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 March 31, 1998 [ ] 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 April 30, 1998 Common Stock, par value $1.00 per share 5,765,735 ARROW FINANCIAL CORPORATION FORM 10-Q MARCH 31, 1998 INDEX PART I FINANCIAL INFORMATION Item 1. Consolidated Balance Sheets as of March 31, 1998 and December 31, 1997 Consolidated Statements of Income for the Three Months Ended March 31, 1998 and 1997 Consolidated Statements of Changes in Shareholders' Equity for the Three Months Ended March 31, 1998 and 1997 Consolidated Statements of Cash Flows for the Three Months Ended March 31, 1998 and 1997 Notes to Consolidated Interim Financial Statements Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations Item 3. Quantitative and Qualitative Disclosures About Market Risk PART II OTHER INFORMATION SIGNATURES <TABLE> <CAPTION> ARROW FINANCIAL CORPORATION AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS (Dollars in Thousands)(Unaudited) 3/31/98 12/31/97 ASSETS <S> <C> <C> Cash and Due from Banks $ 26,927 $ 23,909 Federal Funds Sold 18,700 23,000 Cash and Cash Equivalents 45,627 46,909 Securities Available-for-Sale 221,959 221,837 Securities Held-to-Maturity: (Approximate Fair Value of $52,182 in 1998 and $45,562 in 1997) 50,848 44,082 Loans and Leases 495,962 485,810 Less: Allowance for Credit Losses (6,375) (6,191) Net Loans and Leases 489,587 479,619 Premises and Equipment, Net 10,715 10,760 Other Real Estate Owned, Net 386 315 Other Assets 27,953 28,077 Total Assets $847,075 $831,599 LIABILITIES Deposits: Demand Deposits $ 90,202 $ 96,482 Interest-Bearing Demand Deposits 164,667 162,016 Regular and Money Market Savings 161,713 158,690 Time Deposits of $100,000 or More 105,425 106,620 Other Time Deposits 193,264 197,107 Total Deposits 715,271 720,915 Short-Term Borrowings: Securities Sold Under Agreements to Repurchase 24,244 20,918 Other Short-Term Borrowings 3,706 3,837 Federal Home Loan Bank Advances 15,000 --- Other Liabilities 13,365 12,058 Total Liabilities 771,586 757,728 Commitments and Contingent Liabilities SHAREHOLDERS' EQUITY Preferred Stock, $5 Par Value; 1,000,000 Shares Authorized --- --- Common Stock, $1 Par Value; 20,000,000 Shares Authorized (6,905,888 Shares Issued in 1998 and 1997) 6,906 6,906 Surplus 65,335 65,277 Undivided Profits 24,223 22,531 Accumulated Other Comprehensive Income: Net Unrealized Gain on Securities Available-for-Sale, Net of Tax 599 764 Treasury Stock, at Cost (1,139,153 Shares in 1998 and 1,143,553 in 1997) (21,574) (21,607) Total Shareholders' Equity 75,489 73,871 Total Liabilities and Shareholders' Equity $847,075 $831,599 See Notes to Consolidated Interim Financial Statements. </TABLE> <TABLE> <CAPTION> ARROW FINANCIAL CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF INCOME (In Thousands, Except Per Share Amounts)(Unaudited) Three Months Ended March 31, 1998 1997 <S> <C> <C> INTEREST AND DIVIDEND INCOME Interest and Fees on Loans and Leases $10,627 $ 8,700 Interest on Federal Funds Sold 125 71 Interest and Dividends on Securities Available-for-Sale 3,686 2,761 Interest and Dividends on Securities Held-to-Maturity 716 636 Total Interest and Dividend Income 15,154 12,168 INTEREST EXPENSE Interest on Deposits: Time Deposits of $100,000 or More 1,380 1,149 Other Deposits 4,995 3,708 Interest on Short-Term Borrowings: Federal Funds Purchased and Securities Sold Under Agreements to Repurchase 254 168 Other Short-Term Borrowings 28 70 Federal Home Loan Bank Advances 45 --- Total Interest Expense 6,702 5,095 NET INTEREST INCOME 8,452 7,073 Provision for Credit Losses 342 236 NET INTEREST INCOME AFTER PROVISION FOR CREDIT LOSSES 8,110 6,837 OTHER INCOME Income from Fiduciary Activities 761 658 Fees for Other Services to Customers 957 755 Net Gains (Losses) on Securities Transactions 157 (28) Other Operating Income 232 525 Total Other Income 2,107 1,910 OTHER EXPENSE Salaries and Employee Benefits 3,259 2,934 Occupancy Expense of Premises, Net 419 378 Furniture and Equipment Expense 551 479 Other Operating Expense 1,560 1,145 Total Other Expense 5,789 4,936 INCOME BEFORE PROVISION FOR INCOME TAXES 4,428 3,811 Provision for Income Taxes 1,525 910 NET INCOME $ 2,903 $ 2,901 Average Basic Common Shares Outstanding 5,764 5,995 Average Diluted Common Shares Outstanding 5,857 6,060 Per Common Share: Basic Earnings $ .50 $ .49 Diluted Earnings .50 .48 Dividends Declared .21 .19 Book Value 13.09 12.09 Tangible Book Value 10.72 11.89 Share and per share amounts have been adjusted for the November 1997 five percent stock dividend. See Notes to Consolidated Interim Financial Statements. </TABLE> <TABLE> <CAPTION> ARROW FINANCIAL CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY (In Thousands, Except Share and Per Share Amounts) (Unaudited) Accumulated Other Compre- Shares Common Undivided hensive Treasury Issued Stock Surplus Profits Income Stock Total <S> <C> <C> <C> <C> <C> <C> <C> Balance at December 31, 1997 6,905,888 $6,906 $65,277 $22,531 $764 $(21,607) $73,871 Comprehensive Income, Net of Tax: Net Income --- --- --- 2,903 --- --- 2,903 Net Unrealized Securities Holding Losses Arising During the Period, Net of Tax (Pre-tax $122) --- --- --- --- (72) --- (72) Reclassification Adjustment for Net Securities Gains Included in Net Income, Net of Tax (Pre-tax $157) --- --- --- --- (93) --- (93) Other Comprehensive Income (165) Comprehensive Income 2,738 Cash Dividends Declared, $.21 per Share --- --- --- (1,211) --- --- (1,211) Stock Options Exercised (4,400 Shares) --- --- 27 --- --- 33 60 Tax Benefit for Disposition of Stock Options --- --- 31 --- --- --- 31 Balance at March 31, 1998 6,905,888 $6,906 $65,335 $24,223 $599 $(21,574) $75,489 Balance at December 31, 1996 6,577,036 $6,577 $54,569 $26,992 $208 $(14,050) $74,296 Comprehensive Income, Net of Tax: Net Income --- --- --- 2,901 --- --- 2,901 Net Unrealized Securities Holding Losses Arising During the Period, Net of Tax (Pre-tax $1,531) --- --- --- --- (907) --- (907) Reclassification Adjustment for Net Securities Losses Included in Net Income, Net of Tax (Pre-tax $26) --- --- --- --- 17 --- 17 Other Comprehensive Income (890) Comprehensive Income 2,011 Cash Dividends Declared, $.19 per Share --- --- --- (1,143) --- --- (1,143) Stock