Alerus Financial Corporation

Good morning, afternoon, and evening, and welcome to the Aleros Financial Corporation earnings conference call. Our 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 actual results may differ materially from those indicated in 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 on the company's SEC feelings. I will now like to turn the conference over to the Alaris Financial Corporation President and CEO, Katie Lawrenson, to begin. Katie, please go ahead when you're ready.

All right, thank you. Good morning, everyone, and thank you for joining us today to discuss Allaire's Financial Corporation's first quarter financial results. I'm Katie Lawrenson, President and CEO, and I am pleased to be here in the Twin Cities with our Chief Financial Officer, Al Villalon, our Chief Operating Officer, Karin Taylor, our Chief Banking and Revenue Officer, Jim Collins, and joining us via phone is our Chief Retirement Services Officer, Forrest Wilson. I want to extend my gratitude and thanks to each of these leaders who continue to play a crucial role in driving our company's culture with a mindset of success is never final, and the hard work and courageous leadership that has fueled our transformation over the past two years to the stronger company we are today. The first quarter of 2025 showcased a continued blend of progress in performance and strategic execution. Our performance ratios continued to improve with an adjusted ROA of 1.1%, a 25 basis point improvement from our adjusted ROA last quarter. The first quarter also represented our first full quarter with HMNS fully integrated. The addition of our home federal team members, along with the hiring of dozens of other talented professionals with deep expertise and broad networks, has created continued momentum in high-quality organic growth, driving efficiency improvement, and unleashing new opportunities to deepen relationships with our client base. We remain focused on our one-layered strategy, a unified and collaborative approach that leverages our best-in-class diversified business model, to grow our franchise through full relationships that extend from traditional commercial banking, full-service treasury management, to private banking and wealth management. Our focus over the past few years has been on enhancing our commercial bank with talent and expertise, targeting mid-market and business banking clients in addition to niche segments to consistently grow organically, maintain our well-diversified balance sheets, and build a strong brand across our geographic footprints. I am extremely proud of the leadership and the talent within these banking teams. The integration of their work between the teams in client acquisition and expansion has never been tighter. The results are evident, with another strong quarter of loans, deposit, and wealth management client growth. Our net interest margin improved again this quarter, with the teams across the company executing great discipline in pricing on both sides of the balance sheet. Our loan-to-deposit ratio was stable, with continued success in onboarding full commercial and private banking relationships. In addition, synergistic deposits in our retirement business allowed us to deepen the plan relationship while adding exceptionally stable funding with no related branch for client service costs. We continue to exercise prudent risk management and early and proactive risk identification. Our non-performing loans decrease during the quarter with a full payoff of a large non-accrual loan. While it's hard to predict the ultimate impact of the potential tariffs and government spending cuts, We continue to engage with our client base as we do a normal course to assess their potential exposure. Given the uncertain environment and continued normalization of credit, we are committed to carrying robust reserves, which increase to 1.52% of total loans, in addition to the discounts we carry on the equity portfolio. Our unique business model continued to excel, with poor non-interest income excluding building gains and MSR adjustments, growing almost 11% year over year. Our non-interest income has a percentage of revenues of 40%, continues to position Alaris as one of the highest B-income banks in any peer group, a key differentiator in creating premium valuation and sustainable shareholder value. Our wealth management group, which generated revenues 13% higher than a year ago, shines brighter than ever in times of market uncertainty and volatility. Our exceptionally talented advisors continue their efforts of proactive outreach to clients during the quarter. The trust they build strengthens our reputation and drives referrals and a strong brand. The ultimate differentiator from a diversification standpoint is our national retirement and benefits business, which grew organically 3% on a year-over-year basis. Organic growth and sales continues to improve while retention remains better than industry standards. In addition, we are seeing increasing momentum with meaningful partnerships across the country. We are steadfast in our belief that this business is the cornerstone for delivering consistent, high-quality returns with no credit risk and minimal capital allocations. and I've never been more confident in the continued and future success of this business with the leadership team we have in place, the talent we have across the business unit, and our scale and position in the industry. We continue to engage with smaller subscale firms across the country as an acquirer of choice in an environment where the catalysts