ARROW FINANCIAL CORP annual report, FY2021

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Arrow Financial Corporation — 2021 Form 10-K

Business context and reporting period

Arrow is a New York-based bank holding company operating Glens Falls National Bank and Saratoga National Bank, with banking, wealth-management and insurance businesses focused mainly on northeastern New York. This filing covers the fiscal year ended December 31, 2021; fourth-quarter results are also summarized. Amounts below are in U.S. dollars.

Key financial metrics

  • Full-year earnings: Net income was $49.9 million, up 22.1% from $40.8 million in 2020. Diluted EPS rose 21.2% to $3.10. ROA was 1.28% and ROE 14.09%, compared with 1.17% and 12.77%, respectively, in 2020.
  • Revenue and margins: Net interest income increased 11.2% to $110.4 million; noninterest income was $32.4 million, down 0.9%. Net interest margin was 2.97% versus 2.99% in 2020 (tax-equivalent margin: 3.00% versus 3.02%). The efficiency ratio increased to 54.16% from 52.80%.
  • Credit provision and asset quality: Provision for credit losses fell to $0.3 million from $9.3 million. Net charge-offs were $0.9 million, or 0.03% of average loans. Nonperforming loans rose to $11.7 million (0.44% of loans) from $6.4 million (0.25%); two commercial real estate loans moved to nonaccrual. The allowance was $27.3 million, or 1.02% of loans, versus 1.13% at year-end 2020.
  • Balance sheet and liquidity: Total assets were $4.03 billion, up from $3.69 billion. Loans reached $2.67 billion, up 2.8%; deposits were $3.55 billion, up 9.8%. Cash and cash equivalents were $457.7 million. Management reported no liquidity constraints; available borrowing capacity included approximately $734 million at the FHLBNY and $594 million at the Federal Reserve discount window.
  • Debt and capital: Year-end borrowings included $45 million of FHLBNY term advances and $20 million of junior subordinated obligations; short-term borrowings were zero. Stockholders’ equity was $371.2 million. Arrow’s CET1, Tier 1 risk-based, total risk-based and leverage ratios were 13.8%, 14.6%, 15.7% and 9.2%, respectively; Arrow and both banks were classified as well-capitalized.
  • Cash flow: Operating activities provided $68.2 million; investing activities used $274.6 million; financing activities provided $283.1 million. Cash and cash equivalents increased $76.7 million to $457.7 million.
  • Fourth quarter: Net income was $10.3 million, down 17.5% year over year; diluted EPS was $0.63 versus $0.78. Net interest income increased, but lower noninterest income and higher expenses—including litigation reserve expense—more than offset that improvement.

Material changes versus 2020

  • Net interest income rose $11.2 million, supported by loan growth, lower funding costs and $7.8 million of PPP loan income. Margin nevertheless edged down, reflecting lower asset yields and higher cash balances.
  • Noninterest expense increased 10.4% to $78.0 million, including higher salaries, technology spending, $0.7 million of provision for off-balance-sheet credit exposures, and a $1.5 million litigation reserve.
  • Loan balances grew $72.9 million despite $70.1 million of PPP forgiveness. Excluding forgiven PPP balances, loans grew $143.1 million. Consumer lending grew, while commercial lending declined partly because of PPP forgiveness.
  • Deposits increased $315.8 million at year-end; noninterest-bearing deposits rose $108.9 million. Available-for-sale securities increased to $559.3 million from $365.3 million.
  • Arrow adopted CECL on January 1, 2021. The adoption reduced the loan allowance by $1.3 million and increased the estimated liability for off-balance-sheet credit exposures by $1.1 million; the net retained-earnings effect was a $120,000 increase.

Outlook, commentary, risks and contingencies

  • The filing provides no specific earnings or revenue guidance. Management noted that the Federal Reserve indicated expected rate increases in 2022 and described Arrow as positioned for a range of rate environments. The rate-sensitivity model estimated net interest income changes of +0.83% in year one and +5.11% in year two under a 200-basis-point increase; under a 100-basis-point decrease, changes were -1.88% and -10.26%. These are modeled scenarios, not forecasts.
  • Management cannot reasonably estimate the pandemic’s overall future impact. Risks include regional economic deterioration, borrower repayment capacity and collateral values, interest-rate and deposit repricing, competition, cybersecurity, technology and regulatory requirements. The loan portfolio is concentrated in upstate New York, and tourism is important to the region.
  • A customer class action alleges inadequate disclosure of overdraft-fee practices. Arrow denies wrongdoing; the parties signed a settlement agreement providing for a $1.5 million fund. Preliminary court approval was pending, with a hearing scheduled for April 12, 2022.
  • Nonperforming loans increased, including commercial real estate exposure. The filing also identifies $37.5 million across 56 performing commercial loans as potential problem loans at year-end.
  • Arrow stopped issuing new LIBOR-based instruments by year-end 2021 and began using CME Term SOFR as its primary index and BSBY as a secondary index from January 1, 2022. Existing U.S. dollar LIBOR settings were expected to cease after June 30, 2023; a few legacy contracts still required fallback provisions.
  • Arrow’s $5 million 2021 repurchase authorization expired at year-end; approximately $1.5 million was used under that program. A new authorization permitted up to $5 million of repurchases during 2022.

Important facts for investors to verify

  • Track whether nonperforming and potential-problem commercial real estate loans rise, and whether the CECL allowance remains adequate as economic forecasts change.
  • Confirm final court approval and settlement terms for the overdraft-fee class action.
  • Assess whether deposit growth and low deposit costs persist as interest rates change, and compare actual results with the filing’s modeled rate scenarios.
  • Monitor loan growth, PPP fee runoff, loan yields, and the balance-sheet effects of Arrow’s decision to retain more residential mortgages.
  • Review the 2022 LIBOR fallback transition, available liquidity and borrowing capacity, capital ratios, and the use of the 2022 share-repurchase authorization.