Alerus Financial Corp. (ALRS) Q1 2022 Earnings Call Transcript

Alerus Financial Corp. (ALRS -1.17%)
Q1 2022 Earnings Call
Apr 28, 2022, 10:00 a.m. ET

Contents:

• Prepared Remarks
• Questions and Answers
• Call Participants

Prepared Remarks:

Operator

Good morning, 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 pass the conference over to your host, Alerus Financial Corporation president and CEO, Katie Lorenson. Please go ahead.

Katie Lorenson -- Chief Financial Officer

Thank you, and good morning, everyone. Thank you for dialing into our call today. Joining me today is Karin Taylor, our chief risk officer, and I'm very proud to introduce Al Villalon, our new CFO, who joined our company just about three months ago. Al's background and experience is just what I was looking for as we take Alerus to new heights.

We will continue to distinguish ourselves as a uniquely diversified financial services firm via our One Alerus strategy. This strategy sets us apart from others as we deliver higher returns through a highly annuitized revenue mix. This mix will also deliver more consistent returns through longer periods of time and through the ups and downs of business and economic cycles. As I reflect on the first quarter, I am exceptionally proud of our company's ability to attract and retain talent.

We are continually raising the bar with our new additions, and Al is just another example of talented professionals who are looking to be part of a special story and a special future. Alerus has positioned itself with a diversified business model and a strong foundation to grow and create tremendous value for our shareholders. It is a unique story in the Midwest and people want to be part of it. In addition to Al, we also successfully lifted out a five-person commercial construction lending team and have the privilege of additional Twin Cities talent seeking to join our organization.

I'll take this opportunity to thank our Alerus team members for another strong quarter of sales and great service to our clients. It was a quarter of volatile markets and historically low housing inventory levels; however, we excelled where we have control. Alerus reported net income of $10.2 million, driven by strong annualized loan growth ex PPP of 18.7% and supported by a high level of reserves and continued pristine credit quality. I'm proud of the resource and expense management which remains a discipline throughout our company.

Our mortgage team members are focused on their realtor relationships and purchase business, which is historically 70% to 80% of our origination volume. We also had numerous examples of how our business model wins. As you can see in our numbers, despite being in a down market, we saw a large increase in our AUM based on strong new production and new assets from sale proceeds of one of our long-term commercial clients. Our model is focused on bringing value and advice to our clients all along their financial journey.

It's what set us apart and is what will continue to drive long-term outperformance compared to our peers. With that, I will hand it off to Al to discuss the financial details of the quarter.

Alan Villalon -- Chief Financial Officer

Thanks, Katie. I'll start the commentary on page 14 on our investor deck, which you can find on our website. For the first quarter of 2022, reported average loans declined 80 basis points on a linked-quarter basis. Excluding the impact of PPP, average core loans increased 1.7% on a linked-quarter basis.

The increase in core average loans was driven by a 1.8% growth in C&I, 2.2% growth in commercial real estate and a 1.3% growth in consumer. Within C&I, we saw a pickup in loan production along with an uptick in utilization rates of several clients tapping into their existing lines. C&I utilization increased from 17% to 28% during the quarter. At the end of the first quarter, we had approximately $13.1 million of PPP loans outstanding.

Average deposits declined 1.9% on a linked-quarter basis due to seasonal decline in non-interest-bearing deposits. We saw seasonal higher deposits related to synergistic deposits in the fourth quarter of the prior year, but those balances had a typical outflow in the first quarter. Turning to page 15. Credit continued to remain very strong.

We had net recoveries of 3 basis points in the first quarter compared to 22 basis points in net recoveries in the prior quarter. Our non-performing assets was 15 basis points compared to 9 basis points in the prior quarter. Our allowance was 1.74% of period-end loans. As a reminder, we are a non-CECL institution.

We're already preparing to implement CECL in January 1, 2023. We'll have more details on CECL as we move closer to the implementation date. Turning to page 16 where are some key revenue metrics. On a reported basis, net interest income declined 4.9% on a linked quarter basis.

Excluding the impact of PPP, net interest income increased 2.5%, mainly due to higher interest income from the investment portfolio. Noninterest income declined 12.6% on a linked quarter basis due to lower mortgage banking, retirement and wealth management revenues. I'll go through details about those declines in the later slides. Turning to page 17.

