Alerus Financial Corporation — Q3 2022 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2022. Alerus is a diversified financial services company with banking, retirement and benefit services, wealth management, and mortgage businesses. Dollar amounts below are in millions unless noted.
Financial results and condition
- Q3 earnings: Net income was $9.6 million, down 26.4% from $13.1 million a year earlier. Diluted EPS was $0.47 versus $0.74.
- Nine-month earnings: Net income was $29.1 million, down 27.2% from $40.0 million; diluted EPS was $1.56 versus $2.26.
- Revenue and margins: Q3 net interest income rose 34.0% to $28.3 million, while noninterest income fell 25.1% to $27.0 million. Tax-equivalent net interest margin improved to 3.21% from 2.78% (3.04% excluding Metro Phoenix Bank). The efficiency ratio worsened to 74.76% from 71.49%. For the first nine months, net interest income rose 13.1% to $72.8 million, while noninterest income fell 24.6% to $85.7 million; the efficiency ratio was 73.94% versus 69.69%.
- Drivers: Lower mortgage originations and asset-based fees weighed on noninterest income. Q3 mortgage banking revenue declined to $3.8 million from $11.1 million, as originations fell 44.7%. Higher loan and securities income supported net interest income, partly offset by higher funding costs.
- Assets and loans: Total assets were $3.69 billion, up 8.8% from year-end 2021. Loans were $2.32 billion, up 31.9%, including $270.4 million acquired from Metro Phoenix Bank and reported organic growth of $289.8 million.
- Deposits, liquidity and borrowing: Deposits were $2.96 billion, up 1.4% from year-end, including $353.7 million acquired. Excluding the acquisition, deposits declined 10.7%. Cash and cash equivalents were $54.2 million; reported on-balance-sheet liquidity was $778.9 million, down from $1.1 billion at year-end. Short-term borrowings were $253.8 million, versus none at year-end; long-term debt was $58.8 million.
- Cash flow: For the first nine months, operating cash flow was $54.7 million, investing cash flow was negative $174.2 million, and financing cash flow was negative $68.7 million. Cash declined $188.1 million to $54.2 million.
- Credit and capital: The allowance for loan losses was $31.0 million, or 1.34% of loans. Nonperforming loans were $5.3 million (0.23% of loans), up from $2.2 million at year-end. The company reported a 13.63% consolidated CET1 ratio and said it and the Bank exceeded well-capitalized standards.
Material changes and unusual items
- On July 1, 2022, Alerus acquired Metro Phoenix Bank for approximately $64.0 million in stock. The transaction added $270.4 million of loans and $353.7 million of deposits; $14.7 million of goodwill and $7.6 million of core deposit intangible were recorded. Q3 included $1.8 million of merger and acquisition expenses.
- Available-for-sale securities had $138.1 million of gross unrealized losses at September 30; held-to-maturity securities had $53.1 million of unrealized losses. Management attributed losses to interest-rate changes and considered them temporary. Accumulated other comprehensive loss was $102.9 million, versus $4.3 million at year-end 2021, primarily reflecting the securities valuation decline.
- There was no loan-loss provision in 2022, compared with a $2.0 million reversal in the prior-year periods. The allowance declined from $31.6 million at year-end after net charge-offs and recoveries.
- Stockholders’ equity was $344.8 million, down 4.1% from year-end despite the acquisition-related stock issuance, reflecting the increase in accumulated other comprehensive loss. Tangible common equity to tangible assets was 7.59%, versus 9.21% at year-end.
Outlook, risks and contingencies
- No specific numerical earnings or revenue guidance is provided. Management expects net interest income and margin to remain under pressure as rates rise, anticipates slower loan growth, and expects higher rates and inflation to continue adversely affecting mortgage originations and noninterest income.
- Interest-rate sensitivity modeling estimated that an immediate 400-basis-point rate increase would reduce net interest income 13.4% over the following 12 months, while economic value of equity would decline 25.7%. These are model estimates, not forecasts.
- Key disclosed risks include interest-rate and securities valuation changes, deposit outflows and concentration, liquidity, credit quality and loan concentrations, real estate conditions, mortgage pipeline and repurchase exposure, acquisition execution, cybersecurity and technology disruptions, and regulatory or accounting changes, including CECL. The company said it had adequate resources to fund commitments and remained in compliance with capital requirements.
- Off-balance-sheet commitments to extend credit were $785.7 million and standby letters of credit were $11.4 million. Management reported no material pending legal proceedings and no material changes to previously disclosed risk factors.
Important facts for investors to verify
- Whether deposit trends, funding costs and short-term borrowings improve or continue to pressure liquidity and net interest margin.
- How Metro Phoenix Bank contributes to earnings and whether integration costs, acquired loan performance and deposit retention meet expectations.
- Whether mortgage and other fee revenues stabilize as originations and assets under administration respond to rates and markets.
- Whether securities unrealized losses, accumulated other comprehensive loss and tangible capital ratios change materially with further rate movements.
- Whether loan growth, criticized and nonperforming loans, charge-offs and the allowance remain appropriate as economic conditions evolve.