Alerus Financial Corporation

And welcome to the Alaris Financial Corporation Earnings Conference Call. All participants will be in 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 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 materially from those indicated in the forward-looking statements are listed in the earnings release and the company's SEC filings. I would now like to turn the conference over to Alaris Financial Corporation President and CEO, Katie Lawrenson. Please go ahead.

Good morning. Thank you, Bethany, and thank you to our investors and our analysts joining our call today. We appreciate your time and interest in Aleris. I know we always have good engagement by our employees listening in, and I want to take this opportunity to thank them for their dedication and their client outreach efforts throughout March following the bank failures. The efforts of our team across the company are instrumental in retaining and acquiring our holistic client relationships. This morning, I will provide some commentary on Alaris' strategic positioning in the current environment, along with some comments on the first quarter. Alaris' CFO, Al Villalon, will discuss our financial performance and results for the quarter. Afterwards, Karin Taylor, our Chief Risk Officer, and Jim Collins, our Chief Banking and Revenue Officer, and Barrett Lamb, our Treasurer, will join us to answer any questions you may have about the quarter. Let me begin first by highlighting Alaris' strong balance sheet and liquidity in light of the recent market events. As I will describe in more detail, our capital remains strong, our diverse and relationship-oriented deposit base grew 4% over the quarter, our sources of liquidity more than cover our uninsured and not collateralized deposits, and our asset quality remains sound. Despite the industry-wide challenging conditions, Alaris is strategically positioned to navigate the current operating environment. Alaris is one of the most uniquely diversified financial institutions in the country, with over 50% of revenue derived from fee income. of which a vast majority of this revenue is recurring and annuitized in nature, with little to no capital allocation. The value of these businesses is significant, especially in the face of rapidly changing interest rate environments. Diversification goes beyond the business model and revenue mix and is a fundamental tenant of our long-term strategies of this company. Alaris is well diversified within its client base in both the deposit and the loan portfolio. I'll start first with the deposit portfolio, which is 98% core deposit relationships, most with long-tenured relationships with the company. Insured deposits totals are 74% of total deposits, and although we saw migration from non-interest-bearing to interest-bearing, our overall non-interest-bearing balances of 26% remains above peer averages. Overall, our liquidity position remains robust, primarily driven by our highly granular deposit portfolio built through relationships. While we naturally have some large balances, most are part of full relationships with integrated treasury management solutions and services. Our fee income businesses not only contribute to our relationship-focused differentiated business model, but they also are leveraged to provide significant synergies. Most notably, over $750 million, or 25% of our deposit portfolio, is sourced through our fee income businesses, which helps mitigate funding pressure created by intense deposit competition. These deposits include low-cost HSA deposits in addition to retirement and wealth management money markets, which carry an index market rate but minimal acquisition or servicing costs. Growing our core deposit franchise has been a consistent and constant focus for this company and a key component of our one-o-layer strategy and initiative. This is evidenced by 68% of our lending relationships having a multi-product relationship with the bank and highlighted by our current loan-to-deposit ratio of 82%. consistent with our long-term average of 78%. The company's loan portfolio is also well diversified by type, by industry, and by market. Our non-owner-occupied office exposure is 3.9% of total loans. Alaris has a strong history of outperforming peers during economic downturns, with a long-term historical net charge-off ratio of less than 30 basis points. This quarter's net charge-off ratio was three basis points. Reserve levels remain robust at 1.41%, of allowance for credit losses to total loans. Our credit and risk management teams have completed a review of our office portfolio and conducted bottom-up stress testing on our commercial real estate portfolio. Our diversification strategy has also anchored the company in stable legacy markets while expanding to larger growth markets in Minnesota and Arizona. We will continue to be selective in our growth opportunities and add quality clients, relationships, and credits to our company while supporting our current clients through the cycle. Adding to the company's solid balance sheet, pristine credit quality and ample liquidity are strong capital levels, with CET of 13.3% and TCE levels around 7%, even when including unrealized losses on the HTM portfolio. While near-term margin pressure remains a headwind to earnings, we continue to execute on initiatives to fundamentally improve the profitability of this organization. We have added dedicated and experienced talent to the treasurer role, And while we are continually evaluating opportunities to reposition the balance sheet, we are also strategically focused on transformational opportunities that will return us to our 40-year historical performance levels of a greater than 1.25% ROA and a greater than 12% ROE. This transformation is focused on improving the long-term core organic growth of the organization, including enhancing synergistic opportunities across business lines, while consistently generating positive operating leverage. In January, we restructured our banking division and organized our team members to serve clients in their dedicated segments, improving our speed to market and the client experience. During the quarter, we added team members focused on mid-market commercial banking and treasury management. We recently completed an additional rightsizing as revenue headwinds persist. As a result of these moves, expenses have remained well managed despite inflationary pressures. We will continue to see opportunities to improve our efficiency, while attracting highly experienced and reputable revenue-producing talent to the company. While we have work to do and the battles in the near-term pressure on margins, we continue to build tailwinds in client acquisition and synergistic expansion on our wealth management and retirement platforms. The long-term value embedded in these businesses is substantial and a substantial differentiator in the community bank space from a client and a talent acquisition standpoint, as well as for delivering top-tier shareholder retention. These capital-like businesses will continue to contribute to Alaris' long history of historical cash dividend payouts, currently yielding over 4.5%, and once there is greater visibility on the economic front, potential share repurchases. With that, I will turn it over to Al for financial commentary on the quarter.

