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, 1995 Commission file number 0-12507 ARROW FINANCIAL CORPORATION (Exact name of registrant as specified in its charter) NEW YORK 22-2448962 (State or Other Jurisdiction of (I.R.S. Employer Incorporation or Organization) 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 checkmark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K 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. Indicate by checkmark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes X No Indicate the number of shares outstanding of each of the registrant's classes of common stock, as of the latest practicable date. Class Outstanding at March 4, 1996 Common stock, Par Value $1.00 Per Share 5,587,735 State the aggregate market value of the voting stock held by non-affiliates of registrant. Aggregate market value Based upon the average of the closing bid of voting stock and closing asked prices on the NASDAQ Exchange $108,961,000 March 4, 1996 DOCUMENTS INCORPORATED BY REFERENCE Portions of Registrant's Proxy Statement for the Annual Meeting of Shareholders to be held April 24, 1996 (Part III) and the Annual Report to Shareholders (Part II, Item 8) ARROW FINANCIAL CORPORATION FORM 10-K INDEX PART I Item 1. Business A. General B. Lending Activities C. Supervision and Regulation D. Competition E. Statistical Disclosure (Guide 3) F. Legislative Developments G. Executive Officers of the Registrant Item 2. Properties Item 3. Legal Proceedings Item 4. Submission of Matters to a Vote of Security Holders PART II Item 5. Market for the Registrant's Common Equity and Related Stockholder Matters Item 6. Selected Financial Data Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations A. Overview B. Results of Operations I. Net Interest Income II. Provision for Loan Losses and Allowance for Loan Losses III. Other Income IV. Other Expense V. Income Taxes C. Financial Condition I. Investment Portfolio II. Loan Portfolio a. Distribution of Loans and Leases b. Risk Elements III. Summary of Loan Loss Experience IV. Deposits V. Time Certificates of $100,000 or More D. Liquidity E. Interest Rate Risk F. Capital Resources and Dividends G. Fourth Quarter Results Item 8. Financial Statements and Supplementary Data Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure PART III Item 10. Directors and Executive Officers of the Registrant Item 11. Executive Compensation Item 12. Security Ownership of Certain Beneficial Owners and Management Item 13. Certain Relationships and Related Transactions PART IV Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K Signatures Exhibits Index PART I Item 1: Business A. GENERAL Arrow Financial Corporation (the "Company"), 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. The Company owns two national banks in New York and one state-chartered bank in Vermont. The Company owns directly or indirectly all of the common stock of its subsidiaries. The business of the Company consists primarily of the ownership, supervision and control of its bank subsidiaries. The Company provides its subsidiaries with various advisory and administrative services and coordinates the general policies and operation of the subsidiary banks. There were 421 full-time equivalent employees of the Company and the subsidiary banks at December 31, 1995. <TABLE> <CAPTION> SUBSIDIARY BANKS: GLENS (Dollars in Thousands) FALLS SARATOGA NATIONAL NATIONAL GREEN BANK & BANK & MOUNTAIN TRUST CO. TRUST CO. BANK ("GFNB") ("SNB") ("GMB") <S> <C> <C> <C> Total Assets at Year-End $513,150 $60,890 $234,486 (a) 155,000 Trust Assets Under Management at Year-End (Not Included in Total Assets) $397,176 $ 2,082 $258,960 Date Organized 1851 1988 1891 Employees 161 21 109 (a) 76 State of Headquarters New York New York Vermont Offices 14 2 14 (a) 6 Counties of Operation Warren Saratoga Rutland Washington Addison Saratoga Bennington Essex (b) Orange (b) Windsor 137 So. Main Office 250 Glen St. Broadway 80 West St. Glens Falls, Saratoga, Rutland, New York New York Vermont (a) After branch sale on January 15, 1996. (b) Counties of sold branches. </TABLE> Each subsidiary bank offers a full range of commercial and consumer financial products. The banks' deposit base consists of core deposits derived principally from the communities which the banks serve. The banks target their lending activities to consumers and small and mid-sized companies in the banks' immediate geographic areas. In addition to traditional banking services, the Company offers credit card processing services for other financial institutions and, through its banks' trust departments, provides retirement planning, trust and estate administration services for individuals and pension, profit-sharing and employee benefit plan administration for corporations. B. LENDING ACTIVITIES The Company's subsidiary banks engage in a wide range of lending activities, including commercial and industrial lending primarily to small and mid-sized companies; mortgage lending for the purchase of residential and commercial properties; and consumer installment, credit card and home equity financing. Although the Company's Vermont bank previously held a substantial amount of construction and land development loans in its portfolio, this segment of the portfolio has been steadily reduced in recent years and only a small number of new loans of this type have been extended. Historically, the Company has sold a portion of its residential real estate loan originations into the secondary market, primarily to Freddie Mac and state housing agencies, while retaining servicing rights. Loan sales, have diminished in the past three years, however, as the banks have sought to increase their own portfolios. In addition to interest earned on loans, the banks receive facility fees for various types of commercial and industrial credits, and commitment fees for extension of letters of credit and certain types of loans. Generally, the Company continues to implement conservative lending strategies, policies and procedures which are intended to protect the quality of the loan portfolio. These include stringent underwriting and collateral control procedures and credit review systems through which intensive reviews are conducted. It is the Company's policy to discontinue the accrual of interest on loans when the payment of interest and/or principal is due and unpaid for a designated period (generally 90 days) or when the likelihood of repayment is, in the opinion of management, uncertain. Income on such loans is thereafter recognized only upon receipt (see Item 7.C.II.b. "Risk Elements"). The banks lend primarily to borrowers within the geographic areas served by the banks. The banks' combined loan portfolios do not include any foreign loans or any significant industry concentrations except as described in Note 21 to the Consolidated Financial Statements in Part II Item 8 of this report. The portfolios are substantially secured, and many commercial loans are further secured by personal guarantees. C. SUPERVISION AND REGULATION The following generally describes the regulation to which the Company and its banks are subject. Bank holding companies and banks are extensively regulated under both federal and state law. To the extent that the following information describes statutory or regulatory provisions, it is qualified in its entirety by reference to the particular law or regulation. Any change in applicable law or regulation may have a material effect on the business and prospects of the Company and the banks. The Company is a legal entity separate and distinct from its subsidiaries. Most of the Company's revenues result from management fees, dividends and undistributed earnings from the subsidiary banks. The right of the Company, and consequently the right of creditors and shareholders of the Company, to participate in any distribution of the assets or earnings of the banks through the payment of such dividends or otherwise is necessarily subject to the prior claims of creditors of the banks, except to the extent that claims of the Company in its capacity as a creditor may be recognized. Moreover, there are various legal and regulatory limitations applicable to the payment of dividends to the Company by its subsidiaries as well as the payment of dividends by the Company to its shareholders. The ability of the Company and the banks to pay dividends in the future is, and is expected to continue to be, influenced by regulatory policies and capital guidelines. The Company is a registered bank holding company within the meaning of the Bank Holding Company Act of 1956 (BHC Act) and is subject to regulation by the Board of Governors of the Federal Reserve System (Federal Reserve Board). Additionally, the Company is subject to regulation by the New York State Banking Department. The New York banks are nationally chartered banks and are subject to the supervision of and examination by the Office of the Comptroller of the Currency ("OCC"). The Vermont bank is chartered by the State of Vermont and is supervised at the state level by the Vermont Department of Banking, Insurance and Securities and at the federal level by the Federal Deposit Insurance Corporation ("FDIC"). The New York banks are members of the Federal Reserve System and the deposits of each subsidiary bank are insured by the FDIC. The BHC Act prohibits the Company, with certain exceptions, from engaging, directly or indirectly, in non-bank activities and restricts loans by the banks to the Company or other affiliates. Under the BHC Act, a bank holding company must obtain Federal Reserve Board approval before acquiring, directly or indirectly, 5% or more of the voting shares of another bank or bank holding company (unless it already owns a majority of such shares) or acquiring all or substantially all of the assets of another bank or bank holding company. Under the 1994 Riegle-Neal Act, bank holding companies are now able to acquire banks located in all 50 states (see Item 1.F. "Legislative Developments".) The Federal Reserve Board has adopted various "capital adequacy guidelines" for use in the examination and supervision of bank holding companies. One set of guidelines are the risk-based capital guidelines, which assign risk weightings to all assets and certain off-balance sheet items and establish an 8% minimum ratio of qualified total capital to risk-weighted assets. At least half of total capital must consist of "Tier 1" capital, which comprises common equity, retained earnings and a limited amount of permanent preferred stock, less goodwill. Up to half of total capital may consist of so-called "Tier 2" capital, comprising a limited amount of subordinated debt, other preferred stock, certain other instruments and a limited amount of loan loss reserves. The Reserve Board's other capital guideline is the leverage ratio standard, which establishes minimum limits on the ratio of a bank holding company's "Tier 1" capital to total tangible assets. For top-rated holding companies, the minimum leverage ratio is 3%, but lower-rated companies may be required to meet substantially greater minimum ratios. Each subsidiary bank is subject to similar capital requirements adopted by its primary federal regulator. The year-end 1995 capital ratios of the Company and the banks are set forth in Part II, Item 7.F. "Capital Resources and Dividends." A holding company's ability to pay dividends and expand its business through acquisitions of new subsidiaries can be restricted if capital falls below these capital adequacy guidelines. Neither the Company nor any of its subsidiaries is now, or has been within the past year, subject to any formal or informal regulatory enforcement order. D. COMPETITION The Company and its subsidiaries face intense competition in all markets that they serve. Traditional competitors are other local commercial banks, savings banks, savings and loan institutions and credit unions, as well as local offices of major regional and money center banks. Also, non-banking organizations, such as consumer finance companies, insurance companies, securities firms, money market and mutual funds and credit card companies, which are not subject to the same array of regulatory restrictions and capital requirements as the Company and the subsidiary banks, offer substantive equivalents of transaction accounts, credit cards and various other loan and financial products. E. STATISTICAL DISCLOSURE Statistical disclosure required by Securities Act Guide 3 to be set forth herein is found in Item 7 "Management's Discussion and Analysis of Financial Condition and Results of Operations" and Item 8 "Financial Statements and Supplementary Data." INDEX TO SECURITIES ACT GUIDE 3, STATISTICAL DISCLOSURE BY BANK HOLDING COMPANIES Required Information Location Distribution of Assets, Liabilities and Stockholders' Equity; Interest Rates and Interest Differential Part II, Item 7.B.I. Investment Portfolio Part II, Item 7.C.I. Loan Portfolio Part II, Item 7.C.II. Summary of Loan Loss Experience Part II, Item 7.C.III. Deposits Part II, Item 7.C.IV. Return on Equity and Assets Part II, Item 6. Short-Term Borrowings Part II, Item 8. Note 9. F. LEGISLATIVE DEVELOPMENTS In 1994, the Riegle-Neal Interstate Banking and Branching Efficiency Act was enacted. Under the Act, as of September 29, 1995, bank holding companies were authorized as a matter of federal law to acquire banks located in any of the 50 states, notwithstanding any state laws to the contrary, provided all required regulatory and other approvals have been obtained. Also, under the Act, effective June 1, 1997, banks headquartered in any state will be permitted to branch into any other state, except for those states which may enact legislation prior to June 1, 1997 "opting out" of interstate branching. States may "opt in" to interstate branching prior to June 1, 1997, by affirmatively adopting legislation to that effect. The Act also permits commonly-controlled banks to act as agents for one another, effective September 29, 1995, by accepting deposits or loan payments or closing or servicing loans for one another, regardless of any branching laws to the contrary. In 1991, the Federal Deposit Insurance Corporation Improvement Act of 1991 ("FDICIA") was enacted. Among other things, FDICIA requires the federal banking regulators to take prompt corrective action with respect to depository institutions that do not meet minimum capital requirements. FDICIA establishes five capital classifications for banking institutions, the highest of which is "well-capitalized." Under regulations adopted by the federal regulators, a banking institution is considered "well-capitalized" if it has a total risk-adjusted capital ratio of 10% or greater, a Tier 1 risk-adjusted capital ratio