Options Exercised (22,242 Shares) --- --- 84 --- --- (84) --- Purchase of Treasury Stock (161,701 Shares) --- --- --- --- --- (3,750) (3,750) Balance at March 31, 1997 6,577,036 $6,577 $54,653 $28,750 $(682) $(17,884) $71,414 Share and per share amounts have been adjusted for the November 1997 five percent stock dividend. See Notes to Consolidated Interim Financial Statements. </TABLE> <TABLE> <CAPTION> ARROW FINANCIAL CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (Dollars in Thousands)(Unaudited) Three Months Ended March 31, 1998 1997 <S> <C> <C> Operating Activities: Net Income $ 2,903 $ 2,901 Adjustments to Reconcile Net Income to Net Cash Provided by Operating Activities: Provision for Credit Losses 342 236 Provision for Other Real Estate Owned Losses --- 60 Depreciation and Amortization 611 153 Gains on the Sale of Securities Available-for-Sale (162) (35) Losses on the Sale of Securities Available-for-Sale 5 63 Proceeds from the Sale of Loans 2,981 527 Net Gains on the Sale of Loans, Fixed Assets and Other Real Estate Owned (24) (6) (Increase) Decrease in Deferred Tax Assets (151) 508 Decrease in Interest Receivable 350 158 Increase (Decrease) in Interest Payable (34) 76 Decrease (Increase) in Other Assets (199) (412) Increase (Decrease) in Other Liabilities 1,342 (1,701) Net Cash Provided By Operating Activities 7,964 2,528 Investing Activities: Proceeds from the Sale of Securities Available-for-Sale 31,151 10,935 Proceeds from the Maturities and Calls of Securities Available-for-Sale 17,406 13,895 Purchases of Securities Available-for-Sale (48,832) (14,088) Proceeds from the Maturities and Calls of Securities Held-to-Maturity 1,111 470 Purchases of Securities Held-to-Maturity (7,975) (12,395) Net Increase in Loans and Leases (13,346) (6,046) Proceeds from the Sales of Fixed Assets and Other Real Estate Owned 8 14 Purchase of Fixed Assets (200) (196) Net Cash Used In Investing Activities (20,677) (7,411) Financing Activities: Net (Decrease) Increase in Deposits (5,644) 7,919 Net Increase (Decrease) in Short-Term Borrowings 3,195 (1,652) Increase in Federal Loan Home Bank Advances 15,000 --- Purchase of Treasury Stock --- (3,750) Exercise of Stock Options 60 --- Disqualifying Disposition of Incentive Stock Options 31 --- Cash Dividends Paid (1,211) (1,143) Net Cash Provided By Financing Activities 11,431 1,374 Net Decrease in Cash and Cash Equivalents (1,282) (3,509) Cash and Cash Equivalents at Beginning of Period 46,909 37,497 Cash and Cash Equivalents at End of Period $45,627 $33,988 Supplemental Cash Flow Information: Interest Paid $ 6,736 $ 5,019 Income Taxes Paid 152 1,916 Transfer of Loans to Other Real Estate Owned 71 264 See Notes to Consolidated Interim Financial Statements. </TABLE> Item 2. ARROW FINANCIAL CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED INTERIM FINANCIAL STATEMENTS FORM 10-Q MARCH 31, 1998 1. Financial Statement Presentation In the opinion of the management of Arrow Financial Corporation (the "Company"), the accompanying consolidated interim financial statements contain all of the adjustments necessary to present fairly the financial position as of March 31, 1998 and December 31, 1997; the results of operations for the three month periods ended March 31, 1998 and March 31, 1997; the statements of changes in shareholders' equity for the three month periods ended March 31, 1998 and 1997; and the statements of cash flows for the three month periods ended March 31, 1998 and March 31, 1997. All such adjustments are of a normal recurring nature. Certain items have been reclassified to conform to the 1998 presentation. Share and per share amounts have been restated to reflect the November 1997 five percent stock dividend. The consolidated interim financial statements should be read in conjunction with the annual consolidated financial statements of the Company for the year ended December 31, 1997. 2. Reporting Comprehensive Income In June 1997, the FASB issued SFAS No. 130, "Reporting Comprehensive Income." SFAS No. 130 establishes standards for reporting and displaying of comprehensive income and its components in a full set of general-purpose financial statements. Comprehensive income is defined as "the change in equity of a business enterprise during a period from transactions and other events and circumstances from nonowner sources. It includes all changes in equity during a period except those resulting from investments by owners and distributions to owners." For the Company, the statement was effective for interim financial statements beginning with the first quarter of 1998. SFAS No. 130 accepts a variety of presentations of comprehensive income within the income statement or the statement of changes in shareholders' equity. The Company has elected to present the components of comprehensive income in the Consolidated Statements of Changes in Shareholders' Equity. 3. Disclosures about Operating Segments In June 1997, the FASB issued SFAS No. 131, "Disclosures about Segments of an Enterprise and Related Information." SFAS No. 131 establishes standards for the way that public business enterprises report information about operating segments. For the Company, the statement will be effective for annual financial statements issued for the year ended December 31, 1998, however, the Company does not have operating segments within the meaning of SFAS No. 131. 4. Pensions and Other Postretirement Benefits In February 1998, the FASB issued SFAS No. 132, "Employers' Disclosures about Pensions and Other Postretirement Benefits," which amends the disclosure requirements of SFAS No. 87, "Employers' Accounting for Pensions," SFAS No. 88, "Employers' Accounting for Settlements and Curtailments of Defined Benefit Pension Plans and for Termination Benefits," and SFAS No. 106, "Employers' Accounting for Postretirement Benefits Other Than Pensions." Statement No. 132 standardizes the disclosure requirements of Statements No. 87 and No. 106 to the extent practicable and recommends a parallel format for presenting information about pensions and other postretirement benefits. This Statement is applicable to all entities and addresses disclosure only. The Statement does not change any of the measurement or recognition provisions provided for in Statements No. 87, No. 88, or No. 106. The Statement is effective for fiscal years beginning after December 15, 1997. Management anticipates providing the required disclosures in the December 31, 1998 consolidated financial statements.
