Good morning, and welcome to the Alerus Financial Corporation Earnings Conference Call. [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 earnings release and the company's SEC filings. I would now like to turn the conference over to Alerus Financial Corporation's President and CEO, Katie Lorenson. Please go ahead.

Thank you. Good morning, and thank you for joining us today. I'm Katie Lorenson, President and CEO, and I'm pleased to be here with our Chief Financial Officer, Al Villalon; our Chief Operating Officer, Karin Taylor, our Chief Banking and Revenue Officer, Jim Collins; and our Chief Retirement Services Officer, Forrest Wilson. Each of these leaders continues to play a crucial role in driving our company's progress to transformational growth and top-tier performance. This quarter marked a significant step forward in our journey to deliver long-term, sustainable, top-tier performance as we reported an adjusted earnings per diluted share of $0.72, which represents an adjusted return on assets of 1.41%. Our results reflect our efforts to build on the strength of our uniquely diversified business model combining traditional commercial and private banking, with the highly valuable and capital-light fee-based businesses in Wealth Management and Retirement and Benefits. This business model not only differentiates us in the growing communities and client base we serve, it also provides resilience across economic cycles and the ability to outperform traditional banks. We're seeing encouraging momentum across our core businesses. The transformation in our Commercial Wealth Bank is nearing completion, with our focus turned towards maximizing the capacity in our organization and infrastructure to further enhance profitability. While we continue to see the benefit of purchase accounting, we are replacing this with disciplined pricing on renewals of the core client base. During the quarter, deposit outflows were as expected from public funds and tax payments, while client retention in legacy Alerus, and the recently acquired Home Federal portfolio remained at high levels. We see robust opportunities in our lending pipeline, but we'll continue to be highly selective with our team focused on deposit-rich opportunities and prioritizing full C&I relationships. We also took proactive steps to optimize…

Thanks, Katie. Turning to Page 11 of our investor deck that is posted in the Investor Relations part of our website. On a reported basis, net interest income increased 4.6% over the prior quarter, while fee income increased 15%. The increase in net interest income was primarily driven by remixing of maturing loans being replaced by organic loan growth at higher spreads, while interest expense remained relatively stable. Our fee income remains over 40% of revenues and well above the industry average of 19%. Let's dive into the drivers of net interest income on the next slide. Turning to Page 12. In the second quarter, net interest income continued to reach new heights at $43 million, and our reported net interest margin increased another 10 basis points to 3.51%. Our net interest margin continues to show improvement. Our total cost of funds remained stable at 2.33%. We had 45 basis points of purchase accounting accretion in the quarter. Of those 45 basis points, 9 basis points were from early payoffs. We remain disciplined in pricing as we continue to not price on the version of the yield curve for loans. In the second quarter, we continue to see strong spreads, which contributed to core net interest margin expansion, as average rate on loan portfolio during the quarter increased 8 basis points from the quarter -- from the end of the first quarter. Let's turn to Page 13 to talk about our earning assets. At the end of the second quarter we either sold, or classified as held for sale over $60 million of hospitality loans. Net gain from the sale of all these loans was over $2 million. Excluding the loan sale and reclassification, loan growth was approximately 0.5% over the prior quarter, with the most growth in C&I and…

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

Al, I just wanted to circle back on -- I missed the margin piece there, or components of it. It sounds like accretion was running a little high. Could you repeat -- did you outline third quarter accretion expectations and fourth?

Yes, I did. So Jeff, for the third quarter, we're expecting 27 basis points of purchase accounting accretion, and for the fourth we're expecting 22. Neither of those numbers have any early payoffs embedded in it.

Okay. And I guess if we kind of unpack on a core basis expectations for -- on the core side in the second half?

Yes. In the second half, we still expect at the end of the year to have core margin improvement as we continue to see spreads on both loans and deposits to be above our core net interest margin.

Got you. And then the -- I think the noninterest income guide of -- you said that up low single digits is inclusive of the gains this quarter?

That is correct, Jeff.

Okay. Got it. Just I guess hopping over to the credit side, I wanted to check back in on the larger construction credit. I think we were headed towards occupancy or listing for sale this summer, June and July. So I just wanted to check back in to see where the status of that is?

Sure, Jeff. This is Karin. The final certificate of occupancy was issued and the property was listed for sale in the second quarter. That's a soft listing. The project continues to lease up. It's currently at 57%. And as that progresses, obviously, it will become better positioned for sale. There's just some minor work left on the outside to complete. So it's in line with our expectations.

