ARROW FINANCIAL CORPORATION Selected Quarterly Information
Dollars in thousands, except per share amounts
Share and per share amounts have been restated for the September 2020 3% stock
dividend
Quarter Ended 12/31/2020 9/30/2020 6/30/2020 3/31/2020 12/31/2019
Net Income $ 12,495 $ 11,046 $ 9,159 $ 8,127 $ 9,740
Transactions
Recorded in Net
Income (Net of Tax):
Net Changes in Fair (53) (80) (279)
Value of Equity
Investments 66 50
Share and Per Share
Data: 1
Period End Shares 15,516 15,489 15,461 15,432 15,448
Outstanding
Basic Average Shares 15,499 15,472 15,441 15,446 15,427 Outstanding Diluted Average 15,515 15,481 15,448 15,476 15,476 Shares Outstanding Basic Earnings Per$ 0.81 $ 0.71 $ 0.59 $ 0.53 $ 0.63 Share Diluted Earnings Per 0.81 0.71 0.59 0.53 0.63
Share
Cash Dividend Per
Share 0.260 0.252 0.252 0.252 0.252
Selected Quarterly
Average Balances:
Interest-Bearing
Deposits at Banks
Investment 590,151 592,457 607,094 603,748 582,982 Securities Loans 2,610,834 2,582,253 2,518,198 2,394,346 2,358,110 Deposits 3,256,238 3,082,499 2,952,432 2,670,009 2,607,421 Other Borrowed 95,047 136,117 129,383 170,987 177,877 Funds Shareholders' 331,899 324,269 316,380 306,527 296,124 Equity Total Assets 3,721,954 3,583,322 3,437,155 3,180,857 3,113,114
Return on Average 1.34 % 1.23 % 1.07 % 1.03 % 1.24 % Assets, annualized Return on Average 14.98 % 13.55 % 11.64 % 10.66% 13.05 % Equity, annualized Return on Average Tangible Equity, annualized 2 16.13 % 14.61 % 12.58 % 11.55 % 14.18 %
Average Earning
Assets
Average Paying 2,674,795 2,545,435 2,457,690
2,362,515 2,293,804
Liabilities
Interest Income 28,372 27,296 28,002 28,226 28,367 Tax-Equivalent 251 284 281 288 321
Adjustment 3
Interest Income, 28,623 27,580 28,283 28,514 28,688
Tax-Equivalent 3
Interest Expense 1,918 2,396 3,160 5,220 5,449 Net Interest Income 26,454 24,900 24,842 23,006 22,918 Net Interest Income, 26,705 25,184 25,123 23,294 23,239 Tax-Equivalent 3 Net Interest Margin, annualized 2.96 % 2.90 % 3.05 % 3.05 % 3.06 % Net Interest Margin, Tax-Equivalent, annualized 3 2.99 % 2.93 % 3.08 % 3.09 % 3.10 % Efficiency Ratio Calculation: 4 Noninterest Expense$ 18,192 $ 17,487 $ 17,245 $ 17,754 $ 17,099 Less: Intangible Asset Amortization 56 56 57 58 60 Net Noninterest Expense 18,136 17,431 17,188 17,696 17,039
Net Interest Income,
Tax-Equivalent 26,705 25,184 25,123 23,294 23,239 Noninterest Income 9,103 8,697 7,164 7,694 7,081
Less: Net Changes in Fair Value of Equity Investments 88 (72) (106) (374) 67
Net Gross Income
Efficiency Ratio 50.77 % 51.34 % 53.06 %
56.42 % 56.32 %
Information: 5
Total Stockholders'
Equity (i.e. Book
Value)
Book Value per Share 21.55 21.02 20.55 20.05 19.53
1
Goodwill and Other 23,823 23,662 23,535 23,513 23,534
Intangible Assets,
net
Tangible Book Value
per Share 1,2 20.02 19.50 19.03 18.53 18.01
Capital Ratios: 5
Tier 1 Leverage
Ratio 9.07 % 9.17 % 9.32 % 9.87 % 9.98 %
Common Equity Tier 1
Capital Ratio 13.39 % 13.20 % 13.07 %
12.84 % 12.94 %
Tier 1 Risk-Based
Capital Ratio 14.24 % 14.06 % 13.94 %
13.72 % 13.83 %
Total Risk-Based
Capital Ratio 15.48 % 15.28 % 15.10 %
14.76 % 14.78 %
Administration &
Investment Mgmt
24
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Selected Twelve-Month Information
Dollars in thousands, except per share amounts
Share and per share amounts have been restated for the September 2020 3% stock
dividend
2020 2019 2018
Net Income $ 40,827 $ 37,475 $ 36,279 Transactions Recorded in Net Income (Net of
Tax):
Net (Loss) Gain on Securities (346) 214 158 Period End Shares Outstanding1 15,516 15,448 15,354 Basic Average Shares Outstanding1 15,465 15,388 15,285 Diluted Average Shares Outstanding1 15,479 15,433 15,370 Basic Earnings Per Share1$ 2.64 $ 2.44 $ 2.37 Diluted Earnings Per Share1 2.64 2.43 2.36 Cash Dividends Per Share1 1.02 0.99 0.92 Average Assets 3,481,761 3,028,028 2,855,753 Average Equity 319,814 284,640 259,835 Return on Average Assets 1.17 % 1.24 % 1.27 % Return on Average Equity 12.77 % 13.17 % 13.96 % Average Earning Assets$ 3,320,937 $ 2,891,322 $ 2,734,160 Average Interest-Bearing Liabilities 2,510,655 2,241,942
2,113,102
Interest Income 111,896 109,759 96,503 Interest Income, Tax-Equivalent* 113,000 111,173 98,214 Interest Expense 12,694 21,710 12,485 Net Interest Income 99,202 88,049 84,018 Net Interest Income, Tax-Equivalent* 100,306 89,463 85,729 Net Interest Margin 2.99 % 3.05 % 3.07 % Net Interest Margin, Tax-Equivalent* 3.02 % 3.09 % 3.14 %
Efficiency Ratio Calculation*4
Noninterest Expense$ 70,678 $ 67,450
Less: Intangible Asset Amortization 227 245 263 Net Noninterest Expense 70,451 67,205 64,792 Net Interest Income, Tax-Equivalent 100,306 89,463 85,729 Noninterest Income 32,658 28,555 28,949 Less: Net (Loss) Gain on Securities (464) 289 213 Net Gross Income, Adjusted$ 133,428 $ 117,729 $ 114,465 Efficiency Ratio* 55.69 % 57.08 % 56.60 %
Period-End Capital Information:
Tier 1 Leverage Ratio 9.07 % 9.98 % 9.61 %
Total Stockholders' Equity (i.e. Book Value)
$ 269,584 Book Value per Share 21.55 19.53 17.56 Intangible Assets 23,823 23,534 23,725 Tangible Book Value per Share 2 20.02 18.01 16.01
Asset Quality Information:
Net Loans Charged-off as a Percentage of
Average Loans 0.05 % 0.05 % 0.05 %
Provision for Loan Losses as a Percentage of
Average Loans 0.37 % 0.09 % 0.13 %
Allowance for Loan Losses as a Percentage of
Period-End Loans 1.13 % 0.89 % 0.92 %
Allowance for Loan Losses as a Percentage of
Nonperforming Loans 456.32 % 481.41
% 365.74 %
Nonperforming Loans as a Percentage of
Period-End Loans 0.25 % 0.18 % 0.25 %
Nonperforming Assets as a Percentage of
Total Assets 0.18 % 0.18 % 0.23 %
*See "Use of Non-GAAP Financial Measures" on page 4.
25
--------------------------------------------------------------------------------Arrow Financial Corporation Reconciliation of Non-GAAP Financial Information (Dollars In Thousands, Except Per Share Amounts) Footnotes:
1. Share and per share data have been restated for the
2. Non-GAAP Financial Measure Reconciliation: Tangible Book Value, Tangible Equity, and Return on Tangible Equity exclude goodwill and
other intangible assets, net from total equity. These are non-GAAP financial measures which Arrow believes provides investors with
information that is useful in understanding its financial performance.
12/31/2020 9/30/2020 6/30/2020 3/31/2020 12/31/2019
Total Stockholders' Equity (GAAP) $ 334,392 $ 325,660 $ 317,687 $ 309,398 $ 301,728
Less: Goodwill and Other
Intangible assets, net 23,823 23,662 23,535 23,513 23,534
Tangible Equity (Non-GAAP) $ 310,569 $ 301,998 $ 294,152 $ 285,885 $ 278,194
Period End Shares Outstanding 15,516 15,489 15,461 15,432 15,448
Tangible Book Value per Share
(Non-GAAP) $ 20.02 $ 19.50 $ 19.03 $ 18.53 $ 18.01
Net Income 12,495 11,046 9,159 8,127 9,740
Return on Tangible Equity (Net
Income/Tangible Equity -
Annualized) 16.13 % 14.61 % 12.58 % 11.55 % 14.18 %
3. Non-GAAP Financial Measure Reconciliation: Net Interest Margin is the ratio of annualized tax-equivalent net interest income to
average earning assets. This is also a non-GAAP financial measure which Arrow believes provides investors with information that is
useful in understanding its financial performance.
12/31/2020 9/30/2020 6/30/2020 3/31/2020 12/31/2019
Interest Income (GAAP) $ 28,372 $ 27,296 $ 28,002 $ 28,226 $ 28,367
Add: Tax Equivalent Adjustment
(Non-GAAP) 251 284 281 288 321
Interest Income - Tax Equivalent
(Non-GAAP) $ 28,623 $ 27,580 $ 28,283 $ 28,514 $ 28,688
Net Interest Income (GAAP) $ 26,454 $ 24,900 $ 24,842 $ 23,006 $ 22,918
Add: Tax-Equivalent adjustment
(Non-GAAP) 251 284 281 288 321
Net Interest Income - Tax
Equivalent (Non-GAAP) $ 26,705 $ 25,184 $ 25,123 $ 23,294 $ 23,239
Average Earning Assets $ 3,550,415 $ 3,417,638 $ 3,281,223 $ 3,030,881 $ 2,969,972
Net Interest Margin (Non-GAAP) 2.99 % 2.93 % 3.08 % 3.09 % 3.10 %
4. Non-GAAP Financial Measure Reconciliation: Financial Institutions often use the "efficiency ratio", a non-GAAP ratio, as a measure of
expense control. Arrow believes the efficiency ratio provides investors with information that is useful in understanding its financial
performance. Arrow defines efficiency ratio as the ratio of noninterest expense to net gross income (which equals tax-equivalent net
interest income plus noninterest income, as adjusted).
5. For the current quarter, all of the regulatory capital ratios in the table above, as well as the Total Risk-Weighted Assets and Common
Equity Tier 1 Capital amounts listed in the table below, are estimates based on, and calculated in accordance with bank regulatory
capital rules. All prior quarters reflect actual results. The
the sum of the required minimum CET1 ratio plus the fully phased-in Capital Conservation Buffer (i.e., 7.00%).
12/31/2020 9/30/2020 6/30/2020 3/31/2020 12/31/2019
Total Risk Weighted Assets $ 2,357,094 $ 2,321,637 $ 2,283,430 $ 2,275,902 $ 2,237,127
Common Equity Tier 1 Capital 315,696 306,356 298,362 292,165 289,409
Common Equity Tier 1 Ratio 13.39 % 13.20 % 13.07 % 12.84 % 12.94 %
26
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CRITICAL ACCOUNTING ESTIMATES
The significant accounting policies, as described in Note 2 - Summary of
Significant Accounting Policies to the notes to the Consolidated Financial
Statements are essential in understanding the Management Discussion and
Analysis. Many of the significant accounting policies require complex judgments
to estimate the values of assets and liabilities. Arrow has procedures and
processes in place to facilitate making these judgments. The more judgmental
estimates are summarized in the following discussion. In many cases, there are
numerous alternative judgments that could be used in the process of determining
the inputs to the models. Where alternatives exist, Arrow has used the factors
that are believed to represent the most reasonable value in developing the
inputs. Actual performance that differs from estimates of the key variables
could impact the results of operations.
Allowance for loan losses: The allowance for loan losses represents management's
estimate of probable losses inherent in Arrow's loan portfolio. The process for
determining the allowance for loan losses is discussed in Note 2, Summary of
Significant Accounting Policies and Note 5, Loans, to the notes to the
Consolidated Financial Statements. Arrow evaluates the allowance at the
portfolio segment level and the portfolio segments are commercial, commercial
real estate, consumer loans and residential real estate. Due to the variability
in the drivers of the assumptions used in this process, estimates of the
portfolio's inherent risks and overall collectability change with changes in the
economy, individual industries, and borrowers' ability and willingness to repay
their obligations. The degree to which any particular assumption affects the
allowance for loan losses depends on the severity of the change and its
relationship to the other assumptions. Key judgments used in determining the
allowance for loan losses for individual commercial loans include credit quality
indicators, collateral values and estimated cash flows for impaired loans. For
pools of loans, Arrow considers the historical net loss experience, and as
necessary, adjustments to address current events and conditions, considerations
regarding economic uncertainty, and overall credit conditions. The historical
net loss factors incorporate a rolling average annual twelve quarter look-back
period of the respective segment that have occurred within each pool of loans
over the loss emergence period (LEP), adjusted as necessary based upon
consideration of qualitative considerations impacting the inherent risk of loss
in the respective loan portfolios. The LEP is an estimate of the average amount
of time from the point at which a loss is incurred on a loan to the point at
which the loss is recognized in the financial statements. Since the LEP may
change under various economic environments, the LEP calculation is updated on an
annual basis. The process of determining the level of the allowance for loan
losses requires a high degree of judgment. Any downward trend in the economy,
regional or national, may require Arrow to increase the allowance for loan
losses resulting in a negative impact on the results of operations and financial
condition.
