Alerus Financial Corporation (ALRS) Earnings Call Transcript & Summary

Good morning, and welcome to the conference call to discuss Alerus Financial Corporation plan of a merger to acquire Metro Phoenix Bank Holding Company. [Operator Instructions] Please note, this event is being recorded. 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 press release and the company's SEC filings. I would now like to turn the conference over to Alerus Financial Corporation Chairman, President and CEO, Randy Newman. Please go ahead.

Thank you. Good morning, everyone, and thanks for joining us. As you know, yesterday, we announced our intent to acquire Metro Phoenix Bank, the largest community bank headquartered in Phoenix. Yesterday, we also shared the news with our current staff in Arizona and introduced ourselves to the Metro Bank employees; both meetings went very well. I'd like to complement Metro Bank, their Board and CEO, Steve Haggard, who will become our Arizona market President, on their past success and for their confidence in us by becoming our first acquisition who is taking our stock as currency. We are very happy to build our shareholder base in Arizona. I would also like to recognize Katie Lorenson, currently our CFO, but our new CEO at the beginning of the year. Katie and her team led negotiations and due diligence on this acquisition. Finally, I would like to thank Barack Ferrazzano, led by Joseph Ceithaml; and D.A. Davidson, led by Tom Hayes, who are our legal and financial advisers. Metro Bank is a first-class, high-performing growth community bank that we believe will fit in seamlessly both culturally and strategically with our company. We are simply elated to complete this transaction of 2 high-performing organizations coming together. We believe we have an exciting future together. This also caps off an exciting year for Alerus, another strong year of financial performance, this strategic acquisition, our announcement of 3 new very talented corporate directors joining our Board, and the announcement of Katie to succeed me as CEO at the beginning of the year. Let me now turn it over to Katie for more details, and then we will invite your questions.