Okay. Great. And the -- I guess on the CRE side, just the acquired -- could you recall what -- remind us what deal was that? And then are more cleanup in that segment contemplated?

Are you referring to the loan sale, or to this particular construction project?

The loan sale, I apologize, in the hospitality side.

The hospitality loan sale as part of the Home Federal portfolio. We saw an opportunity on that particular portfolio, the underwriting standards were a little bit more liberal than ours, and we had those well marked, and there was a market for those loans. So it was a good opportunity. We'll continue to look for those opportunities to reduce risk in our balance sheet, and make sure that our resources are aligned with our strategic objectives.

Okay. I mean, I guess, the question of do you think you've ring-fenced the areas that -- where that underwriting was a little more liberal? Have you kind of attack that piece? Or is it a case by case?

No, we addressed that with our identification of purchase credit deteriorated loans. And certainly, this particular group of loans was in that category.

Your next question comes from Brendan Nosal with of Hovde Group.

Maybe just starting off on the loan sale piece. For the piece that closed in this quarter, you recorded a nice gain on that sale. Just kind of curious for the $50 million you sold in July, any line of sight to a potential gain there?

No. Actually, there was just a very, very minimal loss on that one.

Okay. Got it. Got it. Maybe moving over to capital then. You folks created a fair bit of capital this quarter. Just with levels getting up to higher levels. Just kind of curious how you think about deployment for the rest of this year and maybe your thoughts on the M&A landscape?

Sure. Our capital priorities remain consistent, and as we've discussed in the prior quarters. Growing 44 basis points in Q2, consistent with where we had pro forma levels at post Home Federal. We are targeting to get to that 8% or higher TCE. But priorities are organic balance sheet growth with franchise accretive clients, as well as maintaining our dividend history, and M&A on the retirement side of the business, which is typically more of the bite-sized cash deals.

Okay. Perfect. I'm just going to sneak one more in here, on the Retirement business. Revenues were fairly flat for the quarter. But Al you noted nice AUA growth, but it looks like participants were down a little bit. Maybe just talk about which of these two AUA versus participants had a bigger impact on revenues for this business this quarter?

Forrest, I'm going to let you take that one.

Yes. So can you -- sorry, can you repeat that question really quick. It was the participants versus the AUA in terms of revenue?

Yes.

Yes, we had some onetime effects on participants that affected us this quarter. We did some clean out in our HSA business that was very impactful to us in a negative way in terms of participant count. With that said, these were zero balance participants that we weren't making any revenue off of. So in the future, you can expect participant account -- participant numbers to be going up as they have in the past and to see that trend continue. But there were some one-off events this quarter that led to that decline?

We now have Damon DelMonte with KBW.

First question on the loan growth and kind of the outlook that's supporting that. Are you seeing more demand across your footprint in the way of like new credits and new customers coming on board? Or is this the growth opportunities more from kind of leveraging your current client base?

It's leveraging the current client base, and it's taking market share. We're still not seeing a really solid, robust new generation of loans with clients and prospects necessarily. It's still the staff that we brought in all markets. It's really stealing market share from some of the other banks and increasing with our current client base.

Got it. And is there any areas, any segments that are stronger than others that have better opportunity for the growth?

No. We're sticking to full C&I and really focused on that lower mid-market. So we're still really focused on manufacturing, wholesaling and distributing. So that's really where we're focused. There's opportunities across the board in a lot of different segments. But with the team that is really zeroing in on that lower mid- market, that's where we're going to find most of our growth.

Got it. Okay. I appreciate that. And then, Al, with regard to the full year margin outlook of the 3.25% to 3.35%, is that like on a reported basis? So including like the benefit you guys got from the kind of the accelerated fair value accretion?

Yes, that is on a reported basis.

We now have Nathan Race with Piper Sandler.

In your prepared remarks, you referenced some technology upgrades and platform transition. So just curious, maybe, Katie, if you can kind of speak to how some of these technology initiatives could increase, kind of the capture rate across new clients within the Alerus franchise? And just how you see opportunities to also increase existing client wallet share with all these upgrades as well?

Sure. I'll start and then Jim can add on where I miss. So we did a full conversion of our Wealth Management business that was completed in the second quarter. It went very well. In this platform, really improves the client experience, as well as the adviser experience, and the operational experience. And so we believe besides our differentiated recruiting proposition that we have to advisers, this platform allows them to kind of level set in terms of their experience, in addition to the opportunities that they have within our organization because of the retirement synergies.

