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, 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 (State or other jurisdiction of incorporation or organization) 22-2448962 (IRS Employer Identification 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 Common Stock, par value $1.00 per share Outstanding as of July 31, 1998 6,314,062 <TABLE> <CAPTION> ARROW FINANCIAL CORPORATION FORM 10-Q JUNE 30, 1998 INDEX <S> <C> PART I FINANCIAL INFORMATION Page No. Item 1. Consolidated Balance Sheets as of June 30, 1998 and December 31, 1997 3 Consolidated Statements of Income for the Three and Six Months Ended June 30, 1998 and 1997 4 Consolidated Statements of Changes in Shareholders' Equity for the Six Months Ended June 30, 1998 and 1997 5 Consolidated Statements of Cash Flows for the Six Months Ended June 30, 1998 and 1997 6 Notes to Consolidated Interim Financial Statements 7 Independent Auditors' Review Report 8 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations 9 Item 3. Quantitative and Qualitative Disclosures About Market Risk 21 PART II OTHER INFORMATION 22 SIGNATURES 22 </TABLE>
Item 1. <TABLE> <CAPTION> ARROW FINANCIAL CORPORATION AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS (Dollars in Thousands)(Unaudited) 6/30/98 12/31/97 ASSETS <S> <C> <C> Cash and Due from Banks $ 23,987 $ 23,909 Federal Funds Sold --- 23,000 Cash and Cash Equivalents 23,987 46,909 Securities Available-for-Sale 233,293 221,837 Securities Held-to-Maturity: (Approximate Fair Value of $56,283 in 1998 and $45,562 in 1997) 54,938 44,082 Loans and Leases 512,984 485,810 Less: Allowance for Credit Losses (6,468) (6,191) Net Loans and Leases 506,516 479,619 Premises and Equipment, Net 10,841 10,760 Other Real Estate Owned, Net 496 315 Other Assets 27,596 28,077 Total Assets $857,667 $831,599 LIABILITIES Deposits: Demand Deposits $ 97,158 $ 96,482 Interest-Bearing Demand Deposits 161,615 162,016 Regular and Money Market Savings 164,612 158,690 Time Deposits of $100,000 or More 105,969 106,620 Other Time Deposits 194,156 197,107 Total Deposits 723,510 720,915 Short-Term Borrowings: Federal Funds Sold and Securities Sold Under Agreements to Repurchase 23,157 20,918 Other Short-Term Borrowings 5,042 3,837 Federal Home Loan Bank Advances 15,000 --- Other Liabilities 14,538 12,058 Total Liabilities 781,247 757,728 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 65,345 65,277 Undivided Profits 25,875 22,531 Accumulated Other Comprehensive Income: Net Unrealized Gain on Securities Available-for-Sale, Net of Tax 762 764 Reserve for Unearned ESOP Shares (300) --- Treasury Stock, at Cost (1,156,741 Shares in 1998 and 1,143,553 in 1997) (22,168) (21,607) Total Shareholders' Equity 76,420 73,871 Total Liabilities and Shareholders' Equity $857,667 $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 Six Months Ended June 30, Ended June 30, 1998 1997 1998 1997 INTEREST AND DIVIDEND INCOME <S> <C> <C> <C> <C> Interest and Fees on Loans and Leases $11,108 $ 9,094 $21,735 $17,794 Interest on Federal Funds Sold 238 115 363 186 Interest and Dividends on Securities Available-for-Sale 3,764 2,719 7,450 5,480 Interest and Dividends on Securities Held-to-Maturity 766 668 1,482 1,304 Total Interest and Dividend Income 15,876 12,596 31,030 24,764 INTEREST EXPENSE Interest on Deposits: Time Deposits of $100,000 or More 1,556 1,169 2,936 2,318 Other Deposits 4,996 3,973 9,991 7,681 Interest on Short-Term Borrowings: Federal Funds Purchased and Securities Sold Under Agreements to Repurchase 306 204 558 372 Other Short-Term Borrowings 37 92 66 162 Federal Home Loan Bank Advances 197 --- 243 --- Total Interest Expense 7,092 5,438 13,794 10,533 NET INTEREST INCOME 8,784 7,158 17,236 14,231 Provision for Credit Losses 342 236 684 472 NET INTEREST INCOME AFTER PROVISION FOR CREDIT LOSSES 8,442 6,922 16,552 13,759 OTHER INCOME Income from Fiduciary Activities 795 663 1,557 1,321 Fees for Other Services to Customers 1,030 834 1,986 1,589 Net Gains on Securities Transactions 9 65 166 37 Other Operating Income 169 486 401 1,011 Total Other Income 2,003 2,048 4,110 3,958 OTHER EXPENSE Salaries and Employee Benefits 3,455 2,969 6,714 5,903 Occupancy Expense of Premises, Net 434 363 853 741 Furniture and Equipment Expense 542 474 1,094 953 Other Operating Expense 1,657 1,218 3,216 2,363 Total Other Expense 6,088 5,024 11,877 9,960 INCOME BEFORE PROVISION FOR INCOME TAXES 4,357 3,946 8,785 7,757 Provision for Income Taxes 1,497 1,428 3,022 2,338 NET INCOME $ 2,860 $ 2,518 $ 5,763 $ 5,419 Average Shares Outstanding: Basic 6,335 6,451 6,338 6,522 Diluted 6,442 6,528 6,443 6,597 Per Common Share: Basic Earnings $ .45 $ .39 $ .91 $ .83 Diluted Earnings $ .44 $ .38 $ .89 $ .82 Dividends Declared .19 .17 .38 .35 Book Value 12.08 11.16 12.08 11.16 Tangible Book Value 9.97 8.91 9.97 8.91 Per share amounts have been adjusted for the August 1998 ten percent and 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 Unallocated Other Employee Compre- Stock Shares Common Undivided hensive Ownership Treasury Issued Stock Surplus Profits Income Plan Stock Total <S> <C> <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 --- --- --- 5,763 --- --- --- 5,763 Net Unrealized Securities Holding Gains Arising During the Period, Net of Tax (Pre-tax $163) --- --- --- --- 97 --- --- 97 Reclassification Adjustment for Net Securities Gains Included in Net Income, Net of Tax (Pre-tax $166) --- --- --- --- (99) --- --- (99) Other Comprehensive Income (Loss) (2) Comprehensive Income 5,761 Cash Dividends Declared, $.38 per Share --- --- --- (2,419) --- --- --- (2,419) Acquisition of Common Stock by ESOP --- --- --- --- --- (300) --- (300) Stock Options Exercised (5,312 Shares) --- --- 36 --- --- --- 38 74 Purchase of Treasury Stock (18,500 Shares) --- --- --- --- --- --- (599) (599) Tax Benefit for Disposition of Stock Options --- --- 32 --- --- --- --- 32 Balance at June 30, 1998 6,905,888 $6,906 $65,345 $25,875 $762 $(300) (22,168) $76,420 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 --- --- --- 5,419 --- --- --- 5,419 Net Unrealized Securities Holding Losses Arising During the Period, Net of Tax (Pre-tax $229) --- --- --- --- (136) --- --- (136) Reclassification Adjustment for Net Securities Gains Included in Net Income, Net of Tax (Pre-tax $37) --- --- --- --- (22) --- --- (22) Other Comprehensive Income (Loss) (158) Comprehensive Income 5,261 Cash Dividends Declared, $.35 per Share --- --- --- (2,258) --- --- --- (2,258) Stock Options Exercised (43,335 Shares) --- --- 89 --- --- --- 388 477 Purchase of Treasury Stock (267,685 Shares) --- --- --- --- --- --- (6,300) (6,300) Balance at June 30, 1997 6,577,036 $6,577 $54,658 $30,153 $(50) $ --- $(19,962) $71,476 Per share amounts have been adjusted for the August 1998 ten percent and 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) Six Months Ended June 30, 1998 1997 Operating Activities: <S> <C> <C> Net Income $ 5,763 $ 5,419 Adjustments to Reconcile Net Income to Net Cash Provided by Operating Activities: Provision for Credit Losses 684 472 Provision for Other Real Estate Owned Losses --- 60 Depreciation and Amortization 913 598 Gains on the Sale of Securities Available-for-Sale (174) (101) Losses on the Sale of Securities Available-for-Sale 8 63 Proceeds from the Sale of Loans 3,275 1,155 Net Gains on the Sale of Loans, Fixed Assets and Other Real Estate Owned (47) (28) Decrease (Increase) in Deferred Tax Assets 45 (21) Decrease (Increase) in Interest Receivable 203 (571) Increase (Decrease) in Interest Payable (69) (32) Decrease (Increase) in Other Assets (242) (2,706) Increase (Decrease) in Other Liabilities 2,548 (1,738) Net Cash Provided By Operating Activities 12,907 2,570 Investing Activities: Proceeds from the Sale of Securities Available-for-Sale 23,121 23,996 Proceeds from the Maturities of Securities Available-for-Sale 58,885 20,175 Purchases of Securities Available-for-Sale (93,229) (49,961) Proceeds from the Maturities of Securities Held-to-Maturity 2,932 1,073 Purchases of Securities Held-to-Maturity (13,804) (13,978) Loans Purchased in Branch Transactions --- (44,190) Net Increase in Loans and Leases (31,320) (25,824) Fixed Assets Purchased in Branch Transactions --- (1,338) Proceeds from the Sales of Fixed Assets and Other Real Estate Owned 54 93 Purchase of Fixed Assets (595) (486) Net Cash (Used In) Provided By Investing Activities (53,956) (90,440) Financing Activities: Deposits Assumed in Branch Transactions, Net of Premium --- 127,708 Net Increase in Deposits, Excluding Branch Transactions 2,595 5,048 Net (Decrease) Increase in Short-Term Borrowings 3,444 (483) Advance on FHLB Borrowings 15,000 --- Purchase of Treasury Stock (599) (5,822) Sale of Treasury Stock for Exercise of Stock Options 74 --- Disqualifying Disposition of ISO Shares 32 --- Cash Dividends Paid (2,419) (2,258) Net Cash Provided By (Used In) Financing Activities 18,127 124,193 Net Increase (Decrease) in Cash and Cash Equivalents (22,922) 36,323 Cash and Cash Equivalents at Beginning of Period 46,909 37,497 Total Cash and Cash Equivalents $23,987 $73,820 Supplemental Cash Flow Information: Interest Paid $13,863 $10,565 Income Taxes Paid 152 3,596 Transfer of Loans to Other Real Estate Owned 182 343 Acquisition of Common Stock by ESOP 300 --- </TABLE> See Notes to Consolidated Interim Financial Statements.
ARROW FINANCIAL CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED INTERIM FINANCIAL STATEMENTS FORM 10-Q JUNE 30, 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 June 30, 1998 and December 31, 1997; the results of operations for the three and six month periods ended June 30, 1998 and 1997; the statements of changes in shareholders' equity for the six month periods ended June 30, 1998 and 1997; and the statements of cash flows for the six month periods ended June 30, 1998 and 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 August 1998 ten percent and the November 1997 five percent stock dividends. 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. Derivative Instruments and Hedging Activities In June 1998, the FASB issued SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities," which establishes accounting and reporting standards for derivative instruments, including certain derivative instruments embedded in other contracts, and for hedging activities. This Statement is effective for all fiscal quarters of fiscal years beginning after June 15, 1999. Management is currently evaluating the impact of this Statement on the Company's consolidated financial statements.
