Item 1: Business
A. GENERAL
Arrow Financial Corporation (the "Company"), a New York corporation, was incorporated on March 21, 1983 and is registered as a bank holding company within the meaning of the Bank Holding Company Act of 1956. The Company owns two nationally chartered banks in New York, as well as several non-bank subsidiaries, the operations of which are not significant. The Company also owns an inactive bank charter in Vermont (the former Green Mountain Bank) as well as a second- tier bank holding company, also inactive, in Vermont (Arrow Vermont Corporation), both of which are in the process of being liquidated. The Company sold all of its banking operations in Vermont in 1996 in three separate transactions, the last of which was completed in September 1996. The Company owns directly or indirectly all voting stock of all its subsidiaries.
The business of the Company consists primarily of the ownership, supervision and control of its bank subsidiaries. The Company provides its subsidiaries with various advisory and administrative services and coordinates the general policies and operation of the subsidiary banks. There were 302 full-time equivalent employees of the Company and the subsidiary banks at December 31, 1996.
Each subsidiary bank offers a full range of commercial and consumer financial products. The banks' deposit base consists of core deposits derived principally from the communities which the banks serve. The banks target their lending activities to consumers and small and mid-sized companies in the banks' immediate geographic areas. In addition to traditional banking services, the Company offers credit card processing services for other financial institutions and, through its banks' trust departments, provides retirement planning, trust and estate administration services for individuals and pension, profit-sharing and employee benefit plan administration for corporations.
B. LENDING ACTIVITIES
The Company's subsidiary banks engage in a wide range of lending activities, including commercial and industrial lending primarily to small and mid-sized companies; mortgage lending for the purchase of residential and commercial properties; and consumer installment, credit card and home equity financing. Historically, the Company has sold a portion of its residential real estate loan originations into the secondary market, primarily to Freddie Mac and state housing agencies, while retaining the servicing rights. Loan sales into the secondary market, have diminished in the past three years, however, as the banks have sought to increase their own portfolios. In addition to interest earned on loans, the banks receive facility fees for various types of commercial and industrial credits, and commitment fees for extension of letters of credit and certain types of loans.
Generally, the Company continues to implement conservative lending strategies, policies and procedures which are intended to protect the quality of the loan portfolio. These include stringent underwriting and collateral control procedures and credit review systems through which intensive reviews are conducted. It is the Company's policy to discontinue the accrual of interest on loans when the payment of interest and/or principal is due and unpaid for a designated period (generally 90 days) or when the likelihood of repayment is, in the opinion of management, uncertain. Income on such loans is thereafter recognized only upon receipt (see Item 7.C.II.b. "Risk Elements").
The banks lend primarily to borrowers within the geographic areas served by the banks. The banks' combined loan portfolios do not include any foreign loans or any significant industry concentrations except as described in Note 19 to the Consolidated Financial Statements in Part II Item 8 of this report. Except for credit card loans, the portfolios are substantially secured, and many commercial loans are further secured by personal guarantees.
C. SUPERVISION AND REGULATION
The following generally describes the regulation to which the Company and its banks are subject. Bank holding companies and banks are extensively regulated under both federal and state law. To the extent that the following information summarizes statutory or regulatory provisions, it is qualified in its entirety by reference to the particular law or regulation. Any change in applicable law or regulation may have a material effect on the business and prospects of the Company and the banks.
The Company is a legal entity separate and distinct from its subsidiaries. Most of the Company's revenues, on a parent company-only basis, result from management fees, dividends and undistributed earnings from the subsidiary banks. The right of the Company, and consequently the right of creditors and shareholders of the Company, to participate in any distribution of the assets or earnings of the banks through the payment of such dividends or otherwise is necessarily subject to the prior claims of creditors of the banks, except to the extent that claims of the Company in its capacity as a creditor of the banks also may be recognized. Moreover, there are various legal and regulatory limitations applicable to the payment of dividends to the Company by its subsidiaries as well as the payment of dividends by the Company to its shareholders. The ability of the Company and the banks to pay dividends in the future is, and is expected to continue to be, influenced by regulatory policies and capital guidelines.
