Note 3 - Business Combinations

12 Months Ended

Dec. 31, 2024

Notes to Financial Statements

Business Combination Disclosure [Text Block]

NOTE 3 Business Combinations

MPB BHC, Inc.

On July 1, 2022, the Company acquired MPB BHC, Inc., the holding company for Metro Phoenix Bank located in Phoenix, Arizona, for a total purchase price of $64.0 million in a stock-for-stock transaction. The primary reasons for the acquisition were to expand the Company’s operations in the Phoenix MSA and grow the size of the Company’s business. As part of the transaction, $7.6 million was allocated to a customer deposit intangible and $15.1 million to goodwill, which is not deductible for income tax purposes. Goodwill resulting from the acquisition was allocated to the Company’s banking segment. The purchase consisted of $270.4 million in loans and $353.7 million in deposits. The purchased assets and assumed liabilities were recorded at their respective acquisition date estimate fair values indicated in the following table:

	As recorded by		Preliminary Fair Value			As recorded by
(dollars in thousands)	Metro Phoenix Bank		Adjustments			the Company
Assets
Cash and cash equivalents	$	101,819	$	(123	)	$	101,696
Fed funds sold		18,936		—			18,936
Core deposit intangible		—		7,592			7,592
Loans		273,843		(3,440	)		270,403
Accrued interest receivable		1,091		—			1,091
Other assets		3,342		188			3,530
Total assets		399,031		4,217			403,248
Liabilities
Deposits		354,529		(844	)		353,685
Other liabilities		673		—			673
Total liabilities		355,202		(844	)		354,358
Excess assets over liabilities	$	43,829	$	5,061			48,890
Stock issued for MPB							64,019
Total goodwill recorded						$	15,129

As part of the acquisition of MPB and its subsidiary, Metro Phoenix Bank, the Company acquired loans that displayed evidence of deterioration of credit quality since origination and the Company believed it to be probable that all contractually required payments would not be collected. The carrying amounts and contractually required payments of these loans, which are included in the loan balances in Note 6 (Loans and Allowance for Credit Losses) as of December 31, 2022, were as follows:

	December 31,
(dollars in thousands)	2022
Real estate construction	$	175
Outstanding balance		175
Carrying amount		151
Allowance for credit losses on loans		—
Carrying amount, net of allowance for loan losses	$	151

Accretable yield, or income expected to be collected, is shown in the table below:

	For the year ended
	December 31,
(dollars in thousands)	2022
Beginning balance	$	177
New loans purchased		—
Accretion of income		—
Ending balance	$	177

The Company recorded acquisition related costs of $2.5 million for the year ended December 31, 2022. These costs were included in professional fees and assessments expenses in the Company’s consolidated statements of income.

Supplemental Pro Forma Financial Information (Unaudited)

The following table presents certain unaudited pro forma financial information for illustrative purposes only, for the years ended December 31, 2022 and 2021, as if MPB had been acquired on January 1, 2021. This unaudited pro forma information combines the historical results of MPB with the Company's consolidated historical results and includes certain adjustments reflecting the estimated impact of certain fair value adjustments for the respective periods. The pro forma information is not indicative of what would have occurred had the acquisition occurred as of the beginning of the year prior to the acquisition. The unaudited pro forma information does not consider any changes to the provision expense resulting from recording loan assets at fair value, cost savings or business synergies. As a result, actual amounts would have differed from the unaudited pro forma information presented and the differences could be significant.

	Pro Formas (unaudited)
	for the years ended December 31,
(dollars in thousands)	2022		2021
Net interest income after provision for credit losses	$	107,172	$	104,087
Noninterest income		112,755		151,499
Noninterest expense		166,476		178,337
Net income (after tax)		40,784		58,585

HMN Financial, Inc.

On October 9, 2024, the Company completed the acquisition of 100% of the outstanding stock of HMN Financial, Inc. (Nasdaq: HMNF) and its wholly owned subsidiary, Home Federal Savings Bank (together, “Home Federal”), for a total purchase price of $123.6 million in common stock. As a result of the transaction, HMNF merged with and into Alerus Financial Corporation, and Home Federal Savings Bank merged with and into Alerus Financial, National Association. The acquisition enhances and extends the Company's presence in southern Minnesota. In connection with the acquisition, the Company issued 5.55 million shares of its common stock and acquired approximately $1.1 billion of identifiable assets. Goodwill of $38.9 million was recognized as a result of the merger and is not amortizable or deductible for tax purposes. The effects of the acquired assets and liabilities have been included in the consolidated financial statements since that date. As a result of the full integration of the operations of Home Federal, it is not practicable to determine all revenue or net income included in the Company's operating results relating to Home Federal since the date of acquisition as Home Federal results cannot be separately identified.

