Arrow Financial Corporation — Q1 2018 Form 10-Q
Business context and reporting period. Arrow is a New York bank holding company operating two banks and related insurance, fiduciary and investment businesses. This unaudited filing covers the three months ended March 31, 2018; comparisons are with Q1 2017 unless noted.
Financial performance and condition
| Metric | Q1 2018 / March 31, 2018 | Comparable period |
|---|---|---|
| Net interest income (GAAP) | $20.4 million | $18.5 million, Q1 2017; up 10.5% |
| Net income | $8.5 million | $6.6 million, Q1 2017; up 28.7% |
| Diluted earnings per share | $0.61 | $0.47, Q1 2017 |
| Net interest margin (GAAP, annualized) | 3.13% | 2.99%, Q1 2017 |
| Return on average assets / equity | 1.25% / 13.78% | 1.02% / 11.43%, Q1 2017 |
| Total assets | $2.83 billion | $2.66 billion, March 31, 2017 |
| Total loans / deposits | $1.99 billion / $2.41 billion | Loans up 10.1% and deposits up 6.9% year over year |
| Stockholders’ equity | $252.7 million | $236.1 million, March 31, 2017 |
| Cash and cash equivalents | $100.3 million | $64.8 million, March 31, 2017 |
Interest and dividend income rose to $22.4 million from $20.0 million. Total noninterest income was $6.9 million, up 2.9%; noninterest expense was $16.0 million, up 3.1%. The company’s reported non-GAAP efficiency ratio improved to 57.23% from 59.01%. The effective tax rate fell to 19.4% from 28.9%, reflecting the Tax Act’s reduction in the federal statutory rate.
Q1 operating cash flow was $12.3 million, versus $9.9 million a year earlier. Investing activities used $43.1 million, principally reflecting $43.0 million of net loan growth. Financing activities provided $58.2 million, including a $166.2 million increase in deposits; cash and cash equivalents increased $27.4 million during the quarter.
At quarter-end, the allowance for loan losses was $19.1 million, or 0.96% of loans. Nonperforming loans were $4.6 million (0.23% of loans), and nonperforming assets were $6.2 million (0.22% of assets). Net charge-offs were $275,000; the quarterly provision was $746,000.
Total deposits were $2.41 billion. Borrowings included $75.0 million of federal funds and repurchase agreements, $45.0 million of FHLB term advances, and $20.0 million of junior subordinated obligations; no FHLB overnight advances remained outstanding. Regulatory capital ratios showed the holding company and both banks above applicable minimums and classified as well-capitalized. Arrow’s CET1 ratio was 12.97%.
Material changes and management commentary
- Year-over-year earnings growth reflected higher net interest income, increased average earning assets and loan balances, and a lower tax rate. Average loans increased 10.7%; average investment securities declined 7.6%.
- Loan balances rose $42.3 million during the quarter, led by consumer loans, including indirect auto lending. Management cited strong regional vehicle demand and an expanded dealer network. Deposit growth included seasonal municipal funds and $45 million of floating-rate brokered deposits.
- Interest expense increased 31.3% year over year as deposit costs rose. The cost of total deposits increased to 0.24% from 0.17% in Q1 2017; management noted that further rate increases could raise funding costs or pressure deposit balances.
- Unrealized securities losses contributed to a $2.4 million other comprehensive loss in Q1. Management attributed temporary impairment primarily to interest-rate and market-spread changes, and reported no other-than-temporary impairment losses or securities downgraded below investment grade through the filing date.
- The company adopted new revenue-recognition guidance and the standard for equity investments in Q1. Adoption reduced retained earnings by $102,000 for revenue recognition and increased retained earnings by $331,000 for equity-security accounting. Equity-security fair-value changes are now recorded in earnings.
Outlook, risks and contingencies
- The filing gives no specific earnings or revenue guidance. Management said it expected loan growth to continue but cautioned that higher rates, weaker economic conditions, reduced auto demand, or a local real estate downturn could slow growth or affect credit quality.
- Interest-rate simulations estimate that a parallel 200-basis-point increase would reduce first-year net interest income by 1.87%, while a 100-basis-point decrease would reduce it by 0.03%. In year two, the modeled effects reverse to a 2.46% increase and a 3.49% decrease, respectively. These are scenario estimates based on assumptions, not forecasts.
- Management plans to adopt CECL in Q1 2020 and expects it to increase the allowance materially, with an anticipated increase in the single digits based on current expectations. The amount remains uncertain; management expects to remain well-capitalized and does not expect periodic provisions to be materially above historical levels.
- Management reported no liquidity problems and cited an $11.2% basic liquidity ratio, including FHLB borrowing capacity, and approximately $263 million of unused FHLB capacity and $436 million available through Federal Reserve facilities. These sources remain subject to collateral and borrowing terms.
- Off-balance-sheet commitments to extend credit totaled $328.8 million; standby letters of credit totaled $3.6 million. Management said commitments generally may expire undrawn and did not expect material losses. No material pending legal proceedings were reported.
- Arrow disclosed an indirect contingent exposure related to Visa litigation, but judged Visa’s escrow substantially sufficient and assigns no economic value to its Visa Class B shares. The filing identifies no material change to the risk factors in its 2017 Form 10-K.
Key facts for investors to verify
- Whether loan growth, especially indirect auto lending, continues without deterioration in delinquencies, nonperforming assets or charge-offs.
- How deposit pricing, municipal-deposit seasonality and brokered funding affect net interest margin as rates change.
- The eventual CECL allowance and equity impact, given management’s preliminary single-digit increase estimate.
- Whether unrealized securities losses recover or require recognition of credit impairment, and the effect of rate movements on AOCI and capital.
- Continued capital and liquidity strength, including actual availability of collateralized borrowing capacity.
The interim financial statements were reviewed by KPMG, which reported that it was not aware of material modifications needed for conformity with U.S. GAAP; the review was not an audit. Management reported disclosure controls were effective and no material change in internal control over financial reporting during the quarter.