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AROW Arrow Financial

Filed: 7 May 20, 11:58am


UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q

[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934

For the Quarterly Period Ended March 31, 2020
or
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934

Commission File Number: 0-12507

ARROW FINANCIAL CORPORATION

(Exact name of registrant as specified in its charter)
New York 22-2448962
(State or other jurisdiction of incorporation or organization) 
(I.R.S. Employer
Identification No.)
250 GLEN STREET, GLENS FALLS, NEW YORK 12801
(Address of principal executive offices)   (Zip Code)
Registrant’s telephone number, including area code:   (518) 745-1000

Securities registered pursuant to Section 12(b) of the Act:
Title of Each ClassTrading SymbolName of Each Exchange on Which Registered
Common Stock, Par Value $1.00 per shareAROWNASDAQ Global Select Market

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  Yes         No

Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files).   Yes         No

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer     
Accelerated filer   x 
Non-accelerated filer     
 
Smaller reporting company     
       
Emerging growth company     
       
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standard provided pursuant to Section 13(a) of the Exchange Act. __

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).  Yes      x  No

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.
Class Outstanding as of April 30, 2020
Common Stock, par value $1.00 per share 14,983,674




ARROW FINANCIAL CORPORATION
FORM 10-Q
TABLE OF CONTENTS


# 2



PART I - FINANCIAL INFORMATION
Item 1. FINANCIAL STATEMENTS
ARROW FINANCIAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(In Thousands, Except Share and Per Share Amounts)
(Unaudited)
 March 31, 2020 December 31, 2019 March 31, 2019
ASSETS     
Cash and Due From Banks$32,525
 $47,035
 $36,198
Interest-Bearing Deposits at Banks106,004
 23,186
 25,031
Investment Securities:     
Available-for-Sale at Fair Value378,186
 357,334
 298,812
Held-to-Maturity (Approximate Fair Value of $242,804 at March 31, 2020; $249,618 at December 31, 2019; and $280,414 at March 31, 2019)238,520
 245,065
 279,400
Equity Securities1,689
 2,063
 1,850
FHLB and Federal Reserve Bank Stock5,379
 10,317
 7,878
Loans2,414,193
 2,386,120
 2,235,208
Allowance for Loan Losses(23,637) (21,187) (20,373)
Net Loans2,390,556
 2,364,933
 2,214,835
Premises and Equipment, Net40,987
 40,629
 34,949
Goodwill21,873
 21,873
 21,873
Other Intangible Assets, Net1,640
 1,661
 1,777
Other Assets73,973
 70,179
 62,280
Total Assets$3,291,332
 $3,184,275
 $2,984,883
LIABILITIES     
Noninterest-Bearing Deposits$489,151
 $484,944
 $453,089
Interest-Bearing Checking Accounts793,425
 689,221
 823,301
Savings Deposits1,146,683
 1,046,568
 866,861
Time Deposits over $250,000135,854
 123,968
 83,834
Other Time Deposits245,892
 271,353
 263,012
Total Deposits2,811,005
 2,616,054
 2,490,097
Federal Funds Purchased and Securities Sold Under Agreements to Repurchase57,909
 51,099
 58,407
Federal Home Loan Bank Overnight Advances
 130,000
 74,500
Federal Home Loan Bank Term Advances50,000
 30,000
 35,000
Junior Subordinated Obligations Issued to Unconsolidated Subsidiary Trusts20,000
 20,000
 20,000
Finance Leases5,249
 5,254
 2,946
Other Liabilities37,771
 30,140
 27,324
Total Liabilities2,981,934
 2,882,547
 2,708,274
STOCKHOLDERS’ EQUITY     
Preferred Stock, $1 Par Value and 1,000,000 Shares Authorized at March 31, 2020 and December 31, 2019; $5 Par Value and 1,000,000 Shares Authorized at March 31, 2019
 
 
Common Stock, $1 Par Value; 30,000,000 Shares Authorized at March 31, 2020 and December 31, 2019 and 20,000,000 Shares Authorized at March 31, 2019 (19,606,449 Shares Issued at March 31, 2020 and December 31, 2019 and 19,035,565 at March 31, 2019)19,606
 19,606
 19,035
Additional Paid-in Capital336,021
 335,355
 315,262
Retained Earnings37,441
 33,218
 34,231
Unallocated ESOP Shares (None at March 31, 2020 and December 31, 2019 and 5,501 Shares at March 31, 2019)
 
 (100)
Accumulated Other Comprehensive Loss(2,412) (6,357) (11,567)
Treasury Stock, at Cost (4,624,348 Shares at March 31, 2020; 4,608,258 Shares at December 31, 2019 and 4,556,083 Shares at March 31, 2019)(81,258) (80,094) (80,252)
Total Stockholders’ Equity309,398
 301,728
 276,609
Total Liabilities and Stockholders’ Equity$3,291,332
 $3,184,275
 $2,984,883
See Notes to Unaudited Interim Consolidated Financial Statements.

# 3



ARROW FINANCIAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(In Thousands, Except Per Share Amounts)
(Unaudited)
 Three Months Ended March 31 
 2020 2019 
INTEREST AND DIVIDEND INCOME    
Interest and Fees on Loans$24,874
 $22,403
 
Interest on Deposits at Banks124
 195
 
Interest and Dividends on Investment Securities:    
Fully Taxable2,193
 2,369
 
Exempt from Federal Taxes1,035
 1,246
 
Total Interest and Dividend Income28,226
 26,213
 
INTEREST EXPENSE    
Interest-Bearing Checking Accounts487
 482
 
Savings Deposits2,471
 1,601
 
Time Deposits over $250,000533
 396
 
Other Time Deposits1,000
 713
 
Federal Funds Purchased and
Securities Sold Under Agreements to Repurchase
22
 22
 
Federal Home Loan Bank Advances429
 1,594
 
Junior Subordinated Obligations Issued to
Unconsolidated Subsidiary Trusts
228
 269
 
Interest on Financing Leases50
 15
 
Total Interest Expense5,220
 5,092
 
NET INTEREST INCOME23,006
 21,121
 
Provision for Loan Losses2,772
 472
 
NET INTEREST INCOME AFTER PROVISION FOR LOAN LOSSES20,234
 20,649
 
NONINTEREST INCOME    
Income From Fiduciary Activities2,213
 2,107
 
Fees for Other Services to Customers2,451
 2,402
 
Insurance Commissions1,632
 1,719
 
Net (Loss) Gain on Securities(374) 76
 
Net Gain on Sales of Loans213
 104
 
Other Operating Income1,559
 479
 
Total Noninterest Income7,694
 6,887
 
NONINTEREST EXPENSE    
Salaries and Employee Benefits10,383
 9,319
 
Occupancy Expenses, Net1,449
 1,420
 
Technology and Equipment Expense3,352
 3,141
 
FDIC Assessments219
 212
 
Other Operating Expense2,351
 2,560
 
Total Noninterest Expense17,754
 16,652
 
INCOME BEFORE PROVISION FOR INCOME TAXES10,174
 10,884
 
Provision for Income Taxes2,047
 2,150
 
NET INCOME$8,127

$8,734

Average Shares Outstanding 1:
    
Basic14,996
 14,903
 
Diluted15,026
 14,956
 
Per Common Share:    
Basic Earnings$0.54
 $0.59
 
Diluted Earnings0.54
 0.58
 

1 2019 Share and Per Share Amounts have been restated for the September 27, 2019 3% stock dividend.
See Notes to Unaudited Interim Consolidated Financial Statements.

# 4



ARROW FINANCIAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(In Thousands)
(Unaudited)
  Three Months Ended March 31,
  2020 2019
Net Income $8,127
 $8,734
Other Comprehensive Income, Net of Tax:    
  Net Unrealized Securities Holding Gains Arising During
the Period
 4,098
 2,080
  Net Unrealized Loss on Cash Flow Hedge Agreements (219) 
  Amortization of Net Retirement Plan Actuarial Loss 27
 121
  Amortization of Net Retirement Plan Prior Service Cost 39
 42
Other Comprehensive Income 3,945
 2,243
  Comprehensive Income $12,072
 $10,977
     

See Notes to Unaudited Interim Consolidated Financial Statements.


# 5



ARROW FINANCIAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY
(In Thousands, Except Share and Per Share Amounts)
(Unaudited)

 Three-Month Period Ended March 31, 2020
 
Common
Stock
 
Additional
Paid-In
Capital
 
Retained
Earnings
 
Unallo-cated ESOP
Shares
 
Accumu-lated
Other Com-
prehensive
Loss
 
Treasury
Stock
 Total
Balance at December 31, 2019$19,606
 $335,355
 $33,218
 $
 $(6,357) $(80,094) $301,728
Net Income
 
 8,127
 
 
 
 8,127
Other Comprehensive Income
 
 
 
 3,945
 
 3,945
Cash Dividends Paid, $.26 per Share
 
 (3,904) 
 
 
 (3,904)
Stock Options Exercised, Net  (14,282 Shares)
 199
 
 
 
 144
 343
Shares Issued Under the Employee Stock
  Purchase Plan  (3,648 Shares)

 84
 
 
 
 37
 121
Shares Issued for Dividend
  Reinvestment Plans (16,001 Shares)

 280
 
 
 
 162
 442
Stock-Based Compensation Expense
 103
 
 
 
 
 103
Purchase of Treasury Stock
  (50,021 Shares)

 
 
 
 
 (1,507) (1,507)
Balance at March 31, 2020$19,606
 $336,021
 $37,441
 $
 $(2,412) $(81,258) $309,398
              

 Three-Month Period Ended March 31, 2019
Balance at December 31, 2018$19,035
 $314,533
 $29,257
 $(100) $(13,810) $(79,331) $269,584
Net Income
 
 8,734
 
 
 
 8,734
Other Comprehensive Loss
 
 
 
 2,243
 
 2,243
Cash Dividends Paid, $.252 per Share 1

 
 (3,760) 
 
 
 (3,760)
Stock Options Exercised, Net (26,135 Shares)
 249
 
 
 
 286
 535
Shares Issued Under the Employee Stock
  Purchase Plan  (3,709 Shares)

 76
 
 
 
 41
 117
Shares Issued for Dividend
  Reinvestment Plans (13,132 Shares)

 309
 
 
 
 144
 453
Stock-Based Compensation Expense
 95
 
 
 
 
 95
Purchase of Treasury Stock
 (40,852 Shares)

 
 
 
 
 (1,392) (1,392)
Balance at March 31, 2019$19,035
 $315,262
 $34,231
 $(100) $(11,567) $(80,252) $276,609

1 Cash dividends paid per share have been adjusted for the September 27, 2019 3% stock dividend.
See Notes to Unaudited Interim Consolidated Financial Statements.




# 6



ARROW FINANCIAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Dollars in Thousands)
 Three Months Ended March 31,
Cash Flows from Operating Activities:2020 2019
Net Income$8,127
 $8,734
Adjustments to Reconcile Net Income to Net Cash Provided by Operating Activities:   
Provision for Loan Losses2,772
 472
Depreciation and Amortization1,597
 1,309
Net Loss (Gain) on Securities Transactions374
 (76)
Loans Originated and Held-for-Sale(9,322) (4,223)
Proceeds from the Sale of Loans Held-for-Sale7,975
 3,718
Net Gain on the Sale of Loans(213) (104)
Net (Gain) Loss on the Sale of Premises and Equipment, Other Real Estate Owned and Repossessed Assets(91) 130
Contributions to Retirement Benefit Plans(195) (153)
Deferred Income Tax Benefit(873) (297)
Stock-Based Compensation Expense103
 95
Tax Benefit from Exercise of Stock Options28
 78
Net Increase in Other Assets(5,719) (1,565)
Net Increase in Other Liabilities8,563
 2,613
Net Cash Provided By Operating Activities13,126
 10,731
Cash Flows from Investing Activities:   
Proceeds from the Maturities and Calls of Securities Available-for-Sale17,444
 21,261
Purchases of Securities Available-for-Sale(33,201) 
Proceeds from the Maturities and Calls of Securities Held-to-Maturity7,075
 5,319
Purchases of Securities Held-to-Maturity(717) (1,457)
Net Increase in Loans(27,317) (39,545)
Proceeds from the Sales of Premises and Equipment, Other Real Estate Owned and Repossessed Assets781
 442
Purchase of Premises and Equipment(1,072) (2,099)
Net Decrease in Other Investments4,938
 7,628
Net Cash Used By Investing Activities(32,069) (8,451)
Cash Flows from Financing Activities:   
Net Increase in Deposits194,951
 144,513
Net Decrease in Short-Term Federal Home Loan Bank Borrowings(130,000) (159,500)
Net Increase in Short-Term Borrowings6,810
 3,748
Finance Lease Payments(5) (4)
Federal Home Loan Bank Advances40,000
 
Repayments of Federal Home Loan Bank Term Advances(20,000) (10,000)
Purchase of Treasury Stock(1,507) (1,392)
Stock Options Exercised, Net343
 535
Shares Issued Under the Employee Stock Purchase Plan121
 117
Shares Issued for Dividend Reinvestment Plans442
 453
Cash Dividends Paid(3,904) (3,760)
Net Cash Provided (Used) By Financing Activities87,251
 (25,290)
Net Increase (Decrease) in Cash and Cash Equivalents68,308
 (23,010)
Cash and Cash Equivalents at Beginning of Period70,221
 84,239
Cash and Cash Equivalents at End of Period$138,529
 $61,229
    
Supplemental Disclosures to Statements of Cash Flow Information:   
Interest on Deposits and Borrowings$5,264
 $4,924
Income Taxes344
 311
Non-cash Investing and Financing Activity:   
Transfer of Loans to Other Real Estate Owned and Repossessed Assets371
 728

See Notes to Unaudited Interim Consolidated Financial Statements.

# 7



NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

Note 1.     ACCOUNTING POLICIES

In the opinion of the management of Arrow Financial Corporation (Arrow, the Company, we, or us), the accompanying unaudited interim consolidated financial statements contain all of the adjustments necessary to present fairly the financial position as of March 31, 2020, December 31, 2019 and March 31, 2019; the results of operations for the three-month periods ended March 31, 2020 and 2019; the consolidated statements of comprehensive income for the three-month periods ended March 31, 2020 and 2019; the changes in stockholders' equity for the three-month periods ended March 31, 2020 and 2019; and the cash flows for the three-month periods ended March 31, 2020 and 2019. All such adjustments are of a normal recurring nature.

Management’s Use of Estimates -The preparation of the consolidated financial statements in conformity with accounting principles generally accepted in the United States of America (US GAAP) requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of income and expenses during the reporting period.  Due to the uncertainty regarding the impact of the COVID-19 pandemic, management utilized estimates and assumptions in its evaluation of potential impairment of the Company's right-of-use lease assets, goodwill and intangible assets. Our most significant estimate is the allowance for loan losses. Other estimates include the evaluation of other-than-temporary impairment of investment securities, pension and other post-retirement liabilities and an analysis of a need for a valuation allowance for deferred tax assets. Actual results could differ from those estimates.
A material estimate that is particularly susceptible to significant change in the near term is the allowance for loan losses.  In connection with the determination of the allowance for loan losses, management obtains appraisals for properties.  The allowance for loan losses is management’s best estimate of probable loan losses incurred as of the balance sheet date.  While management uses available information to recognize losses on loans, future adjustments to the allowance for loan losses may be necessary based on changes in economic conditions.  
The unaudited interim consolidated financial statements should be read in conjunction with the audited annual consolidated financial statements of Arrow for the year ended December 31, 2019 included in Arrow's Annual Report on Form 10-K for the year ended December 31, 2019.

The following accounting standards have been adopted in the first three months of 2020:

In August 2018, the Financial Accounting Standards Board (FASB) issued ASU 2018-13 "Disclosure Framework-Changes to the Disclosure Requirements for Fair Value Measurement" as part of its disclosure framework, and pursuant to which FASB has eliminated, amended and added disclosure requirements for fair value measurements. For Arrow, the standard became effective, on a prospective basis, on January 1, 2020. The adoption of this change in fair value disclosure did not have a material impact on its financial position or the results of operations in the period subsequent to its adoption.

In August 2018, the FASB issued Accounting Standards Update (ASU) 2018-15 "Customer's Accounting for Implementation Costs Incurred in a Cloud Computing Arrangement That Is a Service Contract" which will require companies to defer potentially significant, specified implementation costs incurred in a cloud computing arrangement that are currently often expensed under US GAAP. For Arrow, the standard was adopted, on a prospective basis, on January 1, 2020. The adoption of this standard did not have a material impact on its financial position or the results of operations in the period subsequent to its adoption.

In October 2018, the FASB issued ASU No. 2018-17, Consolidation (Topic 810): Targeted Improvements to Related Party Guidance for Variable Interest Entities ("ASU 2018-17"). ASU 2018-17 provides that indirect interests held through related parties in common control arrangements should be considered on a proportional basis for determining whether fees paid to decision makers and service providers are variable interests. For Arrow, the standard was effective on January 1, 2020 and the adoption of this standard did not have a material impact on its financial position or the results of operations in the period subsequent to its adoption.

In March 2020, the FASB issued ASU 2020-04, Reference Rate Reform (Topic 848): Facilitation of the Effects of Reference Rate Reform on Financial Reporting ("ASU 2020-04"). ASU 2020-04 provides companies with optional guidance to ease the potential accounting burden associated with transitioning away from reference rates that are expected to be discontinued, such as LIBOR. Companies can apply the ASU immediately. However, the guidance will only be available for a limited time (generally through December 31, 2022), and provides optional relief for contract modifications, hedge accounting and Held-to-maturity debt securities. For Arrow, this standard was effective January 1, 2020 and can be applied prospectively beginning January 1, 2020 for contract modifications and hedging relationships. The one-time election to sell and/or transfer securities classified as Held-to-maturity may be made at any point after March 12, 2020. Arrow is evaluating the impact of this standard as it will provide relief for contracts currently tied to LIBOR and hedge accounting relationships.

# 8



Note 2.    INVESTMENT SECURITIES (In Thousands)

The following table is the schedule of Available-For-Sale Securities at March 31, 2020, December 31, 2019 and March 31, 2019:
Available-For-Sale Securities
  
U.S. Government & Agency
Obligations
 
State and
Municipal
Obligations
 
Mortgage-
Backed
Securities
 
Corporate
and Other
Debt
Securities
 
Total
Available-
For-Sale
Securities
March 31, 2020          
Available-For-Sale Securities,
  at Amortized Cost
 $5,002
 $723
 $365,333
 $1,000
 $372,058
Gross Unrealized Gains 179
 
 7,484
 
 7,663
Gross Unrealized Losses 
 
 (1,335) (200) (1,535)
Available-For-Sale Securities,
  at Fair Value
 5,181
 723
 371,482
 800
 378,186
Available-For-Sale Securities,
  Pledged as Collateral, at Fair Value
         273,124
           
Maturities of Debt Securities,
  at Amortized Cost:
          
Within One Year $
 $26
 $14,201
 $
 $14,227
From 1 - 5 Years 5,002
 257
 325,234
 
 330,493
From 5 - 10 Years 
 
 25,898
 1,000
 26,898
Over 10 Years 
 440
 
 
 440
           
Maturities of Debt Securities,
  at Fair Value:
          
Within One Year $
 $26
 $14,616
 $
 $14,642
From 1 - 5 Years 5,181
 257
 331,422
 
 336,860
From 5 - 10 Years 
 
 25,444
 800
 26,244
Over 10 Years 
 440
 
 
 440
           
Securities in a Continuous
  Loss Position, at Fair Value:
          
Less than 12 Months $
 $
 $18,846
 $
 $18,846
12 Months or Longer 
 
 59,262
 800
 60,062
Total $
 $
 $78,108
 $800
 $78,908
Number of Securities in a
  Continuous Loss Position
 
 
 27
 1
 28
           
Unrealized Losses on
  Securities in a Continuous
  Loss Position:
          
Less than 12 Months $
 $
 $316
 $
 $316
12 Months or Longer 
 
 1,019
 200
 1,219
Total $
 $
 $1,335
 $200
 $1,535
           
Disaggregated Details:          
US Agency Obligations,
at Amortized Cost
 5,002
        
US Agency Obligations,
at Fair Value
 5,181
        
US Government Agency
  Securities, at Amortized Cost
     $58,089
    
US Government Agency
  Securities, at Fair Value
     57,091
    
Government Sponsored Entity
  Securities, at Amortized Cost
     307,244
    
Government Sponsored Entity
Securities, at Fair Value
     314,391
    
           

# 9



Available-For-Sale Securities
  
U.S. Government & Agency
Obligations
 
State and
Municipal
Obligations
 
Mortgage-
Backed
Securities
 
Corporate
and Other
Debt
Securities
 
Total
Available-
For-Sale
Securities
December 31, 2019          
Available-For-Sale Securities,
  at Amortized Cost
 $5,002
 $764
 $349,944
 $1,000
 $356,710
Gross Unrealized Gains 52
 
 1,852
 
 1,904
Gross Unrealized Losses 
 
 (1,080) (200) (1,280)
Available-For-Sale Securities,
  at Fair Value
 5,054
 764
 350,716
 800
 357,334
Available-For-Sale Securities,
  Pledged as Collateral,
  at Fair Value
         164,426
           
Securities in a Continuous
  Loss Position, at Fair Value:
          
Less than 12 Months $
 $
 $52,491
 $
 $52,491
12 Months or Longer 
 
 97,164
 800
 97,964
Total $
 $
 $149,655
 $800
 $150,455
Number of Securities in a
  Continuous Loss Position
 
