UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
Annual Report Pursuant to Section 13 or 15(d) of
The Securities Exchange Act of 1934
For the Fiscal Year Ended December 31, 2012
Commission File Number: 0-12507
ARROW FINANCIAL CORPORATION
(Exact name of registrant as specified in its charter)
New York
(State or other jurisdiction of
incorporation or organization)
22-2448962
(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: NONE
SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT:
Common Stock, Par Value $1.00
(Title of Class)
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes x No
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes x No
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. x Yes No
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Website, if any, every Interactive Data File
required to be submitted and posted 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 and post such files). x Yes No
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§ 229.405 of this chapter) is not contained herein,
and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III
of this Form 10-K or any amendment to this Form 10-K. x 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
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). Yes x No
State the aggregate market value of the voting and non-voting common equity held by non-affiliates computed by reference to the price at which
the common equity was last sold, or the average bid and asked price of such common equity, as of the last business day of the registrant’s most
recently completed second fiscal quarter: $284,027,478
Indicate the number of shares outstanding of each of the registrant’s classes of common stock, as of the latest practicable date.
Class
Common Stock, par value $1.00 per share
Outstanding as of February 22, 2013
12,041,421
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the Registrant’s Proxy Statement for the Annual Meeting of Stockholders to be held May 1, 2013 (Part III)
ARROW FINANCIAL CORPORATION
FORM 10-K
TABLE OF CONTENTS
Note on Terminology
Forward-Looking Statements
Use of Non-GAAP Financial Measures
Item 1. Business
Item 1A. Risk Factors
Item 1B. Unresolved Staff Comments
Item 2. Properties
Item 3. Legal Proceedings
Item 4. Mine Safety Disclosures
PART I
PART II
Item 5. Market for the Registrant's Common Equity, Related Stockholder Matters and
Issuer Purchases of Equity Securities
Item 6. Selected Financial Data
Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations
Item 7A. Quantitative and Qualitative Disclosures About Market Risk
Item 8. Financial Statements and Supplementary Data
Item 9. Changes in and Disagreements With Accountants on Accounting and Financial Disclosure
Item 9A. Controls and Procedures
Item 9B. Other Information
PART III
Item 10. Directors, Executive Officers and Corporate Governance*
Item 11. Executive Compensation*
Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters *
Item 13. Certain Relationships and Related Transactions, and Director Independence*
Item 14. Principal Accounting Fees and Services*
Item 15. Exhibits, Financial Statement Schedules
Signatures
Exhibit Index
PART IV
Page
3
3
4
5
13
15
16
16
16
16
21
22
52
54
99
99
99
100
100
100
100
100
101
102
103
*These items are incorporated by reference to the Corporation’s Proxy Statement for the Annual Meeting of Stockholders to be held
May 1, 2013.
2
NOTE ON TERMINOLOGY
In this Annual Report on Form 10-K, the terms “Arrow,” “the registrant,” “the company,” “we,” “us,” and “our” generally refer to Arrow
Financial Corporation and subsidiaries as a group, except where the context indicates otherwise. Arrow is a two-bank holding company
headquartered in Glens Falls, New York. Our 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. Subsidiaries of Glens Falls National include Capital Financial Group, Inc. (an insurance
agency specializing in selling and servicing group health care policies and life insurance), Loomis & LaPann, Inc. (a property and casualty
and sports accident and health insurance agency), Upstate Agency, LLC ( a property and casualty insurance agency), Glens Falls National
Insurance Agencies, LLC (a property and casualty insurance agency - currently doing business under the name of McPhillips Insurance
Agency), North Country Investment Advisers, Inc. (a registered investment adviser that provides investment advice to our proprietary
mutual funds) and Arrow Properties, Inc., a real estate investment trust (REIT).
At certain points in this Report, our performance is compared with that of our “peer group” of financial institutions. Unless otherwise
specifically stated, this peer group is comprised of the group of 351 domestic bank holding companies with $1 to $3 billion in total consolidated
assets as identified in the Federal Reserve Board’s “Bank Holding Company Performance Report” for December 31, 2012, and peer
group data has been derived from such Report. This peer group is not, however, identical to either of the peer groups comprising the two
bank indices included in the stock performance graphs on pages 18 and 19 of this Report.
FORWARD-LOOKING STATEMENTS
The information contained in this Annual Report on Form 10-K contains statements that are not historical in nature but rather are
based on our 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 “expects,” “believes,” “anticipates,” “estimates” and variations of such words and similar expressions
often identify such forward-looking statements. Some of these statements, such as those included in the interest rate sensitivity analysis
in Item 7A of this Report, 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 our general perceptions of market conditions and trends in activity, both locally and nationally,
as well as current management strategies for future operations and development.
Examples of forward-looking statements in this Report are referenced in the table below:
Topic
Impact of Legislative Developments
Impact of Changing Interest Rates on
Earnings
Adequacy of the Allowance for Loan
Losses
Section
Part I, Item 1.D.
Part II, Item 7.A.
Part II, Item 7.B.I.
Part II, Item 7.C.II.a.
Part II, Item 7.C.II.a.
Part II, Item 7.C.IV.
Part II, Item 7A.
Part II, Item 7.B.II.
Expected Level of Real Estate Loans Part II, Item 7.C.II.a.
Liquidity
Dividend Capacity
Part II, Item 7.D.
Part I, Item 1.C.
Commitments to Extend Credit
Part II, Item 7.E.
Part II, Item 7.E.
Part II, Item 8
VISA Estimation
Part II, Item 7.A.
Noninterest Income
Part II, Item 7.C.IV
Pension plan return on assets
Realization of recognized net
deferred tax assets
Part II, Item 8
Part II, Item 8
3
Page
11
26
31
Location
Last paragraph in Section D
Paragraph in "Health Care Reform"
Last 3 paragraphs
40
41
45
53
33
40
47
7
8
48
49
77
78
27
34
35
89
90
Last paragraph under “Automobile Loans”
3rd and 4th paragraph under table
3rd full paragraph
Last 4 paragraphs
1st paragraph under “II. Provision For Loan
Losses and Allowance For Loan Losses”
2nd paragraph under “Residential
Real Estate Loans”
Last 2 paragraphs under "Liquidity"
1st paragraph under "New Capital Standards
to be Promulgated"
2nd and 4th full paragraphs
Last paragraph under "Important Changes to
Regulatory Capital Standards"
1st paragraph under "Dividends"
3rd paragraph in Note 8
Last 2 paragraphs in Note 8
Last paragraph under "VISA Transactions -
Reversal of the Litigation Reserve"
Last 3 paragraphs
First full paragraph
2nd to last paragraph in Note 13
2nd to last paragraph in Note 15
These statements are not guarantees of future performance and involve certain risks and uncertainties that are difficult to quantify or,
in some cases, to identify. In the case of all forward-looking statements, 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:
a.
rapid and dramatic changes in economic and market conditions, such as the U.S. economy has recently experienced and
continues to experience;
b. sharp fluctuations in interest rates, economic activity, and consumer spending patterns;
c. sudden changes in the market for products we provide, such as real estate loans;
d. significant new banking or other laws and regulations, the Dodd-Frank Wall Street Reform and Consumer Protection Act (the
Dodd-Frank Act or Dodd-Frank) and the rules and regulations issued or to be issued thereunder;
e. enhanced competition from unforeseen sources; and
f.
similar uncertainties inherent in banking operations or business generally, including technological developments and changes.
USE OF NON-GAAP FINANCIAL MEASURES
The Securities and Exchange Commission (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 new rules, although we are 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, 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 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.
We follow 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 expressed on a tax-equivalent basis. Moreover, most 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 (deducted from noninterest expense)
and securities gains or losses (excluded from noninterest income). We follow these practices.
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 is essentially represented by goodwill for Arrow.
Adjustments for Certain Items of Income or Expense: In addition to our disclosures of net income, earnings per share (i.e. EPS),
return on average assets (i.e. ROA), return on average equity (i.e. ROE) and other financial measures in accordance with GAAP, we may
also provide comparative disclosures that adjust these GAAP financial measures by removing the impact of certain transactions or other
material items of income or expense. We believe that the resulting non-GAAP financial measures may improve an understanding of our
results of operations by separating out items that have a disproportional positive or negative impact on the particular period in question.
Additionally, we believe that the adjustment for certain items allows 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.
We believe that the non-GAAP financial measures disclosed by us 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. Our non-GAAP financial measures may differ from similar measures presented by other
companies.
4
Item 1. Business
A. GENERAL
PART I
Our holding company, Arrow Financial Corporation, a New York corporation, was incorporated on March 21, 1983 and is
registered as a bank holding company within the meaning of the Bank Holding Company Act of 1956. Arrow owns two nationally
chartered banks in New York (Glens Falls National and Saratoga National), and through such banks indirectly owns a health and
life insurance agency (Capital Financial Group, Inc.), three primarily property and casualty insurance agencies (Loomis and LaPann,
Inc., Upstate Agency, LLC and Glens Falls National Insurance Agencies, LLC), a registered investment adviser that advises our
proprietary mutual funds (North Country Investment Advisers, Inc.), a Real Estate Investment Trust (Arrow Properties, Inc.) and
four other non-bank subsidiaries whose operations are insignificant.
Subsidiary Banks (dollars in thousands)
Total Assets at Year-End
Trust Assets Under Administration and
Investment Management at Year-End
(Not Included in Total Assets)
Date Organized
Employees (full-time equivalent)
Offices
Counties of Operation
Main Office
Glens Falls National
1,716,629
$
$
991,932
$
$
1851
479
29
Warren, Washington,
Saratoga, Essex &
Clinton
250 Glen Street
Glens Falls, NY
Saratoga National
307,822
54,040
1988
39
6
Saratoga
171 So. Broadway
Saratoga Springs, NY
The holding company’s business consists primarily of the ownership, supervision and control of our two banks. The holding
company provides various advisory and administrative services and coordinates the general policies and operation of the banks.
There were 518 full-time equivalent employees, including 72 employees within our insurance agency affiliates, at December 31,
2012.
We offer a full range of commercial and consumer banking and financial products. Our deposit base consists of deposits
derived principally from the communities we serve. We target our lending activities to consumers and small and mid-sized companies
in our immediate geographic areas. Through our banks' trust operations, we provide retirement planning, trust and estate
administration services for individuals, and pension, profit-sharing and employee benefit plan administration for corporations.
On August 1, 2011, we acquired two privately owned insurance agencies located in the greater Glens Falls area, W. Joseph
McPhillips, Inc. and McPhillips-Northern, Inc., which were controlled by the same group of shareholders. Each of the acquisitions
was structured as a merger of the acquired agency into a newly formed limited liability company wholly owned by Arrow's principal
subsidiary bank, Glens Falls National, named Glens Falls National Insurance Agencies, LLC. Both acquisitions qualified as tax-
free reorganizations under the Internal Revenue Code. At closing of the acquisitions, which occurred on the same day, Arrow issued
a total of 92,559 shares of its common stock (as restated for stock dividends) and $116 thousand in cash to the agencies' shareholders
in exchange for all of their shares of the agencies' stock. Arrow recorded the following intangible assets as a result of the acquisitions
(none of which are deductible for income tax purposes): goodwill ($1,180) and expirations ($720). The value of the expirations is
being amortized over twenty years.
On February 1, 2011, we acquired Upstate Agency, Inc. ("Upstate"), a privately owned, property and casualty insurance agency
with offices located in northern New York. The acquisition was structured as a merger of Upstate into a newly-formed limited liability
company wholly owned by Glens Falls National, and qualified as a tax-free reorganization under the Internal Revenue Code. At
closing of the acquisition and in post-closing payments to date, Arrow has issued to the former sole shareholder of Upstate, in
exchange for all of his Upstate stock, 141,272 shares of Arrow's common stock (as restated for stock dividends) and approximately
$2.7 million in cash. Arrow recorded the following intangible assets as a result of the acquisition (none of which are deductible for
income tax purposes): goodwill ($5,040) and expirations ($2,854). The value of the expirations is being amortized over twenty
years. The acquisition agreement provided for possible additional post-closing payments of Arrow's common stock to the former
sole shareholder of Upstate, contingent upon the financial performance and business results of Upstate as a subsidiary of Glens
Falls National over the three-year period following the closing. The present value of the expected post-closing payments was
included in the basis of goodwill recognized at the acquisition date.
On April 1, 2010, we acquired Loomis & LaPann, Inc. ("Loomis"), a privately owned, property and casualty and sports accident
and health insurance agency located in Glens Falls. The acquisition was structured as a merger between a newly-formed acquisition
subsidiary of Glens Falls National and Loomis, and qualified as a tax-free reorganization under the Internal Revenue Code. Arrow
has issued to the shareholders of Loomis, in exchange for their Loomis stock, 35,048 shares of Arrow's common stock (as restated
for dividends), including the issuance of additional shares in post-closing payments to the former Loomis shareholders. At closing,
Arrow recorded the following intangible assets as a result of the acquisition (none of which are deductible for income tax purposes):
goodwill ($514 thousand) and portfolio expirations ($126 thousand). The value of the expirations is being amortized over twenty
years. The acquisition agreement provided for possible additional post-closing payments of Arrow's common stock to the former
Loomis shareholders, contingent upon the financial performance of Loomis as a subsidiary of Glens Falls National over a three-
5
year period following the closing. The estimated value of all expected post-closing payments was included in the basis of goodwill
recognized at the acquisition date.
In July 2008, we acquired the key operating assets, including the trade name from U.S. Benefits, Inc., a provider of administrative
and recordkeeping services for more complex retirement plans. This acquisition allows the Company to offer enhanced and
broadened services to retirement plan clients and will complement the fiduciary services currently offered by the Company through
its trust administrative and investment management activities.
In April 2005, we acquired from HSBC Bank USA, N.A. ("HSBC") three bank branches located within our service area. Our
subsidiary Glens Falls National acquired two HSBC branches located in Argyle and Salem, New York, and our subsidiary Saratoga
National acquired a branch located in Corinth, New York. The banks acquired substantially all deposit liabilities, the physical facilities
and certain loans related to the branches.
In November 2004, we acquired all of the outstanding shares of common stock of Capital Financial Group, Inc. ("CFG"), an
insurance agency headquartered in South Glens Falls, New York, which specializes in group health and life insurance products.
The acquisition was structured as a tax-free exchange of Arrow's common stock for CFG's common stock with contingent payments
over the five-year period subsequent to the acquisition, ending in 2009.
B. LENDING ACTIVITIES
Arrow engages in a wide range of lending activities, including commercial and industrial lending primarily to small and mid-
sized companies; mortgage lending for residential and commercial properties; and consumer installment and home equity financing.
We also maintain an active indirect lending program through our sponsorship of automobile dealer programs under which we
purchase dealer paper, primarily from dealers that meet pre-established specifications. From time-to-time we sell a portion of our
residential real estate loan originations into the secondary market, primarily to the Federal Home Loan Mortgage Corporation
("Freddie Mac") and state housing agencies, while normally retaining the servicing rights.
Generally, we continue to implement lending strategies and policies that are intended to protect the quality of the loan portfolio,
including strong underwriting and collateral control procedures and credit review systems. Loans are placed on nonaccrual status
either due to the delinquency status of principal and/or interest or a judgment by management that the full repayment of principal
and interest is unlikely. Loans secured by home equity lines of credit are systematically placed on nonaccrual status when 120
days past due, and residential real estate loans when 150 days past due. Commercial and commercial real estate loans are
evaluated on a loan-by-loan basis and are placed on nonaccrual status when 90 days past due if the full collection of principal and
interest is uncertain. (See Part II, Item 7.C.II.c. "Risk Elements.") Subsequent cash payments on loans classified as nonaccrual
may be applied all to principal, although income in some cases may be recognized on a cash basis.
We lend almost exclusively to borrowers within our geographic area, with the exception of our indirect consumer lending line
of business, where we acquire retail paper from an extensive network of automobile dealers that operate in a geographic area (in
the eastern region of upstate New York) that is somewhat larger than our normal retail service area. The loan portfolio does not
include any foreign loans or any other significant risk concentrations. We do not participate in loan syndications, either as originator
or as a participant. Most of the portfolio, in general, is fully collateralized, and many commercial loans are further secured by
personal guarantees. However, from time to time, we buy and sell participations in loans with other financial institutions in our area
of operation.
We do not engage in subprime mortgage lending as a business line and we do not extend or purchase so-called "Alt A,"
"negative amortization," "option ARM's" or "negative equity" mortgage loans. During 2012, we foreclosed on only six loans held in
our own portfolio.
C. SUPERVISION AND REGULATION
The following generally describes the laws and regulations to which we are subject. Bank holding companies, banks and their
affiliates are extensively regulated under both federal and state law. To the extent that the following information summarizes statutory
or regulatory law, it is qualified in its entirety by reference to the particular provisions of the various statutes and regulations. Any
change in applicable law may have a material effect on our business and prospects.
Bank Regulatory Authorities with Jurisdiction over Arrow and its Subsidiary Banks
Arrow is a registered bank holding company within the meaning of the Bank Holding Company Act of 1956 ("BHC Act") and
as such is subject to regulation by the Board of Governors of the Federal Reserve System ("FRB"). Arrow is not, at present, a so-
called "financial holding company" under federal banking law. As a "bank holding company" under New York State law, Arrow is
also subject to regulation by the New York State Department of Financial Services. Our two subsidiary banks are both national
banks and are subject to supervision and examination by the Office of the Comptroller of the Currency ("OCC"). The banks are
members of the Federal Reserve System and the deposits of each bank are insured by the Deposit Insurance Fund of the Federal
Deposit Insurance Corporation ("FDIC"). The BHC Act generally prohibits Arrow from engaging, directly or indirectly, in activities
other than banking, activities closely related to banking, and certain other financial activities. Under the BHC Act, a bank holding
company must obtain FRB approval before acquiring, directly or indirectly, 5% or more of the voting shares of another bank or bank
holding company (unless it already owns a majority of such shares). Bank holding companies are able to acquire banks or other
bank holding companies located in all 50 states, subject to certain limitations. The Gramm-Leach-Bliley Act ("GLBA"), enacted in
1999, authorized bank holding companies to affiliate with a much broader array of other financial institutions than was previously
permitted, including insurance companies, investment banks and merchant banks. See Item 1.D., "Recent Legislative
Developments."
6
The FRB and the OCC have broad regulatory, examination and enforcement authority. The FRB and the OCC conduct regular
examinations of the entities they regulate. In addition, banking organizations are subject to periodic reporting requirements to the
regulatory authorities. The FRB and OCC have the authority to implement various remedies if they determine that the financial
condition, capital, asset quality, management, earnings, liquidity or other aspects of a banking organization's operations are
unsatisfactory or if they determine the banking organization is violating or has violated any law or regulation. The authority of the
FRB and the OCC includes, but is not limited to, prohibiting unsafe or unsound practices; requiring affirmative action to correct a
violation or practice; issuing administrative orders; requiring the organization to increase capital; requiring the organization to sell
subsidiaries or other assets; restricting dividends and distributions; restricting the growth of the organization; assessing civil money
penalties; removing officers and directors; and terminating deposit insurance. The FDIC may terminate a depository institution's
deposit insurance upon a finding that the institution's financial condition is unsafe or unsound or that the institution has engaged in
unsafe or unsound practices or has violated any applicable rule, regulation, order or condition enacted or imposed by the institution's
regulatory agency.
Regulatory Supervision of Other Arrow Subsidiaries
The insurance agency subsidiaries of Arrow's banks are subject to the licensing and other provisions of New York State Insurance
law and are regulated by the New York Department of Financial Services. Arrow's investment adviser subsidiary is subject to the
licensing and other provisions of the federal Investment Advisers Act of 1940 and is regulated by the SEC.
Regulation of Transactions between Banks and their Affiliates
Transactions between banks and their "affiliates" are regulated by Sections 23A and 23B of the Federal Reserve Act (the
"FRA"). For purposes of Sections 23A and 23B, the “affiliates” of each of our banks include Arrow and its non-bank subsidiaries,
other than subsidiaries of the banks themselves, which are considered to be part of the bank that owns them under Sections 23A
and 23B. Each of our banks is also considered an affiliate of the other bank under Section 23A, although certain exemptions apply
to transactions between the banks. Extensions of credit that a bank may make to non-bank affiliates, or to third parties secured by
securities or obligations of the non-bank affiliates, are substantially limited by the FRA and the Federal Deposit Insurance Act (the
"FDIA"). Such acts further restrict the range of permissible transactions between a bank and an affiliate. A bank may engage in
certain transactions, including loans and purchases of assets, with an affiliate, only if the terms and conditions of the transaction,
including credit standards, are substantially the same as, or at least as favorable to the bank as, those prevailing at the time for
comparable transactions with non-affiliated companies or, in the absence of comparable transactions, on terms and conditions that
would be offered to non-affiliated companies.
Regulatory Capital Standards; Dividend Restrictions
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.
New Capital Standards to be Promulgated: The discussion and disclosure below on regulatory capital is qualified in its entirety
by reference to the fact that the Dodd-Frank Act, among other financial reforms, directed the federal bank regulatory authorities to
promulgate new capital standards for all financial institutions, including bank holding companies and banks like ours. Under the
Dodd-Frank Act, the new standards for leverage and risk-based capital, when adopted by regulators must be at least as strict (i.e.,
must establish minimum and target capital levels that are at least as high) for banking organizations on a consolidated basis as the
regulatory capital standards for U.S. insured depository financial institutions at the time Dodd-Frank was enacted in 2010. The U.S.
federal bank regulatory agencies, acting jointly, recently (in June 2012) issued proposed new capital rules for U.S. banking
organizations that aimed at implementing these Dodd-Frank capital requirements. These proposed rules were also intended to
coordinate U.S. bank capital standards with the current drafts of the Basel III proposed international capital standards and would
require significantly more stringent standards upon full implementation than are now required for U.S. financial institutions. For
more information on the Basel III standards, which are currently pending approval by participating nations, and the capital rules
proposed by U.S. regulators, see Item 7, "Management's Discussion and Analysis of Financial Condition and Results of Operations,"
Section E, "Capital Resources and Dividends" on page 47. On November 9, 2012, the U.S. federal bank regulators announced
that they would not implement their proposed new capital rules on the previously suggested effective date of January 1, 2013.
Since this announcement, the regulatory authorities have been in the process of reviewing comments and concerns about the
proposed new rules.
Current Capital Standards: Arrow is currently subject to capital standards implemented by various FRB "capital adequacy
guidelines" used in the examination and supervision of bank holding companies. The FRB's risk-based capital guidelines assign
risk weightings to all assets and certain off-balance sheet items and establish an 8% minimum ratio of qualified total capital to the
aggregate dollar amount of risk-weighted assets (which is almost always less than the dollar amount of such assets without risk
weighting). Under the risk-based guidelines, at least half of total capital must consist of "Tier 1" capital, which comprises common
equity, retained earnings and a limited amount of permanent preferred stock, less goodwill. Under the FRB's guidelines, trust
preferred securities may also qualify as Tier 1 capital, in an amount not to exceed 25% of Tier 1 capital. (Under the recently enacted
Dodd-Frank Act, newly issued trust preferred securities will no longer qualify as Tier 1 capital; previously issued trust preferred
securities for holding companies such as Arrow may continue to qualify as Tier 1 capital until maturity or redemption; however, the
7
pending proposed capital regulations, if adopted in the form proposed in May 2012, would impose a “phase-out” of such qualification
for previously issued trust preferred securities.) The currently applicable capital guidelines limit restricted core capital elements to
a percentage of the sum of core capital elements, net of goodwill less any associated deferred tax liability. We issued trust preferred
securities in 2003 and 2004 to serve as part of our core capital. Up to half of total capital may consist of so-called "Tier 2" capital,
comprising a limited amount of subordinated debt, preferred stock not qualifying as Tier 1 capital, certain other instruments and a
limited amount of the allowance for loan losses.
The FRB's other important guideline for measuring a bank holding company's capital is the leverage ratio standard, which
establishes minimum limits on the ratio of a bank holding company's "Tier 1" capital to total tangible assets (not risk-weighted). For
top-rated holding companies, the minimum leverage ratio is 3%, but lower-rated companies may be required to meet substantially
greater minimum ratios.
Our subsidiary banks are currently subject to capital requirements similar to the capital requirements applicable at the holding
company level described above. Our banks' capital requirements have been promulgated by their primary federal regulator, the
OCC. It is widely anticipated that prevailing bank capital guidelines will be strengthened by the regulatory authorities (in our case,
the OCC) in upcoming years. Indirectly, such future bank capital requirements may also impact our future holding company capital
requirements, because Dodd-Frank requires the regulators to promulgate holding company rules that would make consolidated
bank holding company capital standards at least as strict as those applicable directly to banks.)
Under applicable law, federal banking regulators are required to take prompt corrective action with respect to depository
institutions that do not meet minimum capital requirements. The regulators have established five capital classifications for banking
institutions, the highest being "well-capitalized." Our holding company and both of our subsidiary banks currently qualify as "well-
capitalized." Under regulations adopted by the federal bank regulators, a banking institution is considered "well-capitalized" if it
has a total risk-adjusted capital ratio of 10% or greater, a Tier 1 risk-adjusted capital ratio of 6% or greater and a leverage ratio of
5% or greater and is not subject to any regulatory order or written directive regarding capital maintenance. The year-end 2012
capital ratios of our holding company and our banks are set forth in Part II, Item 7.E. "Capital Resources and Dividends" and in
Note 19 "Regulatory Matters" to the consolidated financial statements under Part II, Item 8 of this Report.
A holding company's ability to pay dividends or repurchase its outstanding stock, as well as its ability to expand its business
through acquisitions of additional banking organizations or permitted non-bank companies, may be restricted if its capital falls below
these minimum capitalization ratios or fails to meet other informal capital guidelines that the regulators may apply from time-to-time
to specific banking organizations. In addition to these potential regulatory limitations on payment of dividends, our holding company's
ability to pay dividends to our shareholders, and our subsidiary banks' ability to pay dividends to our holding company are also
subject to various restrictions under applicable corporate laws, including banking laws (affecting our subsidiary banks) and the New
York Business Corporation Law (affecting our holding company). The ability of our holding company and banks to pay dividends
in the future is, and is expected to continue to be, influenced by regulatory policies, capital guidelines and applicable law.
In cases where banking regulators have significant concerns regarding the financial condition, assets or operations of a bank
or bank holding company, the regulators may take enforcement action or impose enforcement orders, formal or informal, against
the organization. If the leverage ratio (Tier 1 risk-adjusted capital to total tangible assets ratio) of a bank falls below 2%, the bank
may be closed and placed in receivership, with the FDIC as receiver.
The current risk-based capital guidelines that apply to Arrow are based on the 1988 capital accord of the International Basel
Committee on Banking Supervision, a committee of central banks and bank supervisors, as implemented by U.S. federal banking
agencies. In 2008, these federal banking agencies began to phase-in capital standards based on a second capital accord, referred
to as Basel II, for large or "core" international banks (total assets of $250 billion or more or consolidated foreign exposures of
$10 billion or more). Basel II emphasizes internal assessment of credit, market and operational risk, as well as supervisory
assessment and market discipline in determining minimum capital requirements. In 2010 the Basel Committee released the
recommended Basel III capital standards, which are referred to above and further in Item 7, “Management's Discussion and Analysis
of Financial Condition and Results of Operations,” Section E, "Capital Resources and Dividends" on page 47.
Anti-Money Laundering and OFAC
Under federal law, financial institutions must maintain anti-money laundering programs that include established internal policies,
procedures, and controls. Financial institutions are also prohibited from entering into specified financial transactions and account
relationships and must meet enhanced standards for due diligence and customer identification. Financial institutions must take
reasonable steps to conduct enhanced scrutiny of account relationships to guard against money laundering and to report any
suspicious transactions. Law enforcement authorities have been granted increased access to financial information maintained by
financial institutions. Bank regulators routinely examine institutions for compliance with these obligations and they must consider
an institution's compliance in connection with the regulatory review of applications, including applications for banking mergers and
acquisitions. The U.S. Department of the Treasury's Office of Foreign Assets Control, or "OFAC," is responsible for helping to insure
that U.S. entities do not engage in transactions with certain prohibited parties, as defined by various Executive Orders and Acts of
Congress. OFAC publishes lists of persons, organizations, and countries suspected of aiding, harboring or engaging in terrorist
acts, known as Specially Designated Nationals and Blocked Persons. If Arrow finds a name on any transaction, account or wire
transfer that is on an OFAC list, Arrow must freeze or block such account or transaction, file a suspicious activity report and notify
the appropriate authorities.
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Reserve Requirements
Pursuant to regulations of the FRB, all banking organizations are required to maintain average daily reserves at mandated
ratios against their transaction accounts and certain other types of deposit accounts. These reserves must be maintained in the
form of vault cash or in an account at a Federal Reserve Bank.
Community Reinvestment Act
Each of Arrow's subsidiary banks is subject to the Community Reinvestment Act ("CRA") and implementing regulations. CRA
regulations establish the framework and criteria by which the bank regulatory agencies assess an institution's record of helping to
meet the credit needs of its community, including low and moderate-income neighborhoods. CRA ratings are taken into account by
regulators in reviewing certain applications made by Arrow and its bank subsidiaries.
Privacy and Confidentiality Laws
Arrow and its subsidiaries are subject to a variety of laws that regulate customer privacy and confidentiality. GLBA requires
financial institutions to adopt privacy policies, to restrict the sharing of nonpublic customer information with nonaffiliated parties
upon the request of the customer, and to implement data security measures to protect customer information. The Fair Credit
Reporting Act, as amended by the Fair and Accurate Credit Transactions Act of 2003 regulates use of credit reports, providing of
information to credit reporting agencies and sharing of customer information with affiliates, and sets identity theft prevention
standards.
D. RECENT LEGISLATIVE DEVELOPMENTS
The principal federal law enacted since the start of the financial crisis that attempts to deal with the causes of that crisis is the
Dodd-Frank Act. It significantly affects all financial institutions, including Arrow and our banks. There are other earlier-enacted
banking laws that continue to significantly impact our operations. The Dodd-Frank Act and these other statutes are discussed
briefly below.
The Dodd-Frank Act
As a result of the 2008-2009 financial crisis, the U.S. Congress passed and the President signed the Dodd-Frank Act on July
21, 2010. While many of the Act's provisions have not had and likely will not have any direct impact on Arrow, other provisions
have impacted or likely will impact our business operations and financial results in a significant way. These include the establishment
of a new regulatory body known as the Bureau of Consumer Financial Protection, which will operate as an independent entity within
the Federal Reserve System and is authorized to issue rules for consumer protection, some of which likely will significantly increase
banks' compliance expenses, thereby reducing or restraining profitability. For depository institutions with $10 billion or less in assets
(such as Arrow's banks), the banks' traditional regulatory agencies (for our banks, the OCC), and not the Bureau, will have primary
examination and enforcement authority over the banks' compliance with new Bureau rules as well as all other consumer protection
rules and regulations. However, the Bureau will have the right to include its examiners on a "sampling" basis in examinations
conducted by the traditional regulators and will be authorized to give those agencies input and recommendations with respect to
consumer protection laws and to require reports and other examination documents. The Bureau will have broad authority to curb
practices it finds to be unfair, deceptive and abusive. What constitutes "abusive" behavior has been broadly defined and is very
likely to create an environment conducive to increased litigation. This is likely to be exacerbated by the fact that, in addition to the
federal authorities charged with enforcing the Bureau's rules, state attorneys general are also authorized to enforce those Federal
consumer laws transferred to the Bureau and the rules issued by the Bureau thereunder.
Dodd-Frank also directs the federal banking authorities to issue new capital requirements for banks and holding companies
which must be at least as strict as the pre-existing capital requirements for depository institutions and may be much more onerous.
See the discussion under “Important Proposed Changes to Regulatory Capital Standards” on page 47 of this Report. Dodd-Frank
also provided that any new issuances of trust preferred securities (TRUPs) by bank holding companies having between $500 million
and $15 billion in assets (such as Arrow) will no longer be able to qualify as Tier 1 capital, although previously issued and outstanding
TRUPs of such bank holding companies, including Arrow's $20 million of TRUPs that are currently outstanding, will continue to
qualify as Tier 1 capital. However, if the proposed new capital rules to be jointly issued by the federal bank regulatory agencies
were to be issued in the form as proposed in June 2012, even these "grandfathered" TRUPs previously issued by small- to mid-
sized financial institutions like Arrow would be phased out from qualifying as Tier 1 capital, at a rate of 10% per year beginning in
2013. We as well as other community and regional banks would be adversely affected by this particular treatment, which is more
severe in its impact on the capital of affected banks like ours than is required under Dodd-Frank. In any event, TRUPs, which have
been an important financing tool for community banks such as ours, can no longer be counted on as a viable source of new capital.
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Many of the regulations required to be promulgated by bank regulators in order to give effect to Dodd-Frank's provisions have
yet to be promulgated or are pending final approval by the regulators, and will have phase-in periods even after final promulgation.
The following is a summary of some additional Dodd-Frank provisions that are likely to have a material impact, positive or negative,
as the case may be, on us and our customers:
1. Increase of FDIC deposit insurance to $250,000 per customer made permanent by statute.
2. The FDIC insurance assessment on banks is now asset-based, not deposit-based, which actually reduces insurance
costs for most small to mid-sized institutions, like Arrow. Under the new method, our premiums were reduced from $513
thousand of FDIC and FICO assessments for the first quarter of 2011 (the last quarter under the old deposit-based method
of assessment), to $267 thousand of expense for the second quarter of 2011 (under the new asset-based method), a
decline of 48%.
3. New limitations imposed by Dodd-Frank on debit card interchange fees, which technically apply only to the very large
banks having more than $10 billion in assets, have already had and likely will continue to have a negative impact on the
fee income of smaller banks like ours, due to competitive pressures.
4. Requirements for mortgage originators to act in the best interests of a consumer and to seek to ensure that a
consumer will have the capacity to repay any consumer loan.
5. Requirements for comprehensive additional residential mortgage loan related disclosures.
6. Statutory implementation of “source of strength doctrine” for both bank and savings and loan holding companies,
under which the Federal Reserve can compel a holding company to contribute additional capital to its subsidiary
depository institutions.
7. Limitation of current Federal preemption standards for national banks (such as our banks), that is, the Act reduces the
extent to which state law is preempted by Federal law with regard to the operation of national banks. This increases the
potential for State intervention in the operations of national banks.
8. Repeal of the federal prohibitions on the payment of interest on demand deposits, thereby permitting depository
institutions to pay interest on business transaction and other accounts.
Full implementation of the Dodd-Frank Act will result in many new mandatory and discretionary rulemakings by numerous
federal regulatory agencies. This rulemaking will continue for several more years. As a result, bank holding companies are facing
thousands of new pages of regulations, not to mention increased litigation risk. Additional required rules still in the formulation
process that may significantly impact our operations include those related to short-term borrowing disclosures, and disclosures
regarding executive compensation. Several of these issues are highly controversial, and the implementing regulations to be
forthcoming remain the focus of much discussion and concern.
Other Recent Federal Laws Affecting Banks
Federal laws enacted in 2008 addressing the financial crisis included The Emergency Economic Stabilization Act of 2008
(EESA) and the American Recovery and Reinvestment Act of 2008 (ARRA) and related governmental programs. These laws
established emergency capital and liquidity support programs which enabled many major financial institutions to survive the crisis.
Such program served their purpose and have largely been superseded by subsequent statutory and regulatory measures, principally
Dodd-Frank. We did not participate, or need to participate in any of the emergency capital or liquidity support programs.
The Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 became effective October 17, 2005. The Act addressed
many areas of bankruptcy practice, including consumer bankruptcy, general and small business bankruptcy, treatment of tax claims
in bankruptcy, ancillary and cross-border cases, financial contract protection amendments to Chapter 12 governing family farmer
reorganization, and special protection for patients of a health care business filing for bankruptcy. This Act did not have a significant
impact on our earnings or on our efforts to recover collateral on secured loans.
The Sarbanes-Oxley Act, signed into law on July 30, 2002, adopted a number of measures having a significant impact on all
publicly-traded companies, including Arrow. Generally, the Act sought to improve the quality of financial reporting of these companies
by compelling them to adopt good corporate governance practices and by strengthening the independence of their auditors. The
Act placed substantial additional duties on directors, officers, auditors and attorneys of public companies. Among other specific
measures, the Act required that chief executive officers and chief financial officers certify to the SEC in the holding company's
annual and quarterly reports filed with the SEC regarding the accuracy of its financial statements contained therein and the integrity
of its internal controls. The Act also accelerated insiders' reporting requirements for transactions in company securities, restricted
certain executive officer and director transactions, imposed obligations on corporate audit committees, and provided for enhanced
review of company filings by the SEC. As part of the general effort to improve public company auditing, the Act places limits on
consulting services that may be performed by a company's independent auditors by requiring that the company's Audit Committee
of the Board of Directors evaluate amounts to determine independence. The Act created a federal public company accounting
oversight board (the PCAOB) to set auditing standards, inspect registered public accounting firms, and exercise enforcement
powers, subject to oversight by the SEC.
In the wake of the Sarbanes-Oxley Act, the nation's stock exchanges, including the exchange on which Arrow's stock is listed,
the National Association of Securities Dealers, Inc. ("NASD") promulgated a wide array of governance standards that must be
followed by listed companies. The NASD standards include having a Board of Directors the majority of whose members are
independent of management, and having audit, compensation and nomination committees of the Board consisting exclusively of
independent directors. We have implemented a variety of corporate governance measures and procedures to comply with Sarbanes-
Oxley and the amended NASD listing requirements, although we have always relied on a Board of Directors a majority of whose
members are independent and independent Board committees to make important decisions regarding the Company.
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The USA Patriot Act initially adopted in 2001 and re-adopted by the U.S. Congress in 2006 with certain changes (the "Patriot
Act"), imposes substantial record-keeping and due diligence obligations on banks and other financial institutions, with a particular
focus on detecting and reporting money-laundering transactions involving domestic or international customers. The U.S. Treasury
Department has issued and will continue to issue regulations clarifying the Patriot Act's requirements. The Patriot Act requires all
financial institutions, including banks, to maintain certain anti-money laundering compliance and due diligence programs. The
provisions of the Act impose substantial costs on all financial institutions, including ours.
Recent Changes in Deposit Insurance Laws and Regulations
Although the Dodd-Frank Act extended the unlimited FDIC deposit insurance coverage that had been previously established
by FDIC rule for non-interest-bearing transaction accounts (such as certain checking accounts), this unlimited deposit insurance
coverage terminated by statute on December 31, 2012. Consequently, as of January 1, 2013, funds held in non-interest-bearing
transaction accounts at Arrow's banks no longer have unlimited deposit insurance coverage, but are subject to standard FDIC
deposit insurance rules.
The FDIC collects insurance premiums on insured deposits. In recent years, the FDIC has made several modifications to its
deposit insurance premium structure, the most important of which was to calibrate premiums based on the total assets (versus total
deposits) of insured institutions. This has tended to benefit smaller regional banks such as ours, that typically maintain a higher
ratio of deposits to total assets than the large, money-center banks. In 2007, after a several year period in which banks were
charged no or very low premiums for deposit insurance, the FDIC resumed charging financial institutions an FDIC deposit insurance
premium, under a new risk-based assessment system. Under this system, institutions in Risk Category I (the lowest of four risk
categories) paid a rate (based on a formula) of 5 to 7 cents per $100 of assessable deposits.
In 2008, in response to a growing level of claims against the Bank Insurance Fund, resulting from the first stages of the financial
crisis, the FDIC announced that it would raise the lowest rate from 5 cents to 12 cents per $100 of assessable deposits, which
increase remained in effect through 2009. In addition, beginning with the second quarter of 2009, the FDIC added four new factors
to the assessment rate calculation, including factors for brokered deposits, secured liabilities and unsecured liabilities.
In 2009, in light of extraordinary demands on the FDIC's insurance fund, the FDIC imposed a special assessment on all insured
institutions, including our banks, at .05% of total assets as adjusted for Tier 1 capital. We charged $787 thousand to earnings in
the second quarter of 2009 for this assessment, which was paid on September 30, 2009. In the fourth quarter of 2009, the FDIC
collected prepaid assessments for the fourth quarter of 2009 and for all of 2010, 2011 and 2012. Our prepaid assessment amounted
to $6.8 million. The expense was ratably recorded over the respective periods as directed by the FDIC.
