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.

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.

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.