Good morning, and welcome to the Alerus Financial Corporation Earnings Conference Call. This call may include forward-looking statements and the Company's actual results may differ materially from those indicated in any forward-looking statements. Important factors that could cause actual results to differ materially from those indicated in the forward-looking statements are listed in the earnings release and the 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.

Good morning. Thank you, Bethany, and thank you to our investors and analysts joining our call today. We appreciate your time and interest in Alerus. I know we always have good engagement from our employees listening in, and I want to take this opportunity to thank them for their dedication and their client outreach efforts throughout March following the bank failures. The efforts of our team across the company are instrumental in retaining and acquiring our holistic client relationships. This morning, I will provide some commentary on Alerus' strategic positioning in the current environment, along with some comments on the first quarter. Alerus' CFO, Al Villalon will discuss our financial performance and results for the quarter. Afterwards, Karin Taylor, our Chief Risk Officer; Jim Collins, our Chief Banking Officer and Revenue Officer; and Barret Lahm, our Treasurer, will join us to answer any questions you may have about the quarter. Let me begin first by highlighting Alerus' strong balance sheet and liquidity in light of the recent market events. As I will describe in more detail, our capital remains strong. Our diverse and relationship-oriented deposit base grew 4% over the quarter. Our sources of liquidity more than cover our uninsured and uncollateralized deposits and our asset quality remains sound. Despite the industry-wide challenging conditions, Alerus is strategically positioned to navigate the current operating environment. Alerus is one of the most uniquely diversified financial institutions in the country with over 50% of revenue derived from fee income, of which a vast majority of this revenue is recurring and annuitized in nature. The value of these businesses is significant, especially in the face of a rapidly changing interest rate environment. Diversification goes beyond the business model and revenue mix and it's a fundamental tenet of our long-term strategies for this company. Alerus is well diversified within its client base in both the deposit and the loan portfolio. I'll start first with the deposit portfolio, which consists of 98% core deposit relationships, most with long-tenured relationships with the company. Insured deposits totaled 74% of total deposits. And although we saw migration from noninterest-bearing to interest-bearing, our overall noninterest-bearing balances of 26% remain above peer averages. Overall, our liquidity position remains robust, primarily driven by our highly granular deposit portfolio built on relationships. While we naturally have some large balances, most are part of core relationships with integrated treasury management solutions and services. Our fee income businesses not only contribute to our relationship-focused differentiated business model, but they also are leveraged to provide significant synergies, most notably over $750 million or 25% of our deposit portfolio is sourced through our fee income businesses, which helps mitigate funding pressure created by intense deposit competition. These deposits include low-cost HSA deposits in addition to retirement and wealth management money markets, which carry indexed market rates but minimal acquisition or servicing costs. Growing our core deposit franchise has been a consistent and constant focus for this company and a key component of our One Alerus strategy and initiatives. This is evidenced by 68% of our lending relationships having a multiproduct relationship with the bank and highlighted by our current loan-to-deposit ratio of 82%, consistent with our long-term average of 78%. The company's loan portfolio is also well diversified by type, by industry, and by market. Our non-owner-occupied office exposure is 3.9% of total loans. Alerus has a strong history of outperforming peers during economic downturns with a long-term historical net charge-off ratio of less than 30 basis points. This quarter's net charge-off ratio was 3 basis points. Reserve levels remained robust at 1.41% of allowance for credit losses to total loans. Our credit and risk management teams have completed a review of our office portfolio and conducted bottom-up stress testing on our commercial real estate portfolio. Our diversification strategy has also anchored the company in stable legacy markets, while expanding to larger growth markets in Minnesota and Arizona. We will continue to be selective in our growth opportunities and foster quality client relationships and credits to our company while supporting our current clients through the cycle. Adding to the company's solid balance sheet, pristine credit quality, and ample liquidity are strong capital levels with CET of 13.3% and TCE levels around 7%, even when including unrealized losses on the HTM portfolio. While near-term margin pressure remains a headwind to earnings, we continue to execute on initiatives to fundamentally improve the profitability of this organization. We have added dedicated and experienced talent to the treasury role. And while we are continually evaluating opportunities to reposition the balance sheet, we are also strategically focused on transformational opportunities that return us to our 40-year historical performance levels of over 1.25% ROA and more than 12% ROE. This transformation is focused on improving the long-term core organic growth of the organization, including enhancing synergistic opportunities across business lines while consistently generating positive operating leverage. In January, we restructured our banking division and organized our team members to serve clients in their dedicated segments, improving our speed to market and the client experience. During the quarter, we added team members focused on mid-market commercial banking and treasury management. We recently completed an additional rightsizing as revenue headwinds persist. As a result of these moves, expenses have remained well managed despite inflationary pressures. We will continue to see opportunities to improve our efficiency while attracting highly experienced and reputable revenue-producing talent to the company. While we have work to do and it’s a battle with near-term pressure on margins, we continue to build tailwinds in client acquisition and synergistic expansion on our wealth management and retirement platform. The long-term value embedded in these businesses is substantial and a significant differentiator in the community bank space from both a client and talent acquisition standpoint as well as for delivering top-tier shareholder returns. These capital light businesses will continue to contribute to Alerus' long history of consistent cash dividend payouts, currently yielding over 4.5% and one-third greater visibility on the economic front with potential share repurchases. With that, I will turn it over to Al for financial commentary on the quarter.

