Good afternoon and welcome to the Alerus Financial Corporation Earnings Conference Call. Please note, this event is being recorded. This call may include forward-looking statements, and the company's actual results may differ materially from these indicated in any forward-looking statements. Important factors that could cause actual results to differ from those indicated in the forward-looking statements are listed in the earnings release and company's SEC filings. I would now like to turn the conference over to Alerus Financial Corporation President and CEO, Katie Lorenson. Please go ahead.

Thank you. Good morning, everyone, and thank you for dialing into our call today. Joining me today in Minneapolis is Karin Taylor, our Chief Risk Officer; and Al Villalon, our CFO. I am proud to announce that during the quarter, we added Jim Collins, a seasoned bank leader in the Twin Cities, to our executive team as our Chief Banking and Revenue Officer. Jim will lead and support the continued new client growth and existing client expansion while building on our recent successes in adding talented bankers and advisers in the Twin Cities and throughout our footprint. On July 1, we closed on the acquisition of Metro Phoenix Bank, the 25th acquisition in the company's history. We are pleased to have Metro Phoenix join the Alerus franchise. The Phoenix-Scottsdale-Mesa area is one of the fastest-growing regions in the country over the past five years. Metro Phoenix Bank, started by Steve Haggard, is a well-established, high-growth and highly efficient bank with a strong commercial presence. With the approval and closing, Steve has now assumed leadership over the entire market as the Arizona President. Together, our combined organizations are one of the largest community banks and SBA lenders serving the market. This acquisition significantly increases our presence in Phoenix and Scottsdale and demonstrates our commitment to growth and client expansion in Arizona. Looking back on the quarter, we reported EPS of $0.53, which included a $0.05 negative impact related to merger expenses. We continue to experience good loan growth as loans grew 17.3% on an annualized basis excluding PPP. Growth was across products, but was highlighted by additions to our commercial client base, a proven catalyst for growing our retirement business. Year-to-date, new plan sales in the retirement division are nearly 50% higher than last year, while lost plans have remained stable. Our wealth management division produced record levels of new revenue, which drove a linked quarter increase in revenue despite the quarter being the worst midyear market results in over 50 years. We experienced outflows in deposits which were largely linked to seasonal declines in core operating accounts of public entities. Excluding PPP, our underlying core NIM expanded 9 basis points to $2.96. Our mortgage originations on a year-over-year basis declined at a level greater than originally anticipated as 30-year mortgage rates quickly rose from 3% to 6%. While we are coming off peak originations of $1.8 billion in 2021, we never overbuilt on infrastructure and we channeled our One Alerus culture and shared resources across business units to get that level of business done. While the mortgage industry is rapidly changing, our focus has always been on the purchase market due to our long-standing relationships with realtors and builders, especially in the Twin Cities. As our competitors reposition and downsize, this will present opportunities for our top-tier producers to pick up more market share in the purchase market. Despite the headwinds in mortgage, we continue to execute on our One Alerus strategy as we continue to grow the number of plans and participants in retirement and wealth management. We continue to deepen our relationships within our large client base on our platform. Today, we remain uniquely positioned in the banking sector, as we continue to generate over 50% of our revenues from fee income, the majority of which is recurring annuitized revenue with minimal capital allocation and no credit risk. Our loan portfolio remains well diversified and credit is very strong, as we continue to experience minimal past dues, low levels of classified loans, and negligible charge-offs. In addition, as a non-CECL bank, we stand with a healthy allowance for loan losses at 1.66% of total loans. Expense management remains a key focus, with core expenses flat to the previous quarter and down nearly 6.5% compared to the second quarter of 2021. I want to thank all of our employees for their hard work and dedication and welcome the Metro Phoenix Bank employees to our company. Our momentum in attracting and retaining talent, as well as client growth opportunities across our diverse product offering, supported by strong common Tier 1 capital levels of 14.19%, has Alerus well positioned to continue to grow, expand, and deliver strong returns to our shareholders. With that, I will hand it off to Al to discuss the financial details of the quarter. Take it away, Al.