of 6% or greater and a leverage ratio of 5% or greater and is not subject to any regulatory order or written directive regarding capital maintenance. The Company and its subsidiary banks are all well-capitalized. FDICIA also imposed expanded accounting and audit reporting requirements for depository institutions whose total assets exceed $500 million. The FDIC levies assessments on various deposit obligations of the Company's banking subsidiaries. In 1993, the FDIC implemented a new risk-based system of assessing deposit insurance premiums to bring the level of the Bank Insurance Fund (BIF) to a FDICIA required level of 1.25% of insured deposits. During 1995, the FDIC reduced the premium paid by the best-rated banks (including all the Company's subsidiary banks) from $.23 per $100 of insured deposits to $.04, upon the recapitalization of the BIF. In 1996, the FDIC insurance premium was further reduced to a flat charge of $2 thousand per year for the highest-rated banks, including all the Company's subsidiary banks. Legislation is currently under consideration that would recapitalize the Savings Association Insurance Fund (SAIF) and merge the SAIF with the BIF. It is not anticipated that this legislation would have an immediate impact on the assessment rate for BIF insured institutions or otherwise would have any negative impact on the Company or its subsidiary banks. Banks and bank holding companies are also significantly affected by the Financial Institutions Reform, Recovery and Enforcement Act of 1989 ("FIRREA"). Although FIRREA dealt primarily with the thrift industry, it also impacted commercial banking organizations. FIRREA mandates public disclosure by commercial banks of their Community Reinvestment Act ratings and mortgage lending records and imposed cross-liability on any insured financial institutions which are affiliated with any other insured institution to which the FDIC gives financial assistance. Various other banking legislation, including proposals to permit banks to affiliate with full-service securities underwriting firms or non-financial organizations (Glass-Steagall Reform) have been introduced in Congress from time to time. The Company cannot determine the ultimate effect that any such potential legislation, if enacted, would have upon its financial condition or operations. In 1995, the federal bank regulatory authorities promulgated a set of revised regulations addressing the responsibilities of banking organizations under the Community Reinvestment Act ("CRA"). The revised regulations place additional emphasis on the actual experience of a bank in making loans in low- and moderate-income areas within its service area as a key determinant in evaluation of the bank's compliance with the statute. As in the prior regulations, bank regulators are authorized to bring enforcement actions against banks under the CRA only in the context of bank expansion or acquisition affiliations. G. EXECUTIVE OFFICERS OF THE REGISTRANT The names and ages of the principal executive officers of the Company and positions held are presented in the following table. The officers are elected annually by the Board of Directors. Name Age Positions Held and Years from Which Held Michael F. Massiano 61 Chairman, President and CEO. Mr. Massiano has been Chairman and CEO since 1990 and was President and CEO of the Company prior to 1990. Mr. Massiano is also CEO of Glens Falls National Bank. John J. Murphy 44 Executive Vice President, Treasurer and CFO. Mr. Murphy has served as Treasurer and Chief Financial Officer of the Company since 1983. Thomas L. Hoy 47 President and COO of Glens Falls National Bank. Mr. Hoy was Executive Vice President of Glens Falls National Bank prior to 1995. Gerard R. Bilodeau 48 Senior Vice President and Secretary since 1994. Mr. Bilodeau was Vice President and Secretary from 1993 to 1994 and was Director of Personnel prior to 1993. Item 2: Properties The Company is headquartered at 250 Glen Street, Glens Falls, New York. The building is owned by Glens Falls National Bank and serves as its main office. Glens Falls National Bank owns thirteen additional offices. Saratoga National Bank owns both of its offices. Green Mountain Bank owns its main office and nine other offices and leases four offices. Of the eight branches sold on January 15, 1996, six were owned and two were leased. Offices leased from unrelated third parties are at market rates. Rental costs of premises did not exceed 5% of operating costs in 1995. In the opinion of management of the Company, the physical properties of the Company and the Banks are suitable and adequate. Item 3: Legal Proceedings The Company is not the subject of any material pending legal proceedings, other than ordinary routine litigation occurring in the normal course of its business. The Company's subsidiary banks are the subjects of or parties to various legal claims which arise in the normal course of their business. For example, the banks, especially Green Mountain Bank, have in recent periods encountered claims against them grounded in lender liability, of the sort often asserted against financial institutions. These lender liability claims normally take the form of counterclaims to lawsuits filed by the banks for collection of past due loans. The various pending legal claims against the subsidiary banks, including such lender liability claims, will not, in the opinion of management, result in any material liability to the banks or the Company. Item 4: Submission of Matters to a Vote of Security Holders None in the fourth quarter of 1995. PART II Item 5: Market for the Registrant's Common Equity and Related Stockholder Matters The common stock of Arrow Financial Corporation is traded over-the-counter. It is registered with and its price is quoted by the National Association of Securities Dealers, Inc., through its national quotation system (NASDAQ). The price ranges below represent actual transactions rounded to the nearest 1/8 point. Although there may have been isolated sales at prices outside the parameters shown, the Company believes that the price ranges fairly represent the trading ranges. Per share amounts and market prices have been adjusted for the 1995 four percent stock dividend and the 1994 four percent stock dividend. <TABLE> <CAPTION> Market Price Cash (Bid) Dividends High Low Declared <S> <C> <C> <C> 1994 1st Quarter $11.375 $10.625 $.065 2nd Quarter 14.750 10.250 .074 3rd Quarter 16.625 14.250 .102 4th Quarter 15.375 13.500 .115 1995 1st Quarter $15.875 $14.875 $.125 2nd Quarter 15.375 14.000 .135 3rd Quarter 17.125 14.375 .144 4th Quarter 19.000 16.875 .160 </TABLE> The payment of dividends by the Company is at the discretion of the Board of Directors and is dependent upon, among other things, the Company's earnings, financial condition and other factors, including applicable governmental regulations and restrictions. See "Capital Resources and Dividends" in Part II, Item 7.F. of this report. There were approximately 2,505 holders of record of common stock at December 31, 1995. <TABLE> Item 6: Selected Financial Data FIVE YEAR SUMMARY OF SELECTED DATA Arrow Financial Corporation and Subsidiaries (Dollars In Thousands, except per share data) <CAPTION> 1995 1994 1993 1992 1991 Consolidated Statements of Income Data: <S> <C> <C> <C> <C> <C> Interest Income $60,718 $52,514 $51,836 $57,829 $ 73,755 Less: Interest Expense 24,865 18,202 19,583 28,399 43,556 Net Interest Income 35,853 34,312 32,253 29,430 30,199 Less: Provision for Loan Losses 1,170 (950) 690 1,677 46,185 Net Interest Income (Loss) After Provision for Loan Losses 34,683 35,262 31,563 27,753 (15,986) Other Income 14,473 9,049 9,086 8,606 8,934 Net Gains (Losses) on Securities Transactions 23 (481) 26 15 684 Less: Other Expense 29,769 31,374 32,118 32,153 31,879 Income (Loss) Before Income Taxes, Extra- ordinary Item and Cumulative Effect of Accounting Change 19,410 12,456 8,557 4,221 (38,247) Provision for (Benefit from) Income Taxes 6,986 1,131 381 1,331 (4,865) Income (Loss) Before Extraordinary Item & Cumulative Effect of Accounting Change 12,424 11,325 8,176 2,890 (33,382) Extraordinary Item: Utilization of Net Operating Loss Carryforward --- --- --- 811 --- Cumulative Effect of a Change in Accounting for Income Taxes --- --- 1,457 --- --- Net Income (Loss) $12,424 $11,325 $ 9,633 $ 3,701 $(33,382) Primary Earnings (Loss) Per Share: Income (Loss) Before Extraordinary Item and Accounting Change $ 2.17 $ 1.97 $ 1.44 $ .53 $(6.13) Extraordinary Item and Accounting Change --- --- .25 .13 --- Net Income (Loss) $ 2.17 $ 1.97 $ 1.69 $ .66 $(6.13) Fully Diluted Earnings (Loss) Per Share: Income (Loss) Before Extraordinary Item and Accounting Change $ 2.17 $ 1.90 $ 1.44 $ .53 $(6.13) Extraordinary Item and Accounting Change --- --- .25 .13 --- Net Income (Loss) $ 2.17 $ 1.90 $ 1.69 $ .66 $(6.13) Cash Dividends $ .56 $ .36 $ .10 $ --- $ .23 Book Value 12.00 10.20 8.74 7.07 6.40 Consolidated Balance Sheet Data: Total Assets $789,790 $746,431 $733,442 $722,415 $769,942 Securities Held-to-Maturity 13,921 129,735 125,832 97,305 145,250 Securities Available-for-Sale 178,645 53,868 55,892 55,598 --- Loans and Leases, Net of Unearned Income 517,787 507,553 502,784 492,916 547,419 Nonperforming Assets 6,765 7,825 20,136 29,669 43,890 Deposits 694,453 650,485 659,427 657,875 696,402 Other Borrowed Funds 15,297 24,865 12,487 15,162 25,141 Long-Term Debt --- 5,007 5,289 5,371 7,048 Shareholders' Equity 67,504 58,405 50,069 39,735 34,900 Selected Key Ratios: Return on Average Assets 1.60% 1.52% 1.33% .50% (4.07)% Return on Average Equity 19.45 20.79 21.03 10.10 (64.54) Dividend Payout 25.81 18.05 5.93 --- --- Average Equity to Average Assets 8.22 7.34 6.32 4.97 6.30 Per share amounts have been adjusted for the 1995, 1994, 1993 and 1992 four percent stock dividends. </TABLE> Item 7: Management's Discussion and Analysis of Financial Condition and Results of Operations The following discussion presents an analysis of the Company's results of operations for each of the years in the three-year period ended December 31, 1995 and the financial condition of the Company as of December 31, 1995 and 1994. Per share amounts have been restated to reflect the four percent stock dividend paid in November 1995 and the four percent stock dividend paid in November 1994. The discussion below should be read in conjunction with the consolidated financial statements and other financial data presented elsewhere herein. A. OVERVIEW The Company reported net income of $12.4 million for 1995, which compared to net income of $11.3 million for 1994. Primary earnings per share were $2.17 and $1.97 for 1995 and 1994, respectively. The following analysis adjusts net income for unusual and nonrecurring items to arrive at a comparative presentation of the Company's core earnings: <TABLE> SUMMARY OF CORE EARNINGS (In Thousands) <CAPTION> 1995 1994 <S> <C> <C> Net Income, as Reported $12,424 $11,325 Net Operating Loss Benefits --- (3,560) Other Items, Net of Tax: Insurance Settlement (3,250) --- OREO Transactions 136 1,133 Credit to the Provision for Loan Losses --- (990) Severance Benefits 388 --- Net Securities Transactions (12) 285 Other (218) --- Recurring Net Income $ 9,468 $ 8,193 Recurring Primary Earnings per Share $ 1.66 $ 1.43 </TABLE> In May of 1995, the Company received a $5.0 million pre-tax settlement from the Company's financial institution bond company on a claim for losses suffered in earlier periods. During 1994, the Company fully utilized the tax benefits resulting from net operating losses sustained in 1991. In the second quarter of 1994, the Company adjusted its reserve for loan losses by means of a $1.5 million credit to the provision for loan losses, reflected as income. This adjustment was offset by a similar amount of losses in the same period on the sale of real estate acquired through foreclosures (OREO), which was reflected as other operating expense. The increase in core earnings from 1994 to 1995 is attributable to an increase in net interest income, increases in all areas of noninterest income and a decrease in operating expenses. Nonperforming assets, which include nonaccrual loans, loans past due 90 days or more and still accruing interest, restructured loans in compliance with modified terms and OREO, amounted to $6.8 million at December 31, 1995, down from $7.8 million at December 31, 1994. The reduction was primarily attributable to sales of OREO. The allowance for loan losses was $12.1 million at December 31, 1995, which represented 278% of the amount of nonperforming loans at that date. This position was substantially unchanged from the prior year-end. Sale of Vermont Operations On January 15, 1996, the Company completed its sale of eight branches of Green Mountain Bank in eastern Vermont to Mascoma Savings Bank of Lebanon, New Hampshire. The following table presents unaudited consolidated balance sheet information at January 15, 1996 in comparison to December 31, 1995 and 1994. <TABLE> SELECTED BALANCE SHEET INFORMATION (In Thousands) <CAPTION> January 15, December 31, December 31, 1996 1995 1994 <S> <C> <C> <C> Liquid Assets (1) $204,505 $237,151 $ 88,492 Investments 13,851 13,921 129,735 Loans 474,463 517,787 507,553 Total Assets 712,493 789,790 746,431 Deposits 592,633 694,453 650,485 Shareholders' Equity 72,728 67,504 58,405 (1) Cash and Due From Banks, Federal Funds Sold and Securities Available-for-Sale. </TABLE> On February 27, 1996, the Company announced that it had entered into a definitive agreement with ALBANK FSB, an Albany, New York based savings bank with Vermont operations, to sell to ALBANK the remaining six Green Mountain Bank branches including substantially all remaining loans and deposits of Green Mountain Bank ($112 million and $110 million, respectively, at the date of signing). On February 27, 1996, the Company entered into a definitive agreement with Vermont National Bank, Brattleboro, Vermont, to sell to Vermont National the Green Mountain Bank trust business. After the completion of these sales, the Company effectively will have no remaining operations in Vermont. These and other changes are more fully described in the following analysis of the results of operations and changes in financial condition. B. RESULTS OF OPERATIONS The following analysis of net interest income, the provision and allowance for loan losses, noninterest income, other expense and income taxes, presents the factors that are primarily responsible for the Company's results of operations for 1995 and the prior two years. I. NET INTEREST INCOME (Fully Taxable Basis) Net interest income represents the difference between interest earned on loans and investments and interest paid on deposits and other sources of funds. Changes in net interest income result from (I) changes in the level and mix of earning assets and sources of funds (volume) (II) changes in the yields earned and costs paid (rate), and (III) the relative volume of nonperforming assets. 