5. Earnings Per Common Share (In Thousands, Except Per Share Amounts) The following table presents a reconciliation of the numerator and denominator used in the calculation of basic and diluted earnings per common share (EPS) for the three month periods ended March 31, 1998 and 1997. Shares outstanding have been restated for the November 1997 five percent stock dividend. <TABLE> <CAPTION> Income Shares Per Share (Numerator) (Denominator) Amount <S> <C> <C> <C> For the Three Months Ended March 31, 1998: Basic EPS: Income Available to Common Shareholders $2,903 5,764 $.50 Dilutive Effect of Stock Options --- 93 Diluted EPS: Income Available to Common Shareholders and Assumed Conversions $2,903 5,857 $.50 For the Three Months Ended March 31, 1997: Basic EPS: Income Available to Common Shareholders $2,901 5,995 $.49 Dilutive Effect of Stock Options --- 65 Diluted EPS: Income Available to Common Shareholders and Assumed Conversions $2,901 6,060 $.48 </TABLE> ARROW FINANCIAL CORPORATION AND SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS MARCH 31, 1998 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. Peer Ratios: Certain ratios are compared with the Company's peer group. Peer data was taken from the Federal Reserve Board's "December 1997 Bank Holding Company Performance Report." The Company's peer group is comprised of bank holding companies with $500 million to $1 billion in total consolidated assets. Acquisition of Six Fleet Branches On June 27, 1997, the Company completed the acquisition of six branches in upstate New York from Fleet Bank ("Branch Acquisition"), 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 acquisition agreement, GFNB also acquired from Fleet an additional $10 million of residential real estate loans not related to the branches. The Company has experienced several benefits from the Branch Acquisition in the past nine months. Most significant was the positive impact on earnings per share since the acquisition (which was funded internally) leveraged the Company's capital position in tandem with a stock repurchase program during 1997. Other positive impacts of the Branch Acquisition Include: (i) an improvement in the Company's efficiency ratio (noninterest expense to net interest income and noninterest income), and (ii) an increase in the ratio of net income per full time-equivalent employee, another measure of the Company's ability to leverage fixed expenses. The Branch Acquisition was the principal source of the first quarter period-to-period changes in both the consolidated balance sheets and consolidated statements of income as noted in the following discussion. OVERVIEW The Company reported earnings of $2.9 million for the first quarter of both 1998 and 1997. Diluted earnings per share were $.50 and $.48 for the two respective periods. Earnings in the 1997 period, however, reflected the favorable settlement of a combined reporting issue with the New York State Department of Taxation and Finance, resulting in a significant reduction in the provision for income taxes for that period, as well as the settlement of claims against service providers. On a comparable basis, excluding these nonrecurring items and securities transactions, diluted earnings per share for the first quarter of 1998 and 1997 were $.48 and $.38, respectively. The following table presents the adjustments necessary to arrive at recurring net income of the Company. <TABLE> <CAPTION> Analysis of Recurring Net Income (In Thousands, Except Per Share Amounts) Three Months Ended Mar 1998 Mar 1997 <S> <C> <C> Net Income, as Reported $2,903 $2,901 Adjustments, net of Tax: Net Securities Transactions (93) 17 Settlement of Claims --- (163) State Income Tax Benefit --- (464) Recurring Income $2,810 $2,291 Diluted Earnings Per Share, as Reported $ .50 $ .48 Diluted Earnings Per Share, Recurring .48 .38 </TABLE> The returns on average assets were 1.42% and 1.80% for the first quarter of 1998 and 1997, respectively. The returns on average equity were 15.71% and 15.94% for the first quarter of 1998 and 1997, respectively. Excluding the nonrecurring items, the returns on average assets were 1.37% and 1.42%, and the returns on average equity were 15.21% and 12.60%, for the respective quarters. Total assets were $847.1 million at March 31, 1998, which represented an increase of $15.5 million, or 1.9%, from December 31, 1997, and an increase of $192.7 million, or 29.5%, above the level at March 31, 1997. The Branch Acquisition in June 1997, increased total assets by approximately $140 million, and the company also experienced growth of over $50 million at its continuously operated branches over the 12 month period. For the most part, the level of deposits at the acquired branches have remained unchanged since the acquisition date. Shareholders' equity increased $1.6 million to $75.5 million during the first three months of 1998, as net income of $2.9 million was partially offset by cash dividends of $1.2 million and $165 thousand of unrealized losses on securities available-for-sale, net of tax. The Company's risk-based capital ratios and Tier 1 leverage ratio continued to exceed regulatory minimum requirements at period-end and both Company banks qualified as "well-capitalized" under federal bank guidelines. <TABLE> <CAPTION> CHANGE IN FINANCIAL CONDITION Summary of Consolidated Balance Sheets (Dollars in Thousands) $ Change $ Change % Change % Change Mar 1998 Dec 1997 Mar 1997 From Dec From Mar From Dec From Mar <S> <C> <C> <C> <C> <C> <C> <C> Federal Funds Sold $ 18,700 $ 23,000 $ 12,500 $ (4,300) $ 6,200 (18.7)% 49.6% Securities Available for Sale 221,959 221,837 159,456 122 62,503 0.1 39.2 Securities Held to Maturity 50,848 44,082 42,915 6,766 7,933 15.3 18.5 Loans, Net of Unearned Income (1) 495,962 485,810 398,581 10,152 97,381 2.1 24.4 Allowance for Loan Losses 6,375 6,191 5,625 184 750 3.0 13.3 Earning Assets (1) 787,469 774,729 613,452 12,740 174,017 1.6 28.4 Total Assets 847,075 831,599 654,363 15,476 192,712 1.9 29.5 Demand Deposits $ 90,202 $ 96,482 $ 65,995 $ (6,280) $ 24,207 (6.5) 36.7 Interest-Bearing Demand Deposits 164,667 162,016 118,700 2,651 45,967 1.6 38.7 Regular and Money Market Savings 161,713 158,690 129,641 3,023 32,072 1.9 24.7 Time Deposits of $100,000 or More 105,425 106,620 93,145 (1,195) 12,250 (1.1) 13.2 Other Time Deposits 193,264 197,107 142,185 (3,843) 51,079 (1.9) 35.9 Total Deposits $715,271 $720,915 $549,666 $(5,644) $165,605 (0.8) 30.1 Short-Term Borrowings $ 27,950 $ 24,755 $ 21,053 $ 3,195 $ 6,897 12.9 32.8 Federal Home Loan Bank Advances 15,000 --- --- 15,000 15,000 --- --- Shareholders' Equity 75,489 73,871 71,414 1,618 4,075 2.2 5.7 (1) Includes Nonaccrual Loans </TABLE> Total resources at March 31, 1998 amounted to $847.1 million, an increase of $15.5 million, or 1.9%, from year-end 1997 and an increase of $192.7 million, or 29.5%, from March 31, 1997. Total loans at March 31, 1998 amounted to $496.0 million, an increase of $10.2 million, or 2.1%, from December 31, 1997, and an increase of $97.4 million, or 24.4%, from March 31, 1997. The increase from March 31, 1997 was primarily attributable to the Branch Acquisition in June 1997, which increased total loans by approximately $44 million. Apart from the Branch Acquisition, the Company experienced internal loan growth primarily within the indirect and residential real estate portfolios. Indirect consumer loans are principally auto loans financed through local dealerships where the Company acquires the dealer paper. Total deposits of $715.3 million at March 31, 1998 decreased $5.6 million, or 0.8%, from the December 31, 1997 level. The decrease was attributable to seasonal fluctuations in municipal deposits. The amount of deposits at March 31, 1998, however, represents an increase of $165.6 million, or 30.1%, from March 31, 1997. Again, the increase from March 31, 1997 was primarily attributable to the Branch Acquisition in June 1997, in which the Company assumed approximately $140 million in deposits from Fleet Bank. The remaining deposit increase of $25.6 million represented growth at the Company's continuously operated branches. Shareholders' equity increased $1.6 million to $75.5 million during the first three months of 1998. Net income of $2.9 million was partially offset by cash dividends of $1.2 million and a $165 thousand unrealized loss on securities available-for-sale, net of tax, reflected as a separate component of shareholders' equity. The Company paid a $.21 cash dividend for the first quarter of 1998, which followed a dividend of $.21 for the prior quarter and dividends of $.19 for the four previous quarters. Deposit and Loan Trends The following table provides information on trends in the balance and mix of the Company's deposit portfolio by presenting the quarterly average balance by deposit type and the relative proportion of each deposit type for each of the last five quarters. The Branch Acquisition, completed on June 27, 1997, had very little impact on the average balances for the second quarter of 1997, while fully impacting each of the last three quarters. <TABLE> <CAPTION> Quarterly Average Deposit Balances (Dollars in Thousands) Mar 1998 Dec 1997 Sep 1997 Jun 1997 Mar 1997 Amount % Amount % Amount % Amount % Amount % <S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C> Demand Deposits $ 92,584 13 $ 91,309 13 $ 93,907 14 $ 65,976 12 $ 63,147 12 Interest-Bearing Demand Deposits 166,494 23 170,321 24 155,461 22 128,067 23 122,318 22 Regular and Money Market Savings 158,997 22 159,591 22 167,821 24 128,350 23 129,791 24 Time Deposits of $100,000 or More 102,263 14 96,851 13 78,927 11 87,350 16 88,704 16 Other Time Deposits 195,039 28 198,018 28 201,125 29 147,910 26 139,261 26 Total Deposits $715,377 100 $716,090 100 $697,241 100 $557,653 100 $543,221 100 </TABLE> The Company typically experiences little net deposit growth in the first two quarters of the year as seasonal runoff of municipal deposits is only partially offset by normal deposit growth. The increase in the average balance from the second quarter of 1997 to the third quarter of 1997 is primarily attributable to the Branch Acquisition which added approximately $140 million in deposit balances. The remaining growth in the deposit portfolios during the third and fourth quarters of 1997 took place at the Company's continuously operated branches. Over the course of the last five quarters the relative mix of deposit types within the portfolio remained quite stable, not withstanding the Branch Acquisition.
<TABLE> <CAPTION> Quarterly Cost of Deposits Mar 1998 Dec 1997 Sep 1997 Jun 1997 Mar 1997 <S> <C> <C> <C> <C> <C> Demand Deposits --- % --- % --- % --- % --- % Interest-Bearing Demand Deposits 2.99 3.16 2.98 3.21 3.05 Regular and Money Market Savings 2.78 2.79 2.87 2.83 2.94 Time Deposits of $100,000 or More 5.47 5.45 5.45 5.37 5.25 Other Time Deposits 5.57 5.50 5.42 5.54 5.38 Total Deposits 3.61 3.63 3.54 3.70 3.63 </TABLE> Federal Reserve Bank's Discount Rate Changes 1995 - 1998: Date New Rate Old Rate January 31, 1996 5.00% 5.25% February 1, 1995 5.25 4.75 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 remained unchanged. Accordingly, the Company experienced an increase in the total cost of deposits resulting from both this increase in the federal funds rate, as well as from a highly competitive marketplace for deposits during the first two quarters of 1997, which moderated somewhat during the third quarter of 1997. The costs of small denomination time deposits increased during the most recent two quarters as maturing time deposits repriced to market rates. The average cost of funds did not change significantly after 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, interest-bearing demand and savings 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 demand and savings accounts assumed (its rates being slightly higher than Fleet's rates, on average) and continued paying contract rates on time deposits assumed (Fleet's rates for such products being similar to the Company's prevailing rates for time deposits). In the recent past, other sources of short-term borrowings for the Company included repurchase agreements (essentially a substitute deposit product) and tax deposit balances with the U.S. Treasury. During the first quarter of 