Q4 2023 Alerus Financial Corp Earnings Call

Presentation

Operator

Good morning. Afternoon evening and welcome to the Alerus Financial Corporation earnings conference call. (Operator Instructions)
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 Alerus Financial Corporation, President and CEO, Katie Lawrence. Please go ahead.

Thank you thank you, Harry, and thank you to everyone joining our call today. We appreciate your interest and your investment in Alere. Joining me today is where to CFO Al Dolan, who will discuss our financial performance and results for the quarter. Also on the call is current Taylor, our Chief Risk Management Officer, and Jim Collins, our Chief Banking and Revenue Officer.
This morning, I will provide some commentary on an excellent quarter of execution in key areas of the Company. We've been working with incredible urgency over the past two years to strategically transform the commercial wealth bank, we began with assembling a new executive leadership team in addition to putting the right people in the right seats across the Company.
Over the course of the past 18 months, we have completed five restructurings and added over 120 new team members of the company while managing to reduce overall headcount to nearly 10%. The resulting transformation of our commercial wealth bank is evident with exceptional deposit growth supporting high-quality loan growth during the quarter.
In addition, the well-executed balance sheet repositioning in December provided additional flexibility and continued momentum to improve financial performance heading into 2024 and beyond. We believe this quarter marks the normal milestone in turning the corner on our return to top-tier financial performance with improving PPNR.
The ongoing execution of our one Alerus strategy resulted in continued key talent when including adding four commercial bankers in Arizona as well as success in taking market share of well established commercial businesses in the form of full banking relationships with lending and treasury management throughout all of our footprint.
In addition, we decreased leverage on the balance sheet and pay down FHLB advances our highest cost source of funding as we have yet to tap into any brokered CDs or brokered funds market. We finished the year with a loan to deposit ratio ticking down to 89%.
The culmination of the efforts of our team members and our board's strategic prioritization of bringing long-term value to our shareholders, our clients and communities led to net interest margin expansion in the quarter. Net interest margin expansion is another milestone and a critical turning point in our return to top tier performance, our uniquely diversified revenue mix is a differentiator in the industry with a robust contribution of 54% of total revenue.
During the quarter, we restructured and integrated the stand-alone mortgage division into our private wealth banking franchise. And we are already seeing the benefits of the synergies of these teams and backroom working together to serve clients throughout the Twin Cities, Arizona and North Dakota outside of the mortgage business.
The majority of our diversified revenue mix or approximately 90% of our fee income is highly annuitized recurring and noncyclical revenue with minimal capital allocation or balance sheet risk. Alaris is top 25 ranked National Retirement Services business delivered most of the fee income. The business ended the year with record level of sales and the revenue in the retirement business remains highly valuable, and we are committed to extracting this embedded value by achieving net revenue growth in our scaled and highly profitable product line in this business the synergies between the commercial bank and the retirement remain as a source of deposits as well as wealth management assets.
In the fourth quarter, we commenced a nationwide search for a Chief Retirement Services Officer, and we are incredibly proud of the caliber deeply experienced professionals we are attracting to the organization shifting over to the next highest contributor to our 54% of fee income is our Wealth Management Center. Again, most of our wealth management businesses for relationship at high base business, less than 10% of our business is transactional brokerage the milestone I would highlight for well paired with this quarter is another great one, where success this one in our Arizona market in partnership between the commercial teams and wealth advisors and capturing business owner liquidity opportunity.
Moving over to provision expense in the quarter was driven by loan growth as credit quality remains strong with low levels of past dues and nonperforming loan allowance experienced another quarter of net recoveries to loan losses remained robust at 1.3% of total loans. We remain highly selective in our lending and are committed to franchise building core banking relationships.
Capital levels also remain robust, with TTE. of 7.96% and CET1 of 11.81%. During the quarter, we grew tangible book value 8% and returned $5.8 million to shareholders through dividends and share repurchases, which was a breakout quarter for the team and the company after implementing significant change throughout the bakery division.
We are building a stronger than ever franchise with the best in the business talent. We are prudently adding new client relationships and improving profitability through infrastructure right straight, rightsizing and optimization. Each move is purposeful and strategic in positioning layer to bring expertise to our clients in a fast, frictionless and highly responsive manner while delivering value which we believe will directly translate into value creation for our shareholders.
With that, I will turn it over to Alan to talk about the financial performance for the quarter.

