Arrow Financial Corporation — Q1 2017 Form 10-Q
Reporting period: Three months ended March 31, 2017; balance-sheet comparisons are to December 31, 2016 and March 31, 2016. Arrow is a New York bank holding company operating two banks and related financial-services businesses. The interim statements are unaudited; the independent accountant performed a review, not an audit.
Financial performance and position
- Earnings: Net income was $6.63 million, up 1.3% from $6.55 million. Basic and diluted EPS were $0.49, unchanged. Annualized return on average assets was 1.02% versus 1.07%; return on average equity was 11.43% versus 12.07%.
- Interest income and margins: GAAP net interest income was $18.46 million, up 6.3% from $17.36 million; tax-equivalent net interest income was $19.41 million, up 6.1%. Net interest margin was 3.15%, unchanged year over year. Interest expense increased 21.6% to $1.54 million.
- Other income and expenses: Noninterest income declined 2.6% to $6.70 million, including lower loan-sale gains and a $118,000 loss on limited-partnership investments. Noninterest expense rose 7.7% to $15.48 million, led by a 10.9% increase in salaries and benefits. The reported efficiency ratio was 59.01%; the filing gives differing prior-period comparatives in separate tables.
- Loans and credit: Loans were $1.81 billion, up 3.3% from year-end and 11.6% year over year. The allowance for loan losses was $17.22 million, or 0.95% of loans. Nonperforming loans were $4.37 million (0.24% of loans) and nonperforming assets were $6.11 million (0.23% of assets). Quarterly net charge-offs were $154,000; provision expense was $358,000.
- Liquidity and funding: Total assets were $2.66 billion, up 2.0% from year-end and 7.2% year over year. Deposits were $2.26 billion, up $140.0 million, or 6.6%, from year-end. Cash and cash equivalents ended at $64.80 million. Operating cash flow was $9.94 million; investing cash outflow was $44.05 million, mainly reflecting $57.64 million of net loan growth; financing cash inflow was $41.56 million.
- Debt and capital: Period-end borrowings included $32.0 million of overnight FHLB advances, $55.0 million of FHLB term advances, $32.0 million of federal funds and repurchase agreements, and $20.0 million of junior subordinated obligations. Stockholders’ equity was $236.11 million. The holding company’s CET1, total risk-based capital, and leverage ratios were 12.84%, 14.98%, and 9.37%, respectively; the company and both banks were reported as well-capitalized.
- Shareholder returns: The quarter’s cash dividend was $0.25 per share. The board declared a $0.25 second-quarter dividend. A $5 million 2017 repurchase authorization was in effect; $917,000 had been used under the program by March 31.
Material changes and management commentary
- Loan growth and a 7.2% increase in average earning assets supported higher net interest income. Average earning-asset yield rose slightly, while the cost of interest-bearing liabilities also increased; margin remained flat.
- Management attributed higher staff costs to increased staffing in the southern market, normal salary increases, and higher medical claims. Lower FDIC assessments partly offset expense growth.
- Deposits increased, including seasonal municipal balances following New York State aid payments. The company reduced overnight FHLB advances from $123 million at year-end to $32 million.
- Management reported stable local economic conditions and no material weakening in overall loan quality. It cited a rise in substandard commercial and commercial real estate loans to $38.9 million from $35.8 million at year-end, mainly after downgrades of three commercial borrowers; management expected full collection but said the loans would be closely monitored.
- Management expects residential real estate loan growth to continue in 2017. It cautioned that higher rates could pressure margins as deposit costs may reprice faster than asset yields, and that weaker auto demand, economic conditions, or higher rates could constrain loan growth.
Outlook, risks, and contingencies
- The filing provides no formal earnings or revenue guidance. Its interest-rate sensitivity model estimated that a parallel 200-basis-point increase would reduce next-12-month net interest income by 3.28%; a modeled decrease of 100 basis points would reduce it by 0.94%. Management cautioned that these are hypothetical estimates, not forecasts, and actual results may differ.
- Liquidity sources included $35 million of correspondent-bank federal funds lines (undrawn), approximately $324 million of unused FHLB borrowing capacity, and approximately $382 million available through Federal Reserve discount-window facilities (no advances outstanding). Management said liquidity was adequate and reported no liquidity constraints.
- Off-balance-sheet exposure included $294.6 million of commitments to extend credit and $3.37 million of standby letters of credit. These are not necessarily expected cash requirements; management said it did not expect material losses from the commitments.
- The company identified potential risks from interest-rate changes, competition for municipal deposits, economic or real-estate weakness, and auto-loan demand and credit trends. It reported no material pending legal proceedings beyond ordinary-course matters. It also described indirect contingent exposure related to Visa Class B shares, but considered the Visa escrow substantially sufficient and assigned no economic value to its shares.
- Arrow adopted new share-based compensation accounting guidance in 2017; related option tax benefits increased quarterly earnings by less than $45,000, or less than $0.01 per share. Management did not expect material effects from several other pending accounting standards, but had not yet estimated the impact of the expected-credit-loss standard, which it anticipated would significantly affect allowance methodology.
Important facts for investors to verify
- Reconcile the filing’s prior-period efficiency-ratio figures: the MD&A expense table shows 56.37%, while selected quarterly information shows 56.81% for Q1 2016.
- Track deposit mix and pricing, particularly seasonal municipal deposits and deposit-cost increases, against loan yields and net interest margin.
- Monitor loan growth, auto-loan credit performance, substandard commercial exposures, nonperforming assets, and allowance coverage as the portfolio expands.
- Confirm execution of the $5 million repurchase program and the sustainability of dividends relative to earnings and capital needs.
- Assess the assumptions behind the interest-rate sensitivity model and the eventual impact of the expected-credit-loss accounting standard.