Alerus Financial Corporation Q3 FY2025 earnings call

Management Statement and Operational Highlights

• Results for the quarter were consistent with expectations. Alerus' diversified business model drives nearly double the average fee income compared to other banks. The Retirement and Wealth businesses, being annuitized and capital-light, provide revenue resilience across cycles.
• Continued to deepen client relationships and expand reach. Robust organic growth in commercial and private banking segments. Retirement and Benefits business is a national leader, and Wealth Management completed a major platform upgrade.
• Worked on derisking the balance sheet, sold higher risk acquired hospitality loans and realized a gain. Addressed credits not core or negatively impacted in economic downturn. Capital allocation focused on organic growth in full C&I relationships. Nonperforming assets to total assets were 1.13% with a quarter-over-quarter increase due to one commercial relationship.
• Completed team succession, transitioned commercial team, added deposit-rich verticals, engaged third-party consultant for process optimization. Retirement business strengthened leadership and optimized operating model. Wealth Management platform upgrade laid groundwork for client and adviser growth

Segment Performance

• Banking Segment: Net interest income increased 0.2% over the prior quarter, while fee income decreased 7.3% (down 1% excluding one-time items). Mortgage originations saw a slight increase during the quarter but are expected to slow seasonally. Swap income was very little this quarter.
• Retirement Business: Total revenue increased to $16.5 million, a 2.9% increase over the prior quarter. Driven by asset-based fees and slight increase in recordkeeping fees. Assets under administration and management increased 3.7%, synergistic deposits grew 3.4%, and HSA deposits grew almost 2% to over $202 million.
• Wealth Management Business: Revenue decreased to $6.6 million on a linked-quarter basis, while assets under management increased 4.3% mainly due to market performance. Revenue declined due to a decrease in transactional revenues such as brokerage and insurance commissions

Guidance

• Loans: Expect loans to end the year 2025 over $4.1 billion. For 2026, expect low to mid-single-digit loan growth.
• Net Interest Margin: Reported net interest margin remained stable at 3.50% in Q3. For 2025, net interest margin is expected to end around 3.35% - 3.4%, and for 2026, around 3.35% - 3.45% including the recent 25 basis point rate cut (every 25 basis point cut in rates is expected to improve NIM by about 5 basis points).
• Noninterest Income: Expect non-adjusted noninterest income for 2025 to end around $115 million (excluding the $2.1 million gain on sale of loans in Q2). For 2026, expect mid-single-digit growth from the 2025 adjusted amount.
• Adjusted Pre-Provision Net Revenue: Adjusted pre-provision net revenue should end 2025 around $85 million to $86 million, and for 2026, expect low to mid-single-digit growth from that amount.
• Adjusted ROA: Expect adjusted ROA to end 2025 greater than 1.15% and exceed 1.10% for 2026

Risks

• Nonperforming assets to total assets were 1.13%, an increase of 15 basis points from the prior quarter due to one commercial relationship. The commercial relationship is a general equipment lessor with cash flow challenges, and there is a 50% reserve on it. The largest exposure, a large multifamily loan in the Twin Cities, makes up nearly 75% of total nonperformers

Question and Answer

Q: Maybe just on that last one, Al, on the provisioning level this quarter. I guess, pretty good growth is the lack of the provision maybe on the recovery I guess you've got some confidence on that larger credit as well. I just wanted to kind of get to that. And then as we go forward when you say normalized provision, if you could refine that a little bit, that would be great.

A: Karin Taylor: You're correct. The lack of provision this quarter was driven primarily by the recovery as well as a decrease in the requirement for pooled loans, particularly as we move that one problem owned individual impairment and then a decrease in our unfunded commitment requirement. In terms of provisioning going forward, that will be driven primarily by loan growth macroeconomic factors.

Q: Jeff, this is Jim. If we do see some lower rates, I think we could see some higher loan growth closer to the 10%, 11%, 12% loan growth. But that's really going to be -- we're really going to be focusing on a lot of deposit growth -- at the point, for the most part, we're really sticking and focusing on full C&I relationship growth. So depending on how that deposit full relationship goes, Obviously, that comes with loan growth. So my guess is if rates do come in, we're probably inching up closer to that 9% to 10% loan growth.

A: James Collins: Jeff, this is Jim. If we do see some lower rates, I think we could see some higher loan growth closer to the 10%, 11%, 12% loan growth. But that's really going to be -- we're really going to be focusing on a lot of deposit growth -- at the point, for the most part, we're really sticking and focusing on full C&I relationship growth. So depending on how that deposit full relationship goes, Obviously, that comes with loan growth. So my guess is if rates do come in, we're probably inching up closer to that 9% to 10% loan growth.

Q: Brendan Nosal: I just wanted to dig into the margin outlook a little bit. Al, thanks for the comments on the accretion expectations for '26, I guess it kind of stands to reason even without additional rate cuts, it looks like you're baking in some improvement in the level of the core margin from here through 2026 even without additional rate cuts. Could you just maybe unpack the drivers of that a little bit?