The Company is a registered bank holding company within the meaning of the Bank Holding Company Act of 1956 (BHC Act) and is subject to regulation by the Board of Governors of the Federal Reserve System (Federal Reserve Board). Additionally, as a "bank holding company" under New York State Law, the Company is subject to regulation by the New York State Banking Department. The subsidiary banks are nationally chartered banks and are subject to the supervision of and examination by the Office of the Comptroller of the Currency ("OCC"). The banks are members of the Federal Reserve System and the deposits of each subsidiary bank are insured by the Federal Deposit Insurance Corporation ("FDIC"). The BHC Act prohibits the Company, with certain exceptions, from engaging, directly or indirectly, in non-bank activities and restricts loans by the banks to the Company or other affiliates. Under the BHC Act, a bank holding company must obtain Federal Reserve Board approval before acquiring, directly or indirectly, 5% or more of the voting shares of another bank or bank holding company (unless it already owns a majority of such shares) or acquiring all or substantially all of the assets of another bank or bank holding company.
Under the 1994 Riegle-Neal Act, bank holding companies are now able to acquire banks located in all 50 states (see Item 1.F. "Legislative Developments".)
The Federal Reserve Board has adopted various "capital adequacy guidelines" for use in the examination and supervision of bank holding companies. One set of guidelines is the risk-based capital guidelines, which assign risk weightings to all assets and certain off-balance sheet items and establish an 8% minimum ratio of qualified total capital to the aggregate dollar amount of risk-weighted assets (which is almost always less than the dollar amount of such assets without risk weighting). 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 loan losses. The Federal Reserve Board's other capital guideline is the leverage ratio standard, which establishes minimum limits on the ratio of a bank holding company's "Tier 1" capital to total tangible assets (not risk-weighted). For top-rated holding companies, the minimum leverage ratio is 3%, but lower-rated companies may be required to meet substantially greater minimum ratios. Each subsidiary bank is subject to similar capital requirements adopted by its primary federal regulator. The year-end 1996 capital ratios of the Company and the banks are set forth in Part II, Item 7.F. "Capital Resources and Dividends." A holding company's ability to pay dividends and expand its business through acquisitions of new subsidiaries can be restricted if capital falls below these capital adequacy guidelines.
Neither the Company nor any of its subsidiaries is now, or has been within the past year, subject to any formal or informal regulatory enforcement order.
D. COMPETITION
The Company and its subsidiaries face intense competition in all markets that they serve. Traditional competitors are other local commercial banks, savings banks, savings and loan institutions and credit unions, as well as local offices of major regional and money center banks. Also, non-banking organizations, such as consumer finance companies, insurance companies, securities firms, money market and mutual funds and credit card companies, which are not subject to the same array of regulatory restrictions and capital requirements as the Company and its subsidiary banks, offer substantive equivalents of transaction accounts, credit cards and various other loan and financial products.
E. STATISTICAL DISCLOSURE
Statistical disclosure required by Securities Act Guide 3 to be set forth herein is found in Item 7 "Management's Discussion and Analysis of Financial Condition and Results of Operations" and Item 8 "Financial Statements and Supplementary Data."
F. LEGISLATIVE DEVELOPMENTS
In 1994, Congress enacted the Riegle-Neal Interstate Banking and Branching Efficiency Act. Under the Act, as of September 29, 1995, bank holding companies were authorized as a matter of federal law to acquire banks located in any of the 50 states, notwithstanding any state laws to the contrary, provided all required regulatory and other approvals are obtained. Also, under the Act, effective June 1, 1997, banks headquartered in any state will be permitted to branch into any other state, except for those states which may enact legislation prior to June 1, 1997 "opting out" of interstate branching. States may "opt in" to interstate branching prior to June 1, 1997, by affirmatively adopting legislation to that effect. The Act also permitted commonly controlled banks to act as agents for one another, effective September 29, 1995, by accepting deposits or loan payments or closing or servicing loans for one another, regardless of any branching laws to the contrary.
In 1995, the federal bank regulatory authorities promulgated a set of revised regulations addressing the responsibilities of banking organizations under the Community Reinvestment Act ("CRA"). The revised regulations place additional emphasis on the actual experience of a bank in making loans in low- and moderate-income areas within its service area as a key determinant in evaluation of the bank's compliance with the statute. As in the prior regulations, bank regulators are authorized to bring enforcement actions against banks under the CRA only in the context of bank expansion or acquisition transactions.
In 1991, the Federal Deposit Insurance Corporation Improvement Act of 1991 ("FDICIA") was enacted. Among other things, FDICIA requires the federal banking regulators to take prompt corrective action with respect to depository institutions that do not meet minimum capital requirements. FDICIA established five capital classifications for banking institutions, the highest being "well capitalized." Under regulations adopted by the federal bank regulators, a banking institution is considered "well capitalized" if it has a total risk-adjusted capital ratio of 10% or greater, a Tier 1 risk-adjusted capital ratio of 6% or greater and a leverage ratio of 5% or greater and is not subject to any regulatory order or written directive regarding capital maintenance. The Company and its subsidiary banks are all well capitalized.