27
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A. OVERVIEW
The following discussion and analysis focuses on and reviews Arrow's results of
operations for each of the years in the three-year period ended December 31,
2020 and the financial condition as of December 31, 2020 and 2019. The
discussion below should be read in conjunction with the selected quarterly and
annual information set forth above and the Consolidated Financial Statements and
other financial data presented elsewhere in this Report. When necessary,
prior-year financial information has been reclassified to conform to the
current-year presentation.
COVID-19 Pandemic:
In March 2020 , the World Health Organization recognized COVID-19 as a pandemic.
In response, the United States federal government and various state and local
governments have, among other actions, imposed travel and business restrictions
and required or advised communities in which we do business to adopt
stay-at-home orders and social distancing guidelines, causing some businesses to
adjust, reduce or suspend operating activities. Like many businesses, Arrow
expects the operations and financial results to continue to be adversely
impacted by the COVID-19 pandemic. The severity, magnitude and duration of the
current pandemic are still uncertain, rapidly changing and hard to predict.
Arrow continues to manage its COVID-19 response with health and safety concerns
as a top priority. Throughout 2020, the Business Continuity Task Force ,
representing leadership from across the organization, focused on maintaining
protocols that have allowed Arrow to continue operations. Arrow actively
monitors developments, and if future restrictions are imposed, is confident in
its ability to continue to provide essential banking services and meet customer
needs.
Arrow provided full access at its facilities or appointment-only access
depending on conditions present at that time. Drive-ins and ATMs are open, and
Arrow continues to promote digital banking alternatives. Inside Arrow's
facilities, safety measures continue to be followed, including required face
coverings, social distancing and personal protective equipment such as shields
and hand sanitizing stations, along with frequent cleanings. Remote work is
encouraged whenever feasible for employees. In addition, work-related travel
remains paused and in-person meetings have been minimized. Arrow remains
committed to delivering essential financial services to its communities.
Requests for financial hardship assistance were reduced from early pandemic
levels. Loans being deferred as a result of the COVID-19 pandemic were $15.3
million , or 0.6% of loans outstanding, as of December 31, 2020 . Arrow worked
closely with small business borrowers from the initial round of PPP loans on the
forgiveness process. Arrow is currently helping customers obtain funding through
an additional round of PPP support. As of year-end, Arrow had assisted more than
1,400 small businesses, with more than $142.7 million in aggregate PPP loans.
While COVID-19 did not have a material adverse effect on 2020 financial results,
Arrow is actively monitoring the impact of the pandemic on the business and
results of operations.
As Arrow cannot predict the duration or scope of the pandemic or its impact on
economic and financial markets or its impact on the business, Arrow is unable to
reasonably estimate the overall impact on the Company. For further discussion of
the impact COVID-19 has had and may in the future have on Arrow and its
financial results and operations, please refer to the Risk Factors included in
Part I, Item 1A, beginning on page 13 of this Report.
Summary of 2020 Financial Results: For the year ended December 31, 2020 , net
income was a record $40.8 million , up 8.9% over net income of $37.5 million for
2019. Diluted EPS was $2.64 for 2020, up 8.5% from $2.43 in 2019.
Arrow's profitability ratios remained solid in 2020, as return on average equity
and return on average assets were 12.77% and 1.17%, respectively, for the year,
as compared to 13.17% and 1.24%, respectively, for 2019.
At December 31, 2020 , total loan balances reached $2.6 billion , up $209 million ,
or 8.8%, from the prior-year level. The consumer loan portfolio grew by $48.6
million , or 6.0%, over the balance at December 31, 2019 , primarily as a result
of continued strength in the indirect automobile lending program. The
residential real estate loan portfolio increased $9.2 million , or 1.0%. The
increase in the real estate loan portfolio is net of approximately $83.9 million
of loans sold in 2020. Commercial loans, including commercial real estate,
increased $151.1 million , or 22.9%, over the balances at December 31, 2019 . The
increase in commercial loans includes $110.4 million in remaining PPP loans.
At December 31, 2020 , total deposit balances reached $3.2 billion , up by $618.7
million , or 23.6%, from the prior-year level. Noninterest-bearing deposits grew
by $216.4 million , or 44.6%, during 2020, and represented 21.7% of total
deposits at year-end as compared to the prior-year level of 18.5%. At
December 31, 2020 , total time deposits decreased $117.7 million from the
prior-year level, including a reduction of $80.6 million in brokered time
deposits.
Net interest income for the year ending December 31, 2020 was $99.2 million , an
increase of $11.2 million , or 12.7%, from the prior year. Loan growth generated
$100.5 million in interest and fees on loans, an increase of 5.3% from the $95.5
million in interest and fees on loans for the year ending December 31, 2019 .
Interest expense for the year ending December 31, 2020 was $12.7 million . This
is a decrease of $9.0 million , or 41.5%, from the $21.7 million in expense for
the year ending December 31, 2019 . The net interest margin was 2.99% for the
year ending December 31, 2020 , as compared to 3.05% for the year ended
December 31, 2019 . The change in net interest margin from the prior year was due
to a variety of factors, including lower interest rates, increased cash balances
and the impact of participating in the PPP.
Noninterest income was $32.7 million for the year ending December 31, 2020 , an
increase of 14.4% as compared to $28.6 million for the year ending December 31,
2019 . Gain on sale of loans increased $3.3 million due to a variety of factors,
including strong demand for residential mortgages in our operating markets,
favorable market conditions for mortgage sales and strategic balance sheet and
interest-rate risk management decisions. Income generated from fiduciary
activities as well as fees for other services from customers were flat compared
to the prior year. Insurance revenue decreased by $306 thousand from the prior
year. Noninterest income represented 24.8% of total revenues in 2020 as compared
to 24.5% for the year ending December 31, 2019 . Other operating income increased
in 2020 as compared to 2019 as a result of several factors, including gain on
sale of
28
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fixed assets and other real estate owned, as well as increased income related to
interest rate swap agreements and bank owned life insurance.
Noninterest expense for the year ending December 31, 2020 increased by $3.2
million , or 4.8%, to $70.7 million compared to $67.5 million in 2019. The
largest component of noninterest expense is salaries and benefits paid to our
employees, which totaled $42.1 million in 2020, as compared to $38.4 million in
2019.
In 2020, Arrow opened a 12th Saratoga National Bank Branch , as well as a Capital
Region Business Development Office in Latham, New York . Additionally, Glens
Falls National Bank consolidated Branches in Queensbury and Greenwich into
nearby locations.
Asset quality remained strong in 2020, as evidenced by low levels of
nonperforming assets and charge-offs. Net loan losses for the full year 2020
were 0.05% of average loans outstanding, consistent with the 2019 ratio.
Nonperforming assets of $6.6 million at December 31, 2020 , represented 0.18% of
period-end assets, consistent with December 31, 2019 .
Arrow's allowance for loan losses was $29.2 million at December 31, 2020 , which
represented 1.13% of loans outstanding, an increase from 0.89% at year-end 2019.
Although credit quality remains strong, the increase in the allowance reflects
the uncertainty related to the COVID-19 pandemic. When expressed as a percentage
of nonperforming loans, the allowance for loan loss coverage ratio was 456.3% at
year-end 2020. Arrow adopted the Current Expected Credit Losses (CECL)
accounting standard as of January 1, 2021 .
At December 31, 2020 , Arrow's liquidity position was strong. Interest-bearing
cash balances at December 31, 2020 were $338.9 million . Arrow continues to be
well-prepared to address any unexpected volatility due to the COVID-19 pandemic,
which may affect cash flow and deposit balances. At December 31, 2020 ,
contingent collateralized lines of credit available through the Federal Home
Loan Bank of New York and Federal Reserve Bank , totaled $1.5 billion . Arrow also
has additional liquidity options currently available, including unsecured Fed
Funds lines of credit and brokered deposit markets.
The changes in net income, net interest income and net interest margin between
the current and prior year are discussed in detail under the heading "RESULTS OF
OPERATIONS," beginning on page 32.
Regulatory Capital and Increase in Stockholders' Equity: As of December 31,
2020 , Arrow continued to exceed all required minimum capital ratios under the
current bank regulatory capital rules as implemented under Dodd-Frank (the
"Capital Rules") at both the holding company and bank levels. At that date,
both subsidiary banks, as well as the holding company, continued to qualify as
"well-capitalized" under the capital classification guidelines as defined by the
Capital Rules. Because of continued profitability and strong asset quality, the
regulatory capital levels throughout recent years have consistently remained
well in excess of the various required regulatory minimums in effect from time
to time, as they do at present. Pursuant to the Capital Rules, required minimum
regulatory capital levels for insured banks and their parent holding companies
increased in 2019.
The federal bank regulators have issued a final rule to implement the "community
bank leverage ratio", introducing an optional simplified measure of capital
adequacy for qualifying community banking organizations ("CBLR"). To qualify
for the CBLR framework, a community banking organization must satisfy certain
requirements, including having a leverage ratio of greater than 9%, less than
$10 billion in total consolidated assets, and limited amounts of
off-balance-sheet exposures and trading assets and liabilities. A qualifying
community banking organization that opts into the CBLR framework and meets all
the requirements under the CBLR framework will be considered to have met the
well-capitalized ratio requirements under the "prompt corrective action"
regulations and will not be required to report or calculate risk-based capital
ratios. Subsequently, Section 4012 of the Coronavirus Aid, Relief, and Economic
Security (CARES) Act required the federal banking agencies to temporarily lower
the threshold for election of the CBLR framework, issuing two interim final
rules to set the CBLR at 8% as of the second quarter of 2020 and then gradually
re-establish the CBLR at 9%.
Under the final rule, the CBLR remained at 8% through the end of 2020. Community
banks that have a leverage ratio of 8% or greater and meet certain other
criteria may elect to use the CBLR framework. Beginning in 2021, the CBLR
increased to 8.5% for the calendar year. Community banks will have until January
1, 2022 , before the leverage ratio requirement to use the CBLR framework will
return to 9%.
The final rule also maintains a two-quarter grace period for a qualifying
community banking organization whose leverage ratio falls no more than one
percentage point below the applicable CBLR requirement.
The CBLR final rule became effective as of January 1, 2020 , and Arrow and both
subsidiary banks have opted out of utilizing the CBLR framework. Therefore, the
Capital Rules promulgated under Dodd-Frank will remain applicable to Arrow.
Total stockholders' equity was $334.4 million at December 31, 2020 , an increase
of $32.7 million , or 10.8%, from the year earlier level. The components of the
change in stockholders' equity since year-end 2018 are presented in the
Consolidated Statement of Changes in Stockholders' Equity on page 62. Total book
value per share increased by 10.3% over the prior year level. At December 31,
2020 , tangible book value per share, a non-GAAP financial measure calculated
based on tangible book value (total stockholders' equity minus intangible assets
including goodwill) was $20.02 , an increase of $2.01 , or 11.2%, over the
December 31, 2019 amount. The increase in total stockholders' equity during 2020
principally reflected the following factors: $40.83 million of net income for
the year, plus $1.81 million of equity related to various stock-based
compensation plans, plus $1.81 million of equity resulting from the dividend
reinvestment plan, plus other comprehensive income of $5.54 million reduced by
cash dividends of $15.74 million and the repurchases of common stock of $1.58
million . As of December 31, 2020 , Arrow's closing stock price was $29.91 ,
resulting in a trading multiple of 1.49 to Arrow's tangible book value. The
Board of Directors declared and the Company paid a cash dividend of $0.252 per
share for the first three quarters of 2020, as adjusted for a 3% stock dividend
distributed September 25, 2020 , a cash dividend of $0.26 per share for the
fourth quarter of 2020, and has declared a $0.26 per share cash dividend for the
first quarter of 2021.
29
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Loan quality: Nonperforming loans were $6.4 million at December 31, 2020 , an
increase of $2.0 million , or 45.6%, from year-end 2019. The ratio of
nonperforming loans to period-end loans at December 31, 2020 was 0.25%, an
increase from 0.18% at December 31, 2019 and less than the Company's peer group
ratio of 0.64% at September 30, 2020 . Loans charged-off (net of recoveries)
against the allowance for loan losses was $1.3 million for 2020, an increase of
$186 thousand from 2019. The ratio of net charge-offs to average loans was 0.05%
for 2020 and 2019, compared to the peer group ratio of 0.10% for the period
ended September 30, 2020 . At December 31, 2020 , the allowance for loan losses
was $29.2 million , representing 1.13% of total loans, an increase of 24 basis
points from the December 31, 2019 ratio. Although credit quality remains strong,
the increase in loan loss provision expense reflects the uncertainty resulting
from the COVID-19 pandemic. Arrow adopted the Current Expected Credit Losses
("CECL") accounting standard as of January 1, 2021 .
Loan Segments: As of December 31, 2020 , total loans grew $208.9 million , or
8.8%, as compared to the balance at December 31, 2019 . The largest increase was
in commercial and commercial real estate loans, which increased by $151.1
million or 22.9%, from December 31, 2019 . The majority of the increase in
commercial loans resulted from the origination of PPP loans, of which $114.6
million remained outstanding at December 31, 2020 . The residential real estate
loan portfolio increased $9.2 million , or 1.0%. The increase in the real estate
loan portfolio is net of approximately $83.9 million of loans sold in 2020. In
addition, consumer loans expanded $48.6 million , or 6.0%. The economic factors
resulting from the COVID-19 pandemic, including but not limited to restrictions
on non-essential businesses, will most likely adversely impact loan growth for
all or a portion of 2021.
• Commercial and Commercial Real Estate Loans: Combined, these loans comprise
31.3% of the total loan portfolio at period-end. Commercial property values in
the Company's region have largely remained stable in 2020, however, there
remains uncertainty surrounding market conditions due to the pandemic.
