ALRS · Read the filing

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

The following discussion and analysis of the Company’s financial condition and results of operations should be read in conjunction with the “Selected Financial Data” and the Company’s 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. The Company assumes no obligation to update any of these forward-looking statements.

Overview

The Company is a diversified financial services company headquartered in Grand Forks, North Dakota. Through the Company’s subsidiary, Alerus Financial, National Association, the Company provides innovative and comprehensive financial solutions to businesses and consumers through four distinct business lines—banking, retirement

Table of Contents

and benefit services, wealth management and mortgage. These solutions are delivered through a relationship oriented primary point of contact along with responsive and client friendly technology.

The Company’s 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 the Company’s offices located in the Company’s banking markets, its retirement and benefit services business administers plans in all 50 states through offices located in Michigan, Minnesota and Colorado.

The Company’s business model produces strong financial performance and a diversified revenue stream, which has helped the Company establish a brand and culture yielding both a loyal client base and passionate and dedicated employees. The Company believes its client first and advice based philosophy, diversified business model and history of high performance and growth distinguishes the Company from other financial service providers. The Company generates a majority of its overall revenue from noninterest income, which is driven primarily by the Company’s retirement and benefit services, wealth management and mortgage business lines.

As of December 31, 2023, the Company had $3.9 billion of total assets, $2.8 billion of total loans, $3.1 billion of total deposits, $369.1 million of stockholders’ equity, $36.7 billion of AUA/AUM in the Company’s retirement and benefit services segment, and $4.0 billion of AUA/AUM in the Company’s wealth management segment. For the year ended December 31, 2023, the Company had $364.1 million of mortgage originations.

Net Interest Income

Net interest income represents interest income less interest expense. The Company generates interest income on interest-earning assets, primarily loans and available-for-sale securities. The Company incurs interest expense on interest-bearing liabilities, primarily interest-bearing deposits and borrowings. To evaluate net interest income, the Company measures and monitors: (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 the Company earns on interest-earning assets or pay on interest-bearing liabilities.

Noninterest Income

Noninterest income primarily consists of the following:

Table of Contents

Noninterest Expense

Noninterest expense is comprised primarily of the following:

Table of Contents

Operating Segments

The Company measures the overall profitability of business operations based on income before income tax. The Company allocates costs to its 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. The Company measures the profitability of each segment based on the direct and indirect allocations of expense as it believes it better approximates the contribution generated by the Company’s reportable operating segments. All indirect overhead allocations to each segment are determined by management based on an annual review of department expenses. 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 in Item 8 of this Form 10-K.

Critical Accounting Policies

As a result of the complex and dynamic nature of the Company’s 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 the Company’s 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 is discussed below.

Allowance for credit losses (“ACL”)— In 2023, the Company adopted the new accounting standard for credit losses, ASU No. 2016-13, Financial Instruments - Credit Losses(Topic 326):Measurement of Credit Losses on Financial Instruments, as amended (“ASU 2016-13”). This new accounting standard, commonly referred to as “CECL,” significantly changed the Company’s methodology for accounting for reserves on loans, unfunded off balance sheet credit exposures, including certain unfunded loan commitments and standby guarantees, as well as introduced the consideration for an allowance on HTM investment securities. ASU 2016-13 replaced the “incurred loss” methodology used prior to 2023 to establish an allowance on loans and off-balance sheet credit exposures, with an “expected loss” approach. Under CECL, the ACL at each reporting period serves as our best estimate of projected credit losses over the contractual life of certain assets, adjusted for expected prepayments, given an expectation of economic conditions and forecasts as of the valuation date.

The recorded ACL on loans and HTM investment securities is determined based on the amortized cost basis of the assets and may be determined at various levels, including homogeneous loan pools, individual credits with unique risk factors, and homogenous HTM investment securities pools, by credit rating. Since adoption of CECL in 2023, the Company has used a discounted cash flow approach to calculate the ACL for each loan segment. Within the discounted cash flow model, a probability of default (“PD”) and loss given default (“LGD”) assumption is applied to calculate the expected loss for each loan segment. PD is the probability the asset will default within a given timeframe and LGD is the percentage of the assets not expected to be collected due to default. PD and LGD data is derived using a combination of external data and internal historical default and loss experience.

CECL may create more volatility in our ACL, particularly our ACL on loans and ACL on off balance sheet credit exposures. Under CECL, our ACL may increase or decrease period to period based on many factors, including, but not limited to: macroeconomic forecasts and conditions; a change in the prepayment speed assumption; an increase or decrease in loan balances, including changes to the Company’s loan portfolio mix; credit quality of the loan portfolio; and various qualitative factors outlined in ASU 2016-13.

Table of Contents

ASU 2016-13 also changed the Company’s methodology and accounting for credit losses within the investment portfolio designated as AFS. To the extent the fair value of a security designated as AFS is less than its amortized cost and the Company either intends to sell the security or it is more-likely-than-not the Company will be required to sell the security before recovery of its amortized cost basis, then the investment is permanently impaired and the amortized cost basis is written down to fair value and a corresponding impairment charge is recorded within the consolidated statements of income. If neither of the above is true, but the fair value of the investment is below its amortized cost basis at the reporting date, then an allowance is established on the AFS investment for the portion of the impairment that is due to credit reasons (e.g. credit rating downgrades, past due receivables, and/or other macro- or micro-adverse trends). The allowance established on an AFS investment due to credit losses is limited to the amount the fair value of the investment is below its amortized cost basis as of the reporting date. If the fair value of the investment is below its amortized cost basis for non-credit-related reasons (e.g. interest rate environment), then the impairment continues to be recognized within stockholders' equity through AOCI.

ACL on Loans. The Company considers the ACL on loans to be a critical accounting policy given the uncertainty in evaluating the allowance required to cover management’s estimate of all expected credit losses over the expected contractual life of the loans in its portfolio. Determining the appropriateness of the allowance is a key management function that requires significant judgment and estimate by management about the effect of matters that are inherently uncertain. Subsequent evaluations of the current loan portfolio, in light of the factors then prevailing, may result in significant changes in the allowance in future periods. While the Company’s current evaluation indicates that the ACL on loans at December 31, 2023 and 2022 was appropriate, the allowance may need to be increased under adversely different conditions or assumptions.

The significant key assumptions used with the ACL on loans calculation at December 31, 2023 using the CECL methodology, included:

Table of Contents

As of December 31, 2023, the recorded ACL on loans was $35.8 million and represented the Company’s best estimate of expected credit losses within the loan portfolio. However, the Company may adjust its assumptions to account for differences between expected and actual losses each period. A future change of the Company’s assumptions will likely alter the level of allowance required and may have a material impact on future results of operations and financial condition. The ACL is reviewed periodically within a calendar quarter to assess trends in the aforementioned key assumptions, as well as asset quality within the loan portfolio, and the Company considers the impact of these trends on the ACL and the Company's financial condition, if any. The ACL on loans is reviewed and approved on a quarterly basis by the ACL Governance Committee, and later reviewed and ratified by the Bank's Board of Directors.

