Alerus Financial Corporation

Good morning, afternoon, and evening, 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 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 statement. 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 feelings. I will now like to turn the conference over to Alaris Financial Corporation's President and CEO, Katie Lawrenson, to begin. Please go ahead.

Thank you. Good morning, everyone, and thank you for joining us today to discuss Alaris Financial Corporation's fourth quarter and full year 2024 financial results. I'm Katie Lawrenson, President and CEO, and I'm pleased to be here with our Chief Financial Officer, Al Villalon, our Chief Operating Officer, Karin Taylor, our Chief Banking and Revenue Officer, Jim Collins, and our Chief Retirement Services Officer, Forrest Wilson. Each of these leaders continues to play a crucial role in driving our company's progress to transformational growth and top-tier performance. Before we dive into the details, I want to express my heartfelt gratitude to our dedicated employees, our loyal clients, and the shareholders and supportive communities we serve. Your trust and confidence in Alaris have been instrumental in our historical success, and we are deeply appreciative of your continued support. Now let's get into the highlights of our performance. We ended 2024 on a strong note, with performance improving, including an adjusted return on tangible equity eclipsing 14%. This quarter marked meaningful and deliberate progress in our journey back to top-tier profitability. The clear highlight for the quarter was the successful closing and conversion of our acquisition of Home Federal and our launch into the vibrant Rochester and southern Minnesota markets. This acquisition, the largest in our company's history, pushed our total assets to over $5 billion and increased our client base by nearly 50%. In addition, we are on track with our projected cost savings, and deal expenses were 5% less than our original estimates. When we announced this transaction last year, we expected the combination to help drive top quartile performance metrics, and we fully anticipate this to be the case. I am pleased to share with all of you, within the more than 30% reported growth of loans and deposits, We continue to see robust organic growth in all Alaris markets on both sides of our balance sheet. I'd be unproud of the talented team members we have attracted and retained at Alaris. Our continued success in gaining market share and adding new clients throughout our footprints and in our various verticals, including C&I, government not-for-profit, equipment leasing, have been transformational. Even with this organic growth and our continued focus on being highly selective, and allocating our capital and dry powder to franchise accretive holistic relationships, the pipelines moving into 2025 remain robust. We are disciplined and vigilant in our proactive monitoring and identification of credit as trends are normalizing. This involves closely tracking loan performance and making adjustments as needed to mitigate risk. Meanwhile, we continue to build reserves with balances increasing to 1.5% at the end of the year. Our net interest income saw a substantial increase of nearly 70%, and our net interest margin improved by 97 basis points to 3.2%. Al will get into the specifics and all the moving parts, but I wanted to commend the team for their concerted efforts to improve pricing disciplines. Non-interest income, which represents nearly half of our total revenues, grew by almost 20% quarter over quarter, supported by improvements across all fee-based businesses and gains on sale of offices. as we constantly look to invest in and optimize our branch footprints. It is important to note our core fee income grew 10% on a year-over-year basis across all business lines and is our ultimate differentiator. In our retirement business, we saw core year-over-year growth in revenue of 6%, with another record level of new plan sales in 2024. Our talented team continues to execute on several key strategic initiatives to grow our business, our core revenues, and make meaningful operational improvements. We remain especially bullish on this business given the tailwinds coming with Secure Act 2.0, which aims to increase the number of businesses offering retirement plans and has provisions to support higher participation in those plans, in addition to growing opportunities for M&A. Aside from the top-line revenue growth, the value of the retirement business is multifaceted due to the stability and the durability it brings to our company, in addition to the synergies we leverage in deposits and the capture of wealth business. In our wealth business, we saw year-over-year growth of 19% in revenues. We are focused on growing our wealth business with a long-term goal to have our AUM match the asset side of our bank. We intend to continue to add to our deep bench of talented producers, as well as reinvest in systems automation and process improvement. Our focus is on improving the client experience, in addition to creating more capacity for our talented team members to keep growing the clients. Although it was a noisy quarter from an expense management perspective, we achieved a notable improvement in our adjusted efficiency ratio, which decreased to 68.97% from 77.71% in the third quarter. Process improvement, automation, and continued progress to higher profitability through prudent expense management remains key priorities into 2025 and beyond. Capital levels decreased as expected during the quarter due to the acquisition and organic growth. The acquisition is highly accretive to earnings, and we expect to continue to build back capital levels with our superior business mix delivering superior returns. As we look to capital allocation, we will continue to prioritize franchise-building organic growth in addition to maintaining long dividend history. Thank you, and I'll now turn it over to Al for a more detailed review of our financial results.