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 earning assets and net interest margin. <TABLE> COMPARISON OF NET INTEREST INCOME (Dollars In Thousands) (Fully Taxable Basis) <CAPTION> Years Ended December 31, Change From Prior Year 1995 1994 1993 1995 1994 Amount Percent Amount Percent <S> <C> <C> <C> <C> <C> <C> <C> Interest Income $61,411 $52,985 $52,415 $ 8,426 15.9 % $ 570 1.1 % Interest Expense 24,865 18,202 19,583 6,663 36.6 (1,381) (7.1) Net Interest Income $36,546 $34,783 $32,832 $ 1,763 5.1 $ 1,951 5.9 </TABLE> On a tax-equivalent basis, net interest income was $36.5 million in 1995, an increase of $1.8 million or 5.1% from $34.8 million in 1994. Net interest income, for both 1995 and 1994, was favorably impacted by both the changing interest rate environment and an increase in average earning assets. In addition to general changes in rates and volume, net interest income was enhanced by the reduction of nonaccrual loans, both in absolute amounts and as a ratio to earning assets. The Company also benefitted from retained earnings as a source of funds and from the investment of the proceeds from OREO sales into earning assets. In 1989, under the influence of the Federal Reserve Board, interest rates began a steady decline, and for a two year period beginning in the spring of 1992, the prime rate was unchanged. During that period, the Company experienced a benefit from a change in the mix of deposits from higher cost time deposits to lower cost N.O.W. and money market deposit accounts. During 1994, the prolonged period of falling interest rates came to an end as the Federal Reserve Board began a series of interest rate increases which extended into 1995. As a result, the mix of average deposits in 1994 was virtually the same as for 1993, but in 1995, depositors began to move a portion of their deposits back to higher cost time deposits. ANALYSIS OF CHANGES IN NET INTEREST INCOME The following table presents net interest income components on a tax-equivalent basis and reflects changes between periods attributable to movement in either the average daily balance 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. <TABLE> CHANGE IN NET INTEREST INCOME (In Thousands) (Fully Taxable Basis) <CAPTION> 1995 to 1994 1994 to 1993 Change in Net Interest Income Change in Net Interest Income Due to: Due to: Volume Rate Total Volume Rate Total <S> <C> <C> <C> <C> <C> <C> Interest Income: Interest-Bearing Deposits With Banks $ --- $ --- $ --- $ (34) $ (34) $ (68) Federal Funds Sold 521 285 806 (1,051) 934 (117) Securities Available- for-Sale 334 823 1,157 525 (626) (101) Securities Held-to-Maturity: U.S. Treasury and Other Governmental Agencies (372) 75 (297) (776) (469) (1,245) State and Municipal Obligations 548 45 593 218 (321) (103) Mortgage-Backed Securities 233 87 320 1,044 10 1,054 Other Securities 282 11 293 42 71 113 Total Securities Held- to-Maturity 691 218 909 528 (709) (181) Loans 956 4,598 5,554 1,097 (60) 1,037 Total Interest Income 2,502 5,924 8,426 1,065 (495) 570 Interest Expense: Deposits: N.O.W./Super N.O.W. 202 1,279 1,481 65 (430) (365) Regular Savings and M.M.D.A. (1,917) 847 (1,070) 25 (555) (530) Time Certificates of $100,000 or More 2,158 442 2,600 507 (54) 453 Other Time Deposits 1,121 2,319 3,440 (516) (469) (985) Total Deposits 1,564 4,887 6,451 81 (1,508) (1,427) Short-Term Borrowings 288 137 425 29 29 58 Long-Term Debt (230) 17 (213) (11) (1) (12) Total Interest Expense 1,622 5,041 6,663 99 (1,480) (1,381) Net Interest Income $ 880 $ 883 $1,763 $ 966 $ 985 $1,951 </TABLE> The following table reflects the components of the Company's net interest income, setting forth, for years ended December 31, 1995, 1994 and 1993 (I) average assets, liabilities and shareholders' equity, (II) interest 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. Rates are computed on a tax-equivalent basis. Nonaccrual loans are included in average loans and leases, while unearned income has been eliminated. <TABLE> AVERAGE CONSOLIDATED BALANCE SHEETS AND NET INTEREST INCOME ANALYSIS Arrow Financial Corporation and Subsidiaries (Fully Taxable Basis using a marginal tax rate of 35% for 1995 and 34% for 1994 and 1993) (Dollars In Thousands) (Unaudited) <CAPTION> Years Ended December 31, 1995 Interest Rate Average Income/ Earned/ Balance Expense Paid <S> <C> <C> <C> Interest-Bearing Deposits With Banks $ --- $ --- ---% Federal Funds Sold 22,596 1,307 5.78 Securities Available- for-Sale 66,075 4,024 6.09 Securities Held-to-Maturity: U.S. Treasury and Governmental Agencies 57,993 3,108 5.36 State and Municipal 13,271 1,124 8.47 Mortgage-Backed Securities 48,933 3,100 6.34 Other Securities 6,573 486 7.39 Total Securities Held- to-Maturity 126,770 7,818 6.17 Loans & Leases (Net of Unearned Income) 513,266 48,262 9.40 Total Earning Assets 728,707 61,411 8.43 Allowance for Loan Losses (12,288) Cash and Due From Banks 28,081 Other Assets 32,929 Total Assets $777,429 Deposits: N.O.W./Super N.O.W. $139,879 3,975 2.84 Savings/M.M.D.A. 201,932 6,187 3.06 Time Certificates of $100,000 or More 67,029 3,761 5.61 Other Time Deposits 185,166 9,893 5.34 Total Interest-Bearing Deposits 594,006 23,816 4.01 Short-Term Borrowings 15,855 819 5.17 Long-Term Debt. 2,619 230 8.78 Total Interest- Bearing Funds 612,480 24,865 4.06 Demand Deposits 88,961 Other Liabilities 12,097 Total Liabilities 713,538 Shareholders' Equity 63,891 Total Liabilities and Shareholders' Equity $777,429 Net Interest Income (Fully Taxable Basis) 36,546 Reversal of Tax Equivalent Adjustment (693) Net Interest Income $35,853 Net Interest Spread 4.37% Net Interest Margin 5.02% </TABLE> <TABLE> AVERAGE CONSOLIDATED BALANCE SHEETS AND NET INTEREST INCOME ANALYSIS Arrow Financial Corporation and Subsidiaries (Fully Taxable Basis using a marginal tax rate of 35% for 1995 and 34% for 1994 and 1993) (Dollars In Thousands) (Unaudited) <CAPTION> Years Ended December 31, 1994 Interest Rate Average Income/ Earned/ Balance Expense Paid <S> <C> <C> <C> Interest-Bearing Deposits With Banks $ --- $ --- ---% Federal Funds Sold 12,490 501 4.01 Securities Available- for-Sale 60,591 2,867 4.73 Securities Held-to-Maturity U.S. Treasury and Governmental Agencies 64,908 3,405 5.25 State and Municipal 6,761 531 7.85 Mortgage-Backed Securities 45,221 2,780 6.15 Other Securities 2,751 193 7.02 Total Securities Held- to-Maturity 119,641 6,909 5.77 Loans & Leases (Net of Unearned Income) 502,224 42,708 8.50 Total Earning Assets 694,946 52,985 7.62 Allowance for Loan Losses (16,954) Cash and Due From Banks 27,009 Other Assets 37,635 Total Assets $742,636 Deposits: N.O.W./Super N.O.W. $129,999 2,494 1.92 Savings/M.M.D.A. 260,336 7,257 2.79 Time Certificates of $100,000 or More 26,980 1,161 4.30 Other Time Deposits 160,035 6,453 4.03 Total Interest-Bearing Deposits 577,350 17,365 3.01 Short-Term Borrowings 9,838 394 4.00 Long-Term Debt. 5,226 443 8.48 Total Interest- Bearing Funds 592,414 18,202 3.07 Demand Deposits 87,715 Other Liabilities 8,028 Total Liabilities 688,157 Shareholders' Equity 54,479 Total Liabilities and Shareholders' Equity $742,636 Net Interest Income (Fully Taxable Basis) 34,783 Reversal of Tax Equivalent Adjustment (471) Net Interest Income $34,312 Net Interest Spread 4.55% Net Interest Margin 5.01% </TABLE> <TABLE> AVERAGE CONSOLIDATED BALANCE SHEETS AND NET INTEREST INCOME ANALYSIS Arrow Financial Corporation and Subsidiaries (Fully Taxable Basis using a marginal tax rate of 35% for 1995 and 34% for 1994 and 1993) (Dollars In Thousands) (Unaudited) <CAPTION> Years Ended December 31, 1993 Interest Rate Average Income/ Earned/ Balance Expense Paid <S> <C> <C> <C> Interest-Bearing Deposits With Banks $ 2,151 $ 68 3.16% Federal Funds Sold 20,927 618 2.95 Securities Available- for-Sale 49,489 2,968 6.00 Securities Held-to-Maturity: U.S. Treasury and Governmental Agencies 79,060 4,651 5.88 State and Municipal 5,595 634 11.33 Mortgage-Backed Securities 28,235 1,726 6.11 Other Securities 1,935 79 4.08 Total Securities Held- to-Maturity 114,825 7,090 6.17 Loans & Leases (Net of Unearned Income) 489,326 41,671 8.52 Total Earning Assets 676,718 52,415 7.75 Allowance For Loan Losses (16,954) Cash and Due From Banks 26,963 Other Assets 37,998 Total Assets $724,725 Deposits: N.O.W./Super N.O.W. $127,163 2,859 2.25 Savings/M.M.D.A. 259,519 7,787 3.00 Time Certificates of $100,000 or More 15,077 708 4.70 Other Time Deposits 172,422 7,438 4.31 Total Interest-Bearing Deposits 574,181 18,792 3.27 Short-Term Borrowings 9,083 336 3.70 Long-Term Debt. 5,359 455 8.49 Total Interest- Bearing Funds 588,623 19,583 3.33 Demand Deposits 83,971 Other Liabilities 6,317 Total Liabilities 678,911 Shareholders' Equity 45,814 Total Liabilities and Shareholders' Equity $724,725 Net Interest Income (Fully Taxable Basis) 32,832 Reversal of Tax Equivalent Adjustment (579) Net Interest Income $32,253 Net Interest Spread 4.42% Net Interest Margin 4.85% </TABLE> <TABLE> CHANGES IN NET INTEREST INCOME DUE TO RATE YIELD ANALYSIS December 31, <CAPTION> 1995 1994 1993 <S> <C> <C> <C> Yield on Earning Assets 8.43% 7.62% 7.75% Cost of Interest-Bearing Liabilities 4.06 3.07 3.33 Net Interest Spread 4.37% 4.55% 4.42% Net Interest Margin 5.02% 5.01% 4.85% </TABLE> The following items have a major impact on changes in net interest income due to rate: general interest rate changes, the ratio of the Company's rate sensitive assets to rate sensitive liabilities (interest rate sensitive gap) during periods of interest rate changes and the relative level of nonaccrual loans. In 1995, the change in net interest income attributable to changes in interest rates had an $883 thousand positive impact on net interest income. During the first half of the year, the Company was still experiencing the effect from rising interest rates which had begun in the second half of 1994. Various loan and deposit products react to interest rate changes with different speeds and for some products not to the full extent of changes in the prime rate. During 1994, assets in general repriced more quickly than time deposits. Repricing of short-term deposit products also tended to lag behind prime rate changes and did not change to the full extent of prime rate changes. Consequently, the spread between the yield on earning assets and the cost of interest paying liabilities increased from 1993 to 1994 by 13 basis points, while decreasing by 18 basis points from 1994 to 1995. Notwithstanding the decrease in the net interest spread, the Company experienced a beneficial impact from generally rising interest rates due to the fact that the increase in average interest bearing assets exceeded the increase in interest paying liabilities as discussed more fully in the following section on changes in net interest income due to volume. As a result, the net interest margin increased from 1994 to 1995, albeit by only one basis point. In 1994, the change in net interest income attributable to changes in interest rates had a $985 thousand positive impact on net interest income. During the first half of the year, the Company was still experiencing the effect from falling interest rates in prior periods, as higher yielding fixed rate loan and time deposit maturities repriced at current rates. During the second half of the year the Federal Reserve Board began a series of interest rate increases and the Company, as well as many financial institutions, benefitted from a more rapid repricing of earning assets than paying liabilities. The effect of the downward repricing of fixed rate loan and time deposit maturities in the first half of the year was more pronounced than the effect of rising interest rates at the end of the year, as both the yield on earnings assets and the cost of paying liabilities fell from 1993 to 1994. The Company also experienced the benefit of reduced levels of nonaccrual loans, both in absolute amounts and as a ratio to earning assets, and was able to apply the proceeds from OREO sales to earning assets. Nonaccrual loans amounted to $3.6 million and $9.9 million at December 31, 1994 and 1993, respectively, and the proceeds from OREO sales amounted to $4.8 million in 1994. <TABLE> CHANGES IN NET INTEREST INCOME DUE TO VOLUME AVERAGE BALANCES (Dollars in Thousands) <CAPTION> $ Change % Change 1995 1994 1993 1995 1994 1995 1994 <S> <C> <C> <C> <C> <C> <C> <C> Earning Assets $728,707 $694,946 $676,718 $33,761 $18,228 4.9% 2.7% Interest-Bearing Liabilities 612,480 592,414 588,623 20,066 3,791 3.4 .6 Demand Deposits 88,961 87,715 83,971 1,246 3,744 1.4 4.5 Total Assets 777,429 742,636 724,725 34,793 17,911 4.7 2.5 Earning Assets to Total Assets 93.73% 93.58% 93.38% .15% .20% .2 .2 </TABLE> In general, changes in volume will result in corresponding changes in net interest income. However, changes due to volume can be enhanced or restricted by shifts in the relative mix between instruments of different rates. In 1995, the change in volume had an $880 thousand positive impact on net interest income. Of the $33.8 million increase in average earning assets from 1994 to 1995, average loan balances accounted for $11.0 million. The Company used the remaining funds to increase its liquid assets. Only $20.1 million of the $33.8 million increase in average earning assets was funded by paying liabilities. The primary sources of funds for the remainder came from retained earnings ($9.4 million) and proceeds from the sale of OREO ($1.5 million). In 1994, the change in volume had a $966 thousand positive impact on net interest income. Of the $18.2 million increase in average earning assets from 1993 to 1994, average loan balances accounted for $12.9 million. The Company used the remaining funds as well as $8.4 million from decreased average federal funds balances to increase both the held-to-maturity and available-for-sale securities portfolios. Only $3.8 million of the $18.2 million increase in average earning assets was funded by paying liabilities. The primary sources of funds for the remainder came from retained earnings ($8.7 million) and proceeds from the sale of OREO ($4.8 million). II. PROVISION FOR LOAN LOSSES AND ALLOWANCE FOR LOAN LOSSES Through the provision for loan losses, an allowance (reserve) is established for estimated future loan losses. Actual loan losses are charged against this allowance when they occur. In evaluating the adequacy of the allowance for loan losses, management considers various risk factors influencing asset quality. This analysis is based on judgments and estimates and may change in response to economic developments or other conditions that may influence borrowers' economic outlook. On