Good morning, and welcome to the Alerus Financial Corporation Earnings Conference Call. All participants will be in a listen-only mode. [Operator Instructions] Please note that 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 earnings 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, sir.

Thank you, Chuck, and good morning, everyone. This is our third earnings call since our IPO in September 2019. This morning, we intend to discuss our first quarter 2020 financial results in our response to and the current impact of the COVID-19 pandemic. Today, I'm joined by our Chief Financial Officer, Katie Lorenson; and our Chief Risk Officer, Karin Taylor. As always, we appreciate your interest in our company. We recently released an updated presentation for investors. This presentation is available on our Investor Relations website and will serve as a supplement to today's remarks.I will first highlight our pandemic response and other key points before turning it over to Katie and Karin. After that, we would welcome your questions. Before I begin, I'd like to first acknowledge the incredible challenges we are all facing together. Our hearts and thoughts are with all individuals who have been affected by the coronavirus pandemic and subsequent economic crisis. Like many of you, we too are experiencing uncertainty as the impact of this pandemic is being felt in our company, our clients and in the communities where we operate and do business. Although one can never fully prepare for a crisis, you can learn from past experience and apply these lessons moving forward.Our company's past experience with adversity has allowed us to move quickly, respond proactively and remain agile. This discipline doesn't just happen. It's built over time. Quite frankly, it's been built at Alerus over the last 20 years. Coming out of the devastating flood and fire in 1997, our corporate headquarters and operations center were destroyed. Our employees and clients were displaced. Businesses were completely shut down and our Grand Forks community faced the most significant economic challenge of its time. Our company didn't just survive and thrive coming out of…

Thank you, Randy. Good morning, everyone, and thank you for joining our call today. I will spend a few minutes today providing some additional color on the financial results for the first quarter. In summary, we were very pleased with the results of the quarter. Obviously, given the incredible uncertainty of the duration of the health crisis, it is difficult to speak with confidence about forward-looking earnings or expectations.Let me start first with what we believe is the most important attribute of a financial institution today, safety and soundness in our balance sheet. As Randy mentioned previously, we entered this crisis from a significant position of strength due to our recent capital raise. Our TCE at the end of the first quarter exceeded 10%, and our allowance to total loan ratio was 1.54%. With allowance coverage nearly 4x the amount of our nonperforming loans at March 31. Our liquidity position was further strengthened in the first quarter as we added a $150 million of core deposits, a 7.6% linked quarter growth rate. Approximately half of this growth came from our retirement and wealth division and represents sticky and stable funding with quarterly repricing going forward. The other half of this growth was driven by new business and increases in commercial balances.Generally speaking, all consumer deposit products and health savings accounts ended the first quarter up from year-end. We see, we generally see deposits decreasing in the second quarter due to public fund seasonality. However, because of our strong liquidity position in the first quarter, we were limited in our bidding for public funds. This has left us in a better position from an interest expense standpoint and furthermore, we should see less seasonal fluctuation in the second quarter as we are generally holding only operating accounts from those public entities.Our…

[Operator Instructions] And our first question will come from Jeff Rulis of D.A. Davidson.

Randy, you had detailed pretty limited exposure in the ag and oil and gas. More broadly speaking, looking at the portfolio, have you looked at maybe sort of refencing total exposure to most at risk portfolios, perhaps in the hospitality or retail, is there a figure that you've assigned to as far as those most at risk?

Yes. I'll let Karin Taylor answer that.

Yes, Jeff. We have taken a look at the segments that we think are at highest risk. In our C&I portfolio, it includes accommodation, food service, entertainment, oil and gas and some of our other retail trade, which is our smaller businesses. And then, of course, in commercial real estate, we do have about $118 million in retail is the underlying property type. And we have about $36 million in medical and nursing facilities, and we have just $7.5 million in hotels. And so in the investor presentation we posted on our website, there is a slide that summarizes that information. So overall, we would put that at about $162 million. The caveat I would give is that, that entire retail commercial real estate has a great degree of variability in terms of risk just based on what the underlying tenants look like.

Got it. Sorry, I may have missed in the slide deck the number there. Thanks for the detail there. I guess moving to the fee income bucket. Previously, obviously, things have changed quite a bit. But I think in the last call, you mentioned the retirement benefits line item expected to be flattish in '20. You've obviously got a jump-start on a pretty solid mortgage production this year. Any thoughts on how we navigate through the year in terms of a fee income contribution?