FDICIA also imposed expanded accounting and audit reporting requirements for depository institutions whose total assets exceed $500 million. For the Company, these requirements became effective for Glens Falls National Bank and Trust Company beginning in 1996.
The FDIC levies assessments on various deposit obligations of the Company's banking subsidiaries. During 1995, the FDIC reduced the premium paid by the best-rated banks (including all the Company's subsidiary banks) from $.23 per $100 of insured deposits to $.04. In 1996, the FDIC insurance premium was further reduced to a flat charge of $2 thousand per year for the highest-rated banks, including all the Company's subsidiary banks. In 1996, Congress enacted the Deposit Insurance Funds Act, under which deposits insured by the Bank Insurance Fund ("BIF") are subject to assessment for payment on the Financing Corporation ("FICO") bond obligation at 1/5 the rate of the Savings Association Insurance Fund ("SAIF") assessable deposits. Accordingly, for 1997, BIF-assessable deposits (like the Company's) will be assessed an additional 1.3 cents per $100 of insured deposits.
Banks and bank holding companies were also significantly affected by the Financial Institutions Reform, Recovery and Enforcement Act of 1989 ("FIRREA"). FIRREA mandated public disclosure by commercial banks of their Community Reinvestment Act ratings and mortgage lending records and imposed cross-liability on any insured financial institution which is affiliated with any other insured institution to which the FDIC gives financial assistance.
Various other banking legislation, including proposals to permit banks to affiliate with full-service securities underwriting firms or non-financial organizations (Glass-Steagall Reform) have been introduced in Congress from time to time. The Company cannot determine the ultimate effect that any such potential legislation, if enacted, would have upon its financial condition or operations.
G. EXECUTIVE OFFICERS OF THE REGISTRANT
The names and ages of the principal executive officers of the Company and positions held are presented in the following table. The officers are elected annually by the Board of Directors.
Item 2:
Item 2: Properties
The Company is headquartered at 250 Glen Street, Glens Falls, New York. The building is owned by Glens Falls National Bank and serves as its main office. Glens Falls National Bank owns thirteen additional offices and leases one, at market rates. Saratoga National Bank owns both of its offices. The Company continues to own the building in Rutland, Vermont, that served as headquarters for the Company's Vermont operations prior to the divestiture of those operations in 1996. The building was held for sale at December 31, 1996. Rental costs of premises did not exceed 5% of operating costs in 1996.
In the opinion of management of the Company, the physical properties of the Company and the subsidiary banks are suitable and adequate.
Item 3:
Item 3: Legal Proceedings
The Company is not the subject of any material pending legal proceedings, other than ordinary routine litigation occurring in the normal course of its business.
The Company's subsidiary banks are the subjects of or parties to various legal claims which arise in the normal course of their business. For example, from time to time, the banks encounter claims against them grounded in lender liability, of the sort often asserted against financial institutions. These lender liability claims normally take the form of counterclaims to lawsuits filed by the banks for collection of past due loans. The various pending legal claims against the subsidiary banks, including lender liability claims, will not, in the opinion of management, result in any material liability to the banks or the Company.
Item 4:
Item 4: Submission of Matters to a Vote of Security Holders
None in the fourth quarter of 1996.
PART II
Item 5:
Item 5: Market for the Registrant's Common Equity and Related Stockholder Matters
The common stock of Arrow Financial Corporation is traded over-the-counter. It is registered with and its price is quoted by the National Association of Securities Dealers, Inc., through its national quotation system (NASDAQ).
The price ranges listed below represent actual transactions rounded to the nearest 1/8 point. Although there may have been isolated sales at prices outside the parameters shown, the Company believes that the price ranges fairly represent the trading ranges.
Per share amounts and market prices have been adjusted for a 1996 ten percent stock dividend and a 1995 four percent stock dividend.
The payment of dividends by the Company is at the discretion of the Board of Directors and is dependent upon, among other things, the Company's earnings, financial condition and other factors, including applicable governmental regulations and restrictions. See "Capital Resources and Dividends" in Part II, Item 7.F. of this report.
There were approximately 2,653 holders of record of common stock at December 31, 1996.
Item 6:
Item 6: Selected Financial Data
Item 7:
Item 7: Management's Discussion and Analysis of Financial Condition and Results of Operations
The following discussion and analysis focuses on and reviews the Company's results of operations for each of the years in the three-year period ended December 31, 1996 and the financial condition of the Company as of December 31, 1996 and 1995. Per share amounts have been restated to reflect the ten percent stock dividend paid in November 1996 and the four percent stock dividend paid in November 1995. The discussion below should be read in conjunction with the consolidated financial statements and other financial data presented elsewhere herein.