January 1, 1995, the Company adopted Statement of Financial Accounting Standards (SFAS) No. 114, "Accounting by Creditors for Impairment of a Loan." SFAS No. 114, as amended, requires that impaired loans, except for large groups of smaller-balance homogeneous loans, be measured based on (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 if the loan is collateral dependent. The Company applies the provisions of SFAS No. 114 to all impaired commercial and commercial real estate loans over $250,000, and to all loans restructured subsequent to adoption. Reserves for losses for the remaining smaller-balance loans are evaluated under SFAS No. 5. Under the provisions of SFAS No. 114, the Company determines impairment for collateralized loans based on fair value of the collateral less estimated cost to sell. For other loans, impairment is determined by comparing the recorded value of the loan to the present value of the expected cash flows, discounted at the loan's effective interest rate. The Company determines the interest income recognition method on a loan by loan basis. Based upon the borrowers' payment histories and cash flow projections, interest recognition methods include full accrual, cash basis and cost recovery. During 1995, nonperforming assets continued the steady decline begun in 1991. The primary portion of the decrease in nonperforming assets in 1995 came from the sale of OREO. Nonaccrual loans increased $626 thousand or 17.3% from the year-end 1994 balance. The increase in nonaccrual loans represents the aggregate borrowing of one large commercial borrower, which was placed on nonaccrual status in 1995. That loan was accounted for under SFAS No. 114 and was being carried at its estimated fair value. Loans reported as troubled debt restructures at December 31, 1994, were classified as performing in 1995. Net charge-offs for 1995 of $1.4 million, or .27% of average loans for the year, was typical of the Company's historical experience with the exception of 1991 and 1992. The provision for loan losses of $1.2 million, or .23% of average loans, remained below the Company's historical average. The 1995 provision, however, was deemed adequate in consideration of the ratio of the allowance for loan losses to nonperforming loans, which amounted to 278% at December 31, 1995. The provision for loan losses in 1994 was actually a credit to the provision and a reduction in the allowance for loan losses. During the second quarter of 1994, with nonperforming assets at significantly reduced levels and a substantial sale of OREO having been completed, the Company reduced the unallocated portion of the allowance for loan losses by $1.5 million. This reduction was effected by means of a credit to the provision for loan losses. As a result, for the twelve month period ended December 31, 1994, the Company's net provision for loan losses was a negative $950 thousand, compared to a provision of $690 thousand in 1993 and $1.7 million in 1992. As a ratio of average loans, the provisions were (.19)% in 1994 and .14% and .32% for 1993 and 1992, respectively. While the absolute balance of the allowance for loan losses has decreased in each of the past four years, the ratio of the allowance to nonperforming loans has increased or remained steady, with the ratio at the end of 1995 virtually unchanged from the year-end 1994 level. The balance of the allowance for loan losses was $12.1 million, $12.3 million, $16.1 million and $17.3 million at December 31, 1995, 1994, 1993 and 1992, respectively. The ratio of the allowance to nonperforming loans was 278%, 279%, 127% and 72% at the end of the same respective periods. Net loan losses for 1995 were $1.4 million. These losses compare to net loan losses of $2.8 million, $1.9 million and $4.7 million for the years ended December 31, 1994, 1993 and 1992, respectively. As a ratio to average loans, the net loan losses were .27%, .56%, .40% and .92% for the same respective periods. <TABLE> SUMMARY OF THE ALLOWANCE AND PROVISION FOR LOAN LOSSES (Dollars In Thousands) (Loans and Leases, Net of Unearned Income) <CAPTION> Years-Ended December 31, 1995 1994 1993 1992 1991 <S> <C> <C> <C> <C> <C> Loans and Leases at End of Period $517,787 $507,553 $502,784 $492,916 $547,419 Average Loans and Leases 513,266 502,224 489,326 516,711 607,601 Total Assets at End of Period 789,790 746,431 733,442 722,415 769,942 Nonperforming Assets: Nonaccrual Loans: Construction and Land Development $ 104 $ 327 $ 2,534 $ 6,149 $ 13,163 Commercial Real Estate 1,299 1,050 2,649 7,986 9,133 Commercial Loans 1,979 1,017 2,596 4,168 7,393 Other 862 1,224 2,082 3,171 3,764 Total Nonaccrual Loans 4,244 3,618 9,861 21,474 33,453 Loans Past Due 90 or More Days and Still Accruing Interest 111 231 364 1,486 329 Restructured Loans in Compliance with Modified Terms --- 580 2,405 1,161 3,963 Total Nonperforming Loans 4,355 4,429 12,630 24,121 37,745 Other Real Estate Owned 2,410 3,396 7,506 5,548 6,145 Total Nonperforming Assets $ 6,765 $ 7,825 $ 20,136 $ 29,669 $ 43,890 Allowance for Loan Losses: Balance at Beginning of Period $ 12,338 $ 16,078 $ 17,328 $ 20,387 $ 11,656 Loans Charged-off: Commercial, Financial and Agricultural (579) (997) (973) (2,283) (7,804) Real Estate - Commercial (369) (689) (1,106) (645) (6,804) Real Estate - Construction (101) (1,181) (377) (2,015) (20,941) Real Estate - Residential (160) (143) (151) (323) (335) Installment Loans to Individuals (562) (476) (480) (820) (2,128) Lease Financing Receivables --- --- --- (9) (8) Total Loans Charged-off (1,771) (3,486) (3,087) (6,095) (38,020) Recoveries of Loans Previously Charged-off: Commercial, Financial and Agricultural 76 260 694 724 56 Real Estate - Commercial 104 35 75 48 --- Real Estate - Construction 10 68 55 327 138 Real Estate - Residential 8 143 37 22 81 Installment Loans to Individuals 171 188 285 232 291 Lease Financing Receivables --- 2 1 6 --- Total Recoveries of Loans Previously Charged-off 369 696 1,147 1,359 566 Net Loans Charged-off (1,402) (2,790) (1,940) (4,736) (37,454) Provision for Loan Losses Charged to Expense 1,170 (950) 690 1,677 46,185 Balance at End of Period $ 12,106 $ 12,338 $ 16,078 $ 17,328 $ 20,387 Nonperforming Asset Ratio Analysis: Net Loans Charged-off as a Percentage of Average Loans .27% .56 % .40% .92% 6.16% Provision for Loan Losses as a Percentage of Average Loans .23 (.19) .14 .32 7.60 Allowance for Loan Losses as a Percentage of Period-end Loans 2.34 2.43 3.20 3.52 3.72 Allowance for Loan Losses as a Percentage of Nonperforming Loans 277.98 278.57 127.30 71.84 54.01 Nonperforming Loans as a Percentage of Period-end Loans .84 .87 2.51 4.89 6.90 Nonperforming Assets as a Percentage of Period-end Total Assets .86 1.05 2.75 4.11 5.70 </TABLE> III. OTHER INCOME The majority of other (i.e., noninterest) income is derived from fees and commissions from fiduciary services, deposit account service charges, computer processing fees to correspondents and other "core" or recurring sources. Additionally, other income is influenced by transactions involving the sale of investment securities. <TABLE> ANALYSIS OF OTHER INCOME <CAPTION> (Dollars In Thousands) Change December 31, Amount Percent 1995 1994 1993 1995 1994 1995 1994 <S> <C> <C> <C> <C> <C> <C> <C> Income from Fiduciary Activities $ 3,752 $3,657 $3,661 $ 95 $ (4) 2.6% (.1)% Fees for Other Services 4,669 4,345 4,459 324 (114) 7.5 (2.6) Net Securities Gains (Losses) 23 (481) 26 504 (507) -- -- Other Operating Income 6,052 1,047 966 5,005 81 478.0 8.4 Total Other Income $14,496 $8,568 $9,112 $5,928 $(544) 69.2 (6.0) </TABLE> Total other income for 1995 amounted to $14.5 million. The $5.9 million increase from 1994 was primarily attributable to a $5.0 million payment received from the Company's financial institution bond company, in settlement of a lawsuit filed by the Company in 1994 for losses suffered in earlier periods and covered under the Company's $7.0 million financial institution bond. Exclusive of the bond recovery and securities transactions, other income increased $424 thousand in 1995 or 4.7% above the amount earned in 1994. As adjusted, other income to average assets was 1.22% for both years. While all areas of other (noninterest) income increased, including income from fiduciary activities and other operating income, the largest increase was in fees for other services to customers. These fees include deposit account service charges, safe deposit box fees, merchant credit card processing fees and servicing fees on loans sold with servicing retained by the Company. These fees amounted to $4.7 million in 1995, compared to $4.3 million in 1994, a 7.5% increase. The increase was primarily attributable to increases in service charges on deposit accounts and merchant credit card processing income. Other operating income includes, as a primary component, fees earned on servicing credit card portfolios for correspondent banks. This category of noninterest income also includes gains on the sale of loans, other real estate owned and other assets. Without regard to the bond recovery, other operating income in 1995 was virtually unchanged from 1994. Total other income for 1994, was $8.6 million, or 6.0% less than the $9.1 million recorded in 1993. Exclusive of securities transactions, other income for 1994 was essentially unchanged from the prior year, with a small shift from fees for other services to customers to other operating income. As a percentage of average assets, noninterest income was 1.15% and 1.26% for 1994 and 1993, respectively. Without regard to securities transactions the ratios were 1.22% and 1.25% for the same respective periods. Income from fiduciary activities in 1994 was virtually unchanged from the prior year, as was the average dollar amount of assets under administration. Fees for other services to customers amounted to $4.3 million in 1994, a decrease of 2.6% from the prior year. The decrease was primarily attributable to a slight reduction in the average balance of the serviced loan portfolio and the corresponding reduction in related servicing fees. Other operating income for 1994 was $1.0 million, an increase of $81 thousand or 8.4% over 1993. The increase was primarily attributable to increased fees from credit card servicing operations. IV. OTHER EXPENSE Other (i.e., noninterest) expense is a means of measuring the delivery cost of services, products and business activities of the Company. The key components of other expense are presented in the following table. <TABLE> ANALYSIS OF OTHER EXPENSE (Dollars In Thousands) <CAPTION> Change December 31, Amount Percent 1995 1994 1993 1995 1994 1995 1994 <S> <C> <C> <C> <C> <C> <C> <C> Salaries and Benefits $16,710 $16,204 $16,101 $ 506 $ 103 3.1 % .6 % Net Occupancy Expense 2,040 2,168 2,418 (128) (250) (5.9) (10.3) Equipment and Furniture 1,930 2,076 2,254 (146) (178) (7.0) (7.9) Other Operating Expense 9,089 10,926 11,345 (1,837) (419) (16.8) (3.7) Total Other Expense $29,769 $31,374 $32,118 $(1,605) $ (744) (5.1) (2.3) </TABLE> Other expense amounted to $29.8 million for 1995, which compared to $31.4 million for 1994, a decrease of $1.6 million or 5.1%. An increase in salaries and benefits was offset by reduced expenses for occupancy, equipment and other operating expenses. Total salaries of $11.1 million for 1995 decreased $284 thousand from the 1994 level. As in the prior year analysis, the effect of fewer employees was only partially offset by general salary increases. Of the $790 thousand increase in employee benefits from 1994 to 1995, severance benefits of $652 thousand paid in 1995 accounted for most of the increase. Otherwise, slight decreases in payroll taxes and profit sharing expenses were offset by increased expenses for pension plans and health insurance. Occupancy and equipment expenses both decreased from 1994 to 1995 by $128 thousand and $146 thousand, respectively. Both decreases were primarily attributable to reduced depreciation expenses. Other operating expense was $9.1 million for 1995, a decrease of $1.8 million or 16.8% from 1994. The decrease was primarily attributable to a reduction in FDIC deposit insurance premiums and other insurance, as well as to a large reduction in losses on the sale of OREO. In mid-1995, the FDIC reduced the deposit insurance rate for well-capitalized banks from 23 cents per hundred dollars of insured deposits to 4 cents (and the premium has been further reduced in 1996). All of the Company's banks are well-capitalized. Other expense amounted to $31.4 million for 1994, a decrease of $744 thousand or 2.3% from the $32.1 million reported for 1993. Except for a slight increase in salaries and benefits, all areas in 1994 were below 1993 levels. Total salaries of $11.4 million for 1994 decreased $235 thousand or 2.0% from 1993, with the effect of fewer employees being only partially offset by selective salary increases. A $338 thousand increase in employee benefits was attributable to nearly all areas of employee benefits, including pension, postretirement, profit sharing and health insurance costs. Occupancy expenses and furniture and equipment expenses for 1994 decreased by 10.3% and 7.9%, respectively from 1993. The decreases were attributable to the closing of four small branches in Vermont in the last two quarters of 1993 and also to general decreases in depreciation expenses. Other operating expense of $10.9 million in 1994 decreased $419 thousand or 2.3% from $11.3 million in 1993. Included in other operating expense in the 1994 period was a loss of $1.5 million on the sale of OREO, while the 1993 period included a charge of $497 thousand relating to closed branches. The Company experienced a significant decrease in the costs to carry and dispose of OREO and other loan workout expenses, which decreased 56.2% or $865 thousand from 1993 to 1994. V. INCOME TAXES The following table sets forth the Company's income tax expense and effective tax rates for the periods presented herein. <TABLE> INCOME TAXES AND EFFECTIVE RATES <CAPTION> (Dollars in Thousands) Years Ended December 31, 1995 1994 1993 <S> <C> <C> <C> Provision for Income Taxes $6,986 $1,131 $ 381 Effective Tax Rate 36.0% 9.1% 4.5% </TABLE> The provisions for income taxes amounted to $7.0 million, $1.1 million and $381 thousand for 1995, 1994 and 1993, respectively. For all of 1993 and into the fourth quarter of 1994, the provision for income taxes was reduced by a net operating loss carryforward and changes in the valuation allowance for deferred tax assets. Without consideration of the net operating loss carryforward and changes in the valuation allowance, the effective rates for 1995, 1994 and 1993 were 36%, 38% and 37%, respectively. The decrease in the effective rate from 1994 to 1995 reflects the relative increase in the Company's