Thanks, Katie. I will start my commentary on page 11-0 of our investor deck that is posted in the investor relations part of our website. Given all the market uncertainty, this highlight shows how strong and stable Blurris is. We have a high-quality deposit base, superior liquidity, strong capital, and conservative credit. I will go into further details about each of these strengths later in the slide deck. Let's go to page 15 now. First, for the first quarter of 2023, reported average half of the quarter, which I will discuss later. Turning to page 16, credit continues to remain very strong. We had net charge-up of three basis points in the first quarter. Our non-performing In addition, we have a fair value mark of $6.9 million on the Metro Phoenix acquired loans. We incurred a day one adjustment in the allowance for credit losses of $5.9 million and an after-tax adjustment to retained earnings of $4.5 million. $4 million of the adjustment was related to loans, while $1.9 million was related to unfunded commitments. On page 17, Despite the highly competitive environment for deposits, our interest-bearing data was 36% at this point in the cycle. On a period-ending basis, our deposits grew 4% from the prior quarter. We saw very solid client retention and deposit inflows from our core commercial and consumer deposit base and from new clients as we continued to expand our presence in existing markets. We continue to not have any broker deposits. As you'll see on the right-hand side of the slide, our deposit base is well diversified. The strength in our unique and differentiated business model shined in the quarter as synergistic deposits grew 9.6% from the prior quarter to $758 million. Synergistic deposits sourced from our retirement and wealth businesses now account for 25% of our deposit base. On page 8 Non-interest-bearing deposits currently account for 29.5% of total deposits. As you'll see on the top right-hand chart, Alaris has typically operated with a higher percentage of non-interest-bearing deposits relative to the banking industry. On the bottom left part of the slide, you'll see that uninsured and not collateralized deposits account for only 25.1% of total deposits, or approximately 800 million. We also have about 800 million deposits. In addition to our on-balance sheet liquidity, we have another $1.4 billion of off-balance sheet liquidity. This brings our total liquidity to $2.2 billion. Our total liquidity to uninsured and uncollateralized deposits is 286%. We have substantial liquidity, as you can see, to cover those uninsured and not collateralized deposits. As we look forward to the second quarter, we do expect our usual seasonal outflow from our public funds. But for the remainder of the year, we continue to expect deposit balances to be stable or show modest growth. Turning to page 19, our capital base remains very strong as our common equity tier one ratio is at 13.6%. In comparison, our common equity tier one ratio is 5.5%. objected to the Saad Frank stress test. Our current tangible equity to tangible asset ratio is 7.6%. While only 31% of our securities are held to maturity, if we mark these securities to mark the market, our tangible equity ratio would still be around 7%. On the bottom right, you'll see the breakdown in the sources of our $2.2 billion in potential liquidity. Overall, we continue to remain well-positioned from both a liquidity and capital standpoint for weather, economic uncertainty, We currently have $770,000 share repurchase authorization in place. We will repurchase stock when market uncertainty subsides. Page 20 shows some key revenue metrics. On a reported basis, net interest income declined 12.3% on a link quarter basis. The decline was driven primarily by continued increase in funding costs. Non-interest income declined to continue headwinds on mortgage. I will go into detail about our fee income segments in later slides. Our fee income was 51.6% of total revenues. Our high fee income is a big differentiator, especially as over 90% of the fee income is recurring and annuitized in nature. Our strength continues to be providing holistic financial solutions to our clients. Turning to page 21, net interest margin was 2.7%. BASIS POINTS FROM THE PRIOR QUARTER. A 29 BASIS POINT INCREASE IN OUR EARNING ASSET YIELDS WAS OFFSET WITH A 78 POINT INCREASE IN OUR