A: Alan Villalon: Yes. That's a good question, Brendan. I mean we are expecting what you call core margin improvement or the way we look at it here, net interest margin, excluding purchase accounting accretion, but the big drivers of that for right now is -- I commented on earlier, we're seeing really good spreads on loans, and we're also seeing good spreads on deposits. So with that -- what we call the new business margin in excess of 350 basis points we continue to expect that net interest margin, excluding purchase accounting accretion to continue to improve.

Q: Brendan Nosal: Okay. That's helpful. Maybe one for me, just turning to fee income. If I annualize this quarter, you're around $118 million just on what you did this quarter. The guide for next year kind of implies right around there, plus or minus a little bit. So I just want to kind of dig into why the lack of more robust loan growth -- or sorry, more robust fee income growth and maybe what market and organic assumptions you're using for AUA and AUM in your fee business?

A: Alan Villalon: Yes. I'll take the first part of this is in terms of fee income growth for next year, we do expect mortgage to be under pressure just a little bit still. So that's just kind of where we're modeling we have to be conservative. The other part of it, too, is that we're not modeling much in terms of market growth.

Q: Nathan Race: Just going back to the last discussion point on fee income. Maybe Katie, could you just touch on some of the underlying drivers that you're seeing within the wealth and retirements in the areas these days? Particularly just curious around what you're seeing in terms of capture rate increases and just how you're kind of stemming some of the natural attrition within AUA as well these days?

A: Katie Lorenson: I wouldn't say our trends are consistent in both the attrition side as well as the capture rate side on the retirement business. In the wealth business, again, we completed a full conversion onto a platform that is an upgrade for both the client experience as well as an adviser experience. We've had great success in recruiting and retaining exceptional advisers. And the technology now just removes a little bit of an obstacle because we do have such a differentiated recruiting profile. So those are not layered in yet in terms of the revenue growth of the expense side, but we do expect to move full force ahead in adding advisers in our growth markets.

Q: Nathan Race: That's really helpful. And just going back to the loan growth discussion, maybe for Jim. I appreciate there's potential upside to that mid-single-digit guide with lower rates. But curious how much of the M&A-related disruption the Twin Cities can also contribute to that. Obviously, there's been some distribution with a couple of notable competitors recently. So just curious if you guys can attract those clients just via your existing teams or if you're seeing opportunities or any appetite to hire additional commercial folks.

A: James Collins: We are always very opportunistic on talent. So we always look for talent, and we do the cost benefit of that talent. We're -- certainly have upgraded talent and have a really good talented team now. And a lot of that talent has inroads to a lot of the disrupted banks in this market in the Minneapolis and some of the other markets. So we are finding success in those disruptions. So that will be part of the growth for 2026. For sure, that's some of the names that I see on the pipeline, that will be part of that growth. But we are always looking for talent, certainly in all markets where there's disruption and there's disruption in all markets, we definitely -- that is part of our strategy to take advantage of those disruptions, both with the talent and with the customer base.

Q: Nathan Race: Okay. That's great. And then, Al, I appreciate the guidance around PPNR growth for next year. Just curious, what kind of legacy expense growth you're kind of thinking about an underpinning that? There were some sequential increases across a handful of line items in the third quarter. So just wondering if there's any kind of cost that will come out as we enter 4Q or into next year? And just how you're thinking about overall legacy expense growth into 2026?

A: Alan Villalon: Thanks for that question, Dave. We're still in the midst of the budgeting process and evaluating opportunities to reinvest and save costs as well. So that's why there's a rate for PPNR right now, it will be up low to mid-single digits. We'll have more color for that as we get probably in the fourth quarter results when we finish the budgeting process.

Q: Damon DelMonte: Al, just to circle back on the expenses, given the uptick in the software technology line there, is that kind of like a run ratable level from this quarter? Or do you think there's some noise there that shakes out?

A: Alan Villalon: Yes, there's still going to be a little bit because a lot of the contracts these days have escalators in them. So we'll still see a slight uptick in that next year.

Q: Damon DelMonte: Okay. Great. And then the guide for the margin for '26, I may have missed what you said, you expect the fair value accretion impact to be that's embedded in there?

A: Alan Villalon: Yes. That's -- we're only expecting 18 basis points of purchasing accounting accretion in there, and that's with no early payoffs.

Q: Damon DelMonte: Got it. Okay. And then again, just to confirm, for each 25 basis point cut, the core margin should benefit by 5 basis points?

A: Alan Villalon: That's correct.

Q: Damon DelMonte: Okay. Great. And then lastly, do you guys have any NDFI loans in your portfolio?

A: Katie Lorenson: No.

Q: David Long: Just wanted to touch base on a couple of things on the balance sheet. On the funding side, time deposit growth led the deposit growth in the quarter. What are you looking at in deposit growth going forward? And what is the duration of what you've been adding and the yield on that?

A: Alan Villalon: So David, in terms of the deposits. Let me go circle back to you on that one. Let me just look this up what we've been adding on. Do you want to hit me another question and then?