tax exempt loan and securities portfolios. In 1993 the Company recognized a $1.5 million benefit resulting from the January 1, 1993 adoption of Statement of Financial Accounting Standards (SFAS) No. 109, "Accounting for Income Taxes." The benefit was recorded as a cumulative effect of accounting change. C. FINANCIAL CONDITION I. INVESTMENT PORTFOLIO The Company adopted SFAS No. 115 "Accounting for Certain Investments in Debt and Equity Securities" at December 31, 1993. Under SFAS No. 115, securities held-to-maturity are debt securities which the Company has 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 selling them 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 a separate component of shareholders' equity. At December 31, 1995, the Company held no trading securities. In November 1995, the FASB issued "A Guide to Implementation of Statement 115 on Accounting for Certain Investments in Debt and Equity Securities." The Guide allowed a one-time reclassification of held-to-maturity securities before December 31, 1995. Acting under this provision of the Guide, the Company reclassified $118.2 million of held-to-maturity securities to available-for-sale in December of 1995. The Company took advantage of this one-time provision as a means to improve liquidity and to gain some flexibility in the management of the Company's interest rate risk. See the following sections D. on liquidity and E. on interest rate risk. Securities Available-for-Sale: The following table sets forth the book value of the Company's securities available-for-sale portfolio, at year-end 1995, 1994 and 1993. <TABLE> SECURITIES AVAILABLE-FOR-SALE (In Thousands) <CAPTION> December 31, 1995 1994 1993 <S> <C> <C> <C> U.S. Treasury and Agency Obligations $114,502 $49,063 $53,694 State and Municipal Obligations 338 2,180 -- Mortgage-Backed Securities 54,651 475 -- Corporate and Other Debt Securities 7,300 -- -- Mutual Funds and Equity Securities 1,854 2,150 2,198 Total $178,645 $53,868 $55,892 </TABLE> Included in mortgage-backed securities were agency mortgage pass- through securities and agency collateralized mortgage obligations. Pass-through securities provide to the investor monthly portions of principal and interest pursuant to the contractual obligations of the underlying mortgages. Collateralized mortgage obligations ("CMO's") separate the repayments into two or more components (tranches), where each tranche has a separate estimated life and yield. The Company's practice is to purchase pass-through securities guaranteed by federal agencies and tranches of CMO's with the shorter maturities. Regulatory agencies have devised a high-risk test for mortgage- backed securities. The test evaluates the following: (I) Average Life Test - the product has an average life of less than 10 years; (II) Average Life Sensitivity Test - an immediate and sustained change in interest rates of 300 basis points will not extend the expected life by more than four years; and (III) Price Sensitivity Test - an immediate and sustained change in interest rates of 300 basis points will not change the price by more than 17%. The Company evaluates each mortgage-backed security at the time of purchase and quarterly thereafter. Although none of the Company's investments have failed to pass the high-risk test subsequent to acquisition, it is the Company's policy to analyze the appropriateness of divesting high-risk securities. Included in corporate and other debt securities are highly rated corporate bonds. The following table sets forth the maturities of the Company's securities available-for-sale portfolio as of December 31, 1995. <TABLE> MATURITIES OF SECURITIES AVAILABLE-FOR-SALE (In Thousands) <CAPTION> After After Within 1 But 5 But After One Within Within 10 Year 5 Years 10 Years Years Total <S> <C> <C> <C> <C> <C> U.S. Treasury and Agency Obligations $49,983 $ 64,519 $ -- $ -- $114,502 State and Municipal Obligations 192 64 82 -- 338 Mortgage-Backed Securities 3,311 36,562 8,085 6,693 54,651 Corporate and Other Debt Securities -- 7,300 --- -- 7,300 Mutual Funds and Equity Securities -- -- -- 1,854 1,854 Total $53,486 $108,445 $8,167 $8,547 $178,645 </TABLE> The following table sets forth the tax-equivalent yields of the Company's securities available-for-sale portfolio at December 31, 1995. <TABLE> YIELDS ON SECURITIES AVAILABLE-FOR-SALE (Fully Tax-Equivalent Basis) <CAPTION> After After Within 1 But 5 But After One Within Within 10 Year 5 Years 10 Years Years Total <S> <C> <C> <C> <C> <C> U.S. Treasury and Agency Obligations 5.05% 6.63% --% --% 5.93% State and Municipal Obligations 6.68 10.15 8.78 -- 7.85 Mortgage-Backed Securities 8.88 6.42 7.39 6.81 6.76 Corporate and Other Debt Securities -- 7.28 -- -- 7.28 Mutual Funds and Equity Securities -- -- -- 6.72 6.72 Total 5.29 6.60 7.41 6.79 6.25 </TABLE> The yields for debt securities shown in the table above are calculated by dividing annual interest, including accretion of discounts and amortization of premiums, by the carrying value of the securities at December 31, 1995. Yields on obligations of states and municipalities were computed on a fully tax-equivalent basis using a marginal tax rate of 35%. Dividend earnings derived from equity securities were adjusted to reflect applicable federal income tax exclusions. During the last quarter of 1995, the Company recognized net gains of $23 thousand on sales of $4.2 million from the available-for-sale portfolio. The proceeds were used to fund the sale of eight branches of Green Mountain Bank to Mascoma Savings Bank in January 1996. At December 31, 1995, the weighted average maturity was 2.03 years for debt securities in the available-for-sale portfolio. During the last quarter of 1994, the Company recognized net losses of $481 thousand on sales of $16.6 million from the available-for- sale portfolio. The proceeds were reinvested in higher yielding securities. Net securities gains of $26 thousand were recognized in 1993 on sales of $23.9 million from the available-for-sale portfolio. At December 31, 1995, unrealized gains on securities available- for-sale amounted to $1.2 million, net of tax. Unrealized gains or losses are reflected as a separate component of shareholders' equity. These securities, to a great extent, match fixed rate time deposits of similar maturities. Consequently, the Company did not recognize the gains during 1995. Securities Held-to-Maturity: The following table sets forth the book value of the Company's portfolio of securities held-to-maturity for each of the last three years. Year-end amounts and data in the following tables do not include the securities available-for-sale portfolio discussed previously. <TABLE> SECURITIES HELD-TO-MATURITY (In Thousands) <CAPTION> December 31, 1995 1994 1993 <S> <C> <C> <C> U.S. Treasury and Agency Obligations $ --- $ 61,390 $ 76,311 State and Municipal Obligations 13,921 10,409 5,006 Mortgage-Backed Securities --- 51,904 43,350 Other Securities --- 6,032 1,165 Total $13,921 $129,735 $125,832 </TABLE> For information regarding the market value of the Company's portfolio of securities held-to-maturity, see Note 3 to the Consolidated Financial Statements in Part II, Item 8 of this report. The following table sets forth the maturities of the Company's portfolio of securities held-to-maturity, as of December 31, 1995. <TABLE> MATURITIES OF SECURITIES HELD-TO-MATURITY (In Thousands) <CAPTION> After After Within 1 But 5 But After One Within Within 10 Year 5 Years 10 Years Years Total <S> <C> <C> <C> <C> <C> State and Municipal Obligations $1,984 $1,591 $5,492 $4,854 $13,921 </TABLE> The following table sets forth the tax-equivalent yields of the Company's portfolio of securities held-to-maturity at December 31, 1995. <TABLE> YIELDS ON SECURITIES HELD-TO-MATURITY (Fully Tax-Equivalent Basis) <CAPTION> After After Within 1 But 5 But After One Within Within 10 Year 5 Years 10 Years Years Total <S> <C> <C> <C> <C> <C> State and Municipal Obligations 7.48% 8.97% 8.44% 8.58% 8.41% </TABLE> The yields for debt securities shown in the tables above are calculated by dividing annual interest, including accretion of discounts and amortization of premiums, by the carrying value of the securities at December 31, 1995. Yields on obligations of states and municipalities were computed on a fully tax-equivalent basis using a marginal tax rate of 35%. During 1995 and 1994, the Company sold no securities from the held- to-maturity portfolio. The weighted-average maturity of the held- to-maturity portfolio is 8.8 years. II. LOAN PORTFOLIO The amounts and respective percentages of loans and leases outstanding represented by each principal category on the dates indicated were as follows: <TABLE> a. DISTRIBUTION OF LOANS AND LEASES (Dollars In Thousands) <CAPTION> December 31, 1995 1994 1993 Amount % Amount % Amount % <S> <C> <C> <C> <C> <C> <C> Commercial, Financial and Agricultural $ 79,993 15 $ 74,455 15 $ 82,317 16 Real Estate - Commercial 71,622 14 81,704 16 95,981 19 Real Estate - Construction 2,051 1 5,136 1 8,702 2 Real Estate - Residential 238,298 46 230,943 45 221,066 44 Installment Loans to Individuals 125,762 24 115,291 23 94,656 19 Lease Financing Receivables 61 -- 24 -- 62 -- Total Loans and Leases 517,787 100 507,553 100 502,784 100 Allowance for Loan Losses (12,106) (12,338) (16,078) Total Loans and Leases, Net $505,681 $495,215 $486,706 </TABLE> <TABLE> DISTRIBUTION OF LOANS AND LEASES (Dollars In Thousands) <CAPTION> December 31, 1992 1991 Amount % Amount % <S> <C> <C> <C> <C> Commercial, Financial and Agricultural $ 85,428 17 $ 97,237 18 Real Estate - Commercial 110,702 22 134,379 25 Real Estate - Construction 12,167 2 24,290 4 Real Estate - Residential 198,165 40 200,112 37 Installment Loans to Individuals 86,323 19 91,224 16 Lease Financing Receivables 131 -- 177 -- Total Loans and Leases 492,916 100 547,419 100 Allowance for Loan Losses (17,328) (20,387) Total Loans and Leases, Net $475,588 $527,032 </TABLE> During 1995 and 1994, the Company concentrated its lending efforts in the area of residential real estate loans and installment loans to individuals (primarily automobile loans). Since 1990, the Company has de-emphasized commercial, commercial real estate and construction and land development loans. Consequently, balances for these three classifications continued to decrease, while the overall portfolio increased $10.2 million, or 2.0%, from 1994 to 1995 and $4.8 million or 1.0% from 1993 to 1994. Within the installment loan portfolio, the Company has focused on growth in its indirect lending program. Indirect loans are loans to consumers financed through local dealerships where, by prior arrangement, the Company acquires the dealer paper. At year-end 1992, indirect loans amounted to $42.1 million or 49% of installment loans. By December 31, 1995, indirect loans amounted to $91.0 million, or 72% of installment loans. The following table indicates the changing mix in the loan portfolio by presenting the quarterly average balance for the Company's significant loan products for the past five quarters. In addition, the table presents the percentage of total loans represented by each category as well as the annualized tax-equivalent yield. <TABLE> LOAN PORTFOLIO Quarterly Average Loan Balances (Dollars In Thousands) <CAPTION> Quarter Ending the Last Day of Dec 1995 Sep 1995 Jun 1995 Mar 1995 Dec 1994 <S> <C> <C> <C> <C> <C> Commercial and Commercial Real Estate $160,348 $160,268 $166,378 $168,386 $166,528 Residential Real Estate 176,481 175,462 174,927 174,947 176,120 Home Equity 45,993 45,292 44,539 43,282 42,023 Indirect Consumer Loans 89,721 86,799 83,289 80,279 76,827 Direct Consumer Loans 33,529 36,534 35,964 34,091 34,233 Credit Card Loans 9,425 9,349 8,815 8,902 8,939 Total Loans $515,497 $513,704 $513,912 $509,887 $504,670 Percentage of Total Quarterly Average Loans Commercial and Commercial Real Estate 31.1% 31.2% 32.4% 33.0% 33.0% Residential Real Estate 34.2 34.2 34.0 34.3 34.9 Home Equity 8.9 8.8 8.7 8.5 8.3 Indirect Consumer Loans 17.5 16.9 16.2 15.6 15.2 Direct Consumer Loans 6.6 7.1 7.0 7.8 6.8 Credit Card Loans 1.8 1.8 1.7 1.7 1.8 Total Loans 100.0% 100.0% 100.0% 100.0% 100.0% Quarterly Taxable Equivalent Yield on Loans Commercial and Commercial Real Estate 10.21% 10.30% 10.35% 10.29% 9.87% Residential Real Estate 8.42 8.38 8.35 8.22 7.90 Home Equity 9.44 9.59 9.67 9.38 8.80 Indirect Consumer Loans 8.47 8.42 8.27 8.08 7.98 Direct Consumer Loans 9.88 9.91 9.93 9.96 9.81 Credit Card Loans 15.62 13.91 14.66 12.36 12.27 Total Loans 9.31 9.35 9.37 9.32 8.85 </TABLE> During 1995, the Company received certain payments on restructured loans that had not been factored into the effective rate on those loans. The payments, which were recorded as interest income, have not been included in the yields in the table above. While the yields on the consumer portfolios are less than on the commercial portfolios, the Company has historically experienced fewer loan losses in consumer loans than commercial loans. During 1993, the loan portfolio increased $9.9 million, or 2.0%, from the prior year-end balance. The balances in all categories of commercial loans, including commercial real estate and construction and land development loans, decreased during the year, while balances of loans to consumers and residential real estate loans increased during the year. During 1992, the loan portfolio decreased $54.5 million or 10.0%. In part, this reflected the Company's exercise of prudent lending standards as well as a decision to reduce total assets and improve capital ratios. During this period, the various loan categories maintained the same relative proportions, vis-a-vis one another. During 1991, certain commercial loans were reclassified as commercial real estate loans on a prospective basis. Had the reclassification been made on a retroactive basis, the balances of commercial, financial and agricultural loan balances and real estate - commercial loan balances as a percent of total loans and leases for 1990 would have approximated the respective proportions of these categories in 1991. The 1991 decrease in real estate - construction loans was due to loan charge-offs and transfers to OREO. The decrease in 1991 of installment loans to individuals came as a result of a slow-down in consumer credit demand, particularly automobile financing. The following table indicates the respective maturities and repricing structure of the Company's commercial, financial and agricultural loans and its real estate - construction loans at December 31, 1995. Scheduled repayments are reported in the maturity category, based upon the contractual terms, in which the payment is due. Demand loans and overdrafts are reported as due in one year or less. <TABLE> MATURITY AND REPRICING OF COMMERCIAL LOANS (In Thousands) <CAPTION> After 1 After Within But Within Five 1 Year 5 Years Years Total <S> <C> <C> <C> <C> Commercial, Financial and Agricultural $54,822 $7,534 $17,637 $79,993 Real Estate - Construction 1,070 --- 981 2,051 Total $55,892 $7,534 $18,618 $82,044 Fixed Interest Rates $ 5,841 $1,596 $18,618 $26,055 Variable Interest Rates 50,051 5,938 --- 55,989 Total $55,892 $7,534 $18,618 $82,044 </TABLE> COMMITMENTS AND LINES OF CREDIT Letters of credit represent extensions of credit granted in the normal course of business which are not reflected in the accompanying financial statements. As of December 31, 1995, the total contingent liability for standby letters of credit amounted to $3.4 million. In addition to these instruments, the Banks have issued lines of credit to customers, including home equity lines of credit, credit card lines of credit, commitments for residential and commercial construction and other personal and commercial lines of credit. 