Alerus Financial Corporation

Good afternoon and welcome to the Alaris Financial Corporation earnings conference call. All participants will be in a listen-only mode. Should you need assistance, please signal a conference specialist by pressing the star key followed by zero. After today's presentation, there will be an open opportunity to ask questions. Please note this event is being recorded. This call may include forward-looking statements and the company's actual results may differ materially from those indicated in any forward-looking statements. Important factors that could cause actual results to differ from those indicated in the forward-looking statements are listed in the earnings, releasing, and company's SEC filings. I would now like to turn the conference over to Alaris Financial Corporation President and CEO, Katie Larson. Please go ahead.

Thank you. Good morning, everyone, and thank you for dialing into our call today. Joining me today in Minneapolis is Karin Taylor, our Chief Risk Officer, and Al Villalon, our CFO. I am proud to announce that during the quarter we added Jim Collins, a seasoned bank leader in the Twin Cities, to our executive team as our Chief Banking and Revenue Officer. Jim will lead and support the continued new client growth and existing client expansion while building on our recent successes in adding talented bankers and advisors in the Twin Cities and throughout our footprint. On July 1st, we closed on the acquisition of Metro Phoenix Bank, the 25th acquisition in the company's history. We are pleased to have Metro Phoenix join the Alers franchise. The Phoenix Scottsdale MSA is one of the fastest growing areas in the country over the past five years. Metro Phoenix Bank, started by Steve Haggard, is a well-established, high-growth, and highly efficient bank with a strong commercial presence. With the approval in closing, Steve has now assumed leadership over the entire market as the Arizona president. Together, our combined organizations are one of the largest community banks and SBA lenders serving the market. This acquisition significantly increases our presence in Phoenix, Scottsdale, and demonstrates our commitment to growth and client expansion in Arizona. Looking back on the quarter, we reported EPS of 53, which included a 5 cent negative impact related to merger expenses. We continue to experience good loan growth as loans grew 17.3% on an annualized basis ex-PPP. Growth was across products, but highlighted by additions to our commercial client base, a proven catalyst for growing our retirement business. Year-to-date new plan sales in the retirement division are nearly 50% higher than last year, while lost plans have remained at stable levels. Our wealth management division produced at record levels of new revenue, which drove a linked quarter increase in revenue, despite the quarter being the worst mid-year market results in over 50 years. We experienced outflows in deposits, which were largely linked to seasonal declines in core operating accounts of public entities. And excluding PPP, our underlying core NIM expanded nine basis points to 296. Our mortgage originations on a year-over-year basis declined at a level greater than originally anticipated, as 30-year mortgage rates quickly rose from 3% to 6%. While we are coming off peak originations of $1.8 billion in 2021, we never overbuilt on an infrastructure, and we channeled our one hilarious culture and shared resources across business units to get that level of business done. While the mortgage industry is rapidly changing, our focus has always been on the purchase market due to our long-standing relationships with realtors and builders, especially in the Twin Cities. As our competitors reposition and downsize, this will present opportunities for our top-tier producers to pick up more market share in the purchase market. Despite the headwinds in mortgage, we continue to execute on our one-on-one strategy as we continue to grow the number of plans and participants in retirement and wealth management. We continue to deepen our relationships within our large client base on our platform. Today, we remain uniquely positioned in the banking sector as we continue to generate over 50% of our revenues from fee income, the majority of which is recurring, annuitized revenue with minimal capital allocation and no credit risk. Our loan portfolio remains well diversified and credit is very strong as we continue to experience minimal past dues, low levels of classified loans, and negligible charge-offs. In addition, as a non-CECL bank, we stand with a healthy allowance for loan losses at 1.66% of total loans. Expense management remains a key focus with core expenses flat to the previous quarter and down nearly 6.5% compared to the second quarter of 2021. I want to thank all of our employees for their hard work and dedication and welcome the Metro Phoenix Bank employees to our company. Our momentum in attracting and retaining talent as well as client growth opportunities across our diverse product offering supported by strong common tier one capital levels of 14.19% has Alaris well positioned to continue to grow expand and deliver strong returns to our shareholders. With that, I will hand it off to Al to discuss the financial details of the quarter. Take it away, Al.