6. 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 and six month periods ended June 30, 1998 and 1997. Average shares outstanding have been restated for the August 1998 ten percent and the November 1997 five percent stock dividends. <TABLE> <CAPTION> Income Shares Per Share (Numerator) (Denominator) Amount For the Three Months Ended June 30, 1998: <S> <C> <C> <C. Basic EPS: Income Available to Common Shareholders $2,860 6,335 $.45 Dilutive Effect of Stock Options --- 107 Diluted EPS: Income Available to Common Shareholders and Assumed Conversions $2,860 6,442 $.44 For the Three Months Ended June 30, 1997: Basic EPS: Income Available to Common Shareholders $2,518 6,451 $.39 Dilutive Effect of Stock Options --- 77 Diluted EPS: Income Available to Common Shareholders and Assumed Conversions $2,518 6,528 $.38 For the Six Months Ended June 30, 1998: Basic EPS: Income Available to Common Shareholders $5,763 6,338 $ .91 Dilutive Effect of Stock Options --- 105 Diluted EPS: Income Available to Common Shareholders and Assumed Conversions $5,763 6,443 $.89 For the Six Months Ended June 30, 1997: Basic EPS: Income Available to Common Shareholders $5,419 6,522 $.83 Dilutive Effect of Stock Options --- 75 Diluted EPS: Income Available to Common Shareholders and Assumed Conversions $5,419 6,597 $.82 </TABLE> Independent Auditors' Review Report The Board of Directors and Shareholders Arrow Financial Corporation: We have reviewed the consolidated balance sheet of Arrow Financial Corporation and subsidiaries (the "Company") as of June 30, 1998 and the related consolidated statements of income for the three-month and six-month periods ended June 30, 1998 and 1997, and the consolidated statements of changes in shareholders' equity and cash flows for the six-month periods ended June 30, 1998 and 1997. These consolidated financial statements are the responsibility of the Company's management. We conducted our review in accordance with standards established by the American Institute of Certified Public Accountants. A review of interim financial information consists principally of applying analytical procedures to financial data and making inquiries of persons responsible for financial and accounting matters. It is substantially less in scope than an audit conducted in accordance with generally accepted auditing standards, the objective of which is the expression of an opinion regarding the financial statements taken as a whole. Accordingly, we do not express such an opinion. Based on our review, we are not aware of any material modifications that should be made to the consolidated financial statements referred to above for them to be in conformity with generally accepted accounting principles. We have previously audited, in accordance with generally accepted auditing standards, the consolidated balance sheet of Arrow Financial Corporation and subsidiaries as of December 31, 1997, and the related consolidated statements of income, changes in shareholders' equity and cash flows for the year then ended (not presented herein); and in our report dated January 23, 1998, we expressed an unqualified opinion on those consolidated financial statements. In our opinion, the information set forth in the accompanying consolidated balance sheet as of December 31, 1997, is fairly stated, in all material respects, in relation to the consolidated balance sheet from which it has been derived. /s/ KPMG Peat Marwick LLP Albany, New York July 23, 1998 Item 2. ARROW FINANCIAL CORPORATION AND SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS JUNE 30, 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. Some of these statements, such as those included in the interest rate sensitivity analysis in the section entitled "Quantitative and Qualitative disclosures About Market Risk" are merely hypothetical estimates of future performance or changes in future performance based on simulation models. 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 of New York ("Branch Acquisition"). 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 twelve month period. Most significant was the positive impact on earnings per share, because the acquisition was completed without external borrowing or raising additional capital. The Company further improved its earnings per share record during the period through a stock repurchase program. Other positive impacts of the Branch Acquisition include an improvement in the Company's efficiency ratio (noninterest expense to net interest income and noninterest income), and an increase in the ratio of net income per full time-equivalent employee. The Branch Acquisition was the principal source of period-to-period changes in the consolidated statements of income as noted in the following discussion. Share and per share amounts have been restated for the August 1998 10% and the November 1997 5% stock dividends. OVERVIEW The Company reported earnings of $2.9 million for the second quarter of 1998 as compared to $2.5 million for the second quarter of 1997. Diluted earnings per share were $.45 and $.39 for the two respective periods. On a year-to-date basis, net income was $5.8 million for the first six months of 1998, as compared to earnings of $5.4 million for the 1997 period. Diluted earnings per share for the six month periods were $.91 and $.83, respectively. 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 receipt of an insurance settlement. On a comparable basis, excluding these nonrecurring items and securities transactions, diluted earnings per share for the first six months of 1998 and 1997 were $.88 and $.70, respectively, representing a 25.7% improvement between the respective periods.
