Alerus Financial Q3 2024 Earnings Call Transcript

Quartr
Provided by Quartr
October 30, 2024

There are 10 speakers on the call.

Operator

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 are listed in the earnings release and the company's SEC filings. I would now like to turn the conference call over to the Alaris Financial Corporation President and CEO, Katie Lorentzon to begin. Katie, please go ahead.

Speaker 1

Thank you. Good morning, everyone. Thank you for joining us today for our quarterly earnings call. Here in the Twin Cities today with me is Al Villalon, our CFO Karen Taylor, our Chief Operating and Risk Officer and Jim Collins, our Chief Revenue Officer and Head of our Commercial Wealth Bank. Horace Wilson, our Chief Retirement Service Officer is also joining us on the call.

Speaker 1

I'll start the call with some prepared remarks, and strategic highlights for the quarter. Al will spend a few minutes hitting on the key financial highlights and then we will address your questions. There is no question that this was a tough quarter for Alaris. We are not and will not be satisfied with our results until we are delivering superior returns. That being said, we also firmly believe success is not measured by a single quarter And while the Q3 came up short, it was also a period of continued progress and execution of our key long term strategic initiatives for our company.

Speaker 1

While the path to returning to top performance is not linear, the substantial strides we've made demonstrate our commitment to achieving our consistent top tier performance. Our focus remains on driving shareholder value through steady growth, diversified revenue, positive operating leverage and maintaining conservative underwriting standards. Let me begin with the transformational changes we've been making over the year and a half as we build a premier commercial wealth bank. Over this period, we have added key talent, continued to diversify our loan portfolio and closed on our largest acquisition to date. We've also managed through the challenging work of numerous restructuring, rightsizing and exiting of several business lines, which were not core to our focus.

Speaker 1

Regarding talent, we have worked with urgency on getting the right people in the right seats and our great culture and best in class diversified business model has allowed us to retain top talent and recruit dozens of new team members to the company, including many key hires with areas of deep expertise. Our additions on the revenue producing side are supported with key hires and continued investments in risk management infrastructure. These are all long term investments that put some near term pressure on operating expenses, but are critical to growing in the right way to support the consistent top tier returns we expect to deliver in the future and have delivered in the past. A key strategic priority was and will continue to be to build strong mid market and business banking C and I teams in our larger markets to support the well established and successful teams in our North Dakota market. Changes of this significant take time to show through to the bottom line, but the momentum is clear with nearly 45% of year to date loan originations to C and I clients compared to our pre transformation origination percentages of 17%.

Speaker 1

We recently rolled out our formal private banking offering after adding a team of professionals and the synergies between wealth management, commercial banking and mortgage are exceeding our expectations, particularly in deposit and wealth generation. We remain deeply committed to diversification and believe establishing verticals to augment traditional C and I banking is important to growing the client base and expanding relationships. We've added specialty areas of SBA, government, not for profit and most recently our equipment finance vertical. Turning to our most recent announcement, which was the receipt of regulatory approval and the closing of our Home Federal acquisition, both of which happened in the expected timeframe and a signal of our position of strength, relationship with our regulators and capabilities in executing acquisitions. The HomeFredo partnership is our 26th acquisition in the past 20 ish years.

Speaker 1

Our playbook of integration is proven and in this particular partnership the conversion is more straightforward than the previous Solar Bank we've acquired. We are so pleased with the leaders and the banking group that have joined us. Together as a bigger company, we are committed to getting better and achieving the results in our pro form a company and feel confident in our ability to do so. As for the results through the Q3, our deposit growth for the year is over 7% and despite facing the headwinds of seasonal outflows, we held deposits flat by continuing to win new clients despite the incredibly competitive environment. We experienced some deposit migration, but it's important to note the majority was simply movement in between accounts.

Speaker 1

We continue to operate with no broker deposits and highlight our CD portfolio that is core clients with a rollover rate in excess of 96%. Loan growth was also robust during the year with the majority of business coming from market share gains of long established companies. Although the economy in our market continues to be strong, we remain highly selective. And in commercial real estate where we run below regulatory guidelines in terms of concentration, we are stringent with our dry powder, reserving capacity for the highest quality sponsors with underwriting structures that fit within our time tested underwriting standards and those relationships that deliver superior ROE. Credit quality remains a key area of focus.