Appraisals on nonperforming and watched CRE loan properties are updated as
deemed necessary, usually when the loan is downgraded or when there has been
significant market deterioration since the last appraisal. The temporary closure
of nonessential business in New York impacted, and may continue to impact,
Arrow's customer base. Government intervention, with programs such as the PPP,
may mitigate the economic risk to both Arrow and its customers, however the full
impact cannot be determined at this time.
• Consumer Loans: These loans (primarily automobile loans) comprised
approximately 33.1% of the total loan portfolio at period-end. Consumer
automobile loans at December 31, 2020 , were $854.7 million , or 99.4% of this
portfolio segment. In 2020, Arrow did not experience any significant increase in
the delinquency rate or in the percentage of nonperforming loans in this
segment. The vast majority of automobile loans are initiated through the
purchase of vehicles by consumers with automobile dealers. As of December 31,
2020 , the physical sale of vehicles through dealerships is occurring, however,
it had been curtailed for a portion of 2020 as part of the response to the
COVID-19 pandemic in New York and Vermont , our primary dealer network.
• Residential Real Estate Loans: These loans, including home equity loans, made
up 35.6% of the total loan portfolio at period-end. The residential real estate
market in the Company's service area has been stable in recent periods. Arrow
originated nearly all of the residential real estate loans currently held in the
loan portfolio and applies conservative underwriting standards to loan
originations. Arrow typically sells a portion of residential real estate
mortgage originations into the secondary market. The ratio of the sales of
originations to total originations tends to fluctuate from period to period
based on market conditions and other factors. Sales increased in 2020, due to a
variety of factors, including strong demand for residential mortgages in our
operating markets, favorable market conditions for mortgage sales and strategic
balance sheet and interest-rate risk management decisions. The rate at which
mortgage loan originations are sold in future periods will depend on various
circumstances, including prevailing mortgage rates, other lending opportunities,
capital and liquidity needs, and the availability of a market for such
transactions. Due to the COVID-19 pandemic, it is not yet possible to determine
the long term economic impact on our residential real estate loan portfolio. It
should be noted, however, that historically low interest rates led to higher
originations in 2020 as compared to 2019.
Liquidity and access to credit markets: Arrow did not experience any liquidity
problems or special concerns in recent years or in 2020. Arrow's liquidity
position provides the necessary flexibility to address any unexpected near-term
disruptions that may develop as a result of the COVID-19 pandemic such as:
reduced cash-flows from the investment and loan portfolios and aggressive
funding of programs associated with response efforts. Interest-bearing cash
balances at December 31, 2020 were $338.9 million compared to $23.2 million at
December 31, 2019 . Operating collateralized lines of credit are established and
available through the FHLBNY and FRB, totaling $1.5 billion . The terms of
Arrow's lines of credit have not changed significantly in recent periods (see
the general liquidity discussion on page 48). To address liquidity needs beyond
maintaining and growing core deposit balances, Arrow has principally relied on
asset-based liquidity (i.e., funds in overnight investments and cash flow from
maturing investments and loans) with liability-based liquidity as a secondary
source of funds (the main liability-based sources are an overnight borrowing
arrangement with correspondent banks, an arrangement for overnight borrowing and
term credit advances from the FHLBNY, and an additional arrangement for
short-term advances at the Federal Reserve Bank discount window). Regular
liquidity stress tests and tests of the contingent liquidity plan are performed
to ensure that an adequate amount of available funds can be generated to meet a
wide variety of potential liquidity crises including the current COVID-19
pandemic.
Visa Class B Common Stock: Arrow's subsidiary bank, Glens Falls National, like
other Visa member banks, bears some indirect contingent liability for Visa's
direct liability arising out of certain antitrust claims involving merchant
discounts to the extent that Visa's liability might exceed the amount funded in
its litigation escrow account. On December 13, 2019 the Court granted final
approval to a settlement in this class action lawsuit. But, on January 3, 2020
an appeal of the final-approved order was filed
30
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with the court. It is unknown how long the appeals process will take. When the
appeals process is resolved and assuming the balance in the litigation escrow
account is sufficient to cover the litigation claims and related expenses, Arrow
could potentially realize a gain on the receipt of Visa Class A common stock. At
December 31, 2020 , Glens Falls National held 27,771 shares of Visa Class B
common stock, and utilizing the conversion ratio to Class A common stock at that
time, these Class B shares would convert to 45,000 shares of Visa Class A common
stock. Since the litigation settlement is not certain, the Company has not
recognized any economic value for these shares.
31
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B. RESULTS OF OPERATIONS
The following analysis of net interest income, the provision for loan losses,
noninterest income, noninterest expense and income taxes, highlights the factors
that had the greatest impact on the results of operations for December 31, 2020
and the prior two years. For a comparison of the years ended December 31, 2018
and 2019, see Part II. Item 7, Management's Discussion and Analysis of Financial
Condition and Results of Operations, in our Form 10-K for the year ended
December 31, 2019 .
I. NET INTEREST INCOME
Net interest income represents the difference between interest, dividends and
fees earned on loans, securities and other earning assets and interest paid on
deposits and other sources of funds. Changes in net interest income result from
changes in the level and mix of earning assets and sources of funds (volume) and
changes in the yields earned and interest rates paid (rate). Net interest margin
is the ratio of net interest income to average earning assets. Net interest
income may also be described as the product of average earning assets and the
net interest margin.
CHANGE IN NET INTEREST INCOME
(Dollars In Thousands) (GAAP Basis)
Years Ended December 31 , Change From Prior Year
2019 to 2020 2018 to 2019
2020 2019 2018 Amount % Amount %
Interest
and
Dividend
Income $ 111,896 $ 109,759 $ 96,503 $ 2,137 1.9 % $ 13,256 13.7 %
Interest (9,016) (41.5) % 9,225 73.9 %
Expense 12,694 21,710 12,485
Net $ 99,202 $ 88,049 $ 84,018 $ 11,153 $ 4,031
Interest 12.7 %
Income 4.8 %
Net interest income was $99.2 million in 2020, an increase of $11.2 million , or
12.7%, from the $88.0 million in 2019. This compared to an increase of $4.0
million , or 4.8%, from 2018 to 2019. Factors contributing to the year-to-year
changes in net interest income over the three-year period are discussed in the
following portions of this Section B.I.
32-------------------------------------------------------------------------------- The following tables reflects the components of net interest income, setting forth, for years endedDecember 31, 2020 , 2019 and 2018: (i) average balances of assets, liabilities and stockholders' equity, (ii) interest and dividend income earned on earning assets and interest expense incurred on interest-bearing liabilities, (iii) average yields earned on earning assets and average rates paid on interest-bearing liabilities, (iv) the net interest spread (average yield less average cost) and (v) the net interest margin (yield) on earning assets. The yield on securities available-for-sale is based on the amortized cost of the securities. Nonaccrual loans are included in average loans. Average Consolidated Balance Sheets and Net Interest Income Analysis (GAAP basis) (Dollars in Thousands) Years Ended December 31: 2020 2019 2018 Interest Rate Interest Rate Interest Rate Average Income/ Earned/ Average Income/ Earned/ Average Income/ Earned/ Balance Expense Paid Balance Expense Paid Balance Expense Paid Interest-Bearing Deposits at Banks$ 195,821 $ 321 0.16 %$ 26,816 722 2.69 % 30,475 711 2.33 % Investment Securities: Fully Taxable 398,915 7,131 1.79 % 357,669 8,883 2.48 % 382,703 8,582 2.24 % Exempt from Federal Taxes 199,410 3,952 1.98 % 223,130 4,687 2.10 % 258,407 5,563 2.15 % Loans 2,526,791 100,492 3.98 %
2,283,707 95,467 4.18 % 2,062,575 81,647 3.96 %
Total Earning Assets 3,320,937 111,896 3.37 % 2,891,322 109,759 3.80 % 2,734,160 96,503 3.53 % Allowance for Loan Losses (25,128) (20,477) (19,278) Cash and Due From Banks 35,609 34,963 36,360 Other Assets 150,343 122,220 104,511 Total Assets$ 3,481,761 $ 3,028,028 $ 2,855,753 Deposits: Interest-Bearing Checking Accounts$ 772,000 1,292 0.17 % $
727,857 1,985 0.27 % 849,626 1,618 0.19 %
Savings Deposits 1,258,154 5,090 0.40 % 910,840 8,399 0.92 % 753,198 3,457 0.46 % Time Deposits of$250,000 Or More 124,601 1,465 1.18 % 95,932 1,932 2.01 % 78,159 1,183 1.51 % Other Time Deposits 223,111 2,782 1.25 % 259,636 4,224 1.63 % 173,151 1,420 0.82 % Total Interest-Bearing Deposits 2,377,866 10,629 0.45 % 1,994,265 16,540 0.83 % 1,854,134 7,678 0.41 % Short-Term Borrowings 57,929 246 0.42 % 191,258 3,437 1.80 % 192,050 2,980 1.55 % FHLBNY Term Advances and Other Long-Term Debt 69,631 1,623 2.33 % 52,288 1,634 3.13 % 66,918 1,827 2.73 % Finance Leases 5,229 196 3.75 % 4,131 99 2.40 % - - - % Total Interest- Bearing Liabilities 2,510,655 12,694 0.51 % 2,241,942 21,710 0.97 % 2,113,102 12,485 0.59 % Demand Deposits 613,408 472,517 460,355 Other Liabilities 37,884 28,929 22,461 Total Liabilities 3,161,947 2,743,388 2,595,918 Stockholders' Equity 319,814 284,640 259,835 Total Liabilities and
Stockholders'
Equity$ 3,481,761 $ 3,028,028 $ 2,855,753 Net Interest Income$ 99,202 $ 88,049 $ 84,018 Net Interest Spread 2.86 % 2.83 % 2.94 % Net Interest Margin 2.99 % 3.05 % 3.07 % 33
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Changes between periods are attributed to movement in either the average daily
balances or average rates for both earning assets and interest-bearing
liabilities. Changes attributable to both volume and rate have been allocated
proportionately between the categories.
Net Interest Income Rate and Volume Analysis
(Dollars in Thousands) (GAAP basis)
2020 Compared to 2019 Change in Net 2019 Compared to 2018 Change in Net
Interest Income Due to: Interest Income Due to:
Interest and Dividend Volume Rate Total Volume Rate Total
Income:
Balances$ 831 $ (1,232) $ (401) $
(91)
Fully Taxable 941 (2,693) (1,752) (584) 885 301 Exempt from Federal (480) (255) (735) (744) (132) (876)
Taxes
Loans 9,823 (4,798) 5,025 9,076 4,744 13,820
Total Interest and
Dividend Income 11,115 (8,978) 2,137 7,657 5,599 13,256
Interest Expense:
Deposits:
Interest-Bearing 114 (807) (693) Checking Accounts (257) 624 367 Savings Deposits 2,475 (5,784) (3,309) 849 4,093 4,942
Time Deposits of
$250,000 or More 477 (944) (467) 305 444 749 Other Time Deposits (542) (900) (1,442) 944 1,860 2,804 Total Deposits 2,524 (8,435) (5,911) 1,841 7,021 8,862
Short-Term Borrowings (1,523) (1,668) (3,191)
(12) 469 457 Long-Term Debt 464 (475) (11) (434) 241 (193) Finance Leases 31 66 97 99 - 99
Total Interest Expense 1,497 (10,513) (9,016)
1,494 7,731 9,225
Net Interest Income
6,163$ (2,132) $ 4,031 NET INTEREST MARGIN YIELD ANALYSIS (GAAP Basis) December 31, 2020 2019 2018 Yield on Earning Assets 3.37 % 3.80 % 3.53 % Cost of Interest-Bearing Liabilities 0.51 % 0.97 % 0.59 % Net Interest Spread 2.86 % 2.83 % 2.94 % Net Interest Margin 2.99 % 3.05 % 3.07 % Arrow's earnings are derived predominantly from net interest income, which is interest income, net of interest expense. Changes in balance sheet composition, including interest-earning assets, deposits, and borrowings, combined with changes in market interest rates, impact net interest income. Net interest margin is net interest income divided by average interest-earning assets. Interest-earning assets and funding sources are managed, including noninterest and interest-bearing liabilities, in order to maximize this margin. 2020 Compared to 2019: Net interest income increased$11.2 million , or 12.7%, to$99 million for the year endedDecember 31, 2020 from$88.0 million for the year endedDecember 31, 2019 , as the positive impact of continued balance sheet growth outweighed the negative impact of a tighter net interest margin. The net interest margin was 2.99% for the year endedDecember 31, 2020 as compared to 3.05% for the year endedDecember 31, 2019 . The decrease in net interest margin from the prior year was due to a variety of factors, including historically low interest rates and increased cash balances. Interest income on investment securities and interest-bearing deposits at banks (cash) decreased$2.9 million , or 20.2%, between the years endedDecember 31, 2020 andDecember 31, 2019 . Cash balances increased sharply for the year, by$169.0 million , but the average rate paid on excess cash balances fell by 253 basis points as theFederal Reserve cut interest rates to near-zero inMarch 2020 . Average balances on investment securities were higher for the year, but portfolio yields were lower, with fully taxable securities falling by 69 basis points and securities exempt from federal taxes falling by 12 basis points. Interest income from loans increased$5.0 million , or 5.3%, to$100.5 million for the year endedDecember 31, 2020 from$95.5 million for the year endedDecember 31, 2019 . Although the Loan portfolio yield dropped by 0.20% in 2020, to 3.98%, continued loan growth pushed interest income higher. Average loan balances increased by$243.1 million , a 10.6% increase over 2019 average balances. Within the loan portfolio, the three principal segments are residential real estate loans, consumer loans 34 -------------------------------------------------------------------------------- (primarily through the indirect automobile lending program) and commercial loans. The largest increase was in commercial and commercial real estate loans, which increased by$151.1 million or 22.9%, fromDecember 31, 2019 . The majority of the increase in commercial loans resulted from the origination of PPP loans, of which$114.6 million remain atDecember 31, 2020 . The residential real estate loan portfolio increased$9.2 million , or 1.0%. The increase in the real estate loan portfolio is net of approximately$83.9 million of loans sold in 2020. In 2020, Arrow originated a higher volume of residential mortgages than in the previous year, and sold a larger volume of these loans to the secondary market. In addition, consumer loans expanded$48.6 million , or 6.0%, reflecting continuing strong automobile sales. Total interest expense on interest-bearing liabilities decreased$9.0 million , or 41.5%, to$12.7 million for the year endedDecember 31, 2020 from$21.7 million for the year endedDecember 31, 2019 . Although average interest bearing deposit balances increased by$383.6 million , the total cost of interest-bearing deposits decreased by 0.38% to 0.51%. In addition, average demand deposits, which are non-interest bearing, increased by$140.9 million . Total deposit growth outpaced loan growth in 2020. As a result, excess deposit balances were utilized to pay-down borrowings, and average borrowings decreased by$133.3 million . 35 -------------------------------------------------------------------------------- II. PROVISION FOR LOAN LOSSES AND ALLOWANCE FOR LOAN LOSSES Arrow considers the accounting policy relating to the allowance for loan losses to be a critical accounting policy, given the uncertainty involved in evaluating the level of the allowance required to cover loan losses inherent in the loan portfolio, and the material effect that such judgments may have on the results of operations. The provision for loan losses for 2020 was$9.3 million , compared to the$2.1 million provision for 2019. The increase in the allowance reflects loan growth and the uncertainty related to the COVID-19 pandemic. The analysis of the method employed for determining the amount of the loan loss provision is explained in detail in Notes 2, Summary of Significant Accounting Policies, and 5, Loans, to the notes to the Consolidated Financial Statements.