Thanks, Katie. I will start my commentary on Page 14 of our investor deck that is posted in the Investor Relations part of our website. For the second quarter of 2022, reported average loans increased 4.0% on a linked-quarter basis. Excluding the impact of PPP, average core loans increased 4.6% on a linked-quarter basis. The increase in core average loans was driven by a 9.2% growth in C&I and a 5.4% growth in consumer. Within C&I, we saw a pickup in loan production, along with an uptick in utilization rates as clients continue to tap into their existing lines. C&I utilization increased from 28% to 32% during the quarter. At the end of the first quarter, we had approximately $6.9 million of PPP loans outstanding. Average deposits declined 2.7% on a linked-quarter basis due to a seasonal decline in interest-bearing deposits. The decrease in interest-bearing deposits was due to a seasonal decrease in our public unit funds. We typically see a drawdown in these public funds in the summer with an increase happening during the fall usually. Turning to Page 15. Credit continues to remain very strong. We had net charge-offs of 7 basis points in the first quarter compared to 3 basis points of net recoveries in the prior quarter. Our nonperforming assets percentage was 16 basis points compared to 15 basis points in the prior quarter. While our allowance is 1.66% of period-end loans. On Page 16 are some key revenue metrics. On a reported basis, net interest income decreased 5.1% on a linked-quarter basis. Excluding the impact of PPP, net interest income increased 6.9% due to higher loan growth and higher net interest margin. Noninterest income declined 0.8% on a linked-quarter basis due to lower retirement revenues offset by improved mortgage and wealth management. I will go into detail about those segments in later slides. Turning to Page 17. Net interest margin was 2.98% in the first quarter, an increase of 15 basis points from the prior quarter. Excluding the impact of PPP, our core net interest margin was 2.96%, an increase of 19 basis points from the prior quarter. Core net interest margin benefited from higher investment portfolio yields along with higher loan yields from our commercial real estate profile offset by lower yields from our C&I portfolio. Turning to Page 18. $706 million or 37% of our loans are floating, as you can see at the top of the slide. Almost all variable loans are above their stated floors or have no floors. On the bottom left, you can see a waterfall of net interest income and net interest margin that our volumes and rates, as previously mentioned, positively impacted our results. On Page 19, our core funding mix remains very strong. We saw a small increase in our deposit costs due to rising interest rates. Given the recent rise in interest rates, we do anticipate our deposit costs to rise. We are currently anticipating our deposit beta to be between 25% to 30% in the quarter, which is still lower than we previously anticipated. On Page 20, I'll provide some highlights on our retirement business. AUM declined 10.1% primarily due to market volatility, with S&P being down over 16% in the quarter and the Aggregate Bond Index down 5%. While AUM declined, we did see the number of participants increase approximately 450,000 versus 445,000 in the prior quarter. Revenues declined 7.7% from the prior quarter, mainly due to lower asset levels. Turning to Page 21. You can see highlights for our wealth management business. Similar to what we saw in retirement, AUM declined 9.5%, mainly due to market volatility again. Despite the decline in AUM, revenues increased 4.1% from the prior quarter, mainly due to a custody deal that was won at the end of the prior quarter, strong new production by our advisory business, and higher transactional revenues. Turning to Page 22. I'll talk about our mortgage business. Mortgage originations increased approximately 45% from the prior quarter as we rebounded from record low housing inventories in our main markets. Despite the challenging market, the current volumes are over 22% higher than a similar time period in 2019. Lastly, turning to Page 23, here is an overview of our noninterest expense. During the quarter, noninterest expense increased 5.0%, mainly due to higher incentive compensation related to revenue-related activities, mainly an improvement in mortgage. We also saw an increase in professional fees due to higher M&A expenses in the quarter. Other expenses decreased as a result of lower provision for unfunded commitments as we saw a pickup in commercial utilization. And marketing expenses increased quarterly due to a typical seasonal pickup. Now, I'll provide some forward-looking guidance. First, I'll comment on the Metro Phoenix Bank, which we closed on the acquisition on July 1. As of June 30, Metro had the following balances. They had $84 million of cash, $38.5 million of investments, and $277.6 million of loans. We are assuming $354.5 million of deposits. We issued 2.68 million shares of total stock for a consideration of $63.8 million for the purchase of Metro. After the purchase of Metro, we do not anticipate a material impact on our tangible common equity or capital ratios as a result of the transaction. Now, I'll provide guidance for the third quarter. On a stand-alone basis, we are expecting average loan growth to be in the high single digits on a linked-quarter basis. For Metro, we're expecting double-digit loan growth on a linked quarter basis in that loan book. Overall, we expect some interest margin expansion, but the expansion will be limited as we anticipate rising deposit costs due to rising interest rates. Again, we are currently expecting a deposit beta to be between 25% to 30%. With Metro, we expect net interest income to grow in excess of 20% from the prior quarter. We expect overall fee income to be down low single digits, mainly driven by continued decline as we expect overall originations to be under pressure due to seasonality. Given no market growth, we expect revenues to be similar to the second quarter and return to be flattish. On a stand-alone basis, we're expecting expenses to be up mid-single digits, mainly due to merger-related costs. Excluding those merger-related costs, we expect core expenses to be flattish. With Metro, we expect Metro to increase our core expense base by mid-single digits. And lastly, we expect credit to remain strong and continue to expect net charge-offs to be below historic levels. With that, I'll now open it up to Q&A.