Speaker 1

Early identification of problem loans coupled with proactive and decisive actions are part of our credit culture. We continue to closely monitor and proactively downgrade loans where we see potential or emerging weaknesses. We

Speaker 2

monitor

Speaker 1

at the individual loan level on an ongoing basis every one of our large multifamily projects and we do not see systemic issues in this portfolio. However, normalization of credit in the broader portfolio continued during the quarter as 2 large relationships drove the increase in non accrual loans of which we believe we are adequately reserved. 1 of the loans was a long term bank and wealth client who has experienced the personal issues and the other was an acquired CRE loan originated in 2021 that was identified as higher risk during our due diligence. Credit migration has come from the watch category and we do not we have not backfilled despite continuously reviewing our portfolio through annual reviews, independent internal and external loan reviews. Charge offs to average loans remain low for the quarter at 4 basis points and reserves to loans was stable at 129.

Speaker 1

Al will cover the margin in more detail, but I won't shy away from the reality of the magnitude of that. We did take a step back to 2.23 after a much anticipated step forward last quarter. Our long term guidance remains intact. The NIM was impacted by non accruals and continued pricing pressure on deposits. We have consistently discussed the impact of deposit competition in our markets, where many banks face high loan to deposit ratios and a reliance on brokered funds.

Speaker 1

The competition remains fierce and we are focused here again on the long term, retention and doing what's right. We have evaluated all exception price deposits on an account by account level and we will be adjusting incentives to correlate with volume and pricing. Also, always a highlight for Alaris is our Wealth Management division, which has consistently grown top line revenue for many years. Our advisors are the best in the business and our wealth business is deeply embedded in our business lines with over 40% of our clients sourced from part of our retirement focused business and 20% of our wealth clients with a personal or commercial banking relationship. We know how special our wealth business is and we are completely committed to continuing to invest in the business.

Speaker 1

We recently signed to move to a new technology platform that will transform the client experience and greatly improve the processes for our advisors and their support team. This technology upgrade will help build on our established success in recruiting advisors as we offer a great user experience and the exceptional synergies advisors are able to leverage from our retirement business. Speaking of our retirement business and our ultimate differentiator when it comes to value creation given the recurring nature of the business with minimal capital allocation. Here too, we have new leadership, new team members and an enhanced structure. The team had a record quarter of new revenue and we see continued positive growth trends in plans and participants, which is where the majority of our new feeds are sourced.

Speaker 1

National partnerships are one of the key initiatives in building our business and we are pleased with the progress and the momentum we are seeing so far. We will continue to invest in this business with key talent additions and technology to improve efficiencies, increase automation and strengthen overall margins in the business. Year over year core non market related revenues are up 5%. We are very bullish on the retirement industry and our business and view the recent legislation of Secure Act 2.0 as a key catalyst in continuing our trends of improving organic growth. Moving on to expenses during the quarter, which trended upwards due to a few factors.

Speaker 1

The addition of key hires and the correlated severance and retirement related packages in addition to M and A related expenses, which were 1,700,000 dollars We had some lumpiness between the quarters related to FDIC insurance and we had some increases in professional fees, which I would characterize as operational, but not recurring. We believe each of our revenue producing hires will contribute to an improving efficiency with higher levels of production and more profitable business. The platform and technology changes in our wealth and retirement business will also create greatly improve our processes, which will lead to efficiencies, all of which will allow us to continue to effectively manage headcount in the company. In regards to capital levels, they bounced back closer to core with the payoff of the BTFP and we grew book value by 4.6%. Our book value continues to include $63,000,000 of AOCI that will be recaptured over the coming years.

Speaker 1

We believe in maintaining a fortress balance sheet and remain committed to our long history of delivering dividends to support returns to our shareholders. We have not been active in repurchases due to the recently closed acquisition and our priorities remain focused on organic growth, but we absolutely understand the value of the sum of the parts of our business and will be active if deep disconnects on value present themselves. With that, I will turn it over to Al for specifics on the quarter.

Speaker 3

Thanks, Katie. I'll start my commentary on Page 11 of our investor deck that is posted on the Investor Relations part of our website. Let's start on our key revenue drivers. A reported basis, net interest income decreased 6.1% over the prior quarter. All fee income grew 3.6%.

