Arrow Financial Corporation — Q1 2019 Form 10-Q
Business context and reporting period. Arrow is a New York bank holding company operating Glens Falls National Bank and Saratoga National Bank, with wealth management, insurance and related businesses. This unaudited quarterly filing covers the three months ended March 31, 2019; comparisons below are with Q1 2018 unless otherwise noted. The interim financial information received an independent accountant’s review, not an audit.
Financial performance and condition
- Earnings and revenue: Net income was $8.734 million, up 2.4%; diluted EPS was $0.60, versus $0.59. GAAP net interest income plus noninterest income was approximately $28.0 million, up about 2.6%. Income before taxes was $10.884 million.
- Interest income, margin and costs: Net interest income rose 3.5% to $21.121 million as average earning assets grew 7.8%, led by loans. Net interest margin narrowed to 3.01% from 3.13% (tax-equivalent: 3.06% from 3.21%). Interest expense increased 152.6% to $5.092 million, reflecting higher deposit and borrowing costs. The effective tax rate was 19.8%, versus 19.4%.
- Other income and expenses: Noninterest income was essentially flat at $6.887 million. Noninterest expense increased 4.4% to $16.652 million, including higher technology and equipment costs. The company-reported efficiency ratio was 58.55%, compared with 57.23%.
- Cash flow: Operating activities provided $10.731 million, versus $12.283 million. Investing activities used $8.451 million, versus $43.050 million; financing activities used $25.290 million, compared with providing $58.201 million. Cash and cash equivalents declined $23.010 million during Q1 to $61.229 million.
- Balance sheet and lending: Total assets were $2.985 billion, nearly unchanged from year-end and up 5.6% year over year. Loans were $2.235 billion, up 1.8% from year-end and 12.2% year over year. Deposits totaled $2.490 billion, up 6.2% from year-end. Stockholders’ equity was $276.6 million; book value per share was $19.11 and tangible book value per share was $17.48.
- Credit quality: The allowance for loan losses was $20.373 million, or 0.91% of loans, compared with 0.96% a year earlier. Net charge-offs were $295,000; nonperforming loans were $5.348 million, or 0.24% of loans, versus $4.570 million and 0.23% a year earlier. Management described overall portfolio quality as strong.
- Funding, debt and liquidity: At March 31, borrowings included $58.4 million in federal funds and repurchase agreements, $74.5 million in overnight FHLB advances, $35.0 million in FHLB term advances and $20.0 million in junior subordinated obligations. Overnight FHLB advances fell $159.5 million from year-end, while deposits grew; the company also obtained $66.5 million of brokered deposits during the quarter. Management reported unused FHLB borrowing capacity of about $391 million and Federal Reserve discount-window capacity of about $520 million, with no discount-window advances outstanding. It stated that liquidity was sufficient and no liquidity constraints had occurred.
- Capital: Arrow and both subsidiary banks remained “well-capitalized.” Arrow’s estimated CET1, total risk-based capital and leverage ratios were 12.98%, 14.93% and 9.73%, respectively.
Material changes versus the prior comparable period
- Loan growth and higher earning-asset yields lifted interest income, but rising funding costs compressed net interest margin.
- Consumer loans, primarily indirect automobile loans, grew $27.3 million from year-end; consumer lending represented 33.4% of period-end loans. Total loans grew $242.2 million year over year.
- Funding mix shifted toward interest-bearing savings and time deposits. Other time deposits rose $72.6 million from year-end, including brokered funding, while noninterest-bearing deposits declined $19.7 million.
- Net income increased modestly, while annualized return on average assets fell to 1.19% from 1.25% and return on average equity fell to 12.98% from 13.78%.
- Accumulated other comprehensive loss improved to $11.567 million from $13.810 million at year-end, including $2.080 million of after-tax unrealized securities gains during Q1.
Outlook, commentary, risks and unusual items
- The filing provides no quantified earnings or revenue guidance. Management cited continued loan demand but noted that loan growth and portfolio quality could be affected by weaker economic conditions, auto demand, or real estate markets.
- Interest-rate sensitivity modeling estimated that a parallel 200-basis-point increase would reduce net interest income 2.9% in year one and increase it 0.9% in year two; a 100-basis-point decrease would increase it 0.7% in year one and reduce it 1.8% in year two. These are model estimates based on assumptions, not forecasts.
- Arrow planned to adopt the expected-credit-loss standard (CECL) in Q1 2020. It said adoption would likely increase the allowance and reduce equity, but the amount was not clear in the filing; modeling and assumptions remained in development.
- Lease accounting adoption on January 1, 2019 increased assets by $7.9 million and liabilities by $8.0 million, with no retained-earnings adjustment and no material income-statement impact. March 31 lease liabilities totaled $8.585 million.
- Available-for-sale securities had $2.827 million of gross unrealized losses at March 31. Management attributed these primarily to market-rate and spread movements, considered the impairments temporary, and said it did not intend or expect to be required to sell the securities before recovery.
- Glens Falls National held Visa Class B shares related to antitrust litigation. Any potential value or gain was unrecognized because settlement approval and escrow sufficiency remained uncertain.
- Management reported no material pending legal proceedings and no change to the principal risk factors disclosed in the 2018 Form 10-K. The filing identifies interest-rate, credit, liquidity, economic, competitive, regulatory and technology risks.
Important facts for investors to verify
- Whether deposit repricing and additional brokered funding continue to pressure funding costs and net interest margin.
- Credit performance in indirect auto lending and the commercial real estate portfolio, including delinquency, nonperforming-loan and allowance trends.
- Progress toward CECL adoption and the eventual effect on the allowance, retained earnings and regulatory capital.
- Liquidity and funding capacity as loans grow, including reliance on brokered deposits and secured FHLB advances.
- Developments in the Visa litigation settlement and whether the company can ultimately realize value from its Class B shares.