Alerus Financial Q4 2023 Earnings Call Transcript

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January 25, 2024

There are 8 speakers on the call.

Operator

Good morning, afternoon, evening, and welcome to the Alaris Financial Corporation Earnings Conference Call. All participants will be in listen only mode. 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.

Operator

Important factors that could cause actual results to differ materially from those indicated in the forward looking statements 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 Lorentzon. Please go ahead.

Speaker 1

Thank you. Thank you, Harry, and thank you to everyone joining our call today. We appreciate your interest and your investments in Alaris. Joining me today is Alaris' CFO, Al Bilallon, who will discuss our financial performance and results for the quarter. Also on the call is Karen Taylor, our Chief Risk Management Officer and Jim Collins, our Chief Banking and Revenue Officer.

Speaker 1

This morning, I will provide some commentary on an excellent quarter of In key areas of the company. We've been working with incredible urgency over the past 2 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 In months, we have completed 5 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.

Speaker 1

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 notable milestone in turning the corner on our return to top Tier financial performance with improving PPNR. The ongoing execution of our 1 Alaris strategy resulted in continued key talent wins, Including adding 4 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 paid down FHLB Our highest cost source of funding as we have yet to tap into any brokered CDs or brokered funds markets. 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.

Speaker 1

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 standalone mortgage division into our private wealth banking franchise and we are already seeing the benefits of the synergies of these Teams and backrooms 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 non cyclical revenue with minimal capital allocation or balance sheet risk. Alaris' top 25 ranked national retirement services business delivers most of the fee income.

Speaker 1

The business ended the year with record level of sales and new revenue And 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 lines in this business. The synergies between the Commercial Wealth Bank and the Retirement remain as a source of deposits as well as Wealth Management assets. In the Q4, we commenced a nationwide search for a Chief Retirement Services Officer and we are incredibly proud of the Caliber of deeply experienced professionals we are attracting to this organization. Shifting over to the next highest contributor to our 54% of fee income is our Wealth Management business. Again, most of our Wealth Management business is full relationship advice based business, less than 10% of our business is transaction or brokerage.

Speaker 1

The milestone I would highlight for wealth management this quarter is another great one Alaris success. This one in our Arizona market In partnerships between the commercial teams and the wealth advisors in capturing business owner liquidity opportunities. 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 non performing loans. Alaris experienced another quarter of net recoveries, loan losses remains robust at 1.3% of total loans. We remain highly selective in our lending and are committed to franchise building full banking relationship.

Speaker 1

Capital levels also remain robust with TCE of 7.96% and CET1 of 11.81%. During the quarter, we grew tangible book value 8% and returned $5,800,000 to shareholders through dividends and share repurchases. This was a breakout quarter for the team and the company after implementing significant change throughout the Banking 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 rightsizing Each move is purposeful and strategic in positioning Alaris 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.

Speaker 1

With that, I will turn it over to Al to talk about the financial performance for the quarter.

Speaker 2

Thanks, Katie. I'll start with my commentary on Page 14 of our investor deck that is posted in Investor Relations part of our website. Let's start 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.

Speaker 2

Net interest income represented 45.9% of revenues when excluding the loss on investment securities. Switching to fee income, non interest income excluding the loss on investment securities decreased 10.5% on a linked quarter basis, primarily driven by the gain recognized by the divestiture for our ESOP trustee business being recognized in

Speaker 3

the prior

Speaker 2

quarter. Excluding ESOP Trustee Gain, non interest income was relatively stable on a linked quarter basis. I'll go into detail about each of our fee income segments in later slides. Turning to Page 15. Net interest income was $21,600,000 in the 4th quarter.

Speaker 2

Net interest margin was 2.37%, an increase of 10 basis points from the prior quarter. While some of our index liabilities Re priced in October due to last Fed hike in July, we saw the lost quarterly increase interest expense. During the quarter, we had gradual net interest Margin improvement as our balance sheet continues to remix towards higher yielding assets and strong deposit 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 Fed cut rates later in the year, we anticipate our net interest margin to continue to improve faster.

Speaker 2

Any increase in funding costs will be related to competition and a shift from non interest bearing to interest bearing. Let's turn to Page 16 to talk about our loan portfolio. Total loans grew 5.7% from the prior quarter, driven by organic growth in commercial real estate, C and I and Residential Real Estate. Excluding the impact of PPP, 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.

Speaker 2

We continue to track high quality talent in our growth market We've been able to drive growth quickly for Alaris. For 2024, we continue to expect to see modest loan growth. Turning to Page 17. On a period ending basis, our deposits increased 7.8% from the prior quarter. Just like loans, this is one of the highest organic deposit growth for Alaris.

