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, 2013
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: $292,291,158
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 21, 2014
12,342,000
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the Registrant’s Proxy Statement for the Annual Meeting of Stockholders to be held May 7, 2014 (Part III)
ARROW FINANCIAL CORPORATION
FORM 10-K
TABLE OF CONTENTS
Note on Terminology
The Company and Its Subsidiaries
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
3
4
5
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17
17
17
17
18
22
23
52
54
103
103
103
103
103
103
103
104
104
105
106
*These items are incorporated by reference to the Corporation’s Proxy Statement for the Annual Meeting of Stockholders to be held
May 7, 2014.
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. 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 344 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, 2013, 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 19 and 20 of this Report.
THE COMPANY AND ITS SUBSIDIARIES
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).
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
Dividend Capacity
Section
Part I, Item 1.C.
Part II, Item 7.E.
Impact of Legislative Developments Part I, Item 1.D.
Part II, Item 7.A.
Part II, Item 7.A.
VISA Estimation
Impact of Changing Interest Rates
on Earnings
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.
Adequacy of the Allowance for Loan
Losses
Noninterest Income
Part II, Item 7.C.IV
Expected Level of Real Estate
Loans
Liquidity
Commitments to Extend Credit
Pension plan return on assets
Realization of recognized net
deferred tax assets
Part II, Item 7.C.II.a.
Part II, Item 7.D.
Part II, Item 8
Part II, Item 8
Part II, Item 8
Page
9
Location
1st paragraph under "Dividend Restrictions;
Other Regulatory Sanctions"
50
12
27
27
32
42
43
47
53
34
36
42
48
79
94
95
1st paragraph under "Dividends"
Last paragraph in Section D
Paragraph in "Health Care Reform"
Paragraph under "VISA Transactions -
Reversal of the Litigation Reserve"
Paragraphs under "Potential Inflation; Effect on
Interest Rates and Margin"
Last paragraph under “Automobile Loans”
3rd and 4th paragraph under table
3rd paragraph
Last 4 paragraphs
1st paragraph under “II. Provision For Loan
Losses and Allowance For Loan Losses”
Last 3 paragraphs under "2013 Compared to
2012"
Paragraphs under “Residential Real Estate
Loans”
Last 2 paragraphs under "Liquidity"
Last 2 paragraphs in Note 8
2nd to last paragraph in Note 13
2nd to last paragraph in Note 15
3
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 experienced during the financial
crisis of 2008-2010;
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, such as 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 are 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 various non-
bank subsidiaries, including four insurance agencies, a registered investment adviser and a REIT. See "The Company and Its
Subsidiaries," above.
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
$
1,843,285
$
1,110,174
$
$
1851
474
30
Warren, Washington,
Saratoga, Essex &
Clinton
250 Glen Street
Glens Falls, NY
Saratoga National
319,228
64,717
1988
42
7
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 516 full-time equivalent employees, including 70 employees within our insurance agency affiliates, at December 31,
2013.
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 94,410 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 insurance agency primarily engaged in
the sale of property and casualty insurance 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, 147,854 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 final such
payment of Arrow stock to the former sole shareholder was paid in the first quarter of 2014. 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, 41,495 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. These post-closing stock payment to the former Loomis shareholders have now been completed.
The estimated value of all expected post-closing payments was included in the basis of goodwill recognized at the acquisition date.
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. Normally, we retain the servicing rights on mortgage loans originated and sold by us
into the secondary markets, subject to our periodic determinations on the continuing profitability of such activity.
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. Home equity lines of credit, secured by real property, 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 normal retail service 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 (primarily in 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 normally participate in loan syndications, either as originator
or as a participant. However, from time-to-time, we buy and sell participations in loans with other financial institutions in our area
of operation. Most of the portfolio, in general, is fully collateralized, and many commercial loans are further supported by personal
guarantees.
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 2013, we foreclosed on one commercial loan
and no residential real estate loans.
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, voting shares of another bank or bank holding company,
if after the acquisition the acquiror would own 5 percent or more of a class of the voting shares of that other bank or bank holding
company. 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 designated as
"financial 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. Arrow has not been designated as a financial holding
company See Item 1.D., "Recent Legislative Developments."
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 over banking organizations 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
6
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 Glens Falls National 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 only current “affiliate” of each of our two banks, other than the other bank, is
their common holding company, Arrow. All of our organization's non-bank subsidiaries are subsidiaries of the banks themselves,
and are "operating subsidiaries" under Sections 23A and 23B. This means they are considered to be part of the banks that own
them and thus are not "affiliates" of the banks. Extensions of credit that a bank may make to affiliates, or to third parties secured
by securities or obligations of the 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 any affiliate, including a bank affiliate. A bank
may engage in certain transactions, including loans and purchases of assets, with a non-bank 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 by it with non-affiliated companies or, in the absence of comparable transactions, on terms
and conditions that would be offered by it to non-affiliated companies.
Regulatory Capital Standards
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 Bank Regulatory Capital Standards (to be phased in, beginning in 2015). The Dodd-Frank Act, among other things,
directed U.S. bank regulators to promulgate new capital standards for U.S. banking organizations, which must be at least as strict
(i.e., must establish minimum capital levels that are at least as high) as the regulatory capital standards for U.S. insured depository
financial institutions at the time Dodd-Frank was enacted in 2010.
In July 2013, federal bank regulators approved their final new bank capital rules aimed at implementing these Dodd-Frank
capital requirements. These rules were also intended to coordinate U.S. bank capital standards with the current drafts of the Basel
III proposed bank capital standards for all of the developed world banking organizations. The federal regulators' new rules, which
will be phased in over time (beginning for our organization in January 2015), impose significantly more stringent capital standards
on U.S. financial institutions than are now in place.
The following is a summary of the new capital rules which apply both to bank holding companies (such as Arrow) and to insured
financial institutions (such as our subsidiary banks):
In general, the new rules expand the risk-weighted 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 new rules also are more
restrictive in their definitions of what qualifies as capital components and set new, higher minimum capital ratios. As required
under Dodd-Frank, the new rules add a new capital ratio, a "common equity tier 1 capital ratio" (CET1). The primary difference
between this ratio and the current tier 1 leverage ratio is that only common equity will qualify as capital under the new CET1 ratio;
preferred stock and trust preferred securities ("TRUPs") will not be included in CET1. The new CET1 ratio will include, however,
most elements of accumulated other comprehensive income, including unrealized securities gains and losses, as part of both total
regulatory capital (numerator) and total assets (denominator), although community banks are given the opportunity to make a one-
time irrevocable election to include or not to include certain elements of other comprehensive income, most notably unrealized
securities gains or losses. We will elect not to include unrealized securities gains and losses in calculating our CET1 ratio.
In addition to setting higher minimum capital ratios, the new rules, as part of their general thrust in requiring enhanced capital
for all banks, introduce a new concept, a so-called "capital conservation buffer" (set at 2.5%, after full phase-in), which must be
added to each of the minimum capital ratios (some of which by themselves are somewhat higher than the current minimum ratios).
The capital conservation buffer will be phased-in over five years (see table on page 8). 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 such deductions should erode the capital buffer below the required level (2.5% of total assets), the bank
would not necessarily be required to replace the buffer deficit immediately but would face restrictions on paying dividends and other
negative consequences until it did so.
Under the final rule, ("TRUPs") issued by small- to medium-sized banking organizations (such as Arrow) that were outstanding
on the Dodd-Frank Act grandfathering date for TRUPS (May 19, 2010) will continue to qualify as tier 1 capital, up to a limit of 25%
of tier 1 capital, until the TRUPs mature or are redeemed. See the subsequent discussion of grandfathered TRUPs in section D
of this item under "The Dodd-Frank Act."
The following is a summary of the regulatory capital definitions applicable to community banks, based on the July 2013 final
new bank capital rules:
7
Common Equity Tier 1 Capital: Equals the sum of common stock instruments and related surplus (net of treasury stock),
retained earnings, accumulated other comprehensive income (AOCI), and qualifying minority interests, minus applicable regulatory
adjustments and deductions. Such deductions will include AOCI, if the organization exercises its irrevocable option not to include
AOCI in capital. Mortgage-servicing assets, deferred tax assets, and investments in financial institutions are limited to 15 percent
of CET1 in the aggregate and 10 percent of CET1 for each such item individually.
Additional Tier 1 Capital: Equals the sum of noncumulative perpetual preferred stock, tier 1 minority interests, grandfathered
TRUPs, and Troubled Asset Relief Program instruments, minus applicable regulatory adjustments and deductions.
Tier 2 Capital: Equals the sum of subordinated debt and preferred stock, total capital minority interests not included in Tier 1,
and allowance for loan and lease losses (not exceeding 1.25 percent of risk-weighted assets) minus applicable regulatory
adjustments and deductions.
The following table presents the transition schedule for community banks' compliance with each of the new capital ratios:
Year, as of January 1
Minimum CET1 Ratio
Capital Conservation Buffer
CET1 Plus Capital Conservation Buffer
2015
4.500%
N/A
4.500%
2016
4.500%
0.625%
5.125%
2017
4.500%
1.250%
5.750%
2018
4.500%
1.875%
6.375%
2019
4.500%
2.500%
7.000%
Phase-in of Deductions from CET1
40.000%
60.000%
80.000% 100.000% 100.000%
Minimum Tier 1 Capital
Minimum Tier 1 Capital Plus Capital Conservation Buffer
Minimum Total Capital
Minimum Total Capital Plus Capital Conservation Buffer
6.000%
N/A
8.000%
N/A
6.000%
6.625%
8.000%
8.625%
6.000%
7.250%
8.000%
9.250%
6.000%
7.875%
8.000%
6.000%
8.500%
8.000%
9.752%
10.500%
These new minimum risk-based capita ratios, especially CETI (4.5%) and Tier 1 (6.0%), that will apply to our organization on
January 1, 2015, represent a heightened and more restrictive capital regime than banks like ours have previously had to deal with
and the addition of the new regulatory capital buffer over the ensuing four years will add to the stress on profitability.
Under the new bank capital standards, the remaining capital standard--the so-called leverage ratio--remains essentially
unchanged (see discussion in the ensuing section on "Current Bank Regulatory Capital Standards."
We estimate that if the new capital rules, which are being phased-in from 2015 to 2019, had been effective on December 31,
2013, our holding company and each of our banks would have met each of the proposed minimums under the new rules, including
the capital conservation buffer.
Current Bank Regulatory Capital Standards (to be phased out, beginning in 2015): Arrow is currently subject to various capital
standards promulgated by the Fed and used in the examination and supervision of bank holding companies. The Fed's current
regulatory standards consist of risk-based capital guidelines and a leverage ratio. Beginning in 2015, these capital standards will
be replaced by the new bank capital standards discussed in the preceding section.
The FRB's current 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 (i.e., 4% of total risk-weighted assets) 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 current guidelines, TRUPs may also qualify as
Tier 1 capital, in an amount not to exceed 25% of Tier 1 capital. 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 current 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 current minimum leverage ratio is 3%, but lower-rated companies may be required to meet
substantially greater minimum ratios. This standard will remain essentially unchanged under the new bank regulatory capital
standards, which become effective January 1, 2015.
Our subsidiary banks are also 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. As is true at the holding company level, the current capital guidelines at the bank level will be replaced by new capital
standards for banks, beginning in 2015, which are generally stronger than the current standards.
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 current bank regulations, 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 2013 capital ratios of our holding
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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.
Dividend Restrictions; Other Regulatory Sanctions
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 (including the new, more
stringent bank capital guidelines to be phased in beginning in 2015) 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 ratio of tangible equity to total assets of a bank falls to 2% or below, the bank will likely be closed and placed
in receivership, with the FDIC as receiver.
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.
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. The Gramm-
Leach-Bliley Act 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 of 2010. It has significantly affected 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.
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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 some 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 ("the Bureau"), which operates as an independent
entity within the Federal Reserve System and is authorized to issue rules for consumer protection, some of which have increased,
and likely will continue to 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 has the right to include its examiners
on a "sampling" basis in examinations conducted by the traditional regulators and is authorized to give those agencies input and
recommendations with respect to consumer protection laws and to require reports and other examination documents. The Bureau
has 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 directed 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 “Regulatory Capital Standards; New Bank Regulatory Capital Standards” on page 7 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 TRUPs
of such bank holding companies that were outstanding on the Dodd-Frank grandfathering date (May 19, 2010), including $20 million
of TRUPs issued by Arrow before that date, will continue to qualify as Tier 1 capital until maturity or earlier redemption, subject to
certain limitations. The new bank capital rules, in their final form, preserve this "grandfathered" status of TRUPs previously issued
by small- to mid-sized financial institutions like Arrow before the grandfathering date. Generally, however, 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 for
banks, unless the U.S. Congress passes legislation that specifically accords regulatory capital status to newly-issued TRUPs.
Bank regulators have not finished promulgating all the rules required to be issued by them under Dodd-Frank and many of the
new rules will have phase-in periods even after final promulgation. (Many of the rules already issued also will become effective
only on a deferred, phase-in basis, including the new capital rules.) 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 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.
10
Other 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 programs served their purpose and have largely run their course or 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 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. Sarbanes-Oxley 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, Sarbanes-Oxley
places limits on non-audit services that may be performed by a company's independent auditors and requires that the company's
Audit Committee review and approve in advance any non-audit services performed by the independent auditor, as well as its audit
services. 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. ("NASDAQ®") promulgated a wide array of new corporate governance standards
that must be followed by listed companies. The NASDAQ® 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. Over the years, we have implemented a variety of corporate governance measures and
procedures to comply with Sarbanes-Oxley and the NASDAQ® listing requirements.
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.
Changes in Deposit Insurance Laws and Regulations
The FDIC, which collects insurance premiums from banks on insured deposits has made several modifications in recent years
to its deposit insurance premium structure that have had a significant impact on bank earnings, the most important of which was
the FDIC's decision 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
11
system significantly lowered our FDIC insurance assessments in second quarter of 2011, which decreased by over 48% from the
first quarter of 2011. The FDIC has not significantly modified its deposit insurance assessment system since 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 should once again become a significant problem on a system-wide basis.
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.
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 from time-to-time by the very large
government sponsored enterprises ("GSEs") engaged in residential mortgage lending, most importantly, “Fannie Mae” and “Freddie
Mac.” These GSEs purchase and/or guarantee a very substantial dollar amount and number of mortgage loans, which in 2013
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.
12
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, CPA
Age
55
Terry R. Goodemote, CPA
50
David S. DeMarco
52
Positions Held and Years from Which Held
President and Chief Executive Officer of 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, and as Corporate Secretary from 2009 to 2012. Mr. Murphy also has
been the President and Chief Executive Officer of GFNB since January 1, 2013. Prior
to that date he served as Senior Executive Vice President of Arrow and President of
GFNB commencing 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.
Chief Financial Officer of Arrow since January 1, 2007. He is Executive Vice President of
Arrow (since January 1, 2013); prior to that, he was Senior Vice President of Arrow (since
2008). Mr. Goodemote also serves as Chief Financial Officer and Treasurer of GFNB
(since January 1, 2007) and as Senior Executive Vice President of GFNB (since July 1,
2011). Before that he was Executive Vice President of GFNB (since 2008). 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.
Senior Vice President of Arrow since May 1, 2009. Mr. DeMarco has been the President
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.
13
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 risks listed below, as well as other risks and uncertainties not currently known to us or that we have currently determined to be
immaterial may also materially and adversely affect our business. Any of these risks could materially and adversely affect our
business, financial condition or results of operations. (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 continue to adversely affect the U.S. commercial banking industry and its core business
of making and servicing loans and could adversely affect our ability to originate loans. Many existing or potential loan
customers of commercial banks, especially individuals and small businesses, continue to experience financial and budgetary
pressures that both challenge their ability to service their existing indebtedness and sharply restrict their ability or willingness to
incur additional indebtedness. The demand for loans, even among creditworthy customers, continues to be soft in the aftermath
of the 2008-2010 financial crisis, despite the historically low prevailing rates of interest for all types of credit. To date, there is little
expectation that the U.S. consumer or commercial banking industry is likely to experience strong asset or profit growth in the near
future, even as the U.S economy is beginning to show some signs of strengthening. Consumers and small businesses are still
struggling under heavy debt loads, which is likely to weigh against any surge in growth or profitability in the banking sector generally
in upcoming periods. This cautionary scenario confronts us as it confronts all commercial banks, large and small, and could
adversely affect our ability to originate loans.
U.S. bank loan portfolios, although generally improving in quality, continue to experience signs of weakness or stress,
particularly in the consumer loan sector, which could deteriorate quickly if the U.S. economy experiences even a modest
downturn and which could have an adverse impact on our financial condition. Home prices in all regions of the U.S., including
our market area in northeastern New York, have stabilized or even strengthened somewhat in recent periods. Delinquency and
charge-off rates in bank loan portfolios have also begun to improve. However, many banks continue to have substantial exposure
in their loan portfolios to borrowers, particularly individual and small business borrowers, that if confronted by an economic downturn
of any consequence, perhaps one that results in their loss of a job or the failure of a business, may quickly fall in arrears on their
borrowings. We, like most banks, believe that the quality of our loan portfolio is strong and our allowance entirely adequate to cover
all embedded risk, but any downturn of consequence in the economy, nationwide or in our region, would likely rekindle the stress
in loan portfolios that many banks have been living with in recent years, potentially damaging our financial condition and results.
The recent strong performance in U.S. equity markets has not been matched by comparable strengthening in the U.S.
economy generally, or in the core business of the U.S. commercial banking sector and a weak U.S. economy could adversely
impact our financial results. The U.S. financial sector, particularly that portion that is focused on the equity markets (i.e., “Wall
Street”), has largely recovered from the 2008-2010 financial crisis, with a notably strong performance during calendar year 2013,
in which equity markets recorded substantial gains, by some measures exceeding 30%, propelling them beyond pre-crisis levels.
At the same time, the wider U.S. economy, especially the business sector that underlies the day-to-day health of U.S. commercial
banks (“Main Street”), has experienced a much more sluggish recovery, that in many areas has not returned market participants,
including companies, workers and municipalities, to levels of financial health they enjoyed before the crisis. Commercial banks
like ours are much more tied, in terms of growth and profits, to the Main Street Sector rather than the Wall Street Sector. Accordingly,
our financial results and condition may be adversely impacted by weak economic conditions.
Any future economic or financial downturn, including any significant correction in the recent “hot” equity markets,
may negatively affect the volume of income attributable to, and demand for, fee-based services of banks such as ours
which could negatively impact our financial condition and results of operation. Revenues from our trust and wealth
management business are dependent on the level of assets under management. Any significant downturn in the equity markets
may lead our trust and wealth management customers to liquidate their investments, or may diminish account values for those
customers who elect to retain their portfolios with us, in either case reducing our assets under management and thereby decreasing
our revenues from this important sector of our business.
We may be adversely affected by new and enhanced government regulation of banks, especially the new rules
promulgated under Dodd-Frank. Even before the recent financial crisis and the resulting new banking laws and regulations,
including Dodd-Frank, we were subject to extensive Federal and state banking regulations and supervision. Banking laws and
regulations are intended primarily to protect bank depositors’ funds (and indirectly the Federal deposit insurance funds) as well as
bank retail customers, who may lack the sophistication to understand or appreciate bank products and services. These laws and
regulations generally are not, however, aimed at protecting or enhancing the returns on investment enjoyed by bank shareholders.
This depositor/customer orientation is particularly true of the recently adopted set of banking laws and regulations, under the
Dodd-Frank Act, which were passed in the aftermath of the 2008-2010 financial crisis and in large part were intended to better
protect bank customers (and to some degree, banks) against the wide variety of lending products and aggressive lending practices
that pre-dated the crisis and are seen as contributing to its severity. Although not all banks offered such products or engaged in
such practices, all banks are affected by the new laws and regulations to some degree.
Dodd-Frank restricts our lending practices, requires us to expend substantial resources to safeguard customers and otherwise
comply with the new rules, and subjects us to significantly higher minimum capital requirements in future periods, which may serve
14
as a drag on our earnings, growth and ultimately on our dividends and stock price (the new capital standards are separately
addressed in the following risk factor). Failure to meet these new minimum capital requirements or comply with these rules 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.
At this time, it is difficult to predict the extent to which Dodd-Frank and the resulting new regulations and rules may adversely
impact our business or financial results. 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.
New capital and liquidity standards adopted by the U.S. banking regulators will result in banks and bank holding
companies needing to maintain more and higher quality capital and greater liquidity than has historically been the case.
New and evolving capital standards, particularly those adopted as a result of Dodd-Frank, will have a significant effect on banks
and bank holding companies, including Arrow. These new standards, when implemented and fully phased-in, will require bank
holding companies and their bank subsidiaries to maintain substantially more capital, with a greater emphasis on common equity.
The need to maintain more and higher quality capital, as well as greater liquidity, and generally increased regulatory scrutiny with
respect to capital levels, could limit our business activities, including lending, and our ability to expand. It could also result in our
being required to take steps to increase our regulatory capital that may be dilutive to shareholders or limit our ability to pay dividends
or otherwise return capital to shareholders.
If economic conditions, already weak, should worsen and the U.S. experiences a recession or prolonged economic
stagnation, our 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.
The current interest rate environment is not particularly favorable for commercial banks generally or their core
businesses, nor are any prospective changes in prevailing interest rates, in the near- or middle-term, likely to significantly
improve commercial banks’ prospects or financial performance, and may actually have a negative impact on our prospects
and performance. Prevailing market interest rates, and changes in those rates, have a direct and material impact on the financial
performance and condition of commercial banks. A bank’s net interest income is usually the most important part of its income, and
prevailing rates for bank assets and bank liabilities generally determine the net interest income.
Currently, market interest rates in the U.S., across all maturities and for all types of loans, are at historic lows, and have been
for several years. This is a direct consequence of the 2008-2010 financial crisis and the policies adopted by the U.S. federal
government (the Fed) and central bank, as well as other governments and central banks, to counteract and limit the crisis by driving
interest rates to the lowest levels sustainable within the financial system and keeping them there for an extended and indeterminate
period of time. The resulting low rate environment, sometimes referred to as “financial repression,” has placed lending institutions
such as commercial banks in a difficult position. Almost all commercial banks are at the point of maximum margin stress and this
margin stress will not likely abate unless and until central bank policies underlying financial repression abate.
Any substantial increase in market rates would normally be expected to adversely impact the commercial banking sector, at
least in the early stages of such a development. Bank liabilities (deposits) typically reprice much more quickly than bank assets
(especially long-term fixed rate loans such as residential mortgage loans). Most banks have positioned themselves to avoid or
mitigate the risk of rising rates, and would expect to eventually profit from a return to a more normal rate environment. The real
risk to the banking sector from an increase in prevailing rates is the damage that such a rise might exact on the U.S. economy
generally, and on the demand for loans as consumers and businesses see their financial conditions deteriorate. It is this consequential
damage to the economy at large that has led the Fed and other central banks to continue with their efforts to ensure a long-term,
low-rate environment through financial repression, and that presents commercial banks with the conundrum of a bad rate situation
that might not improve, even if rates rise, unless any such rate increase takes place in tiny increments over a very long period of
time. Accordingly, these government policies can affect the activities and results of operations of banks and bank holding companies
such as Arrow. We cannot predict the nature or timing of future changes in monetary and other policies or the effect that they may
have on our operations or financial condition.
We operate in a highly competitive industry and market areas that could negatively affect our growth and profitability.
Competition for commercial banking and other financial services is strong in our market areas. In one or more aspects of its business,
our subsidiaries compete with other commercial banks, savings and loan associations, credit unions, finance companies, Internet-
based financial services companies, mutual funds, insurance companies, brokerage and investment banking companies, and other
financial intermediaries. Additionally, due to their size, many competitors may be able to achieve economies of scale and, as a
result, may offer a broader range of products and services as well as better pricing for those products and services than we can.
Technology has lowered barriers to entry and made it possible for non-banks to offer products and services traditionally provided
15
by banks, such as automatic transfer and automatic payment systems. In addition, many of our competitors are not subject to the
same extensive Federal regulations that govern bank holding companies and Federally insured banks. Failure to offer competitive
services in our market areas could significantly weaken our market position, which could adversely affect our growth and profitability,
which, in turn, could have a material adverse effect on our financial condition and results of operations.
The Company relies on the operations of our banking subsidiaries to provide liquidity which, if limited, could impact
our ability to pay dividends to our shareholders or to repurchase our common stock. We are a bank holding company, a
separate legal entity from our subsidiaries. Our bank holding company does not have significant operations of its own. The ability
of our subsidiaries, including our bank and insurance subsidiaries, to pay dividends is limited by various statutes and regulations.
It is possible, depending upon the financial condition of our subsidiaries and other factors, that our subsidiaries would be restricted
in their ability to pay dividends to the holding company, including by a bank regulator asserting that the payment of dividends or
other payments may result in an unsafe or unsound practice. In addition, under Dodd-Frank, we will be subjected to consolidated
capital requirements. If our subsidiaries are unable to pay dividends to our holding company or if our banking subsidiaries are
required to retain capital, we may not be able to pay dividends on our common stock or repurchase shares of our common stock.
If economic conditions worsen and the U.S. financial markets should suffer another downturn, we may experience
limited access to credit markets. As discussed under Part I, Item 7.D. “Liquidity,” we maintain borrowing relationships with
various third parties that enable us to obtain from them, on relatively short notice, overnight and longer-term funds sufficient to
enable us to fulfill our obligations to customers, including deposit withdrawals. If and to the extent 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.
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. 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.
Changes in accounting standards may materially and negatively impact our 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.
Our business could suffer if we lose 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 regularly reviews emergency staffing plans, any sudden unexpected change at the senior management level may adversely
affect our business.
We rely on other companies to provide key components of our 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.
The soundness of other financial institutions could adversely affect us. 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. We have exposure to many different
counterparties in the normal course of business, and we routinely execute transactions with counterparties in the financial services
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 us or by other financial institutions
on whom we rely or with whom we interact. Some of these transactions expose us to credit risk in the event of default of our
counterparty or client. In addition, our credit risk may be exacerbated when the collateral held by us cannot be liquidated or is
liquidated at prices not sufficient to recover the full amount of the financial instrument exposure due us. There is no assurance that
any such losses would not materially and adversely affect our results of operations.
We face continuing and growing security risks to our own information base and to information on our customers and
this operational risk could have a negative effect on our business operations and financial condition. We have implemented
systems of internal controls and procedures and corporate governance policies and procedures intended to protect our business
16
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 our business
operations from every type of problem in every situation. A failure or circumvention of these controls could have a material adverse
effect on our 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 test 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.
Item 1B. Unresolved Staff Comments - None
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
Arrow and Glens Falls National, our principal subsidiary. The main office of our other banking subsidiary, Saratoga National, is in
Saratoga Springs, New York. We own twenty-nine branch banking offices and lease eight others at market rates. We own three
offices for our insurance operations and lease six others. Three of our insurance agency 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 various subsidiaries 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
17
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 Market 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, 2013, we distributed a 2% stock
dividend on our outstanding shares of common stock.
2013
Market Price
Low
High
Cash
Dividends
Declared
2012
Market Price
Low
High
Cash
Dividends
Declared
First Quarter
Second Quarter
Third Quarter
Fourth Quarter
$ 23.14
22.95
24.25
24.91
$
$
25.07
24.96
27.21
28.00
0.245
0.245
0.245
0.250
$ 22.36
22.15
22.81
22.41
$ 26.10
23.89
25.18
25.00
$
0.240
0.240
0.240
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 7,200 holders of record of Arrow’s common stock at December 31, 2013. Arrow has no other class
of stock outstanding.
Equity Compensation Plan Information
The following table sets forth certain information regarding Arrow's equity compensation plans as of December 31, 2013. These
equity compensation plans were our 2013 Long-Term Incentive Plan ("LTIP") and its predecessors, our 2008 LTIP, and our 1998
LTIP; our 2011 Employee Stock Purchase Plan ("ESPP"); and our 2013 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))
389,392
$
—
389,392
$
22.89
—
22.89
668,749
—
668,749
Plan Category
Equity Compensation Plans Approved by
Security Holders (1)(2)
Equity Compensation Plans Not Approved by
Security Holders
Total
(1) All 389,392 shares of common stock listed in column (a) are issuable pursuant to outstanding stock options granted under
the LTIP.
(2) The total of 668,749 shares listed in column (c) includes 459,000 shares of common stock available for future award grants
under the LTIP, 47,548 shares of common stock available for future issuance under the DSP and 162,201 shares of
common stock available for future issuance under the ESPP.
18
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 first graph presents comparative stock performance for the five-year period from December 31, 2008 to December 31,
2013 and the second graph presents comparative stock performance for the ten-year period from December 31, 2003 to
December 31, 2013.
The historical information in the graphs and accompanying tables may not be indicative of future performance of Arrow stock
on the various stock indices.
