2,050,045
Less: Goodwill 30,201 27,329 27,329 27,329 27,329
Less: Other intangible assets 25,919 18,391 22,473 27,111 32,729
Tangible assets (b) 2,957,651 2,311,158
2,129,268 2,081,641 1,989,987
Tangible common equity to tangible
assets (a)/(b)
9.27 % 10.38 % 6.91 % 6.01 % 5.44 %
Tangible book value per common share
Total common stockholders’ equity $ 330,163$ 285,728$ 196,954$ 179,594$ 168,251
Less: Goodwill 30,201 27,329 27,329 27,329 27,329
Less: Other intangible assets 25,919 18,391 22,473 27,111 32,729
Tangible common equity (c) 274,043 240,008 147,152 125,154 108,193
Total common shares issued and
outstanding (d) 17,125 17,050 13,775 13,699 13,534
Tangible book value per common share
(c)/(d) $ 16.00 $ 14.08 $ 10.68 $ 9.14 $ 7.99
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December 31, December 31, December 31, December 31, December 31,
2020 2019 2018 2017 2016
Return on average tangible common
equity
Net income $ 44,675 $
29,540 $ 25,866$ 15,001$ 14,036
Less: Preferred stock dividends
– – – – 25
Add: Intangible amortization expense
(net of tax) 3,129 3,224 3,664 3,655 4,553
Remeasurement due to tax reform – – – 4,818 –
Net income, excluding intangible
amortization (e) 47,804 32,764 29,530 23,474 18,564
Average total equity 310,208 231,084 187,341 176,779 168,039
Less: Average preferred stock – – – – 2,514
Less: Average goodwill 27,439 27,329 27,329 27,329 25,698
Less: Average other intangible assets
(net of tax) 13,309 16,101 19,522 19,358 22,372
Average tangible common equity (f) 269,460 187,654 140,490 130,092 117,455
Return on average tangible common
equity (e)/(f) 17.74 % 17.46 % 21.02 % 18.04 % 15.81 %
Net interest margin (tax-equivalent)
Net interest income $ 83,846 $
74,551 $ 75,224$ 67,670$ 62,940
Tax-equivalent adjustment
455 347 462 865 599
Tax-equivalent net interest income (g) 84,301 74,898 75,686 68,535 63,539
Average earning assets (h) 2,618,427 2,052,758 1,970,004 1,833,002 1,755,283
Net interest margin (tax-equivalent)
(g)/(h) 3.22 % 3.65 % 3.84 % 3.74 % 3.62 %
Efficiency ratio
Noninterest expense $ 163,799 $
142,537 $ 136,325$ 134,920$ 143,792
Less: Intangible amortization expense
3,961 4,081 4,638 5,623 7,005
Adjusted noninterest expense (i) 159,838 138,456 131,687 129,297 136,787
Net interest income 83,846 74,551 75,224 67,670 62,940
Noninterest income 149,371 114,194 102,749 103,045 105,089
Tax-equivalent adjustment 455 347 462 865 599
Total tax-equivalent revenue (j) 233,672 189,092 178,435 171,580 168,628
Efficiency ratio (i)/(j) 68.40 % 73.22 % 73.80 % 75.36 % 81.12 %
Adjusted net income and ratios for
2017 tax reform
Net income $ 15,001
Remeasurement due to tax reform
4,818
Adjusted net income (k) $ 19,819
Average assets (l) 2,001,503
Average equity (m) 176,779
Adjusted return on average assets
(excluding the remeasurement due to
tax reform) (k)/(l) 0.99 %
Adjusted return on average equity
(excluding the remeasurement due to
tax reform) (k)/(m) 11.21 %
Results of Operations
The following discussion describes the consolidated operations and financial
condition of the Company and the Bank. Results of operations for the year ended
December 31, 2020 are compared to the results for the year ended December 31,
2019, and the consolidated financial condition of the Company as of December 31,
2020 is compared to December 31, 2019. Results of operations for the year ended
December 31, 2019 compared to results for the year ended December 31, 2018, can
be found in Item 7. Management’s Discussion and Analysis of Financial Condition
and Results of Operations of the Company’s 2019 annual report on Form 10-K filed
with the SEC on March 26, 2020.
Summary
Net income for the year ended December 31, 2020 was $44.7 million, an increase
of $15.1 million, or 51.2%, compared to $29.5 million for the year ended
December 31, 2019. Diluted earnings per common share were $2.52 in 2020,
compared to $1.91 for 2019. Return on average total assets was 1.61% in 2020,
compared to 1.34% for 2019. The
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increase in net income was primarily due to an increase of $35.2 million in
noninterest income and an increase of $9.3 million in net interest income. The
increase in noninterest income was primarily driven by an increase in mortgage
banking revenue and the increase in net interest income was primarily due to a
$6.5 million decrease in interest expense along with a $2.4 million increase in
interest income from investment securities. These improvements were partially
offset by a $21.3 million, or 14.9%, increase in noninterest expense driven by a
$15.2 million increase in compensation expense, $2.7 million in business
services, software and technology expense, and $2.2 million in mortgage and
lending expenses. The increases in compensation and mortgage and lending
expenses were directly correlated to the increase in mortgage banking revenue as
mortgage originations totaled $1.8 billion for the year. The provision for loan
losses increased $3.6 million in 2020 compared to 2019, as concerns regarding an
economic slowdown related to COVID-19 increased qualitative factors.
Net Interest Income-With Nontaxable Income Converted to Fully Taxable
Equivalent, or FTE
Net interest income totaled $83.8 million in 2020, an increase of $9.3 million,
or 12.5%, from 2019. Net interest margin decreased 43 basis points to 3.22%, in
2020, from the 3.65% reported in 2019. The decrease in net interest margin was
primarily a result of an 87 basis point decrease in the average yield on
interest earning assets which was partially offset by a corresponding decrease
of 60 basis points in the average rate paid on interest-bearing liabilities.
These decreases were largely driven by a historically low interest rate
environment as the Federal Open Market Committee decreased the target fed funds
rate 150 basis points in reaction to the economic impact related to COVID-19.
Also contributing to the decrease in net interest margin was a shift in balance
sheet mix with a higher percentage of average balances in lower yielding
deposits with banks and investment securities. The increase in these balances
was due to an influx of liquidity from PPP loans, government stimulus and market
uncertainty.
The following table sets forth information related to our average balance sheet,
average yields on assets, and average rates of liabilities for the periods
indicated. We derived these yields 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
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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.
Year ended December 31,
2020 2019 2018
Interest Average Interest Average Interest Average
Average Income/ Yield/ Average Income/ Yield/ Average Income/ Yield/
(dollars in thousands) Balance Expense Rate Balance Expense Rate Balance Expense Rate
Interest Earning Assets
Interest-bearing deposits with banks $ 162,616$ 664
0.41 % $ 34,876$ 656 1.88 % 8,336 $ 166 1.99 %
Investment securities (3)
425,219 8,999 2.12 % 266,204 6,586 2.47 % 255,247 6,232 2.44 %
Loans held for sale 79,201 1,948 2.46 % 36,035 1,138 3.16 % 19,255 607 3.15 %
Loans
Commercial:
Commercial and industrial 687,266 31,600
4.60 % 500,652 27,288 5.45 % 483,182 25,019 5.18 %
Real estate construction
32,804 1,488
4.54 % 23,625 1,287 5.45 % 39,024 2,161 5.54 %
Commercial real estate
523,219 21,884
4.18 % 448,869 22,237 4.95 % 475,778 22,853 4.80 %
Total commercial
1,243,289 54,972 4.42 % 973,146 50,812 5.22 % 997,984 50,033 5.01 %
Consumer
Residential real estate first mortgage 463,174 18,391
3.97 % 455,635 19,257 4.23 % 400,458 16,420 4.10 %
Residential real estate junior lien
159,844 7,696
4.81 % 184,972 10,422 5.63 % 190,838 10,305 5.40 %
Other revolving and installment
79,238 3,621 4.57 % 93,226 4,336 4.65 % 88,605 3,929 4.43 %
Total consumer 702,256 29,708 4.23 % 733,833 34,015 4.64 % 679,901 30,654 4.51 %
Total loans (1)(3) 1,945,545 84,680 4.35 % 1,706,979 84,827 4.97 % 1,677,885 80,687 4.81 %
Federal Reserve/FHLB Stock 5,846 266 4.55 % 8,664 440 5.08 % 9,281 473 5.10 %
Total interest earning assets 2,618,427 96,557 3.69 % 2,052,758 93,647 4.56 % 1,970,004 88,165 4.48 %
Noninterest earning assets 156,713 159,235 159,402
Total assets $ 2,775,140$ 2,211,993$ 2,129,406
Interest-Bearing Liabilities
Interest-bearing demand deposits (2) $ 551,861$ 1,624
0.29 % $ 428,162$ 1,995 0.47 % $ 405,512$ 1,034 0.25 %
Money market and savings deposits (2)
920,072 4,863 0.53 % 681,621 8,320 1.22 % 626,041 3,950 0.63 %
Time deposits (2) 203,413 2,356 1.16 % 186,781 3,019 1.62 % 206,846 2,008 0.97 %
Short-term borrowings 80 – – % 71,421 1,805 2.53 % 86,851 1,896 2.18 %
Long-term debt 58,742 3,413
5.81 % 58,789 3,610 6.14 % 58,813 3,591 6.11 %
Total interest-bearing liabilities
1,734,168 12,256 0.71 % 1,426,774 18,749 1.31 % 1,384,063 12,479 0.90 %
Noninterest-Bearing Liabilities and
Stockholders’ Equity
Noninterest-bearing deposits 673,676 512,586 528,552
Other noninterest-bearing liabilities 57,088 41,549 29,450
Stockholders’ equity 310,208 231,084 187,341
Total liabilities and stockholders’ equity $ 2,775,140
$ 2,211,993$ 2,129,406
Net interest income $ 84,301$ 74,898$ 75,686
Net interest rate spread 2.98 % 3.25 % 3.58 %
Net interest margin on FTE basis (3) 3.22 % 3.65 %
3.84 %
(1) Includes loans held for branch sale at 2018.