 
 54
 1
 55
           
Unrealized Losses on
  Securities in a Continuous
  Loss Position:
          
Less than 12 Months $
 $
 $317
 $
 $317
12 Months or Longer 
 
 763
 200
 963
Total $
 $
 $1,080
 $200
 $1,280
           
Disaggregated Details:          
US Agency Obligations,
at Amortized Cost
 5,002
        
US Agency Obligations,
at Fair Value
 5,054
        
US Government Agency
  Securities, at Amortized Cost
     $61,102
    
US Government Agency
  Securities, at Fair Value
     60,616
    
Government Sponsored Entity
  Securities, at Amortized Cost
     288,842
    
Government Sponsored Entity
Securities, at Fair Value
     290,100
    
           

# 10



Available-For-Sale Securities
  
U.S. Government & Agency
Obligations
 
State and
Municipal
Obligations
 
Mortgage-
Backed
Securities
 
Corporate
and Other
Debt
Securities
 
Total
Available-
For-Sale
Securities
March 31, 2019          
Available-For-Sale Securities,
  at Amortized Cost
 $35,519
 $1,114
 $263,347
 $1,000
 $300,980
Gross Unrealized Gains 
 2
 657
 
 659
Gross Unrealized Losses (136) 
 (2,491) (200) (2,827)
Available-For-Sale Securities,
  at Fair Value
 35,383
 1,116
 261,513
 800
 298,812
Available-For-Sale Securities,
  Pledged as Collateral, at Fair Value
         255,028
           
Securities in a Continuous
  Loss Position, at Fair Value:
          
Less than 12 Months $
 $
 $53,131
 $
 $53,131
12 Months or Longer 35,383
 
 155,108
 800
 191,291
Total $35,383
 $
 $208,239
 $800
 $244,422
Number of Securities in a
  Continuous Loss Position
 7
 
 80
 1
 88
           
Unrealized Losses on Securities
  in a Continuous Loss Position:
          
Less than 12 Months $
 $
 $258
 $
 $258
12 Months or Longer 136
 
 2,233
 200
 2,569
Total $136
 $
 $2,491
 $200
 $2,827
           
Disaggregated Details:          
US Agency Obligations,
at Amortized Cost
 35,519
        
US Agency Obligations,
at Fair Value
 35,383
        
US Government Agency
  Securities, at Amortized Cost
     $70,358
    
US Government Agency
  Securities, at Fair Value
     70,034
    
Government Sponsored Entity
  Securities, at Amortized Cost
     192,989
    
Government Sponsored Entity
Securities, at Fair Value
     191,479
    



# 11




The following table is the schedule of Held-To-Maturity Securities at March 31, 2020, December 31, 2019 and March 31, 2019:
Held-To-Maturity Securities
  
State and
Municipal
Obligations
 
Mortgage-
Backed
Securities
 
Total
Held-To
Maturity
Securities
March 31, 2020      
Held-To-Maturity Securities,
  at Amortized Cost
 $204,148
 $34,372
 $238,520
Gross Unrealized Gains 3,104
 1,329
 4,433
Gross Unrealized Losses (149) 
 (149)
Held-To-Maturity Securities,
  at Fair Value
 207,103
 35,701
 242,804
Held-To-Maturity Securities,
  Pledged as Collateral, at Fair Value
     231,539
       
Maturities of Debt Securities,
  at Amortized Cost:
      
Within One Year $16,308
 $2,857
 $19,165
From 1 - 5 Years 115,665
 31,515
 147,180
From 5 - 10 Years 70,585
 
 70,585
Over 10 Years 1,590
 
 1,590
       
Maturities of Debt Securities,
  at Fair Value:
      
Within One Year $16,329
 $2,964
 $19,293
From 1 - 5 Years 117,119
 32,737
 149,856
From 5 - 10 Years 72,031
 
 72,031
Over 10 Years 1,624
 
 1,624
       
Securities in a Continuous
  Loss Position, at Fair Value:
      
Less than 12 Months $5,625
 $
 $5,625
12 Months or Longer 1,867
 
 1,867
Total $7,492
 $
 $7,492
       
Number of Securities in a
  Continuous Loss Position
 16
 
 16
       
Unrealized Losses on Securities
   in a Continuous Loss Position:
      
Less than 12 Months $16
 $
 $16
12 Months or Longer 133
 
 133
Total $149
 $
 $149
       
Disaggregated Details:      
US Government Agency
  Securities, at Amortized Cost
   $1,594
  
US Government Agency
  Securities, at Fair Value
   1,655
  
Government Sponsored Entity
  Securities, at Amortized Cost
   32,778
  
Government Sponsored Entity
Securities, at Fair Value
   34,046
  
       

# 12



Held-To-Maturity Securities
  
State and
Municipal
Obligations
 
Mortgage-
Backed
Securities
 
Total
Held-To
Maturity
Securities
December 31, 2019      
Held-To-Maturity Securities,
  at Amortized Cost
 $208,243
 $36,822
 $245,065
Gross Unrealized Gains 4,170
 477
 4,647
Gross Unrealized Losses (94) 
 (94)
Held-To-Maturity Securities,
  at Fair Value
 212,319
 37,299
 249,618
Held-To-Maturity Securities,
  Pledged as Collateral, at Fair Value
     237,969
       
Securities in a Continuous
  Loss Position, at Fair Value:
      
Less than 12 Months $1,438
 $
 $1,438
12 Months or Longer 1,994
 
 1,994
Total $3,432
 $
 $3,432
Number of Securities in a
  Continuous Loss Position
 10
 
 10
       
Unrealized Losses on
  Securities in a Continuous
  Loss Position:
      
Less than 12 Months $85
 $
 $85
12 Months or Longer 9
 
 9
Total $94
 $
 $94
      
Disaggregated Details:      
US Government Agency
  Securities, at Amortized Cost
   $1,703
  
US Government Agency
  Securities, at Fair Value
   1,720
  
Government Sponsored Entity
  Securities, at Amortized Cost
   35,119
  
Government Sponsored Entity
Securities, at Fair Value
   35,579
  
       
March 31, 2019      
Held-To-Maturity Securities,
  at Amortized Cost
 $234,454
 $44,946
 $279,400
Gross Unrealized Gains 1,695
 97
 1,792
Gross Unrealized Losses (573) (205) (778)
Held-To-Maturity Securities,
  at Fair Value
 235,576
 44,838
 280,414
Held-To-Maturity Securities,
  Pledged as Collateral, at Fair Value
     265,465
       
Securities in a Continuous
  Loss Position, at Fair Value:
      
Less than 12 Months $
 $
 $
12 Months or Longer 71,450
 26,021
 97,471
Total $71,450
 $26,021
 $97,471
Number of Securities in a
  Continuous Loss Position
 193
 29
 222
       

# 13



Held-To-Maturity Securities
  
State and
Municipal
Obligations
 
Mortgage-
Backed
Securities
 
Total
Held-To
Maturity
Securities
Unrealized Losses on
  Securities in a Continuous
  Loss Position:
      
Less than 12 Months $
 $
 $
12 Months or Longer 573
 205
 778
Total $573
 $205
 $778
      
March 31, 2019      
Disaggregated Details:      
US Government Agency
  Securities, at Amortized Cost
   $2,069
  
US Government Agency
  Securities, at Fair Value
   2,012
  
Government Sponsored Entity
  Securities, at Amortized Cost
   42,877
  
Government Sponsored Entity
Securities, at Fair Value
   42,826
  

In the tables above, maturities of mortgage-backed securities are included based on their expected average lives. Actual maturities will differ because issuers may have the right to call or prepay obligations with or without prepayment penalties.
Securities in a continuous loss position, in the tables above for March 31, 2020, December 31, 2019 and March 31, 2019, do not reflect any deterioration of the credit worthiness of the issuing entities.
 U.S. government agency securities, including mortgage-backed securities, are all rated AAA by Moody's and AA+ by Standard and Poor's.  The state and municipal obligations are general obligations supported by the general taxing authority of the issuer, and in some cases are insured.  Obligations issued by school districts are supported by state aid.  Credit analysis is performed in-house based upon data that has been submitted by the issuers to the New York State Comptroller. That analysis shows no deterioration in the credit worthiness of the municipalities.  Subsequent to March 31, 2020, there were no securities downgraded below investment grade.  
The unrealized losses on these temporarily impaired securities are primarily the result of changes in interest rates for fixed rate securities where the interest rate received is less than the current rate available for new offerings of similar securities, changes in market spreads as a result of shifts in supply and demand, and/or changes in the level of prepayments for mortgage related securities. Because there is no current intention to sell any of our temporarily impaired securities, and because it is not more likely than not that it would be required to sell the securities prior to recovery, the impairment is considered temporary.
Pledged securities, in the tables above, are primarily used to collateralize state and municipal deposits, as required under New York State law. A portion of the pledged securities are used to collateralize repurchase agreements and pooled deposits of our trust customers.

The following table is the schedule of Equity Securities at March 31, 2020, December 31, 2019 and March 31, 2019:
Equity Securities
     
  March 31, 2020December 31, 2019March 31, 2019
Equity Securities, at Fair Value $1,689$2,063$1,850
     

The following is a summary of realized and unrealized gains and losses recognized in net income on equity securities during the three-month periods ended March 31, 2020 and 2019:
 Quarterly Period Ended:
 March 31, 2020 March 31, 2019
Net (Loss) Gain on Equity Securities$(374) $76
Less: Net gain (loss) recognized during the reporting period on equity securities sold during the period
 
Unrealized net (loss) gain recognized during the reporting period on equity securities still held at the reporting date$(374) $76

# 14



Note 3.    LOANS (In Thousands)

Loan Categories and Past Due Loans

The following table presents loan balances outstanding as of March 31, 2020, December 31, 2019 and March 31, 2019 and an analysis of the recorded investment in loans that are past due at these dates.  Generally, Arrow considers a loan past due 30 or more days when the borrower is two payments past due. Loans held-for-sale of $1,905, $215 and $201 as of March 31, 2020, December 31, 2019 and March 31, 2019, respectively, are included in the residential real estate balances for current loans.

Schedule of Past Due Loans by Loan Category
   Commercial      
 Commercial Real Estate Consumer Residential Total
March 31, 2020         
Loans Past Due 30-59 Days$173
 $461
 $5,636
 $1,630
 $7,900
Loans Past Due 60-89 Days70
 110
 1,451
 212
 1,843
Loans Past Due 90 or more Days8
 911
 549
 1,525
 2,993
Total Loans Past Due251
 1,482
 7,636
 3,367
 12,736
Current Loans146,849
 524,648
 817,073
 912,887
 2,401,457
Total Loans$147,100
 $526,130
 $824,709
 $916,254
 $2,414,193
          
Loans 90 or More Days Past Due
  and Still Accruing Interest
$5
 $238
 $93
 $101
 $437
Nonaccrual Loans63
 1,445
 715
 2,720
 4,943
          
December 31, 2019         
Loans Past Due 30-59 Days$150
 $
 $5,670
 $152
 $5,972
Loans Past Due 60-89 Days42
 266
 2,700
 2,027
 5,035
Loans Past Due 90 or more Days21
 326
 445
 1,807
 2,599
Total Loans Past Due213
 592
 8,815
 3,986
 13,606
Current Loans150,447
 509,949
 802,383
 909,735
 2,372,514
Total Loans$150,660
 $510,541
 $811,198
 $913,721
 $2,386,120
          
Loans 90 or More Days Past Due
  and Still Accruing Interest
$
 $
 $
 $253
 $253
Nonaccrual Loans81
 326
 663
 2,935
 4,005
          
March 31, 2019         
Loans Past Due 30-59 Days$168
 $208
 $4,758
 $1,345
 $6,479
Loans Past Due 60-89 Days
 
 1,387
 207
 1,594
Loans Past Due 90 or more Days17
 108
 369
 1,610
 2,104
Total Loans Past Due185
 316
 6,514
 3,162
 10,177
Current Loans133,091
 493,071
 740,285
 858,584
 2,225,031
Total Loans$133,276
 $493,387
 $746,799
 $861,746
 $2,235,208
          
Loans 90 or More Days Past Due
  and Still Accruing Interest
$
 $
 $
 $64
 $64
Nonaccrual Loans415
 248
 588
 3,892
 5,143
    

The Company disaggregates its loan portfolio into the following four categories:

Commercial - The Company offers a variety of loan options to meet the specific needs of commercial customers including term loans, time notes and lines of credit. Such loans are made available to businesses for working capital needs such as inventory and receivables, business expansion and equipment purchases. Generally, a collateral lien is placed on equipment or other assets owned by the borrower. Generally, these loans carry a higher risk than commercial real estate loans, due primarily to the nature of the underlying collateral, which can be business assets such as equipment and accounts receivable and generally have a lower liquidation value than real estate. In the event of default by the borrower, the Company may be required to liquidate collateral at deeply discounted values. To reduce the risk, management usually obtains personal guarantees to support the borrowing, as permitted by applicable law.



# 15



Commercial Real Estate - The Company offers commercial real estate loans to finance real estate purchases, refinancings, expansions and improvements to commercial properties. Commercial real estate loans are often made to finance the purchases of real property which generally consists of real estate with completed structures. These commercial real estate loans are typically secured by first liens on the real estate, which may include apartments, commercial structures, housing businesses, healthcare facilities, and both owner- and non-owner-occupied facilities. These loans are typically less risky than commercial loans, since they are secured by real estate and buildings, and are generally originated in amounts of no more than 80% of the appraised value of the property. However, the Company also offers commercial construction and land development loans to finance projects. Many projects will ultimately be used by the borrowers' businesses, while others are developed for resale. These real estate loans are also typically secured by first liens on the real estate, which may include apartments, commercial structures, housing businesses, healthcare facilities and both owner-occupied and non-owner-occupied facilities. There is enhanced risk during the construction period, since the loan is secured by an incomplete project.

Consumer Loans - Included in this category are automobile loans. The Company primarily finances the purchases of automobiles indirectly through dealer relationships located throughout upstate New York and Vermont. Most of these indirect consumer loans carry a fixed rate of interest with principal repayment terms typically ranging from three to seven years. Indirect consumer loans are underwritten on a secured basis using the underlying collateral being financed. The Company also offers a variety of consumer installment loans to finance personal expenditures. Most of these loans carry a fixed rate of interest with principal repayment terms typically ranging from one to five years, based upon the nature of the collateral and the size of the loan. In addition to installment loans, the Company also offers personal lines of credit and overdraft protection. Several loans are unsecured, which carry a higher risk of loss.

Residential - Residential real estate loans consist primarily of loans secured by first or second mortgages on primary residences. The Company originates fixed-rate and adjustable-rate one-to-four-family residential real estate loans for construction, the purchase of real estate or refinancing of an existing mortgage. These loans are collateralized primarily by owner-occupied properties generally located in the Company’s market area. Loans on one-to-four-family residential real estate are generally originated in amounts of no more than 80% of the purchase price or appraised value (whichever is lower), or have private mortgage insurance. The Company’s underwriting analysis for residential mortgage loans typically includes credit verification, independent appraisals, and a review of the borrower’s financial condition. Mortgage title insurance and hazard insurance are normally required. It is the Company's general practice to underwrite residential real estate loans to secondary market standards. Construction loans have a unique risk, because they are secured by an incomplete dwelling. This risk is reduced through periodic site inspections, including one at each loan draw period. In addition, the Company offers fixed home equity loans, as well as variable rate home equity lines of credit, to consumers to finance home improvements, debt consolidation, education and other uses.  The Company's policy allows for a maximum loan to value ratio of 80%, although periodically higher advances are allowed.  The Company originates home equity lines of credit and second mortgage loans (loans secured by a second junior lien position on one-to-four-family residential real estate).  Risk is generally reduced through underwriting criteria, which include credit verification, appraisals, a review of the borrower's financial condition, and personal cash flows.  A security interest, with title insurance when necessary, is taken in the underlying real estate.

Allowance for Loan Losses

The following table presents a roll-forward of the allowance for loan losses and other information pertaining to the allowance for loan losses:
Allowance for Loan Losses
   Commercial      
 Commercial Real Estate Consumer Residential Total
Roll-forward of the Allowance for Loan Losses for the Quarterly Periods:         
December 31, 2019$1,386
 $5,830
 $9,408
 $4,563
 $21,187
Charge-offs(14) 
 (467) 
 (481)
Recoveries
 
 159
 
 159
Provision267
 1,235
 904
 366
 2,772
March 31, 2020$1,639
 $7,065
 $10,004
 $4,929
 $23,637
          
December 31, 2018$1,218
 $5,644
 $8,882
 $4,452
 $20,196
Charge-offs(1) (29) (418) (14) (462)
Recoveries
 
 167
 
 167
Provision33
 (26) 778
 (313) 472
March 31, 2019$1,250
 $5,589
 $9,409
 $4,125
 $20,373
          

# 16



Allowance for Loan Losses
   Commercial      
 Commercial Real Estate Consumer Residential Total
March 31, 2020         
Allowance for loan losses - Loans Individually Evaluated for Impairment$4
 $
 $
 $37
 $41
Allowance for loan losses - Loans Collectively Evaluated for Impairment1,635
 7,065
 10,004
 4,892
 23,596
Ending Loan Balance - Individually Evaluated for Impairment34
 1,137
 111
 953
 2,235
Ending Loan Balance - Collectively Evaluated for Impairment$147,066
 $524,993
 $824,598
 $915,301
 $2,411,958
          
December 31, 2019         
Allowance for loan losses - Loans Individually Evaluated for Impairment$5
 $
 $
 $42
 $47
Allowance for creditlosses - Loans Collectively Evaluated for Impairment1,381
 5,830
 9,408
 4,521
 21,140
Ending Loan Balance - Individually Evaluated for Impairment35
 
 107
 959
 1,101
Ending Loan Balance - Collectively Evaluated for Impairment$150,625
 $510,541
 $811,091
 $912,762
 $2,385,019
          
March 31, 2019         
Allowance for loan losses - Loans Individually Evaluated for Impairment$
 $
 $
 $
 $
Allowance for credit losses - Loans Collectively Evaluated for Impairment1,250
 5,589
 9,409
 4,125
 20,373
Ending Loan Balance - Individually Evaluated for Impairment40
 387
 101
 2,417
 2,945
Ending Loan Balance - Collectively Evaluated for Impairment$133,236
 $493,000
 $746,698
 $859,329
 $2,232,263
    
Through the provision for loan losses, an allowance for loan losses is maintained that reflects the best estimate of the incurred risk of loss in the Company’s loan portfolio as of the balance sheet date. Additions are made to the allowance for loan losses through a periodic provision for loan losses. Actual loan losses are charged against the allowance for loan losses when loans are deemed uncollectible and recoveries of amounts previously charged off are recorded as credits to the allowance for loan losses.
Our loan officers and risk managers meet at least quarterly to discuss and review the conditions and risks associated with certain criticized and classified commercial-related relationships. In addition, our independent internal loan review department performs periodic reviews of the credit quality indicators on individual loans in the commercial loan portfolio.
The Company uses a two-step process to determine the provision for loan losses and the amount of the allowance for loan losses. An evaluation of impaired loans is performed on a quarterly basis. Impaired loans are generally nonaccrual loans over $250 thousand and all troubled debt restructured loans. Specific reserves on individually identified impaired loans that are not collateral dependent are measured based on the present value of expected future cash flows discounted at the original effective interest rate of each loan. For loans that are collateral dependent, impairment is measured based on the fair value of the collateral less estimated selling costs, and such impaired amounts are generally charged off. In general, Arrow's impaired loans are collateral dependent impaired loans that have limited exposure or require limited specific reserves because of the amount of collateral support with respect to these loans. Interest payments on impaired loans are typically applied to principal unless collectability of the principal amount is reasonably assured. In these cases, interest is recognized on a cash basis.