Yes. I would say, Katie is right on. The new platform on the wealth side will allow us to leverage our current staff and then allow us to recruit better, and it will be a better client experience. It will also allow us better analytics to dive into that synergistic relationship and see where we can help our clients in the other areas that we have in Alerus. The other piece is we have a very solid treasury management group to grow our C&I and we're putting on a new online retail and commercial online system, which acts the same way as the wealth platform. Better customer experience, better analytics and speed to market will be better.

Okay. Great. That's helpful. And then just turn to credit. Your nonperformers are still almost 2x that of peers on a relative basis when you just look at the percentage of loans. So maybe, Karin, just curious to get some thoughts on kind of the outlook for some larger resolutions, or just opportunities to bring down nonperformers going forward?

Yes. Nate, the numbers are really being driven by the same two large relationships that we've been talking about the last couple of quarters. And so as I mentioned earlier, the construction deal is performing as expected in terms of meeting time lines. Realistically, that's probably an early 2026 resolution. The other one is that large residential relationship, and we have -- we are pursuing legal action on that. And I would expect that would also be a first half 2026 resolution.

Okay. Great. And then maybe, Al, I appreciate all the commentary on the margin outlook, but can you just maybe update us in terms of the balance sheet sensitivity to a 25 basis point fed cut?

Yes. Nate, on a 25 basis point Fed cut, we do expect our NIM to improve about 5 basis points. As a reminder, though, our guidance does not have any rate cuts embedded in it.

We now have David Long with Raymond James.

Al, I just want to confirm on the deposit outlook, deposit cost outlook. Did you say up 8 basis points in the third quarter? And then as a follow-up, I just wanted to get a better understanding of what your assumptions are tied to that? And then also maybe some color on overall deposit competition?

David, what we're -- what I guided to was about 8 to 10 basis points of deposit cost increase in the third quarter, and then stable from there going forward. Jim, do you want to take on the deposit outlook?

Yes. The deposit competition is tough, right? We have staffed up with a couple of seasoned commercial deposit bankers. And obviously, I think I talked about earlier, we have a solid treasury management group. So our strategy is still focused on full relationships of mid-market C&I and business banking. I think we have the pieces in place. But the competition is tough and deposits are always hard to forecast, but we're sticking to our strategy.

And just to finish on that, David, too. I mean, if you're thinking about not -- what Jim just said in competition being tough, we are expecting some mix shift from noninterest-bearing to interest-bearing that's going to put that pressure. That's part of the 8 to 10 basis points increase that we're guiding to.

We now have a follow-up from Brendan Nosal with Hovde Group.

Apologies. I just wanted to circle back to the fee income outlook. Because it looks like year-to-date you've got quite a bit of momentum. I think core fees are up, I don't know, 10 or so percent year-over-year through the first half. So just kind of help me square up the [indiscernible] progress you've made year-to-date versus that relatively stable fee outlook you after all of this year?

Right. Part of it, too, Brendan, is that, one, we're not forecasting any market outlook for the remainder of the year. Number two, we are expecting a seasonal downturn in our mortgage business. So the fourth quarter typically is one of our weaker ones for us, and now put some pressure on the fee income as well. And then we're expecting a little bit of a pullback maybe too in the third quarter in mortgage.

We have another follow-up from the line of Nathan Race with Piper Sandler.

It seems like there's been a good amount of M&A-related disruption in the Twin Cities lately. So just curious maybe what the appetite is to hire some additional producers, maybe on the commercial or private wealth side? Or you think some of those share gains are possible just with the existing teams capacity?

I would say at this point, we have capacity with our existing team, but we are always opportunistic. So if there comes a situation where we find the right person that could come into our culture and add some benefits to us right away, we would look at that. But right now, I would say we're pretty set with the team we have.

I can confirm this does conclude our question-and-answer session. And I would like to turn the conference back over to Katie Lorenson for any closing remarks.

Yes. Thank you. Thank you, everyone, for taking the time to listen and for your investment in Alerus. Thank you to our team members who continue to make Alerus better every day. While the macroeconomic uncertainty and competitive pressures remain, we're staying disciplined and focused on getting better and bigger. Managing credit risk proactively, maintaining strong capital and reserve levels, and investing in areas that align with our long- term strategy. While we acknowledge there's more work to do, we're confident in the path we're on, and we're proud of the incredibly talented team we have in place. Thank you, everyone. Have a great day.

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