Arrow Financial Corporation — Q3 2014 Form 10-Q
Reporting period: Quarter ended September 30, 2014; year-to-date comparisons are for the nine months ended September 30. Arrow is a Glens Falls, New York-based bank holding company operating two banks and related insurance and investment businesses. Dollar amounts below are in millions unless stated otherwise.
Financial performance and condition
| Metric | Q3 2014 / Sept. 30, 2014 | Comparable period |
|---|---|---|
| Net income | $6.15; diluted EPS $0.49 | Q3 2013: $5.62; $0.45 per diluted share |
| Net interest income | $15.36 GAAP; $16.44 tax-equivalent | Q3 2013: $14.13 GAAP; $15.29 tax-equivalent |
| Net interest margin | 3.21% tax-equivalent | Q3 2013: 3.06% |
| Total assets | $2,208.7 | Up 2.1% from Dec. 31, 2013 |
| Loans / deposits | $1,381.4 / $1,935.4 | Loans up 9.1% and deposits up 5.0% from year-end 2013 |
| Stockholders’ equity | $200.1 | $192.2 at Dec. 31, 2013 |
| Cash and cash equivalents | $64.7 | $72.1 at Sept. 30, 2013 |
- For the first nine months, net income was $17.0 versus $16.0 million; diluted EPS was $1.35 versus $1.28. Tax-equivalent net interest income increased 8.2% to $48.6 million, and net interest margin rose to 3.17% from 3.06%.
- Q3 return on average assets was 1.13% versus 1.06%; return on average equity was 12.22% versus 12.42%. The nine-month figures were 1.05% and 11.55%, respectively, versus 1.03% and 11.99%.
- Q3 noninterest income was $7.35 million, up 5.9%; noninterest expense was $13.53 million, up 3.0%. The reported efficiency ratio improved to 56.80% from 58.61% in Q3 2013. The nine-month ratio was 58.01% versus 60.25%.
- Cash flow for the first nine months: $21.5 million provided by operations, $34.7 million used in investing, and $27.8 million provided by financing; cash and cash equivalents increased $14.7 million.
- Borrowings included $19.7 million of federal funds and repurchase agreements, $10.0 million of FHLB term advances, and $20.0 million of junior subordinated obligations. No FHLB overnight advances remained, compared with $53.0 million at year-end 2013.
- Capital remained strong: Arrow reported a 9.68% Tier 1 leverage ratio, 14.41% Tier 1 risk-based ratio, and 15.48% total risk-based ratio. The company and both banks were classified as well-capitalized.
Material changes and credit quality
- Loan growth was broad-based: period-end loans increased $115.0 million from year-end 2013. Commercial and commercial real estate balances benefited partly from acquired loan participations; residential real estate and automobile loans also grew.
- Available-for-sale securities declined $83.3 million from year-end, with proceeds and other funding used in part to support loan growth and repay borrowings. Management attributed Q3 margin improvement partly to shifting assets from securities into higher-yielding loans and lower rates on some municipal NOW accounts.
- The provision for loan losses was $0.44 million in Q3 and $1.41 million year to date, compared with no Q3 provision and $0.20 million for the first nine months of 2013. The allowance was $15.3 million, or 1.11% of loans.
- Nonperforming loans were $8.0 million, or 0.58% of loans; nonperforming assets were $8.4 million, or 0.38% of assets. Nine-month annualized net charge-offs were 0.06% of average loans. Management reported that credit quality remained strong, while nonperforming assets rose 5.6% from year-end 2013.
Outlook, risks, contingencies and unusual items
- No numerical earnings or growth guidance was provided. Management cautioned that margin compression could continue and that, in a rising-rate environment, liabilities may reprice faster than assets. Its sensitivity model estimated a 3.38% decrease in net interest income under a 200-basis-point rate increase and a 1.33% decrease under its modeled decline in long-term rates; these are hypothetical scenarios, not forecasts.
- Liquidity was described as sufficient. Available capacity included approximately $183.1 million from the FHLB and $300.8 million under Federal Reserve discount-window facilities; correspondent-bank lines totaled $35 million and were undrawn. The stated basic liquidity ratio, including FHLB collateralized capacity, was 10.6% of assets versus a 4% internal minimum.
- Risks highlighted include interest-rate and repricing exposure, loan and collateral quality, competition and economic conditions, municipal-deposit seasonality and concentration, regulatory changes, and cybersecurity and service interruptions. Municipal deposits were 32.7% of total deposits at quarter-end.
- The quarter included a $0.14 million securities gain before tax. For the first nine months, securities gains were lower than in 2013 and net gains on loan sales fell to $0.50 million from $1.27 million. Management said no investment securities were considered other-than-temporarily impaired; unrealized losses were attributed principally to market-rate and spread movements, not issuer credit deterioration.
- The company paid $9.3 million in dividends and repurchased $2.2 million of stock during the first nine months. The board authorized a new program for up to $5 million of repurchases in calendar 2015 and declared a fourth-quarter dividend of $0.25 per share. A 2% stock dividend was distributed in September; per-share figures were restated.
- Management reported no material pending litigation or material expected liability from routine claims. It assessed disclosure controls as effective and reported no material internal-control changes during the quarter. The interim statements were reviewed by KPMG, not audited.
Most important facts for investors to verify
- Whether loan growth and the shift from securities to loans can sustain net interest income and margin as loan yields decline and funding costs or rates change.
- Whether credit trends, provision expense, nonperforming assets, and the allowance remain appropriate as the portfolio expands, particularly in commercial participations and automobile lending.
- The stability and cost of municipal deposits, which are a significant and seasonally variable funding source.
- Liquidity and capital capacity under stress and as enhanced regulatory capital standards phase in from 2015 through 2019.
- The sustainability of reported earnings growth given securities and loan-sale gains, changing tax comparisons, and higher operating expenses in selected categories.