ALRS US Equity☆

ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

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.

62

Table of Contents

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:

63

Table of Contents

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:

64

Table of Contents

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:

65

Table of Contents

Noninterest Expense

Noninterest expense is comprised primarily of the following:

66

Table of Contents

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

67

Table of Contents

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.

68

Table of Contents

​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​

​ ​ As of and for the year ended December 31, ​

Selected Income Statement Data ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​

Less: preferred stock dividends ​ ​ — ​ ​ — ​ ​ — ​ ​ — ​ ​ 25 ​

Per Common Share Data ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​

Selected Performance Ratios ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​

Selected Balance Sheet Data - Period Ending ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​

Asset Quality Ratios ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​

Other Data ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​

(3) Excludes loans held for branch sale at 2018.

(4) Excludes deposits held for sale at 2018.

(5) Includes ESOP-owned shares.

69

Table of Contents

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,

Tangible common equity to tangible assets ​ ​ ​ ​ ​ ​ ​ ​ ​ ​

Tangible book value per common share ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​

​

70

Table of Contents

​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​

​ ​ December 31, ​ December 31, ​ December 31, ​ December 31, ​ December 31, ​

Return on average tangible common equity ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​

Less: Preferred stock dividends ​ ​ — ​ ​ — ​ ​ — ​ ​ — ​ ​ 25 ​

Remeasurement due to tax reform ​ ​ — ​ ​ — ​ ​ — ​ ​ 4,818 ​ ​ — ​

Less: Average preferred stock ​ ​ — ​ ​ — ​ ​ — ​ ​ — ​ ​ 2,514 ​

Net interest margin (tax-equivalent) ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​

Efficiency ratio ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​

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 ​ ​ ​ ​

​

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

71

Table of Contents

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

72

Table of Contents

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, ​

​ ​ ​ Interest Average ​ ​ Interest Average ​ ​ Interest Average ​

Interest Earning Assets ​ ​ ​ ​ ​ ​ ​ ​ ​

Loans ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​

Commercial: ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​

Consumer ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​

Interest-Bearing Liabilities ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​

Other noninterest-bearing liabilities ​ 57,088 ​ ​ ​ 41,549 ​ ​ ​ ​ 29,450 ​ ​ ​

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.

73

Table of Contents

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

Interest earning assets ​ ​ ​ ​ ​ ​ ​ ​ ​

Loans ​ ​ ​ ​ ​ ​ ​

Commercial: ​ ​ ​ ​ ​ ​ ​

Consumer ​ ​ ​ ​ ​ ​ ​

Federal Reserve/FHLB Stock ​ (143) ​ (31) ​ (174) ​ ​ (31) ​ (2) ​ (33)

Interest-bearing liabilities ​ ​ ​ ​ ​ ​ ​

(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.”

74

Table of Contents

Noninterest Income

The following table presents noninterest income for the years ended December 31, 2020, 2019, and 2018.

​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​

​ ​ Year ended December 31,

​

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, ​

​

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

75

Table of Contents

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.

76

Table of Contents

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, ​

Acquired assets ​ ​ 1,258,382 ​ ​ — ​ ​ — ​

(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.

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.

77

Table of Contents

The following table presents changes in the wealth management combined AUA and AUM, disaggregated by product, for the periods presented.

​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​

​ ​ Year ended ​

​ ​ December 31, ​

(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.

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.

78

Table of Contents

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:

​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​

​ ​ ​ ​ ​ Percent of ​ ​ ​ ​ Percent of ​ ​ ​ ​ Percent of ​

(dollars in thousands) Balance Portfolio Balance Portfolio Balance Portfolio ​

Trading ​ $ — ​ — % $ — ​ — % $ 1,539 ​ 0.6 %

Available-for-sale ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​

Mortgage backed securities ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​

Asset backed securities ​ ​ 115 ​ — % ​ 144 ​ — % ​ 399 ​ 0.2 %

​

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.