(2) Includes deposits held for sale at 2018.
(3) Fully tax-equivalent adjustment was calculated utilizing a marginal income
tax rate of 21.0% .
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Rate/Volume Analysis
The table below presents the effect of volume and rate changes on interest
income and expense for the periods indicated. Changes in volume are changes in
the average balance multiplied by the previous year’s average rate. Changes in
rate are changes in the average rate multiplied by the average balance from the
previous year. The net changes attributable to the combined impact of both rate
and volume have been allocated proportionately to the changes due to volume and
the changes due to rate.
Year ended December 31, 2020 Year ended December 31, 2019
Compared with Compared with
Year ended December 31, 2019 Year ended December 31, 2018
Change due to: Interest Change due to: Interest
(tax-equivalent basis,
dollars in thousands) Volume Rate Variance Volume Rate Variance
Interest earning assets
Interest-bearing deposits
with banks $ 2,402$ (2,394)$ 8$ 528$ (38)$ 490
Investment securities 3,928 (1,515) 2,413 267 87 354
Loans held for sale 1,364 (554) 810 529 2 531
Loans
Commercial:
Commercial and industrial 10,170 (5,858) 4,312 905 1,364 2,269
Real estate construction 500 (299) 201 (853) (21) (874)
Commercial real estate 3,680 (4,033) (353) (1,292) 676 (616)
Total commercial 14,350 (10,190) 4,160 (1,240) 2,019 779
Consumer
Residential real estate first
mortgage 319 (1,185) (866) 2,262 575 2,837
Residential real estate
junior lien (1,415) (1,311) (2,726) (317) 434 117
Other revolving and
installment (650) (65) (715) 205 202 407
Total consumer (1,746) (2,561) (4,307) 2,150 1,211 3,361
Total loans (1) 12,604 (12,751) (147) 910 3,230 4,140
Federal Reserve/FHLB Stock (143) (31) (174) (31) (2) (33)
Total interest income 20,155 (17,245) 2,910 2,203 3,279 5,482
Interest-bearing liabilities
Interest-bearing demand
deposits (2) 581 (952) (371) 57 904 961
Money market and savings
deposits (2) 2,909 (6,366) (3,457) 350 4,020 4,370
Time deposits (2) 269 (932) (663) (195) 1,206 1,011
Short-term borrowings (1,805) – (1,805) (336) 245 (91)
Long-term debt (3) (194) (197) (1) 20 19
Total interest expense 1,951 (8,444) (6,493) (125) 6,395 6,270
Change in net interest income $ 18,204$ (8,801)$ 9,403
2,328 $ (3,116)$ (788)
(1) Includes loans held for branch sale at 2018.
(2) Includes deposits held for sale at 2018.
Provision for Loan Losses
The provision for loan losses was $10.9 million for the year ended December 31,
2020, compared to $7.3 million for the year ended December 31, 2019. The
increase in provision for loan losses in 2020 was primarily due to increased
qualitative factors related to the economic uncertainty resulting from COVID-19,
partially offset by $1.9 million less provision for specific reserves on
impaired loans and $717 thousand less provision related to the decrease in
criticized loan balances.
The provision for loan losses on off-balance sheet items, a component of “other
expense” in our Consolidated Statements of Income, reflects management’s
assessment of the adequacy of the allowance for loan losses on lending-related
commitments. See “Financial Condition-Allowance for Loan Losses.”
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Noninterest Income
The following table presents noninterest income for the years ended December 31,
2020, 2019, and 2018.
Year ended December 31,
(dollars in thousands) 2020 2019 $ Change % Change 2019 2018 $ Change % Change
Retirement and benefit
services $ 60,956$ 63,811$ (2,855) (4.5) % $ 63,811$ 63,316$ 495 0.8 %
Wealth management 17,451 15,502 1,949 12.6 % 15,502 14,900 602 4.0 %
Mortgage banking 61,641 25,805 35,836 138.9
% 25,805 17,630 8,175 46.4 %
Service charges on
deposit accounts
1,409 1,772 (363) (20.5)
% 1,772 1,808 (36) (2.0) %
Net gains (losses) on
investment securities
2,737 357 2,380 666.7 % 357 85 272 320.0 %
Other 5,177 6,947 (1,770) (25.5)
% 6,947 5,010 1,937 38.7 %
Total noninterest income $ 149,371$ 114,194$ 35,177 30.8 % $ 114,194$ 102,749$ 11,445 11.1 %
Noninterest income as a
% of revenue
64.1 % 60.5 % 60.5 % 57.7 %
Total noninterest income increased by $35.2 million, or 30.8%, to $149.4 million
in 2020, from $114.2 for 2019. The increase in noninterest income was primarily
due to a $35.8 million increase in mortgage banking revenue. The increase in
mortgage banking revenue was due to historically high mortgage originations.
Mortgage originations for 2020 were $1.8 billion, an $832.5 million, or 88.0%
increase from 2019. Also contributing to the increase in mortgage banking
revenue, was a $7.1 million increase in the change in fair value of derivatives
and a 50 basis point increase in the gain on sale margin. Wealth management
revenue increased $1.9 million due to an increase of $235.5 million in wealth
management assets under administration/management. We also realized a $2.4
million increase in gains on the sale of investment securities. These increases
were offset by a $2.9 decrease in retirement and benefit services revenue and a
$1.8 million decrease in other noninterest income. The decrease in retirement
and benefit services revenue was primarily due to expected plan attrition
exceeding new business generation and a transition away from revenue sharing.
The decrease in other noninterest income was primarily due to the gain on branch
sale recognized in 2019.
Noninterest income as a percent of total operating revenue, which consists of
net interest income plus noninterest income, was 64.1% in 2020, up from 60.5%
the prior year. The increase in 2020 was due to a 30.8% increase in noninterest
income while net interest income increased by 12.5%.
Noninterest Expense
The following table presents noninterest expense for the years ended
December 31, 2020, 2019, and 2018.