Refer to “—Results of Operations—Provision for Credit Losses,” “—Financial Condition—Asset Quality,” and Note 6 of the consolidated financial statements for further discussion.

ACL on Off Balance Sheet Credit Exposures. The Company considers the ACL on off balance sheet credit exposures to be a critical accounting policy given the uncertainty in evaluating the level of the allowance required to cover management’s estimate of all expected credit losses on expected future loan fundings of, primarily, unfunded loan commitments for those that are not unconditionally cancellable by the Company. The expected credit loss factor calculated for each loan segment using the ACL on loans methodology described above, as well as within Note 1 of the consolidated financial statements, is used to calculate the ACL on off balance sheet credit exposures for each applicable loan segment, and, thus, are subject to the same level of estimation risk and volatility previously described. In addition, one other key assumption is used to derive the allowance on off balance sheet credit exposures and that is the expected funding rate. The expected funding rate is derived using historical loan level data for credit line usage, and is applied to total off balance sheet credit exposures at each reporting date, excluding any that are unconditionally cancellable by the Company, to determine the expected funding amount. As unfunded loan commitments are funded, the allowance migrates from that provided for off balance sheet credit exposures to the ACL on loans. If the expected funding rate or any other key assumption used is not reasonable, then this could have an adverse impact on the total ACL upon funding.

As of December 31, 2023, the recorded ACL on off balance sheet credit exposures was $7.4 million and presented within accrued interest and other liabilities on the consolidated balance sheet. Increases (decreases) to the allowance are presented within provision (credit) for credit losses on the consolidated statements of income. The allowance at December 31, 2023, represented the Company’s best estimate, however, it may adjust assumptions to account for differences between expected and actual losses from period to period. A future change to the Company’s assumptions will likely alter the level of allowance required and may have a material impact on future results of operations and financial condition.

Refer to “—Results of Operations—Provision for Credit Losses,” “—Financial Condition—Asset Quality,” and Note 6 of the consolidated financial statements for further discussion.

ACL for HTM Debt Securities. The estimate of expected credit losses on the Company’s HTM investment portfolio utilizes external PD and LGD data by credit rating to determine a loss rate. Management may exercise discretion to make adjustments based on various environmental factors.

At December 31, 2023, the Company held securities in its HTM portfolio with an amortized cost basis of $299.7 million that primarily consisted of MBS and CMO debt securities issued, municipal bonds or guaranteed by U.S. government-sponsored agencies. Under ASU 2016-13 the Company has the ability to exclude certain securities when the historical credit loss information, adjusted for current conditions and forecasts, resulting in zero risk of nonpayment of the amortized cost basis of the security. Management has evaluated and determined zero risk of nonpayment on all securities guaranteed by the U.S government agencies. At December 31, 2023, the Company recorded an ACL on HTM debt securities of $213 thousand.

Table of Contents

Refer to “—Financial Condition—Investments” and Note 5 of the consolidated financial statements for further discussion.

ACL on AFS Debt Securities. The Company considers the ACL on AFS debt securities to be a critical accounting policy given the size of the investment portfolio and level of estimation used to determine the allowance, as appropriate. As of December 31, 2023, the Company's AFS portfolio was entirely made up of assets that are fair valued using level 2 valuation techniques in accordance with ASC 820, Fair Value Measurement. The Company engages a third party pricing agency to assist with the valuation of such debt securities and the assets are carried at fair value at each reporting period. An allowance is recorded on an AFS debt security to the extent an event has occurred that suggests receipt of full contractual payments are at risk. When such an event has been identified, a discounted cash flow model is used to determine the expected losses due to credit risk, and an allowance is recorded to reduce the carrying value of the debt security by the calculated expected loss amount, limited to the amount by which the fair value of the debt security is below its amortized cost basis.

As further described within “—Financial Condition—Investments,” the Company's AFS portfolio, as of December 31, 2023, primarily consisted of MBS and CMO debt securities issued or guaranteed by U.S. government-sponsored agencies, and, thus, presenting little to no credit risk. As of December 31, 2023, the Company had not identified indications of credit risk and did not carry any allowance for credit losses on its AFS portfolio, nor did it record any permanent impairments during 2023, 2022 or 2021.

Refer to “—Financial Condition—Investments” and Note 5 of the consolidated financial statements for further discussion.

Intangible assets—As a result of acquisitions, the Company carries 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 determine the carrying value of goodwill and identifiable intangible assets could have a material impact on our results of operations.

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, available-for-sale and derivative financial instruments. As of December 31, 2023 and 2022, $495.2 million, or 12.7%, and $723.7 million, or 19.1%, respectively, of the Company’s 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, 2023 and 2022, $9.2 million and $6.3 million of derivative financial instruments, respectively, were classified as Level 2 of the fair value hierarchy, representing less than 1% of the Company’s total liabilities in those years. As of December 31, 2023, the Company had no fair value assets or liabilities classified in Level 3 of the fair value hierarchy.

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 in Item 8 of this Form 10-K.

Table of Contents

Selected Financial Data

The following consolidated selected financial data is derived from the Company’s audited consolidated financial statements as of and for the three years ended December 31, 2023.

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.

As of and for the year ended December 31,

(dollars and shares in thousands, except per share data) 2023 2022 2021

Selected Income Statement Data

Provision for loan losses 2,057 — (3,500)

Per Common Share Data

Earnings - basic $ 0.59 $ 2.12 $ 3.02

Earnings - diluted $ 0.58 $ 2.10 $ 2.97

Dividends declared $ 0.75 $ 0.70 $ 0.63

Tangible book value per common share (1) $ 15.46 $ 14.37 $ 17.87

Selected Performance Ratios

Return on average total assets 0.31 % 1.14 % 1.66 %

Return on average common equity 3.26 % 11.55 % 15.22 %

Return on average tangible common equity (1) 5.37 % 15.09 % 18.89 %

Noninterest income as a % of revenue 47.74 % 52.72 % 62.86 %

Net interest margin (taxable-equivalent basis) 2.46 % 3.04 % 2.90 %

Average equity to average assets 9.39 % 9.89 % 10.89 %

Selected Balance Sheet Data - Period Ending

Asset Quality Ratios

Net charge-offs/(recoveries) to average loans (0.04) % 0.02 % (0.04) %

Nonperforming loans to total loans 0.32 % 0.16 % 0.12 %

Nonperforming assets to total assets 0.22 % 0.10 % 0.09 %

Allowance for credit losses to total loans 1.30 % 1.27 % 1.80 %

Other Data

(2) Includes ESOP-owned shares.

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, the Company routinely supplements its evaluation with an analysis of certain non-GAAP financial measures. These non-GAAP financial measures include the ratio of tangible common equity to tangible assets, tangible common equity per share, return on average tangible common equity, net interest margin (tax-equivalent), the efficiency ratio, and the adjusted 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; (vi) efficiency ratio as noninterest expense less intangible amortization expense, divided by net interest income plus noninterest income plus a tax-equivalent adjustment; and (vii) adjusted efficiency ratio as noninterest expense less intangible amortization expense, divided by net interest income plus noninterest income plus a tax-equivalent adjustment less net gains (losses) on investment securities.

