Arrow Financial Corporation — Q2 2020 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2020. Arrow is a New York bank holding company operating two banks and related insurance and investment businesses. Dollar amounts below are in millions unless otherwise noted.
Financial performance and condition
| Metric | Q2 2020 / June 30, 2020 | Comparable period / change |
|---|---|---|
| Net income | $9.2; diluted EPS $0.61 | Q2 2019: $8.9; EPS $0.60. Net income rose 2.5%. |
| Six-month net income | $17.3; diluted EPS $1.15 | First half 2019: $17.7; EPS $1.18. Net income fell 2.2%. |
| Net interest income | Q2: $24.8; first half: $47.8 | Q2 rose 14.4%; first half rose 11.7% year over year. |
| Net interest margin | Q2: 3.05%; first half: 3.05% | Q2 2019: 3.04%; first half 2019: 3.02%. |
| Noninterest income / expense | Q2: $7.2 / $17.2 | Q2 income rose 3.9%; expense rose 2.0% year over year. |
| Returns and efficiency | Q2 ROA 1.07%, ROE 11.64%; efficiency ratio 53.06% | Q2 2019 ROA 1.20%, ROE 12.79%; efficiency ratio 58.19%. |
| Loans and allowance | Loans $2,561.9; allowance $26.3, or 1.03% of loans | Loans up 12.3% from June 2019; allowance ratio was 0.91% a year earlier. |
| Deposits and liquidity | Deposits $3,068.8; cash and cash equivalents $253.3, including $215.0 in interest-bearing bank deposits | Deposits up 22.6% from June 2019. |
| Assets and equity | Total assets $3,547.2; stockholders’ equity $317.7 | Assets up 18.0% and equity up 11.6% from June 2019. |
| Borrowings | $47.6 federal funds/repurchase agreements; $50.0 FHLB term advances; $20.0 junior subordinated obligations | No FHLB overnight advances at quarter-end, versus $83.0 a year earlier. |
| Capital | Holding-company CET1 13.07%; total risk-based capital 15.10%; leverage 9.32% | Company and both subsidiary banks reported well-capitalized status. |
For the first half, operating cash flow was $15.9, investing cash flow was negative $164.3, and financing cash flow was positive $331.5. Cash and cash equivalents increased $183.0 to $253.3. The filing does not present a conventional free-cash-flow measure.
Material changes and key drivers
- Q2 loan growth included approximately $140.0 of Paycheck Protection Program loans; Arrow funded more than 1,400 PPP loans. Total deposits increased substantially, while lower funding costs and a more favorable funding mix supported net interest income.
- The provision for loan losses rose to $3.0 in Q2 from $0.5 a year earlier; first-half provision was $5.8 versus $0.9. Management attributed the increase to pandemic-related uncertainty. Nonperforming loans were $6.5, or 0.25% of loans; net charge-offs were 0.06% of average loans on an annualized Q2 basis.
- Q2 noninterest income included a $0.5 gain on loan sales and a $0.1 loss on equity securities. Other operating income also benefited from fees on interest-rate swap agreements. Fiduciary fees, customer service fees, and insurance commissions declined year over year.
- First-half diluted EPS and net income declined despite higher net interest income, reflecting the sharply higher credit-loss provision and other changes. First-half ROA and ROE were 1.05% and 11.16%, versus 1.19% and 12.88% in 2019.
- Stockholders’ equity rose $16.0 from year-end, reflecting earnings and other comprehensive income, partly offset by $7.8 of dividends and $1.5 of share repurchases. The quarterly dividend was $0.26 per share.
Outlook, risks, and unusual items
- Management said the pandemic’s duration and overall financial impact could not be reasonably estimated. It warned that unemployment, business closures, market disruption, and borrower payment capacity could affect loan production, credit quality, investment values, and results. Management expected economic conditions could adversely affect loan growth for the remainder of 2020; no earnings or revenue guidance was provided.
- At June 30, pandemic-related loan deferrals totaled $319.0, or 12.5% of loans. Commercial and commercial real estate deferrals were $198.0; hotels and motels accounted for $74.8. PPP loans were not included as deferred. Management reported that CARES Act-eligible short-term deferrals were not treated as troubled debt restructurings.
- Arrow reported $1.3 billion of contingent collateralized credit lines in its broader liquidity discussion. It also disclosed approximately $740 million of unused FHLB capacity, $567 million available through Federal Reserve discount-window facilities, and $52 million of correspondent-bank lines; these facilities were not fully drawn. Management said liquidity was adequate, while noting it could not assure sufficiency under all conditions.
- Arrow deferred CECL adoption under the CARES Act. Based on its December 2019 parallel calculation, management expected the initial retained-earnings impact to be immaterial; this remains an estimate. Pandemic uncertainty also affects the allowance for loan losses and other impairment assessments.
- Interest-rate sensitivity modeling showed estimated net interest income changes of negative 1.39% in year one and negative 0.28% in year two under a 200-basis-point increase; under a 100-basis-point decrease, estimated changes were negative 0.24% and negative 9.24%, respectively. The filing cautions these are hypothetical model results dependent on assumptions.
- Management reported no material pending legal proceedings and no impairment of goodwill or other intangible assets. The independent accountant’s interim review found no material modifications necessary for GAAP conformity; it was a review, not an audit.
Investor verification priorities
- Track loan deferrals, especially hotel and other pandemic-exposed borrowers, and whether deferrals translate into delinquencies, nonaccruals, or charge-offs.
- Assess reserve adequacy and future credit costs, including the allowance excluding PPP loans and the eventual CECL adoption effect.
- Monitor PPP forgiveness and fee recognition, and the effect of low-yield PPP balances and market rates on loan yields and net interest margin.
- Verify the durability of deposit growth, deposit pricing, and available liquidity capacity as funding balances and customer needs change.
- Separate recurring operating performance from equity-security valuation changes, loan-sale gains, and swap-related income; review the assumptions behind interest-rate sensitivity estimates.