Alerus Financial Corporation Reports Second Quarter 2020 Net Income of $11.5 Million

Alerus Financial Corporation (Nasdaq: ALRS) reported net income of $11.5 million for the second quarter of 2020, or $0.65 per diluted common share, compared to $5.4 million of net income, or $0.30 per diluted common share, for the first quarter of 2020, and net income of $8.3 million, or $0.59 per diluted common share, for the second quarter of 2019.

CEO Comments

Chairman, President, and Chief Executive Officer Randy Newman said, “We are proud to report record quarterly net income of $11.5 million. This strong financial performance, driven by our diversified business model, included record quarterly mortgage originations of $431.6 million, an increase in deposits of over $481.8 million in the first half of 2020, and steady performance across our wealth management and retirement and benefit divisions. Despite a challenging and uncertain economy, we continue to focus on serving the holistic financial needs of our consumer and business clients, as evidenced by our ability to fund 1,580 Paycheck Protection Program loans totaling approximately $362.7 million or approximately 18% of our loan portfolio.

In light of the ongoing COVID-19 pandemic and recessionary economic environment, we remain focused on credit quality and are analyzing and assessing the potential impacts on our portfolio at a granular level. Great uncertainty remains and although we are not currently observing credit deterioration in our loan portfolio, we are committed to managing our balance sheet for long term success by increasing our provision expense and building reserves.

We believe our diversified business model positions us, long-term, to have a greater impact on clients, allowing us to serve them across a wide range of financial services through a holistic, guidance-focused approach, and a greater impact on shareholders because our significant earnings power will prepare us for potential credit losses and help us weather the uncertain economic environment. True to our history and culture, we remain disciplined in our response to the COVID-19 pandemic, anticipating and recognizing the impact it is having on our clients, employees, and company, and we are committed to operating from a position of strength, to support our clients and communities.”

Quarterly Highlights

• Return on average assets of 1.68%, compared to 0.89% for the first quarter of 2020
• Return on average common equity of 15.30%, compared to 7.32% for the first quarter of 2020
• Return on average tangible common equity(1) of 18.88%, compared to 9.76% for the first quarter of 2020
• Net interest margin (tax-equivalent)(1) was 3.14%, compared to 3.35% for the first quarter of 2020
• Noninterest income as a percentage of total revenue was 65.55%, compared to 59.07% for the first quarter of 2020
• Noninterest income increased $11.0 million, or 40.6%, compared to the first quarter of 2020
• Mortgage originations totaled $431.6 million, a 88.8% increase from the first quarter of 2020
• Available-for-sale investment securities increased $83.4 million, or 26.9%, from the fourth quarter of 2019
• Loans held for sale increased $54.9 million, or 117.2%, from the fourth quarter of 2019
• Loans held for investment increased $312.9 million, or 18.2%, from the fourth quarter of 2019
• Deposits increased $481.8 million, or 24.4%, from the fourth quarter of 2019

Selected Financial Data (unaudited)

Earnings Per Share

Beginning in the third quarter of 2019, the Company elected to prospectively use the two-class method in calculating earnings per share due to the restricted stock awards and restricted stock units qualifying as participating securities. Under the two-class method, earnings available to common shareholders for the period are allocated between common shareholders and participating securities according to dividends declared (or accumulated) and participating rights in undistributed earnings. Average shares of common stock for diluted net income per common share include shares to be issued upon the vesting of restricted stock awards and restricted stock units granted under the Company's share-based compensation plans.

The following table presents the calculation of basic and diluted earnings per share for the periods indicated:

Results of Operations

Net Interest Income

Net interest income for the second quarter of 2020 was $20.1 million, an increase of $1.3 million, or 6.7%, from $18.8 million for the first quarter of 2020. The increase was primarily driven by an increase of $830 thousand in interest income from loans and a decrease of $834 thousand in interest expense on deposits, partially offset by a decrease of $440 thousand in other interest income. The increase in interest income from loans was primarily driven by interest and fees recognized on Paycheck Protection Program, or PPP, loans in the amount of $2.0 million, partially offset by a 48 basis point decrease in the average yield on total loans. The decrease in interest expense on deposits was primarily a result of a 30 basis point decrease in the cost of deposits as a result of a reduction in the federal funds rate, partially offset by a $174.7 million increase in average deposit balances. The decrease in other interest income was due to a 1.08% decrease in the average yield on interest-bearing deposits with banks.