TOTAL RETURN PERFORMANCE
Period Ending
Index
Arrow Financial Corporation
Russell 2000 Index
NASDAQ Banks Index
Zacks $1B - $5B Bank Assets Index
2008
2009
2010
2011
2012
2013
100.00
100.00
100.00
100.00
106.57
127.09
83.21
75.32
125.70
161.17
98.95
88.33
114.99
154.44
88.50
83.39
130.11
179.75
105.88
100.82
146.99
249.53
151.53
140.74
Source: Prepared by Zacks Investment Research, Inc. Used with permission. All rights reserved. Copyright 1980-2014.
19
TOTAL RETURN PERFORMANCE
Period Ending
Index
Arrow Financial
Corporation
Russell 2000 Index
NASDAQ Banks
Index
Zacks $1B - $5B Bank
Assets Index
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
100.00
114.25
99.98
101.15
94.47
115.34
122.91
144.99
132.63
150.06
169.54
100.00
118.44
123.91
146.77
144.48
95.67
121.58
154.18
147.75
171.96
238.72
100.00
114.52
111.86
125.61
99.40
72.47
60.30
71.71
64.14
76.73
109.82
100.00
118.86
116.55
132.87
103.31
94.46
71.14
83.44
78.77
95.23
132.93
Source: Prepared by Zacks Investment Research, Inc. Used with permission. All rights reserved. Copyright 1980-2014.
The preceding stock performance graphs and tables shall not be deemed incorporated by reference, by virtue of any general
statement contained in this Report, into any other SEC filing by the Company 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 into such filing, and shall not otherwise be deemed filed as part of any such other filing.
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
94,410 shares, as adjusted for subsequent stock dividends, of Arrow's common stock and $116 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
20
residents and the acquired agencies were both New York corporations having substantially all of their assets and business operations
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 147,854 shares, as adjusted for subsequent
stock dividends, of Arrow's common stock and approximately $2.85 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 $91 thousand. The final post-closing stock payment to the former Upstate shareholder was completed in March 2014. 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.
Issuer Purchases of Equity Securities
The following table presents information about repurchases by Arrow during the three months ended December 31, 2013 of
our common stock (our only class of equity securities registered pursuant to Section 12 of the Securities Exchange Act of 1934):
Fourth Quarter 2013
Calendar Month
October
November
December
Total
Total Number of
Shares
Purchased1
2,691
Average Price
Paid Per Share1
$
25.61
8,520
19,122
30,333
26.81
26.72
26.65
Maximum
Approximate Dollar
Value of Shares
that
May Yet be
Purchased Under
the
Plans or Programs2
$
3,761,004
3,761,004
3,761,004
Total Number of
Shares
Purchased as
Part of Publicly
Announced
Plans or
Programs2
—
—
—
—
1The total number of shares purchased and the average price paid per share include shares purchased in open market or
private 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 Arrow's compensatory stock plans in connection with their 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 (2,691 shares) ; November - DRIP purchases (2,214 shares), stock options (6,306 shares); December - DRIP purchases
(18,142 shares), stock options (980 shares).
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 or deemed 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 2013 was the program approved by the Board of Directors and announced in November 2012, under which the
Board authorized management, in its discretion, to repurchase from time to time during 2013, in the open market or in privately
negotiated transactions, up to $5 million of Arrow common stock. In November 2013, the Board authorized a similar repurchase
program for 2014, also having a $5 million total authorization for stock repurchases.
21
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
$
$
$
$
2013
64,138
7,922
56,216
200
56,016
27,521
540
(53,203)
30,874
9,079
21,795
1.77
1.77
0.99
15.55
13.43
$
$
$
$
2012
69,379
11,957
57,422
845
56,577
26,234
865
(51,836)
31,840
9,661
22,179
1.81
1.81
0.97
14.34
12.18
$
$
$
$
2011
76,791
18,679
58,112
845
57,267
23,133
2,795
(51,548)
31,647
9,714
21,933
1.80
1.79
0.94
13.60
11.41
$
$
$
$
2010
84,972
23,695
61,277
1,302
59,975
17,582
1,507
(47,418)
31,646
9,754
21,892
1.81
1.81
0.91
12.63
11.20
$
$
$
$
2009
86,857
26,492
60,365
1,783
58,582
19,235
357
(46,592)
31,582
9,790
21,792
1.81
1.80
0.89
11.69
10.30
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
$2,163,698
457,606
299,261
1,266,472
7,916
1,842,330
73,000
31,777
192,154
$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
Selected Key Ratios:
Return on Average Assets
Return on Average Equity
Dividend Payout 4
1.04%
1.11%
1.13%
1.16%
1.24%
12.11
55.93
12.88
53.59
13.45
52.51
14.56
50.28
16.16
49.44
1Share and per share amounts have been adjusted for subsequent stock splits and dividends, including the most recent
September 2013 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.
22
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 2013 2% stock dividend
Quarter Ended
12/31/2013
9/30/2013
6/30/2013
3/31/2013
12/31/2012
Net Income
Transactions Recorded in Net Income (Net of Tax):
Net Gains on Securities Transactions
Net Gains on Sales of Loans
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 1:
Noninterest Expense
Less: Intangible Asset Amortization
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:
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.
$
5,784
$
5,623
$
5,207
$
5,181
$
5,549
—
114
12,360
12,339
12,387
0.47
0.47
0.25
—
100
12,329
12,308
12,344
0.46
0.46
0.25
$
8
301
12,284
12,261
12,279
0.42
0.42
0.25
318
367
12,251
12,272
12,290
0.42
0.42
0.25
$
$
$
94
476
12,265
12,254
12,273
0.45
0.45
0.25
$
$
46,853
762,768
1,254,957
1,904,922
62,038
184,506
2,176,264
$
14,096
744,928
1,224,840
1,800,181
92,073
179,634
2,095,017
$
26,632
771,018
1,185,041
1,801,346
94,596
178,867
2,099,138
$
41,145
711,848
1,169,870
1,773,126
64,622
176,874
2,039,314
$
40,065
745,150
1,160,226
1,781,778
80,357
176,514
2,064,602
1.05%
12.44%
14.50%
1.06%
12.42%
14.55%
0.99%
11.68%
13.70%
1.03%
11.88%
13.97%
1.07%
12.51%
14.72%
$2,064,578
1,686,993
17,633
1,713
15,920
1,174
$1,983,864
1,614,873
17,032
1,747
15,285
1,158
$1,982,691
1,641,300
16,989
2,223
14,766
1,180
$1,922,863
1,590,401
17,059
2,239
14,820
1,063
$1,945,441
1,612,959
17,787
2,503
15,284
1,047
3.06%
3.06%
2.99%
3.13%
3.13%
$
$
$
$
13,385
(108)
13,277
15,920
6,877
—
22,797
$
$
$
$
13,133
(108)
13,025
15,285
6,939
—
22,224
$
$
$
$
13,274
(112)
13,162
14,766
7,071
(13)
21,824
$
$
$
$
13,411
(124)
13,287
14,820
7,174
(527)
21,467
$
$
$
$
13,117
(126)
12,991
15,284
6,897
(156)
22,025
58.24%
58.61%
60.31%
61.90%
58.98%
$ 192,154
15.55
26,143
13.43
$ 182,683
14.82
26,273
12.69
$ 177,607
14.46
26,387
12.31
$ 177,803
14.51
26,460
12.35
$ 175,825
14.34
26,495
12.18
9.19%
14.70%
15.77%
9.37%
14.59%
15.69%
9.19%
14.82%
15.96%
9.30%
15.15%
16.34%
9.10%
15.02%
16.26%
$1,174,891
$1,111,085
$1,073,523
$1,094,708
$1,045,972
23
Selected Twelve-Month Information
Dollars in thousands, except per share amounts
Share and per share amounts have been restated for the September 2013 2% stock dividend
2013
21,795
$
2012
22,179
$
2011
21,933
$
$
326
882
—
12,360
12,296
12,327
1.77
1.77
0.99
$2,102,788
179,990
$
$
522
1,378
—
12,265
12,247
12,257
1.81
1.81
0.97
$1,997,721
172,175
$
$
1,688
523
(989)
12,239
12,209
12,221
1.80
1.79
0.94
$1,943,263
163,063
$
1.04%
1.11%
1.13%
12.11
$1,988,884
1,633,605
68,713
7,922
60,791
4,575
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
3.06%
3.26%
3.36%
$
$
$
$
53,203
(452)
—
52,751
60,791
28,061
(540)
88,312
$
$
$
$
51,836
(517)
—
51,319
61,316
27,099
(865)
87,550
$
$
$
$
51,548
(510)
(1,638)
49,400
61,706
25,928
(2,795)
84,839
59.73%
58.62%
58.23%
9.24%
9.28%
8.96%
$ 192,154
15.55
26,143
13.43
$ 175,825
14.34
26,495
12.18
$ 166,385
13.59
26,752
11.41
0.09%
0.02%
1.14%
185.71%
0.61%
0.37%
0.05%
0.07%
1.30%
190.37%
0.69%
0.45%
0.05%
0.08%
1.33%
197.10%
0.67%
0.41%
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.
24
CRITICAL ACCOUNTING ESTIMATES
Our significant accounting principles, as described in Note 2 - Summary of Significant Accounting Policies to the Consolidated
Financial Statements are essential in understanding the MD&A. Many of our significant accounting policies require complex
judgments to estimate the values of assets and liabilities. We have procedures and processes in place to facilitate making these
judgments. The more judgmental estimates are summarized in the following discussion. In many cases, there are numerous
alternative judgments that could be used in the process of determining the inputs to the models. Where alternatives exist, we have
used the factors that we believe represent the most reasonable value in developing the inputs. Actual performance that differs from
our estimates of the key variables could impact our results of operations.
Allowance for loan losses: The allowance for loan losses represents management’s estimate of probable losses inherent in
the Company’s loan portfolio. Our process for determining the allowance for loan losses is discussed in Note 2 - Summary of
Significant Accounting Policies and Note 5 - Loans to the Consolidated Financial Statements. We evaluate our allowance at the
portfolio segment level and our portfolio segments are commercial, commercial construction, commercial real estate, automobile,
residential real estate and other consumer loans. Due to the variability in the drivers of the assumptions used in this process,
estimates of the portfolio’s inherent risks and overall collectability change with changes in the economy, individual industries, and
borrowers’ ability and willingness to repay their obligations. The degree to which any particular assumption affects the allowance
for loan losses depends on the severity of the change and its relationship to the other assumptions. Key judgments used in
determining the allowance for loan losses include credit quality indicators for individual commercial loans and collateral values and
estimated cash flows for impaired loans. For pools of loans we consider net loss experience, and as necessary, adjustments to
address current events and conditions, considerations regarding economic uncertainty, and overall credit conditions. The process
of determining the level of the allowance for loan losses requires a high degree of judgment. It is possible that others, given the
same information, may at any point in time reach different reasonable conclusions. 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.
Pension and retirement plans: Management is required to make various assumptions in valuing its pension and postretirement
plan assets, expenses and liabilities. The most significant assumptions include the expected rate of return on plan assets, the
discount rate, and the rate of increase in future compensation levels. Changes to these assumptions could impact earnings in future
periods. The Company utilizes an actuarial firm to assist in determining the various rates used to estimate pension obligations and
expense, including the evaluation of market interest rates and discounted cash flows in setting the appropriate discount rate. In
addition, the Company reviews expected inflationary and merit increases to compensation in determining the rate of increase in
future compensation levels. Changes in these assumptions due to market conditions and governing laws and regulations may result
in material changes to the Company’s pension and other postretirement plan assets, expenses and liabilities.
Other than temporary decline in the value of debt and equity securities: Management systematically evaluates individual
securities classified as either available-for-sale or held-to-maturity to determine whether a decline in fair value below the amortized
cost basis is other than temporary. Management considers historical values and current market conditions as a part of the
assessment. The amount of the total other-than-temporary impairment related to the credit loss, if any, is recognized in earnings
and the amount of the total other-than-temporary impairment related to other factors is generally recognized in other comprehensive
income, net of applicable taxes unless the Company intends to sell the security prior to the recovery of the unrealized loss or it is
more likely than not that the Company would be forced to sell the security, in which case the entire impairment 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 investment portfolio.
25
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, 2013 and our financial condition as of December 31, 2013 and 2012. 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 2013 Financial Results
We reported net income for 2013 of $21.8 million, representing diluted earnings per share ("EPS") of $1.77, a decrease of four
cents, or 2.2% from our 2012 EPS. Return on average equity ("ROE") for the 2013 year continued to be strong at 12.11%, although
down from the ROE of 12.88% for the 2012 year. Return on average assets ("ROA") for 2013 continued to be strong at 1.04%,
although down from ROA of 1.11% for 2012. The decreases in both ROA and ROE were principally due to our shrinking net interest
margin, which led to a slight decrease, 0.9%, in our net interest income, despite the fact that our earning assets grew and our asset
quality remained strong. Our noninterest income increased in 2013 by $1.28 million, or 3.5%, while our noninterest expense
increased by $1.34 million, or 2.6%. The other key factor influencing the change in net income was a $645 thousand decrease in
the provision for loan losses.
Total assets were $2.164 billion at December 31, 2013, which represented an increase of $140.9 million, or 7.0%, above the
$2.023 billion level at December 31, 2012.
Stockholders' equity was $192.2 million at December 31, 2013, an increase of $16.3 million or 9.3%, from the year earlier level.
The components of the change in stockholders' equity since year-end 2012 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 28 entitled,
“Increase in Stockholder Equity.”
Regulatory capital: At period-end, we continued to exceed all current regulatory minimum capital requirements at both the
holding company and bank levels, by a substantial amount. As of December 31, 2013 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 when the new enhanced capital requirements, announced in June 2013, go into effect
in 2015, we expect that Arrow and our subsidiary banks will continue to meet all of these enhanced standards. See "Regulatory
Capital Standards" on pages 7-9.
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 felt 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 modest decline in the credit quality of our
loan portfolio, although by standard measures our portfolio continued to be stronger than the average for our peer group of U.S.
bank holding companies with $1 billion to $3 billion in total assets. By year-end 2010, however, our loan quality began to stabilize.
During 2013, economic activity continued to reflect many positive trends as unemployment declined overall within New York State
(NYS), as well as declined in the region that the Company operates. Along with lower unemployment, housing prices remained
strong with sales and pending sales up year-over-year. Pending sales were up, closed sales also increased, median sales prices
rose and days on the market declined, all indicating improvement in the residential real estate market in NYS. Nonperforming loans
were $7.8 million at December 31, 2013, a decrease of $264 thousand from year-end 2012. The ratio of nonperforming loans to
period-end loans at December 31, 2013 was .61%, a decrease from .69% at December 31, 2012. By way of comparison, this ratio
for our peer group was 1.46% at December 31, 2013, 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 (i.e., before the financial
crisis). Loans charged-off (net of recoveries) against our allowance for loan losses was $1.1 million for 2013. Although our net
charge-offs increased from $550 thousand for 2012, our ratio of net charge-offs to average loans was still only .09% for 2013,
compared to our peer group ratio of .25% for the year ended December 31, 2013. At December 31, 2013, the allowance for loan
losses was $14.4 million, representing 1.14% of total loans, a decrease of 16 basis points from December 31, 2012.
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 and Commercial Real Estate Loans: These loans comprise approximately 32% of our loan portfolio.
Current unemployment rates in our region have continued to decline over the past few years. 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 36% of our portfolio.
We have not experienced any significant increase in our delinquency and 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.
26
Automobile Loans (Primarily Through Indirect Lending): These loans comprise approximately 31% of our loan portfolio.
Throughout the past three years, we did not experience any significant change in our delinquency rate or level of charge-
offs on these loans. We experienced approximately half of the growth in our loan portfolio in this category of loans during
2013.
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 page 10 under "The Dodd-Frank Act" regarding the likely impact on Arrow of the Bureau of Consumer Financial Protection.)
Dodd-Frank also directed 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 "Regulatory Capital Standards" on pages 7-9 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 qualify as Tier 1 capital. Current outstanding TRUPs of such bank holding companies issued by them on or
before the Dodd-Frank grandfathering date (May 19, 2010), including Arrow's $20 million of TRUPs that are currently outstanding,
will continue to qualify as Tier 1 capital until maturity or redemption, subject to certain limitations. Regardless, 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 the various 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, upon us 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 2013, nor
during the prior two years. 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 48). 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, an arrangement for term
credit advances from the FHLBNY, and an additional arrangement for short-term advances at 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 had no such need. We regularly perform a liquidity stress test and periodically
test our 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 thereafter on total assets (with certain adjustments) rather than deposits.
This had the effect of imposing FDIC insurance fees not only on deposits but on other sources of funding that banks typically use
to support their assets, 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: 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. In
December 2013, a federal judge gave final approval to the class settlement agreement in the multi-district interchange litigation
against Visa and Mastercard. The total cash settlement payment is approximately $6.05 billion, of which Visa’s share represents
approximately $4.4 billion. Visa has paid the cash portion of this settlement from the litigation escrow account pursuant to Visa’s
Retrospective Responsibility Plan, which was developed as part of the restructuring process to address potential liability in certain
Visa litigation, including this interchange class action. However, there continues to be restrictions remaining on Visa Class B shares
held by the Company. Visa's share of this settlement, like its prior settlements of similar claims, will be paid out of an escrow fund
previously established by Visa to cover such liabilities. We, like other Visa member banks, bear some indirect contingent liability
for Visa's future liability on such claims to the extent that might exceed the remaining escrow amount. 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 2008 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
27
to believe, that the multi-billion dollar balance that Visa maintains in its escrow fund is substantially sufficient to satisfy Visa's
remaining direct liability to such claim as well as the contingent liability of the Visa member banks. 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, 2013, our tangible book value per share (calculated based on
stockholders' equity reduced by intangible assets including goodwill and other intangible assets) amounted to $13.43, an increase
of $1.25, or 10.3%, from December 31, 2012. Our total stockholders' equity at December 31, 2013 increased 9.3% over the year-
earlier level, and our total book value per share increased by 8.4% over the year earlier level. This increase principally reflected
the following factors: (i) $21.8 million net income for the period, (ii) $4.1 million of other comprehensive income; offset in part by,
(iii) cash dividends of $12.1 million; and (iv) repurchases of our own common stock of $1.7 million. As of December 31, 2013, our
closing stock price was $26.56, resulting in a trading multiple of 1.98 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 a cash dividend of $.245 per share for each of the first three quarters of 2013, as
adjusted for a 2% stock dividend distributed September 27, 2013, a cash dividend of $.25 per share for the fourth quarter of 2013
and has declared a $.25 per share cash dividend for the first quarter of 2014.
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 2013 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)
Years Ended December 31,
Change From Prior Year
Interest and Dividend Income
Interest Expense
Net Interest Income
2013
$ 68,713
7,922
$ 60,791
2012
$ 73,273
11,957
$ 61,316
2011
$ 80,385
18,679
$ 61,706
2012 to 2013
%
(6.2)% $ (7,112)
(6,722)
(390)
Amount
$ (4,560)
(4,035)
(525)
(33.7)
(0.9)
Amount
$
$
2011 to 2012
%
(8.8)%
(36.0)
(0.6)
On a tax-equivalent basis, net interest income was $60.8 million in 2013, a decrease of $525 thousand, or .9%, from $61.3
million in 2012. This compared to an decrease of $390 thousand, or .6%, from 2011 to 2012. 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.
28
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
2013 Compared to 2012 Change in
Net Interest Income Due to:
2012 Compared to 2011 Change in
Net Interest Income Due to:
Volume
Rate
Total
Volume
Rate
Total
$
(21) $
2
$
(19)
$
6
$
4
$
10
(610)
2,968
2,842
(1,756)
(1,937)
(6,048)
(2,366)
1,031
(3,206)
344
233
1,093
(3,479)
(141)
(5,172)
(3,135)
92
(4,079)
5,179
(9,739)
(4,560)
1,676
(8,788)
(7,112)
323
142
(351)
(513)
(399)
20
(141)
(520)
(1,426)
(405)
(458)
(1,255)
(3,544)
25
4
(3,515)
(1,103)
(263)
(809)
(1,768)
(3,943)
45
(137)
(4,035)
890
120
(305)
(520)
185
(39)
(1,628)
(1,482)
(2,378)
(731)
(321)
(893)
(4,323)
(31)
(886)
(5,240)
(1,488)
(611)
(626)
(1,413)
(4,138)
(70)
(2,514)
(6,722)
Net Interest Income
$
5,699
$
(6,224) $
(525)
$
3,158
$
(3,548) $
(390)
29
The following table reflects the components of our net interest income, setting forth, for years ended December 31, 2013, 2012
and 2011 (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:
2013
Interest
Rate
Income/
Earned/
Expense
Paid
Average
Balance
2012
Interest
Rate
Income/
Earned/
Expense
Paid
Average
Balance
2011
Interest
Rate
Income/
Earned/
Expense
Paid
Average
Balance
$
32,148
$
89
0.28% $
39,783
$
108
0.27 % $
37,440
$
98
0.26%
Fully Taxable
432,947
6,920
1.60%
465,105
9,286
2.00 %
452,264
12,421
2.75%
Exempt from Federal
Taxes
Loans
Total Earning Assets
314,835
1,208,954
1,988,884
10,105
51,599
68,713
Allowance for Loan Losses
(14,778)
3.21%
229,105
9,074
3.96 %
223,259
54,805
73,273
4.27% 1,147,286
3.45% 1,881,279
(15,170)
30,936
100,676
$ 1,997,721
4.78 % 1,126,065
3.89 % 1,839,028
(14,821)
28,844
90,212
$ 1,943,263
8,982
58,884
80,385
4.02%
5.23%
4.37%
30,985
97,697
$ 2,102,788
$ 798,230
490,558
86,457
179,997
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
0.84%
0.46%
2.14%
2.15%
1.07%
0.16%
2,461
1,024
1,198
1,962
0.31% $ 726,660
0.21%
437,095
1.39%
1.09%
107,665
212,918
3,564
1,287
2,007
3,730
0.49 % $ 603,965
0.29 %
409,398
1.86 %
1.75 %
122,897
238,865
5,052
1,898
2,633
5,143
1,555,242
6,645
0.43% 1,484,338
10,588
0.71 % 1,375,125
14,726
33,404
88
0.26%
24,225
43
0.18 %
56,206
92
44,959
1,189
2.64%
50,301
1,326
2.64 %
103,753
3,861
3.72%
1,633,605
7,922
0.48% 1,558,864
11,957
0.77 % 1,535,084
18,679
1.22%
264,959
24,234
1,922,798
179,990
240,872
25,810
1,825,546
172,175
221,035
24,081
1,780,200
163,063
$ 2,102,788
$ 1,997,721
$ 1,943,263
60,791
61,316
61,706
(4,575)
0.23%
(3,894)
0.21 %
(3,594)
0.20%
$ 56,216
$ 57,422
$ 58,112
2.97%
3.06%
3.12 %
3.26 %
3.15%
3.36%
30
CHANGES IN NET INTEREST INCOME DUE TO RATE
YIELD ANALYSIS (Tax-equivalent basis)
2013
Yield on Earning Assets
Cost of Interest-Bearing Liabilities
Net Interest Spread
Net Interest Margin
2011
December 31,
2012
3.89% 4.37%
0.77
3.12% 3.15%
3.26% 3.36%
1.22
3.45%
0.48
2.97%
3.06%
In 2013, we experienced a decrease in net interest income from 2012. Over the last several years, beginning in late 2008 and
extending up to the present, our earning assets have tended 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 (when prevailing interest rates were
generally increasing, and our rates paid on liabilities were increasing faster than our rates earned on assets), we experienced four
successive years of increases in net interest income from 2007 through 2010 (although prevailing rates were generally declining
during those years). In each of the four years, we experienced a benefit from an increase in average earning assets and from
modest increases in our net interest margins, as our paying liabilities repriced downwards more quickly than our earning assets.
From 2009 to the present, however, our net interest margin has been consistently under pressure and has generally declined, as
rates paid by us on liabilities have decreased more slowly than rates earned by us on our assets. From 2011 through 2013, our
net interest income leveled off and actually declined slightly, as continuing increases in our average earning assets were not enough
to offset the decease in our margins, a result experienced by many banks whose growth rates like ours were modest during this
period.
The decrease in net interest income was $525 thousand, or 0.9%, from 2012 to 2013. Net interest income decreased $390
thousand, or .6%, from 2011 to 2012. In 2013, an increase in average earning assets, net of a smaller increase in average interest-
bearing liabilities (i.e., changes in volume) had a $5.7 million positive impact on net interest income, while changes in rates provided
a $6.2 million negative impact on our net interest income for the year, as yields on earning assets decreased more rapidly than
rates paid on liabilities.
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 the ensuing years, rapidly in 2008 and 2009 and more slowing
in the 2010-2013 period. 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 subsequent 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 then 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 decreased roughly in parity with the continuing
decreases in short-term rates. Both short- and long-term rates approached historically low levels, a goal explicitly sought by the
Federal Reserve. From mid-2011 to mid-2013, long-term rate decreases generally exceeded short-term rate decreases and the
yield curve 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 fell to levels not seen in many years, if ever. However, even with
this intervention, the yield curve significantly steepened in the second half of 2013, following the mere announcement by the Fed
of its plan to begin to reduce its quantitative easing program (i.e., market purchases by the Fed of treasury bills and mortgage-
backed securities).
Continuing Pressure on Credit Quality. All lending institutions, even those like us who have avoided subprime lending problems
and continue to maintain a comparatively strong asset portfolio, have experienced some continuing pressure on credit quality in
recent periods. 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
31
modest up-tick in loan demand and in the U.S. economy generally experienced during 2013 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.
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 2013 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 2.99%
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-rate assets continue to mature and pay off at a faster pace than newer, lower-rate assets. Thus, we
may continue to experience additional margin compression in upcoming periods. That is, our average yield on assets in upcoming
periods may decline at a faster rate, or if market rates generally increase, increase at a slower 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.
Potential Inflation; Effect on Interest Rates and Margins. Recently, there has been discussion and 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 quantitative easing program 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 period, 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 up to $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. In early 2013, the U.S. economy began to show signs of strengthening and in May 2013,
the Fed announced it would begin at some point in the not-too-distant future to reduce its quantitative easing program, by "tapering"
its market purchases of debt securities. The reductions began in fall of 2013. In early 2014, the Fed scaled back its monthly targeted
purchases to $65 billion a month, still a mix of treasury bonds and mortgage-backed securities. However, inflation in the U.S.
continues at a very low level, and although the rate of inflation may begin to rise, for most in the financial world that is, at worst, a
medium- or long-term worry, not a near-term concern.
Management does not anticipate a substantial increase in the inflation rate, or in prevailing interest rates, short- or long-term.
If modest interest 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.
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".
32
CHANGES IN NET INTEREST INCOME DUE TO VOLUME
AVERAGE BALANCES
(Dollars In Thousands)
Years Ended December 31,
Change From Prior Year
Earning Assets
2013
2012
$ 1,988,884
$ 1,881,279
Interest-Bearing Liabilities
1,633,605
1,558,864
Demand Deposits
Total Assets
264,959
240,872
2,102,788
1,997,721
2012 to 2013
2011 to 2012
2011
$ 1,839,028
1,535,084
221,035
1,943,263
Amount
$ 107,605
74,741
24,087
105,067
%
Amount
%
5.7% $
42,251
2.3%
4.8
10.0
5.3
23,780
19,837
54,458
1.5
9.0
2.8
Earning Assets to Total Assets
94.58%
94.17%
94.64%
2013 Compared to 2012:
In general, an increase in average earning assets has a positive impact on net interest income, especially if average earning
assets increase more rapidly than average paying liabilities. For 2013, average earning assets increased $107.6 million or 5.7%
over 2012, while average interest-bearing liabilities increased $74.7 million or 4.8%. Despite the positive impact of a growth in net
earning assets, we experienced a $525 thousand decrease in net interest income, due to the negative impact of a 20 basis point
decrease in our net interest margin (from 3.26% to 3.06%) between the two years.
The $107.6 million increase in average earning assets from 2012 to 2013 reflected an increase in both the average balance
of our securities portfolio and the average balance of total loans from 2012 to 2013. Within the loan portfolio, our three principal
segments are residential real estate loans, automobile loans (primarily through our indirect lending program) and commercial loans.
Even though we sold a significant portion of our residential real estate loan originations into the secondary market throughout all
of 2013, we still experienced an increase in the average balance of that portfolio from 2012 to 2013. The average balance of our
automobile loan portfolio increased in 2013 reflecting an increase in demand for new vehicles and our determination to remain
competitive on our pricing of these loans with respect to other commercial banks. although we remained 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 during 2013. A significant portion of the growth in our earning assets
in 2013 was in our lower yielding investment portfolio (versus the higher yields in our loan portfolio). This diminished to a degree
the overall positive impact of our growth in total earning assets during the year, which was 5.7% (versus 2.3% in 2012).
The $74.7 million increase in average interest-bearing liabilities was nearly all attributable to an increase in deposits from our
existing branch network.
2012 Compared to 2011:
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%. Nevertheless, despite the positive impact of a growth in net earning assets, we experienced a $690 thousand
decrease in net interest income, due to the negative impact of a 10 basis point decrease in our net interest margin (from 3.36% to
3.26%) between the two years.
The 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 substantial portion of our residential real estate loan originations in 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. 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 only 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 a $85.4 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.”