<TABLE> <CPATION> Analysis of Recurring Net Income (In Thousands, Except Per Share Amounts) Three Months Ended Six Months Ended Jun 1998 Jun 1997 Jun 1998 Jun 1997 <S> <C> <C> <C> <C> Net Income, as Reported $2,860 $2,518 $5,763 $5,419 Adjustments, net of Tax: Net Securities Transactions (5) (39) (98) (22) Restructured Loan Transactions --- (166) --- (166) Insurance Settlement --- --- --- (163) State Income Tax Benefit --- --- --- (464) Recurring Income $2,855 $2,313 $5,665 $4,604 Diluted Earnings Per Share, as Reported $ .44 $ .38 $ .89 $ .82 Diluted Earnings Per Share, Recurring .44 .35 .88 .70 "Cash" earnings per share excludes from net income the amortization, net of tax, of goodwill associated with branch acquisitions: Diluted Earnings Per Share, as Reported $ .44 $ .38 $ .89 $ .82 Cash Diluted Earnings Per Share $ .47 $ .38 $ .94 $ .82 </TABLE> The returns on average assets were 1.33% and 1.51% for the second quarter of 1998 and 1997, respectively. The returns on average equity were 15.09% and 14.13% for the second quarter of 1998 and 1997, respectively. Excluding the nonrecurring items, the returns on average assets were 1.33% and 1.39%, and the returns on average equity were 15.07% and 13.12%, for the respective quarters. On a year-to-date basis, the returns on average assets were 1.37% and 1.66% for the first six months of 1998 and 1997, respectively. The returns on average equity were 15.39% and 15.04% for the first six months of 1998 and 1997, respectively. Excluding the nonrecurring items, the returns on average assets were 1.35% and 1.41%, and the returns on average equity were 15.13% and 12.78%, for the respective periods. Total assets were $857.7 million at June 30, 1998, which represented an increase of $26.1 million, or 3.1%, from December 31, 1997, and an increase of $65.3 million, or 8.2%, above the level at June 30, 1997, immediately after completion of the Branch Acquisition. (The acquisition increased total assets by approximately $140 million) Since the acquisition, the Company has experienced deposit growth of approximately $2.6 million, or 1.9%, at the acquired branches. The Company has experienced more significant growth over the period, in both loans and deposits, at is pre-existing branches. Shareholders' equity increased $2.5 million to $76.4 million during the first six months of 1998, as net income of $5.8 million was partially offset by cash dividends of $2.4 million and $599 thousand used to reacquire the Company's common stock. 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. CHANGE IN FINANCIAL CONDITION <TABLE> <CAPTION> Summary of Consolidated Balance Sheets (Dollars in Thousands) $ Change $ Change % Change % Change Jun 1998 Dec 1997 Jun 1997 From Dec From Jun From Dec From Jun <S> <C> <C> <C> <C> <C> <C> <C> Federal Funds Sold $ --- $ 23,000 $ 48,500 $(23,000) $(48,500) (100.0)% (100.0)% Securities Available for Sale 233,293 221,837 177,243 11,456 56,050 5.2 31.6 Securities Held to Maturity 54,938 44,082 43,720 10,856 11,218 24.6 25.7 Loans, Net of Unearned Income (1) 512,984 485,810 462,396 27,174 50,588 5.6 10.9 Allowance for Loan Losses 6,468 6,191 6,409 277 59 4.5 0.9 Earning Assets (1) 801,215 774,729 731,859 26,486 69,356 3.4 9.5 Total Assets 857,667 831,599 792,372 26,068 65,295 3.1 8.2 Demand Deposits $ 97,158 $ 96,482 $ 91,583 $ 676 $ 5,575 0.7 6.1 Interest-Bearing Demand Deposits 161,615 162,016 152,965 (401) 8,650 (0.2) 5.7 Regular and Money Market Savings 164,612 158,690 169,294 5,922 (4,682) 3.7 (2.8) Time Deposits of $100,000 or More 105,969 106,620 67,274 (651) 38,695 (0.6) 57.5 Other Time Deposits 194,156 197,107 205,473 (2,951) (11,317) (1.5) (5.5) Total Deposits $723,510 $720,915 $686,589 $ 2,595 $ 36,921 0.4 5.4 Short-Term Borrowings $ 28,199 $ 24,755 $ 22,223 $ 3,444 $ 5,976 13.9 26.9 Federal Home Loan Bank Advances 15,000 --- --- 15,000 15,000 --- --- Shareholders' Equity 76,420 73,871 71,476 2,549 4,944 3.5 6.9 (1) Includes Nonaccrual Loans </TABLE> Total resources at June 30, 1998 amounted to $857.7 million, an increase of $26.1 million, or 3.1%, from year-end 1997 and an increase of $65.3 million, or 8.2%, from June 30, 1997. Total loans at June 30, 1998 amounted to $513.0 million, an increase of $27.2 million, or 5.6%, from December 31, 1997, and an increase of $50.6 million, or 10.9%, from June 30, 1997. The increase from June 30, 1997 was primarily attributable growth within the indirect consumer and residential real estate loan portfolios. Indirect consumer loans are principally auto loans financed through local dealerships where the Company acquires the dealer paper. Total deposits of $723.5 million at June 30, 1998 increased $2.6 million, or 0.4%, from the December 31, 1997 level. The amount of deposits at June 30, 1998, represented an increase of $36.9 million, or 5.4%, from June 30, 1997. The primary area of deposit growth was municipal time deposits of $100,000 or more. Shareholders' equity increased $2.5 million to $76.4 million during the first six months of 1998. Net income of $5.8 million was partially offset by cash dividends of $2.4 million, the reacquisition of $599 thousand of the Company's common stock, and an additional acquisition of $300 thousand of common stock in the Company's leveraged ESOP. The Company paid a $.191 cash dividend (as restated) for each of the first two quarters of 1998. The Company recently announced a $.21 cash dividend for the third quarter of 1998 to be paid after distribution of the 10% stock dividend. 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 four quarters. <TABLE> <CAPTION> Quarterly Average Deposit Balances (Dollars in Thousands) Jun 1998 Mar 1998 Dec 1997 Sep 1997 Jun 1997 Amount % Amount % Amount % Amount % Amount % <S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C> Demand Deposits $ 92,590 13 $ 92,584 13 $ 91,309 13 $ 93,907 14 $ 65,976 12 Interest-Bearing Demand Deposits 170,394 23 166,494 23 170,321 24 155,461 22 128,067 23 Regular and Money Market Savings 161,009 22 158,997 22 159,591 22 167,821 24 128,350 23 Time Deposits of $100,000 or More 113,672 15 102,263 14 96,851 13 78,927 11 87,350 16 Other Time Deposits 193,866 27 195,039 28 191,018 28 201,125 29 147,910 26 Total Deposits $731,530 100 $715,377 100 $716,090 100 $697,241 100 $557,653 100 </TABLE> The growth in average deposits from the first quarter of 1998 to the second quarter primarily reflects seasonal placement of municipal deposits in NOW accounts and time deposits of $100,000 or more. 