SECURITIES AND EXCHANGE COMMISSION Washington, D.C. FORM 10-Q [X] QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the Quarter Ended June 30, 1997 [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 Commission File Number: 0-12507 ARROW FINANCIAL CORPORATION (Exact name of registrant as specified in its charter) New York 22-2448962 (State or other jurisdiction of (IRS Employer Identification incorporation or organization) Number) 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 Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for 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 issuer's classes of common stock, as of the latest practicable date. Class Outstanding as of July 31, 1997 Common Stock, par value $1.00 per share 5,495,026 ARROW FINANCIAL CORPORATION FORM 10-Q JUNE 30, 1997 INDEX PART I FINANCIAL INFORMATION Consolidated Balance Sheets as of June 30, 1997 and December 31, 1996 Consolidated Statements of Income for the Three Month and Six Month Periods Ended June 30, 1997 and 1996 Consolidated Statements of Cash Flows for the Six Months Ended June 30, 1997 and 1996 Notes to Consolidated Financial Statements Management's Discussion and Analysis of Financial Condition and Results of Operations Cautionary Statement under Federal Securities Laws Acquisition of Six Fleet Branches Divestiture and Liquidation of Vermont Operations Stock Repurchase Program Overview Change in Financial Condition Capital Resources Liquidity Interest Rate Risk Results of Operations: Quarterly Comparison Results of Operations: Year-to-Date Comparison PART II OTHER INFORMATION SIGNATURES
PART I - FINANCIAL CONDITION <TABLE> <CAPTION> ARROW FINANCIAL CORPORATION AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS (Dollars in Thousands)(Unaudited) 6/30/97 12/31/96 ASSETS <S> <C> <C> Cash and Due from Banks $ 25,320 $ 19,572 Federal Funds Sold 48,500 17,925 Cash and Cash Equivalents 73,820 37,497 Securities Available-for-Sale 177,243 171,743 Securities Held-to-Maturity: (Approximate Fair Value of $44,289 in 1997 and $31,519 in 1996) 43,720 30,876 Loans and Leases 462,396 393,511 Less: Allowance for Loan Losses (6,409) (5,581) Net Loans and Leases 455,987 387,930 Premises and Equipment 10,748 9,414 Other Real Estate Owned 370 136 Other Assets 30,484 15,007 Total Assets $792,372 $652,603 LIABILITIES Deposits: Demand $ 91,583 $ 67,877 Regular Savings, N.O.W. & Money Market Deposit Accounts 322,259 254,312 Time Certificates of $100,000 or More 67,274 83,802 Other Time Deposits 205,473 135,756 Total Deposits 686,589 541,747 Short-Term Borrowings: Federal Funds Purchased and Securities Sold Under Agreements to Repurchase 13,958 16,597 Other Short-Term Borrowings 8,265 6,109 Other Liabilities 12,084 13,854 Total Liabilities 720,896 578,307 SHAREHOLDERS' EQUITY Preferred Stock, $5 Par Value; 1,000,000 Shares Authorized --- --- Common Stock, $1 Par Value; 20,000,000 Shares Authorized (6,577,036 Shares Issued in 1997 and 1996) 6,577 6,577 Surplus 54,658 54,569 Undivided Profits 30,153 26,992 Net Unrealized Gain on Securities ailable-for-Sale, Net of Tax 50 208 Treasury Stock (1,032,010 Shares in 1997 and 817,743 in 1996, at Cost) (19,962) (14,050) Total Shareholders' Equity 71,476 74,296 Total Liabilities and Shareholders' Equity $792,372 $652,603 See notes to consolidated financial statements. </TABLE> <TABLE> <CAPTION> ARROW FINANCIAL CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF INCOME (Dollars in Thousands, Except Per Share Amounts)(Unaudited) Three Months Six Months Ended June 30, Ended June 30, 1997 1996 1997 1996 <S> <C> <C> <C> <C> INTEREST AND DIVIDEND INCOME Interest and Fees on Loans and Leases $9,094 $11,013 $17,794 $22,587 Interest on Federal Funds Sold 115 32 186 170 Interest and Dividends on Securities Available-for-Sale 2,719 2,765 5,480 5,408 Interest and Dividends on Securities Held-to-Maturity 668 205 1,304 399 Total Interest and Dividend Income 12,596 14,015 24,764 28,564 INTEREST EXPENSE Interest on Deposits: Time Certificates of $100,000 or More 1,169 1,043 2,318 1,987 Other Deposits 3,973 4,210 7,681 8,633 Interest on Short-Term Borrowings: Federal Funds Purchased and Securities Sold Under Agreements to Repurchase 204 186 372 365 Other Short-Term Borrowings 92 36 162 66 Total Interest Expense 5,438 5,475 10,533 11,051 NET INTEREST INCOME 7,158 8,540 14,231 17,513 Provision for Loans Losses 236 224 472 448 NET INTEREST INCOME AFTER PROVISION FOR LOAN LOSSES 6,922 8,316 13,759 17,065 OTHER INCOME Income from Fiduciary Activities 663 989 1,321 1,959 Fees for Other Services to Customers 834 1,024 1,589 2,038 Net Gains (Losses) on Securities Transactions 65 (30) 37 82 Net Gain on the Disposition of Branches --- --- --- 7,091 Other Operating Income 486 218 1,011 499 Total Other Income 2,048 2,201 3,958 11,669 OTHER EXPENSE Salaries and Employee Benefits 2,969 3,840 5,903 7,740 Occupancy Expense of Premises, Net 363 453 741 978 Furniture and Equipment Expense 474 413 953 870 Other Operating Expense 1,218 1,797 2,363 3,696 Total Other Expense 5,024 6,503 9,960 13,284 INCOME BEFORE PROVISION FOR INCOME TAXES 3,946 4,014 7,757 15,450 Provision for Income Taxes 1,428 1,433 2,338 5,396 NET INCOME $ 2,518 $ 2,581 $ 5,419 $10,054 Average Shares Outstanding 5,658 5,931 5,719 6,072 Per Common Share: Earnings $ .45 $ .44 $ .95 $ 1.66 Dividends Declared .20 .15 .40 .31 Book Value 12.89 11.49 12.89 11.49 Tangible Book Value 10.30 11.10 10.30 11.10 Per share amounts have been adjusted for the November 1996 ten percent stock dividend. See notes to consolidated financial statements. </TABLE> <TABLE> CAPTION
ARROW FINANCIAL CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (Dollars in Thousands)(Unaudited) Six Months Ended June 30, 1997 1996 Operating Activities: <S> <C> <C> Net Income $ 5,419 $10,054 Adjustments to Reconcile Net Income to Net Cash Provided by Operating Activities: Provision for Loan Losses 472 448 Provision for Other Real Estate Owned Losses 60 215 Depreciation and Amortization 598 651 Compensation Expense for Allocated ESOP Shares --- 68 Net Gain on Divestiture of Vermont Operations --- (7,091) Gains on the Sale of Securities Available-for-Sale (101) (228) Losses on the Sale of Securities Available-for-Sale 63 146 Proceeds from the Sale of Loans 1,155 3,866 Net Gains on the Sale of Loans, Fixed Assets and Other Real Estate Owned (28) --- Decrease (Increase) in Deferred Tax Assets (21) 220 Decrease (Increase) in Interest Receivable (571) 284 Increase (Decrease) in Interest Payable (32) (701) Decrease (Increase) in Other Assets (2,706) 138 Increase (Decrease) in Other Liabilities (1,738) (145) Net Cash Provided By Operating Activities 2,570 7,925 Investing Activities: Proceeds from the Sale of Securities Available-for-Sale 23,996 32,236 Proceeds from the Maturities of Securities Available-for-Sale 20,175 25,250 Purchases of Securities Available-for-Sale (49,961) (52,069) Proceeds from the Maturities of Securities Held-to-Maturity 1,073 521 Purchases of Securities Held-to-Maturity (13,978) (3,244) Proceeds from Loans (Acquired) Sold in Branch Transactions (44,190) 39,543 Net Increase in Loans and Leases (25,824) (13,813) Proceeds from Fixed Assets (Acquired) Sold in Branch Transactions (1,338) 1,533 Proceeds from the Sales of Fixed Assets and Other Real Estate Owned 93 1,846 Purchase of Fixed Assets (486) (805) Net Cash (Used In) Provided By Investing Activities (90,440) 30,998 Financing Activities: Deposits Assumed (Transferred) in Branch Transactions, Net of