2016
ANNUAL
REVIEW
250 Glen Street | PO Box 307
Glens Falls, NY 12801
(518) 745-1000
Performance Comparisons
$1.97
$1.85
$1.76
$2,605
$2,446
$2,023
$2,164
$2,217
$1.69
$1.65
2012
2013
2014
2015
2016
2012
2013
2014
2015
2016
DILUTED EARNINGS PER SHARE
For the 12 Months Ended December 31*
ASSETS
As of December 31
($ in Millions)
$.92
$.94
$.90
$.96
$.98
$1,731
$1,842
$1,903
$2,030
$2,117
2012
2013
2014
2015
2016
2012
2013
2014
2015
2016
CASH DIVIDENDS PAID PER SHARE
DEPOSITS
For the 12 Months Ended December 31*
As of December 31
($ in Millions)
$14.50
$15.16
$13.38
$17.27
$16.05
$233
$214
$201
$192
$176
2012
2013
2014
2015
2016
2012
2013
2014
2015
2016
BOOK VALUE PER SHARE
SHAREHOLDERS’ EQUITY
As of December 31*
As of December 31
($ in Millions)
*Per share amounts have been restated for stock dividends distributed.
To Our Shareholders, Our Team and Our Friends:
Thank you for taking
the time to read our
Annual Review, featur-
ing a brief summary of
Arrow Financial Corpo-
ration’s financial per-
formance and accom-
plishments in 2016.
Thanks to the efforts of our dedicated
team, we reported double-digit growth
in our loan portfolio for the third consec-
utive year, again reaching a record high
at year-end. We also set new records for
net income, total equity and assets under
trust administration and investment man-
agement as of December 31, 2016. It was
an excellent year marked by hard work,
strong profitability ratios and growth in
key markets.
During 2016, we announced the retire-
ments from the Board of two long-term
Arrow Directors: State Sen. Elizabeth
O’Connor Little and retired Executive
Vice President, Treasurer and CFO
John Murphy. The input of both made
our company more successful. We
thank them and wish them well.
Additionally, we welcomed three new
Arrow Directors,with terms beginning
January 1, 2017: Mark Behan, Elizabeth
Miller and Raymond O’Conor. They
bring a rich mix of experience and
expertise to our Board, and we are
honored to have them serve.
Finally, our Company was named one
of America’s “Most Trustworthy” financial
companies by Forbes for the fifth con-
secutive year. Arrow also appeared on
top-performer lists for American Banker
and Bank Director magazines and was
awarded the Raymond James
2016 FINANCIAL HIGHLIGHTS
• Record net income of $26.5 million, up 7.6%
• Third year of double-digit loan growth,
up 11.4%
• $153.6 million in mortgage loans originated,
up 6.6%
• Record assets of $2.61 billion at year-end
• Strong profitability, represented by 11.79%
return on average equity (ROE), 1.06% return
on average assets (ROA), and 13.25% return on
tangible equity
• 3% stock dividend distributed in September
effectively increasing cash dividends by 3%
• Continued strong levels of capital, including
increases in book value per share of 7.6% and
shareholders’ equity of 8.8%
• Strong asset quality, represented by non-
performing assets at year-end of only 0.28%
and loans charged-off just 0.06% of average
loans outstanding
Community Bankers Cup for the
second year in a row. In addition, both
subsidiary banks maintained 5-Star
Superior ratings from BauerFinancial,
and Saratoga National was recognized
as the Capital Region’s No. 1 Small Com-
munity Lender by the Small Business
Administration for the third year running.
Looking ahead, our team will continue to
focus on strategic growth priorities and
growth markets with the ongoing mis-
sion of delivering value to our customers,
our communities and our shareholders.
Thank you for your continued support.
Sincerely,
Tom Murphy
President and Chief Executive Officer
Consolidated Statements of Income (Unaudited)
Years Ended December 31
(in thousands, except per share amounts)
2012
2013
2014
2015
2016
Interest and Dividend Income
Interest Expense
$ 69,379
11,957
$ 64,138
7,922
$ 66,861
5,767
$ 70,738
4,813
$ 76,915
5,356
Net Interest Income
Provision for Loan Losses
Net Interest Income After
Provision for Loan Losses
Total Noninterest Income
Total Noninterest Expense
Income Before Taxes
Provision for Income Taxes
57,422
845
56,577
27,099
51,836
31,840
9,661
56,216
200
56,016
28,061
53,203
30,874
9,079
61,094
1,848
59,246
28,316
54,028
33,534
10,174
65,925
1,347
64,578
28,124
57,430
35,272
10,610
71,559
2,033
69,526
27,832
59,609
37,749
11,215
Net Income
$ 22,179
$ 21,795
$ 23,360
$ 24,662
$ 26,534
Share and Per Share Data
Diluted Average Shares
Outstanding
Diluted Earnings Per Share
Cash Dividends Per Share
Book Value Per Share
Tangible Book Value Per Share
Key Earnings Ratios
Return on Average Assets
Return on Average Equity
Return on Tangible Equity
Net Interest Margin
Capital Ratios
Tier 1 Leverage Ratio
Total Risk-Based Capital Ratio
Asset Quality Ratios
Nonperforming Assets to
Period-End Assets
Allowance for Loan Losses to
Period-End Loans
13,135
$ 1.69
$ .90
$ 13.38
$ 11.36
13,210
$ 1.65
$ .92
$ 14.50
$ 12.53
13,272
$ 1.76
$ .94
$ 15.16
$ 13.22
13,330
$ 1.85
$ .96
$ 16.05
$ 14.18
13,476
$ 1.97
$ .98
$ 17.27
$ 15.45
1.11%
12.88%
15.24%
3.26%
1.04%
12.11%
14.19%
3.06%
1.07%
11.79%
13.56%
3.17%
1.05%
11.86%
13.50%
3.17%
1.06%
11.79%
13.25%
3.18%
9.28%
16.26%
9.24%
15.77%
9.44%
15.54%
9.25%
15.09%
9.47%
15.15%
0.45%
0.37%
0.37%
0.36%
0.28%
1.30%
1.14%
1.10%
1.02%
0.97%
Share and per share amounts have been restated for stock dividends distributed.
Consolidated Balance Sheets (Unaudited)
As of December 31
(in thousands)
2012
2013
2014
2015
2016
Assets
Cash and Due from Banks
Interest-Bearing Deposits
at Banks
Investment Securities
Loans
Allowance for Loan Losses
Net Loans
Premises and Equipment, Net
Goodwill and Intangible
Assets, Net
Other Assets
$ 37,076
$ 37,275
$ 35,081
$ 34,816
$ 43,024
11,756
724,293
1,172,341
(15,298)
12,705
763,148
1,266,472
(14,434)
11,214
673,014
1,413,268
(15,570)
16,252
731,759
1,573,952
(16,038)
14,331
703,335
1,753,268
(17,012)
1,157,043
28,897
1,252,038
29,154
1,397,698
28,488
1,557,914
27,440
1,736,256
26,938
26,495
37,236
26,143
43,235
25,628
46,297
24,980
53,027
24,569
56,789
Total Assets
$ 2,022,796
$2,163,698
$2,217,420
$2,446,188
$2,605,242
Liabilities and
Shareholders’ Equity
Noninterest-Bearing Deposits
Interest-Bearing Checking
and Savings Deposits
Time Deposits of $100,000
or More
Other Time Deposits
$ 247,232
$ 278,958
$ 300,786
$ 358,751
$ 387,280
1,200,650
1,316,145
1,396,319
1,481,855
1,529,953
93,375
189,898
78,928
168,299
61,797
144,046
59,792
130,025
74,778
124,535
Total Deposits
1,731,155
1,842,330
1,902,948
2,030,423
2,116,546
Short-Term Borrowings
Federal Home Loan
Bank Term Advances
Other Long-Term Debt
Other Liabilities
41,678
64,777
60,421
105,173
158,836
30,000
20,000
24,138
20,000
20,000
24,437
10,000
20,000
23,125
55,000
20,000
21,621
55,000
20,000
22,008
Total Liabilities
1,846,971
1,971,544
2,016,494
2,232,217
2,372,390
Total Shareholders’ Equity
175,825
192,154
200,926
213,971
232,852
Total Liabilities and
Shareholders’ Equity
$2,022,796
$2,163,698
$2,217,420
$2,446,188
$2,605,242
Total Return Performance
Comparison of 5 Year Cumulative Total Return
Assumes Initial Investment of $100
Comparison of Five-Year Cumulative Total Return • Assumes Initial Investment of $100
December 2016
300.00
250.00
200.00
150.00
100.00
50.00
0.00
2011
2012
2013
2014
2015
2016
Arrow Financial Corporation
NASDAQ Banks Index
Russell 2000 Index
Zacks $1B-$5B Bank Assets Index
Arrow Financial Corporation
NASDAQ Banks Index
Russell 2000 Index
Zacks $1B-$5B Bank Assets Index
2011
100.00
100.00
100.00
100.00
2012
113.12
119.64
116.35
118.73
2013
127.72
171.23
161.52
161.37
2014
140.05
179.93
169.42
169.29
2015
146.51
195.98
161.95
185.89
2016
232.25
265.31
196.45
267.98
Comparison of 15 Year Cumulative Total Return
Comparison of 15-Year Cumulative Total Return • Assumes Initial Investment of $100
Assumes Initial Investment of $100
December 2016
500.00
450.00
400.00
350.00
300.00
250.00
200.00
150.00
100.00
50.00
0.00
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014
2015
2016
Arrow Financial Corporation
NASDAQ Banks Index
Russell 2000 Index
Zacks $1B-$5B Bank Assets Index
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014
2015 2016
Arrow
Financial
Corporation
NASDAQ
Banks Index
Russell 2000
Index
100.00 114.37 133.42 158.20 142.19 144.44 135.32 165.76 177.11 209.52 192.14 217.34 245.41 269.08 281.50 446.24
100.00 102.37 131.69 150.81 147.31 165.41 130.91
95.44
79.42 94.44
84.46 101.05 144.63 151.98 165.53 224.09
100.00
79.52 117.09 138.68 144.93 171.55 168.87 111.81 142.19 180.38 172.85 201.11 279.18 292.85 279.92 339.57
Zacks $1B-$5B
Bank Assets
Index
100.00 118.21 164.17 195.13 190.45 220.30 173.64 160.60 125.68 145.68 139.24 165.32 224.69 235.72 258.83 373.14
Source: Prepared by Zacks Investment Research, Inc. Used with permission. All rights reserved. Copyright 1980–2017.
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, 2016
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
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: $393,513,749
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 28, 2017
13,510,698
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the Registrant’s Proxy Statement for the Annual Meeting of Stockholders to be held May 3, 2017 (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
13
16
16
17
17
18
22
23
52
53
106
106
106
107
107
107
107
107
107
108
109
*These items are incorporated by reference to the Corporation’s Proxy Statement for the Annual Meeting of Stockholders to be held
May 3, 2017.
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 325 domestic (U.S.-based) bank holding companies with $1 to $3 billion in total consolidated assets as identified
in the Federal Reserve Board’s most recent “Bank Holding Company Performance Report” (which is the Performance Report for the most
recently available period ending September 30, 2016), 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. Active 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),
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, or REIT). Our holding company also owns directly two subsidiary business trusts, organized in 2003 and 2004 to issue
trust preferred securities (TRUPs), which are still outstanding.
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.
Forward-looking statements in this Report include the following:
Section
Page Location
Topic
Dividend Capacity
Impact of Legislative Developments
Visa Stock
Impact of Changing Interest Rates on
Earnings
Adequacy of the Allowance for Loan
Losses
Part I, Item 1.C.
Part II, Item 7.E.
Part I, Item 1.D.
Part II, Item 7.A.
Part II, Item 7.A.
Part II, Item 7.C.II.a.
Part II, Item 7.C.II.a.
Part II, Item 7A.
Part II, Item 7.B.II.
Noninterest Income
Part II, Item 7.C.III
Expected Level of Real Estate Loans
Part II, Item 7.C.II.a.
Expected Level of Commercial Loans Part II, Item 7.C.II.a.
Expected Level of Nonperforming
Assets
Liquidity
Commitments to Extend Credit
Pension plan return on assets
Realization of recognized net
deferred tax assets
Part II, Item 7.C.II.c.
Part II, Item 7.D.
Part II, Item 8
Part II, Item 8
Part II, Item 8
3
8
48
10
11
28
41
40
52
33
34
40
41
43
47
81
96
97
First paragraph under "Dividend Restrictions; Other
Regulatory Sanctions"
First paragraph under "Dividends"
Last paragraph in Section D
Paragraph in "Health Care Reform"
Paragraph under "Visa Class B Common Stock"
Last paragraph under “Automobile Loans”
Last two paragraphs
Last four paragraphs
First paragraph under “II. Provision For Loan
Losses and Allowance For Loan Losses”
Paragraphs four and five under "2016 Compared to
2015"
Paragraphs under “Residential Real Estate Loans”
Paragraphs under “Commercial, Commercial Real
Estate and Construction and Land Development
Loans”
Last two paragraphs under "Potential Problem
Loans"
Last two paragraphs under "Liquidity"
Last two paragraphs in Note 8
Second to last paragraph in Note 13
Second to last paragraph in Note 15
These forward-looking statements may not be exhaustive, are not guarantees of future performance and involve certain risks and
uncertainties that are difficult to quantify or, in some cases, to identify. You should not place undue reliance on any such forward-looking
statements. In the case of all forward-looking statements, 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, or consumer spending patterns;
c. sudden changes in the market for products we provide, such as real estate loans;
d. significant changes in banking or other laws and regulations, including both enactment of new legal or regulatory measures
(e.g., the Dodd-Frank Act) or the modification or elimination of pre-existing measures
e. significant changes in U.S. monetary or fiscal policy, including new or revised monetary programs or targets adopted or
announced by the Federal Reserve ("monetary tightening or easing") or significant new federal legislation materially affecting
the federal budget ("fiscal tightening or expansion");
enhanced competition from unforeseen sources (e.g., so-called Fintech enterprises); and
f.
g. similar uncertainties inherent in banking operations or business generally, including technological developments and changes.
We are under no duty to update any of the forward-looking statements after the date of this Annual Report on Form 10-K to
conform such statements to actual results. All forward-looking statements, express or implied, included in this report and the documents
we incorporate by reference and that are attributable to the Company are expressly qualified in their entirety by this cautionary statement.
This cautionary statement should also be considered in connection with any subsequent written or oral forward-looking statements that
the Company or any persons acting on our behalf may issue.
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, as well as disclosures based on that
tabular presentation, is commonly presented on a tax-equivalent basis. That is, to the extent that some component of the institution's net
interest income, which is presented on a before-tax basis, is exempt from taxation (e.g., is received by the institution as a result of its
holdings of state or municipal obligations), an amount equal to the tax benefit derived from that component is added to the actual before-
tax net interest income total. This adjustment is considered helpful in comparing one financial institution's net interest income to that of
another institution or in analyzing any institution’s net interest income trend line over time, to correct any analytical distortion that might
otherwise arise from the fact that financial institutions vary widely in the proportions of their portfolios that are invested in tax-exempt
securities, and from the fact that even a single institution may significantly alter over time the proportion of its own portfolio that is invested
in tax-exempt obligations. Moreover, net interest income is itself a component of a second financial measure commonly used by financial
institutions, net interest margin, which is the ratio of net interest income to average earning assets. For purposes of this measure as well,
tax-equivalent net interest income is generally used by financial institutions, again to provide a better basis of comparison from institution
to institution and to better demonstrate a single institution’s performance over time. 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 the same as the net interest income presented in Selected Financial Information table discussed
in the preceding paragraph, i.e., it is expressed on a tax-equivalent basis. Moreover, many financial institutions, in calculating the efficiency
ratio, also adjust both noninterest expense and noninterest income to exclude from these items (as calculated under GAAP) certain recurring
component elements of income and expense, such as intangible asset amortization (which is included in noninterest expense under GAAP
but may not be included therein for purposes of calculating the efficiency ratio) and securities gains or losses (which are reflected in the
calculation of noninterest income under GAAP but may be ignored for purposes of calculating the efficiency ratio). We make these
adjustments.
Tangible Book Value per Share: Tangible equity is total stockholders’ equity less intangible assets. Tangible book value per share
is tangible equity divided by total shares issued and outstanding. Tangible book value per share is often regarded as a more meaningful
comparative ratio than book value per share as calculated under GAAP, that is, total stockholders’ equity including intangible assets divided
by total shares issued and outstanding. Intangible assets includes many items, but in our case, essentially represents goodwill.
4
Adjustments for Certain Items of Income or Expense: In addition to our regular utilization in our public filings and disclosures of
the various non-GAAP measures commonly utilized by financial institutions discussed above, we also may elect from time to time, in
connection with our presentation of various financial measures prepared in accordance with GAAP, such as net income, earnings per
share (i.e. EPS), return on average assets (i.e. ROA), and return on average equity (i.e. ROE), to provide as well certain comparative
disclosures that adjust these GAAP financial measures, typically by removing therefrom the impact of certain transactions or other material
items of income or expense that are unusual or unlikely to be repeated. We do so only if we believe that inclusion of the resulting non-
GAAP financial measures may improve the average investor's understanding of our results of operations by separating out items that have
a disproportional positive or negative impact on the particular period in question or by otherwise permitting a better comparison from period-
to-period in our results of operations with respect to our fundamental lines of business, including the commercial banking business.
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.
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 three 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
$
2,158,385
$
1,217,312
$
$
1851
473
30
Saratoga National
443,258
84,096
1988
51
9
Warren, Washington,
Saratoga, Essex &
Clinton
250 Glen Street
Glens Falls, NY
Saratoga, Albany &
Rensselaer
171 So. Broadway
Saratoga Springs, NY
The holding company’s business consists primarily of the ownership, supervision and control of our two banks, including the
banks' subsidiaries. The holding company provides various advisory and administrative services and coordinates the general
policies and operation of the banks. There were 524 full-time equivalent employees, including 62 employees within our insurance
agency affiliates, at December 31, 2016.
We offer a broad 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.
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 governmental 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 in northeastern New York State, with the exception
of our indirect consumer lending line of business, where we acquire retail paper from an extensive network of automobile dealers
5
that operate in a larger area of upstate New York, and in central and southern Vermont. The loan portfolio does not include any
foreign loans or any other significant risk concentrations. We do not generally participate in loan syndications, either as originator
or as a participant. However, from time to time, we buy participations in individual loans, typically commercial loans, originated by
other financial institutions in New York and adjacent states. In recent periods, the total dollar amount of such participations has
fluctuated, but generally represents less than 20% of commercial loans outstanding. Most of the portfolio 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.
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 operations, customers, prospects and investors.
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"). 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 generally 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. Bank holding companies that meet certain qualifications
may choose to apply to the Federal Reserve Board for designation as "financial holding companies." If they obtain such designation,
they will thereafter be eligible to acquire or otherwise affiliate with a much broader array of other financial institutions than "bank
holding companies" are eligible to acquire or affiliate with, including insurance companies, investment banks and merchant banks.
Arrow has not attempted to become, and 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 unsafe or unsound practice; issuing administrative orders; requiring the organization to
increase capital; requiring the organization to sell subsidiaries or other assets; restricting dividends, distributions and repurchases
of the organization's stock; restricting the growth of the organization; assessing civil money penalties; removing officers and directors;
and terminating deposit insurance. The FDIC may terminate a depository institution's deposit insurance upon a finding that the
institution's financial condition is unsafe or unsound or that the institution has engaged in unsafe or unsound practices for certain
other reasons.
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 State 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 Securities
and Exchange Commission (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 (FRA).
Each of our organization's non-bank subsidiaries (other than the business trusts we formed to issue our TRUPs) is a subsidiary of
one of our banks, and also is an "operating subsidiary" under Sections 23A and 23B. This means the non-bank subsidiary is
considered to be part of the bank that owns it and thus is not an affiliate of the bank for purposes of Section 23A and 23B. However,
each of our two banks is an affiliate of the other bank, and our holding company (Arrow) is also an affiliate of each bank. 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 (FDIA). Such acts further restrict the range of permissible transactions
between a bank and any affiliate, including a bank affiliate. Furthermore, under the FRA, a bank may engage in certain transactions,
including loans and purchases of assets, with a non-bank affiliate, only if certain special conditions, including collateral requirements
6
for loans, are met and if the other terms and conditions of the transaction, including interest rates and 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 the
bank with non-affiliated companies or, in the absence of comparable transactions, on terms and conditions that would be offered
by the bank 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.
Bank Capital Rules. The Dodd-Frank Act, among other things, directed U.S. bank regulators to promulgate revised capital
standards for U.S. banking organizations, which needed be at least as strict (i.e., must establish minimum capital levels that are at
least as high) as the regulatory capital standards that were in effect for U.S. insured depository financial institutions at the time
Dodd-Frank was enacted in 2010.
In July 2013, federal bank regulators, including the FRB and the OCC, approved their revised 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's banking organizations. The
federal regulators' revised capital rules (the "Capital Rules"), which impose significantly higher minimum capital ratios on U.S.
financial institutions than the rules they replaced, became effective for our holding company and banks on January 1, 2015, and
will be fully phased in by 2019.
The revised Capital Rules, like the rules they replaced, consist of two basic types of capital measures, a leverage ratio and
set of risk-based capital measures. Within these two broad types of rules, however, significant changes were made in the revised
Capital Rules, as discussed below.
Leverage Rule. The revised Capital Rules did not fundamentally alter the structure of the leverage rule that previously applied
to banks and bank holding companies, except to increase the minimum required leverage ratio from 3.0% to 4.0%. The leverage
ratio continues to be defined as the ratio of the institution's "Tier 1" capital (as defined under the new leverage rule) to total tangible
assets (again, as defined under the revised leverage rule).
Risk-Based Capital Measures. The principal changes under the revised Capital Rules involve the other basic type of regulatory
capital measures, the so-called risk-based capital measures. As a general matter, risk-based capital measures assign various risk
weightings to all of the institution's assets, by asset type, and to certain off-balance sheet items, and then establish minimum levels
of capital to the aggregate dollar amount of such risk-weighted assets. The general effect of the revised risk-based Capital Rules
was to increase most of the pre-existing risk-based minimum capital ratios and to introduce several new minimum capital ratios
and capital definitions. The basic result was to increase required capital for banks and their holding companies.
Under the revised risk-based Capital Rules, there are 8 major risk-weighted categories of assets (although there are several
additional super-weighted categories for high-risk assets that are generally not held by community banking organizations like ours).
The revised rules also are more restrictive in their definitions of what qualify as capital components. Most importantly, the revised
rules, as required under Dodd-Frank, added several risk-based capital measures that also must be met. One such measure is the
"common equity tier 1 capital ratio" (CET1). For this ratio, only common equity (basically, common stock plus surplus plus retained
earnings) qualifies as capital (i.e., CET1). Preferred stock and trust preferred securities, which qualified as Tier 1 capital under the
old Tier 1 risk-based capital measure (and continue to qualify as capital under the revised Tier 1 risk-based capital measure), are
not included in CET1 capital. Technically, under the revised rules, CET1 capital also includes most elements of accumulated other
comprehensive income (AOCI), including unrealized securities gains and losses, as part of both total regulatory capital (numerator)
and total assets (denominator). However, smaller banking organizations like ours were given the opportunity to make a one-time
irrevocable election to include or not to include certain elements of AOCI, most notably unrealized securities gains or losses. We
made such an election, i.e., not to include unrealized securities gains and losses in calculating our CET1 ratio under the revised
Capital Rules. The minimum CET1 ratio under the revised rules, effective January 1, 2015, is 4.50%, which will remain constant
throughout the phase-in period.
Consistent with the general theme of higher capital levels, the revised Capital Rules also increased the minimum ratio for Tier
1 risk-based capital, which was 4.0%, to 6.0%, effective January 1, 2015. The minimum level for total risk-based capital under the
revised Capital Rules remained at 8.0%, the same level as under the old rules.
The revised Capital Rules incorporate a capital concept, the so-called "capital conservation buffer" (set at 2.5%, after full phase-
in), which must be added to each of the minimum required risk-based capital ratios (i.e., the minimum CET1 ratio, the minimum
Tier 1 risk-based capital ratio and the minimum total risk-based capital ratio). The capital conservation buffer is being phased-in
over four years beginning January 1, 2016 (see the table below). 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 buffer below the required level (2.5% of total risk-based assets), the institution will not necessarily be
required to replace the buffer deficit immediately, but will face restrictions on paying dividends and other negative consequences
until the buffer is fully replenished.
Also under the revised Capital Rules, and as required under Dodd-Frank, TRUPs issued by small- to medium-sized banking
organizations (such as ours) that were outstanding on the Dodd-Frank 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 discussion of
grandfathered TRUPs in section D of this item under "The Dodd-Frank Act."
7
The following is a summary of the revised definitions of capital under the various new risk-based measures in the revised
Capital Rules:
Common Equity Tier 1 Capital (CET1): 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 has exercised its irrevocable option
not to include AOCI in capital (we made such an election). 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 applicable to our holding company and banks under the revised Capital
Rules:
Year, as of January 1
Minimum CET1 Ratio
Capital Conservation Buffer ("Buffer")
Minimum CET1 Ratio Plus Buffer
Minimum Tier 1 Risk-Based Capital Ratio
Minimum Tier 1 Risk-Based Capital Ratio Plus Buffer
Minimum Total Risk-Based Capital Ratio
Minimum Total Risk-Based Capital Ratio Plus Buffer
Minimum Leverage Ratio
2016
4.500%
0.625%
5.125%
6.000%
6.625%
8.000%
8.625%
4.000%
2017
4.500%
1.250%
5.750%
6.000%
7.250%
8.000%
9.250%
4.000%
2018
4.500%
1.875%
6.375%
6.000%
7.875%
8.000%
2019
4.500%
2.500%
7.000%
6.000%
8.500%
8.000%
9.875%
10.500%
4.000%
4.000%
These minimum capital ratios, especially the CET1 ratio (4.5%) and the enhanced Tier 1 risk-based capital ratio (6.0%), which
began to apply to our organization on January 1, 2015, represent a heightened and more restrictive capital regime than institutions
like ours previously had to meet, and the four year phase-in of the regulatory capital buffer, which began January 1, 2016, will add
to the stress on banks' profitability.