Well, thank you, Randy, and thank you, everyone, for taking the time to join us on this exciting day. I am going to refer to the slide presentation that summarizes the terms and the highlights of the transaction. If you don't have a copy of that presentation, you can find it on the Alerus investor website at investors.alerus.com under News and Events. So let me start on Page 2 of the slide deck, giving you a brief overview of the strategic transaction and discuss why it is important -- an important step for Alerus franchise going forward. As you all know, M&A has been an important part of the Alerus story, and we truly believe that this is a transaction -- this transaction is a continuation of our long-term plan growth strategy. This is a strategic transaction that will transform our Arizona market presence. Alerus has been in the Phoenix, Arizona, market since 2009, and for quite some time, we have been seeking and looking for the right partner that will help us further establish our position in the market. After many years of looking, we are excited to say that we have found that partner in Metro Phoenix. Metro Phoenix is the largest community bank headquartered in the Phoenix MSA, with over $400 million in total assets and is one of the best-performing community banks in the country. This combination will nearly triple our footings in Arizona, adding significant scale in one of the most dynamic and fastest-growing regions in the United States. On a pro forma basis, Alerus will have approximately $440 million of loans and $480 million of deposits in the MSA and will rank in the top 5 based on deposits for community banks operating here. Metro Phoenix is a core business banking franchise, focused on commercial business. It is very similar to Alerus in the overall holistic approach to making. The bank has a proven track record of strong profitability and quality, sustainable growth since its formation in 2007. As Randy mentioned, we are very pleased to announce that Metro Phoenix's CEO, Steve Haggard, will assume the role as the Arizona market President for Alerus. In this role, Steve will oversee growth for the company in the Arizona market. After spending time with Steve throughout the transaction, we are excited to have him leading the team and the franchise. We are confident in his ability to seamlessly integrate the transaction, retain the talent and the clients while continuing to grow in the market. For our shareholders, the deal metrics are strong, with 8.5% earnings accretion in the first full year, a 25% plus IRR and a tangible book payback of approximately 2.8 years. Turning to Page 3, just a quick overview of Metro Phoenix, the franchise and its performance. Again, it is a high-growth, high-performing and efficiently single branch business bank, strong track record of organic growth of 20% plus CAGR for both loans and deposits since 2015, an excellent asset quality with no NPAs. On Slide 4, the Metro Phoenix's commercial client base is very complementary fit with Alerus. We also really like the way in which Metro does business, approaching the client holistically, albeit with a limited product set at this time. We have not modeled any revenue synergies from overlaying the Alerus suite of solutions. But we believe the Metro talent is excited to be able to offer and provide comprehensive services that not only generate additional production and revenue, but deepen their client relationships. The combined company will have the human capital infrastructure and technology and product solutions along with balance sheet capacity and liquidity needed to capture additional market share in Phoenix. On Slide 5, the geographic fit. With the current Alerus Arizona branches, it was an important consideration when looking at this transaction. Complementary fit with our locations in Scottsdale and Mesa and no branch overlap. This does add a presence, a physical presence in Metro Phoenix, and it increases our Alerus footprint in Arizona to 15% of total deposits and further diversifies our strong deposit base. On Page 6, this slide illustrates the meaningful increase this transaction has on our rank in the Phoenix MSA, and our tremendous opportunity to gain market share. The transaction moves Alerus from 41st ranked up to 24th ranked. In addition, the Metro Phoenix has been focused on developing a leading SBA team, and the results and momentum are strong with Metro Phoenix ranking 12 for SBA loan production in Arizona, outcompeting many large financial institutions. We look forward to combining our recently added Alerus team and continuing on our quest to becoming the carrier provider and partner to small businesses. On -- shifting to Slide 7. This is one of the most exciting slides in the deck and conveys why we are tremendously excited to get the scale and add a strong team in this market. As you can see, Phoenix has been the fastest-growing large city in the United States with over 15% population growth over the last 10 years. In addition, Phoenix has experienced consistent growth having been ranked the fastest-growing large city in the United States for 5 consecutive years. It is important to note that this growth has been supported by billions of dollars in capital investment from companies that are expanding into the market. Also significant is Phoenix's ranking as third in the U.S. for small business growth in metropolitan areas. This is extremely important to us, given that providing banking and financial services to those small and medium businesses is core to both Metro Phoenix and the Alerus franchises. On Page 8 of the deck, we provide some additional stats on the historical and projected population growth of the Phoenix market, which are both extremely strong. On Slide 9, we have the pro forma loan and deposit portfolios. And again, reiterating how strong asset quality is on Metro Phoenix and the attractive core deposit base. Metro Phoenix is a strong asset generator, and the client base is highly attractive to Alerus because of their focus on commercial. With the Alerus business model, commercial clients are a key opportunity to grow our fee income. When we win the banking business of a commercial company, we earn their trust and the opportunity to expand by partnering with their HR team and providing retirements and benefits, which then feeds our consumer segment in bulk with access to the employee base of that company and the opportunity to provide holistic financial planning to those employees. On Slide 10, the transaction overview, discusses the structure key assumptions and the multiple. Again, this acquisition is a 100% stock transaction, our first acquisition using Alerus currency. The transaction value for Metro Phoenix shareholder and options is approximately $85 million. As noted below, this transaction is nicely accretive to Alerus earnings, with 5% earnings accretion in '22 and 8.5% in '23, with fully phased-in cost saves. The tangible book dilution is approximately 2.5%, with the earnback of 2.8 years. Moving into the key merger assumptions. We are projecting cost savings of approximately 29%, which will be fully phased in, in 2023. We are estimating a close of the first -- at the end of the first quarter of 2022, potentially the early beginning quarter -- beginning of the second quarter of 2022, with a close at the end of Q2 of 2022. We expect approximately $5.2 million in deal costs, which is about $4.3 million in after tax. Lastly, on the due diligence process. We conducted a very thorough due diligence process on Metro Phoenix, which was led by our senior executives, our SBA and our credit teams at Alerus. This due diligence was conducted on-site in Arizona over the course of several days and included an in-depth review of 60% of the commercial loans, including 80% of the outdoor media loans and over 50% of the SBA loans. The loan review confirmed that we are aligned in credit culture and policies and are comfortable with the quality of the portfolio. We expect this to allow for a seamless transition for the Metro team members. On Page 12, the Alerus growth that lays off the time line of acquisitions and the key milestones for Alerus over the past 20 years. Again, you can see that M&A has been a key component for the Alerus growth strategy across many business lines with 25 acquisitions. In conclusion, we believe this is a unique opportunity to acquire a high-quality, high-growth, high-performing business bank in a market that provides enormous growth opportunities. The transaction is a fantastic fit for Alerus, and we believe that the combination will be accretive to our franchise. The economics of the transaction are very attractive, and earnings accretion and growth potential stand to enhance our shareholder value for all Alerus shareholders over the long term. We welcome the Metro Phoenix employees to the Alerus team and look forward to completing this transaction, integrating and moving forward. At this point, we'd be happy to answer any questions. Juan, if you would please open up the call.

[Operator Instructions] Our first question comes from Jeff Rulis from D.A. Davidson.