The Company determined that this acquisition constitutes a business combination and therefore was accounted for using the acquisition method of accounting. Accordingly, as of the date of the acquisition, the Company recorded the assets acquired, liabilities assumed and consideration paid at fair value based on management's best estimates using information available at the date of the acquisition and these estimates are subject to adjustment based on updated information not available at the time of the acquisition. The amount of goodwill arising from the acquisition consists largely of the synergies and economies of scale expected from combining the operations of the Company with Home Federal. Accrued income taxes and deferred taxes associated with the Home Federal acquisition were recorded on a provisional basis and could vary from the actual recorded balance and tax provisions when returns are finalized.

Direct costs related to the acquisition were expensed as incurred. Acquisition integration-related expenses were $10.0 million during the year ended December 31, 2024. There were no merger and acquisition expenses during the year ended December 31, 2023. These amounts were included within professional fees and assessments on the consolidated statements of income and are included in operating activities in the consolidated statements of cash flows.

The following table summarizes the estimated fair value of the assets acquired and liabilities assumed:

	As recorded by		Fair Value			As recorded by
(dollars in thousands)	HMN Financial, Inc.		Adjustments			the Company
Assets
Cash and cash equivalents	$	8,610	$	—		$	8,610
Investment securities available-for-sale		189,145		22			189,167
Loans held for sale		1,057		—			1,057
Net loans		856,164		(70,725	)		785,439
Land premises and equipment, net		15,932		2,096			18,028
Operating lease right-of-use assets		1,070		186			1,256
Accrued interest receivable		3,030		—			3,030
Core deposit intangible		—		33,500			33,500
Servicing rights		2,662		2,783			5,445
Deferred income taxes, net		7,234		7,170			14,404
Other assets		4,623		(687	)		3,936
Total assets		1,089,527		(25,655	)		1,063,872
Liabilities
Deposits		957,627		222			957,849
Short-term borrowings		1,600		—			1,600
Operating lease liabilities		1,104		352			1,456
Accrued expenses and other liabilities		22,646		(4,434	)		18,212
Total liabilities		982,977		(3,860	)		979,117
Excess assets over liabilities	$	106,550	$	(21,795	)		84,755
Stock issued for HMNF							123,602
Cash paid for HMNF							4
Total goodwill recorded						$	38,851

The Company determined the fair value of the assets and liabilities acquired with the assistance of third-party specialists. The following is a description of the methods used to determine the fair values of significant assets and liabilities presented above.

Cash and cash equivalents

The carrying amount of these assets is a reasonable estimate of fair value based on the short-term nature of these assets.

Investment securities available-for-sale

Fair values for AFS securities are based on quoted market prices, where available. If quoted market prices are not available, fair value estimates are based on observable inputs including quoted market prices for similar instruments, quoted market prices that are not in an active market or other inputs that are observable in the market. In the absence of observable inputs, fair value is estimated based on pricing models and/or discounted cash flow methodologies.

Net loans

A valuation of the loans portfolio was performed by a third party as of the acquisition date in accordance with ASC 820 to assess the fair value of the loan portfolio, considering adjustments for interest rate risk, required equity return, servicing, credit, and liquidity risk. The loans portfolio was segmented into two groups including PCD loans and non-PCD loans. The non-PCD loans were pooled based on similar characteristics, such as loan type, interest rates, term to maturity, delinquency status, and collateral type. Non-PCD loans did not include any loans more than 60 days delinquent or any non-accrual status loans. Non-PCD loan pools were valued using a discounted cash flow analysis, based on the cash flows projected for each loan pool. The PCD loans were valued at the individual loan level or pooled with similar characteristics as non-PCD pooled loans. Individually valued PCD loans were valued using loan-level probability of default and loss given default estimates, reflecting the individual collateral position and circumstances of each loan. The fair value of pooled loans were calculated using a discounted cash flow analysis to estimate the fair value of the loans using assumptions for the coupon rates, remaining maturities, prepayment speeds, projected default probabilities, loss given defaults, and estimates of prevailing discount rates. The discount rate utilized to analyze fair value considered projected future interest rates based on forward rates, a spread over the forward curve, spreads for estimated servicing costs and illiquidity. The discounted cash flow approach models the credit losses directly in the projected cash flows. The Company estimated the credit risks and principal losses of the loans using the Company’s assumptions of probability of default, loss given default, and foreclosures.