33
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. We recorded a $200 thousand provision for loan losses for 2013,
substantially below the $845 thousand for 2012. The decrease, despite modest growth in the loan portfolio, was attributable to a
variety of factors, including the fact that one large commercial charge-off of $753 thousand in the first quarter of 2013 was fully
provided for at December 31, 2012, and, to a lesser extent, an improvement in the loan credit quality indicators of the loan portfolio
and generally improved economic conditions.
Our method for determining the amount of the loan loss provision is explained in detail in Notes 2 and 5 to the audited financial
statements.
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
2013
$1,266,472
1,208,954
2012
$1,172,341
1,147,286
2011
$1,131,457
1,126,065
2010
$1,145,508
1,134,718
2009
$1,112,150
1,101,759
2,163,698
2,022,796
1,962,684
1,908,336
1,841,627
2,048
352
3,860
219
6,479
652
641
7,772
63
81
—
$
$
7,916
15,298
$
$
(926)
(11)
(15)
(459)
(1,411)
88
—
—
259
347
(1,064)
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
—
—
270
—
4,660
59
53
—
$
$
4,945
14,014
$
$
4,772
13,272
(30)
—
—
(864)
(894)
5
—
—
262
267
(627)
(88)
—
(25)
(1,317)
(1,430)
14
—
6
369
389
(1,041)
200
845
845
1,302
1,783
$
14,434
$
15,298
$
15,003
$
14,689
$
14,014
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%
0.09%
0.02%
1.14%
185.71%
0.61%
0.37%
34
ALLOCATION OF THE ALLOWANCE FOR LOAN LOSSES
(Dollars in Thousands)
Commercial and Commercial Construction
$
Real Estate-Commercial
Real Estate-Residential Mortgage
Automobile and Other Consumer
Unallocated
Total
2013
2012
2011
2010
2009
$
2,303
3,545
3,026
4,478
1,082
$
2,945
3,050
3,405
4,840
1,058
$
2,529
3,136
3,414
4,846
1,078
$
2,037
3,128
3,163
5,088
1,273
1,304
4,000
2,954
4,901
855
$ 14,434
$
15,298
$
15,003
$ 14,689
$ 14,014
The allowance for loan losses declined to $14.4 million at year-end 2013 from $15.3 million at year-end 2012, a decrease of
5.9%. The allowance for loan losses as a percentage of period-end total loans also declined to 1.14% at year-end 2013 from 1.30%
at year-end 2012, a decrease of 12.3%.
The single largest factor in the decrease in the allowance and the allowance coverage ratio between year-end 2012 and year-
end 2013 was the charge-off in the first quarter of 2013 of one large commercial loan that was fully reserved at December 31, 2012.
Excluding this specific loan from both the allowance and total loans at year-end 2012 would have resulted in a coverage ratio at
December 31, 2012 of 1.24%.
A second significant factor in the decline in the allowance and allowance coverage between year-end 2012 and year-end 2013
was a general improvement in the overall quality of the portfolio, including a reduction in other criticized and classified commercial
loans (special-mention loans, substandard loans and doubtful loans excluding the impaired loan with a specific allowance at
December 31, 2012 as discussed above). The ratio of such loans to total commercial loans decreased to 7.0% at December 31,
2013 from 7.4% at December 31, 2012. A third factor in the decline in the allowance and allowance coverage ratio during 2013
was the general improvement in economic conditions in the Company's market area, which, depending upon the particular sector
of the portfolio under consideration, reduced or eliminated the increase in the allowance the sector otherwise would have experienced
or contributed to the decrease in allowance the sector otherwise would have experienced.
The changes in our allowance by specific portfolio sector during 2013 were as follows. The allowance for loan losses allocated
to commercial loans and commercial construction loans declined to $2.3 million at December 31, 2013 from $2.9 million at December
31, 2012 , or by 21.8%, primarily due to the one large commercial loan charge-off discussed above, as well as a reduction of $19.0
million, or 14.1%, in commercial and commercial construction loans outstanding at year-end 2013 from year-end 2012. The
allowance for loan losses related to commercial real estate loans increased to $3.5 million at year-end 2013 from $3.1 million at
year-end 2012, or by 16%, primarily due to significant loan growth of $42.9 million or 17.5% of commercial real estate loans at
year-end 2013 as compared to year-end 2012. The allowance for loan losses allocated to residential real estate loans declined to
$3.1 million at year-end 2013 from $3.4 million at year-end 2012 or 11.1% primarily due to improvement in collateral values, partially
offset by growth of $24.1 million or 5.5% in this loan portfolio at year-end 2013 from year-end 2012. The allowance for loan losses
allocated to automobile and other consumer loans declined to $4.5 million at year-end 2013 from $4.8 million at year-end 2012 or
7.5% primarily due to generally improved economic conditions in the Company’s market area, despite growth of $46.1 or 12.9% in
this loan portfolio at year-end 2013 from year-end 2012. The unallocated portion of the allowance for loan losses methodology
relates to the overall level of imprecision inherent in the estimation of the appropriate level of the allowance for loan losses and is
not considered a significant element of the overall methodology. The unallocated portion of the allowance at December 31, 2013
remained unchanged from December 31, 2012 at $1.1 million.
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, net gains on securities transactions and other recurring fee
income.
35
ANALYSIS OF NONINTEREST INCOME
(Dollars In Thousands)
Years Ended December 31,
Change From Prior Year
Income from Fiduciary Activities
$
6,735
$
6,290
$
6,113
2013
2012
2011
2012 to 2013
2011 to 2012
Amount
445
$
%
Amount
177
7.1% $
%
2.9%
Fees for Other Services to
Customers
Net Gain on Securities Transactions
Insurance Commissions
Net Gain on Sales of Loans
Other Operating Income
9,407
540
8,895
1,460
1,024
8,245
865
8,247
2,282
1,170
Total Noninterest Income
$ 28,061
$ 27,099
8,034
2,795
7,374
866
746
$ 25,928
$
1,162
(325)
648
(822)
(146)
962
14.1
(37.6)
7.9
(36.0)
(12.5)
211
(1,930)
873
1,416
424
3.5
$
1,171
2.6
(69.1)
11.8
163.5
56.8
4.5
2013 Compared to 2012: Total noninterest income in the just completed year was $28.1 million, an increase of $1.0 million,
or 3.5%, from total noninterest income of $27.1 million for 2012. The total for both the 2013 and 2012 periods included net gains
on securities transactions and net gains on the sales of loans, both of which decreased between the two periods. Net gains on the
sales of securities decreased from $865 thousand to $540 thousand, a net decrease of $325 thousand, and net gains on the sales
of loans decreased from $2.3 million to $1.5 million, a decrease of $822 thousand. However, all three of our main categories of
noninterest income (income from fiduciary activities, fees for other services to customers and insurance commissions) all increased
from 2012 to 2013.
Assets under trust administration and investment management at December 31, 2013 were $1.175 billion, up from the prior
year-end balance of $1.046 billion. Largely as a result of such increase our income from fiduciary services for 2013 increased by
$445 thousand, or 7.1%, above the total for 2012. 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
$9.4 million for 2013, an increase of $1.2 million, or 14.1%, from 2012. The principal cause of the increase between the two periods
was an increase in income from debit card transactions, which increased from $2.6 million for 2012 to $2.9 million for 2013. 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.
Noninterest income from insurance commissions increased by $648 thousand, or 7.9%, between the two periods. We expect
that noninterest income from insurance commissions will continue to represent a significant portion of our noninterest income in
upcoming periods, both absolutely and as a percentage of our total net income. We may continue in the future to expand our market
profile in this line of business, by acquiring additional agencies, if favorable opportunities should arise, but can give no assurances
in this regard.
Starting with the third quarter of 2010, we began to sell most of our newly originated residential real estate loans into the
secondary market (i.e., to "Freddie Mac"). Such sales generate 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 sell 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 in subsequent periods (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, which tend to fluctuate from year to year.
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.
36
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 a negative impact on our fee income. However, debit card usage
by our customers grew which has had 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.
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
2012 to 2013
2011 to 2012
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
2013
$ 31,182
4,582
3,703
1,080
452
—
2012
$ 31,703
3,970
2011
$ 30,205
3,891
3,497
1,026
517
—
3,478
1,292
510
1,638
12,204
11,123
10,534
$ 53,203
$ 51,836
$ 51,548
$
Amount
(521)
612
206
54
(65)
—
1,081
$ 1,367
Efficiency Ratio
59.73%
58.62%
58.23%
1.11%
%
Amount
(1.6)% $ 1,498
79
15.4
5.9
5.3
(12.6)
—
9.7
2.6
1.9
19
(266)
7
(1,638)
589
$
288
0.39%
%
5.0%
2.0
0.5
(20.6)
1.4
—
5.6
0.6
0.7
2013 compared to 2012: Noninterest expense for 2013 amounted to $53.2 million, an increase of $1.4 million, or 2.6%, from
2012. For 2013, our efficiency ratio was 59.73%. 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 2013, our peer group ratio was 70.5%, and our ratio
(not adjusted) was 60.2%.
Salaries and employee benefits expense, which typically represents from 55-60% of total noninterest expense, decreased by
$521 thousand, or 1.6%, from 2012 to 2013. Salary expense was virtually the same in 2013 as in 2012. Most of the decrease in
employee benefits was attributable to a decrease in pension expense between the two periods.
Both building and equipment expenses increased from 2012 to 2013. In both cases, the increase is primarily attributable to
an increase in depreciation expense reflecting the significant investments we have made in improving our facilities and information
technology infrastructure over the past two years.
Other operating expense increased $1.1 million, or 9.7% from 2012. This was primarily the result of an increase of $1.3 million
for off-premise computer services offset, in part, by a $319 thousand decrease in telecommunications expense. These two trends
reflect the increasing complexity of electronic services banks now provide apart from our core banking applications and the benefit
from competitive pricing as more vendors enter into the marketplace.
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%. For 2012, our peer group ratio (adjusted to include intangible asset amortization
in the numerator) was 70.2%; our ratio (not adjusted) was 59.2%.
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, due primarily to a decrease in the discount
rate used to calculate the net periodic benefit cost.
37
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 thousand (or 20.5%) between the two years, and the prepayment penalty we recognized in 2011 in connection with our
prepayment of FHLB advances during that year ($1.6 million), was not replicated in 2012.
The significant decrease in our FDIC assessment from 2011 to 2012 directly resulted from a change in the way the FDIC
calculates deposit insurance premiums payable by banks,which first took effect in the second quarter of 2011. Under the new
method, the FDIC now calculates premiums based on adjusted assets rather than deposits. This resulted in substantial decreases
in our FDIC insurance expense both in 2011 and in 2012. The positive impact of the change in our year-to-year noninterest expense
did not, however, extend beyond 2012. In all periods, 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.
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
2013
$ 9,079
2012
$ 9,661
2011
$ 9,714
29.4%
30.3%
30.7%
Amount
$ (582)
2012 to 2013
%
(6.0)% $
(3.0)
(0.9)%
2011 to 2012
%
(0.5)%
(1.3)
Amount
(53)
(0.4)%
The provisions for federal and state income taxes amounted to $9.1 million for 2013 and $9.7 million for both 2012 and 2011. The
effective income tax rates for 2013, 2012 and 2011 were 29.4%, 30.3% and 30.7%, respectively. The changes reflect an increasing
proportion of tax-equivalent income to pre-tax income.
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 2013, 2012 and 2011, 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 2013, 2012 and 2011.
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
2013
$ 136,475
127,389
175,778
16,798
1,166
$ 457,606
December 31,
2012
$ 122,457
84,838
261,804
8,451
1,148
$ 478,698
2011
$ 116,393
44,999
392,712
1,015
1,419
$ 556,538
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"), which are
interests in bundles of mortgage-backed securities, the repayments on which have been separated into two or more components
38
(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, but still at investment grade.
The following table sets forth the maturities of the debt securities in our available-for-sale portfolio as of December 31, 2013.
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
—
48,623
11,181
—
59,804
After
1 But
Within
5 Years
136,475
76,405
150,330
15,998
379,208
After
5 But
Within
10 Years
—
1,681
14,146
—
15,827
After
10 Years
—
680
121
800
1,601
Total
136,475
127,389
175,778
16,798
456,440
The following table sets forth the tax-equivalent yields of the debt securities in our available-for-sale portfolio at December 31,
2013.
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
—%
1.22
4.09
—
1.75
After
1 But
Within
5 Years
After
5 But
Within
10 Years
After
10 Years
Total
0.51%
1.39
2.53
0.89
1.49
—%
—%
7.10
3.75
—
4.12
8.14
4.24
3.00
5.02
0.51%
1.44
2.73
1.01
1.63
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, 2013.
At December 31, 2013 and 2012, the weighted average maturity was 2.3 and 2.6 years, respectively, for debt securities in the
available-for-sale portfolio.
At December 31, 2013, the net unrealized gains on securities available-for-sale amounted to $3.9 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 $9.3 million at December 31, 2012. 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)
39
State and Municipal Obligations
Mortgage Backed Securities - Residential
Corporate and Other Debt Securities
Total
2013
December 31,
2012
$
$
198,206
100,055
1,000
299,261
$
$
183,373
55,430
1,000
239,803
$
$
2011
149,688
—
1,000
150,688
For a description of the various categories of securities held in the securities held-to-maturity portfolio on the reporting dates,
see the paragraph under "SECURITIES AVAILABLE-FOR-SALE" table, above.
For information regarding the fair value of our portfolio of securities held-to-maturity at December 31, 2013, 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, 2013.
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
43,043
$
—
—
43,043
$
After 1 But
Within 5
Years
$
82,001
41,958
—
$ 123,959
After 5 But
Within 10
Years
$
69,832
58,097
—
$ 127,929
After
10 Years
$
$
3,330
—
1,000
4,330
Total
$ 198,206
100,055
1,000
$ 299,261
The following table sets forth the tax-equivalent yields of our portfolio of securities held-to-maturity at December 31, 2013.
YIELDS ON SECURITIES HELD-TO-MATURITY
(Fully Tax-Equivalent Basis)
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
After
10 Years
1.90%
—
—
1.90
3.22%
1.55
—
2.13
4.77%
2.55
—
2.60
6.19%
—
7.00
6.38
Total
3.53%
2.13
7.00
2.36
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, 2013. 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%.
The weighted-average maturity of the held-to-maturity portfolio was 3.5 and 3.2 years at year-end December 31, 2013 and
2012, respectively.
40
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)
2013
2012
December 31,
2011
2010
2009
Amount
%
Amount
%
Amount
%
Amount
%
Amount
%
Commercial
Commercial Real Estate –
Construction
Commercial Real Estate –
Other
Consumer – Other
Consumer – Automobile
Residential Real Estate
$
87,893
27,815
288,119
7,649
394,204
460,792
7
2
23
1
31
36
$
105,536
29,149
245,177
6,684
349,100
436,695
9
2
21
1
30
37
Total Loans
1,266,472
100
1,172,341
100
$
99,791
11,083
232,149
6,318
322,375
459,741
1,131,457
9
1
21
1
28
40
100
$
97,621
7,090
214,291
6,482
334,656
485,368
1,145,508
8
1
19
1
29
42
$
89,222
15,336
185,582
11,981
317,854
492,175
8
1
17
1
29
44
100
1,112,150
100
Allowance for Loan Losses
(14,434)
(15,298)
(15,003)
(14,689)
(14,014)
Total Loans, Net
$ 1,252,038
$ 1,157,043
$ 1,116,454
$ 1,130,819
$ 1,098,136
Maintenance of High Quality in the Loan Portfolio: In late 2010 and through 2011, residential property values continued
to weaken in most of the market areas served by us, and this trend continued for most of 2012, although during the last part of
2012 and 2013 the decline appeared to be slowing or even reversing itself, at least in some of our markets. Some analysts currently
are speculating that a "bottom" may have been established in the real estate markets nationwide, including in our service areas,
both in terms of price and quantity of transactions, but the evidence is still inconclusive.
The weakness in the asset portfolios of many financial institutions remains a serious concern, offset somewhat by the recent
firming up in some real estate markets and significant increase in the equity markets experienced in 2013. Regardless, 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 largely avoided the negative impact on asset
quality that many other banks suffered during the financial crisis. From the start of the crisis 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. 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 having a FICO score of 650 or below, where special circumstances justify doing
so, 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 did not experience as severe a decline in
property values or economic conditions generally as other parts of the U.S., are the principal reasons that we did not experience
significant deterioration during the crisis 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 remains challenging, where competition is intense, and where margins are very tight. If the U.S. economy and
our regional economy continue to experience only slow and halting growth or no growth, our individual borrowers will presumably
continue to proceed cautiously in taking on new or additional debt, as many small businesses are operating on very narrow margins
and many families continue to live on very tight budgets. That is, many of our customers, like U.S. borrowers generally, may
continue to pursue overall strategies of cautious de-leveraging in upcoming periods. This trend, combined with our conservative
underwriting standards, may result in our continuing to experience only modest loan portfolio growth or even no growth. Moreover,
if the U.S. economy 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 36% of the entire portfolio at December 31, 2013), eclipsing both
automobile loans (31% of the portfolio) and our commercial and commercial real estate loans (32%). Our gross originations for
residential real estate loans (including refinancings of mortgage loans) were $118.9 million, $109.1 million and $75.0 million for the
years 2013, 2012, and 2011, respectively. During each of these years, these origination totals have significantly exceeded the sum
of repayments and prepayments of such loans previously in the portfolio, but we have also sold significant portions of these
41
originations (typically, more than half) in the secondary market. primarily to Freddie Mac, as rates on conventional real estate
mortgages generally continued to fall during this period. Such sales amounted to $48.5 million for 2011, $59.9 million for 2012 and
$48.8 million for 2013. 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.
The Federal Reserve began to wind down its quantitative easing program in early 2014, but the uptick in long-term interest
rates, began with the Federal Reserve comments in May 2013 to the effect that the Fed expected to begin winding down this
program in the not-too-distant future. This tapering has had the predicted effect of increasing mortgage rates generally in ensuing
periods, for all durations and types of mortgage loans, although to the date of this Report the increases in rates have been halting
and modest. If in fact this development persists, as is anticipated by some commentators, it may at some point have a significant
impact, possibly negative, on the number of home loans, the pricing of such loans, and the pricing of homes themselves in our
service area and nationwide, and thus may have a significant impact, possibly negative, on our mortgage lending business and on
our financial results generally. While economic conditions have generally improved, leading to the Fed's tapering, management is
not able to predict at this point when, or even if, mortgage rates or interest rates generally will experience a meaningful and substantial
increase in upcoming periods, or what the overall effect of such an increase would be on our mortgage loan portfolio or our loan
portfolio generally, or on our net interest income, net income or financial results, in such periods.
Automobile Loans (primarily through indirect lending): At December 31, 2013, our automobile loans (primarily loans
originated through dealerships located primarily in upstate New York) represented nearly a third of loans in our portfolio, and continue
to be a significant component of our business.
During portions of 2012, and particularly during 2013, there was a nationwide resurgence in automobile sales, due in the view
of many to an aging fleet and a modest resurgence in consumer optimism. Although our automobile loan volume for 2012 was
very strong at $194.0 million, originations for 2013 exceeded that level at $218.0 million.
Net charge-offs on automobile loans for 2013 were $175 thousand, or $26 thousand below the net charge-offs for 2012. 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. If
weakness in auto demand returns, however, 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. In 2013, commercial and commercial real estate loan growth was significant
as outstanding balances increased by $24.0 million over the December 31, 2012 level. Growth was restrained somewhat by
heightened competition for credits in an extremely low rate environment.
Substantially all commercial and commercial real estate loans in our portfolio were extended to businesses or borrowers located
in our regional markets. 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
loan portfolio in recent years.
It is entirely possible that we may experience a reduction in the demand for commercial and commercial real estate loans and/
or a weakening in the quality of our portfolio in upcoming periods. Generally, however, the business sector, at least in our service
areas, appeared to be in reasonably good financial condition at period-end.
42
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 2013
Sep 2013
Jun 2013
Mar 2013
Dec 2012
Quarters Ended
Commercial and Commercial Real Estate
$
397,503
$
386,973
$
379,533
$
381,281
$
366,761
Residential Real Estate
Home Equity
Consumer Loans - Automobile
Other Consumer Loans1
Total Loans
322,080
99,722
408,273
27,379
$ 1,254,957
316,582
94,726
398,329
28,230
$ 1,224,840
305,222
91,339
308,091
88,926
314,583
87,124
380,993
27,954
$ 1,185,041
363,120
28,452
$ 1,169,870
361,723
30,035
$ 1,160,226
Percentage of Total Quarterly Average Loans
Commercial and Commercial Real Estate
Residential Real Estate
Home Equity
Consumer Loans - Automobile
Other Consumer Loans1
Total Loans
Quarters Ended
Dec 2013
Sep 2013
Jun 2013
Mar 2013
Dec 2012
31.7%
25.6
8.0
32.5
2.2
100.0%
31.6%
25.9
7.7
32.5
2.3
100.0%
32.0%
25.7
7.7
32.2
2.4
100.0%
32.6%
26.4
7.6
31.0
2.4
100.0%
31.6%
27.1
7.5
31.2
2.6
100.0%
Quarterly Tax-Equivalent Yield on Loans
Dec 2013
Sep 2013
Jun 2013
Mar 2013
Dec 2012
Quarters Ended
Commercial and Commercial Real Estate
4.65%
Residential Real Estate
Home Equity
Consumer Loans - Automobile
Other Consumer Loans1
Total Loans
4.53
2.94
3.54
5.72
4.15
4.52%
4.62
2.98
3.68
5.96
4.18
4.61%
4.75
3.00
3.83
5.97
4.30
4.74%
4.93
3.03
3.97
6.16
4.46
4.91%
5.00
3.03
4.18
6.24
4.60
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 41, 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 re-energize the economy, coupled with a general
moderation of loan demand on the part of corporate and individual customers.
For the fourth quarter of 2013 the average yield on our loan portfolio declined by 45 basis points from the fourth quarter of
2012, from 4.60% to 4.15%. 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 many of those originations to the secondary market, specifically, to Freddie Mac.
As average yields on the portfolio were dropping in 2013, our margins were also compressing. The decrease in average yield
on our loan portfolio of 45 basis points was 27 basis points greater than the 18 basis point decline in our average cost of deposits
from the last quarter of 2012 to the last quarter of 2013. We expect that average loan yields will continue to decline in 2014, and
at a faster rate than our average cost of deposits, with the result 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
31 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
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 remain flat or even increase slightly in upcoming periods, our average rate on our portfolio may continue to decline
43
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, 2013. 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
After 1
But
Within
5 Years
$ 51,047
3,027
$ 54,074
$ 31,017
23,057
$ 54,074
Within
1 Year
$ 27,121
9,166
$ 36,287
1,726
$
34,560
$ 36,286
After
5 Years
$
9,725
15,622
$ 25,347
$ 22,153
3,194
$ 25,347
Total
$ 87,893
27,815
$ 115,708
$ 54,896
60,811
$ 115,707
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, 2013, our total
contingent liability for standby letters of credit amounted to $3.3 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, 2013, we had outstanding unfunded loan commitments in the aggregate amount of approximately $237.9 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 34 under
the heading "Summary of the Allowance and Provision for Loan Losses".
Loans are placed on nonaccrual status either due to the delinquency status of principal and/or interest or a judgment by
management that the full repayment of principal and interest is unlikely. Unless already placed on nonaccrual status, loans secured
by home equity lines of credit are put on nonaccrual status when 120 days past due; 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, 2013. 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 $8.3 million at December 31, 2013 and represented 0.65% of loans outstanding
at that date, as compared to approximately $8.5 million, or 0.72% of loans at December 31, 2012. These non-current loans at
December 31, 2013 were composed of approximately $4.3 million of consumer loans, principally indirect automobile loans, $1.7
million of residential real estate loans and $2.3 million of commercial and commercial real estate 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 impaired loans, impairment is determined by comparing the recorded value of the loan to the present value of the expected
cash flows, discounted at the loan's effective interest rate. 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.
The loan note to the consolidated financial statements, i.e., Note 5 (beginning on page 70) contains detailed information on
modified loans and impaired loans.
44
2. Potential Problem Loans
On at least a quarterly basis, we re-evaluate our internal credit quality rating for 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 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. In our credit monitoring program, we treat loans that are classified as substandard
but continue to accrue interest as potential problem loans. At December 31, 2013, we identified 172 commercial loans totaling
$25.4 million as potential problem loans. At December 31, 2012, we identified 175 commercial loans totaling $24.5 million as
potential problem loans. For these loans, although positive factors such as payment history, value of supporting collateral, and/or
personal or government guarantees led us to conclude that accounting for them as non-performing at year-end was not warranted,
other factors, specifically, certain risk factors related to the loan or the borrower justified concerns that they may become
nonperforming at some point in the future.
The 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 problem loans likely will continue at their present levels or 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
2013
41
$
40
81
63
$ 144
December 31,
2011
$ 310
150
460
56
$ 516
2012
$ 552
418
970
64
$ 1,034
2010
$ — $
—
—
58
58
2009
53
—
53
59
$ 112
$
The following table summarizes changes in the net carrying amount of OREO and the number of properties for each of the
periods presented.
Schedule of Changes in OREO
(In Thousands)
Balance at Beginning of Year
Properties Acquired Through Foreclosure
Transfer of Bank Property
Sales
Balance at End of Year
Number of Properties, Beginning of Year
Properties Acquired During the Year
Properties Sold During the Year
Number of Properties, End of Year
2013
$ 970
392
—
(1,281)
81
$
2012
$ 460
950
—
(440)
$ 970
2011
$ — $
409
150
(99)
$ 460
2010
53
—
—
(53)
$ — $
2009
$ 581
54
—
(582)
53
7
1
(6)
2
5
7
(5)
7
—
6
(1)
5
1
—
(1)
—
4
1
(4)
1
There was no allowance for OREO losses at year-end 2013, 2012 or 2011.
45
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 34 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 41 of this report.
IV. DEPOSITS
The following table sets forth the average balances of and average rates paid on deposits for the periods indicated.
AVERAGE DEPOSIT BALANCES
(Dollars In Thousands)
Years Ended December 31,
2013
2012
2011
Demand Deposits
NOW Accounts
Savings Deposits
Time Deposits of $100,000 or More
Other Time Deposits
Total Deposits
Average
Balance
$
264,959
798,230
490,558
86,457
179,997
$ 1,820,201
Rate
Average
Balance
Rate
Average
Balance
—% $
—% $
240,872
726,660
437,095
107,665
212,918
$ 1,725,210
0.31
0.21
1.39
1.09
0.37
221,035
603,965
409,398
122,897
238,865
$ 1,596,160
0.49
0.29
1.86
1.75
0.61
Rate
—%
0.84
0.46
2.14
2.15
1.07
During 2013 average deposit balances, in total, increased by $95.0 million, or 5.5%, over the average for 2012. Most of this
growth occurred in the fourth quarter of 2013. The increase was generated from our pre-existing branch network, although we did
open two new branches, one in Queensbury, New York and the other in Clifton Park, New York.
During 2012 average deposit balances, in total, increased by $129.1 million, or 8.1%, over the average for 2011. As in 2013,
a significant amount of the 2012 deposit growth occurred in the fourth quarter. The increase was generated from our pre-existing
branch network.
During 2011 average deposit balances, in total, increased by $104.6 million, or 7.0%, over the average for 2010. The increase
was generated from our pre-existing branch network.
We did not sell or close any branches during the covered period, 2011-2013. We did not hold any brokered deposits during
2013, 2012 and 2011.
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 2013
Sep 2013
$
279,967
855,106
517,542
81,804
170,503
$ 1,904,922
$
277,381
749,654
509,014
85,757
178,375
$ 1,800,181
Quarters Ended
Jun 2013
Mar 2013
Dec 2012
$
254,642
796,330
479,480
87,059
183,835
$ 1,801,346
$
247,347
791,669
455,311
91,322
187,477
$ 1,773,126
$
249,176
798,513
444,603
95,742
193,744
$ 1,781,778
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 26% to 33% of our total deposits. Municipal deposits are typically placed
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.
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 2013, depositors
tend to transfer maturing time deposits to nonmaturity interest-bearing deposit products. This trend continued during 2013. At
46
December 31, 2013 time deposits represented 13.4% of total deposits, down from 16.4% at December 31, 2012. This year-end
2013 level for time deposits was below the low point in the last falling interest rate cycle, when, at June 30, 2004, 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 and interest rates generally remain at their current
extraordinarily low levels. Contrarily, if deposit rates begin to climb, we anticipate the movement of time deposits to nonmaturity
interest bearing deposits to slow, halt altogether or reverse itself at some point.
In general, there is a seasonal pattern to municipal deposits which dip to a low point during July and August. Account balances
tend to increase throughout the fall and into the winter months from tax deposits and increase again at the end of March from the
electronic deposit of NYS Aid payments to school districts. 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, some growth in the second quarter, contraction
in the third quarter and substantial growth in the fourth quarter. Deposit balances followed this general pattern for 2013, 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.
The total quarterly average balances as a percentage of total deposits are illustrated in the table below.