Year ended December 31,
(dollars in thousands) 2020 2019 $ Change % Change 2019 2018 $ Change % Change
Compensation $ 89,206$ 74,018$ 15,188
20.5 % $ 74,018$ 69,403$ 4,615 6.6 %
Employee taxes and benefits 20,050 19,456 594 3.1 % 19,456 17,866 1,590 8.9 %
Occupancy and equipment
expense
11,073 10,751 322 3.0 % 10,751 11,086 (335) (3.0) %
Business services, software
and technology expense 19,124 16,381 2,743 16.7 % 16,381 14,525 1,856 12.8 %
Intangible amortization
expense 3,961 4,081 (120) (2.9) % 4,081 4,638 (557) (12.0) %
Professional fees and
assessments 4,700 4,011 689 17.2 % 4,011 5,098 (1,087) (21.3) %
Marketing and business
development 3,133 3,162 (29) (0.9) % 3,162 3,459 (297) (8.6) %
Supplies and postage 2,169 2,722 (553) (20.3) % 2,722 2,737 (15) (0.5) %
Travel 359 1,787 (1,428) (79.9) % 1,787 1,738 49 2.8 %
Mortgage and lending
expenses 5,039 2,853 2,186 76.6 % 2,853 2,153 700 32.5 %
Other 4,985 3,315 1,670
50.4 % 3,315 3,622 (307) (8.5) %
Total noninterest expense $ 163,799$ 142,537$ 21,262 14.9 % $ 142,537$ 136,325$ 6,212 4.6 %
Total noninterest expense increased $21.3 million, or 14.9%, to $163.8 million
for the year ended December 31, 2020, from $142.5 million for 2019. The increase
in noninterest expense was primarily due to increases of $15.2 million in
compensation expense, $2.7 million in business services, software and technology
expense, $2.2 million in mortgage and lending expenses, $1.7 million in other
noninterest expense and $594 thousand in employee taxes and benefits. The
increases in compensation expense, mortgage and lending expenses and employee
taxes and benefits were a direct result of the increase in mortgage
originations. Business services, software and technology increased due to
purchases of computer equipment, supplies and allowances for home office
equipment as the Company shifted more of its employees
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to a remote work model in response to the COVID-19 pandemic. The increase in
other noninterest expense was primarily driven by a $1.1 million increase in the
provision for unfunded commitments as line of credit utilization decreased
38.6%. These increases were partially offset by a $1.4 million decrease in
travel expense as a result of the COVID-19 pandemic and a $553 thousand decrease
in supplies and postage as we transitioned many of our clients to electronic
statements.
Income Taxes
For the year ended December 31, 2020, we recognized income tax expense of $13.8
million on $58.5 million of pre-tax income resulting in an effective tax rate of
23.7%, compared to the same period in 2019, in which we recognized an income tax
expense of $9.4 million on $38.9 million of pre-tax income, resulting in an
effective tax rate of 24.1%. The decrease in the effective tax rate was
primarily due to an increase in tax exempt interest income, additional
deductions from stock-based compensation, and reduced add backs from a reduction
in entertainment and meal expense due to a curtailed travel budget stemming
from
COVID-19.
Segment Reporting
We determine reportable segments based on the significance of the services
offered, the significance of those services to our financial condition and
operating results, and our regular review of the operating results of those
services. We have four operating segments-banking, retirement and benefit
services, wealth management, and mortgage. These segments are components for
which financial information is prepared and evaluated regularly by management in
deciding how to allocate resources and assess performance.
The selected financial information presented for each segment sets forth net
interest income, provision for loan losses, noninterest income, and direct
noninterest expense before indirect overhead allocations. Corporate
administration includes the indirect overhead and is set forth in the table
below along with income tax expense and the consolidated net income. The segment
net income before taxes represents direct revenue and expense before indirect
allocations and income taxes. Certain reclassification adjustments have been
made between corporate administration and the various lines of business for
consistency in presentation.
For additional financial information on our segments see Note 22 (Segment
Reporting) of the Company’s audited consolidated financial statements included
elsewhere in this report.
Banking
The banking segment 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 various digital
applications. The majority of our assets and liabilities are on the banking
segment balance sheet.
The banking segment reported net income before taxes and indirect allocations of
$37.4 million for the year ended December 31, 2020, an increase of $4.0 million
compared to 2019. The increase was driven primarily by increases of $8.3 million
in net interest income and $3.0 million in noninterest income offset by
increases of $3.7 million in noninterest expense and $3.6 million in provision
for loan losses.
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; HSA, flex spending account, and government health insurance
program recordkeeping and administration services to employers; payroll and
human resource information system services for employers. The division services
approximately 7,500 retirement plans and more than 373,100 plan participants. In
addition, the division employs nearly 300 professionals, and operates within our
banking markets as well as Lansing, Michigan, Littleton, Colorado.
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The retirement and benefit services segment reported net income before taxes and
indirect allocations of $25.7 million for the year ended December 31, 2020, a
decrease of $2.7 million from the $28.4 million for 2019. Revenue of $61.0
million, comprised of $25.6 million in asset based revenue and $35.4 million in
participant and transaction revenues, decreased $2.9 million or 4.5% primarily
due to expected plan attrition exceeding new business generation and a 3 basis
point reduction in yield.
The following table presents changes in the combined AUA and AUM for our
retirement and benefit services segment for the periods presented.
Year ended
December 31,
(dollars in thousands) 2020 2019 2018
AUA & AUM balance beginning of period $ 31,904,648$ 27,812,149$ 29,366,365
Acquired assets 1,258,382 – –
Inflows (1) 4,829,449 5,009,789 4,637,646
Outflows (2) (6,828,573) (5,406,667) (4,981,204)
Market impact (3) 3,036,048 4,489,377 (1,210,658)
AUA & AUM balance end of period $ 34,199,954$ 31,904,648$ 27,812,149
Yield (4) 0.18 % 0.21 % 0.22 %
(1) Inflows include new account assets, contributions, dividends and interest.
(2) Outflows include closed account assets, withdrawals and client fees.
(3) Market impact reflects gains and losses on portfolio investments.
(4) Retirement and benefit services noninterest income divided by simple average
ending balances.
AUA and AUM for the retirement and benefit services segment were $34.2 billion
at December 31, 2020, an increase of $2.3 billion compared to the total at
December 31, 2019. The increase was primarily driven by an increase of
$3.0 billion related to the market impact and $1.3 billion in acquired assets
from the 2020 acquisition of Retirement Planning Services, Inc., offset by
outflows outpacing inflows.
Wealth Management
The wealth management division provides advisory and planning services,
investment management, and trust and fiduciary services to clients across our
Company’s footprint.
Wealth management reported net income before taxes and indirect allocations of
$9.2 million for the year ended December 31, 2020, an increase of $848 thousand,
or 10.2% from 2019. Noninterest income increased $1.9 million, or 12.6%, as
compared to 2019, primarily due to an increase in combined AUA and AUM,
partially offset by a 4 basis points reduction in yield. Wealth management
noninterest expense of $8.3 million increased $1.1 million or 15.3% from 2019
primarily due to an increase in direct allocation expenses.
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The following table presents changes in the wealth management combined AUA and
AUM, disaggregated by product, for the periods presented.
Year ended
December 31,
(dollars in thousands) 2020 2019 2018
Dimension balance beginning of period $ 1,652,454$ 1,276,905
$ 1,369,580
Inflows (1) 402,787 545,606 218,171
Outflows (2) (539,485) (329,974) (199,187)
Market impact (3) 238,891 159,917 (111,659)
Dimension balance end of period $ 1,754,647$ 1,652,454$ 1,276,905
Yield (4)(6) 0.49 % 0.54 % 0.57 %
Blue Print balance beginning of period $ 469,937$ 348,605
$ 334,648
Inflows (1) 131,436 117,846 104,643
Outflows (2) (83,142) (58,832) (55,938)
Market impact (3) 51,705 62,318 (34,748)
Blue Print balance end of period $ 569,936$ 469,937$ 348,605
Yield (4)(6) 0.92 % 0.98 % 1.04 %
Trust balance beginning of period $ 290,677$ 226,305
$ 222,738
Inflows (1) 194,897 200,766 251,327
Outflows (2) (254,542) (187,648) (297,514)
Market impact (3) 19,438 51,254 49,754
Trust balance end of period $ 250,470$ 290,677$ 226,305
Yield (4)(6) 0.57 % 0.60 % 0.65 %
Total Wealth Management balance beginning
of period $ 2,413,068$ 1,851,815$ 1,926,966
Inflows (1) 729,120 864,218 574,141
Outflows (2) (877,169) (576,454) (552,639)
Market impact (3) 310,034 273,489 (96,653)
Total Wealth Management balance end of
period (5) $ 2,575,053$ 2,413,068$ 1,851,815
Yield (4)(6) 0.59 % 0.63 % 0.66 %
(1) Inflows include new account assets, contributions, dividends and interest.
(2) Outflows include closed account assets, withdrawals and client fees.
(3) Market impact reflects gains and losses on portfolio investments.