Premium 127,708 (93,109) Net Increase in Deposits, Excluding Branch Transactions 5,048 17,034 Net (Decrease) Increase in Short-Term Borrowings (483) 8,837 Purchase of Treasury Stock (5,822) (8,107) Sale of Treasury Stock for Exercise of Stock Options --- 195 Disqualifying Disposition of ISO Shares --- 33 Cash Dividends Paid (2,258) (1,849) Net Cash Provided By (Used In) Financing Activities 124,193 (76,966) Net Increase (Decrease) in Cash and Cash Equivalents 36,323 (38,043) Cash and Cash Equivalents at Beginning of Period 37,497 58,506 Total Cash and Cash Equivalents $73,820 $20,463 Supplemental Cash Flow Information: Interest Paid $10,565 $11,752 Income Taxes Paid 3,596 5,180 Transfer of Loans to Other Real Estate Owned 343 215 See notes to consolidated financial statements. </TABLE> ARROW FINANCIAL CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS FORM 10-Q JUNE 30, 1997 1. Financial Statement Presentation In the opinion of the management of Arrow Financial Corporation (the "Company"), the accompanying consolidated financial statements contain all of the adjustments necessary to present fairly the financial position as of June 30, 1997 and December 31, 1996; the results of operations for the three and six month periods ended June 30, 1997 and June 30, 1996; and the statements of cash flows for the six month periods ended June 30, 1997 and June 30, 1996. All such adjustments are of a normal recurring nature. Certain items have been reclassified to conform to the 1997 presentation. Per share amounts have been restated to reflect the November 1996 ten percent stock dividend, declared September 25, 1996. 2. Transfers and Servicing of Financial Assets and Extinguishments of Liabilities In June 1996, the Financial Accounting Standards Board ("FASB") issued Statement of Financial Accounting Standards ("SFAS") No. 125, "Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities." SFAS No. 125 is effective for transfers and servicing of financial assets and extinguishments of liabilities occurring after December 31, 1996 (except for certain provisions which were deferred for one year by SFAS No. 127) and is to be applied prospectively. This statement provides accounting and reporting standards for transfers and servicing of financial assets and extinguishments of liabilities based on consistent application of financial components approach that focuses on control. It distinguishes transfers of financial assets that are sales from transfers that are secured borrowings. The adoption of SFAS No. 125 did not have a material impact on the Company's consolidated financial position, results of operations, or liquidity. 3. Earnings Per Share In February 1997, the FASB issued SFAS No. 128, "Earnings Per Share." SFAS No. 128 simplifies the standards for computing earnings per share ("EPS") previously found in APB Opinion No. 15, and makes them comparable to international EPS standards. It replaces the presentation of primary EPS with a presentation of basic EPS. It also requires dual presentation of basic and diluted EPS on the face of the income statement for all entities with complex capital structures and requires a reconciliation of the numerator and denominator of the basic and diluted EPS computations. The statement is effective for financial statements issued for periods ending after December 15, 1997. Earlier application is not permitted, although the statement will require restatement of all prior-period EPS data presented. 4. Reporting Comprehensive Income and Disclosures about Operating Segments In June 1997, the FASB issued two statements relating to disclosures of financial information: SFAS No. 130, "Reporting Comprehensive Income" and SFAS No. 131, "Disclosures about Segments of an Enterprise and Related Information." SFAS No. 130 establishes standards for reporting and display of comprehensive income and its components in a full set of general-purpose financial statements. SFAS No. 131 establishes standards for the way that public business enterprises report information about operating segments. For the Company, both Statements are effective for interim and annual financial statements beginning with the first quarter of 1998. ARROW FINANCIAL CORPORATION AND SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS JUNE 30, 1997 Arrow Financial Corporation (the "Company") is a two bank holding company headquartered in Glens Falls, New York. The banking subsidiaries are Glens Falls National Bank and Trust Company ("GFNB") whose main office is located in Glens Falls, New York and Saratoga National Bank and Trust Company whose main office is located in Saratoga Springs, New York. Cautionary Statement under Federal Securities Laws The information contained in this Quarterly Report on Form 10-Q contains forward-looking statements that are based on management's beliefs, certain assumptions made by management and current expectations, estimates and projections about the Company's financial condition and results of operations. Words such as "expects," "believes," "should," "plans," "will," "estimates," and variations of such words and similar expressions are intended to identify such forward-looking statements. These statements are not guarantees of future performance and involve certain risks and uncertainties that are difficult to quantify or, in some cases, to identify. Therefore, actual outcomes and results may differ materially from what is expected or forecasted in such forward-looking statements. Factors that could cause or contribute to such differences include, but are not limited to, changes in economic and market conditions, including unanticipated fluctuations in interest rates, effects of state and federal regulation and risks inherent in banking operations. Readers are cautioned not to place undue reliance on these forward-looking statements, which speak only as of the date hereof. The Company undertakes no obligation to revise or update these forward-looking statements to reflect the occurrence of unanticipated events. This Quarterly Report should be read in conjunction with the Company's Annual Report filed on Form 10-K for December 31, 1996. Acquisition of Six Fleet Branches On June 27, 1997, the Company completed the acquisition of six branches in upstate New York from Fleet Bank, a subsidiary of Fleet Financial Group, Hartford, CT. The branches are located in the towns of Plattsburgh (2), Lake Luzerne, Port Henry, Ticonderoga and Warrensburg and became branches of GFNB. GFNB acquired substantially all deposits at the branches and most of the loans held by Fleet Bank related to the branches. Total deposit liabilities at the branches assumed by GFNB were approximately $140 million and the total amount of the branch-related loans acquired was approximately $34 million. Under the purchase agreement, GFNB also acquired from Fleet an additional $10 million of residential real estate loans not related to the branches. Divestiture and Liquidation of Vermont Operations During 1996, the Company completed the divestiture of substantially all the banking operations of its Vermont subsidiary bank, Green Mountain Bank ("GMB") in three separate transactions. Total loans and deposits transferred in these divestiture transactions amounted to approximately $148 million and $208 million, respectively. The only substantial Vermont property not sold in the transactions, the building that served as GMB's main office in Rutland, Vermont, was being held for sale on June 30, 1997. In the first