A. OVERVIEW
The Company reported net income of $20.3 million for 1996, compared to net income of $12.4 million for 1995. Primary earnings per share were $3.40 and $1.98 for 1996 and 1995, respectively. Book value per share was $12.90 at December 31, 1996, an increase of $1.99, or 18.2%, from December 31, 1995. For 1996, cash dividends per share amounted to 66.4 cents, an increase of 15.1 cents or 29.4%, from cash dividends paid in 1995. The following analysis adjusts net income for nonrecurring items to arrive at a comparative presentation of the Company's core earnings:
The company's core earnings for 1996 amounted to $9.9 million, an increase of $433 thousand from core earnings of $9.5 million for 1995. As thus adjusted, core earnings per share were $1.66 and $1.51, for the two respective years, representing an increase of 9.9%.
During 1996, in three separate transactions, the Company completed the divestiture of its Vermont banking operations realizing an after tax gain of $10.3 million. The other major nonrecurring income item in the past two years was the Company's receipt in May of 1995 of a $5.0 million pre-tax settlement from its financial institution bond company on a claim for losses suffered in earlier periods. The core earnings analysis has also been adjusted for securities sale transactions, severance benefits for senior officers of Green Mountain Bank, sales of other real estate owned, and other nonrecurring items.
Nonperforming assets amounted to $2.8 million at December 31, 1996, down from $6.8 million at December 31, 1995. The reduction was primarily attributable to the disposition of OREO and nonperforming loans as part of the sale of the Vermont banking operations in 1996. The allowance for loan losses was $5.6 million at December 31, 1996, which represented 213% of the amount of nonperforming loans.
Divestiture of Vermont Operations
During 1996, in three separate transactions, the Company completed the divestiture of its Vermont subsidiary, Green Mountain Bank ("GMB"). In January, the Company sold eight branches of GMB, with related deposits and loans, to Mascoma Savings Bank, Lebanon, NH. In August, the Company sold GMB's trust business to Vermont National Bank, Brattleboro, VT. In September, the Company sold the remaining branches of GMB, with related deposits and loans, to ALBANK, FSB, Albany, NY. The Company did not sell the building which served as GMB's main office in Rutland, Vermont, which was being held for sale at December 31, 1996.
Total loans and deposits transferred in these sales amounted to approximately $148 million and $208 million, respectively. These and other changes are more fully described in the following analysis of the results of operations and changes in financial condition.
B. RESULTS OF OPERATIONS
The following analysis of net interest income, the provision for loan losses, noninterest income, noninterest expense and income taxes, presents the factors that are primarily responsible for the Company's results of operations for 1996 and the prior two years.
I. NET INTEREST INCOME (Fully Taxable Basis)
Net interest income represents the difference between interest earned on loans securities and other interest-earning assets and interest paid on deposits and other sources of funds. Changes in net interest income result from changes in the level and mix of earning assets and sources of funds (volume) and changes in the yields earned and costs paid (rate). Net interest margin is the ratio of net interest income to average earning assets. Net interest income may also be described as the product of earning assets and the net interest margin.
On a tax-equivalent basis, net interest income was $33.7 million in 1996, a decrease of $2.9 million or, 7.8%, from $36.5 million in 1995. The $2.9 million decrease in net interest income was, for the most part, attributable to the decrease in average earning assets resulting from divestiture during the year of the Vermont operations.
ANALYSIS OF CHANGES IN NET INTEREST INCOME
The following table presents net interest income components on a tax-equivalent basis and reflects changes between periods attributable to movement in either the average daily balances or average rates for both earning assets and interest-bearing liabilities. Changes attributable to both volume and rate have been allocated proportionately between the categories.
The following table reflects the components of the Company's net interest income, setting forth, for years ended December 31, 1996, 1995 and 1994 (I) average balances of assets, liabilities and shareholders' equity, (II) interest income earned on earning assets and interest expense incurred on interest-bearing liabilities, (III) average yields earned on earning assets and average rates paid on interest-bearing liabilities, (IV) the net interest spread (average yield less average cost) and (V) the net interest margin (yield) on earning assets. Rates are computed on a tax-equivalent basis. Nonaccrual loans are included in average loans and leases, while unearned income has been eliminated.