for consolidation continue. Cost savings from Home Federal are on track, and expense management continues to be a top priority. as reflected by our adjusted efficiency ratio of 66.9% this quarter. We aim to achieve further improvements as the year progresses with recent headcount reduction. In addition, as we work to integrate all the new talent that has joined our organization over the past few years, we are engaging in consultants who will take all the best practices and expertise of our team to formulate and develop the Alaris operating model for commercial credit. We expect this consultant will identify opportunities to optimize processes, procedures, and penalties to improve efficiency. In addition, we believe this partnership will allow us to ramp up and carefully grow our company while improving the client experience as we remain focused and committed to getting better, not just bigger. Capital levels improved during the quarter and are at levels consistent with expectations post the home federal closing. We continue to build back capital levels with our enhanced profitability metrics. As we look at capital allocation, we will continue to prioritize franchise-building organic growth, retirement roll-off opportunities, in addition to maintaining our long dividend history. Thank you. And now I will 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 key revenue drivers. The increase in non-interest income was driven by organic loan growth at higher spreads and lower interest expense tied to Fed rate cuts in the back half of 2024. Non-interest income in the prior quarter included the sale of our property resulting in a $3.5 million gain. Excluding this gain, non-interest income was down 9.2% from the prior quarter on an adjusted basis, primarily due to seasonal decline in mortgage originations. Our fee income remains over 40% of revenues and well above the industry average of 19%. interest income on the next slide. Turn to page 12. In the first quarter, net interest income increased to a new record level for Larus at $41.2 million, and our reported net interest margin increased another 21 basis points to 3.41%. Our net interest income is now over two times larger than we initially had on our initial public offering in 2019. Our net interest margin continues to show improvement. Our total cost of funds dropped 19 basis points to 2.34% as we lowered deposit and money market rates due to Fed cuts in the back half of 2024. We had $5.1 million of purchase account increase for 42 basis points in the quarter. Of those 42 basis points, four basis points were from early payoffs. Lastly, we had a non-recrual recovery, which favorably impacted net interest margin by five basis points. Our net interest margin has rebounded not only from our balance sheet being slightly liability-sensitive, but from continued discipline in pricing on both new loan and deposit originations. We continue to focus on delivering a full C&I relationship ROE over 12% in banking. Let's turn to page 13 to talk about our earning assets. Organic loan growth was 2.3% over the prior quarter as we continue to grow our commercial presence, especially in middle market companies and in business banking. Commercial loans now make up over 70% of total loans versus 58% at our initial public offering in 2019. We continue to transform into a prominent commercial wealth bank within our footprint. Our investment portfolio declined to $839 million. We're just under 17% of earning assets. AOCI improved to an unrealized loss of $63 million as we saw the belly of the treasury curve decline over 40 basis points during the first quarter. We continue to let the balance sheet remix from low-yielding investments to higher-yielding loans. Turning to page 14, on a period-ending basis, our deposits organically grew 2.4% from the prior quarter. While we saw pressure on non-interest-bearing deposits, we still grew our commercial banking presence, as public funds and commercial clients were over 42% of total deposits. Synergistic deposits grew 7.5% over the prior quarter, with HSA deposits growing 4.4%. Growth in HSA, which carried a low cost of funds around 10 basis points, helped offset some of the mixed shift away from non-interest-bearing deposits. Non-just bearing deposits are now 19.8% of total deposits. Given an increase in deposits, our loan-to-deposit ratio remains steady at 91.1%, and is still below our targeted level of 95%, with nearly no broker deposits. Turning to page 15, I'll now talk about our banking segment. I'll focus on the fee income components. Overall non-just income from banking was $4.6 million for the first quarter. The prior quarter had $3.5 million gain on the sale of a property. Excluding this gain, non-interest income declined by $2.3 million on an adjusted basis. Of the $2.3 million decline in fee income, mortgage revenues were down $1.8 million as overall mortgage originations were down over 20% sequentially. The first quarter generally tends to be the most seasonally challenging for a mortgage business. We also had a $734,000 decrease in the fair value of mortgage servicing rights, to actively grow this portfolio. Given recent volatility in interest rates, we do anticipate further fluctuations in evaluation of this MSR portfolio. Besides the $1.8 million decline due to mortgage, the remainder of the $2.3 million overall decline on adjusted non-just income was due to less client swap fees being realized. As we said in the past, these swap fees tend to be lumpy each quarter based on client appetites. On page 16, I'll provide some highlights on our retirement business. Total revenue from the business decreased 2.3%, mainly due to market base and other fees. We saw growth across our core products and services. The decline of participants was tied specifically to our administrative services-only line of business. The fees from this administrative product offering are only at the plan level, so the decline of participants had no material impact on overall revenues. Assets under administration and management decreased New business production continues to be solid as we won 161 plans in the first quarter. Lastly, synergistic deposits within retirement grew 8.8% over the prior quarter. 