In February of 2011, the FDIC finalized a new assessment system that took effect in the second quarter of 2011. The final rule
changed the assessment base from domestic deposits to average assets minus average tangible equity, adopted a new large-bank
pricing assessment scheme, and set a target size for the Deposit Insurance Fund (the successor to the Bank Insurance Fund).
The changes went into effect in the second quarter of 2011. The rule (as mandated by Dodd-Frank) finalizes a target size for the
Deposit Insurance Fund at 2% of insured deposits. It also implements a lower assessment rate schedule when the fund reaches
1.15% (so that the average rate over time should be about 8.5 basis points) and, in lieu of dividends, provides for a lower rate
schedule when the reserve ratio reaches 2% and 2.5%. Also as mandated by Dodd-Frank, the rule changes the assessment base
from adjusted domestic deposits to a bank's average consolidated total assets minus average tangible equity. The new assessment
system significantly lowered our FDIC insurance assessments in second quarter of 2011, which decreased by over 48% from the
first quarter of 2011.
We are unable to predict whether or to what extent the FDIC may elect to impose additional special assessments on insured
institutions in upcoming years, although it is commonly understood that the FDIC insurance fund may not be adequate if bank
failures continue at significant levels for any significant period of time and/or the cost to the FDIC of the bank failures recently
resolved by it should prove even greater than was initially anticipated.
E. STATISTICAL DISCLOSURE – (GUIDE 3)
Set forth below is an index identifying the location in this Report of various items of statistical information required to be included
in this Report by the SEC’s industry guide for Bank Holding Companies.
Required Information
Distribution of Assets, Liabilities and Stockholders' Equity; Interest Rates and Interest Differential
Investment Portfolio
Loan Portfolio
Summary of Loan Loss Experience
Deposits
Return on Equity and Assets
Short-Term Borrowings
Location in Report
Part II, Item 7.B.I.
Part II, Item 7.C.I.
Part II, Item 7.C.II.
Part II, Item 7.C.III.
Part II, Item 7.C.IV.
Part II, Item 6.
Part II, Item 7.C.V.
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F. COMPETITION
We face intense competition in all markets we serve. Traditional competitors are other local commercial banks, savings banks,
savings and loan institutions and credit unions, as well as local offices of major regional and money center banks. Like all banks,
we encounter strong competition in mortgage lending from a wide variety of other mortgage originators, all of whom are principally
affected in this business by the rate and terms set, and the lending practices established by the very large government sponsored
enterprises “Fannie Mae” and “Freddie Mac,” who purchase and/or guarantee a very substantial dollar amount and number of
mortgage loans, which in 2012 accounted for a large majority of the total amount of mortgage loans extended in the U.S. Additionally,
non-banking financial organizations, such as consumer finance companies, insurance companies, securities firms, money market,
mutual funds and credit card companies offer substantive equivalents of the various other types of loan and financial products and
transactional accounts that we offer, even though these non-banking organizations are not subject to the same regulatory restrictions
and capital requirements that apply to us. Under federal banking laws, such non-banking financial organizations not only may offer
products comparable to those offered by commercial banks, but also may establish or acquire their own commercial banks.
G. EXECUTIVE OFFICERS OF THE REGISTRANT
The names and ages of the executive officers of Arrow and positions held by each are presented in the following table. Officers
are elected annually by the Board of Directors.
Name
Thomas J. Murphy
Terry R. Goodemote
David S. DeMarco
Age
Positions Held and Years from Which Held
54 President and Chief Executive Officer of the Arrow since January 1, 2013. He has been
a director of Arrow since July 2012. Mr. Murphy served as a Vice President of Arrow
from 2009 to 2012. Mr. Murphy has served as Corporate Secretary from 2009 to 2012.
Mr. Murphy is also the President and Chief Executive Officer of GFNB since January 1,
2013. Prior to that date he served as Senior Executive Vice President and President of
GFNB since July 1, 2011. Prior to July 1, 2011, Mr. Murphy served as Senior Trust Officer
of GFNB since 2010 and Cashier of GFNB since 2009. Murphy previously served as
Assistant Corporate Secretary of Arrow (2008-2009), Senior Vice President of GFNB
(2008-2011) and Manager of the Personal Trust Department of GFNB (2004-2011). Mr.
Murphy started with the Company in 2004.
49 Executive Vice President and Senior Executive Vice President of GFNB since July 1, 2011.
Mr. Goodemote previously served as our Senior Vice President, Treasurer and Chief
Financial Officer and as the Executive Vice President, Treasurer and Chief Financial
Officer of GFNB since 2008. Mr. Goodemote was first appointed Chief Financial Officer
and Treasurer of Arrow and GFNB on January 1, 2007. Prior to becoming Chief Financial
Officer, Mr. Goodemote served as Senior Vice President and Head of the Accounting
Division of GFNB. Mr. Goodemote started with the Company in 1992.
51 Senior Vice President of Arrow since May 1, 2009. Mr. DeMarco has been the President
of and Chief Executive Officer of SNB since January 1, 2013. Prior to that date, Mr.
DeMarco served as Executive Vice President and Head of the Branch, Corporate
Development, Financial Services & Marketing Division of GFNB since January 1, 2003.
Mr. DeMarco started with the Company in 1987.
H. AVAILABLE INFORMATION
Our Internet address is www.arrowfinancial.com. We make available free of charge on or through our Internet website our
annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and amendments to those reports as
soon as practicable after we file or furnish them with the SEC pursuant to the Exchange Act. We also make available on the internet
website various other documents related to corporate operations, including our Corporate Governance Guidelines, the charters of
our principal board committees, and our codes of ethics. We have adopted a financial code of ethics that applies to Arrow’s chief
executive officer, chief financial officer and principal accounting officer and a business code of ethics that applies to all directors,
officers and employees.
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Item 1A. Risk Factors
Our financial results and the market price of our stock in future periods are subject to risks arising from many factors, including
the following: (Please note that the discussions below regarding potential impact on Arrow of certain of these factors that may
develop in the future are not meant to provide predictions by Arrow's management that such factors will develop, but to acknowledge
the possible impact that could occur if the factors do develop.)
Difficult market conditions have adversely affected the financial services industry. For many financial institutions,
dramatic declines in the U.S. housing market over the past three years, with falling home prices and increasing foreclosures and
unemployment, have negatively impacted the credit performance of real estate related loans and resulted in significant write-downs
of asset values. To date, the impact of these adverse market conditions has been less significant on Arrow than it has been on
many other U.S. financial institutions. Write-downs at many of these other institutions, initially of asset-backed securities but
spreading to other securities and loans, have caused a number of those institutions to seek additional capital, to reduce or eliminate
dividends, to merge with larger and stronger institutions and, in some cases, to fail. Reflecting concern about the stability of the
financial markets generally and the strength of counterparties, many lenders have reduced or ceased providing funding to borrowers,
including to other financial institutions. Generally, in the financial services sector, this market turmoil and tightening of credit have
led to an increased level of commercial and consumer delinquencies at many institutions, lack of consumer confidence, increased
market volatility and widespread reduction of business activity. Although this turmoil has affected Arrow and our local markets less
than certain other institutions and markets, the resulting economic pressure on consumers and lack of confidence in the financial
markets has already, to some extent, adversely affected our business, financial condition and results of operations. Market
developments may continue to negatively affect consumer confidence levels and demand for loans, and may cause adverse changes
in payment patterns, causing increases in delinquencies and default rates, which may increase our charge-offs and provision for
credit losses. A worsening of these conditions would likely exacerbate the adverse effects of these difficult market conditions on
Arrow and others in the financial institutions industry.
We may be adversely affected by new and enhanced government regulation, especially the new rules promulgated
under the Dodd-Frank Act. Even before the recent financial crisis and the new banking laws and regulations resulting therefrom,
including the Dodd-Frank Act, we were subject to extensive Federal and state banking regulations and supervision. Banking
regulations are intended primarily to protect our depositors' funds and the Federal deposit insurance funds, not the Company's
shareholders. Regulatory requirements affect our lending practices, capital structure, investment practices, dividend policy and
growth. Failure to meet minimum capital requirements could result in the imposition of limitations on our operations that would
adversely impact our profitability and could, if capital levels dropped significantly, result in our being required to cease or scale back
our operations or raise capital at inopportune times or unsatisfactory prices. On top of the preexisting regulatory structure, the
recent changes in governing law, regulations and regulatory practices have already imposed, and likely will continue to impose,
substantial additional costs on us and thereby hurt our revenues and profitability. Dodd-Frank has already required us to adopt
substantial additional practices and procedures in the normal day-to-day operation of our business, and many of the new and most
onerous rules and regulations required by Dodd-Frank, including new capital requirements that may be substantially enhanced
from the current requirements, have not yet been implemented or in some cases even proposed. In many case, even the general
structure of the new regulations required to be issued under Dodd-Frank is unclear. This uncertainty is a concern. At this time, it
is difficult to predict the extent to which Dodd-Frank or the resulting regulations and rules may adversely impact the Company. It
is reasonably certain, however, that Dodd-Frank will increase our costs, require us to modify certain strategies and business
operations, and require us to revise our capital and liquidity structures, which, individually or collectively, may very well have a
material adverse impact on our financial condition.
If economic conditions, already weak, should worsen and the U.S. experiences a recession or prolonged economic
stagnation, the Company's allowance for loan losses may not be adequate to cover actual losses. Like all financial institutions,
we maintain an allowance for loan losses to provide for probable loan losses at the balance sheet date. Our allowance for loan
losses is based on our historical loss experience as well as an evaluation of the risks associated with our loan portfolio, including
the size and composition of the portfolio, current economic conditions and geographic concentrations within the portfolio and other
factors. If the economy in our geographic market area, the northeastern region of New York State, or in the U.S. generally, should
deteriorate to the point that recessionary conditions return, or if the regional or national economy experiences a protracted period
of stagnation, the quality of our loan portfolio may weaken significantly. If so, our allowance for loan losses may not be adequate
to cover actual loan losses, and future enhanced provisions for loan losses could materially and adversely affect financial results.
Moreover, weak or worsening economic conditions often lead to difficulties in other areas of our business, including growth of our
business generally, thereby compounding the negative effects on earnings.
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A sustained and/or significant change in domestic interest rates could negatively affect the Company's net interest
income. An institution's net interest income is significantly affected by market rates of interest, including short-term and long-term
rates and the relationship between the two. Interest rates are highly sensitive to many factors, which are beyond our control,
including general economic conditions, policies of various governmental and regulatory agencies such as the Federal Reserve
Board, and actions taken by foreign central banks. Like all financial institutions, the Company's balance sheet is affected by
fluctuations in interest rates. Although both short- and long-term interest rates have remained at very low levels for the past several
years, and the Federal Reserve has recently announced that its goal is to keep rates in the U.S. at these low levels at least through
2014, there is a widespread concern that the rapid growth in the money supply, another development actively promoted by the
Federal Reserve and other central banks in the western world, will eventually lead to a surge in inflation in the U.S. and other
developed nations, including in the cost of borrowed funds (i.e., interest rates). Any such development (i.e., a rising rate environment
in the U.S. ) may negatively affect banks' profitability. See the discussion under "Changes in Net Interest Income Due to Rate," on
page 30 of this Report.
If economic conditions worsen significantly and the U.S. financial markets should suffer another downturn, the
company may experience limited access to credit markets. As discussed under Part I, Item 7.D. "Liquidity," the Company has
relationships with various third parties to provide overnight and longer-term credit arrangements. If and as these third parties may
themselves have difficulty in accessing their own credit markets, we may, in turn, experience a decrease in our capacity to borrow
funds from them or other third parties traditionally relied upon by banks for liquidity.
If the value of real estate in our market area were to suffer an additional material decline, a significant portion of our
loan portfolio could become under-collateralized, which might have a material adverse effect on us. In addition to considering
the financial strength and cash flow characteristics of borrowers, we often secure loans with real estate collateral, which in each
case provides an alternate source of repayment in the event of default by the borrower. If mortgaged real property deteriorates in
value significantly during the time the credit is outstanding and we are required to liquidate the collateral securing a loan to satisfy
the debt, our earnings and capital could be adversely affected. Furthermore, the possibility of legislative changes at the Federal
or State level adversely impacting the ability of banks to protect themselves when loans begin to go bad, including through foreclosure
proceedings, may result in negative impacts to those institutions.
If securities prices should significantly decline in upcoming periods, we likely will experience a reduction in income
from fiduciary activities. The most significant portion of the income we earn from managing assets in our fiduciary capacity is
tied to the market value of those assets, i.e., investment securities. If stocks or other equity securities lose market value, in a sudden
market crash as was experienced in 2008-2009, we may see our fiduciary income substantially reduced.
We are subject to the local economies where we operate, and unfavorable economic conditions in these areas could
have a material adverse effect on our financial condition and results of operations. Our success depends upon the growth
in business activity, income levels and deposits in our geographic market area. Unpredictable and unfavorable economic conditions
unique to our market area may have an adverse effect on the quality of our loan portfolio and financial performance. As a community
bank, we are less able than our larger regional competitors to spread the risk of unfavorable local economic conditions over a larger
market area. Although our market area (northeastern New York State) has not been as severely damaged by the financial downturn
of the past three years as many other areas of the U.S., this could change in future periods if the U.S. economy generally continues
to suffer. Moreover, we cannot give any assurances that we, as a single enterprise, will benefit from any unique and favorable
economic conditions in our market area, even if they do occur.
Current levels of market volatility. The market for certain investment securities, including mortgage-backed securities, has
been highly volatile or inactive, and may not stabilize or resume in the near future. This volatility can result in significant fluctuation
in the prices of those securities, some of which we hold in our investment portfolio, which could affect the results of our operations.
Changes in accounting standards may materially impact the company's financial statements. From time-to-time, the
Financial Accounting Standards Board ("FASB") changes the financial accounting and reporting standards that govern the
preparation of our financial statements. These changes can be hard to predict and can materially impact how we record and report
our financial condition and results of operations. In some cases, we may be required to apply a new or revised standard retroactively,
resulting in changes to previously reported financial statements. Specifically, changes in the fair value of our financial assets could
have a significant negative impact on our asset portfolios and indirectly on our capital levels
The Company's business could suffer if it loses key personnel unexpectedly. Our success depends, in large part, on
our ability to retain our key personnel for the duration of their expected terms of service. However, back-up plans are also important,
in the event key personnel are unexpectedly rendered incapable of performing or depart or resign from their positions. While our
Board of Directors actively reviews emergency staffing plans, any sudden unexpected change at the senior management level may
adversely affect our business.
The Company relies on other companies to provide key components of the company's business infrastructure. Third-
party vendors provide key components of our business infrastructure such as Internet connections, network access and mutual
fund distribution. These parties are beyond our control, and any problems caused or experienced by these third parties, including
their not being able to continue to provide their services to us or performing such services poorly, could adversely affect our ability
to deliver products and services to our customers and conduct our business.
14
The soundness of other financial institutions could adversely affect Arrow. Our ability to engage in routine funding
transactions could be adversely affected by the actions and commercial soundness of other financial institutions. Financial services
institutions are interrelated as a result of trading, clearing, counterparty and other relationships. Arrow has exposure to many
different counterparties, and we routinely execute transactions with counterparties in the financial industry, including brokers and
dealers, other commercial banks, investment banks, mutual and hedge funds, and other financial institutions. As a result, defaults
by, or even rumors or questions about, one or more financial services institutions, or the financial services industry generally, could
lead to market-wide liquidity problems and losses or defaults by Arrow or by other institutions and organizations. Many of these
transactions expose Arrow to credit risk in the event of default of our counterparty or client. In addition, Arrow's credit risk may be
exacerbated when the collateral held by Arrow cannot be liquidated or is liquidated at prices not sufficient to recover the full amount
of the financial instrument exposure due Arrow. There is no assurance that any such losses would not materially and adversely
affect our results of operations.
The Company faces continuing and growing security risks to its own information base and to information on its
customers. Arrow has implemented systems of internal controls and procedures and corporate governance policies and procedures
intended to protect its business operations. In addition, we rely on the services of a variety of vendors to meet our data processing
and communication needs. No matter how well designed or implemented our controls are, we cannot provide an absolute guarantee
to protect business operations from every type of problem in every situation. A failure or circumvention of these controls could have
a material adverse effect on Arrow's business operations and financial condition. Also the computer systems and network
infrastructure that we use are always vulnerable to unforeseen disruptions, including theft of confidential customer information
("identity theft") and interruption of service as a result of fire, natural disasters, explosion, general infrastructure failure or cyber
attacks. These disruptions may arise in our internally developed systems, the systems of our third- party service providers or
originating from our consumer and business customers who access our systems from their own networks or digital devices to
process transactions. Information security risks have increased significantly in recent years because of consumer demand to use
the Internet and other electronic delivery channels to conduct financial transactions. This risk is further enhanced due to the increased
sophistication and activities of organized crime, hackers, terrorists and other disreputable parties. We regularly assess and attempt
to improve our security systems and disaster preparedness, including back-up systems, but the risks are substantially escalating.
As a result, cybersecurity and the continued enhancement of our controls and processes to protect our systems, data and networks
from attacks or unauthorized access remain a priority. Accordingly, we may be required to expend additional resources to enhance
our protective measures or to investigate and remediate any information security vulnerabilities or exposures. Such costs or losses
could exceed the amount of insurance coverage, if any, which would adversely affect our earnings.
Our industry is faced with technological advances and changes on a continuing basis, and failure to adapt to these
advances and changes could have a material adverse impact on our business. Technological advances and changes in the
financial services industry are pervasive and constant factors. For our business to remain competitive, we must comprehend
developments in new products, services and delivery systems utilizing new technology and adapt to those developments. Proper
implementation of new technology can increase efficiency, decrease costs and help to meet customer demand. However, many
of our competitors have greater resources to invest in technological advances and changes. We may not always be successful in
utilizing the latest technological advances in offering our products and services or in otherwise conducting our business. Failure to
identify, adapt to and implement technological advances and changes could have a material adverse effect on our business.
Our stock price may begin to reflect market volatility more closely than it has in the past. Our stock price can fluctuate
widely in response to a variety of factors, including: actual or anticipated variations in our operating results; recommendations by
securities analysts; significant acquisitions or business combinations; operating and stock price performance of other companies
that investors deem comparable to us; new technology used or services offered by our competitors; news reports relating to trends,
concerns and other issues in the financial services industry; and changes in government regulations. Many of these factors that
may adversely affect our stock price are less reflective of our particular condition or operating results than general market fluctuations,
industry-wide factors or general economic or political conditions and events, including terrorist attacks, economic slowdowns or
recessions, interest rate changes, credit loss trends or currency fluctuations.
Item 1B. Unresolved Staff Comments - None
15
Item 2. Properties
Our main office is at 250 Glen Street, Glens Falls, New York. The building is owned by us and serves as the main office for
Glens Falls National, our principal subsidiary. We own twenty-eight branch banking offices and lease seven others at market rates.
We own two offices for our insurance operations and lease six others. Four of our insurance offices are located at our branch
locations. We also lease office space in a building near our main office in Glens Falls.
In the opinion of management, the physical properties of our holding company and our subsidiary banks are suitable and
adequate. For more information on our properties, see Notes 2, 6 and 18 to the Consolidated Financial Statements contained in
Part II, Item 8 of this Report.
Item 3. Legal Proceedings
We are not the subject of any material pending legal proceedings, other than ordinary routine litigation occurring in the normal
course of our business. On an ongoing basis, we typically are the subject of or a party to various legal claims, which arise in the
normal course of our business. The various legal claims currently pending against us will not, in the opinion of management based
upon consultation with counsel, result in any material liability.
Item 4. Mine Safety Disclosures - None
PART II
Item 5. Market for the Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of Equity
Securities
The common stock of Arrow Financial Corporation is traded on the Global Select Market of the NASDAQ Stock MarketR under
the symbol AROW.
The high and low prices listed below represent actual sales transactions, as reported by NASDAQ. All stock prices and cash
dividends per share have been restated to reflect subsequent stock dividends. On September 27, 2012, we distributed a 2% stock
dividend on our outstanding shares of common stock.
2012
Market Price
Low
High
Cash
Dividends
Declared
2011
Market Price
Low
High
Cash
Dividends
Declared
First Quarter
Second Quarter
Third Quarter
Fourth Quarter
$ 22.80
22.60
23.26
22.86
$
$
26.62
24.37
25.68
25.50
0.245
0.245
0.245
0.250
$ 21.50
21.92
21.18
21.08
$ 26.74
24.02
23.84
23.53
$
0.238
0.238
0.238
0.245
The payment of cash dividends by Arrow is determined at the discretion of its Board of Directors and is dependent upon, among
other things, our earnings, financial condition and other factors, including applicable legal and regulatory restrictions. See "Capital
Resources and Dividends" in Part II, Item 7.E. of this Report.
There were approximately 6,964 holders of record of Arrow’s common stock at December 31, 2012. Arrow has no other class
of stock outstanding.
16
Equity Compensation Plan Information
The following table sets forth certain information regarding Arrow's equity compensation plans as of December 31, 2012. These
equity compensation plans were our 2008 Long-Term Incentive Plan ("LTIP"), our 2011 Employee Stock Purchase Plan ("ESPP")
and our 2008 Directors' Stock Plan (DSP). All of these plans have been approved by Arrow's shareholders.
(a)
Number of Securities
to be Issued Upon
Exercise of
Outstanding Options,
Warrants and Rights
(b)
Weighted-Average
Exercise Price of
Outstanding Options,
Warrants and Rights
(c)
Number of Securities
Remaining Available
for Future Issuance
Under Equity
Compensation Plans
(Excluding Securities
Reflected in Column
(a))
442,385
$
—
442,385
$
23.03
—
23.03
220,228
—
220,228
Plan Category
Equity Compensation Plans Approved by
Security Holders (1)(2)
Equity Compensation Plans Not Approved by
Security Holders
Total
(1) All 442,385 shares of common stock listed in column (a) are issuable pursuant to outstanding stock options granted under
the LTIP.
(2) The total of 220,228 shares listed in column (c) includes 37,695 shares of common stock available for future award grants
under the LTIP, 3,961 shares of common stock available for future issuance under the DSP and 178,572 shares of common
stock available for future issuance under the ESPP.
17
STOCK PERFORMANCE GRAPHS
The following two graphs provide a comparison of the total cumulative return (assuming reinvestment of dividends) for the
common stock of Arrow as compared to the Russell 2000 Index, the NASDAQ Banks Index and the Zacks $1B-$5B Bank Assets
Index.
The historical information set forth below may not be indicative of the future results. The first graph presents the five-year period
from December 31, 2007 to December 31, 2012 and the second graph presents stock performance for the ten-year period from
December 31, 2002 to December 31, 2012.
TOTAL RETURN PERFORMANCE
Period Ending
Index
Arrow Financial Corporation
Russell 2000 Index
NASDAQ Banks Index
Zacks $1B - $5B Bank Assets Index
2007
2008
2009
2010
2011
2012
100.00
100.00
100.00
100.00
121.80
129.66
66.21
72.91
92.73
84.20
60.66
81.72
152.95
106.82
72.13
90.99
139.87
102.36
64.51
80.34
158.32
119.08
77.18
91.96
Source: Prepared by Zacks Investment Research, Inc. Used with permission. All rights reserved. Copyright 1980-2013.
18
TOTAL RETURN PERFORMANCE
Period Ending
Index
Arrow Financial
Corporation
Russell 2000 Index
NASDAQ Banks
Index
Zacks $1B - $5B Bank
Assets Index
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
100.00
116.55
138.10
124.17
125.62
117.22
142.78
151.99
179.30
163.97
185.59
100.00
147.25
174.25
182.18
215.65
212.27
140.55
178.74
226.74
217.28
252.77
100.00
128.64
147.31
143.90
161.59
127.87
93.23
77.56
92.24
82.49
98.69
100.00
138.88
161.80
159.48
177.14
143.24
132.83
117.06
130.33
115.08
131.73
Source: Prepared by Zacks Investment Research, Inc. Used with permission. All rights reserved. Copyright 1980-2013.
The preceding stock performance graphs shall not be deemed incorporated by reference by virtue of any general statement
incorporating by reference this Report into any filing under the Securities Act of 1933, as amended, or the Securities Exchange Act
of 1934, as amended, except to the extent the company specifically incorporates this information by reference, and shall not
otherwise be deemed filed as part of such other filings.
Unregistered Sales of Equity Securities
In connection with Arrow's acquisition by merger in August 2011 of W. Joseph McPhillips, Inc. and McPhillips-Northern, Inc.,
two affiliated insurance agencies specializing in the sale of property and casualty insurance, Arrow issued to the agencies'
shareholders at closing and in subsequent post-closing payments, in exchange for all of their shares of the agencies, a total of
92,559 shares, as adjusted for subsequent stock dividends, of Arrow's common stock and $191 thousand in cash. All Arrow shares
thus issued to the shareholders were issued without registration under the Securities Act of 1933, as amended, in reliance upon
the exemption for such registration set forth in Section 3(a)(11) of the Act and Rule 147 promulgated by the Securities and Exchange
Commission thereunder. This exemption was available because all of the shareholders of the acquired agencies were New York
residents and the acquired agencies were both New York corporations having substantially all of their assets and business operations
19
in the State of New York.
In connection with Arrow's acquisition by merger in February 2011 of Upstate Agency, Inc., an insurance agency specializing
in the sale of property and casualty insurance, Arrow issued at closing of the transaction and in post-closing payments to date, to
the sole shareholder of Upstate, in exchange for all of his shares of the agency, a total of 141,272 shares, as adjusted for subsequent
stock dividends, of Arrow's common stock and approximately $2.7 million in cash. The acquisition agreement also provided for
possible post-closing payments of additional shares of Arrow's common stock to the former shareholder of Upstate, contingent
upon the financial performance and business results of Upstate as a subsidiary of Glens Falls National over the three-year period
following the closing of the acquisition. The maximum remaining potential value of the Arrow shares issuable under this provision
is $183 thousand. All shares issued to the Upstate shareholder at the original closing and issuable to him in future post-closing
payments were and will be issued without registration under the Securities Act of 1933, as amended, in reliance upon the exemption
for such registration set forth in Section 3(a)(11) of the Act and Rule 147 promulgated by the Securities and Exchange Commission
thereunder. This exemption was and remains available because at closing the sole shareholder of Upstate was a New York resident
and Upstate was a New York corporation having substantially all of its assets and business operations in the State of New York.
In connection with Arrow's acquisition by merger in April 2010 of Loomis & LaPann, Inc., an insurance agency specializing in
the sale of property and casualty insurance, Arrow issued at closing of the transaction to the shareholders of Loomis, in exchange
for all of their shares of the agency, a total of 35,048 shares, as adjusted for subsequent stock dividends and post-closing payments,
of Arrow's common stock. The acquisition agreement also provided for possible post-closing payments of additional shares of
Arrow's common stock to the former shareholders of Loomis, contingent upon the financial performance and business results of
Loomis as a subsidiary of Glens Falls National over the three-year period following the closing of the acquisition. The maximum
remaining potential dollar value of Arrow stock issuable to the former shareholders of Loomis under this post-closing payment
provision is $142 thousand. All shares issued to the Loomis shareholders at the original closing and after the first subsequent year,
and all shares issuable to them in future post-closing payments, were and will be issued without registration under the Securities
Act of 1933, as amended, in reliance upon the exemption for such registration set forth in Section 3(a)(11) of the Act and Rule 147
promulgated by the Securities and Exchange Commission thereunder. This exemption was and remains available because at
closing all of the shareholders of Loomis were New York residents and Loomis was a New York corporation having substantially
all of its assets and business operations in the State of New York.
Issuer Purchases of Equity Securities
The following table presents information about repurchases by us during the three months ended December 31, 2012 of our
common stock (our only class of equity securities registered pursuant to Section 12 of the Securities Exchange Act of 1934):
Fourth Quarter 2012
Calendar Month
Total Number of
Shares Purchased1
Average Price Paid
Per Share1
Total Number of
Shares Purchased as
Part of Publicly
Announced
Plans or Programs2
Maximum
Approximate Dollar
Value of Shares that
May Yet be
Purchased Under the
Plans or Programs2
October
November
December
Total
$
31,230
44,015
22,111
97,356
24.65
24.00
24.67
24.36
$
30,000
28,000
—
58,000
2,349,314
1,682,658
1,682,658
1The total number of shares purchased and the average price paid per share include shares purchased in open market
transactions under the Arrow Financial Corporation Automatic Dividend Reinvestment Plan (the "DRIP") by the administrator of the
DRIP and shares surrendered or deemed surrendered to Arrow by holders of options to acquire Arrow common stock received by
them under the stock plan in connection with the exercise of such options. In the months indicated, the listed number of shares
purchased included the following numbers of shares purchased through such methods: October - DRIP purchases (1,230 shares) ;
November - DRIP purchases (3,339 shares), stock options (12,676 shares); December - DRIP purchases (21,447 shares), stock
options (664 shares). Monthly DRIP purchases do not reflect any so-called “netting” transactions, that is, purchases effected within
the DRIP itself by the DRIP administrator consisting of monthly acquisitions of shares on behalf of purchasing participants who are
investing funds in the plan from selling participants who are withdrawing funds from the plan.
2Includes only those shares acquired by Arrow pursuant to its publicly-announced stock repurchase programs; does not include
shares purchased or subject to purchase under the DRIP or shares surrendered to Arrow upon exercise of options granted under
any compensatory stock plans. Our only publicly-announced stock repurchase program in effect for the fourth quarter of 2012 was
the program approved by the Board of Directors and announced in November 2011, under which the Board authorized management,
in its discretion, to repurchase from time to time during 2012, in the open market or in privately negotiated transactions, up to $5
million of Arrow common stock. In November 2012, the Board authorized a similar repurchase program for 2013, also having a $5
million total authorization for stock repurchases.
20
Item 6. Selected Financial Data
FIVE YEAR SUMMARY OF SELECTED DATA
Arrow Financial Corporation and Subsidiaries
(Dollars In Thousands, Except Per Share Data)
Consolidated Statements of Income Data:
Interest and Dividend Income
Interest Expense
Net Interest Income
Provision for Loan Losses
Net Interest Income After Provision
for Loan Losses
Noninterest Income
Net Gains on Securities Transactions
Noninterest Expense
Income Before Provision for Income Taxes
Provision for Income Taxes
Net Income
Per Common Share: 1
Basic Earnings
Diluted Earnings
Per Common Share: 1
Cash Dividends
Book Value
Tangible Book Value 2
$
$
$
$
2012
69,379
11,957
57,422
845
56,577
26,234
865
(51,836)
31,840
9,661
22,179
1.85
1.85
0.99
14.62
12.42
$
$
$
$
2011
76,791
18,679
58,112
845
57,267
23,133
2,795
(51,548)
31,647
9,714
21,933
1.83
1.83
0.96
13.87
11.64
$
$
$
$
2010
84,972
23,695
61,277
1,302
59,975
17,582
1,507
(47,418)
31,646
9,754
21,892
1.85
1.84
0.93
12.88
11.42
$
$
$
$
2009
86,857
26,492
60,365
1,783
58,582
19,235
357
(46,592)
31,582
9,790
21,792
1.85
1.84
0.90
11.92
10.51
$
$
$
$
2008
89,508
32,277
57,231
1,671
55,560
15,886
383
(42,393)
29,436
8,999
20,437
1.74
1.73
0.88
10.68
9.30
Consolidated Year-End Balance Sheet Data:
Total Assets
Securities Available-for-Sale
Securities Held-to-Maturity
Loans
Nonperforming Assets 3
Deposits
Federal Home Loan Bank Advances
Other Borrowed Funds
Stockholders’ Equity
$ 2,022,796
478,698
239,803
1,172,341
9,070
1,731,155
59,000
32,678
175,825
$ 1,962,684
556,538
150,688
1,131,457
8,128
1,644,046
82,000
46,293
166,385
$ 1,908,336
517,364
159,938
1,145,508
4,945
1,534,004
130,000
73,214
152,259
$ 1,841,627
437,706
168,931
1,112,150
4,772
1,443,566
140,000
93,908
140,818
$ 1,665,086
315,414
133,976
1,109,812
4,971
1,275,063
160,000
79,956
125,802
Selected Key Ratios:
Return on Average Assets
Return on Average Equity
Dividend Payout 4
1.11%
12.88
53.51
1.13%
13.45
52.46
1.16%
14.56
50.54
1.24%
16.16
48.91
1.24%
16.26
50.87
1Share and per share amounts have been adjusted for subsequent stock splits and dividends, including the most recent
September 2012 2% stock dividend.
2Tangible book value excludes goodwill and other intangible assets from total equity.
3Nonperforming assets consist of nonaccrual loans, loans past due 90 or more days but still accruing interest, repossessed
assets, restructured loans, other real estate owned and nonaccrual investments.
4Dividend Payout Ratio – cash dividends per share to fully diluted earnings per share.
21
Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations
Selected Quarterly Information
Dollars in thousands, except per share amounts
Share and per share amounts have been restated for the September 2012 2% stock dividend
Quarter Ended
12/31/2012
9/30/2012
6/30/2012
3/31/2012
12/31/2011
Net Income
Transactions Recorded in Net Income (Net of Tax):
Net Gains on Securities Transactions
Net Gains on Sales of Loans
Reversal of VISA Litigation Reserve
Share and Per Share Data:
Period End Shares Outstanding
Basic Average Shares Outstanding
Diluted Average Shares Outstanding
Basic Earnings Per Share
Diluted Earnings Per Share
Cash Dividend Per Share
Selected Quarterly Average Balances:
Interest-Bearing Deposits at Banks
Investment Securities
Loans
Deposits
Other Borrowed Funds
Shareholders’ Equity
Total Assets
Return on Average Assets
Return on Average Equity
Return on Tangible Equity 1
Average Earning Assets
Average Interest-Bearing Liabilities
Interest Income, Tax-Equivalent
Interest Expense
Net Interest Income, Tax-Equivalent
Tax-Equivalent Adjustment
Net Interest Margin 1
Efficiency Ratio Calculation:
Noninterest Expense
Less: Intangible Asset Amortization
Net Noninterest Expense
Net Interest Income, Tax-Equivalent
Noninterest Income
Less: Net Securities Gains
Net Gross Income, Adjusted
Efficiency Ratio
Period-End Capital Information:
Total Stockholders’ Equity (i.e. Book Value)
Book Value per Share
Intangible Assets
Tangible Book Value per Share 1
Capital Ratios:
Tier 1 Leverage Ratio
Tier 1 Risk-Based Capital Ratio
Total Risk-Based Capital Ratio
Assets Under Trust Administration
and Investment Management
1
See "Use of Non-GAAP Financial Measures" on page 4.
$
5,549
$
5,748
$
5,594
$
5,288
$
5,431
94
476
—
12,025
12,014
12,032
0.46
0.46
0.25
39
362
—
12,034
12,012
12,032
0.48
0.48
0.25
$
86
324
178
12,001
11,994
12,009
0.47
0.47
0.25
303
216
—
11,996
12,005
12,031
0.44
0.44
0.25
$
—
259
—
11,999
12,017
12,024
0.45
0.45
0.25
$
$
$
$
40,065
745,150
1,160,226
1,781,778
80,357
176,514
2,064,602
$
33,332
670,328
1,148,771
1,701,599
68,667
174,069
1,971,215
$
55,023
682,589
1,143,666
1,733,320
66,022
170,199
1,994,883
$
30,780
678,474
1,136,322
1,683,781
83,055
167,849
1,959,741
$
49,101
674,338
1,126,452
1,668,062
101,997
168,293
1,963,915
1.07%
12.51%
14.72%
1.16%
13.14%
15.50%
1.13%
13.22%
15.67%
1.09%
12.67%
15.07%
1.10%
12.80%
15.22%
$1,945,441
1,612,959
17,787
2,503
15,284
1,047
$1,852,431
1,511,634
18,168
2,643
15,525
1,000
3.13%
3.33%
$1,881,278
1,565,692
18,508
3,279
15,229
975
3.26%
$1,845,576
1,545,098
18,810
3,532
15,278
872
3.33%
$1,849,891
1,547,071
19,179
4,022
15,157
832
3.25%
$
$
$
$
13,117
(126)
12,991
15,284
6,897
(156)
22,025
$
$
$
$
12,922
(126)
12,796
15,525
6,835
(64)
22,296
$
$
$
$
12,651
(127)
12,524
15,229
6,808
(143)
21,894
$
$
$
$
13,146
(138)
13,008
15,278
6,559
(502)
21,335
$
$
$
$
12,455
(142)
12,313
15,157
6,199
—
21,356
58.98%
57.39%
57.20%
60.97%
57.66%
$ 175,825
14.62
26,495
12.42
$ 176,314
14.65
26,546
12.45
$ 171,940
14.33
26,611
12.11
$ 168,466
14.04
26,653
11.82
$ 166,385
13.87
26,752
11.64
9.10%
15.02%
16.26%
9.41%
15.20%
16.45%
9.09%
15.08%
16.34%
9.10%
14.84%
16.10%
8.95%
14.71%
15.96%
$1,045,972
$1,051,176
$1,019,702
$1,038,186
$ 973,551
22
Selected Twelve-Month Information
Dollars in thousands, except per share amounts
Share and per share amounts have been restated for the September 2012 2% stock dividend
2012
22,179
$
2011
21,933
$
2010
21,892
$
$
522
1,378
—
12,025
12,007
12,017
1.85
1.85
0.99
$ 1,997,721
172,175
$
$
1,688
523
(989)
11,999
11,970
11,982
1.83
1.83
0.96
$ 1,943,263
163,063
$
$
910
618
—
11,825
11,836
11,872
1.85
1.84
0.93
$ 1,892,324
150,377
$
1.11%
1.13%
1.16%
12.88
$ 1,881,279
1,558,864
73,273
11,957
61,316
3,894
13.45
$ 1,839,028
1,535,084
80,385
18,679
61,706
3,594
14.56
$ 1,807,763
1,512,937
88,424
23,695
64,729
3,452
3.26%
3.36%
3.58%
$
$
$
$
$
$
$
$
$
$
51,836
(517)
—
51,319
61,316
27,099
(865)
87,550
58.62%
9.28%
175,825
14.62
26,495
12.42
0.05%
0.07%
1.30%
190.37%
0.69%
0.45%
$
$
$
$
$
51,548
(510)
(1,638)
49,400
61,706
25,928
(2,795)
84,839
58.23%
8.96%
166,385
13.87
26,752
11.64
0.05%
0.08%
1.33%
197.10%
0.67%
0.41%
47,418
(271)
—
47,147
64,729
19,089
(1,507)
82,311
57.28%
8.78%
152,259
12.88
17,241
11.42
0.06%
0.11%
1.28%
300.57%
0.43%
0.26%
Net Income
Transactions Recorded in Net Income (Net of Tax):
Net Securities Gains
Net Gains on Sales of Loans
Prepayment Penalty on FHLB Advances
Period End Shares Outstanding
Basic Average Shares Outstanding
Diluted Average Shares Outstanding
Basic Earnings Per Share
Diluted Earnings Per Share
Cash Dividends Per Share
Average Assets
Average Equity
Return on Average Assets
Return on Average Equity
Average Earning Assets
Average Interest-Bearing Liabilities
Interest Income, Tax-Equivalent 1
Interest Expense
Net Interest Income, Tax-Equivalent 1
Tax-Equivalent Adjustment
Net Interest Margin 1
Efficiency Ratio Calculation 1
Noninterest Expense
Less: Intangible Asset Amortization
Prepayment Penalty on FHLB Advances
Net Noninterest Expense
Net Interest Income, Tax-Equivalent 1
Noninterest Income
Less: Net Securities Gains
Net Gross Income, Adjusted
Efficiency Ratio 1
Period-End Capital Information:
Tier 1 Leverage Ratio
Total Stockholders’ Equity (i.e. Book Value)
Book Value per Share
Intangible Assets
Tangible Book Value per Share 1
Asset Quality Information:
Net Loans Charged-off as a Percentage of Average Loans
Provision for Loan Losses as a Percentage of Average Loans
Allowance for Loan Losses as a Percentage of Period-End Loans
Allowance for Loan Losses as a Percentage of Nonperforming Loans
Nonperforming Loans as a Percentage of Period-End Loans
Nonperforming Assets as a Percentage of Total Assets
1 See "Use of Non-GAAP Financial Measures" on page 4.
23
CRITICAL ACCOUNTING POLICIES
In order to prepare our consolidated financial statements in accordance with accounting principles generally accepted in the
United States of America, we were required to make estimates and assumptions that affected the amounts reported in these
statements. There are uncertainties inherent in making these estimates and assumptions, which could materially affect our results
of operations and financial position. We consider the following to be critical accounting policies:
The allowance for loan losses: The adequacy of the allowance for loan losses is sensitive to changes in current economic
conditions that may make it difficult for borrowers to meet their contractual obligations. Any downward trend in the economy, regional
or national, may require us to increase the allowance for loan losses resulting in a negative impact on our results of operations and
financial condition at the same time that other areas of our operations, including new loan originations and assets under administration
in our trust department may also be experiencing negative pressures from the same underlying negative economic conditions.
