Alerus Financial Corporation — Q2 2020 Form 10-Q
Business context and reporting period. Alerus is a diversified financial services company with banking, retirement and benefit services, wealth management, and mortgage businesses. This unaudited filing covers the quarter and six months ended June 30, 2020; comparisons are with the corresponding 2019 periods unless otherwise noted. Amounts below are in U.S. dollars.
Financial performance and condition
- Q2 results: Net income was $11.5 million, or $0.65 diluted EPS, versus $8.3 million, or $0.59, in Q2 2019. Net interest income was $20.1 million and noninterest income was $38.2 million; together, operating revenue was $58.3 million, up about 20.8%. Pretax income was $15.1 million.
- First-half results: Net income was $16.8 million, or $0.95 diluted EPS, versus $14.8 million, or $1.05, in first-half 2019. Operating revenue was $104.3 million, up about 12.9%. Higher earnings but lower diluted EPS reflected the larger share count following the 2019 IPO.
- Revenue mix and expenses: Noninterest income was 65.6% of Q2 revenue and 62.7% of first-half revenue. Q2 mortgage banking income rose to $17.5 million from $7.0 million, while retirement and benefit services income declined to $13.7 million from $15.8 million. Q2 noninterest expense increased 12.7% to $39.7 million, including higher compensation tied to mortgage production and a $1.0 million increase in the provision for unfunded commitments.
- Net interest and margins: Q2 net interest margin (tax-equivalent) was 3.14%, down from 3.62%; first-half margin was 3.24%, down from 3.74%. Management attributed pressure to lower market rates and loan yields. Q2 efficiency ratio improved to 66.31% from 70.74%.
- Credit costs: Provision for loan losses was $3.5 million in Q2 and $6.0 million for the first half, versus $1.8 million and $4.0 million, respectively, in 2019. The allowance was $27.3 million, or 1.34% of loans (1.62% excluding PPP loans). Q2 net charge-offs were $3.3 million; nonperforming loans were 0.26% of loans.
- Balance sheet and liquidity: Total assets were $2.88 billion at June 30, up 22.0% from year-end 2019. Loans were $2.03 billion, including $347.3 million in PPP loans; deposits were $2.45 billion, up 24.4%. Cash and cash equivalents were $210.4 million. Management reported on-balance-sheet liquidity of $354.6 million and access to additional borrowing capacity, including up to $579.9 million from the FHLB based on pledged collateral.
- Cash flow: For the first half, operating cash flow was negative $22.7 million, investing cash flow was negative $387.1 million, and financing cash flow was positive $476.2 million, principally reflecting deposit growth. Cash increased $66.4 million to $210.4 million.
- Debt and capital: Long-term debt was $58.8 million; no short-term borrowings were outstanding at quarter-end. The company reported a 12.58% consolidated CET1 ratio and a 16.70% total capital ratio; the Bank’s respective ratios were 11.99% and 13.24%. Both were above applicable well-capitalized thresholds. Tangible common equity to tangible assets was 9.25% (10.55% excluding PPP loans).
Material changes versus comparable periods
- Q2 net income increased $3.1 million year over year, primarily from stronger mortgage banking and net interest income, partly offset by higher operating expense and loan-loss provision.
- First-half net income rose $2.1 million, while diluted EPS fell from $1.05 to $0.95 amid substantially more weighted-average shares outstanding.
- Mortgage originations were $431.6 million in Q2 and $660.2 million for the first half, compared with $246.1 million and $371.7 million, respectively, in 2019. Loans held for sale rose to $101.8 million from $46.8 million at year-end.
- Loan growth included $347.3 million of PPP loans. Excluding PPP, commercial and industrial loans were a smaller share of the portfolio than reported gross balances suggest.
- Accumulated other comprehensive income increased to $9.8 million from $1.9 million at year-end, mainly reflecting unrealized gains on available-for-sale securities.
Outlook, risks, and unusual items
- COVID-19: Management said the pandemic’s full impact was unknown and could not be reasonably estimated. It anticipated adverse effects on credit quality, loan demand, net interest income and margin, fee-based businesses, mortgage activity, and capital and liquidity. Management expected loan-loss provisions could increase and loan growth to slow.
- Borrower relief and PPP: By June 30, Alerus had executed 515 COVID-related payment deferrals on $148.5 million of loans, generally for up to 90 days; these were not treated as troubled debt restructurings under applicable guidance. The Bank had helped more than 1,580 clients secure approximately $362.7 million of PPP financing. Net PPP processing fees of $11.0 million were deferred and are recognized as interest income over the loans’ lives. The Bank had not used the Federal Reserve’s PPP liquidity facility.
- Other risks: The filing highlights possible borrower defaults and collateral declines, concentration and commercial real estate exposure, PPP eligibility or servicing disputes and litigation, mortgage pipeline risk, market and interest-rate risk, cybersecurity and operational disruption, and uncertainty about future credit losses. Commitments to extend credit and standby letters of credit totaled $607.7 million; these amounts are not necessarily expected cash outflows.
- Capital returns: The Board declared a $0.15 quarterly dividend, paid in July, and declared another $0.15 dividend payable in October. Management said the Board then intended to continue quarterly dividends, while noting capital-distribution restrictions if required capital buffers are not maintained. There was no authorized share repurchase program.
- Contingencies and accounting: The company reported no material pending legal proceedings and no goodwill impairment at June 30. It had not yet adopted CECL and said it could not reasonably estimate the adoption impact. No numerical earnings guidance was provided.
Most important facts for investors to verify
- Whether PPP balances and deferred fees materially affect reported loan growth, interest income, margin, and the allowance ratios.
- Subsequent trends in COVID-related deferrals, criticized and nonperforming loans, charge-offs, provisions, and the adequacy of the allowance.
- Whether mortgage origination gains and elevated volume persist, and how mortgage pipeline risk and servicing-rights valuations evolve.
- Whether deposit growth and reported liquidity remain durable as PPP proceeds are used and economic conditions change.
- How falling rates, asset yields, and deposit costs affect net interest margin and earnings in subsequent quarters.
- Whether capital ratios and dividend capacity remain above regulatory requirements under adverse credit and economic scenarios.