AVERAGE CONSOLIDATED BALANCE SHEETS AND NET INTEREST INCOME ANALYSIS Arrow Financial Corporation and Subsidiaries (Fully Taxable Basis using a marginal tax rate of 35% for 1996 and 1995 and 34% for 1994) (Dollars In Thousands) (Unaudited)
The following items have a major impact on changes in net interest income due to rate: general interest rate changes, the ratio of the Company's rate sensitive assets to rate sensitive liabilities (interest rate sensitive gap) during periods of interest rate changes and the performance of nonperforming loans.
The Federal Reserve Board attempts to influence prevailing federal funds and prime interest rates by changing the Federal Reserve Bank discount rate. The following chart presents recent changes to the discount rate:
During 1996, the Company experienced minimal impact on net interest income resulting from changes in interest rates. Throughout 1996, interest rates remained quite stable, largely due to the influence of the Federal Reserve Board's control of the federal discount rate, which changed only once at the beginning of the year. At that time the discount rate decreased 25 basis points to 5.00%.
In 1995, the change in net interest income attributable to changes in interest rates had an $883 thousand positive impact on net interest income. During the first half of the year, the Company was still experiencing the effect from rising interest rates which had begun in the second half of 1994. Various loan and deposit products react to interest rate changes at different rates and the pricing on some products does not change to the full extent of changes in the prime rate. During 1994, assets in general repriced more quickly than time deposits. Repricing of short-term deposit products also tended to lag behind prime rate changes and did not change to the full extent of prime rate changes. Consequently, the spread between the yield on earning assets and the cost of interest paying liabilities increased from 1993 to 1994 by 13 basis points, while decreasing by 18 basis points from 1994 to 1995. Notwithstanding the decrease in the net interest spread in 1995, the Company experienced an overall beneficial impact from generally rising interest rates due to the fact that average interest-earning assets increased more rapidly than average interest-paying liabilities, as discussed more fully in the following section on changes in net interest income due to volume. As a result, the net interest margin increased from 1994 to 1995, albeit by only one basis point.
A discussion of the impact on net interest income resulting from changes in interest rates vis a vis the repricing patterns of the Company's interest-bearing assets and liabilities is included later in this report under Item 7.E. "Interest Rate Risk."
During 1996 and 1995, the Company received certain payments on restructured loans in the Vermont portfolio that had not been factored into the effective rate on those loans. The payments, which were recorded as interest income, have been included in the yields in the table above. These payments increased the loan yields by seven and four basis points for the two respective years.
CHANGES IN NET INTEREST INCOME DUE TO VOLUME
In general, changes in the volume of earning assets or paying liabilities will result in corresponding changes in net interest income. However, changes due to volume can be enhanced or restricted by shifts in the relative mix between instruments of different rates. In 1996, nearly all of the $2.9 million decrease in net interest income was attributable to the change in volume. The decrease was attributable to the divestiture of the Vermont banking operations during 1996. Increases in the volume of loans and deposits, as well as yields and costs by type, for the New York banks are discussed later in this report under Item 7.C. "Financial Condition." In summary, the New York banks experienced significant growth during 1996, with some shifting of emphasis in the loan portfolio from commercial to consumer loans. There was relatively little change in the mix of deposit products from 1995 to 1996.
In 1995, the change in volume had an $880 thousand positive impact on net interest income. Of the $33.8 million increase in average earning assets from 1994 to 1995, average loan balances accounted for $11.0 million. The Company used the remaining funds to increase its liquid assets. Only $20.1 million of the $33.8 million increase in average earning assets was funded by paying liabilities. The primary sources of funds for the remainder came from retained earnings ($9.4 million) and proceeds from the sale of OREO ($1.5 million).
II. PROVISION FOR LOAN LOSSES AND ALLOWANCE FOR LOAN LOSSES
Through the provision for loan losses, an allowance (reserve) is maintained for estimated loan losses. Actual loan losses are charged against this allowance when they are identified. In evaluating the adequacy of the allowance for loan losses, management considers various risk factors influencing asset quality. The analysis is performed on a loan by loan basis for impaired and large balance loans, and by portfolio type for smaller balance homogeneous loans. This analysis is based on judgments and estimates and may change in response to economic developments or other conditions that may influence borrowers' economic outlook.
The provision for loan losses is largely influenced by the level of nonperforming loans, the expected future levels of nonperforming loans and by the level of loans actually charged-off against the allowance for loan losses during the year.
At December 31, 1996, nonperforming loans amounted to $2.6 million, a decrease of 39.9% from the balance at December 31, 1995. The decrease is primarily attributable to nonperforming loans transferred in the divestiture of the Vermont banking operations during 1996. The level of nonperforming loans for the New York based banks was virtually unchanged from 1995 to 1996.