1998, the Company borrowed $15 million from the Federal Home Loan Bank of New York ("FHLB") in the form of a "convertible advance." These advances (extended in three $5 million increments) have a final maturity of 10 years and are callable by the FHLB at certain dates beginning no earlier than one year from the issuance date. If the advances are called, the Company may elect to have the funds replaced by the FHLB at the then prevailing market rate of interest. The following table presents the quarterly average balance by loan type and the relative proportion of each loan type for each of the last five quarters. <TABLE> <CAPTION> Quarterly Average Loan Balances (Dollars in Thousands) Mar 1998 Dec 1997 Sep 1997 Jun 1997 Mar 1997 Amount % Amount % Amount % Amount % Amount % <S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C> Commercial and Commercial Real Estate $102,983 21 $100,604 21 $102,211 22 $ 92,874 23 $ 89,673 23 Residential Real Estate 151,417 31 147,928 31 142,863 31 129,289 32 127,032 32 Home Equity 36,593 7 36,601 7 37,100 7 30,399 7 30,012 8 Indirect Consumer Loans 143,495 29 139,401 29 128,086 27 114,141 28 107,371 27 Direct Consumer Loans 49,084 10 49,747 10 51,185 11 34,212 8 33,300 8 Credit Card Loans 7,413 2 7,602 2 7,582 2 7,769 2 8,153 2 Total Loans $490,985 100 $481,883 100 $469,027 100 $408,684 100 $395,541 100 </TABLE> On June 27, 1997, the Company acquired approximately $44 million in loan balances in the Branch Acquisition (commercial loans - $10.4 million, direct consumer loans - $16.6 million, home equity loans - $7.1 million and residential real estate loans - $10.1 million). Apart from the Branch Acquisition, average loans increased at a steady pace over the five most recent quarters. While all categories of loans, except for credit card loans, experienced increases, indirect consumer loans demonstrated the most significant change. 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, these loans increased from 27% in the first quarter of 1997 to 29% in the first quarter of 1998. Otherwise, there was no significant change in the overall mix of loans within the loan portfolio. <TABLE> <CAPTION> Quarterly Taxable Equivalent Yield on Loans Mar 1998 Dec 1997 Sep 1997 Jun 1997 Mar 1997 <S> <C> <C> <C> <C> <C> Commercial and Commercial Real Estate 9.60% 9.62% 9.56% 9.73% 9.61% Residential Real Estate 8.34 8.23 8.33 8.40 8.47 Home Equity 9.07 9.10 9.20 9.23 9.10 Indirect Consumer Loans 8.17 8.24 8.39 8.35 8.29 Direct Consumer Loans 9.18 9.18 9.00 9.09 9.16 Credit Card Loans 16.41 16.07 16.46 16.84 16.76 Total Loans 8.82 8.81 8.86 8.97 8.96 </TABLE> The yield on the loan portfolio in the first quarter was essentially unchanged from the immediately preceding quarter. Over the prior several quarters, however, yields on the Company's loan portfolio have declined gradually. Although short-term interest rate trends have been quite stable, there has been a general flattening of the yield curve which has had a negative impact on fixed rate residential real estate loans. The Company has experienced (and continues to experience) significant competitive pricing for loan products in its market area. The following table presents information related to the Company's allowance and provision for credit losses for the past five quarters. The provision for credit losses and net charge-offs are reported on a year-to-date basis, and are annualized for the purpose of calculating the ratio of each to average loans for each of the periods presented. <TABLE> <CAPTION> Summary of the Allowance and Provision for Credit Losses (Dollars in Thousands)(Loans Stated Net of Unearned Income) Mar 1998 Dec 1997 Sep 1997 Jun 1997 Mar 1997 <S> <C> <C> <C> <C> <C> Loan Balances: Period-End Loans $495,962 $485,810 $476,863 $462,396 $398,581 Average Loans, Year-to-Date 490,985 439,103 424,686 402,149 395,541 Allowance for Credit Losses: Allowance for Credit Losses, Beginning of Period $6,191 $ 5,581 $ 5,581 $ 5,581 $ 5,581 Allowance Acquired --- 700 700 700 --- Provision for Loan Losses, Y-T-D 342 1,303 972 472 236 Net Charge-offs, Y-T-D (158) (1,393) (1,024) (344) (192) Allowance for Credit Losses, End of Period $6,375 $ 6,191 $ 6,229 $ 6,409 $ 5,625 Nonperforming Assets: Nonaccrual Loans $3,615 $3,321 $3,034 $ 2,232 $ 2,070 Loans Past due 90 or More Days and Still Accruing Interest 242 363 296 764 292 Loans Restructured and in Compliance with Modified Terms --- --- --- --- --- Total Nonperforming Loans 3,857 3,684 3,330 2,996 2,362 Repossessed Assets 64 --- --- --- --- Other Real Estate Owned 386 315 322 370 340 Total Nonperforming Assets $4,307 $3,999 $3,652 $ 3,366 $ 2,702 Performance Ratios: Allowance to Nonperforming Loans 165.28% 168.05% 187.06% 213.92% 238.15% Allowance to Period-End Loans 1.29 1.27 1.31 1.39 1.41 Provision to Average Loans (annualized) 0.28 0.30 0.31 0.24 0.24 Net Charge-offs to Average Loans (annualized) 0.13 0.32 0.32 0.17 0.20 Nonperforming Assets to Loans, OREO & Repossessed Assets 0.87 0.82 0.77 0.73 0.68 </TABLE> The Company's nonperforming assets at March 31, 1998 amounted to $4.3 million, an increase of $308 thousand, or 7.7%, from December 31, 1997. At period-end, nonperforming assets represented .87% of loans, other real estate and repossessed assets, an increase of 5 basis points from year-end 1997. At December 31, 1997, this ratio for the Company's peer group was 1.04%. On an annualized basis, the ratio of the 1998 first quarter net charge-offs to average loans was .13%, seven basis points lower than the annualized ratio of net charge-offs to average loans in the 1997 period of .20%. The provision for credit losses was $342 thousand for the first quarter of 1998, compared to a provision of $236 thousand for the first quarter of 1997. The provision as a percentage of average loans was .28% for the first quarter of 1998, or 15 basis points higher than net charge-offs for the period. The allowance for credit losses at March 31, 1998 amounted to $6.4 million. The ratio of the allowance to outstanding loans at March 31, 1998, was 1.29%, slightly higher than the ratio at December 31, 1997.