The first question comes from the line of Ben Gerlinger with Hovde Group.

Offsetting this, there has been a lot of rumor and some speculation. Hopefully, we can clarify everything. I apologize for starting the Q&A on a somewhat somber note, but Al, during the first pitch, did you cheer for the Yankees?

I cheer for baseball in general, but I appreciate the question there. My roots are from New York, but I've been in the Twin Cities for a long time. I support baseball in general, I love it. So whoever wins that game, I'll support.

Yes, of course, you cheer for whatever team is winning. But anyway, so when you guys think about the market as it is today, obviously, there are different segments within the company and they hold different market forces. So the core bank should have higher rates coming forward, which would lead to stronger revenue. And with that, it gives you an opportunity to reinvest within the broader business overall. When you think about priorities and internal investment, where would you put that next incremental dollar? Is there any one segment, such as technology investment priority, or anything of that degree that would allow Alerus to be better set up for the next decade?

Sure, good question. And I referenced in my opening comments that commercial banking is the catalyst for many components of our company. So as we focus and laser in on where we bring the most value to clients, we are very much focusing on bringing in obviously, Jim Collins on board, who is a proven leader and grower in commercial banking. That is where we're focusing and growing our franchise because it does give us the opportunity to expand on the fee income at a very high level of success.

Got you. Okay. So it's a bit of a lead-in to a broader relationship. My follow-up really relates to a bigger picture question going forward. Is there an opportunity to cut more expenses throughout the franchise overall, assuming that the mortgage business remains stable? Or is it really dependent on whether mortgage rates change? If rates stay about the same, should compensation not change much? Is there anything from a structural perspective regarding expenses that could enhance overall profitability?

Yes. Absolutely.

I could take that one. Go ahead.

Sorry. Go ahead, Al.

Yes. Jim has been on board here now for about 60 days, and he and I have been syncing up on various things, and I've been here for a little over six months. As we kind of look at the structure, we do see that there's an opportunity to kind of rightsize some expenses, but also, too, we're dealing with an inflationary environment right now, so we are facing some of those inflationary pressures that others are dealing with as well. Our goal right now is to keep expenses flat in this high inflationary environment. But as we look for the long term, though, as Katie is going to comment here as well and probably build on this, we are trying to build a structure that will allow us to grow for the long term because there is so much opportunity for us. As I kind of keep working every day to understand the potential of this Alerus story, Jim and I and everybody here see that there's so much runway for us to grow, and some of that growth requires investment as well, which we are currently working on, determining what those investments will be to support not just short-term growth but long-term growth. Katie, do you want to add anything to that?

Yes. I would add. A key focus for us in the past three to five years has been on a couple of things. It's been on developing the credit infrastructure as well as bringing on technologies that allow us to be more efficient and grow. Our opportunity to scale without adding overhead is impressive. Under Jim's leadership and our ability, as you can see from our recent successes in bringing on talent, we think that is the real catalyst to support that growth going forward at a higher level than what we've experienced, with the right credit and operating infrastructure behind it.

Got you. That's helpful. If I can just sneak one more in. I know that the core bank is a bit of the gateway to an all-encompassing relationship. And I don't think that you guys are on the hunt for necessarily a full bank acquisition today, but if you were to think about any incremental lender or any type of lending team or a team of bankers, is there any geography or any lending class that is at the top of your list? I know you don't think much of anything for high-caliber talent, but if you could kind of write the script on who the next incremental banking hire would be or what those characteristics would be?

Sure, absolutely. We are focused on C&I bankers, mid-market strong treasury management. We think we've got great opportunities here to do so in the Twin Cities. Regarding full bank acquisitions, we continue to look and keep that funnel pretty wide at the top as we consider businesses that could add scale or just bring a client base that gives us the opportunity to expand relationships. Talent acquisitions, which we've done numerous times, continue to be one of our highest priorities.

The next question comes from the line of Jeff Rulis with D.A. Davidson.