SUMMARY OF THE ALLOWANCE AND PROVISION FOR LOAN LOSSES (Dollars In Thousands) (Loans, Net of Unearned Income)
Years-Ended December 31, 2020 2019 2018 2017 2016 Period-End Loans$2,595,030 $2,386,120 $2,196,215 $1,950,770 $1,753,268 Average Loans 2,526,791 2,283,707 2,062,575 1,862,247 1,663,225 Period-End Assets 3,688,636 3,184,275 2,988,334 2,760,465 2,605,242 Nonperforming Assets, at Period-End: Nonaccrual Loans: Commercial Loans 78 81 403 588 155 Commercial Real Estate 1,475 326 789 1,530 875 Consumer Loans 1,470 663 658 653 589 Residential Real Estate Loans 3,010 2,935 2,309 2,755 2,574 Total Nonaccrual Loans 6,033 4,005 4,159 5,526 4,193
Loans Past Due 90 or More Days
and Still Accruing Interest 228 253 1,225 319 1,201 Restructured 145 143 138 105 106 Total Nonperforming Loans 6,406 4,401 5,522 5,950 5,500 Repossessed Assets 155 139 130 109 101 Other Real Estate Owned - 1,122 1,130 1,738 1,585 Total Nonperforming Assets 6,561 5,662 6,782 7,797 7,186 Allowance for Loan Losses:
Balance at Beginning of Period
Loans Charged-off:
Commercial Loans (37) (12) (153) (2) (97) Commercial Real Estate (5) (29) (17) (380) (195) Consumer Loans (1,898) (1,603) (1,246) (1,101) (871) Residential Real Estate Loans (49) (91) (116) (76) (107) Total Loans Charged-off (1,989) (1,735)
(1,532) (1,559) (1,270)
Recoveries of Loans Previously
Charged-off:
Commercial Loans 3 1 3 8 23 Commercial Real Estate - - 12 - - Consumer Loans 712 646 520 389 182 Residential Real Estate Loans - - - - 6
Total Recoveries of Loans
Previously Charged-off 715 647 535 397 211 Net Loans Charged-off (1,274) (1,088) (997)
(1,162) (1,059)
Provision for Loan Losses
Charged to Expense 9,319 2,079 2,607 2,736 2,033
Balance at End of Period
Asset Quality Ratios:
Net Charge-offs to Average
Loans 0.05 % 0.05 % 0.05
% 0.06 % 0.06 %
Provision for Loan Losses to
Average Loans 0.37 % 0.09 % 0.13
% 0.15 % 0.12 %
Allowance for Loan Losses to
Period-end Loans 1.13 % 0.89 % 0.92
% 0.95 % 0.97 %
Allowance for Loan Losses to
Nonperforming Loans 456.32 % 481.41 % 365.74
% 312.37 % 309.31 %
Nonperforming Loans to
Period-end Loans 0.25 % 0.18 % 0.25 % 0.31 % 0.31 %
Nonperforming Assets to
Period-end Assets 0.18 % 0.18 % 0.23 % 0.28 % 0.28 %
36
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ALLOCATION OF THE ALLOWANCE FOR LOAN LOSSES
(Dollars in Thousands)
2020 2019 2018 2017 2016
Commercial Loans $ 2,173 $ 1,386 $ 1,218 $ 1,873 $ 1,017
Commercial Real Estate 9,990 5,830 5,644 4,504 5,677
Consumer Loans 11,562 9,408 8,882 7,604 6,120
Residential Real Estate Loans 5,507 4,563 4,452 4,605 4,198
Total $ 29,232 $ 21,187 $ 20,196 $ 18,586 $ 17,012
The allowance for loan losses increased to $29.2 million at year-end 2020 from
$21.2 million at year-end 2019, an increase of 38.0%. A variety of factors were
considered in evaluating the adequacy of the allowance for loan losses at
December 31, 2020 and the provision for loan losses for the year. See Note 5,
Loans, to the notes to the Consolidated Financial Statements for a complete list
of all the factors used to calculate the provision for loan losses, including
the factors that did not change during the year. Most of the adversely
classified loans (special mention and substandard - see the definition for these
classifications in Note 5, Loans, to the notes to the Consolidated Financial
Statements) continued to perform under their contractual terms.
III. NONINTEREST INCOME
The majority of the noninterest income constitutes fee income from services,
principally fees and commissions from fiduciary services, deposit account
service charges, insurance commissions, net gains (losses) on securities
transactions, net gains on sales of loans and other recurring fee income.
ANALYSIS OF NONINTEREST INCOME
(Dollars In Thousands)
Years Ended December 31, Change From Prior Year
2019 to 2020 2018 to 2019
2020 2019 2018 Amount % Amount %
Income from
Fiduciary
Activities $ 8,890 $ 8,809 $ 9,255 $ 81 0.9 % $ (446) (4.8) %
Fees for Other
Services to
Customers 10,003 10,176 10,134 (173) (1.7) % 42 0.4 %
Insurance
Commissions 6,876 7,182 7,888 (306) (4.3) % (706) (9.0) %
Net (Loss) Gain
on Securities (464) 289 213 (753) (260.6) % 76 35.7 %
Net Gain on Sales
of Loans 3,889 622 135 3,267 525.2 % 487 360.7 %
Other Operating
Income 3,464 1,477 1,324 1,987 134.5 % 153 11.6 %
Total Noninterest
Income $ 32,658 $ 28,555 $ 28,949 $ 4,103 14.4 % $ (394) (1.4) %
2020 Compared to 2019: Total noninterest income in 2020 was $32.7 million , an
increase of $4.1 million , or 14.4%, from total noninterest income of $28.6
million for 2019. Income from fiduciary activities increased slightly from 2019
to 2020. Assets under trust administration and investment management at
December 31, 2020 were $1.66 billion , an increase of $115.4 million , or 7.5%,
from the prior year-end balance of $1.54 billion .
Fees for other services to customers (primarily service charges on deposit
accounts, income from debit card transactions, and servicing income on sold
loans) were $10.0 million for 2020, decreased slightly as compared to 2019,
mostly the result of a decline in overdraft charges.
Insurance commissions decreased by $306 thousand , or 4.3% from 2019 to 2020. The
reduction in commissions is due in large part to continued increased
competition. Arrow has enacted expense control initiatives related to the
insurance business to ensure expenses appropriately correspond to the decreased
revenue.
Net loss on securities in 2020 consisted of a change in the fair value of equity
investments of $427 thousand and a realized loss of $37 thousand on the sale of
securities.
Net gains on the sales of loans increased in 2020 to $3.9 million , from $622
thousand in 2019, an increase of $3.3 million , or 525.2%. Sales increased due to
a variety of factors, including strong demand for residential mortgages in our
operating markets, favorable market conditions for mortgage sales and strategic
balance sheet and interest-rate risk management decisions. The rate at which
mortgage loan originations are sold in future periods will depend on various
circumstances, including prevailing mortgage rates, other lending opportunities,
capital and liquidity needs, and the availability of a market for such
transactions. Therefore, Arrow is unable to predict what the retention rate of
such loans in future periods may be. Servicing rights are generally retained for
loans originated and sold, which also generates additional noninterest income in
subsequent periods (fees for other services to customers).
Other operating income increased by $2.0 million , or 134.5% between the two
years due to a variety of factors. In 2020, Arrow had a gain on the sale of OREO
properties of $192.0 thousand compared to a loss of the sale of OREO properties
in 2019 of $242.1 thousand . Fees received as part of interest rate swap
agreements increased $781.4 thousand . Arrow purchased additional bank owned life
insurance in 2020 which generated an increase in income of $130.6 thousand from
the prior year. In 2020, Arrow had a gain on the sale of fixed assets of $16.5
thousand compared to charges related to the disposal of fixed assets of $559.5
thousand in 2019.
37
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IV. NONINTEREST EXPENSE
Noninterest expense is the measure of the delivery cost of services, products
and business activities of a company. The key components of noninterest expense
are presented in the following table.
ANALYSIS OF NONINTEREST EXPENSE
(Dollars In Thousands)
Years Ended December 31, Change From Prior Year
2019 to 2020 2018 to 2019
2020 2019 2018 Amount % Amount %
Salaries and $ 42,061 $ 38,402 $ 38,788 $ 3,659 9.5 % $ (386) (1.0) %
Employee
Benefits
Occupancy 5,614 5,407 5,026 207 381
Expenses, Net 3.8 % 7.6 %
Technology and 12,976 13,054 11,284 (78) (0.6) % 1,770 15.7 %
Equipment
Expense
FDIC Regular 1,063 157 881 906 577.1 % (724) (82.2) %
Assessment
Amortization 227 245 262 (18) (7.3) % (17) (6.5) %
of Intangible
Assets
Other 8,737 10,185 8,814 (1,448) (14.2) % 1,371 15.6 %
Operating
Expense
Total $ 70,678 $ 67,450 $ 65,055 $ 3,228 4.8 % $ 2,395 3.7 %
Noninterest
Expense
Efficiency
Ratio 55.69 % 57.09 % 56.60 % (1.40) % (2.5) % 0.49 % 0.9 %
2020 compared to 2019: Noninterest expense for 2020 amounted to $70.7 million ,
an increase of $3.2 million , or 4.8%, from 2019. For 2020, the efficiency ratio
was 55.69%. This ratio, which is a commonly used non-GAAP financial measure in
the banking industry, is a comparative measure of a financial institution's
operating efficiency. The efficiency ratio (a ratio where lower is better), as
defined by Arrow, is the ratio of operating noninterest expense (excluding
intangible asset amortization) to net interest income (on a tax-equivalent
basis) plus operating noninterest income (excluding net securities gains or
losses). See the discussion of the efficiency ratio on page 4 of this Report
under the heading "Use of Non-GAAP Financial Measures."
Salaries and employee benefits expense, which typically represents between 55%
and 60% of total noninterest expense, increased $3.7 million or 9.5%, from 2019.
A significant portion of the increase, $1.3 million , was the result of a
decrease in the reclassification out of salaries and employee benefits into
other operating expenses. Under ASU 2017-07, interest cost, expected return on
plan assets, amortization of prior service cost and amortization of net loss are
required to be reclassified out of salaries and employee benefits. The
reclassification is also a factor contributing to the decrease in other
operating expense between 2020 and 2019. Salaries and benefits were also
impacted by increased overtime, benefit costs, incentive payments and a
recognition bonus that was paid to most employees in 2020. Many of these costs
were related to the challenges of the COVID-19 pandemic and the required
response needed to address customer needs.
FDIC assessment increased $906 thousand or 577.1%, from 2019 as the result of
the increased assets of Arrow's subsidiaries.
Other operating expense decreased $1.4 million , or (14.2)%, from 2019. In
addition to the reclassification described above, the remaining decrease was
primarily related to travel, supplies and advertising.
V. INCOME TAXES
The following table sets forth the provision for income taxes and effective tax
rates for the periods presented.
INCOME TAXES AND EFFECTIVE RATES
(Dollars In Thousands)
Years Ended December 31, Change From Prior Year
2019 to 2020 2018 to 2019
2020 2019 2018 Amount % Amount %
Provision for $ 11,036 $ 9,600 $ 9,026 $ 1,436 15.0 % $ 574 6.4 %
Income Taxes
Effective Tax 21.3 % 20.4 % 19.9 % 0.9 % 4.4 % 0.5 % 2.5 %
Rate
The provisions for federal and state income taxes amounted to $11.0 million for
2020, $9.6 million for 2019, and $9.0 million for 2018. The effective income tax
rates for 2020, 2019 and 2018 were 21.3%, 20.4% and 19.9%, respectively. The
increase in the effective tax rate in 2020 over 2019 and 2018 was primarily due
to the reduction of tax exempt investments held and the related investment
income.