Question on the -- Katie, maybe if you could just offer some background of the transaction. It sounds like you sort of led the conversation, the kind of Metro Bank's reason for selling. Was this an auction or negotiated? And maybe just some depth of how you met these folks and the process of leading up to the announcement.

Yes, certainly. So we had initial conversation before this became a process. It did move forward as a bid process. And again, Arizona is a key market for us and -- but we did have a lot of time with the leadership team. And the reason for selling, obviously, they're high-growth, high-performing company, but had gotten to a place where the significant investments were going to be needed to move forward. And so from an infrastructure standpoint, they were looking for a partner that could bring that infrastructure, that balance sheet capacity so that they could continue to grow and -- along with the technology offerings that we bring to the table.

Got it. And the -- I think you mentioned some of the accretion of product suite and kind of rolling that into the platform at Metro isn't included in your accretion assumptions. Just any thoughts on timing of either the retirement of benefits or wealth management kind of the mortgage, all of that, how does that kind of weave into either a time line or expected impact at the bank?

Sure. So as we look at integrating the companies, first and foremost, we want our Metro Phoenix talent to be focused on seamless conversion of those clients and retention of the current clients and a comfort level in regards to what's not changing and what has changed. And then as we work through that process, which we expect, again, to complete the end of 2022, then we will spend more and more time with our producers, with our revenue generators, educating them on the offerings and the products and then connecting them with that expertise that is here in their market as well as across the footprint. And once that trust has formed and those relationships are solid, then we'll start to see the client introductions and the expansion move forward. And so, again, not anything modeled at any point within the years of the financial model, but certainly something we expect to see as we move forward.

Okay. And I think, just to clarify, you mentioned the close date is end of the first quarter, but you said conversion expected by year-end?

No. By the end of the second quarter, I'm sorry. Yes, we expect to close at the end of the first quarter, conversion end of Q2.

Our next question comes from Nathan Race from Piper Sandler.

Congrats on what appears to be a solid transaction.

Thanks, Nate.

I was hoping to just start on -- and I apologize if you guys touched on this, and I got on a bit late. But in terms of just the underlying assumptions in terms of the SBA gain on sale revenue stream has been pretty strong at NPA checks for the last several quarters now. Kind of what are the underlying assumptions for '22 and '23 for that line? And also curious just in terms of kind of expectations for pro forma loan growth relative to SBA to access historical low 20% CAGRs as you guys kind of thinking about expectations as well for '22 and '23?

Great question. So on the SBA gain, this year has been very strong, and it is -- it really is the coming together of a great team at Metro Phoenix. And -- so this year, I believe there are over $1 million of SBA gains through reported 930 that will end the year at record levels. And in 2022, the SBA gains were about $600,000. We have modeled, going forward, about $1.2 million, which is $1 million less than what they'll recognize this year. So we believe that to be conservative going forward because the momentum they have is really pretty strong. But we wanted to be conservative in that regard. So it's -- that's the model going forward, it's about the $1.2 million in SBA gains each year. On the loan growth side, again, this company has grown double digits with the 20% CAGR over the 2015 on loan growth. We moved loan growth in the model down to the mid- to high single digits.

Okay. Very helpful. And perhaps just changing gears and kind of just thinking about the outlook going forward in terms of additional excess capital deployment and the acquisition landscape. I imagine just given the fairly digestible size of this deal, at around 30% of Alerus' balance sheet and just given presumably a limited impact from a TCE perspective, with this deal coming online, what are your kind of expectations and outlook? Does this deal kind of preclude you guys from entertaining additional, whether it be whole bank or [indiscernible] acquisitions going forward?

It does not. As you say, it is a fairly small digestible transaction for us. This, again, is our 25th, and so we are built for -- to efficiently and effectively integrate into our company and convert the clients. And we will continue to build our prospect. We'll continue to be having those conversations and continue to be involved in exploring opportunities in both the fee income as well as potential branch or bank opportunities.

Our next question comes from William Wallace from Raymond James.

Katie, just trying to make sure we don't overcount net interest margin related to any PPP fee income or anything. Do you have like a core net interest margin at Metro Phoenix that we should use?

I do. Their PPP revenue for the year of 2021 is barely immaterial, several hundred thousand dollars loans. It is not -- does not have a significant impact on their margins for 2021.

Okay. And I'm just going to go ahead and apologize if these next 2 questions are dumb. But can you educate me on outdoor media lending and what those loans look like, how they're classified, what the pricing is, and what the growth prospects are?

