Alerus Financial Corporation — Q3 2021 Form 10-Q
Reporting period: Three and nine months ended September 30, 2021. Alerus is a diversified financial services company with banking, retirement and benefit services, wealth management, and mortgage businesses. Amounts below are in U.S. dollars; financial statement figures are in millions unless noted.
Financial performance and position
- Q3 earnings: Net income was $13.1 million, down 26% from $17.7 million a year earlier; diluted EPS was $0.74 versus $0.99. Pretax income was $17.1 million. Return on average assets was 1.62% and return on average common equity was 14.68%.
- Nine-month earnings: Net income was $40.0 million, up 16% from $34.5 million; diluted EPS was $2.26 versus $1.94.
- Revenue and margins: Q3 net interest income was $21.1 million, down 3%; noninterest income was $36.0 million, down 20%. Together, these revenue sources totaled $57.2 million, versus $67.0 million in Q3 2020. Tax-equivalent net interest margin was 2.78%, compared with 3.17%; the efficiency ratio was 71.49%, versus 58.42%. For the first nine months, net interest income rose 6% to $64.3 million and noninterest income rose 3% to $113.7 million; net interest margin was 2.92% versus 3.22%, and the efficiency ratio was 69.69% versus 66.22%.
- Credit costs: The company recorded a $2.0 million provision reversal in Q3 and for the nine-month period, compared with provisions of $3.5 million and $9.5 million, respectively, in 2020. The allowance for loan losses was $32.1 million, or 1.78% of loans, at quarter-end.
- Cash flow: For the first nine months, operating cash flow was $117.7 million, investing cash flow was negative $264.0 million, and financing cash flow was positive $132.7 million. Cash and cash equivalents ended at $159.5 million, down from $173.0 million at December 31, 2020.
- Balance sheet and liquidity: Total assets were $3.18 billion, up 5% from year-end 2020. Deposits increased 5% to $2.71 billion. Loans fell 9% to $1.80 billion, largely reflecting PPP loan forgiveness. On-balance-sheet liquidity was $789.5 million; management said resources were adequate to fund commitments.
- Debt and capital: Long-term debt was $59.0 million, broadly unchanged from year-end. During Q1, the company issued $50 million of subordinated notes at a 3.50% fixed rate and repaid $49.9 million of long-term debt. September 30 consolidated ratios included 14.52% common equity tier 1, 18.58% total capital to risk-weighted assets, and 9.88% tier 1 capital to average assets; management reported capital above applicable well-capitalized levels.
- Shareholder returns: The quarterly dividend was $0.16 per share. The board authorized a 770,000-share repurchase program for 36 months; no shares were repurchased under the program through September 30, although employee tax-withholding share repurchases occurred.
Material changes and management commentary
- Q3 earnings declined mainly because mortgage banking revenue fell $11.2 million and noninterest expenses increased $1.8 million. Management attributed weaker mortgage revenue partly to a smaller hedged pipeline and $95.8 million fewer mortgage originations than in Q3 2020.
- For the nine months, higher earnings reflected lower loan-loss provisions and higher net interest and fee income, partly offset by $11.0 million higher noninterest expenses. Compensation expense increased $8.6 million, including acquisition-related and mortgage-incentive costs.
- Retirement and benefit services and wealth management revenue grew year over year in both the quarter and nine-month period. Mortgage banking revenue declined year over year for the nine months despite originations increasing $307.4 million.
- Criticized loans declined to $31.2 million, or 1.73% of total loans, from $56.7 million, or 2.86%, at year-end 2020. However, nonperforming loans rose to $6.2 million from $5.1 million, and nonperforming assets rose to $7.1 million from $5.1 million.
- Available-for-sale securities had $655.3 million of fair value; held-to-maturity securities had $362.6 million carrying value. In April, the company transferred $149.2 million fair value of securities from available-for-sale to held-to-maturity, citing capital protection and reduced volatility in other comprehensive income. Nine-month other comprehensive income included a $10.1 million net loss, primarily reflecting securities valuation changes.
Outlook, risks, and contingencies
- No specific earnings or revenue guidance was provided. Management expects net interest income and margin to remain under pressure, citing low policy rates and balance-sheet mix, with PPP processing fees providing a partial offset.
- Management expects rising interest rates and inflationary pressure to adversely affect mortgage originations and mortgage banking revenue. It also anticipates slower loan growth amid high liquidity and market competition.
- The COVID-19 recovery remained uncertain and potentially uneven, including risks from variants, supply-chain disruption, and effects on borrowers and collateral. Of 587 pandemic-related loan modifications totaling $154.5 million, most had returned to normal payment status; eight loans totaling $3.4 million had additional deferrals and two loans totaling $69,000 remained on initial deferral.
- Outstanding commitments to extend credit and standby letters of credit totaled $633.5 million. These are contingent exposures and do not necessarily represent expected cash outflows.
- Other stated risks include credit quality and allowance estimates, interest-rate and securities-value changes, mortgage pipeline and repurchase risks, liquidity and large-depositor concentrations, cybersecurity and technology disruptions, competition, regulation, and implementation of CECL. The company said it could not reasonably estimate CECL’s eventual impact. It reported no material change in previously disclosed risk factors, no material pending legal proceedings, and effective disclosure controls.
Investor items to verify
- Whether mortgage banking revenue and related hedge valuations continue to weaken as origination volumes and interest rates change.
- Whether PPP runoff, loan growth, and the changing balance-sheet mix put further pressure on net interest margin.
- Whether the improved criticized-loan trend is sustained, given higher nonperforming loans and the allowance reduction.
- How securities marks, the available-for-sale to held-to-maturity transfer, and interest-rate sensitivity affect capital and other comprehensive income.
- Progress on CECL implementation and the potential effect on reserves, alongside liquidity, deposit concentration, and the use of committed credit facilities.