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, 1995, the Banks had outstanding loan commitments in the aggregate amount of approximately $75.9 million. b. RISK ELEMENTS NONACCRUAL, PAST DUE AND RESTRUCTURED LOANS The Company designates loans as nonaccrual when the payment of interest and/or principal is due and unpaid for a designated period (generally 90 days) or when the likelihood of repayment is, in the opinion of management, uncertain. There were no material commitments to lend additional funds on outstanding nonaccrual loans at December 31, 1995. Loans and leases past due 90 days or more and still accruing interest, as identified in the table below, are those loans and leases which were contractually past due 90 days or more but because of expected repayments were still accruing interest. For years prior to 1995, loans were classified as "restructured" in accordance with SFAS No. 15, "Accounting by Debtors and Creditors for Troubled Debt Restructurings." On January 1, 1995, the Company adopted Statement of Financial Accounting Standards (SFAS) No. 114, "Accounting by Creditors for Impairment of a Loan." SFAS No. 114, as amended, requires that impaired loans, except for large groups of smaller-balance homogeneous loans, be measured based on (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 if the loan is collateral dependent. The Company applies the provisions of SFAS No. 114 to all impaired commercial and commercial real estate loans over $250,000, and to all loans restructured subsequent to adoption. Reserves for possible losses for the remaining smaller-balance loans are evaluated under SFAS No. 5. Under the provisions of SFAS No. 114, the Company determines impairment for collateralized loans based on fair value of the collateral less estimated cost to sell. For other loans, impairment is determined by comparing the recorded value of the loan to the present value of the expected cash flows, discounted at the loan's effective interest rate. The Company determines the interest income recognition method on a loan by loan basis. Based upon the borrowers' payment histories and cash flow projections, interest recognition methods include full accrual, cash basis and cost recovery. Loans accounted for under SFAS No. 114 may be reported as either nonaccrual, restructured or performing. Those loans recognizing interest income on a cash or cost recovery basis are reported as nonaccrual. Loans restructured under SFAS No. 15 are reported as restructured if the loan is in compliance with the modified terms. Under SFAS No. 15, as amended, loans bearing a market rate and in compliance with modified terms are not subject to the disclosure requirements of SFAS No. 114 in years subsequent to restructure, and thus would be included in performing loans. At December 31, 1995, $2.1 million of nonaccrual loans were accounted for under SFAS No. 114. There were no performing loans at December 31, 1995 for which the provisions of SFAS No. 114 were first applied in 1995. The Company's nonaccrual, past due and restructured loans and leases were as follows: <TABLE> SCHEDULE OF NONPERFORMING LOANS (Dollars In Thousands) <CAPTION> December 31, 1995 1994 1993 1992 1991 <S> <C> <C> <C> <C> <C> Nonaccrual Loans: Construction and Land Development $ 104 $ 327 $ 2,534 $ 6,149 $13,163 Commercial Real Estate 1,299 1,050 2,649 7,986 9,133 Commercial Loans 1,979 1,017 2,596 4,168 7,393 Other 862 1,224 2,082 3,171 3,764 Total Nonaccrual Loans 4,244 3,618 9,861 21,474 33,453 Loans Past Due 90 Days or More and Still Accruing Interest 111 231 364 1,486 329 Restructured Loans in Compliance with Modified Terms --- 580 2,405 1,161 3,963 Total Nonperforming Loans $4,355 $4,429 $12,630 $24,121 $37,745 Total Nonperforming Loans as a Percentage of Total Loans .84% .87% 2.51% 4.89% 6.90% </TABLE> Nonperforming loans amounted to $4.4 million at December 31, 1995, $74 thousand below the balance at year-end 1994. The increase in nonaccrual commercial loans from 1994 to 1995 is primarily attributable to the aggregate borrowing of one commercial borrower, which was placed on nonaccrual status during 1995. Otherwise, nonaccrual loans at December 31, 1995 would have decreased from the prior year-end balance. Loans reported as restructured and in compliance with modified terms at December 31, 1994 were classified as performing in 1995. During 1995, income recognized on year-end balances of nonaccrual loans was $116 thousand. Income that would have been recognized during that period on nonaccrual loans if such had been current in accordance with their original terms and had been outstanding throughout the period (or since origination if held for part of the period) was $435 thousand. Nonperforming loans amounted to $4.4 million at December 31, 1994, a decrease of $8.2 million or 64.9% from the prior year-end. Of the $12.6 million in nonperforming loans at December 31, 1993, $2.5 million was transferred to OREO, $2.4 million of loans restructured in 1993 was returned to performing status in accordance with SFAS No. 15, and another $3.5 million was charged against the allowance for loan losses. The small remaining difference represents the improvement in nonaccrual loans, net of loans newly classified as nonperforming. Nonperforming loans decreased $11.5 million or 47.6% during 1993. During the year $7.8 million of nonaccrual loans and leases was acquired through foreclosure and transferred to OREO. Much of the $3.1 million of loan charge-offs during the year was also attributable to prior year-end nonaccrual loans. The remaining difference represented a net improvement in the amount of nonaccrual loans and included the return to performing status of certain nonaccrual loans. The balance of $2.4 million of restructured loans in compliance with modified terms as of December 31, 1993 represented three commercial loans restructured during the year. POTENTIAL PROBLEM LOANS While levels of nonperforming loans and delinquency trends have fallen since 1991, the Company expects that there will be continued exposure in the commercial real estate portfolio in forthcoming periods and until the regional economy shows substantial strengthening. FOREIGN OUTSTANDINGS - None 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 previous section of this report. For a further discussion, see Note 21 to the Consolidated Financial Statements in Part II, Item 8 of this report. OTHER REAL ESTATE OWNED Other real estate owned (OREO) consists of real property acquired in foreclosure. OREO is carried at the lower of fair value less estimated cost to sell or cost in accordance with Statement of Position (SOP) 92-3 "Accounting for Foreclosed Assets." Also, in compliance with SOP 92-3, the Company's subsidiary banks have established allowances for OREO losses. The allowances are established and monitored on a property by property basis and reflect management's ongoing estimate of the difference between the property's carrying amount and cost, when the carrying amount is less than cost. For all periods, all OREO was held for sale. <TABLE> DISTRIBUTION OF OTHER REAL ESTATE OWNED (Net of Allowance) (In Thousands) <CAPTION> December 31, 1995 1994 1993 1992 1991 <S> <C> <C> <C> <C> <C> Single Family 1 - 4 Units $ 82 $1,073 $1,189 $ 892 $ 910 Commercial Real Estate 2,328 2,128 3,418 1,536 3,476 Construction & Land Development --- 195 2,899 3,120 1,759 Other Real Estate Owned, Net $2,410 $3,396 $7,506 $5,548 $6,145 </TABLE> The following table summarizes changes in the net carrying amount of other real estate owned at December 31,: <TABLE> SCHEDULE OF CHANGES IN OTHER REAL ESTATE OWNED (Net of Allowance) (In Thousands) <CAPTION> 1995 1994 1993 1992 1991 <S> <C> <C> <C> <C> <C> Balance at Beginning of Year $ 3,396 $ 7,506 $ 5,548 $ 6,145 $ 2,552 Properties Acquired 642 2,493 7,804 6,446 7,498 Provision for Estimated Losses (161) (398) (638) (1,160) (612) Sale of Properties (1,467) (6,205) (5,208) (5,883) (3,293) Balance at End of Year $ 2,410 $ 3,396 $ 7,506 $ 5,548 $ 6,145 </TABLE> The following summarizes the changes in the allowance for OREO losses: <TABLE> ALLOWANCE FOR OTHER REAL ESTATE OWNED LOSSES (In Thousands) <CAPTION> 1995 1994 1993 1992 <S> <C> <C> <C> <C> Balance at Beginning of Year $ 369 $ 1,150 $1,120 $ -- Additions 161 398 638 1,160 Charge-Offs (160) (1,179) (608) (40) Balance at End of Year $ 370 $ 369 $1,150 $1,120 </TABLE> During 1995, the Company acquired $642 thousand of OREO through foreclosure. The Company recognized losses of $48 thousand on the sale of OREO properties carried on the books at $1.5 million. During 1994, the Company acquired $2.5 million of OREO through foreclosure. The Company recognized losses of $1.4 million on the sale of OREO properties carried on the books at $6.2 million. Approximately 65% of the sales took place at an auction of OREO properties held during the second quarter of 1994. During 1993, the Company acquired $7.8 million in OREO through foreclosure, of which $3.6 million was formerly classified as in-substance foreclosed property. The $2.0 million increase in OREO during 1993 was primarily attributable to commercial real estate properties, whereas construction and land development properties held in OREO decreased $221 thousand during 1993. For the year, the Company recognized net gains of $366 thousand on the sale of $5.2 million of OREO properties. These net gains partially offset the $638 thousand provision for estimated OREO losses taken during the year. During 1992, the Company acquired an additional $6.4 million in OREO through foreclosure. The provision for estimated OREO losses of $1.2 million in 1992 reflects the SOP 92-3 adjustment for estimated selling costs as well as adjustments for declines in fair value. The Company disposed of $5.9 million through sales of OREO properties, upon which the Company recognized net gains of $257 thousand. During 1991, the Company acquired over $7.5 million in OREO through foreclosure. The primary OREO acquisitions were in the area of construction and land development loans. During 1991, the Company recognized $25 thousand in net gains on sales of $3.3 million of OREO properties. III. SUMMARY OF LOAN LOSS EXPERIENCE The Company monitors credit quality through a continuous review of the entire loan portfolio. All significant loans (primarily commercial and commercial real estate) and leases are reviewed at least semi-annually, and those under special supervision are reviewed at least quarterly. The boards of directors of the Company's individual subsidiary banks, upon recommendations from management, determine the extent of charge-offs and have the final decision-making responsibility in authorizing charge-offs. Additionally, regulatory examiners perform periodic examinations of the banks' loan and lease portfolios and report on these examinations to the boards of directors. Provisions for loan losses are determined by the managements of the subsidiary banks, in consultation with the Company's management, and are based upon an overall evaluation of the appropriate levels of the allowances for loan losses. Factors incorporated in such determination include the existing risk characteristics of the portfolio, prevailing national and local economic conditions, historical loss experience and expected performance within a range of anticipated future economic conditions. The Company's management believes that the banks' allowances for loan losses are adequate to absorb reasonably foreseeable loan losses. The table in Part II, Item 7.B.II. "Provision for Loan Losses and Allowance for Loan Losses" presents a summary of the activity in the Company's allowance for loan losses. ALLOCATION OF THE ALLOWANCE FOR LOAN AND LEASE LOSSES The allowance for loan losses is a general allowance applicable to estimated future losses. For internal operating purposes, the allowance is not allocated among loan categories. In the following table, the allowance has been distributed for purposes of complying with disclosure requirements of the Securities and Exchange Commission. However, this allocation should not be interpreted as a projection of (I) likely sources of future losses, (II) likely proportional distribution of future losses among loan categories or (III) likely amounts of future losses. Since management regards the allowance as a general balance and has assigned an unallocated value to the schedule, the amounts presented do not represent the total balance available to absorb future losses that might occur within the principal categories. Subject to the qualifications noted above, an allocation of the allowance for loan losses by principal classification and the proportion of the related loan balance is presented below as of December 31 for each of the years indicated. <TABLE> ALLOCATION OF THE ALLOWANCE FOR LOAN AND LEASE LOSSES (Dollars in Thousands) <CAPTION> 1995 1994 1993 1992 1991 <S> <C> <C> <C> <C> <C> Commercial, Financial and Agricultural $ 2,913 $ 2,329 $ 3,908 $ 5,518 $ 4,596 Real Estate-Commercial 1,755 1,841 3,324 3,626 4,558 Real Estate-Construction 305 1,994 2,027 2,525 6,917 Real Estate-Residential Mortgage 1,616 2,098 1,893 1,803 1,268 Installment Loans to Individuals 2,365 1,363 2,032 1,770 1,343 Lease Financing Receivables -- -- -- 15 7 Unallocated 3,152 2,713 2,894 2,071 1,698 Total Loans and Leases $12,106 $12,338 $16,078 $17,328 $20,387 PERCENT OF LOANS IN EACH CATEGORY TO TOTAL LOANS Commercial, Financial and Agricultural 15% 15% 16% 17% 18% Real Estate-Commercial 14 16 19 22 25 Real Estate-Construction 1 1 2 2 4 Real Estate-Residential Mortgage 46 45 44 40 37 Installment Loans to Individuals 24 23 19 19 16 Lease Financing Receivables -- -- -- -- -- Total Loans and Leases 100% 100% 100% 100% 100% </TABLE> At December 31, 1995, the allocated reserve for each indicated classification