Percentage of Total Quarterly Average Deposits
Quarters Ended
Demand Deposits
NOW Accounts
Savings Deposits
Time Deposits of $100,000 or More
Other Time Deposits
Total Deposits
Dec 2013
14.7%
44.8
27.2
4.3
9.0
100.0%
Sep 2013
15.4%
41.6
28.3
4.8
9.9
100.0%
Jun 2013 Mar 2013 Dec 2012
14.0%
44.8
24.9
5.4
10.9
100.0%
13.9%
44.6
25.7
5.2
10.6
100.0%
14.2%
44.2
26.6
4.8
10.2
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. We, like virtually all insured depository institutions, have experienced a steady decrease in the cost of our
deposits over each of the past 5 quarters mirroring and continuing the protracted period of falling interest rates extending from
mid-2007 through the end of 2013. Although some maturing time deposits will continue to reprice at lower rates in forthcoming
periods, the favorable reduction in the cost of deposits may come to a halt in the mid- or near-term future, 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. The total quarterly cost of deposits are illustrated in the table below:
Quarterly Cost of Deposits
Quarters Ended
Demand Deposits
NOW Accounts
Savings Deposits
Time Deposits of $100,000 or More
Other Time Deposits
Total Deposits
Dec 2013
—%
Sep 2013
—%
0.22
0.18
1.34
1.01
0.30
0.22
0.19
1.37
1.05
0.32
Jun 2013 Mar 2013 Dec 2012
—%
—%
—%
0.40
0.23
1.41
1.10
0.42
0.40
0.24
1.42
1.20
0.44
0.43
0.25
1.54
1.34
0.48
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.
We do not use brokered deposits as a regular funding source and there were not any such balances carried during 2013, 2012
or 2011.
47
The maturities of time deposits of $100,000 or more at December 31, 2013 are presented below. (In Thousands)
Maturing in:
Under Three Months
Three to Six Months
Six to Twelve Months
2015
2016
2017
2018
2019
Total
$
$
19,896
13,181
20,923
8,192
4,474
5,994
4,761
1,507
78,928
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
D. LIQUIDITY
2013
2012
2011
$ 64,777
64,777
33,322
$ 41,678
41,678
24,225
$ 68,293
93,988
54,750
0.27%
0.28%
0.18%
0.25%
$
— $
—
—
—%
—%
0.27%
— $
—
—
—%
—%
0.18%
0.17%
0.23%
—
2,211
1,456
—%
—%
0.16%
The objective of effective liquidity management is to ensure that we have the ability to raise 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,
both on- and off-balance sheet, that can be accessed quickly in time of need.
Our primary sources of available liquidity are overnight investments in federal funds sold, interest bearing bank balances at
the Federal Reserve Bank, and cash flow from investment securities and loans. Certain investment securities are selected at
purchase as available-for-sale based on their marketability and collateral value, as well as their yield and maturity. Our securities
available-for-sale portfolio was $457.6 million at year-end 2013, a decrease of $21.1 million from the year-end 2012 level. Due to
the potential for volatility in market values, we are not always able to assume that securities may be sold on short notice at their
carrying value, even to provide needed liquidity.
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"). Our federal funds lines of credit are with three correspondent banks totaling $30 million, but we
only drew on these lines once during 2013.
To support 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 was approximately $214 million at December 31,
2013. 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. Also, our two bank subsidiaries have each established a borrowing facility with the Federal Reserve
Bank of Net York, pledging certain consumer loans as collateral for potential "discount window" advances, which we maintain for
contingency liquidity purposes. At December 31, 2013, the amount available under this facility was approximately $302 million,
but there were no advances then outstanding.
We measure and monitor our basic liquidity as a ratio of liquid assets to total short-term liabilities, both with and without the
availability of borrowing arrangements. Based on the level of overnight funds investments, available liquidity from our investment
securities portfolio, cash flows from our loan portfolio, our stable core deposit base and our significant borrowing capacity, we believe
that our liquidity is sufficient to meet all funding needs that may arise in connection with any reasonably likely events or occurrences.
At December 31, 2013, our basic liquidity ratio was 6.9% of total assets, or $148 million, well above our minimum ratio as defined
in policy of 4%, or $87 million of total assets.
48
Because of Arrow's favorable credit quality and strong balance sheet, Arrow did not experience any significant liquidity
constraints through the date of this report and was never forced to pay premium rates to obtain retail deposits or other funds from
any source.
E. CAPITAL RESOURCES AND DIVIDENDS
Important Changes to Regulatory Capital Standards
New Bank Regulatory Capital Standards.
The Dodd-Frank Act directed U.S. bank regulators to promulgate new bank capital standards, which would be at least as strict
as the regulatory capital standards in effect at the time Dodd-Frank was enacted in 2010. The new bank regulatory capital standards
were adopted in 2013 and will be effective for Arrow and our subsidiary banks beginning in 2015. These new rules are summarized
in an earlier section of this Report, "Supervision and Regulation--Regulatory Capital Standards--New Bank Regulatory Capital
Standards," pages 7-9.
Current Bank Regulatory Capital Standards
The current bank regulatory capital standards for banks and bank holding companies will gradually be replaced by the new
standards recently adopted by the regulators, which will become effective for us beginning on January 1, 2015.
The current regulatory capital standards are discussed above under "Regulation and Supervision--Regulatory Capital
Standards--Current Bank Regulatory 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.
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, 2013, as determined under the current bank regulatory capital standards:
Capital Ratios:
Tier 1 Leverage Ratio
Tier 1 Risk-Based Capital Ratio
Total Risk-Based Capital Ratio
9.2%
14.7%
15.8%
Arrow
8.8%
14.4%
15.4%
GFNB
SNB
9.7%
13.7%
14.8%
At December 31, 2013 our holding company and both banks exceeded the minimum current regulatory capital ratios, and
qualified as "well-capitalized", the highest category, in the capital classification scheme set by federal bank regulatory agencies.
Stockholders' Equity at Year-end 2013: Stockholders' equity was $192.2 million at December 31, 2013, an increase of $16.3
million, or 9.3%, from the prior year-end. The most significant positive changes to stockholders' equity included (a) net income of
$21.8 million, (b) equity received from our various stock-based compensation plans of $3.2 million, (c) other comprehensive income
of $4.1 million, offset, in part by (d) cash dividends of $12.1 million, and (e) purchases of our own common stock of $1.7 million.
Trust Preferred Securities: 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, subject to limitations.
49
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, 2013, 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 $26.7 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, Related Stockholder Matters and Issuer Purchases of Equity
Securities" for a recent history of our cash dividend payments.
Stock Repurchase Program: In November 2012, the Board of Directors approved a $5.0 million stock repurchase program,
effective January 1, 2013 (the 2013 program), under which management was authorized, in its discretion, to repurchase from time-
to-time during 2013, 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, 2013, approximately $1.3 million had been used
under the 2013 Program to repurchase shares. In November 2103, the Board of Directors authorized a similar $5.0 million stock
repurchase program, effective for calendar year 2014.
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, 2013, we had no
derivative securities, including interest rate swaps, credit default swaps, or equity puts or calls, in our investment portfolio.
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
$
20,000
$
10,000
$
10,000
$
— $
—
20,000
2,733
45,337
88,070
$
—
638
4,030
14,668
$
—
1,023
6,317
17,340
$
$
—
624
6,318
6,942
20,000
448
28,672
49,120
$
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 Benefit
Plans.
50
H. FOURTH QUARTER RESULTS
We reported net income of $5.8 million for the fourth quarter of 2013, an increase of $235 thousand, or 4.2%, from the fourth
quarter of 2012. Diluted earnings per common share for the fourth quarter of 2013 were $.47, an increase of $.02, or 4.4%, from
the $.45 amount for the fourth quarter of 2012. The net change in earnings between the two quarters was primarily affected by the
following: (a) a $636 thousand increase in tax-equivalent net interest income, (b) a $20 thousand decrease in noninterest income
(including a $156 thousand decrease in net securities gains), (c) a $175 thousand decrease in the provision for loan losses, (d) a
$268 thousand increase in noninterest expense, and (e) a $161 thousand increase in the provision for income taxes. The principal
factors contributing to these quarter-to-quarter changes are included in the discussion of the year-to-year changes in net income
set forth elsewhere in this Item 7, specifically, in Section B, "Results of Operations," above, as well as in the Company's Current
Report on Form 8-K, as filed with the SEC on January 21, 2014, incorporating by reference the Company's earnings release for
the year ended December 31, 2013.
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,
$
$
$
2013
16,459
1,713
14,746
—
14,746
6,877
13,385
8,238
2,454
5,784
12,339
12,387
0.47
0.47
0.25
$
$
2012
16,740
2,503
14,237
175
14,062
6,897
13,117
7,842
2,293
5,549
12,254
12,273
0.45
0.45
0.25
$ 2,176,264
2,064,578
1,254,957
1,904,922
184,506
$ 2,064,602
1,945,441
1,160,226
1,781,778
176,514
1.05%
12.44%
3.06%
0.05%
—%
1.07%
12.51%
3.13%
0.04%
0.06%
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 2013 and 2012 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
2013
First
Quarter
$ 15,996
13,757
100
527
7,420
5,181
0.42
0.42
Second
Quarter
$ 15,809
13,586
100
13
7,283
5,207
0.42
0.42
Third
Quarter
$ 15,874
14,127
—
—
7,933
5,623
0.46
0.46
Fourth
Quarter
$ 16,459
14,746
—
—
8,238
5,784
0.47
0.47
2012
First
Quarter
$ 17,938
14,406
280
502
7,539
5,288
0.43
0.43
Second
Quarter
$ 17,533
14,254
240
143
8,171
5,594
0.46
0.46
Third
Quarter
$ 17,168
14,525
150
64
8,288
5,748
0.47
0.47
Fourth
Quarter
$ 16,740
14,237
175
156
7,842
5,549
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 (i.e., our assets and operations) 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.
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 2013 the targeted federal funds rate
remained where it had been since late 2008, a range of 0 to .25%, with inferences from the Fed that this rate and other short-term
rates would remain at or near their current historically low rates at least through year-end 2014. Moreover, our average cost of
deposits for 2013 had decreased to a record low of 0.43%. Thus, for purposes of our decreasing rate simulation, we applied a
52
hypothetical 100 basis point downward shift in interest rates for assets and liabilities at the long end of the yield curve with hypothetical
short-term rate decreases for particular assets and liabilities equal to the lesser of 100 basis points or such lower rate (below 100
basis points) as was actually borne by such asset or liability.
Applying the simulation model analysis as of December 31, 2013, a 200 basis point increase in interest rates demonstrated a
7.9% decrease in net interest income, and a 100 basis (as adjusted) decrease in interest rates demonstrated a 1.0% decrease in
net interest income. These amounts were 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 current prevailing interest rates are already extremely low, 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, no matter how quickly they reprice, whereas further decreases in asset rates are
not as likely to run up against the absolute lower boundary of zero, and thus may be experienced in full or nearly full, across the
asset portfolio, even if assets reprice more slowly than liabilities. Thus, even in the short run, rate decreases in the current
environment may not be beneficial to income.
This explains the abnormal 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 continue to 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, (i.e., a positively sloped yield curve) 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 of the 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
Consolidated Balance Sheets as of December 31, 2013 and 2012
Consolidated Statements of Income for the Years Ended December 31, 2013, 2012 and 2011
Consolidated Statements of Comprehensive Income for the Years Ended December 31, 2013, 2012 and 2011
Consolidated Statements of Changes in Stockholders' Equity for the Years Ended December 31, 2013, 2012 and 2011
Consolidated Statements of Cash Flows for the Years Ended December 31, 2013, 2012 and 2011
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, 2013 and 2012, 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, 2013. 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, 2013 and 2012, and the results of their operations and their
cash flows for each of the years in the three year period ended December 31, 2013, 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, 2013, based on criteria established in Internal Control –
Integrated Framework (1992) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO), and
our report dated March 14, 2014, expressed an unqualified opinion on the effectiveness of the Company’s internal control over
financial reporting.
/s/ KPMG LLP
Albany, New York
March 14, 2014
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, 2013, based on criteria established in Internal Control—Integrated Framework (1992) 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, 2013, based on criteria established in Internal Control—Integrated Framework (1992) issued
by 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, 2013 and 2012, 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, 2013, and our report dated March 14, 2014 expressed an unqualified opinion on
those consolidated financial statements.
/s/ KPMG LLP
Albany, New York
March 14, 2014
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 $302,305 at
December 31, 2013 and $248,252 at December 31, 2012)
Federal Home Loan Bank and Federal Reserve Bank Stock
Loans
Allowance for Loan Losses
Net Loans
Premises and Equipment, Net
Goodwill
Other Intangible Assets, Net
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
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
(16,744,486 Shares Issued at December 31, 2013 and
16,416,163 Shares Issued at December 31, 2012)
Additional Paid-in Capital
Retained Earnings
Unallocated ESOP Shares (87,641 Shares at December 31, 2013 and
102,890 Shares at December 31, 2012)
Accumulated Other Comprehensive Loss
Treasury Stock, at Cost (4,296,723 Shares at December 31, 2013 and
4,288,617 Shares at December 31, 2012)
Total Stockholders’ Equity
Total Liabilities and Stockholders’ Equity
December 31,
2013
December 31,
2012
$
37,275
12,705
$
37,076
11,756
457,606
478,698
$
$
299,261
6,281
1,266,472
(14,434)
1,252,038
29,154
22,003
4,140
43,235
2,163,698
278,958
817,366
498,779
78,928
168,299
1,842,330
64,777
20,000
20,000
24,437
1,971,544
$
$
239,803
5,792
1,172,341
(15,298)
1,157,043
28,897
22,003
4,492
37,236
2,022,796
247,232
758,287
442,363
93,375
189,898
1,731,155
41,678
30,000
20,000
24,138
1,846,971
—
—
16,744
229,290
27,457
(1,800)
(4,373)
16,416
218,650
26,251
(2,150)
(8,462)
(75,164)
192,154
2,163,698
$
(74,880)
175,825
2,022,796
$
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,
2012
2011
2013
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
$ 51,319
89
$ 54,511
108
$ 58,599
99
6,903
5,827
64,138
2,461
1,024
1,198
1,962
18
680
579
7,922
56,216
200
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
56,016
56,577
57,267
6,735
9,407
8,895
540
1,460
1,024
28,061
31,182
8,285
1,080
—
12,656
53,203
30,874
9,079
$ 21,795
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
12,296
12,327
12,247
12,257
12,209
12,221
$
$
1.77
1.77
1.81
1.81
$
1.80
1.79
Share and Per Share Amounts have been restated for the September 2013 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,
2012
$ 22,179
2011
$ 21,933
2013
$ 21,795
(2,925)
(326)
6,425
—
914
1
4,089
$ 25,884
(661)
(522)
(1,340)
(245)
1,013
(12)
(1,767)
$ 20,412
4,741
(1,688)
(3,701)
(161)
602
(65)
(272)
$ 21,661
Net Income
Other Comprehensive Income (Loss), Net of Tax:
Unrealized Net Securities Holding (Losses) Gains Arising During the Year
Reclassification Adjustment for Net Securities Gains Included in Net Income
Net Retirement Plan Gain (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)
Balance at December 31, 2010
Net Income
Other Comprehensive (Loss) Income
3% Stock Dividend (468,765 Shares)
Cash Dividends Paid, $.94 per Share 1
Shares Issued for Stock Option Exercises, net
(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 Exercises of
Stock Options
Purchase of Treasury Stock
(251,962 Shares)
Acquisition of Subsidiary (221,517 Shares)
Allocation of ESOP Stock (18,216 Shares)
Common
Stock
$ 15,626
—
—
468
—
—
—
—
—
—
—
—
—
—
Balance at December 31, 2011
$ 16,094
Additional
Paid-In
Capital
Retained
Earnings
$ 191,068
—
$ 24,577
21,933
—
10,647
—
—
(11,115)
(11,448)
705
104
282
1,062
354
51
—
3,275
—
—
—
—
—
—
—
—
52
$ 207,600
—
$ 23,947
Accumu-
lated
Other
Com-
prehensive
Income
(Loss)
Unallo-
cated
ESOP
Shares
Treasury
Stock
Total
$
(2,876) $
—
—
—
—
—
—
—
—
—
—
—
—
376
$
(2,500) $
(6,423) $ (69,713) $ 152,259
21,933
(272)
—
—
(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
—
Balance at December 31, 2011
$ 16,094
$ 207,600
$ 23,947
$
(2,500) $
(6,695) $ (72,061) $ 166,385
Net Income
Other Comprehensive (Loss) Income
2% Stock Dividend (321,886 Shares)
Cash Dividends Paid, $.97 per Share 1
Shares Issued for Stock Option Exercises, net
(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 Exercises of
Stock Options
Purchase of Treasury Stock
(199,323 Shares)
Acquisition of Subsidiaries (9,356 Shares)
—
—
322
—
—
—
—
—
—
—
—
—
—
—
7,738
—
1,152
104
279
1,086
424
68
—
140
22,179
—
(8,060)
(11,815)
—
—
—
—
—
—
—
—
Allocation of ESOP Stock (16,629 Shares)
Balance at December 31, 2012
—
$ 16,416
59
$ 218,650
—
$ 26,251
—
—
—
—
—
—
—
—
—
—
—
—
350
$
(2,150) $
59
—
(1,767)
—
—
—
—
—
—
—
—
—
—
—
—
—
—
22,179
(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
—
ARROW FINANCIAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY, Continued
(In Thousands, Except Share and Per Share Amounts)
Accumu-
lated
Other
Com-
prehensive
Income
(Loss)
Unallo-
cated
ESOP
Shares
Treasury
Stock
Total
(8,462) $ (74,880) $ 175,825
21,795
—
—
4,089
Balance at December 31, 2012
Net Income
Other Comprehensive (Loss) Income
2% Stock Dividend (328,323 Shares) 2
Cash Dividends Paid, $.99 per Share 1
Shares Issued for Stock Option Exercises, net
(58,719 Shares)
Shares Issued Under the Directors’ Stock
Plan (7,643 Shares)
Shares Issued Under the Employee Stock
Purchase Plan (19,679 Shares)
Shares Issued for Dividend Reinvestment
Plans (49,574 Shares)
Stock-Based Compensation Expense
Tax Benefit for Exercises of
Stock Options
Purchase of Treasury Stock
(68,361 Shares)
Acquisition of Subsidiaries (9,503 Shares)
Allocation of ESOP Stock (16,969 Shares)
Common
Stock
$ 16,416
—
—
328
—
—
—
—
—
—
—
—
—
—
Balance at December 31, 2013
$ 16,744
Additional
Paid-In
Capital
Retained
Earnings
$ 218,650
—
$ 26,251
21,795
—
8,152
—
—
(8,480)
(12,109)
676
123
283
796
372
23
—
139
—
—
—
—
—
—
—
—
76
$ 229,290
—
$ 27,457
$
(2,150) $
—
—
—
—
—
—
—
—
—
—
—
—
350
$
(1,800) $
—
—
—
4,089
—
(12,109)
578
1,254
75
194
484
—
—
198
477
1,280
372
23
(1,709)
(1,709)
94
233
—
—
—
—
—
—
—
—
—
—
—
426
(4,373) $ (75,164) $ 192,154
—
1 Cash dividends paid per share have been adjusted for the September 2013 2% stock dividend.
2 Included in the shares issued for the 2% stock dividend in 2013 were treasury shares of 84,863 and unallocated ESOP shares of 1,720.
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
Gains on the Sale of Securities Held-to-Maturity
Losses on the Sale of Securities Available-for-Sale
Losses on the Sale of Securities Held-to-Maturity
Loans Originated and Held-for-Sale
Proceeds from the Sale of Loans Held-for-Sale
Net Gains on the Sale of Loans
Net Losses (Gains) on the Sale of Premises and Equipment,
Other Real Estate Owned and Repossessed Assets
Contributions to Pension Plans
Deferred Income Tax Expense (Benefit)
Shares Issued Under the Directors’ Stock Plan
Stock-Based Compensation Expense
Net Decrease in Other Assets
Net Increase 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 Sale of Securities Held-to-Maturity
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
Net (Increase) Decrease in Federal Home Loan Bank Stock
Purchase of Bank Owned Life Insurance
Net Cash Used In Investing Activities
Cash Flows from Financing Activities:
Net Increase in Deposits
Net Increase (Decrease) in Short-Term Borrowings
Federal Home Loan Bank Advances
Repayments of Federal Home Loan Bank Advances
Purchase of Treasury Stock
Shares Issued for Stock Option Exercises, net
Shares Issued Under the Employee Stock Purchase Plan
Tax Benefit for Exercises of Stock Options
Shares Issued for Dividend Reinvestment Plans
Cash Dividends Paid
Net Cash Provided By Financing Activities
Net Increase 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,
2013
2012
$
21,795
$
22,179
$
2011
21,933
200
8,870
426
(527)
(18)
—
5
(46,101)
50,298
(1,460)
120
(473)
294
198
372
1,888
786
36,673
16,295
132,228
(136,416)
1,181
47,228
(109,620)
(98,903)
1,789
(2,233)
(75)
(489)
—
(149,015)
111,175
23,099
—
(10,000)
(1,709)
1,254
477
23
1,280
(12,109)
113,490
1,148
48,832
49,980
8,067
8,336
971
233
—
—
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
$
$
$
$
$
$
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. 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 upstate 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
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, 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/accreted 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. Unless already placed on nonaccrual status, 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, generally against interest income. 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 when a loss becomes known or based on a new appraisal at the earlier of 180 days past due or repossession.
Commercial and commercial real estate loans loans are evaluated early in their delinquency status and are charged-off when
management concludes 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 consider nonaccrual loans over $250 thousand and all troubled debt restructured loans to be impaired loans and we
evaluate these loans individually to determine the amount of impairment, if any. The amount of impairment, if any, related to
individual impaired loans is 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. Any
excess of the recorded investment in the collateral dependent impaired loan over the estimated collateral value, less costs to sell,
is typically charged off. For impaired loans which are not collateral dependent, impairment is measured 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 this amount
is less than the recorded investment in the loan, an impairment reserve is recognized as part of the allowance for loan losses, or
based upon the judgment of management all or a portion of the excess of the recorded investment in the loan over the present
value of the estimated future cash flow may be charged off.
The allowance for loan losses on the remaining loans is primarily determined based upon consideration of the historical net
loss experience of the respective portfolios, adjusted as necessary based upon consideration of qualitative considerations impacting
the inherent risk of loss in the respective loan portfolios.
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
63
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.
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 determined by preparing an analysis of the respective plan’s expected future cash flows and
high-quality fixed-income investments currently available and expected to be available during the period to maturity of the pension
benefits.
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 released 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.
64
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.
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.
65
Recent Accounting Pronouncements
During 2013 the FASB issued twelve accounting standards updates and, through the date of this report, an additional five in
2014. Of the seventeen updates, fourteen did not apply to Arrow.
ASU 2013-02 "Comprehensive Income" requires additional disclosures relating to reclassifications out of accumulated other
comprehensive income. The new disclosures are included in Note 5 - Comprehensive Income.
ASU 2013-10 "Derivatives and Hedging" now allows the federal funds effective swap rate as a benchmark interest rate for
hedge accounting. While this has no current impact on Arrow, it may provide us an option for future swaps that we did not have
before the ASU.
ASU 2014-01 "Investments-Equity Method and Joint Ventures" allows an entity that invests in affordable housing projects that
qualify for low-income housing tax credits to make an accounting policy election to account for their investments in qualified affordable
housing projects using the proportional amortization method if certain conditions are met. Under the proportional amortization
method, an entity amortizes the initial cost of the investment in proportion to the tax credits and other tax benefits received and
recognizes the net investment performance in the income statement as a component of income tax expense. The standard is
effective for annual years beginning after December 15, 2014, with earlier adoption allowed. We are evaluating the impact of
adopting this election and do not expect that this will have a material impact on our financial condition or results of operations.
ASU 2014-04 "Receivables - Trouble Debt Restructurings by Creditors" provides additional guidance on when an in substance
repossession or foreclosure occurs and is effective for annual periods beginning after December 15, 2014. We are evaluating the
impact of adopting this standard, and we do not expect that it will have a material impact on our financial condition or results of
operations.
Note 3: CASH AND CASH EQUIVALENTS (Dollars In Thousands)
The following table is the schedule of cash and cash equivalents at December 31, 2013 and 2012:
Cash and Due From Banks
Interest-Bearing Deposits at Banks
Total Cash and Cash Equivalents
Supplemental Information:
2013
$ 37,275
12,705
$ 49,980
2012
$ 37,076
11,756
$ 48,832
Total required reserves, including vault cash and Federal Reserve Bank deposits $ 18,879
$ 23,168
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.
Note 4.
INVESTMENT SECURITIES (Dollars In Thousands)
The following table is the schedule of Available-For-Sale Securities at December 31, 2013 and 2012:
December 31, 2013
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
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
$
136,868
$
127,224
$
171,321
$
17,142
$
1,120
$
453,675
136,475
2
395
127,389
306
141
175,778
4,714
257
16,798
10
354
1,166
46
—
10,920
146,677
13,608
116
—
16,142
—
1,000
—
136,868
—
—
48,570
76,308
1,666
680
66
457,606
5,078
1,147
243,769
59,490
375,995
15,274
1,796
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
—
136,475
—
—
60,664
33,849
94,513
26
336
59
395
$
$
$
$
$
$
$
$
48,623
76,405
1,681
680
29,967
4,597
34,564
107
120
21
141
$
$
$
$
11,181
150,330
14,146
121
15,190
11,841
27,031
13
108
149
257
$
$
$
$
—
15,998
—
800
7,375
6,063
13,438
19
92
262
354
$
$
$
$
59,804
379,208
15,827
1,601
— $
—
— $
113,196
56,350
169,546
—
165
— $
—
— $
656
491
1,147
$
122,297
$
84,798
$
252,480
$
8,689
$
1,120
$
469,384
122,457
84,838
261,804
204
44
206
166
9,405
81
8,451
—
238
1,148
478,698
28
—
9,843
529
260,292
$
$
$
$
72,531
$
46,627
$
10,230
$
8,451
$
— $
137,839
—
2,149
4,968
—
—
7,117
72,531
$
48,776
$
15,198
$
8,451
$
— $
144,956
22
198
7
11
—
238
44
—
44
$
$
160
$
6
166
$
50
31
81
$
$
238
$
—
238
$
— $
—
— $
492
37
529
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, 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
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
67
The following table is the schedule of Held-To-Maturity Securities at December 31, 2013 and 2012:
Held-To-Maturity Securities
State and
Municipal
Obligations
Mortgage-
Backed
Securities -
Residential
Corporate
and Other
Debt
Securities
Total
Held-To
Maturity
Securities
$
198,206
$
100,055
$
1,000
$
299,261
202,390
4,762
578
98,915
24
1,164
43,043
82,001
69,832
3,330
43,113
83,896
71,967
3,414
23,633
5,111
28,744
101
519
59
578
$
$
$
$
$
$
$
$
—
41,958
58,097
—
—
41,788
57,127
—
85,339
—
85,339
36
1,164
—
1,164
$
$
$
$
1,000
—
—
—
—
—
1,000
—
—
—
1,000
302,305
4,786
1,742
298,261
43,043
123,959
127,929
4,330
43,113
125,684
129,094
4,414
— $
—
— $
108,972
5,111
114,083
—
137
— $
—
— $
1,683
59
1,742
$
183,373
$
55,430
$
1,000
$
239,803
191,196
7,886
63
56,056
626
—
1,000
—
—
248,252
8,512
63
238,803
December 31, 2013
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
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
68
Held-To-Maturity Securities
State and
Municipal
Obligations
Mortgage-
Backed
Securities -
Residential
Corporate
and Other
Debt
Securities
Total
Held-To
Maturity
Securities
$
$
$
$
21,583
503
22,086
61
62
1
63
$
$
$
$
— $
—
— $
—
— $
—
— $
— $
—
— $
—
— $
—
— $
21,583
503
22,086
61
62
1
63
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, 2013, U.S. agency obligations consisted solely of U.S. Government Agency
securities with an amortized cost of $136.9 million and a fair value of $136.5 million. Mortgage-backed securities-residential consisted
of U.S. Government Agency securities with an amortized cost of $31.5 million and a fair value of $32.2 million and GSE securities
with an amortized cost of $139.8 million and a fair value of $143.6 million. In the held-to-maturity category at December 31, 2013,
mortgage-backed securities-residential consisted of U.S. Government Agency securities with an amortized cost of $4.9 million and
a fair value of $4.7 million and GSE securities with an amortized cost of $95.2 million and a fair value of $94.2 million.
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.
Securities in a continuous loss position, in the tables above for December 31, 2013 and December 31, 2012 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, 2013, 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.
Schedule of Federal Reserve Bank and Federal Home Loan Bank Stock
Federal Reserve Bank and Federal Home Loan Bank Stock are carried at cost.