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,

Tangible common equity to tangible assets

Tangible book value per common share

Tangible book value per common share (c)/(d) $ 15.46 $ 14.37 $ 17.87

Table of Contents

December 31, December 31, December 31,

Return on average tangible common equity

Efficiency ratio

Less: Intangible amortization expense 5,296 4,754 4,380

Tax-equivalent adjustment 671 429 492

Adjusted efficiency ratio

Less: Intangible amortization expense 5,296 4,754 4,380

Tax-equivalent adjustment 671 429 492

Adjusted efficiency ratio (i)/(j) 74.91 % 72.86 % 70.06 %

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, 2023 are compared to the results for the year ended December 31, 2022, and the consolidated financial condition of the Company as of December 31, 2023 is compared to December 31, 2022. Results of operations for the year ended December 31, 2022 compared to results for the year ended December 31, 2021, can be found in Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations of the Company’s 2022 annual report on Form 10-K filed with the SEC on March 10, 2023.

Summary

Net income for the year ended December 31, 2023 was $11.7 million, a decrease of $28.3 million, or 70.8%, compared to $40.0 million for the year ended December 31, 2022. Diluted earnings per common share were $0.58 in 2023, compared to $2.10 in 2022. Return on average total assets was 0.31% in 2023, compared to 1.14% for 2022. The decrease in net income was primarily driven by a $31.0 million decrease in noninterest income and a $11.9 million decrease in net interest income, partially offset by an $8.6 million decrease in noninterest expense. Noninterest income decreased primarily due to a $24.6 million loss on investment securities as a result of a strategic balance sheet repositioning in the fourth quarter, as well as an $8.5 million decrease in mortgage banking revenue, attributable to a decrease in mortgage originations due to the impact of higher interest rates. The decrease in net interest income was due to heightened deposit competition, the impact of rising short-term interest rates on indexed money market deposits, and clients moving deposits out of noninterest bearing products into interest-bearing products. The decrease in noninterest expense was primarily due to a $4.4 million decrease in compensation expense, driven by a decrease in mortgage incentives associated with the decrease in mortgage originations.

Table of Contents

Net Interest Income—With Nontaxable Income Converted to Fully Taxable Equivalent, or FTE

Net interest income totaled $87.8 million in 2023, a decrease of $11.9 million, or 11.90%, from 2022. Net interest margin decreased 58 basis points to 2.46% in 2023, from the 3.04% reported in 2022. The decrease in net interest margin was primarily a result of a $61.2 million increase in interest expense on interest-bearing liabilities, partially offset by a $49.3 million increase in interest income on interest earning assets. The increase in interest expense was primarily driven by a 220 basis point increase in the average rate paid on interest-bearing liabilities due to increases in short-term interest rates and a highly competitive deposit environment. Additionally, the average balance of interest-bearing liabilities increased $411.6 million, driven by increased short-term borrowings to support loan growth, core deposit growth, and deposit migration from noninterest bearing deposit accounts into interest bearing deposit accounts. The increase in the interest income earned on interest bearing assets was driven by a 105 basis point increase in the average rate earned on loans as well as a $475.6 million increase in the average balance of total loans from organic growth.

The following table sets forth information related to the Company’s average balance sheet, average yields on assets, and average rates of liabilities for the periods indicated. The Company derived these yields by dividing income or expense by the average balance of the corresponding assets or liabilities. The Company derived average balances from the daily balances throughout the periods indicated. Average loan balances include loans that have been placed on nonaccrual, while interest previously accrued on these loans is reversed against interest income. In these tables, adjustments are made to the yields on tax-exempt assets in order to present tax-exempt income and fully taxable income on a comparable basis.

Table of Contents

Year ended December 31,

Interest Average Interest Average Interest Average

Interest Earning Assets

Fed funds sold — — — % 7,313 192 2.63 % — — — %

Loans

Commercial:

Consumer

Allowance for loan losses (35,883) (32,011) (34,054)

Land, premises and equipment, net 17,510 17,429 19,081

Interest-Bearing Liabilities

Net interest rate spread 1.70 % 2.81 % 2.81 %

Net interest margin on FTE basis (1) 2.46 % 3.04 % 2.90 %

Table of Contents

Interest Rates and Operating Interest Differential

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

Year ended December 31, 2023 Year ended December 31, 2022

Compared with Compared with

Year ended December 31, 2022 Year ended December 31, 2021

Change due to: Interest Change due to: Interest

Interest earning assets

Fed funds sold (192) — (192) — 192 192

Loans

Commercial:

Consumer

Interest-bearing liabilities

Provision for Credit Losses

The Company recorded a provision for credit losses expense of $2.1 million for the year ended December 31, 2023, compared to no provision for credit losses expense for the year ended December 31, 2022. The provision for credit losses expense for the year ended December 31, 2023, included $(225) thousand recovery for credit losses on loans, $2.2 million in provision for credit losses on unfunded commitments and $40 thousand in provision for credit losses on investment securities held-to-maturity. The Current Expected Credit Loss, or CECL, accounting standard requires the Company to recognize losses over the expected life of the loan as opposed to the losses expected to already have been incurred. The increase in provision for credit losses is primarily a result of a change in forecasting assumptions brought about by the new methodology as well as strong loan growth and unfunded commitments.

Table of Contents

Noninterest Income

The following table presents noninterest income for the years ended December 31, 2023, 2022 and 2021

Year ended December 31,

Total noninterest income decreased $31.0 million, or 27.9%, to $80.2 million in 2023, from $111.2 million for 2022. The decrease in noninterest income was primarily driven by the previously announced balance sheet repositioning, as a result of which a $24.6 million loss on the sale of investment securities was recognized in the fourth quarter of 2023. Mortgage banking revenue decreased $8.5 million in 2023 primarily as a result of a $448.2 million, or 55.2%, decrease in mortgage originations due to the impact of higher interest rates.

Noninterest income as a percent of total operating revenue, which consists of net interest income plus noninterest income, was 47.7% in 2023, down from 52.7% the prior year. The decrease in 2023 was due to a 27.9% decrease in noninterest income and an 11.9% decrease in net interest income.

Noninterest Expense

The following table presents noninterest expense for the years ended December 31, 2023, 2022 and 2021.

Year ended December 31,

Total noninterest expense decreased $8.6 million, or 5.4%, to $150.2 million for the year ended December 31, 2023, from $158.8 million for the year ended December 31, 2022. The decrease in noninterest expense was primarily driven by a $4.4 million decrease in compensation expense, a $1.9 million decrease in employee taxes and benefits expense, and a $1.6 million decrease in professional fees and assessments expense, partially offset by an increase of $1.6 million in business services, software and technology expense. The decreases in compensation expense and employee taxes and benefits expenses were primarily driven by a decrease in mortgage incentives associated with the decrease in mortgage originations, and decreased expenses related to group insurance. Professional fees and assessments expenses decreased due to merger related expenses associated with the acquisition of Metro Phoenix Bank in 2022, partially offset by an increase in FDIC assessments. Business services, software and technology expense increased primarily due to higher contract renewals due to inflationary pressures and equipment purchases.