of loans exceeded 100% of the dollar amount of loans in such classification that were then reported as nonperforming. IV. DEPOSITS The following table sets forth the average balances of and average rates paid on deposits for the periods indicated. <TABLE> AVERAGE DEPOSIT BALANCES Years Ended December 31, (Dollars In Thousands) <CAPTION> 1995 1994 1993 Average Average Average Balance Rate Balance Rate Balance Rate <S> <C> <C> <C> <C> <C> <C> Demand Deposits $ 88,961 --% $ 87,715 --% $ 83,971 --% N.O.W./Super N.O.W. 139,879 2.84 129,999 1.92 127,163 2.25 Savings/M.M.D.A. 201,932 3.06 260,336 2.79 259,519 3.00 Time Certificates of $100,000 or More 67,029 5.61 26,980 4.30 15,077 4.70 Other Time Deposits 185,166 5.34 160,035 4.03 172,422 4.31 Total Deposits $682,967 3.49 $665,065 2.61 $658,152 2.86 </TABLE> During the last half of 1994 and into the first part of 1995, rates on deposit accounts increased, mirroring, although with some time lag, the rise in the prime rate that took place over this period. Changing interest rates also have an impact on the mix of deposits within the deposit portfolio for the Company, as well as financial institutions in general. Beginning in the late 1980's until the middle of 1992, rates declined in small but steady increments, and then remained stable for the next two years. During that period, as the price differential between time deposits and short-term interest-bearing deposits narrowed, depositors transferred a significant portion of maturing time deposits to savings, N.O.W. and money market accounts, and some funds left the Company entirely for competing investment products not offered by financial institutions. During the recent period of rising interest rates, the Company experienced a shift in the mix of deposits from short-term back to time deposits. As interest rates leveled-off and even fell during the latter part of 1995, the increase in the percentage of time deposits to total deposits also stabilized. For the third and fourth quarters of 1995, time deposits averaged 27% of total deposits. V. TIME CERTIFICATES OF $100,000 OR MORE The maturities of time certificates of $100,000 or more at December 31, 1995 are presented below. (In Thousands) Maturing in: Under 3 3 to 6 6 to 12 Over 12 Months Months Months Months Total $34,287 $14,438 $5,566 $3,266 $57,557 D. LIQUIDITY The objective of liquidity management is to satisfy cash flow requirements, principally the needs of depositors and borrowers to access funds. Liquidity is provided through assumption or "purchase" of liabilities, the maturity of asset balances and the sale of assets. Liability liquidity arises primarily from the significant base of "core" and other deposits gathered through a branch network operating over a dispersed geographical area. These "core" balances consist of demand deposits, savings, N.O.W. and money market account balances and small denomination time deposits. Core deposits are considered to be less volatile in their movement into and out of financial institutions, as compared to large denomination time deposits, brokered time deposits and repurchase agreements, which are perceived as more sensitive to changes in interest rates than core deposits. Core deposits represented a substantial proportion of the Company's total assets. At year-end 1995, core deposits represented more than 80% of the Company's total assets and stockholders' equity contributed 8.5% as a source of funds. Large denomination time deposits, repurchase agreements and other borrowed funds represented 9.2% of total assets at December 31, 1995. Federal funds sold are overnight sales of the Company's surplus funds to correspondent banks, while federal funds purchased represent overnight borrowings. The Company's practice is to be a net seller of federal funds on average, and to avoid extended periods of purchasing federal funds. During 1995, average federal funds sold amounted to $22.6 million and average federal funds purchased amounted to $480 thousand. On December 31, 1993, the Company, upon adoption of SFAS No. 115, segregated its investment portfolio into securities available-for - -sale and those held-to-maturity. In November 1995, the FASB issued "A Guide to Implementation of Statement 115 on Accounting for Certain Investments in Debt and Equity Securities." The Guide allowed a one-time reclassification of held-to-maturity securities before December 31, 1995. Acting under those provisions, in December 1995 the Company reclassified $118.2 million of held-to - -maturity securities into its available-for-sale portfolio. Apart from federal funds, securities available-for-sale represent the Company's primary source of liquidity. This liquidity arises both from an ability to quickly sell the securities, as well as from the ability to use the securities as collateral for borrowing. After completion of the Company's sale of eight branches of Green Mountain Bank to Mascoma Savings Bank on January 15, 1996, the Company had $173.4 million of securities in its available-for-sale portfolio. Other sources of funds include term federal funds arrangements with correspondent banks and a borrowing arrangement with the Federal Home Loan Bank. The Company is not aware of any known trends, events or uncertainties that will have or that are reasonably likely to have a material effect or make material demands on the Company's liquidity, capital resources or results of operations. E. INTEREST RATE RISK While managing liquidity, the Company must monitor and control interest rate risk. Interest rate risk is the exposure of the Company's 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 prepayment risks for mortgage-backed assets, early withdrawal of time deposits, and the fact that the speed and magnitude of responses to interest rate changes varies by product. While many of the Company's loan products are indexed to independent rates, such as prime or treasury notes, the rates on most deposit products are set by management pricing committees. The Company's primary short-term measure of interest rate risk projects net interest income for the ensuing twelve-month period based on the maturity, prepayment assumption and repricing characteristic of each individual interest-bearing asset and liability under a variety of interest rate projections. The Company obtains interest rate projections from a third party provider of economic data. These projections are applied to existing interest sensitive assets and liabilities and to expected new and rollover amounts. As a base, the Company projects net interest income for the ensuing twelve months for the most likely projection and for a no-change scenario. Exposure to rising or falling rates are calculated to cover a high distribution of the perceived probable interest rate scenarios. At December 31, 1995, the Company expected interest rates to fall early in 1996 and then again later in the year. For a long-term measure of interest rate risk, the Company measures the economic value of equity for immediate and sustained changes in interest rates. At December 31, 1995, the Company was operating within established internal policy limits for both the short-term and long-term measures of interest rate risk.. The Company is able to reduce interest rate risk by adjusting the mix of loan products as well as the balance of fixed and variable rate products within the various loan categories. To a lesser extent, the Company manages interest rate risk through selection of investments for the securities portfolios. The Company does not, and in the foreseeable future, will not use derivative financial instruments to manage interest rate risk. The Company prepares an interest rate gap analysis to identify the repricing pattern of interest-bearing assets and liabilities. The interest rate sensitive gap is the difference between interest rate sensitive assets and interest rate sensitive liabilities. The interest rate sensitive gap ratio is the ratio of interest rate sensitive assets to interest rate sensitive liabilities. When the interest rate sensitive gap ratio exceeds the balanced position of 1.0, the Company is susceptible to falling interest rates over the time horizon indicated, as assets may reprice downward more rapidly than liabilities. Conversely, the Company is susceptible to rising rates when the gap ratio for a particular time horizon falls below the balanced position of 1.0. While the static gap analysis will reveal mismatches in the repricing patterns of assets and liabilities, the dynamic modeling of projected net interest income, as described above, provides a much more reliable tool for assessing the Company's net interest income exposure to changes in interest rates. The following table "Interest Rate Sensitive Gap Analysis" presents the Company's interest rate sensitive position at December 31, 1995. For purposes of the table, an asset or liability is considered rate sensitive within a specified period when it matures or could be repriced within such period in accordance with its contractual terms except for certain deposit balances without specific maturities. These deposit balances have been allocated to various time horizons to reflect the fact that these deposits do not reprice to the full extent of prime rate changes, and tend to lag behind changes to the prime rate. Certain other assets and liabilities lacking specific maturities are classified in the "Over Five Years" category. Nonaccrual loans are excluded. Securities available-for-sale are presented at amortized cost. Various assets and liabilities that reprice before maturity demonstrate different repricing patterns. Nearly three-fourths of the Company's commercial loans are prime based, and consequently, reprice immediately, or in some cases monthly, upon changes in the prime rate. The greater portion of variable rate residential real estate loans reprice annually and are often tied to an average short-term treasury rate, with the repricing date lagging behind changes in the indexed rate. Rates on credit card lines are largely variable at management's discretion and in general reprice more slowly than prime based loans. The cumulative gap ratio at December 31, 1995 was 1.06 and 1.21 for the ensuing six month and twelve month repricing periods, respectively. These ratios are within the range of ratios the Company seeks to maintain, although the twelve month ratio is at the upper threshold of the established range. Since the Company has more interest-bearing assets than liabilities, the twelve month ratio of 1.21 should be considered vis-a-vis the total ratio of 1.20, which is what the ratio would have been for each period if all interest-bearing assets and liabilities were spread evenly throughout the time periods. Nearly all of the Company's time deposits are fixed rate, and therefore, reprice upon maturity. Money market deposit accounts are immediately repriceable and often fluctuate with the frequency of prime rate changes, but rarely to the magnitude of changes in the prime rate. N.O.W. accounts are also subject to immediate rate changes, but again, rates tend to move more slowly than prime rate changes and to a smaller degree. Savings accounts, which remained stable for an extended period of time after deregulation, have been the least sensitive of deposit balances to interest rate changes. In response to the FDIC Improvement Act of 1991, regulators have proposed an interest rate risk analysis that distributes savings, N.O.W. and money market accounts among the earlier repricing periods. Such a distribution of the Company's savings, N.O.W. and money market accounts could have a material impact on the Company's gap analysis at year-end 1995 if distribution of these deposits are limited to the first three repricing periods, as presented in the table below. <TABLE> INTEREST RATE SENSITIVE GAP ANALYSIS (Dollars In Thousands) <CAPTION> Within Three Six to One to Over Three to Six Twelve Five Five Months Months Months Years Years Total <S> <C> <C> <C> <C> <C> <C> Earning Assets: Securities Held-to-Maturity: State and Municipal Obligations $ 843 $ 350 $ 961 $ 1,598 $ 10,169 $ 13,921 Securities Available-for-Sale: U.S. Treasury and Agency Obligations 13,998 8,000 30,014 61,237 -- 113,249 State and Municipal Obligations 163 172 2 1 -- 338 Mortgage-Backed Securities 1,555 787 4,084 42,626 5,237 54,289 Corporate Bonds -- -- -- 3,016 4,008 7,024 Equity Securities -- -- -- -- 1,798 1,798 Federal Funds Sold 35,100 -- -- -- -- 35,100 Loans and Leases, Net of Unearned Income & Nonaccrual Loans 168,762 29,126 73,898 156,227 85,530 513,543 Total Interest Rate Sensitive Assets 220,421 38,435 108,959 264,705 106,742 739,262 Interest Paying Liabilities: Regular Savings Accounts 22,484 --- --- 111,038 -- 133,522 N.O.W. Accounts 38,560 --- --- 124,861 -- 163,421 Money Market Deposit Accounts 13,634 --- --- 41,725 -- 55,359 Time Deposits of $100,000 or More 34,287 14,438 5,566 3,266 -- 57,557 Other Time Deposits 59,615 46,043 52,979 31,244 --- 189,881 Short-Term Borrowings 15,297 -- -- --- -- 15,297 Long-Term Debt -- -- --- --- -- --- Total Interest Rate Sensitive Liabilities 183,877 60,481 58,545 312,134 --- 615,037 Interest Rate Sensitive Gap $ 36,544 $(22,046) $ 50,414 $(47,429) $106,742 $124,225 Cumulative Interest Rate Sensitive Gap $ 36,544 $ 14,498 $ 64,912 $ 17,483 $124,225 Interest Rate Sensitive Gap Ratio 1.20 .64 1.86 .85 -- 1.20 Cumulative Interest Rate Sensitive Gap Ratio 1.20 1.06 1.21 1.03 1.20 N/A </TABLE> F. CAPITAL RESOURCES AND DIVIDENDS Shareholders' equity was $67.5 million at December 31, 1995, as compared to $58.4 million at December 31, 1994. The increase was primarily attributable to retained earnings. During 1995, in accordance with a program previously approved by the board of directors, the Company repurchased at market prices 110,687 shares of common stock, at an aggregate purchase price of $1.9 million. At year-end the total treasury stock was 309,833 shares with a cost basis of $4.2 million. On February 27, 1996, the Company announced that the board of directors had approved an expanded stock repurchase program. Under the program, the Company's management is authorized to repurchase from time to time during the next two years, at its discretion, up to $10 million of the Company's outstanding common stock in the open market or privately negotiated transactions. Based upon the average of the closing bid and asked prices for the Company's common stock as reported by NASDAQ on March 4, 1996, completion of this repurchase program would represent over 512,000 shares, or 9.3% of the total number of shares then outstanding. The maintenance of appropriate capital levels is a management priority. Overall capital adequacy is monitored on an ongoing basis by management and reviewed regularly