Alerus Financial Corporation — Q2 2022 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2022. Alerus is a diversified financial services company with banking, retirement and benefit services, wealth management, and mortgage businesses. Unless noted, financial amounts below are in millions of dollars.
Key financial results
| Metric | Q2 2022 | Q2 2021 | Six months 2022 | Six months 2021 |
|---|---|---|---|---|
| Net interest income | $22.8 | $21.1 | $44.4 | $43.2 |
| Noninterest income | $29.2 | $36.7 | $58.7 | $77.6 |
| Noninterest expense | $40.0 | $42.6 | $78.1 | $85.6 |
| Net income | $9.3 | $11.7 | $19.5 | $26.9 |
| Diluted EPS | $0.52 | $0.66 | $1.10 | $1.52 |
- Q2 net interest margin was 2.98% on a fully tax-equivalent basis, up from 2.88% a year earlier; first-half margin was 2.91%, down from 3.00%.
- Q2 efficiency ratio was 74.72%, versus 71.46%; first-half ratio was 73.50%, versus 68.84%. Return on average assets was 1.14% in Q2 and 1.20% for the first half.
- Net cash provided by operating activities was $7.6 million in the first half, versus $84.3 million a year earlier. Investing cash use was $147.8 million and financing cash use was $65.0 million. Cash and cash equivalents fell $205.3 million to $37.0 million.
Financial condition, liquidity and capital
- At June 30, total assets were $3.30 billion, loans were $1.89 billion, deposits were $2.62 billion, and stockholders’ equity was $307.2 million.
- Loans increased $132.2 million (7.5%) from year-end 2021; deposits fell $301.0 million (10.3%). Alerus used $242.4 million of short-term borrowings, including $117.4 million in federal funds purchased and $125.0 million in FHLB advances. Long-term debt was $58.9 million.
- Management reported $832.6 million in on-balance-sheet liquidity and stated available additional FHLB borrowing capacity of $538.7 million, unsecured correspondent lines of $102.0 million, and wholesale deposit capacity of $659.0 million. Management believed resources were adequate to fund commitments.
- Regulatory capital ratios remained above well-capitalized thresholds: consolidated CET1 was 14.19% and total capital was 17.95%; the Bank’s corresponding ratios were 13.64% and 14.89%.
Material changes and management commentary
- Net income declined 20.5% in Q2 and 27.6% in the first half. Lower mortgage banking and retirement/benefit-services income drove the decline, partly offset by higher net interest income and lower expenses.
- Mortgage banking income fell $6.2 million in Q2 and $18.5 million in the first half, alongside lower mortgage originations. Retirement and benefit-services revenue also declined, reflecting lower asset-based fees and reduced assets under administration/management. Wealth-management revenue increased.
- Management attributed higher Q2 net interest income largely to a larger investment securities balance and higher securities yields; lower loan interest income included the effect of PPP loan forgiveness. The company expects net interest income and margin to remain under pressure and expects rising rates and inflation to weigh on mortgage originations and noninterest income. Management also expects loan growth to slow in the higher-rate, competitive environment.
- Accumulated other comprehensive loss widened to $70.4 million from $4.3 million at year-end, primarily due to rising rates reducing available-for-sale securities values. Total unrealized losses on investment securities were $132.7 million at June 30; management attributed these generally to interest rates, considered them temporary, and warned losses could increase if rates continued to rise.
- Asset quality indicators were mixed: criticized loans decreased to $18.0 million (0.95% of loans) from $21.2 million (1.21%) at year-end, while nonaccrual loans increased to $4.4 million from $2.1 million. No provision for loan losses was recorded in the quarter or first half; the allowance was $31.4 million, or 1.66% of loans.
- On July 1, 2022, after quarter-end, Alerus completed its acquisition of MPB BHC, Inc. Each MPHX common share converted into 0.74 Alerus shares. At June 30, MPHX reported $399.0 million of assets, $277.6 million of gross loans, $354.5 million of deposits, and $43.8 million of equity.
- The company declared a quarterly dividend of $0.18 per share, paid July 8, 2022. No material legal proceedings or material changes to previously disclosed risk factors were reported. Management said disclosure controls were effective and reported no material change in internal control over financial reporting.
Outlook, risks and contingencies
- The filing provides no numerical earnings or revenue guidance. Management’s outlook flags interest-rate sensitivity, potentially weaker mortgage activity and fee income, and slower loan growth.
- Key disclosed risks include credit quality and allowance adequacy, interest-rate and securities valuation exposure, deposit outflows and depositor concentration, liquidity, real estate and loan concentrations, cybersecurity and technology interruptions, acquisition execution, inflation and economic conditions, and ongoing COVID-19 uncertainty.
- Off-balance-sheet commitments to extend credit totaled $635.3 million and standby letters of credit $11.4 million. These are contractual amounts, not necessarily expected cash requirements; the company reported no performance under financial guarantees or losses on commitments in the prior two years.
- CECL adoption was planned for the applicable delayed effective date after December 15, 2022; management said the impact could not yet be reasonably estimated. The company qualified as an emerging growth company and elected the extended transition period for certain accounting standards.
Important facts for investors to verify
- How deposit trends, short-term funding use, and reported liquidity develop after June 30, including the impact of the MPB acquisition.
- Whether the securities portfolio’s unrealized losses remain temporary and how further rate changes affect tangible equity and capital.
- Whether nonaccrual loans, criticized credits, and the allowance remain manageable as the economy and loan portfolio change.
- How much lower mortgage production and retirement-services assets affect future fee income, and whether expense reductions can offset revenue pressure.
- The acquisition’s final accounting, integration costs, realized synergies, and effects on earnings, capital, and funding.
- The eventual CECL transition impact and any subsequent changes to management’s outlook or risk assessments.