# 17




The remainder of the portfolio is evaluated on a pooled basis, as described below. For each homogeneous loan pool, a total loss factor is estimated based on the historical net loss rates adjusted for applicable qualitative factors. The total loss factors assigned to each loan category are updated on a quarterly basis. For the commercial, commercial construction and commercial real estate categories, the loan categories are further segregated by credit risk profile (pools of loans graded pass, special mention and accruing substandard). Additional description of the credit risk classifications is detailed in the Credit Quality Indicators section of this note.
The historical net loss rate is determined for each loan category using a trailing three-year net charge-off average. While historical net loss experience provides a reasonable starting point for analysis, historical net losses, or even recent trends in net losses, do not by themselves form a sufficient basis to determine the appropriate level of the allowance for loan losses. Therefore, historical net loss factors are considered and adjusted for qualitative factors that impact the incurred risk of loss associated with the loan categories within the total loan portfolio. These include:
Changes in the volume and severity of past due, nonaccrual and adversely classified loans
Changes in the nature and volume of the portfolio and in the terms of loans
Changes in the value of the underlying collateral for collateral dependent loans
Changes in lending policies and procedures, including changes in underwriting standards and collection, charge-off, and recovery practices not considered elsewhere in estimating credit losses
Changes in the quality of the loan review system
Changes in the experience, ability, and depth of lending management and other relevant staff
Changes in international, national, regional, and local economic and business conditions and developments that affect the collectibility of the portfolio
The existence and effect of any concentrations of credit, and changes in the level of such concentrations
The effect of other external factors such as competition and legal and regulatory requirements on the level of estimated credit losses in the  existing portfolio or pool
    

# 18




Loan Credit Quality Indicators

The following table presents the credit quality indicators by loan category at March 31, 2020, December 31, 2019 and March 31, 2019:
Loan Credit Quality Indicators
   Commercial      
 Commercial Real Estate Consumer Residential Total
March 31, 2020         
Credit Risk Profile by Creditworthiness Category:         
Satisfactory$140,218
 $497,243
     $637,461
Special Mention28
 255
     283
Substandard6,854
 28,632
     35,486
Doubtful
 
     
         
Credit Risk Profile Based on Payment Activity:         
Performing    $823,901
 $913,433
 $1,737,334
Nonperforming    808
 2,821
 3,629
          
December 31, 2019         
Credit Risk Profile by Creditworthiness Category:         
Satisfactory$144,283
 $484,267
     $628,550
Special Mention32
 263
     295
Substandard6,345
 26,011
     32,356
Doubtful
 
     
Credit Risk Profile Based on Payment Activity:         
Performing    $810,535
 $910,533
 $1,721,068
Nonperforming    663
 3,188
 3,851
          
March 31, 2019         
Credit Risk Profile by Creditworthiness Category:         
Satisfactory$125,918
 $465,216
     $591,134
Special Mention133
 2,268
     2,401
Substandard7,225
 25,903
     33,128
Doubtful
 
     
Credit Risk Profile Based on Payment Activity:         
Performing    $746,211
 $857,790
 $1,604,001
Nonperforming    588
 3,956
 4,544

For the purposes of the table above, nonperforming consumer and residential loans are those loans on nonaccrual status or are 90 days or more past due and still accruing interest.
For the allowance calculation, an internally developed system of five credit quality indicators is used to rate the credit worthiness of each commercial loan defined as follows:

1) Satisfactory - "Satisfactory" borrowers have acceptable financial condition with satisfactory record of earnings and sufficient historical and projected cash flow to service the debt.  Borrowers have satisfactory repayment histories and primary and secondary sources of repayment can be clearly identified;

2) Special Mention - Loans in this category have potential weaknesses that deserve management’s close attention.  If left uncorrected, these potential weaknesses may result in deterioration of the repayment prospects for the asset or in the institution’s credit position at some future date.  "Special mention" assets are not adversely classified and do not expose an institution to sufficient risk to warrant adverse classification.  Loans which might be assigned this credit quality indicator include loans to borrowers with deteriorating financial strength and/or earnings record and loans with potential for problems due to weakening economic or market conditions;

3) Substandard - Loans classified as “substandard” are inadequately protected by the current sound net worth or paying capacity of the borrower or the collateral pledged, if any.  Loans in this category have well defined weaknesses that jeopardize the repayment.  They are characterized by the distinct possibility that the Company will sustain some loss if the deficiencies are not corrected.  “Substandard”

# 19



loans may include loans which are likely to require liquidation of collateral to effect repayment, and other loans where character or ability to repay has become suspect. Loss potential, while existing in the aggregate amount of substandard assets, does not have to exist in individual assets classified substandard;

4) Doubtful - Loans classified as “doubtful” have all of the weaknesses inherent in those classified as “substandard” with the added characteristic that the weaknesses make collection or liquidation in full, on the basis of current existing facts, conditions, and values, highly questionable and improbable.  Although possibility of loss is extremely high, classification of these loans as “loss” has been deferred due to specific pending factors or events which may strengthen the value (e.g. possibility of additional collateral, injection of capital, collateral liquidation, debt restructure, economic recovery, etc).  Loans classified as “doubtful” need to be placed on non-accrual; and

5) Loss - Loans classified as “loss” are considered uncollectible with collateral of such little value that their continuance as bankable assets is not warranted.  As of the date of the balance sheet, all loans in this category have been charged-off to the allowance for loan losses.  

Commercial loans are generally evaluated on an annual basis depending on the size and complexity of the loan relationship, unless the credit related quality indicator falls to a level of "special mention" or below, when the loan is evaluated quarterly.  The credit quality indicator is one of the factors used in assessing the level of incurred risk of loss in our commercial related loan portfolios.



# 20



Impaired Loans

The following table presents information on impaired loans as of March 31, 2020, December 31, 2019 and March 31, 2019 based on whether the impaired loan has a recorded related allowance or has no recorded related allowance:
Impaired Loans
   Commercial      
 Commercial Real Estate Consumer Residential Total
March 31, 2020  
      
Recorded Investment:         
With No Related Allowance$
 $1,137
 $112
 $697
 $1,946
With a Related Allowance33
 
 
 256
 289
Unpaid Principal Balance:         
With No Related Allowance
 1,137
 111
 697
 1,945
With a Related Allowance34
 
 
 256
 290
          
December 31, 2019      
  
Recorded Investment:         
With No Related Allowance$
 $
 $108
 $699
 $807
With a Related Allowance34
 
 
 260
 294
Unpaid Principal Balance:         
With No Related Allowance
 
 107
 699
 806
With a Related Allowance35
 
 
 260
 295
          
March 31, 2019         
Recorded Investment:         
With No Related Allowance$38
 $389
 $101
 $2,417
 $2,945
With a Related Allowance
 
 
 
 
Unpaid Principal Balance:         
With No Related Allowance424
 2
 101
 2,416
 $2,943
With a Related Allowance
 
 
 
 
          
For the Quarter Ended:         
March 31, 2020         
Average Recorded Balance:         
With No Related Allowance$
 $569
 $110
 $698
 $1,377
With a Related Allowance34
 
 
 258
 292
Interest Income Recognized:         
With No Related Allowance
 10
 
 
 10
With a Related Allowance
 
 
 
 
Cash Basis Income:         
With No Related Allowance
 
 
 
 
With a Related Allowance
 
 
 
 
          
March 31, 2019         
Average Recorded Balance:         
With No Related Allowance$234
 $591
 $101
 $2,011
 $2,937
With a Related Allowance
 
 
 147
 147
Interest Income Recognized:         
With No Related Allowance
 
 
 
 
With a Related Allowance
 
 
 
 
Cash Basis Income:         
With No Related Allowance
 
 
 
 
With a Related Allowance
 
 
 
 

At March 31, 2020, December 31, 2019 and March 31, 2019, all impaired loans were considered to be collateral dependent and were therefore evaluated for impairment based on the fair value of collateral less estimated cost to sell. Interest income recognized in the table above represents income earned after the loans became impaired and includes restructured loans in compliance with their modified terms and nonaccrual loans where interest income was recognized on a cash basis.


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Loans Modified in Trouble Debt Restructurings

The following table presents information on loans modified in trouble debt restructurings during the periods indicated.
Loans Modified in Trouble Debt Restructurings During the Period
   Commercial      
 Commercial Real Estate Consumer Residential Total
For the Quarter Ended:         
March 31, 2020         
Number of Loans
 
 1
 
 1
Pre-Modification Outstanding Recorded Investment$
 $
 $16
 $
 $16
Post-Modification Outstanding Recorded Investment
 
 16
 
 16
Subsequent Default, Number of Contracts
 
 
 
 
Subsequent Default, Recorded Investment
 
 
 
 
          
March 31, 2019         
Number of Loans
 
 1
 
 1
Pre-Modification Outstanding Recorded Investment$
 $
 $13
 $
 $13
Post-Modification Outstanding Recorded Investment
 
 13
 
 13
Subsequent Default, Number of Contracts
 
 
 
 
Subsequent Default, Recorded Investment
 
 
 
 

In general, prior to the COVID-19 pandemic, loans requiring modification are restructured to accommodate the projected cash-flows of the borrower. Such modifications may involve a reduction of the interest rate, a significant deferral of payments or forgiveness of a portion of the outstanding principal balance. As indicated in the table above, no loans modified during the preceding twelve months subsequently defaulted as of March 31, 2020. In accordance with the Coronavirus Aid, Relief, and Economic Security (CARES) Act, if a short-term loan modification (e.g. six months) is made for a borrower as the result of the COVID-19 pandemic, and who was current on contractual payments as of December 31, 2019, this modification is not considered a troubled debt restructuring (TDR).
Note 4.    COMMITMENTS AND CONTINGENCIES (In Thousands)

The following table presents the notional amount and fair value of Arrow's off-balance sheet commitments to extend credit and commitments under standby letters of credit as of March 31, 2020, December 31, 2019 and March 31, 2019:
Commitments to Extend Credit and Letters of Credit
 March 31, 2020 December 31, 2019 March 31, 2019
Notional Amount:     
Commitments to Extend Credit$376,519
 $349,718
 $310,749
Standby Letters of Credit3,301
 3,129
 4,431
Fair Value:     
Commitments to Extend Credit$
 $
 $
Standby Letters of Credit29
 31
 20
    
Arrow is party to financial instruments with off-balance sheet risk in the normal course of business to meet the financing needs of its customers.  These financial instruments include commitments to extend credit and standby letters of credit.  Commitments to extend credit include home equity lines of credit, commitments for residential and commercial construction loans and other personal and commercial lines of credit.  Those instruments involve, to varying degrees, elements of credit and interest rate risk in excess of the amount recognized in the consolidated balance sheets.  The contract or notional amounts of those instruments reflect the extent of the involvement Arrow has in particular classes of financial instruments.
Arrow's exposure to credit loss in the event of nonperformance by the other party to the financial instrument for commitments to extend credit and standby letters of credit is represented by the contractual notional amount of those instruments.  Arrow uses the same credit policies in making commitments and conditional obligations as it does for on-balance sheet instruments.

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Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract.  Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee.  Since many of the commitments are not expected to be fully drawn upon, the total commitment amounts do not necessarily represent future cash requirements.  Arrow evaluates each customer's creditworthiness on a case-by-case basis.  Home equity lines of credit are secured by residential real estate.  Construction lines of credit are secured by underlying real estate.  For other lines of credit, the amount of collateral obtained, if deemed necessary by Arrow upon extension of credit, is based on management's credit evaluation of the counterparty.  Collateral held varies, but may include accounts receivable, inventory, property, plant and equipment, and income-producing commercial properties.  Most of the commitments are variable rate instruments.
Arrow does not issue any guarantees that would require liability-recognition or disclosure, other than its standby letters of credit.
Arrow has issued conditional commitments in the form of standby letters of credit to guarantee payment on behalf of a customer and guarantee the performance of a customer to a third party.  Standby letters of credit generally arise in connection with commercial lending relationships. The credit risk involved in issuing these instruments is essentially the same as that involved in extending loans to customers. Contingent obligations under standby letters of credit at March 31, 2020, December 31, 2019 and March 31, 2019 represent the maximum potential future payments Arrow could be required to make.  Typically, these instruments have terms of 12 months or less and expire unused; therefore, the total amounts do not necessarily represent future cash requirements.  Each customer is evaluated individually for creditworthiness under the same underwriting standards used for commitments to extend credit and on-balance sheet instruments. Company policies governing loan collateral apply to standby letters of credit at the time of credit extension.  Loan-to-value ratios will generally range from 50% for movable assets, such as inventory, to 100% for liquid assets, such as bank CD's.  Fees for standby letters of credit range from 1% to 3% of the notional amount.  Fees are collected upfront and amortized over the life of the commitment. The carrying amount and fair value of Arrow's standby letters of credit at March 31, 2020, December 31, 2019 and March 31, 2019, were insignificant.  The fair value of standby letters of credit is based on the fees currently charged for similar agreements or the cost to terminate the arrangement with the counterparties.
The fair value of commitments to extend credit is determined by estimating the fees to enter into similar agreements, taking into account the remaining terms and present creditworthiness of the counterparties, and for fixed rate loan commitments, the difference between the current and committed interest rates.  Arrow provides several types of commercial lines of credit and standby letters of credit to its commercial customers.  The pricing of these services is not isolated as Arrow considers the customer's complete deposit and borrowing relationship in pricing individual products and services.  The commitments to extend credit also include commitments under home equity lines of credit, for which Arrow charges no fee.  The carrying value and fair value of commitments to extend credit are not material and Arrow does not expect to incur any material loss as a result of these commitments.
In the normal course of business, Arrow and its subsidiary banks become involved in a variety of routine legal proceedings.  At present, there are no legal proceedings pending or threatened, which in the opinion of management and counsel, would result in a material loss to Arrow.








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Note 5.    COMPREHENSIVE INCOME (In Thousands)

The following table presents the components of other comprehensive income for the three-month periods ended March 31, 2020 and 2019:
Schedule of Comprehensive Income
  Three Months Ended March 31,
    Tax  
  Before-Tax (Expense) Net-of-Tax
  Amount Benefit Amount
2020      
Net Unrealized Securities Holding Gains on Securities Available-for-Sale Arising During the Period 5,504
 $(1,406) 4,098
Net Unrealized Losses on Cash Flow Swap (294) 75
 (219)
Amortization of Net Retirement Plan Actuarial Loss 36
 (9) 27
Amortization of Net Retirement Plan Prior Service Cost 54
 (15) 39
  Other Comprehensive Income $5,300
 $(1,355) $3,945
       
2019      
Net Unrealized Securities Holding Gains on Securities Available-for-Sale Arising During the Period 2,788
 $(708) 2,080
Amortization of Net Retirement Plan Actuarial Loss 163
 (42) 121
Amortization of Net Retirement Plan Prior Service Cost 56
 (14) 42
  Other Comprehensive Income $3,007
 $(764) $2,243



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The following table presents the changes in accumulated other comprehensive income by component:
Changes in Accumulated Other Comprehensive Income (Loss) by Component (1)
          
 Unrealized Gains and Losses on Available-for-Sale Securities Unrealized Loss on Cash Flow Swap Defined Benefit Plan Items Total
   Net Actuarial Gain (Loss) Net Prior Service (Cost) Credit 
     
     
For the Quarter-To-Date periods ended:         
          
December 31, 2019$465
 $
 $(5,847) $(975) $(6,357)
Other comprehensive income or loss before reclassifications4,098
 (219) 
 
 3,879
Amounts reclassified from accumulated other comprehensive income
 
 27
 39
 66
Net current-period other comprehensive income4,098
 (219) 27
 39
 3,945
March 31, 2020$4,563
 $(219) $(5,820) $(936) $(2,412)
          
December 31, 2018$(3,697)   $(8,971) $(1,142) $(13,810)
Other comprehensive income or loss before reclassifications2,080
   
 
 2,080
Amounts reclassified from accumulated other comprehensive income
   121
 42
 163
Net current-period other comprehensive income2,080
   121
 42
 2,243
March 31, 2019$(1,617)   $(8,850) $(1,100) $(11,567)
          
 

(1) All amounts are net of tax.

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The following table presents the reclassifications out of accumulated other comprehensive income:
Reclassifications Out of Accumulated Other Comprehensive Income
 
  Amounts Reclassified  
Details about Accumulated Other from Accumulated Other Affected Line Item in the Statement
Comprehensive Income (Loss) Components Comprehensive Income Where Net Income Is Presented
     
For the Quarter-to-date periods ended:    
     
March 31, 2020    
Amortization of defined benefit pension items:    
Prior-service costs $(54)
(1) 
Salaries and Employee Benefits
Actuarial loss (36)
(1) 
Salaries and Employee Benefits
  (90) Total before Tax
  24
 Provision for Income Taxes
  $(66) Net of Tax
     
Total reclassifications for the period $(66) Net of Tax
     
March 31, 2019    
Amortization of defined benefit pension items:    
Prior-service costs $(56)
(1) 
Salaries and Employee Benefits
Actuarial loss (163)
(1) 
Salaries and Employee Benefits
  (219) Total before Tax
  56
 Provision for Income Taxes
  $(163) Net of Tax
     
Total reclassifications for the period $(163) Net of Tax
     

(1) These accumulated other comprehensive income components are included in the computation of net periodic pension cost.

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Note 6.    STOCK-BASED COMPENSATION (Dollars In Thousands, Except Share and Per Share Amounts)

Arrow has established three stock-based compensation plans: a Long Term Incentive Plan, an Employee Stock Purchase Plan (ESPP) and an Employee Stock Ownership Plan (ESOP). All share and per share data have been adjusted for the September 27, 2019 3% stock dividend.

Long Term Incentive Plan

The Long Term Incentive Plan provides for the grant of incentive stock options, non-qualified stock options, restricted stock, restricted stock units, performance units and performance shares. The Compensation Committee of the Board of Directors administers the Long Term Incentive Plan.

Stock Options - Options may be granted at a price no less than the greater of the par value or fair market value of such shares on the date on which such option is granted, and generally expire ten years from the date of grant.  The options usually vest over a four-year period.

The following table summarizes information about stock option activity for the year to date period ended March 31, 2020.

 SharesWeighted Average Exercise Price
   
Outstanding at January 1, 2020241,242
$27.58
Granted50,800
35.28
Exercised(14,282)24.05
Forfeited(2,752)29.65
Outstanding at March 31, 2020275,008
29.17
Vested at Period-End155,195
26.23
Expected to Vest119,813
32.97
   
Stock Options Granted  
Weighted Average Grant Date Information:  
Fair Value of Options Granted$4.99
 
Fair Value Assumptions:  
Dividend Yield2.90% 
Expected Volatility20.25% 
Risk Free Interest Rate1.53% 
Expected Lives (in years)6.68
 


The following table presents information on the amounts expensed related to stock options for the periods ended March 31, 2020 and 2019:
  For the Three Months Ended March 31,
  2020 2019
Amount expensed $76
 $79

Restricted Stock Units - The Company grants restricted stock units which gives the recipient the right to receive shares of Company stock upon vesting. The fair value of each restricted stock unit is the market value of Company stock on the date of grant. 100% of the restricted stock unit awards vest three years from the grant date. Once vested, the restricted stock units become vested units and are no longer forfeitable. Vested units settle upon retirement of the recipient. Unvested restricted stock unit awards will generally be forfeited if the recipient ceases to be employed by the Company, with limited exceptions.


# 27



The following table summarizes information about restricted stock unit activity for the periods ended March 31, 2020 and 2019.
 Restricted Stock UnitsWeighted Average Grant Date Fair Value
Non-vested at January 1, 20207,496
$31.18
Granted3,827
35.28
Non-vested at March 31, 202011,323
32.57
   
Non-vested at January 1, 20193,478
31.62
Granted4,018
30.79
Non-vested at March 31, 20197,496
31.18
   


The following table presents information on the amounts expensed related to restricted stock units for the periods ended March 31, 2020 and 2019:
  For the Three Months Ended March 31,
  2020 2019
Amount expensed $27
 $16

    
Employee Stock Purchase Plan
Arrow sponsors an ESPP under which employees may purchase Arrow's common stock at a 5% discount below market price. Under current accounting guidance, a stock purchase plan with a discount of 5% or less is not considered a compensatory plan.

Employee Stock Ownership Plan
Arrow maintains an ESOP, pursuant to which substantially all employees of Arrow and its subsidiaries are eligible to participate upon satisfaction of applicable service requirements.  The ESOP borrowed funds from one of Arrow’s subsidiary banks to purchase outstanding shares of Arrow’s common stock.  The notes, which were fully repaid as of December 31, 2019, required annual payments of principal and interest through 2019.  As the debt was repaid, shares were released from collateral based on the proportion of debt paid to total debt outstanding for the year and allocated to active employees.  In addition, the Company makes additional cash contributions to the Plan each year.
Shares pledged as collateral were reported as unallocated ESOP shares in stockholders' equity. As shares were released from collateral, Arrow reported compensation expense equal to the current average market price of the shares, and the shares became outstanding for earnings per share computations.