38
--------------------------------------------------------------------------------C. FINANCIAL CONDITION
I. INVESTMENT PORTFOLIO BeginningJanuary 1, 2018 , upon adoption of Accounting Standards Update ("ASU") 2016-01, equity securities with readily determined fair values are stated at fair value, with realized and unrealized gains and losses reported in income. During 2020, 2019 and 2018, Arrow held no trading securities. The available-for-sale securities portfolio, held-to-maturity securities portfolio and the equity securities portfolio are further detailed below. Securities Available-for-Sale: The following table sets forth the carrying value of the securities available-for-sale portfolio at year-endDecember 31, 2020 ,December 31, 2019 andDecember 31, 2018 . SECURITIES AVAILABLE-FOR-SALE (Dollars In Thousands) December 31, 2020 2019 2018
State and Municipal Obligations 528 764 1,195
Mortgage-Backed Securities 298,847 350,716 268,775
Corporate and Other Debt Securities 800 800 800
Total $ 365,287 $ 357,334 $ 317,535
In the periods above, Arrow held no investment securities in the securities
portfolio that consisted of or included, directly or indirectly, obligations of
foreign governments or government agencies of foreign issuers.
In the periods referenced above, Mortgage-Backed Securities consisted solely of
mortgage pass-through securities and Collateralized Mortgage Obligations
("CMOs") issued or guaranteed by U.S. federal agencies. Mortgage pass-through
securities provide to the investor monthly portions of principal and interest
pursuant to the contractual obligations of the underlying mortgages. CMOs are
pools of mortgages, the repayments on which have generally been separated into
two or more components (tranches), where each tranche has a separate estimated
life and yield. Arrow's practice has been to purchase pass-through securities
and CMOs that are issued or guaranteed by U.S. federal agencies, and the
tranches of CMOs purchased are generally those having shorter average lives
and/or durations. As a result of payment deferrals on underlying loan collateral
that make up mortgage-backed securities, some cashflows may be temporarily
impacted.
The following table sets forth the maturities of the debt securities in the
available-for-sale portfolio as of
MATURITIES OF DEBT SECURITIES AVAILABLE-FOR-SALE
(Dollars In Thousands)
After After
Within 1 But 5 But
One Within Within After
Year 5 Years 10 Years 10 Years Total
U.S. Government & Agency Obligations $ - $ 50,133 $ 14,979 $ - $ 65,112
State and Municipal Obligations 68 60 400 - 528
Mortgage-Backed Securities 12,373 281,592 4,882 - 298,847
Corporate and Other Debt Securities - - 800 - 800
Total $ 12,441 $ 331,785 $ 21,061 $ - $ 365,287
39--------------------------------------------------------------------------------
The following table sets forth the tax-equivalent yields of the debt securities
in the available-for-sale portfolio at
YIELDS ON SECURITIES AVAILABLE-FOR-SALE
(Fully Tax-Equivalent Basis)
After After
Within 1 But 5 But
One Within Within After
Year 5 Years 10 Years 10 Years Total% - % 0.62 %
State and Municipal Obligations 6.52 % 6.30 % 6.77
% - % 6.68 %
Mortgage-Backed Securities 0.95 % 1.62 % 0.48% - % 1.57 %
% - % 2.97 %
Total 0.98 % 1.47 % 0.74 % - % 1.41 %
The yields on obligations of states and municipalities exempt from federal
taxation were computed on a tax-equivalent basis. The yields on other debt
securities shown in the table above are calculated by dividing annual interest,
including accretion of discounts and amortization of premiums, by the amortized
cost of the securities at December 31, 2020 .
At December 31, 2020 and 2019, the weighted average maturity was 2.3 and 4.2
years, respectively, for debt securities in the available-for-sale portfolio.
At December 31, 2020 , the net unrealized gains on securities available-for-sale
amounted to $7.8 million . The net unrealized gain or loss on such securities,
net of tax, is reflected in accumulated other comprehensive income/loss. The
net unrealized gains on securities available-for-sale was $0.6 million at
December 31, 2019 . For both periods, net unrealized gains were primarily
attributable to changes in market rates between the date of purchase and the
balance sheet date resulting in higher or lower valuations of the portfolio
securities.
For further information regarding the portfolio of securities
available-for-sale, see Note 4, Investment Securities , to the notes to the
Consolidated Financial Statements.
Securities Held-to-Maturity:
The following table sets forth the carrying value of the portfolio of securities
held-to-maturity at December 31 of each of the last three years.
SECURITIES HELD-TO-MATURITY
(Dollars In Thousands)
December 31,
2020 2019 2018
State and Municipal Obligations $ 192,352 $ 208,243 $ 235,782
Mortgage Backed Securities - Residential 26,053 36,822 47,694
Total $ 218,405 $ 245,065 $ 283,476
For a description of certain categories of securities held in the securities
held-to-maturity portfolio on the reporting dates, as listed in the table above,
specifically, "Mortgage-Backed Securities - Residential" and "Corporate and
Other Debt Securities ," see the paragraph under "SECURITIES AVAILABLE-FOR-SALE"
table, above.
For information regarding the fair value of the portfolio of securities
held-to-maturity at December 31, 2020 , see Note 4, Investment Securities , to the
notes to the Consolidated Financial Statements.
The following table sets forth the maturities of the portfolio of securities
held-to-maturity as of
MATURITIES OF DEBT SECURITIES HELD-TO-MATURITY
(Dollars In Thousands)
Within After 1 But After 5 But After
One Year Within 5 Years Within 10 Years 10 Years Total
State and Municipal
Obligations $ 15,465 $ 140,380 $ 35,503 $ 1,004 $ 192,352 - Residential 3,503 22,550 - - 26,053 Total$ 18,968 $ 162,930 $ 35,503 $ 1,004 $ 218,405 40
--------------------------------------------------------------------------------
The following table sets forth the tax-equivalent yields of the portfolio of
securities held-to-maturity at
YIELDS ON SECURITIES HELD-TO-MATURITY
(Fully Tax-Equivalent Basis)
After 5 But
Within After 1 But Within 10 After
One Year Within 5 Years Years 10 Years Total
State and Municipal Obligations 2.49 % 2.30 % 2.58 % 3.72 % 2.38 %
Mortgage Backed Securities - 2.35 % 2.47 % - % - % 2.46 % Residential Total 2.47 % 2.33 % 2.58 % 3.72 % 2.39 % The yields shown in the table above are calculated by dividing annual interest, including accretion of discounts and amortization of premiums, by the amortized cost of the securities atDecember 31, 2020 . Yields on obligations of states and municipalities exempt from federal taxation were computed on a fully tax-equivalent basis. AtDecember 31, 2020 and 2019, the weighted average maturity was 2.7 and 3.5 years, respectively, for the debt securities in the held-to-maturity portfolio. EQUITY SECURITIES (Dollars In Thousands) The following table is the schedule ofEquity Securities atDecember 31 of each of the last three years. Equity Securities December 31, 2020 2019 2018 Equity Securities, at Fair Value$ 1,636 $ 2,063 $ 1,774 41
--------------------------------------------------------------------------------
II. LOAN PORTFOLIO
The amounts and respective percentages of loans outstanding represented by each
principal category on the dates indicated were as follows:
a. Types of Loans
(Dollars In Thousands)
December 31,
2020 2019 2018 2017 2016
Amount % Amount % Amount % Amount % Amount %
Commercial $ 240,554 9 % $ 150,660 6 % $ 136,890 6 % $ 129,249 7 % $ 105,155 6 %
Commercial Real Estate 571,787 23 % 510,541 22 % 484,562 22 % 444,248 23 % 431,646 25 %
Consumer 859,768 33 % 811,198 34 % 719,510 33 % 602,827 31 % 537,361 30 %
Residential Real Estate 922,921 36 % 913,721 38 % 855,253 39 % 774,446 39 % 679,106 39 %
Total Loans 2,595,030 100 % 2,386,120 100 % 2,196,215 100 % 1,950,770 100 % 1,753,268 100 % Allowance for Loan Losses (29,232)
(21,187) (20,196) (18,586) (17,012)
Total Loans, Net $ 2,565,798 $ 2,364,933 $ 2,176,019 $ 1,932,184 $ 1,736,256
Maintenance of High Quality in the Loan Portfolio: Prior to the COVID-19
pandemic, there were no significant fluctuations in the quality of the loan
portfolio or any segment thereof. In general, residential real estate loans have
historically been underwritten to secondary market standards for prime loans and
Arrow has not engaged in subprime mortgage lending as a business line.
Similarly, high underwriting standards have generally been applied to commercial
and commercial real estate lending operations and generally in the indirect
lending program as well. The economic events related to the COVID-19 pandemic,
specifically elevated unemployment and the temporary mandated closure of
nonessential business, may impact the ability of our borrowers to satisfy their
obligations.
Commercial and Commercial Real Estate Loans: Over the last three years,
commercial and commercial real estate loans have continued to grow. Outstanding
balances have increased by $151.1 million , $39.7 million and $48.0 million in
2020, 2019 and 2018, respectively.
Substantially all commercial and commercial real estate loans in the loan
portfolio were extended to businesses or borrowers located in the Company's
regional markets. A portion of the loans in the commercial portfolio have
variable rates tied to Prime, LIBOR or FHLBNY rates.
Many of the commercial and commercial real estate loans are in industries that
have been heavily impacted by the COVID-19 pandemic. In 2020, Arrow originated
over 1,400 PPP loans totaling approximately $142.7 million . The PPP loans have
an interest rate of 1% and Arrow expects to earn approximately $5.6 million in
fees related to the origination of these loans. The original term on the PPP
loans is two years, however the borrower will have the option to apply for
forgiveness. Subsequent to the funding of certain PPP loans, additional guidance
was provided permitting the term of a PPP loan to be extended to five years if
both parties agree to the revised terms. Arrow is recognizing the fees earned
over the life of the loan and will accelerate recognition of the fees if the
loan is forgiven by the Small Business Administration . Additional government
intervention, if any, may mitigate the economic risk to both Arrow and its
customers, however, the extent of such intervention and its impact cannot be
determined at this time.
Consumer Loans: At December 31, 2020 , consumer loans (primarily automobile loans
originated through dealerships located primarily in upstate New York and
Vermont ) represented 33% of loans in the loan portfolio, and continue to be a
significant component of the Company's business.
Consumer loan originations have remained strong in 2020, with origination volume
for the last three years at $386.4 million , $407.4 million and $391.6 million
for 2020, 2019 and 2018, respectively.
The physical sale of vehicles through dealerships had been curtailed for a
portion of the year as part of the New York State and Vermont response to the
COVID-19 pandemic. Accordingly, we believe, the volume of originations of
consumer loans have been impacted. However, the magnitude of the impact cannot
be determined.
For credit quality purposes, Arrow assigns potential automobile loan customers
into one of four tiers, ranging from lower to higher quality in terms of
anticipated credit risk. Arrow's experienced lending staff not only utilizes
credit evaluation software tools but also reviews and evaluates each loan
individually prior to the loan being funded. Arrow believes that this
disciplined approach to evaluating risk has contributed to maintaining the
strong credit quality in this portfolio. The COVID-19 pandemic has created
elevated unemployment, which may impact borrowers' ability to satisfy their
obligations to Arrow. Government intervention may mitigate a significant portion
of the credit risk, however, the extent of such intervention and its impact
cannot be determined at this time.
Residential Real Estate Loans: In recent years, residential real estate and home
equity loans have represented the largest single segment of the loan portfolio
(comprising approximately 36% of the entire portfolio at December 31, 2020 ),
slightly higher than the consumer loan portfolio (33% of the portfolio) and the
commercial and commercial real estate loans (31%). Gross originations for
residential real estate loans (including refinancings of mortgage loans) were
$250.1 million , $164.7 million and $142.9 million for the years 2020, 2019, and
2018, respectively.
During each of these years, gross origination totals have significantly exceeded
the sum of repayments and prepayments of such loans previously in the portfolio.
Arrow may sell portions of these originations in the secondary market, primarily
to Freddie Mac. Sales amounted to $83.9 million , or 43.7%, of the total loans
originated in 2020. The increase from previous years was due to a variety of
factors, including strong demand for residential mortgages in our operating
markets, favorable market
42
--------------------------------------------------------------------------------
conditions for mortgage sales and strategic balance sheet and interest-rate risk
management decisions. Sales of originations amounted to $24.5 million for 2019
and $4.3 million for 2018 which represented 16.9% and 3.3%, respectively of the
gross originations for those years.
Arrow expects to continue to sell a portion of mortgage loan originations in
upcoming periods if market conditions and strategic balance sheet and
interest-rate risk management decisions warrant. It is not currently possible to
determine the long term economic impact of the COVID-19 pandemic, which had
resulted in the temporary closure of non-essential business and elevated
unemployment.
The following table indicates the changing mix in the loan portfolio by
including the quarterly average balances for the significant loan segments for
the past five quarters. The remaining quarter-by-quarter tables present the
percentage of total loans represented by each category and the annualized yield
of each category.
LOAN PORTFOLIO
Quarterly Average Loan Balances
(Dollars In Thousands)
Quarters Ended
12/31/2020 9/30/2020 6/30/2020 3/31/2020 12/31/2019
Commercial $ 260,527 $ 276,296 $ 234,732 $ 140,486 $ 133,550
Commercial Real Estate 569,309 538,914 530,808 518,931 505,639
Consumer 856,903 841,009 840,734 818,892 817,463
Residential Real Estate 924,095 926,034 911,924 916,037 901,458
Total Loans $ 2,610,834 $ 2,582,253 $ 2,518,198 $ 2,394,346 $ 2,358,110 Percentage of Total Quarterly Average Loans
Quarters Ended
12/31/2020 9/30/2020 6/30/2020 3/31/2020 12/31/2019
Commercial 10.0 % 9.3 % 9.3 % 5.9 % 5.7 %
Commercial Real Estate 21.8 % 21.1 % 21.1 % 21.6 % 21.4 %
Consumer 32.8 % 33.4 % 33.4 % 34.2 % 34.7 %
Residential Real Estate 35.4 % 36.2 % 36.2 % 38.3 % 38.2 %
Total Loans 100.0 % 100.0 % 100.0 % 100.0 % 100.0 %
Quarterly Yield on Loans
Quarters Ended
12/31/2020 9/30/2020 6/30/2020 3/31/2020 12/31/2019
Commercial 4.50 % 3.63 % 3.84 % 4.52 % 4.54 %
Commercial Real Estate 3.84 % 3.91 % 4.05 % 4.34 % 4.53 %
Consumer 3.95 % 3.95 % 3.90 % 3.97 % 4.01 %
Residential Real Estate 3.83 % 3.86 % 4.08 % 4.20 % 4.20 %
Total Loans 3.94 % 3.81 % 4.01 % 4.18 % 4.19 %
The average yield on the loan portfolio decreased from 4.19% for the fourth
quarter of 2019 to 3.94% for the fourth quarter of 2020. Market rates declined
in 2020, which impacted the new loan yields for fixed rate loans, and variable
loan yields as these loans reached their repricing dates. Commercial loan yields
were affected by the $142.7 million of PPP loans originated in 2020. Commercial
loan yields rose in the 4th quarter due to fees from the Small Business
Administration being recognized in full for the $24.8 million loans forgiven in
the 4th quarter. Residential real estate yields declined each quarter of 2020
consistent with overall market behavior as well as the effect of variable home
equity loans.