Yes. Sure, Wally, this is Karen. Outdoor Media Lending is a niche lending business. It provides billboard financing, so the acquisition, construction and refinancing of billboard projects. The niche serves companies nationwide, and so there are currently relationships in over 20 states. They financed both traditional billboards as well as electronic displays that are in some of the larger markets. They've really developed a nice niche. They have a great track record of success and an excellent credit quality on this portfolio. And we believe that there is significant opportunities out there to continue to grow the business, particularly with the balance sheet that we bring.

How are these loans structured?

They're largely C&I loans. Sometimes, there's a real estate component as well. And the pricing you asked about is in about the 5% range.

Do they -- are they priced like a line?

Yes.

Do they float? Or are they repricing annually or what?

I am not certain of that.

Okay. And then on the SBA business, is that more of a balance sheet business for Metro Phoenix? You mentioned in the diligence slide that you did diligence so much of the SBA loans, or is that just you're looking at the unguaranteed portion [indiscernible]?

They've got about $19 million on the balance sheet in SBA loans. And we looked at what was on the balance sheet.

Okay. I meant to ask how big is that outdoor media portfolio?

It's about $80 million.

Okay. And looking at Alerus and Phoenix, prior to this deal, was that more of a consumer market for you guys? Or was it -- was the structure of the loan portfolio of Phoenix similar to the total organization's loan mix?

No, it's similar to the total mix. Primarily commercial [indiscernible].

You mentioned the HOA deposit business. What's the size of that business? And are those low-priced sticky core deposits? Or do those tend to be more price sensitive?

No, those are low cost overall, and so competitive rates. And I think they're at a 40 basis points -- excuse me, competitive rate, but they are -- when I say low cost overall is because they are sourced not by individual HOAs, but by property managers who bring on bulk HOAs business. And so from an acquisition cost and from a scalability, very, very good runway in that regard.

And what's the size of that portfolio?

About 40% of the deposit portfolio.

Okay. Are these like -- I've run across this a couple of times with banks in Florida, but I really haven't seen it a lot. Are these like annual contracts or do you just kind of get the accounts and they can leave at any time? How are they -- how is the business structured?

Yes, they are not under contracts, but it is heavily integrated. And so in regards to -- they are very sticky once you win the business because it is an integrated with the 2 technologies that the clients and the bank bring to the table. And so it takes it takes pretty significant expertise and understanding of the systems, but there's -- once you have those relationships, they stick around, and they tend to grow as those property managers bring on more and more HOAs into their book.

Can the knowledge that you'll gain and the technology that you'll gain with this acquisition be transferred across the rest of your footprint? Could this be a funding source across -- or outside of Phoenix for Alerus?

Yes, we believe so.

Okay. And then I guess just the last question. You mentioned that you're modeling mid- to high single digits, down from, I think, you said -- I think, in the slide deck it says 20% or so CAGR. It certainly seems conservative, which is great. It's -- is this -- should this be a 20% growth market for Alerus 2 to 3 years from now once we kind of integrate everything and we're looking at the #1 growing market in the country, et cetera? I mean, do you really think this should be more of an additive to the Alerus growth profile?

Yes. We absolutely...

Or is there some -- is there a reason that you model mid- to high?

No, we were being conservative. We know that there's disruption here. But yes, we absolutely believe; and under Steve's leadership, expect that our team will continue to grow; our presence in the market will continue to grow and our balance sheet growth, this will become an increasingly bigger contributor to our balance sheet and our loan growth.

Our next question comes from Jeff Rulis from D.A. Davidson.

Just a follow-up. On the cost savings, the source of that, it doesn't look like a big branch network and you're keeping the Market President. So I just wanted to -- where that's coming from largely back office?

Yes. Thank you. It's -- the cost savings were from meaningful, pretty meaningful cost savings from professional services, of course, data processing, technology expenses, directors' fees and then employee composition -- or compensation. And of course, with Steve assuming the role of the Arizona Market President, that resulted in some synergies and savings in -- on the Alerus side.

Got it. And then lastly, Katie, do you have a goodwill estimate that you've put out there?

Yes, 40 -- approximately $40 million of additional goodwill.

[Operator Instructions] We currently have no further questions. This concludes our question-and-answer session. I would like to turn the conference back over to Randy Newman for any closing remarks.

Well, thank you, and thanks to all of you for participating, your questions, which we always enjoy. And with that, I'll just -- we'll conclude the call. If there are any additional follow-up questions, contact Katie or myself at any time. Thank you.

Thank you, everyone.

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