Speaker 3

The decrease in net interest income was driven primarily by lower purchase accounting increase from the Metro Phoenix Bank acquisition, an increase in non accruals and a higher interest expense through a mix shift from non interest bearing deposits to interest bearing deposits. Growth in fee income was primarily driven by an increase in overall asset base fees within our wealth and retirement business line and from a gain recognized in the sale of 1 of our offices. Turning to Page 12, in the Q3, we can dive into net interest income a little more closely. Net interest income decreased to $22,500,000 and our core net interest margin decreased primarily due to 3 factors. The first one being lower purchase account increase from Metro Phoenix,

Speaker 4

as

Speaker 3

you can see above decreased from 10 basis points to 2. Less net interest income due to higher non accruals and higher interest expense from an increase in interest bearing deposits. At the end of the quarter, we repaid our borrowings from the BTFT as the Fed recently reduced interest rates. So going forward, our reported net interest margin will no longer reflect the drag from these low interest earning assets. We continue to see a path to our net interest margin reaching 3%.

Speaker 3

The path will not be linear as each quarter will have their different factors affecting net interest margin. For the migration of non interest bearing deposits to interest bearing would drive our cost of funds higher. Turning to Page 13, we can talk about earning assets. Since acquisition of Metro Phoenix Bank, we had our 8th consecutive quarter of loan growth as loans grew 4% over the prior quarter. We continue to let our loan investment portfolio rundown as we mix low yielding securities to higher yielding

Speaker 4

loans.

Speaker 3

Turning to Page 14, on a period end basis, our deposits increased 0.8% from the prior quarter. While we saw a seasonal outflows from our public funds, we continue to drive organic deposit growth to offset these outflows. Given the 2.7% growth in interest bearing deposits and 6.3% decline in non interest bearing deposits, non interest bearing deposits are now 19.8% of total deposits versus 21.3% in the prior quarter. Given the stable deposit levels overall, our loan to deposit ratio was 91.2%, which is well below our target levels of 95%. We continue to not utilize any broker deposits for funding needs.

Speaker 3

Turning to Page 15, I'll now talk about our banking segment, which also includes our mortgage business. I'll focus on the fee income components now since interest income was previously discussed. Overall non interest income for banking was up 600,000 or over 12% from the prior quarter. Most of the increase was from a gain recognized in the sale of 1 of our offices in Minneapolis Metro market. For the Q4, we expect overall level of non interest income to decrease from 3rd quarter levels as we expect mortgage revenue to slow on the back of a seasonal slowdown in originations.

Speaker 3

On Page 16, I'll provide some highlights on our recurring business. Total revenue from the business increased 0.4%, while assets under management increased 4.7%, mainly as equity and bond markets continue to improve. Participants within retirement grew 1.5% during the quarter. New business production continues to be strong as over 500 opportunities were won this year. For the Q4, we continue to expect fee income for our retirement business to be stable.

Speaker 3

Turning to Page 17, you can see some highlights from our wealth management business. On a linked quarter basis, revenues increased 5.1% while our end of quarter assets under management increased 5.4% due to continued improvement in the equity and bond markets. For the Q4, excluding any market impact, we expect fee income from our wealth business to be up slightly. Page 18 provides an overview of our non interest expense. During the quarter, non interest expense increased 9.5%.

Speaker 3

During the quarter, we did incur $1,700,000 of one time merger related expenses related to recently completed acquisition of HMN Financial. Excluding these merger expenses, core non interest expense increased 7.6%. Compensation and benefits saw an increase due to the onboarding of the equipment finance team, additional key hires and from an increase in employee benefits. We also saw an $800,000 increase in professional fees excluding M and A related activity due to increased examination and audit expenses. For the Q4, reported expenses will increase due to merger of acquisition expenses related to Home Federal deal.

Speaker 3

For 2026, for 2025, we are still committed to achieving 30% cost saves announced in the Home Federal acquisition. Turning to Page 19, you can see our credit metrics. As Katie covered a lot of this in her prepared remarks, I'll go to the next slide. I'll discuss our capital liquidity on Page 20. We continue to remain very well capitalized as our common equity Tier 1 capital to risk weighted assets of 11.1%.

Speaker 3

Our tangible common equity ratio also improved 85 basis points to 8.11% as we saw an improvement in unrealized losses. And we repaid the BTFP. Post acquisition of Home Federal, we now have an outstanding shares of over $25,300,000 which is in line with our original deal assumptions. Additionally, we also added over $858,000,000 of loans and $952,000,000 of deposits. On the bottom right, you'll see the breakdown in the sources of our $2,200,000,000 of potential liquidity.

Speaker 3

Overall, we continue to remain well positioned from both the liquidity and capital standpoint to support future growth or whether any economic uncertainty. Summarizing Page 21, we continue to be continued to see strong organic loan growth and strong deposit growth which offset any seasonal outflows. We continue to see positive momentum in our retirement wealth businesses, both our reserve and capital levels remain strong to weather any economic uncertainty. With that, I will now open up for Q and A.