Federal Reserve Bank Stock
Federal Home Loan Bank Stock
Total Federal Reserve Bank and Federal Home Loan Bank Stock
69
December 31,
2013
2012
$
$
1,035
5,246
6,281
$
$
1,018
4,774
5,792
Note 5:
LOANS (Dollars In Thousands)
Loan Categories and Past Due Loans
The following table presents loan balances outstanding as of December 31, 2013 and December 31, 2012 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, 2013
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
304
601
177
1,082
86,811
$
— $
200
$
—
—
—
1,200
2,034
3,434
37
19
—
56
$
3,233
$
529
$
1,041
98
4,372
1,527
3,113
5,169
4,303
4,388
5,422
14,113
27,815
284,685
7,593
389,832
455,623
1,252,359
$
$
$
$
Total Loans
Loans 90 or More Days Past Due
and Still Accruing Interest
Nonaccrual Loans
December 31, 2012
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
87,893
$
27,815
$
288,119
$
7,649
$ 394,204
$ 460,792
$1,266,472
28
352
$
$
— $
— $
— $
2,048
$
— $
— $
— $
624
219
$
3,860
$
$
652
6,479
1,045
$
— $
534
$
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
$
$
126
1,787
$
$
— $
— $
378
2,026
$
$
— $
1
$
42
419
$
$
374
2,400
$
$
920
6,633
The Company disaggregates its loan portfolio into the following six categories:
Commercial - The Company offers a variety of loan options to meet the specific needs of our commercial customers including term
loans, time notes and lines of credit. Such loans are made available to businesses for working capital needs such as inventory
and receivables, business expansion and equipment purchases. Generally, a collateral lien is placed on equipment or other assets
owned by the borrower. These loans carry a higher risk than commercial real estate loans due to the nature of the underlying
collateral, which can be business assets such as equipment and accounts receivable and generally have a lower liquidation value
than real estate. In the event of default by the borrower, the Company may be required to liquidate collateral at deeply discounted
values. To reduce the risk, management usually obtains personal guarantees of the borrowers.
Commercial Construction - The Company offers commercial construction and land development loans to finance projects within
the communities that we serve. Many projects will ultimately be used by the borrowers’ businesses, while others are developed
for resale. These real estate loans are secured by first liens on the real estate, which may include apartments, commercial
structures, housing businesses, healthcare facilities, and both owner-occupied and nonowner-occupied facilities. There is
enhanced risk during the construction period, since the loan is secured by an incomplete project.
Commercial Real Estate - The Company offers commercial real estate loans to finance real estate purchases, refinancings,
expansions and improvements to commercial properties. Commercial real estate loans are made to finance the purchases of real
property which generally consists of real estate with completed structures. These commercial real estate loans are secured by
70
first liens on the real estate, which may include apartments, commercial structures, housing businesses, healthcare facilities, and
both owner and non owner-occupied facilities. These loans are typically less risky than commercial loans, since they are secured
by real estate and buildings, and are generally originated in amounts of no more than 80% of the appraised value of the property.
Other Consumer Loans - The Company offers a variety of consumer installment loans to finance personal expenditures. Most of
these loans carry a fixed rate of interest with principal repayment terms typically ranging from one to five years, based upon the
nature of the collateral and the size of the loan. In addition to installment loans, the Company also offers personal lines of credit
and overdraft protection. Several loans are unsecured, which carry a higher risk of loss.
Automobile - The Company primarily finances the purchases of automobiles indirectly through dealer relationships located
throughout upstate New York and Vermont. Most of these loans carry a fixed rate of interest with principal repayment terms typically
ranging from three to seven years. The majority of indirect consumer loans are underwritten on a secured basis using the underlying
collateral being financed.
Residential Real Estate Mortgages - Residential real estate loans consist primarily of loans secured by first or second mortgages
on primary residences. We originate adjustable-rate and fixed-rate one-to-four-family residential real estate loans for the
construction, purchase or refinancing of a mortgage. These loans are collateralized primarily by owner-occupied properties
generally located in the Company’s market area. Loans on one-to-four-family residential real estate are generally originated in
amounts of no more than 85% of the purchase price or appraised value (whichever is lower), or have private mortgage insurance.
The Company’s underwriting analysis for residential mortgage loans typically includes credit verification, independent appraisals,
and a review of the borrower’s financial condition. Mortgage title insurance and hazard insurance are normally required.
Construction loans have a unique risk, because they are secured by an incomplete dwelling. This risk is reduced through periodic
site inspections, including one at each loan draw period. In addition, the Company offers fixed home equity loans as well as home
equity lines of credit to consumers to finance home improvements, debt consolidation, education and other uses. Our policy allows
for a maximum loan to value ratio of 80%. The Company originates home equity lines of credit and second mortgage loans (loans
secured by a second junior lien position on one-to-four-family residential real estate). Risk is generally reduced through underwriting
criteria, which include credit verification, appraisals, a review of the borrower's financial condition and personal cash flows. A
security interest, with title insurance when necessary, is taken in the underlying real estate.
Allowance for Loan Losses
The following table presents a rollforward of the allowance for loan losses and other information pertaining to the allowance
Allowance for Loan Losses
Commercial
Commercial
Other
Commercial Construction Real Estate
Consumer
Automobile
Residential
Unallocated
Total
for loan losses:
Rollfoward of the
Allowance for Loan
Losses for the Year
Ended:
December 31, 2012 $
2,344
$
601
$
3,050
$
304
$
4,536
$
3,405
$
1,058
$
15,298
Charge-offs
Recoveries
Provision
(926)
88
380
—
—
(184)
(11)
—
506
(28)
3
(7)
(431)
256
(155)
(15)
—
(364)
—
—
24
(1,411)
347
200
December 31, 2013 $
1,886
$
417
$
3,545
$
272
$
4,206
$
3,026
$
1,082
$
14,434
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
71
Allowance for Loan Losses
Commercial
Commercial
Other
Commercial Construction Real Estate
Consumer
Automobile
Residential
Unallocated
Total
$
— $
— $
— $
— $
— $
— $
— $
—
$
1,886
$
417
$
3,545
$
272
$
4,206
$
3,026
$
1,082
$
14,434
$
221
$
— $
1,785
$
— $
173
$
2,309
$
— $
4,488
$
87,672
$
27,815
$
286,334
$
7,649
$
394,031
$
458,483
$
— $ 1,261,984
$
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
December 31, 2013
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, 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
Through the provision for loan losses, an allowance for loan losses is maintained that reflects our best estimate of the inherent
risk of loss in the Company’s loan portfolio as of the balance sheet date. Additions are made to the allowance for loan losses
through a periodic provision for loan losses. Actual loan losses are charged against the allowance for loan losses when loans are
deemed uncollectible and recoveries of amounts previously charged off are recorded as credits to the allowance for loan losses.
Our loan officers and risk managers meet at least quarterly to discuss and review the conditions and risks associated with
certain criticized and classified commercial-related relationships. In addition, our independent internal loan review department
performs periodic reviews of the credit quality indicators on individual loans in our commercial loan portfolio.
We use a two-step process to determine the provision for loan losses and the amount of the allowance for loan losses. We
measure impairment on our impaired loans on a quarterly basis. Our impaired loans are generally nonaccrual loans over $250
thousand and all troubled debt restructured loans. Our impaired loans are generally considered to be collateral dependent with
the specific reserve, if any, determined based on the value of the collateral less estimated costs to sell.
The remainder of the portfolio is evaluated on a pooled basis, as described below. For each homogeneous loan pool, we
estimate a total loss factor based on the historical net loss rates adjusted for applicable qualitative factors. We update the total
loss factors assigned to each loan category on a quarterly basis. For the commercial, commercial construction, and commercial
real estate categories, we further segregate the loan categories by credit risk profile (pools of loans graded pass, special mention
and accruing substandard). Additional description of the credit risk classifications is detailed in the Credit Quality Indicators section
of this note.
We determine the historical net loss rate for each loan category using a trailing three-year net charge-off average. While
historical net loss experience provides a reasonable starting point for our analysis, historical net losses, or even recent trends in
net losses, do not by themselves form a sufficient basis to determine the appropriate level of the allowance for loan losses.
Therefore, we also consider and adjust historical net loss factors for qualitative factors that impact the inherent risk of loss associated
with our loan categories within our total loan portfolio. These include:
72
• 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
While not a significant part of the allowance for loan losses methodology, we also maintain an unallocated portion of the total
allowance for loan losses related to the overall level of imprecision inherent in the estimation of the appropriate level of allowance
for loan losses.
Loan Credit Quality Indicators
The following table presents the credit quality indicators by loan category at December 31, 2013 and December 31, 2012:
Loan Credit Quality Indicators
Commercial
Commercial Construction
Commercial
Real Estate
Other
Consumer
Automobile Residential
Total
$
$
December 31, 2013
Credit Risk Profile by
Creditworthiness Category:
Satisfactory
Special Mention
Substandard
Doubtful
Credit Risk Profile Based on
Payment Activity:
Performing
Nonperforming
December 31, 2012
Credit Risk Profile by
Creditworthiness Category:
Satisfactory
Special Mention
Substandard
Doubtful
Credit Risk Profile Based on
Payment Activity:
Performing
Nonperforming
$
79,966
204
7,723
—
$
27,815
—
—
—
267,612
634
19,873
—
$ 375,393
838
27,596
—
$
7,649
—
$ 393,985
219
$ 456,308
4,484
857,942
4,703
$
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
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.
For the allowance calculation, 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;
73
2) Special Mention - Loans in this category have potential weaknesses that deserve management’s close attention. If
left uncorrected, these potential weaknesses may result in deterioration of the repayment prospects for the asset or in the
institution’s credit position at some future date. "Special mention" assets are not adversely classified and do not expose
an institution to sufficient risk to warrant adverse classification. Loans which might be assigned this credit quality indicator
include loans to borrowers with deteriorating financial strength and/or earnings record and loans with potential for problems
due to weakening economic or market conditions;
3) Substandard - Loans classified as “substandard” are inadequately protected by the current sound net worth or paying
capacity of the borrower or the collateral pledged, if any. Loans in this category have well defined weaknesses that jeopardize
the repayment. They are characterized by the distinct possibility that the 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 generally evaluated on an annual basis depending on the size and complexity of the loan relationship,
unless the credit related quality indicator falls to a level of "special mention" or below, when the loan is evaluated quarterly. The
credit quality indicator is one of the factors used in assessing the level of inherent risk of loss in our commercial related loan
portfolios.
74
Impaired Loans
The following table presents information on impaired loans based on whether the impaired loan has a recorded allowance
or no recorded allowance:
Impaired Loans
Commercial
Commercial Construction
Commercial
Real Estate
Other
Consumer
Automobile Residential
Total
December 31, 2013
Recorded Investment:
With No Related Allowance
With a Related Allowance
Unpaid Principal Balance:
With No Related Allowance
With a Related Allowance
December 31, 2012
Recorded Investment:
With No Related Allowance
With a Related Allowance
Unpaid Principal Balance:
With No Related Allowance
With a Related Allowance
For the Year-To-Date Period
Ended:
December 31, 2013
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, 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
$
$
$
$
$
$
$
$
$
$
$
$
$
221
—
221
—
45
1,387
45
1,387
133
694
4
—
—
—
56
694
6
—
—
—
40
6
—
$
$
$
$
$
$
$
$
$
$
$
$
$
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
$
$
$
$
$
$
$
$
$
$
$
$
$
1,785
—
1,785
—
2,528
—
2,695
—
2,157
—
—
—
—
—
2,241
—
64
—
64
—
1,993
42
42
$
$
$
$
$
$
$
$
$
$
$
$
$
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
5
—
—
$
$
$
$
$
$
$
$
$
$
$
$
$
173
—
173
—
203
—
203
—
$
$
2,309
—
2,309
—
$ 4,488
—
$ 4,488
—
$ 1,090
—
$ 3,866
$ 1,387
$ 1,090
—
$ 4,033
$ 1,387
188
—
$ 1,700
—
$ 4,178
694
$
$
9
—
—
—
$
$
8
—
—
—
21
—
—
—
236
—
$ 1,599
—
$ 4,132
694
$
$
$
12
—
—
—
9
—
—
—
$
$
$
$
91
—
64
—
274
$ 1,328
$ 3,640
19
—
$
$
7
—
$
$
74
42
At December 31, 2013 and December 31, 2012, 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, 2013. 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.
75
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, 2013
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, 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
169
200
—
—
—
—
—
—
—
—
—
1
63
63
—
—
—
$
$
$
$
$
$
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
2
47
47
—
—
—
1
917
917
—
—
—
$
$
$
$
$
$
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
$
$
$
$
$
$
9
88
88
—
—
—
17
160
160
—
—
—
14
121
121
—
—
—
$
$
$
$
$
$
—
—
—
—
—
—
—
—
—
—
—
—
1
$
$
$
$
10
257
288
—
—
—
19
207
207
—
—
—
17
242
$ 1,343
242
$ 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, 2013 or December 31, 2012.
76
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
2013
2012
$
2,152
501
$
1,571
690
270,372
133,709
156,593
64
134,688
2,801
$ 17,447
(8,819)
2,253
(3,112)
7,769
$
$ 15,772
45
5,939
(4,309)
$ 17,447
Note 6:
PREMISES AND EQUIPMENT (In Thousands)
A summary of premises and equipment at December 31, 2013 and 2012 is presented below:
Land and Bank Premises
Equipment, Furniture and Fixtures
Leasehold Improvements
Total Cost
Accumulated Depreciation and Amortization
Net Premises and Equipment
2013
2012
$
$
35,114
20,851
1,190
57,155
(28,001)
29,154
$
$
33,908
20,123
957
54,988
(26,091)
28,897
Amounts charged to expense for depreciation totaled $1,928, $1,521 and $1,382 in 2013, 2012 and 2011, respectively.
77
Note 7:
OTHER INTANGIBLE ASSETS (In Thousands)
The following table presents information on Arrow’s intangible assets (other than goodwill) as of December 31, 2013, 2012 and
2011:
Gross Carrying Amount, December 31, 2013
Accumulated Amortization
Net Carrying Amount, December 31, 2013
Gross Carrying Amount, December 31, 2012
Accumulated Amortization
Net Carrying Amount, December 31, 2012
Rollforward 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
Intangible Assets Acquired
Amortization of Intangible Assets
Balance, December 31, 2013
Depositor
Intangibles1
2,247
$
(2,186)
61
$
$
$
$
$
2,247
(2,094)
153
460
—
(174)
286
—
(133)
153
—
(92)
61
Mortgage
Servicing
Rights2
$
$
$
$
$
$
1,582
(622)
960
1,251
(392)
859
371
339
(111)
599
417
(157)
859
331
(230)
960
Customer
Intangibles1
4,451
$
(1,332)
3,119
$
$
$
$
$
4,451
(971)
3,480
627
3,573
(336)
3,864
—
(384)
3,480
—
(361)
3,119
Total
8,280
(4,140)
4,140
7,949
(3,457)
4,492
1,458
3,912
(621)
4,749
417
(674)
4,492
331
(683)
4,140
$
$
$
$
$
$
1 Amortization of depositor intangibles and customer intangibles are reported in the consolidated statements of income as a component of other
operating expense.
2 Amortization of mortgage servicing rights is reported in the consolidated statements of income as a reduction of mortgage servicing fee income,
which is included with fees for other services to customers.
The following table presents the remaining estimated annual amortization expense for Arrow's intangible assets as of
December 31, 2013:
Estimated Annual Amortization Expense:
2014
2015
2016
2017
2018
Later Years
Total
Depositor
Intangibles1
Mortgage
Servicing
Rights2
Customer
Intangibles1
Total
$
$
51
10
—
—
—
—
61
$
$
253
230
209
150
96
22
960
$
$
337
319
301
281
263
1,618
3,119
$ 641
559
510
431
359
1,640
$ 4,140
1 Amortization of depositor intangibles and customer intangibles are reported in the consolidated statements of income as a component of other
operating expense.
2 Amortization of mortgage servicing rights is reported in the consolidated statements of income as a reduction of mortgage servicing fee income,
which is included with fees for other services to customers.
78
Note 8:
GUARANTEES (Dollars 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, 2013 and 2012:
Balance at December 31,
Notional Amount:
Commitments to Extend Credit
Standby Letters of Credit
Fair Value:
Commitments to Extend Credit
Standby Letters of Credit
2013
2012
$ 237,940
3,345
$ 198,405
10,929
$
— $
65
—
120
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, 2013 and 2012 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, 2013 and 2012 were insignificant. The fair
value of standby letters of credit is based on the fees currently charged for similar agreements or the cost to terminate the arrangement
with the counterparties.
The fair value of commitments to extend credit is determined by estimating the fees to enter into similar agreements, taking
into account the remaining terms and present creditworthiness of the counterparties, and for fixed rate loan commitments, the
difference between the current and committed interest rates. Arrow provides several types of commercial lines of credit and standby
letters of credit to its commercial customers. The pricing of these services is not isolated as Arrow considers the customer's complete
deposit and borrowing relationship in pricing individual products and services. The commitments to extend credit also include
commitments under home equity lines of credit, for which Arrow charges no fee. The carrying value and fair value of commitments
to extend credit are not material and Arrow does not expect to incur any material loss as a result of these commitments.
In the normal course of business, Arrow and its subsidiary banks become involved in a variety of routine legal proceedings.
At present, there are no legal proceedings pending or threatened, which in the opinion of management and counsel, would result
in a material loss to Arrow.
79
Note 9:
TIME DEPOSITS (Dollars In Thousands)
The following summarizes the contractual maturities of time deposits during years subsequent to December 31, 2013:
Year of Maturity
2014
2015
2016
2017
2018
2019 and Beyond
Total
$
$
Total Time
Deposits
163,032
31,277
17,450
18,418
13,076
3,974
247,227
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
2013
2012
$
$
$
53,000
11,777
64,777
30,000
214,000
302,000
$
$
$
29,000
12,678
41,678
30,000
90,000
268,000
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 advance program which allows for overnight and term advances up to the limit of pledged
collateral, including FHLBNY 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.
Maturity Schedule of FHBLNY Term Advances:
Balances
Weighted Average Rate
Final Maturity
First Year
Second Year
Third Year
Total
2013
10,000
10,000
—
20,000
$
$
2012
10,000
10,000
10,000
30,000
$
$
2013
2012
1.43%
3.88%
—%
2.66%
1.65%
1.43%
3.88%
2.32%
80
Long Term Debt - Guaranteed Preferred Beneficial Interests in Corporation's Junior Subordinated Debentures
During 2013, 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 Statements of Income.
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, 2013, 2012 and 2011 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
2013
2012
$
10,000
$
10,000
3.40%
3.51%
$
10,000
$
10,000
2.25%
2.36%
81
Note 11:
COMPREHENSIVE INCOME (Dollars In Thousands)
The following table presents the components of other comprehensive income for the years ended December 31, 2013, 2012
and 2011:
Schedule of Comprehensive Income
2013
Net Unrealized Securities Holding
Gains Arising During the Period
Reclassification Adjustment for
Securities Gains Included in Net
Income
Net Retirement Plan Loss
Amortization of Net Retirement Plan
Actuarial Loss
Accretion of Net Retirement Plan
Prior Service Credit
Before-Tax
Amount
Tax
(Expense)
Benefit
Net-of-Tax
Amount
$
(4,843) $
1,918
$
(2,925)
(540)
10,640
214
(4,215)
1,513
(599)
2
(1)
(326)
6,425
914
1
Other Comprehensive Income
$
6,772
$
(2,683) $
4,089
2012
Net Unrealized Securities Holding
Gains Arising During the Period
Reclassification Adjustment for
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
$
(1,094) $
433
$
(661)
(865)
(2,218)
(405)
343
878
160
(522)
(1,340)
(245)
1,677
(664)
1,013
(20)
8
(12)
Other Comprehensive Income
$
(2,925) $
1,158
$
(1,767)
2011
Net Unrealized Securities Holding
Gains Arising During the Period
Reclassification Adjustment for
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
$
7,850
$
(3,109) $
4,741
(2,795)
(6,129)
(266)
996
(108)
1,107
2,428
105
(394)
43
(1,688)
(3,701)
(161)
602
(65)
(272)
Other Comprehensive Income
$
(452) $
180
$
82
The following table presents the changes in accumulated other comprehensive income by component:
Changes in Accumulated Other Comprehensive Income (Loss) by Component (1)
Unrealized
Gains and
Losses on
Available-for-
Sale Securities
Defined Benefit Plan Items
Net Gain
(Loss)
Net Prior
Service
(Cost ) Credit
Total
For the Year-To-Date periods ended:
December 31, 2012
Other comprehensive income (loss) before
reclassifications
Amounts reclassified from accumulated other
comprehensive income (loss)
Net current-period other comprehensive income
December 31, 2013
December 31, 2011
Other comprehensive income (loss) before
reclassifications
Amounts reclassified from accumulated other
comprehensive income (loss)
Net current-period other comprehensive income
December 31, 2012
December 31, 2010
Other comprehensive income (loss) before
reclassifications
Amounts reclassified from accumulated other
comprehensive income (loss)
$
$
$
$
$
Net current-period other comprehensive income
December 31, 2011
$
5,625
$
(14,036)
$
(51)
$
(8,462)
(2,925)
6,425
(326)
(3,251)
2,374
6,808
(661)
(522)
(1,183)
5,625
3,755
4,741
(1,688)
3,053
6,808
$
$
$
$
$
914
7,339
(6,697)
(13,709)
(1,340)
1,013
(327)
(14,036)
(10,610)
(3,701)
602
(3,099)
(13,709)
$
$
$
$
$
—
1
1
(50)
206
(245)
(12)
(257)
(51)
432
(161)
(65)
(226)
206
$
$
$
$
$
3,500
589
4,089
(4,373)
(6,695)
(2,246)
479
(1,767)
(8,462)
(6,423)
879
(1,151)
(272)
(6,695)
(1) All amounts are net of tax. Amounts in parentheses indicate debits.
83
The following table presents the reclassifications out of accumulated other comprehensive income:
Reclassifications Out of Accumulated Other Comprehensive Income (1)
Details about Accumulated Other
Comprehensive Income Components
For the Year-to-date periods ended:
December 31, 2013
Unrealized gains and losses on available-
for-sale securities
Amortization of defined benefit pension
items
Prior-service costs
Actuarial gains/(losses)
Total reclassifications for the period
December 31, 2012
Unrealized gains and losses on available-
for-sale securities
Amortization of defined benefit pension
items
Prior-service costs
Actuarial gains/(losses)
Total reclassifications for the period
Amounts Reclassified
from Accumulated Other
Comprehensive Income
Affected Line Item in the Statement
Where Net Income Is Presented
$
$
$
$
$
$
$
$
$
$
540
540
(214)
326
Gain on Securities Transactions, Net
Total before tax
Provision for Income Taxes
Net of tax
(2)
(2)
(2)
(1,513)
(1,515)
600
(915)
Salaries and Employee Benefits
Salaries and Employee Benefits
Total before tax
Provision for Income Taxes
Net of tax
(589)
Net of tax
865
865
(343)
522
Gain on Securities Transactions, Net
Total before tax
Provision for Income Taxes
Net of tax
(2)
(2)
20
(1,677)
(1,657)
656
(1,001)
Salaries and Employee Benefits
Salaries and Employee Benefits
Total before tax
Provision for Income Taxes
Net of tax
(479)
Net of tax
84
Reclassifications Out of Accumulated Other Comprehensive Income (1)
Details about Accumulated Other
Comprehensive Income Components
December 31, 2011
Unrealized gains and losses on available-
for-sale securities
Amortization of defined benefit pension
items
Prior-service costs
Actuarial gains/(losses)
Total reclassifications for the period
Amounts Reclassified
from Accumulated Other
Comprehensive Income
Affected Line Item in the Statement
Where Net Income Is Presented
$
$
$
$
$
2,795
2,795
(1,107)
1,688
Gain on Securities Transactions, Net
Total before tax
Provision for Income Taxes
Net of tax
(2)
(2)
108
(996)
(888)
351
(537)
Salaries and Employee Benefits
Salaries and Employee Benefits
Total before tax
Provision for Income Taxes
Net of tax
1,151
Net of tax
(1) Amounts in parentheses indicate debits to profit/loss.
(2) These accumulated other comprehensive income components are included in the computation of net periodic pension cost (see pension
footnote for additional details).
85
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 2013 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.
Roll Forward Schedule of Stock Option Plan by Shares and Weighted Average Exercise Prices
Roll Forward of Shares Outstanding:
Outstanding at January 1, 2013
Granted
Exercised
Forfeited
Outstanding at December 31, 2013
Exercisable at December 31, 2013
Vested and Expected to Vest
Roll Forward of Shares Outstanding - Weighted Average Exercise Price:
Outstanding at January 1, 2013
Granted
Exercised
Forfeited
Outstanding at December 31, 2013
Exercisable at December 31, 2013
Vested and Expected to Vest
Weighted Average Remaining Contractual Life (in years):
Outstanding at December 31, 2013
Exercisable at December 31, 2013
Vested and Expected to Vest
Aggregate Intrinsic Value:
Outstanding at December 31, 2013
Exercisable at December 31, 2013
Vested and Expected to Vest
Stock Option
Plans
451,210
10,200
(59,612)
(12,406)
389,392
269,758
119,634
$
$
22.67
23.80
21.02
24.71
22.89
22.29
24.25
5.57
4.68
7.58
1,429
1,152
277
Shares Available for Grant at Period-End
459,000
86
Schedule of Shares Authorized Under the Stock Option Plan by Exercise Price Range
Exercise Price Ranges
$19.08 to
$19.87
$21.24 to
$22.27
$23.76 to
$23.80
$24.43
$25.77
Total
Outstanding Options at
December 31, 2013
Number of Shares Outstanding
85,278
98,376
83,015
75,512
47,211
389,392
Weighted-Average Remaining
Contractual Life (in years)
4.73
5.11
7.34
8.05
0.97
Weighted-Average Exercise Price
$
19.64 $
21.95 $
23.77 $
24.43 $
25.77 $
5.57
22.89
Exercisable Options at
December 31, 2013
Number of Shares Outstanding
85,278
81,150
36,391
19,728
47,211
269,758
Weighted-Average Remaining
Contractual Life (in years)
4.73
4.90
7.09
7.94
0.97
Weighted-Average Exercise Price
$
19.64 $
21.88 $
23.77 $
24.42 $
25.77 $
4.68
22.29
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
$
$
2013
10,200
2012
77,302
2011
79,994
$
5.46
$
5.89
$
6.00
4.20%
36.57%
1.31%
6.71
372
420
1.45
1,254
23
267
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
$
$
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
2013
2012
2011
$
600
$
550
$
550
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, 2013 were as follows:
87
Schedule of Shares in ESOP Plan
ESOP Plan Shares:
Allocated Shares
Shares Released for Allocation During 2013
Unallocated Shares
Total ESOP Shares
2013
644,248
16,969
87,641
748,858
Market Value of Unallocated Shares
$
2,328
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
Defined Benefit Plan Funded Status
December 31, 2013
Fair Value of Plan Assets
Benefit Obligation
Funded Status of Plan
December 31, 2012
Fair Value of Plan Assets
Benefit Obligation
Funded Status of Plan
Change in Benefit Obligation
Benefit Obligation, at January 1, 2013
Service Cost
Interest Cost
Plan Participants' Contributions
Amendments
Actuarial Gain
Benefits Paid
Benefit Obligation, at December 31, 2013
Employees'
Pension
Plan
Select
Executive
Retirement
Plan
Postretirement
Benefit
Plans
$
$
$
$
$
$
44,653
33,259
11,394
39,880
37,046
2,834
37,046
1,506
1,261
—
—
(3,820)
(2,734)
33,259
$
$
$
$
$
$
— $
4,459
(4,459)
$
— $
5,324
(5,324)
5,324
—
163
—
—
(555)
(473)
4,459
$
$
$
—
7,619
(7,619)
—
9,213
(9,213)
9,213
211
308
368
—
(1,648)
(833)
7,619
88
Schedule of Defined Benefit Plan Disclosures
Employees'
Pension
Plan
Select
Executive
Retirement
Plan
Postretirement
Benefit
Plans
Benefit Obligation, at January 1, 2012
Service Cost
Interest Cost
Plan Participants' Contributions
Amendments
Actuarial Loss
Benefits Paid
Benefit Obligation, at December 31, 2012
Change in Fair Value of Plan Assets
Fair Value of Plan Assets, at January 1, 2013
Actual Return on Plan Assets
Employer Contributions
Plan Participants' Contributions
Benefits Paid
Fair Value of Plan Assets, at December 31, 2013
Change in Fair Value of Plan Assets, continued
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
Accumulated Benefit Obligation at December 31, 2013
Amounts Recognized in the Consolidated Balance Sheets
December 31, 2013
Prepaid Pension Asset
Accrued Benefit Liability
Net Benefit Recognized
December 31, 2012
Prepaid Pension Asset
Accrued Benefit Liability
Net Benefit Recognized
Amounts Recognized in Other Comprehensive Income (Loss)
For the Year Ended December 31, 2013
Net Unamortized Gain 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, 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
89
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
35,047
1,467
1,436
—
—
2,857
(3,761)
37,046
39,880
7,507
—
—
(2,734)
44,653
39,206
4,435
—
—
(3,761)
39,880
32,886
11,394
—
11,394
2,834
—
2,834
(8,438)
—
(1,231)
(37)
4,529
87
190
—
405
441
(328)
5,324
$
$
— $
—
473
—
(473)
— $
— $
—
328
—
(328)
— $
8,556
202
338
348
—
491
(722)
9,213
—
—
465
368
(833)
—
—
—
374
348
(722)
—
4,459
$
7,619
—
(4,459)
(4,459)
—
(5,324)
(5,324)
(554)
—
(140)
(79)
$
$
$
—
(7,619)
(7,619)
—
(9,213)
(9,213)
(1,648)
—
(142)
114
(9,706)
$
(773)
$
(1,676)
$
1,286
—
(1,387)
(41)
$
441
405
(156)
(53)
(142)
$
637
$
491
—
(134)
114
471
Schedule of Defined Benefit Plan Disclosures
Employees'
Pension
Plan
Select
Executive
Retirement
Plan
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
Accumulated Other Comprehensive Income
December 31, 2013
Net Actuarial Loss
Prior Service (Credit) Cost
Total Accumulated Other Comprehensive Income, Before Tax
December 31, 2012
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, 2013
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, 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
Weighted-Average Assumptions Used in
Calculating Benefit Obligation
December 31, 2013
Discount Rate
Rate of Compensation Increase
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
5,474
191
(778)
(38)
$
151
75
(147)
32
4,849
$
111
$
8,357
(255)
8,102
18,026
(218)
17,808
345
(45)
1,506
1,261
(2,889)
37
1,232
1,147
1,467
1,436
(2,865)
41
1,387
1,466
1,353
1,598
(2,793)
38
778
974
$
$
$
$
$
$
$
$
$
$
$
$
1,674
642
2,316
2,368
721
3,089
90
72
$
$
$
$
$
$
— $
163
—
79
139
381
87
190
—
53
156
486
81
222
—
(32)
147
418
$
$
$
$
$
504
—
(71)
114
547
1,060
(305)
755
2,850
(419)
2,431
26
(114)
211
308
—
(114)
142
547
202
338
—
(114)
134
560
173
372
—
(114)
71
502
5.10%
3.50%
4.85%
3.50%
5.10%
3.50%
90
Schedule of Defined Benefit Plan Disclosures
Employees'
Pension
Plan
Select
Executive
Retirement
Plan
Postretirement
Benefit
Plans
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
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
Weighted-Average Assumptions Used in
Calculating Net Periodic Benefit Cost
December 31, 2013
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, 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
91
4.00%
5.25%
5.25%
3.55%
3.50%
3.00%
4.50%
4.50%
3.55%
7.50%
3.50%
3.00%
4.50%
4.50%
4.05%
7.50%
3.50%
3.25%
5.00%
5.00%
5.15%
7.50%
3.50%
4.25%
5.50%
5.50%
3.55%
3.50%
3.55%
3.50%
4.05%
3.50%
5.15%
3.50%
5.25%
3.15%
3.50%
4.50%
3.15%
3.50%
4.50%
4.05%
3.50%
5.00%
5.15%
3.50%
5.50%
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
$
7
$
— $
— $
7
—%
Asset Category
December 31, 2013
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, 2012
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
3,941
4,291
17,419
14,338
31,757
4,309
348
4,657
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
3,941
4,291
8.8%
9.6%
17,419
39.1%
14,338
31,757
32.1%
71.2%
4,309
9.6%
348
0.8%
$
$
44,653
$
— $
— $ 44,653
100.0%
17
$
— $
— $
17
—%
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%
—%
—%
—%
15.0%
15.0%
10.0%
55.0%
85.0%
—%
—%
—%
15.0%
15.0%
10.0%
55.0%
85.0%
6,227
15.6%
10.0%
30.0%
Total
$
39,880
$
— $
— $ 39,880
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 Advisers, Inc.