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. <TABLE> <CAPTION> Quarterly Cost of Deposits Jun 1998 Mar 1998 Dec 1997 Sep 1997Jun 1997 <S> <C> <C> <C> <C> <C> Demand Deposits --- % --- % --- % --- % --- % Interest-Bearing Demand Deposits 2.92 2.99 3.16 2.98 3.21 Regular and Money Market Savings 2.71 2.78 2.79 2.87 2.83 Time Deposits of $100,000 or More 5.49 5.47 5.45 5.45 5.37 Other Time Deposits 5.52 5.57 5.50 5.45 5.54 Total Deposits 3.59 3.61 3.63 3.54 3.70 </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. The Fed has not changed its discount rate since January 1996. Partly as a result of the Fed's open market operations, however, the prevailing federal funds rate increased in the first quarter of 1997 by 25 basis points. The Company's cost of deposits increased accordingly. Since that time, both the prevailing federal funds rate and the Company's cost of deposits have remained quite stable. The Company's 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, with another $56 million in 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 Company's 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) Jun 1998 Mar 1998 Dec 1997 Sep 1997 Jun 1997 Amount % Amount % Amount % Amount % Amount % <S> <C> <C> <C> <C> <C> <C> C> <C> <C> <C> Commercial and Commercial Real Estate $ 103,805 21 $ 102,983 21 $ 100,604 21 $102,211 22 $ 92,874 23 Residential Real Estate 162,071 32 151,417 31 147,928 31 142,863 31 129,289 32 Home Equity 35,331 7 36,593 7 36,601 7 37,100 7 30,399 7 Indirect Consumer Loans 151,603 30 143,495 29 139,401 29 128,086 27 114,141 28 Direct Consumer Loans 46,495 9 49,047 10 49,747 10 51,185 11 34,212 8 Credit Card Loans 7,138 1 7,413 2 7,602 2 7,582 2 7,769 2 Total Loans $506,444 100 $490,985 100 $481,883 100 $469,027 100 $408,684 100 </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). Since the Branch Acquisition, average loans have increased at a steady pace. Indirect consumer loans and residential real estate loans demonstrated 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, these loans increased from 28% in the second quarter of 1997 to 30% in the second quarter of 1998. The Company also experienced significant activity in residential real estate lending, which is expected to continue into the third quarter of 1998. <TABLE> <CAPTION> Quarterly Taxable Equivalent Yield on Loans Jun 1998 Mar 1998 Dec 1997 Sep 1997 Jun 1997 <S> <C> <C> <C> <C> <C> Commercial and Commercial Real Estate 10.24% 9.60% 9.62% 9.56% 9.73% Residential Real Estate 8.13 8.34 8.23 8.33 8.40 Home Equity 9.10 9.07 9.10 9.20 9.23 Indirect Consumer Loans 8.16 8.17 8.24 8.39 8.35 Direct Consumer Loans 9.00 9.18 9.18 9.00 9.09 Credit Card Loans 16.34 16.41 16.07 16.46 16.84 Total Loans 8.83 8.82 8.81 8.86 8.97 </TABLE> The taxable equivalent yield on the Company's loan portfolio was essentially unchanged in each of the past two quarters. However, during the second quarter of 1998 the Company received full payment on a large commercial loan on nonaccrual status. Without that payment, the yield on the commercial portfolio for the second quarter would have been 9.52% instead of 10.24%, and the yield on the entire loan portfolio would have been 8.68%, as opposed to 8.83%. Thus, the long-term trend on yields in the Company's loan portfolio, taken as a whole, continues to be downward. 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. Moreover, 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 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) Jun 1998 Mar 1998 Dec 1997 ep 1997 Jun 1997 Loan Balances: <S> <C> <C> <C> <C> <C> Period-End Loans $512,984 $495,962 $485,810 $476,863 $462,396 Average Loans, Year-to-Date 498,757 490,985 439,103 424,686 402,149 Allowance for Credit Losses: Allowance for Credit Losses, Beginning of Period $6,191 $ 6,191 $ 5,581 $ 5,581 $ 5,581 Allowance Acquired, YTD --- --- 700 700 700 Provision for Credit Losses, Y-T-D 684 342 1,303 972 472 Net Charge-offs, Y-T-D (407) (158) (1,393) (1,024) (344) Allowance for Credit Losses, End of Period $6,468 $ 6,375 $ 6,191 $ 6,229 $ 6,409 Nonperforming Assets (Period-end): Nonaccrual Loans $2,367 $3,615 $3,321 $3,034 $ 2,232 Loans Past due 90 or More Days and Still Accruing Interest 360 242 363 296 764 Loans Restructured and in Compliance with Modified Terms --- --- --- --- --- Total Nonperforming Loans 2,727 3,857 3,684 3,330 2,996 Repossessed Assets 31 64 --- --- --- Other Real Estate Owned 496 386 315 322 370 Total Nonperforming Assets $3,254 $4,307 $3,999 $3,652 $ 3,366 Performance Ratios: Allowance to Nonperforming Loans 237.18% 165.28% 168.05% 187.06% 213.92% Allowance to Period-End Loans 1.26 1.29 1.27 1.31 1.39 Provision to Average Loans (annualized) 0.28 0.28 0.30 0.31 0.24 Net Charge-offs to Average Loans (annualized) 0.16 0.13 0.32 0.32 0.17 Nonperforming Assets to Loans, OREO & Repossessed Assets 0.63 0.87 0.82 0.77 0.73 </TABLE> The Company's nonperforming assets at June 30, 1998 amounted to $3.3 million, a decrease of $1.1 million, or 24.5%, from March 31, 1998. The decrease was primarily attributable to the cash pay-off from one commercial borrower on a loan that had been on nonaccrual status for the prior three quarters. At period-end, nonperforming assets represented .63% of loans, other real estate and repossessed assets, a decrease of 19 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 second quarter net charge-offs to average loans was .20%, and .16% for the annualized six month period. This compares favorably to the .32% ratio for the 1997 year. The provision for credit losses was $342 thousand and $236 thousand for the second quarter of 1998 and 1997, respectively. The year-to-date provisions were $684 thousand and $472 thousand for the respective periods. The increase in the provisions for both the quarterly and year-to-date comparison relates to the increased size of the loan portfolio between the comparative periods. The provision as a percentage of average loans was .28% for the first six months of 1998, or 12 basis points higher than net charge-offs for the period. The allowance for credit losses at June 30, 1998 amounted to $6.5 million. The ratio of the allowance to outstanding loans at June 30, 1998, was 1.26%, essentially unchanged from the ratio at December 31, 1997.