CAPITAL RESOURCES Shareholders' equity was $75.5 million at March 31, 1998, an increase of $1.6 million, or 2.2%, from December 31, 1997. Net income of $2.9 million for the period was partially offset by cash dividends of $1.2 million and net unrealized losses of $165 thousand on securities available-for-sale, net of tax (reflected as a separate component of shareholders' equity). The Company and its subsidiaries are currently subject to two sets of regulatory capital measures, a leverage ratio test and risk-based capital guidelines. The risk-based 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 the allowance for credit losses. The leverage ratio test establishes minimum limits on the ratio of Tier 1 capital to total tangible assets, without risk weighting. For top-rated companies, the minimum leverage ratio is 3%, but lower-rated or rapidly expanding companies may be required to meet substantially higher minimum leverage ratios. The FDIC Improvement Act of 1991 ("FDICIA") mandated actions to be taken by banking regulators for financial institutions that are undercapitalized as measured by these ratios. FDICIA established five levels of capitalization for financial institutions ranging from "critically undercapitalized" to "well-capitalized." As of March 31, 1998, 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 7.51% 12.23% 13.48% Glens Falls National Bank & Trust Co. 7.38 12.60 13.85 Saratoga National Bank & Trust Co. 7.70 9.62 10.78 Regulatory Minimum 3.00 4.00 8.00 FDICIA's "Well-Capitalized" Standard 5.00 6.00 10.00 </TABLE> All capital ratios for the Company and its subsidiary banks at March 31, 1998 were above minimum capital standards for financial institutions. Additionally, all Company and subsidiary banks' capital ratios at that date were above FDICIA's "well-capitalized" standard. The common stock of Arrow Financial Corporation is traded on The Nasdaq Stock MarketSM under the symbol AROW. The price ranges below represent actual transactions rounded to the nearest 1/8 point. (There may have been sales outside the parameters shown, but management believes that the price ranges fairly represent the trends.) Per share amounts and market prices have been adjusted for the 1997 five percent stock dividend. On April 29, 1998, the Company announced the 1998 second quarter dividend of $.21 payable on June 15, 1998. <TABLE> <CAPTION> Quarterly Stock Prices and Dividends Market Price Cash (Restated for Stock Dividends) (Bid) Dividends High Low Declared <S> <C> <C> <C> 1997 1st Quarter 3.375 $22.125 $.19 2nd Quarter 6.375 23.375 .19 3rd Quarter 28.625 24.500 .19 4th Quarter 33.625 29.500 .21 1998 1st Quarter $33.250 $29.750 $.21 2nd Quarter n/a n/a .21 </TABLE> <TABLE> <CAPTION> 1998 1997 <S> <C> <C> First Quarter Core Diluted Earnings Per Share $.48 $.38 Dividend Payout Ratio: (Second quarter dividends as a percent of first quarter core diluted earnings per share) 43.75% 50.00% Book Value Per Share $13.09 $12.09 Tangible Book Value Per Share $10.72 $11.89 </TABLE> LIQUIDITY Liquidity is measured by the ability of the Company to raise cash when it needs it at a reasonable cost. The Company must be capable of meeting expected and unexpected obligations to its customers at any time. Given the uncertain nature of customer demands as well as the desire to maximize earnings, the Company must have available sources of funds, on- and off-balance sheet, that can be acquired in time of need. Securities available-for-sale represent a primary source of on-balance sheet cash flow. At purchase, selection of these securities is based on their ready marketability and collateral value, as well as their yield and maturity. In addition to liquidity arising from balance sheet cash flows, the Company has supplemented liquidity with additional off-balance sheet sources such as credit lines with the Federal Home Loan Bank and has identified wholesale and retail repurchase agreements and brokered certificates of deposit as appropriate funding alternatives. The Company measures its basic liquidity as a ratio of liquid assets to short-term liabilities, both with and without the availability of borrowing arrangements. Because excess liquidity has a negative impact on earnings, the Company establishes both a high end and a low end on its target range for liquidity ratios. At March 31, 1998, the Company still exceeded the upper limit of this range due to the liquidity resulting from the Fleet branch acquisition. Since June 1997, the Company has been reinvesting this excess liquidity in market-area loans as opportunities arise. The Company is not aware of any known trends, events or uncertainties that will have or are reasonably likely to have a material effect or make material demands on the Company's liquidity, capital resources or results of operations. RESULTS OF OPERATIONS: Three Months Ended March 31, 1998 Compared With Three Months Ended March 31, 1997 <TABLE> <CAPTION> Summary of Earnings Performance (Dollars in Thousands) Mar 1998 Mar 1997 Change % Change <S> <C> <C> <C> <C> Net Income $2,903 $2,901 $ 2 0.1 % Net Income, Recurring 2,810 2,291 519 22.7 Diluted Earnings Per Share .50 .48 0.02 4.2 Diluted Earnings Per Share, Recurring .48 .38 0.10 26.2 Return on Assets 1.42% 1.80% (0.39)% (21.1) Return on Assets, Recurring 1.37% 1.42% (0.05)% (3.5) Return on Equity 15.71% 15.94% (0.23)% (1.4) Return on Equity, Recurring 15.21% 12.60% 2.61 % 20.7 </TABLE> The Company reported earnings of $2.9 million for both the first quarter of 1998 and 1997. However, for the first quarter of 1997, earnings included a favorable settlement of a combined reporting issue with the State of New York Department of Taxation and Finance, as well as a favorable settlement of a claim against a service provider. As adjusted for nonrecurring items, net income was $2.8 million and $2.3 million for the first quarter of 1998 and 1997, respectively. As thus adjusted, diluted earnings per share were $.48 and $.38 for each respective period.
