ALERUS FINANCIAL CORP quarterly report, Q3 FY2020

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Alerus Financial Corporation — Q3 2020 Form 10-Q

Reporting period: Quarter and nine months ended September 30, 2020. Alerus is a diversified financial services company operating banking, retirement and benefit services, wealth management, and mortgage businesses. Figures below are in U.S. dollars; financial-statement amounts are rounded to millions unless stated otherwise.

Financial performance and position

  • Q3 earnings: Net income was $17.7 million, or $0.99 diluted EPS, versus $7.1 million, or $0.48, in Q3 2019. For the first nine months, net income was $34.5 million, or $1.94 diluted EPS, versus $21.9 million, or $1.49.
  • Revenue and costs: Q3 net interest income was $21.8 million and noninterest income was $45.3 million; noninterest expense was $40.2 million. Nine-month amounts were $60.7 million, $110.7 million, and $116.7 million, respectively. Noninterest income represented 67.5% of Q3 operating revenue and 64.6% for the nine-month period.
  • Mortgage contribution: Mortgage banking revenue was $22.3 million in Q3 and $44.9 million year to date, up from $8.1 million and $19.7 million, respectively, in 2019. Originations reached $511.6 million in Q3 and $1.17 billion year to date. Management attributed much of the earnings increase to higher originations and sale margins.
  • Margins and efficiency: Tax-equivalent net interest margin was 3.17% in Q3 and 3.22% year to date, down from 3.69% and 3.72%. The Q3 efficiency ratio improved to 58.42% from 75.17%; the nine-month ratio was 66.22% versus 73.06%.
  • Credit costs: Provision for loan losses was $3.5 million in Q3 and $9.5 million year to date, compared with $1.5 million and $5.5 million in 2019. The allowance was $31.3 million, or 1.52% of loans, at quarter-end; excluding PPP loans, management reported coverage of 1.83%.
  • Balance sheet and funding: Total assets were $2.90 billion, up 23.0% from year-end 2019. Loans were $2.06 billion, including $348.9 million of PPP loans; available-for-sale securities were $495.4 million. Deposits increased 24.9% to $2.46 billion. Cash and cash equivalents were $95.8 million.
  • Debt, liquidity, and capital: Long-term debt was $58.7 million; no short-term borrowings were outstanding. Management reported $311.1 million of on-balance-sheet liquidity and access to up to $565.0 million of FHLB borrowing capacity, subject to collateral. Company and Bank regulatory capital ratios exceeded applicable well-capitalized thresholds; the Bank’s total capital ratio was 13.72%.
  • Cash flow and shareholder returns: For the first nine months, operating cash flow was negative $19.8 million, investing cash flow negative $511.1 million, and financing cash flow positive $482.7 million, primarily reflecting loan and securities growth funded by deposit inflows. Cash declined $48.3 million from year-end. Dividends declared were $0.15 per share in Q3 and $0.45 year to date.

Material changes versus comparable periods

  • Q3 net income rose by $10.6 million year over year; nine-month net income rose by $12.6 million. Higher mortgage banking revenue and net interest income drove the improvement, partly offset by higher expenses, provisions, and taxes.
  • Net interest income increased, but net interest margin declined as lower interest rates and lower loan yields—partly reflecting PPP loans—outweighed lower deposit funding costs.
  • Loans grew $337.1 million from December 31, 2019, with PPP lending a major contributor. Deposits grew $491.1 million, which management linked to PPP proceeds, government stimulus, and precautionary customer balances.
  • The allowance for loan losses increased $7.4 million from year-end. Nonperforming loans fell to $4.8 million from $7.8 million, while criticized loans were $68.6 million, or 3.33% of loans, versus $66.6 million, or 3.87%.

Outlook, risks, and unusual items

  • COVID-19: Management said the pandemic had not adversely affected reported results through September 30, but warned that its future impact remained uncertain and could be significant. It anticipated pressure on credit quality, loan growth, net interest income and margin, fee income, and mortgage activity. Management also expected loan-loss provisions could rise.
  • Borrower relief and PPP: Alerus had modified 552 loans totaling $151.4 million since the pandemic began. At quarter-end, 27 loans totaling $16.9 million had received second deferrals and 56 loans totaling $12.0 million remained on first deferral; others had returned to normal payment status. These short-term modifications were not treated as troubled debt restructurings under applicable guidance. The Bank facilitated $363.6 million of PPP financing for 1,632 borrowers. As of October 22, 2020, it had submitted 79 forgiveness applications totaling $51.7 million and had received no SBA decisions.
  • Revenue outlook: Management anticipated lower retirement and wealth-management asset-based fees, potentially lower mortgage originations, and slower loan and deposit growth. It provided no specific earnings or financial-target guidance in the supplied filing text.
  • Other exposures: Risks include commercial real estate and borrower concentrations, possible collateral-value declines, PPP origination or guarantee disputes, mortgage pipeline risk, cybersecurity and operational disruption, interest-rate sensitivity, and the transition away from LIBOR. Commitments to extend credit and standby letters of credit totaled $603.7 million; actual funding needs may be lower.
  • Capital and distributions: The board stated its intent to continue quarterly dividends while monitoring pandemic conditions. The filing notes restrictions on capital distributions if the capital conservation buffer is not maintained. No material pending legal proceedings were reported; management said disclosure controls were effective.

Investor verification priorities

  1. Track PPP loan forgiveness, fee recognition, and whether SBA guarantee or eligibility challenges arise.
  2. Monitor deferral expirations, criticized and nonperforming loans, charge-offs, and whether the allowance remains adequate as pandemic effects develop.
  3. Assess how much earnings growth depends on unusually strong mortgage volumes and gain-on-sale margins, and whether that activity is sustainable.
  4. Verify deposit retention and liquidity as stimulus and PPP-related balances run off, and review funding capacity and collateral availability.
  5. Evaluate the effect of low rates and the filing’s interest-rate sensitivity scenarios on net interest margin, earnings, and economic value of equity.