Alerus Financial Corporation

Good afternoon 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.

All right. Thank you, Angela. Appreciate it. Greetings, all, and welcome to the Q1 2024 Alaris Earnings Call. We appreciate you all taking the time to join us today. Joining me here today in Minneapolis is Alaris' CFO, Al Villalon, our Chief Operating and Risk Officer, Karin Taylor, our Chief Banking and Revenue Officer, Jim Collins, and making his debut earnings call with us today is our Chief Retirement Services Officer, Forrest Wilson. I am incredibly proud to be surrounded by these talented professionals here in this room, as well as widely and deeply across the Alaris franchise. Earnings for the first quarter of 2024 matched expectations, as our team members delivered again in executing our organic growth one Alaris strategy. Client wins came through in all parts of the business, and most notably resulted in strong deposit and wealth management growth and inflows. We saw new client wins in CNI, which came with lending opportunities and full treasury management relationships. Our one hilarious business model and holistic approach to serving clients continue to differentiate our company with an impressive quarter of net inflows in wealth management. And strong production was driven by business owner liquidity events, as well as robust rollover business sourced from our retirement division. The synergies between private banking, wealth, mortgage, and commercial banking continue to emerge even faster than expected. The results of these efforts by our team members and support services were evident, with deposit balances increasing over 6% in the quarter and commercial loans growing over 2% during the quarter. Highlights for the quarter included an improving core net interest margin, as we saw the benefits from the balance sheet repositioning, as well as the impact of organic growth. Fee income, which accounts for over 50% of total revenues, delivered ongoing positive momentum showing growth across each of the fee-based businesses. Alaris remains in a uniquely strong position to grow with a highly diversified loan portfolio and robust liquidity. Loan balances grew for the ninth consecutive quarter, while deposit balances increased for the fourth consecutive quarter, displaying our proven ability to grow and attract new clients. While deposit growth for the industry remains very challenged, we continue to see strong client flows from within our banking markets, as well as nationally through synergies with our retirement and benefits businesses. We remain consistently disciplined in our risk management and infrastructure investments while selectively taking market share and supporting our clients and our communities. Our commitment to our shareholders and our fortress balance sheet is unwavering with an allowance to total loans of 1.31% and a CET1 capital ratio at 11.85%. With our quarterly dividend 5.6% higher than the same period in the prior year, we maintained our history as a dividend aristocrat and we continued our streak of 40 years of paying a dividend and consistently increasing our dividend. Asset quality remains strong with less than one basis point of net charge-offs and consistently low levels of non-performing loans. We remain confident in our strategic initiatives, including our focus on building efficiencies, and we will continue to get better at managing expenses, proceeding on our path to returning the company to top shareholder returns and earnings per share growth. And with that, I will turn it over to CFO Al Villalon.