92
4,657
10.4%
10.0%
30.0%
Schedule of Defined Benefit Plan Disclosures
Expected Future Benefit Payments
2014
2015
2016
2017
2018
2019-2023
Estimated Contributions During 2014
Assumed Health Care Cost Trend Rates
December 31, 2013
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, 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
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
$
$
$
3,068
2,047
2,344
2,252
2,165
12,516
$
452
440
416
402
388
1,699
— $
452
$
510
531
539
549
562
3,026
510
8.50%
5.00%
2021
9.00%
5.00%
2021
59
(49)
557
(478)
$
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.
93
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 15 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 2013. Arrow makes contributions
for its postretirement benefits in an amount equal to actual expenses for the year.
Note 14:
OTHER EXPENSES (Dollars 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
Stationery and Printing
Advertising and Promotion
Telephone and Communications
Intangible Asset Amortization
All Other
Total Other Operating Expense
2013
$
3,261
1,823
1,046
905
879
804
452
3,486
$ 12,656
2012
$
2,263
1,962
1,040
975
831
808
518
3,243
$ 11,640
2011
$
1,654
1,972
1,088
891
853
981
510
3,095
$ 11,044
94
Note 15:
INCOME TAXES (Dollars 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
$
2013
7,933
852
8,785
172
122
294
9,079
2012
8,763
1,251
10,014
(290)
(63)
(353)
9,661
$
$
2011
6,726
816
7,542
1,775
397
2,172
9,714
$
$
The provisions for income taxes differed from the amounts computed by applying the U.S. Federal Income Tax Rate of 35%
for 2013, 2012 and 2011 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
$
2013
2012
2011
$
10,806
$
11,144
$
11,076
(2,238)
80
633
(202)
9,079
$
(2,132)
95
814
(260)
9,661
$
(2,199)
152
788
(103)
9,714
The tax effects of temporary differences that give rise to significant portions of the deferred tax assets and deferred tax
liabilities at December 31, 2013 and 2012 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
2013
2012
$
5,794
3,999
4,426
566
14,785
—
$ 14,785
$
6,105
4,140
9,241
608
20,094
—
$ 20,094
$
7,724
1,561
3,526
$
8,178
1,475
3,189
1,557
5,230
$ 19,598
3,690
5,225
$ 21,757
Management believes that the realization of the recognized net deferred tax assets at December 31, 2013 and 2012 is more
likely than not, based on existing loss carryback ability, available tax planning strategies and expectations as to future taxable
income.
Interest and penalties are recorded as a component of the provision for income taxes, if any. Tax years 2010 through 2013
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, 2013. All share and per
share amounts have been adjusted for the 2013 2% stock dividend.
95
Earnings Per Share
12/31/2013
Year-to-Date Period Ended:
12/31/2012
12/31/2011
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
$
$
$
$
$
$
21,795
12,296
1.77
21,795
12,296
31
12,327
$
$
$
22,179
12,247
1.81
22,179
12,247
10
12,257
Earnings Per Share - Diluted
Antidilutive Shares Excluded from the Calculation
of Earnings Per Share
$
1.77
$
1.81
$
47
203
21,933
12,209
1.80
21,933
12,209
12
12,221
1.79
136
Note 17:
FAIR VALUES (Dollars In Thousands)
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, 2013 and 2012 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.”
96
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, 2013
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, 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
Fair Value
$ 136,475
127,389
175,778
16,798
1,166
$ 457,606
$ 122,457
84,838
261,804
8,451
1,148
$ 478,698
Fair Value of Assets and Liabilities
Measured on a Nonrecurring Basis:
December 31, 2013
Other Real Estate Owned and
Repossessed Assets, Net
December 31, 2012
Collateral Dependent Impaired Loans
Other Real Estate Owned and
Repossessed Assets, Net
$
$
$
144
1,020
1,034
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)
Total Gains
(Losses)
$
$
$
$
$
$
$
— $
—
—
—
—
— $
— $
—
—
—
—
— $
136,475
127,389
175,778
16,798
1,166
457,606
122,457
84,838
261,804
8,451
1,148
478,698
$
$
$
$
—
—
—
—
—
—
—
—
—
—
—
—
— $
— $
144
— $
— $
— $
1,020
— $
1,034
$
$
$
(79)
(1,021)
(19)
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%.
97
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, 2013 and December 31, 2012.
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, 2013
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, 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
$
$
49,980
457,606
299,261
$
49,980
457,606
302,305
49,980
—
—
6,281
1,252,038
5,745
1,842,330
6,281
1,266,020
5,745
1,839,613
6,281
—
5,745
1,595,103
11,777
73,000
20,000
439
11,777
74,629
20,000
439
11,777
53,000
—
439
$
$
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
$
— $
457,606
302,305
—
—
—
244,510
—
21,629
20,000
—
$
— $
478,698
248,252
—
—
—
285,012
—
31,312
20,000
—
—
—
—
—
1,266,020
—
—
—
—
—
—
—
—
—
—
1,192,628
—
—
—
—
—
—
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
98
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.
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 (Dollars In Thousands)
At December 31, 2013, 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.
Net rental expense for the years ended December 31, 2013, 2012 and 2011 was as follows:
Net Rental Expense
2013 2012
2011
$ 671 $ 597 $ 570
Future minimum lease payments on operating leases at December 31, 2013 were as follows:
2014
2015
2016
2017
2018
Later Years
Total Minimum Lease Payments
$
Operating
Leases
638
583
440
347
277
448
2,733
$
Arrow leases five of its branch offices, at market rates, from Stewart’s Shops Corp. Mr. Gary C. Dake, President of Stewart’s
Shops Corp., serves 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, 2013, the maximum amount that could have been paid by subsidiary
banks to Arrow, without prior regulatory approval, was approximately $26,668.
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-
99
weighted assets (as defined), and of Tier I capital (as defined) to average assets (as defined). Management believes, as of
December 31, 2013 and 2012, that Arrow and both subsidiary banks meet all capital adequacy requirements to which they are
subject.
As of December 31, 2013, 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-
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, 2013 and 2012:
As of December 31, 2013:
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
$ 212,360
172,720
33,396
15.8% $ 107,524
89,725
15.4%
18,052
14.8%
8.0% $ 134,405
112,156
8.0%
22,565
8.0%
10.0%
10.0%
10.0%
197,906
160,849
30,833
14.7%
14.4%
13.7%
197,906
160,849
30,833
9.2%
8.8%
9.7%
53,852
44,680
9,002
86,046
73,113
12,715
4.0%
4.0%
4.0%
4.0%
4.0%
4.0%
80,778
67,020
13,504
86,046
91,391
15,893
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, 2012:
Total Capital
(to Risk Weighted Assets):
Arrow
Glens Falls National
Saratoga National
$ 200,480
164,889
31,911
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
185,170
152,205
29,297
185,170
152,205
29,297
98,395
81,427
16,906
49,379
40,860
8,492
81,393
69,184
12,467
8.0%
8.0%
8.0%
4.0%
4.0%
4.0%
4.0%
4.0%
4.0%
122,994
101,783
21,133
10.0%
10.0%
10.0%
74,068
61,291
12,738
81,393
86,480
15,584
6.0%
6.0%
6.0%
4.0%
5.0%
5.0%
16.3%
16.2%
15.1%
15.0%
14.9%
13.8%
9.1%
8.8%
9.4%
100
Note 20:
PARENT ONLY FINANCIAL INFORMATION (Dollars 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,
2013
$
3,349
1,166
1,000
206,680
5,807
$ 218,002
2012
$
1,913
1,148
1,000
192,985
5,339
$ 202,385
Junior Subordinated Obligations Issued to Unconsolidated Subsidiary Trusts $
Other Liabilities
Total Liabilities
20,000
5,848
25,848
$
20,000
6,560
26,560
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
$
$
192,154
$ 218,002
175,825
$ 202,385
$
Years Ended December 31,
2012
12,700
123
776
63
13,662
2013
12,900
116
549
—
13,565
2011
14,450
127
596
17
15,190
$
640
59
860
1,559
12,006
634
9,155
21,795
692
75
957
1,724
11,938
575
9,666
22,179
$
669
92
820
1,581
13,609
477
7,847
21,933
$
The Statement of Changes in Stockholders’ Equity is not reported because it is identical to the Consolidated Statement of
Changes in Stockholders’ Equity.
101
Years Ended December 31,
2012
2011
2013
$ 21,795
$ 22,179
$ 21,933
(9,155)
—
198
372
(990)
12,220
45
(45)
—
1,254
477
1,280
23
(1,709)
(12,109)
(10,784)
1,436
1,913
3,349
640
233
$
$
(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
$
$
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 Investing Activities
Cash Flows from Financing Activities:
Stock Options Exercised
Shares Issued Under the Employee Stock Purchase Plan
Shares Issued for Dividend Reinvestment Plans
Tax Benefit for Exercises 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
102
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,
2013. 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 the Exchange Act Rules 13(a)-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 (1992)
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, 2013.
Item 9B. Other Information – None.
Item 10. Directors, Executive Officers and Corporate Governance
PART III
The information required by this item regarding directors, nominees for director, and the committees of the Company's Board
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 7, 2014 (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 18.
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.
103
Item 14. Principal Accounting Fees and Services
The information required by this item is set forth under the captions "Voting Item 3 - 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.
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, 2013 and 2012
Consolidated Statements of Income for the Years Ended December 31, 2013, 2012 and 2011
Consolidated Statements of Comprehensive Income for the Years Ended December 31, 2013, 2012 and 2011
Consolidated Statements of Changes in Stockholders’Equity for the Years Ended December 31, 2013, 2012 and 2011
Consolidated Statements of Cash Flows for the Years Ended December 31, 2013, 2012 and 2011
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 106.
104
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 14, 2014
Date: March 14, 2014
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 14, 2014
by the following persons in the capacities indicated.
/s/ John J. Carusone, Jr.
John J. Carusone, Jr.
Director
/s/ Tenee R. Casaccio
Tenee R. Casaccio
Director
/s/ Michael B. Clarke
Michael B. Clarke
Director
/s/ Gary C. Dake
Gary C. Dake
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/ Colin L. Reed
Colin L. Reed
Director
/s/ Richard J. Reisman, D.M.D.
Richard J. Reisman, D.M.D.
Director
105
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
2013 Long Term Incentive Plan of the Registrant, incorporated herein by reference from the Registrant’s Definitive
Proxy Statement on Schedule 14A filed on March 20, 2013 as Annex A*
10.4
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*
10.5
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*
10.6
Directors’ Stock Plan of the Registrant incorporated herein by reference from the Registrant’s Definitive Proxy
Statement on Schedule 14A filed on March 20, 2013 as Annex B*
10.7
10.8
10.9
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*
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*
10.10
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*
106
Exhibit
Number
10.11
10.12
10.13
10.14
Exhibit
Consulting Agreement between the Registrant and Thomas L. Hoy, effective January 1, 2013 incorporated herein by
reference from the Registrant's Annual Report on Form 10-K for the year ended December 31, 2012, Exhibit 10.13
Employment Agreement between the Registrant and Thomas J. Murphy, President and Chief Executive Officer, effective
February 1, 2014 incorporated herein by reference from the Registrant's Current Report on Form 8-K , filed February
4, 2014, Exhibit 10.1*
Employment Agreement between the Registrant and Terry R. Goodemote, Executive Vice President and Chief Financial
Officer, effective February 1, 2014 incorporated herein by reference from the Registrant's Current Report on Form
8-K, filed February 4, 2014, Exhibit 10.2*
Employment Agreement between the Registrant and David S. DeMarco, Senior Vice President, effective February 1,
2014 incorporated herein by reference from the Registrant's Current Report on Form 8-K , filed February 4, 2014,
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
The following exhibits are submitted herewith:
Exhibit
Number
10.15
10.16
10.17
10.18
21
23
31.1
31.2
32
Exhibit
Form of Incentive Stock Option Certificate (Employee Award) of the Registrant*
Form of Non-Qualified Stock Option Certificate (Employee Award) of the Registrant*
Form of Non-Qualified Stock Option Certificate (Director Award) of the Registrant*
Amendment dated October 18, 2013 to Registrant’s Select Executive Retirement Plan for
benefits accrued or vested after December 31, 2004, as amended and restated*
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.
107
Certificate No.
(Employee Award)
ARROW FINANCIAL CORPORATION
2013 Long-Term Incentive Plan
INCENTIVE STOCK OPTION CERTIFICATE
(Employee Award)
(Complete all items before issuance of Certificate)
Date of Option Grant:
Option Price Per Share: $
Number of Shares to Which Option Relates:
The Option is /is not Authorized for Payment in Shares in Lieu of Cash.
(Shares surrendered in payment must meet all conditions for use of such shares as payment, as set by the
Administrator.)
The Option evidenced by this Certificate is non-transferable except upon the death of Optionee.
Record of Partial Option Exercise:
Date of Exercise:
No. of Shares Exercised:
No. of Shares Remaining as to
Which Option Relates:
This certifies that ______________ (“Optionee”), who is a valued and trusted Employee (as defined below), of
Arrow Financial Corporation, a New York corporation (the “Company”), has been granted an option by the Company
to purchase one or more shares of the common stock, par value $1.00 per share, of the Company (“Common Stock”),
subject to the terms and conditions set forth in this Certificate and in accordance with the Company’s 2013 Long-Term
Incentive Plan (the “Plan”), with the expectation that the provision of this award to the Optionee will encourage the
Optionee to acquire and maintain an interest in the Common Stock and have an added incentive to work for the success
of the Company and its subsidiaries. For purposes of this Certificate, an “Employee” means any employee (including
any officer or director who is also an employee) of the Company or any subsidiary of the Company.
The terms and conditions of said option are as follows:
1.
Grant of Option. As of the Date of Option Grant identified above, the Company hereby grants
to Optionee, subject to the conditions set forth in this Certificate and in the Plan, the right, privilege, and option
(the “Option”) to purchase that number of shares of Common Stock identified above opposite the heading
“Number of Shares to Which Option Relates” (the “Shares”), at the per share price (the “Exercise Price”)
specified above opposite the heading “Option Price Per Share,” which Exercise Price is not less than the Fair
Market Value per share of the Common Stock on the Date of Option Grant. For purposes of this Option
Certificate, “Fair Market Value” per share of Common Stock as of any date shall be as determined in the
manner specified from time to time by the Administrator in accordance with the Plan. The “Administrator” shall
be either the Board of Directors of the Company (the “Board”) or the Compensation Committee of the Board
as determined in accordance with the Plan.
2.
(a)
Exercisability of Option; Vesting.
Subject to the provisions, exceptions and limitations set forth elsewhere in this Certificate, including
Sections 3, 5 and 7, the Option may be exercised only to the extent vested and only during the period (the “Option
Period”) commencing on the Date of Option Grant identified above and ending on the tenth (10th) anniversary of the
Date of Option Grant. Subject to Section 2(b), the Option will become exercisable (i.e., will vest) during the Option
Period as follows: on the first anniversary of the Date of Option Grant, the Option will become exercisable with respect
to _____ Shares; on the second anniversary of the Date of Option Grant, the Option will become exercisable with
respect to an additional _______ Shares; on the third anniversary of the Date of Option Grant, the Option will become
exercisable with respect to an additional _______ Shares; and on the fourth anniversary of the Date of Option Grant,
the Option will become exercisable with respect to all remaining Shares.
(b)
Notwithstanding the foregoing, (i) the exercisability (i.e., vesting) of the Option shall be accelerated,
and the Option, if not fully exercisable, shall become fully exercisable (i.e., shall vest), in the event of the death or
Disability of Optionee or the occurrence of a Change in Control of the Company (as defined in Section 7) at any time
after the Date of Option Grant and prior to termination of the Option, and (ii) the exercisability (i.e., vesting) of the
Option may otherwise be accelerated, and the Option, if not fully exercisable, shall become fully exercisable, upon the
occurrence of such other event or events or upon such other circumstance or circumstances arising after the Date of
Option Grant and prior to termination of the Option as the Administrator may determine from time to time as justifying
such acceleration.
3.
Conditions to Exercise of Option. The Option may not be exercised unless, as of the date of
exercise of the Option (the “Date of Exercise”),
(a)
the Option is then exercisable with respect to the number of Shares as to which exercise is sought,
in accordance with Section 2, and the Option shall not have terminated pursuant to Section 5;
(b)
the underlying Shares as to which the Option is then sought to be exercised are the subject of an
effective registration statement under the Securities Act of 1933, as amended, and are registered under applicable
state securities laws, or may then be issued to Optionee exempt from such federal or state registration;
(c)
full payment of the Exercise Price of the Shares as to which the Option is being exercised has been
received by the Company in accordance with Section 4(c); and
(d)
all other actions required to be taken by the Company and Optionee prior to such exercise of the
Option in accordance with the Plan and this Certificate shall have been taken.
(a)
Method of Exercise of Option.
4.
If Optionee or any other person authorized to exercise the Option (an “Exercising Person”) elects to
exercise the Option, in whole or in part, such Exercising Person shall deliver to the Secretary of the Company or his
or her designated representative (the “Secretary”) at the Company’s principal place of business a written notice of
election to exercise the Option, identifying that number of whole Shares as to which exercise is then being sought,
which number may not exceed the number of Shares as to which the Option may then be exercised (i.e., vested shares)
in light of any and all prior partial exercises of the Option and any applicable restrictions on the right to exercise the
Option at such time in accordance with this Certificate or the Plan. If the Exercising Person is not the Optionee, the
notice also shall identify the nature of the Exercising Person’s authority to exercise the Option, which authority must
be acceptable to the Administrator. In all cases, such written notice of election must be accompanied by surrender of
the original of this Certificate.
(b)
The Date of Exercise with respect to any such election shall be as soon as practicable following receipt
by the Secretary of the notice described in Section 4(a) above and the satisfaction of all required conditions to exercise
including, without limitation, receipt of payment as described in Section 4(c) below. The Exercising Person may revoke
the election to exercise at any time prior to the Date of Exercise by subsequent notice to the Secretary, if such notice
of revocation is timely received as determined by the Company.
(c)
Full payment of the Exercise Price of the Shares with respect to which the Option is being exercised
must be delivered to the Company to the attention of the Secretary prior to the Date of Exercise. Payment shall be in
cash or by bank check, or if authorized by the Administrator upon grant of the Option (evidenced by an appropriate
notation in the forepart of this Certificate) or thereafter, may be made at the discretion of the Exercising Person in
whole or in part in shares of Common Stock owned by Optionee subject to such conditions upon such use of shares
of Common Stock as may be set by the Administrator from time to time (a
Exercise"). Any shares
Exercise ("Payment Shares") shall be valued at
surrendered in payment of the Exercise Price in a
Exercise, in lieu of physically surrendering to the
Fair Market Value as of the Date of Exercise. In a
Company a certain number of Payment Shares, the Exercising Person may elect to submit to the Company to the
attention of the Secretary an affidavit attesting ownership by Optionee of such number of shares for the appropriate
period of time and request that such shares, although not physically surrendered, be deemed to have been surrendered
by the Exercising Person to the Company in payment of the Exercise Price (any such payment, a "Deemed Payment").
If Optionee pays the Exercise Price using stock acquired via exercise of an “incentive stock option” (“ISO Stock”) prior
to satisfying the holding period described in Code Section 422(a) (i.e., within 2 years from the date of grant of such
incentive stock option or within 1 year of receipt of the ISO Stock), such payment will constitute a “disqualifying
disposition” of the ISO Stock and trigger tax consequences similar to those imposed upon the conversion of an “incentive
stock option” to a “nonqualified stock option.”
(d)
Upon receipt of payment of the Exercise Price, including an affidavit of ownership in the case of a
Deemed Payment, the Company shall issue and deliver to the Exercising Person, as of the Date of Exercise, evidenced
by book entry or electronic delivery or by delivery of a duly executed stock certificate, the number of Shares as to
which the Option has thus been exercised (less any Tax-Withheld Shares, as described and defined in Section 4(e)
below), provided that, if the Exercising Person has elected in connection with a Stock-for-Stock Exercise to make a
Deemed Payment without physically surrendering to the Company some number of Payment Shares owned by
Optionee, the Company will deduct from the number of Shares to be issued to the Exercising Person on the Date of
Exercise the number of shares deemed surrendered but not physically surrendered by the Exercising Person, and
issue to the Exercising Person only the remaining number of Shares (less any Tax-Withheld Shares). If, on the Date
of Exercise, any Shares remain as to which the Option is not being exercised, the Company, simultaneously with
issuance of the appropriate number of Shares, shall return to the Exercising Person the original of this Certificate, with
appropriate notation in the forepart of this Certificate as to the partial exercise of the Option.
(e)
To the extent that exercise of the Option obligates the Company or any of its subsidiaries to pay any
taxes or other amounts to any taxing or other governmental authority on behalf of or with respect to Optionee, either
(i) the Company will pay such taxes and/or other amounts then due (the “Tax Amount”) and deduct from the number
of Shares otherwise then deliverable by it to the Exercising Person a number of Shares having a Fair Market Value
on the Date of Exercise equal to the Tax Amount (”Tax-Withheld Shares), in which event Optionee shall have no further
rights with respect to such Tax-Withheld Shares, or (ii) withhold the Tax Amount from Optionee's wages or other
compensatory payments due to Optionee, provided that, if the Exercising Person delivers funds to the Company to
the attention of the Secretary in payment of the Tax Amount, the Company will apply such funds to its payment of
Taxes or other amounts then due.
5.
Termination of Option. The Option, to the extent not previously exercised, shall terminate and
cease to be exercisable upon, or within a designated period of time after, the first to occur of the following
“termination of Service events” as set forth below, to be exercisable not later than the expiration of the Option
Period (i.e., the tenth (10th) anniversary of the Date of Option Grant); and if no ”termination of Service event”
occurs before the expiration of the Option Period, the Option will terminate and cease to be exercisable as of
the expiration of the Option Period.
(a)
terminates;
if such termination of Service is for Cause (as defined below), the date on which Optionee’s Service
(b)
if such termination of Service is other than for Cause or by reason of Optionee’s death, Disability or
Retirement (as defined below), the expiration of three (3) months following the date on which Optionee’s Service
terminates; provided, however, that, if the Optionee dies within such
period, then the termination event shall
be the expiration of three (3) months after the date of death of Optionee;
(c)
if such termination of Service is by reason of Optionee’s Disability or Retirement, the expiration of
twelve (12) months following the date on which Optionee’s Service terminates; provided, however that, if the Optionee
dies within such
period, then the termination event shall be the expiration of the Option Period (i.e., the tenth
(10th) anniversary of the Date of Option Grant); or
(d)
if such termination of Service is by reason of Optionee’s death, the expiration of the Option Period
(i.e., the tenth (10th) anniversary of the Date of Option Grant).
Notwithstanding the foregoing, the Administrator may determine from time to time prior to the termination or
expiration of the Option to extend the exercisability of the Option, if a “termination of Service event” as described in
subsections (b) or (c) above should occur prior to the expiration of the Option Period, for an additional period of time
beyond the time period specified in subsections (b) or (c) above following the events identified in such (but in no event
beyond the expiration of the Option Period) if in its judgment such extension of exercisability is in the best interests of
the Company with the understanding that, upon such commencement of such extended period of exercisability, the
Option may cease under certain circumstances to be an “incentive stock option” and shall become a “nonqualified
stock option” subject to all of the terms and conditions then applicable to a “nonqualified stock option” and will thereafter
be treated as a nonqualified stock option for federal income purposes, which may have important tax consequences
to Optionee.
In the event of any termination of Optionee’s Service, for any reason, the Option, to the extent it continues to
be exercisable for a period of time thereafter, as provided above, shall continue to be exercisable during such period
only with respect to that number of Shares as to which the Option was exercisable as of the time of termination,
including those Shares, if any, subject to accelerated vesting as of such termination, as provided in Section 2(b) or
elsewhere in this Certificate.
The Optionee’s “Service” shall mean (i) the full- or part-time employment of Optionee with the Company and/
or its subsidiaries as an employee, or (ii) the rendering of services by Optionee for the Company and/or its subsidiaries
under a Qualifying Services Contract, as defined below. However, the Option will cease to be an “incentive stock
option” and become a “nonqualified stock option” for federal income tax purposes if Optionee’s service under a Qualified
Services Contract exceeds three (3) months after Optionee’s termination of employment as an employee of the
Company and/or its subsidiaries. Service shall not be deemed to terminate for purposes of the Option due to a leave
of absence required by law or otherwise granted by the Company or its subsidiaries or as a result of any transfer of
the employment or service of Optionee between or among the Company and/or its subsidiaries or to any successor
of the Company or its subsidiaries incident to any merger or similar business combination involving the Company or
its subsidiaries.
A “Qualifying Services Contract” shall mean a written agreement between Optionee and the Company under
which Optionee shall continue to render services for the Company and/or its subsidiaries for a specified period of time
following termination of Optionee’s employment with the Company and/or its subsidiaries (or following termination of
a prior Qualifying Services Agreement), which agreement satisfies each of the following conditions: (i) the services to
be rendered thereunder by Optionee shall qualify as “substantial,” as that term is defined and determined by the
Administrator from time to time with such definition to be set forth or referenced in such agreement; (ii) Optionee in
rendering such services shall be acting as or for an independent contractor and not as an employee of the Company
and/or its subsidiaries; and (iii) there shall be no break in service between Optionee’s serving as an employee of the
Company and/or its subsidiaries (or serving under a prior Qualifying Services Contract) and serving under such
agreement.