CAPITAL RESOURCES Shareholders' equity was $76.4 million at June 30, 1998, an increase of $2.5 million, or 3.5%, from December 31, 1997. Net income of $5.8 million was partially offset by cash dividends of $2.4 million, the reacquisition of $599 thousand of the Company's common stock, and an additional acquisition of $300 thousand of common stock in the Company's leveraged ESOP. 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 quarterly average 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 June 30, 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 7.32% 11.89% 13.13% Glens Falls National Bank & Trust Co. 7.20 12.27 13.52 Saratoga National Bank & Trust Co. 7.69 9.39 10.52 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 June 30, 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. On July 22, 1998, the Company declared a 10% stock dividend payable on August 24, 1998 and also declared the 1998 third quarter cash dividend of $.21 payable on September 15, 1998 for shares currently held as well as on new shares received as a result of the stock dividend. 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 August 1998 ten percent and the November 1997 five percent stock dividend. <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 $21.250 $20.125 $.173 2nd Quarter 24.000 21.250 .173 3rd Quarter 26.000 22.250 .173 4th Quarter 30.625 26.875 .191 1998 1st Quarter $30.250 $27.000 $.191 2nd Quarter 31.250 27.625 .191 </TABLE> <TABLE> <CAPTION> 1998 1997 <S> <C> <C> Second Quarter Core Diluted Earnings Per Share $.44 $.35 Dividend Payout Ratio: (Third quarter dividends as a percent of second quarter core diluted earnings per share) 43.41% 49.43% Book Value Per Share $12.08 $11.16 Tangible Book Value Per Share 9.97 8.91 </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. Securities are designated at purchase as available-for-sale. Selection of securities are based on their ready marketability, ability to collateralize borrowed funds, as well as their yield and maturity. In addition to liquidity arising from on-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 also 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 June 30, 1998, the Company still exceeded the upper limit of this range due to the excess liquidity resulting from the Fleet branch acquisition twelve months earlier. Since that acquisition, the Company has been steadily 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. <TABLE> <CAPTION> RESULTS OF OPERATIONS: Three Months Ended June 30, 1998 Compared With Three Months Ended June 30, 1997 Summary of Earnings Performance (Dollars in Thousands, Except Per Share Amounts) As Reported: Jun 1998 Jun 1997 Change % Change <S> <C> <C> <C> <C> Net Income $2,860 $2,518 $342 13.6% Diluted Earnings Per Share .44 .38 .06 15.8 Return on Assets 1.33% 1.51% (.18)% (11.9) Return on Equity 15.09% 14.13% .95% 6.7 Recurring Earnings: Net Income $2,855 $2,313 $542 23.4% Diluted Earnings Per Share .44 .35 .09 25.7 Return on Assets 1.33% 1.39% (.06)% (4.2) Return on Equity 15.07% 13.12% 1.95% 14.8 </TABLE> The Company reported earnings of $2.9 million for the second quarter of 1998, an increase of $342 thousand, or 13.6%, over the second quarter of 1997. As adjusted for nonrecurring items, discussed above in the "Overview" section of this discussion, net income was $2.9 million and $2.3 million for the second quarters of 1998 and 1997, respectively. As thus adjusted, diluted earnings per share were $.44 and $.35 for each respective period. The Branch Acquisition at the end of the second quarter of 1997 had the most significant impact on the period-to-period earnings growth.