I have a question about the deposit flows. The pandemic has clearly disrupted the usual seasonal patterns. You've mentioned that you've seen some public inflows this quarter, but I would like to understand your confidence regarding those trends. In addition to seasonality, we've observed changes in deposit behavior and retention, along with some outflows in the industry. Could you share your thoughts on confidence and seasonality, as well as any rate-chasing activities you might be noticing?

Thanks for the question, Jeff. We actually just did a study on a seasonal approach, and it has been, over the last several years, pretty much tried and true that those public funds leave us in the summer. We're starting to see again a slight pickup in the deposits from the public funds because this quarter, a lot of those public funds were utilized for features that were paid out during the summer, and then they start building back in coming to fall. So we feel comfortable about that. But you're right; there is some seasonality that we're watching very closely, especially with the recent Fed hike. We're going to be monitoring behavior very closely. So that is definitely on our radar.

Outside of that public fund movement, are you seeing some of the other regular customers kind of rate-chasing? Or is there any piece of the deposit mix that you've seen change quarter-over-quarter?

No, Jeff. We actually haven't. The thing that's been impressive here is how sticky our customer base is right now. We've been able to lag our deposit costs right now, and there hasn't been a lot of movement out there. That's why when I said we're expecting our deposit beta to pick up, it's still below what I would have anticipated in a rising rate environment like this. It's been a pleasant surprise for us to see how sticky our customer base is.

Got it. I want to circle back on the expenses. I know you tackled some structural big picture efficiency-type questions. But could you remind us of the timing now of where you think Metro Phoenix's conversion could occur and what maybe could be carved out in terms of targeted cost savings with that and timing?

Yes. We're targeting conversion for the later part of this third quarter, this year. We are still anticipating the cost savings that we've originally disclosed, but there might just be a little bit plus or minus in that range, I'd say, just a little bit.

Okay. And then lastly, just maybe housekeeping related to the deal. Any kind of adjustment on goodwill or tangible book dilution, given sort of rate movement we've had? I don't know if the marks have changed, but basically at announcement, are there any updates on goodwill or tangible book impact?

Yes. Actually, we just received those in not long ago, and I'd say there has been really no change to that. That's why I highlighted in the guidance that we still do not anticipate a material impact to our tangible common equity or capital ratio. So we just got those marks in.

The next question comes from the line of Nathan Race with Piper Sandler.

Yes. I appreciate the guidance for retirement and benefit services revenue in 2Q. But long term, I would love to get an update just in terms of the natural attrition within the market. How you guys are thinking about the opportunity to add clients organically with your sales efforts and also just given how you have increased the capture rate as plan participants and how that translates to future growth after 3Q, assuming equity markets stabilize from here?

Katie, do you want to take that one or do you want to take that one?

So I'll start and then you can fill in, Al. Nate, thank you for the question. Regarding retirement, as I mentioned in my opening comments, we are seeing a higher level of new plan sales than we have in previous years as well as reduced levels of attrition. Many of those new plans are not asset-based; they are on a per plan, per participant basis. We have a couple of tailwinds, certainly the market on the asset-based fees as well as new plan basis. As those plans grow, our fee income naturally increases as participation in the plan increases. So that's one catalyst for growth, and then commercial client expansion. As we grow our commercial banking client base, our typical success rate with commercial clients is about 50% of getting the retirement plan over time. It doesn't always come day one, but as relationships develop, we absolutely get a chance to talk to clients about the services we can offer. Half the time, we end up getting that plan to transition to us. The retirement business is a significant feeder system to our wealth management business and more than it has ever been in the past. We've always been good at capturing rollovers on a reactive basis. Over the past year or two, we've been much more focused on being proactive with that participant base, engaging with individuals who are potentially nearing retirement or are just in a place where financial planning is something that they are considering and need. That opportunity within that division is significant for building out the rest of our fee income opportunities in the future.

Yes. I think Katie gave a great overview. The only thing I could add to that is that our leader in the retirement business, Rob Woytassek, has really stepped in and has done a great job in our commercial client expansion story there. He has identified opportunities for us to gain overlap and synergies in terms of deeper penetration with our clients. We've already seen some initial success in that commercial expansion strategy, and he's targeted some opportunities for us, and we're going to continue executing on that for the foreseeable future.

Got it. And just going back to what Katie said initially in terms of kind of the mix shift change in clients being added. I imagine that also reduces kind of the market sensitivity of this revenue source going forward, if I'm kind of hearing you guys correctly?

Right. It does. Most of the new business is not tied to asset base. Some components, like trust and custody will be, of course, advisory services tied to administrative and recordkeeping fees tend more toward being based on per plan fees and per participant fees.