Table of Contents

Income Taxes

For the year ended December 31, 2023, the Company recognized income tax expense of $4.2 million on $15.9 million of pre-tax income, resulting in an effective tax rate of 26.2%. For the year ended December 31, 2022, the Company recognized an income tax expense of $12.2 million on $52.2 million of pre-tax income, resulting in an effective tax rate of 23.3%. The increase in the effective tax rate was primarily driven by items related to the acquisition of Metro Phoenix Bank in 2022 and an increase in state taxes driven by increased income earned in Minnesota and Arizona.

Segment Reporting

The Company determined reportable segments based on the significance of the services offered, the significance of those services to the Company’s financial condition and operating results, and the Company’s regular review of the operating results of those services. The Company has 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 and indirect noninterest expense overhead allocations. Corporate administration includes all remaining income and expenses not allocated to the four operating segments. Certain reclassification adjustments have been made between corporate administration and the various lines of business for consistency in presentation.

For additional financial information on the Company’s segments see Note 22 (Segment Reporting) of the Company’s audited consolidated financial statements included in Item 8 of this Form 10-K.

Banking

The banking segment offers a complete line of loan, deposit, cash management, and treasury services through 15 offices in North Dakota, Minnesota, and Arizona. These products and services are supported through various digital applications. The majority of the Company’s assets and liabilities are on the banking segment balance sheet.

The banking segment reported net income before taxes of $7.1 million for the year ended December 31, 2023, a decrease of $25.4 million compared to the year ended December 31, 2022. The decrease was primarily driven by a $21.6 million decrease in noninterest income and a $10.5 million decrease in net interest income, partially offset by a $8.8 million decrease in noninterest expense. During the fourth quarter of 2023, the Company sold $171.8 million of available-for-sale (AFS) securities in a balance sheet repositioning. The sale resulted in a one-time pre-tax net loss of $24.6 million. Proceeds from the sale were reinvested into loans to new and existing clients throughout the communities the Company serves, in addition to paying down borrowings.

Retirement and Benefit Services

Retirement and benefit services provide the following services nationally: recordkeeping and administration services to qualified retirement plans; ESOP recordkeeping and administration; investment fiduciary services to retirement plans; HSA, flex spending account, and government health insurance program recordkeeping and administration services to employers. The division services approximately 8,300 retirement plans and more than 474,000 plan participants. In addition, the division employs approximately 243 professionals, and operates within the Company’s banking markets, as well as East Lansing, Michigan, and Lakewood, Colorado.

The retirement and benefit services segment reported net income before taxes of $14.7 million for the year ended December 31, 2023, a decrease of $4.5 million compared to the year ended December 31, 2022. Revenue of $65.3 million, comprised of $23.1 million in asset-based revenue and $42.2 million in participant and transaction revenues, decreased $1.8 million, or 2.7%, primarily due to the divestiture of the payroll services line of business.

Table of Contents

The following table presents changes in the combined AUA and AUM for the Company’s retirement and benefit services segment for the periods presented.

Year ended

December 31,

Acquired assets — — —

(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 was $36.7 billion at December 31, 2023, an increase of $4.6 billion, or 14.2%, compared to the total at December 31, 2022. The increase was primarily driven by an increase of $4.8 billion in market impact, driven by improved bond and equity markets.

Wealth Management

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

Wealth management reported net income before taxes of $9.8 million for the year ended December 31, 2023, a decrease of $3.1 million, or 23.9%, compared to the year ended December 31, 2022. Noninterest expense in 2023 increased $4.1 million, or 51.3%, as compared to 2022, primarily due to an increase of allocated expenses.

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 $3.2 billion, excluding $859.8 million of brokerage assets, at December 31, 2023, an increase of $0.4 million, or 13.4%, compared to the total at December 31, 2022. The increase was driven by a $0.3 million increase in market impact. Additionally, there was a $32 thousand increase as inflows outpaced outflows in 2023, driven by improved bond and equity markets.

Mortgage

The mortgage division offers first and second mortgage loans through the banking office locations.

Mortgage reported a net loss before taxes of $5.4 million for the year ended December 31, 2023, an increase of $2.9 million, or 117.2%, from the $2.5 million net loss reported for the year ended December 31, 2022. Mortgage noninterest income for 2023 of $8.4 million decreased $8.5 million, or 50.3%, from 2022. The decrease was primarily driven by a decrease in mortgage originations and a 32 basis point decrease in the gain on sale margin, partially offset by a $2.0 million increase in the change in fair value of the secondary market derivatives.

Table of Contents

Financial Condition

Overview

Total assets were $3.9 billion at December 31, 2023, an increase of $128.1 million, or 3.4%, compared to $3.8 billion at December 31, 2022. The increase in total assets was primarily due to increases of $312.1 million in loans held for investment and $64.2 million in cash and cash equivalents, partially offset by a decrease of $253.0 million in investment securities.

Investment Securities

The following table presents the carrying amount of the Company’s investment securities portfolio at the dates indicated:

Percent of Percent of

(dollars in thousands) Balance Portfolio Balance Portfolio

Available-for-sale

U.S. Treasury and agencies $ 1,120 0.1 % $ 3,520 0.3 %

Mortgage backed securities

Asset backed securities 25 — % 34 — %

Held-to-maturity

Mortgage backed securities

The composition of the Company’s investment securities portfolio reflects the Company’s investment strategy of maintaining an appropriate level of liquidity for normal operations while providing an additional source of revenue. The investment portfolio also provides a balance to interest rate risk and credit risk in other categories of the balance sheet, while providing a vehicle for the investment of available funds, furnishing liquidity, and supplying securities to pledge as collateral. In 2021, the Company transferred its portfolio of obligations of state and political agencies from available-for-sale to held-to-maturity to protect capital and reduce volatility in other comprehensive income due to market value changes.

At December 31, 2023, total investment securities were $0.8 billion compared to $1.0 billion at December 31, 2022. Investment securities as a percentage of total assets were 20.1% and 27.5%, as of December 31, 2023 and December 31, 2022, respectively. The decrease in investment securities was primarily due to a strategic balance sheet repositioning in the fourth quarter, in which the Company sold $171.8 million of available-for-sale securities. Proceeds from the sale were reinvested into loans to new and existing clients in addition to paying down borrowings. Securities with a carrying value of $250.0 million were pledged at December 31, 2023, to secure public deposits and for other purposes required or permitted by law.

The net pre-tax unrealized market value loss on the available-for-sale investment portfolio as of December 31, 2023 was $98.0 million, as compared to a $132.2 million loss as of December 31, 2022. The decrease is a result of improved markets and an overall reduction of the size of the investment portfolio.