quarter of 1997, GMB transferred to its immediate parent corporation, Arrow Vermont Corporation, as a capital distribution, substantially all of its remaining assets, primarily consisting of investment securities and other liquid assets. Thereafter, on March 21, 1997, GMB filed Articles of Dissolution under Vermont law. On June 10, 1997, Arrow Vermont Corporation, in turn, also filed Articles of Dissolution under Vermont law, having transferred substantially all of its assets to its parent corporation, Arrow Financial Corporation, by way of dividend. Neither GMB nor Arrow Vermont Corporation has received any significant unanticipated claim during the statutory claims period and GMB anticipates making a final distribution of its residual capital to Arrow Vermont in redemption of all its capital stock in the immediate future. Stock Repurchase Program On two separate occasions, in spring and fall 1996, the Board of Directors of the Company authorized an ongoing stock repurchase program, under which management was given the authority to repurchase at its discretion from time to time, in open market or privately negotiated transactions, up to an aggregate of $20 million of the Company's outstanding common stock. As of June 30, 1997, the Company had repurchased under the program $15.0 million, of which $5.8 million was reacquired in the first half of 1997. OVERVIEW The Company reported earnings of $5.4 million for the first six months of 1997, compared to earnings of $10.1 million for the first half of 1996. Earnings per common share were $.95 and $1.66 for the two respective periods. Earnings in the 1996 period included the gain on the sale of eight branches of the Company's Vermont bank, GMB, to Mascoma Savings Bank and for both periods, the Company received unanticipated repayments on certain restructured loans. Exclusive of nonrecurring items, earnings for the first two quarters of 1997 and 1996 amounted to $4.6 million and $5.1 million, respectively, and reflected core earnings per share of $.81 and $.84 for the two respective periods. The annualized returns on average assets were 1.66% and 2.80% for the first six months of 1997 and 1996, respectively. The annualized returns on average equity for the two periods were 15.04% and 29.34%, respectively. Excluding the nonrecurring items, the annualized returns on average assets were 1.41% and 1.43% and the annualized returns on average equity were 12.86% and 15.82%, respectively, for the 1997 and 1996 six month periods. Total assets were $792.4 million at June 30, 1997 an increase of $139.8 million or 21.4% from December 31, 1996, principally reflecting the effects of the Fleet branch acquisition, discussed above, at the end of the second quarter of 1997. Despite the net income of $5.4 million, total shareholders' equity decreased $2.8 million to $71.5 million during the first six months of 1997. The decrease in shareholders' equity resulted from the stock repurchase program described above, cash dividends paid during the period and a decrease in the net unrealized gain on securities available-for-sale, which in the aggregate exceeded net earnings for the period. Despite the decrease in shareholders' equity and increase in total assets during the period, the Company's risk-based capital ratios and Tier 1 leverage ratio significantly exceeded regulatory minimums and both of the Company banks, as well as the Company, qualified as "well-capitalized" under federal bank guidelines. The following table presents the adjustments necessary to arrive at the recurring net income of the Company. <TABLE> <CAPTION> Analysis of Recurring Net Income (In Thousands, Except Per Share Amounts) Three Months Ended Six Months Ended Jun 1997 Jun 1996 Jun 1997 Jun 1996 <S> <C> <C> <C> <C> Net Income, as Reported $2,518 $2,581 $5,419 $10,054 Adjustments, net of Tax: OREO Transactions --- 33 --- 155 Net Securities Transactions (39) 17 (22) (50) Gain on Branch Sale --- --- --- (4,726) Restructured Loan Transactions (166) --- (166) (323) Insurance Settlement --- --- (163) --- State Income Tax Benefit --- --- (464) --- Recurring Income $2,313 $2,631 $4,604 $5,110 Earnings Per Share, as Reported $ .45 $ .44 $ .95 $ 1.66 Earnings Per Share, Recurring .41 .44 .81 .84 </TABLE> CHANGE IN FINANCIAL CONDITION <TABLE> <CAPTION> Summary of Consolidated Balance Sheets (Dollars in Thousands) $ Change $ Change % Change % Change Selected Period-End Balances: Jun 1997 Dec 1996 Jun 1996 From Dec From Jun From Dec From Jun <S> <C> <C> <C> <C> <C> <C> <C> Federal Funds Sold $ 48,500 $ 17,925 $ --- $ 30,575 $ 48,500 170.6% --.-% Securities Available-for-Sale 177,243 171,743 170,524 5,500 6,719 3.2 3.9 Securities Held-to-Maturity 43,720 30,876 16,639 12,844 27,081 41.6 162.8 Loans, Net of Unearned Income (1) 462,396 393,511 487,291 68,885 (24,895) 17.5 (5.1) Allowance for Loan Losses 6,409 5,581 11,540 828 (5,131) 14.8 (44.5) Earning Assets (1) 731,859 614,055 674,454 117,804 57,405 19.2 8.5 Total Assets 792,372 652,603 713,505 139,769 78,867 21.4 11.1 Demand Deposits 91,583 67,877 79,522 23,706 12,061 34.9 15.2 Savings, NOW and MMDA Accounts 322,259 254,312 286,972 67,947 35,287 26.7 12.3 Time Deposits of $100,000 or More 67,274 83,802 81,840 (16,528) (14,566) (19.7) (17.8) Other Time Deposits 205,473 135,756 162,169 69,717 43,304 51.4 26.7 Total Deposits 686,589 541,747 610,503 144,842 76,086 26.7 12.5 Other Borrowed Funds 22,223 22,706 24,134 (483) (1,911) (2.1) (7.9) Shareholders' Equity 71,476 74,296 66,575 (2,820) 4,901 (3.8) 7.4 (1) Includes Nonaccrual Loans </TABLE> Total resources at June 30, 1997 amounted to $792.4 million, an increase of $139.8 million or 21.4% from year-end 1996, and an increase of $78.9 million or 11.1% from June 30, 1996. At the end of the second quarter of 1997, the Company completed the acquisition from Fleet Bank of six branches in northeastern New York. The acquisition increased total assets by approximately $140 million, representing virtually all of the gain in total assets during the first six months of the year. In the second half of 1996, total resources decreased by approximately $60 million, as the result of the sale of substantially all of the Company's remaining Vermont operations to ALBANK in September 1996 (involving disposition of approximately $100 million in net assets) which was offset in part by growth in total assets of the Company's two New York based banks, primarily in the area of consumer loans. Total deposits of $686.6 million at June 30, 1997 represented an increase of $144.8 million from the December 31, 1996 level and an increase of $76.1 million from June 30, 1996. The Company assumed approximately $140 million of deposit liabilities in the Fleet branch acquisition at the end of the second quarter of 1997, representing substantially all of the increase in deposits in the first six months of the year. In the second half of 1996, by contrast, deposits decreased by approximately $69 million, as approximately $108 million of deposits in Vermont transferred to ALBANK in September 1996 were offset in part by a $39 million increase in deposits at the Company's New York banks. Between June 30, 1996 and June 30, 1997, in the Company's continuously-owned New York banking operations, total loans increased at a steady but modest rate, while total deposits also increased although at a slightly higher rate in the last six months of 1996 than in the first six months of 1997. These trends are further discussed in the following section of this