Alerus Financial is a Growing Financial Services Company Hiding Behind a Bank – ALRS

Alerus Financial has provided banking services to North Dakota residents since 1879 as the second bank chartered in the Dakota Territory. In 2000, Alerus began expanding beyond traditional banking into wealth management, retirement planning and mortgage origination. Today, over 60% of revenues are generated by these non-traditional activities. Alerus’s physical footprint now includes Minnesota and Arizona in addition to North Dakota.

Traditional Banking

Alerus provides banking services to individuals and businesses, including small business and agricultural loans. The importance of loan quality can hardly be over-estimated and Alerus’s loan book is pristine. Bauer Financial’s September 30, 2012 report on Alerus showed a Texas ratio of only 5.03%, indicating a vanishingly low risk of failure. Non-performing assets as a percentage of total assets were 1.51%.

Alerus’s loan-to-deposit ratio is in line with its peers at 80.5%. Alerus does have high exposure to commercial real estate and commercial/industrial loans which make up 58.4% of the total loan book. However, the bank’s strong asset quality figures argue for the quality of these loans. Alerus’s deposit base is not dependent on brokered CDs or balances. Alerus is well-capitalized, with an equity to total asset ratio of 11.0% at September 30,2012.

Perhaps the strongest argument for Alerus’s continued success in lending is the rosy economic condition of the bank’s largest markets. North Dakota’s unemployment rate is the lowest in the nation at 3.2% and Minnesota’s is benign at 5.4%, compared to the national average of 7.7%. Alerus’s clients are in far better condition to meet their loan obligations than their peers in other regions.

While Alerus’s traditional banking operations no longer account for the majority of the company’s revenues, it does not mean the business is being neglected. On the contrary, Alerus is opportunistic, acquiring deposits and loans from several failed banks over the last few years and executing loss-sharing agreements with the FDIC. The result (in tandem with organic growth in deposits) is annual deposits growth averaging 12.1% since 2004. While they are technically liabilities, deposits are the “fuel” that allow banks to increase the size of their loan books and increase profits. Net loan growth has averaged 8.7% since 2004.

Net interest income after loan losses reached a record $46.41 million in 2012, more than doubling since 2004.

Wealth Management

Alerus’s assets under management and administration reached a record $11.2 billion as of December 31, 2012, up 14.9% year over year. This figure benefited from the February, 2012 purchase of PensionTrend, Inc and PensionTrend Investment Advisors which added $720 million to assets under management and administration. Alerus Financial’s wealth management practice has been a growth area for the company, with fees rising from $15.44 million in 2004 to $39.39 million in 2012. Alerus manages retirement plans for clients in 49 states.

Wealth management is a great business model and a natural addition to a bank’s core operations. Wealth management is extremely capital light compared to regulated banking, and features very high operating margins. For the price of a some additional personnel, computer systems and some marketing dollars, a bank can build a wealth management practice based on its existing relationships with depositors and borrowers. A wealth management business’s growth is two-pronged: through increasing account sizes through investment returns and through adding new clients.

Mortgage Origination

Alerus’s newest growth business is its mortgage origination group, begun in 2009 with the purchase of Residential Mortgage Group in the Twin Cities. In 2012, mortgage origination revenues reached $32.08 million, almost double that of 2011. Loans originated by the mortgage group are resold to other banks or agencies.

A Non-Bank Bank

Over the last decade, Alerus has transformed itself from a small but successful North Dakota community bank into a fast-growing diversified financial services company with a national footprint. In 2004, traditional banking accounted for 50.7% of revenues, declining to 36.7% in 2012. Expanding into lucrative wealth management and mortgage origination businesses has allowed Alerus to improve its asset turnover. In 2012, Alerus produced 10.94 cents in revenue for every dollar of assets on its balance sheet, compared to 7.32 cents in 2005. Return on average common equity hit 15.32% for 2012.

Income from traditional banking will likely continue to decline in significance as Alerus’s other businesses grow. However, all of Alerus’s lines of businesses have experienced remarkable growth in revenues. The chart below provides annualized figures.

ALRS growth

The high growth in net interest income shown in recent years is an anomaly. Falling short-term rates have allowed banks to earn increased spreads on loans versus deposits. In the long run, growth in net interest income will converge to growth in deposits, as can be seen in the five year figure.

High Growth, Low Valuation

While Alerus has transformed into a high-growth financial services provider, investors are still valuing the company like a sleepy community bank. Alerus has a five year compounded earnings growth rate of 11.5%, yet the company trades at only 9.0 times trailing earnings. Alerus was profitable all through the financial crisis and more than doubled its dividend over the last decade.