(4) Wealth management noninterest income divided by simple average ending
balances.
Total wealth management does not include brokerage assets of $760.5 million,
(5) $690.0 million, and $775.0 million for the years ending December 31, 2020,
2019 and 2018, respectively.
Yield does not include brokerage revenue of $2.7 million, $2.1 million, and
(6) $2.4 million for the years ending December 31, 2020, 2019 and 2018,
respectively.
AUA and AUM for the wealth management segment was $2.6 billion, excluding
$760.5 million of brokerage assets, at December 31, 2020, an increase of
$162.0 million, or 6.7%, compared to the total at December 31, 2019. The
increase was driven by an increase of $310.0 million related to the market
impact, offset by outflows out pacing inflows by $148.0 million.
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.
Mortgage reported net income before taxes and indirect allocations of $27.4
million for the year ended December 31, 2020, an increase of $22.2 million from
the $5.2 million reported in 2019. Mortgage noninterest income for 2020 of
$61.6 million increased $35.8 million, or 138.9%, from the same period in 2019.
The increase was primarily driven by an increase in mortgage originations which
totaled $1.8 billion, for the year ended December 31, 2020, an $832.5 million
increase from 2019. In addition, mortgage recognized a $7.1 million increase in
the change in fair value of secondary market derivatives as well as a 50 basis
point increase in the gain on sale margin. The increase in noninterest income
was offset by an increase of $14.4 million in noninterest expense, primarily due
to increased incentive compensation directly related to the increase in mortgage
originations.
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Financial Condition
Overview
Total assets were $3.0 billion at December 31, 2020, an increase of
$656.9 million compared to $2.4 billion at December 31, 2019. The increase in
total assets was primarily due to increases of $282.0 million in
available-for-sale investment securities, $247.8 million in net loans,
$75.6 million in loans held for sale, $29.0 million in cash and cash equivalents
and $14.2 million in other assets. The increase in loans held for sale was due
to increased mortgage loan originations and our decision to hold loans longer to
utilize liquidity and provide for an increase in earning asset yield compared to
alternative short-term investments. The increase in loans was primarily driven
by $268.4 million of PPP loans. The increase in securities available-for-sale
was a result of management’s decision to utilize liquidity and provide for an
increase in earning asset yield compared to alternative short-term investments.
Investment Securities
The following table presents the fair value of our investment securities
portfolio for the periods indicated:
December 31, 2020 December 31, 2019 December 31, 2018
Percent of Percent of Percent of
(dollars in thousands) Balance Portfolio Balance Portfolio Balance Portfolio
Trading $ – – % $ – – % $ 1,539 0.6 %
Available-for-sale
U.S. Treasury and agencies 5,907 1.0 % 21,240 6.8 % 19,142 7.5 %
Obligations of state and
political agencies 153,773 26.0 % 68,648 21.9 % 66,387 26.0 %
Mortgage backed securities
Residential Agency 262,004 44.2 % 182,538 58.3 % 126,998 49.9 %
Commercial 139,693 23.6 % 30,685 9.8 % 28,767 11.3 %
Asset backed securities 115 – % 144 – % 399 0.2 %
Corporate bonds 30,850 5.2 % 7,095 2.3 % 8,481 3.3 %
Total available-for-sale 592,342 100.0 % 310,350 99.1 % 250,174 98.2 %
Equity – – % 2,808 0.9 % 3,165 1.2 %
Total investment securities $ 592,342 100.0 % $ 313,158 100.0 % $ 254,878 100.0 %
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.
At December 31, 2020 total investment securities were $592.3 million compared to
$313.2 million at December 31, 2019. Investment securities as a percentage of
total assets were 19.7% and 13.3%, as of December 31, 2020 and December 31,
2019, respectively. The decision to increase investment securities was
strategically done to utilize excess liquidity and provide for an increase in
earning asset yield compared to alternative short-term investments. Securities
with a carrying value of $160.8 million were pledged at December 31, 2020, to
secure public deposits and for other purposes required or permitted by law.
The net pre-tax unrealized market value gain on the available-for-sale
investment portfolio as of December 31, 2020 was $14.2 million, as compared to
$2.6 million as of December 31, 2019. This increase is indicative of the
interest rate environment and changes in the size and composition of the
portfolio.
The investment portfolio is principally composed of U.S.Treasury debentures,
U.S. Agency mortgage-backed pass-throughs, U.S. Agency, Commercial Mortgage
Obligations, or CMOs, and municipal bonds. The portfolio does not include any
private label mortgage-backed securities or private label collateralized
mortgage obligations.
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As of December 31, 2020, the Bank held 112 tax-exempt state and local municipal
securities totaling $50.1 million. As of December 31, 2019, the Bank held 114
tax-exempt state and local municipal securities totaling $49.6 million. Other
than the aforementioned investments, at December 31, 2020 and December 31, 2019,
there were no holdings of securities of any one issuer, other than the U.S.
Government and its agencies, in an amount greater than 10% of stockholders’
equity.
As of December 31, 2020 and December 31, 2019, all of the available-for-sale
debt securities in an unrealized loss position were investment grade. For the
years ended December 31, 2020 and 2019, we evaluated all of our debt securities
for credit impairment and determined there were no credit losses evident and we
did not record any other-than-temporary impairment. Furthermore, we do not
intend to sell and it is more likely than not that we will not be required to
sell these debt securities before the anticipated recovery of the amortized cost
basis.
Periodic reviews are conducted to identify and evaluate each investment that has
an unrealized loss for other-than-temporary impairment. An unrealized loss
exists when the current estimated fair value of an individual security is less
than its amortized cost basis. Unrealized losses that are determined to be
temporary in nature are recorded, net of tax, in accumulated other comprehensive
income for available-for-sale securities.
The securities available-for-sale presented in the following table are reported
at fair value and by contractual maturity as of December 31, 2020. Actual timing
may differ from contractual maturities if borrowers have the right to call or
prepay obligations with or without call or prepayment penalties. Additionally,
the mortgage backed securities receive monthly principal payments, which are not
reflected below. The yields below are calculated on a tax equivalent basis.
Maturity as of December 31, 2020
One year or less One to five years Five to ten years After ten years
Fair Average Fair Average Fair Average Fair Average
(dollars in thousands) Value Yield Value Yield
Value Yield Value Yield
Available-for-sale
U.S. Treasury and
agencies $ – – % $ – – % $ 1,530 0.92 % $ 4,377 0.71 %
Obligations of state
and political agencies 2,468 1.39 % 28,747 1.34 %
74,666 1.79 % 47,892 2.31 %
Mortgage backed
securities
Residential Agency 2 3.59 % 1,760 2.62 % 49,658 2.32 % 210,584 1.85 %
Commercial – – % 1,749 3.23 % 4,774 2.25 % 133,170 1.15 %
Asset backed securities – – % – – % – – % 115 5.40 %
Corporate bonds 1,016 2.77 % – – % 29,834 4.49 % – – %
Total
available-for-sale $ 3,486 1.79 % $ 32,256 1.51 % $
160,462 2.46 % $ 396,138 1.66 %
Loans
The loan portfolio represents a broad range of borrowers comprised of commercial
and industrial, commercial real estate, residential real estate, and consumer
financing loans.
Commercial and industrial loans include financing for commercial purposes in
various lines of businesses, including manufacturing, service industry and
professional service areas. Commercial and industrial loans are generally
secured with the assets of the company and/or the personal guarantee of the
business owners.
Commercial real estate loans consist of term loans secured by a mortgage lien on
the real property, such as office and industrial buildings, retail shopping
centers and apartment buildings, as well as commercial real estate construction
loans that are offered to builders and developers.
Residential real estate loans represent loans to consumers for the purchase or
refinance of a residence. These loans are generally financed over a 15- to
30-year term and, in most cases, are extended to borrowers to finance their
primary residence with both fixed-rate and adjustable-rate terms. Real estate
construction loans are also offered to consumers who wish to build their own
homes and are often structured to be converted to permanent loans at the end of
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the construction phase, which is typically twelve months. Residential real
estate loans also include home equity loans and lines of credit that are secured
by a first- or second-lien on the borrower’s residence. Home equity lines of
credit consist mainly of revolving lines of credit secured by residential real
estate.
Consumer loans include loans made to individuals not secured by real estate,
including loans secured by automobiles or watercraft, and personal unsecured
loans.