Operator

Thank you. We will now begin the question and answer session. And our first question comes from the line of Jeff Rulis from D. A. Davidson and Co.

Speaker 5

Thanks. Good morning. Hi, guys. Question on the larger credit, I guess on non accrual, as you extend more to potentially put yourself in a good position there. I guess, is that cap the extension of credit to that the construction item or is there more to come to kind of get it over to completion?

Speaker 5

And then I guess secondarily, could you just remind us kind of where that is located and the timeline on resolution?

Speaker 2

Sure, Jeff. This is Karen. Yes, we continue to evaluate a number of options with regard to this particular credit. If you recall from last time, borrower has been proactive in injecting equity into the project cover overruns. It went to non accrual because additional equity injections were delayed.

Speaker 2

They continue to try and source additional equity. That said, we will look at a range of options as we determine how to best resolve the credit. It is here in the Twin Cities market. It's on the east side of the Twin Cities, relatively close to both downtown St. Paul, Downtown Minneapolis.

Speaker 2

It's well located to entertainment, to public transportation. It's a Class A property in a desirable location. So we continue to feel good about the market dynamics and the market's ability to support that property. It is about 87% complete at this point, and we're looking at early 2025 for completion. Obviously, we're doing everything we can to resolve it as quickly as possible, but I don't have a firm timeline for you.

Speaker 5

Okay. Appreciate it. Thanks, Karen. On the expense side, Katie, I think you have I guess I'm interested in those areas that aren't necessarily that were operational, but maybe not recurring. We can carve out the one timers, but I guess of the areas that were elevated, just trying to get a sense for the comp line, are those hires fully baked in and then maybe professional services, just some areas that you may see maybe tail off potentially that aren't recurring, if you will?

Speaker 1

Sure. Yes, in regards to the professional fees, I would expect to see more normalization if you take the run rate for the past couple of quarters ex the M and A. There's some lumpiness in between the Q2 and Q3, I would say, for both the compensation line as well as the professional fees line item.

Speaker 5

Okay. I guess on a core basis to Al's commentary, I mean, ex the added platform you're bringing on legacy expenses, can we expect flat to down? Trying to get a sense for

Speaker 6

what the

Speaker 5

trend is there?

Speaker 3

So Jeff, you're going to see just on a reported basis, so our expenses, we are going to combine mergers. But on an Alaris standalone basis, if you were just to look at us, we are committed to getting that down. So but from a combined entity, because we're now 2 companies getting combined up, you will see reporting expenses, of course, go up. We're committed to the 30% cost saves, 30 plus percent cost saves that we detailed out in our original performance for the deal.

Speaker 5

Yes. Al, I guess I'm trying to get a sense for we could track the expenses on HMN side and what that potentially could add and we can carve out cost saves in 'twenty five. But just the run rate for legacy, that's the key I'm trying to nail down?

Speaker 3

Yes. You'd expect that to come down.

Speaker 5

Yes. Okay. Got you. Maybe just one last one then. On the loan growth, really strong growth and Katy appreciate the tilted towards the market share gains to the degree of I guess that does that suggest that the market overall, maybe the pie is not growing, you're just taking a bigger piece of that?

Speaker 5

Or the question really is just on the underlying business trends and activity. Is that improving some, but you are executing well on taking share? I just wanted to kind of wade into that discussion a little bit more.

Speaker 4

Jeff, this is Jim. That is taking market share. We brought in a lot of talent over the last 18 months. Those non solicits are up. So a lot of the relationships that are moving over and you're seeing that growth are relationships that have been known to a lot of the employees here now that have come over for a long time.

Speaker 4

So it really is market share in some of the other banks that are probably resting on their laurels a little bit.

Speaker 5

Okay. And Jim, your pulse on the activity, generally speaking, of the market from demand, what would that be?

Speaker 4

I think all the markets that we're currently in are in pretty good economic shape. There's not a ton of robust growth, I would say, but pretty average. So I don't think there's a lot of growth exponentially, but there's enough growth for us as other banks are still not overly active in the marketplace. I think our activities are going to generate a lot as the market competition comes back. Our activities now are going to be more fruitful in 'twenty five and 'twenty six just because they haven't a lot of the banks haven't been in the market as much as we have been.

Speaker 5

Okay. Appreciate it. Thank you.

Operator

We will now take our next question that comes from David Pfister with Raymond James. David, your line is now open.

Speaker 6

Hi, good morning everybody. Good morning. Wanted to dig into the margin for a second. Look, there's a lot of moving parts in here.