Thanks, Katie. I will start my commentary on Page 11 of our investor deck that is posted in the Investor Relations section of our website. Given all the market uncertainty, this highlight shows how strong and stable Alerus is. We have a high-quality deposit base, superior liquidity, strong capital, and conservative credit. I'll go into further details about each of these strengths later in the slide deck. Let's go to Page 15 now. First, for the first quarter of 2023, reported average loans increased 4.1% on a linked-quarter basis. The increase in core average loans was driven by growth across most commercial and consumer loan categories. Average deposits declined 1% on a linked-quarter basis. Average balances were impacted as clients continued to put liquidity to work early in the quarter, but we did see meaningful core deposit growth in the latter half of the quarter, which I will discuss later. Turning to Page 16. Credit continues to remain very strong. We had net charge-offs of 3 basis points in the first quarter. Our nonperforming assets were 5 basis points compared to 10 basis points in the prior quarter. Our allowance for credit losses on loans to total loans is 1.41%, which is a 14 basis point increase from the prior quarter as we transitioned to CECL. In addition, we have a fair value mark of $6.9 million on the Metro Phoenix acquired loans. We incurred a day 1 adjustment in the allowance from credit losses of $5.9 million and an after-tax adjustment to retained earnings of $4.5 million. $4 million of the adjustment was related to loans, while $1.9 million was related to unfunded commitments. On Page 17, we saw the cost of funds increase to 1.71% for the first quarter of 2023. Despite the highly competitive environment for deposits, our interest-bearing beta was 36% at this point in the cycle. On a period-ending basis, our deposits grew 4% from the prior quarter. We saw very solid client retention and deposit inflows from our core commercial and consumer deposit base and from new clients as we continue to expand our presence in existing markets. We continue to not have any broker deposits. As you'll see on the right-hand side of the slide, our deposit base is well diversified. The strength in our unique and differentiated business model shone in the quarter as synergistic deposits grew 9.6% from the prior quarter to $758 million. Synergistic deposits sourced from our retirement and wealth businesses now account for 25% of our deposit base. On Page 18, you'll see further detail of our core deposit franchise. Noninterest-bearing deposits currently account for 29.5% of total deposits. Alerus has typically operated with a higher percentage of noninterest-bearing deposits relative to the banking industry. On the bottom left part of the slide, you'll see that uninsured and uncollateralized deposits account for only 25.1% of total deposits, or approximately $800 million. We hold about $800 million of on-balance sheet liquidity, which can cover all of the uninsured and uncollateralized deposits. In addition to on-balance sheet liquidity, we have another $1.4 billion of balance sheet liquidity. This brings our total liquidity to $2.2 billion. Our total liquidity to uninsured and uncollateralized deposits is 286%. We have substantial liquidity, as you can see, to cover both uninsured and uncollateralized deposits. As we look forward to the second quarter, we do expect our usual seasonal outflow from our public loans, but for the remainder of the year, we continue to expect deposit balances to be stable or show modest growth. Turning to Page 19. Our capital base remains very strong as our common equity Tier 1 ratio is at 13.6%. In comparison, our common equity Tier 1 ratio is 550 basis points higher than 8%, the median for the largest financial institutions subjected to the Dodd-Frank stress test. Our current tangible equity to tangible asset ratio is 7.6%. While only 31% of our securities are held-to-maturity, if we marked these securities to market, our tangible equity ratio would still be around 7%. On the bottom right, you'll see the breakdown in the sources of our $2.2 billion in potential liquidity. Overall, we continue to remain well-positioned from both a liquidity and a capital standpoint to weather economic uncertainty. We currently have a 770,000 share repurchase authorization in place. We will refer to stock when market uncertainty subsides. Page 20 shows some key revenue metrics. On a reported basis, net interest income declined 12.3% on a linked-quarter basis. The decline was driven primarily by continued increases in funding costs. Noninterest income declined 1% on a linked-quarter basis, mainly due to continued headwinds in mortgages. I will go into detail about our fee income segments in later slides. Our fee income accounted for 51.6% of total revenues. Our high fee income mix is a significant differentiator, especially