52.5% of these synergistic deposits in retirement remain indexed. Turning to page 17, you can see highlights for our wealth management business. On a late quarter basis, revenues decreased 1.5%, while end-of-quarter assets under management decreased 1.7%, mainly due to market performance. Synergistic deposits grew over 4.7% from the previous quarter. Almost 94% of these deposits are indexed. Within wealth, we are excited about transitioning from a legacy system to a new platform that will drive a better experience for both a financial advisor and client. We believe this new platform will provide more revenue synergies for Allaire as we continue to grow its commercial wealth bank. Page 18 provides an overview of our non-negligence expense. During the quarter, non-existence expense decreased 16.7% as there were less acquisition expenses in the quarter on a reported basis. Our reported efficiency ratio was 68.8% on an adjusted basis, which excludes M&A and severance and signing bonuses. Our efficiency ratio was 66.9% versus 69% in the prior quarter. Most of the improvement in our adjusted efficiency ratio was driven by core expense improvements. Core operating expenses decreased 2.8% from the prior quarter. Turning to page 19, you can see our credit metrics. During the quarter, net chargeouts were only four basis points. Non-performing assets decreased by almost $11.9 million, mainly due to the payoff of a non-accrual commercial real estate loan during the quarter. NPAs and total assets decreased 24 basis points from the prior quarter to 96 basis points. Our allowance of credit losses is now 1.52% of total loans, which includes over $8.2 million related to non-PCD loans Inquired in the Home Federal and Metro Phoenix fields, otherwise known as the CECL double count. I will discuss our capital liquidity on page 20. We continue to remain well capitalized as a common equity Tier 1 capital to risk-weighted assets at 10%. Our tangible common equity ratio improved 30 basis points to 7.43%. On the bottom right, you'll see a breakdown in sources of 2.9 billion hours in potential liquidity. Overall, we continue to remain well positioned from both a liquidity and capital standpoint to support future growth or weather economic uncertainty. Turning to page 21 now, I'll update you on our guidance for 2025. We expect the following. Loan growth now of mid-single digits for 2025. While we have achieved growth of 2.3% in the first quarter, economic landscape remains fluid. Deposit growth of low single digits remains the same. For the second and third quarters, we will see seasonal deposit outflows from our public funds. Net interest margin of 3.2% to 3.3%. Within the guidance, we're assuming several things. First, we're not expecting any more non-recrual recoveries like we saw in the previous quarter, which aided our margin by five basis points. Second, we are only expecting 35 basis points of purchase accounting accretion in the quarter. Our guidance does not include any early payoffs, which increase purchase account increase by four basis points in the first quarter. Third, we are expecting seasonal outflows from our public points, which will impact our net interest margin. And lastly, we are expecting a further decline in non-interest bearing deposits. We are forecasting a 200 basis point mixed shift from non-interest bearing to interest bearing as we continue to grow our commercial presence. We do believe this mixed shift forecast may be conservative. There is no change to our non-interest income outlook. But with equities down in second quarter, we may see some pressure on fee income with assets under management facing headwinds in both retirement and wealth. On the mortgage side, we're seeing the normal seasonal uptick in mortgage originations, which is encouraging. The Mortgage Bankers Association is still forecasting over a 16% growth in originations for 2025. Lastly, we expect our adjusted efficiency ratio, which excludes one-time items, to be below 6%. 68% for 2025, as we continue to realize cost days from home federal. In the second quarter, we expect our core expenses to be around $49 million, which includes a seasonal uptick in mortgage incentives. We remain focused on continuing to manage our expenses prudently and continue to focus on improving the overall profitability of the company. To summarize on page 22, as we start our first full year after we completed our biggest merger in company history, we are off to a strong start. We continued organic growth in both loans and deposits. For the first quarter, our adjusted pre-provisioned net revenues grew nearly 8.2% over the prior quarter. Our current adjusted ROE, ROTCE, and ROA are either in the top quartile or closer to top quartile based on returns over the last decade. We understand this is just one quarter, and we remain committed to generating consistent returns for our stakeholders in upcoming quarters and years. With that, I'll now open it up for Q&A.