At December 31, 2016, our holding company and both of our banks exceeded by a substantial amount each of the applicable
minimum capital ratios established under the revised Capital Rules, including the minimum CET1 Ratio, the minimum Tier 1 Risk-
Based Capital Ratio, the minimum Total Risk-Based Capital Ratio, and the minimum Leverage Ratio, including in the case of each
risk-based ratio, the phased-in portion of the capital buffer. See Note 19 to our audited financial statements, beginning on page
102, for a presentation of our period-end ratios for 2016 and 2015.
Regulatory Capital Classifications. Under applicable banking 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, ranging from the highest category of "well-capitalized" to the lowest
category of "critically under-capitalized". As a result of the regulators' adoption of the revised Capital Rules, the definitions for
determining which of the five capital classifications a particular banking organization will fall into were changed, effective as of
January 1, 2015. Under the revised capital classifications, a banking institution is considered "well-capitalized" if it meets the
following capitalization standards on the date of measurement: a CET1 risk-based capital ratio of 6.50% or greater, a Tier 1 risk-
based capital ratio of 8.00% or greater, and a total risk-based capital ratio of 10.00% or greater, provided the institution is not subject
to any regulatory order or written directive regarding capital maintenance.
As of December 31, 2016, our holding company and both of our banks qualified as "well-capitalized" under the revised capital
classification scheme.
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
minimum regulatory capital 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 (which affect our subsidiary banks) and the
New York Business Corporation Law (which affects our holding company). The ability of our holding company and banks to pay
dividends or repurchase shares in the future is, and is expected to continue to be, influenced by regulatory policies, the phase-in
of the revised, more stringent bank capital guidelines and applicable law.
8
In cases where banking regulators have significant concerns regarding the financial condition, assets or operations of a bank
holding company or one of its banks, the regulators may take enforcement action or impose enforcement orders, formal or informal,
against the holding company or the particular bank. 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.
Cybersecurity
In additional to the provisions in the Gramm-Leach-Bliley Act relating to data security, Arrow and its subsidiaries are subject to
many federal and state laws, regulations and regulatory interpretations which impose standards and requirements related to
cybersecurity. For example, in March 2015, federal regulators issued two related statements regarding cybersecurity. One statement
indicates that financial institutions should design multiple layers of security controls to establish lines of defense and to ensure that
their risk management processes also address the risk posed by compromised customer credentials, including security measures
to reliably authenticate customers accessing internet-based services of the financial institution. The other statement indicates that
a financial institution’s management is expected to maintain sufficient business continuity planning processes to ensure the rapid
recovery, resumption and maintenance of the institution’s operations after a cyber-attack involving destructive malware. A financial
institution is also expected to develop appropriate processes to enable recovery of data and business operations and address
rebuilding network capabilities and restoring data if the institution or its critical service providers fall victim to this type of cyber-
attack. Financial institutions that fail to observe this regulatory guidance on cybersecurity may be subject to various regulatory
sanctions, including financial penalties.
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. The U.S. Treasury Department's Financial Crises Enforcement Network ("FinCEN") issued a final rule
in 2016 increasing customer due diligence requirements for banks, including adding a requirement to identify and verify the identity
of beneficial owners of customers that are legal entities, subject to certain exclusions and exemptions. Compliance with this rule
is required in May 2018.
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.
9
The Dodd-Frank Act
As a result of the 2008-2009 financial crisis, the U.S. Congress passed and the President signed Dodd-Frank 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 Consumer Financial Protection Bureau (CFPB), 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 negatively impacting 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
CFPB, will have primary examination and enforcement authority over the banks' compliance with new CFPB rules as well as all
other consumer protection rules and regulations. However, the CFPB 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 CFPB 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 CFPB's rules, state attorneys general are also authorized to enforce certain of
the Federal consumer laws transferred to the jurisdiction of the CFPB and the rules issued by the CFPB thereunder.
Dodd-Frank also directed the federal banking authorities to issue new capital requirements for banks and holding companies.
See the discussion under “Regulatory Capital Standards” on pages 7 and 8 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 the $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 were 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. To date,
implementation of Dodd-Frank provisions has resulted in many new mandatory and discretionary rule-makings by regulatory
authorities, a process that is still not completed, almost seven years after Dodd-Frank's enactment. As a result, bank holding
companies and their bank and non-bank operating subsidiaries have faced thousands of new pages of regulations and associated
regulatory burdens still being formulated, several of which are highly controversial and the implementation of which has proven to
be costly and time consuming.
Various legislative proposals have been advanced for consideration or possible consideration by the U.S. Congress that would
rescind or substantially modify various provisions of Dodd-Frank. At present, we are not able to estimate the likelihood of adoption
of any such provisions or the potential impact thereof if adopted.
Sarbanes-Oxley Act
The Sarbanes-Oxley Act of 2002 implemented a broad range of corporate governance, accounting and reporting requirements
for companies that have securities registered under the Exchange Act. These requirements include: (1) requirements for audit
committees, including independence and financial expertise; (2) certification of financial statements by the chief executive officer
and chief financial officer of the reporting company; (3) standards for auditors and regulation of audits; (4) disclosure and reporting
requirements for the reporting company and directors and executive officers; and (5) a range of civil and criminal penalties for fraud
and other violations of securities laws.
The USA Patriot Act
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 Patriot Act impose substantial costs on all financial institutions, including ours.
Incentive Compensation
The Dodd-Frank Act required the federal bank regulatory agencies and the SEC to establish joint regulations or guidelines
prohibiting incentive-based payment arrangements at specified regulated entities, such as the Company, having at least $1 billion
in total assets that encourage inappropriate risks by providing an executive officer, employee, director or principal shareholder with
excessive compensation, fees, or benefits or that could lead to material financial loss to the entity. In addition, these regulators
must establish regulations or guidelines requiring enhanced disclosure to regulators of incentive-based compensation arrangements.
Final regulations and/or guidelines have not yet been issued by the agencies under this provision of Dodd-Frank.
10
However, in 2010, the FRB, OCC and FDIC issued comprehensive final guidance on incentive compensation policies intended
to ensure that the incentive compensation policies of banking organizations do not undermine the safety and soundness of such
organizations by encouraging excessive risk-taking. The guidance, which covers all employees that have the ability to materially
affect the risk profile of an organization, either individually or as part of a group, is based upon the key principles that a banking
organization’s incentive compensation arrangements should (i) provide incentives that do not encourage risk-taking beyond the
organization’s ability to effectively identify and manage risks, (ii) be compatible with effective internal controls and risk management,
and (iii) be supported by strong corporate governance, including active and effective oversight by the organization’s board of
directors. Management believes the current and past compensation practices of the Company do not encourage excessive risk
taking or undermine the safety and soundness of the organization.
The FRB will review, as part of the regular, risk-focused examination process, the incentive compensation arrangements of
banking organizations, such as the Company, that are not “large, complex banking organizations.” These reviews will be tailored
to each organization based on the scope and complexity of the organization’s activities and the prevalence of incentive compensation
arrangements. The findings of the supervisory initiatives will be included in reports of examination. Deficiencies will be incorporated
into the organization’s supervisory ratings, which can affect the organization’s ability to make acquisitions and take other actions.
Enforcement actions may be taken against a banking organization if its incentive compensation arrangements, or related risk-
management control or governance processes, pose a risk to the organization’s safety and soundness and the organization is not
taking prompt and effective measures to correct the deficiencies.
Deposit Insurance Laws and Regulations
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 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 Reserve Ratio at
2% of insured deposits. It also implements a lower assessment rate schedule when the ratio 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.
In August of 2016, the FDIC announced that the reserve ratio reached 1.17% at the end of June, 2016. This represents the
highest level the ratio has reached in more than eight years. The reduction in assessment rates went into effect in the third quarter
of 2016. 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, if bank failures should once again become a significant problem.
D. RECENT LEGISLATIVE DEVELOPMENTS
Health Care Reform
Various proposals have been discussed for consideration that would substantially modify various health care laws. At present,
we are not able to estimate the likelihood of adoption of any such provisions or the potential impact thereof if adopted.
Other Legislative Initiatives
From time to time, various legislative and regulatory initiatives are introduced in Congress and state legislatures, as well as
by regulatory authorities. These initiatives may include proposals to expand or contract the powers of bank holding companies and
depository institutions or proposals to change the financial institution regulatory environment. Such legislation could change banking
laws and the operating environment of our company in substantial, but unpredictable ways. We cannot predict whether any such
legislation will be enacted, and, if enacted, the effect that it, or any implementing regulations would have on our financial condition
or results of operations.
E. STATISTICAL DISCLOSURE – (GUIDE 3)
Set forth below is an index identifying the location in this Report of various items of statistical information required to be included
in this Report by the SEC’s industry guide for Bank Holding Companies.
Required Information
Distribution of Assets, Liabilities and Stockholders' Equity; Interest Rates and Interest Differential
Investment Portfolio
Loan Portfolio
Summary of Loan Loss Experience
Deposits
Return on Equity and Assets
Short-Term Borrowings
Location in Report
Part II, Item 7.B.I.
Part II, Item 7.C.I.
Part II, Item 7.C.II.
Part II, Item 7.C.III.
Part II, Item 7.C.IV.
Part II, Item 6.
Part II, Item 7.C.V.
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F. COMPETITION
We face intense competition in all markets we serve. Competitors include traditional local commercial banks, savings banks
and credit unions, non-traditional internet-based lending alternatives, as well as local offices of major regional and money center
banks. Like all banks, we encounter strong competition in the mortgage lending space 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.” For many years, these GSEs have purchased and/or guaranteed a very substantial
percentage of all newly-originated mortgage loans in the U.S., and in recent years, a large majority of such originations. Additionally,
non-banking financial organizations, such as consumer finance companies, insurance companies, securities firms, money market
funds, mutual funds, credit card companies, wealth management enterprises, and Fintech companies offer substantive equivalents
of the various other types of loan and financial products and services 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 and services comparable to those
offered by commercial banks, but also may establish or acquire their own commercial banks.
G. EXECUTIVE OFFICERS OF THE REGISTRANT
The names and ages of the executive officers of Arrow and positions held by each are presented in the following table. Officers
are elected annually by the Board of Directors.
Name
Thomas J. Murphy, CPA
Age
58
Terry R. Goodemote, CPA
53
David S. DeMarco
David D. Kaiser
55
56
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). Mr. 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 also has been 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 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. On February 7, 2017, the company announced Mr. Goodemote's intention is to
retire from the company. He intends to continue in his current role until his successor is
chosen.
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.
Senior Vice President of Arrow since February 1, 2015. Mr. Kaiser has also served as
Executive Vice President of GFNB since 2012 and as Chief Credit Officer of GFNB and
SNB since 2011. Previously, he served as the Corporate Banking Manager for GFNB
from 2005 to 2011. Mr. Kaiser started with the Company in 2000.
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 of our holding company and its subsidiaries.
12
Item 1A. Risk Factors
Our financial results and the market price of our stock are subject to risks arising from many factors, including the risks listed
below, as well as other risks and uncertainties. Any of these risks could materially and adversely affect our business, financial
condition or results of operations. (Please note that the discussion below regarding the potential impact on Arrow of certain of these
factors that may develop in the future is not meant to provide predictions by Arrow's management that such factors will develop,
but to acknowledge the possible negative consequences to our company and business if certain conditions develop.)
Difficult market conditions continue to present significant challenges to the profitability of the U.S. commercial banking
industry and its core business of making and servicing loans and any substantial downturn in the U.S. economy generally
could adversely affect our ability to maintain steady growth in our loan portfolio and our earnings. 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 has generally increased in recent years, and very low prevailing rates of
interest for all types of credit still exist, which makes borrowing more affordable and attractive to customers of all types. However,
while the U.S. economy and our regional economy have shown signs of improvement in recent years, consumers and small
businesses are still struggling under heavy debt loads, which will continue to weigh against any surge in growth or profitability in
the banking sector. This cautionary scenario confronts us as it confronts all commercial banks, large and small, and could adversely
affect our ability to originate loans.
We face continuing and growing security risks to our information base including the information we maintain relating
to our customers, and any breaches in the security systems we have implemented to protect this information could have
a material negative effect on our business operations and financial condition. In the ordinary course of business, Arrow relies
on electronic communications and information systems to conduct our operations and to store sensitive data. Arrow employs an
in-depth, layered, defensive approach that leverages people, processes and technology to manage and maintain cybersecurity
controls. Arrow employs a variety of preventative and detective tools to monitor, block, and provide alerts regarding suspicious
activity, as well as to report on any suspected advanced persistent threats. We have implemented and regularly review and update
extensive systems of internal controls and procedures as well as corporate governance policies and procedures intended to protect
our business operations, including the security and privacy of all confidential customer information. 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 cybersecurity or
other security problem in every situation. A failure or circumvention of these controls could have a material adverse effect on our
business operations and financial condition. Notwithstanding the strength of our defensive measures, the threat from cyber attacks
is severe, attacks are sophisticated and increasing in volume, and attackers respond rapidly to changes in defensive measures.
While to date, Arrow has not experienced a significant compromise, significant data loss or any material financial losses related to
cybersecurity attacks, our systems and those of our customers and third-party service providers are under constant threat. Risks
and exposures related to cybersecurity attacks are expected to remain high for the foreseeable future due to the rapidly evolving
nature and sophistication of these threats, as well as due to the expanding use of Internet banking, mobile banking and other
technology-based products and services by us and our customers.
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, or the systems of
our third-party service providers or may originate from the actions of our consumer and business customers who access our systems
from their own networks or digital devices to process transactions. Information security and cyber 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. Cybersecurity risk is a major concern to financial services regulators and all financial service providers,
including our company. These risks are further exacerbated 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. Any breach of our system security could result in disruption of our operations,
unauthorized access to confidential customer information, significant regulatory costs, litigation exposure and other possible
damages, loss or liability. Such costs or losses could exceed the amount of available insurance coverage, if any, and would adversely
affect our earnings. Also, any failure to prevent a security breach or to quickly and effectively deal with such a breach could negatively
impact customer confidence, damaging our reputation and undermining our ability to attract and keep customers. In addition, if we
fail to observe any of the cybersecurity requirements in federal or state laws, regulations or regulatory guidance, we could be subject
to various sanctions, including financial penalties.
The quality of our bank loan portfolio remains strong but could erode somewhat if the U.S. economy or our regional
economy experiences even a modest downturn; any such erosion 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 our loan portfolio remain very low. However, we like most banks
continue to have substantial exposure in our portfolio to borrowers, particularly individual and small business borrowers, who if
confronted by an economic downturn of any consequence, including one that results in their loss of their job or the failure of their
13
business, may quickly fall in arrears on their borrowings including on our loans to them. We believe not only that the quality of our
loan portfolio is strong but also that our allowance is entirely adequate to cover all embedded risk. However, any downturn of
consequence in the economy, nationwide or in our region, would likely require increased provisions to our allowance, potentially
damaging our financial condition and results.
Persistent volatility in the U.S. equity markets, coupled with economic instability and uncertainty, has an adverse
effect on the core business of the U.S. commercial banking sector which 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 2008-2009 financial crisis, although periods of enhanced volatility continue to surface-. 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”), continues
to experience only very modest growth. In some areas of the U.S. and some sectors of the U.S. economy. companies, workers
and municipalities have not returned to the levels of financial health they enjoyed before the 2008-2009 crisis. Commercial banks
like ours are much more closely tied, in terms of growth and profits, to the Main Street sector than the Wall Street sector. Accordingly,
our financial results and condition may continue to be pressured by the modest and uneven growth that continues to characterize
the U.S. economy generally and our regional economy as well.
Any future economic or financial downturn, including any significant correction in the equity markets, may negatively
affect the volume of income attributable to, and demand for, fee-based services of banks such as ours, including our
fiduciary business, 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 leave their portfolios with us, in either case reducing our assets under management and thereby
decreasing our revenues from this important sector of our business. Our other fee-based businesses are also susceptible to a
sudden economic or financial downturn.
Rulemaking under Dodd-Frank continues to unfold; these and other regulations being promulgated may adversely
affect our Company and certain players in the financial industry as a whole. Even before the 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.
Our depositor/customer awareness of the changing regulatory environment is particularly true of the set of laws and regulations
under Dodd-Frank, which were passed in the aftermath of the 2008-2009 financial crisis and in large part were intended to better
protect bank customers (and to some degree, banks) against a wide variety of lending products and aggressive lending practices
that pre-dated the crisis and are seen as having contributed 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 additional resources to safeguard customers,
significantly increases our regulatory burden, and subjects us to significantly higher minimum capital requirements which, in the
long run, may serve 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).
While it is difficult to predict the full extent to which Dodd-Frank and the resulting new regulations and rules may adversely
impact our business or financial results, or the extent to which regulations previously adopted under Dodd-Frank or the provisions
of Dodd-Frank itself may be rescinded or modified in upcoming periods, as a result of recent political developments,we believe the
changes flowing from Dodd-Frank will continue to increase our costs. Furthermore, we also believe that any potential changes to
Dodd-Frank will require us to continue to modify certain strategies, business operations and capital and liquidity structures which,
individually or collectively, may very well have a material adverse impact on our financial condition.
Revised capital and liquidity standards adopted by the U.S. banking regulators require banks and bank holding
companies to maintain more and higher quality capital and greater liquidity than has historically been the case. Capital
standards, particularly those adopted as a result of Dodd-Frank, continue to have a significant effect on banks and bank holding
companies, including Arrow. Although many of the remedial measures contained in Dodd-Frank and the regulations promulgated
thereunder may be reconsidered at the federal legislative and regulatory levels as a result of the recent U.S. elections and political
developments, the revised and enhanced regulatory capital standards adopted by bank regulators in response to the mandates in
Dodd-Frank are generally perceived as less likely to be rescinded or relaxed than some of the other restrictive or burdensome
changes mandated by Dodd-Frank. Thus, many if perhaps not all of the enhanced bank capital standards promulgated under
Dodd-Frank are widely expected to remain in effect, including the capital buffers yet to be fully phased in, forcing bank holding
companies and their bank subsidiaries to maintain substantially higher levels of capital as a percentage of their assets, with a
greater emphasis on common equity as opposed to other components of capital. The need to maintain more and higher quality
capital, as well as greater liquidity, and generally increased regulatory scrutiny with respect to capital levels, may at some point
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 and may dilute shareholder value or limit our ability to pay dividends or otherwise return capital to
our investors through stock repurchases.
14
If economic conditions should worsen and the U.S. experiences a recession or prolonged economic stagnation, the
quality of our loan portfolio may weaken so significantly that our allowance for loan losses may not be adequate to cover
actual or expected loan 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. While we have continued to enjoy a very high level
of quality in our loan portfolio generally and very low levels of loan charge-offs and non-performing loans, if the economy in our
geographic market area 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 so significantly that our allowance for
loan losses may not be adequate to cover actual or expected loan losses. If so, future increases in 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.
Although rates have begun to rise somewhat, the current interest rate environment, still is not particularly favorable
for commercial banks or their core businesses, and any future significant increases in prevailing rates may ultimately
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 generally
comprises the majority of its total income, and changes in prevailing rates for bank assets and bank liabilities significantly affect its
net interest income. Currently, market interest rates in the U.S., across all maturities and for all types of loans, although beginning
to rise, still remain low. Lending institutions such as commercial banks remain in a very challenging position.
After raising the Fed funds rate by 25 basis points in December 2016, the Fed elected to raise the Fed funds rate again in
December 2016, again by 25 basis points. Presumably, short-term interest rates will rise again accordingly. Moreover, the general
expectation is that the Fed will proceed with additional rate rises this year and perhaps next year. These increases in market rates,
although possibly helpful to banks at least initially as loans reprice upward, may nevertheless be expected ultimately to adversely
impact the commercial banking sector in certain respects. If rate rises persist, it may be expected that bank liabilities (deposits)
also will reprice upward, pressuring margins once again. Additionally, if rates rise substantially, especially long-term rates, economic
growth is likely to be negatively impacted at some point, and the housing sector particularly may suffer significant damage. It was
out of concern for the long-run health of the U.S. economy at large that led the Fed to pursue the imposition of a long-term, low-
rate environment, and it is to be expected that the Fed will approach further rate increases with great caution and abandon or defer
future increases if any weakness in the economy should surface. Whatever the Fed and the other central banks in the developed
world elect to do from the standpoint of monetary policy, their decisions will affect the activities, results of operations and profitability
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 fierce in our market areas. In one or more aspects of 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
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, adversely affecting our growth, 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 might be restricted
at some point in their ability to pay dividends to the holding company, including by a bank regulator asserting that the payment of
such dividends or other payments would constitute an unsafe or unsound practice. In addition, under Dodd-Frank, we are subjected
to consolidated capital requirements at the holding company level. If our holding company or its bank subsidiaries are required to
retain or increase capital, we may not be able to maintain our cash dividends or pay dividends at all, or to repurchase shares of
our common stock.
If economic conditions worsen and the U.S. financial markets should suffer a 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, in the context of a downturn in the U.S. economy or financial markets,
these third parties should encounter 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.
15
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. Much of our success depends upon the
growth in business activity, income levels and deposits in our geographic market area. Although our market area has experienced
a stabilizing of economic conditions in recent years and even periods of modest growth, if unpredictable or unfavorable economic
conditions unique to our market area should occur in upcoming periods, such will likely 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 or if employee wages increase significantly. Our
success depends, in large part, on our ability to retain our key personnel for the duration of their expected terms of service. On an
ongoing basis, we prepare and review back-up plans, in the event key personnel are unexpectedly rendered incapable of performing
or depart or resign from their positions. However, any sudden unexpected change at the senior management level may adversely
affect our business. In addition, should our industry begin to experience a shortage of qualified employees, we like other financial
institutions may have difficulty attracting and retaining entry level or higher bracket personnel and also may experience, as a result
of such shortages or the enactment of higher minimum wage laws locally or nationwide, increased salary expense, which would
likely negatively impact our results of operations.
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. The
financial health and operational capabilities of these third parties are for the most part beyond our control, and any problems
experienced by these third parties, such that they may not be able to continue to provide services to us or to perform such services
consistent with our expectations, could adversely affect our ability to deliver products and services to our customers and to conduct
our business.
Problems encountered by other financial institutions could adversely affect us. Our ability to engage in routine funding
transactions could be adversely affected by financial or commercial problems confronting 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 only may be liquidated at prices not sufficient to recover the full amount due us under the underlying financial instrument
held by us. There is no assurance that any such losses would not materially and adversely affect our results of operations.
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. The retail financial services sector, like many other retail goods and
services sectors, is currently in the throes of revolutionary change, involving new delivery and communications systems and
technologies that are extraordinarily far-reaching and impactful. For us to remain competitive, we must comprehend and adapt to
these systems and technologies . Proper implementation of new technologies 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, consider, 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 bank. The main office of our other banking subsidiary, Saratoga National,
is in Saratoga Springs, New York. We own twenty-nine branch banking offices, lease ten branch banking offices and lease two
residential loan origination offices, all at market rates. Our insurance agencies are co-located in four bank-owned branches, as well
16
as four leased bank branches and 1 owned stand-alone building. We also lease office space in buildings and parking lots near our
main office in Glens Falls as well as a back-up site for business continuity purposes.
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 National Association of Securities
Dealers, Inc. ("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 29, 2016, we distributed a 3% stock
dividend on our outstanding shares of common stock.
2016
Market Price
Low
High
Cash
Dividends
Declared
2015
Market Price
Low
High
Cash
Dividends
Declared
First Quarter
Second Quarter
Third Quarter
Fourth Quarter
$ 23.83
25.16
28.62
30.56
$
$
26.74
29.51
34.08
41.70
0.243
0.243
0.243
0.250
$24.32
24.06
25.30
25.07
$
$26.20
26.65
27.18
28.39
0.238
0.238
0.238
0.243
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.
Based on information received from our transfer agent and various brokers, custodians and agents, we estimate there were
approximately 7,000 beneficial owners of Arrow’s common stock at December 31, 2016. 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, 2016. These
equity compensation plans were (i) our 2013 Long-Term Incentive Plan ("LTIP"), and its predecessors, our 2008 Long-Term Incentive
Plan and our 1998 Long-Term Incentive Plan; (ii) our 2014 Employee Stock Purchase Plan ("ESPP"); and (iii) 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
355,651
$
22.52
—
355,651
(c)
Number of Securities
Remaining Available
for Future Issuance
Under Equity
Compensation Plans
(Excluding Securities
Reflected in Column
(a)
511,293
—
511,293
Plan Category
Equity Compensation Plans Approved by
Security Holders (1)(2)
Equity Compensation Plans Not Approved by
Security Holders
Total
(1) All 355,651 shares of common stock listed in column (a) are issuable pursuant to outstanding stock options granted under
the LTIP or its predecessor plans.
(2) The total of 511,293 shares listed in column (c) includes (i) 367,775 shares of common stock available for future award
grants under the LTIP, (ii) 115,554 shares of common stock available for future issuance under the ESPP, and (iii) 27,964
shares of common stock available for future issuance under the DSP.
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, 2011 to December 31,
2016 and the second graph presents comparative stock performance for the fifteen-year period from December 31, 2001 to
December 31, 2016.
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
2011
2012
2013
2014
2015
2016
100.00
100.00
100.00
100.00
113.12
116.35
119.64
118.73
127.72
161.52
171.23
161.37
140.05
169.42
179.93
169.29
146.51
161.95
195.98
185.89
232.25
196.45
265.31
267.98
Source: Prepared by Zacks Investment Research, Inc. Used with permission. All rights reserved. Copyright 1980-2017.
19
TOTAL RETURN PERFORMANCE
Period Ending
Index
Arrow Financial
Corporation
2001
2002
2003
2004
2005
2006
2007
2008
100.00
114.37
133.42
158.20
142.19
144.44
135.32
165.76
Russell 2000 Index
100.00
79.52
117.09
138.68
144.93
171.55
168.87
111.81
NASDAQ Banks
Index
Zacks $1B - $5B Bank
Assets Index
100.00
102.37
131.69
150.81
147.31
165.41
130.91
95.44
100.00
118.21
164.17
195.13
190.45
220.30
173.64
160.60
TOTAL RETURN PERFORMANCE (Cont'd.)
Period Ending
Index
Arrow Financial
Corporation
2009
2010
2011
2012
2013
2014
2015
2016
177.11
209.52
192.14
217.34
245.41
269.08
281.50
446.24
Russell 2000 Index
142.19
180.38
172.85
201.11
279.18
292.85
279.92
339.57
NASDAQ Banks
Index
Zacks $1B - $5B Bank
Assets Index
79.42
94.44
84.46
101.05
144.63
151.98
165.53
224.09
125.68
145.68
139.24
165.32
224.69
235.72
258.83
373.14
Source: Prepared by Zacks Investment Research, Inc. Used with permission. All rights reserved. Copyright 1980-2017.
