Arrow Financial Corporation — Q3 2020 Form 10-Q
Business context and reporting period. Arrow Financial is a New York bank holding company operating two banks, alongside insurance, investment-advisory and other businesses. This unaudited filing covers the quarter and nine months ended September 30, 2020; comparisons are with the corresponding 2019 periods unless noted. Financial amounts below are in millions of dollars unless stated otherwise.
Key financial results and condition
- Q3 earnings: Net income was $11.0 million, up 9.7%; diluted EPS was $0.71, up from $0.65. Annualized return on average assets was 1.23% and return on average equity was 13.55%, down from 1.32% and 13.82%, respectively.
- Nine-month earnings: Net income was $28.3 million, up 2.2%, and diluted EPS was $1.83 versus $1.80. Annualized ROA and ROE were 1.11% and 11.99%, compared with 1.24% and 13.21%.
- Revenue and margins: Q3 net interest income rose 11.6% to $24.9 million, while interest and dividend income fell 2.3% to $27.3 million. Noninterest income increased 13.1% to $8.7 million, including $1.4 million in loan-sale gains. Noninterest expense rose 4.1% to $17.5 million. Q3 net interest margin was 2.90%, down from 3.07%; the tax-equivalent margin was 2.93%. For the first nine months, net interest income rose 11.7% to $72.7 million and margin was 3.00% versus 3.04%. The non-GAAP efficiency ratio improved to 51.34% for Q3 and 53.54% year to date, from 55.41% and 57.35%.
- Balance sheet and funding: At September 30, total assets were $3.78 billion, loans $2.59 billion, and deposits $3.26 billion. Year over year, assets grew 21.4%, loans 11.0%, and deposits 24.9%. The allowance for loan losses was $28.4 million, or 1.10% of loans, versus 0.90% a year earlier. Stockholders’ equity was $325.7 million; tangible book value per share, a non-GAAP measure, was $19.50.
- Cash flow and liquidity: For the first nine months, operating cash flow was $27.6 million, investing cash flow was negative $197.8 million, and financing cash flow was positive $550.7 million. Cash and cash equivalents increased $380.4 million to $450.7 million, largely alongside $648.8 million of deposit growth. Interest-bearing bank balances were $396.4 million. Management reported a 29.3% basic liquidity ratio including FHLB collateralized borrowing capacity and said liquidity was sufficient, while noting there can be no assurance.
- Debt and capital: Period-end borrowings included $73.9 million of federal funds/repo obligations, $50.0 million of FHLB term advances and $20.0 million of subordinated obligations; no FHLB overnight advances were outstanding. The company and both bank subsidiaries were reported well-capitalized. Arrow’s estimated CET1, total risk-based capital and leverage ratios were 13.20%, 15.28% and 9.17%, respectively.
Material changes and management commentary
- Lower funding costs and balance-sheet growth supported net interest income, but lower market rates, increased cash balances and PPP lending weighed on asset yields and margin. Q3 interest expense fell 57.6% year over year.
- Loan growth included approximately $142.7 million in more than 1,400 SBA Paycheck Protection Program loans. These loans yield 1%; Arrow expected approximately $5.1 million of origination fees, recognized over loan lives or accelerated upon forgiveness.
- The loan-loss provision was $2.3 million in Q3 versus $0.5 million a year earlier, and $8.1 million for the first nine months versus $1.4 million. Management attributed the increase to pandemic-related uncertainty. Net charge-offs were low at an annualized 0.02% of average loans in Q3.
- Nonperforming loans were $6.3 million, or 0.24% of period-end loans, versus $4.7 million and 0.20% a year earlier. COVID-related payment deferrals totaled $100.0 million, or 3.9% of loans, at September 30; the largest disclosed concentration was hotels and motels. CARES Act-qualifying deferrals were not treated as troubled debt restructurings.
- Management said COVID-19 had not materially adversely affected Q3 results but that the pandemic’s duration and overall business impact could not be reasonably estimated. It warned that economic restrictions, unemployment and market conditions could affect loan growth, borrower repayment, credit costs and mortgage/consumer originations. No formal earnings guidance was provided.
- Arrow deferred CECL adoption as permitted by the CARES Act. Based on its December 2019 parallel run, management expected an immaterial initial retained-earnings impact, while continuing implementation work. The filing also reported no material legal proceedings expected to result in material loss.
Important facts for investors to verify
- Whether PPP forgiveness timing and fee recognition meet management’s expectations, and how much PPP exposure remains in the loan book.
- Trends in COVID-19 deferrals, especially hotel and other exposed commercial real estate borrowers, delinquencies, nonperforming loans and future provisions.
- Whether deposit growth and unusually high cash balances persist, and the effect on net interest margin as low rates and funding costs evolve.
- Liquidity and capital capacity under stress; reported Q3 regulatory capital ratios were estimates, and the liquidity ratio includes available borrowing capacity.
- The actual timing and impact of CECL adoption and the sensitivity of allowance estimates to changing economic forecasts.