Speaker 4

I was hoping you

Speaker 6

could just help us think through maybe like a core margin. What's a good starting point? Look, we've unwound the BTFP, you've got HMNF in the fold. Just thinking through the trajectory, again, you've got the non accrual reversal last quarter. Just how do you think about a good core margin starting point, the trajectory going forward as your liability sensitivity has improved?

Speaker 6

And if you had any updated expectations for accretion just on rate marks now that deals closed?

Speaker 3

Thanks, David. So we ended September on a legacy portfolio with an interest margin around 2.41%. When you think about the acquired portfolio, HMN's portfolio, their net interest margin was around 2.8% for the Q3, okay. So that's those are both quarter to quarter, no deal marks, of course. Now on going forward basis, we did indicate about a $54,200,000 mark on the loan book.

Speaker 3

We're still waiting back on the final valuation there, but we do expect that $54,200,000 on original deal assumptions to be a little bit less, given where the rates have moved since our announcement in May. So we'll have less net interest income accretion purchase account accretion to net interest income for next year in terms of deal accretion, but we also will have less goodwill because of the marks. Okay.

Speaker 7

And then just how do

Speaker 6

you think about deposit betas on the way down? You talked a lot about the competitive landscape in your market for deposits. That's obviously way on the margin. How do you think about the competitive landscape maybe impacting your ability to reprice deposits on the way down? I mean, is that going to make it maybe a bit more difficult to do that?

Speaker 6

And just curious how you think about that and some of the assumptions in your outlook?

Speaker 3

Yes, we've been pretty conservative in our assumptions in terms of deposit betas. We do expect deposit betas, I mean, our deposit pricing to lag a little bit on the way down, because given how many banks are still north of 100% loan to deposit ratio and it still continued again, in this quarter, we saw migration from non interest bearing to interest bearing too, which increased our cost of funds. So in terms of the betas, now we are seeing some rationalization though, because we did see in all our markets CD rates pull back some. So that is encouraging to see some of that now. We're not seeing stuff in the high fives or in 6s anymore.

Speaker 3

We're now seeing things come back, especially with the Fed cut. But I do think deposit betas on the way down will be a little bit slower to realize than it'll probably take another 50 to 100 basis points before we start seeing meaningful shift in deposit costs.

Speaker 6

So that just kind of putting that all together, your margin trajectory is probably going to be more back half weighted for the expansion side. Is that a fair characterization?

Speaker 3

Yes, that's correct. That's correct. I think when we still look though at our ALM modeling, based on what we're seeing still though, and I'm talking without any deal marks, we're looking at it on a legacy book right now, because we're still importing a lot of stuff and understanding the portfolio. When we look at legacy of Elerus book, we still see a past 3% with even that lag effect coming in. So and nothing has changed in our guidance.

Speaker 3

With no rate cuts, we still get to 3% in 2026. And on a down one last thing I'll add there too is that, David, just the last thing I'll add to is on a down 100 basis point scenario, we still see our NII increase on the legacy book above mid single digits. Okay. Ex per slot. And then just a ballpark.

Speaker 6

Blocks. Okay. Good point. That's a good point. Okay.

Speaker 6

And then just last one, you've had a lot of success in the retirement wealth businesses. I appreciate some of the commentary that you had. You talked about some success with some national partners. I'm just curious where are you seeing success in those lines of business? And then just following up on the commentary about improving efficiency, I mean profitability has come down pretty materially in those businesses.

Speaker 6

I'm just kind of curious, when do you start when do you think that that's going to start manifesting itself? And how do you think about the profitability profile of those businesses?

Speaker 8

Yes, I can take that. This is Forrest Olson. I can take that for the retirement business. One of the benefits to this business is it's very steady business, but we do anticipate margins to improve really in response to the groundwork that we're laying in 3 areas in efficiency, increased revenue and reduced client turnover. And Katie mentioned some of this in her opening comments, but we're moving forward multiple efforts in each of these areas, including upgrading some technology that we're very excited about, working on process improvement and forming new partnerships, which you specifically mentioned.

Speaker 8

I think there's about 10 plus states now that have state mandated retirement plans and a lot of private companies do not want to go with the state plan and it's definitely there's a groundswell of startup plans, which with our PEP or pooled employer plan model we're taking advantage of and that's leading to some significant partnerships. One that we could highlight is our partnership with MassMutual Financial Advisors

Speaker 9

that

Speaker 8

has yielded north of 150 new retirement plan clients in the last 14 months or so. So as far as margins go, we anticipate expanding margins through these various efforts, but it's going to be steady over time.