Report. Deposit and Loan Trends The following analysis on trends in the deposit and loan portfolios focuses exclusively on the Company's continuously operated New York banking offices. The Vermont banking operations, substantially all of which were transferred to ALBANK at the end of September 1996, have been excluded. Since the analysis presents average balances, the acquisition of the six Fleet branches on June 27, 1997 had an insignificant effect on the average balances for the second quarter of 1997. The following table presents the quarterly average balance by deposit type and the percentage of total deposits represented by each deposit type for each of the most recent five quarters for the continuously operated New York bank offices. <TABLE> <CAPTION> Quarterly Average Deposit Balances (Continuously Operated New York Offices Only) (Dollars in Thousands) Jun 1997 Mar 1997 Dec 1996 Sep 1996 Jun 1996 Amount % Amount % Amount % Amount % Amount % <S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C> Demand Deposits $ 65,976 12 $ 63,147 12 $ 67,240 12 $ 69,216 13 $ 66,299 13 N.O.W. and Super N.O.W. 128,067 23 122,318 22 125,559 23 111,052 21 104,768 20 Savings and M.M.D.A 128,350 23 129,791 24 133,974 25 137,768 26 142,916 28 Time Deposits of $100,000 or More 87,350 16 88,704 16 80,462 15 84,708 16 78,063 15 Other Time Deposits 147,910 26 139,261 26 133,041 25 127,934 24 120,397 24 Total Deposits $557,653 100 $543,221 100 $540,276 100 $530,678 100 $512,443 100 </TABLE> Average deposits for these banking offices increased $45.2 million, or 8.8%, from the second quarter of 1996 to the second quarter of 1997. Over the five quarters charted in the table above, the offices experienced a shift in the mix of deposits, with the proportionately less expensive savings and money market accounts decreasing as a percentage of total deposits and the relatively more expensive N.O.W. accounts and time deposits increasing in proportion to total deposits. <TABLE> <CAPTION> Quarterly Cost of Deposits (Continuously Operated New York Offices Only) Jun 1997 Mar 1997 Dec 1996 Sep 1996 Jun 1996 <S> <C> <C> <C> <C> <C> Demand Deposits --- % --- % --- % --- % --- % N.O.W. and Super N.O.W. 3.21 3.05 3.04 2.86 2.69 Savings and M.M.D.A 2.83 2.94 2.93 2.92 2.92 Time Deposits of $100,000 or More 5.37 5.25 5.21 5.25 5.15 Other Time Deposits 5.54 5.38 5.34 5.23 5.23 Total Deposits 3.70 3.63 3.52 3.45 3.38 </TABLE> <TABLE> <CAPTION> Federal Reserve Bank's Discount Rate Changes 1992 - 1996 Date New Rate Old Rate <S> <C> <C> January 31, 1996 5.00% 5.25% February 1, 1995 5.25 4.75 November 15, 1994 4.75 4.00 August 16, 1994 4.00 3.50 May 17, 1994 3.50 3.00 July 2, 1992 3.00 3.50 </TABLE> The Federal Reserve Board attempts to influence the prevailing federal funds rate and prime interest rates by changing the Federal Reserve Bank discount rate and/or through open market operations. In the first quarter of 1997, the prevailing Federal Funds rate increased by twenty five basis points even though the discount rate remain unchanged. The Company experienced an increase in the total cost of deposits resulting from competitive pricing in the marketplace as well as a shift in the mix of deposits discussed above. The Company does not expect that its average cost of funds will change significantly due to the acquisition of the Fleet branches. Total deposits assumed at the closing of the transaction (at June 27, 1997) were approximately $140 million. Of that amount, variable rate deposit accounts (including NOW, Super NOW, Money Market Savings and regular savings) constituted approximately $66.3 million, and another $56 million constituted time deposits. After closing, the Company began paying its own rates on the variable rate deposit accounts assumed (its rate being slightly higher than Fleet's rates, on average) and continued paying the previously agree-upon rates on time deposits assumed (Fleets rates for such products being similar to the Company's prevailing rates for time deposits). Accordingly, the Company expects to lose few, if any of the variable rate or time deposits assumed in the Fleet transaction due to interest rate sensitivity. The Company did not acquire any time deposits of $100,000 or more. The following table presents the quarterly average balance by loan type and the percentage of total loans represented by each loan type for each of the most recent five quarters for the Company's continuously operated New York banking offices. <TABLE> <CAPTION> Quarterly Average Loan Balances (Continuously Operated New York Offices Only) (Dollars in Thousands) Jun 1997 Mar 1997 Dec 1996 Sep 1996 Jun 1996 Amount % Amount % Amount % Amount % Amount % <S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C> Commercial and Commercial Real Estate $ 92,874 23 $ 89,673 23 $ 84,059 22 $ 87,789 23 $ 87,304 23 Residential Real Estate 129,289 32 127,032 32 125,897 33 123,884 33 122,858 33 Home Equity 30,399 7 30,012 8 29,863 8 29,109 8 28,804 8 Indirect Consumer Loans 114,141 28 107,371 27 105,227 27 99,059 26 92,757 25 Direct Consumer Loans 34,212 8 33,300 8 32,013 8 30,634 8 31,627 8 Credit Card Loans 7,769 2 8,153 2 8,514 2 8,733 2 8,967 3 Total Loans 408,684 100 $395,541 100 $385,573 100 $376,208 100 $372,317 100 </TABLE> Average loan balances of these offices increased at a steady pace over the five most recent quarters. Average loans for the second quarter of 1997 increased by $36.4 million, or 9.8%, from the second quarter of 1996. Except for credit card loans, all categories of loans increased over the comparative period, with indirect consumer loans and commercial loans demonstrating the most significant changes. Indirect consumer loans are primarily auto loans financed through local dealerships where the Company acquires the dealer paper. As a percentage of the overall loan portfolio of the New York offices, these loans increased from 25% to 28% from the second quarter of 1996 to the second quarter of 1997. <TABLE> <CAPTION> Quarterly Taxable Equivalent Yield on Loans (Continuously Operated New York Offices Only) Jun 1997 Mar 1997 Dec 1996 Sep 1996 Jun 1996 <S> <C> <C> <C> <C> <C> Commercial and Commercial Real Estate 9.73% 9.61% 9.36% 9.76% 9.84% Residential Real Estate 8.40 8.47 8.30 8.26 8.42 Home Equity 9.23 9.10 9.08 9.10 9.23 Indirect Consumer Loans 8.35 8.29 8.35 8.43 8.52 Direct Consumer Loans 9.09 9.16 9.33 9.45 9.44 Credit Card Loans 16.84 16.76 16.46 16.66 16.55 Total Loans 8.97 8.96 8.99 9.00 9.12 </TABLE> Yields on the Company's loan portfolio for its continuously operated New York banking offices remained quite constant over the past four quarters reflecting the period of general interest rate stability. The following table presents information related to the Company's allowance and provision for loan losses for each of the past five quarters. The provision for loan losses and net charge-offs are reported on a year-to-date basis, and are annualized when expressed as a percentage of average loans. <TABLE> <CAPTION> Summary of the Allowance and Provision for Loan Losses (Dollars in Thousands)(Loans Stated Net of Unearned Income) Jun 1997 Mar 1997 Dec 1996 Sep 1996 Jun 1996 Loan Balances: <S> <C> <C> <C> <C> <C> Period-End Loans $462,396 $398,581 $393,511 $381,683 $487,291 Average Loans, Year-to-Date 402,149 395,541 459,946 484,872 484,473 Allowance for Loan Losses: Allowance for Loan Losses, Beginning of Period $5,581 $5,581 $12,106 $12,106 $12,106 Transfer Pursuant to Branch Acquisition (Sale) 700 --- (6,841) (6,841) (596) Provision for Loan Losses, Year-to-Date 472 236 896 672 448 Net Charge-offs, Year-to-Date (344) (192) (580) (388) (418) Allowance for Loan Losses, End of Period $6,409 $5,625 $ 5,581 $ 5,549 $11,540 Nonperforming Assets: Nonaccrual Loans $2,232 $2,070 $2,297 $2,477 $2,962 Loans Past due 90 or More Days and Still Accruing Interest 764 292 321 39 806 Loans Restructured and in Compliance with Modified Terms --- --- --- --- --- Total Nonperforming Loans 2,996 2,362 2,618 2,516 3,768 Other Real Estate Owned 370 340 136 225 540 Total Nonperforming Assets $3,366 $2,702 $2,754 $2,741 $4,308 Performance Ratios: Allowance to Nonperforming Loans 213.92% 238.15% 213.18% 220.54% 306.26% Allowance to Period-End Loans 1.39 1.41 1.42 1.45 2.37 Provision to Average Loans (annualized) 0.24 0.24 0.19 0.18 0.19 Net Charge-offs to Average Loans (annualized) 0.17 0.20 0.13 0.11 0.17 Nonperforming Assets to Loans & OREO 0.73 0.68 0.70 0.72 0.88 </TABLE> The Company's nonperforming assets at June 30, 1997 amounted to $3.4 million, an increase of $612 thousand, or 22.2%, from December 31, 1996 and a decrease of $942 thousand, or 21.9%, from June 30, 1996. The increase from year-end was primarily attributable to an increase of residential real estate loans delinquent 90 or more days, but still accruing interest. At period-end, the Company's nonperforming asset totals did not include any assets acquired from Fleet Bank in the branch acquisition completed on June 27, 1997. Based on a review of the loan portfolio acquired, the Company increased the allowance for loan losses by $700 thousand as a purchase acquisition adjustment to goodwill. This amount represents the allowance for loan losses established for inherent risk of loss in the loans acquired in an amount the Company believes is materially consistent with the general loss reserve on the books of Fleet applicable to these loans. Of the $4.3 million in nonperforming assets at June 30, 1996, $3.0 million was attributable to the New York banks, and the remaining $1.3 million represented loans or OREO held in the Company's Vermont banking operation, substantially all of which were sold or liquidated in connection with the winding up of such operation in the ensuing periods. The provision for loan losses for the first two quarters of 1997 was $472 thousand, compared to a provision of $448 thousand for the first two quarters of 1996. On an annualized basis, the ratio of the provision to average loans for the first six months of 1997 was .24%, seven basis points in excess of the annualized ratio for the period's net charge-offs to average loans of .17% and five basis points higher than the ratio of the provision to average loans for the 1996 period. The provision for the six months ended June 30, 1997 was deemed adequate. The coverage ratio, defined as the ratio of the allowance for loan losses to nonperforming loans, was 213.92% at June 30, 1997. CAPITAL RESOURCES Shareholders' equity was $71.5 million at June 30, 1997, a decrease of $2.8 million or 3.8% from December 31, 1996. The decrease in shareholders' equity was primarily attributable to the repurchase during the period of 235,441 shares of the Company's common stock at an aggregate cost of $5.8 million, cash dividends of $2.3 million and a decrease of $158 thousand in net unrealized gains on securities available-for-sale, offset by net earnings for the period. The Company and its subsidiaries are currently subject to two capital guidelines, a leverage ratio test and a risk-based capital measure. The risk-based capital guidelines assign 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 leverage ratio guideline establishes minimum limits on the ratio of Tier 1 capital to total tangible assets. For top-rated companies, the minimum leverage ratio is 3%, but lower-rated or rapidly expanding companies may be required to meet substantially greater minimum ratios. The FDIC Improvement Act ("FDICIA") of 1991 mandated actions to be taken by banking regulators with respect to banking institutions suffering from various levels of undercapitalization as measured by these capital ratios. FDICIA established five levels of capitalization ranging from "critically undercapitalized" to "well-capitalized." As of June 30, 1997, all capital ratios for the Company and its subsidiary banks not only exceeded the minimum capital standards for financial institutions established by these guidelines, but also exceeded the FDICIA's "well-capitalized" standard. On June 30, 1997 the Tier 1 leverage and risk-based capital ratios for the Company and its subsidiaries were as follows: <TABLE> <CAPTION> Summary of Capital Ratios Tier 1 Total Risk-Based Risk-Based Leverage Capital Capital Ratio Ratio Ratio <S> <C> <C> <C> Arrow Financial Corporation 8.74% 12.31% 13.57% Glens Falls National Bank & Trust Company 8.75 12.43 13.68 Saratoga National Bank & Trust Company 7.21 9.14 10.29 Regulatory Minimum 3.00 4.00 8.00 FDICIA's "Well-Capitalized" Standard 5.00 6.00 10.00 </TABLE> The following table presents the cash dividends paid in 1997 and 1996, restated for the November 1996 ten percent stock dividend. On July 23, 1997, the Company declared a dividend of $.20 payable on September 15, 1997.
<TABLE> <CAPTION> Quarterly Stock Prices and Dividends Market Price Cash (Restated for Stock Dividends) (Bid) Dividends High Low Declared <S> <C> <C> <C> 1996 1st Quarter $18.375 $15.000 $.155 2nd Quarter 21.000 18.625 .155 3rd Quarter 20.750 17.750 .155 4th Quarter 23.750 20.750 .200 1997 1st Quarter $24.500 $23.250 $.200 2nd Quarter 27.750 24.500 .200 3rd Quarter n/a n/a .200 </TABLE> <TABLE> <CAPTION> 1997 1996 <S> <C> <C> Second Quarter Earnings Per Share, as Reported $.45 $.44 Second Quarter Recurring Earnings Per Share $.41 $.44 Dividend Payout Ratio: (Third quarter dividends as a percent of second quarter core earnings per share) 48.8% 35.2% Book Value Per Share $12.89 $11.49 Tangible Book Value Per Share $10.30 $11.10 </TABLE> The Company is not aware of any know trends, event or uncertainties that will have or that are reasonably likely to have a material adverse effect on the Company's capital resources. 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 on an ongoing basis 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. Historically, the Company has maintained high levels of core deposits. At June 30, 1997, core deposits represented more than 78% of the Company's total assets. Additionally, stockholders' equity at a level of 9.0% of total assets represented another substantial source of funds. Large denomination time deposits, repurchase agreements and other borrowed funds represented 11.3% of total assets at June 30, 1997. Federal funds sold are overnight sales of the Company's surplus funds to correspondent banks, while federal funds purchased represent overnight borrowings. Federal funds purchased are thus a source of short-term liquidity. The Company's practice is to be a net seller of federal funds under normal circumstances, and to avoid becoming a net purchaser for any extended periods of time. During the second quarter of 1997, average federal funds sold amounted to $8.4 million and average federal funds purchased were $3.2 million. At June 30, 1997, federal funds sold was an unusually high $48.5 million, due to temporary excess liquidity resulting from the Fleet branch acquisition in which the deposit liabilities assumed were greater than the loan balances and other branch-related assets acquired. Apart from federal funds purchased, securities available-for-sale represent the Company's other significant source of meeting short- term liquidity needs. This liquidity arises both from an ability to sell the securities quickly without significant impact on Company earnings, as well as from the ability to use the securities as collateral for borrowing. At June 30, 1997, securities available-for-sale amounted to $177.2 million and averaged $163.0 million for the quarter then ended. Other short-term sources of funds include 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 materially adverse effect or make material demands on the Company's liquidity. 