The preceding stock performance graphs and tables shall not be deemed incorporated by reference, by virtue of any general
statement contained herein or in any other filing incorporated by reference herein, 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.
20
Unregistered Sales of Equity Securities
None.
Issuer Purchases of Equity Securities
The following table presents information about repurchases by Arrow during the three months ended December 31, 2016 of
our common stock (our only class of equity securities registered pursuant to Section 12 of the Securities Exchange Act of 1934):
Fourth Quarter 2016
Calendar Month
October
November
December
Total
(a) Total
Number of
Shares
Purchased1
3,979
7,035
14,603
25,617
(b) Average
Price Paid Per
Share1
$
32.40
35.82
40.10
37.73
(c) Total
Number of
Shares
Purchased as
Part of Publicly
Announced
Plans or
Programs2
—
(d) Maximum
Approximate Dollar
Value of Shares
that
May Yet be
Purchased Under
the
Plans or Programs2
$
4,505,130
—
—
—
4,505,130
4,505,130
1The total number of shares purchased and the average price paid per share listed in columns (a) and (b) consist of (i) any
shares purchased in such periods in open market or private transactions under the Arrow Financial Corporation Automatic Dividend
Reinvestment Plan (the "DRIP") by the administrator of the DRIP, and (ii) shares surrendered or deemed surrendered to Arrow in
such periods by holders of options to acquire Arrow common stock received by them under Arrow's long-term incentive plans
("LTIPs") in connection with their stock-for-stock exercise of such options. In the months indicated, the listed number of shares
purchased included the following numbers of shares purchased by Arrow through such methods: October - DRIP purchases (2,789
shares), stock-for-stock option exercises (1,190 shares); November - DRIP purchases (1,891 shares), stock-for-stock option
exercises (5,144 shares); December - DRIP purchases (12,360 shares), stock-for-stock option exercises (2,243 shares).
2Includes only those shares acquired by Arrow pursuant to its publicly-announced stock repurchase programs. Our only publicly-
announced stock repurchase program in effect for the fourth quarter of 2016 was the program approved by the Board of Directors
and announced in November 2015, under which the Board authorized management, in its discretion, to repurchase from time to
time during 2016, in the open market or in privately negotiated transactions, up to $5 million of Arrow common stock subject to
certain exceptions (the "2016 Program"). Arrow did not repurchase any of its shares in the fourth quarter of 2016 under the 2016
Program. In October 2016, the Board authorized a repurchase program for 2017 similar to its 2016 program, which also authorizes
management to repurchase up to $5 million of stock in the ensuing year (2017).
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 (Losses) 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
$
$
$
$
2016
76,915
5,356
71,559
2,033
69,526
27,854
(22)
(59,609)
37,749
11,215
26,534
1.98
1.97
0.98
17.27
15.45
$
$
$
$
2015
70,738
4,813
65,925
1,347
64,578
27,995
129
(57,430)
35,272
10,610
24,662
1.86
1.85
0.96
16.05
14.18
$
$
$
$
2014
66,861
5,767
61,094
1,848
59,246
28,206
110
(54,028)
33,534
10,174
23,360
1.76
1.76
0.94
15.16
13.22
$
$
$
$
2013
64,138
7,922
56,216
200
56,016
27,521
540
(53,203)
30,874
9,079
21,795
1.65
1.65
0.92
14.50
12.53
$
$
$
$
2012
69,379
11,957
57,422
845
56,577
26,234
865
(51,836)
31,840
9,661
22,179
1.69
1.69
0.90
13.38
11.36
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
$ 2,605,242
346,996
345,427
1,753,268
7,186
2,116,546
178,000
55,836
232,852
$ 2,446,188
402,309
320,611
1,573,952
8,924
2,030,423
137,000
43,173
213,971
$ 2,217,420
366,139
302,024
1,413,268
8,162
1,902,948
51,000
39,421
200,926
$ 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
1,172,641
9,070
1,731,155
59,000
32,678
175,825
Selected Key Ratios:
Return on Average Assets
Return on Average Equity
Dividend Payout 4
Average Equity to Average Assets
1.06%
1.05%
1.07%
1.04%
1.11%
11.79
49.75
8.95
11.86
51.89
8.88
11.79
53.41
9.05
12.11
55.76
8.56
12.88
53.25
8.62
1Share and per share amounts have been adjusted for subsequent stock splits and dividends, including the most recent
September 29, 2016 3% 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 2016 3% stock dividend
Quarter Ended
12/31/2016
9/30/2016
6/30/2016
3/31/2016
12/31/2015
Net Income
Transactions Recorded in Net Income (Net of Tax):
Net (Loss) Gain on Securities Transactions
$
6,600
$
6,738
$
6,647
$
6,549
$
6,569
(101)
—
88
—
14
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 Equity2
Average Earning Assets
Average Paying Liabilities
Interest Income, Tax-Equivalent
Interest Expense
Net Interest Income, Tax-Equivalent
Tax-Equivalent Adjustment
Net Interest Margin 3
Efficiency Ratio Calculation:
Noninterest Expense
Less: Intangible Asset Amortization
Net Noninterest Expense
Net Interest Income, Tax-Equivalent
Noninterest Income
Less: Net Securities (Losses) Gains
Net Gross Income
Efficiency Ratio
Period-End Capital Information:
Total Stockholders’ Equity (i.e. Book Value)
Book Value per Share
Intangible Assets
Tangible Book Value per Share 2
Capital Ratios:
Tier 1 Leverage Ratio
Common Equity Tier 1 Capital Ratio
Tier 1 Risk-Based Capital Ratio
Total Risk-Based Capital Ratio
Assets Under Trust Administration
and Investment Management
$
$
13,483
13,441
13,565
0.49
0.49
0.250
34,731
684,906
1,726,738
2,160,156
157,044
230,198
2,572,425
$
$
13,426
13,407
13,497
0.50
0.50
0.243
21,635
696,712
1,680,850
2,063,832
209,946
228,048
2,528,124
$
$
13,388
13,372
13,429
0.50
0.49
0.243
22,195
701,526
1,649,401
2,082,449
165,853
223,234
2,496,795
$
$
13,361
13,343
13,379
0.49
0.49
0.243
21,166
716,523
1,595,018
2,069,964
143,274
218,307
2,456,431
13,328
13,306
13,368
0.49
0.49
0.243
$
$
44,603
716,947
1,556,234
2,075,825
127,471
213,219
2,442,964
1.02%
11.41%
12.77%
1.06%
11.75%
13.18%
1.07%
11.98%
13.47%
1.07%
12.07%
13.62%
1.07%
12.22%
13.86%
$ 2,446,375
1,933,974
20,709
1,404
19,305
939
3.14%
$ 2,399,197
1,892,583
20,222
1,405
18,817
940
3.12%
$2,373,122
1,891,017
20,154
1,284
18,870
917
3.20%
$2,332,707
1,867,455
19,549
1,263
18,286
923
3.15%
$2,317,784
1,854,549
19,422
1,231
18,191
912
3.11%
$
$
$
$
15,272
73
15,199
19,305
6,648
(166)
26,119
$
$
$
$
15,082
74
15,008
18,817
7,114
—
25,931
$
$
$
$
14,884
74
14,810
18,870
7,194
144
25,920
$
$
$
$
14,370
75
14,295
18,286
6,875
—
25,161
$
$
$
$
14,242
78
14,164
18,191
6,687
23
24,855
58.19%
57.88%
57.14%
56.81%
56.99%
$ 232,852
17.27
24,569
15.45
$ 229,208
17.07
24,675
15.23
$ 225,373
16.83
24,758
14.98
$ 220,703
16.52
24,872
14.66
$ 213,971
16.05
24,980
14.18
9.47%
12.97%
14.14%
15.15%
9.44%
12.80%
13.98%
14.99%
9.37%
12.74%
13.95%
14.96%
9.36%
12.84%
14.08%
15.09%
9.25%
12.82%
14.08%
15.09%
$ 1,301,408
$ 1,284,051
$1,250,770
$1,231,237
$1,232,890
1 See "Use of Non-GAAP Financial Measures" on page 4.
23
Selected Twelve-Month Information
Dollars in thousands, except per share amounts
Share and per share amounts have been restated for the September 2016 3% stock dividend
2016
26,534
(13)
2015
24,662
78
$
$
2014
23,360
67
$
$
$
$
$
13,483
13,391
13,476
1.98
1.97
0.98
$ 2,513,645
224,969
$
13,328
13,281
13,330
1.86
1.85
0.96
$ 2,341,467
208,017
$
13,260
13,242
13,272
1.76
1.76
0.94
$ 2,190,480
198,208
1.06%
1.05%
1.07%
11.79
$ 2,388,042
1,896,351
80,636
5,356
75,280
3,721
11.86
$ 2,218,440
1,777,867
74,227
4,813
69,414
3,489
11.79
$ 2,068,611
1,675,285
70,188
5,767
64,421
3,327
3.15%
3.13%
3.11%
$
$
$
$
$
$
$
$
$
$
59,609
297
59,312
75,280
27,832
(22)
103,134
57.51%
9.47%
232,852
17.27
24,569
15.45
0.06%
0.12%
0.97%
309.31%
0.31%
0.28%
$
$
$
$
$
57,430
327
57,103
69,414
28,124
129
97,409
58.62%
9.25%
213,971
16.05
24,980
14.18
0.06%
0.09%
1.02%
232.24%
0.44%
0.36%
54,028
387
53,641
64,421
28,316
110
92,627
57.91%
9.44%
200,926
15.15
25,628
13.22
0.05%
0.14%
1.10%
200.41%
0.55%
0.37%
Net Income
Transactions Recorded in Net Income (Net of Tax):
Net Securities (Losses) Gains
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
Net Noninterest Expense
Net Interest Income, Tax-Equivalent 1
Noninterest Income
Less: Net Securities (Losses) 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
Arrow Financial Corporation
Reconciliation of Non-GAAP Financial Information
(Dollars In Thousands, Except Per Share Amounts)
Footnotes:
1. Share and Per Share Data have been restated for the September 29, 2016 3% stock dividend.
2. Tangible Book Value, Tangible Equity, and Return on Tangible Equity exclude goodwill and other intangible assets,
net from total equity. These are non-GAAP financial measures which we believe provide investors with information
that is useful in understanding our financial performance.
Total Stockholders' Equity (GAAP)
Less: Goodwill and Other Intangible
assets, net
Tangible Equity (Non-GAAP)
Period End Shares Outstanding
Tangible Book Value per Share (Non-
GAAP)
Net Income
Return on Tangible Equity (Net
Income/Tangible Equity - Annualized)
12/31/2016
232,852
$
9/30/2016
229,208
$
6/30/2016
225,373
$
3/31/2016
220,703
$
12/31/2015
213,971
$
$
$
24,569
208,283
13,483
15.45
6,600
$
$
24,675
204,533
13,426
15.23
6,738
$
$
24,758
200,615
13,388
14.98
6,647
$
$
24,872
195,831
13,361
14.66
6,549
$
$
24,980
188,991
13,328
14.18
6,569
12.77%
13.18%
13.47%
13.62%
13.86%
3. Net Interest Margin is the ratio of our annualized tax-equivalent net interest income to average earning assets. This
is also a non-GAAP financial measure which we believe provides investors with information that is useful in
understanding our financial performance.
Interest Income (GAAP)
Add: Tax Equivalent Adjustment
(Non-GAAP)
Interest Income - Tax Equivalent
(Non-GAAP)
Net Interest Income (GAAP)
Add: Tax-Equivalent adjustment
(Non-GAAP)
Net Interest Income - Tax Equivalent
(Non-GAAP)
12/31/2016
19,770
$
9/30/2016
19,282
$
6/30/2016
19,237
$
3/31/2016
18,626
$
12/31/2015
18,510
$
939
940
917
923
912
$
$
20,709
18,366
$
$
20,222
17,877
$
$
20,154
17,953
$
$
19,549
17,363
$
$
19,422
17,279
939
940
917
923
912
$
19,305
$
18,817
$
18,870
$
18,286
$
18,191
Average Earning Assets
Net Interest Margin (Non-GAAP)
2,446,375
2,399,197
2,373,122
2,332,707
2,317,784
3.14%
3.12%
3.20%
3.15%
3.11%
4. Financial Institutions often use the "efficiency ratio", a non-GAAP ratio, as a measure of expense control. We
believe the efficiency ratio provides investors with information that is useful in understanding our financial
performance. We define our efficiency ratio as the ratio of our noninterest expense to our net gross income (which
equals our tax-equivalent net interest income plus noninterest income, as adjusted).
5. For the current quarter, all of the regulatory capital ratios in the table above, as well as the Total Risk-Weighted
Assets and Common Equity Tier 1 Capital amounts listed in the table below, are estimates based on, and calculated
in accordance with bank regulatory capital rules. All prior quarters reflect actual results. The December 31, 2016
CET1 ratio listed in the tables (i.e., 12.92%) exceeds the sum of the required minimum CET1 ratio plus the fully
phased-in Capital Conservation Buffer (i.e., 7.00%).
Total Risk Weighted Assets
Common Equity Tier 1 Capital
Common Equity Tier 1 Ratio
12/31/2016
1,707,829
221,472
9/30/2016
1,690,646
216,382
6/30/2016
1,662,381
211,801
3/31/2016
1,617,957
207,777
12/31/2015
1,590,129
203,848
12.97%
12.80%
12.74%
12.84%
12.82%
25
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 real estate, residential real estate, and 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 for individual
commercial loans include credit quality indicators, collateral values and estimated cash flows for impaired loans. For pools of loans
we consider our historical net loss experience, and as necessary, adjustments to address current events and conditions,
considerations regarding economic uncertainty, and overall credit conditions. The historical loss factors incorporate a rolling twelve
quarter look-back period for each loan segment in order to reduce the volatility associated with improperly weighting short-term
fluctuations. The process of determining the level of the allowance for loan losses requires a high degree of judgment. Any downward
trend in the economy, regional or national, may require 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.
A. OVERVIEW
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, 2016 and our financial condition as of December 31, 2016 and 2015. 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.
Summary of 2016 Financial Results: We reported net income for 2016 of $26.5 million, an increase of $1.9 million or 7.6%
over the 2015 total. Diluted earnings per share ("EPS") for 2016 was $1.97, an increase of $0.12, or 6.5% from our 2015 EPS.
Return on average equity ("ROE") for the 2016 year continued to be strong at 11.79%, down from our ROE of 11.86% for the 2015
year. Return on average assets ("ROA") for 2016 also continued to be strong at 1.06%, an increase from an ROA of 1.05% for
2015.
The driving factor behind our increase in net income was a significant increase year-over-year in our net interest income, which
increased to $71.6 million in 2016 from $65.9 million in 2015, an 8.5% increase. Tax-equivalent net interest income (a non-GAAP
measure, see p. 4) was $75.3 million for 2016, an increase of $5.9 million or 8.5% over the $69.4 million total for 2015. This increase
in net interest income was primarily attributable to the significant amount of loan growth we experienced during the year. See our
analysis of changes in the loan portfolio beginning on page 40. Our noninterest income, including net gains (losses) on securities
transactions, decreased in 2016 by $292 thousand, or 1.0%, while our noninterest expense increased by $2.2 million, or 3.8%. The
26
increased provision for loan losses in 2016 over 2015 of $686 thousand was primarily due to the significant growth in our loan
portfolio. Asset quality measures remained strong throughout the year.
Total assets were $2.6 billion at December 31, 2016, which represented an increase of $159.1 million, or 6.5%, above the
$2.4 billion level at December 31, 2015. Virtually all asset growth was the result of organic internal growth from our existing branch
network, as opposed to acquisitions.
Total Stockholders' equity was $232.9 million at December 31, 2016, an increase of $18.9 million, or 8.8%, from the year
earlier level. The components of the change in stockholders' equity since year-end 2015 are presented in the Consolidated Statement
of Changes in Stockholders' Equity on page 59. Total book value per share increased by 7.6% over the prior year level. At
December 31, 2016, our tangible book value per share, a non-GAAP financial measure calculated based on tangible book value
(total stockholders' equity minus intangible assets including goodwill) was $15.45, an increase of $1.27, or 9.0%, over the
December 31, 2015 amount. This increase in total stockholders' equity during 2016 principally reflected the following factors: (i)
$26.5 million net income for the period, plus (ii) $3.1 million of equity received from our various stock-based compensation plans,
plus (iii) a $1.1 million increase in accumulated other comprehensive income, reduced by (iv) cash dividends of $13.1 million; and
(v) repurchases of our own common stock of $2.1 million. As of December 31, 2016, our closing stock price was $40.50, resulting
in a trading multiple of 2.62 to our tangible book value. The Board of Directors declared and the Company paid a cash dividend of
$0.243 per share for each of the first three quarters of 2016, as adjusted for a 3% stock dividend distributed September 29, 2016,
a cash dividend of $0.25 per share for the fourth quarter of 2016, and has declared a $0.25 per share cash dividend for the first
quarter of 2017.
Regulatory capital: As of December 31, 2016, we continued to exceed all regulatory minimum capital requirements at both
the holding company and bank levels, by a substantial amount. As of January 1, 2015, we became subject to revised bank regulatory
capital standards adopted in 2013 by federal bank regulatory agencies pursuant to the Dodd-Frank Act. These revised regulatory
standards generally require financial institutions to meet higher minimum capital levels, measured in new ways. The standards are
being phased in over a 5-year time period ending in 2019. See "Regulatory Capital Standards" on pages 7 and 8.
Economic trends and loan quality: During the past three years, economic activity in our market area has been generally
positive, but employment growth and average hourly wages have been less than the national average. Single family home values
in upstate New York have generally increased at a higher rate than the national average over the same period. Our nonperforming
loans were $5.5 million at December 31, 2016, a decrease of $1.4 million, or 20.4%, from year-end 2015, even with substantial
portfolio growth. The ratio of nonperforming loans to period-end loans at December 31, 2016 was 0.31%, a decrease from 0.44%
at December 31, 2015. By way of comparison, this ratio for our peer group was 0.83% at September 30, 2016 which itself was a
significant improvement for the peer group from its ratio of 3.60% at year-end 2010, and is now below 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
amounted to $1.1 million for 2016, an increase of $180 thousand from 2015. Our ratio of net charge-offs to average loans was
0.06% for 2016, compared to our peer group ratio of 0.07% for the period ended September 30, 2016. At December 31, 2016, our
allowance for loan losses was $17.0 million, representing 0.97% of total loans, a decrease of 5 basis points from the December 31,
2015 ratio.
Our major loan segments are:
Commercial Loans: These loans comprise approximately 6% of our loan portfolio. The business sector in our service
area, including small- and mid-sized businesses with headquarters in the area, continued to be in reasonably good financial
condition at period-end, and some lines of business appear to be experiencing modest improvement during the year.
Commercial Real Estate Loans: These loans comprise approximately 25% of our loan portfolio. Commercial property
values in our region have remained stable in recent periods, although it should be noted such values did not show significant
deterioration even in the worst phases of the financial crisis. 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 39% of our portfolio.
We have not experienced any significant increase in our delinquency and foreclosure rates, primarily due to the fact that
we not 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. The residential real estate market in our
service area has been stable in recent periods. If long-term interest rates, which decreased during the second quarter of
2016 before rebounding modestly during the third quarter, do not increase significantly above their period-end levels, we
may continue to experience a modest volume of mortgage refinancings. We typically sell a portion, sometimes a significant
portion, of our residential real estate mortgage originations to the secondary market, although our sales of originations as
a portion of our total originations have diminished somewhat in recent periods.
Consumer Loans (Primarily Indirect Automobile Loans): These loans comprise approximately 31% of our loan portfolio.
Throughout the past three years we did not experience any significant change in our level of charge-offs on these loans
or in our overall average delinquency rate for automobile loans. Employment in our service area continues to expand
modestly, and unemployment rates remain low, well off their post-crisis levels.
27
Liquidity and access to credit markets: We did not experience any liquidity problems or special concerns during 2016, 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 47). In general, we principally 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 overnight borrowing and term credit advances from the FHLBNY, and an additional arrangement for short-term advances at the
Federal Reserve Bank discount window). 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.
Visa Class B Common Stock: We, like other former Visa member banks, bear some indirect contingent liability for Visa's
future liability on such claims to the extent that Visa's liability 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 substantial remaining dollar amounts in Visa's escrow fund,
we determined that the balance that Visa maintains in its escrow fund is substantially sufficient to satisfy Visa's remaining direct
liability to such claims without further resort to the contingent liability of the former Visa member banks such as ours. At December 31,
2016, the Company held 45,686 shares of Visa Class B common stock. There continue to be restrictions remaining on Visa Class
B shares held by us. We continue not to recognize any economic value for these shares.
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 December 31, 2016 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, for purposes of our presentation of Selected Financial Information in this Report, including in
this Item 7, "Management's Discussion and Analysis of Financial Conditions and Results of Operations," we calculate net interest
income on a tax-equivalent basis, producing a non-GAAP financial measure. For our 2016 adjustment, we used a marginal tax
rate of 35%. See the discussion and calculation of our 2016 tax equivalent net interest income and net interest margin on page 4
of this Report.
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
2016
$ 80,636
5,356
$ 75,280
2015
$ 74,227
4,813
$ 69,414
2014
$ 70,188
5,767
$ 64,421
Amount
6,409
$
543
5,866
$
Amount
4,039
(954)
4,993
$
8.6% $
11.3
8.5
5.8%
(16.5)
7.8
2015 to 2016
%
2014 to 2015
%
On a tax-equivalent basis, net interest income was $75.3 million in 2016, an increase of $5.9 million, or 8.5%, from $69.4 million
in 2015. This compared to an increase of $5.0 million, or 7.8%, from 2014 to 2015. 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:
Interest-Bearing Checking Accounts
Savings Deposits
Time Deposits of $100,000 or More
Other Time Deposits
Total Deposits
Short-Term Borrowings
Long-Term Debt
Total Interest Expense
2016 Compared to 2015 Change in
Net Interest Income Due to:
2015 Compared to 2014 Change in
Net Interest Income Due to:
Volume
Rate
Total
Volume
Rate
Total
$
(26) $
85
$
59
$
12
$
2
$
14
(199)
306
6,808
6,889
3
86
60
(38)
111
182
203
496
88
91
(744)
(480)
—
104
37
(46)
95
83
(131)
47
(111)
397
6,064
428
(536)
5,455
(337)
731
(1,716)
91
195
3,739
6,409
5,359
(1,320)
4,039
3
190
97
(84)
206
265
72
543
103
50
(102)
(170)
(119)
44
797
722
(549)
(148)
(312)
(442)
(1,451)
17
(242)
(1,676)
(446)
(98)
(414)
(612)
(1,570)
61
555
(954)
Net Interest Income
$
6,393
$
(527) $
5,866
$
4,637
$
356
$
4,993
29
The following table reflects the components of our net interest income, setting forth, for years ended December 31, 2016, 2015
and 2014: (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, net interest income and interest rate information is presented on a tax-equivalent basis, using
a marginal tax rate of 35% (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:
2016
Interest
Rate
Income/
Earned/
Expense
Paid
Average
Balance
2015
Interest
Rate
Income/
Earned/
Expense
Paid
Average
Balance
2014
Interest
Rate
Income/
Earned/
Expense
Paid
Average
Balance
$
24,950
$
153
0.61% $
32,562
$
94
0.29% $
28,266
$
80
0.28%
Fully Taxable
420,885
7,950
1.89%
431,445
8,061
1.87%
408,989
7,970
1.95%
Exempt from Federal
Taxes
Loans
Total Earning Assets
Allowance for Loan Losses
Cash and Due From Banks
Other Assets
Total Assets
Deposits:
278,982
1,663,225
2,388,042
(16,449)
33,207
108,845
$ 2,513,645
Interest-Bearing Checking
Accounts
Savings Deposits
$ 912,461
616,208
69,489
129,084
1,727,242
94,109
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
9,187
63,346
80,636
8,790
57,282
74,227
3.29%
269,667
3.81% 1,484,766
3.38% 2,218,440
(15,595)
31,007
107,615
$ 2,341,467
3.26%
286,929
3.86% 1,344,427
3.35% 2,068,611
(14,801)
30,383
106,287
$ 2,190,480
8,595
53,543
70,188
3.00%
3.98%
3.39%
1,279
931
453
658
3,321
393
0.14% $ 915,565
0.15%
554,330
0.65%
0.51%
59,967
136,396
0.19% 1,666,258
0.42%
45,595
1,276
741
356
742
3,115
128
0.14% $ 861,457
0.13%
521,595
0.59%
0.54%
70,475
158,592
0.19% 1,612,119
0.28%
29,166
1,722
839
770
1,354
4,685
67
0.20%
0.16%
1.09%
0.85%
0.29%
0.23%
75,000
1,642
2.19%
66,014
1,570
2.38%
34,000
1,015
2.99%
1,896,351
5,356
0.28% 1,777,867
4,813
0.27% 1,675,285
5,767
0.34%
366,956
25,369
2,288,676
224,969
329,017
26,566
2,133,450
208,017
290,922
26,065
1,992,272
198,208
$ 2,513,645
$ 2,341,467
$ 2,190,480
75,280
69,414
64,421
(3,721)
0.16%
(3,489)
0.16%
(3,327)
0.16%
$ 71,559
$ 65,925
$ 61,094
3.10%
3.15%
3.08%
3.13%
3.05%
3.11%
30
CHANGES IN NET INTEREST INCOME DUE TO RATE
YIELD ANALYSIS (Tax-equivalent basis)
2016
Yield on Earning Assets
Cost of Interest-Bearing Liabilities
Net Interest Spread
Net Interest Margin
2014
December 31,
2015
3.35% 3.39%
0.27
3.08% 3.05%
3.13% 3.11%
0.34
3.38%
0.28
3.10%
3.15%
Our increase in net interest income on a tax-equivalent basis (a non-GAAP measure, see discussion on p. 4) from 2015 to
2016 was $5.9 million, or 8.5%, which continued the trend of increasing net interest income experienced by us in 2015 and 2014.
These increases were similar to increases in our average earning assets during the respective year aided in 2016 by a continued
slight increase in our net interest margin.
