Arrow Financial Corporation — 2023 Form 10-K
Reporting period: Fiscal year ended December 31, 2023. Arrow is a New York bank holding company operating Glens Falls National Bank and Saratoga National Bank, primarily in upstate New York. Financial figures below are in U.S. dollars; annual results are audited, while selected quarterly information is unaudited.
Financial performance and condition
| Metric | 2023 | 2022 | Change |
|---|---|---|---|
| Net income | $30.1 million | $48.8 million | Down 38.4% |
| Diluted EPS | $1.77 | $2.86 | Down 38.1% |
| Net interest income | $104.8 million | $118.3 million | Down 11.4% |
| Net interest margin | 2.65% | 3.03% | Down 38 basis points |
| Noninterest income | $29.1 million | $30.9 million | Down 5.8% |
| Noninterest expense | $93.0 million | $81.5 million | Up 14.1% |
| Return on average assets / equity | 0.74% / 8.29% | 1.21% / 13.55% | Both lower |
- Fourth quarter: Net income was $7.7 million and diluted EPS was $0.46, versus $12.1 million and $0.71 in Q4 2022. Q4 net interest margin fell to 2.53% from 3.08%; net interest income declined $5.0 million year over year.
- Drivers: Loan interest income rose 25.7% for the year, but interest expense increased 410.5% to $57.7 million as deposit costs rose and customers shifted to higher-cost products. Salaries and benefits were nearly flat; higher legal/professional, technology and FDIC assessment costs drove much of the expense increase.
- Credit: Loans grew 7.7% to $3.21 billion. Provision for credit losses was $3.4 million, down from $4.8 million. Net charge-offs were 0.07% of average loans. Nonperforming loans increased to $21.2 million, or 0.66% of loans, from $12.0 million, or 0.40%; the increase was primarily attributable to a roughly $15 million, well-collateralized commercial real estate relationship. The $31.3 million allowance equaled 0.97% of loans, versus 1.00% a year earlier.
- Balance sheet and funding: Total assets were $4.17 billion, up 5.0%; deposits were $3.69 billion, up 5.4%; and shareholders’ equity was $379.8 million, up 7.4%. Noninterest-bearing deposits declined $78.4 million and were 20.6% of year-end deposits, versus 23.9% in 2022. Cash and cash equivalents were $142.5 million, up from $64.7 million.
- Cash flow: Operating activities provided $20.6 million; investing activities used $82.7 million; financing activities provided $139.9 million. Cash and cash equivalents increased $77.9 million during the year.
- Debt and liquidity: Year-end borrowings were $26.5 million, down from $54.8 million; junior subordinated obligations remained $20.0 million. Primary liquidity was $394.4 million, or 9.5% of assets, above the company’s 5% internal policy minimum. Available borrowing capacity included approximately $550 million at FHLBNY and $739 million at the Federal Reserve; these are contingent sources, not cash on hand. The company also had $175 million of brokered CDs.
- Capital: Arrow reported a 13.00% CET1 ratio, 14.74% total risk-based capital ratio and 9.84% leverage ratio; Arrow and both banks were classified as well-capitalized.
Material changes and unusual items
- Annual earnings fell mainly because net interest income decreased $13.5 million and noninterest expense rose $11.5 million; lower credit-loss provision and income taxes partly offset the decline.
- In Q4, Arrow sold its Visa Class B shares for a $9.3 million pretax gain and sold approximately $100 million of lower-yielding securities for a $9.2 million pretax loss. Management said the repositioning was intended to improve asset-liability management and generate more than $3 million of annual pretax interest-income run-rate improvement. The sales are unusual and should be distinguished from recurring operating results.
- Unrealized losses on available-for-sale securities were $42.4 million at year-end, which Arrow attributed primarily to interest rates rather than credit deterioration. Management said it did not intend, and was not more likely than not required, to sell the securities before recovery of amortized cost.
- Common stock dividends were $1.06 per share for 2023, adjusted for the 3% stock dividend. The board expanded the repurchase authorization; Arrow repurchased approximately $3.6 million of shares during 2023.
Outlook, risks and contingencies
- The filing provides no specific earnings or revenue guidance. Management noted that the timing and magnitude of potential 2024 rate decreases were uncertain and said Arrow believed it was positioned for a variety of rate environments. Interest-rate sensitivity modeling estimated net interest income would change by -4.2% in year one and +15.2% in year two under a 200-basis-point rate increase; assumptions are hypothetical, not forecasts.
- Internal controls: Management concluded disclosure controls and internal control over financial reporting were ineffective at December 31, 2023. KPMG issued an adverse opinion on internal control over financial reporting, identifying material weaknesses involving internal-audit monitoring and oversight, and risk assessment of the September 2022 core-system conversion. The weaknesses did not result in identified misstatements in the financial statements; remediation remained in progress and was not considered complete.
- Litigation: The company and certain current/former officers face a putative securities class action alleging misleading statements, and a related shareholder derivative action alleging fiduciary-duty and oversight failures. Arrow denies wrongdoing and intends to defend the cases. The filing does not provide a clear estimate of potential loss.
- Other risks include deposit competition and funding costs, rate and securities valuation exposure, regional economic and credit deterioration, continued core-system issues, cybersecurity and third-party risks, and regulatory requirements. A New York State desk audit of a 2021 mortgage-recording tax credit was ongoing; management reported no uncertain tax positions.
- Subsequent to year-end, Glens Falls National agreed to acquire one branch in Whitehall, New York, from Berkshire Hills Bancorp.
Most important facts for investors to verify
- Whether control weaknesses are effectively remediated in 2024 and whether the company’s filing and reporting processes remain reliable.
- Progress and financial exposure in the securities class action and derivative litigation.
- Whether the securities portfolio repositioning produces the stated interest-income benefit, and how deposit pricing and deposit mix affect margin.
- Developments in the large nonperforming commercial real estate relationship, potential problem loans and allowance adequacy.
- Liquidity and funding composition, including uninsured and brokered deposits, contingent borrowing availability and the cost of time deposits.
- Recurring earnings trends excluding the Visa gain and securities-sale loss, and the sustainability of dividends and repurchases.