Liabilities for retirement plans: We have a variety of pension and retirement plans. Liabilities under these plans rely on estimates
of future salary increases, numbers of employees and employee retention, discount rates and long-term rates of return on plan
investments. Changes in these assumptions due to changes in the financial markets, the economy, our own operations or applicable
law and regulation may result in material changes to our liability for postretirement expense, with consequent impact on our results
of operations and financial condition.
Valuation allowance for deferred tax assets: Accounting standards require a reduction in the carrying amount of deferred tax
assets by a valuation allowance if, based on the weight of available evidence, it is more likely than not (a likelihood of more than
50%) that some portion or all of the deferred tax assets will not be realized. The valuation allowance should be sufficient to reduce
the deferred tax asset to the amount that is more likely than not to be realized. Our analysis of the need for a valuation allowance
for deferred tax assets is, in part, based on an estimate of future taxable income.
Goodwill: Accounting standards require that goodwill be tested for impairment at a level of reporting referred to as a reporting
unit. Impairment is the condition that exists when the carrying amount of goodwill exceeds its implied fair value. An entity may
assess qualitative factors to determine whether it is more likely than not (that is, a likelihood of more than 50 percent) that the fair
value of a reporting unit is less than its carrying amount, including goodwill or apply a two-step impairment analysis. If, after assessing
the qualitative factors, it is determined that the fair value of a reporting unit is less than its carrying amount, we must perform the
two-step impairment test. The first step of the goodwill impairment test, used to identify potential impairment, compares the fair
value of a reporting unit with its carrying amount, including goodwill. The second step of the goodwill impairment test, used to
measure the amount of impairment loss, compares the implied fair value of a reporting unit's goodwill with the carrying amount of
that goodwill.
Other than temporary decline in the value of debt and equity securities: Accounting standards require that, for individual
securities classified as either available-for-sale or held-to-maturity, an enterprise shall determine whether a decline in fair value
below the amortized cost basis is other than temporary. When an other-than-temporary impairment has occurred, the amount of
the other-than-temporary impairment recognized in earnings depends on whether we intend to sell the security or whether or not
it is more likely than not will be required to sell the security before recovery of its amortized cost basis less any current-period credit
loss. If we intend to sell the security or if it is more likely than not will be required to sell the security before recovery of its amortized
cost basis less any current-period credit loss, the other-than-temporary impairment is recognized in earnings equal to the entire
difference between the investment’s amortized cost basis and its fair value at the balance sheet date. If we do not intend to sell
the security and it is not more likely than not that we will be required to sell the security before recovery of its amortized cost basis
less any current-period credit loss, the other-than-temporary impairment is separated into the amount representing the credit loss
and the amount related to all other factors. The amount of the total other-than-temporary impairment related to the credit loss is
recognized in earnings. Any significant economic downturn might result, and historically have on occasion resulted, in an other-
than-temporary impairment in securities held in our portfolio.
Valuation methods for securities: Most of the securities portfolio, which includes U.S. Treasury and agency securities, mortgage-
backed securities, collateralized mortgage obligations, municipal securities, corporate debt and equity securities are priced using
industry-standard models that consider various assumptions that include time value, yield curves, volatility factors, prepayment
speeds, default rates, loss severity, current market and contractual prices for the underlying financial instruments, as well as other
relevant economic measures. Substantially all of these assumptions are either observable in the marketplace, derived from
observable data or are supported by observable levels at which transactions are executed in the marketplace. Municipal and
corporate securities are valued using a type of matrix, or grid, pricing in which securities are benchmarked against the treasury rate
based on credit rating. These model and matrix measurements are classified as Level 2 in the fair value hierarchy.
24
The following discussion and analysis focuses on and reviews our results of operations for each of the years in the three-year
period ended December 31, 2012 and our financial condition as of December 31, 2012 and 2011. 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.
A. OVERVIEW
Summary of 2012 Financial Results
We reported net income for 2012 of $22.2 million, representing diluted earnings per share ("EPS") of $1.85, an increase of two
cents, or 1.1% from our 2011 result. Return on average equity ("ROE") for the 2012 year continued to be strong at 12.88%, although
down from the ROE of 13.45% for the 2011 year. Return on average assets ("ROA") for 2012 continued to be strong at 1.11%,
although down from ROA of 1.13% for 2011. Both decreases were principally due to our shrinking net interest margin, which led
to a slight decrease, 0.6%, in our net interest income, despite the fact that our earning assets grew and our asset quality remained
strong. The decrease in net interest income was more than offset by a 4.5% increase in our noninterest income.
Total assets were $2.023 billion at December 31, 2012, which represented an increase of $60.1 million, or 3.1%, above the
$1.963 billion level at December 31, 2011.
Stockholders' equity was $175.8 million at December 31, 2012, an increase of $9.44 million or 5.7%, from the year earlier level.
The components of the change in stockholders' equity since year-end 2011 are presented in the Consolidated Statement of Changes
in Stockholders' Equity on page 59, and are discussed in more detail in the last section of this Overview on page 27 entitled,
“Increase in Stockholder Equity.”
Regulatory capital: At period-end, we continue to exceed all current regulatory minimum capital requirements at both the
holding company and bank levels, by a substantial amount. As of December 31, 2012 both of our banks, as well as our holding
company, qualified as "well-capitalized" under federal bank regulatory guidelines. Our regulatory capital levels have consistently
remained well in excess of required minimums during recent years, despite the economic downturn, because of our continued
profitability and strong asset quality. Even if the new enhanced capital requirements as set forth in the June 2012 joint bank
regulatory release, "Basel III Notices of Proposed Rulemaking," were to go into effect as they were proposed, Arrow and its banks
would meet all of these enhanced standards. See "Current Regulatory Capital Standards" on page 48, and "Important Proposed
Changes to Regulatory Capital Standards" on page 47.
Economic recession and loan quality: During the early stages of the economic crisis in late 2008 and early 2009, our market
area of northeastern New York was relatively sheltered from the widespread collapse in real estate values and general surge in
unemployment. This may have been due, in part, to the fact that our market area had been less affected by the preceding real
estate "bubble" than other areas of the U.S. As the recession became stronger and deeper through late 2009, even northeastern
New York began to feel the impact of the worsening national economy reflected in a slow-down in regional real estate sales and
increasing unemployment rates. From year-end 2009 and through most of 2010, we experienced a very modest decline in the
credit quality of our loan portfolio, although by standard measures our portfolio continued to be significantly stronger than the average
for our peer group of U.S. bank holding companies with $1 billion to $3 billion in total assets (see page 3 for peer group information).
By year-end 2010, however, our loan quality began to stabilize, a trend that continued through 2011. During this period, although
nonperforming loans increased slightly, charge-offs decreased. Nonperforming loans were $8.0 million at December 31, 2012, an
increase of $424 thousand from year-end 2011. The ratio of nonperforming loans to period-end loans at December 31, 2012
was .69%, an increase from .67% at December 31, 2011. By way of comparison, this ratio for our peer group was 2.18% at
December 31, 2012, which was a significant improvement for the peer group from its ratio of 3.60% at year-end 2010, but still very
high when compared to the group's ratio of 1.09% at December 31, 2007. Loans charged-off (net of recoveries) against our
allowance for loan losses was a very low $550 thousand for 2012, as compared to $531 thousand for 2011. At December 31, 2012,
the allowance for loan losses was $15.3 million, representing 1.30% of total loans, an decrease of 3 basis points from December 31,
2011.
Since the onset of the financial crisis in 2008, we have not experienced significant deterioration in any of our three major loan
portfolio segments:
Commercial Loans: These loans comprise approximately 32% of our loan portfolio. Current unemployment rates in our
region are higher than in the past few years and the total number of jobs has decreased, but these trends are largely
attributable to a scaling back of local operations on the part of a few large corporations having operations in our service
area. Commercial property values have not shown significant deterioration. We update the appraisals on our nonperforming
and watched commercial properties as deemed necessary, usually when the loan is downgraded or when we perceive
significant market deterioration since our last appraisal.
Residential Real Estate Loans: These loans, including home equity loans, make up approximately 37% of our portfolio.
We have not experienced a notable increase in our foreclosure rates, primarily due to the fact that we never have originated
or participated in underwriting high-risk mortgage loans, such as so called "Alt A", "negative amortization ", "option ARM's"
or "negative equity" loans. We originate all of the residential real estate loans held in our portfolio and apply conservative
underwriting standards to all of our originations.
Automobile Loans (Primarily Through Indirect Lending): These loans comprise approximately 30% of our loan portfolio.
Throughout 2010, 2011 and 2012, we did not experience any significant change in our delinquency rate or level of charge-
offs on these loans, although both delinquencies and charge-offs did increase modestly during 2009.
25
Recent legislative developments:
(i) Dodd-Frank Act: As a result of the 2008-2009 financial crisis, the U.S. Congress passed and the President signed the
Dodd-Frank Act on July 21, 2010. While many of the Act's provisions have not had and likely will not have any direct impact on
Arrow, other provisions have impacted or likely will impact our business operations and financial results in a significant way. These
include the establishment of a new regulatory body known as the Bureau of Consumer Financial Protection. (See the discussion
on p. 9 under "The Dodd-Frank Act" regarding the likely impact on Arrow of the Bureau of Consumer Financial Protection.) Dodd-
Frank also directs the federal banking authorities to issue new capital requirements for banks and holding companies that must be
at least as strict as the pre-existing capital requirements for depository institutions and may be much more onerous. See the
discussion under "Important Proposed Changes to Regulatory Capital Standards" on page 47 of this Report. Dodd-Frank also
provided that any new issuances of trust preferred securities ("TRUPs") by bank holding companies having between $500 million
and $15 billion in assets (such as Arrow) will no longer be able to qualify as Tier 1 capital, although previously issued and outstanding
TRUPs of such bank holding companies, including Arrow's $20 million of TRUPs that are currently outstanding, will continue to
qualify as Tier 1 capital. However, if the proposed new capital rules jointly issued by the federal bank regulatory agencies in June
2012 were to be implemented as proposed, even these "grandfathered" TRUPs previously issued by small- to mid-sized financial
institutions like Arrow would be phased out from qualifying as Tier 1 capital, at a rate of 10% per year beginning in 2013. We as
well as other community and regional banks would be adversely affected by this particular treatment, which is more severe in its
impact on the capital of affected banks like ours than is required under Dodd-Frank. In any event, TRUPs, which have been an
important financing tool for community banks such as ours, can no longer be counted on as a viable source of new capital. See
the discussion on p. 9 under "The Dodd-Frank Act" regarding specific provisions of Dodd-Frank that have had, or are likely to have
particular significance to Arrow and its banks in their future operations and financial results.
(ii) Health care reform: In March 2010, comprehensive healthcare reform legislation was passed under the Patient
Protection and Affordable Care Act, as amended by the Health Care and Education Reconciliation Act of 2010 (collectively, the
"Health Reform Act"). Included among the major provisions of the Health Reform Act is a change in tax treatment of the federal
drug subsidy paid with respect to eligible retirees. The statute also contains provisions that may impact the Company's accounting
for some of its benefit plans in future periods. The exact extent of the Health Reform Act's impact, if any, cannot be determined
until final regulations are promulgated and interpretations of the Health Reform Act become available.
Liquidity and access to credit markets: We did not experience any liquidity problems or special concerns during 2012, nor
did we during 2011 or 2010. The terms of our lines of credit with our correspondent banks, the FHLBNY and the Federal Reserve
Bank have not changed (see our general liquidity discussion on page 46). In general, we rely 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
(our main liability-based sources are overnight borrowing arrangements with our correspondent banks, term credit arrangement
advances from the FHLBNY and the Federal Reserve Bank discount window). During the recent financial crisis, many financial
institutions, small and large, relied extensively on the Fed's discount window to support their liquidity positions, but we did not. We
maintain, and periodically test, a contingent liquidity plan to ensure that we can generate an adequate amount of available funds
to meet a wide variety of potential liquidity crises, including a severe crisis.
FDIC Shift From Deposit-Based to Asset-Based Insurance Premiums; Reduction in Premiums: The Dodd-Frank Act
changed the basis on which insured banks would be assessed deposit insurance premiums, which has had a beneficial effect on
the rates we pay and our overall premiums. Beginning with the second quarter of 2011, the calculation of regular FDIC insurance
premiums for insured institutions changed so as to be based on adjusted assets (as defined) rather than deposits. This had the
effect of imposing FDIC insurance fees not only on deposits but on other sources of funding as well, including short-term borrowings
and repurchase agreements. The rate, however, given the significantly larger base on which premiums would be assessed (total
assets versus insured deposits), was set at a lower percentage than the rate applicable under the old formula. Because our banks,
like most community banks, have a much higher ratio of deposits to total assets than the large banks maintain, the new lower rate
even applied to a larger base has resulted in a significant decrease in our FDIC premiums, while even with the lower rates, the
premiums paid by larger banks have generally increased.
VISA Transactions - Reversal of the Litigation Reserve: On March 28, 2008, VISA Inc. redeemed, for cash, from its member
banks, including Glens Falls National, 38.7% of the Visa Class B shares held by the member banks, using some of the proceeds
realized by Visa from the initial public offering and sale of its Class A shares just then completed. With another portion of the IPO
proceeds, Visa established a $3 billion escrow fund to cover certain, but not necessarily all, of its continuing litigation liabilities under
various antitrust claims, which its member banks would otherwise be required to bear. We maintained at year-end 2008 a $294
thousand accrual for our estimated proportional share of future Visa litigation costs, beyond the implicit reserve reflected in Visa's
book valuation of our B shares. In 2008, we did not recognize on our books any dollar value for our remaining Class B Visa shares,
in accordance with SEC guidance, in view of the fact that any future deposits by Visa into the escrow fund for covered litigation,
while simultaneously reducing our proportionate exposure as a Visa member for the litigation, would also directly reduce the dollar
value of our Class B shares.
Since the first quarter of 2008, Visa has settled several claims falling within the category of covered litigation, and from time-
to-time has deposited substantial additional amounts into the escrow fund for covered litigation. Such deposits have reduced Visa's
book value of its outstanding Class B shares proportionately. We did not recognize any income or expense after 2008 resulting
from such additional deposits by Visa into the escrow fund as it was not determinable with an appropriate level of certainty what
26
the impact was of such funding on the Company's contingent obligation beyond its Class B Visa shares to which the Company has
not recognized any economic value for these shares.
Most recently, in July 2012, Visa and MasterCard entered into a Memorandum of Understanding ("MOU") with a class of plaintiffs
to settle certain additional antitrust claims involving merchant discounts. Visa's share of this settlement also will be paid out of its
escrow fund. In light of the current state of covered litigation at Visa, which is winding down, as well as the remaining dollar amounts
in Visa's escrow fund, we determined in the second quarter 2012 to reverse the entire amount of our remaining VISA litigation-
related accrual, which was $294 thousand pre-tax. This reversal reduced our other operating expenses for the year ending December
31, 2012. We believed then, and continue to believe, that the multi-billion dollar balance that Visa maintains in its escrow fund is
substantially sufficient to satisfy the Company's contingent liability for the remaining covered litigation. The Company continues not
to recognize any economic value for its remaining shares of Visa Class B common stock.
Increase in Stockholders' Equity: At December 31, 2012, our tangible book value per share (calculated based on
stockholders' equity reduced by intangible assets including goodwill and other intangible assets) amounted to $12.42, an increase
of $0.78, or 6.7%, from December 31, 2011. Our total stockholders' equity at December 31, 2012 increased 5.7% over the year-
earlier level, and our total book value per share increased by 5.4% over the year earlier level. This increase principally reflected
the following factors: i) $22.2 million net income for the period; offset in part by, ii) cash dividends of $11.8 million; and (iii) repurchases
of our own common stock of $4.9 million. As of December 31, 2012, our closing stock price was $24.95, resulting in a trading
multiple of 2.01 to our tangible book value. From a regulatory capital standpoint, the Company and each of its subsidiary banks
also continued to remain classified as “well-capitalized” at quarter end. The Board of Directors declared and the Company paid
quarterly cash dividends of $.245 per share for the first three quarters of 2012, as adjusted for a 2% stock dividend distributed
September 27, 2012, a cash dividend of $.25 per share for the fourth quarter of 2012 and has declared a $.25 per share cash
dividend for the first quarter of 2013.
B. RESULTS OF OPERATIONS
The following analysis of net interest income, the provision for loan losses, noninterest income, noninterest expense and income
taxes, highlights the factors that had the greatest impact on our results of operations for 2012 and the prior two years.
I. NET INTEREST INCOME (Tax-equivalent Basis)
Net interest income represents the difference between interest, dividends and fees earned on loans, securities and other
earning assets and interest paid on deposits and other sources of funds. Changes in net interest income result from changes in
the level and mix of earning assets and sources of funds (volume) and changes in the yields earned and interest rates paid (rate).
Net interest margin is the ratio of net interest income to average earning assets. Net interest income may also be described as
the product of average earning assets and the net interest margin. As described in the section entitled “Use of Non-GAAP Financial
Measures” on page 4 of this Report we calculate net interest income on a tax-equivalent basis using a marginal tax rate of 35%.
CHANGE IN NET INTEREST INCOME
(Dollars In Thousands) (Tax-equivalent Basis)
Year Ended December 31,
Change From Prior Year
Interest and Dividend Income
Interest Expense
Net Interest Income
2012
$ 73,273
11,957
$ 61,316
2011
$ 80,385
18,679
$ 61,706
2010
$ 88,424
23,695
$ 64,729
2011 to 2012
%
(8.8)% $ (8,039)
(5,016)
$ (3,023)
Amount
$ (7,112)
(6,722)
(390)
(36.0)
(0.6)
Amount
$
2010 to 2011
%
(9.1)%
(21.2)
(4.7)
On a tax-equivalent basis, net interest income was $61.3 million in 2012, a decrease of $390 thousand, or .6%, from $61.7
million in 2011. This compared to an decrease of $3.0 million, or 4.7%, from 2010 to 2011. Factors contributing to the year-to-year
changes in net interest income over the three-year period are discussed in the following portions of this Section B.I.
27
In the following table, net interest income components are presented on a tax-equivalent basis. Changes between periods
are attributed to movement in either the average daily balances or average rates for both earning assets and interest-bearing
liabilities. Changes attributable to both volume and rate have been allocated proportionately between the categories.
Interest and Dividend Income:
Interest-Bearing Bank Balances
Investment Securities:
Fully Taxable
Exempt from Federal Taxes
Loans
Total Interest and Dividend Income
Interest Expense:
Deposits:
NOW Accounts
Savings Deposits
Time Deposits of $100,000 or More
Other Time Deposits
Total Deposits
Short-Term Borrowings
Long-Term Debt
Total Interest Expense
Net Interest Income
2012 Compared to 2011 Change in
Net Interest Income Due to:
2011 Compared to 2010 Change
in Net Interest Income Due to:
Volume
Rate
Total
Volume
Rate
Total
$
6
$
4
$
10
$
(58) $
(1) $
(59)
344
233
1,093
(3,479)
(141)
(5,172)
(3,135)
92
(4,079)
1,301
986
(489)
(3,614)
(1,001)
(5,163)
(2,313)
(15)
(5,652)
1,676
(8,788)
(7,112)
1,740
(9,779)
(8,039)
890
120
(305)
(520)
185
(39)
(1,628)
(1,482)
$ 3,158
(2,378)
(731)
(321)
(893)
(4,323)
(31)
(886)
(5,240)
$ (3,548) $
(1,488)
(611)
(626)
(1,413)
(4,138)
(70)
(2,514)
(6,722)
(390)
601
257
(233)
(238)
387
(22)
(2,058)
(1,693)
$ 3,433
(1,131)
(495)
(37)
(519)
(2,182)
(28)
(1,113)
(3,323)
(530)
(238)
(270)
(757)
(1,795)
(50)
(3,171)
(5,016)
$ (6,456) $ (3,023)
28
The following table reflects the components of our net interest income, setting forth, for years ended December 31, 2012, 2011
and 2010 (i) average balances of assets, liabilities and stockholders' equity, (ii) interest and dividend income earned on earning
assets and interest expense incurred on interest-bearing liabilities, (iii) average yields earned on earning assets and average rates
paid on interest-bearing liabilities, (iv) the net interest spread (average yield less average cost) and (v) the net interest margin (yield)
on earning assets. Interest income and interest rate information is presented on a tax-equivalent basis (see the discussion under
"Use of Non-GAAP Financial Measures" on page 4 of this Report). The yield on securities available-for-sale is based on the
amortized cost of the securities. Nonaccrual loans are included in average loans.
Average Consolidated Balance Sheets and Net Interest Income Analysis
(Tax-equivalent basis using a marginal tax rate of 35%)
(Dollars in Thousands)
Years Ended:
Interest-Bearing Deposits at
Banks
Investment Securities:
2012
Interest
Rate
Income/
Earned/
Expense
Paid
Average
Balance
2011
Interest
Rate
Income/
Earned/
Expense
Paid
Average
Balance
2010
Interest
Rate
Income/
Earned/
Expense
Paid
Average
Balance
$
39,783
$
108
0.27% $
37,440
$
98
0.26 % $
59,771
$
157
0.26%
Fully Taxable
465,105
9,286
2.00
452,264
12,421
2.75 %
413,212
14,734
3.57
Exempt from Federal
Taxes
Loans
Total Earning Assets
Allowance for Loan Losses
Cash and Due From Banks
Other Assets
Total Assets
Deposits:
NOW Accounts
Savings Deposits
Time Deposits of $100,000
Or More
Other Time Deposits
Total Interest-
Bearing Deposits
Short-Term Borrowings
FHLBNY Term Advances and
Other Long-Term Debt
Total Interest-
Bearing Liabilities
Demand Deposits
Other Liabilities
Total Liabilities
Stockholders’ Equity
Total Liabilities and
Stockholders’ Equity
Net Interest Income
(Tax-equivalent Basis)
Reversal of Tax
Equivalent Adjustment
Net Interest Income
Net Interest Spread
Net Interest Margin
229,105
1,147,286
1,881,279
(15,170)
30,936
100,676
$ 1,997,721
$ 726,660
437,095
107,665
212,918
9,074
54,805
73,273
3.96
4.78
3.89
3,564
1,287
2,007
3,730
0.49
0.29
1.86
1.75
0.71
0.18
1,126,065
1,839,028
(14,821)
28,844
90,212
$ 1,943,263
$ 603,965
409,398
122,897
238,865
223,259
8,982
4.02 %
200,062
58,884
80,385
5.23 % 1,134,718
4.37 % 1,807,763
(14,385)
28,717
70,229
$ 1,892,324
8,997
64,536
88,424
4.50
5.69
4.89
5,052
1,898
2,633
5,143
0.84 % $ 541,161
0.46 %
361,949
2.14 %
2.15 %
133,770
249,192
5,582
2,136
2,903
5,900
1.03
0.59
2.17
2.37
1.28
0.19
1,484,338
10,588
24,225
43
1,375,125
14,726
1.07 % 1,286,072
16,521
56,206
92
0.16 %
64,481
125
50,301
1,326
2.64
103,753
3,861
3.72 %
162,384
7,049
4.34
1,558,864
11,957
0.77
1,535,084
18,679
1.22 % 1,512,937
23,695
1.57
240,872
25,810
1,825,546
172,175
221,035
24,081
1,780,200
163,063
205,497
23,513
1,741,947
150,377
$ 1,997,721
$ 1,943,263
$ 1,892,324
61,316
61,706
64,729
(3,894)
0.21%
(3,594)
0.20 %
(3,452)
0.19%
$ 57,422
$ 58,112
$ 61,277
3.12%
3.26%
3.15 %
3.36 %
3.32%
3.58%
29
CHANGES IN NET INTEREST INCOME DUE TO RATE
YIELD ANALYSIS (Tax-equivalent basis)
2012
Yield on Earning Assets
Cost of Interest-Bearing Liabilities
Net Interest Spread
Net Interest Margin
2010
December 31,
2011
4.37% 4.89%
1.22
3.15% 3.32%
3.36% 3.58%
1.57
3.89%
0.77
3.12%
3.26%
In 2012, we experienced a decrease in net interest income from 2011. During the recent period, beginning in late 2008 and
extending up to the present, our earning assets have continued to reprice downwards at least as fast or faster than our cost of
interest bearing liabilities. Following two years of decreases in net interest income in 2005 and 2006 (during a period of rising
interest rates), we experienced four successive years of increases in net interest income from 2007 through 2010. In each of these
years, we experienced a benefit from an increase in average earning assets, although the substantial increase in net interest income
in 2008 was largely attributable to a widened margin during the earlier portion of the year, typical of a period in which interest rates
begin to fall, as our paying liabilities reprice downwards more quickly than our earning assets. From 2009 through 2012, however,
our net interest margin has been consistently under pressure and has generally declined.
The decrease in net interest income was $390 thousand, or .6%, from 2011 to 2012. Net interest income decreased $3.0
million, or 4.7%, from 2010 to 2011. In 2012, an increase in average earning assets, net of a smaller increase in average interest-
bearing liabilities (i.e., changes in volume) had a $3.2 million positive impact on net interest income, while changes in rates provided
a $3.5 million negative impact on our net interest income for the year, as yields on earning assets decreased more rapidly than
rates paid on liabilities, the latter being more constrained by the rapid approach of zero as an absolute limit on short term, no or
very low-risk rates (i.e., the "federal funds rate").
Generally, the following items have a major impact on changes in net interest income due to rate: general interest rate changes,
changes in the yield curve, the ratio of our rate sensitive assets to rate sensitive liabilities ("interest rate sensitivity gap") during
periods of interest rate changes, and changes in the level of nonperforming loans.
Impact of Interest Rate Changes
Changes in Interest Rates in Recent Years. When prevailing rates began to fall at year-end 2007, we saw an immediate impact
in the reduced cost of our deposits and these costs continued to fall in 2008 and 2009 and to a lesser extent throughout 2010, 2011
and 2012. Yields on our earning assets have also fallen since 2008, but at a different pace than our cost of funds. Initially, the
drop in our asset yields was not as significant as the decline in our deposit rates, but in recent periods (since the beginning of 2009)
the decline in yields on our earning assets has generally exceeded the decline in the cost of our deposits. As a result of these
trends, our net interest margin generally increased in late 2007 and early 2008, positively impacting our net interest income, but
since mid-2008 we, like almost all banks, have experienced a fairly steady contraction in our net interest margin.
Changes in the Yield Curve in Recent Years. An additional important aspect in recent years with regard to the effect of prevailing
interest rates on our profitability has been the changing shape in the yield curve. A positive (upward-sloping) yield curve, where
long-term rates significantly exceed short term rates, is both a more common occurrence and generally a better situation for banks,
including ours, than a flat or less upwardly-sloping yield curve. We, like many banks, typically fund longer-duration assets with
shorter-maturity liabilities, and the flattening of the yield curve directly diminishes the benefit of this strategy.
As the financial crisis deepened in the 2008-2010 period, long-term rates also decreased roughly in parity with the continuing
decreases in short-term rates, as both short- and long-term rates approached historically low levels, a goal explicitly sought by the
Federal Reserve. In recent quarters, as short-term rates have neared zero, long-term rate decreases generally have exceeded
short-term rate decreases and the yield curve has flattened somewhat. In the third quarter of 2011 and the second quarter of 2012,
the Federal Reserve undertook new measures specifically designed to reduce longer-term rates as compared to short-term rates,
in an attempt to stimulate the housing market and the economy generally. Thirty-year mortgage rates have subsequently fallen to
levels not seen in many years, if ever.
Continuing Pressure on Credit Quality. All lending institutions, even those like us who have avoided subprime lending problems
and continue to maintain high credit quality, have experienced some continuing pressure on credit quality in recent periods, and
this may continue if the national or regional economies continue to be weak or suffer a new downturn. Any credit or asset quality
erosion will negatively impact net interest income, and will reduce or possibly outweigh the benefit we may experience from the
combination of low prevailing interest rates generally and a modestly upward-sloping yield curve. Thus, no assurances can be
given on our ability to maintain or increase our net interest margin, net interest income or net income generally, in upcoming periods,
particularly as residential mortgage related borrowings have diminished across the economy and the redeployment of funds from
maturing loans and assets into similarly high yielding asset categories has become progressively more difficult. The modest up-
tick in loan demand and in the U.S. economy generally experienced during 2012 may prove transitory, in light of continuing economic
and financial woes across the rest of the developed world and stubborn fiscal pressures in the U.S.
30
Recent Pressure on Our Net Interest Margin. From mid-2008 into 2009, our net interest margin held steady at around 3.90%,
but the margin began to narrow in the last three quarters of 2009 and throughout 2010 and 2011 as the downward repricing of
paying liabilities slowed while interest earning assets continued to reprice downward at a steady rate.
Currently, our net interest margin continues to be under pressure. During the last five quarters, our margin ranged from 3.33%
to 3.13%. Even if new assets do not continue to price downward, our average yield on assets may continue to decline in future
periods as our older, higher-priced assets continue to mature and pay off at a faster rate than newer, lower-priced assets. Thus,
we may continue to experience additional margin compression in upcoming periods. That is, our average yield on assets may
decline in upcoming periods at a slightly higher rate than our average cost of deposits. In this light, no assurances can be given
that our net interest income will resume the growth it experienced in 2010 and prior years, even if asset growth continues or
increases, or that net earnings will continue to grow, if net interest income decreases more rapidly than other sources of operating
income increase.
Potential Inflation; Effect on Interest Rates and Margins. Currently, there is considerable discussion, and some disagreement,
about the possible emergence of meaningful inflation across some or all asset classes in the U.S. or other world economies. To
the extent that such inflation may occur, it is likely to be the result of persistent efforts by the Federal Reserve and other central
banks, including the European Central Bank, to significantly increase the money supply in the U.S. and western world economies,
which in the U.S. started at the onset of the crisis in 2008 and continues. The Fed has increased the U.S. money supply by setting
and maintaining the Fed funds rate at historically low levels (with consequent downward pressure on all rates), and by purchasing
massive amounts of U.S. Treasuries and other debt securities through the Federal Reserve Bank (i.e., "quantitative easing"), which
is intended in part to have the identical effect of lowering and reinforcing already low interest rates in addition to directly expanding
the supply of credit. When the second round of quantitative easing expired on June 30, 2011, the Fed elected not to continue the
program, for a variety of reasons including some concern over inflation. Instead, the Fed announced it would support economic
recovery through a new series of interest rate manipulations, dubbed "Operation Twist", under which it would reinvest the proceeds
from maturing short-term (and long-term) securities in its substantial U.S. Treasury and mortgage-backed securities portfolios into
longer-dated securities, thereby seeking to lower long-term rates (and mortgage rates), as a priority over further reductions in short-
term rates. However, in the ensuing summer months of 2012, the underlying inflation rate in the U.S., exclusive of the historically
volatile categories of fuel and food purchases, remained quite low, and the U.S. economy, though slowly improving, remained
sluggish. As a result, in September 2012, the Fed announced that it would resume quantitative easing, by embarking on a program
of purchasing $40 billion of mortgage-backed securities on a monthly basis in the market until the economy regained suitable
momentum (so-called "infinite QE"), while at the same time monitoring inflation in the economy, with a view toward taking appropriate
corrective measures if inflation increased beyond acceptable levels. As the U.S. economy continued to demonstrate weakness in
the second half of 2012, the Fed increased the level of its fixed monthly purchases of debt securities to $85 billion, approximately
half treasury bonds and the rest in mortgage-backed securities. However, there has now emerged a certain level of concern not
only about the weak U.S. economy, but also that at some point prevailing interest rates may begin to rise, along with inflation,
perhaps significant inflation, potentially damaging U.S. financial markets.
For the present, management does not anticipate near-term substantial increases in prevailing rates, short- or long-term. If
modest rate increases should occur, there is some expectation that the impact on our margins, as well as on our net interest income
and earnings, may be somewhat negative in the short run but possibly positive in the long run. Given the extraordinary forces
currently in play in the financial markets, any speculation on the likelihood of significant inflation in the near future, or the impact of
such inflation on prevailing interest rates, short- or long-term, or on the net interest margins or the net interest income of banks
such as ours, must be regarded as highly subjective. A discussion of the models we use in projecting the impact on net interest
income resulting from possible changes in interest rates vis-à-vis the repricing patterns of our earning assets and interest-bearing
liabilities is included later in this Report.
A discussion of the models we use in projecting the impact on net interest income resulting from possible changes in interest
rates vis-à-vis the repricing patterns of our earning assets and interest-bearing liabilities is included later in this report under Item
7.A., "Quantitative and Qualitative Disclosures About Market Risk".
31
CHANGES IN NET INTEREST INCOME DUE TO VOLUME
AVERAGE BALANCES
(Dollars In Thousands)
Years Ended December 31,
Change From Prior Year
Earning Assets
2012
2011
$ 1,881,279
$ 1,839,028
Interest-Bearing Liabilities
1,558,864
1,535,084
Demand Deposits
Total Assets
240,872
221,035
1,997,721
1,943,263
2011 to 2012
2010 to 2011
2010
$ 1,807,763
1,512,937
205,497
1,892,324
Amount
$
42,251
23,780
19,837
54,458
%
Amount
%
2.3% $
31,265
1.7%
1.5
9.0
2.8
22,147
15,538
50,939
1.5
7.6
2.7
Earning Assets to Total Assets
94.17%
94.64%
95.53%
2011 to 2012:
In general, an increase in average earning assets has a positive impact on net interest income. For 2012, average earning
assets increased $42.3 million or 2.3% over 2011, while average interest-bearing liabilities increased $23.8 million or 1.5%. This
combination led to a $3.2 million increase in net interest income, partially offsetting the negative impact of a 10 basis point decrease
in our net interest margin (from 3.36% to 3.26%) between the two years which resulted in a $3.5 million decrease in net interest
income.
The $42.3 million increase in average earning assets from 2011 to 2012 reflected an increase in the average balance of our
securities portfolio and the average balance of total loans from 2011 to 2012. Within the loan portfolio, our three principal segments
are residential real estate loans, automobile loans (primarily through our indirect lending program) and commercial loans. Through
all of 2012 we sold a significant portion of our residential real estate loan originations into the secondary market, leading to a
decrease in the average balance of that portfolio. The average balance of our automobile loan portfolio increased over the past
year reflecting an increase in demand for new vehicles and our pricing on these loans (which, although competitive with the rates
charged by other commercial banks, still left us at a disadvantage compared to the subsidized, below-market loan rates offered by
the financing affiliates of the automobile manufacturers). Our commercial and commercial real estate loan portfolio also experienced
growth over the past year. Overall, a significant portion of the growth in our earning assets in 2012 was in our lower yielding
investment portfolio (versus the higher yields in our loan portfolio) diminishing to a degree the financial impact of our growth in total
earning assets, which was 2.3% in 2012 (versus 1.7% in 2011).
The $23.8 million increase in average interest-bearing liabilities reflected the offsetting impact of an $109.2 million increase in
interest-bearing deposits and an $85.4 million decrease in our other borrowed funds, primarily FHLB term advances.
2010 to 2011:
For 2011, average earning assets increased $31.3 million or 1.7% over 2010, while average interest-bearing liabilities increased
$22.1 million or 1.5%. This combination had a positive impact of $3.4 million on our net interest income for the year, diminishing
in part the negative effect of the decrease in our, net interest margin, which decreased by 22 basis points (from 3.58% to 3.36%)
between the two years.
The $31.3 million increase in average earning assets from 2010 to 2011 reflected an increase in the average balance of our
securities portfolio, while the average balance of total loans actually decreased from 2010 to 2011. Through all of 2011, we sold a
substantial portion of our residential real estate loan originations leading to a decrease in the average balance of that portfolio. The
average balance of our indirect portfolio also decreased between the two years, reflecting both the weak demand for new vehicles
and our pricing on these loans (like many other banks, we could not compete with the subsidized, below-market loan rates offered
by the financing affiliates of the automobile manufacturers). Only our commercial loan portfolio experienced growth in 2011. As in
2012, most of the growth in our earning assets was in our lower yielding investment portfolio (versus the higher yields in our loan
portfolio) and such growth, in total earning assets was only 1.7% in 2011 (versus 7.1% in 2010).
The $22.1 million increase in average interest-bearing liabilities reflected the offsetting impact of an $89.1 million increase in
interest-bearing deposits and a $66.9 million decrease in our other borrowed funds, primarily FHLB term advances.
Increases in the volume of loans and deposits, as well as yields and costs by type, are discussed later in this Report under
Item 7.C. “Financial Condition.”
32
II. PROVISION FOR LOAN LOSSES AND ALLOWANCE FOR LOAN LOSSES
We consider our accounting policy relating to the allowance for loan losses to be a critical accounting policy, given the uncertainty
involved in evaluating the level of the allowance required to cover credit losses inherent in the loan portfolio, and the material effect
that such judgments may have on our results of operations. Beginning in 2010, Note 5 to our consolidated financial statements
includes all of the disclosures about our method for calculating our provision for loan losses that was formerly reported in this section
of managements’ discussion and analysis. Note 5 also provides information about impaired loans.
SUMMARY OF THE ALLOWANCE AND PROVISION FOR LOAN LOSSES
(Dollars In Thousands) (Loans, Net of Unearned Income)
Years-Ended December 31,
Period-End Loans
Average Loans
Period-End Assets
Nonperforming Assets, at Period-End:
Nonaccrual Loans:
Commercial Real Estate
Commercial Loans
Residential Real Estate Loans
Consumer Loans
Total Nonaccrual Loans
Loans Past Due 90 or More Days and
Still Accruing Interest
Restructured
Total Nonperforming Loans
Repossessed Assets
Other Real Estate Owned
Nonaccrual Investments
Total Nonperforming Assets
Allowance for Loan Losses:
Balance at Beginning of Period
Loans Charged-off:
Commercial Loans
Real Estate - Commercial
Real Estate - Residential
Consumer Loans
Total Loans Charged-off
Recoveries of Loans Previously Charged-off:
Commercial Loans
Real Estate – Commercial
Real Estate – Residential
Consumer Loans
Total Recoveries of Loans Previously Charged-off
Net Loans Charged-off
Provision for Loan Losses
Charged to Expense
Balance at End of Period
Asset Quality Ratios:
Net Charged-offs to Average Loans
Provision for Loan Losses to Average Loans
Allowance for Loan Losses to Period-end Loans
Allowance for Loan Losses to Nonperforming Loans
Nonperforming Loans to Period-end Loans
Nonperforming Assets to Period-end Assets
2012
1,172,341
1,147,286
2,022,796
2011
1,131,457
1,126,065
1,962,684
2010
1,145,508
1,134,718
1,908,336
2009
1,112,150
1,101,759
1,841,627
2008
1,109,812
1,071,384
1,665,086
$
$
2,026
1,787
2,400
420
6,633
920
483
8,036
64
970
—
9,070
15,003
(90)
(206)
(33)
(453)
(782)
23
—
—
209
232
(550)
$
$
1,503
6
2,582
437
4,528
1,662
1,422
7,612
56
460
—
8,128
14,689
(105)
—
(147)
(522)
(774)
17
—
—
226
243
(531)
2,237
2,235
94
916
814
309
901
945
4,061
4,390
810
16
4,887
58
—
—
4,945
14,014
$
$
270
—
4,660
59
53
—
$
$
4,772
13,272
$
$
(30)
—
—
(864)
(894)
5
—
—
262
267
(627)
(88)
—
(25)
(1,317)
(1,430)
14
—
6
369
389
(1,041)
2,263
50
100
1,056
3,469
457
—
3,926
64
581
400
4,971
12,401
(83)
—
(25)
(1,184)
(1,292)
38
197
2
255
492
(800)
845
845
1,302
1,783
1,671
$
15,298
$
15,003
$
14,689
$
14,014
$
13,272
0.05%
0.07%
1.30%
190.37%
0.69%
0.45%
0.05%
0.08%
1.33%
197.10%
0.67%
0.41%
0.06%
0.11%
1.28%
300.57%
0.43%
0.26%
0.09%
0.16%
1.26%
300.73%
0.42%
0.26%
0.07%
0.16%
1.20%
338.05%
0.35%
0.30%
33
ALLOCATION OF THE ALLOWANCE FOR LOAN LOSSES
(Dollars in Thousands)
Commercial
Real Estate-Commercial
Real Estate-Residential Mortgage
Automobile and Other Consumer
Unallocated
Total
2012
$
2,945
3,050
3,405
4,840
1,058
$ 15,298
$
$
2011
2010
2009
2008
2,529
3,136
3,414
4,846
1,078
15,003
$
$
2,037
3,128
3,163
5,088
1,273
14,689
$
1,304
4,000
2,954
4,901
855
$ 14,014
$
1,735
3,568
2,610
4,859
500
$ 13,272
III. NONINTEREST INCOME
The majority of our noninterest income constitutes fee income from services, principally fees and commissions from fiduciary
services, deposit account service charges, insurance commissions, and other recurring fee income. Net gains or losses on the
sale of securities available-for-sale is another category of noninterest income.