Compared to the second quarter of 2019, net interest income for the second quarter of 2020 increased $1.8 million due to a $1.8 million decrease in interest expense. The decrease in interest expense was primarily due to a 60 basis point decrease in the average rate paid on interest-bearing liabilities and a direct result of the reduction of the federal funds rate.

Net Interest Margin (Tax-Equivalent)

Net interest margin (tax-equivalent), a non-GAAP financial measure, for the second quarter of 2020 was 3.14%, compared to 3.35% for the first quarter of 2020. The net interest margin excluding PPP loans would have been 3.16% for the second quarter of 2020. The decrease in net interest margin was primarily due to a 43 basis point lower average earning asset yield partially offset by a 32 basis point decrease in the average rate on total interest-bearing liabilities. The decrease in average earning asset yield was primarily due to a 1.08% decrease in the average yield earned on interest-bearing deposits with banks along with a 48 basis point decrease in the average yield on total loans. The decline in loan yield was primarily due to PPP loan balances which averaged $273.8 million during the quarter with a yield of 3.01%. Commercial and industrial loans, excluding PPP loans, averaged $466.0 million with a yield of 4.78%, a decrease of 48 basis points since the first quarter. The decrease in the average rate on total interest-bearing liabilities was primarily due to a 37 basis point decrease in the average rate on money market and savings deposits and a 29 basis point decrease in the average rate on time deposits.

Compared to the second quarter of 2019, net interest margin (tax-equivalent) for the second quarter of 2020 decreased 48 basis points from 3.62%. The decrease in net interest margin from the second quarter of 2019 was due to a 96 basis point lower average earning asset yield and a $338.6 million increase in the average balance of interest-bearing deposits. In addition, the average yield on loans fell from 4.99% in the second quarter of 2019 to 4.24% in the second quarter of 2020 and the average rate on total interest-bearing liabilities decreased 60 basis points to 0.81% in the second quarter of 2020.

Noninterest Income

Noninterest income for the second quarter of 2020 was $38.2 million, an $11.0 million, or 40.6%, increase from the first quarter of 2020. The increase was primarily due to a $12.5 million increase in mortgage banking revenue along with a $1.3 million increase in gains on investment securities partially offset by a decrease of $2.5 million in retirement and benefit services revenue. The increase in mortgage banking revenue was primarily due to a $203.1 million increase in mortgage originations and an increase in the unrealized gain on secondary market derivatives of $6.9 million due to an increase in volume and the stabilization of the mortgage backed securities market in the second quarter. The decrease in retirement and benefit services revenue was primarily due to a $1.8 million decrease in asset based revenue as a result of a decline in the average balance of assets under administration/management and the final adjustments to eliminate revenue sharing.

Noninterest income for the second quarter of 2020 increased $8.2 million, or 27.5%, from the $30.0 million in the second quarter of 2019. Mortgage banking revenue increased $10.5 million as mortgage originations increased from $246.1 million in the second quarter of 2019 to $431.6 million in the second quarter of 2020 and the unrealized gain on secondary market derivatives increased from $0.4 million to $6.0 million. Retirement and benefit services revenue decreased $2.1 million primarily due to decreases in asset based fees as a result of a decrease the average balance of assets under administration/management and the finalized transition away from revenue sharing. Gains on investment securities revenue increased $1.1 million due to sales in the portfolio during the second quarter of 2020. Other noninterest income decreased $1.4 million in the second quarter of 2020 due to a $1.5 million gain on sale of a branch in 2019.