The investment portfolio is composed of U.S. Treasury debentures, U.S. Agency mortgage-backed pass-throughs, U.S. Agency, Commercial Mortgage Obligations, or CMOs, Corporate bonds and Municipal bonds.

Table of Contents

As of December 31, 2023 and December 31, 2022 the Company held 75 tax-exempt state and local municipal securities totaling $35.0 million and held 85 tax-exempt state and local municipal securities totaling $40.9 million, respectively. Other than the aforementioned investments, at December 31, 2023 and December 31, 2022, 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.

The Company’s available-for-sale (“AFS”) debt securities that are in an unrealized loss position are assessed to determine if an allowance should be recorded or if a write-down is required in accordance with Accounting Standards Update (“ASU”) 2016-13. As of and for the years ended years ended December 31, 2023 and 2022, the Company did not record any allowances or write-down any of the AFS debt securities in an unrealized loss position. Refer to Note 1 (Significant Accounting Policies) of the consolidated financial statements included in Item 8 of this Form 10-K for additional details of the Company’s assessment of the allowance for AFS investments as of and for the year ended December 31, 2023.

In accordance with ASU 2016-13, each reporting period the Company’s held-to-maturity (“HTM”) debt securities are assessed to determine if any allowance should be recorded or if a write-down is required. As of and for the years ended December 31, 2023, the Company recorded an allowance of $213 thousand and did not write-down any HTM debt securities. As of and for the year ended December 31, 2022, the Company did not record any allowances or write-down any HTM debt securities. Refer to Note 1 (Significant Accounting Policies) of the consolidated financial statements included in Item 8 of this Form 10-K for additional details of the Company’s assessment of the allowance for HTM investments as of and for the year ended December 31, 2023.

The investment securities presented in the following table are reported at fair value and by contractual maturity as of December 31, 2023. Actual timing may differ from contractual maturities if borrowers have the right to call or prepay obligations with or without call or prepayment penalties. Additionally, the mortgage backed securities receive monthly principal payments, which are not reflected below. The yields below are calculated on a tax equivalent basis, assuming a 21.00% income tax rate.

Maturity as of December 31, 2023

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 $ — — % $ 521 5.90 % $ — — % $ 599 5.95 %

Mortgage backed securities

Commercial — — % — — % 1,353 2.40 % — — %

Asset backed securities — — % — — % 7 4.70 % 18 5.09 %

Corporate bonds — — % — — % 48,644 3.69 % — — %

Held-to-maturity

Mortgage backed securities

Residential agency — — % — — % — — % 141,627 2.21 %

Table of Contents

Loans

The loan portfolio represents a broad range of borrowers comprised of commercial and industrial, real estate construction, commercial real estate (“CRE”), residential real estate, and consumer financing loans.

Total loans outstanding were $2.8 billion as of December 31, 2023, an increase of $315.6 million, or 12.9%, from December 31, 2022. The increase in total loans was primarily due to organic loan growth due to the Company’s expanded commercial lending team. The increases in organic loan growth included increases of $245.2 million in CRE, $47.3 million in residential real estate first mortgages, $26.2 million in real estate construction, and $11.0 million in commercial and industrial loans, partially offset by a $21.3 million decrease in other revolving and installment loans.

The Company’s loan portfolio is highly diversified. As of December 31, 2023, approximately 21.7% of loans outstanding were commercial and industrial, while 45.3% of loans outstanding were CRE, and 31.9% of loans outstanding were residential real estate.

Percent of Percent of

(dollars in thousands) Balance Portfolio Balance Portfolio

Commercial and industrial: (1)

Commercial real estate:

Non-owner occupied

Consumer

Commercial loans represent loans for working capital, purchases of equipment and other needs of commercial customers primarily located within our geographical footprint. These loans are underwritten individually and represent ongoing relationships based on a thorough knowledge of the customer, the customer's industry, and market. While commercial loans are generally secured by the customer's assets including real property, inventory, accounts receivable, operating equipment, and other property and may also include personal guarantees of the owners and related parties, the primary source of repayment of the loans is the ongoing cash flow from operations of the customer's business. In addition, revolving lines of credit are generally governed by a borrowing base. Inherent lending risks are monitored on a continuous basis through interim reporting, covenant testing and annual underwriting.

CRE loans consist of term loans secured by a mortgage lien on the real property and includes both owner occupied CRE loans as well as non-owner-occupied loans. Non-owner occupied CRE loans consist of mortgage loans to finance investments in real property that may include, but are not limited to, multi-family, industrial, office, retail and

Table of Contents

other specific use properties as well as CRE construction loans that are offered to builders and developers generally within our geographical footprint. The primary risk characteristics in the non-owner-occupied portfolio include impacts of overall leasing rates, absorption timelines, levels of vacancy rates and operating expenses. The Company requires collateral values in excess of the loan amounts, cash flows in excess of expected debt service requirements and equity investment in the project. The expected cash flows from all significant new or renewed income producing property commitments are stress tested to reflect the risks in varying interest rates, vacancy rates and rental rates. Inherent lending risks are monitored on a continuous basis through quarterly monitoring and our annual underwriting process, incorporating an analysis of cash flow, collateral, market conditions and guarantor liquidity, if applicable. CRE loan policies are specific to individual product types and underwriting parameters vary depending on the risk profile of each asset class. CRE loan policies are reviewed no less than semi-annually by management and approved by the Bank’s Board of Directors to ensure they align with current market conditions and the Bank’s moderate risk appetite. Construction loans are monitored monthly and includes on-site inspections. Management reviews all construction loans quarterly to ensure projects are on time and within budget. CRE concentration limits have been established by product type and are monitored quarterly by the Bank’s Credit Governance Committee and Bank Board of Directors.

CRE loans may be adversely affected by conditions in the real estate markets or in the general economy. The Company does not monitor the CRE portfolio for attributes such as loan to value ratios, occupancy rates, and net operating income as these characteristics are assessed and evaluated on an individual loan basis. Portfolio stress testing is completed based on property type and takes into consideration changes to net operating income and capitalization rates. The Company does not have exposure to the office building sector in central business districts as the office portfolio is generally diversified in suburban markets with strong occupancy levels. As of December 31, 2023, at 202%, the Company’s applicable investor commercial real estate loans, as a percentage of its risk-based capital, remained below the regulatory guideline limit of 300%. Construction loans at 31% were also below the regulatory guideline limit of 100%.

The following table presents the geographical markets of the collateral related to the non-owner occupied commercial real estate loans for the periods presented:

Percent of Percent of

(dollars in thousands) Balance Total Balance Total

Geographical Market:

Oregon 14,953 1.8 % — — %

The Bank does not currently monitor owner occupied CRE loans based on geographical markets as the primary source of repayment for these loans is predicated on the cash flow from the underlying operating entity. These loans are generally located within the Company’s geographical footprint.