ANALYSIS OF NONINTEREST INCOME
(Dollars In Thousands)
Years Ended December 31,
Change From Prior Year
2011 to 2012
2010 to 2011
Income from Fiduciary Activities
$
6,290
$
6,113
$
5,391
2012
2011
2010
Amount
177
$
%
Amount
722
2.9 % $
Fees for Other Services to
Customers
Net Gain on Securities Transactions
Insurance Commissions
Net Gain on Sales of Loans
Other Operating Income
8,245
865
8,247
2,282
1,170
8,034
2,795
7,374
866
746
Total Noninterest Income
$ 27,099
$ 25,928
7,864
1,507
2,987
1,024
316
$ 19,089
211
(1,930)
873
1,416
424
2.6 %
(69.1)%
11.8 %
163.5 %
56.8 %
170
1,288
4,387
(158)
430
$
1,171
4.5 % $
6,839
%
13.4 %
2.2 %
85.5 %
146.9 %
(15.4)%
136.1 %
35.8 %
2012 compared to 2011: Total noninterest income in the just completed year was $27.1 million, an increase of $1.2 million, or
4.5%, from total noninterest income of $25.9 million for 2011. The total for both the 2012 and 2011 periods included net gains on
securities transactions, although this item of noninterest income decreased between the two periods, from $2.8 million to $865
thousand, a net decrease of $1.93 million. However, noninterest income from insurance commissions increased by $873 thousand,
or 11.8%, between the two periods, and our net gains on the sale of loans also increased from 2011 to 2012, from $866 thousand
to $2.28 million, a net increase of $1.41 million. All other categories of noninterest income also increased modestly between the
two periods.
Assets under trust administration and investment management at December 31, 2012 were $1.046 billion, up from the prior
year-end balance of $973.6 million. Largely as a result of such increase our income from fiduciary services for 2012 increased by
$177 thousand, or 2.9%, above the total for 2011. A significant portion of our fiduciary fees is indexed to the dollar amount of assets
under administration. Any significant downturn in the U.S. stock markets in future periods would likely have a corresponding negative
impact on our income from fiduciary activities.
Fees for other services to customers (primarily service charges on deposit accounts, revenues related to the sale of mutual
funds to our customers by third party providers, income from debit card transactions, and servicing income on sold loans) were
$8.2 million for 2012, an increase of $211 thousand, or 2.6%, from 2011. The principal cause of the increase between the two
periods was an increase in income from debit card transactions, which increased from $2.5 million for 2011 to $2.6 million for 2012.
Effective October 1, 2011 VISA announced reduced debit interchange rates and related modifications to comply with new Debit
Regulatory Requirements. This reduced rate structure has had, and will likely continue to have, a negative impact on our fee income.
However, debit card usage by our customers continues to grow which has had, and if such growth persists, will continue to have,
a positive impact on our debit card fee income. Thus, the new law's limits on debit transaction interchange fees has not had a
material adverse impact on our financial condition or results of operations since the law's enactment. This increase in income from
debit card transactions was offset, in part, by a decrease in fee income from service charges on deposit accounts.
Insurance commissions first became a significant source of noninterest income for us following our 2004 acquisition of an
insurance agency, Capital Financial Group, Inc. Capital Financial specializes in selling and servicing group health care policies as
well as life insurance. On April 1, 2010, we acquired a second insurance agency, Loomis & LaPann, Inc., which sells property and
casualty insurance to retail customers in our service area and sports insurance products to various sports organizations. In February
of 2011, we acquired our third insurance agency, the Upstate Agency, also a property and casualty insurance agency, and in August
2011 we acquired and consolidated two affiliated insurance agencies, the McPhillips Agencies, also sellers of property and casualty
insurance. All of these acquired agencies do business within the service areas of our banks. We expect that noninterest income
from insurance commissions will continue to represent a significant portion of our noninterest income in upcoming periods, both
34
absolutely and as a percentage of our total net income, as a result of our recent expansion of this line of business by acquisition,
which may continue in the future if favorable opportunities should arise.
Starting with the third quarter of 2010, we began to resell most of our newly originated residential real estate loans into the
secondary market (i.e., to "Freddie Mac"), which generates additional noninterest income in the form of net gains on sales of loans.
We are unable to predict at what rate we may continue to resell loan originations in future periods, versus holding such loans in
our own portfolio. Much depends on the volume of originations, the rates attaching thereto and the ready availability of sale thereof
into the secondary market. We generally retain servicing rights for loans originated and sold by us, which generates additional
noninterest income (fees for other services to customers). Other operating income includes net gains on the sale of other real
estate owned as well as other miscellaneous revenues.
2011 compared to 2010: Total noninterest income in 2011 was $25.9 million, an increase of $6.8 million, or 35.8%, from total
noninterest income of $19.1 million for 2010. The total for both the 2011 and 2010 periods included net gains on securities transactions
(of $2.8 million and $1.5 million, respectively). However, the expansion of our insurance agency line of business in 2011 had the
greatest impact on the increase in noninterest income between the two years. Our insurance commissions increased by $4.4 million
(or 147%) between 2010 and 2011, as we acquired three new agencies in 2011. See the more detailed discussion of our agency
acquisitions above, under "2012 Compared to 2011."
Assets under trust administration and investment management at December 31, 2011 were $973.6 million, down somewhat
from the prior year-end balance of $984.4 million. However, income from fiduciary services for 2011 increased by $722 thousand,
or 13.4%, above the total for 2010, primarily because, despite the year-end totals being lower in 2011 than in 2010, the average
dollar amount of assets under trust administration during 2011 exceeded the average dollar amount during 2010. The year-end
total of assets under administration for 2011 was lower than the year-end total for 2010 because, at the end of the third quarter of
2011, the U.S. stock markets experienced a sharp downturn. A significant portion of our fiduciary fees is indexed to the dollar
amount of assets under administration.
Fees for other services to customers were $8.0 million for 2011, an increase of $170 thousand, or 2.2%, from 2010. The
increase between the two periods was attributable to an increase in revenues derived from third-party mutual fund sales and to an
increase in income from debit card transactions, which increased from $2.3 million for 2010 to $2.5 million for 2011.
Starting with the third quarter of 2010, we began to resell most of our newly originated residential real estate loans into the
secondary market (i.e., to "Freddie Mac"), which generates additional noninterest income in the form of net gains on sales of loans.
We generally retain servicing rights for loans originated and sold by us, which generates additional noninterest income (fees for
other services to customers). Other operating income includes net gains on the sale of other real estate owned as well as other
miscellaneous revenues.
IV. NONINTEREST EXPENSE
Noninterest expense is a means of measuring the delivery cost of services, products and business activities of a company.
The key components of noninterest expense are presented in the following table.
ANALYSIS OF NONINTEREST EXPENSE
(Dollars In Thousands)
Years Ended December 31,
Change From Prior Year
2011 to 2012
2010 to 2011
Salaries and Employee Benefits
Occupancy Expense of Premises, Net
Furniture and Equipment Expense
FDIC Regular Assessment
Amortization of Intangible Assets
Prepayment Penalty on FHLB Advances
Other Operating Expense
Total Noninterest Expense
2012
$ 31,703
3,970
2011
$ 30,205
3,891
2010
$ 27,552
3,456
3,497
1,026
517
—
3,478
1,292
510
1,638
11,123
$ 51,836
10,534
$ 51,548
3,393
1,982
271
—
10,764
$ 47,418
Amount
$
1,498
79
19
(266)
7
(1,638)
589
$
288
%
Amount
2,653
5.0% $
2.0
0.5
(20.6)
1.4
—
5.6
0.6
435
85
(690)
239
1,638
(230)
4,130
$
%
9.6%
12.6
2.5
(34.8)
88.2
—
(2.1)
8.7
2012 compared to 2011: Noninterest expense for 2012 amounted to $51.8 million, an increase of $288 thousand, or .6%, from
2011. For 2012, our efficiency ratio was 58.62%. This ratio, which is a commonly used non-GAAP financial measure in the banking
industry, is a comparative measure of a financial institution's operating efficiency. The efficiency ratio (a ratio where lower is better),
as we define it, is the ratio of operating noninterest expense (excluding intangible asset amortization and the FHLB prepayment
penalty) to net interest income (on a tax-equivalent basis) plus operating noninterest income (excluding net securities gains or
losses). See the discussion of the efficiency ratio on page 4 of this Report under the heading “Use of Non-GAAP Financial Measures.”
The efficiency ratio as defined by the Federal Reserve Board and reported for banks in its "Peer Holding Company Performance
Reports" excludes net securities gains or losses from the denominator (as does our calculation), but unlike our ratio includes
intangible asset amortization in the numerator, and thus tends to result in higher ratios than our definition. Our efficiency ratios in
recent periods compared favorably to the ratios of our peer group, even as adjusted to add intangible asset amortization back into
the numerator of our ratio (i.e., into our operating noninterest expense). For 2012, our peer group ratio was 70.2%, and our ratio
(not adjusted) was 59.2%.
35
Salaries and employee benefits expense, which typically represents from 55-60% of total noninterest expense, increased by
$1.5 million, or 5.0%, from 2011 to 2012. Salary expense increased $885 thousand, or 4.3%, from 2011 primarily due to annual
salary increases. Pension costs increased $563 thousand, or 40.5% from 2011 to 2012.
The principal reason noninterest expense remained virtually unchanged from 2011 to 2012, despite the 5.0% increase between
the two years in the largest component of this measure (salaries and employee benefits), is because our FDIC assessments dropped
by $266,000 (or 20.5 percent) between the two years, and the prepayment penalty recognized by the Company in 2011 in connection
with its prepayment of FHLB advances during that year ($1.6 million), was not replicated in 2012.
Just as our FDIC assessment decreased from 2010 to 2011, it also decreased from 2011 to 2012. Beginning in the second
quarter of 2011, calculation of the FDIC's premium converted to a new method, based on adjusted assets rather than deposits.
That resulted in continuing and substantial decreases in our FDIC insurance expense beginning mid-2011 and continuing in 2012.
We continued to pay the lowest possible rate.
Other operating expense increased $589 thousand, or 5.6% from 2011. This was primarily the result of an increase of $295
thousand, or 17.8% for off-premise computer services and $245 thousand, or 28.9% increase in loan fees.
Occupancy and equipment expenses did not significantly change from 2011 to 2012.
2011 compared to 2010: Noninterest expense for 2011 amounted to $51.5 million, an increase of $4.1 million, or 8.7%, from
2010. However, the 2011 period included a $1.6 million prepayment penalty from our prepayment of $40 million of FHLB advances.
For 2011, our efficiency ratio was 58.23%. This ratio is a commonly used non-GAAP financial measure. A more detailed discussion
of this measure is set forth above under the heading "2012 compared to 2011." Our efficiency ratio in recent periods has compared
favorably to the ratios of our peer group.
The financial results for 2011 include (i) five months of operations for the McPhillips Insurance Agency, which we acquired on
August 1, 2011, (ii) eleven months of operations for Upstate Agency, which we acquired on February 1, 2011, and (iii) a full year of
operations for Loomis and LaPann, which we acquired on April 1, 2010. The results for the prior year 2010 do not reflect any
expense or income attributable to either Upstate or McPhillips, and only nine months of operations for Loomis and LaPann. All
categories of noninterest expense, including amortization, experienced increases from the acquisition of the agencies in 2011 (and
in mid-year 2010) except for FDIC and FICO assessments and the FHLB prepayment penalty. Thus, both the increase in noninterest
expense for 2011, as well as in noninterest income for the year, discussed above, reflect expenses and income attributable to the
recently acquired agencies.
Salaries and employee benefits expense increased by $2.7 million, or 9.6%, from 2010 to 2011. All full-time equivalent
employees of the agencies acquired in 2011 continued employment with us after the acquisitions and the related expense is included
in the 2011 expense total, but not the 2010 expense total.
Occupancy expense increased from 2010 to 2011. The increase was primarily attributable to increases in net rental expense,
including offices rented by the recently acquired agencies. The increase in furniture and equipment expense was primarily attributable
to data processing and equipment maintenance expenses. Arrow's banks and its subsidiaries sustained little or no physical damage
due to tropical storm Irene in August 2011 allowing us to provide uninterrupted banking and financial services to our customers.
Beginning with the second quarter of 2011, the method previously used by the FDIC to calculate insurance premiums payment
by covered banks was converted to a new method, based on adjusted assets rather than deposits. The changeover resulted in a
significant decrease in our FDIC insurance expense from 2010 to 2011.
Other operating expense remained essentially unchanged from 2010. This was the result of offsetting increases and decreases
among a variety of operating categories.
V. INCOME TAXES
The following table sets forth our provision for income taxes and effective tax rates for the periods presented.
INCOME TAXES AND EFFECTIVE RATES
(Dollars In Thousands)
Years Ended December 31,
Change From Prior Year
Provision for Income Taxes
Effective Tax Rate
2012
$ 9,661
2011
$ 9,714
2010
$ 9,754
30.3%
30.7%
30.8%
2011 to 2012
%
(0.5)% $
(1.3)
Amount
(53)
$
(0.4)%
2010 to 2011
%
(0.4)%
(0.3)
Amount
(40)
(0.1)%
The provisions for federal and state income taxes amounted to $9.7 million for both 2012 and 2011, and $9.8 million for 2010. The
effective income tax rates for 2012, 2011 and 2010 were 30.3%, 30.7% and 30.8%, respectively, with no significant change in the
effective tax rates from year to year.
36
C. FINANCIAL CONDITION
I. INVESTMENT PORTFOLIO
Investment securities are classified as held-to-maturity, trading, or available-for-sale, depending on the purposes for which
such securities are acquired and thereafter held. Securities held-to-maturity are debt securities that we have both the positive intent
and ability to hold to maturity; such securities are stated at amortized cost. Debt and equity securities that are bought and held
principally for the purpose of sale in the near term are classified as trading securities and are reported at fair value with unrealized
gains and losses included in earnings. Debt and equity securities not classified as either held-to-maturity or trading securities are
classified as available-for-sale and are reported at fair value with unrealized gains and losses excluded from earnings and reported
net of taxes in accumulated other comprehensive income or loss. During 2012, 2011 and 2010, we held no trading securities. Set
forth below is certain information about our securities available-for-sale portfolio and securities held-to-maturity portfolio.
Securities Available-for-Sale:
The following table sets forth the carrying value of our securities available-for-sale portfolio at year-end 2012, 2011 and 2010.
SECURITIES AVAILABLE-FOR-SALE
(In Thousands)
U.S. Agency Obligations
State and Municipal Obligations
Mortgage-Backed Securities - Residential
Corporate and Other Debt Securities
Mutual Funds and Equity Securities
Total
2012
$ 122,457
84,838
261,804
8,451
1,148
$ 478,698
December 31,
2011
$ 116,393
44,999
392,712
1,015
1,419
$ 556,538
$
2010
98,173
89,528
326,890
1,417
1,356
$ 517,364
In all periods, Mortgage-Backed Securities-Residential consisted solely of mortgage pass-through securities issued or
guaranteed by U.S. federal agencies. Pass-through securities provide to the investor monthly portions of principal and interest
pursuant to the contractual obligations of the underlying mortgages. Collateralized Mortgage Obligations ("CMOs") separate the
repayments on mortgage-backed securities into two or more components (tranches), where each tranche has a separate estimated
life and yield. Our practice has been to purchase only pass-through securities and CMOs that are issued or guaranteed by U.S.
federal agencies, and the tranches of CMOs that we purchase generally are those having shorter maturities. Included in our
Corporate and Other Debt Securities for each of the periods are corporate bonds that were highly rated at the time of purchase,
although in some cases the securities had been downgraded before the reporting date.
The following table sets forth the maturities of our debt securities available-for-sale portfolio as of December 31, 2012. CMOs
and other mortgage-backed securities are included in the table based on their expected average lives.
MATURITIES OF DEBT SECURITIES AVAILABLE-FOR-SALE
(In Thousands)
U.S. Agency Obligations
State and Municipal Obligations
Mortgage-Backed Securities - Residential
Corporate and Other Debt Securities
Total
Within
One
Year
28,267
28,284
19,838
—
76,389
After
1 But
Within
5 Years
94,190
53,574
224,982
6,349
379,095
After
5 But
Within
10 Years
—
1,363
16,984
1,302
19,649
After
10 Years
—
1,617
—
800
2,417
Total
122,457
84,838
261,804
8,451
477,550
37
The following table sets forth the tax-equivalent yields of our securities available-for-sale portfolio at December 31, 2012.
YIELDS ON SECURITIES AVAILABLE-FOR-SALE
(Fully Tax-Equivalent Basis)
U.S. Agency Obligations
State and Municipal Obligations
Mortgage-Backed Securities - Residential
Corporate and Other Debt Securities
Total
Within
One
Year
After
1 But
Within
5 Years
After
5 But
Within
10 Years
0.46
1.57
3.99
—
1.77
0.56
1.46
2.19
0.68
1.64
—
6.64
4.41
0.97
4.32
After
10 Years
—
7.64
—
3.11
5.91
Total
0.54
1.70
2.46
1.00
1.79
The yields on obligations of states and municipalities exempt from federal taxation were computed on a fully tax-equivalent
basis using a marginal tax rate of 35%. The yields on other debt securities shown in the table above are calculated by dividing
annual interest, including accretion of discounts and amortization of premiums, by the amortized cost of the securities at
December 31, 2012. Dividend earnings derived from equity securities were adjusted to reflect applicable federal income tax
exclusions.
At December 31, 2012 and 2011, the weighted average maturity was 2.6 and 3.0 years, respectively, for debt securities in the
available-for-sale portfolio.
At December 31, 2012, the net unrealized gains on securities available-for-sale amounted to $9.3 million. The net unrealized
gain or loss on such securities, net of tax, is reflected in accumulated other comprehensive income/loss. The net unrealized gains
on securities available-for-sale was $11.3 million at December 31, 2011. For both periods, the net unrealized gain was primarily
attributable to a decrease in market rates between the date of purchase and the balance sheet date resulting in higher valuations
of the portfolio securities.
For further information regarding our portfolio of securities available-for-sale, see Note 4 to the Consolidated Financial
Statements contained in Part II, Item 8 of this Report.
Securities Held-to-Maturity:
The following table sets forth the carrying value of our portfolio of securities held-to-maturity at December 31 of each of the
last three years.
SECURITIES HELD-TO-MATURITY
(In Thousands)
State and Municipal Obligations
Mortgage Backed Securities - Residential
Corporate and Other Debt Securities
Total
2012
December 31,
2011
$
$
183,373
55,430
1,000
239,803
$
$
149,688
—
1,000
150,688
$
$
2010
158,938
—
1,000
159,938
For information regarding the fair value of our portfolio of securities held-to-maturity at December 31, 2012, see Note 4 to the
Consolidated Financial Statements contained in Part II, Item 8 of this Report.
The following table sets forth the maturities of our portfolio of securities held-to-maturity as of December 31, 2012.
MATURITIES OF DEBT SECURITIES HELD-TO-MATURITY
(In Thousands)
State and Municipal Obligations
Mortgage Backed Securities - Residential
Corporate and Other Debt Securities
Total
Within
One Year
24,968
$
—
—
24,968
$
After 1 But
Within 5
Years
$
95,186
55,430
—
$ 150,616
After 5 But
Within 10
Years
$
$
58,862
—
—
58,862
After
10 Years
4,357
$
—
1,000
5,357
$
Total
$ 183,373
55,430
1,000
$ 239,803
38
The following table sets forth the tax-equivalent yields of our portfolio of securities held-to-maturity at December 31, 2012.
YIELDS ON SECURITIES HELD-TO-MATURITY
(Fully Tax-Equivalent Basis)
Within
One Year
After 1 But
Within 5
Years
After 5 But
Within 10
Years
After
10 Years
Total
State and Municipal Obligations
Mortgage Backed Securities - Residential
Corporate and Other Debt Securities
Total
3.15
—
—
3.15
3.21
1.22
—
2.03
4.83
—
—
4.83
5.23
—
7.00
5.56
3.77
1.22
7.00
2.91
The yields shown in the table above are calculated by dividing annual interest, including accretion of discounts and amortization
of premiums, by the amortized cost of the securities at December 31, 2012. Yields on obligations of states and municipalities
exempt from federal taxation (which constituted the entire portfolio) were computed on a fully tax-equivalent basis using a marginal
tax rate of 35%.
During 2012, 2011 and 2010, we sold no securities from the held-to-maturity portfolio nor were there any transfers to or from
the portfolio. The weighted-average maturity of the held-to-maturity portfolio was 3.2 and 4.2 years at year-end December 31,
2012 and 2011, respectively.
II. LOAN PORTFOLIO
The amounts and respective percentages of loans outstanding represented by each principal category on the dates indicated
were as follows:
a. Types of Loans
(Dollars In Thousands)
2012
2011
December 31,
2010
2009
2008
Amount
%
Amount
%
Amount
%
Amount
%
Amount
%
Commercial
Commercial Real Estate –
Construction
Commercial Real Estate –
Other
Consumer – Other
Consumer – Automobile
Residential Real Estate
$
105,536
29,149
245,177
6,684
349,100
436,695
9
2
21
1
30
37
$
99,791
11,083
232,149
6,318
322,375
459,741
9
1
21
1
28
40
Total Loans
1,172,341
100
1,131,457
100
$
97,621
7,090
214,291
6,482
334,656
485,368
1,145,508
8
1
19
1
29
42
100
$
89,222
15,336
185,582
11,981
317,854
492,175
1,112,150
8
1
17
1
29
44
$
86,872
22,525
183,676
22,870
337,311
456,558
8
2
17
2
30
41
100
1,109,812
100
Allowance for Loan Losses
(15,298)
(15,003)
(14,689)
(14,014)
(13,272)
Total Loans, Net
$ 1,157,043
$ 1,116,454
$ 1,130,819
$ 1,098,136
$ 1,096,540
Maintenance of High Quality in the Loan Portfolio: In late 2010 and through 2011, residential property values continued
to weaken in most markets, and this trend continued for most of 2012, although at year-end 2012 the decline appeared to be slowing
or even reversing itself, at least in some markets. Some analysts currently are speculating that a "bottom" may have been established
in the real estate markets, both in terms of price and quantity of transactions, but the evidence is still inconclusive. As was true
during the initial stages of the real estate collapse, indications of stability or revival in the residential and commercial real estate
markets vary significantly from market-to-market.
The weakness in the asset portfolios of many financial institutions remains a serious concern, offset somewhat by recent firming
up in some real estate markets and by the general stabilization in the equity markets in recent years, including a modest rebound
in the equities in first three quarters of 2012 reaching a high in the fourth quarter not seen since 2007. In sum, many lending
institutions large and small continue to suffer from a lingering weakness in large portions of their existing loan portfolios as well as
by limited opportunities for secure and profitable expansion of their portfolios.
For many reasons, including our conservative credit underwriting standards, we have largely avoided the negative impact on
asset quality that other banks have suffered. Through the date of this Report, we have not experienced a significant deterioration
in our loan portfolios. In general, we underwrite our residential real estate loans to secondary market standards for prime loans.
We have never engaged in subprime mortgage lending as a business line and we never extended or purchased any so-called "Alt-
A", "negative amortization", "option ARM", or "negative equity" mortgage loans. On occasion we have made loans to borrowers
39
having a FICO score of 650 or below or have had extensions of credit outstanding to borrowers who have developed credit problems
after origination resulting in deterioration of their FICO scores.
We also on occasion have extended community development loans to borrowers whose creditworthiness is below our normal
standards as part of the community support program we have developed in fulfillment of our statutorily-mandated duty to support
low and moderate-income borrowers within our service area. However, we are a prime lender and apply prime lending standards
and this, together with the fact that the service area in which we make most of our loans has not experienced as severe a decline
in property values or economic conditions generally as other parts of the U.S., are the principal reasons that we have not to date
experienced significant deterioration in our loan portfolio, including the real estate categories of our loan portfolio.
However, like all other banks we operate in an environment where identifying opportunities for secure and profitable expansion
of our loan portfolio is challenging, where competition is intense, and where margins are very tight. If the U.S. economy continues
to be weak, our region also will continue to experience stress from an economic and financial standpoint, and individual borrowers
will also continue to experience stress, as many small businesses are operating on very narrow margins and many families are
living on very tight budgets. Given our conservative underwriting standards, we may continue to experience only modest loan
portfolio growth or even no growth. Moreover, if the U.S. or our regional economy worsens, which we think unlikely but possible,
we may experience elevated charge-offs, higher provisions to our loan loss reserve, and increasing expense related to asset
maintenance and supervision.
Residential Real Estate Loans: In recent years, residential real estate and home equity loans have represented the largest
single segment of our loan portfolio (comprising approximately 37% of the entire portfolio at year-end 2012), eclipsing both indirect
loans (30% of the portfolio) and our commercial and commercial real estate loans (32%). Our gross originations for residential real
estate loans were $109.1 million, $75.0 million and $94.2 million for the years 2012, 2011, and 2010, respectively. These origination
totals have significantly exceeded the sum of repayments and prepayments in the portfolio, but we have also sold significant
quantities of originations. During the last quarter of 2008 and the first two quarters of 2009, as prevailing mortgage rates began to
decline, we sold most of our mortgage originations in the secondary market. During the second half of 2009 and the first two
quarters of 2010, for a variety of reasons, we began to retain a larger percentage of the newly originated loans in our portfolio,
selling only a relatively small portion of the originations to Freddie Mac (with further reductions in the portfolio as a result of normal
principal amortization and prepayments on pre-existing loans).
After April 2010, rates on conventional real estate mortgages continued to fall, even as demand for such mortgages (other
than refinancings) remained relatively weak. In April 2010, the national average for 30-year conventional (fixed rate) mortgage
loans was 5.21%, but by the last quarter of 2011 the national average had dropped below 4.00%, a relative decline of more than
20 percent. In response, we determined to resume selling most of our originations to Freddie Mac, amounting to $48.5 million for
2011 and $59.9 million for all of 2012. If the current low-rate environment for newly originated residential real estate loans persists,
we may continue to sell a significant portion of our loan originations and, as a result, may even experience a decrease in our
outstanding balances in this segment of our portfolio. Moreover, if our local economy or real estate market suffers further major
downturns, the demand for residential real estate loans in our service area may decrease, which also may negatively impact our
real estate portfolio and our financial performance.
Automobile Loans (primarily through indirect lending): At December 31, 2012, our automobile loans (primarily loans
originated through dealerships located primarily in the eastern region of upstate New York) represented the third largest category
of loans in our portfolio, but still a significant component of our business.
During 2012, there was a modest nation-wide resurgence in automobile sales (especially in the first quarter), due in the view
of many to an aging fleet and a modest resurgence in consumer optimism. We too saw an increase in our originations, from $154.3
million for 2011 to $194.0 million for 2012, and our outstanding balances increased.
For 2011, our originations of indirect loans were $154.3 million, a decrease of $23.6 million, or 13.3%, from the total for 2010.
Prepayments and normal amortization during the year exceeded our originations, and as a consequence the outstanding balance
of our automobile loan portfolio decreased by $12.3 million, or 3.7%, during 2011.
In 2011, net charge-offs for our automobile loans were less than our net-charge offs for the 2010 period, and net charge-offs
for 2012 were below the net charge-offs for 2011. Our experienced lending staff not only utilizes credit evaluation software tools
but also reviews and evaluates each loan individually. We believe our disciplined approach to evaluating risk has contributed to
maintaining our strong loan quality in this portfolio. However, if weakness in auto demand returns, our portfolio is likely to experience
limited, if any, overall growth, either in real terms or as a percentage of the total portfolio, regardless of whether the auto company
affiliates are offering highly-subsidized loans. Although recently somewhat improved, customer demand for vehicle loans is still
well below pre-crisis levels and if demand does not continue to improve, neither will our financial performance in this important loan
category.
Commercial, Commercial Real Estate and Construction and Land Development Loans: Over the last decade, we have
experienced moderate and occasionally strong demand for commercial and commercial real estate loans. These loan balances
have generally increased, both in dollar amount and as a percentage of the overall loan portfolio, and this segment of our portfolio
was the segment least affected by the 2008-2009 crisis. For 2012, commercial loan growth was steady as outstanding balances
increased by $36.8 million, or 10.7%, over the December 31, 2011 level. In 2011 our balances also grew over the 2010 levels,
increasing at year-end by $24.0 million, or 7.5% over the year-end 2010 amount.
Substantially all commercial and commercial real estate loans in our portfolio are extended to businesses or borrowers located
in our regional market. Many of the loans in the commercial portfolio have variable rates tied to prime, FHLBNY rates or U.S.
Treasury indices. Although on a national scale the commercial real estate market suffered a major downturn in the 2008-2009
period from which it has not yet fully recovered, we have not experienced any significant weakening in the quality of our commercial
40
loan portfolio in recent years.
It is entirely possible, however, that we may experience a reduction in the demand for such loans and/or a weakening in the
quality of our commercial and commercial real estate loan portfolio in upcoming periods. Generally, however, the corporate sector,
at least in our service area, appears to be in reasonably good financial condition at present.
The following table indicates the changing mix in our loan portfolio by including the quarterly average balances for our significant
loan products for the past five quarters. The remaining quarter-by-quarter tables present the percentage of total loans represented
by each category and the annualized tax-equivalent yield of each category.
LOAN PORTFOLIO
Quarterly Average Loan Balances
(Dollars In Thousands)
Dec 2012
Sep 2012
Jun 2012
Mar 2012
Dec 2011
Quarter Ended
Commercial and Commercial Real Estate
$
366,761
$
357,148
$
354,316
$
348,472
$
336,580
Residential Real Estate
Home Equity
Consumer Loans - Automobile
Other Consumer Loans1
Total Loans
314,583
87,124
361,723
30,035
$ 1,160,226
322,750
84,849
352,597
31,427
$ 1,148,771
327,763
82,992
332,764
82,635
340,611
81,560
346,080
32,515
$ 1,143,666
339,409
33,042
$ 1,136,322
334,561
33,140
$ 1,126,452
Percentage of Total Quarterly Average Loans
Dec 2012
Sep 2012
Jun 2012
Mar 2012
Dec 2011
Quarter Ended
Commercial and Commercial Real Estate
31.6%
Residential Real Estate
Home Equity
Consumer Loans - Automobile
Other Consumer Loans1
Total Loans
27.1
7.5
31.2
2.6
100.0%
31.1%
28.1
7.4
30.7
2.7
100.0%
31.0%
28.6
7.3
30.3
2.8
100.0%
30.7%
29.3
7.3
29.8
2.9
100.0%
29.9%
30.2
7.3
29.7
2.9
100.0%
Quarterly Tax-Equivalent Yield on Loans
Dec 2012
Sep 2012
Jun 2012
Mar 2012
Dec 2011
Quarter Ended
Commercial and Commercial Real Estate
4.91%
Residential Real Estate
Home Equity
Consumer Loans - Automobile
Other Consumer Loans1
Total Loans
5.00
3.03
4.18
6.24
4.60
5.07%
5.01
3.01
4.38
6.42
4.72
5.11%
5.15
2.99
4.50
6.39
4.82
5.36%
5.24
2.98
4.63
6.56
4.97
5.42%
5.29
2.96
4.83
6.84
5.07
1 Other Consumer Loans includes certain home improvement loans secured by mortgages. However, these same loan balances are reported as
Residential Real Estate in the table of period-end balances on page 39, captioned “Types of Loans.”
As the yield table above indicates, average rates across our portfolio have steadily declined over the last 5 quarters, in direct
response to the Fed's maintaining historically low interest rates in its attempt to revive the economy, coupled with a general moderation
of loan demand on the part of corporate and individual customers.
For the fourth quarter of 2012 the average yield on our loan portfolio declined by 47 basis points from the fourth quarter of
2011, from 5.07% to 4.60%. The decrease was exacerbated by extremely competitive pressures on rates for new commercial and
commercial real estate loans as well as automobile loans and the decreasing rate environment generally. The yields on new 30
year fixed-rate residential real estate loans (the choice of most of our mortgage customers) remained very low during the quarter,
so we continued to sell most of those originations to the secondary market, specifically, to Freddie Mac.
As average yields on the portfolio were dropping in 2012, our margins were also compressing. The decrease in average yield
on our loan portfolio of 47 basis points was 6 basis points greater than the 41 basis point decline in our average cost of deposits
from the last quarter of 2011 to the last quarter of 2012. We expect that average loan yields will continue to decline in 2013, at a
faster rate than our average cost of deposits, and that margins too may continue to diminish.
In general, the yield (tax-equivalent interest income divided by average loans) on our loan portfolio and other earning assets
has historically been impacted by changes in prevailing interest rates, as previously discussed in this Report beginning on page
30 under the heading "Impact of Interest Rate Changes." We expect that such will continue to be the case; that is, that loan yields
will continue to rise and fall with changes in prevailing market rates, although the timing and degree of responsiveness will be
influenced by a variety of other factors, including the extent of federal government and Federal Reserve participation in the home
41
mortgage market, the makeup of our loan portfolio, the shape of the yield curve, consumer expectations and preferences, and the
rate at which the portfolio expands. Additionally, there is a significant amount of cash flow from normal amortization and prepayments
in all loan categories, and this cash flow reprices at current rates as new loans are generated at the current yields. Thus, even if
prevailing rates do not fall significantly or at all in upcoming periods, our average rate on our portfolio may continue to decline as
older credits in our portfolio bearing generally higher rates continue to mature and roll over or are redeployed into lower priced
loans.
The following table indicates the respective maturities and interest rate structure of our commercial and commercial real estate
construction loans at December 31, 2012. For purposes of determining relevant maturities, loans are assumed to mature at (but
not before) their scheduled repayment dates as required by contractual terms. Demand loans and overdrafts are included in the
“Within 1 Year” maturity category. Most of the commercial construction loans are made with a commitment for permanent financing,
whether extended by us or unrelated third parties. The maturity distribution below reflects the final maturity of the permanent
financing.
b. Maturities and Sensitivities of Loans to Changes in Interest Rates
(In Thousands)
Commercial
Commercial Real Estate - Construction
Total
Fixed Interest Rates
Variable Interest Rates
Total
Within
1 Year
$ 34,071
16,699
$ 50,770
9,591
$
41,179
$ 50,770
After 1
But Within
5 Years
$
$
$
$
63,458
717
64,175
31,752
32,424
64,176
After
5 Years
8,007
$
11,733
$ 19,740
$ 19,345
394
$ 19,739
Total
$ 105,536
29,149
$ 134,685
$ 60,688
73,997
$ 134,685
COMMITMENTS AND LINES OF CREDIT
Stand-by letters of credit represent extensions of credit granted in the normal course of business, which are not reflected in
the financial statements at a given date because the commitments are not funded at that time. As of December 31, 2012, our total
contingent liability for standby letters of credit amounted to $10.9 million. In addition to these instruments, we also have issued
lines of credit to customers, including home equity lines of credit, commitments for residential and commercial construction loans
and other personal and commercial lines of credit, which also may be unfunded or only partially funded from time-to-time. Commercial
lines, generally issued for a period of one year, are usually extended to provide for the working capital requirements of the borrower.
At December 31, 2012, we had outstanding unfunded loan commitments in the aggregate amount of approximately $198.4 million.
c. Risk Elements
1. Nonaccrual, Past Due and Restructured Loans
The amounts of nonaccrual, past due and restructured loans for the past five years are presented in the table on page 33 under
the heading "Summary of the Allowance and Provision for Loan Losses".
Loans are placed on nonaccrual status either due to the delinquency status of principal and/or interest or a judgment by
management that the full repayment of principal and interest is unlikely. Loans secured by home equity lines of credit are put on
nonaccrual status when 120 days past due; residential real estate loans when 150 days past due; commercial and commercial real
estate loans are evaluated on a loan-by-loan basis and are placed on nonaccrual status when 90 days past due if the full collection
of principal and interest is uncertain. Under the Uniform Retail Credit Classification and Account Management Policy established
by banking regulators, fixed-maturity consumer loans not secured by real estate must generally be charged-off no later than when
120 days past due. Loans secured with non-real estate collateral in the process of collection are charged-down to the value of the
collateral, less cost to sell. Open-end credits, residential real estate loans and commercial loans are evaluated for charge-off on
a loan-by-loan basis when placed on nonaccrual status. We had no material commitments to lend additional funds on outstanding
nonaccrual loans at December 31, 2012. Loans past due 90 days or more and still accruing interest are those loans which were
contractually past due 90 days or more but because of expected repayments, were still accruing interest.
The balance of loans 30-89 days past due totaled $8.5 million at December 31, 2012 and represented 0.72% of loans outstanding
at that date, as compared to approximately $6.7 million, or 0.59% of loans at December 31, 2011. These non-current loans at
December 31, 2012 were composed of approximately $3.2 million of consumer loans, principally indirect automobile loans, $2.7
million of residential real estate loans and $2.6 million of commercial and commercial real estate loans.
Prior to June 2011, banking regulators excluded modified consumer loans from the amount financial institutions were required
to report as restructured loans. Beginning with the second quarter of 2011, all modified loans, as defined by generally accepted
accounting principles, are reported as restructured loans in compliance with modified terms, unless the restructured loan is on
nonaccrual status and is included with the reported amount of nonaccrual loans.
We evaluate nonaccrual loans over $250 thousand and all troubled debt restructured loans individually for impairment. All our
impaired loans are measured based on either (i) the present value of expected future cash flows discounted at the loan's effective
interest rate, (ii) the loan's observable market price or (iii) the fair value of the collateral, less cost to sell, if the loan is collateral
dependent. We determine impairment for collateralized loans based on the fair value of the collateral less estimated cost to sell.
For other loans, impairment is determined by comparing the recorded value of the loan to the present value of the expected cash
42
flows, discounted at the loan's effective interest rate. We determine the interest income recognition method for impaired loans on
a loan-by-loan basis. Based upon the borrowers' payment histories and cash flow projections, interest recognition methods include
full accrual or cash basis. Our method for measuring all other loans is described in detail in Notes 2 and 5 to the consolidated
financial statements.
Beginning in 2011, the loan note to the consolidated financial statements (beginning on page 70) now contains the detailed
information on modified loans and impaired loans, that was formerly described in this section.
2. Potential Problem Loans
On at least a quarterly basis, we apply an internal credit quality rating system to commercial loans that are either past due or
fully performing but exhibit certain characteristics that could reflect a potential weakness. Loans are placed on nonaccrual status
when the likely amount of future principal and interest payments are expected to be less than the contractual amounts, even if such
loans are not 90 days past due.
Periodically we review the loan portfolio for evidence of potential problem loans. Potential problem loans are loans that are
currently performing in accordance with contractual terms, but where known information about possible credit problems of the
borrower causes doubt about the ability of the borrower to comply with the loan payment terms and may result in disclosure of such
loans as nonperforming at some time in the future. Through our on-going credit monitoring, we consider loans which, in our internal
classification system, are classified as substandard but continue to accrue interest to be potential problem loans. At December 31,
2012, we identified 175 commercial loans totaling $24.5 million as potential problem loans. At December 31, 2011, we identified
171 commercial loans totaling $20.9 million as potential problem loans. Factors such as payment history, value of supporting
collateral, and personal or government guarantees led us to conclude that the current risk exposure on these loans did not warrant
accounting for the loans as nonperforming. Although in a performing status as of year-end, these loans exhibited certain risk factors,
which have the potential to cause them to become nonperforming at some point in the future.