“Retirement” shall mean the “retirement” or “early retirement” of Optionee from employment with the Company
and/or its subsidiaries under the principal retirement plan of the Company then in effect (the “Retirement Plan”), or, if
Optionee’s employment with the Company and/or its subsidiaries terminates and Optionee continues to render Service
for a period of time thereafter under a Qualifying Services Contract or a continuous succession of Qualifying Services
Contracts, “Retirement” after the commencement of such period of time shall mean Optionee’s ceasing to render
Service under such contract or the last such contract.
In the case of Optionee’s Retirement, subsequent exercise of the Option (or any part thereof to the extent
vested) after the three (3) month period following the date on which Optionee’s Service terminates, will impact the
Option’s qualification as an “incentive stock option” and may have important tax consequences to Optionee as noted
in Section 10 hereof.
Termination for "Cause" of Optionee shall mean: (i) if Optionee is serving under an employment or services
agreement with the Company and/or its subsidiaries, including a Qualifying Services Contract, that contains a provision
for termination for "Cause," termination of the Service of Optionee for "Cause" pursuant to such provision, and (ii) if
Optionee is not serving under such an employment or services agreement, termination of the Service of Optionee by
vote of the entire Board or of the entire board of directors of a subsidiary of the Company for which
a
Optionee is then rendering Service expressly for one or more of the following "Causes," as evidenced in a board
resolution: (A) any willful misconduct by Optionee that is materially injurious to the Company or a subsidiary of the
Company, monetarily or otherwise; (B) any willful failure by Optionee to follow the reasonable directions of the applicable
board or a
executive officer of the Company or a subsidiary of the Company; (C) any failure by Optionee
substantially to perform any reasonable directions of the Board or the board of directors of any subsidiary of the
Company (other than failure resulting from Disability or death), within thirty (30) days after delivery to the Optionee by
the respective board of a written demand for substantial performance, which written demand shall specifically identify
the manner in which such board believes that the Optionee has not substantially performed; (D) any inability of
Optionee to serve as an officer or director of any subsidiary of the Company, or perform any substantial portion of
Optionee’s duties, by reason of any order of the Federal Deposit Insurance Corporation, the Office of the Comptroller
of Currency, or any other regulatory authority or agency having jurisdiction over the Company or any of its subsidiaries;
or (E) intentionally providing false or misleading information to, or otherwise misleading the Board or the board of
directors of any of the Company’s subsidiaries.
6.
Adjustments. If, after the Date of Option Grant, all issued and outstanding shares of Common
Stock shall be increased or decreased in number, pursuant to stock dividends, stock splits, consolidations of
shares, recapitalizations, mergers, consolidations, reorganizations, combinations or exchange of shares or
similar transactions, the number of Shares to which the Option theretofore related and the option price per
share theretofore applicable to such Option shall be appropriately adjusted by the Company to provide the
same overall economic value to the Optionee immediately after the occurrence of such event as existed
immediately prior to the occurrence of such event (subject to applicable rules and regulations); provided,
however, that if the Company shall issue additional shares of Common Stock for a consideration, no such
adjustment shall be made.
7.
Change in Control. In the event of a Change in Control of the Company (as defined below), the Option,
if not then fully exercisable shall become fully exercisable (i.e., shall vest) as of the date of such Change in Control,
and shall remain fully exercisable thereafter until termination in accordance with Section 5 hereof. For this purpose,
a “Change in Control of the Company” shall be deemed to have occurred upon the first to occur of any of the following:
(a)
The acquisition by one person, or more than one person acting as a group, of ownership of stock of
the Company that, together with stock held by such person or group, constitutes more than 50% of the total fair market
value or total voting power of the stock of the Company;
(b)
The acquisition by one person, or more than one person acting as a group, of ownership of stock of
the Company, that together with stock of the Company acquired during the twelve-month period ending on the date
of the most recent acquisition by such person or group, constitutes 30% or more of the total voting power of the stock
of the Company;
(c)
A majority of the Board is replaced during any twelve-month period by Directors whose appointment
or election is not endorsed by a majority of the Board before the date of the appointment or election;
(d)
One person, or more than one person acting as a group, acquires (or has acquired during the twelve-
month period ending on the date of the most recent acquisition by such person or group) assets from the Company
that have a total gross fair market value (determined without regard to any liabilities associated with such assets) equal
to or more than 40% of the total gross fair market value of all of the assets of the Company immediately before such
acquisition or acquisitions.
Persons will not be considered to be acting as a group solely because they purchase or own stock of the same
corporation at the same time, or as a result of the same public offering. However, persons will be considered to be
acting as a group if they are owners of a corporation that enters into a merger, consolidation, purchase or acquisition
of stock, or similar business transaction with the Company.
This definition of Change in Control of the Company shall be interpreted in accordance with, and in a manner
that will bring the definition into compliance with, the regulations under Section 409A of the Internal Revenue Code of
1986, as amended (the “Code”).
8.
Non-transferability; Rights Prior to Exercise. The Option shall be
except in the event
of Optionee’s death (in which such case, Section 9 shall apply), and during Optionee’s lifetime shall be exercisable
only by Optionee. Neither Optionee nor any permitted transferee of any interest in the Option shall have any rights
as a shareholder with respect to any Shares to which the Option relates until the Option shall have been exercised
with respect to such Shares and such Shares shall have been issued and delivered to the Exercising Person.
9.
Designation of Beneficiary. Optionee may designate a person or persons to receive the Option in the
event of the death of Optionee. Any such designation must be made upon properly completed forms supplied by and
returned to the Company and, once made, may be revoked only in writing. If Optionee fails to designate a beneficiary,
the estate of Optionee or any heir or successor who by reason of Optionee’s death acquired the rights to exercise the
Option will be deemed to be the beneficiary of Optionee with respect to the Option. Any such person with rights under
the Option, shall possess all rights of Optionee under this Certificate with respect to such Option and shall remain
subject to all the terms and conditions applicable thereto, including without limitation, the provision of this Certificate
regarding payment of the Exercise Price and termination of the Option.
10.
Incentive Stock Option. The Option is intended to be an "incentive stock option" within the meaning
of Section 422 of the Code. In order for the Option to qualify as such, certain requirements set forth in the Code must
be met, including the requirement that, generally, the Option be exercised within three (3) months following the date
of Optionee's termination of Service. Special rules apply in the case of termination of Optionee’s Service due to
Optionee’s death or. Failure to satisfy this or any other requirement applicable to incentive stock options will cause
the Option to be treated as a nonqualified stock option which may have important tax consequences to Optionee.
11.
Definitions. Unless otherwise indicated herein, all capitalized terms used herein shall have the same
meaning given such terms in the Plan as in effect on the Date of Grant.
[Signature page follows]
IN WITNESS WHEREOF, the undersigned, being duly authorized, has executed this Certificate on behalf of
the Company.
ARROW FINANCIAL CORPORATION
By:
Name:
Title:
ATTEST:
____________________________, Secretary
Date
Certificate No. NQSO _____
(Employee Award)
ARROW FINANCIAL CORPORATION
2013 Long-Term Incentive Plan
NON-QUALIFIED STOCK OPTION CERTIFICATE
(Employee Award)
____________________________________________________________________________________
(Complete all items before issuance of Certificate)
Date of Option Grant: ____________ Number of Shares to Which Option Relates: ____________
Option Price Per Share: $
The Option is / is not ___ Authorized for Payment in Shares in Lieu of Cash.
(Shares surrendered in payment must meet all conditions for use of such shares as payment, as set by the Administrator.)
The Option evidenced by this Certificate is non-transferable except upon the death of Optionee.
Record of Partial Option Exercise:
Date of Exercise:
No. of Shares Exercised:
No. of Shares Remaining as to
Which Option Relates:
This certifies that
(“Optionee”), who is a valued and trusted Employee (as defined
below) of Arrow Financial Corporation, a New York corporation (the “Company”), has been granted an option by the
Company to purchase one or more shares of the common stock, par value $1.00 per share, of the Company ("Common
Stock"), subject to the terms and conditions set forth in this Certificate and in accordance with the Company's 2013
Long-Term Incentive Plan (the "Plan"), with the expectation that the provision of this award to the Optionee will
encourage the Optionee to acquire and maintain an interest in the Common Stock and have an added incentive to
work for the success of the Company and its subsidiaries. For purposes of this Certificate, an “Employee” means any
employee (including any officer or director who is also an employee) of the Company or any subsidiary of the Company.
The terms and conditions of said option are as follows:
1.
Grant of Option. As of the Date of Option Grant identified above, the Company hereby grants to
Optionee, subject to the conditions set forth in this Certificate and in the Plan, the right, privilege, and option (the
"Option") to purchase that number of shares of Common Stock identified above opposite the heading “Number of
Shares to Which Option Relates” (the "Shares"), at the per share price (the “Exercise Price”) specified above opposite
the heading “Option Price Per Share,” which Exercise Price is not less than the Fair Market Value per share of the
Common Stock on the Date of Option Grant. For purposes of this Option Certificate, “Fair Market Value” per share of
Common Stock as of any date shall be as determined in the manner specified from time to time by the Administrator
in accordance with the Plan. The “Administrator” shall be either the Board of Directors of the Company (the “Board”)
or the Compensation Committee of the Board as determined in accordance with the Plan.
2.
Exercisability of Option; Vesting.
(a)
Subject to the provisions, exceptions and limitations set forth elsewhere in this Certificate, including
Sections 3, 5 and 7, the Option may be exercised only to the extent vested and only during the period (the "Option
Period") commencing on the Date of Option Grant identified above and ending on the tenth (10th) anniversary of the
Date of Option Grant. Subject to Section 2(b), the Option will become exercisable (i.e., will vest) during the Option
Period as follows: on the first anniversary of the Date of Option Grant, the Option will become exercisable with respect
to ______ Shares; on the second anniversary of the Date of Option Grant, the Option will become exercisable with
respect to an additional _____ Shares; on the third anniversary of the Date of Option Grant, the Option will become
exercisable with respect to an additional _____ Shares; and on the fourth anniversary of the Date of Option Grant, the
Option will become exercisable with respect to all remaining Shares.
(b)
Notwithstanding the foregoing, (i) the exercisability (i.e., vesting) of the Option shall be accelerated,
and the Option, if not fully exercisable, shall become fully exercisable (i.e., shall vest), in the event of the death or
Disability of Optionee or the occurrence of a Change in Control of the Company (as defined in Section 7) at any time
after the Date of Option Grant and prior to termination of the Option, and (ii) the exercisability (i.e., vesting) of the
Option may otherwise be accelerated, and the Option, if not fully exercisable, shall become fully exercisable, upon the
occurrence of such other event or events or upon such other circumstance or circumstances arising after the Date of
Option Grant and prior to termination of the Option as the Administrator may determine from time to time as justifying
such acceleration.
3.
Conditions to Exercise of Option. The Option may not be exercised unless, as of the date of exercise
of the Option (the "Date of Exercise"),
(a)
the Option is then exercisable with respect to the number of Shares as to which exercise is sought,
in accordance with Section 2, and the Option shall not have terminated pursuant to Section 5;
(b)
the underlying Shares as to which the Option is then sought to be exercised are the subject of an
effective registration statement under the Securities Act of 1933, as amended, and are registered under applicable
state securities laws, or may then be issued to Optionee exempt from such federal or state registration;
(c)
full payment of the Exercise Price of the Shares as to which the Option is being exercised has been
received by the Company in accordance with Section 4(c); and
(d)
all other actions required to be taken by the Company and Optionee prior to such exercise of the
Option in accordance with the Plan and this Certificate shall have been taken.
4.
Method of Exercise of Option.
(a)
If Optionee or any other person authorized to exercise the Option (an "Exercising Person") elects to
exercise the Option, in whole or in part, such Exercising Person shall deliver to the Secretary of the Company or his
or her designated representative (the “Secretary”) at the Company's principal place of business a written notice of
election to exercise the Option, identifying that number of whole Shares as to which exercise is then being sought,
which number may not exceed the number of Shares as to which the Option may then be exercised (i.e., vested shares)
in light of any and all prior partial exercises of the Option and any applicable restrictions on the right to exercise the
Option at such time in accordance with this Certificate or the Plan. If the Exercising Person is not the Optionee, the
notice also shall identify the nature of the Exercising Person's authority to exercise the Option, which authority must
be acceptable to the Administrator. In all cases, such written notice of election must be accompanied by surrender of
the original of this Certificate.
(b)
The Date of Exercise with respect to any such election shall be as soon as practicable following receipt
by the Secretary of the notice described in Section 4(a) above and the satisfaction of all required conditions to exercise
including, without limitation, receipt of payment as described in Section 4(c) below. The Exercising Person may revoke
the election to exercise at any time prior to the Date of Exercise by subsequent notice to the Secretary, if such notice
of revocation is timely received as determined by the Company.
(c)
Full payment of the Exercise Price of the Shares with respect to which the Option is being exercised
must be delivered to the Company to the attention of the Secretary prior to the Date of Exercise. Payment shall be in
cash or by bank check, or if authorized by the Administrator upon grant of the Option (evidenced by an appropriate
notation in the forepart of this Certificate) or thereafter, may be made at the discretion of the Exercising Person in
whole or in part in shares of Common Stock owned by Optionee subject to such conditions upon such use of shares
of Common Stock as may be set by the Administrator from time to time (a
Exercise"). Any shares
Exercise ("Payment Shares") shall be valued at
surrendered in payment of the Exercise Price in a
Fair Market Value as of the Date of Exercise. In a
Exercise, in lieu of physically surrendering to the
Company a certain number of Payment Shares, the Exercising Person may elect to submit to the Company to the
attention of the Secretary an affidavit attesting ownership by Optionee of such number of shares for the appropriate
period of time and request that such shares, although not physically surrendered, be deemed to have been surrendered
by the Exercising Person to the Company in payment of the Exercise Price (any such payment, a "Deemed Payment").
(d)
Upon receipt of payment of the Exercise Price, including an affidavit of ownership in the case of a
Deemed Payment, the Company shall issue and deliver to the Exercising Person, as of the Date of Exercise, evidenced
by book entry or electronic delivery or by delivery of a duly executed stock certificate, the number of Shares as to
which the Option has thus been exercised (less any Tax-Withheld Shares, as described and defined in Section 4(e)
below), provided that, if the Exercising Person has elected in connection with a
Exercise to make a
Deemed Payment without physically surrendering to the Company some number of Payment Shares owned by
Optionee, the Company will deduct from the number of Shares to be issued to the Exercising Person on the Date of
Exercise the number of shares deemed surrendered but not physically surrendered by the Exercising Person, and
issue to the Exercising Person only the remaining number of Shares (less any Tax-Withheld Shares). If, on the Date
of Exercise, any Shares remain as to which the Option is not being exercised, the Company, simultaneously with
issuance of the appropriate number of Shares, shall return to the Exercising Person the original of this Certificate, with
appropriate notation in the forepart of this Certificate as to the partial exercise of the Option.
(e)
To the extent that exercise of the Option obligates the Company or any of its subsidiaries to pay any
taxes or other amounts to any taxing or other governmental authority on behalf of or with respect to Optionee, either
(i) the Company will pay such taxes and/or other amounts then due (the “Tax Amount”) and deduct from the number
of Shares otherwise then deliverable by it to the Exercising Person a number of Shares having a Fair Market Value
on the Date of Exercise equal to the Tax Amount (“Tax-Withheld Shares”), in which event Optionee shall have no further
rights with respect to such Tax-Withheld Shares, or (ii) withhold the Tax Amount from Optionee's wages or other
compensatory payments due to Optionee, provided that, if the Exercising Person delivers funds to the Company to
the attention of the Secretary in payment of the Tax Amount, the Company will apply such funds to its payment of
Taxes or other amounts then due.
5.
Termination of Option. The Option, to the extent not previously exercised, shall terminate and cease
to be exercisable upon, or within a designated period of time after, the first to occur of the following “termination of
Service events” as set forth below, to be exercisable not later than the expiration of the Option Period (i.e., the tenth
(10th) anniversary of the Date of Option Grant); and if no ”termination of Service event” occurs before the expiration
of the Option Period, the Option will terminate and cease to be exercisable as of the expiration of the Option Period.
(a)
terminates;
if such termination of Service is for Cause (as defined below), the date on which Optionee’s Service
(b)
if such termination of Service is other than for Cause or by reason of Optionee’s death, Disability or
Retirement (as defined below), the expiration of three (3) months following the date on which Optionee’s Service
period, then the termination event shall
terminates; provided, however, that, if the Optionee dies within such
be the expiration of three (3) months after the date of death of Optionee;
(c)
if such termination of Service is by reason of Optionee’s Disability or Retirement, the expiration of
twelve (12) months following the date on which Optionee’s Service terminates; provided, however that, if the Optionee
period, then the termination event shall be the expiration of the Option Period (i.e., the tenth
dies within such
(10th) anniversary of the Date of Option Grant); or
(d)
if such termination of Service is by reason of Optionee’s death, the expiration of the Option Period
(i.e., the tenth (10th) anniversary of the Date of Option Grant).
Notwithstanding the foregoing, the Administrator may determine from time to time prior to the termination or
expiration of the Option to extend the exercisability of the Option, if a “termination of Service event” as described in
subsections (b) or (c) above should occur prior to the expiration of the Option Period, for an additional period of time
beyond the time period specified in subsections (b) or (c) above following the events identified in such (but in no event
beyond the expiration of the Option Period) if in its judgment such extension of exercisability is in the best interests of
the Company.
In the event of any termination of Optionee’s Service, for any reason, the Option, to the extent it continues to
be exercisable for a period of time thereafter, as provided above, shall continue to be exercisable during such period
only with respect to that number of Shares as to which the Option was exercisable as of the time of termination,
including those Shares, if any, subject to accelerated vesting as of such termination, as provided in Section 2(b) or
elsewhere in this Certificate.
The Optionee’s “Service” shall mean (i) the full- or part-time employment of Optionee with the Company and/
or its subsidiaries as an employee, or (ii) the rendering of services by Optionee for the Company and/or its subsidiaries
under a Qualifying Services Contract, as defined below. Service shall not be deemed to terminate for purposes of the
Option due to a leave of absence required by law or otherwise granted by the Company or its subsidiaries or as a
result of any transfer of the employment or service of Optionee between or among the Company and/or its subsidiaries
or to any successor of the Company or its subsidiaries incident to any merger or similar business combination involving
the Company or its subsidiaries.
A “Qualifying Services Contract” shall mean a written agreement between Optionee and the Company under
which Optionee shall continue to render services for the Company and/or its subsidiaries for a specified period of time
following termination of Optionee’s employment with the Company and/or its subsidiaries (or following termination of
a prior Qualifying Services Agreement), which agreement satisfies each of the following conditions: (i) the services to
be rendered thereunder by Optionee shall qualify as “substantial,” as that term is defined and determined by the
Administrator from time to time with such definition to be set forth or referenced in such agreement; (ii) Optionee in
rendering such services shall be acting as or for an independent contractor and not as an employee of the Company
and/or its subsidiaries; and (iii) there shall be no break in service between Optionee’s serving as an employee of the
Company and/or its subsidiaries (or serving under a prior Qualifying Services Contract) and serving under such
agreement.
“Retirement” shall mean the “retirement” or “early retirement” of Optionee from employment with the Company
and/or its subsidiaries under the principal retirement plan of the Company then in effect (the “Retirement Plan”), or, if
Optionee’s employment with the Company and/or its subsidiaries terminates and Optionee continues to render Service
for a period of time thereafter under a Qualifying Services Contract or a continuous succession of Qualifying Services
Contracts, “Retirement” after the commencement of such period of time shall mean Optionee’s ceasing to render
Service under such contract or the last such contract.
Termination for "Cause" of Optionee shall mean: (i) if Optionee is serving under an employment or services
agreement with the Company and/or its subsidiaries, including a Qualifying Services Contract, that contains a provision
for termination for "Cause," termination of the Service of Optionee for "Cause" pursuant to such provision, and (ii) if
Optionee is not serving under such an employment or services agreement, termination of the Service of Optionee by
vote of the entire Board or of the entire board of directors of a subsidiary of the Company for which
a
Optionee is then rendering Service, expressly for one or more of the following "Causes," as evidenced in a board
resolution: (A) any willful misconduct by Optionee that is materially injurious to the Company or a subsidiary of the
Company, monetarily or otherwise; (B) any willful failure by Optionee to follow the reasonable directions of the applicable
board or a
executive officer of the Company or a subsidiary of the Company; (C) any failure by Optionee
substantially to perform any reasonable directions of the Board or the board of directors of any subsidiary of the
Company (other than failure resulting from Disability or death), within thirty (30) days after delivery to the Optionee by
the respective board of a written demand for substantial performance, which written demand shall specifically identify
the manner in which such board believes that the Optionee has not substantially performed; (D) any inability of
Optionee to serve as an officer or director of any subsidiary of the Company, or perform any substantial portion of
Optionee’s duties, by reason of any order of the Federal Deposit Insurance Corporation, the Office of the Comptroller
of Currency, or any other regulatory authority or agency having jurisdiction over the Company or any of its subsidiaries;
or (E) intentionally providing false or misleading information to, or otherwise misleading the Board or the board of
directors of any of the Company’s subsidiaries.
6.
Adjustments. If, after the Date of Option Grant, all issued and outstanding shares of Common Stock
shall be increased or decreased in number, pursuant to stock dividends, stock splits, consolidations of shares,
recapitalizations, mergers, consolidations, reorganizations, combinations or exchange of shares or similar transactions,
the number of Shares to which the Option theretofore related and the option price per share theretofore applicable to
such Option shall be appropriately adjusted by the Company to provide the same overall economic value to the Optionee
immediately after the occurrence of such event as existed immediately prior to the occurrence of such event (subject
to applicable rules and regulations); provided, however, that if the Company shall issue additional shares of Common
Stock for a consideration, no such adjustment shall be made.
7.
Change in Control. In the event of a Change in Control of the Company (as defined below), the Option,
if not then fully exercisable shall become fully exercisable (i.e., shall vest) as of the date of such Change in Control,
and shall remain fully exercisable thereafter until termination in accordance with Section 5 hereof. For this purpose,
a "Change in Control of the Company" shall be deemed to have occurred upon the first to occur of any of the following:
(a)
The acquisition by one person, or more than one person acting as a group, of ownership of stock of
the Company that, together with stock held by such person or group, constitutes more than 50% of the total fair market
value or total voting power of the stock of the Company;
(b)
The acquisition by one person, or more than one person acting as a group, of ownership of stock of
the Company, that together with stock of the Company acquired during the twelve-month period ending on the date
of the most recent acquisition by such person or group, constitutes 30% or more of the total voting power of the stock
of the Company;
(c)
A majority of the Board is replaced during any twelve-month period by Directors whose appointment
or election is not endorsed by a majority of the Board before the date of the appointment or election;
(d)
One person, or more than one person acting as a group, acquires (or has acquired during the twelve-
month period ending on the date of the most recent acquisition by such person or group) assets from the Company
that have a total gross fair market value (determined without regard to any liabilities associated with such assets) equal
to or more than 40% of the total gross fair market value of all of the assets of the Company immediately before such
acquisition or acquisitions.
Persons will not be considered to be acting as a group solely because they purchase or own stock of the same
corporation at the same time, or as a result of the same public offering. However, persons will be considered to be
acting as a group if they are owners of a corporation that enters into a merger, consolidation, purchase or acquisition
of stock, or similar business transaction with the Company.
This definition of Change in Control of the Company shall be interpreted in accordance with, and in a manner
that will bring the definition into compliance with, the regulations under Section 409A of the Internal Revenue Code of
1986, as amended (the “Code”).
8.
Non-transferability; Rights Prior to Exercise. The Option shall be
except in the event
of Optionee's death (in which such case, Section 9 shall apply), and during Optionee's lifetime shall be exercisable
only by Optionee. Neither Optionee nor any permitted transferee of any interest in the Option shall have any rights
as a shareholder with respect to any Shares to which the Option relates until the Option shall have been exercised
with respect to such Shares and such Shares shall have been issued and delivered to the Exercising Person.
9.
Designation of Beneficiary. Optionee may designate a person or persons to receive the Option in the
event of the death of Optionee. Any such designation must be made upon properly completed forms supplied by and
returned to the Company and, once made, may be revoked only in writing. If Optionee fails to designate a beneficiary,
the estate of Optionee or any heir or successor who by reason of Optionee’s death acquired the rights to exercise the
Option will be deemed to be the beneficiary of Optionee with respect to the Option. Any such person with rights under
the Option shall possess all rights of Optionee under this Certificate with respect to such Option and shall remain
subject to all the terms and conditions applicable thereto, including without limitation, the provision of this Certificate
regarding payment of the Exercise Price and termination of the Option.
10.
Non-Qualified Stock Option. The Option is not intended to be, and will not be treated as, an "incentive
stock option" within the meaning of Section 422 of the Code.
11.
Definitions. Unless otherwise indicated herein, all capitalized terms used herein shall have the same
meaning given such terms in the Plan as in effect on the Date of Grant.
[Signature page follows]
IN WITNESS WHEREOF, the undersigned, being duly authorized, has executed this Certificate on behalf of
the Company.
ARROW FINANCIAL CORPORATION
By:
Name:
Title:
ATTEST:
____________________________, Secretary
Date
Certificate No. NQSO _____
(Non-Employee Director Award)
ARROW FINANCIAL CORPORATION
2013 Long-Term Incentive Plan
NON-QUALIFIED STOCK OPTION CERTIFICATE
(Director Award)
____________________________________________________________________________________
(Complete all items before issuance of Certificate)
Date of Option Grant: ____________ Number of Shares to Which Option Relates: ____________
Option Price Per Share: $
The Option is / is not ___ Authorized for Payment in Shares in Lieu of Cash.
(Shares surrendered in payment must meet all conditions for use of such shares as payment, as set by the Administrator.)
The Option evidenced by this Certificate is non-transferable except upon the death of Optionee.
Record of Partial Option Exercise:
Date of Exercise:
No. of Shares Exercised:
No. of Shares Remaining as to
Which Option Relates:
This certifies that
(“Optionee”), who is a valued and trusted Director of Arrow Financial
Corporation, a New York corporation (the “Company”), has been granted an option by the Company to purchase one
or more shares of the common stock, par value $1.00 per share, of the Company ("Common Stock"), subject to the
terms and conditions set forth in this Certificate and in accordance with the Company's 2013 Long-Term Incentive
Plan (the "Plan"), with the expectation that the provision of this award to the Optionee will encourage the Optionee to
acquire and maintain an interest in the Common Stock and have an added incentive to work for the success of the
Company and its subsidiaries.
The terms and conditions of said option are as follows:
1.
Grant of Option. As of the Date of Option Grant identified above, the Company hereby grants to
Optionee, subject to the conditions set forth in this Certificate and in the Plan, the right, privilege, and option (the
"Option") to purchase that number of shares of Common Stock identified above opposite the heading “Number of
Shares to Which Option Relates” (the "Shares"), at the per share price (the “Exercise Price”) specified above opposite
the heading “Option Price Per Share,” which Exercise Price is not less than the Fair Market Value per share of the
Common Stock on the Date of Option Grant. For purposes of this Option Certificate, “Fair Market Value” per share of
Common Stock as of any date shall be as determined in the manner specified from time to time by the Administrator
in accordance with the Plan. The “Administrator” shall be either the Board of Directors of the Company (the “Board”)
or the Compensation Committee of the Board as determined in accordance with the Plan.
2.
Exercisability of Option; Vesting.
(a)
Subject to the provisions, exceptions and limitations set forth elsewhere in this Certificate, including
Sections 3, 5 and 7, the Option may be exercised only to the extent vested and only during the period (the "Option
Period") commencing on the Date of Option Grant identified above and ending on the tenth (10th) anniversary of the
Date of Option Grant. Subject to Section 2(b), the Option will become exercisable (i.e., will vest) during the Option
Period as follows: on the first anniversary of the Date of Option Grant, the Option will become exercisable with respect
to ______ Shares; on the second anniversary of the Date of Option Grant, the Option will become exercisable with
respect to an additional ______ Shares; on the third anniversary of the Date of Option Grant, the Option will become
exercisable with respect to an additional ______ Shares; and on the fourth anniversary of the Date of Option Grant,
the Option will become exercisable with respect to all remaining Shares.
(b)
Notwithstanding the foregoing, (i) the exercisability (i.e., vesting) of the Option shall be accelerated,
and the Option, if not fully exercisable, shall become fully exercisable (i.e., shall vest), in the event of the death or
Disability of Optionee or the occurrence of a Change in Control of the Company (as defined in Section 7) at any time
after the Date of Option Grant and prior to termination of the Option, and (ii) the exercisability (i.e., vesting) of the
Option may otherwise be accelerated, and the Option, if not fully exercisable, shall become fully exercisable, upon the
occurrence of such other event or events or upon such other circumstance or circumstances arising after the Date of
Option Grant and prior to termination of the Option as the Administrator may determine from time to time as justifying
such acceleration.
3.