Thanks, Jeff. This is Katie. Certainly, I can't emphasize again the uncertainty that we will, that we're seeing in our fee income as well as in our margin and provision expense. Really as we break down each component, we are continuing to see mortgage operate at extremely high levels of applications through April and May. We are seeing now a transition to, actually, I think the most recent was 30% purchase versus refi. And so the sustainability of that, I think, is something that we're not exactly sure of. That being said, we have not done really any marketing or active reach out to our clients. So I think we'll see a strong second quarter for mortgage. And then after that, again, just the uncertainty of how long and the duration of the crisis will have an impact.On the retirement side, we're very pleased with the year-over-year growth. The market-sensitive revenue will certainly be impacted in a sustained down market. And -- but that's just a portion of the revenue. There are other attributes of that revenue, which bears some uncertainty today. That would be -- those would be around the distribution and the loan and the fees surrounding those. We have seen only a modest increase in distributions and loans coming into April, and we have not been waiving any fees on those though there is some of our competitors who are doing that. The other piece of the retirement revenue would be our ESOP transaction fees, which are typically heavily weighted toward the fourth quarter, but most of those transactions are on hold, too.So -- and on the wealth management side, again, really impressive growth, impressed about reach by our advisers and just really highly dependent on the market volatility there. So that's a lot. But I guess what I would say is where we see today and where we see the second quarter, I think that -- I think our results for the first quarter can be sustained at least into the second quarter.

Fair enough. Thanks. And maybe 1 last one, just on the -- Randy, you spent a good amount just sort of detailing the diversity and the -- I guess, the position that you put Alerus in is almost acknowledging some trying times, but part of that is setting yourself up for being opportunistic, should things return to some form of normalcy. I guess on the M&A side, how do you view having those conversations and anything that's kind of that you're looking at on that and maybe as a back burner item, but should we kind of emerge from this? What are you thinking about on M&A? Thanks.

I'll offer a couple of thoughts. In your choice of words, which is true. Right now, we definitely have put that on the back burner. Our focus is, as I expressed, our employees, our clients and then just making sure that we operate from a great source of strength with a fortress balance sheet. That being said, we do have that past experience, which I think is real, and I think is very much a part of our culture that every one of the 9/11, 2009. We entered those periods, which I think again speaks to the conservative financial guidelines of the company, philosophies of the company is that I think we entered those in very, very good balance sheet strength, and we were able to take advantage of opportunities. So as a result of the IPO last year, heading into 2020, top of mind was really the deployment of that capital. And we were in some discussions with some key -- or key companies. And we have visited with them and put them on hold and we'll reengage with our Board at the right time.

Great. Thank you.

Our next question will come from Nathan Race with Piper Sandler. Please go ahead.

Good morning. This is actually Bob Shone on for Nathan. My first question is around the strong deposit growth you saw in the quarter. You mentioned that you had $200 million of the PPP loans go directly into operating accounts. Can you maybe talk about the excess liquidity and how that impacts the margin going forward?

Sure. This is Katie. Great question. Yes. So the PPP loans, which were disbursed, of course, in April, significant impact on the margin, if we can continue to keep those fundings in-house. What we also don't know, which impacts the margin is the speed at which those pay off and the recognition of those fees upon paying off. But it is, there will be lumpiness in the margin. So I think it's kind of anybody's guess as to how it plays out. But I think because of the fees and, because we do anticipate at this point that a majority of the loans will pay off within the first 6 months or so of disbursement. I think that we will see the margin actually kind of stabilize with where and potentially increase in 2020, assuming again that those loans pay off fairly quickly, and we recognize all the fee income within the net interest margin or a majority of the fee income in the margin.

Okay. And then in regards to the PPP loans, do you by chance know the percentage of commercial loans that were granted payment relief that have also been approved for PPP loans?

Yes. This is Karin. I don't have the exact percentage, but there has been a correlation between the 2.

Okay. And then you spoke to both approving PPP loans for existing and new customers. Do you guys have the breakdown by chance between new and existing clients? And then maybe if you could provide some color on how those new clients came to the bank? Were they existing prospects or them calling in?

Sure. So that during the first round, the 900 loans we did initially for just over $300 million. About $40 million of that $300 million was either to existing clients who didn't have a previous lending relationship with us. So they had a different kind of relationship or a few new clients. We were really focused on prioritizing our existing clients through that first round. I can tell you that through the second round, we have seen more applications from prospects. And those are primarily prospects that we've been working with in our markets for some time in order to win their business.

Okay. And then last one for me. In the slide deck, I saw that you provided the average LTVs for the residential real estate portfolio. But do you by chance have the average loan to values of the CRE portfolios that you deem more at risk, the retail, medical and hotel?

I don't have the actual LTVs. I can tell you that our LTV limits are generally 75%. And on retail, sometimes it's lower than that. In terms of the hotels on the books, 1 larger relationship is newer and would have been within those target limits, the others have been aged on the books for some time.

Our next question will come from William Wallace with Raymond James.

Maybe as a quick follow-up to the PPP lines of questioning. Correct me if I heard this wrong, but of the $300 million, you're saying $40 million works in non-lending customers, but all $40 million were, or almost all $40 million were customers of the bank in another form. Is that correct?

That's correct. There were a few customers new to the bank but not many.

Okay. And what are the average fees on that $300 million?

In terms of dollar amount?

Yes. Or if you, yes if you know the dollar amount of the fees expected or the percentage, either way is fine.

8.8 in total fee, about $8.8 million in total fees on the first, round about 2.95% on average.

And then what is the pipeline on the kind of the second wave here?

So we received over 500 applications. And those are tending to be lower dollar loan amounts. And so we're looking at about $57 million or $58 million in the pipeline.

The average fees on that, I assume it's probably higher given the...

