Executive Summary / Key Takeaways

• Alerus Financial (ALRS) is executing a strategic transformation into a premier Commercial Wealth Bank, leveraging its diversified model across Banking, Retirement & Benefit Services, and Wealth Management to drive consistent, top-tier returns.
• The recent Home Federal acquisition significantly expanded its footprint and client base, with integration on track and cost savings being realized, positioning ALRS for enhanced profitability and scale.
• Strong Q2 2025 financial performance, including diluted EPS of $0.78 and an adjusted ROA of 1.41%, demonstrates momentum, driven by disciplined loan pricing, strategic balance sheet optimization, and resilient fee income.
• Technological investments in wealth management and commercial credit platforms are enhancing client experience, improving operational efficiency, and supporting ambitious growth targets for wealth advisors and assets under management.
• While credit normalization and deposit competition present challenges, robust reserves, proactive risk management, and a clear strategic roadmap for organic growth and targeted M&A in fee-based segments underpin a compelling long-term investment thesis.

The Ascent of a Commercial Wealth Powerhouse

Alerus Financial Corporation, rooted in its 1879 founding as First National Bank North Dakota, has undergone a profound transformation, evolving into a "premier Commercial Wealth Bank" and a national retirement services provider. This strategic pivot, particularly pronounced in recent years, leverages a uniquely diversified business model that combines traditional commercial and private banking with capital-light, fee-based businesses in Wealth Management and Retirement and Benefits. This diversification is not merely a structural choice; it is a foundational strength, providing resilience across economic cycles and enabling Alerus to consistently outperform traditional banks.

The company's strategic journey is marked by a relentless focus on enhancing its Commercial Bank. This has involved a concerted effort to recruit key talent and expertise, specifically targeting mid-market and business banking clients. The success of this initiative is evident in the shifting composition of its loan portfolio: commercial loans now constitute over 70% of total loans, a significant increase from 58% at its 2019 IPO. Alerus has further diversified its offerings by rolling out a formal private banking service and establishing specialty verticals in SBA, government non-profit, and equipment finance. These initiatives are designed to capture "full relationships" that extend across banking, treasury management, private banking, and wealth management, fostering deeper client engagement and synergistic revenue generation.

Technological differentiation is a cornerstone of Alerus's strategy, underpinning its ability to deliver responsive and client-friendly solutions. The company has made significant investments in upgrading its digital infrastructure. This includes a new online retail and commercial online system, which is designed to enhance the customer experience, provide superior analytics, and improve speed to market. Critically, Alerus completed a full conversion of its Wealth Management business to a new platform in Q2 2025. This upgraded platform is expected to significantly improve both the client and advisor experience, offering a more streamlined and efficient operational environment. Management's long-term goal for this technology is ambitious: to double the number of wealth advisors and grow assets under management (AUM) at the same pace as banking assets. The new platform is a key differentiator in recruiting top wealth advisors, offering them a best-in-class user experience and leveraging the exceptional synergies available from Alerus's Retirement business. These technological advancements are not just about modernization; they are about creating capacity for growth, enhancing efficiency, and strengthening the company's competitive moat against larger, more generalized financial institutions.

The competitive landscape for Alerus is multifaceted, encompassing larger national players like Wells Fargo & Company (WFC) and U.S. Bancorp (USB), as well as regional banks such as Huntington Bancshares Incorporated (HBAN), KeyCorp (KEY), and Regions Financial Corporation (RF). Alerus differentiates itself through a community-focused approach and specialized expertise, particularly in its fee-based services. While larger competitors benefit from extensive geographic reach and broader digital capabilities, Alerus's personalized service and localized expertise foster stronger customer loyalty in its Midwest and Arizona markets. For instance, in wealth management and retirement services, Alerus's tailored solutions and integrated offerings provide a material efficiency advantage for small to mid-sized businesses, often surpassing the agility of its larger rivals. However, Alerus's smaller scale can lead to higher costs and potentially slower technological innovation compared to the substantial R&D budgets of national banks. The company actively addresses this by strategically repurposing FTEs for new hires and engaging consultants to optimize processes, aiming to "get better, not just bigger."

Financial Momentum and Strategic Execution

Alerus has demonstrated compelling financial momentum, particularly in the first half of 2025, reflecting the successful execution of its strategic initiatives and the benefits of its diversified model. For the second quarter of 2025, the company reported net income of $20.3 million, or $0.78 per diluted common share, a substantial increase from $6.2 million, or $0.31 per diluted common share, in Q2 2024. This performance translated into an adjusted return on assets (ROA) of 1.41% and an adjusted return on tangible common equity (ROTCE) exceeding 21%, placing Alerus firmly in the top quartile of the banking industry.

Net interest income (NII) for Q2 2025 reached $43.0 million, an impressive 79.3% increase from $24.0 million in Q2 2024. This growth was primarily driven by a $17.4 million increase in interest income, as average earning assets expanded by $1.0 billion and the average interest-earning asset yield rose by 43 basis points. The increase in asset yields was a direct result of disciplined organic loan growth at higher rates and the favorable impact of purchase accounting accretion. Concurrently, interest expense decreased by $1.6 million, largely due to an 85 basis point decline in the average rate paid on interest-bearing liabilities, influenced by the Home Federal acquisition and lower deposit rates following 2024 rate cuts. The net interest margin (NIM) on a tax-equivalent basis significantly improved to 3.51% in Q2 2025, up from 2.39% in the prior year period.

