Business context and reporting period
Arrow Financial Corporation (NASDAQ: AROW) is a New York bank holding company operating Glens Falls National Bank and Saratoga National Bank, with insurance, investment-advisory, trust and real-estate subsidiaries. This Form 10-K covers the fiscal year ended December 31, 2019; fourth-quarter results are also summarized below. Amounts are in U.S. dollars; financial-statement figures are generally in millions unless stated otherwise.
Financial performance and condition
| Metric | 2019 | 2018 | Change |
|---|---|---|---|
| Net income | $37.5 million | $36.3 million | Up 3.3% |
| Diluted earnings per share | $2.50 | $2.43 | Up 2.9% |
| Net interest income | $88.0 million | $84.0 million | Up 4.8% |
| Net interest margin | 3.05% | 3.07% | Down 2 basis points |
| Noninterest income | $28.6 million | $28.9 million | Down 1.4% |
| Noninterest expense | $67.5 million | $65.1 million | Up 3.7% |
| Return on average assets / equity | 1.24% / 13.17% | 1.27% / 13.96% | Both lower |
- Fourth quarter: Net income was $9.74 million and diluted EPS was $0.65, versus $8.76 million and $0.59 in Q4 2018. Quarterly net interest income increased to $22.9 million from $21.7 million; net interest margin was 3.06% versus 3.03%.
- Growth and balance sheet: Year-end assets were $3.18 billion, up 6.6%. Loans reached $2.39 billion, up $189.9 million (8.6%); deposits were $2.62 billion, up $270.5 million (11.5%). Stockholders’ equity rose 11.9% to $301.7 million; tangible book value per share increased 12.5% to $18.55.
- Credit quality: Nonperforming assets were $5.7 million, or 0.18% of assets, down from $6.8 million, or 0.23%, in 2018. Nonperforming loans were 0.18% of loans. Net charge-offs were $1.1 million, 0.05% of average loans. The allowance was $21.2 million, 0.89% of loans, compared with 0.92% a year earlier.
- Cash flow: Operating activities provided $43.9 million; investing activities used $192.2 million, principally reflecting loan growth and securities activity; financing activities provided $134.3 million, including $270.5 million of deposit growth. Cash and cash equivalents decreased $14.0 million to $70.2 million.
- Debt and liquidity: Year-end short-term borrowings were $181.1 million, FHLB term advances $30.0 million, trust-preferred subordinated obligations $20.0 million, and finance leases $5.3 million. The company reported $516 million of unused FHLB borrowing capacity and approximately $580 million available through Federal Reserve discount-window facilities; correspondent-bank lines totaled $67 million and were not drawn except for testing. Management reported no significant liquidity constraints.
- Capital: Arrow and both banks were classified as well-capitalized. At year-end, Arrow’s CET1, Tier 1 risk-based, total risk-based and leverage ratios were 12.9%, 13.8%, 14.8% and 10.0%, respectively. Cash dividends were $1.02 per share for 2019.
Material changes versus prior period
- Loan and deposit growth supported higher interest income, but interest expense rose 73.9% to $21.7 million as deposit rates and interest-bearing balances increased. Loan interest income grew 16.9%; the net interest margin edged down.
- Noninterest income declined mainly because fiduciary income and insurance commissions fell; gains on loan sales increased by $487,000 to $622,000. Fiduciary assets under administration and investment management rose 11.4% to $1.54 billion.
- Noninterest expense increased $2.4 million. Technology and equipment expense rose 15.7%; salaries and benefits were slightly lower. A $687,000 FDIC assessment credit was recorded in Q3 2019, contributing to lower FDIC assessment expense.
- Available-for-sale securities had a net unrealized gain of $0.6 million at year-end 2019 versus a net unrealized loss of $5.0 million in 2018; 2019 other comprehensive income was $7.5 million.
Outlook, risks and unusual items
- The filing provides no quantified earnings or revenue guidance. Management described regional economic growth as modest and labor markets as tight. It expects to use the optional Community Bank Leverage Ratio framework if eligible; preliminary estimates indicated the ratio would exceed 9%.
- Arrow adopted the CECL expected-credit-loss standard on January 1, 2020. Management expected an immaterial effect on retained earnings, but was still reviewing model results and assumptions at the filing date.
- Key risks include local and national economic deterioration, interest-rate and yield-curve movements, loan losses and allowance estimates, competition, deposit funding costs, cybersecurity and third-party service providers, regulatory and capital requirements, and the LIBOR transition. Interest-rate simulations estimated net interest income changes of -6.80% in year one and +0.18% in year two under a 200-basis-point increase; under a 100-basis-point decrease, -0.99% and -8.93%, respectively. These are model-based scenarios, not forecasts.
- Unfunded loan commitments totaled approximately $349.7 million and standby letters of credit $3.1 million. A Visa-related contingent matter remained unresolved; the company assigned no economic value to its Visa Class B shares. Management reported no material pending legal proceedings.
- The 2019 results include $289,000 of unrealized gains on equity securities and the FDIC assessment credit. The filing also reports a 3% stock dividend in September 2019; share and per-share figures have been adjusted for it.
Important facts for investors to verify
- Whether loan growth and deposit funding remain profitable as deposit costs and competition evolve, and how margins respond to interest-rate changes.
- Whether credit quality and the allowance remain adequate as the loan book grows, particularly consumer auto and commercial real-estate exposures, and how CECL affects reserves after adoption.
- Whether the $125.6 million of brokered deposits and $256.1 million of reciprocal deposits remain stable and cost-effective.
- Whether management elects the CBLR framework and confirms the expected capital ratio, and how capital, dividends and repurchases develop.
- Whether fiduciary and insurance revenue recover, technology spending delivers operating benefits, and the Visa litigation settlement produces any eventual value.
- The audited financial statements received unqualified opinions, and the auditor reported effective internal control over financial reporting as of December 31, 2019.