ALRS record

Alerus trades at 1.12 times total equity and 1.31 times common equity. 1.31 times common equity may seem dear at a time when many small banks trade well below book value, but Alerus’s trouble-free loan book, attractive non-bank businesses and exceptional return on equity more than justify the premium to book value.

Investors in Alerus have done well. At today’s bid/ask mid-point, Alerus stock produced a total return of 33.8% for the last five years, compared with 27.3% for the S&P 500. And yet, Alerus’s modest valuation leaves plenty of room for Alerus to rise.

Disclosure: I own shares in Alerus Financial.

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6 Responses to Alerus Financial is a Growing Financial Services Company Hiding Behind a Bank – ALRS

  1. Don says:

    Great post.
    I like this bank, however, a few concerns include:
    The fact that this is a small regional bank. The problem with this bank and with other small banks are the uncertainties associated with financial reform. An example is the rising insurance costs imposed by the FDIC on these banks (http://online.wsj.com/article/SB10001424127887324096404578354461397993792.html). The reforms have just begun and a lot of uncertainty remains on what the future of the industry will look like… thus explaining the reason why many small/mid size banks are trading at a discount.

    Also in regards to the wealth management division. 1) ETF’s will make a dent in the WM industry. This change is partially cyclical and partially structural. 2) WM charges clients a fee of at least 1-2% of total assets per annum. With interest rates at historical lows, a client will think twice before handing his money over to WM… 3) One must also consider the changes in regulations for the WM industry.

    I think you’re blog is great along with you’re writing and ideas. I’d like to know what you think about these points.

    • John Huber says:

      I was doing some research on ALRS, and I thought I’d make a few comments after reading the post, mainly some food for thought to the two comments above. I considered the fact that ND is experiencing low unemployment because of the oil boom, but I would counter that point by some facts from the 2012 annual report that I think indicate the staying power of this quality bank…. Over the past 30 years, ALRS has averaged 1.15% ROA and 12.24% ROE. They have made around $200 million in earnings, they’ve paid out around $60 million in dividends, and they’ve repurchased about $35 million of stock. They’ve retained the balance, and they’ve grown their book value from $12 million to $134 million over that time.

      Also, they’ve raised their dividend just about every year since 1980, averaging 9.0% CAGR in dividend growth.

      They’ve achieved these excellent returns while keeping risk very low and loan losses to a minimum.

      I think this is an outstanding bank with an excellent asset management business that is becoming a larger piece of the pie, which should drive ROE higher over time if that continues.

      Also, consider that they made $43.4 million on AUM of around $12.9 billion in 2013, so the fees are much lower than the 1-2% that you are assuming. (I calculate roughly 0.36% on average AUM for 2013).

      As Dave mentions in the post, asset management is an excellent business model with high returns on capital. Many of the best asset managers have operating margins of 30% or more (some of the best have 40%+). If we estimate 30% margins on $43.4 of revenue, this business line produced an estimated $13 million of operating earnings in 2013.

      That’s significant when you consider that most asset managers are valued at 10-15 times operating earnings and this entire company is worth around $230 million. I wouldn’t necessarily value ALRS using sum of the parts, but I like the fact that the asset management business is growing to become a larger piece of the pie.

      I think this is an excellent business with a long stable history of producing excellent returns on equity with prudent loan underwriting.

      Nice post!

      • otcadventures says:

        John, could not agree more on Alerus. The company is actually a quickly-growing asset manager with a strong bank attached, but it’s valued like a regular, average bank. I’ve held Alerus since I wrote this post a while back, and the stock has done very well. I think there is plenty more upside to come.

  2. Dan says:

    North Dakota is experiencing an oil boom, when the boom goes bust Alerus will get hurt

    • The North Dakota oil is mostly shale oil and the deposit is massive — covering over 1/3 of the N.Dakota state (you can litterally sink a drill bit anywhere in the general vicinity and have a 98
      % chance of hitting oil) … This type of oil requires lots of drilling (slow flow) and fracing … Due to the massive size of the deposit (and Americas need and desire to be oil self sufficient) I doubt this will be a boom/bust type of oil program…. I see this oil economy in North Dakota lasting for 20 years….. Incedently Alberta Canada’s oil economy is the big looser, and the reason the price spread between US and Canadian oil has risen so sharply… I think its about $35 per barrel difference now.. As a side, there must be some good small energy services companies with good upside in the North Dakota area…

  3. Joe says:

    Good write up. I’d be tempted to buy it except it seems that an awful lot of their eps is coming from mortgage origination. This mortgage refi boom has been going on for longer than most expected, but I think is likely to die down one of these days when interest rates uptick or everyone has refi’d. It is a price to earnings play trading this high above tangible book. And I would be cautious paying a multiple for the mortgage origination earnings at this point.

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