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, possible 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 rates 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 characteristics of each individual interest-bearing asset and liability under a variety of interest rate projections. To make interest rate projections, the Company obtains information from third party providers of economic data. The rate projections are applied to existing interest sensitive assets and liabilities and to expected new and rollover amounts. The Company estimates net interest income for the ensuing twelve months using the most likely rate projection and then using a no-change scenario. Exposure to rising or falling rates are calculated to cover a distribution of perceived probable interest rate scenarios. At June 30, 1997, the Company was operating within established internal policy limits for both the short-term and long-term measures of interest rate risk. Based upon a review of the repricing characteristics of the deposits and loan portfolio acquired by the Company in the Fleet branch transaction, management believes the transaction will not significantly affect the Company's interest rate risk position. 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. RESULTS OF OPERATIONS: Three Months Ended June 30, 1997 Compared With Three Months Ended June 30, 1996 <TABLE> <CAPTION> Summary of Earnings Performance (Dollars in Thousands, Except Per Share Amounts) As Reported: Jun 1997 Jun 1996 Change % Change <S> <C> <C> <C> <C> Net Income $2,518 $2,581 $(63) (2.4)% Earnings Per Share .45 .44 .01 2.3 Return on Assets 1.51% 1.44% .07% 4.9 Return on Equity 14.13% 15.44% (1.31)% (8.5) Recurring Earnings: Net Income $2,313 $2,631 $(318) (12.1)% Earnings Per Share .41 .44 (.03) (6.8) Return on Assets 1.39% 1.47% (.08)% (5.4) Return on Equity 13.12% 16.81% (3.69)% (22.0) </TABLE> The Company's net income for the three month period ended June 30, 1997 was $2.5 million, which compared to earnings of $2.6 million for the second quarter of 1996. Earnings per share for the 1997 period was slightly higher, however, at $.45, compared to $.44 for the 1996 period. The $63 thousand decrease in earnings, was primarily attributable to a decrease in earning assets following the various sales of the Company's Vermont banking operations in 1996, offset in-part by the receipt of an unexpected payment by the Company during the 1997 period in connection with the restructure of a fully charged-off loan. As adjusted for nonrecurring items, net income decreased $318 thousand, or 12.1% from the second quarter of 1996 to the second quarter of 1997, again reflective of a decrease in earning assets. Net interest income and other income for the second quarter of 1997, as adjusted for nonrecurring items, were 15.4% and 7.0%, respectively, below the totals for the 1996 period. These decreases were offset, however, by a favorable 22.7% reduction in noninterest (other) expense between the two periods. These and other changes are reviewed in the following sections on net interest income, other income, other expense and income taxes. Net Interest Income <TABLE> <CAPTION> Summary of Net Interest Income (Taxable Equivalent Basis) (Dollars in Thousands) Jun 1997 Jun 1996 Change % Change <S> <C> <C> <C> <C> Interest Income $12,797 $14,169 $(1,372) (9.7)% Interest Expense 5,438 5,475 (37) (0.7) Net Interest Income $ 7,359 $ 8,694 $(1,335) (15.4) Average Earning Assets (1) $623,364 $675,480 $(52,116) (7.7)% Average Paying Liabilities 514,243 557,017 (42,774) (7.7) Taxable Equivalent Adjustment 201 154 47 30.5 Yield on Earning Assets (1) 8.23% 8.44% (0.21)% (2.5)% Cost of Paying Liabilities 4.24 3.96 0.28 7.1 Net Interest Spread 3.99 4.48 (0.49) (10.9) Net Interest Margin 4.74 5.18 (0.44) (8.5) (1) Includes Nonaccrual Loans </TABLE> On a taxable equivalent basis, net interest income for the second quarter of 1997 decreased $1.3 million, or 15.4%, from net interest income in the second quarter of 1996. The change from the 1996 period was primarily attributable to a $52.1 million or a 7.7% decrease in average earning assets, principally resulting from the Company's sale in September 1996 of substantially all of its remaining Vermont operations to ALBANK. Net interest income for the second quarter of 1997 as compared to the second quarter of 1996 was also adversely impacted by a decrease in the yield on average earning assets compared to an increase in the cost of average paying liabilities. The decrease in the yield on the loan portfolio was attributable to a shift in the mix of loan products favoring lower yielding indirect loans. The change in the mix of deposits was also unfavorable as relatively more expensive time deposits and NOW accounts increased in proportion to savings and money market accounts. The provision for loan losses was $236 thousand for the quarter ended June 30, 1997, compared to a provision of $224 thousand for the 1996 period. The provision for loan losses was discussed previously under the "Summary of the Allowance and Provision for Loan Losses" section of this report. Other Income <TABLE> <CAPTION> Summary of Other Income (Dollars in Thousands) Jun 1997 Jun 1996 $ Change % Change <S> <C> <C> <C> <C> Income From Fiduciary Activities $ 663 $ 989 $(326) (33.0)% Fees for Other Services to Customers 834 1,024 (190) (18.5) Net Gains (Losses) on Securities Transactions 65 (30) 95 --- Other Operating Income 486 218 268 122.9 Total Other Income $2,048 $2,201 $(153) (7.0) Without Regard to Nonrecurring Items: Other Operating Income $ 230 $ 218 $ 12 5.5 % Total Other Income 1,792 2,201 (409) (18.6) </TABLE> Other income decreased $153 thousand or 7.0% in the second quarter of 1997 from the second quarter of 1996. Income from fiduciary services decreased $326 thousand or 33.0% from the 1996 level. The decrease was directly attributable to the sale of the Vermont trust business to Vermont National Bank in August of 1996, part of the disposition of the Company's Vermont operations. At that time, the Vermont trust business represented approximately 50% of the Company's trust business. Subsequently, the Company has experienced growth in the New York trust business. Income for other services to customers (primarily service charges on deposit accounts, credit card fee income and servicing income on sold loans) decreased $189 thousand, or 18.5%, again due to the disposition of the Vermont operations in the third quarter of 1996. Other operating income (primarily credit card processing income and gains on the sale of other real estate owned, loans and other assets) increased $268 thousand between the two periods. The increase was fully attributable to the receipt in the 1997 period of an unexpected payment in connection with the former Vermont operations. During the second quarter of 1997 the