During 2016, our net interest margin (NIM) increased two basis points, as our yield on earning assets increased more than our
cost of interest bearing liabilities. Our NIM has continued to increase as we have repositioned our asset portfolio in favor of loans
versus investment securities. While our continued loan growth has been the primary driver for maintaining a stable NIM for the
past three years, our increased ratio of non-interest-bearing demand deposits to total deposits has helped limit the increase in our
cost of funds. We can give no assurances regarding our NIM in 2017 or following periods, even though the Fed has raised short
term rates in December of each of the last two years and has signaled the markets that additional rate increases are likely in 2017.
We continue to believe that the Fed will be extremely cautious in following through on additional rate increases in future periods.
Our existing, higher-rate assets continue to mature and pay off at a faster pace than we originate new loans (at slightly higher
rates) and purchase new investment securities (at slightly higher rates). As a result, we may continue to experience margin
compression in upcoming periods, even if prevailing rates ascend slowly. In this light, no assurances can be given that our net
interest income will increase in 2017 and subsequent periods, even if asset growth continues or increases, or that net earnings will
continue to grow.
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."
CHANGES IN NET INTEREST INCOME DUE TO VOLUME
AVERAGE BALANCES
(Dollars In Thousands)
Years Ended December 31,
Change From Prior Year
Earning Assets
2016
2015
$ 2,388,042
$ 2,218,440
Interest-Bearing Liabilities
1,896,351
1,777,867
Demand Deposits
Total Assets
366,956
329,017
2,513,645
2,341,467
2015 to 2016
2014 to 2015
2014
$ 2,068,611
1,675,285
290,922
2,190,480
Amount
$ 169,602
118,484
37,939
172,178
%
Amount
%
7.6% $ 149,829
102,582
6.7
11.5
38,095
7.4
150,987
7.2%
6.1
13.1
6.9
Earning Assets to Total Assets
95.00%
94.75%
94.44%
2016 Compared to 2015: In general, an increase in average earning assets has a positive impact on net interest income. For
2016, average earning assets increased $169.6 million or 7.6% over 2015, while average interest-bearing liabilities increased
$118.5 million, or 6.7%, and non-interest bearing demand deposits increased $37.9 million or 11.5%. The growth in our net earning
assets and demand deposits were the primary factors in the $5.9 million, or 7.8%, increase in our net interest income in 2016 (on
a tax-equivalent basis).
An underlying factor in our net asset growth in 2016, and the resulting increase in our net interest income, was a positive
change in the mix of our earning assets. The $169.6 million increase in average earning assets from 2015 to 2016 resulted from
the average balance of our securities portfolio remaining virtually unchanged, while the average balance of our total loans increased
substantially. Within the loan portfolio, our three principal segments are residential real estate loans, automobile loans (primarily
through our indirect lending program) and commercial loans. We continued to sell a portion of our residential real estate loan
originations into the secondary market in 2016, approximately 16% of our originations. Additionally, we originated a higher volume
of residential mortgages in 2016 than in the prior two years and as a result, we experienced a significant increase in the average
balance of this segment of the portfolio in 2016. The average balance of our automobile loan portfolio also increased in 2016,
reflecting continuing strong demand in automobile sales 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 2016.
The $118.5 million increase in average interest-bearing liabilities during 2016 was primarily attributable to an increase in deposits
from our existing branch network and secondarily to a $41 million increase in our FHLBNY advances.
31
2015 Compared to 2014: For 2015, average earning assets increased $149.8 million or 7.2% over 2014, while average interest-
bearing liabilities increased $102.6 million, or 6.1%. The growth in our net earning assets was the primary factor in the $4.7 million,
or 7.2%, increase in our net interest income in 2015 (on a tax-equivalent basis).
An underlying factor in our net asset growth in 2015, and the resulting increase in our net interest income, was a positive
change in the mix of our earning assets. The $149.8 million increase in average earning assets from 2014 to 2015 resulted from a
slight increase in the average balance of our securities portfolio, while the average balance of our total loans increased substantially.
Within the loan portfolio, our three principal segments are residential real estate loans, automobile loans (primarily through our
indirect lending program) and commercial loans. We sold a portion of our residential real estate loan originations into the secondary
market in 2015, but such sales were a significantly smaller percentage of our originations than in either of the prior two years.
Additionally, we originated a higher volume of residential mortgages in 2015 than in the prior two years. As a result, we experienced
a significant increase in the average balance of this segment of the portfolio in 2015. The average balance of our automobile loan
portfolio also increased in 2015, reflecting continuing strong demand in automobile sales 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 2015.
The $102.6 million increase in average interest-bearing liabilities during 2015 was primarily attributable to an increase in
deposits from our existing branch network and secondarily to a $49 million increase in our FHLBNY advances.
32
II. PROVISION FOR LOAN LOSSES AND ALLOWANCE FOR LOAN LOSSES
We consider our accounting policy relating to the allowance for loan losses to be a critical accounting policy, given the uncertainty
involved in evaluating the level of the allowance required to cover credit losses inherent in the loan portfolio, and the material effect
that such judgments may have on our results of operations. We recorded a $2.0 million provision for loan losses for 2016, compared
to the $1.3 million provision for 2015. The level of the 2016 provision was impacted primarily by the significant growth in loan
balances during 2016. Our analysis of the method we employ 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
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 Charge-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
2016
$1,753,268
1,663,225
2015
$1,573,952
1,484,766
2014
$1,413,268
1,344,427
2013
$1,266,472
1,208,954
2012
$1,172,341
1,147,286
2,605,242
2,446,188
2,217,420
2,163,698
2,022,796
$
$
875
155
2,574
589
4,193
1,201
106
5,500
101
1,585
7,186
16,038
(97)
(195)
(107)
(871)
(1,270)
23
—
6
182
211
(1,059)
$
$
2,402
387
3,195
449
6,433
187
286
6,906
140
1,878
8,924
15,570
(62)
(7)
(326)
(711)
(1,106)
33
—
—
194
227
(879)
$
$
2,071
473
3,940
415
6,899
537
333
7,769
81
312
8,162
14,434
(212)
—
(91)
(718)
(1,021)
86
—
—
223
309
(712)
$
$
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)
2,033
1,347
1,848
200
845
$
17,012
$
16,038
$
15,570
$
14,434
$
15,298
0.06%
0.12%
0.97%
309.31%
0.31%
0.28%
0.06%
0.09%
1.02%
232.24%
0.44%
0.36%
0.05%
0.14%
1.10%
200.41%
0.55%
0.37%
0.09%
0.02%
1.14%
185.71%
0.61%
0.37%
0.05%
0.07%
1.30%
190.37%
0.69%
0.45%
33
ALLOCATION OF THE ALLOWANCE FOR LOAN LOSSES
(Dollars in Thousands)
Commercial Loans
Real Estate-Commercial
Real Estate-Residential
Consumer Loans
Unallocated
Total
2016
2015
2014
2013
2012
$
$
1,017
5,677
4,198
6,120
—
$
1,827
4,520
3,790
5,554
347
$
2,382
3,846
3,369
5,210
763
$
2,303
3,545
3,026
4,478
1,082
2,945
3,050
3,405
4,840
1,058
$
17,012
$
16,038
$
15,570
$
14,434
$
15,298
The allowance for loan losses increased to $17.0 million at year-end 2016 from $16.0 million at year-end 2015, an increase
of 6.1%. However, the loan portfolio increased at an even faster rate during 2016 (the portfolio at year-end 2016 was up by 11.4%
compared to year-end 2015), with the result that the allowance for loan losses as a percentage of period-end total loans declined
to 0.97% at year-end 2016 from 1.02% at year-end 2015, a decrease of 4.90%.
A variety of factors were considered in evaluating the adequacy of the allowance for loan losses at December 31, 2016 and
the provision for loan losses for the year, including:
Factors leading to an increase in the provision for loan losses:
Loan growth in all three major portfolio segments (commercial, automobile and residential real estate)
A small increase in classified construction and commercial real estate loans
A slight increase in the historical loss factor for commercial real estate and automobile loans
•
•
•
• Modest increases in the qualitative factors for automobile and other consumer loans
Factors leading to a decrease in the provision for loan losses:
•
•
A decrease in the historical loss factor for commercial loans
A general decrease in most qualitative factors for certain loan segments, primarily for the commercial loan segment (related
to the nature and volume of the portfolio and loan terms), but also for the residential real estate loan segment (related to
a general improvement in collateral values).
See Note 5 to our audited financial statements for a complete list of all the factors used to calculate the provision for loan
losses, including the factors that did not change during the year.
Most of our adversely classified loans (special mention and substandard - see our definition for these classifications in Note 5
to our audited financial statements) continued to perform under their contractual terms. The decrease in nonaccrual and impaired
loans from 2015 to 2016 was primarily due to just two loans: one transferred to other real estate owned, and one that paid-off during
2016.
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 (losses) on securities transactions and other recurring
fee income.
ANALYSIS OF NONINTEREST INCOME
(Dollars In Thousands)
Income from Fiduciary Activities
$
Fees for Other Services to Customers
Insurance Commissions
Net (Loss) Gain on Securities Transactions
Net Gain on Sales of Loans
Other Operating Income
Total Noninterest Income
Years Ended December 31,
Change From Prior Year
2015 to 2016
2014 to 2015
2016
2015
2014
Amount
%
7,783
9,469
8,668
(22)
821
1,113
$
7,762
9,220
8,967
129
692
1,354
$ 28,124
$
7,468
9,261
9,455
110
784
1,238
$ 28,316
$
$
21
249
(299)
(151)
129
(241)
(292)
$ 27,832
0.3% $
2.7
(3.3)
(117.1)
18.6
(17.8)
(1.0)
Amount
294
(41)
(488)
19
(92)
116
(192)
$
%
3.9%
(0.4)
(5.2)
17.3
(11.7)
9.4
(0.7)
2016 Compared to 2015: Total noninterest income in 2016 was $27.8 million, a decrease of $292 thousand, or 1.0%, from
total noninterest income of $28.1 million for 2015. Sales of securities resulted in a loss of $22 thousand in 2016 compared to a
gain of $129 thousand in 2015, a net decrease of $151 thousand. Net gains on the sales of loans increased in 2016 to $821
thousand, from $692 thousand in 2015, an increase of $129 thousand, or 18.6%. Income from fiduciary activities increased from
2015 to 2016, by $21 thousand and insurance commissions decreased by $299 thousand, or 3.3% from 2015 to 2016, and other
operating income decreased by $241 thousand, or 17.8% between the two years.
34
Assets under trust administration and investment management at December 31, 2016 were $1.301 billion, an increase of $68.5
million, or 5.6%, from the prior year-end balance of $1.233 billion. Income from fiduciary services for 2016 increased by $21
thousand, or 0.3% above the total for 2015. Much of the increase in balance of assets under trust administration and investment
management was attributable to activity late in the third quarter, primarily in response to market performance. In addition, a significant
portion of the current year's growth was derived from increased custodial accounts which are business lines that generate lower
fee income as a percentage of assets under management.
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
$8.5 million for 2016, an increase of $249 thousand, or 2.7%, from 2015. The principal cause of the increase was an increase in
income from debit card transactions, offset in part by a decline in fee income from service changes on deposit accounts and overdraft
fee income. In 2011, VISA reduced its debit interchange rates to comply with new Debit Charges Regulatory Requirements issued
by the Federal Reserve Board. In subsequent years, this reduced rate structure imposed on large banks has resulted in smaller
banks like ours reducing rates as well, for competitive reasons, which has negatively impacted 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 that in most subsequent periods has largely offset or more than offset the negative impact of lower
rates.
Noninterest income from insurance commissions decreased by $299 thousand, or 3.3%, between the two periods. This net
decrease was primarily attributable to our sale in October 2015 of a specialty line of insurance business previously maintained by
one of our insurance agency subsidiaries, specifically, insurance services to out-of-market amateur sports management associations
(see "Sale of Loomis Agency" below) which was partially offset by an increase in the contingent annual payments we receive based
on the loss experience of our property and casualty insurance clients. We expect that income from insurance commissions will
continue to constitute a significant and stable source of noninterest income for us in upcoming periods. We may continue in the
future to expand our market profile in this line of business, including through suitable acquisitions, if favorable opportunities should
arise.
Net gains on sales of loans amounted to $821 thousand during 2016 an increase of $129 thousand or 18.6% over the 2015
level. This reflects a similar percentage increase in total loans sold between the two years, which increased from $21.1 million in
2015 to $25.0 million in 2016, an 18.7% increase. The rate at which we sell mortgage loan originations in future periods will depend
on various circumstances, including prevailing mortgage rates, other lending opportunities, capital and liquidity needs, and the
ready availability of a market for such sales. We are unable to predict what our retention rate of such loans in future periods may
be, although our retention rates have increased in each of the last 3 years, as the long-term decline in mortgage rates has bottomed
out and rates have stabilized. We generally retain servicing rights for loans originated and sold by us, which also 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.
2015 Compared to 2014: Total noninterest income in 2015 was $28.1 million, a decrease of $192 thousand, or 0.7%, from
total noninterest income of $28.3 million for 2014. Net gains on the sales of securities increased in 2015 to $129 thousand from
$110 thousand in 2014, a net increase of $19 thousand or 17.3%, and net gains on the sales of loans decreased in 2015 to $692
thousand, from $784 thousand in 2014, a decrease of $92 thousand, or 11.7%. Income from fiduciary activities and other operating
income both increased from 2014 to 2015, by $294 thousand and $116 thousand, respectively, while insurance commissions, net
gains on the sale of loans and fees for other services to customers decreased from 2014 to 2015, by $488 thousand, $92 thousand
and $41 thousand, respectively.
Assets under trust administration and investment management at December 31, 2015 were $1.233 billion, up from the prior
year-end balance of $1.227 billion. Largely as a result of such increase our income from fiduciary services for 2015 increased by
$294 thousand, or 3.9%, above the total for 2014. 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 or bond 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
$9.2 million for 2015, a decrease of $41 thousand, or .4%, from 2014. The principal cause of the decrease was decline in fee
income from service charges on deposit accounts and overdraft fee income, offset in part by an increase in income from debit card
transactions. Debit card usage by our customers continues to grow, which has had a positive impact on our debit card fee income.
Noninterest income from insurance commissions decreased by $488 thousand, or 5.2%, between the two periods. The decrease
was primarily attributable to a change in the contingent annual payments we receive based on the loss experience of our customers,
and to a lesser extent by our sale, in October 2015, of a specialty line of insurance business previously maintained by one of our
insurance agency subsidiaries, specifically, insurance services to out-of-market amateur sports management associations. See
"Sale of Loomis Agency", below. We expect that income from insurance commissions will continue to constitute a significant and
stable source of noninterest income for us in upcoming periods. We may continue in the future to expand our market profile in this
line of business, including through suitable acquisitions, if favorable opportunities should arise.
As noted above, our net gains on sales of loans decreased significantly, by 11.7%, between 2014 and 2015. Moreover, because
our total mortgage loan originations increased significantly between the two years, loan sales as a percentage of our total originations
decreased by an even higher percentage between the two years. Correspondingly, our retention rate of originations increased
between 2014 and 2015.
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. Included in other operating income for 2015 were a net gain on the sale of one of our
35
insurance agency subsidiaries ($204 thousand) and net gains recognized in our investment in limited partnerships ($260 thousand),
offset in part, by the write-down of a bank-owned property ($404 thousand), which we transferred into other real estate owned and
held for sale in the fourth quarter of 2015.I
Sale of Loomis Agency. In October 2015 we sold 100% of the stock of one of our wholly-owned subsidiary insurance agencies,
Loomis and LaPann ("Loomis"), to a local insurance agency headquartered in Glens Falls, NY. Historically, Loomis specialized in
servicing sports accident and health insurance needs of customers primarily located outside of New York State, and in addition
sold property and casualty insurance in our local market area. Before selling Loomis, we transferred most of its property and
casualty insurance accounts to another of our subsidiary insurance agencies.
IV. NONINTEREST EXPENSE
Noninterest expense is the measure of the delivery cost of services, products and business activities of a company. The key
components of noninterest expense are presented in the following table.
ANALYSIS OF NONINTEREST EXPENSE
(Dollars In Thousands)
Salaries and Employee Benefits
Occupancy Expense of Premises, Net
Furniture and Equipment Expense
FDIC Regular Assessment
Amortization of Intangible Assets
Other Operating Expense
Total Noninterest Expense
Years Ended December 31,
Change From Prior Year
2015 to 2016
2014 to 2015
2016
$ 34,330
4,983
4,419
1,076
297
2015
$ 33,064
5,005
4,262
1,186
327
2014
$ 30,941
4,898
4,092
1,117
387
14,504
13,586
12,593
Amount
$ 1,266
(22)
157
(110)
(30)
918
$ 59,609
$ 57,430
$ 54,028
$ 2,179
3.8
%
Amount
3.8% $ 2,123
107
(0.4)
3.7
(9.3)
(9.2)
6.8
69
(60)
993
$ 3,402
170
%
6.9%
2.2
4.2
6.2
(15.5)
7.9
6.3
1.2
Efficiency Ratio
57.51%
58.62%
57.91%
(1.11)%
(1.9)
0.71%
2016 compared to 2015: Noninterest expense for 2016 amounted to $59.6 million, an increase of $2.2 million, or 3.8%, from
2015. For 2016, our efficiency ratio was 57.51%. 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 any FHLB prepayment
penalties) 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.”
Our efficiency ratios in recent periods compared favorably to the ratios of our peer group. For the nine month period ended
September 30, 2016, our peer group ratio (as calculated by the Federal Reserve Bank's most recently available report) was 67.14%,
compared to our ratio for such period (not adjusted) of 57.15%.
Salaries and employee benefits expense, which typically represents between 55% and 60% of total noninterest expense,
increased by $1.3 million, or 3.8%, from 2015 to 2016. The net increase reflects a 2.9% increase in employee benefits, including
increases in expenses related to our defined benefit pension and post retirement plans, health benefit plans and incentive
compensation plans. Salary expenses increased by 4.2% and were attributable to increased staffing levels as we expanded in our
southern market area and to normal salary increases.
Occupancy expense remained consistent while furniture and equipment expenses increased modestly from 2015 to 2016. The
increase in equipment expense was primarily attributable to increased data processing costs.
Other operating expense increased $918.0 thousand, or 6.8%, from 2015. This was primarily the result of an increase in the
cost of providing our customers with a wide and more complex variety of electronic banking products and services.
2015 compared to 2014: Noninterest expense for 2015 amounted to $57.4 million, an increase of $3.4 million, or 6.3%, from
2014. For 2015, our efficiency ratio was 58.09%. 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. See the discussion of the efficiency ratio on page
4 of this Report under the heading “Use of Non-GAAP Financial Measures” and in the current period paragraph above. For the
nine-month period ended September 30, 2015, our peer group ratio (as calculated by the Federal Reserve Bank's most recently
available report) was 68.6%, compared to our ratio for such period (not adjusted) of 58.4%.
Salaries and employee benefits expense, which typically represents between 55% and 60% of total noninterest expense,
increased by $2.1 million, or 6.9%, from 2014 to 2015. The net increase reflects a 10.2% increase in employee benefits, including
increases in expenses related to our defined benefit pension and post retirement plans, health benefit plans and incentive
compensation plans. Salary expenses increased by 5.7% and were attributable to increased staffing levels as we expanded in our
southern market area and to normal salary increases.
Both building and equipment expenses increased modestly from 2014 to 2015. For buildings, the increase was primarily
attributable to increases in maintenance and net rental expense, while the increase in equipment expense was primarily attributable
to increased data processing costs.
36
Other operating expense increased $993.0 thousand, or 7.9% from 2014. This was primarily the result of an increase in
outsourced third party providers, including operating costs to implement an Enterprise Performance Management (EPM) system.
In addition, during 2015 there were increased legal and professional fees and an increase in the cost of providing our customers
with a wide and more complex variety of electronic banking products and services.
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
2016
$ 11,215
2015
$ 10,610
2014
$ 10,174
29.7%
30.1%
30.3%
2015 to 2016
%
5.7 % $
(1.3)%
Amount
605
$
(0.4)%
2014 to 2015
%
4.3 %
(0.7)%
Amount
436
(0.2)%
The provisions for federal and state income taxes amounted to $11.2 million for 2016, $10.6 million for 2015, and $10.2 million for
2014. The effective income tax rates for 2016, 2015 and 2014 were 29.7%, 30.1% and 30.3%, respectively. The changes reflect
fluctuations in the ratio 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 2016, 2015 and 2014, we held no trading securities. Set
forth below is certain information about our securities available-for-sale portfolio and securities held-to-maturity portfolio as of recent
year-ends.
Securities Available-for-Sale:
The following table sets forth the carrying value of our securities available-for-sale portfolio at year-end December 31, 2016,
December 31, 2015 and December 31, 2014.
SECURITIES AVAILABLE-FOR-SALE
(In Thousands)
U.S. Government & Agency Obligations
State and Municipal Obligations
Mortgage-Backed Securities - Residential
Corporate and Other Debt Securities
Mutual Funds and Equity Securities
Total
2016
$ 147,377
27,690
167,239
3,308
1,382
$ 346,996
December 31,
2015
$ 155,782
52,408
178,588
14,299
1,232
$ 402,309
2014
$ 137,603
81,730
128,827
16,725
1,254
$ 366,139
In all periods, Mortgage-Backed Securities-Residential consisted solely of mortgage pass-through securities and Collateralized
Mortgage Obligations ("CMOs") issued or guaranteed by U.S. federal agencies. Mortgage pass-through securities provide to the
investor monthly portions of principal and interest pursuant to the contractual obligations of the underlying mortgages. CMOs are
pools of mortgage-backed securities, the repayments on which have been separated into two or more components (tranches),
where each tranche has a separate estimated life and yield. Our practice has been to purchase only pass-through securities and
CMOs that are issued or guaranteed by U.S. federal agencies, and the tranches of CMOs that we purchase generally are those
having shorter maturities. Included in our Corporate and Other Debt Securities for each of the periods are corporate bonds that
were highly rated (i.e., investment grade) at the time of purchase, although in some cases the securities had been downgraded
before the reporting date, but were still investment grade.
37
The following table sets forth the maturities of the debt securities in our available-for-sale portfolio as of December 31, 2016.
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. Government & Agency Obligations
State and Municipal Obligations
Mortgage-Backed Securities - Residential
Corporate and Other Debt Securities
Total
Within
One
Year
—
16,994
5,753
2,508
25,255
After
1 But
Within
5 Years
147,377
9,628
100,447
—
257,452
After
5 But
Within
10 Years
—
508
61,039
—
61,547
After
10 Years
—
560
—
800
1,360
Total
147,377
27,690
167,239
3,308
345,614
The following table sets forth the tax-equivalent yields of the debt securities in our available-for-sale portfolio at December 31,
2016.
YIELDS ON SECURITIES AVAILABLE-FOR-SALE
(Fully Tax-Equivalent Basis)
U.S. Government & Agency Obligations
State and Municipal Obligations
Mortgage-Backed Securities - Residential
Corporate and Other Debt Securities
Total
Within
One
Year
—%
1.40
2.48
0.95
1.60
After
1 But
Within
5 Years
After
5 But
Within
10 Years
After
10 Years
Total
1.51%
2.15
2.06
—
1.75
—%
—%
7.25
2.32
—
2.36
8.14
—
3.59
5.22
1.51%
1.90
2.17
1.70
1.86
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, 2016.
At December 31, 2016 and 2015, the weighted average maturity was 3.4 and 2.8 years, respectively, for debt securities in the
available-for-sale portfolio.
At December 31, 2016, the net unrealized losses on securities available-for-sale amounted to $619 thousand. The net
unrealized gain or loss on such securities, net of tax, is reflected in accumulated other comprehensive income/loss. For 2016, the
net unrealized losses were primarily attributable to an average increase in market rates between the date of purchase and the
balance sheet date, resulting in lower valuations of the portfolio securities. The net unrealized gains on securities available-for-
sale was $1.0 million at December 31, 2015. For both periods, the net unrealized gain was primarily attributable to an average
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.
38
Securities Held-to-Maturity:
The following table sets forth the carrying value of our portfolio of securities held-to-maturity at December 31 of each of the
last three years.
SECURITIES HELD-TO-MATURITY
(In Thousands)
State and Municipal Obligations
Mortgage Backed Securities - Residential
Corporate and Other Debt Securities
Total
2016
December 31,
2015
$
$
268,892
75,535
1,000
345,427
$
$
226,053
93,558
1,000
320,611
$
$
2014
188,472
112,552
1,000
302,024
For a description of certain categories of securities held in the securities held-to-maturity portfolio on the reporting dates, as
listed in the table above, specifically, "Mortgage-Backed Securities--Residential" and "Corporate and Other Debt Securities," see
the paragraph under "SECURITIES AVAILABLE-FOR-SALE" table, above.
For information regarding the fair value of our portfolio of securities held-to-maturity at December 31, 2016, 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, 2016.
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
32,456
$
—
1,000
33,456
$
After 1 But
Within 5
Years
$
86,070
61,712
—
$ 147,782
After 5 But
Within 10
Years
$ 146,603
13,823
—
$ 160,426
After
10 Years
$
$
3,763
—
—
3,763
Total
$ 268,892
75,535
1,000
$ 345,427
The following table sets forth the tax-equivalent yields of our portfolio of securities held-to-maturity at December 31, 2016.
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
2.52%
—
7.00
2.52%
4.09%
2.21
—
2.38%
2.90%
2.57
—
2.65%
4.47%
—
—
5.00%
Total
3.26%
2.28%
7.00%
2.56%
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, 2016. 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%.
At December 31, 2016 and 2015, the weighted average maturity was 4.3 and 3.8 years, respectively, for the debt securities in
the held-to-maturity portfolio.