The overall level of our performing loans that demonstrate characteristics of potential weakness from time-to-time is for the
most part dependent on economic conditions in northeastern New York State, which in turn are generally impacted at least in part
by economic conditions in the U.S. On both the regional and national level, economic conditions are generally improved over the
2009-2010 period, but are much weaker than was the case in 2007 and earlier periods. If weak or stagnant economic conditions
persist, potential problems loans likely will increase.
3. Foreign Outstandings - None
4. Loan Concentrations
The loan portfolio is well diversified. There are no concentrations of credit that exceed 10% of the portfolio, other than the
general categories reported in the preceding Section C.II.a. of this Item 7. For further discussion, see Note 1 to the Consolidated
Financial Statements in Part II, Item 8 of this Report.
5. Other Real Estate Owned and Repossessed Assets
Other real estate owned ("OREO") primarily consists of real property acquired in foreclosure. OREO is carried at fair value
less estimated cost to sell. We establish allowances for OREO losses, which are determined and monitored on a property-by-
property basis and reflect our ongoing estimate of the property's estimated fair value less costs to sell. For all periods, all OREO
was held for sale. Repossessed assets for each of the five years in the table below consist of motor vehicles.
Distribution of OREO and Repossessed Assets
(In Thousands)
Single Family 1 - 4 Units
Commercial Real Estate
Other Real Estate Owned, Net
Repossessed Assets
Total OREO and Repossessed Assets
2012
$ 552
418
970
64
$ 1,034
December 31,
2010
$ — $
—
—
58
58
$
2009
53
—
53
59
$ 112
2011
$ 310
150
460
56
$ 516
2008
$ 581
—
581
64
$ 645
The following table summarizes changes in the net carrying amount of OREO for each of the periods presented.
Schedule of Changes in OREO
(In Thousands)
Balance at Beginning of Year
Properties Acquired Through Foreclosure
Transfer of Bank Property
Sales
Balance at End of Year
2012
$ 460
950
—
(440)
$ 970
2011
$ — $
409
150
(99)
$ 460
2010
53
—
—
(53)
$ — $
2009
$ 581
54
—
(582)
53
2008
89
$
581
—
(89)
$ 581
There was no allowance for OREO losses at year-end 2012, 2011 or 2010. We started 2012 with five properties in OREO.
During 2012, we acquired seven and sold all five properties in inventory at the beginning of the year. For 2011, we started the year
43
with no properties in OREO. During 2011, we acquired five new OREO properties as a result of foreclosure, transferred-in a former
branch building owned by us, and sold one property, with the net result that we held five properties in OREO at year-end 2011,
having an aggregate carrying amount as listed in the above table. During 2010, we did not acquire any properties through foreclosure
and we sold the one property remaining at the end of 2009. We started 2009 with four properties in OREO. During 2009 we
acquired one new property and sold all four properties in inventory at the beginning of that year. We started 2008 with one property
in OREO. During the year we acquired four more and sold one, ending 2008 with four properties.
III. SUMMARY OF LOAN LOSS EXPERIENCE
The information required in this section is presented in the discussion of the "Provision for Loan Losses and Allowance for
Loan Losses" in Part II Item 7.B.II. beginning on page 33 of this Report, including:
• Charge-offs and Recoveries by loan type
•
•
Factors that led to the amount of the Provision for Loan Losses
Allocation of the Allowance for Loan Losses by loan type
The percent of loans in each loan category is presented in the table of loan types in the preceding section on page 39 of this report.
IV. DEPOSITS
The following table sets forth the average balances of and average rates paid on deposits for the periods indicated.
AVERAGE DEPOSIT BALANCES
(Dollars In Thousands)
Year Ended December 31,
2012
2011
2010
Demand Deposits
NOW Accounts
Savings Deposits
Time Deposits of $100,000 or More
Other Time Deposits
Total Deposits
Average
Balance
$
240,872
726,660
437,095
107,665
212,918
$ 1,725,210
Rate
Average
Balance
Rate
Average
Balance
—% $
—% $
221,035
603,965
409,398
122,897
238,865
$ 1,596,160
0.49
0.29
1.86
1.75
0.61
205,497
541,161
361,949
133,770
249,192
$ 1,491,569
0.84
0.46
2.14
2.15
1.07
Rate
—%
1.03
0.59
2.17
2.37
1.28
During 2012 average deposit balances increased by $129.1 million, or 8.1%, over the average for 2011. The increase was
generated from our pre-existing branch network.
During 2011 average deposit balances increased by $104.6 million, or 7.0%, over the average for 2010. The increase was
generated from our pre-existing branch network.
During 2010 average deposit balances increased by $127.9 million, or 9.4%, over the average for 2009. The increase was
generated from our pre-existing branch network, although we did open a new branch in Queensbury, New York during the year.
We did not sell or close any branches during the covered period, 2010-2012, although we did move our Salem branch to a
larger and more accessible location. We did not hold any brokered deposits during 2012, 2011 and 2010.
The following table presents the quarterly average balance by deposit type for each of the most recent five quarters.
DEPOSIT PORTFOLIO
Quarterly Average Deposit Balances
(Dollars In Thousands)
Demand Deposits
NOW Accounts
Savings Deposits
Time Deposits of $100,000 or More
Other Time Deposits
Total Deposits
Dec 2012
Sep 2012
$
249,176
798,513
444,603
95,742
193,744
$ 1,781,778
$
258,632
685,212
446,450
102,230
209,075
$ 1,701,599
Quarter Ended
Jun 2012
Mar 2012
Dec 2011
$
233,650
733,600
431,896
111,766
222,408
$ 1,733,320
$
221,738
688,982
425,247
121,112
226,702
$ 1,683,781
$
222,988
672,426
415,603
125,679
231,366
$ 1,668,062
Fluctuations in balances of our NOW accounts and time deposits of $100,000 or more are largely the result of municipal deposit
fluctuations. Municipal deposits on average represent 24% to 32% of our total deposits. Municipal deposits are typically placed
44
in NOW accounts and time deposits of short duration. Many of our municipal deposit relationships are subject to annual renewal,
by formal or informal agreements.
In general, there is a seasonal pattern to municipal deposits starting with a low point during July and August. Account balances
tend to increase throughout the fall and into the winter months from tax deposits and receive an additional boost at the end of March
from the electronic deposit of state funds. In addition to these seasonal fluctuations within types of accounts, the overall level of
municipal deposit balances fluctuates from year-to-year as some municipalities move their accounts in and out of our banks due
to competitive factors. Often, the balances of municipal deposits at the end of a quarter are not representative of the average
balances for that quarter.
For a variety of reasons, including the seasonality of municipal deposits, we typically experience little net growth or a small
contraction in average deposit balances in the first quarter of each calendar year, significant growth in the second quarter, contraction
in the third quarter and substantial growth in the fourth quarter. Deposit balances followed this general pattern for 2012, enhanced
by the addition of new municipal account relationships throughout the year. We also experienced growth in our non-municipal
account balances, primarily in NOW accounts and money market savings accounts.
We typically experience a shift within the mix of deposit categories during periods of significant interest rate increases or
decreases. During periods of falling rates and very low rates, such as the period from mid-2007 through the end of 2012, depositors
tend to transfer maturing time deposits to nonmaturity interest-bearing deposit products. This was our experience during 2012. At
December 31, 2012 time deposits represented 16.4% of total deposits, down from 21.5% at December 31, 2011. This year-end
2012 level for time deposits was the lowest level since June 30, 2004, when the ratio was 22.5%, and compares to a high ratio of
40.8% at June 30, 2000. We expect this shift from time deposits to nonmaturity deposit products to continue, although perhaps at
a slower pace, if deposit rates remain at their current extraordinarily low levels.
The total quarterly average balances as a percentage of total deposits are illustrated in the table below.
Percentage of Total Quarterly Average Deposits
Quarter Ended
Demand Deposits
NOW Accounts
Savings Deposits
Time Deposits of $100,000 or More
Other Time Deposits
Total Deposits
Dec 2012
14.0%
44.8
24.9
5.4
10.9
100.0%
Sep 2012
15.2%
40.3
26.2
6.0
12.3
100.0%
Jun 2012 Mar 2012
13.2%
40.9
25.3
7.2
13.4
100.0%
13.5%
42.3
24.9
6.5
12.8
100.0%
Dec 2011
13.4%
40.3
24.9
7.5
13.9
100.0%
Time deposits of $100,000 or more are to a large extent comprised of municipal deposits and are typically obtained on a
competitive bid basis.
Quarterly Cost of Deposits
Quarter Ended
Demand Deposits
NOW Accounts
Savings Deposits
Time Deposits of $100,000 or More
Other Time Deposits
Total Deposits
Dec 2012
—%
Sep 2012
—%
Jun 2012 Mar 2012
—%
—%
Dec 2011
—%
0.43
0.25
1.54
1.34
0.48
0.39
0.28
1.79
1.63
0.54
0.54
0.31
2.05
1.94
0.68
0.62
0.34
2.02
2.03
0.76
0.76
0.39
2.03
2.10
0.85
In general, rates paid by us on various types of deposit accounts are influenced by the rates being offered or paid by our
competitors, which in turn are influenced by prevailing interest rates in the economy as impacted from time-to-time by the actions
of the Federal Reserve Bank. There typically is a time lag between the Federal Reserve’s actions undertaken to influence rates
and the actual repricing of our deposit liabilities, although this lag is normally shorter than the lag between Federal Reserve rate
actions and the repricing of our loans and other earning assets.
As demonstrated in the table above, we like all insured depository institutions experienced a steady decrease in the cost of
our deposits in each of the past 5 quarters mirroring and continuing the protracted period of falling interest rates extending from
mid-2007 through the end of 2012. Although some maturing time deposits will continue to reprice at lower rates in forthcoming
periods, the favorable reduction in the cost of deposits may not continue since most of our time deposits have already repriced to
current rates and the rates on our nonmaturity deposit balances have already been reduced to (or nearly to) the lowest sustainable
levels.
We do not use brokered deposits as a regular funding source and there were not any such balances carried during 2012, 2011
or 2010.
45
The maturities of time deposits of $100,000 or more at December 31, 2012 are presented below. (In Thousands)
Maturing in:
Under Three Months
Three to Six Months
Six to Twelve Months
2014
2015
2016
2017
2018
Total
$
$
19,864
13,559
15,824
24,508
6,707
4,943
6,523
1,447
93,375
V. SHORT-TERM BORROWINGS
Overnight Advances from the Federal Home Loan Bank of New York,
Federal Funds Purchased and Securities Sold Under Agreements to Repurchase:
Balance at December 31
Maximum Month-End Balance
Average Balance During the Year
Average Rate During the Year
Rate at December 31
Other Short-Term Borrowings:
Balance at December 31
Maximum Month-End Balance
Average Balance During the Year
Average Rate During the Year
Rate at December 31
Average Aggregate Short-Term Borrowing Rate During the Year
2012
2011
2010
$ 41,678
41,678
24,225
$ 68,293
93,988
54,750
$ 51,581
67,772
63,082
0.18%
0.25%
0.17%
0.23%
$
— $
—
—
—%
—%
0.18%
— $
2,211
1,456
—%
—%
0.16%
0.20%
0.19%
1,633
2,077
1,399
—%
—%
0.19%
D. LIQUIDITY
Our liquidity is measured by our ability to access cash when we need it at a reasonable cost. We must be capable of meeting
expected and unexpected obligations to our customers at any time. Given the uncertain nature of customer demands as well as
the need to maximize earnings, we must have available reasonably priced sources of funds, on- and off-balance sheet, that can
be accessed quickly in time of need.
Overnight investments in federal funds sold, interest bearing bank balances at the Federal Reserve Bank, and cash flow from
investment securities and loans, both from normal repayment cash-flows and prepayments, and the ability to quickly pledge a
substantial portion of our available marketable investment securities and loans to obtain funds, represent our primary sources of
available operating liquidity. 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. Our securities available-for-sale portfolio was $478.7 million at year-end
2012. Due to the potential for volatility in market values, we are not able to assume that large quantities of such securities could
be sold at short notice at their carrying value, if needed immediately for liquidity purposes. But, if market conditions are favorable
resulting in unrealized gains in the available-for-sale portfolio, we may pursue modest sales of such securities conducted in an
orderly fashion to provide for anticipated future liquidity needs.
In addition to liquidity from short-term investments, investment securities and loans, we have supplemented available operating
liquidity with additional off-balance sheet sources such as federal funds lines of credit and credit lines with the Federal Home Loan
Bank of New York ("FHLBNY"). We have established federal funds lines of credit with three correspondent banks totaling $30
million, but did not draw on those lines during 2012.
Through our borrowing relationship with the FHLBNY, we have pledged collateral, including mortgage-backed securities and
residential mortgage loans. Our unused borrowing capacity at the FHLBNY for both overnight and term advances was $61.8 at
December 31, 2012. During 2012, we used the overnight facility for a short period. The average balance of these overnight advances
was $6.0 million for 2012.
The average balance in other short-term borrowings for 2011 consisted entirely of treasury, tax and loan balances at the Federal
Reserve Bank of New York against which we could borrow on a short-term basis, but by year-end 2011 the Federal Reserve had
canceled this program.
We measure and monitor our liability needs as a ratio of liquid assets to total short-term and potentially volatile liabilities,
including the availability of dependable borrowing sources. At December 31, 2012, our basic liquidity ratio was 8.8% of total assets,
or $177 million, well above our minimum ratio as defined in policy of 4%, or $81 million of total assets at December 31, 2012. In
addition, we have identified brokered certificates of deposit as an appropriate off-balance sheet source of funding accessible in a
relatively short time period. We have not utilized brokered CDs to raise funds in recent years.
46
Also, our 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" borrowings which we maintain for contingency liquidity purposes.
At December 31, 2012, the amount available under this facility was $268.8 million, but there were no advances then outstanding.
Based on the level of overnight funds investments, available liquidity from our investment securities portfolio, cash flow from
our loan portfolio, our stable core deposit base and our significant borrowing capacity, we believe that our available operating and
contingency liquidity is sufficient to meet funding needs that may arise in upcoming periods in connection with any reasonably likely
events or occurrences.
During the past several quarters, our liquidity position has been strong, as depositors and investors in the wholesale funding
markets have shown no hesitations on placing or maintaining their funds with our banks. In addition, management has consciously
maintained a strong liquidity position by emphasizing its short maturity asset portfolios, including cash and due from banks, as
opposed to investments in longer-term assets which might generate slightly higher returns. The financial markets have been
challenging for many financial institutions, and in the view of many, lack of liquidity has been as great a problem as capital shortage.
As a result, liquidity premiums have widened and many banks have experienced certain liquidity constraints, including substantially
increased pricing to retain deposit balances. Because of Arrow's favorable credit quality and strong balance sheet, Arrow has not
experienced any significant liquidity constraints through the date of this Report and has not been forced to pay premium rates to
obtain retail deposits or other funds from any source.
E. CAPITAL RESOURCES AND DIVIDENDS
Important Proposed Changes to Regulatory Capital Standards
The Dodd-Frank Act directed U.S. bank regulators to promulgate new capital standards, which when adopted by regulators,
must be at least as strict (i.e., must establish minimum capital levels that are at least as high) for banking organizations on a
consolidated basis as the regulatory capital standards for U.S. insured depository financial institutions at the time Dodd-Frank was
enacted in 2010.
The regulators, acting jointly, in June 2012, issued proposed new capital rules for U.S. banking organizations that aimed at
implementing these Dodd-Frank capital requirements. These proposed rules were also intended to coordinate U.S. bank capital
standards with the current drafts of the Basel III proposed international capital standards and would result in significantly more
stringent standards upon full implementation than are now in place for U.S. financial institutions.
On November 9, 2012, the U.S. federal bank regulators announced that they would not implement their proposed new capital
rules on the previously suggested effective date of January 1, 2013. Since this announcement, the regulatory authorities have
been in the process of reviewing comments and concerns about the proposed new rules, which may be revised and re-issued by
the regulators, perhaps in proposed form. However, no specific guidance was provided as of the end of 2012 regarding any planned
revisions.
The following is a summary of the proposed new capital rules, as issued in June of 2012:
In general, the proposed new rules expand the risk-weighting categories of assets from 4 to 8 (although there are several other
super-weighted categories for high-risk assets that are generally not held by community banks like us). The proposed rules also
are more restrictive in their definitions of what qualify as capital components and set new, higher minimum capital ratios. Importantly,
the June 2012 proposed rules require community banks like us to begin amortizing the trust preferred securities (TRUPs) held on
our books as of May 19, 2010, over a 10-year period commencing in 2013, even though such TRUPs generally were accorded
“grandfathered” status under Dodd-Frank itself (i.e., would be eligible in their entirety for Tier 1 capital treatment until maturity or
redemption). Any such early amortization of TRUPs may present substantial additional difficulties for community banks, like us,
that are and will remain well capitalized but would prefer not have to seek additional capital in what are currently very tight capital
markets, to replace their amortized TRUPs, as the price of continuing to grow their asset portfolios.
For community banks, such as ours, the proposed new rules would add a new capital ratio, a "common equity tier 1 capital
ratio." The primary difference between this ratio and the current tier 1 leverage ratio is that only common equity will qualify as tier
1 capital under the new ratio. The new common equity tier 1 capital ratio also will include unrealized securities gains and losses
as part of both capital and assets. In addition to setting higher minimum capital ratios, the June 2012 proposed new rules, as part
of their general thrust in requiring enhanced capital for all banks, would introduce a new concept, a so-called "capital conservation
buffer" (set at 2.5% under the proposed rules), which must be added to each of the proposed new minimum capital ratios (which
by themselves are somewhat higher than the current minimum ratios). When, during economic downturns, an institution's capital
begins to erode, the first deductions from a regulatory perspective would be taken against the conservation buffer; to the extent
that buffer should erode below the required level, the bank would not necessarily be required to replace the capital deficit immediately
but would face restrictions on paying dividends and other negative consequences until it did so. The following table compares the
minimum capital ratios under the June 2012 proposed rules, including the 2.5% capital conservation buffer, with the current well-
capitalized ratios:
47
Capital Ratios
Comparison of Proposed Minimum Ratios (including the buffer) to
Current Well-Capitalized Ratios
Capital Ratio
Common Equity Tier 1 Capital Ratio
Tier 1 Leverage Ratio
Tier 1 Risk-Based Capital Ratio
Total Risk-Based Capital Ratio
Proposed
Minimum (with
2.5% buffer)
Current Well-
Capitalized
7.00%
6.50%
8.50%
10.50%
N/A
5.00%
6.00%
10.00%
The changes in the proposed new rules that would have the largest impact on our regulatory capital position, at the holding
company and the bank level, include:
• the possible phase-out over 10 years of TRUPs as Tier 1 capital for mid-sized banks such as Arrow (see the discussion
in the section "Recent Legislative Developments--The Dodd-Frank Act" on page 9, above, and the discussion below
under “Current Regulatory Capital Standards”);
• a risk-weighting scheme for residential real estate loans based on loan to value ratios;
• weighting nonperforming loans at 150% versus 100% at present; and
• a requirement to include unrealized gains or losses on available-for-sale securities, net of tax, as a component of
capital.
We note that if the proposed new capital rules issued in June 2012 had been effective on December 31, 2012, as initially
planned, our capital ratios would have exceeded each of the proposed minimums, including the capital conservation buffer.
Because of the uncertainty surrounding the proposed new capital and liquidity requirements, we are not able to predict at this
time the standards that may become applicable to Arrow under those rules, as they may be revised and implemented in the future,
or the impact that these new rules may have on Arrow. The new standards are likely to require significantly higher minimum levels
of capital for U.S. financial institutions than the current standards require.
Current Regulatory Capital Standards
The discussion and disclosure below on regulatory capital is qualified in its entirety by reference to the fact that, as discussed
above, the content and impact of the capital standards to be implemented under the Dodd-Frank Act are currently not known.
Regulatory Capital: The following discussion of capital focuses on regulatory capital ratios, as defined and mandated for
financial institutions by federal bank regulatory authorities. Regulatory capital, although a financial measure that is not provided
for or governed by GAAP, nevertheless has been exempted by the SEC from the definition of "non-GAAP financial measures" in
the SEC's Regulation G governing disclosure by registered companies of non-GAAP financial measures. Thus, certain information
which is generally required to be presented in connection with our disclosure of non-GAAP financial measures need not be provided,
and has not been provided, for the regulatory capital measures discussed below.
Current Capital Standards: Our holding company and our subsidiary banks are currently subject to two sets of regulatory
capital measures, risk-based capital guidelines and a leverage ratio test. The risk-based guidelines assign risk weightings to all
assets and certain off-balance sheet items of financial institutions, which generally results in a substantial discounting of low-risk
or risk-free assets, that is, a significant dollar amount of such assets disappears from the balance sheet. The guidelines then
establish an 8% minimum ratio of qualified total capital to risk-weighted assets. At least half of total capital must consist of "Tier 1"
capital, which comprises common equity and common equity equivalents, retained earnings, a limited amount of permanent preferred
stock and (for holding companies) a limited amount of trust preferred securities (see the discussion below on these securities), less
intangible assets, net of associated deferred tax liabilities. Up to half of total capital may consist of so-called "Tier 2" capital,
comprising a limited amount of subordinated debt, other preferred stock, certain other instruments and a limited amount of the
allowance for loan losses.
The second regulatory capital measure, the leverage ratio test, establishes minimum limits on the ratio of Tier 1 capital to total
tangible assets, without risk weighting (i.e, discounting). For top-rated companies, the minimum leverage ratio currently is 4%, but
lower-rated or rapidly expanding companies may be required by bank regulators to meet substantially higher minimum leverage
ratios. Federal banking law mandates certain actions to be taken by banking regulators for financial institutions that are deemed
undercapitalized as measured under regulatory capital guidelines. The law establishes five levels of capitalization for financial
institutions ranging from "well-capitalized” (the highest ranking) to "critically undercapitalized" (the lowest ranking). Federal banking
law also ties the ability of banking organizations to engage in certain types of non-banking financial activities to such organizations'
continuing to qualify as "well-capitalized" under these standards.
48
Capital Ratios: The table below sets forth the capital ratios of our holding company and subsidiary banks, Glens Falls National
and Saratoga National, as of December 31, 2012:
Capital Ratios:
Tier 1 Leverage Ratio
Tier 1 Risk-Based Capital Ratio
Total Risk-Based Capital Ratio
9.1%
15.0%
16.3%
Arrow
8.8%
14.9%
16.2%
GFNB
SNB
9.4%
13.8%
15.1%
At December 31, 2012 our holding company and both banks exceeded the minimum capital ratios established by the currently
applicable regulatory guidelines, and qualified as "well-capitalized", the highest category, in the capital classification scheme set
by federal bank regulatory agencies (see the further discussion under "Supervision and Regulation" in Part I Item 1.C. of this Report).
As referenced above, based on the Dodd-Frank Act capital standard statutory directives and the pending Dodd-Frank capital
standard regulations, there is considerable current speculation in banking and financial circles that bank regulatory capital guidelines
will likely be adjusted in forthcoming periods so as to require a greater degree of capital protection against sudden financial stress
within banks. However, there is no consensus on what these enhanced capital standards will look like or over what period they
will be imposed on the banking sectors.
Capital Components; Dividends; Stock Repurchases
Stockholders' Equity: Stockholders' equity was $175.8 million at December 31, 2012, an increase of $9.4 million, or 5.7%, from
the prior year-end. The most significant positive changes to stockholders' equity included (a) net income of $22.2 million, (b) equity
received from our various stock-based compensation plans of $3.3 million, offset, in part by (d) a net retirement plan losses reflected
as a component of other comprehensive income of $584 thousand, (e) cash dividends of $11.8 million, and (f) purchases of our
own common stock of $4.9 million.
Trust Preferred Securities Under Dodd-Frank: In each of 2003 and 2004, we issued $10 million of trust preferred securities
(TRUPs) in a private placement. Under the Federal Reserve Board's pre-existing rules on regulatory capital, TRUPs typically would
qualify as Tier 1 capital for bank holding companies such as ours 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, trust preferred securities issued by Arrow on or after the
grandfathering date set forth in Dodd-Frank (May 19, 2010) will no longer qualify as Tier 1 capital under bank regulatory capital
guidelines; however, our TRUPs outstanding prior to the grandfathering cutoff date set forth in Dodd-Frank (May 19, 2010) may
continue to qualify as Tier 1 capital until maturity or redemption. However, as stated above, the proposed new capital rules, if
adopted in the form proposed in June of 2012, would impose a “phase-out” of such qualification for our previously issued trust
preferred securities.
Dividends: The source of funds for the payment of stockholder dividends by our holding company consists primarily of dividends
declared and paid to the holding company by our bank subsidiaries. In addition to indirect regulatory limitations on payments of
dividends by our holding company (i.e., the need to maintain adequate regulatory capital), there are statutory limitations applicable
to the payment of dividends by our bank subsidiaries to our holding company. As of December 31, 2012, under this statutory
limitation, the maximum amount that could have been paid by the bank subsidiaries to the holding company, without special regulatory
approval, was approximately $27.3 million. The ability of our holding company and our banks to pay dividends in the future is and
will continue to be influenced by regulatory policies, capital guidelines and applicable laws.
See Part II, Item 5, "Market for the Registrant's Common Equity and Related Stockholder Matters and Issuer Purchases of
Equity Securities" for a recent history of our cash dividend payments.
Stock Repurchase Program: In November 2011, the Board of Directors approved a $5.0 million stock repurchase program,
effective January 1, 2012 (the 2012 program), under which management was authorized, in its discretion, to repurchase from time
to time during 2012, in the open market or in privately negotiated transactions, up to $5 million of Arrow common stock, to the extent
management believed the Company's stock was reasonably priced and such repurchases appeared to be an attractive use of
available capital and in the best interests of stockholders. As of December 31, 2012, approximately $3.3 million had been used
under the 2012 Program to repurchase shares. In December 2012, the Board of Directors authorized a similar $5.0 million stock
repurchase program, effective for calendar year 2013.
F. OFF-BALANCE SHEET ARRANGEMENTS
In the normal course of operations, we may engage in a variety of financial transactions or arrangements, including derivative
transactions or arrangements, that in accordance with generally accepted accounting principles are not recorded in the financial
statements, or are recorded in amounts that differ from the notional amounts. These transactions or arrangements involve, to
varying degrees, elements of credit, interest rate, and liquidity risk. Such transactions or arrangements may be used by us or our
customers for general corporate purposes, such as managing credit, interest rate, or liquidity risk or to optimize capital, or may be
used by us or our customers to manage funding needs.
We have no off-balance sheet arrangements that are reasonably likely to have a material current or future effect on our financial
condition, revenues or expenses, results of operations, liquidity or capital expenditures. As of December 31, 2012, we had no
derivative securities, including interest rate swaps, credit default swaps, or equity puts or calls, in our investment portfolio.
49
G. CONTRACTUAL OBLIGATIONS (In Thousands)
Contractual Obligation
Long-Term Debt Obligations:
Federal Home Loan Bank Advances 1
Junior Subordinated Obligations
Issued to Unconsolidated
Subsidiary Trusts 2
Operating Lease Obligations 3
Obligations under Retirement Plans 4
Total
Payments Due by Period
Total
Less Than
1 Year
1-3 Years
3-5 Years
More Than
5 Years
$
30,000
$
10,000
$
20,000
$
— $
—
20,000
3,080
51,583
$ 104,663
—
618
3,179
13,797
—
1,158
6,668
27,826
$
$
$
—
732
6,607
7,339
20,000
572
35,129
55,701
$
1 See Note 10 to the Consolidated Financial Statements in Item 8 of this Report for additional information on Federal Home Loan
Bank Advances, including call provisions.
2 See Note 10 to the Consolidated Financial Statements in Item 8 of this Report for additional information on Junior Subordinated
Obligations Issued to Unconsolidated Subsidiary Trusts (trust preferred securities).
3 See Note 18 to the Consolidated Financial Statements in Item 8 of this Report for additional information on our Operating Lease
Obligations.
4 See Note 13 to the Consolidated Financial Statements in Item 8 of this Report for additional information on our Retirement Plans
50
H. FOURTH QUARTER RESULTS
We reported net income of $5.5 million for the fourth quarter of 2012, an increase of $118 thousand, or 2.2%, from the fourth
quarter of 2011. Diluted earnings per common share for the fourth quarter of 2012 were $.46, an increase of $.01, or 2.2%, from
the $.45 amount for the fourth quarter of 2011. The net change in earnings was primarily affected by the following: (a) a $127
thousand increase in tax-equivalent net interest income, (b) a $698 thousand increase in noninterest income, (c) a $105 thousand
decrease in the provision for loan losses, (d) a $662 thousand increase in noninterest expense, and (e) a $65 thousand decrease
in the provision for income taxes. The factors contributing to these quarter-to-quarter changes are included in the discussion of
the year-to-year changes in net income set forth elsewhere in this Item 7., specifically, in Section B., "Results of Operations," above,
as well as in the Company's Current Report on Form 8-K, as filed with the SEC on January 22, 2013, incorporating by referenced
the Company's earnings release for the fiscal year ended December 31, 2012.
SELECTED FOURTH QUARTER FINANCIAL INFORMATION
(Dollars In Thousands, Except Per Share Amounts)
Interest and Dividend Income
Interest Expense
Net Interest Income
Provision for Loan Losses
Net Interest Income after Provision for Loan Losses
Noninterest Income
Noninterest Expense
Income Before Provision for Income Taxes
Provision for Income Taxes
Net Income
SHARE AND PER SHARE DATA:
Weighted Average Number of Shares Outstanding:
Basic
Diluted
Basic Earnings Per Common Share
Diluted Earnings Per Common Share
Cash Dividends Per Common Share
AVERAGE BALANCES:
Assets
Earning Assets
Loans
Deposits
Stockholders’ Equity
SELECTED RATIOS (Annualized):
Return on Average Assets
Return on Average Equity
Net Interest Margin 1
Net Charge-offs to Average Loans
Provision for Loan Losses to Average Loans
For the Quarters Ended
December 31,
$
$
$
2012
16,740
2,503
14,237
175
14,062
6,897
13,117
7,842
2,293
5,549
12,014
12,032
0.46
0.46
0.25
$
$
2011
18,347
4,022
14,325
280
14,045
6,199
12,455
7,789
2,358
5,431
12,017
12,024
0.45
0.45
0.25
$ 2,064,602
1,945,441
1,160,226
1,781,778
176,514
$ 1,963,915
1,849,891
1,126,452
1,668,062
168,293
1.07%
12.51%
3.13%
0.04%
0.06%
1.10%
12.80%
3.25%
0.07%
0.10%
1 Net Interest Margin is the ratio of tax-equivalent net interest income to average earning assets. (See “Use of Non-GAAP Financial
Measures” on page 4).
51
SUMMARY OF QUARTERLY FINANCIAL DATA (Unaudited)
The following quarterly financial information for 2012 and 2011 is unaudited, but, in the opinion of management, fairly presents
the results of Arrow.
SELECTED QUARTERLY FINANCIAL DATA
(In Thousands, Except Per Share Amounts)
Total Interest and Dividend Income
Net Interest Income
Provision for Loan Losses
Net Securities Gains
Income Before Provision for Income Taxes
Net Income
Basic Earnings Per Common Share
Diluted Earnings Per Common Share
Total Interest and Dividend Income
Net Interest Income
Provision for Loan Losses
Net Securities Gains
Income Before Provision for Income Taxes
Net Income
Basic Earnings Per Common Share
Diluted Earnings Per Common Share
2012
First
Quarter
$ 17,938
14,406
280
502
7,539
5,288
0.44
0.44
Second
Quarter
$ 17,533
14,254
240
143
8,171
5,594
0.47
0.47
Third
Quarter
$ 17,168
14,525
150
64
8,288
5,748
0.48
0.48
Fourth
Quarter
$ 16,740
14,237
175
156
7,842
5,549
0.46
0.46
2011
First
Quarter
$ 19,891
14,554
220
542
7,635
5,281
0.44
0.44
Second
Quarter
$ 19,556
14,581
170
482
8,468
5,849
0.49
0.49
Third
Quarter
$ 18,997
14,652
175
1,771
7,755
5,372
0.45
0.45
Fourth
Quarter
$ 18,347
14,325
280
—
7,789
5,431
0.45
0.45
Item 7A. Quantitative and Qualitative Disclosures About Market Risk
In addition to credit risk in our loan portfolio and liquidity risk, discussed earlier, our business activities also generate market
risk. Market risk is the possibility that changes in future market rates (interest rates) or prices (fees for products and services) will
make our position less valuable. The ongoing monitoring and management of interest rate and market risk is an important component
of our 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 our asset/liability profile
based upon estimated market risk sensitivity, policy limits and overall market interest rate levels and trends. We have not made
use of derivatives, such as interest rate swaps, in our risk management process.
Interest rate risk is the most significant market risk affecting us. Interest rate risk is the exposure of our net interest income to
changes in interest rates. Interest rate risk is directly related to the different maturities and repricing characteristics of interest-
bearing assets and liabilities, as well as to the risk of prepayment of loans and early withdrawal of time deposits, and the fact that
the speed and magnitude of responses to interest rate changes varies by product.
The ALCO utilizes the results of a detailed and dynamic simulation model to quantify the estimated exposure of net interest
income to sustained interest rate changes. While ALCO routinely monitors simulated net interest income sensitivity over a rolling
two-year horizon, it also utilizes additional tools to monitor potential longer-term interest rate risk, including periodic stress testing
involving hypothetical sudden and significant interest rate spikes.
Our standard simulation model attempts to capture the impact of changing interest rates on the interest income received and
interest expense paid on all interest-sensitive assets and liabilities reflected on our consolidated balance sheet. This sensitivity
analysis is 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, and a repricing of interest-bearing assets and liabilities at their earliest reasonably predictable repricing date. We normally
apply a parallel and pro rata shift in rates over a 12 month period. However, at year-end 2012 the targeted federal funds rate
remained where it had been since late 2009, a range of 0 to .25%, with assurances from the Fed that prevailing rates would remain
at or near their current historically low rates at least through year-end 2014. Moreover, our average cost of deposits for 2012 had
decreased to 0.71%. Thus, for purposes of our decreasing rate simulation, we applied a hypothetical 100 basis point downward
52
shift in interest rates for the long end of the yield curve with hypothetical short-term rate decreases equal to the lesser of 100 basis
points or such lower rate decrease required to reach zero percent.
Applying the simulation model analysis as of December 31, 2012, a 200 basis point increase in interest rates demonstrated a
2.6% decrease in net interest income, and a 100 basis point/zero limit decrease in interest rates demonstrated a 1.1% decrease
in net interest income. These amounts were well within our ALCO policy limits. Historically there has existed an inverse relationship
between changes in prevailing rates and our net interest income, reflecting the fact that our liabilities and sources of funds generally
reprice more quickly than our earning assets. However, when prevailing interest rates are already extremely low, as is the case at
present, a further decline in prevailing rates may not produce the otherwise expected increase in net interest income, even over a
relatively short time horizon, because as noted above, further decreases in rates with respect to liabilities (deposits) may be
significantly impeded by the absolute lower boundary of the zero rate, whereas further decreases in asset rates are not, as a
technical matter at least, subject to the same absolute lower boundary and thus assets may more fully, if more slowly, reprice
downward in response to general rate declines than liabilities. Even in the short run, rate decreases may not be beneficial to income.
This explains the anomalous result of our simulation model, above, i.e., that over the indicated time horizon of 12 months,
an assumed increase in prevailing rates projects a decrease in our net interest income, as might normally be expected (due to
assets repricing more slowly than liabilities), while at the same time, an assumed decrease in prevailing rates also projects a
decrease, if a smaller decrease, in our net interest income, presumably due to the zero rate boundary factor.
Moreover, if the impact of rate change on our income is projected over a longer time horizon, e.g., two years or longer, it
might be expected that a decrease in prevailing rates would have a greater negative impact on our income, as compared to the
short-term result, as assets reprice downward in full response, while liabilities do not further reprice but remain trapped by the
absolute zero rate boundary. On the other hand, an increase in prevailing rates would have a much less negative impact over the
longer term, and perhaps even a neutral or positive impact, on our net interest income, as our asset portfolios eventually reprice
upward fully to match the repricing of our liabilities. However, other factors may play a significant role in any analysis of the impact
of rising rates on our income, including a possible softening of loan demand and/or slowing of the economy that might be expected
to accompany any general rate rise.
The preceding sensitivity analysis does not represent a forecast on our part and should not be relied upon as being indicative
of expected operating results.
We continue to believe that, in a normalized rate environment, any downturn in prevailing interest rates will generally have a
short-term positive impact on our net interest margin and net interest income, which would be mitigated or perhaps reversed over
the mid- to longer-term of ensuing rate decreases. We also believe an upturn in prevailing rates will generally have a short-term
negative impact on our margin and net interest income, which again would likely be mitigated or perhaps reversed as rates continue
to rise over the medium- or long-term. We believe that, whether rates are generally increasing, decreasing or stable, changes in
the slope of the yield curve will also affect net interest income and the net interest margin. Other things being equal, a more sharply
sloping (upward) yield curve will generally have a positive impact on our net interest income and interest margin, whereas a flattening
yield curve will generally have a negative impact. We are not able to predict with certainty what the magnitude of these effects
taken together-that is, changes in rates, plus changes in the yield curve-would be in any particular case, especially if changes in
rate and curve, taken independently, would normally work against each other (e.g., lower rates, combined with a flattening yield
curve).
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, we 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.
53
Item 8. Financial Statements and Supplementary Data
The following audited consolidated financial statements and unaudited supplementary data are submitted herewith:
Reports of Independent Registered Public Accounting Firm
Financial Statements:
Consolidated Balance Sheets as of December 31, 2012 and 2011
Consolidated Statements of Income for the Years Ended December 31, 2012, 2011 and 2010
Consolidated Statements of Comprehensive Income for the Years Ended December 31, 2012, 2011 and 2010
Consolidated Statements of Changes in Stockholders' Equity for the Years Ended December 31, 2012, 2011 and 2010
Consolidated Statements of Cash Flows for the Years Ended December 31, 2012, 2011 and 2010
Notes to Consolidated Financial Statements
Report of Independent Registered Public Accounting Firm
The Board of Directors and Stockholders
Arrow Financial Corporation:
We have audited the accompanying consolidated balance sheets of Arrow Financial Corporation and subsidiaries (the Company)
as of December 31, 2012 and 2011, and the related consolidated statements of income, comprehensive income, changes in
stockholders’ equity and cash flows for each of the years in the three-year period ended December 31, 2012. These consolidated
financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these
consolidated financial statements based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States).
Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements
are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures
in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable
basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position
of Arrow Financial Corporation and subsidiaries as of December 31, 2012 and 2011, and the results of their operations and their
cash flows for each of the years in the three year period ended December 31, 2012, in conformity with U.S. generally accepted
accounting principles.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the
Company’s internal control over financial reporting as of December 31, 2012, based on criteria established in Internal Control –
Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO), and our report
dated March 15, 2013, expressed an unqualified opinion on the effectiveness of the Company’s internal control over financial
reporting.
/s/ KPMG LLP
Albany, New York
March 15, 2013
54
Report of Independent Registered Public Accounting Firm
The Board of Directors and Stockholders
Arrow Financial Corporation:
We have audited Arrow Financial Corporation and subsidiaries’ (the Company) internal control over financial reporting as of
December 31, 2012, based on criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring
Organizations of the Treadway Commission (COSO).The Company’s management is responsible for maintaining effective internal
control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in
the accompanying Management’s Report. Our responsibility is to express an opinion on the Company’s internal control over
financial reporting based on our audit.
We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States).
Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control
over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control
over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating
effectiveness of internal control based on the assessed risk. Our audit also included performing such other procedures as we
considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.
