Alerus Financial Corporation

Good morning and welcome to the Alaris Financial Corporation Earnings Conference Call. All participants will be on 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 statement. Important factors that could cause actual results to differ materially from those indicated in the forward-looking statement 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's President and CEO, Katie Lawenson. Please go ahead.

Thank you. Good morning, and thank you for joining us today. I'm Katie Orenson, President and CEO, and I'm pleased to be here with our Chief Financial Officer, Al Hillelon, our Collaborating Officer, Karin Taylor, our Chief Banking and Revenue Officer, Jim Collins, and our Chief Retirement Services Officer, Forrest Wilkins. Each of these leaders continues to play a crucial role in driving our company's progress to transformational growth and top-tier performance. This quarter marks a significant step forward in our journey to deliver long-term, sustainable top-tier performance as we reported an adjusted earnings per diluted share of of 72 cents, which represents an adjusted return on assets of 1.41%. Our results reflect our efforts to build on the strength of our uniquely diversified business model, combining traditional commercial and private banking with the highly valuable and capital-light fee-based businesses in wealth management and retirement benefits. This business model not only differentiates us in the growing communities and client base we serve, it also provides resilience across economic cycles and the ability to outperform traditional banks. We're seeing encouraging momentum across our core businesses. The transformation in our commercial wealth bank is nearing completion, with our focus turned towards maximizing the capacity in our organization and infrastructure to further enhance profitability. While we continue to see the benefit of purchase accounting, we are replacing this with disciplined pricing on renewals of the core client base. During the quarter, deposit outflows were as expected from public and tax payments, while client retention in legacy layers and the recently acquired home's federal portfolio remained at high levels. We see robust opportunities in our lending pipeline, but we'll continue to be highly selective with our team focused on deposit-based opportunities and prioritizing full C&I relationships. We also took proactive steps to optimize our balance sheet, including the strategic sale of $60 million in non-owner-occupied CRE hospitality loans, which resulted in a next $2 million gain during the quarter. As a result of the sale, we were able to reverse related reserves on the portfolio, which allowed us to record no provision for the quarter. Reserve levels remain robust at 1.47% of loans, and notably net charges were limited to seven basis points when excluding the accounting entries of the hospitality loan sale. Industry-leading fee income of more than 42% will be the ultimate differentiator of our valuation. The cornerstone of our top tier fee income levels is our retirement and benefits business. Our talented team continues to execute on several key strategic initiatives to grow our business, secure meaningful partnerships, and make impactful operational improvements. We remain bullish on this business given the scale of the Secure Act 2.0 in addition to growing opportunities for M&A. The value of the retirement business is multifaceted due to the stability and durability it brings to our company's earnings with minimal capital allocation and balance sheet risk in addition to the tangible synergies we leverage in deposits and the capture of wealth business. Similarly, our wealth business has strong momentum and we're investing in talent and technology to deepen client relationships and expand our reach. As an enhancement for the business, we upgraded our wealth management platform which will allow us to continue to progress in our long-term goal of doubling the number of wealth advisors and growing our access under management at the same pace as our banking assets. It showed up to all of our team members and wealth advisors who made this conversion seamless for our clients. Results of our team's focus on expense management are evident, with another quarter of improvements in our efficiency ratio. We continue to balance our investments in talent and technology with long-term and sustainable improvements while optimizing everywhere. In short, we're making significant progress, This quarter's results were excellent, and I want to thank our team members for their continued efforts to return awareness to top-tier performance. We know this path is not linear and requires an unwavering focus on constant improvement and expense management. Our guidance for the year remains consistent with prior quarter's communication with the ultimate goal of achieving this quarter's level of performance consistently. The foundation is solid, the strategy is clear, and the opportunity ahead is compelling. Thank you again for your continued support, and I'll turn it over to Al to walk through the financials in more detail.