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Note 7.    RETIREMENT BENEFIT PLANS (Dollars in Thousands)

Arrow sponsors qualified and non-qualified defined benefit pension plans and other postretirement benefit plans for its employees. Arrow maintains a non-contributory pension plan, which covers substantially all employees.  Effective December 1, 2002, all active participants in the qualified defined benefit pension plan were given a one-time irrevocable election to continue participating in the traditional plan design, for which benefits were based on years of service and the participant’s final compensation (as defined), or to begin participating in the new cash balance plan design.  All employees who participate in the plan after December 1, 2002 automatically participate in the cash balance plan design.  The interest credits under the cash balance plan are based on the 30-year U.S. Treasury rate in effect for November of the prior year with a minimum interest credit of 3%.  The service credits under the cash balance plan are equal to 6.0% of eligible salaries for employees who become participants on or after January 1, 2003.  For employees in the plan prior to January 1, 2003, the service credits are scaled based on the age of the participant, and range from 6.0% to 12.0%.  The funding policy is to contribute up to the maximum amount that can be deducted for federal income tax purposes and to make all payments required under The Employee Retirement Income Security Act (ERISA).  Arrow also maintains a supplemental non-qualified unfunded retirement plan to provide eligible employees of Arrow and its subsidiaries with benefits in excess of qualified plan limits imposed by federal tax law.
Arrow has multiple non-pension postretirement benefit plans.  The health care, dental and life insurance plans are contributory, with participants’ contributions adjusted annually.  Arrow’s policy is to fund the cost of postretirement benefits based on the current cost of the underlying policies.  However, the health care plan provision for automatic increases of Company contributions each year is based on the increase in inflation and is limited to a maximum of 5%.  
As of December 31, 2019, Arrow updated its mortality assumption to the Pri-2012 mortality tables for employees, healthy annuitants and contingent survivors, adjusted for mortality improvements with the Scale MP-2019 mortality improvement scale on a generational basis to reflect newly published mortality tables. The Pension Plan uses the sex-distinct amount-weighted tables, the Select Executive Retirement Plan uses the sex-distinct white collar amount-weighted tables, and the Postretirement Benefit Plan uses the sex-distinct headcount-weighted tables. The change in mortality tables resulted in a decrease in liabilities for the Employee's Pension Plan, the Select Executive Retirement Plan and the Postretirement Benefit Plan.
The mortality table used in determining the present value of a lump sum payment/annuitizing cash balance accounts was changed to the applicable mortality table for the determination of present values under Internal Revenue Code (IRC) Section 417(e)(3)(B). This table is currently a 50/50 blend of male and female rates from the 2020 sex distinct optional combined mortality tables, as prescribed under IRC Section 430. The change in mortality table was made to reflect the continued improvement in mortality rates and resulted in an increase in liabilities for the Employee's Pension Plan and the Select Executive Retirement Plan.
The interest rates used in determining the present value of a lump sum payment/annuitizing cash balance accounts were changed to the segment rates in effect for the January 1, 2020 plan year (2.04%, 3.09%, 3.68%) as of December 31, 2019. This change resulted in a decrease in liability for the Employees' Pension Plan and the Select Executive Retirement Plan.
The following tables provide the components of net periodic benefit costs for the three-month periods ended March 31, 2020 and 2019.
  Employees' Select Executive Postretirement
  Pension Retirement Benefit
  Plan Plan Plans
Net Periodic Benefit Cost      
For the Three Months Ended March 31, 2020      
Service Cost 1
 $430
 $103
 $33
Interest Cost 2
 417
 54
 78
Expected Return on Plan Assets 2
 (904) 
 
Amortization of Prior Service Cost 2
 16
 11
 27
Amortization of Net Loss 2
 1
 33
 2
Net Periodic Cost $(40) $201
 $140
       
Plan Contributions During the Period $
 $117
 $78
       
For the Three Months Ended March 31, 2019:      
Service Cost 1
 $399
 $97
 $30
Interest Cost 2
 397
 52
 89
Expected Return on Plan Assets 2
 (770) 
 
Amortization of Prior Service Cost 2
 17
 14
 25
Amortization of Net Loss 2
 153
 27
 (17)
Net Periodic (Benefit) Cost $196
 $190
 $127
       
Plan Contributions During the Period $
 $116
 $37
Footnotes:
1. Included in Salaries and Employee Benefits on the Consolidated Statements of Income
2. Included in Other Operating Expense on the Consolidated Statements of Income

A contribution to the qualified pension plan in 2020 was not required, and currently, additional contributions in 2020 are not expected. Arrow makes contributions to its other post-retirement benefit plans in an amount equal to benefit payments for the year.



# 29



Note 8.    EARNINGS PER COMMON SHARE (In Thousands, Except Per Share Amounts)

The following table presents a reconciliation of the numerator and denominator used in the calculation of basic and diluted earnings per common share (“EPS”) for periods ended March 31, 2020 and 2019.  All share and per share amounts have been adjusted for the September 27, 2019, 3% stock dividend.
Earnings Per Share
 Three Months Ended
 March 31, 2020 March 31, 2019
Earnings Per Share - Basic:   
Net Income$8,127
 $8,734
Weighted Average Shares - Basic14,996
 14,903
Earnings Per Share - Basic$0.54
 $0.59
    
Earnings Per Share - Diluted:   
Net Income$8,127
 $8,734
Weighted Average Shares - Basic14,996
 14,903
Dilutive Average Shares Attributable to Stock Options30
 53
Weighted Average Shares - Diluted15,026
 14,956
Earnings Per Share - Diluted$0.54
 $0.58

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Note 9.    FAIR VALUES (Dollars In Thousands)

FASB ASC Subtopic 820-10 defines fair value, establishes a framework for measuring fair value in GAAP and requires certain disclosures about fair value measurements. There are no nonfinancial assets or liabilities measured at fair value on a recurring basis. The only assets or liabilities that Arrow measured at fair value on a recurring basis at March 31, 2020, December 31, 2019 and March 31, 2019 were securities available-for-sale, equity securities and derivatives. Arrow held no securities or liabilities for trading on such dates.
The table below presents the financial instrument's fair value and the amounts within the fair value hierarchy based on the lowest level of input that is significant to the fair value measurement:
Fair Value of Assets and Liabilities Measured on a Recurring and Nonrecurring Basis
   Fair Value Measurements at Reporting Date Using:
 Fair Value 
Quoted Prices
In Active Markets for Identical Assets
(Level 1)
 
Significant Other
Observable Inputs
(Level 2)
 
Significant Unobservable Inputs
(Level 3)
Fair Value of Assets and Liabilities Measured on a Recurring Basis:       
March 31, 2020       
Assets:       
Securities Available-for Sale:       
   U.S. Government & Agency Obligations$5,181
 $
 $5,181
 $
   State and Municipal Obligations723
 
 723
 
   Mortgage-Backed Securities371,482
 
 371,482
 
   Corporate and Other Debt Securities800
 
 800
 
     Total Securities Available-for-Sale378,186
 
 378,186
 
Equity Securities1,689
 
 1,689
 
     Total Securities Measured on a Recurring Basis379,875
 
 379,875
 
Derivatives, included in other assets5,191
 
 5,191
 
     Total Measured on a Recurring Basis$385,066
 $
 $385,066
 $
Liabilities:       
Derivatives, included in other liabilities5,191
 
 5,191
 
     Total Measured on a Recurring Basis$5,191
 $
 $5,191
 $
December 31, 2019       
Assets:       
Securities Available-for Sale:       
   U.S. Government & Agency Obligations$5,054
 $
 $5,054
 $
   State and Municipal Obligations764
 
 764
 
   Mortgage-Backed Securities350,716
 
 350,716
 
   Corporate and Other Debt Securities800
 
 800
 
     Total Securities Available-for-Sale357,334
   357,334
  
Equity Securities2,063
 
 2,063
 
     Total Securities Measured on a Recurring Basis359,397
 
 359,397
 

# 31



Fair Value of Assets and Liabilities Measured on a Recurring and Nonrecurring Basis
   Fair Value Measurements at Reporting Date Using:
 Fair Value 
Quoted Prices
In Active Markets for Identical Assets
(Level 1)
 
Significant Other
Observable Inputs
(Level 2)
 
Significant Unobservable Inputs
(Level 3)
Derivatives, included in other liabilities69
 
 69
 
Total Measured on a Recurring Basis$359,466
 $
 $359,466
 $
Liabilities:       
Derivatives, included in other liabilities$69
 $
 $69
 $
Total Measured on a Recurring Basis$69
 $
 $69
 $
March 31, 2019       
Assets:       
Securities Available-for Sale:       
   U.S. Government & Agency Obligations$35,383
 $
 $35,383
 $
   State and Municipal Obligations1,116
 
 1,116
 
   Mortgage-Backed Securities261,513
 
 261,513
 
   Corporate and Other Debt Securities800
 
 800
 
     Total Securities Available-for-Sale298,812
   298,812
  
Equity Securities1,850
 
 1,850
 
     Total Securities Measured on a Recurring Basis$300,662
 $
 $300,662
 $
        

 Fair Value 
Quoted Prices
In Active Markets for Identical Assets
(Level 1)
 
Significant Other
Observable Inputs
(Level 2)
 
Significant Unobservable Inputs
(Level 3)
 Gains (Losses) Recognized in Earnings
Fair Value of Assets and Liabilities Measured on a Nonrecurring Basis:         
March 31, 2020         
Collateral Dependent Impaired Loans$582
 $
 $
 $582
 
Other Real Estate Owned and Repossessed Assets, Net942
 
 
 942
 
December 31, 2019         
Collateral Dependent Impaired Loans$285
 $
 $
 $285
 
Other Real Estate Owned and Repossessed Assets, Net1,261
 
 
 1,261
 (186)
March 31, 2019         
Collateral Dependent Impaired Loans$684
 $
 $
 $684
 
Other Real Estate Owned and Repossessed Assets, Net1,445
 
 
 1,445
 (101)

The fair value of financial instruments is determined under the following hierarchy:
Level 1 - Unadjusted quoted prices in active markets that are accessible at the measurement date for identical, unrestricted assets or liabilities;

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Level 2 - Quoted prices for similar assets or liabilities in active markets, quoted prices for identical or similar assets or liabilities in markets that are not active, or inputs that are observable, either directly or indirectly, for substantially the full term of the asset or liability;
Level 3 - Prices or valuation techniques that require inputs that are both significant to the fair value measurement and unobservable (i.e., supported by little or no market activity).

Fair Value Methodology for Assets and Liabilities Measured on a Recurring Basis

The fair value of Level 1 securities available-for-sale are based on unadjusted, quoted market prices from exchanges in active markets. The fair value of Level 2 securities available-for-sale are based on an independent bond and equity pricing service for identical assets or significantly similar securities and an independent equity pricing service for equity securities not actively traded.  The pricing services use a variety of techniques to arrive at fair value including market maker bids, quotes and pricing models.  Inputs to the pricing models include recent trades, benchmark interest rates, spreads and actual and projected cash flows.  The fair value of Level 2 derivatives is determined using inputs that are observable in the market place obtained from third parties including yield curves, publicly available volatilities, and floating indexes.

Fair Value Methodology for Assets and Liabilities Measured on a Nonrecurring Basis

The fair value of collateral dependent impaired loans and other real estate owned was based on third-party appraisals less estimated cost to sell. The appraisals may be adjusted by management for qualitative factors such as economic conditions and estimated liquidation expenses. Other assets which might have been included in this table include mortgage servicing rights, goodwill and other intangible assets. Arrow evaluates each of these assets for impairment at least annually, with no impairment recognized for these assets at March 31, 2020, December 31, 2019 and March 31, 2019.

Fair Value Methodology for Financial Instruments Not Measured on a Recurring or Nonrecurring Basis

The fair value for securities held-to-maturity is determined utilizing an independent bond pricing service for identical assets or significantly similar securities.  The pricing service uses a variety of techniques to arrive at fair value including market maker bids, quotes and pricing models.  Inputs to the pricing models include recent trades, benchmark interest rates, spreads and actual and projected cash flows.
ASU 2016-01 "Recognition and Measurement of Financial Assets and Financial Liabilities" requires that the fair value for loans must be disclosed using the "exit price" notion which is a reasonable estimate of what another party might pay in an orderly transaction. Fair values for loans are calculated for portfolios of loans with similar financial characteristics.  Loans are segregated by type such as commercial, commercial real estate, residential mortgage, indirect auto and other consumer loans.  Each loan category is further segmented into fixed and adjustable interest rate terms and by performing and nonperforming categories.  The fair value of performing loans is calculated by determining the estimated future cash flow, which is the contractual cash flow adjusted for estimated prepayments. The discount rate is determined by starting with current market yields, and first adjusting for a liquidity premium. This premium is separately determined for each loan type. Then a credit loss component is determined utilizing the credit loss assumptions used in the allowance for loan and lease loss model. Finally, a discount spread is applied separately for consumer loans vs. commercial loans based on market information and utilization of the Swap Curve.  
The fair value of time deposits is based on the discounted value of contractual cash flows, except that the fair value is limited to the extent that the customer could redeem the certificate after imposition of a premature withdrawal penalty.  The discount rates are estimated using the Federal Home Loan Bank of New York ("FHLBNY") yield curve, which is considered representative of Arrow’s time deposit rates. The fair value of all other deposits is equal to the carrying value.
The fair value of FHLBNY advances is calculated by the FHLBNY.
The carrying amount of FHLBNY and FRB stock approximates fair value. If the stock was redeemed, the Company will receive an amount equal to the par value of the stock.
The book value of the outstanding trust preferred securities (Junior Subordinated Obligations Issued to Unconsolidated Subsidiary Trusts) are considered to approximate fair value since the interest rates are variable (indexed to LIBOR) and Arrow is well-capitalized.

# 33





Fair Value by Balance Sheet Grouping

The following table presents a summary of the carrying amount, the fair value or an amount approximating fair value and the fair value hierarchy of Arrow’s financial instruments:
Schedule of Fair Values by Balance Sheet Grouping
     Fair Value Hierarchy
 Carrying Value Fair Value Level 1 Level 2 Level 3
March 31, 2020         
Cash and Cash Equivalents$138,529
 $138,529
 $138,529
 $
 $
Securities Available-for-Sale378,186
 378,186
 
 378,186
 
Securities Held-to-Maturity238,520
 242,804
 
 242,804
 
Equity Securities1,689
 1,689
 
 1,689
 
Federal Home Loan Bank and Federal
  Reserve Bank Stock
5,379
 5,379
 
 5,379
 
Net Loans2,390,556
 2,368,033
 
 
 2,368,033
Accrued Interest Receivable7,856
 7,856
 
 7,856
 
Derivatives, included in other assets5,191
 5,191
   5,191
  
Deposits2,811,005
 2,811,668
 
 2,811,668
 
Federal Funds Purchased and Securities
  Sold Under Agreements to Repurchase
57,909
 57,909
 
 57,909
 
Federal Home Loan Bank Term Advances50,000
 51,194
 
 51,194
 
Junior Subordinated Obligations Issued
  to Unconsolidated Subsidiary Trusts
20,000
 20,000
 
 20,000
 
Accrued Interest Payable1,392
 1,392
 
 1,392
 
Derivatives, included in other liabilities5,191
 5,191
 
 5,191
 

# 34



Schedule of Fair Values by Balance Sheet Grouping
     Fair Value Hierarchy
 Carrying Value Fair Value Level 1 Level 2 Level 3
          
December 31, 2019         
Cash and Cash Equivalents$70,221
 $70,221
 $70,221
 $
 $
Securities Available-for-Sale357,334
 357,334
 
 357,334
 
Securities Held-to-Maturity245,065
 249,618
 
 249,618
 
Equity Securities2,063
 2,063
 
 2,063
  
Federal Home Loan Bank and Federal
  Reserve Bank Stock
10,317
 10,317
 
 10,317
 
Net Loans2,364,933
 2,332,797
 
 
 2,332,797
Accrued Interest Receivable7,377
 7,377
 
 7,377
 
Derivatives, included in other assets69
 69
 
 69
 
Deposits2,616,054
 2,614,170
 
 2,614,170
 
Federal Funds Purchased and Securities
  Sold Under Agreements to Repurchase
51,099
 51,099
 
 51,099
 
Federal Home Loan Bank Overnight Advances130,000
 130,000
 
 130,000
 
Federal Home Loan Bank Term Advances30,000
 29,993
 
 29,993
 
Junior Subordinated Obligations Issued
  to Unconsolidated Subsidiary Trusts
20,000
 20,000
 
 20,000
 
Accrued Interest Payable1,436
 1,436
 
 1,436
 
Derivatives, included in other liabilities69
 69
 
 69
 
          
March 31, 2019         
Cash and Cash Equivalents$61,229
 $61,229
 $61,229
 $
 $
Securities Available-for-Sale298,812
 298,812
 
 298,812
 
Securities Held-to-Maturity279,400
 280,414
 
 280,414
 
Equity Securities1,850
 1,850
 
 1,850
  
Federal Home Loan Bank and Federal
  Reserve Bank Stock
7,878
 7,878
 
 7,878
 
Net Loans2,214,835
 2,164,298
 
 
 2,164,298
Accrued Interest Receivable8,180
 8,180
 
 8,180
 
Deposits2,490,097
 2,484,479
 
 2,484,479
 
Federal Funds Purchased and Securities
  Sold Under Agreements to Repurchase
58,407
 58,407
 
 58,407
 
Federal Home Loan Bank Overnight Advances74,500
 74,500
 
 74,500
 
Federal Home Loan Bank Term Advances35,000
 34,805
 
 34,805
 
Junior Subordinated Obligations Issued
  to Unconsolidated Subsidiary Trusts
20,000
 20,000
 
 20,000
 
Accrued Interest Payable737
 737
 
 737
 

# 35



Note 10.    LEASES (Dollars In Thousands)

The Company is a lessee in its leases, which are mainly for financial services locations in addition to leases for corporate vehicles. These leases generally require the Company to pay third-party expenses on behalf of the Lessor, which are referred to as variable payments. Under some leases, the Company pays the variable payments to the lessor, and in other leases, the Company pays the variable payments directly to the applicable third party. None of the Company's current leases include any residual value guarantees or any subleases, and there are no significant rights and obligations of the Company for leases that have not commenced as of the reporting date.
Arrow leases five of its branch offices, at market rates, from Stewart’s Shops Corp.  Mr. Gary C. Dake, President of Stewart’s Shops Corp., serves as a director on the board of directors of each of Arrow and Saratoga National Bank and Trust Company.

The following includes quantitative data related to the Company's leases as of and for the three months ended March 31, 2020 and March 31, 2019:
  Three Months Ended
Finance Lease Amounts:ClassificationMarch 31, 2020 March 31, 2019
Right-of-use AssetsPremises and Equipment, Net$5,124
 $2,922
Lease LiabilitiesFinance Leases5,249
 2,946
     
Operating Lease Amounts:    
Right-of-use AssetsOther Assets$5,529
 $5,587
Lease LiabilitiesOther Liabilities5,602
 5,639
     
Other Information:    
Cash Paid For Amounts Included In The Measurement Of Lease Liabilities:    
Operating Outgoing Cash Flows From Finance Leases $50
 $15
Operating Outgoing Cash Flows From Operating Leases 158
 173
Financing Outgoing Cash Flows From Finance Leases 5
 4
Right-of-use Assets Obtained In Exchange For New Finance Lease Liabilities 
 2,939
Right-of-use Assets Obtained In Exchange For New Operating Lease Liabilities 
 5,725
Weighted-average Remaining Lease Term—Finance Leases (Yrs.) 29.90
 26.91
Weighted-average Remaining Lease Term—Operating Leases (Yrs.) 13.70
 14.63
Weighted-average Discount Rate—Finance Leases % 3.75% 3.82%
Weighted-average Discount Rate—Operating Leases % 3.36% 3.50%


Lease cost information for the Company's leases is as follows:
 Three Months Ended
 March 31, 2020 March 31, 2019
Lease Cost:   
Finance Lease Cost:   
   Amortization of Right-of-use assets$44
 $17
   Interest on Lease Liabilities50
 15
Operating Lease Cost207
 173
Short-term Lease Cost7
 33
Variable Lease Cost55
 56
Total Lease Cost$363
 $294


# 36



Future Lease Payments at March 31, 2020 are as follows:
 
Operating
Leases
Financing
Leases
Twelve Months Ended:  
3/31/2021$776
$240
3/31/2022640
243
3/31/2023563
132
3/31/2024548
243
3/31/2025515
252
Thereafter4,028
8,110
Total Undiscounted Cash Flows$7,070
$9,220
Less: Net Present Value Adjustment1,468
3,971
   Lease Liability$5,602
$5,249

# 37





Note 11.    DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES (In Thousands)

Arrow is exposed to certain risks arising from both its business operations and economic conditions. Arrow principally manages its exposures to a wide variety of business and operational risks through management of its core business activities. The Bank manages economic risks, including interest rate, primarily by managing the amount, sources and duration of its assets and liabilities and through the use of derivative instruments. Specifically, the Bank enters into derivative financial instruments to manage exposures that arise from business activities that result in the receipt or payment of future known and uncertain cash amounts, the value of which are determined by interest rates. Arrow's derivative financial instruments are used to manage differences in the amount, timing and duration of the Bank’s known or expected cash receipts and its known or expected cash payments principally related to certain fixed rate borrowings. Arrow also has interest rate derivatives that result from a service provided to certain qualifying customers and, therefore, are not used to manage interest rate risk in the Company’s assets or liabilities. The Company manages a matched book with respect to its derivative instruments in order to minimize its net risk exposure resulting from such transactions.

Derivatives Not Designated as Hedging Instruments
Arrow enters 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.
These interest rate swap agreements are not designated as a hedge for accounting purposes. As the interest rate swap agreements have substantially equivalent and offsetting terms, they do not present any material exposure to the Arrow's consolidated statements of income. The Bank 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.

The following table depicts the fair value adjustment recorded related to the notional amount of derivatives outstanding as well as the notional amount of the interest rate swap agreements.

Derivatives Not Designated as Hedging Instruments - Interest Rate Swap Agreements
 March 31, 2020 December 31, 2019 March 31, 2019
Fair value adjustment included in other assets$5,191
 $69
 $
Fair value adjustment included in other liabilities5,191
 69
 
Notional amount121,559
 44,531
 

Derivatives Designated as Hedging Instruments
Arrow has entered into interest rate swaps to synthetically fix the variable rate interest payments associated with $20 million in outstanding subordinated trust securities. These agreements are designated as cash flow hedges.
For derivatives designated and that qualify as cash flow hedges of interest rate risk, the gain or loss on the derivative is recorded in AOCI and subsequently reclassified into interest expense in the same period during which the hedge transaction affects earnings. Amounts reported in AOCI related to derivatives will be reclassified to interest expense as interest payments are made on the Arrow's Junior Subordinated Obligations Issued to Unconsolidated Subsidiary Trusts borrowings.

The following table indicates the effect of cash flow hedge accounting on AOCI and on the unaudited interim consolidated statement of income.

Derivatives Designated as Hedging Instruments - Cash Flow Hedge Agreements
 March 31, 2020 December 31, 2019 March 31, 2019
Amount of loss recognized in AOCI$(294) $
 $
Amount of gain reclassified from AOCI interest expense
 
 




Note 12.    COVID-19 PANDEMIC

The outbreak of the novel coronavirus (COVID-19) pandemic has impacted the global economy, including the banking sector and many industries in which our customers operate, in a variety of significant ways. 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 factor included in Item 8.01 of Arrow's Current Report on Form 8-K filed April 24, 2020.
 