Speaker 2

Non interest bearing deposits balances Increased 1.4% and represented 24% of total deposits. Client retention remains very high and we continue to attract new clients, especially in the mid market commercial space. For 2024, we expect deposit levels to remain stable. We also expect the usual seasonality in deposits with public fund outflows occurring in the 2nd and third quarters. Turn to Page 18, you can see a further breakdown of our strong deposit base.

Speaker 2

Our synergistic deposits, those funds sourced from our wealth and retirement businesses grew 23% over the prior year and 11.5% from the prior quarter. The continued growth in synergistic deposits was driven mainly by strong organic client growth within our Retirement and Wealth segments. Synergistic deposits sourced from our Retirement Wealth This now account for over 27% of our deposit base. As you can see here, continued growth on our synergistic deposits shows the Our unique and differentiated business model. Turning to Page 19, you'll see details of our investment portfolio.

Speaker 2

Currently, almost 62% of our securities are available for sale versus approximately 38% in held to maturity. Excluding the loss trade, we did see improvement in unrealized losses as the bond Given recent Fed commentary, we continue to remix the balance sheet towards commercial lending relationships that will add higher yielding loans and treasury management relationships. On Page 20, I'll start talking about our fee income businesses. On this page, I'll provide some highlights on our retirement business. Excluding the impact of the ESOP Trust Services gain and non recurring ESOP Trustee revenues in the prior quarter, revenues increased 1.6%.

Speaker 2

End of 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 Q1 of 2024, Excluding any market impact, we expect fee income for our retirement business to be stable. Turning to Page 21, you can see highlights for 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.

Speaker 2

Over 83% of revenues in the segment are asset based fees. For the Q1, 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 our mortgage business. Mortgage revenues decreased 49% from the prior quarter as originations decreased 41%. We saw our usual seasonal decline in mortgage production given that most of our production comes from the Twin Cities.

Speaker 2

For the Q1, we expect mortgage originations to decrease 40% from the prior quarter as we enter again another seasonally weaker quarter for our mortgage business. Page 23 provides an overview of our non interest expense. During the quarter, non interest expense increased 3.7%. Excluding one time items such as severance and a donation to Minnesota Housing, Non interest expense grew 2.4%. The increase in expenses is mainly due to inflationary pressures experienced in our technology contract renewals And due to higher audit examination fees.

Speaker 2

As we continue to deal with deflationary pressures, we do expect our overall expenses for 2024 to grow low single digits on a reported basis. Turning to Page 24, credit continues to remain very strong. We had net recoveries of 4 basis points in the quarter. Our non performing 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%.

Speaker 2

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 $2,100,000 of outstanding stock at an average price of $17.65 Our capital remains well above regulatory minimum levels, which is well above the 6.5% minimum threshold. On the bottom right, you'll see the breakdown of our sources of over $2,000,000,000 in Overall, we continue to remain well positioned from both the liquidity and capital standpoint to support future growth or whether any economic uncertainty. To summarize on Page 26, we ended the year on a very strong note with Great momentum going into the New Year.

Speaker 2

We saw strong organic loan and deposit growth, the highest in our history. Our net interest margin improved as the Fed finally paused and strong organic production helped continue to remix the balance sheet. We expect continued improvement in our net interest margin going forward. Our fee businesses, which continue to be a differentiator for us, has over 54% of our revenues are non spread base. Our capital remains strong and remain committed to returning capital prudently.

Speaker 2

With that, I will now open it up for Q and A.

Operator

We will now begin the question and answer session. The first question today comes from Jeff Rulis of D. A. Davidson and Co. Jeff, your line is now open.

Operator

Please proceed.

Speaker 4

Thanks. Good morning.

Speaker 5

Just a

Speaker 4

question on the The loan and deposit growth is really strong and wanted to get a sense for is there was anything Kind of lumpy towards the end and or did you pull forward looking at kind of a little more muted Growth in 'twenty four, did you sort of cannibalize some activity, just a really strong quarter, wanted to see if there was Some production that maybe you pulled into Q4 versus what was maybe going to book in 2024?

Speaker 3

Jeff, this is Jim Collins.

Speaker 5

No, I would say we didn't pull anything forward. The real loan growth and deposit growth, specifically in the Q4, was just the buildup Of the talent that we acquired throughout 2023 and their pipelines coming forward into production. I anticipate that those pipelines will continue through 2024. Typically, We will see a strong second quarter, strong third quarter. 1st quarter will be a little light and then 4th quarter generally It's a little light.

Speaker 5

So, it usually goes 2nd quarter, 3rd quarter, Q1 and Q4. So, I do anticipate that those pipelines will continue And there wasn't anything lumpy necessarily. All of what was getting booked are stronger mid market C and I loans and then again our continued growth in commercial real estate. But the focus still is mid market C and I And we're pulling in the full relationship and that's what I anticipate for the rest of 2024.