Thanks, Katy. I'll start my commentary on page 14 of our investor deck that is posted in Investor Relations portion of our website looks on our key revenue drivers on a reported basis, net interest income increased 5.7% on a linked quarter basis. The increase was driven primarily by strong organic loan and deposit growth. Net interest income represented 45.9% of revenues when excluding the loss on investment securities.
Switching to fee income, noninterest income, excluding the loss on investment securities decreased 10.5% on a linked quarter basis. Primarily driven by the gain recognized by the commission for its U.S. trustee business being recognized in the prior quarter. Excluding Aesop trustee gain, non-interest income was relatively stable on a linked quarter basis. I'll go into detail by each of our fee income statements in later slides.
Turn to Page 13. Net interest income was $21.6 million in the fourth quarter, net interest margin was 2.37%, an increase of 10 basis points from the prior quarter, while some of our indexed liabilities reprice in October due to less Fed hike. In July, we saw the lowest quarterly increase interest expense during the quarter. We had gradual net interest margin improvement and our balance sheet continues to remix towards higher-yielding assets and strong.
Our strong organic deposit growth helped lower borrowings. Based on the recent Fed commentary on a potential pause, we do expect our net interest margin to improve even without any rate cuts should the Fed cuts up to the Fed cut rates later in the year?
We anticipate our net interest margin to continue to improve faster. Any increase in funding costs will be related to competition and a shift from noninterest-bearing to interest-bearing.
Let's turn to page 16 to talk about the loan portfolio. Total loans grew 5.7% from the prior quarter, driven by organic growth in commercial real estate, C&I and residential real estate. Excluding the impact of TPP., this was one of the highest organic loan growth that we have experienced growth across the board was driven by newly onboarded talent and legacy producers as well. We continue to attract highly qualified, high quality talent in our growth markets and they've been able to drive growth quickly for Alerus for 2024, we continue to expect see modest loan growth.
Turning to page 17, on a period end basis, our deposits increased 7.8% from the prior quarter. Just like loans, this is one of the highest organic deposit growth for Alerus. Non-interest-bearing deposit balances increased 1.4% and represented 24% of total deposits by retention remained very high, and we can do attract new clients, especially in the mid-market commercial space. For 2024, we expect deposit levels remained stable. We also expect the usual seasonality in deposits with public fund outflows occurring in the second and third quarters.
Please turn to Page 18. You could see a further breakdown of our strong deposit base. Our synergistic deposits, those sold on source from our wealth and retirement businesses grew 23% over the prior year and 11.5% from the prior quarter. The continued growth and synergistic deposits was driven mainly by strong organic client growth within our retirement and wealth segment, synergistic deposits sourced from retirement businesses.
Now account for over 27% of our deposit base. As you can see here, continued growth strategies and synergistic deposits shows the strength of our unique and differentiated business model. Turn to page 19, you'll see details about our patent portfolio. Currently almost 62% of our securities available for sale versus approximately 30% in held to maturity, excluding the lost trade, we did see improvement in unrealized losses at the bond market rally. Given recent Fed commentary, we continue to remix the balance sheet towards commercial lending relationships, store at higher-yielding loans and treasury management relationships.
But on page 20 of our talking about our fee income businesses on this page, I'll provide some highlights on our retirement business. Excluding the impact of the Aesop trust services gain and nonrecurring Aesop trustee revenues in the prior quarter, revenues increased 1.6% in the quarter. Assets under management and administration increased 6.2% mainly due to improved equity and bond markets. Participants within Retirement have grown 4.4% over the prior year for the first quarter of 2024. Excluding any market impact, we expect fee income for our retirement business to be stable.
Turning to page 21, you could see highlights of our wealth management business. On a linked-quarter basis, revenues increased 12.7%, while end-of-quarter assets under management increased 7.9%, again due to improved equity and bond markets, or 83% of revenues in the segment. Our asset base fees for the first quarter. Excluding any market impact, we do expect our fee income for our wealth business to be up slightly.
Turning to page 22, I'll talk about the mortgage business. Mortgage revenues decreased 49% from the prior quarter. As I read it, as originations decreased 41%. We saw our usual seasonal decline in mortgage production. Given that most of our production comes from the Twin Cities for the first quarter, we expect mortgage originations to decrease 40% on the prior quarter. As we and again, another seasonally weaker quarter for mortgage business.
Page 23 provides an overview of our noninterest expense. During the quarter, noninterest expense increased 3.7%, excluding one-time items, one-time items such as severance and a donation to Minnesota housing.
Noninterest expense grew 2.4%. Increase in expenses is mainly due to inflationary pressures expense experienced in our technology to technology contract renewal and due to higher audit examination fees as we continue to deal deflationary pressures, we do expect the overall expenses for 2024 grow low single digit on a reported basis.
Turning to page 24, credit continued to remain very strong. We had net recoveries of four basis points in the quarter. Our non nonperforming assets percentage was 22 basis points compared to 23 basis points in the prior quarter. Our allowance for credit losses on loans to total loans was 1.3%. We had a provision during the quarter, mainly due to strong loan growth and unfunded commitments.
I'll discuss our capital liquidity on Page 25. During the quarter, we repurchased $2.1 million of outstanding stock at an average price of $17.65. Our capital remains well above regulatory minimum wells, which is well above the 6.5% minimum threshold on the bottom right, you'll see the breakdown of our sources of over two donors and potential liquidity. Overall, we continue to remain well positioned from both a liquidity and capital standpoint for future growth or what, if any, economic uncertainty.
To summarize on page 26, we ended the year in a very strong note with great momentum going into the new year. We saw strong organic loan and deposit growth, a high since our sense of the highest in our history. Our net interest margin improved as the Fed belly pause and strong organic production help continue to remix the balance sheet. We expect continued improvement or net interest margin going forward. Our fee businesses, which continue to be a differentiator for us, and our 50% 54% of our revenues or non-spread base. Our capital remains strong and remain committed to returning capital prudently.
With that, I will now open it up for Q&A.