INTEREST-BEARING LIABILITIES. BASED ON THE LATEST FED DOT PLOTS, WE CONTINUE TO EXPECT OUR NAND INTEREST MARGINS TO COMPRESS AT A MORE MODEST PACE IN THE SECOND QUARTER. EARNING ASSET YIELDS WILL CONTINUE TO IMPROVE WITH MIXSHIFT AND LOAN REPRICING WHERE OUR COST OF FUNDS IS STABILIZING. TURNING TO PAGE 22, Over $1 billion or almost 41% of our loans are floating, as you can see at the top left of the slide. As you see, almost all of our variable loans are above their stated floors or have no floors. For 2023, we continue to expect modest loan growth. Turning to page 23, you'll see details about our investment portfolio. Currently, 69% of our securities are available for sale versus 31% in health and maturity. Within the health and maturity portfolio, 42% are in municipal securities, while the rest are in MBS. As we restructure and transform our banking division, we are strategically focused on growing commercial relationships, which will add higher yielding and variable rate loans with deposit and treasury management relationships. We will continue to let the investment portfolio run down from approximately 28% of earning assets Today, our investment portfolio has an effective duration slightly over five years. As we right-size our investment portfolio, we plan on maintaining a duration around three years. On page 24, I'll provide some highlights on retirement business. End-of-quarter assets under management increased 4% due to higher domestic bond and equity markets in the first quarter and continued client wins. Revenues declined on the link quarter basis mainly due to lower average assets during the quarter For the second quarter, excluding any market impact, we expect fee income from our retirement business to be up slightly. Turning to page 25, you can see highlights of our wealth management business. Revenues increased 1% or end of quarter assets under management increased 2.6%. We continue to see strong client acquisition in our geographical markets and retirement rollovers in our national and established markets as we execute on our one-letter strategy. We continue to retain deposit dollars with our synergistic wealth money market offering, which represents 30% of our synergistic deposits. For the second quarter, excluding any market impact, we expect the income from our wealth business to be up slightly. Turning to page 26, I will talk about our mortgage business. Mortgage revenues declined $454,000 from the prior quarter due to lower originations as the macro and local environment remain challenged. Mortgage originations decreased approximately 38% from the prior quarter, as the first quarter is typically slow. Inventory of homes available for sale continue to remain at a very low 1.5-month supply versus a typical level of 3 to 4 months in the Twin Cities. We do expect a pickup in the mortgage business in the second quarter. However, the increase in volume may be more muted than the NBA forecast of a 36%. Page 27 provides an overview of our non-interest expense. During the quarter, non-interest expense decreased 30 basis points from the prior quarter, which was in line with original expectations of expenses being stable. Compensation expense increased due to seasonality, but also due to a one-time expense of $900,000 related to talent acquisition and service expense. Despite inflationary pressures, we do expect expenses to be down low single digits for 2023 on a year-over-year basis. We continue to be focused on improving our profitability by reducing expenses, increasing capacity throughout our organization. We recently made continued progress in right-sizing our expense infrastructure through numerous initiatives. Some of these expense saves will be reinvested in efficiency improvement and revenue production initiatives. To summarize on page 28, we remain well-precision from both the liquidity and capital standpoint. We have ample liquidity to weather economic volatility, and capital ratios remain very solid, even if you factor in the unrealized losses from our health and maturity investments, as our tangible common equity ratio would still be around 7%. Credit remains strong. Lastly, we continue to see growth in our core existing deposit base, and with new customers as people value the holistic approach of our professionals and business value provides. With that, I will now open it up for Q&A.