Net interest margin was 2.83% in the first quarter, a decline of 1 basis point from the prior quarter. Excluding the impact of PPP, our core net interest margin was 2.77%. That's an increase of 15 basis points from the prior quarter. Core net interest margin benefited from higher investment portfolio yields along with higher loan yields from our consumer portfolio, offset by lower yields from our C&I portfolio.

During the quarter, the reinvestment grade of our investment portfolio was accretive, as new investments were at a higher rate compared to investments that were maturing. On page 18, you'll see that we have $698 million or 38% of our loans are floating, as you can see on the top right of the slide. On the bottom left, you can see a little field of the net interest income and net interest margin. The $1.6 million decrease in PPP is -- negatively impacted both net interest income and margin.

Offsetting some of the PPP impact, the high investment portfolios and higher yields from consumer portfolio. On page 19, our core funding mix remained very strong. We saw a small increase in our deposit costs due to rising interest rates. Despite the increase in funding costs, the impacted our interest expense was minimal due to decline in deposit balances, as discussed earlier.

On page 20, I'll talk about the retirement business. Assets under management and administration declined 3.2%, mainly due to market volatility and partly to net outflows. For AUM decline, we did see that the number of participants increased to approximately 435,000 versus 430,000 in the prior quarter. Revenues declined 4.9% to the prior quarter, mainly due to lower asset loans.

Turning to page 21, you can see highlights of our Wealth Management business. Despite the market volatility, assets under management and administration saw an increase due to a new custody deal was brought in during the quarter. We brought in roughly approximately $800 million in assets and administration near the end of the quarter. Revenues declined 5.5% from prior quarter, mainly due to higher fees recognized at the year-end time due to lower average assets and due to lower average assets impacted by challenging markets during the quarter.

Turning to page 22, I'll talk about our mortgage business. Mortgage originations declined approximately 48% in the prior quarter due to lower refinancing and purchase activity. The decline in activity was driven by higher interest rates in the quarter as the 30-year mortgage rate recently eclipsed 5%. Additionally, we saw a lack of housing inventory that negatively impacted our volume during the quarter.

We saw record low housing inventory in our main markets. Despite the challenging markets, our current volumes are still 49% higher than the similar time period in 2019. Lastly, turning to page 23 is an overview of our noninterest expense. During the quarter, noninterest expense declined 7.8%, mainly due to lower incentive compensation related to revenue-related activities.

We also saw a decrease in professional fees due to lower M&A expenses in the quarter. Other expenses decreased as a result of lower marketing expenses. We believe this is more of a timing issue and expect marketing to pick up through the course of the year. Now, I'll provide some forward-looking guidance.

For 2022, we are still expecting average loan growth to be in the mid to high single digits. We expect overall 2022 revenues to be down low to mid-single digits when compared to 2021. The biggest variable in our revenue outlook is our mortgage business, with a lack of inventory that's caused unforeseen headwinds for us. Also, the recent market volatility has impacted our retirement and wealth businesses.

We now expect expenses to be down low single digits when compared to 2021. And lastly, we expect the trend to remain strong. I'll now open up to Q&A.

Questions & Answers:

Operator

[Operator instructions]. The first question is from the line of Jeff Rulis with D.A. Davidson. You may proceed.

Jeff Rulis -- D.A. Davidson -- Analyst

Thanks. Good morning. Just a question on the loan growth side of things. A bit of a breakout, I guess.

If you could kind of talk about any geographic strength? I know you rattled through sort of the segment detail, but just wanted to get a sense for a pretty big start to the year and the sustainability of that.

Alan Villalon -- Chief Financial Officer

Hey, Jeff, it's Al. Thanks for the question. We're seeing pretty much broad-based economic activity in our loan portfolio. Particularly, especially in our Twin Cities market, we saw some very good growth there, too.

But I would say, too, it's pretty much broad-based across all markets and across the both portfolio, especially both the consumer, C&I, CRE.

Jeff Rulis -- D.A. Davidson -- Analyst

And the pipeline, I mean, typically, you put on this level of growth. Does that sort of draw down and you got to rebuild that? Maybe just speak to the pipeline as you entered the quarter and as you exited?

Alan Villalon -- Chief Financial Officer

Yes. The one thing I'd like to highlight on our pipeline, we recently implemented Salesforce which has been a big product -- a big innovation for us. And as I look at our pipelines right now, they're very good. We recently just are looking at the data coming in there, and we're encouraged by what we're seeing.