Conditions to Exercise of Option. The Option may not be exercised unless, as of the date of exercise
of the Option (the "Date of Exercise"),
(a)
the Option is then exercisable with respect to the number of Shares as to which exercise is sought,
in accordance with Section 2, and the Option shall not have terminated pursuant to Section 5;
(b)
the underlying Shares as to which the Option is then sought to be exercised are the subject of an
effective registration statement under the Securities Act of 1933, as amended, and are registered under applicable
state securities laws, or may then be issued to Optionee exempt from such federal or state registration;
(c)
full payment of the Exercise Price of the Shares as to which the Option is being exercised has been
received by the Company in accordance with Section 4(c); and
(d)
all other actions required to be taken by the Company and Optionee prior to such exercise of the
Option in accordance with the Plan and this Certificate shall have been taken.
4.
Method of Exercise of Option.
(a)
If Optionee or any other person authorized to exercise the Option (an "Exercising Person") elects to
exercise the Option, in whole or in part, such Exercising Person shall deliver to the Secretary of the Company or his
or her designated representative (the “Secretary”) at the Company's principal place of business a written notice of
election to exercise the Option, identifying that number of whole Shares as to which exercise is then being sought,
which number may not exceed the number of Shares as to which the Option may then be exercised (i.e., vested shares)
in light of any and all prior partial exercises of the Option and any applicable restrictions on the right to exercise the
Option at such time in accordance with this Certificate or the Plan. If the Exercising Person is not the Optionee, the
notice also shall identify the nature of the Exercising Person's authority to exercise the Option, which authority must
be acceptable to the Administrator. In all cases, such written notice of election must be accompanied by surrender of
the original of this Certificate.
(b)
The Date of Exercise with respect to any such election shall be as soon as practicable following receipt
by the Secretary of the notice described in Section 4(a) above and the satisfaction of all required conditions to exercise
including, without limitation, receipt of payment as described in Section 4(c) below. The Exercising Person may revoke
the election to exercise at any time prior to the Date of Exercise by subsequent notice to the Secretary, if such notice
of revocation is timely received as determined by the Company.
(c)
Full payment of the Exercise Price of the Shares with respect to which the Option is being exercised
must be delivered to the Company to the attention of the Secretary prior to the Date of Exercise. Payment shall be in
cash or by bank check or if authorized by the Administrator upon grant of the Option (evidenced by an appropriate
notation in the forepart of this Certificate) or thereafter, may be made at the discretion of the Exercising Person in
whole or in part in shares of Common Stock owned by Optionee subject to such conditions upon such use of shares
of Common Stock as may be set by the Administrator from time to time (a
Exercise"). Any shares
Exercise ("Payment Shares") shall be valued at
surrendered in payment of the Exercise Price in a
Exercise, in lieu of physically surrendering to the
Fair Market Value as of the Date of Exercise. In a
Company a certain number of Payment Shares, the Exercising Person may elect to submit to the Company to the
attention of the Secretary an affidavit attesting ownership by Optionee of such number of shares for the appropriate
period of time and request that such shares, although not physically surrendered, be deemed to have been surrendered
by the Exercising Person to the Company in payment of the Exercise Price (any such payment, a "Deemed Payment").
(d)
Upon receipt of payment of the Exercise Price, including an affidavit of ownership in the case of a
Deemed Payment, the Company shall issue and deliver to the Exercising Person, as of the Date of Exercise, evidenced
by book entry or electronic delivery or by delivery of a duly executed stock certificate, the number of Shares as to
which the Option has thus been exercised (less any Tax-Withheld Shares, as described and defined in Section 4(e)
below), provided that, if the Exercising Person has elected in connection with a
Exercise to make a
Deemed Payment without physically surrendering to the Company some number of Payment Shares owned by
Optionee, the Company will deduct from the number of Shares to be issued to the Exercising Person on the Date of
Exercise the number of shares deemed surrendered but not physically surrendered by the Exercising Person, and
issue to the Exercising Person only the remaining number of Shares (less any Tax-Withheld Shares). If, on the Date
of Exercise, any Shares remain as to which the Option is not being exercised, the Company, simultaneously with
issuance of the appropriate number of Shares, shall return to the Exercising Person the original of this Certificate, with
appropriate notation in the forepart of this Certificate as to the partial exercise of the Option.
(e)
To the extent that exercise of the Option obligates the Company or any of its subsidiaries to pay any
taxes or other amounts to any taxing or other governmental authority on behalf of or with respect to Optionee, either
(i) the Company will pay such taxes and/or other amounts then due (the “Tax Amount”) and deduct from the number
of Shares otherwise then deliverable by it to the Exercising Person a number of Shares having a Fair Market Value
on the Date of Exercise, equal to the Tax Amount (“Tax-Withheld Shares”), in which event Optionee shall have no
further rights with respect to such Tax-Withheld Shares, or (ii) the Exercising Person delivers funds to the Company
to the attention of the Secretary in payment of the Tax Amount, the Company will apply such funds to its payment of
Taxes or other amounts then due.
5.
Termination of Option. The Option, to the extent not previously exercised, shall terminate and cease
to be exercisable upon, or within a designated period of time after, the first to occur of the following “termination of
Service events” as set forth below, to be exercisable not later than the expiration of the Option Period (i.e., the tenth
(10th) anniversary of the Date of Option Grant); and if no ”termination of Service event” occurs before the expiration
of the Option Period, the Option will terminate and cease to be exercisable as of the expiration of the Option Period.
(a)
terminates;
if such termination of Service is for Cause (as defined below), the date on which Optionee’s Service
(b)
if such termination of Service is other than for Cause or by reason of Optionee’s death, Disability or
Retirement (as defined below), the expiration of three (3) months following the date on which Optionee’s Service
terminates; provided, however, that, if the Optionee dies within such
period, then the termination event shall
be the expiration of three (3) months after the date of death of Optionee;
(c)
if such termination of Service is by reason of Optionee’s Disability or Retirement, the expiration of
twelve (12) months following the date on which Optionee’s Service terminates; provided, however that, if the Optionee
dies within such
period, then the termination event shall be the expiration of the Option Period (i.e., the tenth
(10th) anniversary of the Date of Option Grant); or
(d)
if such termination of Service is by reason of Optionee’s death, the expiration of the Option Period
(i.e., the tenth (10th) anniversary of the Date of Option Grant.
Notwithstanding the foregoing, the Administrator may determine from time to time prior to the termination or
expiration of the Option to extend the exercisability of the Option, if a “termination of Service event” as described in
subsections (b) or (c) above should occur prior to the expiration of the Option Period, for an additional period of time
beyond the time period specified in subsections (b) or (c) above following the events identified in such (but in no event
beyond the expiration of the Option Period) if in its judgment such extension of exercisability is in the best interests of
the Company.
In the event of any termination of Optionee’s Service, for any reason, the Option, to the extent it continues to
be exercisable for a period of time thereafter, as provided above, shall continue to be exercisable during such period
only with respect to that number of Shares as to which the Option was exercisable as of the time of termination,
including those Shares, if any, subject to accelerated vesting as of such termination, as provided in Section 2(b) or
elsewhere in this Certificate.
The Optionee’s “Service” shall mean (i) service as a Director of the Company or any subsidiary of the Company
but excluding service as an honorary, advisory of emeritus director or any other individual whose title includes the word
“director” but who does not possess all powers possessed by a director as a matter of law, or (ii) the rendering of
services by Optionee for the Company and/or its subsidiaries under a Qualifying Services Contract, as defined below.
A “Qualifying Services Contract” shall mean a written agreement between Optionee and the Company under
which Optionee shall continue to render services for the Company and/or its subsidiaries for a specified period of time
following termination of Optionee’s Service (or following termination of a prior Qualifying Services Agreement), which
agreement satisfies each of the following conditions: (i) the services to be rendered thereunder by Optionee shall
qualify as “substantial,” as that term is defined and determined by the Administrator from time to time with such definition
to be set forth or referenced in such agreement; (ii) Optionee in rendering such services shall be acting as or for an
independent contractor and not as an employee of the Company and/or its subsidiaries; and (iii) there shall be no
break in service between Optionee’s Service (or serving under a prior Qualifying Services Contract) and serving under
such agreement.
“Retirement” shall mean the Optionee’s termination of continuous Service as a Director of the Company or
any subsidiary or under a Qualifying Services Contract or continuous succession of Qualifying Services Contracts.
If Optionee is serving under a Qualifying Services Contract, then termination for “cause” shall include (i) if
defined therein, termination of the Service of Optionee for "cause" as defined in such Qualifying Services Contract
and (ii) if not defined therein, shall include termination of Service thereunder by a
vote of the entire Board
for one or more of the following "Causes," as evidenced in a board resolution: (A) any willful misconduct by Optionee
that is materially injurious to the Company or a subsidiary of the Company, monetarily or otherwise; (B) any willful
failure by Optionee to follow the reasonable directions of the Board or the board of directors of a subsidiary of the
Company or a
executive officer of the Company or a subsidiary of the Company; or (C) intentionally
providing false or misleading information to, or otherwise misleading the applicable board or a committee thereof.
6.
Adjustments. If, after the Date of Option Grant, all issued and outstanding shares of Common Stock
shall be increased or decreased in number, pursuant to stock dividends, stock splits, consolidations of shares,
recapitalizations, mergers, consolidations, reorganizations, combinations or exchange of shares or similar transactions,
the number of Shares to which the Option theretofore related and the option price per share theretofore applicable to
such Option shall be appropriately adjusted by the Company to provide the same overall economic value to the Optionee
immediately after the occurrence of such event as existed immediately prior to the occurrence of such event (subject
to applicable rules and regulations); provided, however, that if the Company shall issue additional shares of Common
Stock for a consideration, no such adjustment shall be made.
7.
Change in Control. In the event of a Change in Control of the Company (as defined below), the Option,
if not then fully exercisable shall become fully exercisable (i.e., shall vest) as of the date of such Change in Control,
and shall remain fully exercisable thereafter until termination in accordance with Section 5 hereof. For this purpose,
a "Change in Control of the Company” shall be deemed to have occurred upon the first to occur of any of the following:
(a)
The acquisition by one person, or more than one person acting as a group, of ownership of stock of
the Company that, together with stock held by such person or group, constitutes more than 50% of the total fair market
value or total voting power of the stock of the Company;
The acquisition by one person, or more than one person acting as a group, of ownership of stock of
the Company, that together with stock of the Company acquired during the twelve-month period ending on the date
(b)
of the most recent acquisition by such person or group, constitutes 30% or more of the total voting power of the stock
of the Company;
(c)
A majority of the Board is replaced during any twelve-month period by Directors whose appointment
or election is not endorsed by a majority of the Board before the date of the appointment or election;
(d)
One person, or more than one person acting as a group, acquires (or has acquired during the twelve-
month period ending on the date of the most recent acquisition by such person or group) assets from the Company
that have a total gross fair market value (determined without regard to any liabilities associated with such assets) equal
to or more than 40% of the total gross fair market value of all of the assets of the Company immediately before such
acquisition or acquisitions.
Persons will not be considered to be acting as a group solely because they purchase or own stock of the same
corporation at the same time, or as a result of the same public offering. However, persons will be considered to be
acting as a group if they are owners of a corporation that enters into a merger, consolidation, purchase or acquisition
of stock, or similar business transaction with the Company.
This definition of Change in Control of the Company shall be interpreted in accordance with, and in a manner
that will bring the definition into compliance with, the regulations under Section 409A of the Internal Revenue Code of
1986, as amended (the “Code”).
8.
Non-transferability; Rights Prior to Exercise. The Option shall be
except in the event
of Optionee's death (in which such case, Section 9 shall apply), and during Optionee's lifetime shall be exercisable
only by Optionee. Neither Optionee nor any permitted transferee of any interest in the Option shall have any rights
as a shareholder with respect to any Shares to which the Option relates until the Option shall have been exercised
with respect to such Shares and such Shares shall have been issued and delivered to the Exercising Person.
9.
Designation of Beneficiary. Optionee may designate a person or persons to receive the Option in the
event of the death of Optionee. Any such designation must be made upon properly completed forms supplied by and
returned to the Company and, once made, may be revoked only in writing. If Optionee fails to designate a beneficiary,
the estate of Optionee or any heir or successor who by reason of Optionee’s death acquired the rights to exercise the
Option will be deemed to be the beneficiary of Optionee with respect to the Option. Any such person with rights under
the Option shall possess all rights of Optionee under this Certificate with respect to such Option and shall remain
subject to all the terms and conditions applicable thereto, including without limitation, the provision of this Certificate
regarding payment of the Exercise Price and termination of the Option.
10.
Non-Qualified Stock Option. The Option is not intended to be, and will not be treated as, an "incentive
stock option" within the meaning of Section 422 of the Code.
11.
Definitions. Unless otherwise indicated herein, all capitalized terms used herein shall have the same
meaning given such terms in the Plan as in effect on the Date of Grant.
IN WITNESS WHEREOF, the undersigned, being duly authorized, has executed this Certificate on behalf of
the Company.
[Signature page follows]
ARROW FINANCIAL CORPORATION
By:
Name:
Title:
ATTEST:
____________________________, Secretary
Date
ARROW FINANCIAL CORPORATION
SELECT EXECUTIVE RETIREMENT PLAN
Amendment dated October 18, 2013
As Amended and Restated Effective as of January 1, 2005
For Benefits Accrued or Vested After December 31, 2004,
and as the same may be further amended
Pursuant to Article V of the Arrow Financial Corporation Select Executive Retirement Plan as
amended and restated effective January 1, 2005 for benefits accrued or vested after December 31, 2004, as
the same may be further amended (the “Plan”), the Plan is hereby amended effective as of the date hereof:
1.
Article II is hereby amended in its entirety to provide as follows:
Eligibility
This Plan shall provide Retirement Benefits solely to those employees or former employees as are
determined by the Administrator to be Participants hereunder in accordance with the Plan and the
guidelines set forth on Schedules A and B hereto.
The Participants eligible for Retirement Benefits under the Plan shall constitute a select group of
management or highly compensated employees as set forth in ERISA.
Schedules A and B are hereby amended in their entirety and are replaced in full with the
2.
Schedules A and B attached to this Amendment.
3.
General
a. Any capitalized term or phrase used in this Amendment shall have the same meaning as the meaning ascribed
to such term or phrase in the Engagement Agreement unless expressly otherwise defined in this Amendment.
b. Except as amended by this Amendment, the terms of the Engagement Agreement remain in full force and
effect.
[Signature Page Follows]
IN WITNESS WHEREOF, the undersigned has executed this Amendment to the Plan as of the day
and year first above written.
ARROW FINANCIAL CORPORATION
By:
Name:
Title:
/s/ Mark Bulmer
Mark Bulmer
Arrow Financial Corporation Corporate Secretary
SCHEDULE A
Arrow Financial Corporation
Select Executive Retirement Plan
The named Participants to receive Retirement Benefits under this Schedule A shall have been so
designated in writing by the Board of Directors or, effective October 18, 2013, by the Administrator
thereof, for such benefits (or increases) as are so designated in writing by the Board or the Administrator,
as applicable, on or after January 1, 2005 and shall qualify as a select group of management or highly
compensated employees as set forth in ERISA.
In its discretion, the Employer can increase the supplement each year by a fixed percentage, determined
solely by the Participating Employer.
SCHEDULE B
Arrow Financial Corporation
Select Executive Retirement Plan
1. Participants eligible to receive Retirement Benefits under this Schedule B shall consist of those
employees or former employees of the Employer or Participating Employer who qualify as a select
group of management or highly compensated employees as set forth in ERISA, and whose benefits
under the Defined Benefit Pension Plan and/or ESOP have been limited, as described below, by
Section 415 and/or Section 401(a)(17) of the Code or are otherwise deemed by the Board or,
effective October 18, 2013, the Administrator thereof, not to be sufficient and, effective January 1,
2008, to which the Board or the Administrator, as applicable, has granted eligibility in writing
under the Plan.
2. Any employee or former employee shall become a Participant in the Plan if:
a. His Compensation, as defined in the Defined Benefit Pension Plan or ESOP, for the current Plan Year
or any prior Plan Year would exceed, if not for such limitation, the amount specified in Section 401(a)
(17) of the Code ($210,000 in 2005); or
b. His projected annual pension benefit under the Defined Benefit Pension Plan, if determined without
regard to the benefit limits imposed by Section 415(b) of the Code or the compensation limit imposed
by Section 401(a)(17) of the Code, would exceed the dollar amount specified in Section 415(b)(1) of
the Code ($170,000 for 2005); or
c. His annual additions, as defined in Section 415(c)(2) of the Code, under the ESOP, if determined
without regard to the annual additions limits imposed by Section 415(c) of the Code or the
compensation limit imposed by Section 401(a)(17) of the Code, for any Plan Year beginning after
1993, would exceed the dollar amount specified in Section 415(c)(1) of the Code ($42,000 for 2005);
d. and, effective January 1, 2008, the Board or, effective October 18, 2013, the Administrator thereof,
has granted eligibility in writing under the Plan to the employee.
3. Retirement Benefits payable under this Schedule B by reason of Code limitations shall be the
Actuarial Equivalent, as defined in the Defined Benefit Pension Plan, of:
a. The Vested annual Retirement Benefit to which the Participant or surviving spouse would be eligible
to receive at the time of retirement or death as determined under the Defined Benefit Pension Plan
formula based upon the Participant’s Compensation, as defined in the Defined Benefit Pension Plan
but without regard to the limit imposed by Section 401(a)(17) of the Code, and without regard to any
benefit limitation under Section 415(b) of the Code, adjusted for the form of payment selected by the
Participant, less
b. The annual pension benefit that is payable to the Participant or surviving spouse under the Defined
Benefit Pension Plan, less
c. The benefit accrued and vested under the Plan as of December 31, 2004 under the terms of the Plan
as then in effect (“Grandfathered Benefit”).
4. Additional ESOP Benefits shall be payable under this Schedule B to any Participant who, for any
Plan Year beginning on or after January 1, 1994, receives an allocation under the ESOP which is
less than the allocation he would have received if the limitations imposed by Section 415(c) and
Section 401(a)(17) of the Code did not apply.
a. As of the last day of each Plan Year, such a Participant shall receive an allocation under the Plan
equal to the sum of (i), (ii) and (iii) below:
(i) Phantom Share Allocation - an allocation of phantom shares of Employer stock equal to the
excess, if any, of (1) over (2), where:
1.
2.
is the number of shares of Employer stock that would have been allocated to the
Participant’s account under the ESOP with respect to such Plan Year if the limitations
of Sections 415(c) and 401(a)(17) of the Code were disregarded, and
is the number of shares of Employer stock actually allocated to the Participant’s
account under the ESOP for such Plan Year.
The phantom shares allocated pursuant to this subparagraph (i) shall be held in the Participant’s Phantom
Share Account.
(ii) Cash Allocation - a dollar amount allocation equal to the excess, if any, of (1) over (2),
where:
1.
2.
is the dollar amount that would have been allocated in cash to the Participant’s account
under the ESOP with respect to such Plan Year if the limitations of Sections 415(c)
and 401(a)(17) of the Code were disregarded, and
is the dollar amount actually allocated in cash to the Participant’s account under the
ESOP for such Plan Year.
The dollar amounts allocated pursuant to this subparagraph (ii) shall be held in the Participant’s Cash
Account.
(iii) Dividend and Interest Allocation - Stock and cash dividends on Employer stock shall be
credited to the Participant’s Phantom Share Account when paid, as if such phantom shares
were actual shares, and interest on the value of the Participant’s Cash Account, determined as
of the last day of the immediately preceding Plan Year, shall be allocated at a rate to be
determined annually by the Plan Administrator and credited to the Participant’s Cash Account
as of the last day of the Plan Year.
b. Additional ESOP Benefits, if any, shall be distributed to the Participant, or his Beneficiary, in a single
lump sum cash payment within 90 days after the date of termination of his employment in an amount
equal to the Vested portion of:
(i) The number of phantom shares of Employer stock credited to the Participant’s Phantom
Share Account as of the last day of the Plan Year coinciding with or immediately preceding
the date of distribution, multiplied by the fair market value of one share of the Employer’s
stock as determined by the Plan Administrator in its discretion; plus
(ii) The value of the Participant’s Cash Account as of the same date.
Notwithstanding, if the Participant is a Key Employee (as defined by the Code) of a Participating
Employer, the payment of additional ESOP Benefits, if any, as described above shall be distributed no
sooner than the date that is 6 months following the Participant’s separation from service with the
Participating Employer.
A Participant’s Vested percentage shall be determined in accordance with the ESOP.
c. This section shall apply to benefits that have accrued or become vested after December 31, 2004,
including any increase attributable to Grandfathered Benefits’ investment experience after December
31, 2004.
Exhibit 21
Arrow Financial Corporation
250 Glen Street
Glens Falls, NY 12801
Subsidiaries
December 31, 2013
Subsidiary
Subsidiaries of Arrow Financial Corporation:
Glens Falls National Bank and Trust Company
A Nationally Chartered Commercial Bank
Headquarters: Glens Falls, NY
Saratoga National Bank and Trust Company
A Nationally Chartered Commercial Bank
Headquarters: Saratoga Springs, NY
Arrow Capital Statutory Trust II
A Non-deposit Trust Company
Headquarters: Glens Falls, NY
Arrow Capital Statutory Trust III
A Non-deposit Trust Company
Headquarters: Glens Falls, NY
Subsidiaries of Glens Falls National Bank and Trust Company:
Arrow Properties, Inc.
A Real Estate Investment Trust
(Glens Falls National Bank also holds approximately 82%
of non-voting preferred stock)
Headquarters: Glens Falls, NY
North Country Investment Advisers, Inc.
A New York Corporation
Headquarters: Glens Falls, NY
NC Financial Services, Inc.
A New York Corporation
Headquarters: Warrensburg, NY
Glens Falls National Community Development Corporation
A New York Corporation
Headquarters: Glens Falls, NY
Capital Financial Group, Inc.
A New York Corporation
Headquarters: South Glens Falls, NY
Loomis & LaPann, Inc.
A New York Corporation
Headquarters: South Glens Falls, NY
Upstate Agency, LLC
A New York Corporation
Headquarters: Warrensburg, NY
Glens Falls National Insurance Agencies, LLC
A New York Corporation
Headquarters: South Glens Falls, NY
Subsidiaries of Saratoga National Bank and Trust Company:
NC Financial Services, Inc.
A New York Corporation
Headquarters: Warrensburg, NY
Percent of Common Stock Owned
100
100
100
100
100
100
90
100
100
100
100
100
10
Consent of Independent Registered Public Accounting Firm
The Board of Directors
Arrow Financial Corporation:
We consent to the incorporation by reference in the registration statements, Forms S-3 (No. 333-187293 and No.
333-175236) and S-8 (No. 333-62719, No. 333-151550, No. 333-188479 and No. 333-188480) of Arrow Financial
Corporation and subsidiaries of our reports dated March 14, 2014, with respect to the consolidated balance sheets of
Arrow Financial Corporation and subsidiaries as of December 31, 2013 and 2012, and the related consolidated
statements of income, comprehensive income, changes in shareholders' equity and cash flows for each of the years
in the three-year period ended December 31, 2013, and the effectiveness of internal control over financial reporting
as of December 31, 2013, which reports appear in the December 31, 2013 annual report on Form 10-K of Arrow
Financial Corporation.
/s/ KPMG LLP
Albany, NY
March 14, 2014
Certification of the Chief Executive Officer Pursuant to
Securities Exchange Act Rules 13a-14 and 15d-14
As Adopted Pursuant to
Section 302 of the Sarbanes-Oxley Act of 2002
I, Thomas J. Murphy, certify that:
1.
2.
3.
4.
I have reviewed the annual report on Form 10-K of Arrow Financial Corporation;
Based on my knowledge, this report does not contain any untrue statement of a material fact or omit
to state a material fact necessary to make the statements made, in light of the circumstances under
which such statements were made, not misleading with respect to the period covered by this report;
Based on my knowledge, the financial statements, and other financial information included in this
report, fairly present in all material respects the financial condition, results of operations and cash
flows of the registrant as of, and for, the periods presented in this report;
The registrant's other certifying officers and I are responsible for establishing and maintaining
disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and
internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f))
for the registrant and have:
(a)
(b)
(c)
(d)
Designed such disclosure controls and procedures, or caused such disclosure controls and
procedures to be designed under our supervision, to ensure that material information relating
to the registrant, including its consolidated subsidiaries, is made known to us by others within
those entities, particularly during the period in which this report is being prepared;
Designed such internal control over financial reporting, or caused such internal control over
financial reporting to be designed under our supervision, 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;
Evaluated the effectiveness of the registrant's disclosure controls and procedures and
presented in this report our conclusions about the effectiveness of the disclosure controls and
procedures, as of the end of the period covered by this report based on such evaluation; and
Disclosed in this report any change in the registrant's internal control over financial reporting
that occurred during the registrant's most recent fiscal quarter (the registrant's fourth fiscal
quarter in the case of an annual report) that has materially affected, or is reasonably likely to
materially affect, the registrant's internal control over financial reporting.
5.
The registrant's other certifying officers and I have disclosed, based on our most recent evaluation of
internal control over financial reporting, to the registrant's auditors and the audit committee of the
registrant's board of directors (or persons performing the equivalent functions):
(a)
(b)
All significant deficiencies and material weaknesses in the design or operation of internal
control over financial reporting which are reasonably likely to adversely affect the registrant's
ability to record, process, summarize and report financial information; and
Any fraud, whether or not material, that involves management or other employees who have
a significant role in the registrant's internal control over financial reporting.
Date: March 14, 2014
By:
/s/ Thomas J. Murphy
Thomas J. Murphy
Chief Executive Officer
Certification of the Chief Financial Officer Pursuant to
Securities Exchange Act Rules 13a-14 and 15d-14
As Adopted Pursuant to
Section 302 of the Sarbanes-Oxley Act of 2002
I, Terry R. Goodemote, certify that:
1.
2.
3.
4.
I have reviewed the annual report on Form 10-K of Arrow Financial Corporation;
Based on my knowledge, this report does not contain any untrue statement of a material fact or omit
to state a material fact necessary to make the statements made, in light of the circumstances under
which such statements were made, not misleading with respect to the period covered by this report;
Based on my knowledge, the financial statements, and other financial information included in this
report, fairly present in all material respects the financial condition, results of operations and cash
flows of the registrant as of, and for, the periods presented in this report;
The registrant's other certifying officers and I are responsible for establishing and maintaining
disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and
internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f))
for the registrant and have:
(a)
(b)
(c)
(d)
Designed such disclosure controls and procedures, or caused such disclosure controls and
procedures to be designed under our supervision, to ensure that material information relating
to the registrant, including its consolidated subsidiaries, is made known to us by others within
those entities, particularly during the period in which this report is being prepared;
Designed such internal control over financial reporting, or caused such internal control over
financial reporting to be designed under our supervision, 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;
Evaluated the effectiveness of the registrant's disclosure controls and procedures and
presented in this report our conclusions about the effectiveness of the disclosure controls and
procedures, as of the end of the period covered by this report based on such evaluation; and
Disclosed in this report any change in the registrant's internal control over financial reporting
that occurred during the registrant's most recent fiscal quarter (the registrant's fourth fiscal
quarter in the case of an annual report) that has materially affected, or is reasonably likely to
materially affect, the registrant's internal control over financial reporting.
5.
The registrant's other certifying officers and I have disclosed, based on our most recent evaluation of
internal control over financial reporting, to the registrant's auditors and the audit committee of the
registrant's board of directors (or persons performing the equivalent functions):
(a)
(b)
All significant deficiencies and material weaknesses in the design or operation of internal
control over financial reporting which are reasonably likely to adversely affect the registrant's
ability to record, process, summarize and report financial information; and
Any fraud, whether or not material, that involves management or other employees who have
a significant role in the registrant's internal control over financial reporting.
Date: March 14, 2014
By:
/s/ Terry R. Goodemote
Terry R. Goodemote
Chief Financial Officer
Certification of Chief Executive Officer and Chief Financial Officer
Pursuant to 18 U.S.C. Section 1350
As Adopted Pursuant To
Section 906 of The Sarbanes-Oxley Act of 2002
In connection with the Annual Report of Arrow Financial Corporation (the "Company") on Form 10-K for the
year ended December 31, 2013, filed with the Securities and Exchange Commission (the "Report"), we, Thomas J.
Murphy, Chief Executive Officer of the Company, and Terry R. Goodemote, Chief Financial Officer of the Company,
hereby certify, in accordance with 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley
Act of 2002, that, to the best of our knowledge:
The Report fully complies with the requirements of Section 13(a) or 15(d) of the Securities
(a)
Exchange Act of 1934, as amended; and
The information contained in the Report fairly presents, in all material respects, the financial
(b)
condition and results of operations of the Company.
Dated: March 14, 2014
/s/ Thomas J. Murphy
Thomas J. Murphy
Chief Executive Officer
/s/ Terry R. Goodemote
Terry R. Goodemote
Chief Financial Officer
A signed original of this written statement required by Section 906 has been provided to Arrow Financial
Corporation and will be retained by Arrow Financial Corporation and furnished to the Securities and Exchange
Commission or its staff upon request.