79

Table of Contents

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

Available-for-sale ​ ​ ​ ​ ​

U.S. Treasury and agencies ​ $ — — % $ — — % $ 1,530 0.92 % $ 4,377 0.71 %

Mortgage backed securities ​ ​ ​ ​ ​ ​

Asset backed securities ​ — — % — — % — — % 115 5.40 %

​

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

80

Table of Contents

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:

​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​

Commercial ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​

Consumer ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​

(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.

81

Table of Contents

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:

​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​

​ ​ ​ ​ ​ After one ​ ​ ​ ​ ​ ​

​ ​ One year ​ but within ​ After ​ ​ ​

(dollars in thousands) or less five years five years Total

Commercial ​ ​ ​ ​

Consumer ​ ​ ​ ​

Sensitivity of loans to changes in interest rates ​ ​ ​ ​

​

82

Table of Contents

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

83

Table of Contents

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, ​

Commercial ​ ​ ​ ​ ​ ​ ​ ​

Real estate construction ​ — ​ ​ 1,259 ​ ​ 1,055 ​

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 ​ ​ — ​

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, ​

Accruing loans 90+ days past due ​ 30 ​ 448 ​ — ​ — ​ 48

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.

84

Table of Contents

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.

85

Table of Contents

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

​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​

​ ​ Year ended ​

​ ​ December 31, ​

Commercial loan charge-offs ​ ​ ​ ​ ​ ​ ​ ​ ​

Real estate construction ​ — ​ (1) ​ ​ (60) ​ ​ — ​ ​ (1,655) ​

Commercial real estate ​ (865) ​ — ​ ​ (600) ​ ​ — ​ ​ (43) ​

Consumer loan charge-offs ​ ​ ​ ​ ​ ​ ​ ​ ​

Residential real estate first mortgage ​ — ​ — ​ ​ (29) ​ ​ — ​ ​ — ​

Other revolving and installment ​ (242) ​ (572) ​ ​ (308) ​ ​ (429) ​ ​ (280) ​

Commercial loan recoveries ​ ​ ​ ​ ​ ​ ​ ​ ​

Real estate construction ​ — ​ 3 ​ ​ 2 ​ ​ 279 ​ ​ 587 ​

Consumer loan recoveries ​ ​ ​ ​ ​ ​ ​ ​ ​

Residential real estate first mortgage ​ 5 ​ — ​ ​ — ​ ​ 103 ​ ​ 211 ​

Residential real estate junior lien ​ 207 ​ 232 ​ ​ 207 ​ ​ 872 ​ ​ 94 ​

Commercial loan provision ​ ​ ​ ​ ​ ​ ​ ​ ​

Consumer loan provision ​ ​ ​ ​ ​ ​ ​ ​ ​

Residential real estate junior lien ​ 507 ​ 99 ​ ​ (171) ​ ​ 247 ​ ​ 453 ​

Other revolving and installment ​ 514 ​ 383 ​ ​ (24) ​ ​ 276 ​ ​ 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.

86

Table of Contents

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

​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​

​

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 ​

​ ​ Average ​ Average ​ Average ​ Average ​ Average ​ Average ​

(dollars in thousands) Balance Rate Balance Rate Balance Rate

(1) Includes deposits held for sale at 2018.

87

Table of Contents

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: ​

​

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:

​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​

​ ​ ​ ​ ​ Percent of ​ ​ ​ ​ Percent of ​ ​ ​ ​ Percent of ​

(dollars in thousands) Balance Portfolio Balance Portfolio Balance Portfolio

Fed funds purchased $ — — % $ — ​ — % $ 93,460 61.4 %

​

88

Table of Contents

Capital Resources

The following table summarizes the changes in our stockholders’ equity for the periods indicated.

​ ​ ​ ​ ​ ​ ​ ​ ​ ​

​ ​ For the years ended December 31,

​

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.

89

Table of Contents

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, ​

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 %

Total capital to risk weighted assets ​ 13.36 % 13.15 % 12.62 %

Tier 1 capital to average assets ​ 8.50 % 10.20 % 9.63 %

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.

90

Table of Contents

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.

​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​

​ ​ Less than ​ One to ​ Three to ​ Over ​ ​ ​

(dollars in thousands) one year three years five years five years Total

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

​

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.