Highly competitive conditions continue to prevail in the small and middle market commercial segments in which the Company primarily operates. The Company maintains a commitment to generating growth in the Company’s business portfolio in a manner that adheres to its twin goals of maintaining strong asset quality and producing profitable margins. The Company continues to invest in additional personnel, technology, and business development resources to further strengthen its capabilities.

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

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.

The Company originates 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 the Company’s fixed rate residential loans, along with some of the Company’s adjustable rate mortgages are sold to other financial institutions with which the Company has established a correspondent lending relationship.

The Company’s 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 increased over the last few years due to low long-term interest rates and comparatively stable real estate valuations in the Company’s primary markets. As of December 31, 2023, the Company’s consumer mortgage portfolio was $881.0 million, which was a $51.0 million, or 9.4%, increase from $830.0 million as of December 31, 2022. Market interest rates, expected duration, and the Company’s overall interest rate sensitivity profile continue to be the most significant factors in determining whether the Company chooses to retain versus sell portions of new consumer mortgage originations.

Table of Contents

The following table shows the maturities and sensitivity to interest rates for the loan portfolio as of December 31, 2023:

After one After five

One year but within but within After

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

Commercial

Consumer

Loans with fixed interest rates:

Commercial

Consumer

Loans with floating interest rates:

Commercial

Consumer

Other revolving and installment 6,014 3,538 — — 9,552

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

Asset Quality

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

Table of Contents

Credit Quality Indicators

Loans are assigned a risk rating and grouped into categories based on relevant information about the ability of borrowers to service their debt, such as: current financial information, historical payment experience, credit documentation, public information, and current economic trends, among other factors. The risk ratings are aligned to pass and criticized categories. The criticized categories include special mention, substandard, and doubtful risk ratings. See Note 6 (Loans and Allowance for Credit Losses) to the consolidated financial statements included in Item 8 of this Form 10-K for a definition of each of the risk ratings.

The table below represents criticized loans outstanding by loan portfolio segment as of December 31, 2023, 2022, and 2021:

December 31, December 31,

Commercial

Commercial and industrial $ 29,840 $ 25,182

Real estate construction 20,667 262

Commercial real estate 9,170 8,400

Consumer

Residential real estate first mortgage 105 808

Residential real estate junior lien 1,781 632

Other revolving and installment — 1

Criticized loans as a percent of total loans 2.23 % 1.44 %

Criticized loans represented 2.23% and 1.44% of total loans as of December 31, 2023 and 2022, respectively. The increase in criticized loans was primarily due to one $20.6 million multi-family construction loan that became criticized in the third quarter of 2023.

The following table presents information regarding nonperforming assets as of the dates presented:

December 31, December 31,

Accruing loans 90+ days past due 139 —

Total nonperforming loans 8,735 3,794

OREO and repossessed assets 32 30

Total nonperforming assets 8,767 3,824

Total restructured accruing loans — 151

Nonperforming loans to total loans 0.32 % 0.16 %

Nonperforming assets to total assets 0.22 % 0.10 %

Allowance for credit losses on loans to nonperforming loans 410 % 821 %

The allowance for credit losses to nonperforming loans ratio decreased 411 basis points from December 31, 2022. The decrease was primarily the result of a modest increase in nonperforming loans for the year ended December 31, 2023. The increase in nonperforming loans was primarily due to one $6.1 million loan being added to nonperforming loans for the year ended December 31, 2023.

Interest income lost on nonaccrual loans approximated $467 thousand, $155 thousand, and $183 thousand for the years ended December 31, 2023, 2022 and 2021, respectively. There was no interest income included in net income related to nonaccrual loans for the years ended December 31, 2023, 2022 and 2021.

Table of Contents

Allowance for Credit Losses

The allowance for credit losses, or ACL, on loans is maintained at a level management believes is sufficient to absorb expected losses in the loan portfolio over the remaining estimated life of loans in the portfolio. Under CECL accounting standard the ACL is a valuation estimated at each balance sheet date and deducted from the amortized cost basis of loans held for investment to present the net amount expected to be collected. 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.

Management estimates the ACL using relevant information, from internal and external sources, relating to past events, current conditions, and reasonable supportable forecasts. Historical loss experience provides the basis for estimation of expected credit losses. Adjustments to historical loss information are made for differences in the current loan-specific risk characteristics such as different underwriting standards, portfolio mix, delinquency level, or life of the loan, as well as changes in environmental conditions, levels of economic activity, unemployment rates, property values and other relevant factors. The calculation also contemplates that the Company may not be able to make or obtain such forecasts for the entire life of the financial assets and requires a reversion to historical loss information.

Loans that do not share risk characteristics are evaluated on an individual basis. Loans evaluated individually are not also included in the collective evaluation. The ACL on individually evaluated loans is recognized on the basis of the present value of expected future cash flows discounted at the effective interest rate, the fair value of collateral adjusted of estimated costs to sell, or observable market price as of the relevant date.

In the ordinary course of business, the Company enters into commitments to extend credit, including commitments under credit arrangements, commercial letters of credit, and standby letters of credit. Such financial instruments are recorded when they are funded. 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 expense for provision for unfunded commitments was $2.2 million, $1.1 million, and $0.2 million for the years ended years ended December 31, 2023, 2022 and 2021, respectively.

Table of Contents

The following table presents, by loan type, the changes in the allowance for credit losses, after the opening adjustment related to the adoption of CECL in 2023, for the periods presented:

Year ended

December 31,

Commercial loan charge-offs

Commercial and Industrial (436) (1,396) (1,230)

Real estate construction — — —

Commercial real estate — — (536)

Total commercial loan charge-offs (436) (1,396) (1,766)

Consumer loan charge-offs

Residential real estate first mortgage (49) — —

Residential real estate junior lien (77) — —

Other revolving and installment (51) (153) (156)

Total consumer loan charge-offs (177) (153) (156)

Total loan charge-offs (613) (1,549) (1,922)

Commercial loan recoveries

Real estate construction — 76 —

Commercial real estate 45 134 822

Total commercial recoveries 1,204 671 2,482

Consumer loan recoveries

Residential real estate first mortgage 330 — —

Residential real estate junior lien 52 282 123

Other revolving and installment 92 170 143

Total consumer loan recoveries 474 452 266

Net loan charge-offs (recoveries) (1,065) 426 (826)

Commercial loan provision

Commercial and Industrial 645 950 (1,759)

Real estate construction 2,125 551 120

Commercial real estate (778) (151) (2,082)

Total commercial loan provision 1,992 1,350 (3,721)

Consumer loan provision

Residential real estate first mortgage (1,829) (1,017) 700

Residential real estate junior lien (115) (344) (215)

Other revolving and installment (273) 11 (264)

Total consumer loan provision (2,217) (1,350) 221

Unallocated provision expense — — —

Total provision for credit losses on loans (225) — (3,500)

Allowance for credit losses on loans to total loans 1.30 % 1.27 % 1.80 %

The ACL on loans was $35.8 million at December 31, 2023, compared to $31.1 million at December 31, 2022. The $4.7 million increase in the allowance for credit losses was primarily due to the adoption of CECL, which resulted in an additional allowance of $3.9 million in the ACL on loans. The ratio of nonperforming loans to total loans at December 31, 2023 was 0.32%, compared to 0.16% at December 31, 2022.