Company recognized a net gain of $65 thousand on the sale of $13.0 million of securities from the portfolio of securities classified as available- for-sale. The sales were effected for the primary purpose of reinvestment at a higher yield, and secondarily to extend the average maturity of the available-for-sale portfolio. Other Expense <TABLE> <CAPTION> Summary of Other Expense (Dollars in Thousands) Jun 1997 Jun 1996 $ Change % Change <S> <C> <C> <C> <C> Salaries and Employee Benefits $2,969 $3,840 $ (871) (22.7)% Occupancy Expense of Premises, Net 363 453 (90) (19.9) Furniture and Equipment Expense 474 413 61 14.8 Other Operating Expense 1,218 1,797 (579) (32.2) Total Other Expense $5,024 $6,503 $(1,479) (22.7) </TABLE> Other (i.e. noninterest) expense decreased $1.5 million, or 22.7%, from the second quarter of 1996 to the second quarter of 1997. While the Company experienced decreases in all major categories of other expense, except for furniture and equipment expense, the major reductions occurred in the areas of salaries and employee benefits and other operating expense. The principal reason for decreases in these areas was the sale of the remaining Vermont banking operations in August and September of 1996. These decreases were offset, only in part, by a $61 thousand increase in furniture and equipment expense. This increase was primarily attributable to increased depreciation expense associated with the Company's investment, in late 1996, in data processing equipment for the production of imaged checking account statements. The Company expects that decreases in statement processing expenses, which are primarily reported in other operating expense and salaries and benefits expense, will fully offset equipment acquisition costs in future periods, while providing the Company's customers with enhanced statements and at the same time streamlining the Company's operations. Income Taxes <TABLE> <CAPTION> Summary of Income Taxes (Dollars in Thousands, Except Per Share Amounts) Jun 1997 Jun 1996 Change % Change <S> <C> <C> <C> <C> Provision for Income Taxes $1,428 $1,433 $(5) .3% Effective Tax Rate 36.19% 35.70% 0.49% 1.4 </TABLE> The provision for federal and state income taxes amounted to $1.4 million for the second quarter of 1997, virtually unchanged from the amount for the 1996 period. The effective tax rate increased by 49 basis points from the 1996 period to the 1997 period. The increase was attributable to the fact that, in the 1997 period, a greater portion of the Company's taxable income was subject to New York State income taxes. (Vermont has no income-based tax for banks.) RESULTS OF OPERATIONS: Six Months Ended June 30, 1997 Compared With Six Months Ended June 30, 1996 <TABLE> <CAPTION> Summary of Earnings Performance (Dollars in Thousands) As Reported: Jun 1997 Jun 1996 Change % Change <S> <C> <C> <C> <C> Net Income $5,419 $10,054 $(4,635) (46.1)% Earnings Per Share .95 1.66 (.71) (42.8) Return on Assets 1.66% 2.80% (1.14)% (40.7) Return on Equity 15.04% 28.97% (13.93)% (48.1) Recurring Earnings: Net Income $4,604 $5,110 $(506) (9.9)% Earnings Per Share .81 .84 (.03) (3.6) Return on Assets 1.41% 1.43% (.02)% (1.4) Return on Equity 12.86% 15.82% (2.96)% (18.7) </TABLE> The Company's net income was $5.4 million for the first six months of 1997, compared to earnings of $10.1 million for the first six months of 1996. Earnings per share were $.95 and $1.66 for the two respective periods. As noted in the "Analysis of Recurring Income" table in the Overview section of this Management's Discussion and Analysis, there were several nonrecurring items in both years, most notably the gain in the 1996 period from the Company's sale of eight branches in eastern Vermont to Mascoma Savings Bank. Adjusting for the nonrecurring events in both periods, as further discussed in the following analysis, net income for the first half of 1997 decreased $506 thousand or 9.9% from the first half of 1996. The period-to-period change for the first half of 1997 as compared to the first half of 1996 is reviewed in the following sections on net interest income, other income, other expense and income taxes. Net Interest Income <TABLE> <CAPTION> Summary of Net Interest Income (Taxable Equivalent Basis) (Dollars in Thousands) Jun 1997 Jun 1996 Change % Change <S> <C> <C> <C> <C> Interest Income $25,146 $28,871 $(3,725) (12.9)% Interest Expense 10,533 1,051 (518) (4.7) Net Interest Income $14,613 $17,820 $(3,207) (18.0) Average Earning Assets (1) $616,349 $677,776 $(61,427) (9.1)% Average Paying Liabilities 507,269 556,799 (49,530) (8.9) Taxable Equivalent Adjustment 382 307 75 24.4 Yield on Earning Assets (1) 8.23% 8.57% (0.34)% (4.0)% Cost of Paying Liabilities 4.19 3.99 0.20 5.0 Net Interest Spread 4.04 4.58 (0.53) (11.6) Net Interest Margin 4.78 5.29 (0.51) (9.6) Recurring Net Interest Margin 4.78 5.14 (0.36) (7.0) (1) Includes Nonaccrual Loans </TABLE> On a taxable equivalent basis, net interest income for the first half of 1997 decreased $3.2 million, or 18.0%, from the first half of 1996. The decrease in net interest income in the 1997 period was primarily attributable to a 9.1% decrease in average earning assets resulting from the sale of the remaining Vermont banking operations in September 1996. Net interest income for the second quarter of 1997 as compared to the second quarter of 1996 was also adversely impacted from a decrease in the yield on earning assets and an increase in the cost of paying liabilities. The decrease in the yield on the loan portfolio was attributable to a shift in the mix of loan products favoring lower yielding indirect loans. The change in the mix of deposits was also unfavorable as more expensive time deposits and NOW accounts increased in proportion to savings and money market accounts. Net interest income for the first two quarters of 1996 also received a benefit from unexpected repayments received on two major loans in the Vermont operation that had been restructured in earlier periods. The effect of these payments increased net interest margin for the 1996 period by 15 basis points over the level that would otherwise have been attained. Average earning assets amounted to $616.3 million for the first half of 1997, a $61.4 million, or 9.1%, decrease from the first half of 1996. There was a similar decrease of 8.9% in average paying liabilities. The decrease between the two periods in both earning assets and paying liabilities was primarily attributable to the sale of the remaining six branches in Vermont to ALBANK in September of 1996, offset in part, by growth in the New York loan and deposits balances. The acquisition of the Fleet branches had only a minimal impact on average balances for the 1997 period since they were acquired near the end of the period. The provision for loan losses was $472 thousand for the six month period ended June 30, 1997, compared to a provision of $448 thousand for the 1996 period. The provision for loan losses was discussed previously under the "Summary of the Allowance and Provision for Loan Losses" section of this report. Other Income <TABLE> <CAPTION> Summary of Other Income (Dollars in Thousands) Jun 1997 Jun 1996 $ Change % Change <S> <C> <C> <C> <C> Income From Fiduciary Activities $1,321 $ 1,959 $ (638) (32.6)% Fees for Other Services to Customers 1,589 2,038 (449) (22.0) Net Gains on Securities Transactions 37 82 (45) (54.9) Gain on the Disposition of Branches --- 7,091 (7,091) --- Other Operating Income 1,011 499 512 102.6 