Loans outstanding, by type, as of the dates presented are as follows:
December 31, 2020 December 31, 2019 December 31, 2018 December 31, 2017 December 31, 2016
Percent of Percent of Percent of Percent of Percent of
(dollars in thousands) Balance Portfolio Balance Portfolio Balance Portfolio Balance Portfolio Balance Portfolio
Commercial
Commercial and
industrial (1) $ 691,858 35.0 % $ 479,144 27.8 % $ 510,706 30.0 % $ 480,595 30.5 % $ 472,449 34.6 %
Real estate construction 44,451 2.2 % 26,378 1.5 % 18,965 1.1 % 22,348 1.4 % 35,174 2.6 %
Commercial real estate 563,007 28.5 % 494,703 28.8 % 439,963 25.9 % 444,857 28.3 % 391,533 28.6 %
Total commercial 1,299,316 65.7 % 1,000,225 58.1 % 969,634 57.0 % 947,800 60.2 % 899,156 65.8 %
Consumer
Residential real estate
first mortgage 463,370 23.4 % 457,155 26.6 % 448,143 26.3 % 348,964 22.2 % 202,217 14.8 %
Residential real estate
junior lien 143,416 7.2 % 177,373 10.3 % 188,855 11.1 % 195,103 12.4 % 178,795 13.1 %
Other revolving and
installment 73,273 3.7 % 86,526 5.0 % 95,218 5.6 % 82,607 5.2 % 86,784 6.3 %
Total consumer 680,059 34.3 % 721,054 41.9 % 732,216 43.0 % 626,674 39.8 % 467,796 34.2 %
Total loans $ 1,979,375 100.0 % $ 1,721,279 100.0 % $ 1,701,850 100.0 % $ 1,574,474 100.0 % $ 1,366,952 100.0 %
(1) Includes PPP loans of $268.4 million as of December 31, 2020.
Total loans outstanding of $2.0 billion as of December 31, 2020, increased
$258.1 million, or 15.0%, from December 31, 2019. The increase was primarily due
to increases of $212.7 million in commercial and industrial loans and $68.3
million in our commercial real estate loan portfolio, partially offset by $41.0
million decrease in our consumer loan portfolio. The increase in commercial and
industrial loans was due to an increase of $268.4 million in net PPP loans
offset by a decrease in commercial lines of credit due to low line utilization.
The decrease in our consumer portfolio was primarily due to a decrease in
residential real estate junior liens due to a large number of refinances as a
result of the historically low interest rates.
Our loan portfolio is highly diversified. The long-term goal of the overall
portfolio mix is to retain balance with approximately one third of the portfolio
in each of the commercial and industrial, commercial real estate, and
residential real estate categories. As of December 31, 2020, approximately 35.0%
of loans outstanding were commercial and industrial, while 28.5% of loans
outstanding were commercial real estate, and 30.6% of loans outstanding were
residential real estate. The commercial lending portfolio is also broadly
diversified by industry type as demonstrated by the following distributions at
December 31, 2020: real estate (32%), retail trade (12%), healthcare (7%),
finance & insurance (6%),wholesale trade (6%), construction (6%), professional
services (6%), manufacturing (5%), transportation (3%), agriculture, forestry,
fishing and hunting (3%), restaurant & lodging (2%), accommodation and food
services (2%) management of companies (2%), educational services (1%), and
administrative and support (1%). A variety of other industries with less than a
1% share of the total portfolio comprise the remaining 6%. The loan portfolio is
also diversified by market distribution with 48.4% of the portfolio in the Twin
Cities MSA, 39.8% in the eastern North Dakota cities of Grand Forks and Fargo,
9.7% in the Phoenix MSA and 2.1% in our national market, as of December 31,
2020.
We originate both fixed and adjustable rate residential real estate loans
conforming to the underwriting guidelines of the Federal National Mortgage
Association or the Federal Home Loan Mortgage Corporation, as well as home
equity loans and lines of credit that are secured by first or junior liens. Most
of our fixed rate residential loans, along with some of our adjustable rate
mortgages are sold to other financial institutions with which we have
established a correspondent lending relationship.
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Our consumer mortgage loans have minimal direct exposure to subprime mortgages
as the loans are underwritten to conform to secondary market standards. Volume
in this portion of the loan portfolio has been strong over the last few years
due to low long-term interest rates and comparatively stable real estate
valuations in our primary markets. As of December 31, 2020, our consumer
mortgage portfolio was $606.8 million which was a slight decline from $634.5
million as of December 31, 2019. Consumer mortgages had slightly decreased in
2019. Market interest rates, expected duration, and our overall interest rate
sensitivity profile continue to be the most significant factors in determining
whether we choose to retain versus sell portions of new consumer mortgage
originations.
The combined total of general-purpose business lending to commercial,
industrial, non-profit and municipal customers, mortgages on commercial property
and dealer floor plan financing is characterized as commercial lending activity.
As of December 31, 2020, the commercial loan portfolio was $1.3 billion, an
increase of $299.1 million, or 29.9%, from $1.0 billion as of December 31, 2019.
The increase was primarily due to $268.4 million in PPP loans. Highly
competitive conditions continue to prevail in the small and middle market
commercial segments in which we primarily operate. We maintain a commitment to
generating growth in our business portfolio in a manner that adheres to our twin
goals of maintaining strong asset quality and producing profitable margins. We
continue to invest in additional personnel, technology, and business development
resources to further strengthen our capabilities in this important product
category.
Consistent with regulatory guidance urging banks to work with borrowers during
this unprecedented situation, the Company offered a payment deferral program for
its lending clients that have been adversely affected by COVID-19. These
deferrals were generally no more than 90 days in duration. During 2020, the
Company had entered into principal and interest deferrals on 577 loans,
representing $153.6 million in principal balances. Of those loans, 18 loans with
a total outstanding principal balance of $8.4 million have been granted second
deferrals, 21 loans with a total outstanding principal balance of $3.7 million
remain on the first deferral and the remaining loans have been returned to
normal payment status. In accordance with the Interagency Statement on Loan
Modifications and Reporting for Financial Institutions as issued on April 7,
2020, these short-term deferrals were not considered TDRs. See “Note 6 Loans and
Allowance for Loan Losses” to the consolidated financial statements for
additional information regarding TDRs.
We anticipate that loan demand will be under pressure in the future for our
commercial and industrial, commercial real estate, residential real estate, and
consumer loan portfolios as a result of COVID-19 and the related decline in
economic conditions in our market areas.
The following table shows the maturities and type of interest rates for the loan
portfolio as of December 31, 2020:
December 31, 2020
After one
One year but within After
(dollars in thousands) or less five years five years Total
Commercial
Commercial and industrial $ 121,551$ 516,471$ 53,836$ 691,858
Real estate construction 6,091 15,957 22,403 44,451
Commercial real estate 41,419 221,197 300,391 563,007
Total commercial 169,061 753,625 376,630 1,299,316
Consumer
Residential real estate first mortgage 18,698 18,064 426,608 463,370
Residential real estate junior lien 15,518 48,798 79,100 143,416
Other revolving and installment 9,225 52,088 11,960 73,273
Total consumer 43,441 118,950 517,668 680,059
Total loans $ 212,502$ 872,575$ 894,298$ 1,979,375
Sensitivity of loans to changes in interest rates
Fixed interest rates $ 739,727$ 416,886
Floating interest rates 132,848 477,412
Total $ 872,575$ 894,298
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As of December 31, 2020, 61.8% of the loan portfolio bears interest at fixed
rates and 38.2% at floating rates. The expected life of our loan portfolio will
differ from contractual maturities because borrowers may have the right to
curtail or prepay their loans with or without penalties. Consequently, the table
above includes information limited to contractual maturities of the underlying
loans.
Asset Quality
Our strategy for credit risk management includes well-defined, centralized
credit policies; uniform underwriting criteria; and ongoing risk monitoring and
review processes for all commercial and consumer credit exposures. The strategy
also emphasizes diversification on a geographic, industry, and client level;
regular credit examinations; and management reviews of loans experiencing
deterioration of credit quality. We strive to identify potential problem loans
early, take necessary charge-offs promptly, and maintain adequate reserve levels
for probable loan losses inherent in the portfolio. Management performs ongoing,
internal reviews of any problem credits and continually assesses the adequacy of
the allowance. We utilize an internal lending division, Special Credit Services,
to develop and implement strategies for the management of individual
nonperforming loans.