as over 90% of the fee income is recurring and annuitized in nature. Our strength continues to provide holistic financial solutions to our clients. Turning to Page 21. Net interest margin was 2.7% in the first quarter, a decrease of 39 basis points from the prior quarter. A 29 basis point increase in our earning asset yields was offset by a 78-point increase in our interest-bearing liabilities. Based on the latest information, we continue to expect our net interest margin to compress at a more modest pace in the second quarter. Earning asset yields will continue to improve with mix shift and loan repricing where our cost of funds is stabilizing. Turning to Page 22, over $1 billion, or almost 41% of our loans are floating, as you can see at the top left of the slide. As you see, almost all of our variable loans are above their stated floors or have no floors. For 2023, we continue to expect modest loan growth. Turning to Page 23, you'll see details about our investment portfolio. Currently, 69% of our securities are available for sale versus 31% in held-to-maturity. Within the held-to-maturity portfolio, 42% are in municipal securities, while the rest are in MBS. As we restructure and transform our banking division, we are strategically focused on growing commercial relationships, which will add higher yielding loans with deposit and treasury management relationships. We'll continue to reduce the investment portfolio from approximately 28% of earning assets to a long-term target of 15% to 20% of total earning assets. Today, our investment portfolio has an effective duration slightly over 5 years. As we right-size our investment portfolio, we plan to maintain the duration around 3 years. On Page 24, I will provide some highlights on our retirement business. Core assets under management increased 4% due to higher domestic bonded equity markets in the first quarter and continued client wins. Revenues declined on a linked-quarter basis, mainly due to lower average assets during the quarter and transaction fees that are seasonally higher in the fourth quarter. Our retirement business accounts for almost 70% of our synergistic deposits. For the second quarter, excluding any market impact, we expect fee income from our retirement business to be up slightly. Turning to Page 25, you can see highlights of our Wealth Management business. Revenues increased 1% as assets under management increased 2.6%. We continue to see strong client acquisition in our geographical markets and retirement rollovers in our national and established markets as we execute on our One Alerus strategy. We continue to retain deposit dollars with our synergistic wealth money market offering, which represents 30% of our synergistic deposits. For the second quarter, excluding any market impact, we expect fee income from our wealth business to be up slightly. Turning to Page 26, I will talk about our mortgage business. Mortgage revenues declined $454,000 from the prior quarter due to lower originations as the macro and local environment remains challenged. Mortgage originations decreased approximately 38% from the prior quarter as the first quarter is typically slow. The inventory of homes available for sale continues to remain at a low 1.5 month supply versus a typical level of 3 to 4 months in the Twin Cities. We do expect a pickup in the mortgage business in the second quarter. However, the increase in volume may be more muted than the MBA forecast of a 36% increase in purchase volume due to the low supply of homes for sale in the Twin Cities. Page 27 provides an overview of our noninterest expense. During the quarter, noninterest expense decreased 30 basis points from the prior quarter, which was in line with original expectations of expenses being stable. Compensation expense increased due to seasonality, but also due to a one-time expense of $900,000 related to talent acquisition and severance expense. Despite inflationary pressures, we do expect expenses to be down by low single digits for 2023 on a year-over-year basis. We continue to focus on improving our profitability by reducing expenses and increasing capacity throughout our organization. We recently made continued progress on rightsizing our expense infrastructure through numerous initiatives. Some of these expense savings will be reinvested into efficiency improvements and revenue production initiatives. To summarize on Page 28, we remain well-positioned from both a liquidity and capital standpoint. We have ample liquidity to weather economic volatility and capital ratios remain very solid, even if you factor in the unrealized losses from our held-to-maturity investments as our tangible common equity ratio will be around 7%. Credit remains strong. Lastly, we continue to see growth in our core existing deposit base and with new customers as people value the holistic approach of our professional business.