Okay, great. And then, if I could just switch gears and think about overall balance sheet dynamics. With Metro Phoenix adding roughly $450 million or so in earning assets here in the third quarter, how do you guys think about overall deposit flows from here? It sounds like you're going to compete on deposit pricing going forward? Is it fair to expect that the earning asset base stabilizes around $3.5 billion from here? How do you think about that, and how that would in turn support margin expansion given the asset-sensitive nature of your balance sheet? Or how are you thinking about the overall balance sheet flow and level going forward?

Yes. Thanks for that, Nate. As we think about the balance sheet right now, I mean, I highlighted in there. We are seeing very strong loan growth. On a lower stand-alone basis, we're expecting high single digits there on a linked quarter basis. For Metro, talking to Steve Haggard down there, we are really excited about the opportunity and we're expecting that loan book to grow in the double-digit range as well. Our preference right now is loan growth with a 14.19% Tier 1 capital and common Tier 1 capital. We have a lot of dry powder to support loan growth, and we'd like to keep supporting that. From an investment portfolio side, we're allowing some of that to mature to help continue supporting loan growth there while remixing the balance sheet a bit. But with that loan growth, we are expecting deposits to come in to help support that from a funding standpoint.

Okay. Yes. And so just given the ongoing earning asset mix optimization with loan growth remaining strong, and just given the asset-sensitive nature of the balance sheet, is it fair to expect the margin to get kind of north of $3.20 and perhaps even north of $3.50 in both the third and fourth quarters, respectively, of this year?

Yes, on that, NIM is always kind of an output function for us, but we expect growth at this time. The question right now is that we've had frequent discussions on deposit pricing because we need to monitor it, given the rapid rise in rates. It's hard for us to pinpoint where it's going to land. The one thing I can say is that with Metro coming on board, there's going to be an uplift to our NIM, especially because their margins are definitely higher than ours, probably in the range of about 40 to 50 basis points compared to us. If you examine their year-to-date performance and strip out PPP for both companies, they definitely have a higher margin than we do, and that's going to help our margin as well. However, tempering that just a little is the rising rates—we're just monitoring the deposit dynamic right now.

Got you. Makes sense. And if I could just ask one more. Credit has historically been a nonissue for you guys, and it remained the case in the second quarter for the most part. Just kind of thinking about the SBA team that you guys added in the Twin Cities fairly recently and then, I believe you are picking up an SBA team in Phoenix as well. Generally, that asset class has looked at as higher risk/reward. I'm curious if your plans to continue portfolio production are still intact and how you might shift, if at all, your underwriting approach to SBA relative to conventional commercial loans?

I think, in this environment, we're certainly looking to continue to grow SBA from a relationship perspective, but we'll also look at the potential to sell some of those loans on the secondary market. I think we're open to both approaches. I don't see us changing our underwriting standards. We've got strong standards in place, and certainly with the guarantee that affords us a level of protection.

Okay, great. And sorry if I ask, perhaps, one more for Katie. You touched on whole bank acquisition opportunities, but I'm curious to know about retirement and benefit services space for additional deals?

Yes. We continue to increase our sources in regards to partnering with advisers across the country who are in the business of finding these businesses and positioning them to sell within one, two, three, or four years. That boosts our pipeline and increases the volume of conversations we're having. We're very pleased with that activity. There continues to be competition in the space, which speaks to the value of retirement businesses due to the annuitized fees and the minimal capital allocation required for those fees. We like where we're at from a conversation and pipeline standpoint, and we find tremendous value within that business unit.

This concludes our question-and-answer session. I would like to turn the conference back over to Katie Lorenson for closing remarks.

Perfect. Thank you. And thank you, everyone, for joining our call this morning. We appreciate your participation. I'll close with just a few comments regarding clearly, our industry is facing some headwinds. Our company has historically outperformed, and we remain well positioned for future success because of our diversified business model and the momentum we're seeing in building our pipeline for new business, client expansion across all products, and the high level of engagement we have within our team and our leaders. That is very special. We are proud to be where we are. We remain focused on working together to grow our company, and the steady and strong foundation we have is allowing us again to differentiate ourselves as we go out into the market and invest, and recruit and retain top talent while serving the best interest of our clients and delivering long-term value for our shareholders. We thank our shareholders for their investment, our team members for bringing value to our clients each and every day, and all of you for your continued support and interest in our company. Have a great day, everyone.

The conference call has now concluded. Thank you for attending today's presentation. You may now disconnect.