Loan Deferrals Related to COVID-19 Pandemic
The COVID-19 pandemic has created economic uncertainty resulting in elevated
unemployment as well as the temporary closure of nonessential businesses. In the
table below, loans deferred by industry sector as the result of the COVID-19
pandemic are presented and compared to total loans by sector as of December 31,
2020 . In accordance with the CARES Act, the deferrals listed below are not
considered troubled debt restructurings. In 2020, Arrow originated $142.7
million of PPP loans. These loans are included in the loan balances by sector as
listed below, however, these loans are not considered deferred as of
December 31, 2020 .
43
--------------------------------------------------------------------------------
COVID-19 Deferrals by Loan Category at December 31, 2020
(Dollars In Thousands)
Balances by Sector Deferrals
% of Total % of Loan % of Total
Total Loans Balance Segment Loans
Commercial and Commercial Real Estate Loans:
Lessors of Non-Residential Real Estate $ 157,680 6.1 % $ 120 - % - %
Lessors of Residential Real Estate 127,156 4.9 % - - % - %
Health Care and Social Assistance 113,242 4.4 % - - % - %
Hotels and Motels 108,508 4.2 % 2,722 0.3 % 0.1 %
Arts/Recreation/Restaurants/Vacation Camps 48,173 1.9 % 94 - % - %
Retail 42,955 1.7 % - - % - %
Construction & Related 28,466 1.1 % - - % - %
Other 186,161 7.2 % 3,594 0.3 % 0.1 %
Total Commercial and Commercial Real Estate Loans 812,341 31.3 % 6,530 0.6 % 0.2 %
Consumer Loans 859,768 33.1 % 2,103 0.2 % 0.1 %
Residential Real Estate Loans 922,921 35.6 % 6,660 0.7 % 0.3 %
Total Loans $ 2,595,030 $ 15,293 0.6 %
PPP Loans
Many of the commercial and commercial real estate loans are in industries that
have been heavily impacted by the COVID-19 pandemic. In 2020, Arrow originated
over 1,400 PPP loans totaling $142.7 million . The PPP loans have an interest
rate of 1% and Arrow expects to earn approximately $5.6 million in fees related
to the origination of these loans. The original term on the PPP loans is two
years, however the borrower will have the option to apply for forgiveness.
Subsequent to the funding of the loans, additional guidance was provided that
the term of the loan may be extended to five years if both parties agree to the
revised terms. Arrow will recognize the fees earned over the life of the loan
and will accelerate recognition of the fees if the loan is forgiven by the Small
Business Administration . Arrow expects to fund additional PPP loans in early
2021, subject to the availability of government programs and the needs of the
communities Arrow serves.
Outstanding PPP Loans as of December 31, 2020
(Dollars In Thousands)
Initial PPP Funding $ 142,685
Loans Fully Forgiven in 2020 (24,775)
Loans Partial Forgiven in 2020 (3,280)
Outstanding PPP Loans $ 114,630
Income Earned on PPP Loans for the Year Ended December 31, 2020
(Dollars In Thousands)
Interest Earned at Rate of 1% $ 977
Fees from Fully Satisfied Loans 907
Fees Recognized in 2020 on Currently Outstanding Loans 740
Income Earned on PPP Loans $ 2,624
44-------------------------------------------------------------------------------- The following table indicates the respective maturities and interest rate structure of commercial loans and commercial real estate construction loans atDecember 31, 2020 . For purposes of determining relevant maturities, loans are assumed to mature at (but not before) their scheduled repayment dates as required by contractual terms. Demand loans and overdrafts are included in the "Within 1 Year" maturity category. Most of the commercial construction loans are made with a commitment for permanent financing, whether extended by us or unrelated third parties. The maturity distribution below reflects the final maturity of the permanent financing. b. Maturities and Sensitivities of Loans to Changes in Interest Rates (Dollars in Thousands) After 1 Within But Within After 1 Year 5 Years 5 Years Total Commercial$ 23,197 $ 175,496 $ 41,861 $ 240,554 Commercial Real Estate - Construction 14,276 3,560 18,839 36,675 Total$ 37,473 $ 179,056 $ 60,700 $ 277,229 Fixed Interest Rates$ 2,792 $ 159,039 $ 34,718 $ 196,549 Variable Interest Rates 34,681 20,017 25,982 80,680 Total$ 37,473 $ 179,056 $ 60,700 $ 277,229 COMMITMENTS AND LINES OF CREDIT Stand-by letters of credit represent extensions of credit granted in the normal course of business, which are not reflected in the financial statements at a given date because the commitments are not funded at that time. As ofDecember 31, 2020 , the total contingent liability for standby letters of credit amounted to$3.7 million . In addition to these instruments, there are lines of credit to customers, including home equity lines of credit, commitments for residential and commercial construction loans and other personal and commercial lines of credit, which also may be unfunded or only partially funded from time-to-time. Commercial lines, generally issued for a period of one year, are usually extended to provide for the working capital requirements of the borrower. AtDecember 31, 2020 , outstanding unfunded loan commitments in the aggregate amount were approximately$399.9 million .
c. Risk Elements
1. Nonaccrual, Past Due and Restructured Loans The amounts of nonaccrual, past due and restructured loans at year-end for each of the past five years are presented in the table on page 36 under the heading "Summary of the Allowance and Provision for Loan Losses." Loans are placed on nonaccrual status either due to the delinquency status of principal and/or interest or a judgment by management that the full repayment of principal and interest is unlikely. Unless already placed on nonaccrual status, loans secured by home equity lines of credit are put on nonaccrual status when 120 days past due and residential real estate loans are put on nonaccrual status when 150 days past due. Commercial and commercial real estate loans are evaluated on a loan-by-loan basis and are placed on nonaccrual status when 90 days past due if the full collection of principal and interest is uncertain. Under the Uniform Retail Credit Classification and Account Management Policy established by banking regulators, fixed-maturity consumer loans not secured by real estate must generally be charged-off no later than when 120 days past due. Loans secured with non-real estate collateral in the process of collection are charged-down to the value of the collateral, less cost to sell. Arrow had no material commitments to lend additional funds on outstanding nonaccrual loans atDecember 31, 2020 . Loans past due 90 days or more and still accruing interest are those loans which were contractually past due 90 days or more but because of expected repayments, were still accruing interest. The balance of loans 30-89 days past due and still accruing interest totaled$9.2 million atDecember 31, 2020 and represented 0.35% of loans outstanding at that date, as compared to approximately$10.7 million , or 0.45% of loans outstanding atDecember 31, 2019 . These non-current loans atDecember 31, 2020 were composed of approximately$7.7 million of consumer loans (principally indirect automobile loans),$1.3 million of residential real estate loans and$0.2 million of commercial and commercial real estate loans. Arrow evaluates nonaccrual loans over$250 thousand and all troubled debt restructured loans individually for impairment. All impaired loans are measured based on either (i) the present value of expected future cash flows discounted at the loan's effective interest rate, (ii) the loan's observable market price or (iii) the fair value of the collateral, less cost to sell, if the loan is collateral dependent. Arrow determines impairment for collateralized loans based on the fair value of the collateral less estimated cost to sell. For other impaired loans, impairment is determined by comparing the recorded value of the loan to the present value of the expected cash flows, discounted at the loan's effective interest rate. Arrow determines the interest income recognition method for impaired loans on a loan-by-loan basis. Based upon the borrowers' payment histories and cash flow projections, interest recognition methods include full accrual or cash basis. The method for measuring all other loans is described in detail in Notes 2, Summary of Significant Accounting Policies, and 5, Loans, to the notes to the Consolidated Financial Statements. 45 --------------------------------------------------------------------------------
Note 5, Loans, to the notes to the Consolidated Financial Statements contains detailed information on modified loans and impaired loans.
2. Potential Problem Loans On at least a quarterly basis, the internal credit quality rating is re-evaluated for commercial loans that are either past due or fully performing but exhibit certain characteristics that could reflect well-defined weaknesses. Loans are placed on nonaccrual status when the likely amount of future principal and interest payments are expected to be less than the contractual amounts, even if such loans are not past due. Periodically, Arrow reviews the loan portfolio for evidence of potential problem loans. Potential problem loans are loans that are currently performing in accordance with contractual terms, but where known information about possible credit problems of the borrower may jeopardize loan repayment and result in a non-performing loan. In the credit monitoring program, Arrow treats loans that are classified as substandard but continue to accrue interest as potential problem loans. AtDecember 31, 2020 , Arrow identified 47 commercial loans totaling$38.1 million as potential problem loans. AtDecember 31, 2019 , Arrow identified 54 commercial loans totaling$32.0 million as potential problem loans. For these loans, although positive factors such as payment history, value of supporting collateral, and/or personal or government guarantees led Arrow to conclude that accounting for them as non-performing at year-end was not warranted, other factors, specifically, certain risk factors related to the loan or the borrower justified concerns that they may become nonperforming at some point in the future. The economic impact of the COVID-19 pandemic, specifically unemployment levels and the temporary mandated closure of nonessential businesses, may impact borrowers' ability to satisfy their obligations, and may therefore result in increased delinquencies. Government interventions, on both the federal and state level, have been deployed to mitigate a significant portion of the credit risk. Arrow cannot make a determination as to the overall impact on its business of the COVID-19 pandemic at this time.
3. Foreign Outstandings - None
4. Loan Concentrations The loan portfolio is well diversified. There are no concentrations of credit that exceed 10% of the portfolio, other than the general categories reported in the preceding SectionC.II .a. of this Item 7, beginning on page 42. For further discussion, see Note 1, Risks and Uncertainties, to the notes to the Consolidated Financial Statements. 5. Other Real Estate Owned and Repossessed Assets Other real estate owned ("OREO") primarily consists of real property acquired in foreclosure. OREO is carried at fair value less estimated cost to sell. Arrow establishes allowances for OREO losses, which are determined and monitored on a property-by-property basis and reflect the ongoing estimate of the property's estimated fair value less costs to sell. All Repossessed Assets for each of the five years in the table below consist of motor vehicles.
Distribution of OREO and Repossessed Assets
(Dollars In Thousands)
2020 2019 2018 2017 2016
Single Family 1 - 4 Units $ -$ 187 $
47
Commercial Real Estate - 935
1,083 1,215 790
Other Real Estate Owned, Net - 1,122
1,130 1,738 1,585
Repossessed Assets 155 139
130 109 101
Total OREO and Repossessed Assets$ 155 $ 1,261 $
1,260
The following table summarizes changes in the net carrying amount of OREO and the number of properties for each of the periods presented.
Schedule of Changes in OREO
(Dollars In Thousands) 2020 2019
2018 2017 2016
Balance at Beginning of Year$ 1,122 $ 1,130 $
1,738
Properties Acquired Through Foreclosure - 544 47 778 1,009
Gain of Sale of OREO properties 192 - - - - Subsequent Write-downs to Fair Value - (244)
(195) (160) (162)
Sales (1,314) (308)
(460) (465) (1,140)
Balance at End of Year $ -$ 1,122 $
1,130
Number of Properties, Beginning of Year 3 3 6 5 6 Properties Acquired During the Year - 2 1 4 3 Properties Sold During the Year (3) (2)
(4) (3) (4)
Number of Properties, End of Year - 3 3 6 5
46-------------------------------------------------------------------------------- III. SUMMARY OF LOAN LOSS EXPERIENCE The information required in this section is presented in the discussion of the "Provision for Loan Losses and Allowance for Loan Losses" in Part II Item 7, SectionB.II . beginning on page 36 of this Report, including: •Charge-offs and Recoveries by loan type •Factors that led to the amount of the Provision for Loan Losses •Allocation of the Allowance for Loan Losses by loan type
The percent of loans in each loan category is presented in the table of loan types in the preceding section on page 42 of this Report.
IV. DEPOSITS
The following table sets forth the average balances of and average rates paid on
deposits for the periods indicated.
AVERAGE DEPOSIT BALANCES
(Dollars In Thousands)
Years Ended
12/31/2020 12/31/2019 12/31/2018
Average Average Average
Balance Rate Balance Rate Balance Rate
Demand Deposits $ 613,408 - % $ 472,517 - % $ 460,355 - %
Interest-Bearing Checking 772,000 727,857 849,626
Accounts 0.17 % 0.27 % 0.19 %
Savings Deposits 1,258,154 0.40 % 910,840 0.92 % 753,198 0.46 %
Time Deposits of $250,000 or 124,601 95,932 78,159
More 1.18 % 2.01 % 1.51 %
Other Time Deposits 223,111 1.25 % 259,636 1.63 % 173,151 0.82 %
Total Deposits $ 2,991,274 0.36 % $ 2,466,782 0.67 % $ 2,314,489 0.33 %
Average total deposit balances increased by $524.5 million , or 21.3% in 2020,
mainly in the demand deposit and savings deposit categories.
