Arrow Financial Corporation — Q2 2019 Form 10-Q
Business context and period: Arrow is a New York-based two-bank holding company with banking, insurance, fiduciary and investment-advisory businesses. This unaudited filing covers the quarter and six months ended June 30, 2019; comparisons are with the corresponding 2018 periods unless noted.
Financial performance and position
| Metric | Q2 2019 | Q2 2018 | Six months 2019 | Six months 2018 |
|---|---|---|---|---|
| Net interest income | $21.7 million | $21.0 million | $42.8 million | $41.4 million |
| Noninterest income | $6.9 million | $7.9 million | $13.8 million | $14.8 million |
| Net income | $8.9 million | $9.7 million | $17.7 million | $18.3 million |
| Diluted EPS | $0.62 | $0.67 | $1.22 | $1.26 |
| Net interest margin, GAAP | 3.04% | 3.11% | 3.02% | 3.12% |
| Noninterest expense | $16.9 million | $16.2 million | $33.6 million | $32.1 million |
- Q2 return on average assets was 1.20% and return on average equity was 12.79%; both were lower than a year earlier. The six-month figures were 1.19% and 12.88%, respectively.
- Loans were $2.280 billion at June 30, up 10.8% year over year. Total assets were $3.006 billion. Deposits were $2.504 billion, up 8.6% year over year.
- Six-month operating cash flow was $21.1 million; investing cash outflow was $24.2 million and financing cash outflow was $18.4 million. Cash and cash equivalents declined $21.5 million to $62.7 million.
- At June 30, borrowings included $83.0 million of overnight and $30.0 million of term FHLB advances, $51.1 million of federal funds/repo borrowings, and $20.0 million of junior subordinated obligations. Finance lease liabilities were $5.3 million.
- Stockholders’ equity was $284.6 million, up 5.6% from year-end 2018. The estimated holding-company ratios were 12.99% CET1, 13.93% Tier 1 risk-based, 14.91% total risk-based and 9.88% leverage; Arrow and both subsidiary banks remained “well-capitalized.”
- Quarterly cash dividend was $0.26 per share. Tangible book value per share, a non-GAAP measure, was $17.99.
Material changes and management commentary
- Q2 net income fell 8.2% and diluted EPS fell 7.5%. Net interest income grew 3.6%, mainly on loan growth, but higher deposit and borrowing costs pressured margins: Q2 interest expense more than doubled year over year. The GAAP net interest margin declined 7 basis points.
- Noninterest income decreased 12.8% in Q2. Fiduciary income and insurance commissions fell, partly reflecting large estate settlements in Q2 2018 and competitive pressures; Q2 2018 also included a $223,000 securities gain. Noninterest expense rose 4.4%, including higher technology/equipment and other operating costs. The company cited ongoing technology projects intended to improve efficiency and customer experience.
- For the first half, net income declined 3.2%; net interest income rose 3.5%, while noninterest income fell 6.9% and expenses increased 4.4%. The six-month efficiency ratio was 58.37%, versus 56.28% a year earlier (company-defined non-GAAP measure).
- Management reported continued loan demand and generally strong asset quality. Consumer lending, primarily indirect auto loans, was a significant growth driver; consumer loans represented 34.2% of period-end loans. Loan growth strategy included reallocating earning assets from securities to loans.
- Deposits rose $158.2 million from year-end, including $84.5 million of brokered deposits acquired during the first half to diversify funding and replace more expensive FHLB overnight advances. Brokered deposits outstanding totaled $129.6 million at June 30.
Liquidity, credit, risks and outlook
- Management reported no significant liquidity constraints. Available liquidity included $57 million of undrawn correspondent-bank lines, approximately $439 million of unused FHLB borrowing capacity and approximately $551 million available through Federal Reserve discount-window facilities. The reported basic liquidity ratio, including FHLB collateralized borrowing capacity, was 13.4% of assets, or $281 million above the internal 4% minimum target.
- The allowance for loan losses was $20.7 million, or 0.91% of loans. Nonperforming loans were $5.5 million (0.24% of loans); nonperforming assets were $6.9 million (0.23% of assets). Net charge-offs were $133,000 in Q2. Management said the allowance was appropriate, but noted that economic conditions and portfolio changes could require future adjustments.
- Interest-rate sensitivity modeling estimated net interest income would change by -2.4% in year one and +1.1% in year two under a 200-basis-point increase; under a 100-basis-point decrease, the estimates were +0.4% and -3.6%. These are hypothetical model outputs, not guidance, and depend on assumptions about rates, customer behavior and prepayments.
- No specific earnings or growth guidance was provided. Management said it expected to manage through varied rate environments, while noting that market indicators anticipated lower short-term rates through the rest of 2019. Loan demand, deposit pricing, auto demand, regional economic conditions and real-estate markets could affect results.
- Arrow planned to adopt the CECL expected-credit-loss standard in Q1 2020. It expected adoption likely to increase the allowance and reduce shareholders’ equity, with the amount dependent on portfolio characteristics and economic forecasts; the company expected to remain well-capitalized. Implementation methods were still subject to further testing.
- Other contingencies and unusual items: Glens Falls National held 27,771 Visa Class B shares tied to antitrust litigation. Any potential value or gain was not recognized because settlement approval and escrow sufficiency remained uncertain. Management reported no material pending legal proceedings and no material loss expected from routine claims. The filing also reports adoption of lease accounting in 2019, increasing assets by $7.9 million and liabilities by $8.0 million, with no material income-statement impact.
Most important facts to verify
- Whether loan growth—particularly indirect auto lending—continues without deterioration in delinquencies, nonperforming loans or loss rates.
- Whether deposit costs and funding mix continue to pressure net interest margin, and how results compare with management’s interest-rate sensitivity assumptions.
- The sustainability of fiduciary and insurance revenue, expense growth from technology projects, and the resulting trend in earnings and efficiency.
- The adequacy of the loan-loss allowance and the eventual CECL transition impact on reserves, equity and regulatory capital.
- Brokered-deposit levels, liquidity capacity and capital ratios, including final implementation of the proposed community-bank leverage-ratio rules.
- Any material developments in the Visa litigation settlement or related contingent value.