Speaker 4

Thanks, Jim. And just the Was that growth also pretty even 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 Q4.

Speaker 2

Hey, Jeff. We did see a little bit more pickup after October. So I'd say that was probably more when the activity came. It was probably after October, November, December related.

Speaker 4

Got it. And Al, just to kind of circle back on the margin, I 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 sensitivity on either NII Higher margin bump per each 25 basis point cut should we get this?

Speaker 2

Yes. So Jeff, thanks for that. I mean, this is the 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 in the Fed and potential rate cuts. With us, in terms of sensitivity, The one thing you'll notice on our disclosures, if you look at our last 10 Q, is that you did see that little bit of that liability sensitivity decrease because we did put into effect A little bit of balance sheet swaps last year.

Speaker 2

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 on our Ninjas margin probably towards the back Next year. So with that being said, I'll probably have you look at probably our disclosures in terms of net interest income improvement, probably Mid to high single digits, which is a jive to what our 10 ks was last year prior to the swaps being put on the balance sheet.

Speaker 4

Okay. So just to your comments, you think in Q1, Steady state sees a margin improvement, but cuts should accelerate that improvement. Okay. That is correct. And maybe one last one.

Speaker 4

Okay. Thank you. One Go ahead. I'm sorry, go ahead.

Speaker 2

No, the rate of also the rate of the improvement also be dictated by deposits well, because we did have very strong deposits in the Q4. So as we know there's a pretty much strong deposit demand out there right now. No, we continue to keep deposits stable. That will also dictate how much improvement we see.

Speaker 4

Okay. And Katy, the just wanted to check-in on capital and The buyback appetite, pretty strong growth, but maybe if that ebbs, so that front, but also Hutting around on the M and A side, you mentioned looking for an individual on the retirement front, but Would you also consider kind of M and A on the retirement side as well?

Speaker 1

Yes, absolutely. So from a capital prioritization standpoint, they remain consistent in terms of our priorities. And so 1st 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 is the number one priority. Returns to our shareholders remains a top priority As you 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 strategic lift outs, market expansion as well as acquisitions in both the commercial wealth space as well as on the retirement

Speaker 4

Bye. Okay. Thank you.

Speaker 2

Thanks, Jeff.

Speaker 1

Thanks, Seth.

Operator

Our next question today is from the line of Nathan Race of Piper Sandler. Nathan, your line is open if you'd like to proceed.

Speaker 3

Yes. Hi, everyone. Good morning. Thank you for taking

Speaker 4

my questions.

Speaker 3

I just want to clarify one question to your early response Jeff's item on NII growth for this year. That mid to high single digit kind of NII trajectory that I think you described Al, Does that include maybe 2 or 3 rate cuts in the back half of this year?

Speaker 2

Yes. Thanks for clarifying for that. That is on the plus 100 scenario that we're I'm sorry, the minus 100 scenario. Let me clarify, I think, the minus 100 scenario that we had in the 10 ks last year.

Speaker 3

Got you. And perhaps supporting that outlook with rate cuts, is the plan with some of the liquidity that you guys Bill, with the repositioning late in the Q4, is it planning to kind of keep borrowings where they're at just to provide at least the short term That where it's at just to kind of provide that insulation to floating rate loans to the extent Fed cuts occurred, you kind of Plan on maybe bringing down wholesale funding to the extent deposit growth remains as strong as it was in the Q4 and loan growth also remains Strong albeit likely not to the level that we saw in the Q4. Right.

Speaker 2

So from the restructuring we did in the Q4, we did use That predominantly 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 eliminate that if we can potentially with and if we have continued strong deposit growth.

Speaker 3

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

Speaker 2

So we're thinking modest, but I'll let Jim also answer.

Speaker 5

Yes. I think we will have loan growth. Obviously, with the borrowing situation, it 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 helps The entire 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 good solid Profitable loan growth, that's my expectation.

Speaker 3

Got you. In terms of commercial real estate Maturities expected this year, is that a meaningful headwind to growth, net growth that is?

Speaker 5

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

Speaker 3

Got it. And just changing gears, Al, I think you mentioned retirement Benefit service revenue should be kind of flat in the Q1 versus the 4Q

Speaker 2

level. I noticed

Speaker 3

in the release that retirement plan participants That's a nice growth quarter over quarter. So just curious what you guys are seeing from an organic growth perspective in terms of adding new accounts On to that platform and just kind of how you're thinking about growth in that line this year assuming equity markets are relatively stable?

Speaker 1

Nate, it's Katie. I'll take that one. From a new sales standpoint from new plans, new revenue, new participants, it was a record setting year in 2023. We continue to sustain headwinds as plans that leave through, they either get acquired or Move out for RFP continues to be a headwind to that new business. And so, considering stable markets, that's where we end up with a Fairly flattish outlook for that revenue line item going forward.