The percentage will be higher because the loan size is somewhat smaller, yes.

So okay, I'm going to ask the margin question in a different way. Let's just take PPP out of the equation. What would you anticipate to see on a net interest margin in the second quarter ex all of that noise?

Certainly a decline. The commercial portfolio we expect, excluding the PPP loans, would have dropped probably about 20 basis points in yield. Now what we have done has been very aggressive on our deposit cuts. And so we expect moving into the, an average of 30 basis points cuts by product moving into the second quarter and continuing on through the year, as we talk about those pools of deposits that reprice every quarter, a couple hundred million of that was that 1.64% at the end of March. We anticipate that moving down to well below 1% by the end of the year. So there is some balance there, but we would have expected to see continued compression in the yield without the, within the NIM without the PPP loans.

So I'm wondering if you could maybe help quantify it. If I look at your scenarios in your K, 150 basis points of cuts within the, implies as much as close to 40 basis points of pressure to the NIM. I don't anticipate it would be that great. I wondered if you could just kind of putting all those pieces together will give us a sense of what that level of pressure might be.

I think with the deposit cuts, I think it could be all together on the NIM, probably about 20 basis points pressure.

And then the wealth and retirement businesses, you mentioned in your preamble the fees calculated on average daily basis. Can you kind of give us a sense of what's left in the second quarter? Are we talking about probably starting at a level of down about 10%?

Right.

Okay.

Right. So yes, I think that's -- yes, we certainly got some recovery. So we're not going to see the 20% impact that we saw those couple of weeks in March.

Yes. Great. Okay. And then obviously, whatever happens for us this quarter will inform the ultimate result. In the prepared remarks, there was two comments about mortgage. I believe you said there was a pipeline hedge loss. And then I didn't catch the dollar amount there. And then I think as you said a $400,000 impairment on the MSR. Is that can you give me that dollar amount of the hedge loss? And then also does that $400,000 impairment, did that flow through the fee income line?

Yes, no problem. So approximately $900,000 of unrealized loss in the mortgage revenue line item at the end of the first quarter. And then there was an approximately $400,000 of expense in the mortgage and lending expense line item that related to the MSR impairment.

Okay. I thought maybe it went through expense. So where does that roll up to? Is that in other on the consolidated financials?

That is it gets own separate line item on mortgage and lending expense.

Okay. Yes. All right. Thank you. And if you could -- on the retirement and businesses segment, I'm just -- can you kind of -- Randy, maybe this is for you, just kind of talk us through bigger picture how this shutdown disrupts that business if it disrupts it? And how -- what it takes to kind of get back to "normal"? Not talking about market moves, but just sort of the customer acquisition and customer retention side of it? Thanks.

Wally, on what business is that?

The retirement and benefits business.

Yes. Randy, maybe I'll take that one to start, and you then you can supplement.

Sure, go ahead.

So on the retirement business, in terms of -- let me start with clients. First of all, there's obviously a lot of outreach to our clients. Randy talked about that in the call, but the CARES Act could increase distributions, it could increase loans. From a new business standpoint, we had a really solid pipeline coming in to the year and coming into the first quarter and the second quarter. Most of those clients have put us on notice of pause. So that is a strain on new business. But of course, it's a positive when it comes to attrition and clients that had notified us that they were leaving for one reason or another, certainly are pushing that out, too. I think the uncertainty that comes with this, and I don't think it's a 2020 impact, but we do service a fair amount of small businesses, small clients. And how they weather this form could mean that planned terminations because of closures becomes a headwind in the future. It could also mean that companies stop providing matches. And so we couldn't be at a risk of where outflows are exceeding inflows in terms of distributions exceeding those contribution levels. That's some of the color that I would provide on just the overall landscape of the business.

Okay. Thanks. And then I guess on the other side, to the extent that you guys have customers that may be leaving, they stick around as well. What's the turnover like in that business?

We usually see attrition of about 5%. So that's been declining as we've introduced a new technology that was, the technology investments were both an offensive as well as a defensive play. But historically, that rate has been about 5%.

[Operator Instructions] This concludes our question-and-answer session. I would like to turn the conference back over to Randy Newman for any closing remarks. Please go ahead.

Okay. First, let me extend our appreciation to everyone who joined our call this morning. Thank you for listening and asking questions. 2019 was a record year for Alerus, both in terms of our solid financial performance and also in terms of achieving strategic nonfinancial initiatives. We were fortunate to have had our IPO last year for many reasons. We were very optimistic in the first quarter of 2020 of sourcing opportunities to deploy the capital that we raised and to continue the strategic growth of the Alerus franchise.Due to COVID-19, we have prudently paused these efforts and focused on our employee safety, serving our clients and making sure that our balance sheet is fortress strong. While we are concerned about the health-related impact of the virus and the resultant effects on our economy and borrowers, we are patient, focused and ready to pursue at the right time, strategic opportunities when they present themselves. For the reason expressed during today's call, we are confident in our leadership abilities to manage through the crisis and we believe that our strong balance sheet and core operating earnings will enable us to perform well during this period of economic uncertainty. Thank you again for joining today's call.

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