Arrow Financial Corporation — Q3 2017 Form 10-Q
Business and period: Arrow is a New York bank holding company with two banking subsidiaries and insurance, investment-advisory and other businesses. This unaudited report covers the quarter and nine months ended September 30, 2017; comparisons below are with the corresponding 2016 periods unless stated otherwise. Amounts are in U.S. dollars.
Financial performance and position
- Q3 earnings: Net income was $7.416 million, up 10.1%; diluted EPS was $0.53 versus $0.48. Return on average assets was 1.08% and return on average equity was 12.07%.
- Nine-month earnings: Net income was $21.255 million, up 6.6%; diluted EPS was $1.52 versus $1.44. ROAA was 1.06% versus 1.07%, and ROAE was 11.86% versus 11.93%.
- Net interest income and margin: Q3 GAAP net interest income was $19.650 million; tax-equivalent net interest income was $20.616 million, up 9.6%. Tax-equivalent net interest margin was 3.15%, versus 3.12%. For nine months, GAAP net interest income was $57.338 million and tax-equivalent net interest income was $60.201 million, up 7.6%; the tax-equivalent margin remained 3.16%.
- Other income and costs: Q3 noninterest income was $7.141 million, up 0.4%, while noninterest expense was $15.548 million, up 3.1%. The company-reported non-GAAP efficiency ratio improved to 55.79% from 57.88%. For nine months, noninterest income declined 1.4% to $20.893 million, expenses rose 5.2% to $46.661 million, and the efficiency ratio was essentially unchanged at 57.29%.
- Credit costs and asset quality: Q3 loan-loss provision was $0.800 million versus $0.480 million; net charge-offs were $0.547 million versus $0.303 million. At September 30, the allowance was $17.695 million, or 0.93% of loans; nonperforming loans were $7.277 million (0.38% of loans) and nonperforming assets were $8.990 million (0.33% of assets).
- Growth and funding: Total assets were $2.744 billion, up 5.3% from year-end 2016. Loans were $1.909 billion, up 8.9% from year-end and 11.8% year over year. Deposits were $2.307 billion, up 9.0% from year-end. Period-end stockholders’ equity was $244.648 million; book value per share was $17.61 and tangible book value per share was $15.86.
- Cash flow and liquidity: For the first nine months, operating cash flow was $26.398 million, investing cash flow was negative $118.695 million, and financing cash flow was $115.608 million. Cash and cash equivalents increased $23.311 million to $80.666 million. The company reported an 11.0% basic liquidity ratio, including FHLB borrowing capacity, and approximately $242 million of unused FHLB capacity, $416 million available through Federal Reserve facilities, and $35 million in correspondent-bank lines.
- Borrowings and capital: At quarter-end, reported short-term borrowings and FHLB advances totaled $149.419 million; junior subordinated obligations were $20 million. The company and both banks qualified as “well-capitalized”; Arrow’s CET1 ratio was 12.70%, above the 7.00% fully phased-in minimum cited for 2019.
Changes, outlook and risks
- Management attributed higher Q3 net interest income mainly to 8.3% growth in average earning assets, particularly higher-yielding loans. Loan growth was funded by deposit growth, short-term borrowing, and a smaller securities portfolio. Interest expense rose faster than income as borrowing and deposit costs increased.
- Q3 loan growth was concentrated in residential real estate and consumer loans; commercial loans declined slightly during the quarter. Management said local conditions and overall loan quality remained solid, but noted potential weakening in auto demand and possible pressure on commercial lending and credit quality if rates rise substantially or economic conditions weaken.
- Management expected elevated residential mortgage originations to continue through 2017 and into 2018. No formal earnings or full-year financial guidance is provided.
- Interest-rate simulations estimated that a 200-basis-point rate increase would reduce net interest income 2.8% over the following 12 months, while a modeled 100-basis-point decrease would increase it 0.5%. These are hypothetical estimates, not forecasts; management cautioned that deposit costs could reprice faster than some assets.
- Key risks include credit quality, interest-rate and liquidity exposure, competition, economic conditions, and regulatory or tax changes. Management said existing 2016 Form 10-K risk factors remained applicable. It reported no material pending legal proceedings beyond routine business litigation.
- Unusual or notable items: the company issued a 3% stock dividend in September (per-share figures are restated); adopted share-based-payment accounting guidance that increased nine-month earnings by approximately $112,000, or less than $0.01 per share; and disclosed a former CFO separation agreement providing a $260,000 payment in 2018 plus specified benefits. The board declared a fourth-quarter cash dividend of $0.250 per share and authorized a new repurchase program of up to $5 million for 2018.
- The company is evaluating the expected-loss accounting standard (ASU 2016-13), effective for it in 2020, and said the change is expected to significantly affect its allowance methodology; it had not estimated the financial impact.
Important facts for investors to verify
- Whether loan growth and deposit gathering can continue without materially increasing funding costs, credit losses, or pressure on net interest margin.
- Trends in auto-loan demand, delinquencies, nonperforming assets, net charge-offs, and allowance coverage as the loan portfolio expands.
- How rising interest rates, deposit repricing, and municipal-deposit seasonality affect liquidity and earnings relative to the filing’s sensitivity assumptions.
- The effects of the forthcoming expected-credit-loss standard and other pending accounting changes, including whether actual impacts differ from management’s expectations.
- The full terms and accounting treatment of the former CFO’s separation benefits, and the use of the 2018 share-repurchase authorization and declared dividend.