During 1996, loan losses charged against the reserve, net of recoveries, were $580 thousand, or .13% of average loans for the period. However, the most significant reduction to the allowance for loan losses was the amount of the reserve attributable to loans transferred in the divestiture of the Vermont banking operations of $6.8 million. These reductions in the allowance for loan losses were offset in part by a provision for loan losses of $896 thousand, or .19% of average loans for the year.
At December 31, 1996 the allowance for loan losses was $5.6 million. The allowance for loan losses was 213% of the amount of nonperforming loans at that date.
During 1995, nonperforming assets continued the steady decline begun in 1991. The primary portion of the decrease in nonperforming assets in 1995 came from the sale of OREO. Nonaccrual loans increased $626 thousand or 17.3% from the year-end 1994 balance. The increase in nonaccrual loans was due primarily to the aggregate borrowing of one large commercial borrower, which was placed on nonaccrual status in 1995. That loan was accounted for under SFAS No. 114 and was being carried at its estimated fair value. Loans reported as troubled debt restructures at December 31, 1994, were classified as performing in 1995.
Net loan losses for 1995 were $1.4 million. These losses compare to net loan losses of $2.8 million, $1.9 million and $4.7 million for the years ended December 31, 1994, 1993 and 1992, respectively. As a ratio to average loans, the net loan losses were .27%, .56%, .40% and .92% for the same respective periods.
The provision for loan losses in 1994 was actually a credit to the consolidated statement of income resulting in a reduction in the allowance for loan losses. During the second quarter of 1994, with nonperforming assets at significantly reduced levels and a substantial sale of OREO having been completed, the Company reduced the allowance for loan losses by $1.5 million. This reduction was effected by means of a credit to the provision for loan losses. As a result, for the twelve month period ended December 31, 1994, the Company's net provision for loan losses was a benefit $950 thousand, compared to a provision of $690 thousand in 1993 and $1.7 million in 1992. As a ratio of average loans, the provisions were (.19)% in 1994 and .14% and .32% for 1993 and 1992, respectively.
III. OTHER INCOME
The majority of other (i.e., noninterest) income is derived from fees and commissions from fiduciary services, deposit account service charges, computer processing fees to correspondents and other "core" or recurring sources. Additionally, other income is influenced by transactions involving the sale of securities available-for-sale.
Total other income for 1996 was $23.7 million as compared to $14.5 million for 1995. Without regard to nonrecurring items included in other income for the two years, specifically the divestiture of Vermont operations in 1996, the financial institution bond recovery in 1995 and securities sale transactions for both years, other income was $8.5 million for 1996, compared to $9.5 million in 1995, a decrease of 10.5%. As thus adjusted, other income as a percentage of average assets was 1.20% in 1996, virtually the same as in 1995.
During 1996, the Company completed the divestiture of its Vermont banking operations. The pre-tax gain of $15.3 million is net of recording the remaining assets and liabilities at fair value less estimated costs to sell. The major remaining asset, which at December 31, 1996, was held for sale, was the building in Rutland, Vermont, which was the former main office of GMB. Principal remaining liabilities included pension and post-retirement obligations of GMB and amounts reserved for costs and expenses of liquidating GMB's charter.
In 1995, the Company received a $5.0 million payment from the Company's financial institution bond carrier, in settlement of a lawsuit filed in 1994 for losses suffered in earlier periods, covered under the Company's policy.
During 1996, the Company recognized net losses of $101 thousand on the sale of $51.1 million of securities classified as available-for-sale. Most of the sales were made for the purpose of extending the term of the securities at higher yields. During 1995, the Company recognized net gains of $23 thousand on the sale of $4.2 million of available-for-sale securities. During 1994, the Company recognized net securities losses of $481 thousand on the sale of $16.5 million of available-for-sale securities.
Income from fiduciary activities for 1996 was $3.5 million, a decrease of $294 thousand, or 7.8% from 1995. On August 31, 1996, the Company sold its Vermont trust business as part of the divestiture of Vermont operations. In 1995, the Vermont trust business represented approximately 42% of the Company's fiduciary income for the year of $3.8 million. During 1996, the New York based trust business generated $2.4 million in income, an increase of $232 thousand, or 10.6%, from 1995. The increase was attributable to a $35.3 million increase in assets under management, which were $434.6 million at December 31, 1996.