Jeff Rulis -- D.A. Davidson -- Analyst

OK. So pipelines are as good as they were entering the quarter as you are entering Q2?

Alan Villalon -- Chief Financial Officer

Yes.

Jeff Rulis -- D.A. Davidson -- Analyst

OK. Thanks. And Al, I had some -- I apologize. I had some audio issues on the call right when you were delivering the fee income outlook.

Do you mind just quickly rattling through the -- each of those expectations?

Alan Villalon -- Chief Financial Officer

Yes. Actually, Jeff, what I did there is we talked about overall revenues. And what I said on the call is that we expect overall revenues to be down low to mid-single digits. And the biggest thing that we're seeing right now is that in the mortgage business, we're seeing some challenges there because of low inventory in our main markets.

That's something we didn't foresee, but we're hoping there will be a seasonal pickup there because just given winter conditions and just low -- hopefully, we expect inventory to pick back up. And then, on our retirement and wealth businesses, what I commented on is that we just had the market volatility impact that right now. So we didn't expect the quarter to be as volatile as it was when we did our initial outlook.

Jeff Rulis -- D.A. Davidson -- Analyst

OK. Great. And last one, if I could. Just checking in a bit on the Metro Phoenix on potential deal timing.

Is that looking like May or June? And then if you can kind of maybe update just how they did in Q1 in terms of a growth standpoint? Or is it pretty much at announcement, those balances will be kind of as expected, again, kind of announcement through close?

Alan Villalon -- Chief Financial Officer

Yes. I mean, I can comment on briefly on -- go ahead. Go ahead, Katie.

Katie Lorenson -- Chief Financial Officer

Sorry about that. I'll take that one. In regards to Metro performance, it was in line with theirs and our expectations, both in terms of net income, as well as balance sheet growth. And so, it's a good, strong start to their first quarter.

In regards to timing, we have no reason to believe that it won't close in the second quarter, but we are going through the regulatory process and so out of our control in that regard.

Jeff Rulis -- D.A. Davidson -- Analyst

OK. Thanks. I'll step back.

Operator

Thank you. The next question comes from the line of Nathan Race with Piper Sandler. You may proceed.

Nathan Race -- Piper Sandler -- Analyst

Yes. Hi, everyone. Good morning.

Alan Villalon -- Chief Financial Officer

Good morning, Nate.

Nathan Race -- Piper Sandler -- Analyst

I wanted to drill a little bit more, I think last quarter, thinking about retirement benefit services revenue flat year over year. Curious if that's still the case. And it sounds like you guys had a nice wealth management client win in the quarter, drove a nice increase in AUM levels. And so, I'm just trying to kind of put the pieces together to get to that kind of low single digits -- I'm sorry, mid- to high single-digit decline in overall fees this quarter.

And does it also contemplate kind of the hedge gain that you guys had coming through mortgage last year?

Alan Villalon -- Chief Financial Officer

Yes. Hey, Nate. I just want to make sure. We actually guided to low to mid-single digits, not mid to high.

So just to make sure you got that down correctly. So it's low to mid. And then, yes, so the biggest thing, when you think about our retirement business right now, so in the fourth quarter, we did have some fees that are not annual in nature that impacted, so that's a decline. And also, we had the volatility markets impact our asset levels.

So that's going to be -- we're just taking a little bit headwind there right now. So our outlook for retirement business, I'd say that we're trying to keep revenues as high as we can right now, but that might be a little bit challenged given the markets where they are right now.

Nathan Race -- Piper Sandler -- Analyst

OK. Great. And just kind of in light of your mortgage volume expectations this quarter, just directly in terms of expenses. How should we kind of think about that run rate over the course of this year? Imagine we'll see an increase in Q3 due to mortgage volumes presumably pick up, but just kind of any thoughts on just the overall run rate, excluding deals --

Alan Villalon -- Chief Financial Officer

Right. So when it comes to mortgage business right now, we actually had a little bit of a challenging quarter given the low inventory. We're expecting that to pick up in 2Q and for the rest of the year. So we do have some leverage there in terms of as revenues pick up for us in that segment, there will be a little bit higher expenses because we have more production coming through.