# 38






Report of Independent Registered Public Accounting Firm
To the Stockholders and Board of Directors
Arrow Financial Corporation:

Results of Review of Interim Financial Information
We have reviewed the consolidated balance sheet of Arrow Financial Corporation and subsidiaries (the Company) as of March 31, 2020 and 2019, the related consolidated statements of income, comprehensive income, changes in stockholders’ equity and cash flows for the three-month periods ended March 31, 2020 and 2019, and the related notes (collectively, the consolidated interim financial information). Based on our reviews, we are not aware of any material modifications that should be made to the consolidated interim financial information for it to be in conformity with U.S. generally accepted accounting principles.
We have previously audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the consolidated balance sheet of the Company as of December 31, 2019, and the related consolidated statements of income, comprehensive income, changes in stockholders’ equity, and cash flows for the year then ended (not presented herein); and in our report dated February 28, 2020, we expressed an unqualified opinion on those consolidated financial statements. In our opinion, the information set forth in the accompanying consolidated balance sheet as of December 31, 2019, is fairly stated, in all material respects, in relation to the consolidated balance sheet from which it has been derived.
Basis for Review Results
This consolidated interim financial information is the responsibility of the Company’s management. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.
We conducted our reviews in accordance with the standards of the PCAOB. A review of consolidated interim financial information consists principally of applying analytical procedures and making inquiries of persons responsible for financial and accounting matters. It is substantially less in scope than an audit conducted in accordance with the standards of the PCAOB, the objective of which is the expression of an opinion regarding the financial statements taken as a whole. Accordingly, we do not express such an opinion.

/s/ KPMG LLP
Albany, New York
May 7, 2020



# 39



Item 2.
ARROW FINANCIAL CORPORATION AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
March 31, 2020

NOTE ON TERMINOLOGY
In this Quarterly Report on Form 10-Q (this Report), the terms "Arrow," "the registrant," "the Company," "we," "us," and "our" generally refer to Arrow Financial Corporation and its subsidiaries as a group, except where the context indicates otherwise. At certain points in this Form 10-Q, Arrow's performance is compared with that of the Company's "peer group" of financial institutions. Unless otherwise specifically stated, the peer group for the purposes of this Form 10-Q is comprised of the group of 146 domestic bank holding companies with $3 to $10 billion in total consolidated assets as identified in the Federal Reserve Board’s "Bank Holding Company Performance Report" for December 31, 2019 (the most recent such report currently available), and peer group data contained herein has been derived from such report.

THE COMPANY AND ITS SUBSIDIARIES
Arrow is a two-bank holding company headquartered in Glens Falls, New York.  The banking subsidiaries are Glens Falls National Bank and Trust Company (Glens Falls National) whose main office is located in Glens Falls, New York, and Saratoga National Bank and Trust Company (Saratoga National) whose main office is located in Saratoga Springs, New York.  Active subsidiaries of Glens Falls National include Upstate Agency, LLC (an insurance agency that sells property and casualty insurance and also specializes in selling and servicing group health care policies and life insurance), North Country Investment Advisers, Inc. (a registered investment adviser that provides investment advice to Arrow's proprietary mutual funds) and Arrow Properties, Inc. (a real estate investment trust, or REIT). Arrow also owns directly two subsidiary business trusts, organized in 2003 and 2004, which issued trust preferred securities (TRUPs), which are still outstanding.

FORWARD LOOKING STATEMENTS
This Report on Form 10-Q contains statements that are not historical in nature but rather are based on the Company's beliefs, assumptions, expectations, estimates and projections about the future. These statements are "forward-looking statements" within the meaning of Section 21E of the Securities Exchange Act of 1934, as amended, and involve a degree of uncertainty and attendant risk. Words such as "may," "will," "expect," "believe," "anticipate," "estimate," "continue," and variations of such words and similar expressions are intended to identify such forward-looking statements. Examples of forward-looking statements include statements regarding the Company's asset quality, the level of allowance for credit losses, the sufficiency of liquidity sources, interest rate change exposure, changes in accounting standards, and the Company's tax plans and strategies. Some of these statements, such as those included in the interest rate sensitivity analysis in Part I, Item 3, entitled "Quantitative and Qualitative Disclosures About Market Risk," are merely presentations of what future performance or changes in future performance would look like based on hypothetical assumptions and on simulation models. Other forward-looking statements are based on Arrow's general perceptions of market conditions and trends in business activity, both the Company's and in the banking industry generally, as well as current management strategies for future operations and development.

These forward-looking statements may not be exhaustive, are not guarantees of future performance and involve certain risks and uncertainties that are difficult to quantify or, in some cases, to identify.  You should not place undue reliance on any such forward-looking statements. In the case of all forward-looking statements, our actual outcomes and results may differ materially from what the statements predict or forecast.  Factors that could cause or contribute to such differences include, but are not limited to the following, which are or may be amplified by the novel coronavirus (COVID-19) pandemic:
the current and rapidly evolving COVID-19 pandemic and its impact on economic, market and social conditions;
other rapid and dramatic changes in economic and market conditions;
sharp fluctuations in interest rates, economic activity, or consumer spending patterns;
sudden changes in the market for products provided, such as real estate loans;
significant changes in banking or other laws and regulations, including both enactment of new legal or regulatory measures or the modification or elimination of pre-existing measures;
significant changes in U.S. monetary or fiscal policy, including new or revised monetary programs or targets adopted or announced by the Federal Reserve ("monetary tightening or easing") or significant new federal legislation materially affecting the federal budget ("fiscal tightening or expansion");
competition from other sources (e.g., non-bank entities);
similar uncertainties inherent in banking operations or business generally, including technological developments and changes; and
other risks detailed from time to time within our filings with the Securities and Exchange Commission ("SEC").

The Company is under no duty to update any of the forward-looking statements after the date of this Report to conform such statements to actual results. All forward-looking statements, express or implied, included in this Report and the documents incorporated by reference and that are attributable to the Company are expressly qualified in their entirety by this cautionary statement. This cautionary statement should also be considered in connection with any subsequent written or oral forward-looking statements that the Company or any persons acting on our behalf may issue. This Report should be read in conjunction with our Annual Report on Form 10-K for the year ended December 31, 2019 (the 2019 Annual Report) and our other filings with the SEC.


# 40



USE OF NON-GAAP FINANCIAL MEASURES
The SEC has adopted Regulation G, which applies to all public disclosures, including earnings releases, made by registered companies that contain "non-GAAP financial measures."  GAAP is generally accepted accounting principles in the United States of America.  Under Regulation G, companies making public disclosures containing non-GAAP financial measures must also disclose, along with each non-GAAP financial measure, certain additional information, including a reconciliation of the non-GAAP financial measure to the closest comparable GAAP financial measure and a statement of the Company’s reasons for utilizing the non-GAAP financial measure as part of its financial disclosures.  The SEC has exempted from the definition of "non-GAAP financial measures" certain commonly used financial measures that are not based on GAAP.  When these exempted measures are included in public disclosures, supplemental information is not required.  The following measures used in this Report, which are commonly utilized by financial institutions, have not been specifically exempted by the SEC and may constitute "non-GAAP financial measures" within the meaning of the SEC's rules, although the Company is unable to state with certainty that the SEC would so regard them.

Tax-Equivalent Net Interest Income and Net Interest Margin: Net interest income, as a component of the tabular presentation by financial institutions of Selected Financial Information regarding their recently completed operations, as well as disclosures based on that tabular presentation, is commonly presented on a tax-equivalent basis.  That is, to the extent that some component of the institution's net interest income, which is presented on a before-tax basis, is exempt from taxation (e.g., is received by the institution as a result of its holdings of state or municipal obligations), an amount equal to the tax benefit derived from that component is added to the actual before-tax net interest income total.  This adjustment is considered helpful in comparing one financial institution's net interest income to that of another institution or in analyzing any institution’s net interest income trend line over time, to correct any analytical distortion that might otherwise arise from the fact that financial institutions vary widely in the proportions of their portfolios that are invested in tax-exempt securities, and from the fact that even a single institution may significantly alter over time the proportion of its own portfolio that is invested in tax-exempt obligations.  Moreover, net interest income is itself a component of a second financial measure commonly used by financial institutions, net interest margin, which is the ratio of net interest income to average earning assets.  For purposes of this measure as well, tax-equivalent net interest income is generally used by financial institutions, again to provide a better basis of comparison from institution to institution and to better demonstrate a single institution’s performance over time. The Company follows these practices.

The Efficiency Ratio: Financial institutions often use an "efficiency ratio" as a measure of expense control.  The efficiency ratio typically is defined as the ratio of noninterest expense to net interest income and noninterest income.  Net interest income as utilized in calculating the efficiency ratio is typically the same as the net interest income presented in Selected Financial Information table discussed in the preceding paragraph, i.e., it is expressed on a tax-equivalent basis.  Moreover, many financial institutions, in calculating the efficiency ratio, also adjust both noninterest expense and noninterest income to exclude from these items (as calculated under GAAP) certain recurring component elements of income and expense, such as intangible asset amortization (which is included in noninterest expense under GAAP but may be excluded therefrom for purposes of calculating the efficiency ratio) and securities gains or losses (which are reflected in the calculation of noninterest income under GAAP but may be excluded therefrom for purposes of calculating the efficiency ratio).  The Company makes these adjustments.

Tangible Book Value per Share:  Tangible equity is total stockholders’ equity less intangible assets.  Tangible book value per share is tangible equity divided by total shares issued and outstanding.  Tangible book value per share is often regarded as a more meaningful comparative ratio than book value per share as calculated under GAAP, that is, total stockholders’ equity including intangible assets divided by total shares issued and outstanding.  Intangible assets includes many items, but in our case, essentially represents goodwill.

Adjustments for Certain Items of Income or Expense: In addition to our regular utilization in our public filings and disclosures of the various non-GAAP measures commonly utilized by financial institutions discussed above, the Company also may elect from time to time, in connection with our presentation of various financial measures prepared in accordance with GAAP, such as net income, earnings per share (i.e. EPS), return on average assets (i.e. ROA), and return on average equity (i.e. ROE), to provide as well certain comparative disclosures that adjust these GAAP financial measures, typically by removing them from the impact of certain transactions or other material items of income or expense that are unusual or unlikely to be repeated.  The Company will do so only if it believes that provision of the resulting non-GAAP financial measures may improve the average investor's understanding of our results of operations by separating out items that have a disproportional positive or negative impact on the particular period in question or by otherwise permitting a better comparison from period-to-period in our results of operations with respect to our fundamental lines of business, including the commercial banking business.

The Company believes that the non-GAAP financial measures disclosed from time-to-time are useful in evaluating our performance and that such information should be considered as supplemental in nature, and not as a substitute for or superior to, the related financial information prepared in accordance with GAAP.  Non-GAAP financial measures may differ from similar measures presented by other companies.
    

 


# 41



Arrow Financial Corporation
Selected Quarterly Information
(Dollars In Thousands, Except Per Share Amounts - Unaudited)
Quarter Ended3/31/2020 12/31/2019 9/30/2019 6/30/2019 3/31/2019
Net Income$8,127
 $9,740
 $10,067
 $8,934
 $8,734
Transactions in Net Income (Net of Tax):         
Net Changes in Fair Value of Equity Investments(279) 50
 109
 
 57
          
Share and Per Share Data:1
         
Period End Shares Outstanding14,982
 14,998
 14,969
 14,949
 14,909
Basic Average Shares Outstanding14,996
 14,978
 14,955
 14,922
 14,903
Diluted Average Shares Outstanding15,026
 15,026
 14,991
 14,963
 14,956
Basic Earnings Per Share$0.54
 $0.65
 $0.67
 $0.60
 $0.59
Diluted Earnings Per Share0.54
 0.65
 0.67
 0.60
 0.58
Cash Dividend Per Share0.260
 0.260
 0.252
 0.252
 0.252
          
Selected Quarterly Average Balances:         
  Interest-Bearing Deposits at Banks$32,787
 $28,880
 $27,083
 $25,107
 $26,163
  Investment Securities603,748
 582,982
 545,073
 584,679
 611,161
  Loans2,394,346
 2,358,110
 2,308,879
 2,255,299
 2,210,642
  Deposits2,670,009
 2,607,421
 2,472,528
 2,436,290
 2,347,985
  Other Borrowed Funds170,987
 177,877
 231,291
 250,283
 327,138
  Stockholders’ Equity306,527
 296,124
 289,016
 280,247
 272,864
  Total Assets3,180,857
 3,113,114
 3,023,043
 2,997,458
 2,977,056
Return on Average Assets, annualized1.03% 1.24% 1.32% 1.20% 1.19%
Return on Average Equity, annualized10.66% 13.05% 13.82% 12.79% 12.98%
Return on Average Tangible Equity, annualized 2
11.55% 14.18% 15.05% 13.96% 14.22%
Average Earning Assets$3,030,881
 $2,969,972
 $2,881,035
 $2,865,085
 $2,847,966
Average Paying Liabilities2,362,515
 2,293,804
 2,213,642
 2,235,462
 2,224,403
Interest Income28,226
 28,367
 27,952
 27,227
 26,213
Tax-Equivalent Adjustment  3
288
 321
 344
 376
 373
Interest Income, Tax-Equivalent 3
28,514
 28,688
 28,296
 27,603
 26,586
Interest Expense5,220
 5,449
 5,649
 5,520
 5,092
Net Interest Income23,006
 22,918
 22,303
 21,707
 21,121
Net Interest Income, Tax-Equivalent 3
23,294
 23,239
 22,647
 22,083
 21,494
Net Interest Margin, annualized3.05% 3.06% 3.07% 3.04% 3.01%
Net Interest Margin, Tax Equivalent, annualized 3
3.09% 3.10% 3.12% 3.09% 3.06%
          
Efficiency Ratio Calculation: 4
         
Noninterest Expense$17,754
 $17,099
 $16,791
 $16,908
 $16,652
Less: Intangible Asset Amortization58
 60
 61
 44
 79
Net Noninterest Expense$17,696
 $17,039
 $16,730
 $16,864
 $16,573
Net Interest Income, Tax-Equivalent 3
$23,294
 $23,238
 $22,647
 $22,083
 $21,494
Noninterest Income7,694
 7,081
 7,691
 6,896
 6,887
Less: Net Changes in Fair Value of Equity Invest.(374) 67
 146
 
 76
Net Gross Income$31,362
 $30,252
 $30,192
 $28,979
 $28,305
Efficiency Ratio 4
56.42% 56.32% 55.41% 58.19% 58.55%
          
Period-End Capital Information:         
Total Stockholders’ Equity (i.e. Book Value)$309,398
 $301,728
 $292,228
 $284,649
 $276,609
Book Value per Share 1
20.65
 20.12
 19.52
 19.04
 18.55
Goodwill and Other Intangible Assets, net23,513
 23,534
 23,586
 23,603
 23,650
Tangible Book Value per Share 1,2
19.08
 18.55
 17.95
 17.46
 16.97
          
Capital Ratios:5
         
Community Bank Leverage Ratio9.87%        
Tier 1 Leverage Ratio  9.98% 10.04% 9.88% 9.73%
Common Equity Tier 1 Capital Ratio  12.94% 12.93% 12.99% 12.98%
Tier 1 Risk-Based Capital Ratio  13.83% 13.85% 13.93% 13.95%
Total Risk-Based Capital Ratio  14.78% 14.81% 14.91% 14.93%
Assets Under Trust Admin. & Investment Mgmt.$1,342,531
 $1,543,653
 $1,485,116
 $1,496,966
 $1,483,259

# 42



Arrow Financial Corporation
Selected Quarterly Information - Continued
(Dollars In Thousands, Except Per Share Amounts - Unaudited)

Footnotes:        
           
1.Share and Per Share Data have been restated for the September 27, 2019, 3% stock dividend.
  
2.Non-GAAP Financial Measures 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 the Company believes provide investors with information that is useful in understanding our financial performance. See "Use of Non-GAAP Financial Measures" on page 43.
  3/31/2020 12/31/2019 9/30/2019 6/30/2019 3/31/2019
 Total Stockholders' Equity (GAAP)$309,398
 $301,728
 $292,228
 $284,649
 $276,609
 Less: Goodwill and Other Intangible assets, net23,513
 23,534
 23,586
 23,603
 23,650
 Tangible Equity (Non-GAAP)$285,885
 $278,194
 $268,642
 $261,046
 $252,959
           
 Period End Shares Outstanding14,982
 14,998
 14,969
 14,949
 14,909
 
Tangible Book Value per Share
     (Non-GAAP)
$19.08
 $18.55
 $17.95
 $17.46
 $16.97
 Net Income8,127
 9,740
 10,067
 8,934
 8,734
 Return on Average Tangible Equity (Net Income/Tangible Equity - Annualized)11.55% 14.18% 15.05% 13.96% 14.22%
           
3.Non-GAAP Financial Measures Reconciliation: Net Interest Margin is the ratio of our annualized tax-equivalent net interest income to average earning assets. This is also a non-GAAP financial measure which the Company believes provides investors with information that is useful in understanding our financial performance. See "Use of Non-GAAP Financial Measures" on page 43.
  3/31/2020 12/31/2019 9/30/2019 6/30/2019 3/31/2019
 Interest Income (GAAP)$28,226
 $28,367
 $27,952
 $27,227
 $26,213
 Add: Tax-Equivalent adjustment
(Non-GAAP)
288
 321
 344
 376
 373
 Interest Income - Tax Equivalent
(Non-GAAP)
$28,514
 $28,688
 $28,296
 $27,603
 $26,586
 Net Interest Income (GAAP)$23,006
 $22,918
 $22,303
 $21,707
 $21,121
 Add: Tax-Equivalent adjustment
(Non-GAAP)
288
 321
 344
 376
 373
 Net Interest Income - Tax Equivalent
(Non-GAAP)
$23,294
 $23,239
 $22,647
 $22,083
 $21,494
 Average Earning Assets$3,030,881
 $2,969,972
 $2,881,035
 $2,865,085
 $2,847,966
 Net Interest Margin (Non-GAAP)*3.09% 3.10% 3.12% 3.09% 3.06%
           
4.Non-GAAP Financial Measures: Financial Institutions often use the "efficiency ratio", a non-GAAP ratio, as a measure of expense control. The Company believes the efficiency ratio provides investors with information that is useful in understanding our financial performance. The Company defines efficiency ratio as the ratio of our noninterest expense to our net gross income (which equals tax-equivalent net interest income plus noninterest income, as adjusted). There is no GAAP financial measure that is closely comparable to the efficiency ratio. See "Use of Non-GAAP Financial Measures" on page 43.
           
5.For the current quarter, the Community Bank Leverage Ratio (CBLR) in the table above is an estimation. The previous Total Risk-Weighted Assets and Common Equity Tier 1 Capital amounts listed in the table below reflect actual results. The CBLR at March 31, 2020 listed below (i.e., 9.87%) exceeds the required minimum CBLR (i.e., 9.00%).
  3/31/2020 12/31/2019 9/30/2019 6/30/2019 3/31/2019
 Community Bank Leverage Ratio9.87%        
 Total Risk Weighted Assets  $2,237,127
 $2,184,214
 $2,121,541
 $2,075,115
 Common Equity Tier 1 Capital  289,409
 282,485
 275,528
 269,363
 Common Equity Tier 1 Capital Ratio  12.94% 12.93% 12.99% 12.98%

     * Quarterly ratios have been annualized.