91

Table of Contents

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

ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

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

Interest Rate Risk

Interest rate risk management is an active process that encompasses monitoring loan and deposit flows complemented by investment and funding activities. The objectives of interest rate risk management are to control exposure of net interest income changes associated with interest rate movements and to achieve sustainable growth in net interest income. Effective interest rate risk management begins with understanding the dynamic characteristics of assets and liabilities and determining the appropriate interest rate risk position given business activities, management objectives, market expectations and ALCO policy limits and guidelines.

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

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

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

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

92

Table of Contents

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

The estimated impact on our net interest income in hypothetical rising and declining rate scenarios assuming immediate, parallel moves in interest rates, calculated as of December 31, 2020 and December 31, 2019, are presented in the table below.

​ ​ ​ ​ ​ ​ ​ ​ ​ ​

​ Following Following Following Following

​ ​ 12 months ​ 24 months ​ 12 months ​ 24 months

−200 basis points N/A % N/A % N/A % N/A %

​

The above interest rate simulation suggests that the Corporation’s balance sheet is asset sensitive as of December 31, 2020, demonstrating that an increase in interest rates would have a positive impact on net interest income over the next 12 and 24 months. The balance sheet was more asset sensitive in a rising-rate environment as of December 31, 2020 than it was as of December 31, 2019. The increase is primarily related to a change in the mix and repricing characteristics of our liabilities along with an increase cash and cash equivalents.

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

Management uses economic value of equity sensitivity analysis to understand the impact of interest rate changes on long-term cash flows, income, and capital. Economic value of equity is based on discounting the cash flows for all balance sheet instruments under different interest rate scenarios. Deposit premiums are based on external industry studies and utilizing historical experience.

The table below presents the change in the economic value of equity as of December 31, 2020 and December 31, 2019, assuming immediate parallel shifts in interest rates.

​ ​ ​ ​ ​ ​

​ ​ December 31, ​ December 31,

−200 basis points N/A % N/A %

​

Operational Risk

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

93

Table of Contents

Compliance Risk

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

Strategic and/or Reputation Risk

Strategic and/or reputation risk represents the risk of loss due to impairment of reputation, failure to fully develop and execute business plans, failure to assess current and new opportunities in business, markets and products, and any other event not identified in the defined risk types mentioned previously. Mitigation of the various risk elements that represent strategic and/or reputation risk is achieved through initiatives to help management better understand and report on various risks, including those related to the development of new products and business initiatives.

​

94

Table of Contents

ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

​

​

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

To the Stockholders and the Board of Directors of Alerus Financial Corporation

Opinion on the Financial Statements

We have audited the accompanying consolidated balance sheets of Alerus Financial Corporation and Subsidiaries (the “Company”) as of December 31, 2020 and 2019, the related consolidated statements of income, comprehensive income, changes in stockholders’ equity, and cash flows for each of the three years in the period ended December 31, 2020, and the related notes (collectively referred to as the “financial statements”). In our opinion, the financial statements present fairly, in all material respects, the financial position of the Company as of December 31, 2020 and 2019, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 2020, in conformity with accounting principles generally accepted in the United States of America.

Basis for Opinion

These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on the Company’s financial statements based on our audits. We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States) (“PCAOB”) and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.

We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether due to error or fraud. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting in accordance with the standards of the PCAOB. As part of our audits, we are required to obtain an understanding of internal control over financial reporting, but not for the purpose of expressing an opinion on the effectiveness of the Company's internal control over financial reporting in accordance with the standards of the PCAOB. Accordingly, we express no such opinion.

Our audits included performing procedures to assess the risks of material misstatement of the financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the financial statements. We believe that our audits provide a reasonable basis for our opinion.

/s/ CliftonLarsonAllen LLP

Minneapolis, Minnesota

March 12, 2021

We have served as the Company’s auditor since 2014.