Speaker 6

Okay. Okay. Thanks, everybody.

Speaker 3

Thanks, David.

Operator

And the next question comes from Brandon Nussell from Hoof. Your line is now open, Brandon.

Speaker 3

Hey, everybody. Thanks for taking the questions. Hope you're doing well.

Speaker 8

Maybe just to unpack like this quarter's margin before we get into the outlook here. Could you help us understand some of the drivers of the loan and earning asset yield pressure? I guess, 1, how much of a drag came from the non accrual piece? And is that recurring as long as those loans remain non accrual? And then 2, was there any impact from the swap maturity kind of this quarter?

Speaker 8

Thanks.

Speaker 3

Yes. Thanks, Brandon. So nothing on the swap maturity, when it comes to the non accruals, you could see that about roughly about 7 to 8 basis points was from the non accruals.

Speaker 8

And does that drag stick around as long as those loans are non accrual or is that more of an interest reversal?

Speaker 3

It will be a reversal.

Speaker 8

So that 7 or 8 basis point drag will not be present in the Q4, just to make sure I understand completely clearly?

Speaker 3

Yes, that should not be there, correct.

Speaker 8

Okay, got it. Okay, thank you. And then as the rest of the swap book rolls off, just as it pertains to timing versus where the terms of those slots are versus where Fed funds is, is there any kind of intermediate impact one way or the other as those fall off the sheet?

Speaker 3

No. I mean, what we're anticipating in this quarter is a slight decrease in our on the legacy interest expense. But we there is we should start seeing margin improvement going forward because those swaps we have $200,000,000 rolling off here in January. So that will and then we only have another $200,000,000 left for January 2026. So there will be very minor impact left from the remaining swap.

Speaker 8

Okay, okay. Perfect. And then maybe last one on mortgage. I know you kind of offered the guidance for the Q4 there. I mean, for this quarter, it seemed like things were better than I was thinking, even though originations were down, kind of the core gain on sale was quite a bit stronger quarter over quarter.

Speaker 8

I'm just wondering if there's anything that was kind of worth calling out for the Q3 performance?

Speaker 3

No, we just disciplined pricing in that area is what really helped in the mortgage area. Hence why you saw the better gain on sale. Yes, yes. All right. Thank you for taking the questions.

Speaker 3

Thanks, Brandon.

Operator

And our next question comes from Nathan Race with Piper Sandler.

Speaker 9

Hi, everyone. Good morning. Thanks for taking the questions.

Speaker 3

Hi, Nathan.

Speaker 9

Hi, everyone. Good morning.

Speaker 4

Thanks for

Speaker 9

taking the questions. Just put all the pieces together around the margin outlook and just the impact from home federal. Al, can you kind of just help us with kind of a 4Q NII starting point both on the core and reported basis?

Speaker 3

Yes. So I would look at it as like if home federal did 2.8%, take 20% of that, and then 80% and a lot of around 2.4%, you're going to get somewhere in the mid-2s, like 2.45 ish.

Speaker 1

Oh, so

Speaker 9

you're talking margin. I was referring to NII.

Speaker 3

Oh, I'm sorry, for NII, my bad, sorry. When we talk about NII, we're looking at right now let me just get that number up for you. Because we're doing about, I'm going to say around 32,000,000 to 33,000,000 in total for NII.

Speaker 9

That's kind of the starting point for 4Q with Home Federal?

Speaker 3

Yes. Yes, without any deal

Speaker 9

right. And just thinking about the opportunity to maybe deleverage the balance sheet at Home Federal or any other balance sheet optimization initiatives that could come to fruition with that deal. Just curious to hear any thoughts as

Speaker 3

it relates to maybe loan sales or just securities portfolio restructurings that could help that margin outlook as we get through the integration into early 2025? Yes. So we've already looked at doing some loan sales for that. We're contemplating layman options on the loan front. On securities front, you can expect that we're going to make we've done some stuff in that front to help with NI.

Speaker 3

But the lift from the securities book is they only had about $190,000,000 worth of securities is going to be very small.

Speaker 9

Okay, perfect. Very helpful. And then just in terms of just the rate sensitivity of the combined franchise going forward, I think we talked about the liabilities since the position of the balance sheet previously. You have some swaps going off next year. So just curious how you're kind of thinking about just the static margin or NII impact from each 25 basis points going forward?

Speaker 3

Yes, we're still working through that right now as we get our 2 systems merged in place. But what we could see from the surface right now is that they're liability sensitive, so that's just going to add to liability sensitivity that we have.

