Arrow Financial Corporation — Q2 2015 Form 10-Q
Business context and reporting period
Arrow is a New York-based bank holding company operating Glens Falls National Bank and Trust Company and Saratoga National Bank and Trust Company, alongside insurance, trust, investment-advisory and other businesses. This unaudited 10-Q covers the quarter and six months ended June 30, 2015; balance-sheet comparisons include December 31 and June 30, 2014. Unless indicated otherwise, dollar amounts below are in millions.
Financial performance and condition
| Metric | Q2 2015 | Q2 2014 | Six months 2015 | Six months 2014 |
|---|---|---|---|---|
| Interest and dividend income | $17.4 | $16.7 | $34.4 | $33.0 |
| Net interest income, GAAP | $16.2 | $15.1 | $32.1 | $29.8 |
| Net interest margin, tax-equivalent | 3.15% | 3.17% | 3.20% | 3.14% |
| Noninterest income | $7.4 | $7.0 | $14.3 | $13.9 |
| Noninterest expense | $14.4 | $13.7 | $28.3 | $27.2 |
| Provision for loan losses | $0.07 | $0.51 | $0.35 | $0.96 |
| Net income | $6.3 | $5.5 | $12.2 | $10.8 |
| Diluted EPS | $0.50 | $0.44 | $0.96 | $0.86 |
- Q2 net income rose 14.1% and diluted EPS rose 13.6% year over year. Six-month net income increased 12.1% and diluted EPS increased 11.6%.
- Q2 GAAP net interest income increased 6.8%; tax-equivalent net interest income increased 6.0%, mainly as average earning assets grew 6.4% and lower funding costs offset lower asset yields. The six-month tax-equivalent margin was up six basis points year over year, while Q2 margin was down two basis points.
- Q2 return on average assets was 1.09% and return on average equity was 12.23%, versus 1.01% and 11.28%, respectively, a year earlier. The Q2 efficiency ratio was 57.94%, compared with 58.48%.
- For the first six months, operating cash flow was $13.7 million, investing cash flow was negative $116.0 million and financing cash flow was positive $101.1 million. Cash and cash equivalents ended at $45.1 million, down $1.2 million from year-end 2014.
At June 30, 2015, assets were $2.333 billion, up 5.2% from year-end 2014 and 8.4% from June 2014. Loans were $1.480 billion, up 4.7% from year-end and 10.1% year over year; deposits were $1.972 billion, up 3.7% from year-end and 6.0% year over year. Stockholders’ equity was $206.9 million, up 3.0% from year-end. Book value per share was $16.39 and tangible book value per share was $14.38.
Period-end funding included $29.5 million of overnight FHLB advances, $55.0 million of FHLB term advances, $24.3 million of federal funds and repurchase-agreement borrowings, and $20.0 million of junior subordinated obligations. The company added $45 million of medium-term FHLB advances during the first half to extend funding maturity. Management reported $214.9 million of unused FHLB borrowing capacity and $318.9 million available through Federal Reserve facilities, with no Federal Reserve advances outstanding. Its liquidity ratio including FHLB collateralized borrowing capacity was 9.8% of assets, above its 4% internal minimum.
Material changes, outlook and risks
- Loan growth was broad-based: residential real estate balances rose 7.3% and consumer balances 4.1% from year-end; commercial and commercial real estate balances rose 2.2%. Deposit mix continued shifting from time deposits toward lower-cost demand, NOW and savings accounts.
- Credit measures remained comparatively low, but nonperforming assets rose to $9.1 million from $8.2 million at year-end. Nonperforming loans were $8.8 million, or 0.59% of loans; the allowance was $15.6 million, or 1.05% of loans. Management attributed much of the increase in nonperforming assets to one commercial loan being restructured with a U.S. government agency guaranteeing 80% of its balance. Management cited strong overall asset quality but offered no assurance that problem assets would not rise.
- Management cautioned that prolonged low rates and loan competition may continue to pressure yields and margins. It said liabilities could reprice faster than assets if rates rise. Its modeled 12-month net interest income declined 2.53% under a 200-basis-point rate increase and 1.26% under a 100-basis-point decrease in long-term rates; management emphasized these are hypothetical scenarios, not forecasts.
- Management reported no liquidity problems and considered liquidity sufficient, while noting municipal deposit seasonality and possible future pressure from higher rates or competition. Risks also include local economic weakness, commercial real estate and construction exposures, indirect auto lending, cybersecurity, regulation and competition.
- No formal earnings guidance is provided in the supplied filing. The board declared a $0.25-per-share third-quarter dividend, payable September 15, 2015. The 2015 repurchase authorization permits up to $5 million; approximately $0.7 million had been repurchased under the program through June 30.
- Off-balance-sheet commitments to extend credit totaled $290.7 million and standby letters of credit totaled $3.2 million. Management said commitments generally expire undrawn and did not expect material losses from them. The company also disclosed contingent exposure relating to Visa litigation; it held 27,771 Visa Class B shares and assigned them no economic value. Management believed Visa’s litigation escrow was substantially sufficient, but merchant challenges left settlement finalization uncertain.
- The filing reports no material pending legal proceedings beyond ordinary-course matters and no material changes to the risk factors in the 2014 Form 10-K. KPMG conducted an interim review, not an audit, and reported no material modifications it believed necessary for GAAP conformity.
Important facts for investors to verify
- Whether continued loan growth can offset margin pressure, particularly given management’s warning that funding costs may rise faster than asset yields.
- Trends in nonperforming assets, delinquency, charge-offs and reserve adequacy, including the progress and government guarantee on the identified commercial loan.
- Deposit stability and seasonality, municipal deposit concentration, and the company’s use and cost of FHLB and other borrowings.
- The sustainability of noninterest income and expense trends, including insurance commissions, deposit service charges, legal and professional fees, and gains from limited-partnership investments.
- Regulatory capital disclosures: the filing reports a 12.92% holding-company Common Equity Tier 1 ratio in its capital table, while a later footnote refers to 13.12%; confirm the intended value and applicable calculation.