Arrow Financial Corporation — Q3 2013 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2013. Arrow is a New York bank holding company operating two banks and insurance, trust, and investment-related subsidiaries. Financial amounts are in U.S. dollars; unless noted, figures below are in millions.
Financial performance
| Metric | Q3 2013 | Q3 2012 | Nine months 2013 | Nine months 2012 |
|---|---|---|---|---|
| Net income | $5.623 | $5.748 | $16.011 | $16.630 |
| Diluted EPS | $0.46 | $0.47 | $1.30 | $1.36 |
| Net interest income, GAAP | $14.127 | $14.525 | $41.470 | $43.185 |
| Net interest margin, tax-equivalent | 3.06% | 3.33% | 3.06% | 3.31% |
| Noninterest income | $6.939 | $6.835 | $21.184 | $20.202 |
| Noninterest expense | $13.133 | $12.922 | $39.818 | $38.719 |
Third-quarter return on average assets was 1.06% and return on average equity 12.42%, down from 1.16% and 13.14%, respectively, a year earlier. Nine-month returns were 1.03% and 11.99%, versus 1.12% and 13.01%. The nine-month efficiency ratio was 60.25%, compared with 58.49%.
For the nine months, operating cash flow was $26.2 million; investing activities used $123.2 million, largely reflecting securities purchases and loan growth; financing activities provided $120.2 million, principally from deposit growth. Cash and cash equivalents ended at $72.1 million, versus $136.4 million a year earlier.
Financial position, lending, and capital
- At September 30, total assets were $2.157 billion, up 6.6% from December 31, 2012. Loans were $1.243 billion, up 6.1%; deposits were $1.895 billion, up 9.5%. Deposit growth was attributed mainly to municipal deposits, alongside growth in other customer deposits.
- Stockholders’ equity was $182.7 million. Tangible book value per share was $12.69; book value per share was $14.82. The company and both subsidiary banks met the filing’s “well-capitalized” standard. Arrow’s Tier 1 leverage, Tier 1 risk-based, and total risk-based capital ratios were 9.37%, 14.59%, and 15.69%, respectively.
- Interest-bearing deposits at banks were $24.5 million. Borrowings included $16.0 million of federal funds/repurchase agreements, $20.0 million of FHLB term advances, and $20.0 million of junior subordinated obligations (trust preferred securities). No FHLB overnight advances were outstanding at quarter-end.
- The allowance for loan losses was $14.6 million, or 1.17% of loans. Nonperforming loans were $7.5 million (0.61% of loans); nonperforming assets were $8.0 million (0.37% of assets). The allowance equaled 193.32% of nonperforming loans.
- Available-for-sale securities were $486.9 million and held-to-maturity securities $273.6 million. Unrealized losses reduced accumulated other comprehensive income during the first nine months; management attributed securities valuation changes chiefly to higher market rates and said it did not expect to sell temporarily impaired securities before recovery.
Changes versus comparable periods
- Q3 net income declined 2.2% and diluted EPS fell one cent year over year. Nine-month net income declined 3.7% and diluted EPS fell from $1.36 to $1.30.
- Management attributed weaker earnings mainly to net interest margin compression. Q3 tax-equivalent net interest income fell 1.5% despite 7.1% growth in average earning assets; nine-month tax-equivalent net interest income fell 2.5% despite 5.6% growth in average earning assets. Lower asset yields were only partly offset by lower funding costs.
- Noninterest income rose 1.5% in Q3 and 4.9% year to date, led by customer fees, fiduciary income, and insurance commissions. Loan-sale gains declined as Arrow retained a larger share of mortgage originations. Noninterest expense rose 1.6% in Q3 and 2.8% year to date.
- The nine-month loan-loss provision was $0.2 million, versus $0.67 million in 2012; there was no provision in Q3 2013. Net charge-offs for the first nine months were $0.914 million, including a $0.753 million commercial loan charge-off in Q1 that had been fully reserved previously.
Outlook, risks, and unusual items
- No specific earnings or revenue guidance was provided. Management cautioned that margin compression could continue: asset yields may keep declining as higher-yielding loans mature, and deposit costs could reprice faster than asset yields if rates rise. Higher long-term rates could support margins but may weigh on loan demand.
- Management cited economic and regional conditions, competition, interest-rate and yield-curve movements, deposit seasonality, loan demand and credit quality, regulatory changes, and potential inflation as risks. It reported no liquidity problems and described its liquidity position as sufficient, supported by core deposits and borrowing capacity, including $212.4 million of unused FHLB capacity and $296.7 million available through the Federal Reserve discount-window facility.
- Interest-rate sensitivity modeling estimated net interest income decreases of 7.24% under a hypothetical 200-basis-point rate increase and 1.14% under its modeled decline in long-term rates. The filing stresses these are scenario estimates, not forecasts.
- A one-time tax-credit benefit lowered the effective tax rate in 2013. The 2012 comparison included a $0.294 million pre-tax reversal of a Visa litigation reserve and a one-time gain from a business-incubator partnership. A 2% stock dividend was distributed in September 2013; reported per-share data were restated. The board declared a $0.25-per-share fourth-quarter cash dividend, payable December 13, 2013.
- Management said it expected to meet the new, phased-in capital rules even if they had applied at quarter-end. It identified no material pending legal proceedings and reported effective disclosure controls.
Important facts for investors to verify
- Whether net interest margin and net interest income stabilize as interest rates and asset yields change.
- Whether deposit growth—particularly municipal deposits—is sustained, and how much funding costs rise if competition or rates increase.
- Trends in loan growth, nonperforming loans, charge-offs, and allowance coverage, including the composition of the automobile and real estate portfolios.
- The effect of securities valuation changes on equity and the timing or terms of the new regulatory capital requirements.
- Whether the announced dividend and any future repurchases remain supported by earnings, liquidity, and regulatory capital.