A company's internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability
of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted
accounting principles. A company's internal control over financial reporting includes those policies and procedures that (1) pertain
to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets
of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial
statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are
being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable
assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that
could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections
of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes
in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
In our opinion, Arrow Financial Corporation and subsidiaries maintained, in all material respects, effective internal control over
financial reporting as of December 31, 2012, based on criteria established in Internal Control—Integrated Framework issued by
the Committee of Sponsoring Organizations of the Treadway Commission (COSO).
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the
consolidated balance sheets of Arrow Financial Corporation and subsidiaries as of December 31, 2012 and 2011, and the related
consolidated statements of income, comprehensive income, changes in stockholders’ equity, and cash flows for each of the years
in the three-year period ended December 31, 2012, and our report dated March 15, 2013 expressed an unqualified opinion on
those consolidated financial statements.
/s/ KPMG LLP
Albany, New York
March 15, 2013
55
ARROW FINANCIAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(In Thousands, Except Share and Per Share Amounts)
ASSETS
Cash and Due From Banks
Interest-Bearing Deposits at Banks
Investment Securities:
Available-for-Sale
Held-to-Maturity (Approximate Fair Value of $248,252 at
December 31, 2012 and $159,059 at December 31, 2011)
Federal Home Loan Bank and Federal Reserve Bank Stock
Loans
Allowance for Loan Losses
Net Loans
Premises and Equipment, Net
Other Real Estate and Repossessed Assets, Net
Goodwill
Other Intangible Assets, Net
Accrued Interest Receivable
Other Assets
Total Assets
LIABILITIES
Noninterest-Bearing Deposits
NOW Accounts
Savings Deposits
Time Deposits of $100,000 or More
Other Time Deposits
Total Deposits
Short-Term Borrowings
Federal Home Loan Bank Term Advances
Junior Subordinated Obligations Issued to Unconsolidated Subsidiary Trusts
Accrued Interest Payable
Other Liabilities
Total Liabilities
STOCKHOLDERS’ EQUITY
Preferred Stock, $5 Par Value; 1,000,000 Shares Authorized
Common Stock, $1 Par Value; 20,000,000 Shares Authorized
(16,416,163 Shares Issued at December 31, 2012 and
16,094,277 Shares Issued at December 31, 2011)
Additional Paid-in Capital
Retained Earnings
Unallocated ESOP Shares (102,890 Shares at December 31, 2012 and
117,502 Shares at December 31, 2011)
Accumulated Other Comprehensive Loss
Treasury Stock, at Cost (4,288,617 Shares at December 31, 2012 and
4,213,470 shares at December 31, 2011)
Total Stockholders’ Equity
Total Liabilities and Stockholders’ Equity
December
31, 2012
December
31, 2011
$
37,076
11,756
$
29,598
14,138
478,698
556,538
239,803
5,792
1,172,341
(15,298)
1,157,043
28,897
1,034
22,003
4,492
5,486
30,716
$ 2,022,796
150,688
6,722
1,131,457
(15,003)
1,116,454
22,629
516
22,003
4,749
6,082
32,567
$ 1,962,684
$
247,232
758,287
442,363
93,375
189,898
1,731,155
41,678
30,000
20,000
584
23,554
1,846,971
$
232,038
642,521
416,829
123,668
228,990
1,644,046
68,293
40,000
20,000
1,147
22,813
1,796,299
—
—
16,416
218,650
26,251
(2,150)
(8,462)
16,094
207,600
23,947
(2,500)
(6,695)
(74,880)
175,825
$ 2,022,796
(72,061)
166,385
$ 1,962,684
See Notes to Consolidated Financial Statements.
56
ARROW FINANCIAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(In Thousands, Except Per Share Amounts)
Years Ended December 31,
2011
2010
2012
INTEREST AND DIVIDEND INCOME
Interest and Fees on Loans
Interest on Deposits at Banks
Interest and Dividends on Investment Securities:
Fully Taxable
Exempt from Federal Taxes
Total Interest and Dividend Income
INTEREST EXPENSE
NOW Accounts
Savings Deposits
Time Deposits of $100,000 or More
Other Time Deposits
Federal Funds Purchased and
Securities Sold Under Agreements to Repurchase
Federal Home Loan Bank Advances
Junior Subordinated Obligations Issued to
Unconsolidated Subsidiary Trusts
Total Interest Expense
NET INTEREST INCOME
Provision for Loan Losses
NET INTEREST INCOME AFTER PROVISION FOR
LOAN LOSSES
NONINTEREST INCOME
Income From Fiduciary Activities
Fees for Other Services to Customers
Insurance Commissions
Net Gain on Securities Transactions
Net Gain on Sales of Loans
Other Operating Income
Total Noninterest Income
NONINTEREST EXPENSE
Salaries and Employee Benefits
Occupancy Expenses, Net
FDIC Assessments
Prepayment Penalty on FHLB Advances
Other Operating Expense
Total Noninterest Expense
INCOME BEFORE PROVISION FOR INCOME TAXES
Provision for Income Taxes
NET INCOME
Average Shares Outstanding:
Basic
Diluted
Per Common Share:
Basic Earnings
Diluted Earnings
$ 54,511
108
$ 58,599
99
$ 64,283
157
9,269
5,491
69,379
3,564
1,287
2,007
3,730
22
729
618
11,957
57,422
845
12,402
5,691
76,791
5,052
1,898
2,633
5,143
74
3,295
584
18,679
58,112
845
14,701
5,831
84,972
5,582
2,136
2,903
5,900
124
6,458
592
23,695
61,277
1,302
56,577
57,267
59,975
6,290
8,245
8,247
865
2,282
1,170
27,099
31,703
7,467
1,026
—
11,640
51,836
31,840
9,661
$ 22,179
6,113
8,034
7,374
2,795
866
746
25,928
30,205
7,369
1,292
1,638
11,044
51,548
31,647
9,714
$ 21,933
5,391
7,864
2,987
1,507
1,024
316
19,089
27,552
6,849
1,982
—
11,035
47,418
31,646
9,754
$ 21,892
12,007
12,017
11,970
11,982
11,836
11,872
$
1.85
1.85
$
1.83
1.83
$
1.85
1.84
Share and Per Share Amounts have been restated for the September 2012 2% stock dividend.
See Notes to Consolidated Financial Statements.
57
ARROW FINANCIAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(In Thousands)
Years Ended December 31,
2011
$ 21,933
2010
$ 21,892
2012
$ 22,179
(661)
(522)
(1,340)
(245)
1,013
(12)
(1,767)
$ 20,412
4,741
(1,688)
(3,701)
(161)
602
(65)
(272)
$ 21,661
1,514
(910)
(1,093)
146
672
(112)
217
$ 22,109
Net Income
Other Comprehensive Income (Loss), Net of Tax:
Unrealized Securities Holding (Losses) Gains Arising During the Period
Reclassification Adjustment for Net Securities Gains Included in Net Income
Net Retirement Plan Loss
Net Retirement Plan Prior Service (Cost) Credit
Amortization of Net Retirement Plan Actuarial Loss
Accretion of Net Retirement Plan Prior Service Credit
Other Comprehensive (Loss) Income
Comprehensive Income
See Notes to Consolidated Financial Statements.
58
ARROW FINANCIAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY
(In Thousands, Except Share and Per Share Amounts)
Accumu-
lated
Other
Com-
prehensive
Income
(Loss)
Unallo-
cated
ESOP
Shares
Treasury
Stock
Total
(6,640) $ (67,800) $ 140,818
21,892
—
Balance at December 31, 2009
Net Income
Other Comprehensive (Loss) Income
3% Stock Dividend (455,113 Shares)
Cash Dividends Paid, $.93 per Share 1
Stock Options Exercised
(52,662 Shares)
Shares Issued Under the Directors’ Stock
Plan (5,587 Shares)
Shares Issued Under the Employee Stock
Purchase Plan (19,564 Shares)
Shares Issued for Dividend Reinvestment
Plans (66,177 Shares)
Stock-Based Compensation Expense
Tax Benefit for Disposition of
Stock Options
Purchase of Treasury Stock
(135,812 Shares)
Acquisition of Subsidiary (26,240 Shares)
Acquisition by ESOP of Arrow Stock
(40,890 Shares)
Allocation of ESOP Stock (17,616 Shares)
Common
Stock
$ 15,170
—
—
456
—
—
—
—
—
—
—
—
—
—
—
Balance at December 31, 2010
$ 15,626
Additional
Paid-In
Capital
Retained
Earnings
$ 178,192
—
$ 24,100
21,892
—
9,962
—
—
(10,418)
(10,997)
352
101
310
1,163
299
105
—
459
—
—
—
—
—
—
—
—
—
—
125
$ 191,068
—
$ 24,577
$
(2,204) $
—
—
—
—
—
—
—
—
—
—
—
—
(1,000)
328
$
(2,876) $
—
217
—
—
—
—
—
—
—
—
—
—
—
—
—
—
446
48
165
552
—
—
217
—
(10,997)
798
149
475
1,715
299
105
(3,347)
(3,347)
223
682
—
(1,000)
—
453
(6,423) $ (69,713) $ 152,259
—
Balance at December 31, 2010
$ 15,626
$ 191,068
$ 24,577
$
(2,876) $
(6,423) $ (69,713) $ 152,259
Net Income
Other Comprehensive (Loss) Income
3% Stock Dividend (468,765 Shares)
Cash Dividends Paid, $.96 per Share 1
Stock Options Exercised
(72,802 Shares)
Shares Issued Under the Directors’ Stock
Plan (7,456 Shares)
Shares Issued Under the Employee Stock
Purchase Plan (20,484 Shares)
Shares Issued for Dividend Reinvestment
Plans (76,447 Shares)
Stock-Based Compensation Expense
Tax Benefit for Disposition of
Stock Options
Purchase of Treasury Stock
(251,962 Shares)
Acquisition of Subsidiary (221,517 Shares)
Allocation of ESOP Stock (18,216 Shares)
Balance at December 31, 2011
$ 16,094
—
—
—
—
—
—
—
—
—
—
—
—
376
$
(2,500) $
—
(272)
—
—
—
—
—
—
—
—
—
—
—
—
—
—
21,933
(272)
—
(11,448)
708
1,413
71
192
734
—
—
175
474
1,796
354
51
(6,039)
1,986
(6,039)
5,261
—
428
(6,695) $ (72,061) $ 166,385
—
—
—
468
—
—
21,933
—
10,647
—
—
(11,115)
(11,448)
—
—
—
—
—
—
—
—
—
705
104
282
1,062
354
51
—
3,275
—
—
—
—
—
—
—
—
52
$ 207,600
—
$ 23,947
59
ARROW FINANCIAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY, Continued
(In Thousands, Except Share and Per Share Amounts)
Balance at December 31, 2011
Net Income
Other Comprehensive (Loss) Income
2% Stock Dividend (321,886 Shares) 2
Cash Dividends Paid, $.99 per Share 1
Stock Options Exercised
(96,471 Shares)
Shares Issued Under the Directors’ Stock
Plan (7,226 Shares)
Shares Issued Under the Employee Stock
Purchase Plan (20,687 Shares)
Shares Issued for Dividend Reinvestment
Plans (74,260 Shares)
Stock-Based Compensation Expense
Tax Benefit for Disposition of
Stock Options
Purchase of Treasury Stock
(199,323 Shares)
Acquisition of Subsidiaries (9,356 Shares)
Allocation of ESOP Stock (16,629 Shares)
Common
Stock
$ 16,094
—
—
322
—
—
—
—
—
—
—
—
—
—
Balance at December 31, 2012
$ 16,416
Additional
Paid-In
Capital
Retained
Earnings
$ 207,600
—
$ 23,947
22,179
—
7,738
—
1,152
104
279
1,086
424
68
—
140
—
(8,060)
(11,815)
—
—
—
—
—
—
—
—
59
$ 218,650
—
$ 26,251
Accumu-
lated
Other
Com-
prehensive
Income
(Loss)
Unallo-
cated
ESOP
Shares
Treasury
Stock
Total
$
(2,500) $
—
—
—
—
—
—
—
—
—
—
—
—
350
$
(2,150) $
—
(6,695) $ (72,061) $ 166,385
22,179
(1,767)
—
(1,767)
—
—
—
—
—
—
—
—
—
—
—
—
—
—
(11,815)
953
2,105
71
205
736
—
—
175
484
1,822
424
68
(4,877)
(4,877)
93
233
—
409
(8,462) $ (74,880) $ 175,825
—
1 Cash dividends paid per share have been adjusted for the September 2012 2% stock dividend.
2 Included in the shares issued for the 2% stock dividend in 2012 were treasury shares of 83,824 and unallocated ESOP shares of 2,017.
See Notes to Consolidated Financial Statements.
60
ARROW FINANCIAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Dollars in Thousands)
Cash Flows from Operating Activities:
Net Income
Adjustments to Reconcile Net Income to Net Cash Provided by Operating Activities:
Provision for Loan Losses
Depreciation and Amortization
Allocation of ESOP Stock
Gains on the Sale of Securities Available-for-Sale
Losses on the Sale of Securities Available-for-Sale
Loans Originated and Held-for-Sale
Proceeds from the Sale of Loans Held-for-Sale
Net Gains on the Sale of Loans
Net (Gain) Loss on the Sale of Premises and Equipment,
Other Real Estate Owned and Repossessed Assets
Contributions to Pension Plans
Deferred Income Tax (Benefit) Expense
Shares Issued Under the Directors’ Stock Plan
Stock-Based Compensation Expense
Net Decrease in Other Assets
Net Increase (Decrease) in Other Liabilities
Net Cash Provided By Operating Activities
Cash Flows from Investing Activities:
Proceeds from the Sale of Securities Available-for-Sale
Proceeds from the Maturities and Calls of Securities Available-for-Sale
Purchases of Securities Available-for-Sale
Proceeds from the Maturities and Calls of Securities Held-to-Maturity
Purchases of Securities Held-to-Maturity
Net (Increase) Decrease in Loans
Proceeds from the Sales of Premises and Equipment, Other
Real Estate Owned and Repossessed Assets
Purchase of Premises and Equipment
Cash Paid for Subsidiaries
Net Decrease in Other Investments
Purchase of Bank Owned Life Insurance
Net Cash Used In Investing Activities
Cash Flows from Financing Activities:
Net Increase in Deposits
Net (Decrease) Increase in Short-Term Borrowings
Federal Home Loan Bank Advances
Federal Home Loan Bank Repayments
Purchase of Treasury Stock
Stock Options Exercised
Shares Issued Under the Employee Stock Purchase Plan
Tax Benefit from Exercise of Stock Options
Treasury Stock Issued for Dividend Reinvestment Plans
Acquisition by ESOP of Arrow Stock
Cash Dividends Paid
Net Cash Provided By Financing Activities
Net Increase (Decrease) in Cash and Cash Equivalents
Cash and Cash Equivalents at Beginning of Year
Cash and Cash Equivalents at End of Year
Supplemental Disclosures to Statements of Cash Flow Information:
Interest on Deposits and Borrowings
Income Taxes
Non-cash Investing and Financing Activity:
Transfer of Loans to Other Real Estate Owned and Repossessed Assets
Shares Issued for Acquisition of Subsidiary
Fair Value of Assets from Acquisition of Subsidiary
Fair Value of Liabilities from Acquisition of Subsidiary
See Notes to Consolidated Financial Statements.
61
Years Ended December 31,
2012
2011
$
22,179
$
21,933
$
2010
21,892
845
8,856
409
(949)
84
(60,668)
61,041
(2,282)
(71)
(328)
(353)
175
424
2,108
990
32,460
58,718
210,224
(197,029)
49,983
(140,635)
(40,951)
1,263
(8,073)
(75)
930
—
(65,645)
87,109
(26,615)
—
(10,000)
(4,877)
2,105
484
68
1,822
—
(11,815)
38,281
5,096
43,736
48,832
12,520
8,866
1,426
233
—
—
845
6,509
428
(2,795)
—
(39,111)
49,378
(866)
(32)
(5,319)
2,172
175
354
1,725
689
36,085
39,009
280,126
(354,310)
40,692
(31,701)
3,108
770
(5,372)
(3,296)
1,880
(15,702)
(44,796)
110,042
15,079
10,000
(100,000)
(6,039)
1,413
474
51
1,796
—
(11,448)
21,368
12,657
31,079
43,736
19,490
7,952
1,011
5,261
10,638
2,081
1,302
3,563
453
(1,507)
—
(41,030)
31,760
(1,024)
10
(1,813)
154
149
299
638
(4,627)
10,219
25,497
278,804
(382,614)
15,227
(6,532)
(24,259)
612
(1,081)
264
333
—
(93,749)
90,438
(20,694)
10,000
(20,000)
(3,347)
798
475
105
1,715
(1,000)
(10,997)
47,493
(36,037)
67,116
31,079
23,995
15,223
568
682
882
465
$
$
$
$
$
$
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 1:
RISKS AND UNCERTAINTIES
Nature of Operations - Arrow Financial Corporation, a New York corporation, was incorporated on March 21, 1983 and is
registered as a bank holding company within the meaning of the Bank Holding Company Act of 1956. Arrow derives most of its
earnings from the ownership of two nationally chartered commercial banks and through the ownership of four insurance agencies.
The two banks provide a full range of services to individuals and small to mid-size businesses in northeastern New York State from
just north of Albany, the State's capitol, to the Canadian border. Both banks have trust departments which provide investment
management and administrative services. The insurance agencies specialize in property and casualty insurance, group health
insurance, sports accident and health insurance, and individual life insurance.
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 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. Our most significant estimates
are the allowance for loan losses, the evaluation of other-than-temporary impairment of investment securities, goodwill impairment,
pension and other postretirement liabilities, analysis of a need for a valuation allowance for deferred tax assets and other fair value
calculations. 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.
Concentrations of Credit - Virtually all of Arrow's loans are with customers in northeastern New York. Although the loan
portfolios of the subsidiary banks are well diversified, tourism has a substantial impact on the northeastern New York economy. The
commitments to extend credit are fairly consistent with the distribution of loans presented in Note 5, generally have the same credit
risk and are subject to normal credit policies. Generally, the loans are secured by assets and are expected to be repaid from cash
flow or the sale of selected assets of the borrowers. Arrow evaluates each customer's creditworthiness on a case-by-case basis.
The amount of collateral obtained, if deemed necessary by Arrow upon extension of credit, is based upon management's credit
evaluation of the counterparty. The nature of the collateral varies with the type of loan and may include: residential real estate,
cash and securities, inventory, accounts receivable, property, plant and equipment, income producing commercial properties and
automobiles.
Note 2: SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Dollars In Thousands)
Principles of Consolidation - The financial statements of Arrow and its wholly owned subsidiaries are consolidated and all
material inter-company transactions have been eliminated. In the “Parent Company Only” financial statements in Note 20, the
investment in wholly owned subsidiaries is carried under the equity method of accounting. When necessary, prior years’ consolidated
financial statements have been reclassified to conform to the current-year financial statement presentation.
Segment Reporting - Arrow operations are primarily in the community banking industry, which constitutes Arrow’s only segment
for financial reporting purposes. Arrow provides other services, such as trust administration, retirement plan administration, advice
to our proprietary mutual funds and insurance products, but these services do not rise to the quantitative thresholds for separate
disclosure. Arrow operates primarily in the northeastern region of New York State in Warren, Washington, Saratoga, Essex and
Clinton counties and surrounding areas.
Cash and Cash Equivalents - Cash and cash equivalents include the following items: cash at branches, due from bank
balances, cash items in the process of collection, interest-bearing bank balances and federal funds sold.
Securities - Management determines the appropriate classification of securities at the time of purchase. Securities reported
as held-to-maturity are those debt securities which Arrow has both the positive intent and ability to hold to maturity and are stated
at amortized cost. Securities available-for-sale are reported at fair value, with unrealized gains and losses reported in accumulated
other comprehensive income or loss, net of taxes. Realized gains and losses are based upon the amortized cost of the specific
security sold. A decline in the fair value of any available-for-sale or held-to-maturity security below cost that is deemed to be other-
than-temporary results in an impairment to reduce the carrying amount to fair value. To determine whether an impairment is other-
than-temporary, we consider all available information relevant to the collectibility of the security, including past events, current
conditions, and reasonable and supportable forecasts when developing an estimate of cash flows expected to be collected. Evidence
considered in this assessment includes the reasons for impairment, the severity and duration of the impairment, changes in value
subsequent to year-end, forecasted performance of the investee, and the general market condition in the geographic area or industry
the investee operates in. When an other-than-temporary impairment has occurred on a debt security, the amount of the other-
than-temporary impairment recognized in earnings depends on whether we intend to sell the debt security or more likely than not
62
will be required to sell the debt security before recovery of its amortized cost basis less any current-period credit loss. If we intend
to sell the debt security or it is more likely than not that we will be required to sell the debt security before recovery of its amortized
cost basis less any current-period credit loss, the other-than-temporary impairment is recognized in earnings equal to the entire
difference between the investment’s amortized cost basis and its fair value at the balance sheet date. If we do not intend to sell
the debt security and it is not more likely than not that we will be required to sell the debt security before recovery of its amortized
cost basis less any current-period credit loss, the other-than-temporary impairment is separated into the amount representing the
credit loss and the amount related to all other factors. The amount of the total other-than-temporary impairment related to the credit
loss is recognized in earnings. The amount of the total other-than-temporary impairment related to other factors is recognized in
other comprehensive income, net of applicable income taxes.
Loans and Allowance for Loan Losses - Interest income on loans is accrued and credited to income based upon the principal
amount outstanding. Loan fees and costs directly associated with loan originations are deferred and amortized as an adjustment
to yield over the lives of the loans originated.
From time-to-time, Arrow has sold (most with servicing retained) residential real estate loans at or shortly after origination. Any
gain or loss on the sale of loans, along with the value of the servicing right, is recognized at the time of sale as the difference
between the recorded basis in the loan and net proceeds from the sale. Loans held for sale are recorded at the lower of cost or
fair value on an aggregate basis.
Loans are placed on nonaccrual status either due to the delinquency status of principal and/or interest or a judgment by
management that the full repayment of principal and interest is unlikely. Loans secured by home equity lines of credit are put on
nonaccrual status when 120 days past due; residential real estate loans when 150 days past due; commercial and commercial real
estate loans are evaluated on a loan-by-loan basis and are placed on nonaccrual status when 90 days past due if the full collection
of principal and interest is uncertain. The balance of any accrued interest deemed uncollectible at the date the loan is placed on
nonaccrual status is reversed - against earnings for interest accrued during the calendar year and against the allowance for loan
losses for interest accrued for the prior year. A loan is returned to accrual status at the later of the date when the past due status
of the loan falls below the threshold for nonaccrual status or management deems that it is likely that the borrower will repay all
interest and principal. For payments received while the loan is on nonaccrual status, we may recognize interest income on a cash
basis if the repayment of the remaining principal and accrued interest is deemed likely.
The allowance for loan losses is maintained by charges to operations based upon our best estimate of the probable amount
of loans that we will be unable to collect based on current information and events. Provisions to the allowance for loan losses are
offset by actual loan charge-offs (net of any recoveries). We evaluate the loan portfolio for potential charge-offs on a monthly basis.
In general, automobile and other consumer loans are charged-off when 120 days delinquent. Residential real estate loans are
charged-off upon repossession based on a new appraisal. Commercial and commercial real estate loans loans are evaluated
early in their delinquency status and are charged-off when it is apparent that not all principal will be repaid from on-going cash flows
or liquidation of collateral. An evaluation of estimated proceeds from the liquidation of the loan’s collateral is compared to the loan
carrying amount and a charge to the allowance for loan losses is taken for any deficiency. While management uses available
information to recognize losses on loans, future additions to the allowance may be necessary based on changes in economic
conditions in Arrow's market area. In addition, various Federal regulatory agencies, as an integral part of their examination process,
review Arrow's allowance for loan losses. Such agencies may require Arrow to recognize additions to the allowance in future
periods, based on their judgments about information available to them at the time of their examination, which may not be currently
available to management.
We evaluate nonaccrual loans over $250 thousand and all troubled debt restructured loans individually for impairment. Impaired
loans are measured based on either the present value of expected future cash flows discounted at the loan's effective interest rate,
the loan's observable market price or the fair value of the collateral if the loan is collateral dependent. Arrow determines impairment
for collateral dependent loans based on the fair value of the collateral less estimated costs to sell. For other loans, impairment is
determined by comparing the recorded investment in the loan to the present value of the expected cash flows, discounted at the
loan’s effective interest rate. If the measurement of the fair value of the impaired loan is less than the recorded investment in the
loan, an impairment reserve is recognized as part of the allowance for loan losses. Any further impairment, over time, is also
charged to the allowance for loan losses.
Allowance for loan losses on the remaining loans are primarily determined based on historical loss factors adjusted for current
trends. Arrow determines the interest income recognition method for impaired loans on a loan-by-loan basis. Based upon the
borrowers’ payment histories and cash flow projections, interest recognition methods include full accrual or cash basis.
In management’s opinion, the balance of the allowance for loan losses, at each balance sheet date, is sufficient to provide for
probable loan losses inherent in the corresponding loan portfolio.
Other Real Estate Owned and Repossessed Assets - Real estate acquired by foreclosure and assets acquired by
repossession are recorded at the fair value of the property less estimated costs to sell at the time of repossession. Subsequent
declines in fair value, after transfer to other real estate owned and repossessed assets are recognized through a valuation allowance.
Such declines in fair value along with related operating expenses to administer such properties or assets are charged directly to
operating expense.
Premises and Equipment - Premises and equipment are stated at cost, less accumulated depreciation and amortization.
Depreciation and amortization included in operating expenses are computed largely on the straight-line method. Depreciation is
based on the estimated useful lives of the assets (buildings and improvements 20-40 years; furniture and equipment 7-10 years;
data processing equipment 5-7 years) and, in the case of leasehold improvements, amortization is computed over the terms of the
respective leases or their estimated useful lives, whichever is shorter. Gains or losses on disposition are reflected in earnings.
63
Income Taxes - Arrow accounts for income taxes under the asset and liability method. Deferred tax assets and liabilities are
recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing
assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates
expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled.
The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income tax expense in the period that
includes the enactment date. Arrow’s policy is that deferred tax assets are reduced by a valuation allowance if, based on the weight
of available evidence, it is more likely than not that some or all of the deferred tax assets will not be realized.
Goodwill and Other Intangible Assets – Identifiable intangible assets acquired in a business combination are capitalized
and amortized. Any remaining unidentifiable intangible asset is classified as goodwill, for which amortization is not required but
which must be evaluated for impairment. Arrow tests for impairment of goodwill on an annual basis, or when events and
circumstances indicate potential impairment. In evaluating goodwill for impairment, Arrow first assesses certain qualitative factors
to determine if it is more likely than not that the fair value of the reporting unit is less than its carrying value. If it is more likely than
not that the fair value of a reporting unit exceeds its carrying amount, goodwill of the reporting unit is considered not impaired. If
the carrying amount of a reporting unit exceeds its fair value, the second step of the goodwill impairment test is performed to
measure the amount of impairment loss, if any.
The carrying amounts of other recognized intangible assets that meet recognition criteria and for which separate accounting
records have been maintained (core deposit intangibles and mortgage servicing rights), have been included in the consolidated
balance sheet as “Other Intangible Assets, Net.” Core deposit intangibles are being amortized on a straight-line basis over a period
of ten to fifteen years.
Arrow has sold residential real estate loans, primarily to Freddie Mac, with servicing retained. Mortgage servicing rights are
recognized as an asset when loans are sold with servicing retained, by allocating the cost of an originated mortgage loan between
the loan and servicing right based on estimated relative fair values. The cost allocated to the servicing right is capitalized as a
separate asset and amortized in proportion to, and over the period of, estimated net servicing income. Capitalized mortgage
servicing rights are evaluated for impairment by comparing the asset’s carrying value to its current estimated fair value. Fair values
are estimated using a discounted cash flow approach, which considers future servicing income and costs, current market interest
rates, and anticipated prepayment, and default rates. Impairment losses are recognized through a valuation allowance for servicing
rights having a current fair value that is less than amortized cost on an aggregate basis. Adjustments to increase or decrease the
valuation allowance are charged or credited to income as a component of other operating income.
Pension and Postretirement Benefits - Arrow maintains a non-contributory, defined benefit pension plan covering substantially
all employees, a supplemental pension plan covering certain executive officers selected by the Board of Directors, and certain
post-retirement medical, dental and life insurance benefits for employees and retirees. The costs of these plans, based on actuarial
computations of current and future benefits for employees, are charged to current operating expenses. The cost of post-retirement
benefits other than pensions is recognized on an accrual basis as employees perform services to earn the benefits. Arrow recognizes
the overfunded or underfunded status of our single employer defined benefit pension plan as an asset or liability on its consolidated
balance sheet and recognizes changes in the funded status in comprehensive income in the year in which the change occurred.
Prior service costs or credits are amortized on a straight-line basis over the average remaining service period of active
participants. Gains and losses in excess of 10% of the greater of the benefit obligation or the fair value of assets are amortized
over the average remaining service period of active participants.
The discount rate assumption is based on the Citigroup Pension Discount Curve as adjusted to provide the necessary cash
flows for the payment of benefits when due.
Stock-Based Compensation Plans – Arrow has two stock option plans, which are described more fully in Note 12. The
Company expenses the grant date fair value of options granted. The expense is recognized over the vesting period of the grant,
typically four years, on a straight-line basis. Shares are generally issued from treasury for the exercise of stock options.
Arrow sponsors an Employee Stock Purchase Plan (“ESPP”) under which employees may purchase Arrow’s common stock
at a 5% discount below market price at the time of purchase. This stock purchase plan is not considered a compensatory plan.
Arrow sponsors an Employee Stock Ownership Plan (ESOP), a qualified defined contribution plan. The ESOP has borrowed
funds from one of Arrow’s subsidiary banks to purchase Arrow common stock. The shares pledged as collateral are reported as
a reduction of Arrow’s stockholders’ equity. Compensation expense is recognized as shares are release for allocation to individual
employee accounts equal to the current average market price.
Securities Sold Under Agreements to Repurchase - In securities repurchase agreements, Arrow receives cash from a
counterparty in exchange for the transfer of securities to a third party custodian’s account that explicitly recognizes Arrow’s interest
in the securities. These agreements are accounted for by Arrow as secured financing transactions, since it maintains effective
control over the transferred securities, and meets other criteria for such accounting. Accordingly, the cash proceeds are recorded
as borrowed funds, and the underlying securities continue to be carried in Arrow’s securities available-for-sale portfolio.
Earnings Per Share (“EPS”) - Basic EPS excludes dilution and is computed by dividing income available to common
stockholders by the weighted average number of common shares outstanding for the period. Diluted EPS reflects the potential
dilution that could occur if securities or other contracts to issue common stock were exercised or converted into common stock or
resulted in the issuance of common stock that then shared in the earnings of the entity (such as Arrow’s stock options), computed
using the treasury stock method. Unallocated common shares held by Arrow’s Employee Stock Ownership Plan are not included
in the weighted average number of common shares outstanding for either the basic or diluted EPS calculation.
64
Financial Instruments - Arrow is a party to certain financial instruments with off-balance sheet risk, such as: commercial
lines of credit, construction lines of credit, overdraft protection, home equity lines of credit and standby letters of credit. Arrow's
policy is to record such instruments when funded. Fair value estimates are made at a specific point in time, based on relevant
market information and information about the financial instrument. These estimates do not reflect any premium or discount that
could result from offering for sale at one time Arrow's entire holdings of a particular financial instrument. Because no market exists
for a significant portion of Arrow's financial instruments, fair value estimates are based on judgments regarding future expected
loss experience, current economic conditions, risk characteristics of various financial instruments, and other factors. These
estimates are subjective in nature and involve uncertainties and matters of significant judgment and therefore cannot be determined
with precision. Changes in assumptions could significantly affect the estimates.
Fair value estimates are based on existing on- and off-balance sheet financial instruments without attempting to estimate the
value of anticipated future business and the value of assets and liabilities that are not considered financial instruments. For example,
Arrow has a trust department that contributes net fee income annually. The value of trust department customer relationships is not
considered a financial instrument of the Company, and therefore this value has not been incorporated into the fair value estimates.
Other significant assets and liabilities that are not considered financial assets or liabilities include deferred taxes, premises and
equipment, the value of low-cost, long-term core deposits and goodwill. In addition, the tax ramifications related to the realization
of the unrealized gains and losses can have a significant effect on fair value estimates and have not been considered in any of the
estimates.
The carrying amount of the following short-term assets and liabilities is a reasonable estimate of fair value: cash and due from
banks, federal funds sold and purchased, securities sold under agreements to repurchase, demand deposits, savings, N.O.W. and
money market deposits, other short-term borrowings, accrued interest receivable and accrued interest payable. The fair value
estimates of other on- and off-balance sheet financial instruments, as well as the method of arriving at fair value estimates, are
included in the related footnotes and summarized in Note 17.
•
•
•
Fair Value Measures – We determine the fair value of financial instruments 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;
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).
A financial instrument’s level within the fair value hierarchy is based on the lowest level of input that is significant to the fair
value measurement.
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 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. Our most significant estimates
are the allowance for loan losses, the evaluation of other-than-temporary impairment of investment securities, goodwill impairment,
pension and other postretirement liabilities, analysis of a need for a valuation allowance for deferred tax assets and other fair value
calculations. 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.
Recent Accounting Pronouncements
During 2012, the FASB issued seven accounting standards updates. Two were for technical corrections, which did not have
an impact on accounting standards or reporting requirements. The other five did not apply to Arrow.
65
Note 3: CASH AND CASH EQUIVALENTS (Dollars In Thousands)
The following table is the schedule of cash and cash equivalents at December 31, 2012 and 2011:
Cash and Due From Banks
Interest-Bearing Deposits at Banks
Total Cash and Cash Equivalents
Supplemental Information:
2012
$ 37,076
11,756
$ 48,832
2011
$ 29,598
14,138
$ 43,736
Total required reserves, including vault cash and Federal Reserve Bank deposits $ 23,168
$ 24,268
The Company is required to maintain reserve balances with the Federal Reserve Bank of New York. The required reserve is
calculated on a fourteen day average and the amounts presented in the table above represent the average for the period that
includes December 31.
66
Note 4.
INVESTMENT SECURITIES (Dollars In Thousands)
The following table is the schedule of Available-For-Sale Securities at December 31, 2012 and 2011:
December 31, 2012
Available-For-Sale Securities,
at Amortized Cost
Available-For-Sale Securities,
at Fair Value
Gross Unrealized Gains
Gross Unrealized Losses
Available-For-Sale Securities,
Pledged as Collateral
Maturities of Debt Securities,
at Amortized Cost:
Within One Year
From 1 - 5 Years
From 5 - 10 Years
Over 10 Years
Maturities of Debt Securities,
at Fair Value:
Within One Year
From 1 - 5 Years
From 5 - 10 Years
Over 10 Years
Securities in a Continuous
Loss Position, at Fair Value:
Less than 12 Months
12 Months or Longer
Total
Number of Securities in a
Continuous Loss Position
Unrealized Losses on
Securities in a Continuous
Loss Position:
Less than 12 Months
12 Months or Longer
Total
December 31, 2011
Available-For-Sale Securities,
at Amortized Cost
Available-For-Sale Securities,
at Fair Value
Gross Unrealized Gains
Gross Unrealized Losses
Available-For-Sale Securities,
Pledged as Collateral
Securities in a Continuous
Loss Position, at Fair Value:
Less than 12 Months
12 Months or Longer
Total
Available-For-Sale Securities
U.S.
Agency
Obligations
State and
Municipal
Obligations
Mortgage-
Backed
Securities -
Residential
Corporate
and Other
Debt
Securities
Mutual
Funds
and Equity
Securities
Total
Available-
For-Sale
Securities
$
122,297
$
84,798
$
252,480
$
8,689
$
1,120
$
469,384
122,457
204
44
84,838
206
166
261,804
9,405
81
—
122,297
—
—
—
122,457
—
—
72,531
—
72,531
22
44
—
44
$
$
$
$
$
$
$
$
28,231
53,797
1,593
1,177
28,284
53,731
1,646
1,177
46,627
2,149
48,776
198
160
6
166
$
$
$
$
19,180
217,387
15,913
—
19,838
224,982
16,984
—
10,230
4,968
15,198
7
50
31
81
$
$
$
$
8,451
—
238
—
6,381
1,308
1,000
—
6,350
1,301
800
8,451
—
8,451
11
238
—
238
1,148
28
—
478,698
9,843
529
260,292
47,411
399,862
18,814
2,177
48,122
407,520
19,931
1,977
$
$
$
$
— $
—
— $
137,839
7,117
144,956
—
238
— $
—
— $
492
37
529
$
116,055
$
44,712
$
382,118
$
1,015
$
1,365
$
545,265
116,393
44,999
342
4
305
18
392,712
10,813
219
1,015
1,419
—
—
69
15
556,538
11,529
256
265,854
$
$
25,956
$
4,505
$
9,857
$
—
—
5,715
25,956
$
4,505
$
15,572
$
— $
—
— $
— $
40,318
78
78
5,793
$
46,111
67
Available-For-Sale Securities
U.S.
Agency
Obligations
State and
Municipal
Obligations
Mortgage-
Backed
Securities -
Residential
Corporate
and Other
Debt
Securities
Mutual
Funds
and Equity
Securities
Total
Available-
For-Sale
Securities
7
12
5
—
2
26
$
$
4
—
4
$
$
18
—
18
$
$
204
$
15
219
$
— $
—
— $
— $
15
15
$
226
30
256
Number of Securities in a
Continuous Loss Position
Unrealized Losses on
Securities in a Continuous
Loss Position:
Less than 12 Months
12 Months or Longer
Total
The following table is the schedule of Held-To-Maturity Securities at December 31, 2012 and 2011:
December 31, 2012
Held-To-Maturity Securities,
at Amortized Cost
Held-To-Maturity Securities,
at Fair Value
Gross Unrealized Gains
Gross Unrealized Losses
Held-To-Maturity Securities,
Pledged as Collateral
Maturities of Debt Securities,
at Amortized Cost:
Within One Year
From 1 - 5 Years
From 5 - 10 Years
Over 10 Years
Maturities of Debt Securities,
at Fair Value:
Within One Year
From 1 - 5 Years
From 5 - 10 Years
Over 10 Years
Securities in a Continuous
Loss Position, at Fair Value:
Less than 12 Months
12 Months or Longer
Total
Number of Securities in a
Continuous Loss Position
Unrealized Losses on
Securities in a Continuous
Loss Position:
Less than 12 Months
12 Months or Longer
Total
Held-To-Maturity Securities
State and
Municipal
Obligations
Mortgage-
Backed
Securities -
Residential
Corporate
and Other
Debt
Securities
Total
Held-To
Maturity
Securities
$
183,373
$
55,430
$
1,000
$
239,803
191,196
7,886
63
56,056
626
—
1,000
—
—
—
—
—
1,000
—
—
—
1,000
—
55,430
—
—
—
56,056
—
—
— $
—
— $
—
— $
—
— $
— $
—
— $
—
— $
—
— $
248,252
8,512
63
238,803
32,047
124,861
76,096
6,799
32,115
126,427
82,476
7,234
21,583
503
22,086
61
62
1
63
32,047
69,431
76,096
5,799
32,115
70,371
82,476
6,234
21,583
503
22,086
61
62
1
63
68
$
$
$
$
$
$
$
$
Held-To-Maturity Securities
State and
Municipal
Obligations
Mortgage-
Backed
Securities -
Residential
Corporate
and Other
Debt
Securities
Total
Held-To
Maturity
Securities
$
149,688
$
— $
1,000
$
150,688
158,059
8,378
7
—
—
—
1,000
—
—
$
$
$
$
510
—
510
1
7
—
7
$
$
$
$
— $
—
— $
—
— $
—
— $
— $
—
— $
—
— $
—
— $
159,059
8,378
7
149,688
510
—
510
1
7
—
7
December 31, 2011
Held-To-Maturity Securities,
at Amortized Cost
Held-To-Maturity Securities,
at Fair Value
Gross Unrealized Gains
Gross Unrealized Losses
Held-To-Maturity Securities,
Pledged as Collateral
Securities in a Continuous
Loss Position, at Fair Value:
Less than 12 Months
12 Months or Longer
Total
Number of Securities in a
Continuous Loss Position
Unrealized Losses on
Securities in a Continuous
Loss Position:
Less than 12 Months
12 Months or Longer
Total
In the tables above, maturities of mortgage-backed-securities - residential are included based on their expected average lives.