Nonperforming assets consist of loans 90 days or more past due, nonaccrual
loans, foreclosed assets and other real estate owned. We do not consider
performing troubled debt restructurings, or TDRs, to be nonperforming assets,
but they are included as part of impaired assets. The level of nonaccrual loans
is an important element in assessing asset quality. Loans are classified as
nonaccrual when principal or interest is in default for 90 days or more, unless
in the opinion of management, the loan is well secured and in the process of
collection. Exclusive of any delinquency, a loan will be placed in nonaccrual
when there is deterioration in the financial condition of the borrower and full
payment of principal and interest is not expected.
A loan is categorized as a TDR if a concession is granted, such as to provide
for the reduction of either interest or principal due to deterioration in the
financial condition of the borrower. Typical concessions include reduction of
the interest rate on the loan to a rate considered lower than market and other
modification of terms including forgiveness of a portion of the loan balance,
extension of the maturity date, and/or modifications from principal and interest
payments to interest-only payments for a certain period. Loans are not
classified as TDRs when the modification is short-term or results in only an
insignificant delay or shortfall in the payments to be received. See “Note 6
Loans and Allowance for Loan Losses” to the consolidated financial statements
for additional information regarding TDRs.
Credit Quality Indicators
Loans are categorized into risk 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. A risk rating is
assigned to all commercial loans, except pools of homogeneous loans. We
periodically perform 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. 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 following definitions
are used for risk ratings:
Pass. Higher quality loans that do not fit any of the other categories described
below. This category includes loans risk rated with the following ratings:
minimal credit risk, modest credit risk, average credit risk, acceptable credit
risk, acceptable with risk and management attention.
Special Mention. Loans classified as special mention have a potential weakness
that deserves management’s close attention. If left uncorrected, these potential
weaknesses may result in deterioration of the repayment prospects for the loan
or of the institution’s credit position.
Substandard. Loans classified as substandard are inadequately protected by the
current net worth and paying capacity of the obligor or of the collateral
pledged, if any. Loans so classified have a well-defined weakness or
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weaknesses that jeopardize the liquidation of the debt. They are characterized
by the distinct possibility that the institution 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 liquidation in full, on the basis of currently existing
facts, conditions, and values, highly questionable and improbable.
Criticized loans represent loans that are categorized as special mention,
substandard, and doubtful. The following table presents criticized loans by type
as of December 31, 2020, 2019, and 2018:
December 31, December 31, December 31,
(dollars in thousands) 2020 2019 2018
Commercial
Commercial and industrial $ 22,256$ 30,838$ 51,141
Real estate construction – 1,259 1,055
Commercial real estate 29,274 32,409 32,785
Total commercial 51,530 64,506 84,981
Consumer
Residential real estate first mortgage 2,149 797 19
Residential real estate junior lien 2,955 1,251 2,485
Other revolving and installment 37
6 –
Total consumer 5,141 2,054 2,504
Total loans $ 56,671$ 66,560$ 87,485
Criticized loans as a percent of total loans 2.86 %
3.87 % 5.14 %
The following table presents information regarding nonperforming assets as of
the dates presented:
December 31, December 31,
December 31, December 31, December 31,
(dollars in thousands)
2020 2019 2018 2017 2016
Nonaccrual loans $ 5,050 $ 7,379
$ 6,963 $ 5,873 $ 7,616
Accruing loans 90+ days past due
30 448 – – 48
Total nonperforming loans 5,080 7,827 6,963 5,873 7,664
OREO and repossessed assets 63 8 204 483 1,917
Total nonperforming assets 5,143 7,835 7,167 6,356 9,581
Total restructured accruing loans 3,427 957 823 240 576
Total nonperforming assets and
restructured accruing loans $ 8,570 $ 8,792
$ 7,990 $ 6,596 $ 10,157
Nonperforming loans to total loans
0.26 % 0.45 % 0.41 % 0.37 % 0.56 %
Nonperforming assets to total assets 0.17 % 0.33 % 0.34 % 0.30 % 0.47 %
Allowance for loan losses to
nonperforming loans 674 % 306 % 318 % 282 % 205 %
Nonaccrual loans included nonperforming TDRs of $0.0 million, $0.0 million,
(1) $0.2 million, $0.7 million, and $1.5 million at the respective dates
indicated above.
Interest income lost on nonaccrual loans approximated $0.5 million,
$0.4 million, and $0.3 million for the years ended December 31, 2020, 2019, and
2018, respectively. There was no interest income included in net income related
to nonaccrual loans for the years ended December 31, 2020, 2019, and 2018.
Allowance for Loan Losses
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 and other factors. These evaluations
are inherently subjective as they require management to make material estimates,
all of which may be susceptible to significant change. The allowance is
increased by provisions charged to expense and decreased by actual charge-offs,
net of recoveries.
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The allowance for loan losses represents management’s assessment of probable
credit losses inherent in the loan portfolio. The allowance for loan losses
consists of specific components, based on individual evaluation of certain
loans, and general components for homogeneous pools of loans with similar risk
characteristics.
Impaired loans include loans placed on nonaccrual status and TDRs. Loans are
considered impaired when, based on current information and events, it is
probable that all amounts due, in accordance with the original contractual terms
of the loan agreement, will not be collected. When determining if all amounts
due in accordance with the original contractual terms of the loan agreement will
be collected, the borrower’s overall financial condition, resources and payment
record, support from guarantors, and the realizable value of any collateral, are
taken into consideration. Loans that experience insignificant payment delays and
payment shortfalls generally are not classified as impaired. Management
determines the significance of payment delays and payment shortfalls on a
case-by-case basis, taking into consideration all of the circumstances
surrounding the loan and the borrower, including the length of the delay, the
reasons for the delay, the borrower’s prior payment record, and the amount of
the shortfall in relation to the principal and interest owed.
All impaired loans are individually evaluated for impairment. If a loan is
impaired, a portion of the allowance is allocated so that the loan is reported,
net, at the discounted expected future cash flows or at the fair value of
collateral if repayment is collateral dependent.
The allowance for non-impaired loans is based on historical losses adjusted for
current qualitative factors. The historical loss experience is determined by
portfolio segment and is based on the actual loss history over the most recent
five years. This actual loss experience is adjusted for economic factors based
on the risks present for each portfolio segment. These economic factors include
consideration of the following: levels of and trends in delinquencies and
impaired loans; levels of and trends in charge-offs and recoveries; trends in
volume and terms of loans; effects of any changes in risk selection and
underwriting standards; other changes in lending policies, procedures, and
practices; experience, ability, and depth of lending management and other
relevant staff; national and local economic trends and conditions; industry
conditions; and effects of changes in credit concentrations. These factors are
inherently subjective and are driven by the repayment risk associated with each
portfolio segment. These portfolio segments include commercial and industrial,
real estate construction, commercial real estate, residential real estate first
mortgage, residential real estate junior liens, and other revolving and
installment.
In the ordinary course of business, we enter into commitments to extend credit,
including commitments under credit arrangements, commercial letters of credit,
and standby letters of credit. Such financial instruments are recorded when they
are funded. A reserve for unfunded commitments is established using historical
loss data and utilization assumptions. This reserve is located under accrued
expenses and other liabilities on the Consolidated Balance Sheets. The provision
for unfunded commitments was an expense of $800 thousand for the year ended
December 31, 2020 compared to a reversal of $308 thousand for the year ended
December 31, 2019.
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The following table presents, by loan type, the changes in the allowance for
loan losses for the periods presented.