Our first question comes from the line of Jeff Rulis with D.A. Davidson. Please go ahead.

Thanks. Good morning. I wanted to check in on the margin. Al, I continue to recall your coiled spring commentary. Just I guess, first question would be, do you have a March net interest margin average? And then I guess, as we look at 2Q, I think you talked about some compression, but the balance of the year and timing in terms of the sensitivity, just update from what you left us, Al, in the prior quarter.

Thanks for the question, Jeff. So, for end of March, our net interest margin was around 2.59%. Going for the second quarter, we do think there will be a little bit of compression from there. But I'd say that the worst is behind us. We are probably thinking that with our 60% of our deposits being indexed with the last Fed hike of about 25 basis points, that will price our money market index deposits in July. And then our assets will repriced higher. So, the coiled spring is in effect still.

Thank you. I appreciate the thorough information on expenses and fee income. Regarding the fee income, can you clarify the BOLI benefit? Was it around $1 million for the quarter? Also, can we exclude that from future projections?

Yes. Just to clarify, yes.

It was about $1 million with give or take.

Yes, $1.2 million.

Okay. Got it. And then last one, maybe, Katie, just looking at the credit statistics, I mean, they're phenomenal. And I know this is work you've done years prior in terms of addressing some choppier credit figures and now certainly in a great spot, and you talked about your exposures going forward. Just wanted to check backing on credit, and I know that we're all sort of guarded for maybe tougher economic times, but your thoughts on credit overall from your perspective, how you're positioned?

Hi, this is Karin. I will address that question. We have certainly benefited, like the rest of the industry, over the past couple of years with very low asset quality issues. We still expect that credit will gradually return to normal levels, aligning more with historical metrics. That said, due to the efforts we've made on our portfolio, we believe we are well-prepared to handle any downturn.

Thank you, Karin. From a talent perspective and considering our risk management and credit team infrastructure, we have spent the past four years building a team to support organic growth and advance in the lending and credit markets. I am confident that we are well-prepared in all areas to engage with the right clients.

And I guess on a related front, then, Katie, heard your comments about maybe guarded on a buyback or on hold, but capital priorities and thoughts on fee income acquisition or anything else, should we also consider that things are on hold for right now? Or what is the update there?

Sure. We are clearly in a very strong capital position. We have a long history of paying a strong dividend. So that is also a priority for us. When it comes to buybacks, the environment is uncertain right now, but we will absolutely move forward if the financial metrics make sense. We do see continued opportunities on the commercial banking side in terms of taking market share, again, growing with the right companies and the right people even in this environment. On the acquisition side, in the retirement space, we're actually seeing more opportunities, and we're seeing less competition as some of the PE firms on their cost of capital has increased significantly. So still very active in that space, but remaining very disciplined in our pricing.

Okay. I will step back. Thanks.

Thanks, Jeff. Thanks, Jeff.