But we also -- we were trying to do the best we can to manage in that environment right now. And you saw the competition did drop less in 1Q. We looked as we had a negative impact from their revenue decline.

Nathan Race -- Piper Sandler -- Analyst

Got it. OK. Great. And then, maybe just turning to kind of the outlook for the reserve.

I mean you guys are still operating with a very robust reserve level these days. It sounds like you guys are expecting mid- to high single-digit loan growth going forward. Just curious in terms of any need to provide for that growth for the quarter, or is the plan to just grow into kind of the unallocated excess if there's any exists still?

Alan Villalon -- Chief Financial Officer

Yeah. I'm going to let Karin take this one.

Karin Taylor -- Chief Risk Officer

Thanks, Al. Good morning, Nate. Yes, we expect, similar to previous quarters, that increases will be driven by loan growth. And a large portion of our reserve at this point is due to qualitative factors.

Obviously, we will continue to watch the environment in terms of how we need to be reserved there. But as we have loan growth, we could see some provisioning later in the year.

Nathan Race -- Piper Sandler -- Analyst

Understood. And does that loan growth outlook, does that contemplate additional increases in line mitigation? We've seen nice increases recently, but still below pre-pandemic levels. So I was just trying to understand how much of an opportunity in terms of outside of loan growth potential exists if line utilization continues to increase.

Karin Taylor -- Chief Risk Officer

Do you want me to take that, Al?

Alan Villalon -- Chief Financial Officer

Yes. Go ahead, Karin.

Karin Taylor -- Chief Risk Officer

OK. OK. Yes, Nate, I think looking at our available balances and where our utilization rate has been historically pre-pandemic, I would say there is upside in the $20 million to $30 million range.

Nathan Race -- Piper Sandler -- Analyst

OK. Maybe just one last one on capital. You guys had a little bit of a decline in PC with the AOCIs end of the quarter, but you guys are still operating with ample capital levels. Stock pulled back like with your peers over the last few months.

So just curious just to get an update in terms of the buyback appetite presently and just kind of what you're seeing in terms of acquisition options, as well as JV.

Katie Lorenson -- Chief Financial Officer

Thank you. So our share repurchase plan is suspended, of course, until we close on the Metro deal. We do have in place, but our priority continues to be balance sheet growth, loan growth, as well as on the fee income side. And I would reiterate my comments from the prior quarter in regards to our focus is on building our pipeline, as well as building our sources for those fee income deals.

Nathan Race -- Piper Sandler -- Analyst

OK. Great. And I apologize. If I could just ask some more on the commercial real estate team that you guys added in the Twin Cities.

Are there any non-competes or non-solicits in place? Or do you expect those guys to kind of hit the ground running now that they're onboard?

Karin Taylor -- Chief Risk Officer

Nate, this is Karin again. There are no noncompetes or nonsolicits, and we're already seeing a high degree of activity from the team. So we expect that they'll be building their pipeline through the rest of 2022.

Nathan Race -- Piper Sandler -- Analyst

Got it. I appreciate all the color and you guys taking the question. Congrats on the quarter. Thanks.

Alan Villalon -- Chief Financial Officer

Thank you.

Operator

Thank you. [Operator instructions]. This concludes our quarterly investor session. I would like to turn the conference back over to Katie Lorenson for any closing remarks.

Katie Lorenson -- Chief Financial Officer

Thank you. And thank you again to everyone joining our call this morning. Thank you for listening and asking questions. Our industry is facing headwinds.

Our company has some of our own, but this company again has historically outperformed, and we remain well positioned for future success because of our business model. We continue to see momentum in building our pipelines and our new business and client expansion, as well as the high level of engagement within our team and within our markets and our brand. We have constancy of purpose that is embraced and magnified by our leadership team, and we remain focused on working together to grow. The steady and strong foundation is allowing us to retain and recruit top talent, serving the best interest of our clients and deliver long-term value to our shareholders.

We thank our shareholders for their investments and all of our team members for doing great work every day. We thank you for your continued support and interest in our company. Have a great day, everyone.

Operator

[Operator signoff]

Duration: 22 minutes

Call participants:

Katie Lorenson -- Chief Financial Officer

Alan Villalon -- Chief Financial Officer

Jeff Rulis -- D.A. Davidson -- Analyst

Nathan Race -- Piper Sandler -- Analyst

Karin Taylor -- Chief Risk Officer

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