​

95

Table of Contents

Alerus Financial Corporation and Subsidiaries

Consolidated Balance Sheets

​ ​ ​ ​ ​ ​ ​

​ December 31, December 31,

(dollars in thousands, except share and per share data) 2020 2019

Assets ​ ​ ​

Investment securities, at fair value ​ ​

Land, premises and equipment, net ​ 20,289 ​ 20,629

Operating lease right-of-use assets ​ 6,918 ​ 8,343

Accrued interest receivable ​ 9,662 ​ 7,551

Deferred income taxes, net ​ 9,409 ​ 7,891

Liabilities and Stockholders’ Equity ​ ​

Deposits ​ ​

Operating lease liabilities ​ 7,861 ​ 8,864

Accrued expenses and other liabilities ​ 45,019 ​ 32,201

Stockholders’ equity ​ ​

Accumulated other comprehensive income (loss) ​ 10,638 ​ 1,936

​

See Accompanying Notes to Consolidated Financial Statements

Alerus Financial Corporation

​

96

Table of Contents

Alerus Financial Corporation and Subsidiaries

Consolidated Statements of Income

​ ​ ​ ​ ​ ​ ​ ​ ​ ​

​ ​ Year ended

​ ​ December 31,

(dollars and shares in thousands, except per share data) 2020 2019 2018

Interest Income ​ ​ ​ ​ ​ ​ ​ ​ ​

Investment securities ​ ​ ​ ​

Exempt from federal income taxes ​ 949 ​ 798 ​ ​ 1,234

Interest Expense ​ ​ ​ ​

Short-term borrowings ​ — ​ 1,805 ​ ​ 1,896

Net interest income after provision for loan losses ​ 72,946 ​ 67,239 ​ ​ 66,614

Noninterest Income ​ ​ ​ ​

Service charges on deposit accounts ​ 1,409 ​ 1,772 ​ ​ 1,808

Net gains (losses) on investment securities ​ 2,737 ​ 357 ​ ​ 85

Noninterest Expense ​ ​ ​ ​

Business services, software and technology expense ​ 19,124 ​ 16,381 ​ ​ 14,525

Per Common Share Data ​ ​ ​ ​ ​ ​ ​ ​ ​

Basic earnings per common share ​ $ 2.57 ​ $ 1.96 ​ $ 1.88

Diluted earnings per common share ​ $ 2.52 ​ $ 1.91 ​ $ 1.84

Dividends declared per common share ​ $ 0.60 ​ $ 0.57 ​ $ 0.53

​

See Accompanying Notes to Consolidated Financial Statements

Alerus Financial Corporation

​

97

Table of Contents

Alerus Financial Corporation and Subsidiaries

Consolidated Statements of Comprehensive Income

​ ​ ​ ​ ​ ​ ​ ​ ​ ​

​ ​ Year ended

​ ​ December 31,

Other Comprehensive Income (Loss), Net of Tax ​ ​ ​ ​ ​

Total other comprehensive income (loss), before tax ​ 11,618 ​ 7,394 ​ ​ (3,393)

Other comprehensive income (loss), net of tax ​ 8,702 ​ 5,537 ​ ​ (2,541)

​

See Accompanying Notes to Consolidated Financial Statements

Alerus Financial Corporation

​

98

Table of Contents

Alerus Financial Corporation and Subsidiaries

Consolidated Statements of Changes in Stockholders’ Equity

​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​

​ ​ Year ended December 31, 2020

​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ Accumulated ​ ​ ​ ​ ​ ​

​ ​ ​ ​ ​ Additional ​ ​ ​ ​ Other ​ ESOP- ​ ​ ​

​ ​ Common ​ Paid-in ​ Retained ​ Comprehensive ​ Owned ​ ​ ​

Other comprehensive income (loss) ​ — ​ — ​ — ​ 8,702 ​ — ​ 8,702

Common stock repurchased ​ (16) ​ (249) ​ (217) ​ — ​ — ​ (482)

Common stock dividends ​ — ​ — ​ (10,387) ​ — ​ — ​ (10,387)