Speaker 9

Got it. Thank you for that. Switching gears, maybe a question for Karen. Curious if you could just touch on what you saw in terms of criticized classified loan trends in the quarter?

Speaker 2

Sure. Good morning, Nate. We did see those increase again. What I would say about that is that while we've been experiencing increases, overall levels are fairly consistent with what we saw pre pandemic. And so the non performing obviously are higher and those are being driven over half of that by that one loan.

Speaker 2

So those are higher than what we've experienced in the past. But generally speaking, the criticized and classified levels are more consistent with pre pandemic. And when you look past these few credits that Katie pointed out in her comments, there's they're really made up of all different segments, even the asset classes within the commercial real estate are different and then origination dates kind of span all the way back actually the mid-twenty 15. And so, I think really what we're seeing is we're seeing some continued normalization, which isn't unexpected, but then we've got these couple of big deals that are really bouncing those non performing numbers.

Speaker 9

Got it. That's very helpful. Maybe one last question for me for Katie. Now that you got Home Federal closed in a pretty timely fashion here in the Q4, we'd just love to hear your updated perspectives in terms of managing excess capital. Obviously, with the profitability improvement with Home Federal, you guys should be accreting excess capital at stronger clips going forward.

Speaker 9

So just curious how you're thinking about weighing those options when deploying excess capital between additional acquisitions, whether it's on the retirement or well side or in terms of whole bank acquisitions or perhaps resuming share repurchases just given where the stock is trading?

Speaker 1

Sure. Yes, thank you. In regards to capital, our priorities remain consistent with previous quarters. Organic growth is certainly a key priority. Maintaining our fortress balance sheet is always number 1 in our priority books.

Speaker 1

Our commitment to our dividend remains consistent with our long history. And as I mentioned in my opening comments, we understand the value embedded in this company. And so having the share repurchase out there from a defensive standpoint, I think, serves us all well. In regards to M and A, again, there's a couple of catalysts, particularly in the retirement space, for sub scale providers. And we are known and have proven that we are a partner of choice for many of those companies.

Speaker 1

We will be highly selective of course because there is a lot of work that we are doing internally in that business. But we believe we will continue to see opportunities, specifically in that retirement, as well as in the wealth space.

Speaker 9

Got it. Very helpful. Thanks for all the color.

Operator

Thanks Dave. The next question comes from Damon DelMonte with KBW. Your line is now open, Damon.

Speaker 7

Hi everyone. Thanks for taking my questions. First one, just regards to expenses. Al, kind of just wondering what your thoughts are on the combined company here in the Q4. I think you guys mentioned the wealth management platform upgrade you guys are going to be doing.

Speaker 7

So just trying to get a gauge on kind of what we could expect here in the Q4?

Speaker 3

Yes. Damon, I'm going to say the Q4 is going to be a little messy here because we're going to have a lot of the deal expenses flowing through, especially we have contract terminations and onboarding of new stuff. So I don't have a good guide for you at this moment in terms of the Q4 run rate, but what I could say for the 2025 run rate is that we are looking once you get past all the deal costs and everything from a combined basis that we are still on track to meeting all the goals we set for in 2025.

Speaker 7

Okay. Yes, I understand there'll be a lot of moving parts, but I mean, is a simple way of looking at it is, if you take out the merger charges this quarter, you're around $40,800,000 say, basically layer on the HMNF expense base and then start to take off some expenses, which would kind of put you in the upper $47,000,000 low $48,000,000 range, is that ballpark?

Speaker 3

That's the way to think about it, right, on a core basis, correct.

Speaker 7

Okay, great. And then with regards to the 2 new loans that moved into non accrual this quarter, could you just give a little bit more color? One of them was a large residential relationship. How big was it and what kind of reserve do you have against that?

Speaker 2

Yes. Damon, this is Karen. That relationship was about is about $8,500,000 and it's comprised of an owner occupied property as well as the previous property that's listed for sale. The current reserve on it is about 5%, and we will be getting updated valuations on both of those properties.

Speaker 7

Okay, great. Great. So both of those were to 1 borrower, one part of it was a residential and one was owner occupied?

Speaker 2

Yes. It's a long term banking and wealth client, as Katie mentioned. And he had a primary residence, constructed a new residence, which we financed. And so he both of those residents are single family residences. And he is in the new home now, and the previous home is listed for sale.

Speaker 7

Got it. Okay. And then with regard to the construction loan, this may have been asked before, so I apologize. But is there any additional funds to be released to this borrower to help complete the project? Or are you at full exposure right now?