Question and Answer Session

Operator

We will now begin the question and answer session to ask a question. (Operator Instructions)
At this time, we will momentarily pause to assemble our roster. Our first question today comes from Jeff Rulis of D.A. Davidson & Co. Jeff, your line is now open. Please proceed.
Thanks.

Good morning. My question on the US, maybe the loan to deposit growth is really strong and wanted to get a sense for if there was anything have you kind of lumpy towards the end there or and or did you pull forward looking at kind of a little more muted growth in 24 digits, sort of cannibalized some activity, just a really strong quarter and wanted to see if there was some some production that may be pulled into the Q4 versus what maybe going to book in '24?

Jeff, this is Jim Collins down.
No, I would say we didn't pull anything forward. The real bone growth and deposit growth specifically in the fourth quarter was just the buildup of the talent that we acquired threw out 2023 and their pipelines coming on forward into production. I anticipate that those pipelines will continue through 2024 on typically, we will see a strong second quarter.
Strong third quarter first quarter will be a little light and then fourth quarter generally is a little light. So it usually goes second quarter, third quarter, first quarter and fourth quarter. So I do anticipate that those pipelines will continue and there wasn't anything lumpy necessarily, although all of what was getting booked are stronger, middle market, C&I loans and the like. And again, our continued growth in commercial real estate. But the focus still is midmarket C&I, and we're pulling in the full relationship, and that's what I anticipate for the rest of 2024.

Thanks, Jim. And just the was that growth also pretty evenly through the quarter kind of thinking about margin and if it was sort of back-end loaded on the loan side, or was it pretty steady throughout fourth quarter?

Jeff, we did see a little bit more pickup after October. So I'd say that was probably borrowed activity came as PI, you know, after October, November, December, early data.

And Al, just kind of circle back on the margin reminded of the coiled spring reference and just wanted to see if that's kind of the beginning of this releasing. And so that's part A. And part B is when we do see those rate cuts. I don't know if you've got a sensitivity on either NI or margin bump per each 25 basis point cut, should we get them?

Yes. So Jeff, thanks for that. I mean, it is beginning of our net interest margin to improve. So we're very optimistic here about the trajectory of our net interest margin given the pause now and the Fed and potential rate hike rate cuts with the in terms of sensitivity, you'll one thing you'll notice our disclosures. If you look at our last 10 Q that you did see it a little bit of that liability sensitivity decreased because we did put into effect a little bit of balance sheet swaps last year. Those swaps will be rolling off during the course of 2024, and that liability sensitivity will begin to increase again. So you'll see more improvement, our net interest margin probably towards the back half of next year.
So with that being said, I pay, Mike, have you look at probably our disclosures in terms of managed margin improved and managed income improvement, probably mid to high single digits which is Jive's what our 10 K was last year prior to the swaps we put on on the balance sheet.

So just to your comments, as you think in Q1, steady-state, we see some margin improvement, but cuts should decelerate that improvement.
Can Dennis Crowley, I guess one last one.

