Arrow Financial Corporation (NASDAQ: AROW) — Q3 2023 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2023. Arrow is a New York bank holding company operating two community banks and related wealth-management and insurance businesses, primarily in upstate New York. Financial statements are unaudited; the independent accountant performed a review, not an audit.
Financial performance and position
Unless otherwise noted, amounts are in millions of dollars.
| Metric | Q3 2023 | Comparable period |
|---|---|---|
| Net interest income | $25.4 | $30.9 in Q3 2022 |
| Net interest margin | 2.53% | 3.14% in Q3 2022 |
| Net income | $7.7 | $12.2 in Q3 2022 |
| Diluted earnings per share | $0.46 | $0.72 in Q3 2022 |
| Return on average assets / equity | 0.75% / 8.47% | 1.19% / 13.34% in Q3 2022 |
| Efficiency ratio | 69.93% | 55.01% in Q3 2022 |
- Nine-month results: Net income was $22.4 million, down 39.1% year over year; diluted EPS was $1.31 versus $2.15. Net interest income declined 9.7% to $79.2 million, while net interest margin fell to 2.70% from 3.02%.
- Revenue and costs: Q3 interest and dividend income increased 23.1% year over year to $42.1 million, but interest expense rose 407.1% to $16.8 million as deposit rates and funding costs increased. Q3 noninterest income was $8.1 million, up 2.8%; noninterest expense rose 9.5% to $23.5 million. For nine months, noninterest expense increased 15.0% to $69.9 million and noninterest income decreased 8.8% to $21.6 million.
- Credit: Q3 provision for credit losses was $0.4 million, versus $1.7 million a year earlier. The allowance was $31.1 million, or 0.99% of loans. Nonperforming loans were $6.3 million (0.20% of loans); nonperforming assets were $6.9 million (0.16% of assets). Net charge-offs were $0.4 million in Q3.
- Balance sheet at September 30: Total assets were $4.27 billion; loans were $3.14 billion, up $155.4 million, or 5.2%, from year-end 2022. Deposits were $3.67 billion, up $168.1 million from year-end but down $128.6 million year over year. Stockholders’ equity was $360.0 million.
- Cash flow and liquidity: Nine-month operating cash flow was $36.9 million, versus $48.2 million in 2022. Investing activities used $80.8 million and financing activities provided $274.0 million; cash and cash equivalents ended at $294.7 million, up from $64.7 million at year-end 2022. Management attributed the cash increase to a strategic liquidity enhancement following recent banking-industry events. The company reported a 16.7% basic liquidity ratio including FHLBNY collateralized borrowing capacity, above its 4% internal minimum.
- Funding and debt: Borrowings totaled $174.3 million, including $150 million of Bank Term Funding Program advances carrying a weighted-average rate of 4.83% and maturing in under 12 months. Total deposits included $451.6 million of time deposits; noninterest-bearing deposits were 21.8% of deposits. Uninsured deposits were less than 30% of the deposit base. The company reported approximately $449 million of unused FHLBNY capacity and $722 million available through the Federal Reserve facility.
- Capital and shareholder returns: Arrow reported a 13.17% CET1 ratio and a 9.94% Tier 1 leverage ratio; the company and both subsidiary banks qualified as well-capitalized. Q3 cash dividend was $0.262 per share. A 3% stock dividend was issued in September; share and per-share figures were adjusted accordingly.
Material changes and notable items
- Higher loan yields and loan growth increased interest income, but deposit repricing, migration to higher-cost accounts, and additional borrowings more than offset that benefit. Q3 net interest margin was 2.53%, down from 2.61% in Q2 2023.
- Legal and professional costs related to delayed filings were a significant unusual expense: $4.1 million year to date, including approximately $1.1 million in Q3. Management also cited higher technology costs and FDIC assessments.
- Available-for-sale securities had $70.4 million of gross unrealized losses at September 30, primarily attributed by management to interest rates rather than credit deterioration. No securities credit-loss allowance was recorded; management said it did not intend, and was not likely required, to sell securities before recovery of amortized cost.
- One commercial real estate relationship drove a notable increase in loans past due 30–59 days. Management said the property collateral value exceeded the loan exposure and that it was working with the borrower. Total loans past due 30–89 days and accruing interest were $34.6 million, including this relationship.
Outlook, risks, and contingencies
- The filing provides no formal earnings or revenue guidance. Management noted that inflation, higher rates, competition, deposit pricing and mix, and weaker loan demand may affect future results. It also cautioned that a prolonged elevated-rate environment could pressure residential and consumer loan demand.
- Interest-rate sensitivity modeling estimated net interest income would change by negative 3.4% in year one and positive 13.5% in year two under a 200-basis-point rate increase; under a 100-basis-point decrease, modeled changes were positive 0.9% and 12.4%. These are hypothetical estimates dependent on assumptions, not forecasts.
- Management identified unremediated material weaknesses in internal control over financial reporting concerning oversight of internal audit testing and risk assessment related to the core banking system conversion. Remediation work is underway; management said the weaknesses had not caused a material misstatement of the reported financial statements.
- A shareholder class action filed in June 2023 alleges misleading statements in company filings from March 2022 through May 2023. The company denies wrongdoing, considers the case without merit, and intends to defend it. The filing does not provide a clear estimate of potential financial exposure.
- Commitments to extend credit totaled $464.7 million and standby letters of credit $4.2 million. The company said commitments are not necessarily expected to be fully drawn and did not expect material losses from them. The Visa antitrust settlement appeals process remained unresolved; no value was recognized for Arrow’s Visa Class B shares.
Important facts for investors to verify
- Whether deposit costs continue to rise faster than asset yields, and the effect on net interest margin and earnings.
- Deposit stability and mix, uninsured and reciprocal deposit balances, and the company’s reliance on BTFP and other borrowing facilities.
- Performance and collateral coverage of the delinquent commercial real estate relationship, and trends in past-due loans, nonperforming assets, and charge-offs.
- Progress in remediating the disclosed material weaknesses, particularly controls related to the core banking system and internal audit oversight.
- Further developments and potential exposure in the shareholder lawsuit, as well as the impact of delayed-filing costs on future expenses.
- Changes in unrealized securities losses, liquidity needs, and the company’s ability to hold securities until recovery of amortized cost.