Arrow used reciprocal deposits for a select group of municipalities to reduce
the amount of investment securities required to be pledged as collateral for
municipal deposits where municipal deposits in excess of the FDIC insurance
coverage limits were transferred to other participating banks, divided into
portions so as to qualify such transferred deposits for FDIC insurance coverage
at each transferee bank. In return, reciprocal amounts are transferred to Arrow
in equal amounts of deposits from the participant banks. The balances of
reciprocal deposits were $404.2 million and $256.1 million at December 31, 2020
and 2019, respectively.
The following table presents the quarterly average balance by deposit type for each of the most recent five quarters.
DEPOSIT PORTFOLIO
Quarterly Average Deposit Balances
(Dollars In Thousands)
Quarters Ended
12/31/2020 9/30/2020 6/30/2020 Demand Deposits$ 676,490 $ 673,181 $ 624,125 $ 478,481 $ 491,494 Interest-Bearing 874,314 724,668 Checking Accounts 764,614 740,284 707,747 Savings Deposits 1,407,837 1,314,241 1,215,296
1,092,980 1,003,612
Time Deposits of 115,492 120,321$250,000 or More 121,027 135,978
126,046
Other Time Deposits 182,105 209,436 236,749
264,755 267,326
Total Deposits $ 3,256,238 $ 3,082,499 $ 2,952,432 $ 2,670,009 $ 2,607,421
The quarterly average balances of both noninterest-bearing deposits and
interest-bearing checking and savings accounts have increased significantly in
the last three quarters. Time deposits, over $250,000 as well as other time
deposits, have decreased over the last three quarters, including $80.6 million
of brokered deposits that matured. Market rates, which began to decline prior to
the COVID-19 pandemic, reached historic lows in the first quarter and have
remained low for the remainder of 2020. Short term interest rates, heavily
impacted by Federal Reserve monetary policy, are not expected to change for an
extended period.
In general, there is a seasonal pattern to municipal deposits which dip to a low
point in August each year. Account balances tend to increase throughout the
fall and into early winter from tax deposits, flatten out after the beginning of
the ensuing calendar year, and increase again at the end of March from the
electronic deposit of NYS Aid payments to school districts. In addition to
seasonal behavior, the overall level of municipal deposit balances fluctuates
from year-to-year as a result of local economic factors as well as competition
from other banks and non-bank entities.
47
--------------------------------------------------------------------------------The total quarterly average balances as a percentage of total deposits are illustrated in the table below.
Percentage of Total Quarters Ended
Quarterly Average Deposits
12/31/2020 9/30/2020 6/30/2020 3/31/2020 12/31/2019
Demand Deposits 20.8 % 21.8 % 21.1 % 17.9 % 18.8 %
Interest-Bearing Checking
Accounts 27.0 % 24.8 % 25.1
% 26.5 % 27.8 %
Savings Deposits 43.1 % 42.7 % 41.2
% 41.0 % 38.5 %
Time Deposits of
or More 3.5 % 3.9 % 4.6 % 4.7 % 4.6 % Other Time Deposits 5.6 % 6.8 % 8.0 % 9.9 % 10.3 % Total Deposits 100.0 % 100.0 % 100.0 % 100.0 % 100.0 % Demand deposits, as well as lower costing interest-bearing checking accounts and savings deposits, all increased or remained consistent as a percentage of total deposits to the previous year. Higher costing time deposits decreased as a percentage of total deposits.
The total quarterly interest cost of deposits, by type of deposit and in total, for each of the most recent five quarters is set forth in the table below:
Quarterly Cost of Deposits Quarters Ended
12/31/2020 9/30/2020 6/30/2020 Demand Deposits - % - % - % - % - %
Interest-Bearing Checking
Accounts 0.11 % 0.14 % 0.17
% 0.28 % 0.30 %
Savings Deposits 0.18 % 0.24 % 0.39
% 0.91 % 0.98 %
Time Deposits of
or More 0.70 % 0.96 % 1.30 % 1.70 % 1.88 % Other Time Deposits 0.92 % 1.09 % 1.33 % 1.52 % 1.67 % Total Deposits 0.18 % 0.25 % 0.37 % 0.68 % 0.72 % Throughout 2020, the total cost of deposits continued to decrease. TheFederal Reserve lowered the Fed Funds target rate to 0.00%-0.25% in response to the economic disruption related to the COVID-19 pandemic. Arrow's balance sheet is well positioned for a variety of rate environments.
The maturities of time deposits of
Maturing in:
Under Three Months $ 66,504
Three to Six Months 28,537
Six to Twelve Months 21,224
2022 2,169
2023 1,868
2024 -
2025 299
Later 3,021
Total $ 123,622 V. SHORT-TERM BORROWINGS (Dollars in Thousands)
12/31/2020
Overnight Advances from the FHLBNY, Federal Funds
Purchased
and Securities Sold Under Agreements to
Repurchase: Balance at December 31$ 17,486 $ 181,099 $ 288,659 Maximum Month-End Balance 73,949 268,805 288,659 Average Balance During the Year 57,929 191,256 192,047 Average Rate During the Year 0.43 % 1.80 % 1.55 % Rate at December 31 0.07 % 1.35 % 2.13 % D. LIQUIDITY The objective of effective liquidity management is to ensure that the Company has the ability to raise cash when needed at a reasonable cost. This includes the capability of meeting expected and unexpected obligations to Arrow's customers at any time. Given the uncertain nature of customer demands and the need to maximize earnings, Arrow must have available reasonably priced sources of funds, both on- and off-balance sheet, that can be accessed quickly in time of need. With the COVID-19 48 -------------------------------------------------------------------------------- pandemic, liquidity management is critical for Arrow. Arrow's liquidity position provides the necessary flexibility to address any unexpected near-term disruptions that may develop as a result of the COVID-19 pandemic such as: reduced cash-flows from the investment and loan portfolios and aggressive funding of programs associated with response efforts. Arrow's primary sources of available liquidity are overnight investments in federal funds sold, interest bearing bank balances at theFederal Reserve Bank of New York , and cash flow from investment securities and loans. Certain investment securities are categorized as available-for-sale at time of purchase based on their marketability and collateral value, as well as their yield and maturity. The securities available-for-sale portfolio was$365.3 million at year-end 2020, an increase of$8.0 million from the year-end 2019 level. Due to the potential for volatility in market values, Arrow may not always be able to sell securities on short notice at their carrying value, even to provide needed liquidity. Arrow also held interest-bearing cash balances atDecember 31, 2020 of$338.9 million compared to$23.2 million atDecember 31, 2019 . In addition to liquidity from cash, short-term investments, investment securities and loans, the Company has supplemented available operating liquidity with additional off-balance sheet sources such as a federal funds lines of credit with correspondent banks and credit lines with the FHLBNY. The federal funds lines of credit are with two correspondent banks totaling$52 million which were not drawn on in 2020. To support the borrowing relationship with the FHLBNY, Arrow has pledged collateral, including residential mortgage, home equity and commercial real estate loans. AtDecember 31, 2020 , Arrow had outstanding collateralized obligations with the FHLBNY of$45 million ; as of that date, the unused borrowing capacity at the FHLBNY was approximately$814 million . Brokered deposits have also been identified as an available source of funding accessible in a relatively short time period. AtDecember 31, 2020 , the balance of outstanding brokered deposits totaled$47.5 million . Also, Arrow's two bank subsidiaries have each established a borrowing facility with theFederal Reserve Bank of New York , pledging certain consumer loans as collateral for potential "discount window" advances, which are maintained for contingency liquidity purposes. AtDecember 31, 2020 , the amount available under this facility was approximately$610 million in the aggregate, and there were no advances then outstanding. Arrow performs regular liquidity stress tests and tests of the contingent liquidity plan to ensure that an adequate amount of available funds can be generated to meet a wide variety of potential liquidity crises including the current COVID-19 pandemic. Arrow measures and monitors basic liquidity as a ratio of liquid assets to total short-term liabilities, both with and without the availability of borrowing arrangements. Based on the level of overnight funds investments, available liquidity from the investment securities portfolio, cash flows from the loan portfolio, the stable core deposit base and the significant borrowing capacity, the Company believes that the available liquidity is sufficient to meet all funding needs that may arise in connection with the COVID-19 pandemic or any other reasonably likely events or occurrences, although there can be no assurance that it will be sufficient. AtDecember 31, 2020 , Arrow's basic liquidity ratio, including FHLBNY collateralized borrowing capacity, was 32.1% of total assets, or$1.04 billion in excess of Arrow's internally-set minimum target ratio of 4%. Arrow did not experience any liquidity constraints in 2020 and did not experience any such constraints in recent prior years. Arrow has not at any time during such period been forced to pay above-market rates to obtain retail deposits or other funds from any source.
E. CAPITAL RESOURCES AND DIVIDENDS
Important Regulatory Capital Standards: Dodd-Frank, enacted in 2010, directedU.S. bank regulators to promulgate revised bank organization capital standards, which were required to be at least as strict as the regulatory capital standards for banks then in effect. The Capital Rules under Dodd-Frank were adopted by the Federal bank regulatory agencies in 2013 and became effective for Arrow and its subsidiary banks onJanuary 1, 2015 . These Capital Rules are summarized in an earlier section of this Report, "Regulatory Capital Standards," beginning on page 7. The table below sets forth the various capital ratios achieved by Arrow and its subsidiary banks, Glens Falls National and Saratoga National, as ofDecember 31, 2020 , as determined under the bank regulatory capital standards in effect on that date, as well as the minimum levels for such capital ratios that bank holding companies and banks are required to maintain under the Capital Rules (not including the "capital conservation buffer"). As demonstrated in the table, all of Arrow's and the banks' capital ratios at year-end were well in excess of the minimum required levels for such ratios, as established by the regulators. (See Item 1, Section C, under "Regulatory Capital Standards" and Item 8, Note 19 in the Notes to Consolidated Financial Statements, for information regarding the "capital conservation buffer.") In addition, onDecember 31, 2020 , Arrow and each of the banks qualified as "well-capitalized", the highest capital classification category under the revised capital classification scheme recently established by the federal bank regulators, that was in effect on that date. Minimum Required Capital Ratios: Arrow GFNB SNB Ratio Tier 1 Leverage Ratio 9.1% 8.7% 8.9% 4.0%
Common Equity Tier 1 Capital Ratio 13.4% 13.9% 13.0% 4.5%
Tier 1 Risk-Based Capital Ratio 14.2% 13.9% 13.0% 6.0%
Total Risk-Based Capital Ratio 15.5% 15.2% 14.2% 8.0%
As reported in the Regulatory Reform section above, the federal bank regulators
have issued a final rule to implement the Community Bank Leverage Ratio
("CBLR"), introducing an optional simplified measure of capital adequacy for
qualifying community banks that satisfy certain requirements, including having a
leverage ratio of greater than 9%, less than $10 billion in
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total consolidated assets, and limited amounts of off-balance-sheet exposures
and trading assets and liabilities. A qualifying community bank that opts into
the CBLR framework and meets all requirements under the CBLR framework will be
considered to have met the well-capitalized ratio requirements under the "prompt
corrective action" regulations and will not be required to report or calculate
risk-based capital ratios. The CBLR is calculated as the ratio of "tier 1
capital" divided by "average total consolidated assets." This final rule was
effective as of January 1, 2020 , and qualifying community banks can utilize the
CBLR framework for purposes of filing their call reports or Form FR Y-9C, as
applicable, for the first quarter of 2020 (i.e., as of March 31, 2020 ). Arrow
elected to opt out of utilizing the CBLR framework. The Capital Rules
promulgated under Dodd-Frank will remain applicable to Arrow.
Stockholders' Equity at Year-end 2020: Total stockholders' equity was $334.4
million at December 31, 2020 , an increase of $32.7 million , or 10.8%, from the
year earlier level. The increase in total stockholders' equity during 2020
principally reflected the following factors: $40.83 million of net income for
the year, plus $1.81 million of equity related to various stock-based
compensation plans, plus $1.81 million of equity resulting from the dividend
reinvestment plan, plus other comprehensive income of $5.54 million reduced by
cash dividends of $15.74 million and the repurchases of common stock of $1.58
million .
Trust Preferred Securities: In each of 2003 and 2004, Arrow issued $10 million
of trust preferred securities (TRUPs) in a private placement. Under the Federal
Reserve Board's regulatory capital rules then in effect, TRUPs proceeds
typically qualified as Tier 1 capital for bank holding companies such as Arrow,
but only in amounts up to 25% of Tier 1 capital, net of goodwill less any
associated deferred tax liability. Under the Dodd-Frank Act, any trust preferred
securities that Arrow might issue on or after the grandfathering date set forth
in Dodd-Frank (May 19, 2010 ) would not qualify as Tier 1 capital under bank
regulatory capital guidelines. For Arrow, TRUPs outstanding prior to the
grandfathering cutoff date set forth in Dodd-Frank (May 19, 2010 ) would continue
to qualify as Tier 1 capital until maturity or redemption, subject to
limitations. Thus, Arrow's outstanding TRUPs continue to qualify as Tier 1
regulatory capital, subject to such limitations.
In the first quarter of 2020, Arrow entered into two interest rate swap
agreements to synthetically fix the variable rate interest payments associated
with $20 million in outstanding subordinated trust securities. The effective
fixed rate is 3.43% until maturity. These agreements are designated as cash flow
hedges.
Dividends: The source of funds for the payment by Arrow of cash dividends to
stockholders consists primarily of dividends declared and paid to it by its bank
subsidiaries. In addition to legal and regulatory limitations on payments of
dividends by Arrow (i.e., the need to maintain adequate regulatory capital),
there are also legal and regulatory limitations applicable to the payment of
dividends by the bank subsidiaries to Arrow. As of December 31, 2020 , under the
statutory limitations in national banking law, the maximum amount that could
have been paid by the bank subsidiaries to Arrow, without special regulatory
approval, was approximately $71.8 million The ability of Arrow and its banks to
pay dividends in the future is and will continue to be influenced by regulatory
policies, capital guidelines and applicable laws.