Noninterest Expense

Noninterest expense for the second quarter of 2020 was $39.7 million, an increase of $3.0 million, or 8.2%, compared to the first quarter of 2020. The increase was due to increases of $2.5 million in compensation expense, $926 thousand in other noninterest expense, partially offset by decreases of $561 thousand in employee taxes and benefits and $210 thousand in travel expenses. The increase in compensation expense was primarily driven by an increase in mortgage originations. Other noninterest expense increased primarily due to an increase of $820 thousand in the provision for unused commitments as lines of credit utilization decreased 9.2%.

Compared to the second quarter of 2019, noninterest expense for the second quarter of 2020 increased $4.5 million, or 12.7%, from $35.3 million. The increase was attributable to increases of $3.1 million in compensation expenses, $1.1 million in other noninterest expense, partially offset by decreases of $413 thousand in employee taxes and benefits and $347 in travel expenses. The increase in compensation expense was primarily the result of higher mortgage originations. The increase in other noninterest expense was due to an increase of $1.0 million in the provision for unused commitments due to a decrease in line of credit utilization from 43.2% to 31.3%. Mortgage and lending expenses increased due to an increase in origination volume and an impairment of mortgage servicing right assets of $265 thousand.

Financial Condition

Total assets were $2.9 billion as of June 30, 2020, an increase of $518.6 million, or 22.0%, from December 31, 2019. The increase in total assets was primarily due to increases of $312.9 million in loans, $83.4 million in available-for-sale investment securities, $66.4 million in cash and cash equivalents, $54.9 million in loans held for sale, and $7.8 million in other assets.

Loans

Total loans were $2.03 billion as of June 30, 2020, an increase of $312.9 million, or 18.2%, from December 31, 2019. The increase was primarily due to increases of $315.1 million in commercial and industrial loans and $24.4 million in our commercial real estate loan portfolio, partially offset by a $31.5 million decrease in our consumer loan portfolio. The increase in commercial and industrial loans was due to an increase of $347.3 million in net PPP loans, offset by a decrease of $25.3 million due to a 7.86% decrease in operating line utilization.

The following table presents the composition of our loan portfolio as of the dates indicated:

Deposits

Total deposits were $2.45 billion as of June 30, 2020, an increase of $481.8 million, or 24.4%, from December 31, 2019. The increase was comprised of an increase of $358.6 million in interest-bearing deposits and an increase of $123.2 million in noninterest-bearing deposits. Key drivers of the increase in deposits included deposits from PPP loan clients, inflows from government stimulus programs and higher depositor balances due to the uncertain financial markets. The increase in interest-bearing deposits included an $89.7 million increase in synergistic deposits from our retirement and benefit services and wealth management segments. In addition, health savings account, or HSA, deposits were $128.6 million as of June 30, 2020, an increase of $8.8 million, or 7.4%, from December 31, 2019. Commercial transaction deposits increased $311.3 million, or 38.8%, while consumer transaction deposits increased $40.5 million, or 7.6%, since December 31, 2019. Noninterest-bearing deposits as a percentage of total deposits were 28.6% and 29.3% as of June 30, 2020 and December 31, 2019, respectively.

The following table presents the composition of our deposit portfolio as of the dates indicated:

Asset Quality

Total nonperforming assets were $5.4 million as of June 30, 2020, a decrease of $2.5 million, or 31.7%, from December 31, 2019. As of June 30, 2020, the allowance for loan losses was $27.3 million, or 1.34% of total loans, compared to $23.9 million, or 1.39% of total loans, as of December 31, 2019. Excluding PPP loans, the ratio of allowance for loan losses to total loans increased 23 basis points to 1.62% as of June 30, 2020, compared to 1.39% as of December 31, 2019.