Share‐based compensation expense ​ 14 ​ 1,913 ​ — ​ — ​ — ​ 1,927

Vesting of restricted stock ​ 77 ​ (77) ​ — ​ — ​ — ​ —

​

​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​

​ ​ Year ended December 31, 2019

​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ Accumulated ​ ​ ​ ​ ​ ​

​ ​ ​ ​ ​ Additional ​ ​ ​ ​ Other ​ ESOP- ​ ​ ​

​ ​ Common ​ Paid-in ​ Retained ​ Comprehensive ​ Owned ​ ​ ​

(dollars in thousands) Stock Capital Earnings Income (Loss) Shares Total

Other comprehensive income (loss) ​ — ​ — ​ — ​ 5,537 ​ — ​ 5,537

Common stock repurchased ​ (81) ​ (291) ​ (1,576) ​ — ​ — ​ (1,948)

Common stock dividends ​ — ​ — ​ (8,909) ​ — ​ — ​ (8,909)

ESOP repurchase obligation termination ​ — ​ — ​ — ​ — ​ 34,494 ​ 34,494

Share‐based compensation expense ​ 13 ​ 1,737 ​ — ​ — ​ — ​ 1,750

Vesting of restricted stock ​ 54 ​ (54) ​ — ​ — ​ — ​ —

​

​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​

​ ​ Year ended December 31, 2018

​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ Accumulated ​ ​ ​ ​ ​ ​

​ ​ ​ ​ ​ Additional ​ ​ ​ ​ Other ​ ESOP- ​ ​ ​

​ ​ Common ​ Paid-in ​ Retained ​ Comprehensive ​ Owned ​ ​ ​

Adjustment for adoption of ASU 2016-01 — ​ — ​ (71) ​ 71 ​ — —

Other comprehensive income (loss) — ​ — ​ — ​ (2,541) ​ — (2,541)

Common stock repurchased (15) ​ (53) ​ (288) ​ — ​ — (356)

Common stock dividends — ​ — ​ (7,456) ​ — ​ — (7,456)

Net change in fair value of ESOP shares — ​ — ​ — ​ — ​ (3,003) (3,003)

Share‐based compensation expense 11 ​ 1,836 ​ — ​ — ​ — 1,847

Vesting of restricted stock 80 ​ (80) ​ — ​ — ​ — —

​

See Accompanying Notes to Consolidated Financial Statements

Alerus Financial Corporation

99

Table of Contents

Alerus Financial Corporation and Subsidiaries

Consolidated Statements of Cash Flows

​ ​ ​ ​ ​ ​ ​ ​ ​ ​

​ ​ Year ended

​ ​ December 31,

Operating Activities ​ ​ ​ ​ ​

Provision for foreclosed asset losses ​ ​ — ​ ​ — ​ ​ 245

Amortization of operating lease right-of-use assets ​ ​ (25) ​ ​ — ​ ​ —

Increase in value of bank-owned life insurance ​ (797) ​ (803) ​ (804)

Realized loss (gain) on sale of branch ​ — ​ (1,544) ​ —

Realized loss (gain) on sale of fixed assets ​ ​ 707 ​ (541) ​ (11)

Realized loss (gain) on derivative instruments ​ 1,927 ​ (2,051) ​ 1

Realized loss (gain) on sale of foreclosed assets ​ (28) ​ (122) ​ (114)

Realized loss (gain) on sale of investment securities ​ (2,737) ​ (357) ​ (129)

Realized loss (gain) on servicing rights ​ 936 ​ (209) ​ (577)

Net change in: ​ ​ ​ ​ ​ ​

Securities held for trading ​ — ​ 1,539 ​ 406

Accrued interest receivable ​ (2,111) ​ 12 ​ (828)

Accrued expenses and other liabilities ​ (5,527) ​ 2,179 ​ 832

Net cash provided (used) by operating activities ​ (22,262) ​ 19,248 ​ 53,553

Investing Activities ​ ​ ​

Net (increase) decrease in equity securities ​ 2,808 ​ 357 ​ 2,280

Payment to FDIC for termination of loss share agreements ​ ​ — ​ ​ — ​ ​ (3,000)

Net cash paid for business combinations ​ ​ (9,279) ​ ​ — ​ ​ —

Proceeds from sale of branch ​ — ​ 10,379 ​ —