Total Other Income $3,958 $11,669 $(7,711) (66.1) Without Regard to the Nonrecurring Items: Other Operating Income $ 480 $ 499 $ (19) (3.8) Total Other Income 3,427 4,578 (1,151) (25.1) </TABLE> Other income (i.e. noninterest income) for the first two quarters of 1996 reflected the $7.1 million pre-tax gain on the sale of eight Vermont branches to Mascoma Savings Bank in January 1996, while other income for the 1997 period reflected $256 thousand from an unexpected payment in connection with the former Vermont operations. Without regard to these items, other income decreased $1.2 million, or 25.1%, for the first half of 1997 compared with the first half of 1996. Income from fiduciary services decreased $638 thousand or 32.6% from the first half of 1996. Fees for other services to customers (primarily service charges on deposit accounts, credit card fee income and servicing income on sold loans) decreased $449 thousand, or 22.0%, between the periods. Both of these decreases were primarily attributable to the sale of the Vermont trust business in August of 1996 and the sale of the remaining six Vermont branches in September of 1996. Other operating income (primarily credit card processing income and gains on the sale of loans and other assets), as adjusted for nonrecurring items, was only $19 thousand or 3.8% below the 1996 amount. During the first six months of 1997, the Company recognized net securities gains of $37 thousand on the sale of $24.0 million of securities available-for-sale. The sales were effected for the primary purpose of reinvestment at a higher yield, and secondarily to extend the average maturity of the available-for-sale portfolio. Other Expense <TABLE> <CAPTION> Summary of Other Expense (Dollars in Thousands) Jun 1997 Jun 1996 $ Change % Change <S> <C> <C> <C> <C> Salaries and Employee Benefits $5,903 $ 7,740 $(1,837) (23.7)% Occupancy Expense of Premises, Net 741 978 (237) (24.2) Furniture and Equipment Expense 953 870 83 9.5 Other Operating Expense 2,363 3,696 (1,333) (36.1) Total Other Expense $9,960 $13,284 $(3,324) (25.0) </TABLE> Other (i.e. noninterest) expense decreased $3.3 million, or 25.0%, between the first half of 1997 and the first half of 1996. While the Company experienced decreases in all major categories of other expense, except furniture and equipment expense, the major reductions occurred in the areas of salaries and employee benefits and other operating expense. The principal reason for these decreases was the completion of the disposition of the Vermont banking business in August and September of 1996. As in the quarter-to-quarter comparison, these decreases were offset, only in part, by an $83 thousand increase in furniture and equipment expense. This increase was primarily attributable to increased depreciation expense associated with the Company's investment in data processing equipment, late in 1996, principally for the production of imaged checking account statements. Income Taxes <TABLE> <CAPTION> Summary of Income Taxes (Dollars in Thousands) Jun 1997 Jun 1996 $ Change % Change <S> <C> <C> <C> <C> Provision for Income Taxes $2,338 $5,396 $(3,058) (56.7)% Effective Tax Rate 30.14% 34.93% ( 4.79)% (13.7) </TABLE> The provisions for federal and state income taxes amounted to $2.3 million and $5.4 million for the first six months of 1997 and 1996, respectively. During the first quarter of 1997, the Company reached a favorable settlement with the New York Department of Taxation and Finance over a combined reporting issue. The effects of the settlement resulted in a $464 thousand decrease in the Company's provision for income taxes for the first quarter of 1997. As adjusted for this settlement, the effective tax rates for the first half of 1997 and 1996 were 36.12% and 34.93%, respectively. As thus adjusted, the effective tax rate increased by 119 basis points from the 1996 period to the 1997 period. The increase was attributable to the fact that a greater portion of the Company's taxable income in the 1997 period was subject to New York State income taxes. (Vermont has no income-based tax for banks.)
PART II - OTHER INFORMATION Item 1. Legal Proceedings The Company is not involved in any material pending legal proceedings, other than ordinary routine litigation occurring in the normal course of its business. The Company's subsidiary banks are parties to various legal claims which arise in the normal course of their business, for example, lender liability claims that 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 will not, in the current opinion of management, likely result in any material liability to the subsidiary banks or the Company. Item 2. Changes in Securities - None See the discussion in Item 6(b), below, regarding the Company's adoption of a shareholder rights plan in the second quarter of 1997. Item 3. Defaults Upon Senior Securities - None Item 4. Submission of Matters to a Vote of Security Holders <TABLE> <CAPTION> At the Company's Annual Meeting of Shareholders held April 30, 1997, shareholders elected the following directors to serve terms expiring in 2000: Withhold Broker Director For Authority Non-Votes <S> <C> <C> <C> John J. Carusone, Jr. 4,440,034 29,725 --- Thomas L. Hoy 4,449,083 20,677 --- David G. Kruczlnicki 4,449,020 20,740 --- David L. Moynehan 4,448,949 20,811 --- Daniel L. Robertson 4,448,827 20,932 --- Directors continuing in office were: Michael B. Clarke, George C. Frost, Kenneth C. Hopper, M.D., Dr. Edward F. Huntington, Michael F. Massiano and Daniel L. Robertson </TABLE> Item 5. Other Information - None Item 6. Exhibits and Reports Filed on Form 8-K (a) Exhibits Exhibit 27 Financial Data Schedule (with electronic filing only) (b) Current Reports Filed on Form 8-K On May 16, 1997 the Company filed a Form 8-K dated May 1, 1997 related to a shareholder rights plan. On April 30, 1997, the Board of Directors of the Company declared a dividend payable May 12, 1997 of one right (a "Right") for each outstanding share of Common Stock of the Company held of record at the close of business on May 12, 1997 (the "Record Time"), or issued thereafter and prior to termination of the plan. The Rights are issuable pursuant to and governed by a Shareholder Protection Rights Agreement, dated as of May 1, 1997 (the "Rights Agreement"), between the Company and Glens Falls National Bank and Trust Company, as Rights Agent. Each Right, when exercisable, entitles its registered holder to purchase one one-hundredth of a share of a new series of non voting preferred stock of the Company, designated as Series I Junior Participating Preferred Stock (the "Preferred Stock"), or under certain circumstances, shares of Common Stock or other securities having a market value of $150.00, at a purchase price of $75.00 per Right, subject to adjustment. The Rights become exercisable only under those circumstances described in the Rights Agreement. The description and terms of the Rights are set forth in the Rights Agreement. On July 8, 1997, the Company filed a Form 8-K dated June 27, 1997 related to the consummation of the acquisition of six banking branches in northeastern New York, from Fleet Bank. SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. ARROW FINANCIAL CORPORATION Registrant Date: August 12, 1997 s/Thomas L. Hoy Thomas L. Hoy, President and Chief Executive Officer Date: August 12, 1997 s/John J. Murphy John J. Murphy, Executive Vice President and Treasurer/CFO (Principal Financial Officer and Principal Accounting Officer)