The following table presents selected asset quality data as of and for the periods indicated:

For the second quarter of 2020, we had net charge-offs of $3.3 million compared to net recoveries of $595 thousand for the first quarter of 2020 and $3.2 million of net charge-offs for the second quarter of 2019. For the three months ended June 30, 2020, the ratio of net charge-offs to average total loans was 0.66%, and if PPP loans were excluded, the ratio was 11 basis points higher at 0.77%. The increase in charge-offs for the second quarter of 2020 was mostly attributable to the charge-off of two commercial and industrial loan relationships that were previously on nonaccrual. Management does not believe that these charge-offs were a result of economic uncertainties in the current environment.

The provision for loan losses for the second quarter of 2020 was $3.5 million, an increase of $1.0 million from the first quarter of 2020 and an increase of $1.7 million from the second quarter of 2019. The increase in provision expense was due to allocations of reserves for the economic uncertainties related to the novel coronavirus, or COVID-19, which increased the allowance for loan losses balance by $3.3 million to $27.3 million, a 13.9% increase from December 31, 2019.

The ratio of nonperforming loans to total loans at June 30, 2020 was 0.26%, and if PPP loans were excluded, this ratio would have been 0.32%. Nonperforming assets as a percentage of total assets was 0.19% at June 30, 2020. Excluding PPP loans, nonperforming assets as a percentage of total assets would have been 0.21% at June 30, 2020.

As of June 30, 2020, we had entered into principal and interest deferrals on 515 loans with outstanding balances of $148.5 million. All of these loan modifications are being accounted for in accordance with the Interagency Statement on Loan Modifications and Reporting for Financial Institutions as issued on April 7, 2020, or have been evaluated under existing accounting policies and are not considered troubled debt restructurings.

Capital

Total stockholders’ equity was $305.7 million as of June 30, 2020, an increase of $20.0 million from December 31, 2019. The tangible book value per common share increased to $15.30 as of June 30, 2020, from $14.08 as of December 31, 2019. Tangible common equity to tangible assets, a non-GAAP financial measure, decreased to 9.25% as of June 30, 2020, from 10.38% as of December 31, 2019. Tangible common equity to tangible assets would have been 10.55% as of June 30, 2020, if PPP loans were excluded.

The following table presents our capital ratios as of the periods indicated:

Conference Call

The Company will host a conference call at 9:00 a.m. Central Time on Wednesday, July 29, 2020, to discuss its financial results. The call can be accessed via telephone at (888) 317-6016. A recording of the call and transcript will be available on the Company’s investor relations website at investors.alerus.com following the call.

About Alerus Financial Corporation

Alerus Financial Corporation is a diversified financial services company headquartered in Grand Forks, ND. Through its subsidiary, Alerus Financial, N.A., Alerus provides innovative and comprehensive financial solutions to businesses and consumers through four distinct business segments—banking, retirement and benefit services, wealth management, and mortgage. These solutions are delivered through a relationship-oriented primary point of contact along with responsive and client-friendly technology. Alerus Financial banking and wealth management offices are located in Grand Forks and Fargo, ND, the Minneapolis-St. Paul, MN metropolitan area and Scottsdale and Mesa, AZ. Alerus Retirement and Benefits plan administration offices are located in St. Paul and Albert Lea, MN, East Lansing and Troy, MI, and Bedford, NH.

Non-GAAP Financial Measures

Some of the financial measures included in this press release are not measures of financial performance recognized by U.S. Generally Accepted Accounting Principles, or GAAP. These non-GAAP financial measures include the ratio of tangible common equity to tangible assets, tangible common equity per share, return on average tangible common equity, net interest margin (tax-equivalent), and the efficiency ratio. Management uses these non-GAAP financial measures in its analysis of its performance, and believes financial analysts and investors frequently use these measures, and other similar measures, to evaluate capital adequacy. Reconciliations of non-GAAP disclosures used in this press release to the comparable GAAP measures are provided in the accompanying tables. Management, banking regulators, many financial analysts and other investors use these measures in conjunction with more traditional bank capital ratios to compare the capital adequacy of banking organizations with significant amounts of goodwill or other intangible assets, which typically stem from the use of the purchase accounting method of accounting for mergers and acquisitions.

