Arrow Financial Corporation — Q2 2022 Form 10-Q
Business context and reporting period: Arrow is a two-bank holding company headquartered in Glens Falls, New York, operating primarily through Glens Falls National Bank and Saratoga National Bank. This unaudited filing covers the quarter and six months ended June 30, 2022; comparisons are with the corresponding 2021 periods unless otherwise noted. Amounts below are in U.S. dollars.
Key financial results
| Metric | Q2 2022 | Q2 2021 | Six months 2022 | Six months 2021 |
|---|---|---|---|---|
| Net interest income | $29.0 million | $28.4 million | $56.9 million | $54.5 million |
| Provision for credit losses | $0.9 million | $0.3 million | $1.7 million | $(0.4) million |
| Noninterest income | $7.7 million | $8.5 million | $15.9 million | $17.1 million |
| Noninterest expense | $20.3 million | $19.1 million | $39.3 million | $37.8 million |
| Net income | $12.0 million | $13.3 million | $24.5 million | $26.6 million |
| Diluted EPS | $0.75 | $0.83 | $1.53 | $1.65 |
| Net interest margin | 3.02% | 3.08% | 2.96% | 3.04% |
| Return on average assets / equity | 1.20% / 13.44% | 1.38% / 15.21% | 1.23% / 13.61% | 1.42% / 15.50% |
Balance sheet, liquidity and capital
- At June 30, 2022, total assets were $3.99 billion, loans were $2.84 billion, deposits were $3.55 billion, and stockholders’ equity was $356.5 million.
- Loans increased 6.6% from year-end 2021 and 7.6% year over year. Consumer loans, primarily indirect auto, and residential real estate loans drove growth; PPP balances continued to run off.
- Deposits were down $4.8 million from year-end and up $107.6 million year over year. Q2 deposits fell $169.7 million, partly reflecting seasonal municipal deposit outflows. Noninterest-bearing deposits were 23.3% of deposits.
- Cash and cash equivalents were $217.3 million, down from $457.7 million at year-end 2021. Management cited loan growth outpacing deposit growth. The company reported no significant liquidity constraints and identified approximately $661 million of unused FHLB borrowing capacity, $637 million available through Federal Reserve discount-window facilities, and $52 million of correspondent-bank lines. Its basic liquidity ratio including FHLB collateralized capacity was 24.9% of assets.
- Debt included $25 million of FHLB term advances, $20 million of junior subordinated obligations, and $5.1 million of finance leases. FHLB advances were repaid by $20 million during the first half. No short-term borrowings were outstanding at June 30.
- All reported regulatory capital ratios exceeded minimums; Arrow and both subsidiary banks qualified as “well-capitalized.” Holding-company CET1 was 13.14% and the Tier 1 leverage ratio was 9.60%. Q2 capital ratios were estimates under regulatory rules.
Cash flow and asset quality
- For the first six months, operating cash flow was $30.7 million, investing cash outflow was $236.5 million, and financing cash outflow was $34.6 million. Cash and cash equivalents decreased $240.4 million.
- The allowance for credit losses was $28.1 million, or 0.99% of loans. Q2 net charge-offs were $476,000, an annualized 0.07% of average loans.
- Nonperforming loans were $9.7 million (0.34% of loans) and nonperforming assets were $10.0 million (0.25% of assets). Past-due loans 30–89 days and accruing interest totaled $12.7 million, up from $7.0 million a year earlier.
- Management said the Q2 provision reflected loan growth, net charge-offs and economic forecasts. Its CECL forecast assumed a slight rise in national unemployment and a 0.75% GDP decline over the forecast period; a qualitative adjustment addressed concerns that the home-price forecast did not reflect local conditions.
Material changes and management commentary
- Q2 net income fell 9.8% and diluted EPS fell 9.6% year over year. Management attributed the earnings decline mainly to higher credit-loss provision, $615,000 lower loan-sale gains, and a $2.6 million reduction in PPP income.
- Q2 net interest income rose 2.4%, while net interest margin declined six basis points. Excluding PPP income, Q2 net interest margin was 2.98%, up from 2.86% a year earlier. For the first half, net interest income excluding PPP rose 10.5%; reported net interest margin declined eight basis points.
- Noninterest income declined 8.7% in Q2, primarily due to fewer loan sales. Noninterest expense increased 6.6%, including higher salaries, technology, occupancy and FDIC assessment costs. Q2 efficiency ratio was 55.01%, versus 51.53% a year earlier.
- Management said it had chosen to retain more newly originated residential mortgages, reducing loan-sale gains while supporting portfolio growth. Future mortgage sales depend on rates, market conditions, capital and liquidity needs, and balance-sheet strategy.
- Q2 AFS securities unrealized losses were attributed primarily to higher interest rates rather than credit concerns. AFS securities had $43.9 million of gross unrealized losses at June 30; the first-half after-tax securities holding loss was $32.0 million. No securities credit-loss allowance was recorded. These losses contributed to a $29.9 million first-half other comprehensive loss and a $14.7 million decline in equity from year-end.
Outlook, risks and unusual items
- The filing provides no formal earnings or revenue guidance. Management noted expectations for further Federal Reserve rate increases in 2022, possible deposit repricing, and potential effects of inflation and rising rates on loan demand. Its interest-rate simulation estimated Q1-year net interest income changes of negative 1.90% under a 200-basis-point increase and negative 0.38% under a 100-basis-point decrease; second-year estimates were positive 7.32% and 2.87%, respectively. These are model scenarios, not forecasts.
- Key risks include changing economic and market conditions, interest-rate and liquidity exposures, credit quality, competition, regulation, the continuing effects of COVID-19, and execution of a new core banking system. The company warned that implementation delays, cost increases or operational problems could affect results, cash flows or internal controls.
- On July 22, 2022, a court approved settlement of a customer overdraft-fee class action. Arrow established an approximately $1.5 million settlement fund, which had been accrued in 2021; the company denies wrongdoing.
- Arrow had $447.2 million of commitments to extend credit and $3.7 million of standby letters of credit. These are contingent exposures, not necessarily expected cash requirements. A Visa-related antitrust matter remained subject to appeal; any potential value from Visa shares was not recognized.
- Arrow repurchased $2.4 million of common stock under its $5 million 2022 repurchase program by June 30 and paid a $0.27 quarterly dividend. The board declared another $0.27 dividend payable September 15, 2022.
- Management reported effective disclosure controls and no material change in internal control over financial reporting during the quarter. The independent accountant performed a review, not an audit, of the interim financial statements.
Most important facts for investors to verify
- Whether loan and deposit growth can be sustained as PPP runoff continues and seasonal municipal deposits fluctuate.
- How rising rates affect deposit costs, net interest margin, liquidity and the substantial unrealized securities losses.
- Whether credit delinquencies, nonperforming loans, charge-offs and the CECL allowance remain consistent with management’s assumptions.
- Progress, costs and control implications of the new core banking system implementation.
- Final settlement terms and any subsequent developments in the overdraft-fee litigation and Visa appeal.