Arrow Financial Corporation — 2017 Form 10-K
Reporting period: Fiscal year ended December 31, 2017. This summary covers the full year; fourth-quarter results are noted separately. Arrow is a New York bank holding company operating Glens Falls National Bank and Saratoga National Bank, with related insurance, trust and investment-management businesses in northeastern New York.
Financial performance and position
| Metric | 2017 | 2016 |
|---|---|---|
| Interest and dividend income | $84.7 million | $76.9 million |
| Net interest income | $77.7 million | $71.6 million |
| Noninterest income | $27.6 million | $27.8 million |
| Provision for loan losses | $2.7 million | $2.0 million |
| Noninterest expense | $62.7 million | $59.6 million |
| Net income | $29.3 million | $26.5 million |
| Diluted earnings per share | $2.10 | $1.91 |
| Net interest margin, tax-equivalent | 3.17% | 3.15% |
| Return on average assets / equity | 1.09% / 12.14% | 1.06% / 11.79% |
| Efficiency ratio, adjusted non-GAAP | 56.96% | 57.51% |
- Growth and balance sheet: Total assets were $2.76 billion, up 6.0%; loans were $1.95 billion, up 11.3%; deposits were $2.25 billion, up 6.1%. Stockholders’ equity was $249.6 million. Tangible book value per share was $16.18.
- Cash flow: Operating cash flow was $37.8 million; investing activities used $148.6 million, principally reflecting net loan growth; financing activities provided $126.2 million. Cash and cash equivalents increased $15.5 million to $72.8 million.
- Debt and liquidity: Period-end short-term borrowings were $170.0 million, FHLB term advances were $55.0 million, and junior subordinated obligations were $20.0 million. Management reported no liquidity constraints. The liquidity ratio including FHLB collateralized borrowing capacity was 10.5%; unused capacity was approximately $226 million at the FHLB and $425 million at the Federal Reserve discount window. The company also had $35 million in correspondent-bank lines.
- Capital and credit quality: Arrow’s CET1, Tier 1 risk-based, total risk-based and leverage ratios were 12.9%, 14.0%, 15.0% and 9.5%, respectively; Arrow and both banks qualified as well-capitalized. Nonperforming loans were $6.0 million, or 0.31% of loans; the allowance was $18.6 million, or 0.95% of loans and 312% of nonperforming loans.
Material changes and notable items
- Net income rose 10.5% and diluted EPS rose 9.9%. Management attributed the principal earnings improvement to loan growth and higher net interest income; average earning assets increased 7.5%.
- Noninterest income declined 0.7%, including a $448,000 securities loss versus a $22,000 loss in 2016. Noninterest expense increased 5.2%, driven chiefly by salaries and employee benefits, which rose 8.3%.
- The loan-loss provision increased 34.6% to $2.7 million, primarily reflecting loan growth. Net charge-offs remained 0.06% of average loans. Nonperforming loans increased 8.2% year over year, while the ratio to loans was unchanged.
- The Tax Cuts and Jobs Act prompted a $1.1 million fourth-quarter deferred-tax remeasurement benefit and contributed to the decline in the effective tax rate to 26.4% from 29.7%.
- Fourth-quarter net income was $8.1 million, up 22.3% from $6.6 million a year earlier; diluted EPS was $0.58 versus $0.47. The quarter also included a $458,000 pretax securities loss and a $1.157 million loan-loss provision.
- Arrow distributed a 3% stock dividend in September 2017. Cash dividends paid during the year totaled $13.6 million; the Board also authorized a 2018 repurchase program of up to $5 million.
Outlook, commentary and risks
- The filing provides no formal quantified earnings or revenue guidance. Management said additional Federal Reserve rate increases were anticipated by markets in 2018, but gave no assurance about future net interest margin. It expected loan yields to rise if prevailing rates continued upward.
- Management described local economic conditions as generally positive but modest, and asset quality as strong. It noted that loan demand, credit performance and fee income remain exposed to regional economic weakness, interest-rate movements, competition and market conditions.
- Key risks include interest-rate and repricing risk, regional loan concentration, credit losses, deposit and funding availability, cybersecurity and third-party service-provider disruptions, regulatory and capital requirements, and competition from banks and financial-technology providers. The company reported no significant cybersecurity compromise or material cyber-related financial loss to date.
- Interest-rate modeling estimated that a 200-basis-point increase would reduce net interest income by 1.6%, while a 100-basis-point decrease showed no modeled reduction. Management cautioned these hypothetical scenarios are not forecasts and depend on assumptions.
- Unfunded commitments to extend credit were $315.3 million and standby letters of credit totaled $3.5 million. The company reported no material pending litigation or off-balance-sheet arrangements reasonably likely to have a material effect.
- Arrow expects CECL adoption in 2020 to materially increase the allowance for loan losses; management estimated the increase would likely be in the single digits, while noting the estimate remained under evaluation. The financial statements received an unqualified audit opinion, and the auditor also found internal control over financial reporting effective.
Most important facts for investors to verify
- Whether loan growth and deposit funding can continue without weakening underwriting standards or materially increasing funding costs.
- Whether the $18.6 million allowance remains adequate as the loan portfolio expands, particularly given the increase in nonaccrual loans and the $27.6 million of identified potential problem commercial loans.
- How rising rates affect net interest margin, deposit pricing and the value of available-for-sale securities; unrealized losses in that portfolio were $1.7 million at year-end.
- The recurring earnings effect of the Tax Act benefit, securities transactions and higher compensation and technology costs.
- The eventual CECL allowance and capital impact, and the extent to which parent-company dividends depend on distributions from regulated bank subsidiaries.