Year ended
December 31,
(dollars in thousands) 2020 2019 2018 2017 2016
Balance-beginning of period $ 23,924$ 22,174$ 16,564$ 15,615$ 14,688
Commercial loan charge-offs
Commercial and Industrial (4,249) (6,540) (3,123) (3,287) (1,629)
Real estate construction – (1) (60) – (1,655)
Commercial real estate (865) – (600) – (43)
Total commercial loan charge-offs (5,114) (6,541) (3,783) (3,287) (3,327)
Consumer loan charge-offs
Residential real estate first
mortgage – – (29) – –
Residential real estate junior
lien (12) (465) (133) (1,124) (829)
Other revolving and installment (242) (572) (308) (429) (280)
Total consumer loan charge-offs (254) (1,037) (470) (1,553) (1,109)
Total loan charge-offs (5,368) (7,578) (4,253) (4,840) (4,436)
Commercial loan recoveries
Commercial and Industrial 4,352 1,470 750 930 1,084
Real estate construction – 3 2 279 587
Commercial real estate 97 150 81 73 188
Total commercial recoveries 4,449 1,623 833 1,282 1,859
Consumer loan recoveries
Residential real estate first
mortgage 5 – – 103 211
Residential real estate junior
lien 207 232 207 872 94
Other revolving and installment 129 161 213 252 139
Total consumer loan recoveries 341 393 420 1,227 444
Total loan recoveries 4,790 2,016 1,253 2,509 2,303
Net loan charge-offs (recoveries) 578 5,562 3,000 2,331 2,133
Commercial loan provision
Commercial and Industrial (2,168) 5,213 6,911 3,244 507
Real estate construction 355 51 (35) (416) 1,304
Commercial real estate 8,185 259 1,889 352 269
Total commercial loan provision 6,372 5,523 8,765 3,180 2,080
Consumer loan provision
Residential real estate first
mortgage 4,321 292 (226) 182 (328)
Residential real estate junior
lien 507 99 (171) 247 453
Other revolving and installment 514 383 (24) 276 16
Total consumer loan provision 5,342 774 (421) 705 141
Unallocated provision expense (814) 1,015
266 (605) 839
Total loan loss provision 10,900 7,312 8,610 3,280 3,060
Balance-end of period $ 34,246$ 23,924$ 22,174$ 16,564$ 15,615
Total loans $ 1,979,375$ 1,721,279$ 1,701,850$ 1,574,474$ 1,366,952
Average total loans 1,945,545 1,706,979 1,677,885 1,475,042 1,345,208
Allowance for loan losses to total
loans 1.73 % 1.39 % 1.30 % 1.05 % 1.14 %
Net charge-offs/(recoveries) to
average total loans (annualized) 0.03 % 0.33 %
0.18 % 0.16 % 0.16 %
The allowance for loan losses was $34.2 million at December 31, 2020, compared
to $23.9 million at December 31, 2019. The $10.3 million increase in the
allowance for loan losses was due to additional provision for loan losses of
$10.9 million due to additional qualitative factors related to borrowers
impacted by COVID-19, offset by net loan charge-offs of $578 thousand. The ratio
of nonperforming loans to total loans at December 31, 2020 was 0.26%, compared
to 0.45% at December 31, 2019. If PPP loans were excluded, the ratio of
nonperforming loans to total loans was at December 31, 2020 would have been
0.30%. The allowance for loan losses to total loans was 1.73% at December 31,
2020, compared to 1.39% at December 31, 2019. If PPP loans were excluded, the
allowance for loan losses to total loans would have been 2.00% at December
31,
2020.
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The following table presents the allocation of the allowance for loan losses as
of the dates presented.
December 31, 2020December 31, 2019
December 31, 2018 December 31, 2016 December 31, 2015
Percentage Percentage Percentage Percentage Percentage
Allocated of loans to Allocated of loans to Allocated of loans to Allocated of loans to Allocated of loans to
(dollars in
thousands) Allowance total loans Allowance total loans Allowance total loans Allowance total loans Allowance total loans
Commercial and
industrial $ 10,205 35.0 % $ 12,270 27.8 % $ 12,127 30.0 % $ 7,589 30.5 % $ 6,509 34.6 %
Real estate
construction 658 2.2 % 303 1.5 % 250 1.1 % 343 1.4 % 674 2.6 %
Commercial real
estate 14,105 28.5 % 6,688 28.8 % 6,279 25.9 % 4,909 28.3 % 4,484 28.6 %
Residential real
estate first
mortgage 5,774 23.4 % 1,448 26.6 % 1,156 26.3 % 1,411 22.2 % 1,037 14.8 %
Residential real
estate junior lien 1,373 7.2 % 671 10.3 % 805 11.1 % 902 12.4 % 907 13.1 %
Other revolving and
installment 753 3.7 % 352 5.0 % 380 5.6 % 499 5.2 % 488 6.3 %
Unallocated 1,378 – % 2,192 – % 1,177 – % 911 – % 1,516 – %
Total loans $ 34,246 100.0 % $ 23,924 100.0 % $ 22,174 100.0 % $ 16,564 100.0 % $ 15,615 100.0 %
Deposits
Total deposits were $2.57 billion as of December 31, 2020, an increase of $600.7
million, or 30.5%, from December 31, 2019. Interest-bearing deposits increased
$423.7 million while noninterest-bearing deposits increased $177.0 million. Key
drivers of the increase in deposits included strong deposit production of
deposits from new and existing PPP loan clients, synergistic deposit growth,
inflows from government stimulus programs and higher depositor balances due to
the uncertain economic environment and financial markets. The increase in
interest-bearing deposits included a $184.0 million increase in synergistic
deposits including HSA deposits from our retirement and benefit services and
wealth management segments, bringing our total deposits sourced outside of our
branch footprint to $595.6 million. Commercial transaction deposits increased
$289.5 million, or 35.5%, while consumer transaction deposits increased $108.1
million, or 20.2%, since December 31, 2019. Noninterest-bearing deposits as a
percentage of total deposits were 29.3% as of December 31, 2020 and 2019.
Interest-bearing deposit costs were 0.53% and 1.03% for the years ended
December 31, 2020 and 2019, respectively. The decrease in interest-bearing
deposit costs resulted from the low interest rate environment due to the Federal
Reserve’s response to COVID-19.
We compete for local deposits by offering products with competitive rates and
rely on the deposit portfolio to fund loans and other asset growth. Management
understands the importance of core deposits as a stable source of funding and
may periodically implement various deposit promotion strategies to encourage
core deposit growth. For periods of rising interest rates, management has
modeled the aggregate yields for non-maturity deposits and time deposits to
increase at a slower pace than the increase in underlying market rates, which
results in net interest margin expansion and projections of an increase in net
interest income. The mix of average deposits has been changing throughout the
last several years. The weighting of core funds (noninterest checking, interest
checking, savings, and money market accounts) has increased, while time
deposits’ weighting has decreased. This change in deposit mix reflects our focus
on expanding core account relationships and customers’ preference for
unrestricted accounts in the low interest rate environment.
The following table details the average balance and rate of our deposit
portfolio by category for the periods indicated.
Year ended Year ended Year ended
December 31, 2020 December 31, 2019 December 31, 2018
Average Average Average Average Average Average
(dollars in thousands) Balance Rate Balance Rate Balance Rate
Noninterest-bearing demand $ 673,676 – % $ 512,586
– % $ 528,552 – %
Interest-bearing demand 551,861 0.29 % 428,162 0.47 % 405,512 0.25 %
Money market and savings 920,072 0.53 % 681,621 1.22 % 626,041 0.63 %
Time deposits 203,413 1.16 % 186,781 1.62 % 206,846 0.97 %
Total deposits (1) $ 2,349,022 0.38 % $ 1,809,150 0.74 % $ 1,766,951 0.56 %
(1) Includes deposits held for sale at 2018.
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The following table shows the contractual maturity of time deposits, including
certificate of deposit account registry services, or CDARS, and IRA deposits of
$100 thousand and over, that were outstanding as of the date presented.
December 31,
(dollars in thousands) 2020
Maturing in:
3 months or less $ 49,627
3 months to 6 months 62,809
6 months to 1 year 6,718
1 year or greater 8,818
Total $ 127,972
Borrowings and Subordinated Debt
We utilize both short-term and long-term borrowings as part of our
asset/liability management and funding strategies. Short-term borrowings
consists of FHLB advances and federal funds purchased. We had no short-term
borrowings outstanding at December 31, 2020 or December 31, 2019.
FHLB advances were secured by specific investment securities and real estate
loans with a carrying amount of approximately $943.5 million and $881.2 million
at December 31, 2020 and 2019, respectively.
Long-term debt is utilized to fund longer term assets and as a source of
regulatory capital. At December 31, 2020, we had $50.0 million of outstanding
5.75% Fixed to Floating Rate Subordinated Notes due 2025, or Subordinated Notes.
The Subordinated Notes currently bear interest at a fixed rate of 5.75%
per year, payable semi-annually through December 30, 2020, and then convert
automatically to floating rate notes that reset quarterly to an interest rate
equal to the three-month LIBOR plus 412 basis points. The Subordinated Notes
mature on December 30, 2025, and we have the option to redeem or prepay any or
all of the Subordinated Notes without premium or penalty any time after
December 30, 2020 or at any time in the event of certain changes that affect the
deductibility of interest for tax purposes or the treatment of the notes as
Tier 2 Capital.