The Company is required to record PCD assets, defined as a more-than-insignificant deterioration in credit quality since origination or issuance, at the purchase price plus the allowance for credit losses expected at the time of acquisition. Under this method, there is no credit loss expense affecting net income on acquisition of PCD assets. Changes in estimates of expected credit losses after acquisition are recognized in subsequent periods as credit loss expense (or reversal of credit loss expense) arise. Any non-credit discount or premium resulting from acquiring a pool of purchased financial assets with credit deterioration is allocated to each individual asset. At the acquisition date, the initial allowance for credit losses determined on a collective or individual basis is allocated to individual assets to appropriately allocate any non-credit discount or premium. For PCD loans, an allowance is recognized on day 1 by adding it to the fair value of the loan, which is the “day 1 amortized cost.” Non-PCD loans will have an allowance established on the acquisition date, which is recognized as an expense through the provision for credit losses. A day 1 allowance for credit losses on non-PCD loans of $7.3 million was recorded through the provision for loan losses within the consolidated statements of income. The following table provides details related to the fair value of acquired PCD loans:

(dollars in thousands)	PCD Loans
Par value of PCD loans at acquisition	$	173,922
Allowance for credit losses at acquisition		10,151
Discount at acquisition		(31,313	)
Fair value of PCD loans at acquisition	$	152,760

Land, premises and equipment

The fair values of land, premises and equipment are based on a combination of sales comparison approach and cost approach, using third-party appraisals and other analysis of value for land and premises.

Core deposit intangible

Core deposit intangible assets were determined using the income approach, after-tax cost savings method. This method estimates the fair value by discounting to present value the favorable funding spread attributable to the core deposit balances over their estimated average remaining life. The favorable funding spread is calculated as the difference in the alternative cost of funds and the net deposit cost. The core deposit intangible represents the costs saved by the Company between maintaining the existing deposits and obtaining alternative funds over the life of the deposit base. These costs are amortized using the sum of the years digits method over the estimated useful life of 10 years for the related deposits.

Deposits

The fair values for time deposits were estimated using a discounted cash flow analysis as no active trading market exists with which to obtain pricing on comparable financial instruments. The projected cash flows included assumptions of interest paid at maturity and no early withdrawals. The time deposits were combined based on maturity into cash flow buckets, and an average interest rate for each bucket was used in conjunction with the months to maturity to project the cash flows required to settle the time deposits upon maturity. The projected cash flows were discounted using a discount rate curve to reflect current market rates at the acquisition date which included the acquired time deposit rates prior to acquisition, rate sheets for the acquired time deposits, and FHLB advance rates as of the acquisition date. For transactional deposits, carrying amounts approximate fair value.

Accrued expenses and other liabilities

Accrued expenses and other liabilities include items such as accrued interest payable, accounts payable, accrued liabilities, and other miscellaneous liabilities. For all accrued expenses and other liabilities it was determined that the carrying value equals book value, except for accrued liabilities related to contract terminations. Contract termination accrued liabilities were not assumed by the Company as part of the business combination with HMNF, and were recorded separately in the postcombination period in accordance with the acquisition method of accounting.

Supplemental Pro Forma Financial Information (Unaudited)

The following table presents certain unaudited pro forma financial information for illustrative purposes only, for the years ended December 31, 2024 and 2023, as if Home Federal had been acquired on January 1, 2023. This unaudited pro forma information combines the historical results of Home Federal with the Company's consolidated historical results and includes certain adjustments reflecting the estimated impact of certain fair value adjustments for the respective periods. The pro forma information is not indicative of what would have occurred had the acquisition occurred as of the beginning of the year prior to the acquisition. The unaudited pro forma information does not consider any changes to the provision expense resulting from recording loan assets at fair value, cost savings or business synergies. As a result, actual amounts would have differed from the unaudited pro forma information presented and the differences could be significant.

	Pro Formas (unaudited)
	for the years ended December 31,
(dollars in thousands)	2024		2023
Net interest income after provision for credit losses	$	118,367	$	134,492
Noninterest income		121,765		88,510
Noninterest expense		203,542		186,020
Net income (after tax)		28,159		26,981