Actual maturities will differ from the table below because issuers may have the right to call or prepay obligations with or without
prepayment penalties.
In the available-for-sale category at December 31, 2012, U.S. agency obligations consisted solely of U.S. Government Agency
securities with an amortized cost of $122.3 million and a fair value of $122.5 million. Mortgage-backed securities-residential consisted
of U.S. Government Agency securities with an amortized cost of $36.4 million and a fair value of $37.8 million and GSE securities
with an amortized cost of $216.1 million and a fair value of $224.0 million. In the held-to-maturity category at December 31, 2012,
mortgage-backed securities-residential consisted of GSEs with an amortized cost of $55.4 million and a fair value of $56.1 million.
In the available-for-sale category at December 31, 2011, U.S. agency obligations consisted solely of U.S. Government Agency
securities with an amortized cost of $116.1 million and a fair value of $116.4 million. Mortgage-backed securities-residential consisted
of US Government Agency securities with an amortized cost of $52.6 million and a fair value of $54.5 million and GSEs with an
amortized cost of $329.5 million and a fair value of $338.2 million.
Securities in a continuous loss position, in the tables above for December 31, 2012 and December 31, 2011 do not reflect any
deterioration of the credit worthiness of the issuing entities. U.S. agency issues, 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. For any non-rated municipal securities, credit analysis is performed in-house based upon data that has been submitted by the
issuers to the NY State Comptroller. That analysis shows no deterioration in the credit worthiness of the municipalities. Subsequent
to December 31, 2012, 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 we do not currently intend to sell any of our temporarily impaired securities, and because it is not more likely-than-not we
would be required to sell the securities prior to recovery, the impairment is considered temporary.
69
Other investments consist solely of Federal Reserve Bank and Federal Home Loan Bank Stock and are carried at cost.
Schedule of Federal Reserve Bank and Federal Home Loan Bank Stock
Federal Reserve Bank Stock
Federal Home Loan Bank Stock
Total Federal Reserve Bank and Federal Home Loan Bank Stock
December 31,
2012
2011
$
$
1,018
4,774
5,792
$
$
1,031
5,691
6,722
Note 5:
LOANS (Dollars In Thousands)
Loan Categories and Past Due Loans
The following table presents loan balances outstanding as of December 31, 2012 and December 31, 2011 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
if the borrower is two or more payments past due.
Schedule of Past Due Loans by Loan Category
Commercial
Commercial
Other
Commercial Construction
Real Estate
Consumer
Automobile Residential
Total
December 31, 2012
Loans Past Due 30-59 Days
$
1,045
$
— $
534
$
Loans Past Due 60-89 Days
Loans Past Due 90 or More Days
Total Loans Past Due
Current Loans
1,588
494
3,127
—
—
—
1,332
1,871
3,737
43
17
—
60
$
2,427
$
407
$
793
185
3,405
2,466
1,462
4,335
4,456
6,196
4,012
14,664
102,409
29,149
241,440
6,624
345,695
432,360
1,157,677
Total Loans
$
105,536
$
29,149
$
245,177
$
6,684
$
349,100
$ 436,695
$ 1,172,341
Loans 90 or More Days Past Due
and Still Accruing Interest
Nonaccrual Loans
December 31, 2011
Loans Past Due 30-59 Days
Loans Past Due 60-89 Days
Loans Past Due 90 or more Days
Total Loans Past Due
Current Loans
Total Loans
Loans 90 or More Days Past Due
and Still Accruing Interest
Nonaccrual Loans
$
$
$
$
$
$
$
$
$
126
1,787
538
197
17
752
— $
— $
378
2,026
$
$
— $
1
$
42
419
$
$
374
2,400
$
$
920
6,633
— $
284
$
—
—
—
—
1,825
2,109
75
12
6
93
$
3,512
$
1,544
$
670
314
4,496
226
3,056
4,826
5,953
1,105
5,218
12,276
99,039
11,083
230,040
6,225
317,879
454,915
1,119,181
99,791
$
11,083
$
232,149
$
6,318
$
322,375
$ 459,741
$ 1,131,457
17
6
$
$
— $
— $
684
1,503
$
$
— $
6
$
56
431
$
$
905
2,582
$
$
1,662
4,528
70
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
Other
Commercial Construction Real Estate
Consumer
Automobile
Residential
Unallocated
Total
Rollfoward of the
Allowance for Loan
Losses for the Year
Ended:
December 31, 2011 $
1,927
$
602
$
3,136
$
350
$
4,496
$
3,414
$
1,078
$
15,003
Charge-offs
Recoveries
Provision
(90)
23
484
—
—
(1)
(206)
—
120
(52)
9
(3)
(401)
200
241
(33)
—
24
—
—
(20)
(782)
232
845
December 31, 2012 $
2,344
$
601
$
3,050
$
304
$
4,536
$
3,405
$
1,058
$
15,298
December 31, 2010 $
2,037
$
135
$
2,993
$
328
$
4,760
$
3,163
$
1,273
$
14,689
Charge-offs
Recoveries
Provision
(105)
17
(22)
—
—
467
—
—
143
(42)
28
36
(480)
198
18
(147)
—
398
—
—
(195)
(774)
243
845
December 31, 2011 $
1,927
$
602
$
3,136
$
350
$
4,496
$
3,414
$
1,078
$
15,003
December 31, 2009 $
1,304
$
— $
4,000
$
— $
4,901
$
2,954
$
855
$
14,014
Charge-offs
Recoveries
Provision
(30)
5
758
—
—
135
—
—
(1,007)
—
—
328
(864)
262
461
—
—
209
—
—
418
(894)
267
1,302
December 31, 2010 $
2,037
$
135
$
2,993
$
328
$
4,760
$
3,163
$
1,273
$
14,689
December 31, 2012
Allowance for loan
losses - Loans
Individually
Evaluated for
Impairment
Allowance for loan
losses - Loans
Collectively
Evaluated for
Impairment
Ending Loan
Balance -
Individually
Evaluated for
Impairment
Ending Loan
Balance -
Collectively
Evaluated for
Impairment
December 31, 2011
Allowance for loan
losses - Loans
Collectively
Evaluated for
Impairment
$
853
$
— $
— $
— $
— $
— $
— $
853
$
1,491
$
601
$
3,050
$
304
$
4,536
$
3,405
$
1,058
$
14,445
$
1,432
$
— $
2,528
$
— $
203
$
1,090
$
— $
5,253
$
104,104
$
29,149
$
242,649
$
6,684
$
348,897
$
435,605
$
— $ 1,167,088
$
1,927
$
602
$
3,136
$
350
$
4,496
$
3,414
$
1,078
$
15,003
71
Allowance for Loan Losses
Commercial
Commercial
Other
Commercial Construction Real Estate
Consumer
Automobile
Residential
Unallocated
Total
$
66
$
— $
1,953
$
— $
268
$
2,108
$
— $
4,395
$
99,725
$
11,083
$
230,196
$
6,318
$
322,107
$
457,633
$
— $ 1,127,062
Ending Loan
Balance -
Individually
Evaluated for
Impairment
Ending Loan
Balance -
Collectively
Evaluated for
Impairment
Through the provision for loan losses, an allowance is maintained that reflects our best estimate of losses related to specifically
identified loans and the inherent risk of probable losses for categories of loans in the remaining portfolio. Actual loan losses are
charged against this allowance when loans are deemed uncollectible.
We use a two-step process to determine the provision for loans losses and the amount of the allowance for loan losses. We
evaluate nonaccrual loans over $250 thousand and all troubled debt restructured loans individually for impairment, while we
evaluate the remainder of the portfolio on a pooled basis as described below.
Quantitative Analysis: Quantitatively, we determine the historical loss rate for each homogeneous loan pool. During the
past five years we have had little charge-off activity on loans secured by residential real estate. Indirect consumer lending (principally
automobile loans) represents a significant component of our total loan portfolio and contains the majority of our total loan charge-
offs. We have had only two small losses on commercial real estate loans in the past five years. Losses on commercial loans
(other than those secured by real estate) are also historically low, but can vary widely from year-to-year; this is the most complex
category of loans in our loss analysis. Our net charge-offs for the past five years have been at or near historical lows for our
Company. Annualized net charge-offs for the entire loan portfolio has ranged from .04% to .09% of average loans during this
period.
Qualitative Analysis: While historical loss experience provides a reasonable starting point for our analysis, historical losses,
or even recent trends in losses, do not by themselves form a sufficient basis to determine the appropriate level for the allowance.
Therefore, we also consider and adjust historical loss factors for qualitative and environmental factors that are likely to impact the
inherent risk of loss associated with our existing portfolio. These included:
• 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
For each homogeneous loan pool, we estimate a loss factor expressed in basis points for each of the qualitative factors above,
and for historical net credit losses. We update and change, if necessary, the loss-rates assigned to various pools based on the
analysis of loss trends and the change in qualitative and environmental factors on a quarterly basis.
Due to the imprecise nature of the loan loss estimation process and ever changing economic conditions, the risk attributes of
our portfolio may not be adequately captured in data related to the formula-based loan loss components used to determine
allocations in our analysis of the adequacy of the allowance for loan losses. Management, therefore, has established and held an
unallocated portion within the allowance for loan losses reflecting the uncertainty of unknown incurred adverse events.
72
Credit Quality Indicators
The following table presents the credit quality indicators by loan category at December 31, 2012 and December 31, 2011:
Loan Credit Quality Indicators
Commercial
Commercial Construction
Commercial
Real Estate
Other
Consumer
Automobile Residential
Total
$
$
December 31, 2012
Credit Risk Profile by
Creditworthiness Category:
Satisfactory
Special Mention
Substandard
Doubtful
Credit Risk Profile Based on
Payment Activity:
Performing
Nonperforming
December 31, 2011
Credit Risk Profile by
Creditworthiness Category:
Satisfactory
Special Mention
Substandard
Doubtful
Credit Risk Profile Based on
Payment Activity:
Performing
Nonperforming
$
97,085
192
6,872
1,387
$
27,913
—
1,236
—
225,312
1,419
18,446
—
$ 350,310
1,611
26,554
1,387
$
6,683
1
$
348,676
424
$ 433,922
2,773
789,281
3,198
$
91,555
3,975
4,261
—
$
9,195
—
1,888
—
213,413
458
18,278
—
$ 314,163
4,433
24,427
—
$
6,312
6
$
321,888
487
$ 456,254
3,487
$ 784,454
3,980
We use an internally developed system of five credit quality indicators 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 risk rating 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 bank will sustain some loss if the deficiencies are
not corrected. “Substandard” 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 (i.e.
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 and 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 evaluated on an annual basis, unless the credit quality indicator falls
to a level of "substandard" or below, when the loan is evaluated quarterly. The credit quality indicator is one of the factors
used to determine any loss, as further described in this footnote.
73
For the purposes of the table above, nonperforming automobile, residential and other consumer loans are those loans on
nonaccrual status or are 90 days or more past due and still accruing interest.
Impaired Loans
The following table presents information on impaired loans based on whether the impaired loan has a recorded related
allowance or has no recorded related allowance:
Impaired Loans
Commercial
Commercial Construction
Commercial
Real Estate
Other
Consumer
Automobile Residential
Total
December 31, 2012
Recorded Investment:
With No Related Allowance
With a Related Allowance
Unpaid Principal Balance:
With No Related Allowance
With a Related Allowance
December 31, 2011
Recorded Investment:
With No Related Allowance
Unpaid Principal Balance:
With No Related Allowance
For the Year-To-Date Period
Ended:
December 31, 2012
Average Recorded Balance:
With No Related Allowance
With a Related Allowance
Interest Income Recognized:
With No Related Allowance
With a Related Allowance
Cash Basis Income:
With No Related Allowance
With a Related Allowance
December 31, 2011
Average Recorded Balance:
With No Related Allowance
Interest Income Recognized:
With No Related Allowance
Cash Basis Income:
With No Related Allowance
December 31, 2010
Average Recorded Balance:
With No Related Allowance
Interest Income Recognized:
With No Related Allowance
Cash Basis Income:
With No Related Allowance
$
$
45
1,387
— $
—
$
2,528
—
— $
—
45
1,387
—
—
2,695
—
—
—
203
—
203
—
$
$
1,090
—
1,090
—
3,866
1,387
4,033
1,387
$
66
$
— $
1,953
$
— $
268
$
2,108
$
4,395
66
—
1,953
—
268
2,108
4,395
$
$
56
694
— $
—
$
2,241
—
— $
—
$
236
—
$
1,599
—
4,132
694
6
—
—
—
—
—
—
—
64
—
64
—
—
—
—
—
12
—
—
—
9
—
—
—
91
—
64
—
$
40
$
— $
1,993
$
5
$
274
$
1,328
$
3,640
6
—
—
—
42
42
—
—
19
—
7
—
74
42
$
13
$
— $
1,983
$
11
$
280
$
550
$
2,837
4
—
—
—
123
57
1
—
16
—
17
—
161
57
At December 31, 2012 and December 31, 2011, 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. There was no allowance for
loan losses allocated to impaired loans at December 31, 2011. 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 we have recognized interest income on a cash basis.
74
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 Construction
Commercial
Real Estate
Other
Consumer
Automobile Residential
Total
For the Year Ended:
December 31, 2012
Number of Loans
Pre-Modification Outstanding
Recorded Investment
Post-Modification Outstanding
Recorded Investment
Subsequent Default, Number
of Contracts
Subsequent Default, Recorded
Investment
Commitments to lend
additional funds to modified
loans
December 31, 2011
Number of Loans
Pre-Modification Outstanding
Recorded Investment
Post-Modification Outstanding
Recorded Investment
Subsequent Default, Number
of Contracts
Subsequent Default, Recorded
Investment
Commitments to lend
additional funds to modified
loans
$
$
$
$
—
—
— $
— $
— $
— $
—
—
—
1
63
63
—
—
—
—
—
—
—
$
$
— $
— $
—
—
—
$
$
$
$
2
47
47
—
—
—
1
917
917
—
—
—
—
— $
— $
—
—
—
—
— $
— $
—
—
—
$
$
$
$
17
160
160
—
—
—
14
121
121
—
—
—
—
19
— $
207
— $
207
—
—
—
1
242
242
—
—
—
—
—
—
17
$
$
1,343
1,343
—
—
—
In general, 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 December 31, 2012 and December 31, 2011.
Schedule of Supplemental Loan Information
Supplemental Information:
Unamortized deferred loan origination costs, net of deferred loan
origination fees, included in the above balances
Overdrawn deposit accounts, included in the above balances
Pledged loans secured by one-to-four family residential mortgages
under a blanket collateral agreement to secure borrowings from
the Federal Home Loan Bank of New York
Residential real estate loans serviced for Freddie Mac, not included
in the balances above
Loans held for sale at period-end, included in the above balances
Loans to Related Parties:
Balance at beginning of year
Adjustment due to change in composition of related parties
New loans and renewals, during the year
Repayments, during the year
Balance at end of year
75
2012
2011
$
$
1,571
690
1,445
390
133,709
172,704
134,688
2,801
106,220
893
$
$
15,772
45
5,939
(4,309)
17,447
$
$
14,987
—
3,016
(2,231)
15,772
Note 6:
PREMISES AND EQUIPMENT (In Thousands)
A summary of premises and equipment at December 31, 2012 and 2011 is presented below:
Land and Bank Premises
Equipment, Furniture and Fixtures
Leasehold Improvements
Total Cost
Accumulated Depreciation and Amortization
Net Premises and Equipment
2012
2011
$
$
33,908
20,123
957
54,988
(26,091)
28,897
$
$
28,391
18,028
932
47,351
(24,722)
22,629
Amounts charged to expense for depreciation totaled $1,521, $1,382 and $1,286 in 2012, 2011 and 2010, respectively.
Note 7:
OTHER INTANGIBLE ASSETS (In Thousands)
The following table presents information on Arrow’s intangible assets (other than goodwill) as of December 31, 2012, 2011 and
2010:
Gross Carrying Amount, December 31, 2012
Accumulated Amortization
Net Carrying Amount, December 31, 2012
Gross Carrying Amount, December 31, 2011
Accumulated Amortization
Net Carrying Amount, December 31, 2011
Roll Forward of Intangible Assets:
Balance, December 31, 2009
Intangible Assets Acquired
Amortization of Intangible Assets
Balance, December 31, 2010
Intangible Assets Acquired
Amortization of Intangible Assets
Balance, December 31, 2011
Intangible Assets Acquired
Amortization of Intangible Assets
Balance, December 31, 2012
Depositor
Intangibles1
2,247
$
(2,094)
153
$
$
$
$
$
2,247
(1,961)
286
674
—
(214)
460
—
(174)
286
—
(133)
153
Mortgage
Servicing
Rights2
$
$
$
$
$
$
1,251
(392)
859
834
(235)
599
212
226
(67)
371
339
(111)
599
417
(157)
859
Customer
Intangibles1
4,451
$
(971)
3,480
$
$
$
$
$
4,451
(587)
3,864
557
126
(56)
627
3,573
(336)
3,864
—
(384)
3,480
Total
7,949
(3,457)
4,492
7,532
(2,783)
4,749
1,443
352
(337)
1,458
3,912
(621)
4,749
417
(674)
4,492
$
$
$
$
$
$
1 Reported in the income statement as a component of other operating expense.
2 Reported in the income statement as a reduction of fees for other services to customers.
76
The following table presents the remaining estimated annual amortization expense for Arrow's intangible assets as of
December 31, 2012:
Estimated Annual Amortization Expense:
2013
2014
2015
2016
2017
Later Years
Total
Depositor
Intangibles1
Mortgage
Servicing
Rights2
Customer
Intangibles1
Total
$
$
92
51
10
—
—
—
153
$
$
197
197
175
154
95
41
859
$
$
361
336
319
301
281
1,882
3,480
$
$
650
584
504
455
376
1,923
4,492
1 Reported in the income statement as a component of other operating expense.
2 Reported in the income statement as a reduction of servicing fee income.
Note 8:
GUARANTEES (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 December 31, 2012 and 2011:
Balance at December 31,
Notional Amount:
Commitments to Extend Credit
Standby Letters of Credit
Fair Value:
Commitments to Extend Credit
Standby Letters of Credit
2012
2011
$ 198,405 $ 203,556
11,641
10,929
$ 198,405 $ 203,556
11,641
10,929
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.
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 expected to expire without being 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 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 December 31, 2012 and 2011 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 December 31, 2012 and 2011 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.
77
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.
Note 9:
TIME DEPOSITS (In Thousands)
The following summarizes the contractual maturities of time deposits during years subsequent to December 31, 2012:
Year of Maturity
2013
2014
2015
2016
2017
2018 and Beyond
Total
$
$
Total Time
Deposits
153,777
68,493
21,154
17,387
18,965
3,497
283,273
Note 10:
DEBT (Dollars in Thousands)
Schedule of Short-Term Borrowings:
Balances at December 31:
Overnight Advances from the Federal Home Loan Bank of New York
Securities Sold Under Agreements to Repurchase
Total Short-Term Borrowings
Maximum Borrowing Capacity at December 31:
Federal Funds Purchased
Overnight Advances from the Federal Home Loan Bank of New York
Federal Reserve Bank of New York
2012
2011
$
$
$
29,000
12,678
41,678
30,000
90,000
268,000
$
$
$
42,000
26,293
68,293
30,000
114,000
244,000
Securities sold under agreements to repurchase mature in one day. Arrow maintains effective control over the securities
underlying the agreements.
Arrow's subsidiary banks have in place unsecured federal funds lines of credit with three correspondent banks. As a member
of the FHLBNY, we participate in the an advance program which allows for overnight and term advances up to the limit of pledged
collateral, including FHLB NY stock, mortgage-backed securities and residential real estate loans (see Note 4. "Investment Securities"
and Note 5. "Loans"). Our investment in FHLBNY stock is proportional to the total of our overnight and term advances (see the
Schedule of Federal Reserve Bank and Federal Home Loan Bank Stock in Note 4. "Investment Securities"). Our bank subsidiaries
have also established borrowing facilities with the Federal Reserve Bank of New York for potential “discount window” advances,
pledging certain consumer loans as collateral (see Note 5. "Loans").
Long Term Debt - FHLBNY Term Advances
In addition to overnight advances, Arrow also borrows longer-term funds from the FHLBNY. Certain borrowings are in the form
of “convertible advances.” These advances have a set final maturity, but are callable by the FHLBNY at certain dates beginning
no earlier than one year from the issuance date. If the advances are called, Arrow may elect to have the funds replaced by the
FHLBNY at the then prevailing market rate of interest.
78
Maturity Schedule of FHBLNY Term Advances Over the Next Five Years:
Balances
Weighted Average Rate
Final Maturity
First Year
Second Year
Third Year
Fourth Year
Fifth Year
Years After
Total
2012
10,000
10,000
10,000
—
—
—
30,000
$
$
2011
10,000
10,000
10,000
10,000
—
—
40,000
$
$
2012
2011
1.65%
1.43%
3.88%
—%
—%
—%
2.32%
4.70%
1.65%
1.43%
3.88%
—%
—%
2.92%
Long Term Debt - Guaranteed Preferred Beneficial Interests in Corporation's Junior Subordinated Debentures
During 2012, there were outstanding two classes of financial instruments issued by two separate subsidiary business trusts
of Arrow, identified as “Junior Subordinated Obligations Issued to Unconsolidated Subsidiary Trusts” on the Consolidated Balance
Sheets and the Consolidated Income Statements.
The first of the two classes of trust-issued instruments outstanding at year-end was issued by Arrow Capital Statutory Trust II
("ACST II"), a Delaware business trust established on July 16, 2003, upon the filing of a certificate of trust with the Delaware
Secretary of State. In July 2003, ACST II issued all of its voting (common) stock to Arrow and issued and sold to an unaffiliated
purchaser 30-year guaranteed preferred beneficial interests in the trust's assets ("ACST II trust preferred securities"). The rate on
the securities is variable, adjusting quarterly to the 3-month LIBOR plus 3.15%. ACST II used the proceeds of the sale of its trust
preferred securities to purchase an identical amount of junior subordinated debentures issued by Arrow that bear an interest rate
identical at all times to the rate payable on the ACST II trust preferred securities. The ACST II trust preferred securities became
redeemable after July 23, 2008 and mature on July 23, 2033.
The second of the two classes of trust-issued instruments outstanding at year-end was issued by Arrow Capital Statutory
Trust III ("ACST III"), a Delaware business trust established on December 23, 2004, upon the filing of a certificate of trust with the
Delaware Secretary of State. On December 28, 2004, the ACST III issued all of its voting (common) stock to Arrow and issued and
sold to an unaffiliated purchaser 30-year guaranteed preferred beneficial interests in the trust's assets ("ACST III"). The rate on
the ACST III trust preferred securities is a variable rate, adjusted quarterly, equal to the 3-month LIBOR plus 2.00%. ACST III used
the proceeds of the sale of its trust preferred securities to purchase an identical amount of junior subordinated debentures issued
by Arrow that bear an interest rate identical at all times to the rate payable on the ACST III trust preferred securities. The ACST III
trust preferred securities became redeemable on or after March 31, 2010 and mature on December 28, 2034.
The primary assets of the two subsidiary trusts having trust preferred securities outstanding at year-end, ACST II and ACST
III (the “Trusts”), are Arrow's junior subordinated debentures discussed above, and the sole revenues of the Trusts are payments
received by them from Arrow with respect to the junior subordinated debentures. The trust preferred securities issued by the Trusts
are non-voting. All common voting securities of the Trusts are owned by Arrow. Arrow used the net proceeds from its sale of junior
subordinated debentures to the Trusts, facilitated by the Trust’s sale of their trust preferred securities to the purchasers thereof, for
general corporate purposes. The trust preferred securities and underlying junior subordinated debentures, with associated expense
that is tax deductible, qualify as Tier I capital under regulatory definitions.
Arrow's primary source of funds to pay interest on the debentures that are held by the Trusts are current dividends received
by Arrow from its subsidiary banks. Accordingly, Arrow's ability to make payments on the debentures, and the ability of the Trusts
to make payments on their trust preferred securities, are dependent upon the continuing ability of Arrow's subsidiary banks to pay
dividends to Arrow. Since the trust preferred securities issued by the subsidiary trusts and the underlying junior subordinated
debentures issued by Arrow at December 31, 2012, 2011 and 2010 are classified as debt for financial statement purposes, the
expense associated with these securities is recorded as interest expense in the consolidated statements of income for the three
years.
Schedule of Guaranteed Preferred Beneficial Interests in Corporation's Junior Subordinated Debentures
ACST II
Balance at December 31,
Period-End Interest Rate
ACST III
Balance at December 31,
Period-End Interest Rate
2012
2011
$
10,000
$
10,000
3.51%
3.52%
$
10,000
$
10,000
2.36%
2.37%
79
Note 11:
COMPREHENSIVE INCOME (Dollars In Thousands)
The following table presents the components of other comprehensive income for the years ended December 31, 2012, 2011
and 2010:
Before-Tax
Amount
Tax
(Expense)
Benefit
Net-of-Tax
Amount
2012
Unrealized Securities Holding Gains Arising During the Period
Reclassification Adjustment for Net Securities Gains Included in Net Income
Net Retirement Plan Loss
Net Retirement Plan Prior Service Cost
Amortization of Net Retirement Plan Actuarial Loss
Accretion of Net Retirement Plan Prior Service Credit
Other Comprehensive Income
2011
Unrealized Securities Holding Gains Arising During the Period
Reclassification Adjustment for Net Securities Gains Included in Net Income
Net Retirement Plan Loss
Net Retirement Plan Prior Service Credit
Amortization of Net Retirement Plan Actuarial Loss
Accretion of Net Retirement Plan Prior Service Credit
Other Comprehensive Income
2010
Unrealized Securities Holding Gains Arising During the Period
Reclassification Adjustment for Net Securities Gains Included in Net Income
Net Retirement Plan Loss
Net Retirement Plan Prior Service Cost
Amortization of Net Retirement Plan Actuarial Loss
Accretion of Net Retirement Plan Prior Service Credit
Other Comprehensive Income
$
$
$
$
$
$
(1,094) $
(865)
(2,218)
(405)
1,677
(20)
(2,925) $
$
7,850
(2,795)
(6,129)
(266)
996
(108)
(452) $
2,507
(1,507)
(1,811)
242
1,112
(186)
357
$
$
433
343
878
160
(664)
8
1,158
(3,109)
1,107
2,428
105
(394)
43
180
(993)
597
718
(96)
(440)
74
(140)
$
$
$
$
$
$
(661)
(522)
(1,340)
(245)
1,013
(12)
(1,767)
4,741
(1,688)
(3,701)
(161)
602
(65)
(272)
1,514
(910)
(1,093)
146
672
(112)
217
The following table presents the components, net of tax, of accumulated other comprehensive loss as of December 31:
Retirement Plan Net Loss
Retirement Plan Prior Service Credit
Net Unrealized Securities Holding Gains
$
Total Accumulated Other Comprehensive Loss $
2012
(14,036)
(51)
5,625
(8,462)
2011
(13,709)
206
6,808
(6,695)
$
$
Note 12:
STOCK BASED COMPENSATION (Dollars In Thousands, Except Share and Per Share Amounts)
Arrow has established two stock based compensation plans: an Incentive and Non-qualified Stock Option Plan (Stock Option Plan)
and an Employee Stock Ownership Plan (ESOP). All share and per share data have been adjusted for the September 2012 2% stock
dividend.
Stock Option Plan
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.
80
Roll Forward Schedule of Stock Option Plan by Shares and Weighted Average Exercise Prices
Roll Forward of Shares Outstanding:
Outstanding at January 1, 2012
Granted
Exercised
Forfeited
Outstanding at December 31, 2012
Exercisable at December 31, 2012
Vested and Expected to Vest
Roll Forward of Shares Outstanding - Weighted Average Exercise Price:
Outstanding at January 1, 2012
Granted
Exercised
Forfeited
Outstanding at December 31, 2012
Exercisable at December 31, 2012
Vested and Expected to Vest
Weighted Average Remaining Contractual Life ( in years):
Outstanding at December 31, 2012
Exercisable at December 31, 2012
Vested and Expected to Vest
Aggregate Intrinsic Value:
Outstanding at December 31, 2012
Exercisable at December 31, 2012
Vested and Expected to Vest
Stock Option
Plans
482,765
75,786
(97,804)
(18,362)
442,385
259,150
183,235
$
$
22.46
24.92
21.53
23.93
23.03
22.46
23.83
5.95
4.45
8.08
849
645
204
Shares Available for Grant at Period-End
37,695
Schedule of Shares Authorized Under the Stock Option Plan by Exercise Price Range
Exercise Price Ranges
$19.47 to
$20.27
$21.63 to
$21.66
$22.19 to
$22.71
$24.24 to
$24.92
$26.29
Total
Outstanding Options at
December 31, 2012
Number of Shares Outstanding
103,872
32,719
102,916
148,676
54,202
442,385
Weighted-Average Remaining
Contractual Life (in years)
5.66
3.92
5.25
8.55
1.96
Weighted-Average Exercise Price
$
19.99 $
21.66 $
22.56 $
24.59 $
26.29 $
5.95
23.03
Exercisable Options at
December 31, 2012
Number of Shares Outstanding
86,021
32,719
66,826
19,382
54,202
259,150
Weighted-Average Remaining
Contractual Life (in years)
5.58
3.92
4.26
8.01
1.96
Weighted-Average Exercise Price
$
19.93 $
21.66 $
22.47 $
24.26 $
26.29 $
4.45
22.46
81
Schedule of Other Stock Option Plan Information
Shares Granted
Weighted Average Grant Date Information:
Fair Value of Options Granted
Fair Value Assumptions:
Dividend Yield
Expected Volatility
Risk Free Interest Rate
Expected Lives (in years)
Amount Expensed During the Year
Compensation Costs for Non-vested Awards Not Yet Recognized
Weighted Average Expected Vesting Period, In Years
Proceeds From Stock Options Exercised
Tax Benefits Related to Stock Options Exercised
Intrinsic Value of Stock Options Exercised
$
$
2012
75,786
2011
78,425
2010
77,047
$
6.01
$
6.12
$
6.12
3.93%
37.43%
1.22%
6.46
424
737
1.71
2,105
68
2,434
4.00%
36.50%
2.54%
6.40
354
705
1.80
1,413
51
1,740
$
$
3.80%
35.40%
3.14%
7.79
299
579
1.80
798
105
1,404
$
$
Employee Stock Ownership Plan
Arrow maintains an employee stock ownership plan (“ESOP”). 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 require annual payments of principal and interest through 2018. As
the debt is repaid, shares are 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.
Schedule of ESOP Compensation Expense
ESOP Compensation Expense
2012
2011
2010
$
550 $
550 $
500
As the debt is repaid, shares are released from collateral based on the proportion of debt paid to total debt outstanding for the year
and allocated to active employees.
Shares pledged as collateral are reported as unallocated ESOP shares in stockholders’ equity. As shares are released from collateral,
Arrow reports compensation expense equal to the current average market price of the shares, and the shares become outstanding for
earnings per share computations. The ESOP shares as of December 31, 2012 were as follows:
Schedule of Shares in ESOP Plan
ESOP Plan Shares:
Allocated Shares
Shares Released for Allocation During 2012
Unallocated Shares
Total ESOP Shares
2012
740,124
16,629
102,890
859,643
Market Value of Unallocated Shares
$
2,570
82
Note 13:
RETIREMENT BENEFIT PLANS (Dollars in Thousands)
Arrow sponsors qualified and nonqualified 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. 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 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%.
The following tables set forth changes in the plans’ benefit obligations (projected benefit obligation for pension benefits and
accumulated benefit obligation for postretirement benefits) and changes in the plans’ assets and the funded status of the pension
plans and other postretirement benefit plan at December 31:
Schedule of Defined Benefit Plan Disclosures
Employees'
Pension
Plan
Select
Executive
Retirement
Plan
Postretirement
Benefit
Plans
Defined Benefit Plan Funded Status
December 31, 2012
Fair Value of Plan Assets
Benefit Obligation
Funded Status of Plan
December 31, 2011
Fair Value of Plan Assets
Benefit Obligation
Funded Status of Plan
Change in Benefit Obligation
Benefit Obligation, at January 1, 2012
Service Cost
Interest Cost
Plan Participants' Contributions
Amendments
Actuarial Loss
Benefits Paid
Benefit Obligation, at December 31, 2012
Benefit Obligation, at January 1, 2011
Service Cost
Interest Cost
Plan Participants' Contributions
Amendments
Actuarial Loss
Benefits Paid
Benefit Obligation, at December 31, 2011
$
$
$
$
$
$
$
$
39,880
37,046
2,834
39,206
35,047
4,159
35,047
1,467
1,436
—
—
2,857
(3,761)
37,046
32,337
1,353
1,598
—
191
1,616
(2,048)
35,047
$
$
$
$
$
$
$
$
— $
5,324
(5,324)
$
— $
4,529
(4,529)
4,529
87
190
—
405
441
(328)
5,324
4,319
81
222
—
75
151
(319)
4,529
$
$
$
$
$
—
9,213
(9,213)
—
8,556
(8,556)
8,556
202
338
348
—
491
(722)
9,213
7,873
173
372
382
—
505
(749)
8,556
83
Schedule of Defined Benefit Plan Disclosures
Employees'
Pension
Plan
Select
Executive
Retirement
Plan
Postretirement
Benefit
Plans
Change in Fair Value of Plan Assets
Fair Value of Plan Assets, at January 1, 2012
Actual Return on Plan Assets
Employer Contributions
Plan Participants' Contributions
Benefits Paid
Fair Value of Plan Assets, at December 31, 2012
Change in Fair Value of Plan Assets, continued
Fair Value of Plan Assets, at January 1, 2011
Actual Return (Loss) on Plan Assets
Employer Contributions
Plan Participants' Contributions
Benefits Paid
Fair Value of Plan Assets, at December 31, 2011
Accumulated Benefit Obligation at December 31, 2012
Amounts Recognized in the Consolidated Balance Sheets
December 31, 2012
Prepaid Benefit Cost
Accrued Benefit Liability
Net Benefit Cost Recognized
December 31, 2011
Prepaid Benefit Cost
Accrued Benefit Liability
Net Benefit Cost Recognized
Amounts Recognized in Other Comprehensive Income
For the Year Ended December 31, 2012
Net Unamortized Loss Arising During the Period
Net Prior Service Cost Arising During the Period
Amortization of Net Loss
Amortization of Prior Service (Cost) Credit
Total Other Comprehensive (Loss) Income for Pension and
Other Postretirement Benefit Plans
For the Year Ended December 31, 2011
Net Unamortized Loss Arising During the Period
Net Prior Service Cost Arising During the Period
Amortization of Net Loss
Amortization of Prior Service (Cost) Credit
Total Other Comprehensive (Loss) Income for Pension and
Other Postretirement Benefit Plans
For the Year Ended December 31, 2010
Net Unamortized Loss Arising During the Period
Net Prior Service Cost Arising During the Period
Amortization of Net Loss
Amortization of Prior Service (Cost) Credit
Total Other Comprehensive (Loss) Income for Pension and
Other Postretirement Benefit Plans
84
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
39,206
4,435
—
—
(3,761)
39,880
37,319
(1,065)
5,000
—
(2,048)
39,206
36,519
2,834
—
2,834
4,159
—
4,159
1,286
—
(1,387)
(41)
(142)
$
$
$
$
5,474
191
(778)
(38)
4,849
1,018
—
(899)
(25)
— $
—
328
—
(328)
— $
— $
—
319
—
(319)
— $
—
—
374
348
(722)
—
—
—
367
382
(749)
—
5,324
$
9,213
—
(5,324)
(5,324)
—
(4,529)
(4,529)
441
405
(156)
(53)
637
151
75
(147)
32
111
339
—
(128)
105
$
$
$
$
$
$
$
—
(9,213)
(9,213)
—
(8,556)
(8,556)
491
—
(134)
114
471
504
—
(71)
114
547
454
(242)
(85)
106
233
94
$
316
$
Schedule of Defined Benefit Plan Disclosures
Employees'
Pension
Plan
Select
Executive
Retirement
Plan
Postretirement
Benefit
Plans
Accumulated Other Comprehensive Income
December 31, 2012
Net Actuarial Loss
Prior Service (Credit) Cost
Total Accumulated Other Comprehensive Income, Before Tax
December 31, 2011
Net Actuarial Loss
Prior Service (Credit) Cost
Total Accumulated Other Comprehensive Income, Before Tax
Amounts that will be Amortized from Accumulated
Other Comprehensive Income the Next Year
Net Actuarial Loss
Prior Service (Credit) Cost
Net Periodic Benefit Cost
For the Year Ended December 31, 2012
Service Cost
Interest Cost
Expected Return on Plan Assets
Amortization of Prior Service (Credit) Cost
Amortization of Net Loss
Net Periodic Benefit Cost
For the Year Ended December 31, 2011
Service Cost
Interest Cost
Expected Return on Plan Assets
Amortization of Prior Service (Credit) Cost
Amortization of Net Loss
Net Periodic Benefit Cost
For the Year Ended December 31, 2010
Service Cost
Interest Cost
Expected Return on Plan Assets
Amortization of Prior Service (Credit) Cost
Amortization of Net Loss
Net Periodic Benefit Cost
Weighted-Average Assumptions Used in
Calculating Benefit Obligation
December 31, 2012
Discount Rate
Rate of Compensation Increase
Interest Rate Credit for Determining
Projected Cash Balance Account
Interest Rate to Annuitize Cash
Balance Account
Interest Rate to Convert Annuities To Actuarially
Equivalent Lump Sum Amounts
85
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
18,026
(218)
17,808
18,127
(177)
17,950
1,246
37
1,467
1,436
(2,865)
41
1,387
1,466
1,353
1,598
(2,793)
38
778
974
1,185
1,667
(2,454)
25
899
1,322
3.55%
3.50%
3.00%
4.50%
4.50%
2,368
721
3,089
2,083
369
2,452
151
78
87
190
—
53
156
486
81
222
—
(32)
147
418
56
235
—
(105)
128
314
$
$
$
$
$
$
$
$
$
$
$
$
2,850
(419)
2,431
2,493
(533)
1,960
164
(114)
202
338
—
(114)
134
560
173
372
—
(114)
71
502
163
421
—
(105)
85
564
3.15%
3.50%
3.55%
3.50%
4.50%
Schedule of Defined Benefit Plan Disclosures
Employees'
Pension
Plan
Select
Executive
Retirement
Plan
Postretirement
Benefit
Plans
December 31, 2011
Discount Rate
Rate of Compensation Increase
Interest Rate Credit for Determining
Projected Cash Balance Account
Interest Rate to Annuitize Cash
Balance Account
Interest Rate to Convert Annuities To Actuarially
Equivalent Lump Sum Amounts
Weighted-Average Assumptions Used in
Calculating Net Periodic Benefit Cost
December 31, 2012
Discount Rate
Expected Long-Term Return on Plan Assets
Rate of Compensation Increase
Interest Rate Credit for Determining
Projected Cash Balance Account
Interest Rate to Annuitize Cash
Balance Account
Interest Rate to Convert AnnuitiesTo Actuarially
Equivalent Lump Sum Amounts
December 31, 2011
Discount Rate
Expected Long-Term Return on Plan Assets
Rate of Compensation Increase
Interest Rate Credit for Determining
Projected Cash Balance Account
Interest Rate to Annuitize Cash
Balance Account
Interest Rate to Convert AnnuitiesTo Actuarially
Equivalent Lump Sum Amounts
December 31, 2010
Discount Rate
Expected Long-Term Return on Plan Assets
Rate of Compensation Increase
Interest Rate Credit for Determining
Projected Cash Balance Account
Interest Rate to Annuitize Cash
Balance Account
Interest Rate to Convert AnnuitiesTo Actuarially
Equivalent Lump Sum Amounts
86
4.05%
3.50%
3.25%
5.00%
5.00%
4.05%
7.50%
3.50%
3.25%
5.00%
5.00%
5.15%
7.50%
3.50%
4.25%
5.50%
5.50%
5.80%
7.50%
3.50%
4.50%
6.00%
6.00%
4.05%
3.50%
4.05%
3.50%
5.00%
4.05%
3.50%
5.00%
5.15%
3.50%
5.50%
5.80%
3.50%
6.00%
4.05%
3.50%
5.15%
3.50%
5.80%
3.50%
Schedule of Defined Benefit Plan Disclosures
Information about Defined Benefit Plan Assets - Employees' Pension Plan
Fair Value Measurements Using:
Quoted Prices
in Active Markets
for Identical
Assets
(Level 1)
Significant
Other
Observable
Inputs
(Level 2)
Significant
Unobservable
Inputs
(Level 3)
Total
Percent
of Total
Target
Allocation
Minimum
Target
Allocation
Maximum
$
17
$
— $
— $
17
—%
Asset Category
December 31, 2012
Cash
Interest-Bearing Money
Market Fund
Arrow Common Stock1
North Country Funds -
Equity 2
Other Mutual Funds -
Equity
Total Equity Funds
North Country Funds -
Fixed income 2
Other Mutual Funds -
Fixed Income
Total Fixed Income
Funds
Total
December 31, 2011
Cash
Interest-Bearing Money
Market Fund
Arrow Common Stock
North Country Funds -
Equity 2
Other Mutual Funds -
Equity
Total Equity Funds
North Country Funds -
Fixed income 2
Other Mutual Funds -
Fixed Income
Total Fixed Income
Funds
5,236
4,197
13,043
11,160
24,203
4,236
1,991
6,227
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
5,236
4,197
13.1%
10.5%
13,043
32.8%
11,160
24,203
28.0%
60.8%
4,236
10.6%
1,991
5.0%
$
$
39,880
$
— $
— $ 39,880
100.0%
7
$
— $
— $
7
—%
1,857
3,843
13,259
14,908
28,167
4,151
1,181
5,332
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
1,857
3,843
4.7%
9.8%
13,259
33.9%
14,908
28,167
38.0%
71.9%
4,151
10.6%
1,181
3.0%
—%
—%
—%
15.0%
15.0%
10.0%
55.0%
85.0%
—%
—%
—%
15.0%
15.0%
10.0%
55.0%
85.0%
5,332
13.6%
10.0%
30.0%
Total
$
39,206
$
— $
— $ 39,206
100.0%
1
Acquisition of Arrow Financial Corporation common stock was under 10% of the total fair value of the employee's pension plan assets at the time of acquisition.