Speaker 3

Okay. Katie, have you noticed just The natural headwind from that line of business in terms of the natural attrition there, that's slowing relative to the past year, just as you guys Have launched a number of initiatives and new sales efforts to kind of offset what occurs with that attrition break.

Speaker 1

It's slowing incrementally, and we're growing new revenue incrementally, but we think there There is continued additional opportunity to improve that net revenue growth year over year. And there are initiatives being put in place That contractually will do some things for us. There's also some efficiencies and some process improvements that will be implemented in 2024 That will continue to help that net revenue pace higher. So I'm confident that we will see incremental continued growth, but it's going to take A little bit of time and 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 list.

Speaker 3

Got you. I know it's been an ongoing initiative you guys in terms of increasing the capture rate From the retirements platform on the wealth, I was just curious if to what extent maybe some progress on that front was evident in the wealth Management revenue increase in the Q4, is that just more so a function of some of the private banking teams that you've added? And also just given that equity Markets were higher in the

Speaker 5

Q4. We actually had one specific large win in that arena from capturing That permanent participant into wealth in the Q4 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 advisors in 2024 2025 to Capture more of that piece of the business.

Speaker 3

Okay, great. And Al, just Just to clarify on the expense growth outlook for this year, that low single digit expectation, that's off $151,000,000 reported expenses 23.

Speaker 2

Yes, also 150.1 or 0.2 reported expenses.

Operator

Okay. Got

Speaker 3

you. Good deal. And then maybe one last one for Fahren. Just curious if there's any additional tail to the recoveries that we saw in 2023 and if you're just seeing any major Credit issues on the horizon obviously is not evident from the numbers that we can glean that you guys reported this quarter, but I would just be curious on kind of your outlook for charge offs in 2024 and how you see the reserve trending relative to loans as well.

Speaker 6

Sure. Hi, Nate. 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. Just in terms of the general outlook for asset quality, I don't don't see anything significant on the horizon.

Speaker 6

We're just continuing to see some normalization, no specific patterns, just Just what we would expect as we return to a more normalized environment.

Speaker 3

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

Speaker 2

story. Yes. This is Al. Hey, Nate, on terms of buybacks, opportunistic is a good word for it. We do look at buybacks to make sure that The earn back on those any repurchases is still definitely under 3 years.

Speaker 2

So we definitely look at where our stock price is trading relative to that earn back scenario.

Operator

And our next Question today is from the line of Matthew Rehnke of KBW. Matthew, please go ahead.

Speaker 7

Hey, everybody. Hope everybody is doing well today. A lot of my questions have been asked and answered, but just as a follow-up to the loan growth discussion, are rate cuts baked into that outlook or do you think and

Speaker 4

if they're not, Do you think

Speaker 7

we will see a meaningful uptick in loan growth in the back half of the year perhaps?

Speaker 5

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. That's fairly natural when you see the business tax returns come in and businesses are planning for events. We had a strong Q4 this year, but that had more to do with the talent we brought on in 2023 and them Getting their pipeline set and then starting flushing out their pipeline, that could happen again in 2024. If we find additional talent, we're going to be very Tunistic to find good solid mid market commercial bankers, specifically in Minneapolis and Arizona. So if we do find that In the first half of this year, we might see similar results next year of a stronger Q4 than I'm anticipating, but that would be Because of talent acquisition, not rate cuts.

Speaker 4

Okay, great. Thank you. And I think that's all

Speaker 2

I had right now, so I'll step back.

Speaker 5

Thanks, Matt. Thanks, Matt.

Operator

Okay. It seems 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 Katie Lawrenson for any closing

Speaker 1

Great. Thank you, Harry. Thank you for the questions. Thank you for everyone listening in today. 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 Q4.

Speaker 1

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, our talent investments, 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.

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Key Takeaways

  • Completed 5 restructurings, added over 120 new team members and cut headcount by nearly 10% to transform the commercial wealth bank.
  • Deposits grew 7.8% and loans grew 5.7% organically in Q4, driving net interest income up 5.7% and net interest margin expansion to 2.37% with further upside expected.
  • 54% of revenue now comes from highly annuitized fee income, evidenced by record retirement services sales and a 12.7% qoq increase in wealth management revenues.
  • Mortgage revenues declined 49% qoq and originations dropped 41%, with another ~40% seasonal decline expected in Q1 reflecting market seasonality.
  • Credit quality remains strong with net recoveries, non-performing assets at 22 bps and a 1.3% loan loss allowance, while capital ratios (CET1 11.81%, TCE 7.96%) and an 8% tangible book value increase supported $5.8 M in shareholder returns.
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Earnings Conference Call
Alerus Financial Q4 2023
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