39
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)
2016
2015
December 31,
2014
2013
2012
Amount
%
Amount
%
Amount
%
Amount
%
Amount
%
Commercial
Commercial Real Estate –
Construction
Commercial Real Estate –
Other
Consumer
Residential Real Estate
$
105,155
36,948
394,698
537,361
679,106
6
2
23
31
39
$
102,587
31,018
353,921
464,523
621,903
7
2
22
29
40
Total Loans
1,753,268
100
1,573,952
100
$
99,511
18,815
321,297
437,041
536,604
1,413,268
7
1
23
31
38
100
$
87,893
27,815
288,119
401,853
460,792
1,266,472
7
2
23
32
36
$
105,536
29,149
245,177
355,784
436,695
9
2
21
31
37
100
1,172,341
100
Allowance for Loan Losses
(17,012)
(16,038)
(15,570)
(14,434)
(15,298)
Total Loans, Net
$ 1,736,256
$ 1,557,914
$ 1,397,698
$ 1,252,038
$ 1,157,043
Maintenance of High Quality in the Loan Portfolio: For many reasons, including our credit underwriting standards and our
market stability, we largely avoided the negative impact on asset quality that many other banks suffered during and after the
2008-2009 financial crisis. From the start of the crisis through the date of this Report, we did not experience 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 have not 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 justified doing so, or have had extensions of credit outstanding
to borrowers who 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 many other areas of the U.S. did, 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 in which identifying opportunities for secure and profitable expansion
of our loan portfolio remains challenging, competition is intense, and margins are very tight. If the U.S. economy and our regional
economy continue to experience only very modest growth, our individual borrowers will presumably continue to proceed cautiously
in taking on new or additional debt. Many small businesses are operating on very narrow margins and many families continue to
live on very tight budgets. If the U.S. economy or our regional economy worsens in upcoming periods, 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 39% of the entire portfolio at December 31, 2016), eclipsing both
other consumer loans (31% of the portfolio) and our commercial and commercial real estate loans (31%). Our gross originations
for residential real estate loans (including refinancings of mortgage loans) were $153.6 million, $144.2 million and $131.2 million
for the years 2016, 2015, and 2014, respectively. During each of these years, these gross 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 originations in the secondary market, primarily to Freddie Mac, particularly when rates on conventional 30-year
fixed rate real estate mortgages reached historically low levels in the 2013-2014 period. Sales of originations amounted to $25.0
million for 2016, $21.1 million for 2015 and $29.8 million for 2014, which represented a significant percentage of the gross originations
in each year (16.3%, 14.6% and 22.7%, respectively). We expect to continue to sell a portion of our mortgage loan originations in
upcoming periods, although perhaps a decreasing percentage of overall originations if rates continue their slow rise across longer
maturities. At the same time, if prevailing rates rise substantially, we may see a slowdown in loan growth and perhaps decreasing
total originations, particularly if the general economy also falters. At some point, it is possible that we may experience a decrease
in our outstanding balances in this largest segment of our portfolio. Additionally, if our local economy or real estate market should
suffer a major downturn, the quality of our real estate portfolio may also be negatively impacted.
The Federal Reserve wound down its quantitative easing program in 2014. Although it was expected that the winding down
process might lead to, or accompany, a general rise in long-term mortgage loan rates, the 30-year and 15-year rates have not
experienced any significant increase, and have in some markets actually decreased, in ensuing periods. While economic conditions
have generally improved, which led in part to the Fed's decision to terminate its quantitative easing program in 2014, management
40
is not able to predict at this point when, or if, mortgage rates or interest rates generally will experience a meaningful and substantial
increase, 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 future periods.
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. Particularly over the last three years, commercial and commercial real
estate loan growth was significant as outstanding balances increased by $49.3 million, $47.9 million, and $35.8 million in 2016,
2015 and 2014, respectively. 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 or FHLBNY rates. Although
on a national scale the commercial real estate market suffered a major downturn in the 2008-2009 period (from which it has largely
recovered), we did not experience any significant weakening in the quality of our commercial loan portfolio even in the depths of
the crisis, nor have we in the subsequent years.
However, 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. But at period-end 2016, the business sector, at least
in our service area, appeared to be in reasonably good financial condition.
Automobile Loans (primarily through indirect lending): At December 31, 2016, our automobile loans (primarily loans
originated through dealerships located primarily in upstate New York and Vermont) represented nearly a third of loans in our portfolio,
and continue to be a significant component of our business.
During recent years. including 2016, there was a nationwide resurgence in automobile sales, due initially to an aging fleet but
more recently to a modest growth in consumer optimism. Our automobile loan origination volume for the last three years was very
strong at $286.7 million, $228.8 million and $222.9 million for 2016, 2015 and 2014, respectively.
Our indirect automobile loan portfolio reflects a modest shift to a slightly larger (but still very small in absolute terms) percentage
of such loans that have been extended to individuals with lower credit scores matching a widely noted recent development auto
lending generally. In addition, our average maturity for automobile loan originations has expanded in recent years as well, again
reflective of a larger market development. In 2016, net charge-offs on our automobile loans remained very low. at 0.13% of average
balances. Net charge-offs were $662 thousand for 2016 compared to net charge-offs of $498 thousand for 2015, an increase that
reflected this modest shift in the quality of the portfolio noted above. Our experienced lending staff not only utilizes credit evaluation
software tools but also reviews and evaluates each loan individually prior to the loan being funded. We believe our disciplined
approach to evaluating risk has contributed to maintaining our strong loan quality in this portfolio. However, if weakness in auto
demand returns, our portfolio is likely to experience limited, if any, overall growth, either in absolute amounts or as a percentage of
the total portfolio, regardless of whether the auto company affiliates are offering highly-subsidized loans. If demand levels off, or
slackens, so will our financial performance in this important loan category.
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)
12/31/2016
9/30/2016
Quarters Ended
6/30/2016
3/31/2016
12/31/2015
Commercial and Commercial Real Estate
$
532,456
$
524,523
$
519,775
$
502,392
$
495,173
Residential Real Estate
Home Equity
Consumer Loans1
Total Loans
490,427
135,939
567,916
$ 1,726,738
470,865
133,009
462,253
131,513
451,330
130,227
438,987
128,085
552,454
$ 1,680,851
535,860
$ 1,649,401
511,069
$ 1,595,018
493,989
$ 1,556,234
Percentage of Total Quarterly Average Loans
Commercial and Commercial Real Estate
Residential Real Estate
Home Equity
Consumer Loans1
Total Loans
Quarters Ended
12/31/2016
9/30/2016
6/30/2016
3/31/2016
12/31/2015
30.8%
28.4
7.9
32.9
100.0%
31.2%
28.0
7.9
32.9
100.0%
31.5%
28.0
8.0
32.5
100.0%
31.5%
28.3
8.2
32.0
100.0%
31.8%
28.2
8.2
31.8
100.0%
41
Quarterly Tax-Equivalent Yield on Loans
Commercial and Commercial Real Estate
Residential Real Estate
Home Equity
Consumer Loans1
Total Loans
Quarters Ended
12/31/2016
9/30/2016
6/30/2016
3/31/2016
12/31/2015
4.29%
4.09
3.11
3.18
3.78%
4.28%
4.20
3.13
3.19
3.82%
4.44%
4.22
3.08
3.18
3.86%
4.32%
4.22
3.05
3.17
3.82%
4.37%
4.21
2.92
3.19
3.83%
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 40, captioned “Types of Loans.”
During the fourth quarter of 2016, the average yield on our loan portfolio from the average yield during the fourth quarter of
2015, fell slightly from 3.83% to 3.78%. The yields on new 30 year fixed-rate residential real estate loans (the choice of most of
our mortgage customers) remained very low during all five quarters. We continued to sell a portion of our originations to the secondary
market, specifically, to Freddie Mac, although we retained a higher proportion of our gross originations in 2016 than in 2015,
continuing a multi-year trend of expanding our retention rate versus our sale rate.
In 2016, the average yield on the loan portfolio continued to decline at a slightly faster pace then the cost of our deposits,
although our net interest margin held steady during the year. We expect that average loan yields may begin to stabilize in 2017;
any slight increase in origination rates are likely to be counterbalanced, for a period of time, by continuing repayments of even
higher rate maturing loans.
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
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, 2016. 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
$ 58,159
18,225
$ 76,384
$ 38,576
37,808
$ 76,384
Within
1 Year
$ 18,861
10,602
$ 29,463
2,315
$
27,148
$ 29,463
After
5 Years
$ 28,135
8,121
$ 36,256
$ 17,476
18,780
$ 36,256
Total
$ 105,155
36,948
$ 142,103
$ 58,367
83,736
$ 142,103
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, 2016, our total
contingent liability for standby letters of credit amounted to $3.4 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, 2016, we had outstanding unfunded loan commitments in the aggregate amount of approximately $383.6 million.
42
c. Risk Elements
1. Nonaccrual, Past Due and Restructured Loans
The amounts of nonaccrual, past due and restructured loans at year-end for each of the past five years are presented in the
table on page 33 under the heading "Summary of the Allowance and Provision for Loan Losses."
Loans are placed on nonaccrual status either due to the delinquency status of principal and/or interest or a judgment by
management that the full repayment of principal and interest is unlikely. Unless already placed on nonaccrual status, loans secured
by home equity lines of credit are put on nonaccrual status when 120 days past due and residential real estate loans are put on
nonaccrual status when 150 days past due. Commercial and commercial real estate loans are evaluated on a loan-by-loan basis
and are placed on nonaccrual status when 90 days past due if the full collection of principal and interest is uncertain. Under the
Uniform Retail Credit Classification and Account Management Policy established by banking regulators, fixed-maturity consumer
loans not secured by real estate must generally be charged-off no later than when 120 days past due. Loans secured with non-
real estate collateral in the process of collection are charged-down to the value of the collateral, less cost to sell. 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, 2016. 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 $9.1 million at December 31, 2016 and represented 0.52% of loans outstanding
at that date, as compared to approximately $8.1 million, or 0.51% of loans outstanding at December 31, 2015. These non-current
loans at December 31, 2016 were composed of approximately $6.4 million of consumer loans (principally indirect automobile loans),
$2.5 million of residential real estate loans and $0.3 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 72) contains detailed information on
modified loans and impaired loans.
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, 2016, we identified 101 commercial loans totaling
$34.8 million as potential problem loans. At December 31, 2015, we identified 111 commercial loans totaling $24.6 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 levels, economic conditions have largely recovered from the
2008-2009 financial crisis, although growth in the economy remained slow by comparison to previous historical post-recession
recoveries. If growth remains weak , potential problem loans likely will continue at or near their present levels or may even 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, beginning on page 40. For further discussion, see Note
1 to the Consolidated Financial Statements in Part II, Item 8 of this Report.
43
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. All 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
2016
$ 795
790
1,585
101
$ 1,686
December 31,
2014
$ — $
312
312
81
$ 393
2013
41
40
81
63
$ 144
2015
$ 1,357
521
1,878
140
$ 2,018
2012
$ 552
418
970
64
$ 1,034
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
Subsequent Write-downs to Fair Value
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
2016
$ 1,878
1,009
—
(162)
(1,140)
$ 1,585
2015
$ 312
1,889
270
(9)
(584)
$ 1,878
2014
81
$
469
—
—
(238)
$ 312
2013
$ 970
392
—
—
(1,281)
81
$
2012
$ 460
950
—
—
(440)
$ 970
6
3
(4)
5
1
8
(3)
6
2
2
(3)
1
7
1
(6)
2
5
7
(5)
7
III. SUMMARY OF LOAN LOSS EXPERIENCE
The information required in this section is presented in the discussion of the "Provision for Loan Losses and Allowance for
Loan Losses" in Part II Item 7.B.II. beginning on page 33 of this Report, including:
• Charge-offs and Recoveries by loan type
•
•
Factors that led to the amount of the Provision for Loan Losses
Allocation of the Allowance for Loan Losses by loan type
The percent of loans in each loan category is presented in the table of loan types in the preceding section on page 40 of this report.
44
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,
12/31/2016
12/31/2015
12/31/2014
Demand Deposits
Interest-Bearing Checking Accounts
Savings Deposits
Time Deposits of $100,000 or More
Other Time Deposits
Total Deposits
Average
Balance
$
366,956
912,461
616,208
69,489
129,084
$ 2,094,198
Rate
Average
Balance
Rate
Average
Balance
—% $
329,017
915,565
0.14%
554,330
0.15%
59,967
0.65%
136,396
0.51%
0.16% $ 1,995,275
—% $
290,922
861,457
521,595
70,475
158,592
$ 1,903,041
0.14
0.13
0.59
0.54
0.16
Rate
—%
0.20
0.16
1.09
0.85
0.25
During 2016 average total deposit balances increased by $99 million, or 5.0%, over the average for 2015. Most of this growth
occurred in the fourth quarter of 2016, which is the result of typical seasonal fluctuations primarily in our municipal deposit balances
and was largely generated from our pre-existing branch network, although we did open one new branch, in Troy, New York, in
September 2015.
During 2015 average total deposit balances increased by $92.2 million, or 4.8%, over the average for 2014. Most of this growth
occurred in the fourth quarter of 2015, which is the result of typical seasonal fluctuations primarily in our municipal deposit balances
and was largely generated from our pre-existing branch network, although we did recently open two new branches: in Troy, New
York, in September 2015, and in Colonie, New York, in June 2014.
During 2014 average total deposit balances increased by $82.8 million, or 4.6%, over the average for 2013. Most of this growth
occurred in the fourth quarter of 2014, consistent with our typical seasonal fluctuations in deposits and was largely generated from
our pre-existing branch network, although we did recently open one new branch, in Colonie, New York, in June 2014.
We did not sell or close any branches during the covered period, 2014-2016. We did not hold any brokered deposits during
2014. However, in 2015 we began to use reciprocal brokered deposits for a select group of municipalities to reduce the amount
of investment securities required to be pledged as collateral for municipal deposits where through a well-established brokerage
program, we transferred amounts in municipal deposits in excess of our FDIC insurance coverage limits to other participating banks,
divided into portions so as to qualify such transferred deposits for FDIC insurance coverage at each transferee bank, in return for
reciprocal transfers to us of equal amounts of deposits from the participant banks. Our balances of reciprocal broker deposits were
$57.1 million and $23.8 million at December 31, 2016 and 2015, respectively.
The following table presents the quarterly average balance by deposit type for each of the most recent five quarters.
DEPOSIT PORTFOLIO
Quarterly Average Deposit Balances
(Dollars In Thousands)
Demand Deposits
Interest-Bearing Checking Accounts
Savings Deposits
Time Deposits of $100,000 or More
Other Time Deposits
Total Deposits
Dec 2016
Sep 2016
$
383,226
921,971
649,928
79,196
125,835
$ 2,160,156
$
381,195
869,439
607,850
75,388
129,960
$ 2,063,832
Quarters Ended
Jun 2016
Mar 2016
Dec 2015
$
357,285
928,904
602,625
63,117
130,518
$ 2,082,449
$
345,783
929,898
604,151
60,085
130,047
$ 2,069,964
$
348,748
953,609
582,140
60,294
131,035
$ 2,075,826
Fluctuations in balances of our interest-bearing checking and savings accounts and time deposits of $100,000 or more are
largely the result of municipal deposit fluctuations. Municipal deposits on average represent 28% to 34% of our total deposits.
Municipal deposits are typically placed in interest-bearing checking and savings accounts, as well as time deposits of short duration.
In general, there is a seasonal pattern to municipal deposits which dip to a low point in August each year. Account balances
tend to increase throughout the fall and into 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. We expect that this shift from time deposits to nonmaturity deposit products may continue
45
to occur in upcoming periods, although perhaps at a slower pace, if deposit rates and interest rates remain at their current
extraordinarily low levels. Contrarily, if deposit rates should begin to climb, we anticipate the movement of time deposits to nonmaturity
interest bearing deposits to halt altogether, and likely to reverse itself if the rate rise is continuing or significant.
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 seasonal pattern during 2016, as
in the prior two years. From 2015 to 2016, growth occurred in both municipal accounts (0.6%) as well as other deposit accounts
(4.2%). The growth in our non-municipal account balances during 2016 was distributed among all our deposit categories.
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
Interest-Bearing Checking Accounts
Savings Deposits
Time Deposits of $100,000 or More
Other Time Deposits
Total Deposits
Dec 2016
17.7%
42.7
30.1
3.7
5.8
100.0%
Sep 2016
18.5%
42.1
29.5
3.7
6.3
100.0%
Jun 2016 Mar 2016 Dec 2015
16.8%
46.0
28.0
2.9
6.3
100.0%
16.7%
44.9
29.2
2.9
6.3
100.0%
17.2%
44.6
28.9
3.0
6.3
100.0%
Time deposits, including time deposits of $100,000 or more, decreased significantly and consistently in recent years, both
absolutely and as a percentage of total deposits, as deposit rates generally continued their fall during these years. A portion of our
time deposits of $100,000 or more are 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 extending from
mid-2007 through the end of 2015. Our cost of deposits remain virtually unchanged over the past 5 quarters, as evidenced in the
table below, although the Fed increased the federal funds rate twice during that period.
The total quarterly interest cost of our deposits, by type of deposit and in total, for each of the most recent five quarters is set
forth in the table below:
Quarterly Cost of Deposits
Quarters Ended
Demand Deposits
Interest-Bearing Checking Accounts
Savings Deposits
Time Deposits of $100,000 or More
Other Time Deposits
Total Deposits
Dec 2016
—%
0.15%
0.16%
0.70%
0.51%
0.16%
Sep 2016
—%
0.15
0.15
0.68
0.50
0.16
Jun 2016 Mar 2016 Dec 2015
—%
—%
—%
0.13
0.15
0.62
0.51
0.15
0.13
0.15
0.58
0.52
0.15
0.13
0.14
0.59
0.53
0.15
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,
upward or downward, and the actual repricing of our deposit liabilities up or down, although this lag may be shorter or longer than
the lag between Federal Reserve rate actions and the repricing of our loans and other earning assets, depending upon the particular
circumstances.
In 2015, we began to use reciprocal brokered deposits for a select group of municipal deposit relationships. The balances of
deposits transfered to, and received from, reciprocating banks was $57.1 million at December 31, 2016. Except for these certain
municipal reciprocal relationships, we do not use traditional brokered deposits as a regular funding source and there were not any
additional such brokered deposit balances carried during 2016, 2015 or 2014.
46
The maturities of time deposits of $100,000 or more at December 31, 2016 are presented below. (In Thousands)
Maturing in:
Under Three Months
Three to Six Months
Six to Twelve Months
2018
2019
2020
2021
Later
Total
$
$
17,228
15,661
19,732
7,078
7,366
2,488
3,050
2,175
74,778
V. SHORT-TERM BORROWINGS
(Dollars in Thousands)
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
D. LIQUIDITY
12/31/2016
12/31/2015
12/31/2014
$ 158,836
158,836
94,103
$ 105,173
105,173
45,595
$ 60,421
60,421
29,166
0.42%
0.59%
0.29%
0.27%
0.25%
0.26%
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 $347.0 million million at year-end 2016, a decrease of $55.3 million from the year-end 2015 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 with correspondent banks and credit lines
with the Federal Home Loan Bank of New York ("FHLBNY"). Our federal funds lines of credit are with two correspondent banks
totaling $35 million; we did not draw on these lines during 2016.
To support our borrowing relationship with the FHLBNY, we have pledged collateral, including residential mortgage and home
equity loans. At December 31, 2016, we had outstanding collateral obligations with the FHLBNY of $183 million; on such date, our
unused borrowing capacity at the FHLBNY was approximately $263 million. 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 New York, pledging certain consumer
loans as collateral for potential "discount window" advances, which we maintain for contingency liquidity purposes. At December 31,
2016, the amount available under this facility was approximately $370 million, and 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, 2016, our basic liquidity ratio, including our FHLB collateralized borrowing capacity, was 11.2% of total assets, or
$188 million in excess of our internally-set minimum target ratio of 4%.
Because of our consistently favorable credit quality and strong balance sheet, we did not experience any significant liquidity
constraints in 2016 and did not experience any such constraints in any prior year, back to and including the financial crisis years.
We have not at any time during such period been forced to pay premium rates to obtain retail deposits or other funds from any
source.
47
E. CAPITAL RESOURCES AND DIVIDENDS
Important Regulatory Capital Standards
Revised Bank Capital Rules.
The Dodd-Frank Act enacted in 2010 directed U.S. bank regulators to promulgate revised bank capital standards, which were
required to be at least as strict as the regulatory capital standards then in effect. The revised bank regulatory capital standards
were adopted by the Federal bank regulatory agencies in 2013 and became effective for our holding company and our subsidiary
banks on January 1, 2015. These revised capital rules are summarized in an earlier section of this Report, "Regulatory Capital
Standards," on pages 7 and 8.
The table below sets forth the various capital ratios achieved by our holding company and our subsidiary banks, Glens Falls
National and Saratoga National, as of December 31, 2016, as determined under the revised bank regulatory capital standards in
effect on that date, as well as the minimum levels for such capital ratios that bank holding companies and banks are required to
maintain under the revised rules. As demonstrated in the table, all of our holding company and bank capital ratios at year-end were
well in excess of the minimum required levels for such ratios, as established by the regulators under these revised rules. In addition,
on December 31, 2016, our holding company and each of our banks qualified as "well-capitalized", the highest capital classification
category under the revised capital classification scheme recently established by the federal bank regulators, as in effect on that
date.
Capital Ratios:
Tier 1 Leverage Ratio
Common Equity Tier 1 Capital Ratio
Tier 1 Risk-Based Capital Ratio
Total Risk-Based Capital Ratio
Arrow
9.5%
13.0%
14.1%
15.2%
GFNB
9.1%
13.9%
14.0%
15.0%
Minimum
Required
Ratio
4.0%
4.5%
6.0%
8.0%
SNB
8.9%
11.9%
11.9%
12.8%
Stockholders' Equity at Year-end 2016: Stockholders' equity was $232.9 million at December 31, 2016, an increase of $18.9
million, or 8.8%, from the prior year-end. During 2016 stockholders' equity was positively impacted by (a) net income of $26.5
million, (b) equity received from our various stock-based compensation plans of $3.1 million, and (c) other comprehensive income
of $1.1 million, while stockholders' equity was reduced by (d) cash dividends of $13.1 million, and (e) purchases of our own common
stock of $2.1 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 regulatory capital rules then in effect, TRUPs proceeds typically qualified 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, any trust preferred securities that Arrow might issue on or after the grandfathering
date set forth in Dodd-Frank (May 19, 2010) would no longer qualify as Tier 1 capital under bank regulatory capital guidelines,
whereas TRUPs outstanding prior to the grandfathering cutoff date set forth in Dodd-Frank (May 19, 2010) would continue to qualify
as Tier 1 capital until maturity or redemption, subject to limitations. Thus, our outstanding TRUPs continue to qualify as Tier 1
regulatory capital, subject to such limitations.
Dividends: The source of funds for the payment by our holding company of cash dividends to stockholders consists primarily
of dividends declared and paid to the holding company by our bank subsidiaries. In addition to legal and regulatory limitations on
payments of dividends by our holding company (i.e., the need to maintain adequate regulatory capital), there are also legal and
regulatory limitations applicable to the payment of dividends by our bank subsidiaries to our holding company. As of December 31,
2016, under the statutory limitations in national banking law, the maximum amount that could have been paid by the bank subsidiaries
to the holding company, without special regulatory approval, was approximately $37.1 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 October 2016, the Board of Directors approved a $5.0 million stock repurchase program,
effective January 1, 2017 (the 2017 program), under which management is authorized, in its discretion, to repurchase from time-
to-time during 2017, in the open market or in privately negotiated transactions, up to $5 million of Arrow common stock, to the extent
management believes the Company's stock is reasonably priced and such repurchases appear to be an attractive use of available
capital and in the best interests of stockholders. This 2017 program replaced a similar repurchase program which was in effect
during 2016 (the 2016 program), which also authorized the repurchase of up to $5.0 million of Arrow common stock. As of
December 31, 2016 approximately $495 thousand had been used under the 2016 program to repurchase Arrow shares. This total
does not include approximately $1.6 million of Arrow's Common Stock that the Company repurchased during 2016 other than
through its repurchase program, i.e., repurchases of Arrow shares on the market utilizing funds accumulated under Arrow's Dividend
Reinvestment Plan and the surrender or deemed surrender of Arrow stock to the Company in connection with employees' stock-
for-stock exercises of compensatory stock options to buy Arrow stock.
48
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, 2016, 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
$
55,000
$
— $
30,000
$
25,000
$
—
20,000
2,251
35,358
$ 112,609
$
—
675
3,354
4,029
—
895
6,527
37,422
—
403
7,039
32,442
$
20,000
278
18,438
38,716
$
$
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.
49
H. FOURTH QUARTER RESULTS
We reported net income of $6.6 million for the fourth quarter of 2016, an increase of $31 thousand, or 0.5%, from the net
income of $6.57 million we reported for the fourth quarter of 2015. Diluted earnings per common share for the fourth quarter of
2016 were $0.49, was unchanged from the fourth quarter of 2015. The net change in earnings between the two quarters was
primarily affected by the following: (a) a $1.1 million increase in tax-equivalent net interest income, (b) a $39 thousand decrease
in noninterest income, (c) an $18 thousand increase in the provision for loan losses, (d) a $1.0 million increase in noninterest
expense, and (e) a $31 thousand decrease 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 20, 2017, incorporating by reference the Company's earnings release for the year ended December 31, 2016.
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,
12/31/2016
19,770
$
1,404
18,366
483
17,883
6,648
15,272
9,259
2,659
6,600
$
$
13,441
13,565
0.49
0.49
0.250
$ 2,572,425
2,446,375
1,726,738
2,160,156
230,198
12/31/2015
18,510
$
1,231
17,279
465
16,814
6,687
14,242
9,259
2,690
6,569
$
13,306
13,368
0.49
0.49
0.243
$ 2,442,964
2,317,784
1,556,234
2,075,825
213,219
1.02%
11.41%
3.14%
0.10%
0.11%
1.07%
12.22%
3.11%
0.05%
0.12%
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).
50
SUMMARY OF QUARTERLY FINANCIAL DATA (Unaudited)
The following quarterly financial information for 2016 and 2015 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 (Losses)
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
2016
First
Quarter
$ 18,626
17,363
401
—
9,467
6,549
0.49
0.49
Second
Quarter
$ 19,237
17,953
669
144
9,594
6,647
0.50
0.49
Third
Quarter
$ 19,282
17,877
480
—
9,429
6,738
0.50
0.50
Fourth
Quarter
$ 19,770
18,366
483
(166)
9,259
6,600
0.49
0.49
2015
First
Quarter
$ 16,990
15,904
275
90
8,530
5,855
0.44
0.44
Second
Quarter
$ 17,407
16,164
70
16
9,155
6,305
0.48
0.47
Third
Quarter
$ 17,831
16,578
537
—
8,328
5,933
0.45
0.45
Fourth
Quarter
$ 18,510
17,279
465
23
9,259
6,569
0.49
0.49
51
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 2016 the targeted federal funds rate was
only 50 basis points above the rate where it had been from late 2008 to December 16, 2015, a range of 0 to .25%. Thus, for
purposes of our decreasing rate simulation, we applied a 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, 2016, a 200 basis point increase in interest rates demonstrated a
3.3% decrease in net interest income, and a 100 basis point (as adjusted) decrease in interest rates demonstrated a 0.3% 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 assumed boundary of a zero rate, whereas further decreases in asset rates are not as likely to run up against the assumed
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.