These non-GAAP financial measures should not be considered in isolation or as a substitute for total stockholders’ equity, total assets, book value per share, return on average assets, return on average equity, or any other measure calculated in accordance with GAAP. Moreover, the manner in which we calculate these non-GAAP financial measures may differ from that of other companies reporting measures with similar names.

Forward-Looking Statements

This press release contains “forward-looking statements” within the meaning of the safe harbor provisions of the U.S. Private Securities Litigation Reform Act of 1995. Forward-looking statements include, without limitation, statements concerning plans, estimates, calculations, forecasts and projections with respect to the anticipated future performance of Alerus Financial Corporation. These statements are often, but not always, identified by words such as “may”, “might”, “should”, “could”, “predict”, “potential”, “believe”, “expect”, “continue”, “will”, “anticipate”, “seek”, “estimate”, “intend”, “plan”, “projection”, “would”, “annualized”, “target” and “outlook”, or the negative version of those words or other comparable words of a future or forward-looking nature. Examples of forward-looking statements include, among others, statements we make regarding our projected growth, anticipated future financial performance, financial condition, credit quality, management’s long-term performance goals and the future plans and prospects of Alerus Financial Corporation.

Forward-looking statements are neither historical facts nor assurances of future performance. Instead, they are based only on our current beliefs, expectations and assumptions regarding the future of our business, future plans and strategies, projections, anticipated events and trends, the economy and other future conditions. Because forward-looking statements relate to the future, they are subject to inherent uncertainties, risks and changes in circumstances that are difficult to predict and many of which are outside of our control. Our actual results and financial condition may differ materially from those indicated in the forward-looking statements. Therefore, you should not rely on any of these forward-looking statements. Important factors that could cause our actual results and financial condition to differ materially from those indicated in the forward-looking statements include, among others, the following: the effects of the COVID-19 pandemic, including its effects on the economic environment, our clients, and our operations, as well as any changes to federal, state, or local government laws, regulations, or orders in response to the pandemic; our ability to successfully manage credit risk and maintain an adequate level of allowance for loan losses; new or revised accounting standards, including as a result of the implementation of the new Current Expected Credit Loss Standard; business and economic conditions generally and in the financial services industry, nationally and within our market areas; the overall health of the local and national real estate market; concentrations within our loan portfolio; the level of nonperforming assets on our balance sheet; our ability to implement our organic and acquisition growth strategies; the impact of economic or market conditions on our fee-based services; our ability to continue to grow our retirement and benefit services business; our ability to continue to originate a sufficient volume of residential mortgages; the occurrence of fraudulent activity, breaches or failures of our information security controls or cybersecurity-related incidents; interruptions involving our information technology and telecommunications systems or third-party servicers; potential losses incurred in connection with mortgage loan repurchases; the composition of our executive management team and our ability to attract and retain key personnel; rapid technological change in the financial services industry; increased competition in the financial services industry; our ability to successfully manage liquidity risk; the effectiveness of our risk management framework; the commencement and outcome of litigation and other legal proceedings and regulatory actions against us or to which we may become subject; potential impairment to the goodwill we recorded in connection with our past acquisitions; the extensive regulatory framework that applies to us; the impact of recent and future legislative and regulatory changes; interest rate risks associated with our business; fluctuations in the values of the securities held in our securities portfolio; governmental monetary, trade and fiscal policies; severe weather, natural disasters, widespread disease or pandemics, such as the COVID-19 global pandemic, acts of war or terrorism or other adverse external events; any material weaknesses in our internal control over financial reporting; our success at managing the risks involved in the foregoing items; and any other risks described in the “Risk Factors” sections of the reports filed by Alerus Financial Corporation with the Securities and Exchange Commission.

Any forward-looking statement made by us in this press release is based only on information currently available to us and speaks only as of the date on which it is made. We undertake no obligation to publicly update any forward-looking statement, whether written or oral, that may be made from time to time, whether as a result of new information, future developments or otherwise.