See Part II, Item 5, "Market for the Registrant's Common Equity, Related
Stockholder Matters and Issuer Purchases of Equity Securities " for a recent
history of its cash dividend payments.
Stock Repurchase Program: In October 2019 , the Board of Directors approved a
$5.0 million stock repurchase program. effective January 1, 2020 (the 2020
program), under which management was authorized, in its discretion, to cause
Arrow to repurchase up to $5 million of shares of Arrow's common stock during
2020, in the open market or in privately negotiated transactions, to the extent
management believed the Company's stock was reasonably priced and such
repurchases appeared to be an attractive use of available capital and in the
best interests of its shareholders. This 2020 program replaced a similar
repurchase program which was in effect over the period from January 30, 2019
through December 31, 2019 (the 2019 program), which also authorized the
repurchase of up to $5.0 million of shares of Arrow's common stock. As of
December 31, 2020 approximately $1.5 million had been used under the 2020
program to repurchase Arrow shares. This total does not include approximately
$1.6 million of Arrow's Common Stock that the Company repurchased during 2020
other than through its repurchase program, i.e., repurchases of Arrow shares on
the market utilizing funds accumulated under Arrow's Dividend Reinvestment Plan
and the surrender or deemed surrender of Arrow stock to the Company in
connection with employees' stock-for-stock exercises of compensatory stock
options to buy Arrow stock. The 2020 program expired on December 31, 2020 . A
similar 2021 program, allowing for stock repurchases of up to $5 million over
the period of January 27, 2021 through December 31, 2021 , was approved by the
Board of Directors in January 2021 .
F. OFF-BALANCE SHEET ARRANGEMENTS
In the normal course of operations, Arrow may engage in a variety of financial
transactions or arrangements, including derivative transactions or arrangements,
that in accordance with GAAP are not recorded in the financial statements, or
are recorded in amounts that differ from the notional amounts. These
transactions or arrangements involve, to varying degrees, elements of credit,
interest rate, and liquidity risk. Such transactions or arrangements may be
used by Arrow or Arrow's customers for general corporate purposes, such as
managing credit, interest rate, or liquidity risk or to optimize capital, or may
be used by Arrow or Arrow's customers to manage funding needs.
In 2020 and 2019, Arrow entered into interest rate swap agreements with its
commercial customers to provide them with a long-term fixed rate, while
simultaneously Arrow entered into offsetting interest rate swap agreements with
a counterparty to swap the fixed rate to a variable rate to manage interest rate
exposure. In the first quarter of 2020, Arrow entered into two interest rate
swap agreements to synthetically fix the variable rate interest payments
associated with $20 million in outstanding subordinated trust securities.
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Arrow's commercial loan interest rate swap agreements are not designated as a
hedge for accounting purposes. The commercial loan interest rate swap agreements
have substantially equivalent and offsetting terms, they do not present any
material exposure to Arrow's consolidated statements of income. Arrow records
its interest rate swap agreements at fair value and is presented on a gross
basis within other assets and other liabilities on the consolidated balance
sheets. Changes in the fair value of assets and liabilities arising from these
derivatives are included, net, in other income in the consolidated statement of
income.
G. CONTRACTUAL OBLIGATIONS (Dollars In Thousands)
Payments Due by Period
Less Than
Contractual Obligation Total 1 Year 1-3 Years 3-5 Years More Than 5 Years
Long-Term Debt Obligations:
Federal Home Loan Bank
Advances 1 $ 45,000 $ - $ 5,000 $ 40,000 $ -
Junior Subordinated
Obligations
Issued to Unconsolidated
Subsidiary Trusts 2 20,000 - - - 20,000
Operating Lease Obligations
3 6,751 743 1,245 1,119 3,644
Finance Lease Obligations 3 9,041 243 486 512 7,800
Obligations under Retirement
Plans 4 41,784 3,886 8,034 8,962 20,902
Total $ 122,576 $ 4,872 $ 14,765 $ 50,593 $ 52,346
1 See Note 10, Debt, to the Consolidated Financial Statements for additional
information on Federal Home Loan Bank Advances, including call provisions.
2 See Note 10, Debt, to the Consolidated Financial Statements for additional
information on Junior Subordinated Obligations Issued to Unconsolidated
Subsidiary Trusts (trust preferred securities).
3 See Note 18, Leases, to the Consolidated Financial Statements for additional
information on Operating Lease Obligations.
4 See Note 13, Retirement Benefit Plans, to the Consolidated Financial
Statements for additional information on Retirement Benefit Plans.
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--------------------------------------------------------------------------------H. RECENTLY ISSUED ACCOUNTING STANDARDS
The following accounting standards have been issued and become effective for the Company at a future date:
InJune 2016 , the FASB issued ASU 2016-13 "Financial Instruments - Credit Losses" ("CECL") which will change the way financial entities measure expected credit losses for financial assets, primarily loans. Under this ASU, the "incurred loss" model will be replaced with an "expected loss" model which will recognize losses over the life of the instrument and requires consideration of a broader range of reasonable and supportable information. Currently, credit losses on available-for-sale securities reduce the carrying value of the instrument and cannot be reversed. Under CECL, the amount of the credit loss is carried as a valuation allowance and can be reversed. The standard also requires expanded credit quality disclosures. InApril 2019 , the FASB issued ASU 2019-04 "Codification Improvements to Topic 326, Financial Instruments-Credit Losses; Topic 815, Derivatives and Hedging; and Topic 825, Financial Instruments," which clarifies that the estimate of expected credit losses should include expected recoveries of financial assets, and that contractual extension or renewal options that are not unconditionally cancellable by the lender are considered when determining the contractual term over which expected credit losses are measured. The Company's loan terms for contractual extensions and renewal options are unconditionally cancellable by the Company (that is, the Company has no obligation to extend or renew existing loans), and therefore are not considered in measuring expected credit losses. InMay 2019 , the FASB issued ASU 2019-05 "Targeted Transition Relief," which allows entities to irrevocably elect the fair value option for certain financial assets measured at amortized cost, not including held-to-maturity investment securities which will continue to be measured at amortized cost. This will apply to those institutions that elect the fair value option on newly originated or purchased financial assets, to avoid the possibility of dual measurement methodologies for identical or similar financial assets. As permitted by the Coronavirus Aid, Relief, and Economic Security ("CARES") Act, Arrow deferred the adoption of the Current Expected Credit Losses ("CECL") methodology in determining credit losses untilJanuary 1, 2021 . The initial adjustment to the allowance for credit losses and unfunded commitments recorded as other liabilities was not reported in earnings, but as the cumulative effect of a change in accounting principle and the adoption will require additional disclosures in future periods. To prepare for the adoption of CECL, (a) the Company held CECL working group meetings that included individuals from various functional areas relevant to the implementation of CECL; (b) the CECL working group developed accounting policies for credit losses including, among other things, management's decisions regarding portfolio segmentation, life of loan considerations, and a reasonable and supportable forecasting methodology; (c) the Company established a CECL governance and approval process, and completed an analysis of the results from a third-party model validation and the results from an internal model validation; and (d) the Company established an internal control framework and finalized the testing of controls related to the adoption of CECL. The CECL pronouncement describes several acceptable methodologies for calculating expected losses on a loan or a pool of loans. Arrow identified the discounted cash flow method for determining losses for the commercial loan portfolios and the residential real estate portfolios, and the vintage method for the consumer indirect loan portfolio. As a result of analyses performed, including the availability of future economic data, the Company will utilize an 18-month reasonable and supportable forecast period, and revert to an historic net loss rate using the straight-line method over a two year reversion period. The Company has identified the economic data that it believes best correlate with expected credit losses through the use of various regression analyses of historical economic information and loan losses. The Company has developed a qualitative factor framework in accordance with this standard that has changed how qualitative factors are determined as compared to the current incurred loss allowance for loan losses model, and has developed a methodology to determine unfunded loan commitments that are recorded as other liabilities. The Company has continued to monitor updates to financial reporting requirements and regulatory guidance, and evaluated the impact on the consolidated financial statements, disclosures, processes and internal controls. The Company has performed parallel CECL reserve estimated calculations for each quarterly period beginningDecember 31, 2019 and is completing its final review of the most recent model run including an evaluation of model back-testing and sensitivity analysis results and finalizing certain assumptions primarily related to qualitative factor adjustments. The Company does not expect to incur a material adjustment to the stockholders' equity balance as ofJanuary 1, 2021 related to the adoption of CECL for held-to-maturity securities, loans carried at amortized cost and unfunded commitments recorded as other liabilities. In addition, the Company has also evaluated the composition of the available-for-sale investment securities portfolio and determined that the changes in ASU 2016-13 will not have a significant effect on the current portfolio. With the adoption of CECL onJanuary 1, 2021 , Arrow expects to remain a well-capitalized financial institution. Regulators have developed a deferral option related to the adoption of CECL and the resulting computation of regulatory capital ratios, the 2019 CECL Rule, which allows a financial institution to elect a three year deferral of the initial CECL adoption amount for the computation of regulatory capital. Arrow is in the process of evaluating this deferral method. InDecember 2019 , the FASB issued ASU 2019-12 "Simplifying the Accounting for Income Taxes" (Topic 740), which removes certain exceptions to the general principles in Topic 740 and improves consistent application of and simplifies GAAP for other areas of Topic 740 by clarifying and amending existing guidance. This ASU is effective for fiscal years beginning afterDecember 15, 2020 and interim periods within those fiscal years, with early adoption permitted. Arrow adopted this standard onJanuary 1, 2021 . The Company does not expect that the adoption of this standard will have a material impact on its financial position or the results of operations in periods subsequent to its adoption. 52 -------------------------------------------------------------------------------- I. FOURTH QUARTER RESULTS Arrow reported net income of$12.5 million for the fourth quarter of 2020, an increase of$2.8 million , or 28.3%, from the net income of$9.7 million reported for the fourth quarter of 2019. Diluted earnings per common share for the fourth quarter of 2020 were$0.81 , up from$0.63 during the fourth quarter of 2019. The net change in earnings between the two quarters was due to the following: (a) a$2.9 million increase in net interest income, (b) a$2.0 million increase in noninterest income, (c) a $602 thousand increase in the provision for loan losses, (d) a$1.1 million increase in noninterest expense, and (e) a$1.1 million increase in the provision for income taxes. The principal factors contributing to these quarter-to-quarter changes are included in the discussion of the year-to-year changes in net income set forth elsewhere in this Item 7, specifically, in Section B, "Results of Operations," above, as well as in Arrow's Current Report on Form 8-K, as filed with theSEC onJanuary 28, 2021 , incorporating by reference Arrow's earnings release for the year endedDecember 31, 2020 . SELECTED FOURTH QUARTER FINANCIAL INFORMATION (Dollars In Thousands, Except Per Share Amounts) For the Quarters Ended December 31, 2020 2019 Interest and Dividend Income$ 28,372 $ 28,367 Interest Expense 1,918 5,449 Net Interest Income 26,454 22,918 Provision for Loan Losses 1,236 634 Net Interest Income after Provision for Loan Losses 25,218 22,284 Noninterest Income 9,103 7,081 Noninterest Expense 18,192 17,099 Income Before Provision for Income Taxes 16,129 12,266 Provision for Income Taxes 3,634 2,526 Net Income$ 12,495 $ 9,740 SHARE AND PER SHARE DATA: Weighted Average Number of Shares Outstanding: Basic 15,499 15,427 Diluted 15,515 15,476 Basic Earnings Per Common Share$ 0.81 $ 0.63 Diluted Earnings Per Common Share 0.81 0.63 Cash Dividends Per Common Share 0.260 0.252 AVERAGE BALANCES: Assets$ 3,721,954 $ 3,113,114 Earning Assets 3,550,415 2,969,972 Loans 2,610,834 2,358,110 Deposits 3,256,238 2,607,421
Stockholders' Equity 331,899 296,124
SELECTED RATIOS (Annualized):
Return on Average Assets 1.34 % 1.24 %
Return on Average Equity 14.98 % 13.05 %
Net Interest Margin 2.96 % 3.06 %
Net Charge-offs to Average Loans 0.07 % 0.06 %
Provision for Loan Losses to Average Loans 0.19 % 0.11 %
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SUMMARY OF QUARTERLY FINANCIAL DATA (Unaudited)
The following quarterly financial information for 2020 and 2019 is unaudited,
but, in the opinion of management, fairly presents the results of Arrow.
SELECTED QUARTERLY FINANCIAL DATA
(Dollars In Thousands, Except Per Share Amounts)
2020
First Second Third Fourth
Quarter Quarter Quarter Quarter
Total Interest and Dividend Income $ 28,226 $ 28,002 $ 27,296 $ 28,372
Net Interest Income 23,006 24,842 24,900 26,454
Provision for Loan Losses 2,772 3,040 2,271 1,236
Net (Loss) Gain on Securities (374) (106) (72) 88
Income Before Provision for Income Taxes 10,174 11,721
13,839 16,129
Net Income 8,127 9,159 11,046 12,495
Basic Earnings Per Common Share 0.53 0.59 0.71 0.81
Diluted Earnings Per Common Share 0.53 0.59 0.71 0.81
2019
First Second Third Fourth
Quarter Quarter Quarter Quarter
Total Interest and Dividend Income $ 26,213 $ 27,227 $ 27,952 $ 28,367
Net Interest Income 21,121 21,707 22,303 22,918
Provision for Loan Losses 472 455 518 634
Net Gain on Securities 76 - 146 67Income Before Provision for Income Taxes 10,884 11,240
12,685 12,266
Net Income 8,734 8,934 10,067 9,740
Basic Earnings Per Common Share 0.57 0.58 0.65 0.63
Diluted Earnings Per Common Share 0.57 0.58 0.65 0.63
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