Arrow Financial Corporation — Q1 2015 Form 10-Q
Reporting period: Three months ended March 31, 2015. Arrow is a New York bank holding company with banking, insurance, investment-advisory and related subsidiaries. Dollar amounts below are in millions unless stated otherwise. Comparative operating results are year over year; balance-sheet comparisons are primarily to March 31, 2014.
Financial performance and position
- Earnings: Net income was $5.86 million, up 10.1% from $5.32 million. Diluted EPS rose 9.5% to $0.46 from $0.42. Return on average assets was 1.06% (0.99% prior year), and return on average equity was 11.72% (11.11%).
- Revenue and margins: Net interest income was $15.90 million, up 8.4%; on a tax-equivalent basis it was $16.99 million, up 7.2%. Net interest margin increased 12 basis points to 3.24%. Interest and dividend income was $16.99 million versus $16.27 million; noninterest income was $6.86 million versus $6.89 million. Noninterest expense rose 3.6% to $13.96 million. The efficiency ratio improved to 58.37% from 58.77%. The effective tax rate was 31.4%, up from 30.3%.
- Cash flow: Operating activities provided $8.50 million; investing activities used $51.40 million; financing activities provided $108.20 million. Cash and cash equivalents increased $65.30 million to $111.60 million. Financing inflows included $115.76 million in deposit growth and $40 million of FHLB advances, partly offset by lower short-term borrowings.
- Balance sheet and liquidity: Total assets were $2.34 billion, up 5.1% year over year. Loans were $1.43 billion, up 9.5%; deposits were $2.02 billion, up 3.6%. Stockholders’ equity was $204.97 million, up 5.4%. Management reported a 9.6% basic liquidity ratio, or approximately $224 million, versus its 4% internal minimum; unused FHLB borrowing capacity was about $113.7 million and Federal Reserve borrowing capacity about $308.8 million.
- Debt and capital: Period-end borrowings included $15.90 million of federal funds and repurchase-agreement balances, $50 million of FHLB term advances, and $20 million of junior subordinated obligations. No FHLB overnight advances remained, compared with $41 million at year-end 2014. Arrow reported a 13.27% common equity Tier 1 ratio, 14.65% Tier 1 risk-based ratio, 15.73% total risk-based ratio and 9.57% leverage ratio; the company and both banks qualified as well-capitalized.
- Credit quality: The allowance for loan losses was $15.63 million, or 1.09% of loans, compared with 1.12% a year earlier. Quarterly net charge-offs were $220,000 versus $256,000; nonperforming loans were $7.89 million, or 0.55% of loans, and nonperforming assets were $8.41 million, or 0.36% of assets.
Material changes versus Q1 2014
- Net income increased $535,000, supported by higher net interest income and a lower loan-loss provision ($275,000 versus $458,000). Interest expense declined 31.9% to $1.09 million, while average earning assets increased 3.4%.
- Average loan yields declined to 3.92% from 4.06%, but lower funding costs helped lift net interest margin. Management attributed part of the margin improvement to prior-period repricing of municipal NOW accounts and redeployment of securities-sale proceeds into higher-yielding loans; it cautioned these benefits should not be expected to recur.
- Noninterest income was nearly unchanged. Insurance commissions fell 12.5%, primarily because of lower contingent commissions; fiduciary income and customer-service fees increased. Noninterest expense rose 3.6%, including higher data-processing, maintenance and legal costs.
- Period-end loans grew $124.4 million year over year. Deposits shifted toward demand, NOW and savings accounts and away from time deposits. Available-for-sale securities were $393.13 million, down 8.4% year over year but up 7.4% from year-end 2014.
Outlook, risks and unusual items
- No formal earnings or revenue guidance is provided. Management said multi-year net interest margin compression may continue; in a rising-rate environment, liabilities may reprice faster than assets initially. Its model estimated net interest income would decline 1.74% under a 200-basis-point rate increase and 1.57% under a 100-basis-point decline in long-term rates, subject to stated assumptions and limitations.
- Management described local economic and loan conditions as generally stable, but identified potential exposure to weaker regional economic conditions, commercial real-estate and borrower credit deterioration, indirect auto-loan underwriting trends, competition, deposit seasonality and interest-rate movements. Auto loans were nearly one-third of the portfolio; the company noted a slightly higher share of recent originations in lower credit tiers, without a significant change in auto net charge-offs.
- Commitments to extend credit totaled $259.63 million and standby letters of credit $3.19 million. These are off-balance-sheet exposures; the filing notes that commitments may expire unused and are not necessarily future cash requirements.
- The company reported no material pending legal proceedings beyond ordinary-course matters. It described a contingent exposure related to former Visa membership, while stating it believed Visa’s litigation escrow was substantially sufficient; Arrow assigned no economic value to its 27,771 Visa Class B shares. No other-than-temporary securities impairment was recorded, and management considered disclosed unrealized losses temporary.
- The board declared a $0.25 per-share second-quarter dividend, payable June 15, 2015. A $5 million 2015 repurchase authorization was in place, but no shares were repurchased under that program during Q1. The quarter’s reported share purchases were through the dividend reinvestment plan or option-related share surrenders.
- The interim financial statements were reviewed, not audited; the independent accountant reported no material modifications needed for GAAP conformity. Management concluded disclosure controls were effective and reported no material change in internal control over financial reporting.
Important facts for investors to verify
- Whether net interest margin and earnings growth can persist after the nonrecurring factors management cited, and how asset and deposit repricing affect results.
- Trends in loan delinquencies, nonperforming assets, charge-offs, criticized commercial credits and the adequacy of the allowance as the loan portfolio grows.
- The durability and seasonal composition of deposits, particularly municipal balances, and the company’s continued reliance on FHLB advances and other contingent liquidity sources.
- Credit performance in indirect auto lending, including the effect of a higher proportion of recent loans in lower credit tiers.
- Potential outcomes of the Visa-related contingent exposure and the extent to which off-balance-sheet commitments could be drawn.