by the Board of Directors. The Company's principal capital planning goals are to provide an adequate return to shareholders while retaining a sufficient base to provide for future expansion and compliance with all regulatory standards. Under regulatory capital guidelines, the Company and the subsidiary banks are required to satisfy certain risk-based capital measures. The minimum ratio of "Tier 1" capital to risk-weighted assets is 4.0% and the minimum ratio of total capital to risk-weighted assets is 8.0%. For the Company, Tier 1 capital is comprised of shareholders' equity less intangible assets. Total capital includes a portion of the allowance for loan losses. In addition to the risk-based capital measures, the federal bank regulatory agencies require banks and bank holding companies to satisfy another capital guideline, the Tier 1 leverage ratio (Tier 1 capital to total assets less goodwill). The minimum Tier 1 leverage ratio is 3.0% for the most highly rated institutions. The guidelines provide that other institutions should maintain a Tier 1 leverage ratio that is at least 1.0% to 2.0% higher than the 3.0% minimum level for top-rated institutions. The table below sets forth the capital ratios of the Company and its subsidiary banks as of December 31, 1995: <TABLE> Risk-Based Capital Ratios: <CAPTION> Arrow GFNB GMB SNB <S> <C> <C> <C> <C> Tier 1 13.48% 13.71% 14.93% 11.90% Total Capital 14.75 14.96 16.22 13.15 Tier 1 Leverage Ratio 8.09 7.61 9.73 8.42 </TABLE> At December 31, 1995, all subsidiary banks and the Company exceeded the minimum capital ratios established by these guidelines, as well as the "well-capitalized" thresholds set by federal bank regulatory agencies pursuant to FDICIA (see the disclosure under "Legislative Developments" in Part I, Item 1.F. of this report). After the January 15, 1996 sale of Green Mountain Bank branches to Mascoma Savings Bank, the Company's consolidated Tier 1 leverage ratio increased to 9.91% from 8.09% at December 31, 1995. The principal source of funds for the payment of shareholder dividends by the Company has been dividends declared and paid to the Company by its bank subsidiaries. As of December 31, 1995, only the Company's principal bank subsidiary, the Glens Falls National Bank and Trust Company ("GFNB") was in a position to pay any material amount of dividends without prior regulatory approval. At that time, the maximum amount that could have been paid by GFNB to the Company was approximately $8.7 million. Payments of dividends by Green Mountain Bank ("GMB") to the Company were restricted during 1995 as a matter of law by the negative undivided profits account of GMB, despite the very high capital ratios maintained by GMB (which became even higher after the sale by GMB of eight branches to Mascoma Savings Bank on January 15, 1996). In 1995, however, with regulatory approval, GMB did repurchase a portion of its common stock from its holding company, Arrow Vermont Corporation, for $3.15 million, thereby achieving the equivalent of a dividend. See Part II, Item 5 "Market for the Registrant's Common Equity and Related Stockholder Matters" for a recent history of the Company's cash dividend payments. G. FOURTH QUARTER RESULTS The Company reported earnings of $2.6 million for the fourth quarter of 1995, an increase of $256 thousand or 10.9% from the fourth quarter of 1994. During the 1991 - 1994 period, the provision for income taxes was reduced to low levels because of the availability of a significant net operating loss carryforward. During the fourth quarter of 1994 the net operating loss carryforward was fully utilized. As a result, for the fourth quarter of 1994 the provision for income taxes was reduced by $415 thousand, while income for the 1995 quarter was fully tax effected. Net interest income of $9.3 million in 1995 increased $290 thousand or 3.2% from the fourth quarter of 1994. The increase was primarily attributable to an increase in average earning assets. Average earning assets amounted to $747.7 million and $699.1 million for the fourth quarter of 1995 and 1994, respectively. Noninterest income of $2.3 million in the fourth quarter of 1995 increased $595 thousand from the respective period in 1994. The increase was primarily attributable to net securities losses of $471 thousand in the fourth quarter of 1994, while the Company recognized $23 thousand of net securities gains in the fourth quarter of 1995. Noninterest expenses decreased $453 thousand or 6.1% in the same comparative time frame. As discussed above in the year-to-year analysis, the decrease in noninterest expense between the quarterly periods was primarily attributable to lower FDIC insurance premiums and decreased expenses for salaries, offset only partially by increases in legal and professional fees. <TABLE> SELECTED FOURTH QUARTER FINANCIAL INFORMATION (Dollars In Thousands) <CAPTION> For the Quarter Ended December 31, 1995 1994 <S> <C> <C> Interest Income $15,846 $13,813 Interest Expense 6,577 4,834 Net Interest Income 9,269 8,979 Provision for Loan Losses 530 67 Net Interest Income after Provision for Loan Losses 8,739 8,912 Other Income 2,342 1,747 Other Expense 7,009 7,462 Income Before Income Taxes 4,072 3,197 Provision for Income Taxes 1,462 843 Net Income $ 2,610 $ 2,354 Weighted Average Number of Shares and Equivalents Outstanding Primary 5,672 5,750 Fully Diluted 5,677 6,079 Primary Earnings Per Share $ .46 $ .41 Fully Diluted Earnings Per Share .46 .40 SELECTED RATIOS: Return on Average Assets 1.30% 1.25% Return on Average Equity 15.58% 16.44% Per share amounts have been adjusted for the 1995 four percent stock dividend. </TABLE> Item 8: Financial Statements and Supplementary Data The following audited financial statements and supplementary data are incorporated herein by reference to the Company's Annual Report to Shareholders for December 31, 1995, which financial statements and supplementary data are also filed as Exhibit 13 to this report: Independent Auditors' Report Financial Statements: Consolidated Balance Sheets as of December 31, 1995 and 1994 Consolidated Statements of Income for the Years Ended December 31, 1995, 1994 and 1993 Consolidated Statements of Changes in Shareholders' Equity for the Years Ended December 31, 1995, 1994 and 1993 Consolidated Statements of Cash Flows for the Years Ended December 31, 1995, 1994 and 1993 Notes to Consolidated Financial Statements Supplementary Data: (Unaudited) Quarterly Financial Data for the Years Ended December 31, 1995 and 1994 Item 9: Changes in and Disagreements with Accountants on Accounting and Financial Disclosure. - None. PART III Item 10: Directors and Executive Officers of the Registrant Item 1, "Election of Directors and Information with Respect to Directors and Officers" of the Company's Proxy Statement for its Annual Meeting of Shareholders to be held April 24, 1996 is incorporated herein by reference. Required information regarding the Company's Executive Officers is contained in Part I, Item 1.E., "Executive Officers of the Registrant." Item 11: Executive Compensation Item 1, "Election of Directors and Information with Respect to Directors and Officers" of the Company's Proxy Statement for its Annual Meeting of Shareholders to be held April 24, 1996 is incorporated herein by reference. Item 12: Security Ownership of Certain Beneficial Owners and Management Item 1, "Election of Directors and Information with Respect to Directors and Officers" of the Company's Proxy Statement for its Annual Meeting of Shareholders to be held April 24, 1996 is incorporated herein by reference. Item 13: Certain Relationships and Related Transactions Item 1, "Election of Directors and Information with Respect to Directors and Officers" of the Company's Proxy Statement for its Annual Meeting of Shareholders to be held April 24, 1996 is incorporated herein by reference. PART IV Item 14: Exhibits, Financial Statement Schedules and Reports on Form 8-K A) Documents filed as part of this report: I Financial Statements: The following financial statements, the notes thereto, and the independent auditors' reports thereon are filed as part of this report. See the index to such financial statements in Part II, Item 8 of this report. Independent Auditors' Report Consolidated Balance Sheets as of December 31, 1995 and 1994 Consolidated Statements of Income for the Years Ended December 31, 1995, 1994 and 1993 Consolidated Statements of Changes in Shareholders' Equity for the Years Ended December 31, 1995, 1994 and 1993 Consolidated Statements of Cash Flows for the Years Ended December 31, 1995, 1994 and 1993 Notes to Consolidated Financial Statements II Schedules: All schedules are omitted since the required information is either not applicable or not required or is contained in the respective financial statements or in the notes thereto. III. Exhibits: The following exhibits are incorporated by reference herein. Exhibit Number Exhibit 2.1 Purchase and Assumption Agreement among Arrow Financial Corporation, Arrow Vermont Corporation, Green Mountain Bank and Mascoma Savings Bank, dated June 1, 1995 incorporated herein by reference to Form 8-K dated June 1, 1995 filed as exhibit 2.1. 2.2 Supplement to Purchase and Assumption Agreement among Arrow Financial Corporation, Arrow Vermont Corporation, Green Mountain Bank and Mascoma Savings Bank, dated January 12, 1996 incorporated herein by reference to Form 8-K dated January 15, 1996 filed as exhibit 2.2. 2.3 Purchase and Assumption Agreement among Arrow Financial Corporation, Arrow Vermont Corporation, Green Mountain Bank and ALBANK, FSB, dated February 26, 1996 incorporated herein by reference to Form 8-K dated February 26, 1995 filed as exhibit 2.1. 2.4 Service Purchasing Agreement among Arrow Financial Corporation, Arrow Vermont Corporation, Green Mountain Bank and ALBANK, FSB, dated February 26, 1996 incorporated herein by reference to Form 8-K dated February 26, 1995 filed as exhibit 2.2. 2.5 Stock Purchase Agreement among Arrow Financial Corporation, Arrow Vermont Corporation, Green Mountain Bank and Vermont National Bank, dated February 27, 1996 incorporated herein by reference to Form 8-K dated February 26, 1995 filed as exhibit 2.3. 3.(i) Certificate of Incorporation of the Registrant, as amended, incorporated by reference herein from Registrant's Annual Report for the year ended December 31, 1990 filed on Form 10-K. 4.1 Indenture and Form of Debenture, incorporated herein by reference from Registrant's 1933 Act Registration Statement on Form S-2 (file number 33-10109; effective December 16, 1986). 4.2 Equity Contract Agency Agreement and Form of Equity Contract, incorporated herein by reference from Registrant's 1933 Act Registration Statement on Form S-2 (file number 33-10109; effective December 16, 1986). 10.1 1985 Incentive Stock Option Plan of the Registrant, incorporated herein by reference from Registrant's 1933 Act Registration Statement on Form S-8 (file number 2-98736; filed on July 1, 1985).* 10.2 1985 Non-Qualified Stock Option Plan of the Registrant, incorporated herein by reference from Registrant's 1933 Act Registration Statement on Form S-8 (file number 2-98735; filed July 1, 1985).* 10.3 Executive Incentive Plan of Glens Falls National Bank and Trust Company, incorporated herein by reference from Registrant's 1933 Act Registration Statement on Form S-2 (file number 33-10109; filed December 16, 1986).* 10.4 Employment Agreement between the Registrant and Michael F. Massiano dated December 31, 1990, incorporated by reference herein from Registrant's Annual Report for the year ended December 31, 1990 filed on Form 10-K.* 10.5 Employment Agreement between the Registrant and John J. Murphy dated December 31, 1990, incorporated by reference herein from Registrant's Annual Reports for the years ended December 31, 1990 and 1992 filed on Form 10-K.* 10.6 Employment Agreement between the Registrant, its subsidiary bank, Glens Falls National Bank & Trust Company, and Thomas L. Hoy dated December 31, 1990, incorporated by reference herein from Registrant's Annual Reports for the years ended December 31, 1990 and 1992 filed on Form 10-K.* 10.7 Select Executive Retirement Plan of the Registrant effective January 1, 1992 incorporated by reference herein from Registrant's Annual Report for December 31, 1992 on Form 10-K.* 10.8 Long Term Incentive Plan of the Registrant, incorporated by reference herein from Registrant's 1933 Act Registration Statement on Form S-8 (File number 33-66192; filed July 19, 1993).* 10.9 Directors Deferred Compensation Plan of Registrant, incorporated by reference herein from Registrant's Annual Report for December 31, 1993 filed on Form 10-K.* 10.10 Senior Officers Deferred Compensation Plan of the Registrant, incorporated by reference herein from Registrant's Annual Report for December 31, 1993 filed on Form 10-K.* * Management contracts or compensation plans required to be filed as an exhibit. The following exhibits are submitted herewith: Exhibit Number Exhibit 3.(ii) By-Laws of the Registrant 10.11 Automatic Dividend Reinvestment Plan of the Registrant 11 Computation of Earnings per Share 13 Annual Report to Shareholders 21 Subsidiaries of the Company 23 Consent of Independent Certified Public Accountants 27 Financial Data Schedule (submitted with electronic filing only) (B) No reports on Form 8-K have been filed for the 3 months ended December 31, 1995. SIGNATURES 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 27, 1996 By: /s/ Michael F. Massiano Michael F. Massiano Chairman and President (Chief Executive Officer) Date: March 27, 1996 By: /s/ John J. Murphy John J. Murphy 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 27, 1996 by the following persons in the capacities indicated. /s/ Richard J. Bartlett /s/ David L. Moynehan Richard J. Bartlett David L. Moynehan Director Director /s/ Michael B. Clark Michael B. Clark Doris E. Ornstein Director Director /s/ George C. Frost George C. Frost Edward C. Pike Director Director /s/ Herbert A. Heineman, Jr. /s/ Daniel L. Robertson Herbert A. Heineman, Jr. Daniel L. Robertson Director Director /s/ Kenneth C. Hopper, M.D. /s/ Preston Leete Smith Kenneth C. Hopper, M.D. Preston Leete Smith Director Director /s/ Edward F. Huntington Edward F. Huntington Thomas C. Webb Director Director /s/ David G. Kruczlnicki /s/ Michael F. Massiano David G. Kruczlnicki Michael F. Massiano Director Director & Chairman EXHIBIT INDEX Exhibit Number Exhibit 3.(ii) By-Laws of the Registrant 10.11 Automatic Dividend Reinvestment Plan of the Registrant 11 Computation of Earnings per Share 13 Annual Report to Shareholders 21 Subsidiaries of the Company 23 Consent of Independent Certified Public Accountants 27 Financial Data Schedule (submitted with electronic filing only)