2
The North Country Funds - Equity and the North Country Funds - Fixed Income are publicly traded mutual funds advised by Arrow's subsidiary, North Country
Investment Advisors, Inc.
87
6,227
15.6%
10.0%
30.0%
Schedule of Defined Benefit Plan Disclosures
Expected Future Benefit Payments
2013
2014
2015
2016
2017
2018-2022
Estimated Contributions During 2013
Assumed Health Care Cost Trend Rates
December 31, 2012
Health Care Cost Trend
Rate Assumed for Next Year
Rate to which the Cost Trend
Rate is Assumed to Decline
(the Ultimate Trend Rate)
Year that the Rate Reaches
the Ultimate Trend Rate
December 31, 2011
Health Care Cost Trend
Rate Assumed for Next Year
Rate to which the Cost Trend
Rate is Assumed to Decline
(the Ultimate Trend Rate)
Year that the Rate Reaches
the Ultimate Trend Rate
Effect of a One-Percentage Point Change in Assumed
Health Care Cost Trend Rates
Effect of a One Percentage Point Increase on
Service and Interest Cost Components
Effect of a One Percentage Point Decrease on
Service and Interest Cost Components
Effect of a One Percentage Point Increase on
Accumulated Postretirement Benefit Obligation
Effect of a One Percentage Point Decrease on
Accumulated Postretirement Benefit Obligation
Fair Value of Plan Assets (Defined Benefit Plan):
Employees'
Pension
Plan
Select
Executive
Retirement
Plan
Postretirement
Benefit
Plans
$
$
$
2,228
2,463
2,226
2,189
2,435
12,415
$
457
468
443
431
418
1,883
— $
457
$
494
527
541
562
572
3,113
494
9.00%
5.00%
2021
8.50%
5.00%
2019
66
(54)
763
(643)
$
For information on fair value measurements, including descriptions of level 1, 2 and 3 of the fair value hierarchy and the valuation
methods employed by Arrow, see Note 2 - “Summary of Significant Accounting Policies” and Note 17 - “Fair Values.”
The fair value of level 1 financial instruments in the table above are based on unadjusted, quoted market prices from exchanges
in active markets.
In accordance with ERISA guidelines, the Board authorized the purchase of Arrow common stock up to 10% of the fair market
value of the plan's assets at the time of acquisition.
88
Pension Plan Investment Policies and Strategies:
The Company maintains a non-contributory pension benefit plan covering substantially all employees for the purpose of
rewarding long and loyal service to the Company. The pension assets are held in trust and are invested in a prudent manner for
the exclusive purpose of providing benefits to participants. The investment objective is to achieve an inflation-protected rate of
return that meets the actuarial assumption which is used for funding purposes. The investment strategy attempts to maximize the
investment return on assets at a level of risk deemed appropriate by the Company while complying with ERISA and any applicable
regulations and laws. The investment strategy utilizes asset allocation as a principal determinant for establishing the risk/reward
profile of the assets. Asset allocation ranges are established, periodically reviewed, and adjusted as funding levels, and participant
benefit characteristics change. Active and passive investment management is employed to help enhance the risk/return profile of
the assets.
The Plan’s assets are invested in a diversified portfolio of equity securities comprised of companies with small, mid, and large
capitalizations. Both domestic and international equities are allowed to provide further diversification and opportunity for return in
potentially higher growth economies with lower correlation of returns. Growth and value styles of investment are employed to
increase the diversification and offer varying opportunities for appreciation. The fixed income portion of the plan may be invested
in U.S. dollar denominated debt securities that shall be rated within the top four ratings categories by nationally recognized ratings
agencies. The fixed income portion will be invested without regard to industry or sector based on analysis of each target security’s
structural and repayment features, current pricing and trading opportunities as well as credit quality of the issuer. Individual bonds
with ratings that fall below the Plan’s rating requirements will be sold only when it is in the best interests of the Plan. Hybrid
investments, such as convertible bonds, may be used to provide growth characteristics while offering some protection to declining
equity markets by having a fixed income component. Alternative investments such as Treasury Inflation Protected Securities,
commodities, and REITs may be used to further enhance diversification while offering opportunities for return. In accordance with
ERISA guidelines, common stock of the Company may be purchased up to 10% of the fair market value of the Plan’s assets at the
time of acquisition. Derivative investments are prohibited in the plan.
The return on assets assumption was developed through review of historical market returns, historical asset class volatility and
correlations, current market conditions, the Plan’s past experience, and expectations on potential future market returns. The
assumption represents a long-term average view of the performance of the assets in the Plan, a return that may or may not be
achieved during any one calendar year. The assumption is based on the return of the Plan using the historical fifteen year return
adjusted for the potential for lower than historical returns due to low interest rates, and an expected modest recovery in global
economic growth as a result of the deep recession.
Cash Flows - We were not required to make any contribution to our qualified pension plan in 2012. Arrow makes contributions
for its postretirement benefits in an amount equal to actual expenses for the year.
Note 14:
OTHER EXPENSES (In Thousands)
Other operating expenses included in the consolidated statements of income are as follows:
Computer Services
Legal and Other Professional Fees
Postage and Courier
Advertising and Promotion
Stationery and Printing
Telephone and Communications
Intangible Asset Amortization
All Other
Total Other Operating Expense
2012
$
2,263
1,962
1,040
831
975
808
518
3,243
$ 11,640
2011
$
1,654
1,972
1,088
853
891
981
510
3,095
$ 11,044
2010
$
1,372
2,102
1,218
1,024
980
896
270
3,173
$ 11,035
89
Note 15:
INCOME TAXES (In Thousands)
The provision for income taxes is summarized below:
Current Tax Expense:
Federal
State
Total Current Tax Expense
Deferred Tax Expense (Benefit):
Federal
State
Total Deferred Tax Expense (Benefit)
Total Provision for Income Taxes
$
$
2012
8,763
1,251
10,014
(290)
(63)
(353)
9,661
2011
2010
$
$
6,726
816
7,542
1,775
397
2,172
9,714
$
$
8,369
1,231
9,600
273
(119)
154
9,754
The provisions for income taxes differed from the amounts computed by applying the U.S. Federal Income Tax Rate of 35%
for 2012, 2011 and 2010 to pre-tax income as a result of the following:
Computed Tax Expense at Statutory Rate
Increase (Decrease) in Income Taxes Resulting From:
Tax-Exempt Income
Nondeductible Interest Expense
State Taxes, Net of Federal Income Tax Benefit
Other Items, Net
Total Provision for Income Taxes
$
2012
2011
2010
$
11,144
$
11,076
$
11,076
(2,132)
95
814
(260)
9,661
$
(2,199)
152
788
(103)
9,714
$
(2,236)
176
723
15
9,754
The tax effects of temporary differences that give rise to significant portions of the deferred tax assets and deferred tax
liabilities at December 31, 2012 and 2011 are presented below:
Deferred Tax Assets:
Allowance for Loan Losses
Pension and Deferred Compensation Plans
Pension Liability Included in Accumulated Other Comprehensive Income
Other
Total Gross Deferred Tax Assets
Valuation Allowance for Deferred Tax Assets
Total Gross Deferred Tax Assets, Net of Valuation Allowance
Deferred Tax Liabilities:
Pension Plans
Depreciation
Deferred Income
Net Unrealized Gains on Securities Available-for-Sale Included in
Accumulated Other Comprehensive Income
Goodwill
Total Gross Deferred Tax Liabilities
2012
2011
$
6,105
4,140
9,241
608
20,094
—
$ 20,094
$
5,957
3,965
8,859
669
19,450
—
$ 19,450
$
8,178
1,475
3,189
$
8,758
1,347
3,017
3,690
5,225
$ 21,757
4,465
5,036
$ 22,623
The following table presents supplemental income tax information for the periods ending December 31, 2012 and 2011:
Supplemental Information:
Deferred Tax Assets During the Year from the Acquisition of Subsidiaries
Deferred Tax Liabilities During the Year from the Acquisition of Subsidiaries
Unrecognized Tax Benefits
2012
2011
$
— $
—
—
44
1,061
—
Management believes that the realization of the recognized net deferred tax assets at December 31, 2012 and 2011 is more
likely than not, based on existing loss carryback ability, available tax planning strategies and expectations as to future taxable
income.
90
Interest and penalties are recorded as a component of the provision for income taxes, if any. Tax years 2009 through 2012
are subject to Federal and New York State examination.
Note 16:
EARNINGS PER 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 each of the years in the three-year period ended December 31, 2012. All share and per
share amounts have been adjusted for the 2012 2% stock dividend.
Earnings Per Share
12/31/2012
Year-to-Date Period Ended:
12/31/2011
12/31/2010
Earnings Per Share - Basic:
Net Income
Weighted Average Shares - Basic
Earnings Per Share - Basic
Earnings Per Share - Diluted:
Net Income
Weighted Average Shares - Basic
Dilutive Average Shares Attributable to Stock Options
Weighted Average Shares - Diluted
Earnings Per Share - Diluted
Antidilutive Shares Excluded from the Calculation
of Earnings Per Share
Note 17:
FAIR VALUES (In Thousands)
$
$
$
$
$
$
22,179
12,007
1.85
22,179
12,007
10
12,017
1.85
$
203
$
$
$
$
21,933
11,970
1.83
21,933
11,970
12
11,982
1.83
136
$
21,892
11,836
1.85
21,892
11,836
36
11,872
1.84
70
FASB ASC Subtopic 820-10 defines fair value, establishes a framework for measuring fair value in generally accepted
accounting principles (GAAP) and requires certain disclosures about fair value measurements. We do not have any 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 December 31, 2012 and 2011 were securities available-for-sale. Arrow held no securities or liabilities for trading
on such date. For information on fair value measurements, including descriptions of level 1, 2 and 3 of the fair value hierarchy and
the valuation methods employed by Arrow, see Note 2 - “Summary of Significant Accounting Policies.”
91
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 of Assets and Liabilities Measured on a
Recurring Basis:
December 31, 2012
Securities Available-for Sale:
U.S. Agency Obligations
State and Municipal Obligations
Mortgage-Backed Securities - Residential
Corporate and Other Debt Securities
Mutual Funds and Equity Securities
Total Securities Available-for-Sale
December 31, 2011
Securities Available-for Sale:
U.S. Agency Obligations
State and Municipal Obligations
Mortgage-Backed Securities - Residential
Corporate and Other Debt Securities
Mutual Funds and Equity Securities
Total Securities Available-for Sale
Fair Value
$
$
$
$
122,457
84,838
261,804
8,451
1,148
478,698
116,393
44,999
392,712
1,015
1,419
556,538
Fair Value of Assets and Liabilities Measured on a
Nonrecurring Basis:
December 31, 2012
Collateral Dependent Impaired Loans
$
Other Real Estate Owned and Repossessed Assets, Net $
December 31, 2011
Other Real Estate Owned and Repossessed Assets, Net $
1,020
1,034
516
Fair Value Measurements at Reporting Date Using:
Quoted Prices
In Active Markets
for Identical Assets
(Level 1)
Significant
Other
Observable
Inputs
(Level 2)
Significant
Unobservable
Inputs
(Level 3)
$
$
$
$
$
$
$
— $
—
—
—
—
— $
— $
—
—
—
257
257
$
122,457
84,838
261,804
8,451
1,148
478,698
116,393
44,999
392,712
1,015
1,162
556,281
$
$
$
$
—
—
—
—
—
—
—
—
—
—
—
—
— $
— $
— $
— $
1,020
1,034
— $
— $
516
We determine the fair value of financial instruments 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;
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.
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. The
appraisals may be adjusted by management for qualitative factors such as economic conditions and estimated liquidation expenses
ranging from 10% to 35%.
92
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 on an annual basis, with no impairment recognized for these assets
at December 31, 2012 and December 31, 2011.
Unobservable Input Reconciliation of the Fair Value of Assets Measured on a Recurring Basis
The following table is a reconciliation of the beginning and ending balances for 2011 of the Level 3 assets of Arrow, i.e., as to
which fair value is measured using significant unobservable inputs, all of which are securities available-for-sale:
Roll-Forward of the Fair Value of Level 3 Assets Measured on a Recurring Basis
Beginning Balance, January 1, 2011
Principal payment received
Total net gains (realized/unrealized) included in other comprehensive income
Ending Balance, December 31, 2011
There was no other-than-temporary impairment of the assets in the table above.
Available-for-
Sale Securities
283
$
(331)
48
—
$
93
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
Carrying
Amount
Fair
Value
Level 1
Level 2
Level 3
Fair Value Hierarchy
December 31, 2012
Cash and Cash Equivalents
Securities Available-for-Sale
Securities Held-to-Maturity
Federal Home Loan Bank and Federal
Reserve Bank Stock
Net Loans
Accrued Interest Receivable
Deposits
Federal Funds Purchased and Securities
Sold Under Agreements to Repurchase
Federal Home Loan Bank Term Advances
Junior Subordinated Obligations Issued
to Unconsolidated Subsidiary Trusts
Accrued Interest Payable
December 31, 2011
Cash and Cash Equivalents
Securities Available-for-Sale
Securities Held-to-Maturity
Federal Home Loan Bank and Federal
Reserve Bank Stock
Net Loans
Accrued Interest Receivable
Deposits
Federal Funds Purchased and Securities
Sold Under Agreements to Repurchase
Federal Home Loan Bank Term Advances
Junior Subordinated Obligations Issued
to Unconsolidated Subsidiary Trusts
Accrued Interest Payable
$
$
48,832
478,698
239,803
$
48,832
478,698
248,252
48,832
—
—
5,792
1,157,043
5,486
1,731,155
5,792
1,192,628
5,486
1,732,894
5,792
—
5,486
1,447,882
12,678
59,000
20,000
584
12,678
60,312
20,000
584
12,678
29,000
—
584
$
$
43,736
556,538
150,688
$
43,736
556,538
159,059
43,736
257
—
6,722
1,116,454
6,082
1,644,046
6,722
1,141,310
6,082
1,650,849
6,722
—
6,082
1,291,388
26,293
82,000
20,000
1,147
26,293
83,553
20,000
1,147
26,293
—
—
1,147
$
— $
478,698
248,252
—
—
—
285,012
—
31,312
20,000
—
$
— $
556,281
159,059
—
—
—
359,461
—
83,553
20,000
—
—
—
—
—
1,192,628
—
—
—
—
—
—
—
—
—
—
1,141,310
—
—
—
—
—
—
Fair Value Methodology for Financial Instruments Not Measured on a Recurring or Nonrecurring Basis
Securities held-to-maturity are fair valued 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.
Fair values for loans are estimated for portfolios of loans with similar financial characteristics. Loans are segregated by type
such as commercial, commercial real estate, residential mortgage, indirect 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 methodology
does not use an exit price methodology. The fair value of performing loans is calculated by discounting scheduled cash flows
through the estimated maturity using estimated market discount rates that reflect the credit and interest rate risk inherent in the
loan. The estimate of maturity is based on historical experience with repayments for each loan classification, modified, as required,
by an estimate of the effect of current economic and lending conditions. Fair value for nonperforming loans is generally based on
recent external appraisals. If appraisals are not available, estimated cash flows are discounted using a rate commensurate with
the risk associated with the estimated cash flows. Assumptions regarding credit risk, cash flows and discount rates are judgmentally
determined using available market information and specific borrower information.
94
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 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 estimated based on the discounted value of contractual cash flows. The discount rate
is estimated using current rates on FHLBNY advances with similar maturities and call features.
Based on Arrow’s capital adequacy, 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.
Note 18:
LEASES (In Thousands)
At December 31, 2012, Arrow was obligated under a number of noncancellable operating leases for buildings and equipment.
Certain of these leases provide for escalation clauses and contain renewal options calling for increased rentals if the lease is
renewed.
Rent expense for the years ended December 31, 2012, 2011 and 2010 was as follows:
Rent Expense
$
597 $
570 $
351
2012
2011
2010
Future minimum lease payments on operating leases at December 31, 2012 were as follows:
2013
2014
2015
2016
2017
Later Years
Total Minimum Lease Payments
$
Operating
Leases
618
603
555
412
320
572
3,080
$
Arrow leases four of its branch offices, at market rates, from Stewart’s Shops Corp. Mr. Gary C. Dake, President of Stewart’s
Shops Corp., serves on both the boards of Arrow and Saratoga National Bank and Trust Company.
Note 19:
REGULATORY MATTERS (Dollars in Thousands)
In the normal course of business, Arrow and its subsidiaries operate under certain regulatory restrictions, such as the extent
and structure of covered inter-company borrowings and maintenance of reserve requirement balances.
The principal source of the funds for the payment of stockholder dividends by Arrow has been from dividends declared and
paid to Arrow by its bank subsidiaries. As of December 31, 2012, the maximum amount that could have been paid by subsidiary
banks to Arrow, without prior regulatory approval, was approximately $27,323.
Under current Federal Reserve regulations, Arrow is prohibited from borrowing from the subsidiary banks unless such borrowings
are secured by specific obligations. Additionally, the maximum of any such borrowing is limited to 10% of an affiliate’s capital and
surplus.
Arrow and its subsidiary banks are subject to various regulatory capital requirements administered by the federal banking
agencies. Failure to meet minimum capital requirements can initiate certain mandatory--and possibly additional discretionary--
actions by regulators that, if undertaken, could have a direct material effect on an institution’s financial statements. Under capital
adequacy guidelines and the regulatory framework for prompt corrective action, Arrow and its subsidiary banks must meet specific
capital guidelines that involve quantitative measures of assets, liabilities, and certain off-balance sheet items as calculated under
regulatory accounting practices. Capital amounts and classification are also subject to qualitative judgments by the regulators
about components, risk weightings, and other factors.
Quantitative measures established by regulation to ensure capital adequacy require Arrow and its subsidiary banks to maintain
minimum capital amounts and ratios (set forth in the table below) of total and Tier I capital (as defined in the regulations) to risk-
weighted assets (as defined), and of Tier I capital (as defined) to average assets (as defined). Management believes, as of
December 31, 2012 and 2011, that Arrow and both subsidiary banks meet all capital adequacy requirements to which they are
subject.
As of December 31, 2012, Arrow and both subsidiary banks qualified as well-capitalized under the regulatory framework for
prompt corrective action. To be categorized as “well-capitalized,” Arrow and its subsidiary banks must maintain minimum total risk-
95
based, Tier I risk-based, and Tier I leverage ratios as set forth in the table below. There are no conditions or events that management
believes have changed Arrow’s or its subsidiary banks’ categories.
Arrow’s and its subsidiary banks’, Glens Falls National Bank and Trust Company (“Glens Falls National”) and Saratoga National
Bank and Trust Company (“Saratoga National”), actual capital amounts and ratios are presented in the table below as of
December 31, 2012 and 2011:
As of December 31, 2012:
Total Capital
(to Risk Weighted Assets):
Arrow
Glens Falls National
Saratoga National
Tier I Capital
(to Risk Weighted Assets):
Arrow
Glens Falls National
Saratoga National
Tier I Capital
(to Average Assets):
Arrow
Glens Falls National
Saratoga National
Actual
Minimum Amounts
For Capital Adequacy
Purposes
Amount
Ratio
Amount
Ratio
Minimum Amounts To
Be Well-Capitalized
Ratio
Amount
$ 200,480
164,889
31,911
16.3% $
16.2%
15.1%
98,395
81,427
16,906
8.0% $ 122,994
101,783
8.0%
21,133
8.0%
10.0%
10.0%
10.0%
185,170
152,205
29,297
15.0%
14.9%
13.8%
185,170
152,205
29,297
9.1%
8.8%
9.4%
49,379
40,860
8,492
81,393
69,184
12,467
4.0%
4.0%
4.0%
4.0%
4.0%
4.0%
74,068
61,291
12,738
81,393
86,480
15,584
6.0%
6.0%
6.0%
4.0%
5.0%
5.0%
Actual
Amount
Ratio
Minimum Amounts
For Capital
Adequacy Purposes
Ratio
Amount
Minimum Amounts To
Be Well-Capitalized
Ratio
Amount
As of December 31, 2011:
Total Capital
(to Risk Weighted Assets):
Arrow
Glens Falls National
Saratoga National
$ 187,681
155,209
29,853
Tier I Capital
(to Risk Weighted Assets):
Arrow
Glens Falls National
Saratoga National
Tier I Capital
(to Average Assets):
Arrow
Glens Falls National
Saratoga National
172,956
142,998
27,365
172,956
142,998
27,365
16.0%
15.9%
15.0%
14.7%
14.6%
13.8%
9.0%
8.6%
9.3%
93,841
78,093
15,922
47,063
39,178
7,932
76,869
66,511
11,770
8.0%
8.0%
8.0%
4.0%
4.0%
4.0%
4.0%
4.0%
4.0%
117,301
97,616
19,902
10.0%
10.0%
10.0%
70,594
58,766
11,898
76,869
83,138
14,712
6.0%
6.0%
6.0%
4.0%
5.0%
5.0%
96
Note 20:
PARENT ONLY FINANCIAL INFORMATION (In Thousands)
Condensed financial information for Arrow Financial Corporation is as follows:
BALANCE SHEETS
ASSETS
Interest-Bearing Deposits with Subsidiary Banks
Available-for-Sale Securities
Held-to-Maturity Securities
Investment in Subsidiaries at Equity
Other Assets
Total Assets
LIABILITIES
December 31,
2012
$
1,913
1,148
1,000
192,985
5,339
$ 202,385
2011
$
2,395
1,433
1,000
184,515
3,915
$ 193,258
Junior Subordinated Obligations Issued to Unconsolidated Subsidiary Trusts $
Other Liabilities
Total Liabilities
20,000
6,560
26,560
$
20,000
6,873
26,873
STOCKHOLDERS’ EQUITY
Total Stockholders’ Equity
Total Liabilities and Stockholders’ Equity
STATEMENTS OF INCOME
Income:
Dividends from Bank Subsidiaries
Interest and Dividends on Investments
Other Income (Including Management Fees)
Net Gains on Securities Transactions
Total Income
Expense:
Interest Expense
Salaries and Employee Benefits
Other Expense
Total Expense
Income Before Income Tax Benefit and Equity
in Undistributed Net Income of Subsidiaries
Income Tax Benefit
Equity in Undistributed Net Income of Subsidiaries
Net Income
$
$
175,825
$ 202,385
166,385
$ 193,258
$
Years Ended December 31,
2011
14,450
127
596
17
15,190
2012
12,700
123
776
63
13,662
2010
12,400
129
720
27
13,276
$
692
75
957
1,724
11,938
575
9,666
22,179
669
92
820
1,581
13,609
477
7,847
21,933
$
666
109
908
1,683
11,593
489
9,810
21,892
$
The Statement of Changes in Stockholders’ Equity is not reported because it is identical to the Consolidated Statement of
Changes in Stockholders’ Equity.
97
Years Ended December 31,
2011
2010
2012
$ 22,179
$ 21,933
$ 21,892
(9,666)
(63)
175
424
(1,640)
11,409
681
(359)
322
2,105
484
1,822
68
(4,877)
(11,815)
(12,213)
(482)
2,395
1,913
692
233
$
$
(7,847)
(17)
175
354
(165)
14,433
410
(253)
157
1,413
474
1,796
51
(6,039)
(11,448)
(13,753)
837
1,558
2,395
669
5,261
$
$
(9,810)
(27)
149
299
(1,253)
11,250
270
(373)
(103)
798
475
1,715
105
(3,347)
(10,997)
(11,251)
(104)
1,662
1,558
666
682
$
$
STATEMENTS OF CASH FLOWS
Cash Flows from Operating Activities:
Net Income
Adjustments to Reconcile Net Income to Net Cash Provided by Operating
Activities:
Undistributed Net Income of Subsidiaries
Net Gains on the Sale of Securities Available-for-Sale
Shares Issued Under the Directors’ Stock Plan
Stock-Based Compensation Expense
Changes in Other Assets and Other Liabilities
Net Cash Provided by Operating Activities
Cash Flows from Investing Activities:
Proceeds from the Sale of Securities Available-for-Sale
Purchases of Securities Available-for-Sale
Net Cash Provided by (Used in) Investing Activities
Cash Flows from Financing Activities:
Stock Options Exercised
Shares Issued Under the Employee Stock Purchase Plan
Treasury Stock Issued for Dividend Reinvestment Plans
Tax Benefit from Exercise of Stock Options
Purchase of Treasury Stock
Cash Dividends Paid
Net Cash Used in Financing Activities
Net (Decrease) Increase in Cash and Cash Equivalents
Cash and Cash Equivalents at Beginning of the Year
Cash and Cash Equivalents at End of the Year
Supplemental Disclosures to Statements of
Cash Flow Information:
Interest Paid
Non-cash Investing and Financing Activities:
Shares Issued for Acquisition of Subsidiary
98
Item 9. Changes in and Disagreements With Accountants on Accounting and Financial Disclosure - None.
Item 9A. Controls and Procedures
Senior management maintains disclosure controls and procedures that are designed to ensure that information required to be
disclosed in our Exchange Act reports is recorded, processed, summarized and reported within the time periods provided in the
SEC's rules and forms, and that such information is accumulated and communicated to our management, including the Chief
Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure. In designing
and evaluating the disclosure controls and procedures, senior management has recognized that any controls and procedures, no
matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives, and
therefore has been required to apply its judgment in evaluating the cost-benefit relationship of possible controls and procedures.
Senior management, including the Chief Executive Officer and Chief Financial Officer, evaluated the effectiveness of the design
and operation of our disclosure controls and procedures (as defined in Rule 13(a)-15(e) under the Exchange Act) as of December 31,
2012. Based upon that evaluation, senior management, including the Chief Executive Officer and Chief Financial Officer, concluded
that our disclosure controls and procedures were effective on that date. There were no changes made in our internal controls or
in other factors that could significantly affect these internal controls subsequent to the date of the evaluation performed by the Chief
Executive Officer and Chief Financial Officer.
Management’s Report on Internal Control Over Financial Reporting
Our management is responsible for establishing and maintaining adequate internal control over financial reporting, as such
term is defined in Exchange Act Rules 13a-15(f). Under the supervision and with the participation of our management, including
our Chief Executive Officer and Chief Financial Officer, we conducted an assessment of the effectiveness of our internal control
over financial reporting. Our evaluation is based on the framework set forth in Internal Control – Integrated Framework issued by
the Committee of Sponsoring Organizations of the Treadway Commission. Based on our assessment, our management concluded
that our internal control over financial reporting was effective as of December 31, 2012.
Item 9B. Other Information – None.
99
Item 10. Directors, Executive Officers and Corporate Governance
PART III
The information required by this item regarding directors and nominees for directors and the Company's committees is set
forth under the captions "Voting Item 1: Election of Directors" and “Corporate Governance” of Arrow's Proxy Statement for its
Annual Meeting of Shareholders to be held May 1, 2013 (the Proxy Statement), which sections are incorporated herein by
reference. Information regarding Compliance with Section 16(a) of the Exchange Act is set forth in the Company's Proxy
Statement under the caption "Section 16(a) Beneficial Ownership Reporting” and is incorporated herein by reference. Certain
required information regarding our Executive Officers is contained in Part I, Item 1.G., of this Report, "Executive Officers of the
Registrant." Arrow has adopted a Financial Code of Ethics applicable to our principal executive officer, principal financial officer
and principal accounting officer, a copy of which can be found on our website at www.arrowfinancial.com under the link
"Corporate Governance."
Item 11. Executive Compensation
The information required by this item is set forth under the captions “Corporate Governance - Director Independence,”
"Compensation Discussion and Analysis” including the “Compensation Committee Report” thereof, “Executive Compensation,”
“Agreements with Executive Officers” including the ”Potential Payments Upon Termination or Change of Control” and “Potential
Payments Table” sections thereof, and “Voting Item 1: Election of Directors - Director Compensation” of the Proxy Statement,
which sections are incorporated herein by reference.
Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
Certain information required by this item is set forth under the caption "Stock Ownership Information" of the Proxy
Statement, which section is incorporated herein by reference, and under the caption "Equity Compensation Plan Information" in
Part II of this Form 10-K on page 17.
Item 13. Certain Relationships and Related Transactions, and Director Independence
The information required by this item is set forth under the captions “Corporate Governance - Related Party Transactions”
and ““Corporate Governance - Director Independence” of the Proxy Statement, which sections are incorporated herein by
reference.
Item 14. Principal Accounting Fees and Services
The information required by this item is set forth under the captions "Voting Item 4 - Ratification of Independent Registered
Public Accounting Firm - Independent Registered Public Accounting Firm Fees," and “Corporate Governance - Board
Committees” of the Proxy Statement, which sections are incorporated herein by reference.
100
Item 15. Exhibits, Financial Statement Schedules
1. Financial Statements
PART IV
The following financial statements, the notes thereto, and the independent auditors’ report thereon are filed in Part II, Item 8
of this report. See the index to such financial statements at the beginning of Item 8.
Reports of Independent Registered Public Accounting Firm
Consolidated Balance Sheets as of December 31, 2012 and 2011
Consolidated Statements of Income for the Years Ended December 31, 2012, 2011 and 2010
Consolidated Statements of Comprehensive Income for the Years Ended December 31, 2012, 2011 and 2010
Consolidated Statements of Changes in Stockholders’
Equity for the Years Ended December 31, 2012, 2011 and 2010
Consolidated Statements of Cash Flows for the Years Ended December 31, 2012, 2011 and 2010
Notes to Consolidated Financial Statements
2. Schedules
All schedules are omitted as the required information is either not applicable or not required or is contained in the respective
financial statements or in the notes thereto.
3. Exhibits:
See Exhibit Index on page 103.
101
Pursuant to the requirements of Section 13 or 15(d) 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
Date: March 15, 2013
Date: March 15, 2013
By /s/ Thomas J. Murphy
Thomas J. Murphy
President and Chief Executive Officer
By: /s/ Terry R. Goodemote
Terry R. Goodemote
Executive Vice President, Treasurer and
Chief Financial Officer
(Principal Financial and Accounting Officer)
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below on March 15, 2013
by the following persons in the capacities indicated.
/s/ Herbert O. Carpenter
Herbert O. Carpenter
Director
/s/ John J. Carusone, Jr.
John J. Carusone, Jr.
Director
/s/ Michael B. Clarke
Michael B. Clarke
Director
/s/ Gary C. Dake
Gary C. Dake
Director
/s/ Mary Elizabeth T. FitzGerald
Mary Elizabeth T. FitzGerald
Director
/s/ Thomas L. Hoy
Thomas L. Hoy
Director and Chairman
/s/ David G. Kruczlnicki
David G. Kruczlnicki
Director
/s/ Elizabeth O’C. Little
Elizabeth O’C. Little
Director
/s/ David L. Moynehan
David L. Moynehan
Director
/s/ John J. Murphy
John J. Murphy
Director
/s/ Thomas J. Murphy
Thomas J. Murphy
Director
/s/ Richard J. Reisman, D.M.D.
Richard J. Reisman, D.M.D.
Director
102
EXHIBIT INDEX
The following exhibits are incorporated by reference herein.
Exhibit
Number
3.(i)
Exhibit
Certificate of Incorporation of the Registrant, incorporated herein by reference from the Registrant’s Annual Report
filed on Form 10-K for the year ended December 31, 2007, Exhibit 3.(i)
3.(ii)
By-laws of the Registrant, as amended, incorporated herein by reference from the Registrant’s Current Report on
Form 8-K filed on November 24, 2009, Exhibit 3.(ii)
4.1
4.2
4.3
4.4
4.5
4.6
4.7
4.8
Amended and Restated Declaration of the Trust by and among U.S. Bank National Association, as Institutional Trustee,
the Registrant, as Sponsor and certain Administrators named therein, dated as of July 23, 2003, relating to Arrow
Capital Statutory Trust II, incorporated herein by reference from the Registrant’s Quarterly Report on Form 10-Q
for the quarter ended September 30, 2003, Exhibit 4.1
Indenture between the Registrant, as Issuer, and U.S. Bank National Association, as Trustee, dated as of July 23,
2003, incorporated herein by reference from the Registrant’s Quarterly Report on Form 10-Q for the quarter ended
September 30, 2003, Exhibit 4.2
Placement Agreement by and among the Registrant, Arrow Capital Statutory Trust II and SunTrust Capital Markets,
Inc., dated July 23, 2003, incorporated herein by reference from the Registrant’s Quarterly Report on Form 10-Q
for the quarter ended September 30, 2003, Exhibit 4.3
Guarantee Agreement by and between the Registrant and U.S. Bank National Association, dated as of July 23, 2003,
incorporated herein by reference from the Registrant’s Quarterly Report on Form 10-Q for the quarter ended
September 30, 2003, Exhibit 4.4
Amended and Restated Trust Agreement among the Registrant, as Depositor, Wilmington Trust Company, as Property
Trustee, Wilmington Trust Company, as Delaware trustee, and certain Administrators named therein, dated as of
December 28, 2004, relating to Arrow Capital Statutory Trust III, incorporated herein by reference from the
Registrant’s Annual Report on Form 10-K for the year ended December 31, 2004, Exhibit 4.6
Junior Subordinated Indenture between the Registrant, as Issuer, and Wilmington Trust Company, as Trustee, dated
as of December 28, 2004, incorporated herein by reference from the Registrant’s Annual Report on Form 10-K for
the year ended December 31, 2004, Exhibit 4.7
Placement Agreement among the Registrant, Arrow Capital Statutory Trust III and SunTrust Capital Markets, Inc.,
dated December 28, 2004, incorporated herein by reference from the Registrant’s Annual Report on Form 10-K for
the year ended December 31, 2004, Exhibit 4.8
Guarantee Agreement between the Registrant and Wilmington Trust Company, dated as of December 28, 2004,
incorporated herein by reference from the Registrant’s Annual Report on Form 10-K for the year ended December
31, 2004, Exhibit 4.9
10.1
1998 Long Term Incentive Plan of the Registrant, incorporated herein by reference from Registrant’s 1933 Act
Registration Statement on Form S-8, Exhibit 4.1 (File number 333-62719; filed on September 2, 1998)*
10.2
2008 Long Term Incentive Plan of the Registrant, incorporated herein by reference from the Registrant’s Current
Report on Form 8-K filed on May 6, 2008, Exhibit 10.1*
10.3
Profit Sharing Plan of the Registrant, as amended, incorporated herein by reference from the Registrant’s Annual
Report filed on Form 10-K for the year ended December 31, 2008, Exhibit 10.6*
10.4
Directors’ Deferred Compensation Plan of the Registrant, as amended and restated, incorporated herein by reference
from the Registrant’s Annual Report filed on Form 10-K for the year ended December 31, 2008, Exhibit 10.7*
10.5
Directors’ Stock Plan of the Registrant, as amended, incorporated herein by reference from the Registrant’s Annual
Report filed on Form 10-K for the year ended December 31, 2008, Exhibit 10.8*
10.6
10.7
Select Executive Retirement Plan of the Registrant for benefits accrued or vested after December 31, 2004, as amended
and restated, incorporated herein by reference from the Registrant’s Annual Report filed on Form 10-K for the year
ended December 31, 2008, Exhibit 10.9*
Select Executive Retirement Plan of the Registrant for benefits accrued or vested on or before December 31, 2004,
as amended and restated, incorporated herein by reference from the Registrant’s Annual Report filed on Form 10-
K for the year ended December 31, 2008, Exhibit 10.10*
10.8
Senior Officers Deferred Compensation Plan of the Registrant, as amended, incorporated herein by reference from
the Registrant’s Annual Report filed on Form 10-K for the year ended December 31, 2008, Exhibit 10.11*
10.9
Short Term Incentive Plan of the Registrant, as amended, incorporated herein by reference from the Registrant’s
Annual Report filed on Form 10-K for the year ended December 31, 2008, Exhibit 10.12*
10.10
Form of Incentive Stock Option Certificate (Employee Award) of the Registrant, incorporated herein by reference from
the Registrant’s Quarterly Report filed on Form 10-Q for the quarter ended June 30, 2009, Exhibit 10.1*
103
Exhibit
Number
10.11
Exhibit
Form of Non-Qualified Stock Option Certificate (Employee Award) of the Registrant, incorporated herein by reference
from the Registrant’s Quarterly Report filed on Form 10-Q for the quarter ended June 30, 2009, Exhibit 10.2*
10.12
Form of Non-Qualified Stock Option Certificate (Director Award) of the Registrant, incorporated herein by reference
from the Registrant’s Quarterly Report filed on Form 10-Q for the quarter ended June 30, 2009, Exhibit 10.3*
14
Financial Code of Ethics, incorporated herein by reference from the Registrant’s Annual Report on Form 10-K for the
year ended December 31, 2003, Exhibit 14
* Management contracts or compensation plans required to be filed as an exhibit.
The following exhibits are submitted herewith:
Exhibit
Number
10.13
10.14
10.15
Consulting Agreement between the Registrant and Thomas L. Hoy, effective January 1, 2013.
Consulting Agreement between the Registrant and Raymond F. O'Conor, effective January 1, 2013.
Employment Agreement between the Registrant and Thomas J. Murphy, President and Chief Executive Officer, effective
February 1, 2013.*
Exhibit
10.16
Employment Agreement between the Registrant and Terry R. Goodemote, Executive Vice President, Treasurer and
Chief Financial Officer, effective February 1, 2013.*
10.17
Employment Agreement between the Registrant and David S. DeMarco, Senior Vice President, effective February 1,
2013.*
21
23
31.1
31.2
32
Subsidiaries of Arrow Financial Corporation
Consent of Independent Registered Public Accounting Firm
Certification of Chief Executive Officer under SEC Rule 13a-14(a)/15d-14(a)
Certification of Chief Financial Officer under SEC Rule 13a-14(a)/15d-14(a)
Certification of Chief Executive Officer under 18 U.S.C. Section 1350 and
Certification of Chief Financial Officer under 18 U.S.C. Section 1350
101.INS
XBRL Instance Document
101.SCH XBRL Taxonomy Extension Schema Document
101.CAL XBRL Taxonomy Extension Calculation Linkbase Document
101.DEF XBRL Taxonomy Extension Definition Linkbase Document
101.LAB XBRL Taxonomy Extension Labels Linkbase Document
101.PRE XBRL Taxonomy Extension Presentation Linkbase Document
* Management contracts or compensation plans required to be filed as an exhibit.
104