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 assumed 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. 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.
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.
52
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, 2016 and 2015
Consolidated Statements of Income for the Years Ended December 31, 2016, 2015 and 2014
Consolidated Statements of Comprehensive Income for the Years Ended December 31, 2016, 2015 and 2014
Consolidated Statements of Changes in Stockholders' Equity for the Years Ended December 31, 2016, 2015 and 2014
Consolidated Statements of Cash Flows for the Years Ended December 31, 2016, 2015 and 2014
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, 2016 and 2015, and the related consolidated statements of income, comprehensive income, changes in
stockholders’ equity, and cash flows for each of the years in the
period ended December 31, 2016. 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, 2016 and 2015, and the results of their operations and their
period ended December 31, 2016, in conformity with U.S. generally accepted
cash flows for each of the years in the
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, 2016, based on criteria established in Internal Control -
Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO), and
our report dated March 14, 2017, expressed an unqualified opinion on the effectiveness of the Company’s internal control over
financial reporting.
/s/ KPMG LLP
Albany, New York
March 14, 2017
53
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, 2016, based on criteria established in Internal Control - Integrated Framework (2013) 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 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, 2016, based on criteria established in Internal Control - Integrated Framework (2013)
issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO).
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the
consolidated balance sheets of Arrow Financial Corporation and subsidiaries as of December 31, 2016 and 2015, 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, 2016, and our report dated March 14, 2017 expressed an unqualified
opinion on those consolidated financial statements.
/s/ KPMG LLP
Albany, New York
March 14, 2017
54
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 $343,751 at
December 31, 2016, and $325,930 at December 31, 2015)
Other Investments
Loans
Allowance for Loan Losses
Net Loans
Premises and Equipment, Net
Goodwill
Other Intangible Assets, Net
Other Assets
Total Assets
LIABILITIES
Noninterest-Bearing Deposits
Interest-Bearing Checking Accounts
Savings Deposits
Time Deposits of $100,000 or More
Other Time Deposits
Total Deposits
Federal Funds Purchased and
Securities Sold Under Agreements to Repurchase
Federal Home Loan Bank Overnight Advances
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
(17,943,201 Shares Issued at December 31, 2016, and
17,420,776 Shares Issued at December 31, 2015)
Additional Paid-in Capital
Retained Earnings
Unallocated ESOP Shares (19,466 Shares at December 31, 2016, and
55,275 Shares at December 31, 2015)
Accumulated Other Comprehensive Loss
Treasury Stock, at Cost (4,441,093 Shares at December 31, 2016, and
4,426,072 Shares at December 31, 2015)
Total Stockholders’ Equity
Total Liabilities and Stockholders’ Equity
December 31,
2016
December 31,
2015
$
43,024
14,331
$
34,816
16,252
346,996
402,309
$
$
$
$
345,427
10,912
1,753,268
(17,012)
1,736,256
26,938
21,873
2,696
56,789
2,605,242
387,280
877,988
651,965
74,778
124,535
2,116,546
35,836
123,000
55,000
20,000
22,008
2,372,390
320,611
8,839
1,573,952
(16,038)
1,557,914
27,440
21,873
3,107
53,027
2,446,188
358,751
887,317
594,538
59,792
130,025
2,030,423
23,173
82,000
55,000
20,000
21,621
2,232,217
—
—
17,943
270,880
28,644
(400)
(6,834)
17,421
250,680
32,139
(1,100)
(7,972)
(77,381)
232,852
2,605,242
$
(77,197)
213,971
2,446,188
$
See Notes to Consolidated Financial Statements.
55
ARROW FINANCIAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(In Thousands, Except Per Share Amounts)
Years Ended December 31,
2015
2014
2016
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
Interest-Bearing Checking 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
Net (Loss) Gain on Securities Transactions
Insurance Commissions
Net Gain on Sales of Loans
Other Operating Income
Total Noninterest Income
NONINTEREST EXPENSE
Salaries and Employee Benefits
Occupancy Expenses, Net
FDIC Assessments
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
$ 62,823
152
$ 56,856
94
$ 53,194
80
7,934
6,006
76,915
1,280
932
453
658
33
1,340
660
5,356
71,559
2,033
8,043
5,745
70,738
7,954
5,633
66,861
1,276
741
356
742
20
1,097
581
4,813
65,925
1,347
1,722
839
770
1,354
22
490
570
5,767
61,094
1,848
69,526
64,578
59,246
7,783
9,469
(22)
8,668
821
1,113
27,832
7,762
9,220
129
8,967
692
1,354
28,124
7,468
9,261
110
9,455
784
1,238
28,316
34,330
9,402
1,076
14,801
59,609
37,749
11,215
$ 26,534
33,064
9,267
1,186
13,913
57,430
35,272
10,610
$ 24,662
30,941
8,990
1,117
12,980
54,028
33,534
10,174
$ 23,360
13,391
13,476
13,281
13,330
13,242
13,272
$
$
1.98
1.97
$
1.86
1.85
1.76
1.76
Share and Per Share Amounts have been restated for the September 29, 2016 3% stock dividend.
See Notes to Consolidated Financial Statements.
56
ARROW FINANCIAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(In Thousands)
Net Income
Other Comprehensive Income (Loss), Net of Tax:
Unrealized Net Securities Holding (Losses) Gains Arising During the Year
Reclassification Adjustment for Net Securities Losses (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 Income (Loss)
Comprehensive Income
See Notes to Consolidated Financial Statements.
Years Ended December 31,
2014
2015
2016
$ 23,360
$ 24,662
$ 26,534
(1,024)
13
1,721
—
435
(7)
1,138
$ 27,672
(1,832)
(78)
848
(224)
514
(34)
(806)
$ 23,856
232
(67)
(2,846)
(347)
288
(53)
(2,793)
$ 20,567
57
ARROW FINANCIAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY
(In Thousands, Except Share and Per Share Amounts)
Balance at December 31, 2013
Net Income
Other Comprehensive Income (Loss)
2% Stock Dividend (334,890 Shares)
Cash Dividends Paid, $.94 per Share 1
Shares Issued for Stock Option Exercises, net
(61,364 Shares)
Shares Issued Under the Directors’ Stock
Plan (7,584 Shares)
Shares Issued Under the Employee Stock
Purchase Plan (19,575 Shares)
Stock-Based Compensation Expense
Tax Benefit for Exercises of
Stock Options
Purchase of Treasury Stock
(95,064 Shares)
Acquisition of Subsidiaries (3,595 Shares)
Allocation of ESOP Stock (17,300 Shares)
Common
Stock
$ 16,744
—
—
335
—
—
—
—
—
—
—
—
—
Additional
Paid-In
Capital
Retained
Earnings
$ 229,290
—
$ 27,457
23,360
—
8,617
—
—
(8,952)
(12,407)
852
123
296
360
25
—
56
102
—
—
—
—
—
—
—
—
Accumu-
lated
Other
Com-
prehensive
Income
(Loss)
Unallo-
cated
ESOP
Shares
Treasury
Stock
Total
$
(1,800) $
—
—
—
—
—
—
—
—
—
—
—
350
—
(4,373) $ (75,164) $ 192,154
23,360
(2,793)
—
(2,793)
—
—
—
—
—
—
—
—
—
—
—
—
—
—
(12,407)
602
1,454
74
192
—
—
197
488
360
25
(2,455)
(2,455)
35
—
91
452
Balance at December 31, 2014
$ 17,079
$ 239,721
$ 29,458
$
(1,450) $
(7,166) $ (76,716) $ 200,926
Balance at December 31, 2014
$ 17,079
$ 239,721
$ 29,458
$
(1,450) $
(7,166) $ (76,716) $ 200,926
Net Income
Other Comprehensive (Loss) Income
2% Stock Dividend (341,400 Shares)
Cash Dividends Paid, $.96 per Share 1
Shares Issued for Stock Option Exercises, net
(43,096 Shares)
Shares Issued Under the Directors’ Stock
Plan (8,480 Shares)
Shares Issued Under the Employee Stock
Purchase Plan (19,036 Shares)
Shares Issued for Dividend Reinvestment
Plans (32,171 Shares)
Stock-Based Compensation Expense
Tax Benefit for Exercises of
Stock Options
Purchase of Treasury Stock
(55,368 Shares)
Allocation of ESOP Stock (17,645 Shares)
—
—
342
—
—
—
—
—
—
—
—
—
Balance at December 31, 2015
$ 17,421
—
—
8,939
—
24,662
—
(9,281)
(12,700)
489
143
306
570
308
59
—
—
—
—
—
—
—
—
145
$ 250,680
—
$ 32,139
—
—
—
—
—
—
—
—
—
—
—
350
$
(1,100) $
58
—
(806)
—
—
—
—
—
—
—
—
—
—
—
—
—
429
84
188
316
—
—
24,662
(806)
—
(12,700)
918
227
494
886
308
59
(1,498)
(1,498)
—
495
(7,972) $ (77,197) $ 213,971
—
ARROW FINANCIAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY, Continued
(In Thousands, Except Share and Per Share Amounts)
Balance at December 31, 2015
Net Income
Other Comprehensive (Loss) Income
3% Stock Dividend (522,425 Shares) 2
Cash Dividends Paid, $.98 per Share 1
Shares Issued for Stock Option Exercises, net
(109,651 Shares)
Shares Issued Under the Directors’ Stock
Plan (6,005 Shares)
Shares Issued Under the Employee Stock
Purchase Plan (17,113 Shares)
Shares Issued for Dividend Reinvestment
Plans ( 55,432 Shares)
Stock-Based Compensation Expense
Tax Benefit for Exercises of
Stock Options
Purchase of Treasury Stock
(72,723 Shares)
Allocation of ESOP Stock (36,927 Shares)
Common
Stock
$ 17,421
—
—
522
—
—
—
—
—
—
—
—
—
Balance at December 31, 2016
$ 17,943
Additional
Paid-In
Capital
Retained
Earnings
$ 250,680
—
$ 32,139
26,534
—
16,415
—
1,265
138
318
1,167
287
188
—
—
(16,937)
(13,092)
—
—
—
—
—
—
—
$
(1,100) $
—
—
—
—
—
—
—
—
—
—
—
Accumu-
lated
Other
Com-
prehensive
Income
(Loss)
Unallo-
cated
ESOP
Shares
Treasury
Stock
Total
(7,972) $ (77,197) $ 213,971
26,534
—
—
1,138
—
—
—
1,138
—
(13,092)
1,139
2,404
67
175
576
—
—
205
493
1,743
287
188
(2,141)
(2,141)
—
—
—
—
—
—
—
—
—
422
$ 270,880
—
$ 28,644
$
700
(400) $
—
1,122
(6,834) $ (77,381) $ 232,852
—
1 Cash dividends paid per share have been adjusted for the September 29, 2016 3% stock dividend.
2 Included in the shares issued for the 3% stock dividend in 2016 were treasury shares of 130,499 and unallocated ESOP shares of 1,118.
See Notes to Consolidated Financial Statements.
59
ARROW FINANCIAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Dollars in Thousands)
Cash Flows from Operating Activities:
Net Income
Adjustments to Reconcile Net Income to Net Cash Provided by Operating Activities:
Provision for Loan Losses
Depreciation and Amortization
Allocation of ESOP Stock
Gains on the Sale of Securities Available-for-Sale
Losses on the Sale of Securities Available-for-Sale
Loans Originated and Held-for-Sale
Proceeds from the Sale of Loans Held-for-Sale
Net Gains on the Sale of Loans
Net Losses on the Sale or Write-down of Premises and Equipment,
Other Real Estate Owned and Repossessed Assets
Net Gain on the Sale of a Subsidiary
Contributions to Pension & Postretirement Plans
Deferred Income Tax (Benefit) Expense
Shares Issued Under the Directors’ Stock Plan
Stock-Based Compensation Expense
Net (Increase) in Other Assets
Net Increase (Decrease) in Other Liabilities
Net Cash Provided By Operating Activities
Cash Flows from Investing Activities:
Proceeds from the Sale of Securities Available-for-Sale
Proceeds from the Maturities and Calls of Securities Available-for-Sale
Purchases of Securities Available-for-Sale
Proceeds from the Maturities and Calls of Securities Held-to-Maturity
Purchases of Securities Held-to-Maturity
Net Increase in Loans
Proceeds from the Sales or Write-down of Premises and Equipment, Other
Real Estate Owned and Repossessed Assets
Purchase of Premises and Equipment
Cash Paid for Subsidiaries, Net
Proceeds from the Sale of a Subsidiary, 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 Federal Home Loan Bank Borrowings
Net Increase 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 (Decrease) in Cash and Cash Equivalents
Cash and Cash Equivalents at Beginning of Year
Cash and Cash Equivalents at End of Year
Supplemental Disclosures to Statements of Cash Flow Information:
Interest on Deposits and Borrowings
Income Taxes
Non-cash Investing and Financing Activity:
Transfer of Loans to Other Real Estate Owned and Repossessed Assets
Shares Issued for Acquisition of Subsidiary
See Notes to Consolidated Financial Statements.
60
December 31,
2016
2015
$
26,534
$
24,662
$
2014
23,360
2,033
5,940
1,122
(317)
339
(23,787)
24,422
(821)
232
—
(690)
(283)
205
287
(1,598)
1,077
34,695
97,930
88,719
(134,950)
56,461
(82,433)
(182,065)
1,991
(1,441)
—
72
(2,073)
—
(157,789)
86,123
41,000
12,663
—
—
(2,141)
2,404
493
188
1,743
(13,092)
129,381
6,287
51,068
57,355
5,341
11,961
1,876
—
1,347
6,293
495
(172)
43
(20,731)
21,524
(692)
297
(204)
(3,858)
1,036
227
308
(1,147)
(502)
28,926
66,551
93,817
(201,820)
48,409
(68,210)
(164,710)
1,901
(1,621)
—
132
(3,988)
—
(229,539)
127,475
41,000
3,752
55,000
(10,000)
(1,498)
918
494
59
886
(12,700)
205,386
4,773
46,295
51,068
4,856
9,357
3,046
—
1,848
7,042
452
(137)
27
(23,156)
23,606
(784)
77
—
(921)
(299)
197
360
(806)
(225)
30,641
49,928
153,127
(113,953)
56,714
(60,906)
(148,482)
1,237
(1,468)
(75)
—
1,430
(5,245)
(67,693)
60,618
(12,000)
7,644
—
(10,000)
(2,455)
1,454
488
25
—
(12,407)
33,367
(3,685)
49,980
46,295
5,932
10,060
1,308
91
$
$
$
$
$
$
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
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 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 borrowers 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.
The Company determines whether it has a controlling financial interest in an entity by first evaluating whether the entity is a
voting interest entity or a variable interest entity under GAAP. Voting interest entities are entities in which the total equity investment
at risk is sufficient to enable the entity to finance itself independently and provides the equity holders with the obligation to absorb
losses, the right to receive residual returns and the right to make decisions about the entity’s activities. The Company consolidates
voting interest entities in which it has all, or at least a majority of, the voting interest. As defined in applicable accounting standards,
variable interest entities (VIE) are entities that lack one or more of the characteristics of a voting interest entity. A controlling financial
interest in a VIE is present when the Company has both the power and ability to direct the activities of the VIE that most significantly
impact the VIE's economic performance and an obligation to absorb losses or the right to receive benefits that could potentially be
significant to the VIE. The Company’s wholly owned subsidiaries Arrow Capital Statutory Trust II and Arrow Capital Statutory Trust
III are VIEs for which the Company is not the primary beneficiary. Accordingly, the accounts of these entities are not included in
the Company’s consolidated financial statements.
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, Clinton
and Albany 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
61
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
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 loss
factor incorporating a rolling twelve quarter look-back period of the respective segment that have occurred within each pool of loans
over the loss emergence period (LEP), adjusted as necessary based upon consideration of qualitative considerations impacting
the inherent risk of loss in the respective loan portfolios. The LEP is an estimate of the average amount of time from the point at
62
which a loss is incurred on a loan to the point at which the loss is recognized in the financial statements. Since the LEP may change
under various economic environments, we update the LEP calculation on an annual basis. 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:
• 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 collectability 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
In management’s opinion, the balance of the allowance for loan losses, at each balance sheet date, is sufficient to provide for
probable loan losses inherent in the corresponding loan portfolio.
Other Real Estate Owned and Repossessed Assets - Real estate acquired by foreclosure and assets acquired by
repossession are recorded at the fair value of the property less estimated costs to sell at the time of repossession. Subsequent
declines in fair value, after transfer to other real estate owned and repossessed assets are recognized through a valuation allowance.
Such declines in fair value along with related operating expenses to administer such properties or assets are charged directly to
operating expense.
Premises and Equipment - Premises and equipment are stated at cost, less accumulated depreciation and amortization.
Depreciation and amortization included in operating expenses are computed largely on the straight-line method. Depreciation is
based on the estimated useful lives of the assets (buildings and improvements 20-40 years; furniture and equipment 7-10 years;
data processing equipment 5-7 years) and, in the case of leasehold improvements, amortization is computed over the terms of the
respective leases or their estimated useful lives, whichever is shorter. Gains or losses on disposition are reflected in earnings.
Investments in Real Estate Limited Partnerships - These limited partnerships acquire, develop and operate low and
moderate-income housing. As a limited partner in these projects, we receive low income housing tax credits and tax deductions
for losses incurred by the underlying properties. We apply the proportional amortization method allowed in Accounting Standards
Update 2014-01 "Investments - Equity Method and Joint Ventures (Topic 323): Accounting for Investments in Qualified Affordable
Housing Projects." The proportional amortization method permits an entity to amortize the initial cost of the investment in proportion
to the amount of the tax credits and other tax benefits received and to recognize the net investment performance in the income
statement as a component of income tax expense.
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
63
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.
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.
64
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 and an analysis of a need for a valuation allowance for deferred tax assets. Actual
results could differ from those estimates.
A material estimate that is particularly susceptible to significant change in the near term is the allowance for loan losses. In
connection with the determination of the allowance for loan losses, management obtains appraisals for properties. The allowance
for loan losses is management’s best estimate of probable loan losses incurred as of the balance sheet date. While management
uses available information to recognize losses on loans, future adjustments to the allowance for loan losses may be necessary
based on changes in economic conditions.
Recent Accounting Pronouncements
During 2016, through the date of this report, the FASB issued 15 accounting standards updates. Some of the standards listed
below did not have an immediate impact on Arrow, but could in the future.
ASU 2016-01 "Recognition and Measurement of Financial Assets and Financial Liabilities" will significantly change the income
statement impact of equity investments. For Arrow, the standard is effective for the first quarter of 2018, and will require that equity
investments be measured at fair value, with changes in fair value measured in net income. As of December 31, 2016 , we hold a
$1.1 million cost basis in a small portfolio of equity investments and we do not expect that the adoption of this change in accounting
for equity investments will have a material impact on our financial position or the results of operations in periods subsequent to its
adoption.
ASU 2016-02 "Leases" will require the recognition of operating leases. For Arrow, the standard becomes effective in the first
quarter of 2019. We do not expect that the adoption of this change in accounting for operating leases will have a material impact
on our financial position or the results of operations in periods subsequent to its adoption. As of December 31, 2016, we have $2.3
million in minimum lease payments for existing operating leases of branch and insurance locations with varying expiration dates
from 2017 to 2031.
ASU 2016-09 "Compensation - Stock Compensation" simplifies certain aspects of accounting for share-based payment
transactions, including the tax consequences, classification of awards as either equity or liabilities, and classification on the statement
of cash flows. For Arrow, the standard becomes effective in the first quarter of 2017. We do not expect that the adoption of this
change in accounting for stock-based compensation will have a material impact on our financial position or the results of operations
in periods subsequent to its adoption. Although we do have previously granted Non-qualifying Stock Options (NQSO's), none are
scheduled to expire during 2017 and 2018. The exercise of these NQSO's as well as any disqualifying dispositions from Incentive
Stock Option exercises will create an income tax benefit which in prior years would have created an increase in Stockholders’
Equity. Due to the fluctuation in fair value of these stock options and the unpredictability of the number that will be exercised, it is
not practical for us to estimate the potential impact of the increase to earnings in the future.
ASU 2016-13 "Financial Instruments - Credit Losses" will change the way we and other financial entities recognize losses on
assets measured at amortized costs and change the method for recognizing credit losses on securities available-for-sale. Currently,
loan losses are recognized using an "incurred loss" methodology. Under ASU 2016-13, the methodology will change to a current
expected loss over the life of the loan. Currently, credit losses on available-for-sale securities reduce the carrying value of the
instrument and cannot be reversed. Under ASU 2016-13, the amount of the credit loss is carried as a valuation allowance and can
be reversed. For Arrow, the standard is effective for the first quarter of 2020 and early adoption is allowed in 2019. The Company
is currently evaluating the impact of the pending adoption of the ASU on its consolidated financial statements. The initial adjustment
will not be reported in earnings, but as the cumulative effect of a change in accounting principle. At this time we have not calculated
the estimated impact that this Update will have on our Allowance for Loan Losses, however, we anticipate it will have a significant
impact on the methodology process we utilize to calculate the allowance.
ASU 2016-15 "Statement of Cash Flows" provides guidance on the classification of eight specific cash flow issues in order to
increase consistency in reporting. Currently, GAAP is either unclear or does not include specific guidance on the cash flow issues
addressed in this Update. Arrow currently reports the specifically identified cash flow transactions using the appropriate classification
as outlined in the Update. For Arrow, the standard becomes effective in the first quarter of 2017. We do not expect that the adoption
of this change in classification for financial reporting will have a material impact on our financial position or the results of operations
in periods subsequent to its adoption.
65
ASU 2017-01 "Business Combinations" defines when a set of assets and activities constitutes a business for the purposes of
determining whether transactions should be accounted for as acquisitions (or disposals) of assets or businesses. Currently, the
three elements required to be present in a business are inputs, processes, and outputs. The amendments in this Update allow for
a business to consist of inputs, processes, and the ability to create output. For Arrow, the standard becomes effective in the first
quarter of 2018. This Update will likely have no effect on our accounting for acquisitions and dispositions of businesses.
ASU 2017-04 "Intangibles-Goodwill and Other" changes the procedures for evaluating impairment of goodwill. Prior to this
Update, entities were required to perform procedures o determine the fair value of the underlying assets and liabilities following
the guidance for determining the fair value of assets and liabilities in a business combination. This additional step to impairment
testing has been eliminated. Under the amendments in this Update, entities should perform goodwill impairment testing by comparing
the fair value of a reporting unit to its carrying value. This amendment should reduce the cost and complexity of evaluating goodwill
for impairment. For Arrow, the standard becomes effective in the first quarter of 2019, however, early adoption is permitted as early
as the first quarter of 2017. This amendment will not affect our assessment of goodwill impairment since we currently perform the
analysis of comparing carrying value to fair value of our reporting units that have goodwill.
Note 3: CASH AND CASH EQUIVALENTS (Dollars In Thousands)
The following table is the schedule of cash and cash equivalents at December 31, 2016 and 2015:
Cash and Due From Banks
Interest-Bearing Deposits at Banks
Total Cash and Cash Equivalents
Supplemental Information:
2016
$ 43,024
14,331
$ 57,355
2015
$ 34,816
16,252
$ 51,068
Total required reserves, including vault cash and Federal Reserve Bank deposits $ 28,610
$ 23,446
The Company is required to maintain reserve balances with the Federal Reserve Bank of New York. The required reserve is
calculated on a fourteen day average and the amounts presented in the table above represent the average for the period that
includes December 31.
66
Note 4.
INVESTMENT SECURITIES (Dollars In Thousands)
The following table is the schedule of Available-For-Sale Securities at December 31, 2016 and 2015:
Available-For-Sale Securities
U.S.
Government
& 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
$
147,110
$
27,684
$
168,189
$
3,512
$
1,120
$
347,615
147,377
304
37
27,690
24
18
167,239
986
1,936
3,308
—
204
1,382
262
—
December 31, 2016
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,
at Fair Value
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
Disaggregated Details:
US Treasury Obligations,
at Amortized Cost
US Treasury Obligations,
at Fair Value
US Agency Obligations,
at Amortized Cost
US Agency Obligations,
at Fair Value
US Government Agency
Securities, at Amortized Cost
US Government Agency
Securities, at Fair Value
Government Sponsored Entity
Securities, at Amortized Cost
Government Sponsored Entity
Securities, at Fair Value
17,001
9,615
508
560
16,994
9,628
508
560
12,165
7,377
19,542
84
13
5
18
$
$
$
$
5,716
101,008
61,465
—
5,753
100,447
61,039
—
126,825
—
126,825
40
1,936
—
1,936
$
$
$
$
$
$
$
$
2,512
—
—
1,000
2,508
—
—
800
500
2,809
3,309
4
1
203
204
$
$
$
$
—
147,110
—
—
—
147,377
—
—
70,605
—
70,605
19
37
—
37
54,701
54,706
92,409
92,671
$
$
$
$
$
$
3,694
3,724
164,495
163,515
67
346,996
1,576
2,195
262,852
25,229
257,733
61,973
1,560
25,255
257,452
61,547
1,360
— $
—
— $
210,095
10,186
220,281
—
147
— $
—
— $
1,987
208
2,195
Available-For-Sale Securities
U.S.