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 69.8 percent over the prior quarter, while fee income grew 19.4 percent. The increase in both was primarily driven by the acquisition of Home Federal. Fee income represented almost 47 percent of revenues during the quarter. Let's dive into the drivers of net interest income on the next slide. Turn to page 12. In the fourth quarter, net interest income increased to $38.3 million. and our reported net interest margin increased 97 basis points to 3.2%. As you can see on the bottom left, our adjusted net interest margin was 2.81%, or a 46 basis point improvement over the last quarter. Our net interest margin improved mainly due to acquisition of Home Federal, organic balance sheet growth, and repricing of both loans and deposits. We saw a 54 basis point improvement in our cost of funds, mainly due to Home Federal acquisition, as our cost of funds dropped 2.53%. Of the 100 basis points declined in the Fed's fund so far, we have seen our deposit beta around 30%. We anticipate our deposit beta to be around 45% once all Fed cuts have been fully priced in. Total earning asset yield increased 48 basis points to 5.6%, again, due to the acquisition of Home Federal and the remixing of the investment portfolio. Let's turn to page 13 to talk about our earning assets. Total loans grew 31.7% over the prior quarter, mainly due to the acquisition of Home Federal. Outside of the acquisition, Alera still saw organic loan growth of 157 million, or over 5% from the prior quarter. Turning to page 14, on a period-ending basis, our deposits also increased 31.7% from the prior quarter. Excluding the acquisition of Home Federal, Alera still saw organic deposit growth of 93 million, or almost 3% from the prior quarter. Given an increase in deposits, our loan-to-deposit ratio remains steady at 91.2% and still below our target level of 95%. Turning to page 15, I will now talk about our banking segment, which also includes our mortgage business. I will focus on the fee income components now since net interest income was previously discussed. Overall, non-interest income for banking was up $4.8 million, or over 87% from the prior quarter. Most of the increase was from a $3.5 million gain recognized in the sale of one of our offices in the Fargo market. Excluding gains on properties from both quarters, non-interest income was up over 37%. In the fourth quarter, there was $1 million in fee income related to client swaps. Just a reminder, these swap fees tend to be lumped from quarter to quarter based on client appetite. On page 16, I'll provide some highlights on our retirement business. Total revenue from the business increased 2.1%, mainly due to non-market-based fees from our HSA business. While assets under management decreased 1.3%, mainly due to market performance, we did see organic net inflows of over $37 million. We continue to see steady organic growth in plan participants as well. Participants within retirement grew 1.6% during the quarter. New business production continues to be strong as over 500 opportunities were won this year. Synergistic deposits within retirement grew 6.6% over the prior quarter. HSA deposits, which carry low cost of funds around 10 basis points, grew 2.2% over the previous quarter. Turning to page 17, you can see highlights for our wealth management business. On a linked quarter basis, revenues increased 4.9%, while end-of-quarter assets under management increased 4.1%, mainly due to the acquisition of Home Federal. Synergistic deposits here grew over 3.7% from the previous quarter. Page 18 provides an overview of our non-interest expense. During the quarter, non-interest expense increased 32% over the previous quarter, mainly due to the acquisition of Home Federal. Within the quarter, we had $3.3 million of merger-related expenses and $2.3 million in severance and signing bonus expenses. Excluding these one-time expenses, our adjusted efficiency ratio was 68.97% versus 77.71% in the prior quarter. During page 19, you can see our credit metrics. During the quarter, net charge-offs were 13 basis points. Non-performing assets increased to $62.9 million, mainly due to one construction land and development deal. As a percentage of total assets, NPAs increased from 1.18% in the prior quarter to 1.19%. Our allowance from credit losses is now at 1.5% of total loans. Within the allowance, we have over $6.9 million related to non-PCD loans acquired in the home federal deal, otherwise known as the CECL double count. I'll discuss our capital equity on page 20. We continue to remain well capitalized as our Tier 1 equity capital to risk-weighted assets is at 10%, while our tangible common equity ratio is at 7.15%. On the bottom right, you'll see a breakdown in the sources of $2.9 billion in potential liquidity. Overall, we continue to remain well positioned from both a liquidity and capital standpoint to support future growth or weather any economic uncertainty. Turning to page 21 now, I'll provide some guidance. On this slide, you'll see the 2024 starting points used for guidance given for 2025. So we expect the following. First, loan growth of low to mid single digits based on a bigger combined balance sheet at the end of 2024. Deposit growth of low single digits. A net interest margin greater than 3% for 2025 with no further rate cuts by the Fed being factored in. Within the reported margin, we also expect 30 to 35 basis points of purchase account increase in each quarter. We will start the year closer to 3%. If the margin improvement, if the improvement in our margin was linear, which it won't be due to timing of projected balance sheet growth and the timing of purchase account increase, you would see a three to four basis point improvement each quarter in the margin. Reminder that in the second and third quarters of each year, we typically see seasonal outflows from our public funds, which will affect the margin. Next, with no market appreciation being factored in or revenue synergies from the Home Federal Deal, we can continue to expect our fee income to remain stable year over year on a reported basis that you see here. Reminder that a reported fee income of $114.9 million had gains from property sold and fee income from client swaps. So, on an adjusted basis, excluding both property gains and swaps, our core fee income would be up mid-single digits. Lastly, We expect our adjusted efficiency ratio for one-time items to be below 70% for 2025 as we continue to realize cost saves from home federal. There will be some volatility from quarter to quarter due to the timing of expected cost saves and the seasonality of some expenses. To summarize on page 22, excluding the largest merger in company history, we continue to see both strong organic loan and strong deposit growth in the quarter. For fourth quarter, our adjusted pre-provision net revenue grew nearly 90% over the prior quarter. For the full year, we saw our adjusted PPNR increase almost 25% compared to 2023. While we are a little over three months since the official completion of the merger, we continue to see strong momentum in our new markets. Beyond growth, as Katie mentioned, process improvement, automation, and continued improvement of profitability through prudent expense management remain key priorities heading to 2025 and beyond. With that, I will now open up for Q&A.