# 43




Average Consolidated Balance Sheets and Net Interest Income Analysis
(GAAP Basis)
(Dollars In Thousands)
    
Quarter Ended March 31:2020 2019
   Interest Rate   Interest Rate
 Average Income/ Earned/ Average Income/ Earned/
 Balance Expense Paid Balance Expense Paid
Interest-Bearing Deposits at Banks$32,787
 $124
 1.52% $26,163
 $195
 3.02%
Investment Securities:           
Fully Taxable399,307
 2,193
 2.21
 378,120
 2,369
 2.54
Exempt from Federal Taxes204,441
 1,035
 2.04
 233,041
 1,246
 2.17
Loans2,394,346
 24,874
 4.18
 2,210,642
 22,403
 4.11
Total Earning Assets3,030,881
 28,226
 3.75
 2,847,966
 26,213
 3.73
Allowance for Credit Losses(22,186)     (20,108)    
Cash and Due From Banks34,211
     35,125
    
Other Assets137,951
     114,073
    
Total Assets$3,180,857
     $2,977,056
    
Deposits:           
Interest-Bearing Checking Accounts$707,747
 487
 0.28
 $768,354
 482
 0.25
Savings Deposits1,092,980
 2,471
 0.91
 833,832
 1,601
 0.78
Time Deposits of $250,000 or More126,046
 533
 1.70
 79,346
 396
 2.02
Other Time Deposits264,755
 1,000
 1.52
 212,785
 713
 1.36
Total Interest-Bearing Deposits2,191,528
 4,491
 0.82
 1,894,317
 3,192
 0.68
Short-Term Borrowings92,444
 208
 0.90
 264,471
 1,421
 2.18
FHLBNY Term Advances & Other Long-Term Debt73,297
 471
 2.58
 62,667
 464
 3.00
Finance Leases5,246
 50
 3.83
 2,948
 15
 2.06
Total Interest-Bearing Liabilities2,362,515
 5,220
 0.89
 2,224,403
 5,092
 0.93
Noninterest-bearing deposits478,481
     453,668
    
Other Liabilities33,334
     26,121
    
Total Liabilities2,874,330
     2,704,192
    
Stockholders’ Equity306,527
     272,864
    
Total Liabilities and Stockholders’ Equity$3,180,857
     $2,977,056
    
Net Interest Income  $23,006
     $21,121
  
Net Interest Spread    2.86%     2.80%
Net Interest Margin    3.05%     3.01%



# 44



OVERVIEW
    
The following discussion and analysis focuses on and reviews the results of operations for the three-month period ended March 31, 2020 and the financial condition as of March 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, we expect the operations and financial results of Arrow 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 has been proactive and continually assessing the potential impact of the pandemic. It formed a Business Continuity Task Force in advance of the impending arrival of the pandemic to Upstate New York. The task force, representing leadership from across the organization, has overseen a robust and expansive effort to protect employees and customers while continuing to deliver essential banking services during the pandemic. In that regard, Arrow has been limiting access at all facilities to appointment-only and encouraging customers to use no-contact alternatives such as digital banking, drive-ins and ATMs. Additionally, Arrow expanded remote work arrangements for a large portion of its employee base, discontinued employee travel, minimized in-person meetings, and implemented social distancing for essential employees who remained on-site. Arrow believes that between remote working arrangements and cross training initiatives, current human capital resources should be able to continue operations during the current COVID-19 pandemic, absent unforeseen facts.
Demand for the Small Business Administration’s Paycheck Protection Program has been significant. Both of Arrow’s subsidiary banks are proudly participating in the program as a way to deliver relief for small businesses in Upstate New York. In order to process the large volume of Paycheck Protection Program applications, Arrow reinforced its lending team with resources and support from across the Company. Arrow believes it will be able to effectively manage its liquidity position while being able to satisfy the significant demand for the Small Business Administration’s Paycheck Protection Program.
The COVID-19 pandemic has significantly impacted economic activity and markets around the world, and we expect it will negatively impact Arrow's business in numerous ways. In particular, the rapid rise in unemployment and the mandated closure of non-essential businesses in New York, will most likely reduce loan production as well as impact borrowers' ability to satisfy their obligations. Investments are analyzed to determine if any impairment not considered temporary exists. Municipal investments may be impacted if tax revenue deceases significantly. Management will continue to evaluate investment securities for impairment. Arrow has increased its allowance for loan losses as a result of the uncertainty surrounding the ability of its borrowers to satisfy loan obligations to Arrow. Arrow will continue to assess potential loan losses. Arrow does not anticipate any impairment of its right-of-use lease assets, goodwill or other intangible assets as a result of COVID-19, however, the Company will continue to assess impairment throughout the pandemic.
We continue to monitor closely the Company’s financial health and liquidity and the impact of the pandemic on the Company. As we cannot predict the duration or scope of the pandemic or its impact on economic and financial markets or its impact on our business, we are not able 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 factor included in Item 8.01 of Arrow's Current Report on Form 8-K filed April 24, 2020.

Summary of Q1 2020 Financial Results: Net income for the first quarter of 2020 was $8.1 million, compared to $8.7 million in the first quarter of 2019. Although loan growth slowed in March, primarily as a result of the COVID-19 pandemic, total loans grew in the first quarter by $28.1 million from December 31, 2019 to $2.4 billion. Net interest income increased to $23.0 million in the first quarter of 2020, compared to $21.1 million for the comparable quarter of 2019.
Diluted earnings per share (EPS) for the quarter was $0.54, a decrease of 6.9% from the EPS of $0.58 reported for the first quarter of 2019. Return on average equity (ROE) for the first quarter of 2020 decreased to 10.66%, as compared to a ROE of 12.98% for the quarter ended March 31, 2019. Return on average assets (ROA) for the 2020 first quarter was 1.03%, a decrease from an ROA of 1.19% for the quarter ended March 31, 2019.
Total loans reached $2.4 billion as of March 31, 2020, which represents an increase of $179.0 million, or 8.0% as compared to March 31, 2019. The consumer loan portfolio grew by $77.9 million, or 10.4%, as compared to March 31, 2019, primarily within the indirect automobile lending program. Total outstanding residential real estate loans increased $54.5 million, or 6.3%, as compared to March 31, 2019. Total outstanding commercial loans increased $46.6 million, or 7.4%, as compared to March 31, 2019.
At March 31, 2020, deposit balances reached $2.8 billion, up $320.9 million, or 12.9%, from the prior-year level. Noninterest-bearing deposits represented 17.4% of total deposits at March 31, 2020, compared to 18.2% of total deposits on March 31, 2019. At March 31, 2020, other time deposits were $245.9 million, a decrease of $17.1 million compared to the prior year. Municipal deposits increased $174.7 million, or 28.1% from March 31, 2019. Total combined Federal Home Loan Bank Overnight and Term Advances declined $110.0 million from December 31, 2019.
First quarter 2020 net interest income increased to $23.0 million, up 8.9% from $21.1 million in the comparable quarter of 2019. The net interest margin was 3.05% for the quarter, compared to 3.01% for the first quarter of 2019. The increase in net interest margin from the prior year was primarily the result of both the increase in the deposit balances as described above combined with the decrease in market rates. The yield on earning assets has been consistent between years with increased loan yields offset by declining yields on investments.

# 45



Noninterest income for the three months ended March 31, 2020 was $7.7 million, compared to $6.9 million in the comparable 2019 quarter. For the first quarter of 2020, the fair value of equity securities at March 31, 2020 decreased $374 thousand primarily as a result of the equity market disruption related to the COVID-19 pandemic. In addition, $866 thousand of interest rate swap income was recorded in the first quarter of 2020.
Noninterest expense for the first quarter of 2020 increased 6.6% to $17.8 million, from $16.7 million for the first quarter of 2019. Salaries and benefits increased $1.1 million, primarily the result of increased cost of health insurance benefits.
Asset quality remained strong at March 31, 2020, with continued low levels of nonperforming loans and net charge-offs. Nonperforming loans at March 31, 2020, were $5.5 million, up $168 thousand from the level at March 31, 2019. Net charge-offs, expressed as an annualized percentage of average loans outstanding, were 0.05% for the three-month period ended March 31, 2020, consistent with March 31, 2019. The allowance for loan losses was $23.6 million at March 31, 2020, which represented 0.98% of loans outstanding, as compared to 0.91% at March 31, 2019. The loss provision expense for the first quarter of 2020 was $2.8 million, up $2.3 million from the provision expense for the comparable 2019 quarter. Although credit quality remains very strong, the increase in loss provision reflects the uncertainty resulting from the COVID-19 pandemic.

The changes in net income, net interest income and net interest margin between the three-month periods are discussed in detail under the heading "RESULTS OF OPERATIONS," beginning on page 59.

Regulatory Capital and Increase in Stockholders' Equity: 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 (the CBLR framework).  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 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 CLBR at 8% as of the second quarter of 2020 and then gradually re-establish the CBLR at 9%.
Under the interim final rules, the CBLR will be set at 8% beginning in the second quarter of 2020 through the end of the year. Thus, 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 will increase 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 CBLR final rule became effective as of January 1, 2020, and Arrow and both subsidiary banks utilized the CBLR framework for purposes of filing their Form FR Y-9C and call reports for the first quarter of 2020. At March 31, 2020, the CBLR ratio for the Company and both subsidiary banks exceeded the 9% minimum threshold and therefore continued to qualify as "well-capitalized" under the regulatory capital classification guidelines.
Stockholders’ equity was $309.4 million at March 31, 2020, an increase of $7.7 million, or 2.5%, from the December 31, 2019 level of $301.7 million, and an increase of $32.8 million, or 11.9%, from the prior-year level. The increase in stockholders' equity over the first three months of 2020 principally reflected the following factors: (i) $8.13 million of net income for the period, plus (ii) other comprehensive income of $3.95 million, plus (iii) issuance of $1.01 million of common stock through employee benefit and dividend reinvestment plans; reduced by (iv) cash dividends of $3.90 million; and (v) repurchases of common stock of $1.51 million. The components of the change in stockholders’ equity since year-end 2019 are presented in the Consolidated Statement of Changes in Stockholders’ Equity on page 6, and are discussed in more detail in the next section.
At March 31, 2020, book value per share was $20.65, up by 11.3% over the prior-year level. Tangible book value per share (a non-GAAP measure that deducts intangible assets from stockholders' equity) was $19.08, an increase of $2.11, or 12.4%, over the level as of March 31, 2019. See the disclosure on page 41 related to the use of non-GAAP financial measures including tangible book value.
On March 31, 2020, the Company's closing stock price was $27.87, representing a trading multiple of 1.46 to tangible book value. In the first quarter of 2020, the Company paid a quarterly cash dividend of $0.26. Further discussion of dividends is included in the Capital Components; Stock Repurchases; Dividends section located on page 56.

Loan Quality: Net charge-offs for the first quarter of 2020 were $322 thousand as compared to $295 thousand for the comparable 2019 quarter. The ratio of net charge-offs to average loans (annualized) was 0.05% for the first quarter of 2020 consistent with the first quarter of 2019. At March 31, 2020, the allowance for credit losses was $23.6 million representing 0.98% of total loans, which is an increase from the March 31, 2019 ratio of 0.91%. Although credit quality remains very strong, the increase in loan loss provision expense reflects the uncertainty resulting from the COVID-19 pandemic. As permitted by the CARES Act, Arrow has elected to defer the adoption of the Current Expected Credit Losses ("CECL") methodology in determining credit losses.
Nonperforming loans were $5.5 million at March 31, 2020, representing 0.23% of period-end loans, a decrease from the March 31, 2019 ratio of 0.24%. The ratio continues to compare favorably with the weighted average ratio of the peer group of 0.53% at December 31, 2019.


# 46



Loan Segments: During the quarter ended March 31, 2020, total loans grew by $28.1 million, or 1.2% as compared to the balance at December 31, 2019. The largest increase was in commercial real estate loans, which increased during the quarter by $15.6 million, or 3.1%. In addition, consumer loans expanded $13.5 million, or 1.7% and commercial loans increased by $3.6 million, or 2.4%. The economic factors resulting from the COVID-19 pandemic will most likely adversely impact loan growth for the remainder of the year.
Commercial and Commercial Real Estate Loans: Combined, these loans comprise 27.9% of the total loan portfolio at period-end. Commercial property values in the Company's region have remained stable in recent periods leading 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 mandatory closure of nonessential business in New York will impact the Bank's customer base. Government intervention, with programs such as the Small Business Administration’s Paycheck Protection Program, 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 34.2% of the total loan portfolio at period-end. Consumer automobile loans at March 31, 2020, were $819 million, or 99.3% of this portfolio segment. In the first three months of 2020, the Company 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. The physical sale of vehicles through dealerships has been curtailed and not deemed essential as part of the response to the COVID-19 pandemic in New York and Vermont, our primary dealer network. Thus, the volume of originations of consumer loans will be negatively impacted, although the magnitude of the impact cannot be determined.
Residential Real Estate Loans: These loans, including home equity loans, made up 37.9% 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. The Company originated nearly all of the residential real estate loans currently held in the loan portfolio and applies conservative underwriting standards to loan originations. The Company 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. Due to the COVID-19 pandemic, it is not yet possible to determine the long term economic impact of the mandated closure of non-essential business and its resulting impact on our residential real estate loan portfolio.

Liquidity and Access to Credit Markets: The Company has not experienced any liquidity problems or special concerns thus far in 2020, or at any time in recent history. 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, including the Small Business Administration’s Paycheck Protection Program.  Interest-bearing cash balances at March 31, 2020 were $106.0 million compared to $25.0 million at March 31, 2019.  Contingent collateralized lines of credit are established and available through the FHLBNY and FRB, totaling $1.2 billion. The terms of Arrow's lines of credit have not changed significantly in recent periods (see the general liquidity discussion on page 57). Historically, the Company 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 September 18, 2018, Visa issued a press release announcing that it and other defendants entered into a settlement agreement with class plaintiffs in the related litigation case. But certain merchants opted out of the class settlement and filed separate litigation cases. Once the class action and other merchant litigation cases are settled and 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. On September 27, 2019, Visa deposited $300 million into the litigation escrow account that was established pursuant to Visa’s U.S. retrospective responsibility plan, which reduces the conversion rate of Class B shares to Class A shares. This did not have a significant effect on the number of Class B shares currently convertible to Class A shares by Glens Falls National. At March 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 does not recognize any economic value for these shares.

# 47



CHANGE IN FINANCIAL CONDITION

Summary of Selected Consolidated Balance Sheet Data
(Dollars in Thousands)
 March 31, 2020 
At Period-End


December 31,
2019
 March 31, 2019 
$ Change
From December
 
$ Change
From
March
 
% Change
From December (not annualized)
 
% Change
From
March
Interest-Bearing Bank Balances$106,004
 $23,186
 $25,031
 $82,818
 $80,973
 357.2 % 323.5 %
Securities Available-for-Sale378,186
 357,334
 298,812
 20,852
 79,374
 5.8 % 26.6 %
Securities Held-to-Maturity238,520
 245,065
 279,400
 (6,545) (40,880) (2.7)% (14.6)%
Equity Securities1,689
 2,063
 1,850
 (374) (161) (18.1)% (8.7)%
Loans (1)
2,414,193
 2,386,120
 2,235,208
 28,073
 178,985
 1.2 % 8.0 %
Allowance for loan losses23,637
 21,187
 20,373
 2,450
 3,264
 11.6 % 16.0 %
Earning Assets (1)
3,143,971
 3,024,085
 2,848,179
 119,886
 295,792
 4.0 % 10.4 %
Total Assets$3,291,332
 $3,184,275
 $2,984,883
 $107,057
 $306,449
 3.4 % 10.3 %
Noninterest-Bearing Deposits$489,151
 $484,944
 $453,089
 $4,207
 $36,062
 0.9 % 8.0 %
Interest-Bearing Checking
Accounts
793,425
 689,221
 823,301
 104,204
 (29,876) 15.1 % (3.6)%
Savings Deposits1,146,683
 1,046,568
 866,861
 100,115
 279,822
 9.6 % 32.3 %
Time Deposits over $250,000135,854
 123,968
 83,834
 11,886
 52,020
 9.6 % 62.1 %
Other Time Deposits245,892
 271,353
 263,012
 (25,461) (17,120) (9.4)% (6.5)%
Total Deposits$2,811,005
 $2,616,054
 $2,490,097
 $194,951
 $320,908
 7.5 % 12.9 %
Federal Funds Purchased and
Securities Sold Under
Agreements to Repurchase
$57,909
 $51,099
 $58,407
 $6,810
 $(498) 13.3 % (0.9)%
FHLBNY Advances - Overnight
 130,000
 74,500
 (130,000) (74,500) (100.0)% (100.0)%
FHLBNY Advances - Term50,000
 30,000
 35,000
 20,000
 15,000
 66.7 % 42.9 %
Junior Subordinated Obligations Issued to Unconsolidated
Subsidiary Trusts
20,000
 20,000
 20,000
 
 
  %  %
Stockholders' Equity309,398
 301,728
 276,609
 7,670
 32,789
 2.5 % 11.9 %
(1) Includes Nonaccrual Loans.
    
Changes in Earning Assets: The loan portfolio at March 31, 2020, was $2.4 billion, an increase of $28.1 million, or 1.2%, from the December 31, 2019 level and up by $179.0 million, or 8.0%, from the March 31, 2019 level. The following trends were experienced in our largest segments:
Commercial and commercial real estate loans: This segment of the loan portfolio increased by $12.0 million, or 1.8%, during the first three months of 2020.
Consumer loans (primarily automobile loans through indirect lending): As of March 31, 2020, these loans, primarily auto loans, increased by $13.5 million, or 1.7%, from the December 31, 2019 balance, reflecting a strong demand for new and used vehicles throughout our region-wide dealer network during the time leading up to COVID-19 pandemic. As previously stated, the physical sale of vehicles through dealerships has been curtailed and not deemed essential as part of the New York State and Vermont responses to the COVID-19 pandemic. The volume of originations of consumer loans will be impacted. The magnitude of the impact cannot be determined at this time.
Residential real estate loans: This segment increased during the first three months of 2020 by $2.5 million, or 0.3%. The likely impact of the COVID-19 pandemic on the volume of residential real estate loans is difficult to determine. We expect that high unemployment and the mandated closure of non-essential businesses in New York State will have an adverse impact on new originations. The rapid decline of interest rates may, however, increase demand for refinancing loans, both with existing and new customers.

Changes in Sources of Funds: Deposit balances reached $2.8 billion, up $320.9 million, or 12.9%, from the prior-year level. Noninterest-bearing deposits represented 17.4% of total deposits at March 31, 2020, compared to 18.2% of total deposits on March 31, 2019. At March 31, 2020, other time deposits were $245.9 million, a decrease of $17.1 million compared to the prior year. Municipal deposits increased $174.7 million, or 28.1% from March 31, 2019. Total combined Federal Home Loan Bank Overnight and Term Advances declined $110.0 million from December 31, 2019.


# 48



Municipal Deposits: Fluctuations in balances of interest-bearing checking accounts are largely the result of timing and behavior of municipal deposits.  Municipal deposits on average represent 20% to 25% of total deposits. Municipal deposits are typically placed in interest-bearing checking, savings and various time deposit accounts.
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.


FINANCIAL CONDITION
Investment Portfolio Trends
The table below presents the changes in the period-end balances for available-for-sale, held-to-maturity and equity securities from December 31, 2019 to March 31, 2020 (in thousands).
 (Dollars in Thousands)
 Fair Value at Period-End 
Net Unrealized Gains (Losses)
For Period Ended
 3/31/2020 12/31/2019 Change 3/31/2020 12/31/2019 Change
Securities Available-for-Sale:           
U.S. Agency Securities$5,181
 $5,054
 $127
 $179
 $52
 $127
State and Municipal Obligations723
 764
 (41) 
 
 
Mortgage-Backed Securities371,482
 350,716
 20,766
 6,149
 772
 5,377
Corporate and Other Debt Securities800
 800
 
 (200) (200) 
Total$378,186
 $357,334
 $20,852
 $6,128
 $624
 $5,504
            
Securities Held-to-Maturity:           
State and Municipal Obligations$207,103
 $212,319
 $(5,216) $2,955
 $4,076
 $(1,121)
Mortgage-Backed Securities35,701
 37,299
 (1,598) 1,329
 477
 852
Total$242,804
 $249,618
 $(6,814) $4,284
 $4,553
 $(269)
            
Equity Securities$1,689
 $2,063
 $(374) $
 $
 $
            
    
At March 31, 2020, the Company held no investment securities in the securities portfolios that consisted of or included, directly or indirectly, obligations of foreign governments or governmental 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 mortgage-backed securities, the repayments on which have generally been separated into two or more components (tranches), where each tranche has a separate estimated life and yield.  The Company'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.

Other-Than-Temporary Impairment
Each quarter all investment securities with a fair value less than amortized cost are evaluated in the available-for-sale portfolio, the held-to-maturity portfolio and the equity securities portfolio, to determine if there exists other-than-temporary impairment for any such security as defined under generally accepted accounting principles. The evaluation also examined the potential impact of the COVID-19 pandemic on other-than-temporary impairment. There were no other-than-temporary impairment losses in the first three months of 2020.
Change in Net Unrealized Securities Gains (Losses): Nearly all of the change in net unrealized gains or losses during recent periods has been attributable to changes in the market rates during the periods in question, with no change in the credit-worthiness of the issuers. Fixed income valuations increased sharply, while equities dropped, in the period primarily as the result of market disruptions associated with the COVID-19 pandemic.


# 49



Investment Sales, Purchases and Maturities
There were no sales of investment securities within the three-month periods ended March 31, 2020 or 2019.

The following table summarizes purchases of investment securities within the available-for-sale and held-to-maturity portfolios for the three-month periods ended March 31, 2020 and 2019, as well as proceeds from the maturity and calls of investment securities within each portfolio for the respective periods presented:
(In Thousands)Three Months Ended
Purchases:3/31/2020 3/31/2019
Available-for-Sale Portfolio   
Mortgage-Backed Securities$33,201
 $
    
Maturities & Calls$17,444
 $21,261

 Three Months Ended
Purchases:3/31/2020 3/31/2019
Held-to-Maturity Portfolio   
State and Municipal Obligations$717
 $1,457
    
Maturities & Calls$7,075
 $5,319

Loan Trends
The following three tables present, for each of the last five quarters, the quarterly average balances by loan type, the percentage of total loans represented by each loan type and the annualized yield of each loan category. Over the last five quarters, the average balances for Commercial, Commercial Real Estate, Consumer and Residential Real Estate have steadily increased, although at different rates. As result of the economic impact of the COVID-19 pandemic, it is uncertain if this consistent growth will continue in the remaining quarters of 2020.

Quarterly Average Loan Balances
(Dollars in Thousands)
 Quarter Ended
 3/31/2020 12/31/2019 9/30/2019 6/30/2019 3/31/2019
Commercial$140,486
 $133,550
 $125,498
 $120,979
 $118,634
Commercial Real Estate518,931
 505,639
 493,819
 492,673
 488,836
Consumer818,892
 817,463
 809,641
 775,634
 742,775
Residential Real Estate916,037
 901,458
 879,921
 866,013
 860,397
Total Loans$2,394,346
 $2,358,110
 $2,308,879
 $2,255,299
 $2,210,642

Percentage of Total Quarterly Average Loans
 Quarter Ended
 3/31/2020 12/31/2019 9/30/2019 6/30/2019 3/31/2019
Commercial5.9% 5.7% 5.4% 5.4% 5.4%
Commercial Real Estate21.6% 21.4% 21.4% 21.8% 22.1%
Consumer34.2% 34.7% 35.1% 34.4% 33.6%
Residential Real Estate38.3% 38.2% 38.1% 38.4% 38.9%
Total Loans100.0% 100.0% 100.0% 100.0% 100.0%


# 50




Quarterly Yield on Loans
 Quarter Ended
 3/31/2020 12/31/2019 9/30/2019 6/30/2019 3/31/2019
Commercial4.52% 4.54% 4.60% 4.64% 4.43%
Commercial Real Estate4.34% 4.53% 4.57% 4.53% 4.58%
Consumer3.97% 4.01% 3.95% 3.85% 3.67%
Residential Real Estate4.20% 4.20% 4.27% 4.28% 4.33%
Total Loans4.18% 4.19% 4.23% 4.18% 4.11%
    
The average yield of the overall total loan portfolio increased throughout 2019 and remained steady for the large portion of the 1st quarter of 2020. The COVID-19 pandemic and the rapid decline to historic low in market rates will lower loan yields for the remainder of 2020.