Government
& 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
$
155,932
$
52,306
$
177,376
$
14,544
$
1,120
$
401,278
155,782
52,408
178,588
14,299
1,232
402,309
264
414
105
3
2,236
1,024
—
245
112
—
2,717
1,686
310,857
$
$
$
$
$
76,802
$
4,289
$
99,569
$
3,616
$
— $
184,276
—
1,443
903
10,671
—
13,017
76,802
$
5,732
$
100,472
$
14,287
$
— $
197,293
21
19
30
19
—
89
413
$
1
414
$
2
1
3
$
$
1,023
$
2
$
— $
1,440
1
1,024
$
243
245
—
246
$
— $
1,686
155,932
155,782
$
15,701
15,848
161,675
162,740
December 31, 2015
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,
at Fair Value
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
Disaggregated Details:
US Agency Obligations,
at Amortized Cost
US Agency Obligations,
at Fair Value
US Government Agency
Securities, at Amortized Cost
US Government Agency
Securities, at Fair Value
Government Sponsored Entity
Securities, at Amortized Cost
Government Sponsored Entity
Securities, at Fair Value
68
The following table is the schedule of Held-To-Maturity Securities at December 31, 2016 and 2015:
Held-To-Maturity Securities
State and
Municipal
Obligations
Mortgage-
Backed
Securities -
Residential
Corporate
and Other
Debt
Securities
Total
Held-To
Maturity
Securities
$
268,892
$
75,535
$
1,000
$
345,427
267,127
2,058
3,823
75,624
258
169
1,000
—
—
December 31, 2016
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,
at Fair Value
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
343,751
2,316
3,992
321,202
33,456
147,782
160,426
3,763
32,505
149,250
157,235
4,761
1,000
—
—
—
—
—
—
1,000
— $
—
— $
120,561
12,363
132,924
—
360
— $
—
— $
3,298
694
3,992
32,456
86,070
146,603
3,763
32,505
87,486
143,375
3,761
107,255
12,363
119,618
347
3,129
694
3,823
$
$
$
$
$
$
$
$
—
61,712
13,823
—
—
61,764
13,860
—
13,306
—
13,306
13
169
—
169
$
$
$
$
69
Held-To-Maturity Securities
State and
Municipal
Obligations
Mortgage-
Backed
Securities -
Residential
Corporate
and Other
Debt
Securities
Total
Held-To
Maturity
Securities
$
3,206
3,222
72,329
72,402
$
226,053
$
93,558
$
1,000
$
320,611
230,621
4,619
51
94,309
868
117
1,000
—
—
325,930
5,487
168
299,767
— $
—
— $
—
8,302
15,918
24,220
62
— $
—
— $
104
64
168
$
$
$
$
2,302
11,764
14,066
54
11
40
51
$
$
$
$
$
$
$
$
$
6,000
4,154
10,154
8
93
24
117
3,802
3,852
89,756
90,457
Disaggregated Details:
US Government Agency
Securities, at Amortized Cost
US Government Agency
Securities, at Fair Value
Government Sponsored Entity
Securities, at Amortized Cost
Government Sponsored Entity
Securities, at Fair Value
December 31, 2015
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,
at Fair Value
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
Disaggregated Details:
US Government Agency
Securities, at Amortized Cost
US Government Agency
Securities, at Fair Value
Government Sponsored Entity
Securities, at Amortized Cost
Government Sponsored Entity
Securities, at Fair Value
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.
Securities in a continuous loss position, in the tables above for December 31, 2016 and December 31, 2015 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, 2016, 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
70
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.
Pledged securities, in the tables above, are primarily used to collateralize state and municipal deposits, as required under New
York State law. A small portion of the pledged securities are used to collateralize repurchase agreements and pooled deposits of
our trust customers.
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
December 31,
2016
2015
$
$
1,071
9,841
10,912
$
$
1,060
7,779
8,839
71
Note 5:
LOANS (Dollars In Thousands)
Loan Categories and Past Due Loans
The following table presents loan balances outstanding as of December 31, 2016 and December 31, 2015 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
Real Estate
Consumer
Residential
Total
December 31, 2016
Loans Past Due 30-59 Days
$
Loans Past Due 60-89 Days
Loans Past Due 90 or More Days
Total Loans Past Due
112
29
148
289
Current Loans
Total Loans
Loans 90 or More Days Past Due
and Still Accruing Interest
Nonaccrual Loans
December 31, 2015
Loans Past Due 30-59 Days
Loans Past Due 60-89 Days
Loans Past Due 90 or more Days
Total Loans Past Due
Current Loans
Total Loans
Loans 90 or More Days Past Due
and Still Accruing Interest
Nonaccrual Loans
$
$
$
$
$
$
$
$
121
$
5,593
$
2,368
$
—
—
121
898
513
7,004
530,357
142
1,975
4,485
8,194
1,069
2,636
11,899
104,866
431,525
674,621
1,741,369
105,155
$
431,646
$
537,361
$ 679,106
$1,753,268
— $
155
$
— $
875
$
98
186
203
487
$
— $
—
1,469
1,469
$
$
$
158
589
4,598
1,647
295
6,540
1,043
2,574
$
$
1,201
4,193
955
$
1,370
2,184
4,509
5,651
3,203
4,151
13,005
102,100
383,470
457,983
617,394
1,560,947
102,587
$
384,939
$
464,523
$ 621,903
$1,573,952
— $
387
$
— $
2,401
$
— $
187
450
$
3,195
$
$
187
6,433
The Company disaggregates its loan portfolio into the following four categories:
Commercial - The Company offers a variety of loan options to meet the specific needs of 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 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
first liens on the real estate, which may include apartments, commercial structures, housing businesses, healthcare facilities, and
both owner and non owner-occupied facilities. These loans are typically less risky than commercial loans, since they are secured
by real estate and buildings, and are generally originated in amounts of no more than 80% of the appraised value of the property.
However, the Company also offers commercial construction and land development loans to finance projects, primarily 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 also secured by first liens on the real estate, which may include apartments, commercial
structures, housing business, healthcare facilities and both owner-occupied and non-owner-occupied facilities. There is enhanced
risk during the construction period, since the loan is secured by an incomplete project.
72
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. Also included in this category are automobile
loans. The Company primarily finances the purchases of automobiles indirectly through dealer relationships located throughout
upstate New York and Vermont. Most of these loans carry a fixed rate of interest with principal repayment terms typically ranging
from three to seven years. Indirect consumer loans are underwritten on a secured basis using the underlying collateral being
financed.
Residential - 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 an existing mortgage. These loans are collateralized primarily by owner-occupied properties generally located in
the Company’s market area. Loans on one-to-four-family residential real estate are generally originated in amounts of no more
than 80% of the purchase price or appraised value (whichever is lower), or have private mortgage insurance. The Company’s
underwriting analysis for residential mortgage loans typically includes credit verification, independent appraisals, and a review of
the borrower’s financial condition. Mortgage title insurance and hazard insurance are normally required. It is our general practice
to underwrite our residential real estate loans to secondary market standards. Construction loans have a unique risk, because
they are secured by an incomplete dwelling. This risk is reduced through periodic site inspections, including one at each loan
draw period. In addition, the Company offers fixed home equity loans as well as 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%,
although periodically higher advances are allowed. The Company originates home equity lines of credit and second mortgage
loans (loans secured by a second junior lien position on one-to-four-family residential real estate). Risk is generally reduced
through underwriting criteria, which include credit verification, appraisals, a review of the borrower's financial condition, and personal
cash flows. A security interest, with title insurance when necessary, is taken in the underlying real estate.
Allowance for Loan Losses
The following table presents a rollforward of the allowance for loan losses and other information pertaining to the allowance
for loan losses:
Allowance for Loan Losses
Commercial
Commercial
Real Estate
Consumer
Residential
Unallocated
Total
Rollfoward of the
Allowance for Loan
Losses for the Year
Ended:
December 31, 2015 $
1,827
$
4,520
$
5,554
$
3,790
$
347
$
16,038
Charge-offs
Recoveries
Provision
(97)
23
(736)
(195)
—
1,352
(871)
182
1,255
(107)
6
509
—
—
(347)
(1,270)
211
2,033
December 31, 2016 $
1,017
$
5,677
$
6,120
$
4,198
$
— $
17,012
December 31, 2014 $
2,100
$
4,128
$
5,210
$
3,369
$
763
$
15,570
Charge-offs
Recoveries
Provision
(62)
34
(245)
(7)
—
399
(711)
193
862
(326)
—
747
—
—
(416)
(1,106)
227
1,347
December 31, 2015 $
1,827
$
4,520
$
5,554
$
3,790
$
347
$
16,038
December 31, 2013 $
1,886
$
3,962
$
4,478
$
3,026
$
1,082
$
14,434
Charge-offs
Recoveries
Provision
(212)
86
340
—
—
166
(718)
223
1,227
(91)
—
434
—
—
(319)
(1,021)
309
1,848
December 31, 2014 $
2,100
$
4,128
$
5,210
$
3,369
$
763
$
15,570
73
Allowance for Loan Losses
Commercial
Commercial
Real Estate
Consumer
Residential
Unallocated
Total
$
— $
— $
— $
— $
— $
—
$
1,017
$
5,677
$
6,120
$
4,198
$
— $
17,012
$
— $
890
$
91
$
1,098
$
— $
2,079
$
105,155
$
430,756
$
537,270
$
678,008
$
— $ 1,751,189
$
— $
— $
— $
— $
— $
—
$
1,827
$
4,520
$
5,554
$
3,790
$
347
$
16,038
$
155
$
2,372
$
114
$
645
$
— $
3,286
$
102,432
$
382,567
$
464,409
$
621,258
$
— $ 1,570,666
December 31, 2016
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, 2015
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. Our indirect automobile loan portfolio reflects a modest shift,
since mid 2013, to a slightly larger percentage of loans within the portfolio comprised of loans to individuals with lower credit
scores. 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.
74
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:
• 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 collectability 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, 2016 and December 31, 2015:
Loan Credit Quality Indicators
Commercial
Commercial
Real Estate
Consumer Residential
Total
$
$
December 31, 2016
Credit Risk Profile by
Creditworthiness Category:
Satisfactory
Special Mention
Substandard
Doubtful
Credit Risk Profile Based on
Payment Activity:
Performing
Nonperforming
December 31, 2015
Credit Risk Profile by
Creditworthiness Category:
Satisfactory
Special Mention
Substandard
Doubtful
Credit Risk Profile Based on
Payment Activity:
Performing
Nonperforming
$
95,722
1,359
8,074
—
396,907
7,008
27,731
—
$ 492,629
8,367
35,805
—
$ 536,614
747
$ 675,489
3,617
1,212,103
4,364
$
93,607
1,070
7,910
—
360,654
4,901
19,384
—
$ 454,261
5,971
27,294
—
$ 464,074
449
$ 618,521
3,382
1,082,595
3,831
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;
75
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.
76
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
Real Estate
Commercial
Consumer Residential
Total
December 31, 2016
Recorded Investment:
With No Related Allowance
With a Related Allowance
Unpaid Principal Balance:
With No Related Allowance
With a Related Allowance
December 31, 2015
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, 2016
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, 2015
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, 2014
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
$
$
$
$
$
$
$
$
$
$
$
$
$
—
—
—
—
155
—
155
—
78
—
—
—
—
—
325
—
—
—
—
—
—
348
—
11
—
—
—
$
$
$
$
$
$
$
$
$
$
$
$
$
91
—
91
—
114
—
114
—
103
—
6
—
—
—
$
$
$
$
$
$
$
1,098
—
1,098
—
645
—
645
—
$ 2,079
—
$ 2,079
—
$ 3,286
—
$ 3,286
—
872
—
$ 2,684
—
$
$
1
—
—
—
36
—
—
—
116
—
$ 1,162
280
$ 3,535
280
$
$
$
14
—
—
—
—
—
—
—
—
—
$
$
23
—
—
—
121
—
$ 1,673
546
$ 3,634
546
$
$
$
7
—
—
—
$
$
1
—
—
—
19
—
—
—
890
—
890
—
2,372
—
2,372
—
1,631
—
29
—
—
—
1,932
—
9
—
—
—
—
1,492
—
—
—
—
—
$
$
$
$
$
$
$
$
$
$
$
$
$
77
At December 31, 2016 and December 31, 2015, all impaired loans were considered to be collateral dependent and were
therefore evaluated for impairment based on the fair value of collateral less estimated cost to sell. Interest income recognized in
the table above, represents income earned after the loans became impaired and includes restructured loans in compliance with
their modified terms and nonaccrual loans where we have recognized interest income on a cash basis.
Loans Modified in Trouble Debt Restructurings
The following table presents information on loans modified in trouble debt restructurings during the periods indicated:
Loans Modified in Trouble Debt Restructurings During the Period
Commercial
Commercial
Real Estate
Consumer Residential
Total
For the Year Ended:
December 31, 2016
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, 2015
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, 2014
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
883
883
—
—
—
—
—
—
—
—
—
$
$
$
$
$
$
4
39
39
—
—
—
4
51
51
—
—
—
4
36
36
—
—
—
$
$
$
$
—
—
—
—
—
—
—
—
—
—
—
—
1
$
$
$
$
4
39
39
—
—
—
5
934
934
—
—
—
5
$
$
574
574
$
$
610
610
—
—
—
—
—
—
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, 2016 or December 31, 2015.
78
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
2016
2015
$
3,717
1,009
$
3,268
477
445,805
396,956
153,617
483
153,795
298
Note 6:
PREMISES AND EQUIPMENT (In Thousands)
A summary of premises and equipment at December 31, 2016 and 2015 is presented below:
Land and Bank Premises
Equipment, Furniture and Fixtures
Leasehold Improvements
Total Cost
Accumulated Depreciation and Amortization
Net Premises and Equipment
2016
2015
$
$
35,017
23,604
1,604
60,225
(33,287)
26,938
$
$
34,609
22,879
1,461
58,949
(31,509)
27,440
Amounts charged to expense for depreciation totaled $1,928, $1,892 and $1,879 in 2016, 2015 and 2014, respectively.
79
Note 7:
OTHER INTANGIBLE ASSETS (In Thousands)
The following table presents information on Arrow’s other intangible assets (other than goodwill) as of December 31, 2016,
2015 and 2014:
Gross Carrying Amount, December 31, 2016
Accumulated Amortization
Net Carrying Amount, December 31, 2016
Gross Carrying Amount, December 31, 2015
Accumulated Amortization
Net Carrying Amount, December 31, 2015
Rollforward of Intangible Assets:
Balance, December 31, 2013
Intangible Assets Acquired
Amortization of Intangible Assets
Balance, December 31, 2014
Intangible Assets Acquired
Intangible Assets Disposed
Amortization of Intangible Assets
Balance, December 31, 2015
Intangible Assets Acquired
Intangible Assets Disposed
Amortization of Intangible Assets
Balance, December 31, 2016
$
$
$
$
$
Depositor
Intangibles1
2,247
$
(2,247)
Mortgage
Servicing
Rights2
$
1,968
(1,403)
565
— $
$
2,247
(2,247)
— $
1,822
(1,143)
679
$
61
—
(51)
10
—
—
(10)
—
—
—
—
— $
960
133
(261)
832
107
—
(260)
679
146
—
(260)
565
Customer
Intangibles1
4,382
$
(2,251)
2,131
$
$
$
$
$
4,382
(1,954)
2,428
3,119
—
(336)
2,783
—
(38)
(317)
2,428
—
—
(297)
2,131
Total
8,597
(5,901)
2,696
8,451
(5,344)
3,107
4,140
133
(648)
3,625
107
(38)
(587)
3,107
146
—
(557)
2,696
$
$
$
$
$
$
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, 2016:
Estimated Annual Amortization Expense:
2017
2018
2019
2020
2021
2022 and beyond
Total
Mortgage
Servicing
Rights
Customer
Intangibles
$
$
215
160
87
56
34
13
565
$
$
276
259
242
225
208
921
2,131
Total
$ 491
419
329
281
242
934
$ 2,696
80
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, 2016 and 2015:
Balance at December 31,
Notional Amount:
Commitments to Extend Credit
Standby Letters of Credit
Fair Value:
Commitments to Extend Credit
Standby Letters of Credit
2016
2015
$ 383,586
3,445
$ 278,623
3,065
$
— $
30
—
2
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, 2016 and 2015 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, 2016 and 2015 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.
81
Note 9:
TIME DEPOSITS (Dollars In Thousands)
The following summarizes the contractual maturities of time deposits during years subsequent to December 31, 2016:
Year of Maturity
2017
2018
2019
2020
2021
2022 and beyond
Total
$
$
Total Time
Deposits
124,780
25,031
21,439
9,520
9,997
8,546
199,313
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
Federal Home Loan Bank of New York
Federal Reserve Bank of New York
2016
2015
$ 123,000
35,836
$ 158,836
$
82,000
23,173
$ 105,173
$
35,000
445,805
370,136
$
35,000
396,956
319,623
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 two 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, residential real estate and home equity 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.
Maturity Schedule of FHBLNY Term Advances:
Balances
Weighted Average Rate
Final Maturity
First Year
Second Year
Third Year
Fourth Year
Fifth Year
Total
2016
2015
2016
2015
$
— $
10,000
20,000
25,000
—
55,000
$
$
—
—
10,000
20,000
25,000
55,000
—%
1.50%
1.70%
2.02%
—%
1.81%
—%
—%
1.50%
1.70%
2.02%
1.81%
82
Long Term Debt - Guaranteed Preferred Beneficial Interests in Corporation's Junior Subordinated Debentures
During 2016, 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, 2016, 2015 and 2014 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
2016
2015
$
10,000
$
10,000
3.99%
3.48%
$
10,000
$
10,000
2.84%
2.33%
83
Note 11:
COMPREHENSIVE INCOME (Dollars In Thousands)
The following table presents the components of other comprehensive income for the years ended December 31, 2016, 2015
and 2014:
Schedule of Comprehensive Income
2016
Net Unrealized Securities Holding
Losses Arising During the Period
Reclassification Adjustment for
Securities Losses 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
Before-Tax
Amount
Tax
Expense
(Benefit)
Net-of-Tax
Amount
$
(1,672) $
648
$
(1,024)
22
3,017
(9)
(1,296)
13
1,721
—
716
(12)
—
(281)
5
—
435
(7)
Other Comprehensive Income
$
2,071
$
(933) $
1,138
2015
Net Unrealized Securities Holding
Losses 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
$
(3,017) $
1,185
$
(1,832)
(129)
1,395
(368)
846
(56)
51
(547)
144
(332)
22
(78)
848
(224)
514
(34)
(806)
Other Comprehensive Loss
$
(1,329) $
523
$
2014
Net Unrealized Securities Holding
Gains Arising During the Period
Reclassification Adjustment for
Securities Gains Included in Net
Income
Net Retirement Plan Gains
Net Retirement Plan Prior Service
Credit
Amortization of Net Retirement Plan
Actuarial Loss
Accretion of Net Retirement Plan
Prior Service Credit
$
356
$
(124) $
232
(110)
(4,610)
(570)
474
(87)
43
1,764
223
(186)
34
(67)
(2,846)
(347)
288
(53)
Other Comprehensive Loss
$
(4,547) $
1,754
$
(2,793)
84
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, 2015
Other comprehensive income (loss) before
reclassifications
Amounts reclassified from accumulated other
comprehensive income (loss)
Net current-period other comprehensive income
December 31, 2016
December 31, 2014
Other comprehensive income (loss) before
reclassifications
Amounts reclassified from accumulated other
comprehensive income (loss)
Net current-period other comprehensive loss
December 31, 2015
December 31, 2013
Other comprehensive income (loss) before
reclassifications
Amounts reclassified from accumulated other
comprehensive income (loss)
Net current-period other comprehensive loss
December 31, 2014
$
$
$
$
$
$
629
$
(7,893)
$
(708)
$
(7,972)
(1,024)
1,721
13
(1,011)
(382)
2,539
(1,832)
(78)
(1,910)
629
2,374
232
(67)
165
2,539
$
$
$
$
$
435
2,156
(5,737)
(9,255)
848
514
1,362
(7,893)
(6,697)
(2,846)
288
(2,558)
(9,255)
$
$
$
$
$
—
(7)
(7)
(715)
(450)
(224)
(34)
(258)
(708)
(50)
(347)
(53)
(400)
(450)
$
$
$
$
$
697
441
1,138
(6,834)
(7,166)
(1,208)
402
(806)
(7,972)
(4,373)
(2,961)
168
(2,793)
(7,166)
(1) All amounts are net of tax. Amounts in parentheses indicate debits.
85
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, 2016
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, 2015
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
$
$
$
$
$
$
$
$
$
$
(22)
(22)
9
(13)
Loss on Securities Transactions, Net
Total before tax
Provision for Income Taxes
Net of tax
(2)
(2)
12
(716)
(704)
276
(428)
Salaries and Employee Benefits
Salaries and Employee Benefits
Total before tax
Provision for Income Taxes
Net of tax
(441)
Net of tax
129
129
(51)
78
Gain on Securities Transactions, Net
Total before tax
Provision for Income Taxes
Net of tax
(2)
(2)
56
(846)
(790)
310
(480)
Salaries and Employee Benefits
Salaries and Employee Benefits
Total before tax
Provision for Income Taxes
Net of tax
(402)
Net of tax
86
Reclassifications Out of Accumulated Other Comprehensive Income (1)
Details about Accumulated Other
Comprehensive Income Components
December 31, 2014
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
$
$
$
$
$
110
110
(43)
67
Gain on Securities Transactions, Net
Total before tax
Provision for Income Taxes
Net of tax
(2)
(2)
87
(474)
(387)
152
(235)
Salaries and Employee Benefits
Salaries and Employee Benefits
Total before tax
Provision for Income Taxes
Net of tax
(168)
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).
87
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 29, 2016 3% 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, 2016
Granted
Exercised
Forfeited
Outstanding at December 31, 2016
Exercisable at Period-End
Vested and Expected to Vest
Roll Forward of Shares Outstanding - Weighted Average Exercise Price:
Outstanding at January 1, 2016
Granted
Exercised
Forfeited
Outstanding at December 31, 2016
Exercisable at Period-End
Vested and Expected to Vest
Weighted Average Remaining Contractual Life (in years):
Outstanding at December 31, 2016
Exercisable at December 31, 2016
Vested and Expected to Vest
Aggregate Intrinsic Value:
Outstanding at December 31, 2016
Exercisable at December 31, 2016
Vested and Expected to Vest
Stock Option
Plans
421,751
56,650
(111,992)
(10,758)
355,651
224,039
131,612
$
$
21.93
25.10
21.47
23.97
22.52
21.40
24.44
5.59
4.05
8.21
6,395
4,279
2,116
Shares Available for Grant at Period-End
367,775
88
Schedule of Shares Authorized Under the Stock Option Plan by Exercise Price Range
Exercise Price Ranges
$17.82 to
$18.54
$20.78
$22.18 to
$22.80
23.33
$24.61 to
$25.10
Total
Outstanding at December 31, 2016
Number of Shares Outstanding
51,254
40,305
100,747
59,912
103,433
355,651
Weighted-Average Remaining
Contractual Life (in years)
1.71
3.08
4.58
7.05
8.61
Weighted-Average Exercise Price
$
18.32 $
20.78 $
22.46 $
23.33 $
24.87 $
5.59
22.52
Exercisable at December 31, 2016
Number of Shares Outstanding
51,254
40,305
98,555
25,134
8,791
224,039
Weighted-Average Remaining
Contractual Life (in years)
1.71
3.08
4.56
7.01
8.08
Weighted-Average Exercise Price
$
18.32 $
20.78 $
22.46 $
23.33 $
24.61 $
4.05
21.40
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
$
$
2016
56,650
2015
57,258
2014
77,784
$
5.60
$
5.50
$
5.63
3.88%
32.95%
1.80%
7.56
287
521
2.71
2,404
188
1,010
3.90%
33.55%
1.57%
7.66
$
$
$
$
308
500
2.12
917
59
250
3.97%
35.30%
2.19%
6.85
360
478
1.68
1,454
25
170
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
2016
$ 1,200
2015
900
$
2014
800
$
89
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, 2016 were as follows:
Schedule of Shares in ESOP Plan
ESOP Plan Shares:
Allocated Shares
Shares Released for Allocation During 2016
Unallocated Shares
Total ESOP Shares
2016
713,814
36,927
19,466
770,207
Market Value of Unallocated Shares
$
789
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%.
As of December 31, 2016, Arrow updated its mortality assumption to the RP-2014 Mortality Table for annuitants and non-
annuitants with projected generational mortality improvements using Scale MP-2016. The revised assumption resulted in a decrease
in postretirement liabilities.