On December 29, 2020, we gave notice pursuant to Section 4(b) of the
Subordinated Notes, that the entire aggregate $50.0 million outstanding
principal amount of the Subordinated Notes is being called for redemption on
Friday, January 29, 2021, the Redemption Date. On the Redemption Date, holders
of record of the Subordinated Notes were paid 100 % of the outstanding principal
amount of each Subordinated Note plus accrued and unpaid interest thereon to,
but excluding, the Redemption Date. See Note 32 (Subsequent Events) of the
Company’s audited consolidated financial statements included elsewhere in this
report.
Junior subordinated debentures issued to capital trusts that issued trust
preferred securities were $8.6 million as of December 31, 2020, compared to
$8.5 million as of December 31, 2019. The increase was due to purchase
accounting amortization on the junior subordinated notes assumed in the Beacon
Bank acquisition. See Note 14 (Long-Term Debt) of the Company’s audited
consolidated financial statements included elsewhere in this report.
Selected financial information pertaining to the components of our borrowings
and subordinated debt as of the dates indicated is as follows:
December 31, 2020 December 31, 2019 December 31, 2018
Percent of Percent of Percent of
(dollars in thousands) Balance Portfolio Balance Portfolio Balance Portfolio
Fed funds purchased $ – – % $ – – % $ 93,460 61.4 %
Subordinated notes 49,688 84.6 % 49,625 84.4 % 49,562 32.5 %
Junior subordinated debentures 8,617 14.7 % 8,504
14.5 % 8,392 5.5 %
Finance lease liability 430 0.7 % 640 1.1 % 870 0.6 %
Total borrowed funds $ 58,735 100.0 % $ 58,769 100.0 % $ 152,284 100.0 %
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Capital Resources
The following table summarizes the changes in our stockholders’ equity for the
periods indicated.
For the years ended December 31,
(dollars in thousands) 2020 2019 2018
Beginning balance $ 285,728$ 196,954$ 179,594
Net income 44,675 29,540 25,866
Other comprehensive income (loss) 8,702
5,537 (2,541)
Common stock repurchased (482) (1,948) (356)
Common stock dividends (10,387) (8,909) (7,456)
Stockbased compensation expense 1,927 1,750 1,847
Initial public offering of 3,289,000 shares of common
stock net of issuance costs – 62,804 –
Ending balance $ 330,163$ 285,728$ 196,954
Total stockholders’ equity was $330.2 million at December 31, 2020, compared to
$285.7 million at December 31, 2019. The increase was primarily due to $44.7
million of net income and $8.7 million in accumulated other comprehensive income
and partially offset by $10.4 million in common stock dividends.
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.
During the first quarter of 2015, regulations implementing the Basel III
regulatory capital framework and the Dodd-Frank Act became effective, which
include requirements that were subject to a multi-year phase-in period. These
rules modified the calculation of the various capital ratios, added a new ratio,
the Common Equity Tier 1 Capital ratio, and revised the adequately and well
capitalized thresholds. As of January 1, 2019, the rules require us to maintain
a capital conservation buffer of common equity capital that exceeds by more than
2.50% the minimum risk weighted asset ratios. The capital conservation buffer
requirement was 2.50%, 2.50%, and 1.875% as of December 31, 2020, 2019, and
2018, respectively, which is not reflected in the table below.
At December 31, 2020, 2019, and 2018, we met all the capital adequacy
requirements to which we were subject.
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The table below sets forth the capital ratios for the Company and the Bank as of
the dates indicated. See Note 26 (Regulatory Matters) for additional
disclosures.
December 31, December 31, December 31,
Capital Ratios 2020 2019 2018
Alerus Financial Corporation
Common equity tier 1 capital to risk weighted assets 12.75 % 12.48 % 8.43 %
Tier 1 capital to risk weighted assets 13.15 % 12.90 % 8.87 %
Total capital to risk weighted assets 16.79 % 16.73 % 12.86 %
Tier 1 capital to average assets 9.24 % 11.05 % 7.51 %
Tangible common equity to tangible assets (1) 9.27 % 10.38 % 6.91 %
Alerus Financial, National Association
Common equity tier 1 capital to risk weighted assets 12.10 % 11.91 % 11.39 %
Tier 1 capital to risk weighted assets 12.10 % 11.91 % 11.39 %
Total capital to risk weighted assets 13.36 % 13.15 % 12.62 %
Tier 1 capital to average assets 8.50 % 10.20 % 9.63 %
(1) Represents a non-GAAP financial measure. See “Non-GAAP to GAAP
Reconciliations and Calculation of Non-GAAP Financial Measures.”
Contractual Obligations and Off-Balance Sheet Arrangements
Off-Balance Sheet Arrangements
In the normal course of business, we enter into various transactions to meet the
financing needs of clients, which, in accordance with GAAP, are not included in
the consolidated balance sheets. These transactions include commitments to
extend credit, standby letters of credit, and commercial letters of credit,
which involve, to varying degrees, elements of credit risk and interest rate
risk in excess of the amounts recognized in the consolidated balance sheets.
Most of these commitments are expected to expire without being drawn upon. All
off-balance sheet commitments are included in the determination of the amount of
risk-based capital that the Company and the Bank are required to hold.
Our exposure to credit loss in the event of non-performance by the other party
to the financial instrument for commitments to extend credit, standby letters of
credit, and commercial letters of credit is represented by the contractual or
notional amount of those instruments. We decrease our exposure to losses under
these commitments by subjecting them to credit approval and monitoring
procedures. We assess the credit risk associated with certain commitments to
extend credit and establishes a liability for probable credit losses.
Further information related to financial instruments can be found in Note 16
(Financial Instruments with Off-Balance Sheet Risk) in the notes to the
consolidated financial statements found elsewhere in this report.
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Contractual Obligations
In the ordinary course of our operations, we enter into certain contractual
obligations. The following table presents our contractual obligations as of
December 31, 2020.
December 31, 2020
Less than One to Three to Over
(dollars in thousands) one year three years five years five years Total
Operating lease obligations $ 1,788$ 3,410$ 1,492$ 1,597$ 8,287
Time deposits 183,811 15,018 5,897 4,612 209,338
Subordinated notes payable – – 49,688 – 49,688
Junior subordinated debenture
(Trust I) – – – 3,447 3,447
Junior subordinated debenture
(Trust II) – – – 5,170 5,170
Finance lease liability 251 209 – – 460
Total contractual obligations $ 185,850$ 18,637$ 57,077$ 14,826$ 276,390
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 ALCO, a group of senior officers from the finance, enterprise risk
management, deposit, investment, treasury, and lending areas. It is 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. 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.
At December 31, 2020, we had on balance sheet liquidity of $511.1 million,
compared to $250.7 million at December 31, 2019 and $152.1 million at
December 31, 2018. On balance sheet liquidity includes total due from banks,
federal funds sold, interest-bearing deposits with banks, unencumbered
securities available-for-sale and over collateralized securities pledging
position.
The Bank is a member of the FHLB, which provides short- and long-term funding to
its members through advances collateralized by real estate-related assets and
other select collateral, most typically in the form of debt securities. The
actual borrowing capacity is contingent on the amount of collateral available to
be pledged to the FHLB. As of December 31, 2020 we had $943.5 million of
collateral pledged to the FHLB. Based on this collateral we are eligible to
borrow up to $631.7 million and had $631.7 million available capacity as of
December 31, 2020. In addition, we can borrow up to $102.0 million through
unsecured lines of credit we have established with four other banks.
In addition, because the Bank is “well capitalized,” we can accept wholesale
deposits up to 20.0% of total assets based on current policy limits. Management
believed that we had adequate resources to fund all of our commitments as of
December 31, 2020 and December 31, 2019.
Our primary sources of liquidity include liquid assets, as well as unencumbered
securities that can be used to collateralize additional funding. At December 31,
2020, we had $173.0 million of cash and cash equivalents of which $143.3 million
were interest-earning deposits held at the Federal Reserve, FHLB and other
correspondent banks.
Though remote, the possibility of a funding crisis exists at all financial
institutions. The economic impact of COVID-19 could place increased demand on
our liquidity if we experience significant credit deterioration and as we meet
borrower’s 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.
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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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