The company's fee income, a critical differentiator, remains robust, representing over 42% of total revenues in Q2 2025, well above the industry average of 19%. Total noninterest income for Q2 2025 was $31.8 million, a 16.0% increase from $27.4 million in Q2 2024. This was notably boosted by a $2.1 million gain from the strategic sale of non-mortgage hospitality loans. Wealth Management revenues increased by 15.8% year-over-year to $7.4 million, driven by improved market performance and the Home Federal acquisition's impact on assets under administration/management (AUA/AUM). Mortgage banking income also saw a 43.0% increase to $3.7 million, benefiting from a higher gain on sale rate and increased mortgage servicing revenue.

Expense management remains a core priority. Total noninterest expense for Q2 2025 was $48.4 million, a 25.0% increase from $38.8 million in Q2 2024. This increase was primarily due to higher compensation, employee taxes and benefits, intangible amortization (including a $33.5 million core deposit intangible from HMNF), and occupancy and equipment expenses, largely attributable to the Home Federal acquisition and increased headcount. However, the adjusted efficiency ratio improved to 62.4% in Q2 2025 from 66.9% in Q1 2025, reflecting core expense and revenue improvements.

Alerus maintains a strong capital and liquidity position. As of June 30, 2025, total assets stood at $5.32 billion, an increase of $62.1 million from December 31, 2024. Total loans were $4.04 billion, up $52.1 million, driven by growth in CRE, consumer, agricultural, and C&I loans. Total deposits were $4.34 billion, a slight decrease of $40.9 million, primarily due to seasonal outflows from public funds and a decrease in clearing deposits, partially offset by an increase in brokered deposits to diversify funding. The company's common equity Tier 1 capital ratio to risk-weighted assets improved to 10.54% from 9.91% at year-end 2024, and tangible common equity to tangible assets increased to 7.87% from 7.13%. Alerus has substantial liquidity, with $505.9 million in on-balance sheet liquidity and $2.2 billion in off-balance sheet liquidity, including $1.1 billion in additional FHLB borrowing capacity.

Outlook, Guidance, and Risk Assessment

Alerus's guidance for 2025 reflects a commitment to sustained performance, albeit with an acknowledgment that progress will not be linear. The company anticipates mid-single-digit loan growth for 2025, excluding loans moved to held for sale, driven by its strategy of taking market share in the C&I segment. Deposit growth is projected at low single digits, with an expectation of continued seasonal outflows from public funds in Q3, which the company aims to offset through organic growth.

The net interest margin is guided to be between 3.25% and 3.35% for 2025. This outlook incorporates several key assumptions: less purchase accounting accretion in the latter half of the year (27 basis points in Q3, 22 basis points in Q4, based on contractual payoffs), no expectation of early payoff-driven accretion, and an anticipated 8-10 basis point increase in deposit costs in Q3 due to mix shift and competition, stabilizing thereafter. Management projects core margin improvement in the second half of 2025, assuming no further Fed rate cuts, with a 25 basis point Fed cut potentially improving NIM by 5 basis points. Noninterest income is expected to be up low single digits on a reported basis for the year, factoring in the Q2 loan sale gain. Mortgage revenues are expected to ease in Q3 and experience a seasonal downturn in Q4.

Expense management remains a top priority, with an adjusted efficiency ratio targeted below 68% for 2025, driven by cost savings from the Home Federal acquisition. Core expenses for Q3 2025 are projected around $49 million to $50 million, reflecting investments in talent and technology. The company's capital allocation priorities remain consistent: supporting franchise-building organic growth, pursuing bite-sized M&A opportunities in the Retirement space, and maintaining its long-standing dividend payments.

Despite this positive outlook, several risks warrant attention. Credit risk remains a key focus, with nonperforming assets (NPAs) at 98 basis points in Q2 2025. The company proactively sold $60 million in non-owner-occupied CRE hospitality loans from the Home Federal portfolio, citing more liberal underwriting standards, which resulted in a $2 million gain and allowed for reserve reversals. Two large non-performing relationships, a construction project and a residential loan, are driving the current NPA figures, with resolutions anticipated by early 2026. While credit trends are normalizing, the company maintains robust reserves, with the allowance for credit losses at 1.47% of loans. Legal contingencies, including a DOL lawsuit related to its divested ESOP fiduciary services business, pose an unquantifiable but "reasonably possible" material loss contingency. Interest rate risk is actively managed through simulation models, but actual results may differ from assumptions. A material weakness in internal controls related to goodwill calculation in 2024 has been identified and addressed with new control activities and training.

Conclusion

Alerus Financial is in the midst of a strategic transformation, successfully evolving into a diversified Commercial Wealth Bank. Its core investment thesis is built upon the synergistic strength of its Banking, Retirement & Benefit Services, and Wealth Management segments, underpinned by a commitment to technological innovation and disciplined growth. The successful integration of the Home Federal (HMNF) acquisition, coupled with robust organic growth in C&I lending and resilient fee income, positions Alerus for continued financial momentum.

The company's Q2 2025 performance, marked by strong earnings and improving efficiency, underscores the effectiveness of its "One Alerus" strategy. While challenges such as credit normalization and intense deposit competition persist, Alerus's proactive risk management, robust capital levels, and clear guidance for loan growth, NIM expansion, and expense control provide a compelling roadmap for investors. The ongoing investments in technology, particularly in wealth management and commercial credit platforms, are critical differentiators that will enhance client experience, drive operational efficiencies, and support the long-term goal of achieving consistent top-tier performance and superior shareholder value.