Fees for other services include deposit service charges, safe deposit box fees, credit card merchant processing fees, and servicing fees on loans sold with servicing retained by the Company. These fees amounted to $4.0 million for 1996, a decrease of $710 thousand, or 15.2% from 1995, again reflecting the disposition of the Vermont operations during 1996. For the New York based operations, these fees amounted to $3.4 million for both years.
Other operating income includes, as a primary component, fees earned on servicing credit card portfolios for correspondent banks. This category of noninterest income also includes gains on the sale of loans, other real estate owned and other assets. Without regard to the bond recovery, other operating income amounted to $1.1 million for both 1996 and 1995.
Total other income for 1995 amounted to $14.5 million, a $5.9 million increase from 1994. The increase was primarily attributable to a $5.0 million payment received from the Company's financial institution bond carrier.
Exclusive of the bond recovery and net securities transactions, total other income in 1995 increased $424 thousand, or 4.7%, above the 1994 level. As adjusted, the ratio of total other income to average assets was 1.22% for both years.
Fees for other services to customers amounted to $4.7 million in 1995, compared to $4.3 million in 1994, a 7.5% increase. The increase was primarily attributable to increases in service charges on deposit accounts and credit card merchant processing income.
Other operating income in 1995 was virtually unchanged from 1994.
IV. OTHER EXPENSE
Other (i.e., noninterest) expense is a means of measuring the delivery cost of services, products and business activities of the Company. The key components of other expense are presented in the following table.
Other expense for 1996 was $24.8 million, a decrease of $5.0 million, or 16.8%, from 1995. All four major categories of other expense decreased as a result of the divestiture of the Vermont banking operations.
Salaries and benefits for 1996 was $15.0 million, a decrease of $1.7 million, or 10.4%, from 1995. Net occupancy expense and furniture and equipment expense both decreased approximately $250 thousand from 1995, or 12.3% and 13.1%, respectively. ` Other operating expense for 1996 was $6.3 million, a decrease of $2.8 million, or 30.3%, from 1995. In addition to the savings resulting from the divestiture of the Vermont operations, the Company experienced decreased costs for FDIC insurance premiums, legal expenses, expenses related to problem loans and in costs to maintain and dispose of OREO. In mid-1995, the FDIC reduced the insurance premiums for well- capitalized banks, such as the Company's subsidiary banks, from 23 cents per $100 of insured deposits to a flat fee of two thousand dollars per year.
Other expense for 1995 amounted to $29.8 million, which compared to $31.4 million for 1994, a decrease of $1.6 million, or 5.1%. An increase in salaries and benefits in 1995 was more than offset by reduced expenses for net occupancy expense, furniture and equipment expense and other operating expenses.
Total salaries of $11.1 million for 1995 decreased $284 thousand from the 1994 level. The effect of fewer employees was only partially offset by general salary increases. Between 1994 and 1995, employee benefits increased by $790 thousand, of which $652 thousand represented severance costs incurred the latter year. Otherwise, a slight decrease in payroll taxes was offset by increased expenses for pension plans and health insurance.
From 1995 to 1994, net occupancy expense and furniture and equipment expense decreased by $128 thousand and $146 thousand, respectively. The decreases were primarily attributable to reduced depreciation expenses.
Other operating expense was $9.1 million for 1995, a decrease of $1.8 million, or 16.8%, from 1994. The decrease was primarily attributable to a reduction in FDIC and other insurance premiums, as well as to a large reduction in losses on the sale of OREO.
V. INCOME TAXES
The following table sets forth the Company's income tax expense and effective tax rates for the periods presented herein.
The provisions for federal and state income taxes amounted to $10.8 million, $7.0 million and $1.1 million for 1996, 1995 and 1994, respectively.
The 1994 provision was relatively small as a result of a net operating loss carryforward tracing from 1991 and changes in the valuation allowance for deferred tax assets. Eliminating the effect of these two benefits in 1994, the effective income tax rates for 1996, 1995 and 1994 were 34.8%, 36.0% and 38.1%, respectively. The decrease in the effective tax rate in each of the past two years primarily reflected a relative increase in the Company's tax exempt loan and securities portfolios.
C. FINANCIAL CONDITION
I. INVESTMENT PORTFOLIO
The Company adopted SFAS No. 115 "Accounting for Certain Investments in Debt and Equity Securities" at December 31, 1993. Under SFAS No. 115, investment securities must be classified as held- to-maturity, trading, or available-for-sale, depending on the purposes for which such securities were acquired or are being held. Securities held-to-maturity are debt securities that the Company has both the positive intent and ability to hold to maturity; such securities are stated at amortized cost. Debt and equity securities that are bought and held principally for the purpose of sale in the near term are classified as trading securities and are reported at fair value with unrealized gains and losses included in earnings. Debt and equity securities not classified as either held-to-maturity or trading securities are classified as available- for-sale and are reported at fair value with unrealized gains and losses excluded from earnings and reported net of taxes in a separate component of shareholders' equity. At December 31, 1996, the Company held no trading securities.