Thank you. Our next question comes from the line of Eric Spector with Raymond James. Please go ahead.

Hey, this is Eric on the line for David Feaster. I appreciate you guys taking the question. You guys talked about it a little bit in the prepared remarks, but it was nice to see the team hire in the quarter. I'm just curious how you think about hiring near-term. Obviously, expense controls and focus is now a time to be greedy and maybe pick off some talent. Just curious if you have any thoughts on the hiring front and maybe what you think is attractive folks to Alerus?

Eric, Jim Collins. I'll take that one. This is definitely the time that we are going to continue to look for more talent. As we see banks that tend to have to buy brokered CDs and tend to have to reduce their accrued compensation. That gives us the opportunity to go after talent in the marketplace. So, as talent gets nervous and we are well-positioned, we are definitely in all of our markets going after top-tier talent.

Okay. And what do you think is attracting folks to Alerus? What's your guys' competitive advantage, just curious.

We are in excellent markets, and the infrastructure developed in our organization over the past five years has positioned us well with a strong balance sheet. We already have a skilled employee base and are set for substantial growth. The opportunity to accelerate this growth by adding talent is what attracts many people to us. Our values and culture are outstanding, which is one reason I joined the company. Ultimately, we are ready to grow this organization thoughtfully and profitably, which energizes top producers and draws their interest.

Got it. I appreciate the color. And then just kind of going off that, just curious if you have any thoughts on the loan growth side of things and where you're seeing strong risk-adjusted returns and how loan yields are trending so far this quarter? Just kind of general color on your loan growth outlook going forward?

Certainly, the pipelines are a little soft for everybody. But as I said earlier, I mean, this is our opportunity to take talent and market share from other banks. We are pricing 6.75% to 7.5%. That's kind of the market right now in most of our markets. But again, I think with where we are positioned and as we pick off talent, we will have good loan growth to our budget. Certainly, it won't be gutting for double-digit loan growth in this economic times, but we certainly will build a team that will perform that in later years.

Got it. Appreciate you guys taking the question and congrats on a good quarter. Step back.

Thank you, Eric.

Thank you. Our next question comes from the line of Nathan Race with Piper Sandler. Please go ahead.

Yes. Hi, everyone. Appreciate you taking the questions. Maybe balance sheet dynamics. It sounds like you guys have a pretty strong pipeline of deposit gathering across both the synergistic deposit platform and also within the Twin Cities. I'm just curious, with the pretty solid deposit growth relative to peers, is there an opportunity to reduce wholesale borrowings that are added to the balance sheet over the back half of last year?

So, Nate, we are currently working on reducing our borrowings since we are borrowing at FHLB overnight. We would like to pay those down with some of the core deposits we are seeing, while also ensuring we have enough cash on hand to meet any short-term liquidity needs.

Okay. Got it. And then just kind of think about the drivers for loan growth and just kind of the profitability of the loan growth that you guys have generated recently, just given the incrementally higher cost of funds. It looks like a lot of the growth in the first quarter was commercial real estate driven. So just curious if there's going to be a mix shift in terms of the type of growth that you guys are willing to add to the portfolio going forward, just given kind of the incrementally higher cost of deposits and wholesale funding these days?

Our main focus is on the mid-market and lower mid-market Commercial and Industrial sector. We are actively hiring and targeting this niche for growth. We expect to increase our lines of credit and equipment term debt, which should contribute to our growth later this year and beyond. While there will still be some growth in Commercial Real Estate, we have a strong team and are operating in favorable markets where we can access some excellent deals. However, our primary emphasis will remain on mid-market C&I.

Okay, great. And Jim, just how does that C&I pipeline back up coming out of the first quarter? I know a lot of these team additions were pretty recent, but just kind of any thoughts on just kind of overall C&I growth expectations over the course of this year and just how we should generally be thinking about the overall rate of loan growth for 3Q and 4Q?