Table of Contents

The following table summarized the activity of the allowance for credit losses on loans, after the opening adjustment related to the adoption of CECL in 2023, for the periods indicated:

Year ended

December 31,

Net charge-offs (recoveries):

Commercial net charge-offs (recoveries)

Commercial and Industrial (723) 935 (430)

Real estate construction — (76) —

Commercial real estate (45) (134) (286)

Total commercial net charge-offs (recoveries) (768) 725 (716)

Consumer net charge-offs (recoveries)

Residential real estate first mortgage (281) — —

Residential real estate junior lien 25 (282) (123)

Other revolving and installment (41) (17) 13

Total consumer net charge-offs (recoveries) (297) (299) (110)

Total net charge-offs (recoveries) (1,065) 426 (826)

Provision for credit losses on loans (225) — (3,500)

Net charge-offs (recoveries) to average loans

Commercial net charge-offs (recoveries) to average loans

Commercial and Industrial (0.03) % 0.05 % (0.02) %

Real estate construction — % — % — %

Commercial real estate — % (0.01) % (0.02) %

Consumer net charge-offs (recoveries) to average loans

Residential real estate first mortgage (0.01) % — % — %

Residential real estate junior lien — % (0.01) % (0.01) %

Other revolving and installment — % — % — %

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

Percentage Percentage

Allocated of loans to Allocated of loans to

(dollars in thousands) Allowance total loans Allowance total loans

Residential real estate first mortgage 6,578 26.3 % 5,857 27.8 %

Residential real estate junior lien 1,151 5.6 % 1,318 6.2 %

Other revolving and installment 212 1.1 % 540 2.1 %

The increase in the allocation of the ACL on loans was primarily driven by the adoption of CECL and strong organic loan growth.

Table of Contents

Deposits

Deposit inflows and outflows are influenced by prevailing market interest rates, competition, local and economic conditions, and fluctuations in the Company’s customers’ own liquidity needs and may also be influenced by recent developments in the financial services industry, including the large-scale deposit withdrawals over a short period of time at Silicon Valley Bank, Signature Bank, and First Republic Bank that resulted in the failure of those institutions.

Total deposits were $3.1 billion as of December 31, 2023, an increase of $180.1 million, or 6.2%, from December 31, 2022. Interest-bearing deposits increased $313.0 million while noninterest-bearing deposits decreased $132.9 million. The increase in interest-bearing deposits consisted primarily of increases of $134.4 million in interest-bearing demand deposits and $199.2 million in time deposits. Noninterest-bearing deposits decreased primarily due to heightened deposit competition, the impact of rising short-term interest rates on indexed money market deposits, and clients moving deposits out of noninterest bearing products into interest-bearing products.

Interest-bearing deposit costs were 2.44% and 0.45% for the years ended December 31, 2023 and 2022, respectively. The increase in interest-bearing deposit costs were the result of a rising interest rate environment and a highly competitive deposit environment.

The Company competes 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. The mix of average deposits has been changing throughout the last several years. The weightings of core funds (noninterest checking, interest checking, savings, and money market accounts) and time deposits’ have increased. The Company is focused on expanding core account relationships and customers’ preference for unrestricted accounts in the low interest rate environment. The weighting of time deposits increased as clients are looking for higher yielding alternative investments with increased short-term rates.

The following table presents the average balances and rates of the Company’s 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

The following table presents the contractual maturity of time deposits, including certificate of deposits and IRA deposits of $250 thousand and over, that were outstanding as of the date presented.

December 31,

(dollars in thousands) 2023

Maturing in:

Table of Contents

The Company’s total uninsured deposits, which are amounts of deposit accounts that exceed the FDIC insurance limit, currently $250,000, were approximately $1.1 billion and $1.8 billion at December 31, 2023 and 2022, respectively. These amounts were estimated based on the same methodologies and assumptions used for regulatory reporting purposes.

Borrowings and Subordinated Debt

The Company utilizes both short term and long term borrowings as part of its asset/liability management and funding strategies. Short term borrowings consist of FHLB advances and federal funds purchased. The Company had $314.2 million and $378.1 million in short term borrowings outstanding at December 31, 2023 and 2022, respectively.

FHLB advances were secured by specific investment securities and real estate loans with a carrying amount of approximately $1.0 billion and $909.8 million at December 31, 2023 and 2022, respectively.

Long-term debt is utilized to fund longer term assets and as a source of regulatory capital. At December 31, 2023, the Company had $50.0 million of one outstanding 3.50% Fixed Rate Subordinated Note due 2031, or the Subordinated Note. The Subordinated Note currently bears interest at a fixed rate of 3.50% per year, payable annually through March 31, 2026. At the fifth anniversary of the issuance date of the Subordinated Note, on March 30, 2026, the interest rate will reset to a fixed interest rate equal to the FHLB rate, plus 2.0%, with a minimum annual fixed rate of not less than 3.5%. The Subordinated Note matures on March 30, 2031, and the Company has the option to redeem or prepay any or all of the Subordinated Note without premium or penalty any time after March 31, 2026, 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.

Junior subordinated debentures issued to capital trusts that issued trust preferred securities were $9.0 million as of December 31, 2023, compared to $8.8 million as of December 31, 2022. The increase was due to purchase accounting amortization on the junior subordinated notes assumed in the Beacon Bank acquisition in 2016. See Note 14 (Long-Term Debt) of the Company’s audited consolidated financial statements included in Item 8 of this Form 10-K.

Selected financial information pertaining to the components of the Company’s 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

Finance lease liability — — % — — 203 0.3 %

Table of Contents

Capital Resources

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

For the years ended December 31,

Common stock issued — 63,830 —

Total stockholders’ equity was $369.1 million at December 31, 2023, an increase of $12.3 million, or 3.4%, compared to $356.9 million at December 31, 2022. The increase was primarily due to a $119.4 million increase in other comprehensive income (loss). The increase in other comprehensive income (loss) was due in part to the sale of AFS securities as part of the previously reported balance sheet repositioning in the fourth quarter, as well as improved market conditions, which resulted in a higher fair value of the Company’s available-for-sale investment securities. This increase was partially offset by a $28.3 million decrease in net income and a $4.5 million decrease to opening stockholders’ equity related to the adoption of the CECL accounting standard.

The Company strives to maintain an adequate capital base to support its 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 the Company’s balance sheet, recognizing that unexpected loss is the common denominator of risk and that common equity has the greatest capacity to absorb unexpected loss.

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

At December 31, 2023, 2022, and 2021, the Company met all capital adequacy requirements to which the Company was subject.

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) of the Company’s audited consolidated financial statements included in Item 8 of this Form 10-K for additional disclosures.