Look at your pub.
Yes, I know you have given go ahead.
I'm sorry, go ahead.
No doubt the rate of also the rate of improvement will be dictated by deposits as well because we did have very strong deposit in Q4. So now, as we noted, a pretty much strong deposit man out there right now. We continue to keep the margins stable down or that dictate how much improvement we see.
Okay.
Maybe Katy, the I just wanted to check in on capital. The buyback appetite is pretty strong growth. But maybe if that as Mitch said that front, but also hanging around on the M&A side. You mentioned that I'm looking for the individual on the retirement front. But would you would you also consider kind of M&A on the retirement side as well?

Yes. Absolutely. So from a capital prioritization standpoint, they remain consistent in terms of our priorities. And first and foremost, prudent and disciplined organic growth is our number one priority being selective, but taking market share at a time as we're adding talent in our growth markets as the number one priority returns to our shareholders remains a top priority. And as we saw with the activity this quarter with share buybacks and continued dividends, but continuing to also be as we have in our history, very opportunistic with on strategic lift-outs market expansion as well as acquisitions in both the commercial wealth base as well as on the retirement.
Bye.

Okay.
Thank you.

Thanks, Jeff.

Perfect.

Operator

Our next question today is from the line of Nathan Race of Piper Sandler and your line is open if it wants to proceed.

Yes, hi, everyone. Good morning. Thank you for taking the call today. I just wanted to clarify one question to your earlier response to Jeff's item on ag growth for this year that mid to high single digit kind of a trajectory that I think you described out. Does that include maybe two or three rate cuts in the back half of this year?

Yes, I think sort of clarify for that is on the plus 100 scenario that were I'm sorry, the minus 100 scenario, reclassifying it to minus 100 scenario that we had in the 10 K last year, fashion and perhaps supporting that outlook with rate cuts.

The plan with some of the liquidity that you guys have, Bill with the repositioning play in the fourth quarter, the plan to kind of keep borrowings where they're at just to provide at least a short term debt or is that just to kind of provide that and installations and floating rate loans to the extent Fed cuts occurred? You kind of plan on maybe bringing down wholesale funding. To the extent your deposit growth remains strong as it was in the in the fourth quarter. And your loan growth also remains strong, albeit likely not to the level that we saw in the fourth quarter.

Right. So from the restructuring we did in the fourth quarter, we did use of that predominately to support loan growth. As you saw that we had very strong loan growth. But on a go-forward basis, as you think about our borrowings, we'd like to decrease that, especially if you have more deposit growth there, I mean we'd like to have pretty much eliminated and we can potentially with it, we have continued strong deposit growth.

Okay, great. And I apologize, I jumped on somewhat late, but just in terms of kind of the loan growth outlook for this year, would you remind me what you guys are thinking there?

So we've taken modest, but I'll let Jim also answer.

yes, I think I think we will have loan growth, obviously with the borrowing situation, depends on how much deposit growth we have. But with the talent that we acquired in 2023, some of the processes and procedures that we have streamlined in 2022 and 2023 help so far are these higher commercial lending group as well as the rollout of our private banking group acquiring market share from some of the other banks that are not lending. We will definitely have some some good, solid profitable loan growth.

That's my expectation you've got just in terms of commercial real estate maturities expected this year, is that a meaningful headwind to growth and that growth as

we do not have a meaningful amount that will be maturing in the next 18 months to have a headwind on that and that category.

Got it. And just changing gears, Al, I think you mentioned retirement and benefit service revenue should be kind of flat in the first quarter versus the 4Q level get home. I mean, I noticed in the release that retirement plan participants had some nice growth quarter over quarter. So just curious what you guys are seeing from an organic growth perspective in terms of adding new accounts onto that platform and just kind of how you're thinking about growth in that line this year, assuming equity markets are relatively stable?

The latest?
Katy, I'll take that one on to know from a new sales standpoint from new plants and new revenue, new participants, I was a record-setting year in 2023. We continue to sustain headwinds as some plans that leave through they either get acquired or and move out for RFPs continues to be a headwind to that new business. And so and considering stable markets, that's where we end up with a fairly flattish outlook for that revenue line.

Item going forward, Q2 or just a natural headwind from them line of business in terms of the natural attrition they're slowing relative to past years, just as you guys and we have launched a number of initiatives and new sales efforts to kind of offset what occurs with that attrition rate?