Thanks, Katie. I'll start my commentary on page 11 of our investor deck that is posted in the investor relations part of our website. Let's start on our key revenue drivers. On a reported basis, net interest income increased 3.1% on a linked quarter basis. The increase was driven primarily by organic loan growth, strong deposit growth, and an arbitrage opportunity using the bank term funding program. Net interest income represented 46.7% of revenues. Switching to fee income, non-interest income decreased 0.4%. on a linked quarter basis, primarily driven by client swap income over approximately $1.3 million that was recognized in the prior quarter and other non-interest income. Despite not having any swap income in the current quarter, we did see fee income increase across all of our fee income segments. I will go into detail about each of our fee income segments in later slides. Turning to page 12, non-interest income increased to $22.2 million in the first quarter. The BTFP arbitrage was accreted to net interest income by $349,000. We can pay back the BTFP anytime or at the due date in 2025 with no penalty. Adjusted core net interest margin, which excludes the impact of the BTFP arbitrage, was 2.44%, an increase of seven basis points from the prior quarter. During the quarter, higher loan balances and rates along with lower borrowings helped drive margin expansions. We expect our reported net interest margin to continue to improve in 2024. After 2024, or when we repay BTFP, our reported net interest margin will revert to the core margin we show, primarily due to reduction in average earning assets. Should the trend remain on pause, we continue to expect our net interest margin to improve. While the Fed outlook is uncertain, our ALM modeling shows that with a static balance sheet and at current spreads, Our net interest margin will exceed 3% for the full year in 2026. Should the Fed cut interest rates sooner, we expect to get to 3% net interest margin sooner depending on the timing and magnitude of rate cuts, especially as our net interest margin returns to being liability sensitive with $400 million of swaps maturing in July of this year and another $200 million of swaps in January of 2025. Let's turn to page 13 to talk about our earning assets. Total loans grew 1.4% from the prior quarter driven by organic growth in C&I and commercial real estate. Our investment portfolio declined 2.2% as we continue to remix low-yielding securities into higher-yielding loans. For 2024, we continue to expect to see modest loan growth. While 7% to 8% of loans are expected to contractually pay off during the remainder of the year, we do expect loan production to offset this runoff and expect our earning assets to continue to grow. Turning to page 14, On a period-ending basis, our deposits increased 6.1% from the prior quarter. The momentum and deposit growth we saw in the prior quarter continued into this quarter. While overall deposits grew, non-sparing deposit balances decreased 4.9% and now represent 21% of total deposits. Overall synergistic deposits, so those sourced from our retirement wealth businesses, increased 3.7% from the prior quarter. Given the strong deposit growth, we saw our loans-to-deposit ratio decrease to 85.2%. For the second and third quarters of 2024, we do expect a seasonal outflow of approximately $200 million, mainly from our public funds. While these outflows will pressure deposit balances in upcoming quarters, we do expect deposit levels at the end of the year to rebound to the end of the year higher than where we ended 2023. Turning to page 14, I will now talk about our banking segment. which also includes our mortgage business. I'll focus on the fee income components now since I already covered net interest income. Overall non-interest income for banking was down $627,000, or 15% from the prior quarter. Most of the decline was attributed to $1.3 million of client swap income that was recognized in the prior quarter. This swap income does not relate to our balance sheet swaps. Rather, these swaps are done at the client level when a banking relationship would like to lock in a fixed rate by swapping out the floating rate loan. This type of swap income tends to be lumpy and unpredictable. For the second quarter, we do expect the overall level of non-interest income to increase from the first quarter level as we expect mortgage income to improve with a typical seasonal pickup in the second and third quarters. The current level of other non-interest income of $1.5 million is a better run rate on a go-forward basis, and we expect that level to be stable as we do not expect any client swap income in the upcoming quarter at this moment. On page 16, I'll provide some highlights on the retirement business. Total non-injurious income increased 2.2% from the prior quarter. End-of-quarter assets under management increased 4.9%, mainly due to improved equity and bond markets. Participants within retirement grew 1.5% during the quarter. As we did in our 10-K, we broke out the non-injurious expense that is allocated to the retirement segment. The table in the top left does not include any credit for synergistic deposits, since those earning assets of those deposits are within the banking segment. These synergistic deposits are highly valuable when compared to borrowing at FHLB, which are currently in the low 5% range. While almost 53% of retirement synergistic deposits are indexed, 16% are non-interest-bearing, and 31% consist of HSA deposits, which only carry a cost of funds around 10 to 15 basis points. For the second quarter, we expect the income from retirement business to be stable at $15.7 million, despite the recent downturn in the markets. Turning to page 17, you can see highlights for our wealth management business. On a linked quarter basis, net revenues increased 9.3%, while end-of-quarter assets under management increased 5.5% due to improved equity and bond markets. Over 85% of revenues in this segment are asset-based fees. Similar to the prior slide, we show on the top left the non-interest expenses allocated to the wealth segment, but we have also excluded any credit of our synergistic deposits. As you can see here, 88.6% of our synergistic deposits and wealth are indexed, while the remainder are non-interest bearing. For the second quarter, excluding any market impact, we expect the income from wealth business to be stable given recent market volatility. Page 18 provides an overview of our non-interest expense. During the quarter, non-interest expense increased 0.9%, mainly due to higher seasonal compensation and benefits. As we continue to deal with inflationary pressures, we continue to expect expenses to grow for 2024 to grow low single digits when compared to 2023 on a reported basis. Turning to page 19, credit continues to remain very strong. We had net charges to total loans of one basis point in the quarter. A non-performing assets percentage was 17 basis points compared to 22 basis points in the prior quarter. And our allowance for credit losses on loans to total loans was 1.31%, or 498% over non-performing loans. I will discuss our capital and liquidity on page 20. A common equity tier one capital to risk-weighted assets is 11.9%, which is almost 200 basis points above the 9.9% percent stress minimum required by the largest financial institution subjected to the Dodd-Frank stress test. On the bottom right, you'll see a breakdown in the sources of over $2 billion in potential liquidity. Overall, we continue to remain well positioned from both a liquidity and a capital standpoint to support future growth or weather any economic uncertainty. While we did not repurchase any shares in the quarter, we have an active 10B51 share repurchase plan out there that is very disciplined in our share repurchase approach. The recent sharp run-up in our share price ended up being above the purchase levels we set in our 10b-5-1 plan. Our 10b-5-1 plan currently remains in place today. So to summarize on page 21, the momentum we had in the fourth quarter of 2023 continues into 2024. We continue to see organic loan growth and strong deposit growth. Our net interest margin continues to improve in the quarter. Even if the Fed remains on pause, we continue to see a path of the margin to improve to over 3%. Our fee businesses, which are non-spread-based, represented over 53% of revenue in the quarter and continue to be differentiator for us. Our capital levels remain strong, and we remain committed to returning capital prudently. With that now, I will open it up for Q&A.