Arrow Financial Corporation — 2015 Form 10-K Summary
Reporting period: Fiscal year ended December 31, 2015; fourth-quarter results are also presented. Arrow is a New York bank holding company operating Glens Falls National Bank and Saratoga National Bank, principally in northeastern New York, with related trust, investment-advisory and insurance businesses.
Financial performance and condition
| Metric | 2015 | 2014 | Change |
|---|---|---|---|
| Net income | $24.7 million | $23.4 million | Up 5.6% |
| Diluted earnings per share | $1.91 | $1.81 | Up 5.4% |
| Net interest income, GAAP | $65.9 million | $61.1 million | Up 7.9% |
| Net interest income, tax-equivalent | $70.3 million | $65.6 million | Up 7.2% |
| Noninterest income | $28.1 million | $28.3 million | Down 0.7% |
| Noninterest expense | $57.4 million | $54.0 million | Up 6.3% |
| Return on average assets / equity | 1.05% / 11.86% | 1.07% / 11.79% | ROA lower; ROE higher |
Fourth quarter: Net income was $6.6 million and diluted EPS was $0.51, versus $6.4 million and $0.49 in fourth-quarter 2014. The quarter’s tax-equivalent net interest margin was 3.15%, compared with 3.17% a year earlier.
- Margins and revenue: Full-year tax-equivalent net interest margin was 3.17%, unchanged from 2014. Growth in average loans and earning assets drove higher net interest income; lower deposit costs helped offset declining asset yields.
- Credit quality: Loans grew 11.4% to $1.574 billion. Nonperforming loans declined to $6.9 million, or 0.44% of loans, from 0.55%. Net charge-offs were $879,000, or 0.06% of average loans. The allowance was $16.0 million, equal to 1.02% of loans, versus 1.10% in 2014.
- Cash flow: Operating activities provided $28.9 million; investing activities used $229.5 million, principally reflecting a $164.7 million net increase in loans and securities purchases; financing activities provided $205.4 million, including $127.5 million of deposit growth and increased borrowings. Cash and cash equivalents ended at $51.1 million, up from $46.3 million.
- Balance sheet and funding: Total assets rose 10.3% to $2.446 billion; deposits increased 6.7% to $2.030 billion; stockholders’ equity rose 6.5% to $214.0 million. Year-end borrowings included $105.2 million of short-term borrowings, $55.0 million of FHLB term advances and $20.0 million of junior subordinated obligations.
- Liquidity and capital: Management reported no material liquidity constraints. Unused borrowing capacity was approximately $260 million at the FHLB and $320 million at the Federal Reserve discount window; the basic liquidity ratio, including FHLB capacity, was 12.1% of assets. Arrow’s year-end CET1, Tier 1 risk-based, total risk-based and leverage ratios were 12.8%, 14.1%, 15.1% and 9.3%, respectively; the company and both banks were classified as well-capitalized.
- Returns to shareholders: Cash dividends were $0.99 per share for 2015, and the company declared a $0.25-per-share first-quarter 2016 dividend. A new 2016 repurchase authorization permits up to $5 million of purchases at management’s discretion.
Material changes and notable items
- Growth in lending—particularly residential real estate, automobile, commercial and commercial real estate loans—was the principal driver of higher net interest income. Average earning assets increased 7.2%.
- Noninterest expense rose $3.4 million, led by salaries and benefits, third-party and data-processing costs, and legal and professional fees. The reported efficiency ratio increased to 58.09% from 57.21%.
- Noninterest income was slightly lower: increased fiduciary income was offset in part by lower insurance commissions and loan-sale gains. Arrow sold its Loomis and LaPann insurance agency in October 2015. Other operating income included a $204,000 gain on an insurance agency sale and a $404,000 write-down of a bank-owned property transferred to other real estate owned.
- Other real estate owned increased to $1.9 million from $312,000. Potential problem commercial loans totaled $24.6 million, down from $27.3 million, but management noted that these loans could become nonperforming.
- Available-for-sale securities had net unrealized gains of $1.0 million at year-end, compared with $4.2 million in 2014. The filing attributes fluctuations primarily to market rates; management considered identified unrealized losses temporary.
Outlook, risks and contingencies
Management provided no specific earnings or growth guidance. It cautioned that it could not assure continued loan growth, margin stability or earnings growth. It expected loan yields could continue to decline in 2016, potentially at least as quickly as deposit costs, and described the low-rate environment and flattened yield curve as ongoing pressures. The company’s model estimated that a 200-basis-point rate increase would reduce net interest income by 2.1%, while a modeled rate decrease would reduce it by 1.0%; these are hypothetical sensitivities, not forecasts.
- Key risks include local and national economic weakness, loan losses and adequacy of the allowance, competition, interest-rate and liquidity exposure, cybersecurity and third-party service-provider risks, and added regulatory costs and capital requirements.
- Municipal deposits are seasonal and represented approximately 29%–35% of deposits. Arrow began using reciprocal brokered deposits for certain municipal relationships; the year-end balance was $23.8 million.
- Unfunded commitments to extend credit were $278.6 million, and standby letters of credit totaled $3.1 million. The filing states these commitments generally expire undrawn and are not expected to cause material losses.
- Arrow held 45,686 Visa Class B shares with no economic value recognized. It described possible indirect contingent exposure to Visa litigation if remaining escrow funds prove insufficient, while stating it believed the escrow was substantially sufficient.
- No material pending legal proceedings were reported. KPMG issued unqualified opinions on the financial statements and internal control over financial reporting; management also concluded disclosure controls were effective.
Important facts for investors to verify
- Whether loan growth continues without weakening underwriting, and whether auto-loan credit trends, potential problem loans and other real estate owned develop adversely.
- Whether net interest margin and net interest income withstand further asset-yield compression, deposit repricing and changes in the yield curve.
- Whether expense growth, especially compensation, technology and outsourced services, moderates relative to revenue growth.
- How deposits, municipal funding seasonality and borrowings evolve, and whether liquidity and capital remain comfortably above regulatory requirements as new buffers phase in.
- The future effect of the Loomis sale, Visa-related contingent exposure, securities valuation changes, and the company’s discretionary 2016 repurchase and dividend decisions.