Thanks, Katie. I will start my commentary on page 14 of our investor deck that is posted in the investor relations part of our website. For the second quarter of 2022, reported average loans increased 4.0% on a link quarter basis. Excluding the impact of PPP, average core loans increased 4.6% on a one-quarter basis. The increase in core average loans was driven by a 9.2% growth in CNI and a 5.4% growth consumer. Within CNI, we saw a pickup in loan production along with an uptick in utilization rates as clients continued to tap into their existing lines. CNI utilization increased from 28% to 32% during the quarter. At the end of the first quarter, we had approximately 6.9 million of PPP loans outstanding. Average deposits declined 2.7% on a one-quarter basis due to seasonal decline in interest-bearing deposits. The decrease in interest-bearing deposits was due to seasonal decrease in our public unit funds. We typically see a drawdown in these public funds in the summer, with an increase happening during the fall usually. Turning to page 15, credit continues to remain very strong. We had net charge-offs of seven basis points in the first quarter compared to three basis points of net recoveries in the prior quarter. Our non-performing assets percentage was 16 basis points compared to 15 basis points in the prior quarter, while our allowance is 1.66% of period end loans. On page 16 are some key revenue metrics. On a reported basis, net interest income decreased 5.1% on a link quarter basis, excluding the impacted PPP and net interest income increased 6.9% due to higher loan growth and higher net interest margin. Net interest income declined 0.8% on a linked quarter basis due to lower retirement revenues offset by improved mortgage and wealth management. I will go into detail about those segments in later slides. Turning to page 17, Net interest margin was 2.98% in the first quarter, an increase of 15 basis points from the prior quarter. Excluding the impact of PPP, our core net interest margin was 2.96%, an increase of 19 basis points from the prior quarter. Core net interest margin benefited from higher investment portfolio yields along with higher loan yields from our commercial real estate portfolio, offset by lower yields from our C&I portfolio. Turning to page 18, $706 million, or 37% of our loans, are floating, as you can see at the top of the slide. As you see, almost all our variable loans are above their stated floors or have no floors. On the bottom left, you can see a waterfall of net interest income and net interest margin. Better volumes and rate, as previously mentioned, positively impacted our results. On page 19, our core funding mix remains very strong. we saw a small increase in our deposit costs due to rising interest rates. Given the recent rise in interest rates, we do anticipate our deposit costs to rise now. We are currently anticipating our deposit beta to be between 25 to 30% in the quarter, which is still lower than we previously anticipated. On page 20, I'll provide some highlights on our retirement business. AOM declined 10.1% due to mainly to market volatility, with S&P being down over 16% in the quarter, and that aggregate bond index down 5%. While AEDOM declined, we did see the number of participants increase to approximately 450,000 versus 445,000 in the prior quarter. Revenues declined 7.7% in the prior quarter, mainly due to lower asset levels. Turning to page 21, you can see highlights for our wealth management business. Similar to what we saw in retirement, AUM declined 9.5%, mainly due to the market volatility again. Despite the decline in AUM, revenues increased 4.1% from prior quarter, mainly to a custody deal that was won at the end of the prior quarter. Strong new production by advisory business and higher transactional revenues. Turning to page 22, I'll talk about a mortgage business. Mortgage originations increased approximately 45% for prior quarter as we rebounded from record low housing inventories in our main markets. Despite the challenging market, our current bonds are over 22% higher than the similar time period in 2019. Lastly, turning to page 23 is an overview of our non-interest expense. During the quarter, non-interest expense increased 5.0% mainly due to higher incentive compensation related to revenue-related activities, mainly in improvement and mortgage. We also saw an increase in professional fees due to higher M&A expenses in the quarter. Other expenses decreased as a result of lower provision for unfunded commitments as we saw pickup and commercial utilization. And market expenses increased quarterly due to a typical seasonal pickup. Now I'll provide some forward-looking guidance. First, I'll comment on the Metro Phoenix Bank, which we closed on the acquisition on July 1st. As of June 30th, Metro had the following balances. They had $84 million of cash, $38.5 million of investments, and $277.6 million of loans. We are assuming $354.5 million of deposits. We issued 2.68 million shares of total stock for consideration of $63.8 million for the purchase of Metro. After the purchase of Metro, we do not anticipate a material impact on our tangible common equity or capital ratios as a result of the transaction. Now I'll provide guidance for the third quarter. On a standalone basis, we are expecting average loan growth to be in the high single digits on a linked quarter basis. For Metro, we're expecting double-digit loan growth on a linked quarter basis in that loan book. Overall, we expect some interest margin expansion, but expansion will be limited as we anticipate rising deposit costs given rising interest rates. Again, we are currently expecting our deposit beta to be between 25 to 30 percent. With Metro, we expect net interest income to grow in excess of 20 percent from the prior quarter. We expect overall fee income to be down low single digits, mainly driven by continued decline, as we expect overall originations to be under pressure due to seasonality. Given no market growth, we expect wealth to be up similar as the second quarter and retirement to be flash. On a standalone basis, we're expecting expenses to be up mid-single digits, mainly due to merger-related costs. Excluding those merger-related costs, we expect core expenses to be flattish. With Metro, we expect Metro to increase our core expense base by mid-single digits. And lastly, we expect credit to remain strong and continue to expect net charge-offs to be below historic levels. With that, I'll now open it up to Q&A.