Speaker 2

We're at full exposure on that deal.

Speaker 7

Okay. And then that's at about how much now? Is it 20 upper 20s?

Speaker 4

You shouldn't take me back.

Speaker 2

Oh, I'm sorry. You're talking about the original deal. I thought you were talking about the residential deal.

Speaker 7

No, I'm sorry. I'm talking about the construction loan. Yes, sorry.

Speaker 2

Okay. Yes. That one, we're considering we still are considering a number of options on that one, Damon. The borrower is continuing to try to raise equity. They've demonstrated their willingness to inject equity.

Speaker 2

And so we're supporting that process. But certainly, additional fundings may be on the table as we look at how we can most quickly resolve this.

Speaker 7

Got you. Okay. And have you quantified what the total exposure is to that one particular borrower?

Speaker 2

Right now, as of ninethirty, the balance was $25,000,000 and he's approved or they're approved up to just under $29,000,000

Speaker 7

Great. Okay, that's helpful. Thank you. I think that covers everything. So thank you very much.

Operator

Thanks, David. Your next question comes from David Fuse with Raymond James. David, your line is now open.

Speaker 6

Hey, thanks for letting me hop back in. I just wanted to touch on the hiring front. You guys have been really active. You've attracted a lot of new talent. I'm curious, I guess, A, what's your appetite for new hires?

Speaker 6

And how much of the production, like how much of the growth that you're seeing is coming from those guys? Or is that kind

Speaker 3

of still on the come?

Speaker 4

Hi, David. This is Jim. I will say we're still active on hires, but I do want to note that we are as we have some individuals leaving the organization, we are repurposing those FTEs for a lot of the new hires. The growth is coming from those new hires because they have capacity and relationships that are new, but we also have a lot of growth coming from our existing traditional portfolios as well.

Speaker 6

Okay. And I guess as you think about funding growth going forward, I know we've kind of talked about a mid-90s loan to deposit ratio. Is that kind of still the target? And I just how do you think about funding growth of core deposits in light of the competition that you talked about?

Speaker 3

Yes. Thanks, David, for the question. I mean, that is our target of 95%, but we understand too that we'll drift up above that certain quarters due to seasonality. So you could see us get up to 97%, 98% and then maybe some quarters below 95%. So average will get to 95% through the cycle.

Speaker 3

But with that being said too though, as we continue to grow, we will probably utilizing other areas, other means to fund those growth if we can't get core deposits in the door. Okay.

Speaker 4

I do want to note, David, we do have some very specific deposit strategies around our homeowners associations, around large nonprofits and large specific mid market clients that generate a lot of cash and don't need a lot of loans. So we are very focused on driving those core deposits. And I think we've been fairly successful the last year and we will continue to drive those.

Speaker 6

Okay. That's and just to be crystal clear, that $245,000,000 is a core margin that we talked about, Al, right? Accretion would

Speaker 7

be on top of that.

Speaker 3

Correct. That is correct.

Speaker 6

Okay. Okay. Appreciate it. Thanks, everybody.

Speaker 1

Thanks, Steven. Thanks.

Operator

So this does conclude our question and answer session. And I would like to turn the conference back over to Katie Lorensen for any closing remarks.

Speaker 1

Thank you. Thank you all for joining our call and for your relationships and of course for your investments. We acknowledge and take full responsibility for a tough quarter. The path to superior returns is certainly not linear. It does take time for some of these investments we have made to result in top tier performance.

Speaker 1

So some of the parts of this incredibly valuable company will be recognized with time and we are transforming from within and we are making progress every day. We have a best in class diversified business model and a company that will deliver superior profitability and tremendous value creation to our shareholders. I want to say thank you to all of our team members who are part of our journey to get better every day. 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

  • The company acknowledged a tough Q3 with results below targets, emphasizing the non-linear path to achieving top-tier performance.
  • Net interest margin compressed to 2.23% due to higher non-accruals and competitive deposit pricing, challenging short-term margin expansion.
  • Closed the acquisition of Home Federal, its largest to date and 26th in ~20 years, demonstrating regulatory strength and proven integration capabilities.
  • Deposit growth exceeded 7% YTD and remained flat in Q3 despite seasonal outflows, supported by a CD rollover rate above 96% without relying on brokered funds.
  • Loan balances grew 4% QoQ for the 8th consecutive quarter, with C&I originations rising to 45% of YTD volume versus 17% pre-transformation, signaling clear market share gains.
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Earnings Conference Call
Alerus Financial Q3 2024
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