Maintenance of High Quality in the Loan Portfolio: In the first three months of 2020, 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 the Company 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 high unemployment and the mandated closure of nonessential business, may impact the ability of our borrowers to satisfy their obligations.

Commercial Loans and Commercial Real Estate Loans: Combined commercial and commercial real estate loan originations continued to grow in the period leading up to the COVID-19 pandemic.
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 heavily impacted by the COVID-19 pandemic. Arrow is working closely with customers who wish to obtain Small Business Administration Paycheck Protection Program funding. Also, 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 March 31, 2020, consumer loans (primarily automobile loans originated through dealerships located primarily in upstate New York and Vermont) continues to be a significant component of business, comprising more than a third of this total loan portfolio. The physical sale of vehicles through dealerships has been curtailed and not deemed essential 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 will be adverselyimpacted. However, the magnitude of the impact cannot yet be determined.
New consumer loan volume for the first three months of 2020 was $95.9 million, down from the $100.4 million originated in the first three months of 2019.
For credit quality purposes, the Company assigns potential automobile loan customers into one of four tiers, ranging from lower to higher quality in terms of anticipated credit risk. The Company'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. The Company 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 significant unemployment, which may impact borrowers' ability to satisfy their obligations to the Company. 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 loans, including home equity loans, have represented the largest category of the total loan portfolio. Gross originations for residential real estate loans (including refinancings of mortgage loans) for the first three months of 2020 were $32.4 million. The Company has also sold portions of these originations in the secondary market. In the first three months of 2020, the Company sold $8.2 million, or 25.5%, of originations. In the first three months of 2019, $3.6 million, or 15.5%, of originations were sold. The Company expects to continue to sell a portion of mortgage loan originations in upcoming periods if market conditions warrant. It is not currently possible to determine the long term economic impact of the COVID-19 pandemic, which has resulted in the mandated closure of non-essential business and potential unemployment.



# 51



Deposit Trends
The following tables provide information on trends in the balance and mix of the deposit portfolio by presenting, for each of the last five quarters, the quarterly average balances by deposit type and the percentage of total deposits represented by each deposit type. Savings deposits and total time deposits, both over and under $250,000, have increased each of the last five quarters as a result of the migration to higher yielding deposit accounts due to the previous rise in short-term market rates, which occurred for the majority of 2019. Market rates, beginning to decline prior to the COVID-19 pandemic, reached historic lows at March 31, 2020.

Quarterly Average Deposit Balances
(Dollars in Thousands)
 Quarter Ended
 3/31/2020 12/31/2019 9/30/2019 6/30/2019 3/31/2019
Noninterest-bearing deposits$478,481
 $491,494
 $490,177
 $454,130
 $453,668
Interest-Bearing Checking Accounts707,747
 724,668
 686,017
 733,327
 768,354
Savings Deposits1,092,980
 1,003,612
 924,868
 879,026
 833,832
Time Deposits over $250,000126,046
 120,321
 86,018
 97,703
 79,346
Other Time Deposits264,755
 267,326
 285,448
 272,104
 212,785
Total Deposits$2,670,009
 $2,607,421
 $2,472,528
 $2,436,290
 $2,347,985

Percentage of Total Quarterly Average Deposits
 Quarter Ended
 3/31/2020 12/31/2019 9/30/2019 6/30/2019 3/31/2019
Noninterest-bearing deposits17.9% 18.8% 19.8% 18.6% 19.3%
Interest-Bearing Checking Accounts26.5
 27.8
 27.7
 30.1
 32.7
Savings Deposits41.0
 38.5
 37.5
 36.0
 35.5
Time Deposits over $250,0004.7
 4.6
 3.5
 4.0
 3.4
Other Time Deposits9.9
 10.3
 11.5
 11.2
 9.1
Total Deposits100.0% 100.0% 100.0% 100.0% 100.0%
    
Quarterly Cost of Deposits
 Quarter Ended
 3/31/2020 12/31/2019 9/30/2019 6/30/2019 3/31/2019
Demand Deposits% % % % %
Interest-Bearing Checking Accounts0.28% 0.30% 0.29% 0.25% 0.25%
Savings Deposits0.91% 0.98% 0.99% 0.92% 0.78%
Time Deposits over $250,0001.70% 1.88% 2.08% 2.11% 2.02%
Other Time Deposits1.52% 1.67% 1.74% 1.67% 1.36%
Total Deposits0.68% 0.72% 0.73% 0.68% 0.55%
    
During the quarter ended March 31, 2020, the total cost of deposits decreased. The Federal Reserve cut the targeted short-term rates on two occasions, one cut was 50 basis points and the other was 100 basis points in response to the economic uncertainty related to the COVID-19 pandemic. The balance sheet of the Company is well positioned for a variety of rate environments, see Part I, Item 3, entitled "Quantitative and Qualitative Disclosures About Market Risk," for further discussion.
 
Non-Deposit Sources of Funds
The Company's other sources of funds include securities sold under agreements to repurchase, overnight advances and term advances from the FHLBNY. The securities sold under agreements to repurchase are short-term in nature and are collateralized by investment securities. The term advances from the FHLBNY are fixed rate non-callable advances with original maturities of three to five years.
Arrow no longer relies on TRUPs as a source of new funds. As a result of the passage of Dodd-Frank in 2010 and its removal of Tier 1 regulatory capital treatment for TRUPs issued after Dodd-Frank's grandfathering date, the Company, like other banking organizations of Arrow's size or larger, have not issued any TRUPs since that date and are not likely to issue any TRUPs in the future. However, consistent with the grandfathering provision in Dodd-Frank, the $20 million principal amount of Junior Subordinated Obligations Issued to Unconsolidated Subsidiary Trusts listed on the consolidated balance sheet as of March 31, 2020 (i.e., previously issued TRUPs) will, subject to certain limits, continue to qualify as Tier 1 regulatory capital for Arrow until such TRUPs mature or are redeemed. This is further discussed under "Capital Resources" beginning on page 55 of this Report. These trust preferred securities are subject to early redemption by the Company if the proceeds cease to qualify as Tier 1 capital of Arrow for any reason, or if certain other unanticipated but negative events should occur. An example of such an event would be an adverse change in tax laws that might deny the Company the ability to deduct interest paid on these obligations for federal income tax purposes.
In the first quarter of 2020, Arrow entered into an interest rate swap agreement to synthetically fix the variable rate interest payments associated with $20 million in outstanding subordinated trust securities.

# 52




ASSET QUALITY
The following table presents information related to the allowance and provision for loan losses for the past five quarters.

Summary of the Allowance and Provision for Loan Losses
(Dollars in Thousands, Loans Stated Net of Unearned Income)
 3/31/2020 12/31/2019 9/30/2019 6/30/2019 3/31/2019
Loan Balances:         
Period-End Loans$2,414,193
 $2,386,120
 $2,335,591
 $2,280,308
 $2,235,208
Average Loans, Year-to-Date2,394,346
 2,283,707
 2,258,633
 2,233,094
 2,210,642
Average Loans, Quarter-to-Date2,394,346
 2,358,110
 2,308,879
 2,255,299
 2,210,642
Period-End Assets3,291,332
 3,184,275
 3,112,822
 3,005,750
 2,984,883
          
Allowance for loan losses, Year-to-Date:         
Allowance for loan losses, Beginning of Period$21,187
 $20,196
 $20,196
 $20,196
 20,196
Provision for Loan Losses, YTD2,772
 2,079
 1,445
 927
 472
Loans Charged-off, YTD(481) (1,735) (1,232) (830) (462)
Recoveries of Loans Previously Charged-off159
 647
 522
 402
 167
Net Charge-offs, YTD(322) (1,088) (710) (428) $(295)
Allowance for loan losses, End of Period$23,637
 $21,187
 $20,931
 $20,695
 $20,373
          
Allowance for loan losses, Quarter-to-Date:         
Allowance for loan losses, Beginning of Period$21,187
 $20,931
 $20,695
 $20,373
 $20,196
Provision for Loan Losses, QTD2,772
 634
 518
 455
 472
Loans Charged-off, QTD(481) (503) (402) (368) (462)
Recoveries of Loans Previously Charged-off159
 125
 120
 235
 167
Net Charge-offs, QTD(322) (378) (282) (133) (295)
Allowance for loan losses, End of Period$23,637
 $21,187
 $20,931
 $20,695
 $20,373
          
Nonperforming Assets, at Period-End:         
Nonaccrual Loans$4,943
 $4,005
 $3,465
 $4,949
 $5,143
Loans Past Due 90 or More Days
and Still Accruing Interest
437
 253
 1,066
 457
 64
Restructured and in Compliance with
  Modified Terms
136
 143
 150
 142
 141
Total Nonperforming Loans5,516
 4,401
 4,681
 5,548
 5,348
Repossessed Assets160
 139
 76
 115
 123
Other Real Estate Owned782
 1,122
 1,198
 1,258
 1,322
Total Nonperforming Assets$6,458
 $5,662
 $5,955
 $6,921
 $6,793
          
Asset Quality Ratios:         
Allowance to Nonperforming Loans428.52% 481.41% 447.15% 373.02% 380.95%
Allowance to Period-End Loans0.98% 0.89% 0.90% 0.91% 0.91%
Provision to Average Loans (Quarter) (1)
0.47% 0.11% 0.09% 0.08% 0.09%
Provision to Average Loans (YTD) (1)
0.47% 0.09% 0.09% 0.08% 0.09%
Net Charge-offs to Average Loans (Quarter) (1)
0.05% 0.06% 0.05% 0.02% 0.05%
Net Charge-offs to Average Loans (YTD) (1)
0.05% 0.05% 0.04% 0.04% 0.05%
Nonperforming Loans to Total Loans0.23% 0.18% 0.20% 0.24% 0.24%
Nonperforming Assets to Total Assets0.20% 0.18% 0.19% 0.23% 0.23%
  (1) Annualized
         

Provision for Loan Losses
Through the provision for loan losses, an allowance is maintained that reflects the Company's best estimate of probable incurred loan losses related to specifically identified impaired loans as well as the inherent risk of loss related to the remaining portfolio. Loan charge-offs are recorded to this allowance when loans are deemed uncollectible, in whole or in part. As loans become past due, consideration is given to the status of those loans and whether or not to classify them as nonaccrual loans. Any loans listed as "past due 90 or more days and still accruing interest" have been evaluated and determined to be secured and is the process of collection.
As permitted by the CARES Act, Arrow has elected to defer the adoption of the Current Expected Credit Losses ("CECL") methodology in determining credit losses.
In the first quarter of 2020, the Company made a $2.77 million provision for loan losses, compared to a provision of $472 thousand for the first quarter of 2019 and a provision of $634 thousand for the fourth quarter of 2019. The significant increase in loss provision for

# 53



loan losses reflects the uncertainty resulting from the COVID-19 pandemic despite the continued strong asset quality of Arrow. See Note 3 to the unaudited interim consolidated financial statements for a discussion on how the Company classifies credit quality indicators as well as the balance in each category.
The ratio of the allowance for credit losses to total loans was 0.98% at March 31, 2020, an increase from 0.89% at December 31, 2019 and an increase of 7 basis points from 0.91% at March 31, 2019.
The accounting policy relating to the allowance for credit losses is considered to be a critical accounting policy, given the uncertainty involved in evaluating the level of the allowance required to cover credit losses inherent in the loan portfolio, and the material effect that such judgments may have on the results of operations. The process for determining the provision for loan losses is described in Note 3 to the unaudited interim consolidated financial statements.

Risk Elements
Nonperforming assets at March 31, 2020 amounted to $6.5 million, up from the $5.7 million total at December 31, 2019 and a decrease of $0.3 million, from March 31, 2019. For the three-month periods ended March 31, 2020 and 2019, ratios of nonperforming assets to total assets have remained below the average ratios for the peer group. (See page 40 for a discussion of the peer group.) At December 31, 2019, the ratio of loans past due 90 or more days plus nonaccrual loans plus other real estate owned to total assets was 0.18%, well below the 0.44% ratio of the peer group at such date (the latest date for which peer group information is available). At March 31, 2020 the ratio was 0.20%, which is below the most recent ratio for the peer group.
The following table presents the balance of other non-current loans at period-end as to which interest income was being accrued (i.e. loans 30 to 89 days past due, as defined in bank regulatory guidelines). These non-current loans are not included in nonperforming assets, but entail heightened risk.
Loans Past Due 30-89 Days and Accruing Interest
($ in 000's)
 3/31/2020 12/31/2019 3/31/2019
Commercial Loans$244
 $192
 $157
Commercial Real Estate Loans
 266
 208
Residential Real Estate Loans1,632
 1,960
 1,552
Consumer Loans - Primarily Indirect Automobile7,015
 8,305
 6,113
   Total Loans Past Due 30-89 Days
   and Accruing Interest
$8,891
 $10,723
 $8,030
    
At March 31, 2020, the loans in the above-referenced category totaled $8.9 million, a decrease of $1.8 million, or 17.1%, from the $10.7 million of such loans at December 31, 2019. The March 31, 2020 total of non-current loans equaled 0.37% of loans then outstanding, compared to 0.49% at December 31, 2019 and 0.36% at March 31, 2019. The decrease from December 31, 2019 is primarily attributable to a decrease in delinquent automobile loans as well as residential real estate loans.
The number and dollar amount of performing loans that demonstrate characteristics of potential weakness from time-to-time (potential problem loans) typically is a very small percentage of the loan portfolio. See the table of Credit Quality Indicators in Note 3 to the unaudited interim consolidated financial statements. The Company considers all performing commercial and commercial real estate loans classified as substandard or lower (as reported in Note 3) to be potential problem loans. The dollar amount of such loans at March 31, 2020 was $35.5 million, up from the dollar amount of such loans at December 31, 2019, when the amount was $32.4 million. These loans will continue to be closely monitored and the Company expects to collect all payments of contractual principal and interest in full on these classified loans. Total nonperforming assets at period-end decreased by $0.3 million, or 4.9% from March 31, 2019.
The economic impact of the COVID-19 pandemic, specifically unemployment levels and the mandated closure of nonessential businesses, may impact the borrowers' ability to satisfy their obligations, and may therefore result in delinquencies. Government intervention, on both the federal and state level, have been deployed to mitigate a significant portion of the credit risk. Arrow cannot make a determination of the overall impact on its business of the COVID-19 pandemic at this time.
As of March 31, 2020, the Company held for sale one commercial property and one residential property in other real estate owned. The Company does not expect to acquire a significant number of other real estate properties in the near term as a result of payment defaults or the foreclosure process.


# 54



Loan Deferrals Related to COVID-19 Pandemic
The COVID-19 pandemic has created economic uncertainty resulting in increased temporary unemployment as well as the mandated closure of nonessential businesses. In the table below, the loan portfolio is presented with loan deferrals as the result of the COVID-19 pandemic as of March 31, 2020. In accordance with the CARES Act, the deferrals listed below are not considered troubled debt restructuring.
COVID-19 Deferrals by Loan Category at March 31, 2020
($ in 000's)
    
 Balances by Sector Deferrals
  Total % of Total Loans Balance % of Loan Segment % of Total Loans
Commercial and Commercial Real Estate Loans:          
Lessors of Non-Residential Real Estate $129,880
 5.4% $1,064
 0.2% %
Health Care and Social Assistance 104,177
 4.3% 1,341
 0.2% 0.1%
Lessors of Residential Real Estate 99,569
 4.1% 527
 0.1% %
Hotels & Motels 97,914
 4.1% 3,787
 0.6% 0.2%
Arts/Recreation/Restaurants/Vacation Camps 39,385
 1.6% 3,102
 0.5% 0.1%
Retail 30,226
 1.3% 6,326
 0.9% 0.3%
Construction & Related 17,551
 0.7% 216
 % %
Other 154,528
 6.4% 22,312
 3.2% 0.9%
Total Commercial and Commercial Real Estate Loans 673,230
 27.9% 38,675
 5.7% 1.6%
           
Consumer Loans 824,709
 34.2% 2,643
 0.3% 0.1%
           
Residential Real Estate Loans 916,254
 37.9% 126
 % %
           
Total Loans 2,414,193
   41,444
   1.7%

CAPITAL RESOURCES

Regulatory Capital Standards

Capital Adequacy Requirements. An important area of banking regulation is the federal banking system's promulgation and enforcement of minimum capitalization standards for banks and bank holding companies.  
As reported in the Regulatory Reform section above, the federal bank regulators have issued a final rule to implement the 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 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 utilize the CBLR framework beginning with the first quarter of 2020.
Subsequently, Section 4012 of the 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 CLBR at 8% as of the second quarter of 2020 and then gradually re-establish the CBLR at 9%. Under the interim final rules, the CBLR will be set at 8% beginning in the second quarter of 2020 through the end of the year. Thus, 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 will increase 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%.

Prompt Corrective Action Capital Classifications. Under the current capital classifications, a banking institution is considered "well-capitalized" if it meets the minimum CBLR levels. If a banking entity fails to qualify for the CBLR framework or if the banking entity's CBLR ratio falls below the minimum threshold, the banking entity will be subject to the regulatory capital guidelines established under the Dodd Frank legislation. Under the Dodd Frank capital guidelines, federal banking regulators are required to take prompt corrective action with respect to depository institutions that do not meet certain minimum capital requirements.  For these purposes, the regulators have established five capital classifications for banking institutions, ranging from the highest category of "well-capitalized" to the lowest category of "critically under-capitalized".

Current Capital Ratios: The table below sets forth the regulatory capital ratios of Arrow's holding company and two subsidiary banks, Glens Falls National and Saratoga National, under the current CBLR Rules, as of March 31, 2020:

# 55



 Community Bank
 Leverage Ratio
Arrow Financial Corporation9.87%
Glens Falls National Bank & Trust Co.9.44%
Saratoga National Bank & Trust Co.9.49%

At March 31, 2020, Arrow and its subsidiary banks exceeded the minimum regulatory capital ratios established under the CBLR framework and each also qualified as "well-capitalized", the highest category in the new capital classification scheme established by federal bank regulatory agencies, as described above.

Capital Components; Stock Repurchases; Dividends
Stockholders' Equity: Stockholders’ equity was $309.4 million at March 31, 2020, an increase of $7.7 million, or 2.5%, from the December 31, 2019 level of $301.7 million, and an increase of $32.8 million, or 11.9%, from the prior-year level. The increase in stockholders' equity over the first three months of 2020 principally reflected the following factors: (i) $8.13 million of net income for the period, plus (ii) other comprehensive income of $3.95 million, plus (iii) issuance of $1.01 million of common stock through employee benefit and dividend reinvestment plans; reduced by (iv) cash dividends of $3.90 million; and (v) repurchases of common stock of $1.51 million under the Board-approved stock repurchase program described below.

Trust Preferred Securities: In each of 2003 and 2004, the Company 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 an interest rate swap agreement 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.

Stock Repurchase Program: In October 2019, the Board of Directors approved a $5.0 million stock repurchase program, effective January 1, 2020 (the 2020 Repurchase Program), under which management is authorized, in its discretion, to permit the Company 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 believes the Company's stock is reasonably priced and such repurchases appear to be an attractive use of available capital and in the best interests of shareholders. This 2020 Repurchase Program replaced a similar repurchase program which was in effect during 2019 (the 2019 program), which also authorized the repurchase of up to $5.0 million of shares of Arrow's common stock. As of March 31, 2020 approximately $1.5 million had been used under the 2020 Repurchase Program to repurchase Arrow shares. This total does not include repurchases of Arrow's Common Stock other than through its 2020 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.

