Alerus Financial Corporation — Q2 2021 Form 10-Q
Reporting period: Three and six months ended June 30, 2021. Comparisons below are to the corresponding 2020 periods unless otherwise noted. Dollar figures are in millions unless stated otherwise.
Business context
Alerus is a diversified financial services company operating in banking, retirement and benefit services, wealth management, and mortgage. Management says fee-based businesses generate the majority of revenue.
Financial performance
| Metric | Q2 2021 | Q2 2020 | H1 2021 | H1 2020 |
|---|---|---|---|---|
| Net interest income | $21.1 | $20.1 | $43.2 | $38.9 |
| Noninterest income | $36.7 | $38.2 | $77.6 | $65.4 |
| Total operating revenue* | $57.9 | $58.3 | $120.8 | $104.3 |
| Net income | $11.7 | $11.5 | $26.9 | $16.8 |
| Diluted EPS | $0.66 | $0.65 | $1.52 | $0.95 |
| Net interest margin, tax-equivalent | 2.88% | 3.14% | 3.00% | 3.24% |
| Efficiency ratio | 71.46% | 66.31% | 68.84% | 71.23% |
*Net interest income plus noninterest income. Q2 net income rose modestly as higher net interest income and no loan-loss provision offset lower noninterest income and higher expenses. H1 net income increased substantially, supported by higher fee income, higher net interest income, and no provision expense.
- Fee income: Q2 noninterest income declined 3.9%, mainly because mortgage banking income fell $5.3 million and the prior-year period included $1.3 million of securities gains. H1 noninterest income increased 18.7%, including gains of $6.8 million in mortgage banking, $5.2 million in retirement and benefit services, and $2.0 million in wealth management.
- Expenses: Noninterest expense increased 7.1% in Q2 and 11.9% in H1. Compensation was the largest driver, associated in part with higher mortgage originations. Q2 included a $919,000 year-over-year decrease in provision for unfunded commitments.
- Credit provision: No loan-loss provision was recorded in Q2 or H1 2021, versus $3.5 million in Q2 2020 and $6.0 million in H1 2020. Management attributed this to declining loan balances and strong credit indicators.
Financial position, cash flow, and capital
- Assets and liquidity: Total assets were $3.16 billion at June 30, up $143.5 million from year-end. Cash and cash equivalents were $315.4 million, versus $173.0 million at December 31, 2020. Management reported on-balance-sheet liquidity of $870.5 million, up from $511.1 million.
- Loans and deposits: Loans were $1.84 billion, down 7.3% from year-end; the decline included PPP forgiveness and repayment activity. Deposits increased 5.4% to $2.71 billion. PPP loans outstanding were $165.0 million, compared with $268.4 million at year-end.
- Credit quality: Allowance for loan losses was $33.8 million, or 1.84% of loans (2.02% excluding PPP loans). Criticized loans declined to $40.3 million, or 2.19% of loans, from $56.7 million, or 2.86%. Nonperforming assets were $7.8 million, or 0.25% of assets, compared with $5.1 million, or 0.17%, at year-end. Nonaccrual loans increased to $7.0 million from $5.1 million.
- Debt: Long-term debt was $59.0 million, broadly unchanged from year-end. In Q1, the company redeemed prior subordinated debt and issued $50 million of new subordinated notes at a fixed 3.50% rate, due 2031 and callable in 2026.
- Cash flows, H1: Operating activities provided $84.3 million (versus $22.7 million used in H1 2020); investing activities used $75.4 million (versus $387.1 million); financing activities provided $133.5 million (versus $476.2 million). Financing included $50 million of subordinated debt proceeds and $138.9 million of net deposit growth.
- Capital: Stockholders’ equity was $344.4 million, up from $330.2 million at year-end. Consolidated common equity tier 1 and total capital ratios were 14.30% and 18.43%, respectively; management said the company and bank met applicable capital requirements.
Material changes and unusual items
- On April 1, 2021, Alerus transferred $149.2 million fair value of state and political agency securities from available-for-sale to held-to-maturity, citing capital protection and reduced accumulated-OCI volatility. The transfer contributed to the change in securities classification; accumulated other comprehensive income fell by $8.1 million in H1.
- Retirement and benefit services growth included revenue from the RPS Plan Administrators and 24HourFlex acquisition. Management cites the acquisition, organic growth, market gains in assets under administration, and document restatement fees as contributors.
- Alerus had assisted clients with approximately $474.2 million of PPP financing since program participation began; as of June 30, borrowers had received forgiveness approval for 1,447 loans totaling $297.7 million.
Outlook, commentary, and risks
The filing provides no specific full-year earnings or revenue guidance. Management expects net interest income and margin to remain under pressure because of the low-rate environment and balance-sheet mix, while PPP processing fees provide a partial offset. It also warns that higher rates and inflationary pressure could adversely affect mortgage originations and mortgage banking revenue, and anticipates slower loan growth amid high liquidity and market competition.
COVID-19’s full economic impact remains uncertain, including the uneven recovery and possible effects of new variants. Management says the pandemic had not adversely affected reported financial condition or results through June 30, 2021, but notes potential credit deterioration and future loan defaults. Other cited risks include credit concentrations, deposit concentration and liquidity, interest-rate and securities valuation exposure, mortgage pipeline and repurchase risk, cybersecurity and technology disruptions, regulatory changes, and CECL implementation. CECL adoption is planned for the delayed effective date; the impact could not yet be reasonably estimated.
- H1 interest-rate sensitivity modeling showed estimated net interest income changes of +1.2% over 12 months and -4.9% over 24 months under an immediate +100 basis-point shock; under a -100 basis-point shock, the modeled changes were -7.1% and -21.0%. These are model estimates, not forecasts.
- Management reported effective disclosure controls and no material change in internal control over financial reporting during the quarter. No material pending legal proceedings or material changes to previously disclosed risk factors were reported.
- The board declared a $0.16-per-share quarterly dividend in May, paid July 9; it declared another $0.16 dividend in July, payable October 8. A 770,000-share repurchase authorization is in place for 36 months, but no shares were repurchased under the program through June 30.
Most important facts for investors to verify
- Whether the zero loan-loss provision remains appropriate as nonaccrual loans and nonperforming assets increased from year-end, despite lower criticized balances.
- How PPP forgiveness, loan runoff, and new originations affect core loan growth, net interest income, and the allowance ratio.
- Whether margin pressure, mortgage revenue normalization, and higher compensation costs persist, particularly given the weaker Q2 efficiency ratio.
- The impact of the securities reclassification and subsequent interest-rate movements on reported equity, accumulated OCI, and securities valuation.
- Liquidity and funding resilience, including deposit mix and concentration, available borrowing capacity, and the $616.9 million of commitments and standby letters of credit.
- Future CECL adoption effects and the evolution of COVID-related borrower deferrals; 584 loans totaling $154.5 million had received deferrals, with 12 loans totaling $5.3 million granted additional deferrals and four totaling $653,000 still on an initial deferral at June 30.