Thanks, Katie. Turn to page 11 of our investor deck that is posted in an investor relations part of our website. On a reported basis, net interest income increased 4.6% over the prior quarter, while fee income increased 15%. The increase in net interest income was primarily driven by remixing of maturing loans being replaced by organic loan growth at higher spreads, while interest expense remained relatively stable. Our fee income remained over 40% of revenues, and the low of interest rate averaged at 19%. Let's dive into the drivers of net interest income in the next slide. Turning to Phase 12, in the second quarter, managers' income continued to reach new heights at $43 million, and our reported managers' margin increased another 10 basis points to 3.51%. Our managers' margin continued to show improvement. Our total cost of funds remained stable at 2.33%. We had 25 basis points of purchase accounting increases in the quarter. Of those 45 basis points, 9 basis points were from early payoff. We remain disciplined in pricing as we continue to not price on the version of the yield curve for loans. In the second quarter, we continue to see strong spreads, which contributed to the quarter's net interest margin expansion, and the average rate on the loan portfolio during the quarter increased eight basis points from the end of the first quarter. Let's turn to pay security and talk about our earning assets. At the end of the second quarter, we were sold and classified and held for sale over $60 million of hospitality loans. Net gain from the sale of all these loans was over $2 million. Excluding the loan sale and the intensification, loan growth was approximately 0.5% over the prior quarter, with the most growth in C&I and owner-occupied CREs. We remain focused on full relationships within the middle market and business banking space. For the remainder of 2025, we expect over $271 million of loan contractual maturities, which is almost 7% of total loan. Our best portfolio declines at $807 million, or just around 16% of earning assets. AOCI improves an unreliable loss of under $60 million. For the remainder of 2025, we expect over $45 million, or close to 6% of the total portfolio, of principal payouts with a yield in the low 2% range. We will continue to invest, but the balance sheet remains a low-yielding investment for higher-yielding loans. Turn to page 14. On a period-ending basis, our deposit shrank 3.3% as we saw expected seasonal outflow from public funds and our clients using liquidity to meet tax applications. Since 2010, the median decrease in deposits from one QDC due has been over 5%. We do expect that seasonal volatility continuing increases our average deposit account size has gone over 20% since the end of 2019 due to our focus efforts to grow in the commercial space. Lastly, since the hold of acquisition of Home Federal, our net retention rate remains close to 97%. During the phase 15, I'll now talk about our banking segment, which also includes a mortgage business. I will focus on the fee income components now since net interest income was previously discussed. Overall non-interest income from banking was $8.4 million for the second quarter. The quarter concluded a $2.1 million gain rate and a sale of hospitality loans. very low swap income this quarter, which tends to be lumpy from quarter to quarter. On page 16, I'll provide some highlights on the retiring business. Total revenue from their business was relatively stable at over $16 million. Retiring services continues to be a stable and reliable source of fee income and is not a capital-intensive segment. Passes under administration and management increased 0.3%, mainly due to market performance. We continue to see solid business production with over through the first half of 2025. During the phase 17, you can see highlights for our wealth management business. On a late quarter basis, revenues increased 6.6%, while end-of-quarter assets under management increased 2.5%, mainly due to market performance. During the quarter, we transitioned to a new platform that will deliver a better experience for both clients and financial advisors. With a new and highly regarded system, we not only provide the unique value proposition to our clients, but we also are able to differentiate ourselves in our recruiting efforts to add more law advisors. Day-to-day teams provides an overview of our non-existence expense. During the quarter, non-existence expense decreased 3.8% due to a seasonal decrease in benefits, less acquisition expenses in the quarter on a reported basis, and due to an insurance reimbursement. Our adjusted efficiency ratio was 52.4% versus 66.9% in the prior quarter. Most of the improvement in our adjusted efficiency ratio was driven by both core expense and revenue improvement. Turn to page 19, you can see our credit metrics. During the quarter, adjusted net charge-offs were only 7 basis points, which excludes the impact of the Hoppitelli loan sale. Non-performing assets remained stable at 98 basis points compared to the prior quarter. We continue to have close to $7.8 million in reserves related to the seasonal double count and approximately $50 million of fair value marks related to the whole federal acquisition. I'll discuss our capital liquidity on page 20. We continue to remain well capitalized with our common equity to one capital ratio to risk-weighted assets at 10.5% or a tangible common equity ratio of 0.5%. On the bottom right, you'll see a breakdown of sources of $2.7 billion in potential liquidity. We did utilize some broker deposits in the quarter to optimize our funding structure. Overall, we continue to remain well-positioned from both a liquidity and capital standpoint to support future growth. On page 21, I will now update you on our guidance for 2025. Our guidance for the year remains consistent with prior quarters and has not materially changed. While we continue to make improvements, given the seasonality we experience in our businesses, improvement is never linear from quarter to quarter. We are still expecting loans over mid-single digits for 2025, excluding loans moved to help for sale. Deposit growth over low single digits remains the same. For the third quarter, though, we will see continuous seasonal deposit outflows from our public funds. Net interest margin of 3.25% to 3.35%. Within this guidance, we are assuming several things. purchase account accretion in the back half of the year. We're expecting less in purchase account accretion for the remaining quarter due to accelerated payoffs already recognized. Currently, we're expecting 27 basis points of purchase account accretion in the third quarter, which is an 18 basis point reduction compared to the second quarter. For the fourth quarter, we're only expecting 22 basis points of accretion. Both accretion numbers are based on contractual payoff data. Second, we are not expecting any early payoffs, which has averaged over eight basis points over the past three quarters since the closing of the home federal acquisition. Lastly, we're expecting an increase in deposit costs by eight to ten basis points due to mischief in deposits and continued competition. We expect our non-existent income per year to be up low single digits now on a reported basis due to the gain on loan sales recognized in the first half. On the mortgage side, we expect mortgages to ease a little in the third quarter and hit a few low downturns in the fourth quarter. We expect our adjusted efficiency ratio to include one-time items to be below 68% for the 2025 as we continue to realize cost savings from home federal. In the upcoming third quarter, we expect our core expenses to be around $49 to $50 million as we recognize investments made in our core business lines in talent and technology. To summarize on page 22, we continue to build on the momentum we saw in the first quarter. Adjusted pre-provision net revenue grew 23.2% over the prior quarter. A current adjusted ROA of 1.41% and adjusted ROTCE of over 21% are definitely an awkward fellow in the banking industry. We see this as another thought quarter in the line of war to come. With that, I will now open up the Q&A.