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, 2016
Fair Value of Plan Assets
Benefit Obligation
Funded Status of Plan
December 31, 2015
Fair Value of Plan Assets
Benefit Obligation
Funded Status of Plan
Change in Benefit Obligation
Benefit Obligation, at January 1, 2016
Service Cost
Interest Cost
Plan Participants' Contributions
Amendments
Actuarial Gain
Benefits Paid
Benefit Obligation, at December 31, 2016
Employees'
Pension
Plan
Select
Executive
Retirement
Plan
Postretirement
Benefit
Plans
$
$
$
$
$
$
50,220
36,154
14,066
47,234
35,982
11,252
35,982
1,400
1,641
—
—
(738)
(2,131)
36,154
$
$
$
$
$
$
— $
4,547
(4,547)
$
— $
4,784
(4,784)
4,784
40
206
—
—
(31)
(452)
4,547
$
$
$
—
7,623
(7,623)
—
7,701
(7,701)
7,701
147
340
402
—
(327)
(640)
7,623
90
Schedule of Defined Benefit Plan Disclosures
Employees'
Pension
Plan
Select
Executive
Retirement
Plan
Postretirement
Benefit
Plans
Benefit Obligation, at January 1, 2015
Service Cost
Interest Cost
Plan Participants' Contributions
Amendments
Actuarial Gain
Benefits Paid
Benefit Obligation, at December 31, 2015
Change in Fair Value of Plan Assets
Fair Value of Plan Assets, at January 1, 2016
Actual Return on Plan Assets
Employer Contributions
Plan Participants' Contributions
Benefits Paid
Fair Value of Plan Assets, at December 31, 2016
Fair Value of Plan Assets, at January 1, 2015
Actual Return on Plan Assets
Employer Contributions
Plan Participants' Contributions
Benefits Paid
Fair Value of Plan Assets, at December 31, 2015
Accumulated Benefit Obligation at December 31, 2016
Amounts Recognized in the Consolidated Balance Sheets
December 31, 2016
Prepaid Pension Asset
Accrued Benefit Liability
Net Benefit Recognized
December 31, 2015
Prepaid Pension Asset
Accrued Benefit Liability
Net Benefit Recognized
Amounts Recognized in Other Comprehensive Income (Loss)
For the Year Ended December 31, 2016
Net Unamortized Gain Arising During the Period
Net Prior Service Cost Arising During the Period
Amortization of Net Loss
Amortization of Prior Service Credit (Cost)
Total Other Comprehensive (Loss) for Pension and
Other Postretirement Benefit Plans
For the Year Ended December 31, 2015
Net Unamortized Loss Arising During the Period
Net Prior Service Cost Arising During the Period
Amortization of Net Loss
Amortization of Prior Service Credit (Cost)
Total Other Comprehensive Income (Loss) for Pension and
Other Postretirement Benefit Plans
91
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
36,966
1,503
1,545
—
277
(1,670)
(2,639)
35,982
47,234
5,117
—
—
(2,131)
50,220
45,704
1,169
3,000
—
(2,639)
47,234
35,770
14,066
—
14,066
11,252
—
11,252
(2,657)
—
(591)
57
5,072
32
211
—
91
(152)
(470)
4,784
$
$
— $
—
452
—
(452)
— $
— $
—
470
—
(470)
— $
9,170
250
394
481
—
(1,715)
(879)
7,701
—
—
238
402
(640)
—
—
—
398
481
(879)
—
4,547
$
7,623
—
(4,547)
(4,547)
—
(4,784)
(4,784)
(32)
—
(125)
(57)
$
$
$
—
(7,623)
(7,623)
—
(7,701)
(7,701)
(328)
—
—
12
(316)
(1,715)
—
(114)
31
(3,191)
$
(214)
$
$
472
277
(601)
83
$
(152)
91
(131)
(58)
231
$
(250)
$
(1,798)
Schedule of Defined Benefit Plan Disclosures
For the Year Ended December 31, 2014
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, 2016
Net Actuarial Loss
Prior Service (Credit) Cost
Total Accumulated Other Comprehensive Income, Before Tax
December 31, 2015
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, 2016
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, 2015
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, 2014
Service Cost
Interest Cost
Expected Return on Plan Assets
Amortization of Prior Service (Credit) Cost
Amortization of Net Loss
Net Periodic Benefit Cost
Employees'
Pension
Plan
Select
Executive
Retirement
Plan
Postretirement
Benefit
Plans
$
2,855
—
(356)
45
$
871
—
(93)
(72)
884
570
(25)
114
2,544
$
706
$
1,543
7,479
207
7,686
10,727
150
10,877
232
(57)
1,400
1,641
(3,198)
(57)
591
377
1,503
1,545
(3,311)
(83)
601
255
1,410
1,621
(3,230)
(45)
356
112
$
$
$
$
$
$
$
$
$
$
$
$
2,012
546
2,558
2,169
603
2,772
117
57
40
206
—
57
125
428
32
211
—
58
131
432
10
206
—
72
93
381
$
$
$
$
$
$
$
$
$
$
$
$
(238)
422
184
90
410
500
—
(10)
147
340
—
(12)
—
475
250
394
—
(31)
114
727
173
374
—
(114)
25
458
$
$
$
$
$
$
$
$
$
$
$
$
$
$
92
Schedule of Defined Benefit Plan Disclosures
Employees'
Pension
Plan
Select
Executive
Retirement
Plan
Postretirement
Benefit
Plans
Weighted-Average Assumptions Used in
Calculating Benefit Obligation
December 31, 2016
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
December 31, 2015
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, 2016
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 Annuities to Actuarially
Equivalent Lump Sum Amounts
December 31, 2015
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 Annuities to Actuarially
Equivalent Lump Sum Amounts
December 31, 2014
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 Annuities to Actuarially
Equivalent Lump Sum Amounts
93
4.83%
3.50%
3.00%
4.50%
4.50%
4.73%
3.50%
3.03%
5.00%
5.00%
4.73%
7.00%
3.50%
3.03%
5.00%
5.00%
4.31%
7.50%
3.50%
3.04%
4.75%
4.75%
5.10%
7.50%
3.50%
4.00%
5.25%
5.25%
4.73%
3.50%
4.80%
3.50%
4.69%
3.50%
4.69%
3.50%
4.31%
3.50%
5.10%
3.50%
4.50%
4.61%
3.00%
5.00%
4.61%
3.50%
5.00%
4.26%
3.50%
4.75%
4.85%
3.50%
5.25%
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
8,308
16.5%
10.0%
30.0%
Asset Category
December 31, 2016
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, 2015
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
$
40
$
— $
— $
40
0.1%
3,080
6,592
18,640
13,560
32,200
7,332
976
8,308
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
3,080
6,592
6.1%
13.1%
18,640
37.2%
13,560
32,200
27.0%
64.2%
7,332
14.6%
976
1.9%
$
$
50,220
$
— $
— $ 50,220
100.0%
44
$
— $
— $
44
0.1%
2,471
4,554
19,625
13,194
32,819
7,346
—
7,346
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
2,471
4,554
5.2%
9.6%
19,625
41.6%
13,194
32,819
27.9%
69.5%
7,346
15.6%
—
—%
—%
—%
—%
15.0%
15.0%
10.0%
55.0%
85.0%
—%
—%
—%
15.0%
15.0%
10.0%
55.0%
85.0%
7,346
15.6%
15.0%
30.0%
Total
$
47,234
$
— $
— $ 47,234
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.
94
Schedule of Defined Benefit Plan Disclosures
Expected Future Benefit Payments
2017
2018
2019
2020
2021
2022 - 2026
Estimated Contributions During 2017
Assumed Health Care Cost Trend Rates
December 31, 2016
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, 2015
Health Care Cost Trend
Rate Assumed for Next Year
Rate to which the Cost Trend
Rate is Assumed to Decline
(the Ultimate Trend Rate)
Year that the Rate Reaches
the Ultimate Trend Rate
Effect of a One-Percentage Point Change in Assumed
Health Care Cost Trend Rates
Effect of a One Percentage Point Increase on
Service and Interest Cost Components
Effect of a One Percentage Point Decrease on
Service and Interest Cost Components
Effect of a One Percentage Point Increase on
Accumulated Postretirement Benefit Obligation
Effect of a One Percentage Point Decrease on
Accumulated Postretirement Benefit Obligation
Fair Value of Plan Assets (Defined Benefit Plan):
Employees'
Pension
Plan
Select
Executive
Retirement
Plan
Postretirement
Benefit
Plans
$
$
$
2,398
2,168
2,413
2,684
2,418
13,716
$
441
429
417
403
388
1,767
— $
441
$
515
539
561
560
586
2,955
515
7.50%
3.89%
2075
7.75%
3.89%
2075
47
(40)
513
(443)
$
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.
95
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.
Cash Flows - We were not required to and we did not make any contribution to our qualified pension plan in 2016. 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:
Information Technology Services
Legal and Other Professional Fees
Postage and Courier
Advertising and Promotion
Stationery and Printing
Telephone and Communications
Intangible Asset Amortization
All Other
Total Other Operating Expense
2016
$
4,706
2,119
1,087
1,084
892
840
297
3,776
$ 14,801
2015
$
3,909
2,188
1,050
965
796
832
327
3,846
$ 13,913
2014
$
3,659
1,836
1,084
886
851
746
387
3,531
$ 12,980
96
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
2016
$ 10,496
1,002
11,498
(69)
(214)
(283)
$ 11,215
$
2015
8,570
1,004
9,574
860
176
1,036
$ 10,610
$
2014
9,270
1,203
10,473
(315)
16
(299)
$ 10,174
The provisions for income taxes differed from the amounts computed by applying the U.S. Federal Income Tax Rate of 35%
for 2016, 2015 and 2014 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
$
2016
2015
2014
$
13,212
$
12,345
$
11,737
(2,437)
40
554
(154)
11,215
$
(2,292)
36
805
(284)
10,610
$
(2,215)
51
791
(190)
10,174
The tax effects of temporary differences that give rise to significant portions of the deferred tax assets and deferred tax liabilities
at December 31, 2016 and 2015 are presented below:
Deferred Tax Assets:
Allowance for Loan Losses
Pension and Deferred Compensation Plans
Pension Liability Included in Accumulated Other Comprehensive Income
Other
Net Unrealized Losses on Securities Available-for-Sale Included in
Accumulated Other Comprehensive Income
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
2016
2015
$
6,609
3,961
4,023
502
$
6,453
3,973
5,550
557
239
15,334
—
$ 15,334
—
16,533
—
$ 16,533
$
8,399
1,430
4,199
$
8,680
1,383
4,167
—
5,324
$ 19,352
405
5,316
$ 19,951
Management believes that the realization of the recognized gross deferred tax assets at December 31, 2016 and 2015 is
more likely than not, based on historic earnings and expectations as to future taxable income.
Interest and penalties are recorded as a component of the provision for income taxes, if any. There are no current examinations
of our Federal or state income tax returns, nor have we been notified of any up-coming examinations. Tax years 2013 through
2016 are subject to Federal and New York State examination.
97
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, 2016. All share and per
share amounts have been adjusted for the September 29, 2016 3% stock dividend.
Earnings Per Share
12/31/2016
Year-to-Date Period Ended:
12/31/2015
12/31/2014
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
$
$
$
$
$
$
26,534
13,391
1.98
26,534
13,391
85
13,476
$
$
$
24,662
13,281
1.86
24,662
13,281
49
13,330
Earnings Per Share - Diluted
$
1.97
$
1.85
$
23,360
13,242
1.76
23,360
13,242
30
13,272
1.76
98
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, 2016 and 2015 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.”
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, 2016
Securities Available-for Sale:
U.S. Government & 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, 2015
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 of Assets and Liabilities
Measured on a Nonrecurring Basis:
December 31, 2016
Collateral Dependent Impaired Loans
Other Real Estate Owned and
Repossessed Assets, Net
December 31, 2015
Collateral Dependent Impaired Loans
Other Real Estate Owned and
Repossessed Assets, Net
Fair Value Measurements at Reporting Date Using:
Quoted Prices
In Active
Markets for
Identical
Assets
(Level 1)
Significant
Other
Observable
Inputs
(Level 2)
Significant
Unobservabl
e Inputs
(Level 3)
Total Gains
(Losses)
Fair Value
$
$
$
$
$
$
$
$
147,377
27,690
167,239
3,308
1,382
346,996
155,782
52,408
178,588
14,299
1,232
402,309
$
$
$
$
— $
1,686
$
— $
2,018
$
54,706
—
—
—
—
54,706
$
$
— $
—
—
—
—
— $
— $
— $
— $
— $
92,671
27,690
167,239
3,308
1,382
292,290
155,782
52,408
178,588
14,299
1,232
402,309
$
$
$
$
—
—
—
—
—
—
—
—
—
—
—
—
— $
— $
— $
1,686
$
— $
— $
—
587
—
— $
2,018
$
(687)
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).
99
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.
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, 2016 and 2015.
100
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, 2016
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 Overnight
Advances
Federal Home Loan Bank Term Advances
Junior Subordinated Obligations Issued
to Unconsolidated Subsidiary Trusts
Accrued Interest Payable
December 31, 2015
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 Overnight
Advances
Federal Home Loan Bank Term Advances
Junior Subordinated Obligations Issued
to Unconsolidated Subsidiary Trusts
Accrued Interest Payable
$
$
57,355
346,996
345,427
$
57,355
346,996
343,751
57,355
54,706
—
10,912
1,736,256
6,684
2,116,546
10,912
1,720,078
6,684
2,109,557
10,912
—
6,684
1,917,233
$
— $
292,290
343,751
—
—
—
192,324
—
—
—
—
1,720,078
—
—
35,836
35,836
35,836
—
123,000
55,000
20,000
247
123,000
55,118
20,000
247
123,000
—
—
247
—
55,118
20,000
—
$
$
51,068
402,309
320,611
$
51,068
402,309
325,930
51,068
—
—
8,839
1,557,914
6,360
2,030,423
8,839
1,557,511
6,360
2,024,224
8,839
—
6,360
1,840,606
$
— $
402,309
325,930
—
—
—
183,618
23,173
19,421
19,421
—
82,000
55,000
20,000
231
82,000
55,063
20,000
231
82,000
—
—
231
—
55,063
20,000
—
—
—
—
—
—
—
—
—
—
1,557,511
—
—
—
—
—
—
—
Fair Value Methodology for Financial Instruments Not Measured on a Recurring or Nonrecurring Basis
Securities held-to-maturity are fair valued utilizing an independent bond pricing service for identical assets or significantly similar
securities. The pricing service uses a variety of techniques to arrive at fair value including market maker bids, quotes and pricing
models. Inputs to the pricing models include recent trades, benchmark interest rates, spreads and actual and projected cash flows.
Fair values for loans are estimated for portfolios of loans with similar financial characteristics. Loans are segregated by type
such as commercial, commercial real estate, residential mortgage, indirect and other consumer loans. Each loan category is further
segmented into fixed and adjustable interest rate terms and by performing and nonperforming categories. The fair value methodology
does not use an exit price methodology. The fair value of performing loans is calculated by discounting scheduled cash flows through
the estimated maturity using estimated market discount rates that reflect the credit and interest rate risk inherent in the loan. The
estimate of maturity is based on historical experience with repayments for each loan classification, modified, as required, by an
estimate of the effect of current economic and lending conditions. Fair value for nonperforming loans is generally based on recent
101
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. In addition, these instruments do not trade in the open markets since Dodd-Frank deemed
new issuances ineligible for treatment as Tier-1 capital.
Note 18:
LEASES (Dollars In Thousands)
At December 31, 2016, 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, 2016, 2015 and 2014 was as follows:
Net Rental Expense
2016 2015 2014
$ 822 $ 862 $ 784
Future minimum lease payments on operating leases at December 31, 2016 were as follows:
2017
2018
2019
2020
2021
2022 and beyond
Total Minimum Lease Payments
$
Operating
Leases
675
517
378
225
178
278
2,251
$
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, 2016, the maximum amount that could have been paid by subsidiary
banks to Arrow, without prior regulatory approval, was approximately $37 million.
Under current Federal Reserve regulations, Arrow is prohibited from borrowing from the subsidiary banks unless such borrowings
are secured by specific obligations. Additionally, the maximum of any such borrowing is limited to 10% of an affiliate’s capital and
surplus.
Arrow and its subsidiary banks are subject to various regulatory capital requirements administered by the federal banking
agencies. Failure to meet minimum capital requirements can initiate certain mandatory--and possibly additional discretionary--
actions by regulators that, if undertaken, could have a direct material effect on an institution’s financial statements. Under capital
adequacy guidelines and the regulatory framework for prompt corrective action, Arrow and its subsidiary banks must meet specific
capital guidelines that involve quantitative measures of assets, liabilities, and certain off-balance sheet items as calculated under
regulatory accounting practices. Capital amounts and classification are also subject to qualitative judgments by the regulators
about components, risk weightings, and other factors.
Quantitative measures established by regulation to ensure capital adequacy require Arrow and its subsidiary banks to maintain
minimum capital amounts and ratios (set forth in the table below) of total and Tier I capital (as defined in the regulations) to risk-
weighted assets (as defined), and of Tier I capital (as defined) to average assets (as defined). Management believes, as of
December 31, 2016 and 2015, that Arrow and both subsidiary banks meet all capital adequacy requirements to which they are
subject.
102
As of December 31, 2016, 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, Tier I leverage, and CET1 risk-based 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, 2016 and 2015:
Actual
Minimum Amounts
For Capital Adequacy
Purposes
Amount
Ratio
Amount
Ratio
Minimum Amounts To
Be Well-Capitalized
Ratio
Amount
$ 258,653
205,573
42,168
15.2% $ 146,343
117,862
15.0%
28,332
12.8%
8.6% $ 170,166
137,049
8.6%
32,944
8.6%
10.0%
10.0%
10.0%
241,523
191,679
39,050
14.1%
14.0%
11.9%
113,053
90,363
21,658
241,523
191,679
39,050
9.5%
9.1%
8.9%
101,694
84,255
17,551
221,472
191,628
39,050
13.0%
13.9%
11.9%
86,885
70,310
16,736
239,988
193,302
37,658
15.1%
15.0%
12.6%
127,146
103,094
23,910
223,899
180,280
34,642
14.1%
14.0%
11.6%
223,899
180,280
34,642
9.3%
8.9%
8.9%
203,848
180,229
34,642
12.8%
14.0%
11.6%
95,276
77,263
17,918
96,301
81,025
15,569
71,665
57,931
13,439
6.6%
6.6%
6.6%
4.0%
4.0%
4.0%
5.1%
5.1%
5.1%
8.0%
8.0%
8.0%
6.0%
6.0%
6.0%
4.0%
4.0%
4.0%
4.5%
4.5%
4.5%
137,034
109,531
26,252
127,117
105,318
21,938
110,736
89,610
21,330
8.0%
8.0%
8.0%
5.0%
5.0%
5.0%
6.5%
6.5%
6.5%
158,932
128,868
29,887
10.0%
10.0%
10.0%
127,035
103,017
23,891
120,376
101,281
19,462
103,517
83,678
19,411
8.0%
8.0%
8.0%
5.0%
5.0%
5.0%
6.5%
6.5%
6.5%
As of December 31, 2016
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
Common Equity Tier 1 Capital
(to Risk Weighted Assets):
Arrow
Glens Falls National
Saratoga National
As of December 31, 2015
Total Capital
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
Common Equity Tier 1 Capital
(to Risk Weighted Assets):
Arrow
Glens Falls National
Saratoga National
103
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
Junior Subordinated Obligations Issued to
Unconsolidated Subsidiary Trusts
Other Liabilities
Total Liabilities
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)
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
$
$
December 31,
2016
$
3,593
1,382
1,000
243,031
7,951
$ 256,957
2015
$
3,441
1,232
1,000
225,934
7,390
$ 238,997
$
20,000
4,105
24,105
$
20,000
5,026
25,026
232,852
$ 256,957
213,971
$ 238,997
Years Ended December 31,
2015
13,400
118
847
14,365
2016
11,650
117
635
12,402
$
$
2014
13,300
116
578
13,994
691
77
865
1,633
10,769
482
15,283
26,534
619
80
885
1,584
12,781
372
11,509
24,662
$
620
77
754
1,451
12,543
473
10,344
23,360
$
The Statement of Changes in Stockholders’ Equity is not reported because it is identical to the Consolidated Statement of
Changes in Stockholders’ Equity.
104
Years Ended December 31,
2015
2014
2016
$ 26,534
$ 24,662
$ 23,360
(15,283)
196
287
(1,177)
10,557
—
—
—
2,404
493
1,743
188
(2,141)
(13,092)
(10,405)
152
3,441
3,593
691
—
$
$
(11,509)
227
308
(1,419)
12,269
47
(47)
—
918
494
886
59
(1,498)
(12,700)
(11,841)
428
3,013
3,441
619
—
$
$
(10,344)
197
360
(1,014)
12,559
45
(45)
—
1,454
488
—
25
(2,455)
(12,407)
(12,895)
(336)
3,349
3,013
620
91
$
$
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
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 (Used in) 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 Increase (Decrease) 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
105
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,
2016. 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 assessed the effectiveness of our internal control over financial reporting as of December 31, 2016. In May
2013, the Committee of Sponsoring Organizations of the Treadway Commission (COSO) published an updated Internal Control-
Integrated Framework and related illustrative documents. We adopted the 2013 framework in 2015. Accordingly, in making its
assessment of the effectiveness of our internal control over financial reporting as of December 31, 2016, management used the
criteria established in the 2013 framework. Based on our assessment, our management concluded that our internal control over
financial reporting was effective as of December 31, 2016.
Item 9B. Other Information – None.
106
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 3, 2017 (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"
on the header tab "Corporate."
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 Named 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.
Item 14. Principal Accounting Fees and Services
The information required by this item is set forth under the captions "Voting Item 2 - 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, 2016 and 2015
Consolidated Statements of Income for the Years Ended December 31, 2016, 2015 and 2014
Consolidated Statements of Comprehensive Income for the Years Ended December 31, 2016, 2015 and 2014
Consolidated Statements of Changes in Stockholders’ Equity for the Years Ended December 31, 2016, 2015 and 2014
Consolidated Statements of Cash Flows for the Years Ended December 31, 2016, 2015 and 2014
Notes to Consolidated Financial Statements
2. Schedules
107
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 109.
Item 16. Form 10-K Summary - None
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, 2017
Date: March 14, 2017
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, 2017
by the following persons in the capacities indicated.
/s/ Mark L. Behan
Mark L. Behan
Director
/s/ John J. Carusone, Jr.
John J. Carusone, Jr.
Director
/s/ Tenée R. Casaccio
Tenée 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 A. Miller
Elizabeth A. Miller
Director
/s/ David L. Moynehan
David L. Moynehan
Director
/s/ Thomas J. Murphy
Thomas J. Murphy
Director
/s/ Raymond F. O'Conor
Raymond F. O'Conor
Director
/s/ William L. Owens
William L. Owens
Director
/s/ Colin L. Reed
Colin L. Reed
Director
/s/ Richard J. Reisman, D.M.D.
Richard J. Reisman, D.M.D.
Director
108
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
Select Executive Retirement Plan of the Registrant for benefits accrued or vested after December 31, 2004, as amended
and restated, incorporated herein by reference from the Registrant’s Annual Report filed on Form 10-K for the year
ended December 31, 2008, Exhibit 10.9*
Select Executive Retirement Plan of the Registrant for benefits accrued or vested on or before December 31, 2004,
as amended and restated, incorporated herein by reference from the Registrant’s Annual Report filed on Form
10-K for the year ended December 31, 2008, Exhibit 10.10*
10.9
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*
109
Exhibit
Number
10.11
10.12
10.13
10.14
10.16
10.17
10.18
10.19
10.20
10.21
14
Exhibit
Employment Agreement between the Registrant and Thomas J. Murphy, President and Chief Executive Officer, effective
February 1, 2017 incorporated herein by reference from the Registrant's Current Report on Form 8-K , filed February
7, 2017, Exhibit 10.1*
Employment Agreement between the Registrant and Terry R. Goodemote, Executive Vice President and Chief Financial
Officer, effective February 1, 2016 incorporated herein by reference from the Registrant's Current Report on Form
8-K, filed February 2, 2016, Exhibit 10.2*
Employment Agreement between the Registrant and David S. DeMarco, Senior Vice President, effective February 1,
2017 incorporated herein by reference from the Registrant's Current Report on Form 8-K , filed February 7, 2017,
Exhibit 10.2*
Employment Agreement between the Registrant and David D. Kaiser, Senior Vice President and Chief Loan Officer,
effective February 1, 2017 incorporated herein by reference from the Registrant's Current Report on Form 8-K , filed
February 7, 2017, Exhibit 10.3*
Form of Incentive Stock Option Certificate (Employee Award) of the Registrant, incorporated herein by reference from
the Registrant’s Annual Report filed on Form10-K for the year ended December 31, 2013, Exhibit 10.15*
Form of Non-Qualified Stock Option Certificate (Employee Award) of the Registrant, incorporated herein by reference
from the Registrant’s Annual Report filed on Form10-K for the year ended December 31, 2013, Exhibit 10.16*
Form of Non-Qualified Stock Option Certificate (Director Award) of the Registrant, incorporated herein by reference
from the Registrant’s Annual Report filed on Form10-K for the year ended December 31, 2013, Exhibit 10.17*
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, incorporated herein by reference from the Registrant’s Annual
Report filed on Form10-K for the year ended December 31, 2013, Exhibit 10.18*
The Arrow Financial Corporation Employees' Pension Plan and Trust, as amended and restated, effective January 1,
2012, incorporated herein by reference from the Registrant's Quarterly Report on Form 10-Q for the quarter ended
Consulting Agreement between the Registrant and Thomas L. Hoy, effective January 1, 2016, incorporated herein by
reference from the Registrant's Annual Report on Form 10-K for the year ended December 31, 2015, Exhibit 10.20*
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
21
23
31.1
31.2
32
Exhibit
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.
110
Arrow Financial Corporation
Board of Directors
Thomas L. Hoy (Chairman)
Retired President and CEO
Arrow/Glens Falls National Bank
Gary C. Dake
President
Stewart’s Shops Corp.
Mark L. Behan
President
Behan Communications, Inc.
David G. Kruczlnicki
Retired President and CEO
Glens Falls Hospital
John J. Carusone, Jr.
Attorney
Carusone & Carusone
Elizabeth A. Miller
President and CEO
Miller Mechanical Services, Inc.
Tenée R. Casaccio
President
JMZ Architects and Planners, P.C.
David L. Moynehan
Retired President
Riverside Gas & Oil Company, Inc.
Raymond F. O’Conor
Chairman and Retired President
and CEO
Saratoga National Bank
William L. Owens
Partner
Stafford, Owens, Piller, Murnane,
Kelleher & Trombley, PLLC
Colin L. Read
Mayor, City of Plattsburgh
Professor of Economics
and Finance
SUNY Plattsburgh
Michael B. Clarke
Retired President and CEO
Lone Star Industries
Thomas J. Murphy
President and CEO
Arrow/Glens Falls National Bank
Richard J. Reisman, DMD
Chairman - Section of Dentistry
Glens Falls Hospital
Director Emeriti
Jan-Eric O. Bergstedt
(In Memoriam)
Herbert O. Carpenter
Mary-Elizabeth T. FitzGerald
George C. Frost
Corporate Officers
Herbert A. Heineman, Jr.
Dr. Edward F. Huntington
Elizabeth O’Connor Little
Michael F. Massiano
(Chairman Emeritus)
John J. Murphy
Doris E. Ornstein
Thomas J. Murphy
President and CEO
David S. DeMarco
Senior Vice President
Terry R. Goodemote
Executive Vice President and CFO
David D. Kaiser
Senior Vice President
Shareholder Information
Arrow Stock
Arrow’s common stock trades on the NASDAQ Global Select MarketSM under the symbol “AROW.”
Dividend Reinvestment Plan
The Arrow Financial Corporation Dividend
Reinvestment Plan offers participants a
convenient and economical way to acquire
common stock of Arrow Financial Corporation
without payment of any brokerage
commission or service charge.
Participants may reinvest all cash dividends in
additional shares as well as make optional cash
contributions to buy shares.
Since the Plan is entirely voluntary, you may
join at any time and terminate whenever
you wish.
For more information, please contact:
American Stock Transfer and Trust Company
6201 15th Avenue
Brooklyn, NY 11219
Tel: (888) 444-0058 or amstock.com
Source: Prepared by Zacks Investment Research, Inc. Used with permission. All rights reserved. Copyright 1980–2017.
250 Glen Street | PO Box 307
Glens Falls, NY 12801
(518) 745-1000
arrowfinancial.com