Arrow Financial Corporation — Q1 2020 Form 10-Q
Reporting period: Three months ended March 31, 2020; balance-sheet comparisons are primarily to March 31, 2019 and December 31, 2019. Arrow is a New York bank holding company with two banking subsidiaries and related insurance, investment-advisory and trust businesses. Amounts below are in U.S. dollars.
Financial performance and condition
| Metric | Q1 2020 / March 31, 2020 | Comparable period / date |
|---|---|---|
| Net income | $8.1 million | $8.7 million in Q1 2019; down 6.9% |
| Diluted EPS | $0.54 | $0.58 in Q1 2019; down 6.9% |
| Net interest income | $23.0 million | $21.1 million in Q1 2019; up 8.9% |
| Net interest margin | 3.05% | 3.01% in Q1 2019 |
| Provision for loan losses | $2.8 million | $0.5 million in Q1 2019 |
| Noninterest income / expense | $7.7 million / $17.8 million | $6.9 million / $16.7 million in Q1 2019 |
| Total assets | $3.29 billion | $2.98 billion at March 31, 2019; $3.18 billion at December 31, 2019 |
| Loans / deposits | $2.41 billion / $2.81 billion | Loans up 8.0% and deposits up 12.9% year over year |
| Allowance for loan losses | $23.6 million; 0.98% of loans | $20.4 million; 0.91% at March 31, 2019 |
| Stockholders’ equity | $309.4 million | $276.6 million at March 31, 2019 |
Higher net interest income reflected loan growth and balance-sheet mix. Net income nevertheless declined, principally amid the much higher loan-loss provision and increased expenses. Noninterest income included a $374,000 loss from equity securities, partly offset by increased other operating income, including fees from interest-rate swap agreements. Salaries and benefits rose 11.4%, primarily because of higher health-insurance costs. Return on average assets was 1.03% versus 1.19%; return on average equity was 10.66% versus 12.98%.
Q1 cash flows were $13.1 million provided by operating activities, $32.1 million used in investing activities and $87.3 million provided by financing activities. Cash and cash equivalents increased $68.3 million to $138.5 million, compared with $61.2 million at March 31, 2019. Deposit inflows of $195.0 million supported financing cash flow; short-term FHLB borrowings declined by $130.0 million. At quarter-end, borrowings included $57.9 million of federal funds and repurchase agreements, $50.0 million of FHLB term advances and $20.0 million of junior subordinated obligations.
Arrow reported a 9.87% Community Bank Leverage Ratio and said the company and both subsidiary banks exceeded applicable minimums and qualified as well-capitalized. The company paid a quarterly dividend of $0.26 per share and repurchased approximately $1.5 million of stock under its 2020 program.
Material changes and operating developments
- Loans grew $28.1 million during the quarter and $179.0 million year over year. Commercial real estate loans and consumer loans were notable contributors to quarterly growth.
- Deposits rose $194.9 million during the quarter and $320.9 million year over year. The filing notes that municipal deposits are seasonal; municipal deposits increased $174.7 million year over year.
- Allowance coverage increased as the provision rose sharply in response to uncertainty from COVID-19, despite management’s characterization of asset quality as strong. Net charge-offs were $322,000, or 0.05% of average loans on an annualized basis.
- Nonperforming loans were $5.5 million, or 0.23% of loans, and nonperforming assets were $6.5 million at quarter-end. Commercial and commercial real estate loans classified as substandard totaled $35.5 million, up from $32.4 million at year-end 2019.
- COVID-19-related payment deferrals totaled $41.4 million, or 1.7% of loans. Commercial and commercial real estate deferrals were $38.7 million; these CARES Act modifications were not treated as troubled debt restructurings.
Outlook, risks and unusual items
- COVID-19 outlook: Management expected the pandemic to adversely affect operations and results but said its overall impact could not be reasonably estimated. It anticipated potential pressure on loan growth, borrower repayment, loan yields and new consumer originations, while refinancing demand could benefit residential lending. The filing gives no quantified earnings or revenue guidance.
- Operations and relief programs: The company adopted appointment-only access at facilities, expanded remote work and participated in the SBA Paycheck Protection Program. Management said it believed it could manage liquidity and continue essential services, subject to uncertainty and unforeseen events.
- Liquidity: Management reported no significant liquidity constraints and cited approximately $1.2 billion of combined contingent collateralized FHLB and Federal Reserve credit lines. It reported a 20.9% basic liquidity ratio, including FHLB collateralized borrowing capacity, and said liquidity was sufficient for reasonably likely needs, while cautioning that sufficiency could not be assured.
- Credit and accounting estimates: Management identified the loan-loss allowance as its most significant estimate and particularly susceptible to near-term change as economic conditions evolve. Arrow elected under the CARES Act to defer CECL adoption and continued implementation work; its estimate of the initial retained-earnings effect was based on a December 2019 parallel run and may not reflect subsequent economic changes.
- Interest-rate exposure: The filing’s simulation estimated net interest income changes of -3.43% in year one and -0.78% in year two under a 200-basis-point increase, and +0.38% in year one and -8.99% in year two under a 100-basis-point decrease. These are model scenarios, not forecasts, and depend on assumptions that may change.
- Unusual and contingent items: Equity securities recorded a $374,000 loss as markets were disrupted. A new swap synthetically fixed the variable-rate payments on $20 million of subordinated trust securities at an effective 3.43% rate until maturity. Off-balance-sheet commitments to extend credit were $376.5 million and standby letters of credit were $3.3 million; the filing says commitments are not expected to be fully drawn. Management reported no pending or threatened legal proceedings expected to result in a material loss.
Important facts for investors to verify
- How COVID-19, payment deferrals, unemployment and sector exposures affect delinquencies, charge-offs and the adequacy of the loan-loss allowance.
- Whether loan and deposit growth, including seasonal municipal balances, persists and how funding costs and liquidity capacity evolve.
- Whether lower market rates, loan repricing and deposit repricing pressure net interest margin and earnings relative to the filing’s interest-rate scenarios.
- How much reported noninterest income from swap activity is recurring, and whether market-related securities gains or losses continue.
- CECL adoption timing and impact, and any changes in capital ratios, liquidity, or the company’s ability to maintain dividends and repurchases.