December 31, December 31,

Alerus Financial Corporation Consolidated

Common equity tier 1 capital to risk weighted assets 11.82 % 13.39 %

Tier 1 capital to risk weighted assets 12.10 % 13.69 %

Total capital to risk weighted assets 14.76 % 16.48 %

Tier 1 capital to average assets 10.57 % 11.25 %

Tangible common equity to tangible assets (1) 7.94 % 7.74 %

Alerus Financial, National Association

Common equity tier 1 capital to risk weighted assets 11.40 % 12.76 %

Tier 1 capital to risk weighted assets 11.40 % 12.76 %

Total capital to risk weighted assets 12.51 % 13.83 %

Tier 1 capital to average assets 9.92 % 10.48 %

Contractual Obligations and Off-Balance Sheet Arrangements

Off Balance Sheet Arrangements

In the normal course of business, the Company enters 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.

The Company’s 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. The Company decreased its exposure to losses under these commitments by subjecting them to credit approval and monitoring procedures. The Company assesses 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 15 (Commitments and Contingencies) of the Company’s audited consolidated financial statements included in Item 8 of this Form 10-K.

Liquidity

Liquidity management is the process by which the Company manages the flow of funds necessary to meet its financial commitments on a timely basis and at a reasonable cost and to take advantage of earnings enhancement opportunities. These financial commitments include withdrawals by depositors, credit commitments to borrowers, expenses of the Company’s operations, and capital expenditures. Liquidity is monitored and closely managed by the Company’s asset and liability committee, or 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 the Company has the necessary level of funds available for normal operations as well as maintain a contingency funding policy to ensure that potential liquidity stress events are planned for, quickly identified, and management has plans in place to respond. 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.

Table of Contents

At December 31, 2023, the Company had on balance sheet liquidity of $668.2 million, compared to $778.9 million at December 31, 2022 and $1.1 billion at December 31, 2021. On balance sheet liquidity includes cash and cash equivalents, federal funds sold, unencumbered securities available-for-sale and over collateralized securities pledging positions available-for-sale.

The Bank is a member of the FHLB, which provides short and long term funding to its members through advances collateralized by real estate related assets and other select collateral, most typically in the form of debt securities. The actual borrowing capacity is contingent on the amount of collateral available to be pledged to the FHLB. As of December 31, 2023, the Company had $1.0 billion of collateral pledged to the FHLB. Based on this collateral the Company is eligible to borrow up to $1.0 billion and had $706.6 million available capacity as of December 31, 2023. In addition, the Company can borrow up to $107.0 million through unsecured lines of credit the Company has established with four other banks.

In addition, because the Bank is “well capitalized,” it can accept brokered deposits up to 20.0% of total assets based on current policy limits. Management believed that the Company had adequate resources to fund all of its commitments as of December 31, 2023 and December 31, 2022.

The Company’s primary sources of liquidity include liquid assets, as well as unencumbered securities that can be used to collateralize additional funding. At December 31, 2023, the Company had $129.9 million of cash and cash equivalents of which $91.2 million were interest-bearing deposits held at the Federal Reserve, FHLB and other correspondent banks.

Though remote, the possibility of a funding crisis exists at all financial institutions. Accordingly, management has addressed this issue by formulating a liquidity contingency plan, which has been reviewed and approved by both the Bank’s Board of Directors and the ALCO. The plan addresses the actions that the Company would take in response to both a short-term and long-term funding crisis.

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

Recent Developments

Stockholder Dividend

On February 27, 2024, the Board of Directors of the Company declared a quarterly cash dividend of $0.19 per common share. This dividend is payable on April 12, 2024, to stockholders of record on March 15, 2024.

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. The Company seeks to achieve consistent growth in net interest income and equity while managing volatility arising from shifts in market interest rates. The Company’s 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.

Table of Contents

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 the Company’s assets and liabilities. Basis risk is the risk of adverse consequence resulting from unequal change in the spread between two or more rates for different instruments with the same maturity. Yield curve risk is the risk of adverse 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 the Company’s exposure to changes in interest rates. Among the factors considered are changes in the mix of interest-earning assets and interest-bearing liabilities, interest rate spreads and repricing periods. ALCO reviews, on at least a quarterly basis, the interest rate risk position.

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

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

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

The estimated impact on the Company’s net interest income in hypothetical rising and declining rate scenarios assuming immediate, parallel moves in interest rates, calculated as of December 31, 2023 and December 31, 2022, are presented in the table below.

Following Following Following Following

12 months 24 months 12 months 24 months

The above interest rate simulation suggests that the Company’s balance sheet is slightly asset sensitive, in the short-term, as of December 31, 2023, demonstrating that an increase in interest rates would have a marginal positive

Table of Contents

impact on net interest income over the next 12 and 24 months. The balance sheet has shifted from being liability sensitive as of December 31, 2022. This change is attributable to both the derivatives strategies put in place throughout 2023 that will begin to mature in 2024 as well as deposit growth and the balance sheet repositioning that consisted of selling fixed rate securities and redeploying the funds into both fixed and floating-rate loans.

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, 2023 and December 31, 2022, assuming immediate parallel shifts in interest rates.

December 31, December 31,

Operational Risk

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

Compliance Risk

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

Strategic and/or Reputation Risk

Strategic and/or reputation risk represents the risk of loss due to impairment of reputation, failure to fully develop and execute business plans, failure to assess current and new opportunities in business, markets and products, 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.

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 sheet of Alerus Financial Corporation and its subsidiaries (the Company) as of December 31, 2023, the related consolidated statement of income, comprehensive income, changes in stockholders' equity and cash flows for the year then ended, and the related notes to the consolidated financial statements (collectively, 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, 2023, and the results of its operations and its cash flows for the year then ended, in conformity with accounting principles generally accepted in the United States of America.

Adoption of New Accounting Standard

As discussed in Note 2 to the financial statements, the Company has changed its method of accounting for credit losses on financial instruments in 2023 due to the adoption of Accounting Standards Update 2016-13, Financial Instruments – Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments.

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 audit. 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 U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.

We conducted our audit 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. As part of our audit 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. Accordingly, we express no such opinion.

Our audit 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 audit 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 audit provides a reasonable basis for our opinion.

/s/ RSM US LLP

We have served as the Company's auditor since 2022.

Des Moines, Iowa

March 8, 2024

Table of Contents

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

Board of Directors and Stockholders

Alerus Financial Corporation

Opinion on the Financial Statements

We have audited the accompanying consolidated balance sheet of Alerus Financial Corporation and Subsidiaries (the Company) as of December 31, 2022, and the related consolidated statements of income, comprehensive income, stockholders’ equity, and cash flows for each of the two years in the period ended December 31, 2022, 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, 2022, and the results of its operations and its cash flows for each of the two years in the period ended December 31, 2022, in conformity with accounting principles generally accepted in the United States of America.

Basis for Opinion

The Company’s management is responsible for these financial statements. 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.

ALRS US Equity

ALRS · 10-K · period ended 2023-12-31

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

ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

ALRS US Equity☆

ALRS · 10-K · period ended 2023-12-31

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

ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

ALRS US Equity