Net Interest Income <TABLE> <CAPTION> Summary of Net Interest Income (Taxable Equivalent Basis) (Dollars in Thousands) Jun 1998 Jun 199 Change % Change <S> <C> <C> <C> <C> Interest Income $16,135 $12,797 $ 3,338 26.1 % Interest Expense 7,092 5,438 1,654 30.4 Net Interest Income $ 9,043 $ 7,359 $ 1,684 22.9 Average Earning Assets (1) $810,249 $623,364 $186,885 30.0% Average Paying Liabilities 682,499 514,243 168,256 32.7 Taxable Equivalent Adjustment 259 201 58 28.9 Yield on Earning Assets (1) 7.99% 8.23% (0.25)% (3.0)% Cost of Paying Liabilities 4.17 4.24 (0.07) (1.7) Net Interest Spread 3.82 3.99 (0.17) (4.3) Net Interest Margin 4.48 4.74 (0.26) (5.5) (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 26 basis points from the second quarter of 1997 to the second quarter of 1998. Net interest income for the second quarter of 1997 did not reflect the operations acquired in the Branch Acquisition completed on June 27, 1997, whereas net income from the 1998 period did. As previously mentioned, the Company acquired approximately $140 million of deposits in the Branch Acquisition, but only $44 million in loans. The Company received cash from the seller, Fleet Bank, 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 higher-yielding 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 June 30, 1998, the loan to deposit ratio had risen to 71%. Although the Branch Acquisition has had a negative impact on the Company's net interest margin, due to the increase in average earning assets between the two periods (an increase of $187 million) net interest income increased $1.7 million from the second quarter of 1997 to the second quarter of 1998. The provision for credit losses was $342 thousand and $236 thousand for the quarters ended June 30, 1998 and 1997, respectively. The provision for credit losses was discussed previously under the heading "Summary of the Allowance and Provision for Credit Losses." Other Income <TABLE> <CAPTION> Summary of Other Income (Dollars in Thousands) Jun 1998 Jun 1997 $ Change % Change <S> <C> <C> <C> <C> Income From Fiduciary Activities $ 795 $ 663 $ 132 19.9% Fees for Other Services to Customers 1,030 834 196 23.5 Net Gains (Losses) on Securities Transactions 9 65 (56) (86.2) Other Operating Income 169 486 (317) (65.2) Total Other Income $2,003 $2,048 $(153) (2.2) Without Regard to Nonrecurring Items: Other Operating Income $ 169 $ 230 $ (61) (26.5) Total Other Income 1,994 1,727 267 15.5 </TABLE> Other (i.e. noninterest) income for the second quarter of 1997 included $256 thousand of nonrecurring other operating income relating to the former Vermont operations. Other income, on a recurring basis, increased $211 thousand, or 11.8%, from the second quarter of 1997 to the second quarter of 1998. Trust income increased $132 thousand, or 19.9%, 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 $1.0 million for the second quarter of 1998, an increase of $196 thousand, or 23.5%, from the 1997 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 $169 thousand, a decrease of $61 thousand, or 26.5%, from the second 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 normal fluctuations in this type of income. During the second quarter of 1998, the Company recognized $9 thousand in net gains on the sale of $8.0 million of securities from the available-for-sale portfolio. The securities were sold mainly to extend the average maturity on the portfolio. 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 its available-for-sale portfolio. Other Expense <TABLE> <CAPTION> Summary of Other Expense (Dollars in Thousands) Jun 1998 Jun 1997 $ Change % Change <S> <C> <C> <C> <C> Salaries and Employee Benefits $3,455 $2,969 $ 486 16.4% Occupancy Expense of Premises, Net 434 363 71 19.6 Furniture and Equipment Expense 542 474 68 14.3 Other Operating Expense 1,657 1,218 439 36.0 Total Other Expense $6,088 $5,024 $1,064 21.2 Efficiency Ratio 55.15% 55.29% (.14)% (.3)% </TABLE> Other (i.e. noninterest) expense increased $1.1 million, or 21.2%, from the second quarter of 1997 to the second quarter of 1998. 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 improved slightly (a ratio where smaller is better) between the two periods. The efficiency ratio, which is the ratio of other expense to tax-equivalent net interest income and other income (excluding nonrecurring items and securities gains and losses), is a standard measure of a financial institution's operating efficiency. For the year ended December 31, 1997, the ratio for the Company's peer group was 61.63%, approximately 6.4% higher than the Company's ratio for the year. Salaries and employee benefits expense increased $486 thousand, or 16.4%, from the second quarter of 1997 to the second 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 (19.3% and 14.3%, respectively) were primarily attributable to the Branch Acquisition. Other operating expense increased $439 thousand, or 36.0%, from the second quarter of 1997 to the second quarter of 1998. An increase in the amortization of goodwill of $226 thousand represented 51.4% of the total increase. Otherwise, the increase in other operating expense would have been 17.7%, 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) Jun 1998 Jun 1997 Change % Change <S> <C> <C> <C> <C> Provision for Income Taxes $1,497 $1,428 $69 4.8% Effective Tax Rate 34.37% 36.19% (1.81)% (5.0) </TABLE> The provision for federal and state income taxes amounted to $1.5 million and $1.4 million for the second quarter of 1998 and 1997, respectively. The decrease in the effective tax rate from the 1997 period to the 1998 period is primarily attributable to a reduction in state income taxes and an increase in tax exempt income. <TABLE> <CAPTION> RESULTS OF OPERATIONS: Six Months Ended June 30, 1998 Compared With Six Months Ended June 30, 1997 Summary of Earnings Performance (Dollars in Thousands, Except Per Share Amounts) As Reported: Jun 1998 Jun 1997 Change % Change <S> <C> <C> <C> <C> Net Income $5,763 $5,419 $ 344 6.3% Diluted Earnings Per Share .89 .82 .07 8.5 Return on Assets 1.37% 1.66% (.29)% (17.3) Return on Equity 15.39% 15.04% .35% 2.3 Recurring Earnings: Net Income $5,665 $4,604 $1,061 23.0% Diluted Earnings Per Share .88 .70 .18 25.7 Return on Assets 1.35% 1.41% (.06)% (4.4) Return on Equity 15.13% 12.78% 2.35% 18.4 </TABLE> The Company's net income was $5.8 million for the first six months of 1998, compared to earnings of $5.4 million for the first six months of 1997. Diluted earnings per share were $.89 and $.82 for the two respective periods. Adjusting for the nonrecurring events in both periods, as discussed above in the "Overview" section, net income for the first half of 1998 increased $1.1 million, or 23.0%, from the first half of 1997. The Branch Acquisition was the most significant factor in the period-to-period increase in recurring net income. The period-to-period change for the first six months of 1998 as compared to the first six months of 1997 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 1998 Jun 1997 Change % Change <S> <C> <C> <C> <C> Interest Income $31,546 $25,146 $ 6,400 25.5% Interest Expense 13,794 10,533 3,261 31.0 Net Interest Income $17,752 $14,613 $ 3,139 21.5 Average Earning Assets (1) $792,896 $616,349 $176,547 28.6% Average Paying Liabilities 666,618 507,269 159,349 31.4 Taxable Equivalent Adjustment 516 382 134 35.1 Yield on Earning Assets (1) 8.02% 8.23% (0.20)% (2.5)% Cost of Paying Liabilities 4.17 4.19 (0.02) (0.3) Net Interest Spread 3.85 4.04 (0.19) (4.7) Net Interest Margin 4.51 4.78 (0.27) (5.6) (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 six months of 1997 to the first six months of 1998. Net interest income for the 1997 period does not include the effects of the Branch Acquisition on June 27, 1997. As previously mentioned, the Company acquired approximately $140 million in deposits in the Branch Acquisition, but only $44 million in loans. The Company received cash from the seller, Fleet Bank, 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 higher-yielding 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 June 30, 1998, the loan to deposit ratio had risen to 71%. The temporary consequence of placing a greater portion of the newly-acquired 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 June 30, 1997 to June 30, 1998. However, due to the increase in average earning assets between the two periods (an increase of $177 million) net interest income increased $3.1 million from the six month period in 1997 to the 1998 period. The provision for credit losses was $684 thousand and $472 thousand for the respective 1998 and 1997 six month periods. The provision for credit losses was discussed previously under the heading "Summary of the Allowance and Provision for Credit Losses." Other Income <TABLE> <CAPTION> Summary of Other Income (Dollars in Thousands) Jun 1998 Jun 1997 $ Change % Change <S> <C> <C> <C> <C> Income From Fiduciary Activities $1,557 $ 1,321 $ 236 17.9% Fees for Other Services to Customers 1,986 1,589 397 25.0 Net Gains on Securities Transactions 166 37 129 348.6 Other Operating Income 401 1,011 (610) (60.3) Total Other Income $4,110 $3,958 $ 152 3.8 Without Regard to the Nonrecurring Items: Other Operating Income $ 401 $ 480 $ (79) (16.5) Total Other Income 3,944 3,390 554 19.9 </TABLE>
Other (i.e. noninterest) income for the first six months of 1997 included $531 thousand of nonrecurring other operating income relating to the former Vermont operations. Other income, on a recurring basis, increased $554 thousand, or 19.9%, from the first six months of 1997 to the first six months of 1998. Trust income increased $236 thousand, or 17.9%, between the two comparative periods. The Company did not acquire any trust business in the Branch Acquisition, but the newly-acquired branches did provide the Company with an expanded customer base for its offerings of trust and investment services. Fees for other services to customers (primarily service charges on deposit accounts, credit card merchant fee income and servicing income on sold loans) was $2.0 million for the first half of 1998, an increase of $397 thousand, or 25.0%, from the 1997 period. 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 $401 thousand for the first six months of 1998, a decrease of $79 thousand, or 16.5%, from the first six months 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 six months 1998, the Company recognized $166 thousand in net gains on the sale of $23.1 million of securities from the available-for-sale portfolio. The securities were sold for the main purpose of extending the average maturity on the portfolio. During the 1997 period, the Company recognized a net gain of $37 thousand on the sale of $24.0 million of securities from the portfolio of securities classified as available-for-sale. Other Expense <TABLE> <CAPTION> Summary of Other Expense (Dollars in Thousands) Jun 1998 Jun 1997 $ Change % Change <S> <C> <C> <C> <C> Salaries and Employee Benefits $ 6,714 $5,903 $ 811 13.7% Occupancy Expense of Premises, Net 853 741 112 15.1 Furniture and Equipment Expense 1,094 953 141 14.8 Other Operating Expense 3,216 2,363 853 36.1 Total Other Expense $11,877 $9,960 $ 1,917 19.2 Efficiency Ratio 54.74% 55.32% (.58)% (1.1)% </TABLE> Other (i.e. noninterest) expense increased $1.9 million, or 19.2%, for the first six months of 1998 compared with the first six 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 improved (a ratio where smaller is better) between the two periods. The efficiency ratio, which is 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 standard measure of a financial institution's operating efficiency. For the year ended December 31, 1997, the ratio for the Company's peer group was 61.63%, approximately 6.4% higher than the Company's ratio for that year. Salaries and employee benefits expense increased $811 thousand, or 13.7%, from the 1997 year-to-date period to the 1998 period primarily because of the increase salary expense associated with the Branch Acquisition. The Company retained all 34 former Fleet Bank employees working at the acquired branches. The increase also reflects normal salary increases. Increases in occupancy expense of premises and furniture and fixture expense (15.1% and 14.8%, respectively) were primarily attributable to the Branch Acquisition. Other operating expense increased $853 thousand, or 36.1%, from the first six months of 1997 to the first six months of 1998. An increase in the amortization of goodwill of $452 thousand represented 52.9% of the total increase. Excluding the additional goodwill charge, the increase in other operating expense would have been 17.2%, 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) Jun 1998 Jun 1997 $ Change % Change <S> <C> <C> <C> <C> Provision for Income Taxes $3,022 $2,338 $684 29.3% Effective Tax Rate 34.40% 30.14% 4.26% 14.1 Effective Tax Rate, without NYS Settlement 34.40% 36.12% (1.72)% (4.8) </TABLE> The provisions for federal and state income taxes amounted to $3.0 million and $2.3 million for the first six months 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 six months of 1997. As adjusted for this settlement, the effective tax rates for the first half of 1998 and 1997 were 34.40% and 36.12%, respectively. The decrease in the effective tax rate from the 1997 period to the 1998 period is primarily attributable to a reduction in state income taxes and an increase in tax exempt income. 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 attempts to capture 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. The hypothetical estimates generated by the anlaysis 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 other speculative assumptions. While the 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 the Company 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 - Exhibit 27 Selected Financial Data 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 7, 1998 s/Thomas L. Hoy Thomas L. Hoy, President and Chief Executive Officer Date: August 7, 1998 s/John J. Murphy John J. Murphy, Executive Vice President, Treasurer and CFO (Principal Financial Officer and Principal Accounting Officer)