Arrow Financial Corporation — Q1 2023 Form 10-Q
Business context and period: Arrow is a bank holding company operating Glens Falls National Bank and Trust Company and Saratoga National Bank in northeastern New York, with banking, wealth management and insurance activities. This unaudited report covers the three months ended March 31, 2023, with balance-sheet comparisons to December 31, 2022 and March 31, 2022. The 10-Q was filed July 27, 2023, following delayed periodic filings.
Financial performance and condition
| Metric | Q1 2023 / March 31, 2023 | Comparable period / change |
|---|---|---|
| Net interest income | $28.1 million | Up 1.0% year over year |
| Net interest margin | 2.96% | 2.90% in Q1 2022; 2.96% excluding prior-year PPP income versus 2.81% |
| Net income; diluted EPS | $8.6 million; $0.52 | Down 31.9% and 31.6%, respectively |
| Return on average assets / equity | 0.87% / 9.66% | 1.26% / 13.77% in Q1 2022 |
| Non-interest income / expense | $6.7 million / $22.3 million | Income down 18.2%; expense up 17.7% |
| Loans / deposits | $3.005 billion / $3.546 billion | Loans up 9.8% year over year; deposits down 4.5% |
| Cash and cash equivalents | $203.5 million | $64.7 million at year-end 2022; $487.6 million a year earlier |
| Stockholders’ equity | $363.4 million | Up 2.8% from year-end 2022 |
| Allowance for loan losses | $30.8 million; 1.02% of loans | $27.7 million; 1.01% a year earlier |
Loan interest income rose 23.9% year over year to $31.9 million, reflecting loan growth and higher rates. This was largely offset by interest expense rising $6.9 million to $8.0 million as deposit costs repriced upward. The cost of interest-bearing liabilities increased to 1.17% from 0.16%; the reported net interest spread narrowed to 2.64% from 2.86%.
Operating cash flow was $13.2 million; investing activities used $5.7 million and financing activities provided $131.3 million. Financing inflows included $100 million of FHLB advances and a $48.0 million net increase in deposits. At quarter-end, FHLB advances totaled $142.8 million, and junior subordinated obligations were $20.0 million. The company reported $1.3 billion of aggregate available borrowing capacity through collateralized facilities, including FHLB and Federal Reserve arrangements.
Regulatory capital remained strong: the holding company’s CET1, Tier 1 risk-based, total risk-based and leverage ratios were 13.34%, 14.03%, 15.15% and 10.13%, respectively. Arrow and both subsidiary banks qualified as well-capitalized.
Material changes versus prior periods
- Net income declined $4.0 million year over year, reflecting higher funding costs, lower non-interest income and increased expenses despite stronger loan income.
- Non-interest income fell $1.5 million, including lower fiduciary fees and other operating income. Non-interest expense increased $3.4 million; management cited approximately $1.0 million of additional legal and professional fees related to the delayed 2022 Form 10-K, higher technology spending and employee benefit costs.
- Loans increased $22.1 million from year-end 2022, reaching a period-end record. Deposits rose $48.0 million during Q1, but remained $169.0 million below March 2022; balances shifted toward higher-cost time deposits.
- Cash increased substantially from year-end, primarily from deposit inflows and $80 million of additional FHLB term advances taken to strengthen liquidity amid industry events.
- Net charge-offs were $722,000 versus $389,000 in Q1 2022. Nonperforming loans were $11.2 million, or 0.37% of loans, compared with 0.36% a year earlier.
- Available-for-sale securities had $57.5 million of gross unrealized losses at March 31, primarily attributed by management to interest rates rather than credit deterioration. The company recorded no securities credit-loss allowance, stating it did not intend, and was not likely required, to sell before recovery.
Outlook, risks and unusual items
The filing provides no specific earnings or financial guidance. Management noted that loan demand may be affected by higher rates and inflation, while deposit competition and repricing could pressure funding costs. Interest-rate simulation showed net interest income down 2.96% in year one under a 200-basis-point rate increase, but up 13.09% in year two; results depend on assumptions and are not forecasts.
- Controls and reporting: Management concluded internal control over financial reporting was not effective because of two unremediated material weaknesses: monitoring and oversight of Internal Audit’s control testing, and risk assessment related to conversion of the core banking system. Remediation was underway; management reported no resulting material misstatement in the financial statements.
- Filing-related restrictions: The delayed filings led Arrow to suspend its Employee Stock Purchase Plan and Dividend Reinvestment Plan. Management did not expect to resume the DRIP for at least 12 months after filing the outstanding reports. The late report could also constitute an indenture default if required notice were delivered; the trustee had not given notice as of the filing date.
- Legal matter after quarter-end: A shareholder putative class action filed June 23, 2023 alleges misleading public statements and seeks damages. Arrow denied wrongdoing, intends to defend the case, and had not been served as of the 10-Q filing date.
- Leadership transition: The former CEO departed effective May 12, 2023; David S. DeMarco became CEO effective May 13.
- Other exposures: The loan portfolio is concentrated primarily in upstate New York, with regional economic and tourism exposure. Commitments to extend credit totaled $478.3 million, in addition to $3.4 million of standby letters of credit. A related-party contractor received $1.3 million for the company’s headquarters renovation during Q1.
Investor facts to verify
- Whether deposit retention and pricing stabilize, and whether margin pressure persists as deposits reprice.
- Progress in remediating the disclosed internal-control material weaknesses and the status of delayed filings and suspended shareholder plans.
- Loan delinquency, charge-off and nonperforming-loan trends, including performance in commercial real estate and indirect auto lending.
- Liquidity and funding dependence, including use of FHLB advances, uninsured deposits and the availability of pledged-collateral borrowing capacity.
- Potential effects of securities unrealized losses if liquidity needs require sales, and developments in the shareholder litigation and CEO transition.