Dividends: The Company's common stock is traded on NasdaqGS® under the symbol AROW. The high and low stock prices for the past five quarters listed below represent actual sales transactions, as reported by NASDAQ. On April 29, 2020, the Board of Directors declared a 2020 second quarter cash dividend of $0.26 payable on June 15, 2020. Per share amounts and share counts in the following tables have been restated for the September 27, 2019 3% stock dividend.
     Cash
 Market Price Dividends
 Low High Declared
2019     
First Quarter$29.57
 $35.19
 $0.252
Second Quarter30.96
 33.93
 0.252
Third Quarter30.26
 35.31
 0.252
Fourth Quarter32.03
 38.31
 0.260
2020     
First Quarter$20.79
 $38.04
 $0.260
Second Quarter (dividend payable June 15, 2020)TBD
 TBD
 0.260

# 56



 Quarter Ended March 31
 2020 2019
Cash Dividends Per Share$0.260
 $0.252
Diluted Earnings Per Share0.54
 0.58
Dividend Payout Ratio48.15% 43.45%
Total Equity (in thousands)309,398
 $276,609
Shares Issued and Outstanding (in thousands)14,982
 14,909
Book Value Per Share$20.65
 $18.55
Intangible Assets (in thousands)23,513
 23,650
Tangible Book Value Per Share$19.08
 $16.97

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 the Company's customers at any time.  Given the uncertain nature of customer demands and the need to maximize earnings, the Company 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 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, including the Small Business Administration’s Paycheck Protection Program. 
The primary sources of available liquidity are overnight investments in federal funds sold, interest bearing bank balances at the Federal Reserve Bank of New York, and cash flow from investment securities and loans.  Certain investment securities are selected at purchase as available-for-sale based on their marketability and collateral value, as well as their yield and maturity.  The securities available-for-sale portfolio was $378.2 million at March 31, 2020, an increase of $20.9 million, from the year-end 2019 level. Due to the potential for volatility in market values, the Company 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 at March 31, 2020 of $106.0 million compared to $25.0 million at March 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 during the three months ended March 31, 2020.
To support the borrowing relationship with the FHLBNY, the Company has pledged collateral, including residential mortgage, home equity and commercial real estate loans. At March 31, 2020, the Company had outstanding collateral obligations with the FHLBNY of $115 million; as of that date, the unused borrowing capacity at the FHLBNY was approximately $620 million. Brokered deposits have also been identified as an available source of funding accessible in a relatively short time period. At March 31, 2020, the balance of outstanding brokered deposits totaled $108.1 million. Also, the Company's two bank subsidiaries have each established a borrowing facility with the Federal Reserve Bank of New York, pledging certain consumer loans as collateral for potential "discount window" advances, which are maintained for contingency liquidity purposes. At March 31, 2020, the amount available under this facility was approximately $593 million, 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.
The Company 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. At March 31, 2020, the basic liquidity ratio, including the FHLBNY collateralized borrowing capacity, was 20.9% of total assets, or $558 million in excess of the internally-set minimum target ratio of 4%.
The Company did not experience any significant liquidity constraints in the three-month period ended March 31, 2020 and did not experience any such constraints in recent prior years. The Company 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.


# 57



RECENTLY ISSUED ACCOUNTING STANDARDS

The following accounting standards have been issued and become effective for the Company at a future date:
    
In June 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. In April 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. In May 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 has elected to defer the adoption of the Current Expected Credit Losses ("CECL") methodology in determining credit losses. The initial adjustment will not be reported in earnings, but as the cumulative effect of a change in accounting principle and the adoption will require additional disclosures in future periods. The Company has held CECL working group meetings that included individuals from various functional areas relevant to the implementation of CECL. The Company's CECL working group has 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. The CECL pronouncement describes several acceptable methodologies for calculating expected losses on a loan or a pool of loans. The Company has 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 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 loan losses through the use of various regression analyses of historical economic information and loan losses. The adoption of this standard will change the way qualitative factors are determined as compared to the current incurred loss allowance for loan losses model.
The Company has performed a parallel run as of December 31, 2019 and is in process of reviewing the most recent model run, reviewing the results of model back-testing, finalizing certain assumptions including qualitative adjustments, and incorporating the feedback from the third-party model validation process into the model. The Company has also developed a control framework and is in process of finalizing controls. The Company continues to monitor the effect of this guidance, as well as regulatory guidance, and evaluate the effect it will have on the consolidated financial statements, disclosures and processes and internal controls.
Based on the December 31, 2019 parallel run, review of the portfolio, including the composition, characteristics and quality of the underlying loans, and the prevailing economic conditions and forecasts as of the adoption date, the Company believes that the adjustment to retained earnings related to the initial adoption of CECL will result in an immaterial impact. The Company will remain a well-capitalized financial institution under the CBLR framework. Regulators have developed two deferral options related to the adoption of CECL and the resulting computation of regulatory capital ratios. The initial deferral method, the 2019 CECL Rule, allows a financial institution to elect a three-year deferral of the initial CECL adoption amount for the computation of regulatory capital. An additional deferral method, the Interim Final Rule, allows a financial institution that implements CECL before the end of 2020, the option to delay for two years an estimate of CECL's effect on regulatory capital, followed by a three-year transition period. Arrow is in the process of evaluating these deferral methods.

In August 2018, the FASB issued ASU 2018-14 "Disclosure Framework-Changes to the Disclosure Requirements for Defined Benefit Plans" which applies to all companies that provide defined benefit pension or other postretirement benefit plans for their employees. Certain disclosure requirements have been eliminated such as reporting the amounts in accumulated other comprehensive income expected to be recognized as components of net periodic benefit cost over the next year, and reporting the effects of a one-percentage-point change in the assumed healthcare cost trend rate on the aggregate of the service cost and interest cost components of net periodic benefit cost and on the benefit obligation for postretirement healthcare benefits. New required disclosures for reporting the weighted-average interest rate used to credit cash balance and similar plans that have a promised interest credit, the reasons for significant gains and losses affecting benefit obligations and other requirements for reporting aggregate information related to pension plans. For Arrow, the standard becomes effective at December 31, 2020. The Company does not expect that the adoption of this change affecting defined benefit plan disclosures will have a material impact on its financial position or the results of operations.

In December 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 after December 15, 2020 and interim periods within those fiscal years, with early adoption permitted. Arrow will adopt this standard effective on January 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.


# 58



RESULTS OF OPERATIONS
Three Months Ended March 31, 2020 Compared With
Three Months Ended March 31, 2019

Summary of Earnings Performance
(Dollars in Thousands, Except Per Share Amounts)
 Three Months Ended    
 March 31, 2020 March 31, 2019 Change % Change
Net Income$8,127
 $8,734
 $(607) (6.9)%
Diluted Earnings Per Share0.54
 0.58
 (0.04) (6.9)%
Return on Average Assets1.03% 1.19% (0.16)% (13.4)%
Return on Average Equity10.66% 12.98% (2.32)% (17.9)%
    
Net income was $8.1 million and diluted earnings per share (EPS) of $.54 for the first quarter of 2020, compared to net income of $8.7 million and diluted EPS of $.58 for the first quarter of 2019. Return on average assets (ROA) for the first quarter of 2020 was 1.03%, up from 1.19% in the first quarter of 2019. In addition, return on average equity (ROE) decreased to 10.66% for the first quarter of 2020, down from 12.98% in the first quarter of 2019.
        
The following narrative discusses the quarter-to-quarter changes in net interest income, noninterest income, noninterest expense and income taxes.

Net Interest Income
Summary of Net Interest Income
(Dollars in Thousands)
 Three Months Ended    
 March 31, 2020 March 31, 2019 Change % Change
Interest and Dividend Income$28,226
 $26,213
 $2,013
 7.7 %
Interest Expense5,220
 5,092
 128
 2.5 %
Net Interest Income23,006
 21,121
 1,885
 8.9 %
Average Earning Assets(1)
3,030,881
 2,847,966
 182,915
 6.4 %
Average Interest-Bearing Liabilities2,362,515
 2,224,403
 138,112
 6.2 %
        
Yield on Earning Assets(1)
3.75% 3.73% 0.02
 0.5 %
Cost of Interest-Bearing Liabilities0.89
 0.93
 (0.04) (4.3)
Net Interest Spread2.86
 2.80
 0.06
 2.1
Net Interest Margin3.05
 3.01
 0.04
 1.3
(1) Includes Nonaccrual Loans.

Net interest income for the recently completed quarter increased by $1.9 million, or 8.9%, from the first quarter of 2019, due primarily to loan growth and balance sheet mix. Total loans increased $28.1 million in the first quarter of 2020. In addition, average earning assets increased 6.4% from March 31, 2019. In order to fund the consistent loan growth, total average-interest-bearing liabilities increased 6.2% from the first quarter of 2019. Net interest margin increased 4 basis points in the first quarter of 2020 to 3.05%, from 3.01% during the first quarter of 2019. Average earning asset yields were 2 basis points higher as compared to the first quarter of 2019 due primarily to the increase of loans as a percentage of earning assets. The cost of interest-bearing liabilities decreased 4 basis points from the quarter ended March 31, 2019. The Company defines net interest margin as net interest income divided by average earning assets, annualized. Further detailed information is presented above under the section entitled "Average Consolidated Balance Sheets and Net Interest Income Analysis." The impact of recent interest rate changes on Arrow's deposit and loan portfolios are discussed above in this Report under the sections entitled "Deposit Trends" and "Loan Trends."
As discussed previously under the heading "Asset Quality" beginning on page 53, the provision for loan losses for the first quarter of 2020 was $2.77 million, compared to a provision of $472 thousand for the first quarter of 2019.


# 59



Noninterest Income
Summary of Noninterest Income
(Dollars in Thousands)
 Three Months Ended    
 March 31, 2020 March 31, 2019 Change % Change
Income From Fiduciary Activities$2,213
 $2,107
 $106
 5.0 %
Fees for Other Services to Customers2,451
 2,402
 49
 2.0 %
Insurance Commissions1,632
 1,719
 (87) (5.1)%
Net (Loss) Gain on Securities Transactions(374) 76
 (450) (592.1)%
Net Gain on the Sale of Loans213
 104
 109
 104.8 %
Other Operating Income1,559
 479
 1,080
 225.5 %
Total Noninterest Income$7,694
 $6,887
 $807
 11.7 %
    
Total noninterest income in the current quarter was $7.7 million, an increase of $807 thousand from the comparable quarter of 2019. Income from fiduciary activities for the first quarter of 2020 increased by $106 thousand, or 5.0% from the first quarter of 2019.
Fees for other services to customers were $2.5 million for the first quarter of 2020. Fees were consistent with the first quarter of 2019.
Insurance commissions decreased to $1.6 million for the first quarter of 2020 compared to $1.7 million for the first quarter of 2019, due primarily to a decline in the employee benefits sector of the business.
Net loss on security transactions of $374 thousand for the first quarter of 2020 was the result in the decrease in the fair value of equity securities.
Net gain on the sale of loans in the first quarter of 2020 increased by $109 thousand from the first quarter of 2019. The change was a result of favorable market conditions leading to an increase in loan sale volume. See page 51 for the discussion of loan sales.
Other operating income increased $1.1 million from the comparable quarter in 2019, primarily the result of fees received as part of interest rate swap agreements.

Noninterest Expense
Summary of Noninterest Expense
(Dollars in Thousands)
 Three Months Ended    
 March 31, 2020 March 31, 2019 Change % Change
Salaries and Employee Benefits$10,383
 9,319
 $1,064
 11.4 %
Occupancy Expense of Premises, Net1,449
 1,420
 29
 2.0 %
Technology and Equipment Expense3,352
 3,141
 211
 6.7 %
FDIC and FICO Assessments219
 212
 7
 3.3 %
Amortization58
 79
 (21) (26.6)%
Other Operating Expense2,293
 2,481
 (188) (7.6)%
Total Noninterest Expense$17,754
 $16,652
 $1,102
 6.6 %
Efficiency Ratio56.42% 58.55% (2.13) (3.6)%
    
Noninterest expense for the first quarter of 2020 was $17.8 million, an increase of $1.1 million, or 6.6%, from the first quarter of 2019. Salaries and benefit expenses increased $1.1 million, or 11.4%, from the comparable quarter in 2019. The increase in salaries and benefits was primarily due to the increase in the cost of health insurance benefits. Technology and equipment expenses have increased from the previous year as a result of the continued efforts with ongoing projects to enhance operational efficiencies.
The efficiency ratio continues to be solid at 56.42% for the first quarter of 2020 and 58.55% for the comparable 2019 quarter. The efficiency ratio (a ratio where lower is better), is a commonly used non-GAAP financial measure in the banking industry that purports to reflect an institution's operating efficiency. The Company calculates the efficiency ratio as the ratio of noninterest expense (excluding, under the Company's definition, intangible asset amortization) to (i) net interest income (on a tax-equivalent basis) plus (ii) noninterest income (excluding net securities gains or losses). See the discussion on this non-GAAP measure on page 41 of this Report under the heading "Use of Non-GAAP Financial Measures" and the related tabular information and notes on pages 42 and 43 of this Report. The efficiency ratio included by the Federal Reserve Board in its "Bank Holding Company Performance Reports" excludes net securities gains or losses from the denominator (as does the Company's calculation), but unlike the Company's ratio does not exclude intangible asset amortization from the numerator. The Company's efficiency ratios in recent periods have generally compared favorably to the ratios of the peer group as disclosed in the Federal Reserve Performance Reports (see page 40 for a discussion of the peer group). For the three-month period ended December 31, 2019 (the most recent reporting period for which peer group information is available), the peer group's efficiency ratio was 60.47% compared to the Company's ratio of 56.32% (not adjusted for the definitional difference).
    

# 60



Income Taxes
Summary of Income Taxes
(Dollars in Thousands)
 Three Months Ended    
 March 31, 2020 March 31, 2019 Change % Change
Provision for Income Taxes$2,047
 $2,150
 $(103) (4.8)%
Effective Tax Rate20.1% 19.8% 0.3
 1.5 %

The increase in the effective tax rate in the first three months ended March 31, 2020 over the three months ended March 31, 2019 was primary due to the reduction in tax exempt income combined with the reduced tax benefit related to stock based compensation.


# 61



Item 3.
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
In addition to credit risk in the loan portfolio and liquidity risk, discussed earlier, the Company's business activities also generate market risk.  Market risk is the possibility that changes in future market rates (interest rates) or prices (market value of financial instruments) will make the Company's position (i.e., assets and operations) less valuable.  The Company's primary market risk is interest rate volatility. The ongoing monitoring and management of interest rate risk is an important component of the asset/liability management process, which is governed by policies that are reviewed and approved annually by the Board of Directors.  The Board of Directors delegates responsibility for carrying out asset/liability oversight and control to management's Asset/Liability Committee ("ALCO").  In this capacity ALCO develops guidelines and strategies impacting the asset/liability profile based upon estimated market risk sensitivity, policy limits and overall market interest rate levels and trends.  
Changes in market interest rates, whether increases or decreases, can trigger repricing and changes in the pace of payments for both assets and liabilities (prepayment risk). This may individually or in combination affect net interest income, net interest margin, and ultimately net income, either positively or negatively. ALCO utilizes the results of a detailed and dynamic simulation model to quantify this interest rate risk by projecting net interest income in various interest rate scenarios.  
The Company's standard simulation model applies a parallel shift in interest rates, ramped over a 12-month period, to capture the impact of changing interest rates on net interest income.  The results are compared to ALCO policy limits which specify a maximum tolerance level for net interest income exposure over a one-year horizon, assuming no balance sheet growth and a 200 basis point upward and a 100 basis point downward shift in interest rates. Additional tools to monitor potential longer-term interest rate risk, including periodic stress testing involving hypothetical sudden and significant interest rate spikes, are also evaluated.
The following table summarizes the percentage change in net interest income as compared to the base scenario, which assumes no change in market interest rates as generated from the standard simulation model. The results are presented for each of the first two years of the simulation period for the 200 basis point increase in interest rate scenario and the 100 basis point decrease in interest rate scenario.
As of March 31, 2020:
 Change in Interest Rate 
 + 200 basis points - 100 basis points 
Calculated change in Net Interest Income - Year 1(3.43)% 0.38% 
Calculated change in Net Interest Income - Year 2(0.78)% (8.99)% 

Historically, there has existed an inverse relationship between changes in prevailing rates and the Company's net interest income, suggesting that liabilities and sources of funds generally reprice more quickly than earning assets (near-term liability sensitivity). However, when net interest income is simulated over a longer time frame, this exposure is limited, and actually reverses, as asset yields continue to reprice while the cost of funding reaches assumed ceilings or floors (long-term asset sensitivity).
The hypothetical estimates underlying the sensitivity analysis are based upon numerous assumptions, including: the nature and timing of changes in interest rates including yield curve shape, prepayments on loans and securities, deposit decay rates, pricing decisions on loans and deposits, reinvestment/replacement of asset and liability cash flows, and others.  While assumptions are developed based upon current economic and local market conditions, the Company cannot make any assurance as to the predictive nature of these assumptions including how customer preferences or competitor influences might change.
Also, as market conditions vary from those assumed in the sensitivity analysis, actual results will differ due to: prepayment/refinancing levels likely deviating from those assumed, the varying impact of interest rate changes on caps or floors on adjustable rate assets, the potential effect of changing debt service levels on customers with adjustable rate loans, depositor early withdrawals and product preference changes, unanticipated shifts in the yield curve and other internal/external variables.  Furthermore, the sensitivity analysis does not reflect actions that ALCO might take in responding to or anticipating changes in interest rates. The COVID-19 pandemic may impact markets, rates, behavior and other estimates used in the above scenarios.

Item 4.
CONTROLS AND PROCEDURES
Senior management, including the Chief Executive Officer and Chief Financial Officer, has evaluated the effectiveness of the design and operation of Arrow's disclosure controls and procedures (as defined in Rule 13a-15(e) under the Securities Exchange Act of 1934, as amended) as of March 31, 2020. Based upon that evaluation, senior management, including the Chief Executive Officer and Chief Financial Officer, concluded that disclosure controls and procedures were effective. Further, there were no changes made in the Company's internal control over financial reporting that occurred during the most recent fiscal quarter that had materially affected, or are reasonably likely to materially affect, the Company's internal control over financial reporting.

# 62




PART II - OTHER INFORMATION
Item 1.
Legal Proceedings
The Company, including its subsidiary banks, is not currently the subject of any material pending legal proceedings, other than ordinary routine litigation occurring in the normal course of their business. On an ongoing basis, the Company is often the subject of, or a party to, various legal claims by other parties against the Company, by the Company against other parties, or involving the Company, which arise in the normal course of business. The various pending legal claims against the Company will not, in the opinion of management based upon consultation with counsel, result in any material liability.
Item 1.A.
Risk Factors
The Risk Factors identified in the Company's Annual Report on Form 10-K for the year ended December 31, 2019, continue to represent the most significant risks to the Company's future results of operations and financial conditions, without modification or amendment. Please refer to such Risk Factors as listed in Part I, Item 1A, of the Annual Report on Form 10-K for the fiscal year ended December 31, 2019, as supplemented by the risk factor included in Item 8.01 of the Company's Current Report on Form 8-K filed April 24, 2020.
Item 2.
Unregistered Sales of Equity Securities and Use of Proceeds
Unregistered Sales of Equity Securities
None.

Issuer Purchases of Equity Securities
The following table presents information about purchases by Arrow during the three months ended March 31, 2020 of common stock (our only class of equity securities registered pursuant to Section 12 of the Securities Exchange Act of 1934):
First Quarter
2020
Calendar Month
(A)
Total Number of
Shares Purchased 1
 
(B)
Average Price
Paid Per Share 1
 
(C)
Total Number of
Shares Purchased as
Part of Publicly
Announced
Plans or Programs 2
 
(D)
Maximum
Approximate Dollar
Value of Shares that
May Yet be
Purchased Under the
Plans or Programs 2
January1,091
 $37.17
 
 $5,000,000
February12,056
 33.06
 9,448
 4,692,520
March60,000
 28.96
 40,573
 3,493,345
   Total73,147
 29.76
 50,021
  
1 The total number of shares purchased by the Company and the average price paid per share listed in columns (A) and (B) consist of (i) any shares purchased in such periods in open market or private transactions under the Arrow Financial Corporation Automatic Dividend Reinvestment Plan (the "DRIP") by the administrator of the DRIP, (ii) shares surrendered or deemed surrendered to Arrow in such periods by holders of options to acquire Arrow common stock received by them under Arrow's long-term incentive plans in connection with their stock-for-stock exercise of such options and (iii) shares purchased under the publicly-announced 2020 Repurchase Program. In the months indicated, the listed number of shares purchased included the following number of shares purchased by Arrow through such methods: January - DRIP purchases (1,091 shares); February - DRIP purchases (2,608 shares) and repurchased under the 2020 Repurchase Program (9,448 shares); and March - DRIP purchases (19,427 shares) and repurchased under the 2020 Repurchase Program (40,573 shares)
2 Includes only those shares acquired by Arrow pursuant to its publicly-announced stock repurchase programs. Our only publicly-announced stock repurchase program in effect for the first quarter of 2020 was the 2020 Repurchase Program approved by the Board of Directors and announced in October 2019, under which the Board authorized management, in its discretion, to repurchase from time to time during calendar year 2020, in the open market or in privately negotiated transactions, up to $5 million of Arrow common stock subject to certain exceptions.
Item 3.
Defaults Upon Senior Securities - None
Item 4.
Mine Safety Disclosures - None

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Item 5.
Other Information - None
Item 6.
Exhibits
Exhibit NumberExhibit
3.(i)
3.(ii)
15
31.1
31.2
32
10.1
10.2
10.3
10.4
10.5
101.INSXBRL Instance Document
101.SCHXBRL Taxonomy Extension Schema Document
101.CALXBRL Taxonomy Extension Calculation Linkbase Document
101.DEFXBRL Taxonomy Extension Definition Linkbase Document
101.LABXBRL Taxonomy Extension Labels Linkbase Document
101.PREXBRL Taxonomy Extension Presentation Linkbase Document
  
 

* Management contracts or compensation plans required to be filed as an exhibit.













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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this Report to be signed on its behalf by the undersigned thereunto duly authorized.
ARROW FINANCIAL CORPORATION
Registrant
  
May 7, 2020/s/Thomas J. Murphy
DateThomas J. Murphy, President and
 Chief Executive Officer
  
May 7, 2020/s/Edward J. Campanella
DateEdward J. Campanella, Senior Vice President,
 Treasurer and Chief Financial Officer
 (Principal Financial Officer and
 Principal Accounting Officer)



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