ALERUS FINANCIAL CORP Q3 FY2024 earnings call

Management Statement and Operational Highlights

• Transformational Changes: Alerus has added key talent, diversified its loan portfolio, and completed its largest acquisition to date (Home Federal). It has also restructured non-core business lines.
• Home Federal Acquisition: Received regulatory approval and closed the acquisition within the expected timeframe. The integration playbook is proven, and the conversion process is straightforward.
• Deposit and Loan Performance: Deposits grew over 7% year-to-date, and deposits were held flat despite competitive pressures. Loans grew robustly with market share gains, and the company remains selective in commercial real estate lending.
• Credit Quality: The company focuses on early identification of problem loans and proactive actions. Non-accrual loans increased due to two large relationships, but reserves are adequate.
• Expenses: Expenses increased due to key hires, severance packages, M&A expenses, and professional fees. However, revenue-producing hires are expected to improve fees, and platform/technology changes in Wealth and Retirement are aimed at driving efficiencies.
• Capital Levels: Capital levels bounced back with the payoff of BTFP, book value grew 4.6%, and the company is committed to dividends, with repurchases not active due to the recent acquisition.

Segment Performance

• Banking Segment (including Mortgage): Non-interest income from Banking increased by over $600,000 or 12% from the prior quarter, primarily driven by a gain from the sale of an office. Mortgage revenue is expected to slow in the fourth quarter due to seasonal originations slowdown.
• Retirement Business: Total revenue increased by 0.4%, with assets under management up 4.7% and participants growing by 1.5%. New business production remained strong, and fee income for the retirement business is expected to be stable in the fourth quarter.
• Wealth Management Business: Revenues rose 5.1% on a linked-quarter basis, and assets under management increased 5.4% due to market improvements. Fee income for the wealth business is expected to be slightly up in the fourth quarter excluding market impact.
• Loan and Deposit Growth: Loans grew 4% over the prior quarter. Deposits had over 7% year-to-date growth, and deposits were held flat despite seasonal outflows. The loan-to-deposit ratio was 91.2%, below the target of 95%.

Guidance

• Net Interest Margin: Aiming to reach 3%, though the path is not linear with factors like non-accruals and deposit mix affecting the margin.
• Fee Income: Wealth and Retirement fee income is expected to grow, while Mortgage revenue is projected to slow in the fourth quarter.
• Expenses: Fourth-quarter expenses are expected to increase due to Home Federal merger expenses, but the company is committed to achieving 30% cost savings from the Home Federal acquisition by 2025.
• Loan and Deposit Growth: Strong organic loan and deposit growth is expected to offset seasonal outflows.

Risks

• Credit Risks: Non-accrual loans increased due to specific large relationships, requiring continued monitoring and resolution of problem loans for credit normalization.
• Deposit Competition: Intense competition for deposits is increasing the cost of funds, with deposit betas expected to lag on rate cuts.
• Integration Risks: Potential challenges in integrating Home Federal, including managing expenses and ensuring a smooth transition.

Question and Answer

• Q: On larger credit and non-accrual, where is the credit located and timeline? A: Karin Taylor stated the credit is in the Twin Cities market, approximately 87% complete, with an expected completion in early 2025, but no firm timeline was provided.
• Q: On expenses, are non-recurring expenses tailing off? A: Katie Lorenson mentioned professional fees may normalize, and core non-interest expense is expected to decrease over time.
• Q: Loan growth and market share, market demand? A: Jim Collins noted the company is taking market share, with non-solicits up, and markets are in good shape but not robustly growing, with activities expected to be more fruitful in 2025-2026.
• Q: Margin trajectory, core margin, deposit betas? A: Al Villalon said the legacy margin was around 2.41%, the HMN portfolio had a net interest margin of ~2.8% in Q3, and deposit betas are expected to lag on rate cuts, with deposit pricing slower to adjust.
• Q: Retirement and Wealth profitability, national partners? A: Forrest Wilson said the Retirement business has partnerships like with Mass Mutual, and margins are expected to improve through efficiency, revenue, and reduced turnover.
• Q: Margin outlook, Home Federal impact, NII? A: Al Villalon said NII is expected to be in the mid-2s, with swap roll-offs impacting the margin and legacy interest expense decreasing.
• Q: Criticized classified loan trends, capital deployment? A: Karin Taylor said criticized classified levels are consistent with pre-pandemic, and Katie Lorenson mentioned capital priorities are on organic growth, dividends, and selective M&A.
• Q: Expenses, Home Federal integration, capital excess? A: Al Villalon stated Q4 expenses would be messy due to merger, and Katie Lorenson said capital priorities include organic growth, dividends, and selective M&A.
• Q: Hiring and funding growth, loan-to-deposit ratio? A: Jim Collins said the company is active on hires, repurposing FTEs, and Al Villalon noted the target loan-to-deposit ratio is 95%, with focus on core deposits.