No, it is slowing incrementally on and we're growing new revenue incrementally but we think there's there's continued additional opportunity to improve that net revenue growth year over year. And there are initiatives being put in place and that contractually will do some things for us, and there's the result of some efficiencies and some process improvements that will be implemented in 2024. There will continue to help that net net revenue are paid higher. So I'm confident that we will see incremental continued growth, but it's going to take a little bit of time. And I'm looking forward to having the Chief Revenue Services Officer and the executive team to help us guide through and prioritize some of those changes as well as help us build out that acquisition opportunity lists.

Jonathan, I know it's been an ongoing initiative for you guys in terms of increasing the capture rate from the retirement platform as well. I'm just curious to what extent maybe some progress on that front was evident in the wealth management revenue increase in the fourth quarter. Was that just more so a function of some of the privates? It seems that you've added now also just given that equity markets were higher in the fourth QUARTER.

We actually had one specific large win in that arena from capturing that determined and participant into wealth in the fourth quarter was a sizable number, but we continue to fine-tune and streamline that process. And over the years, we will continue to capture more of a percentage and we will be adding additional wealth advisers in 2024 and 25 to capture more of that piece of the business.

Okay, great. And then, Al, just to clarify on the expense growth outlook for this year, that's a low single-digit expectation. That's of $151 million in reported expenses in 23?

Yes, of the yes, of the 150.1 0.2 reported expenses.

Okay. But just some idea then maybe one last one for boring down. I'm just curious if there's any additional sale to the recoveries that we saw in 2023 and known, if you've seen any major credit issues in there rather than us is not evident from the numbers that we can glean that you guys reported this quarter. But I'm just curious on kind of your outlook for charge-offs in 2024 and how you see the reserve trending relative to loans as well?

High-need, most of those larger recovery opportunities have been exhausted. And so I expect that as credit continues to normalize, we'll start to see some level of charge-off activity come in or just in terms of the general outlook for asset quality?
I don't I don't see anything significant on the horizon. We're just continuing to see some normalization, no specific pattern shifts, just what we would expect as we return to a more normalized environment.

Okay, great.
And just sorry, one last one. Just curious on the appetite for share repurchases continuing at this point, and I imagine you guys are going to be fairly opportunistic, but so have a good amount of excess capital flexibility on. But just curious to what extent you maybe want buybacks to be kind of more recurring component to your capital return to shareholder story?

Yes, this is Al eight, Nate. On terms of buybacks, opportunistically, good word for it. We do look at buybacks make sure that I feel the earn-back on those by any repurchases is still definitely under three years. So we definitely look at where our stock price is trading relative to our different scenarios.
Yes.

Okay. I will leave it there. I appreciate the color.
Thank you, everyone

thinks they say again,

Operator

if you have a question, (Operator Instructions) and our next question today is from the line of Matthew Frank from KBW. Please go ahead.

Hey, everybody. I hope everybody is doing well that a lot of my questions have been asked and answered. But just as a follow-up to the loan growth discussion, our rate cut baked into that outlook or do you think and if they're not, do you think we'll see a meaningful uptick in loan growth in the back half of the year, perhaps. And then we didn't anticipate the loan cuts in that loan forecast of growth.

Like I said, a little bit earlier, we should have a strong second quarter and third quarter, and that's fairly natural when you see the business tax returns come in and business or businesses are planning for events. We had a strong fourth quarter this year, but that had more to do with the talent we brought on, I mean 2023 and them getting their pipeline set and then starting flushing out and pushing out their pipeline.
That could happen again in 2024. If we find additional talent, we're going to be very opportunistic to find good solid mid market commercial bankers, specifically in Minneapolis in Arizona. So we do find that in there first half of this year, we might see similar results next year from a stronger fourth quarter than I'm anticipating, but that would be because of talent acquisition, not rate cuts.

Okay, great. Thank you. And I think that I had run out of that. Thanks mat segment.

Operator

And as a final reminder, if you'd like to ask any further questions, please star star one.
Since we have no further questions in the queue, so this will conclude the question and answer session. I would like to turn the conference back over to Keith Lawrence for any closing remarks.

And maybe, Gary, they do have further questions. I thank you for everyone listening in today. And as you can tell, we feel very confident as we move forward into 2024 about in regards to sustaining the momentum that we saw in the fourth quarter.
Our unique strength of this company's diversified business model continues to differentiate our ability to attract and retain clients as well as talented professionals we remain absolutely laser focused on our strong and diversified balance sheet, Artelon investment fee income and investments in those key business lines, while optimizing our infrastructure to return this company to our long history of delivering strong profitability, tangible book value growth and top-tier returns to our shareholders.
Thank you to our investors, our analysts and to everyone for joining our call today have a great day, everyone.

Operator

The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.