Sure. We just introduced our line of business under three months ago and added some strong mid-market players during that period. Commercial and industrial has a longer recruiting cycle for a banking organization, and we will keep adding talent in that area. Consequently, those pipelines should begin to grow. However, there are challenges such as rate issues and non-solicitation agreements that prevent many from breaking, as well as the overall time required to engage with customers. Nevertheless, we expect to see that trend strengthen as the year progresses and into 2024.

Okay, great. And if I could just add, just in terms of some of the success you guys have had in terms of going over some of your retirement clients under the wealth platform. I know this is more of a longer story component to the Alerus story, but has there been any recent changes in terms of the capture rate in onboarding clients from the retirement platform into wealth more recently?

Hi, Nate. I'll take that one. This is Katie. I would say the business has been pretty consistent. Again, our focus on any approach to a client is what's best for them and what aligns with their goals on how can we help them be more successful with those goals. And so, it is an opportunity at times with clients. But at other times, they may want to move in, for instance, to transition to the money markets like we saw in this quarter. So consistent outreach, great engagement with the client base. And then the results are in various components of the company's division.

Okay, got it. And just another question just going back to deposits. Obviously, noninterest bearing was down in the quarter, and it's come down from around 30% of deposits close to 20% over the last year. So, any thoughts on just if we're nearing a trough there or still seeing clients move into higher cost products, perhaps kind of what inning are we in, in terms of some additional attrition and just the proportion of that deposit bucket?

This is Barret. I can take this one. We did see noninterest-bearing deposits decrease from 30% to 26% in the quarter. We do, as I believe we have in the investor presentation, remain at a high level within the industry. So I think if you look at maybe what the risk is, I think that puts it into context. But I think we expect to stay above the industry.

Okay. And if I could just ask one more on just kind of the reserve trajectory and just maybe for Karin. I don't think the criticized classified trends were disclosed in the slide deck. So perhaps any update there and just kind of how you think about the reserve or ACL trajectory, I should say, from here?

Yes. The criticized classified combined remained about the same quarter-over-quarter. In terms of the trajectory of the reserve, it's really going to depend on loan growth and the economic forecast that we are using within the methodology.

Okay, great. Thanks guys for taking all the questions and all the color.

Thanks, Nathan.

Thank you. Our next question comes from the line of Damon DelMonte with KBW. Please go ahead.

Hey, good morning, everyone. Thanks for taking my questions. I wanted to just start off with expenses. Al, if you exclude the severance and the talent acquisition cost, I think that puts operating expenses somewhere around $37 million. Can you just talk a little bit about your outlook over the coming quarters? Or is there some opportunities to maybe reduce some of the expense base? Or kind of how do you see that playing out?

Yes, we are still exploring niches and have implemented some changes in the past month. There are definitely more opportunities to manage expenses, although we anticipate some volatility from quarter to quarter. Overall, we expect expenses to decrease by single digits for the year.

Okay. All right. And going off from last year's like what 158, 159?

Yes. Yes, correct.

Okay. That's helpful. Thanks. And with respect to the margin, I apologize if I missed this in the release, but what was the accretable yield included in the margin this quarter?

Yes, those about 2 basis points from Metro.

2 basis points, okay. And is that something we should model going forward? I know it's kind of tough to do, but is that kind of what your schedule looks like?

Yes, I would say that's about right.

Okay, great. And then you kind of touched on this with the loan growth outlook. You said it appears that will be kind of modest growth from this point forward. So, should we kind of factor in kind of low single digits on a quarterly basis after this quarter's stronger start?

Yes, I'd say low single-digit is fine. That’s the comment around modest.

Okay. All right. Great. That's all that I had. Everything else we asked and answered. Thanks a lot.

Thanks, Damon.

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

Thank you, and thank you, everyone, for listening in and for the questions. I will close with Alerus is a resilient company with a fundamentally differentiated business model and a strong foundation. We will continue to take a long-term view and will be protective of credit, capital, and our culture as we consider growth and work with urgency to continue to implement efficiency enhancing opportunities. We thank you, our shareholders and our clients for the trust that you put in us and our team members for your constant efforts in taking Alerus to new heights. Thank you, and have a good day, everyone.

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