Net Interest Income <TABLE> <CAPTION> Summary of Net Interest Income (Taxable Equivalent Basis) (Dollars in Thousands) Mar 1998 Mar 1997 Change % Change <S> <C> <C> <C> <C> Interest Income $ 15,411 $ 12,350 $ 3,061 24.8 % Interest Expense 6,702 5,095 1,607 31.5 Net Interest Income $ 8,709 $ 7,255 $ 1,454 20.0 Average Earning Assets (1) $775,282 $609,257 $166,025 27.3 % Average Paying Liabilities 650,561 500,218 150,343 30.1 Taxable Equivalent Adjustment 257 182 75 41.2 Yield on Earning Assets (1) 8.06% 8.22% (0.16)% (1.9)% Cost of Paying Liabilities 4.18 4.13 0.05 1.1 Net Interest Spread 3.88 4.09 (0.21) (5.0) Net Interest Margin 4.56 4.83 (0.27) (5.7) (1) Includes Nonaccrual Loans </TABLE> The Company's net interest margin (net interest income on a tax-equivalent basis divided by average earning assets, annualized) decreased by 27 basis points from the first quarter of 1997 to the first quarter of 1998. Net interest income for the first quarter of 1997 does not include the effects of the Branch Acquisition on June 27, 1997. As indicated in the earlier discussion on balance sheet changes, the Company acquired approximately $140 million in deposits in the Branch Acquisition, but only $44 million in loans. The Company received cash from Fleet equal to the difference, less an agreed-upon premium on the deposits and the value of other assets acquired (e.g., real and personal property at the branches). Initially, the Company invested the surplus cash received in securities and federal funds, with a view to reinvesting these amounts in market area loans as opportunities allowed. At March 31, 1997, prior to the Branch Acquisition, the Company's loan to deposit ratio was approximately 73%. At June 30, 1997, shortly after the acquisition, the loan to deposit ratio was 67%. By March 31, 1998, the loan to deposit ratio had risen to 69%. The effect of placing a greater portion of earning assets in lower yielding federal funds and securities (the short-term consequence of the Branch Acquisition) was a decrease in the Company's net interest margin, which decreased 27 basis points from March 31, 1997 to March 31, 1998. However, due to the increase in average earning assets between the two periods (an increase of $166 million) net interest income increased $1.5 million from the first quarter of 1997 to the first quarter of 1998. The provision for loan losses was $342 thousand and $236 thousand for the quarters ended March 31, 1998 and 1997, respectively. The provision for loan losses was discussed previously under the heading "Summary of the Allowance and Provision for Loan Losses." Other Income <TABLE> <CAPTION> Summary of Other Income (Dollars in Thousands) Mar 1998 Mar 1997 $ Change % Change <S> <C> <C> <C> <C> Income From Fiduciary Activities $ 761 $ 658 $ 103 15.7 % Fees for Other Services to Customers 957 755 202 26.8 Net Gains (Losses) on Securities Transactions 157 (28) 185 --- Other Operating Income 232 525 (293) (55.8) Total Other Income $ 2,107 $ 1,910 $ 197 10.3 Other Operating Income, Recurring $ 232 $ 250 $ (18) (7.2)% Total Other Income, Recurring 1,950 1,663 287 17.3 </TABLE> Other (i.e. noninterest) income for the first quarter of 1997 included $275 thousand of nonrecurring other operating income relating to settlements of various claims during the period. Other income, on a recurring basis, increased $287 thousand, or 17.3%, from the first quarter of 1997 to the first quarter of 1998. Trust income increased $103 thousand, or 15.7%, between the two comparative quarters. The Company did not acquire any trust business in the Branch Acquisition, but the newly-acquired branches did expand the market area for the Company's trust and investment division. Fees for other services to customers (primarily service charges on deposit accounts, credit card merchant fee income and servicing income on sold loans) was $957 thousand for the first quarter of 1998, an increase of $202 thousand, or 26.8%, from the 1997 first quarter. The increase was primarily attributable to service charges on the deposits assumed in the Branch Acquisition. Other operating income, on a recurring basis (primarily third party credit card servicing income and gains on the sale of loans and other assets), amounted to $232 thousand, a decrease of $18 thousand, or 7.2%, from the first quarter of 1997. This area of other income was not significantly impacted by the Branch Acquisition, and the period-to-period decrease was attributable to the fluctuating nature of this type of income. During the first quarter of 1998, the Company recognized $162 thousand in gains on the sale of $22.2 million of securities from the available-for-sale portfolio, offset in part by $5 thousand of securities losses. During the first quarter of 1997, the Company recognized net securities losses of $28 thousand on the sale of $11.0 million of securities available-for-sale. The securities were sold for the main purpose of extending the average maturity on the portfolio. Other Expense <TABLE> <CAPTION> Summary of Other Expense (Dollars in Thousands) Mar 1998 Mar 1997 Change % Change <S> <C> <C> <C> <C> Salaries and Employee Benefits $3,259 $2,934 $ 325 11.1% Occupancy Expense of Premises, Net 419 378 41 10.8 Furniture and Equipment Expense 551 479 72 15.0 Other Operating Expense 1,560 1,145 415 36.2 Total Other Expense $5,789 $4,936 $ 853 17.3 Efficiency Ratio 54.31% 55.35% (1.04)% 1.8% </TABLE> Other (i.e. noninterest) expense increased $853 thousand, or 17.3%, for the first three months of 1998 compared with the first three months of 1997. The increase was almost entirely attributable to the Branch Acquisition, which, measured by total assets, increased the size of the Company by 21.4% at the closing of the transaction, June 27, 1997. In spite of the increased operating expenses, including amortization of goodwill associated with the Branch Acquisition, the Company's efficiency ratio decreased (a ratio where smaller is better) between the two periods. The efficiency ratio is calculated as the ratio of other expense to tax-equivalent net interest income and other income (excluding nonrecurring items and securities gains and losses), and is a comparative measure of a financial institution's operating efficiency. At December 31, 1997, the ratio for the Company's peer group was 61.63%. Salaries and employee benefits expense increased $325 thousand, or 11.1%, from the first quarter of 1997 to the first quarter of 1998. The Company retained all 34 former Fleet employees associated with the Branch Acquisition. The increase also reflects normal salary increases. Increases in occupancy expense of premises and furniture and fixture expense (10.8% and 15.0%, respectively) were primarily attributable to the Branch Acquisition. Other operating expense increased $415 thousand, or 36.2%, from the first quarter of 1997 to the first quarter of 1998. An increase in the amortization of goodwill of $226 thousand represented 54.5% of the total increase. Otherwise, the increase in other operating expense would have been 16.5%, similar to, but somewhat higher than, the other cost increases triggered by the Branch Acquisition, but still well below the 21.4% increase in total assets.
