Arrow Financial Corporation — Form 10-Q Summary
Reporting period: Quarter and nine months ended September 30, 2015. Arrow is a New York-based bank holding company with banking, insurance, investment-advisory and other subsidiaries. Financial statements are unaudited; the independent accountant performed an interim review, not an audit. Dollar amounts below are in millions unless stated otherwise.
Financial performance and condition
- Third-quarter earnings: Net income was $5.93 million, down 3.5% from $6.15 million a year earlier; diluted EPS was $0.46 versus $0.48. Return on average assets was 1.00% (1.13% prior year) and return on average equity was 11.24% (12.22%).
- Nine-month earnings: Net income was $18.09 million, up 6.5% from $16.99 million; diluted EPS was $1.40 versus $1.32. ROA was 1.05% in both periods; ROE increased to 11.73% from 11.55%.
- Net interest: Third-quarter GAAP net interest income rose 7.9% to $16.58 million. Tax-equivalent net interest income rose 7.5% to $17.67 million, while net interest margin declined 7 basis points year over year to 3.14%. For nine months, GAAP net interest income was $48.65 million, up 7.7%; tax-equivalent margin was 3.18%, up 1 basis point.
- Other income and expenses: Third-quarter noninterest income fell 2.9% to $7.14 million, partly because there were no securities gains versus $137,000 a year earlier, and insurance commissions declined. Noninterest expense rose 9.8% to $14.85 million; the efficiency ratio increased to 59.54% from 56.80%. For nine months, noninterest income increased 0.9% to $21.44 million and expenses rose 6.0% to $43.19 million.
- Balance-sheet growth: Total assets were $2.42 billion, up 9.1% from year-end 2014. Loans were $1.54 billion, up 8.7%; deposits were $2.08 billion, up 9.4%. Stockholders’ equity was $211.1 million, up 5.1% from year-end.
- Credit quality: The allowance for loan losses was $15.8 million, or 1.03% of loans. Nonperforming loans were $9.1 million (0.59% of loans), and nonperforming assets were $10.0 million (0.41% of assets). Year-to-date net charge-offs were $678,000; the annualized ratio to average loans was 0.06%.
- Cash flow and liquidity: For the first nine months, operating cash flow was $20.0 million, investing cash flow was negative $175.3 million, and financing cash flow was $178.7 million. Cash and cash equivalents ended at $69.7 million, up $23.4 million. Management reported no liquidity problems; unused FHLB borrowing capacity was approximately $213.5 million and Federal Reserve discount-window capacity approximately $322.7 million. The reported basic liquidity ratio, including FHLB collateralized borrowing capacity, was 9.0% of assets.
- Funding and capital: At quarter-end, borrowings included $24.4 million of federal funds/repo financing, $55.0 million of FHLB term advances and $20.0 million of junior subordinated obligations; no FHLB overnight advances were outstanding. Arrow and both bank subsidiaries were classified as well-capitalized. Arrow’s CET1, Tier 1 risk-based, total risk-based and leverage ratios were 12.66%, 13.93%, 14.94% and 9.40%, respectively.
Material changes versus comparable periods
- Quarterly earnings and EPS declined despite higher net interest income: margin compression, higher operating costs, and the absence of prior-year securities gains weighed on results. Average earning assets increased 10.0% year over year, partly offsetting the lower margin.
- Nine-month net income and EPS improved, supported by higher net interest income and lower loan-loss provision ($882,000 versus $1.41 million). The nine-month tax-equivalent margin increased slightly, although management noted the third-quarter margin continued to weaken.
- Loan growth was broad-based. Residential real estate balances increased $64.8 million from year-end, commercial and commercial real estate loans increased $37.9 million, and consumer loans increased $21.9 million.
- Deposits grew, with a continuing shift toward demand, NOW and savings balances and away from time deposits. Arrow added $45 million of FHLB term advances during the first nine months to extend funding maturity.
Outlook, management commentary and risks
- No formal earnings or financial guidance was provided. Management cautioned that margin compression may continue. It also said that, in a rising-rate environment, deposit and other liability costs could increase faster than asset yields in the short term.
- Interest-rate simulations estimated a 2.99% decrease in net interest income under a 200-basis-point increase and a 1.52% decrease under the modeled decline in long-term rates. Management emphasized that these are hypothetical estimates, not forecasts, and depend on assumptions about rates, customer behavior, prepayments and balance-sheet composition.
- Management attributed the quarter’s higher staffing and benefit costs partly to 19 additional full-time-equivalent employees, merit increases, pension and post-retirement costs, and elevated medical claims. Legal, professional and third-party processing costs also increased.
- Nonperforming assets rose from year-end, primarily due to two commercial loans. One was being restructured with a U.S. government agency guaranteeing 80% of the balance; the other was described as fully collateralized. Management did not anticipate significant near-term increases in problem assets but gave no assurance.
- Key risks include interest-rate and margin sensitivity, credit deterioration from regional economic weakness, competition and deposit repricing, municipal-deposit seasonality, auto-lending standards, cybersecurity and regulatory changes. Management reported no material pending legal proceedings beyond routine matters.
- Subsequent event: On October 30, 2015, Arrow sold the stock of Loomis & LaPann, Inc.; the sports-insurance business was the primary business transferred. Management estimated an after-tax gain of approximately $206,000 to be recognized in fourth-quarter results.
- The board approved a new 2016 stock repurchase authorization of up to $5 million. A fourth-quarter cash dividend of $0.25 per share was declared, payable December 15, 2015.
Most important facts for investors to verify
- Whether net interest margin stabilizes, and how deposit-cost repricing compares with loan and securities yield changes.
- Whether loan growth can continue without deterioration in delinquencies, nonperforming assets, charge-offs or allowance coverage.
- The sustainability of expense growth, particularly staffing, employee benefits, legal and technology-processing costs, and its effect on the efficiency ratio.
- The composition, renewal and seasonality of municipal deposits, alongside use and maturity of FHLB and other borrowings.
- The final accounting and reported fourth-quarter proceeds or gain from the Loomis sale, as well as actual use of the 2016 repurchase authorization.
- The filing reports securities unrealized losses as temporary and says they were not due to issuer-credit deterioration; investors may wish to review the portfolio’s interest-rate exposure and pledged collateral.