Income Taxes <TABLE> <CAPTION> Summary of Income Taxes (Dollars in Thousands) Mar 1998 Mar 1997 Change <S> <C> <C> <C> Provision for Income Taxes $ 1,525 $ 910 $ 615 Effective Federal Rate 34.44% 23.88% 10.56 % Effective Federal Rate, without the 1997 state tax benefit 34.44% 36.05% (1.61)% </TABLE> The provision for federal and state income taxes amounted to $1.5 million and $910 thousand for the first quarter of 1998 and 1997, 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 quarter of 1998 and 1997 were 34.44% and 36.05%, respectively. The decrease is primarily attributable to a reduction in state income taxes. Item 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK In addition to credit risk in the Company's loan portfolio and liquidity risk, discussed earlier, the Company's business activities also generate market risk. Market risk is the possibility that changes in future market rates or prices will make the Company's position less valuable. The ongoing monitoring and management of risk is an important component of the Company's asset/liability management process which is governed by policies established by its Board of Directors that are reviewed and approved annually. The Board of Directors delegates responsibility for managing the asset/liability profile to management's Asset/Liability Committee ("ALCO"). In this capacity ALCO develops guidelines and strategies impacting the Company's asset/liability management related activities based upon estimated market risk sensitivity, policy limits and overall market interest rate levels and trends. Interest rate risk is the most significant market risk affecting the Company. 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-related assets, early withdrawal of time deposits, and the fact that the speed and magnitude of responses to interest rate changes varies by product. The ALCO utilizes the results of a detailed and dynamic simulation model to quantify the estimated exposure of net interest income to sustained interest rate changes. While ALCO routinely monitors simulated net interest income sensitivity over a rolling two-year horizon, it also utilizes additional tools to monitor potential longer-term interest rate risk. The simulation model captures the impact of changing interest rates on the interest income received and interest expense paid with respect to all interest-bearing assets and liabilities on the Company's consolidated balance sheet. This sensitivity analysis is compared to ALCO policy limits which specify a maximum tolerance level for net interest income exposure over a one year horizon, assuming no balance sheet growth and a 200 basis point upward and downward shift in interest rates. A parallel and pro rata shift in rates over a 12 month period is assumed. As of March 31, 1998, under this analysis, a 200 basis point increase in interest rates would result in a 3.9% decrease in net interest income for the ensuing twelve months and a 200 basis point decrease in interest rates would result in a 4.0% increase in net interest income. These amounts were well within the Company's ALCO policy limits. The preceding sensitivity analysis does not represent a Company forecast and should not be relied upon as being indicative of expected operating results in the event of comparable interest rate changes or otherwise. These hypothetical estimates are based upon numerous assumptions including: the nature and timing of interest rate levels including yield curve shape, prepayments on loans and securities, deposit decay rates, pricing decisions on loans and deposits, reinvestment/replacement of asset and liability cashflows, and others. While assumptions are developed based upon current economic and local market conditions, the Company cannot make any assurance as to the predictive nature of these assumptions including how customer preferences or competitive influences might change. Also, as market conditions vary from those assumed in the sensitivity analysis, actual results will differ due to: prepayment/refinancing levels likely deviating from those assumed, the varying impact of interest rate changes on caps or floors on adjustable rate assets, the potential effect of changing debt service levels on customers with adjustable rate loans, depositor early withdrawals and product preference changes, and other internal/external variables. Furthermore, the sensitivity analysis does not reflect actions that ALCO might take in responding to or anticipating changes in interest rates. 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 Item 3. Defaults Upon Senior Securities - None Item 4. Submission of Matters to a Vote of Security Holders At the Company's Annual Meeting of Shareholders held April 29, 1998, shareholders elected the following directors to serve terms expiring in 2001. Shareholders also approved the Company's Long-Term Incentive Plan, authorizing the issuance of up to 300,000 shares of the Company's Common Stock in the form of stock options and restricted shares. The voting results were as follows: <TABLE> <CAPTION> Withhold Broker Director For Authority Non-Votes <S> <C> <C> <C> Thomas L. Hoy 4,622,715 28,938 --- Dr. Edward F. Huntington 4,637,083 14,570 --- Doris E. Ornstein 4,606,643 45,010 --- </TABLE> <TABLE> <CAPTION> Broker For Against Abstain Non-Votes <S> <C> <C> <C> <C> Long-Term Incentive Plan 3,430,623 432,603 123,036 --- </TABLE> Item 5. Other Information - None Item 6. Exhibits and Reports on Form 8-K - None 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: May 14, 1998 s/Thomas L. Hoy Thomas L. Hoy, President and Chief Executive Officer Date: May 14, 1998 s/John J. Murphy John J. Murphy, Executive Vice President, Treasurer and CFO (Principal Financial Officer and Principal Accounting Officer)