In November 1995, the FASB issued "A Guide to Implementation of Statement 115 on Accounting for Certain Investments in Debt and Equity Securities." The Guide allowed a one-time reclassification of held-to-maturity securities before December 31, 1995. Acting under this provision of the Guide, the Company reclassified $118.2 million of held-to-maturity securities to available-for-sale in December of 1995. The Company took advantage of this one-time provision as a means to improve liquidity and to gain some additional flexibility in the management of the Company's interest rate risk. See the following sections D. on "Liquidity" and E. on "Interest Rate Risk."
Securities Available-for-Sale:
The following table sets forth the book value of the Company's securities available-for-sale portfolio, at year-end 1996, 1995 and 1994.
Other mortgage-backed securities principally included agency mortgage pass-through securities. Pass-through securities provide to the investor monthly portions of principal and interest pursuant to the contractual obligations of the underlying mortgages. Collateralized mortgage obligations ("CMO's") separate the repayments into two or more components (tranches), where each tranche has a separate estimated life and yield. The Company's practice is to purchase pass-through securities guaranteed by federal agencies and tranches of CMO's with shorter maturities.
Regulatory agencies have devised a high-risk test for mortgage-backed securities. The test evaluates the following: (I) Average Life Test - the product has an average life of less than 10 years; (II) Average Life Sensitivity Test - an immediate and sustained change in interest rates of 300 basis points will not extend the expected life by more than four years; and (III) Price Sensitivity Test - an immediate and sustained change in interest rates of 300 basis points will not change the price by more than 17%. The Company evaluates each mortgage-backed security at the time of purchase and quarterly thereafter. Although none of the Company's investments have failed to pass the high-risk test subsequent to acquisition, it is the Company's policy to analyze the appropriateness of divesting high-risk securities.
Included in corporate and other debt securities are highly rated corporate bonds.
The following table sets forth the maturities of the Company's securities available-for-sale portfolio as of December 31, 1996. CMO's are included in the table based on their expected average life and other mortgage-backed securities by final maturity date.
The following table sets forth the tax-equivalent yields of the Company's securities available-for-sale portfolio at December 31, 1996.
The yields for debt securities shown in the table above are calculated by dividing annual interest, including accretion of discounts and amortization of premiums, by the carrying value of the securities at December 31, 1996. Yields on obligations of states and municipalities were computed on a fully tax-equivalent basis using a marginal tax rate of 35%. Dividend earnings derived from equity securities were adjusted to reflect applicable federal income tax exclusions.
During 1996 the Company recognized net losses of $101 thousand on the sale of $51.1 million from securities within the available-for-sale portfolio. Proceeds from sales early in the year were used to provide funds in completing the branch sale to Mascoma Savings Bank, a transaction in which the deposit liabilities assumed by the purchaser substantially exceeded the purchase price of the loans and other assets acquired and the deposit premium. Other sales of securities from the available-for-sale portfolio were used to extend the maturity dates and increase the yield on the portfolio.
During the last quarter of 1995, the Company recognized net gains of $23 thousand on sales of $4.2 million from the available-for-sale portfolio. The proceeds were used to fund the deposits transferred with the sale of eight branches of Green Mountain Bank to Mascoma Savings Bank in January 1996.
At December 31, 1996 and 1995, the weighted average maturity was 2.71 and 2.03 years, respectively, for debt securities in the available-for-sale portfolio.
During the last quarter of 1994, the Company recognized net losses of $481 thousand on sales of $16.5 million from the available-for-sale portfolio. The proceeds were reinvested in higher yielding securities.
At December 31, 1996, unrealized gains on securities available-for-sale amounted to $208 thousand, net of tax. Unrealized gains or losses, net of tax, are reflected as a separate component of shareholders' equity. Securities Held-to-Maturity:
The following table sets forth the book value of the Company's portfolio of securities held-to- maturity for each of the last three years. Year-end amounts and data in the following tables do not include the securities available-for-sale portfolio discussed previously. The substantial reduction in the held-to-maturity portfolio between year-end 1994 and year-end 1995 reflects the one-time reclassification in November 1995 discussed previously in the introduction to the investment portfolio discussion.
For information regarding the fair value of the Company's portfolio of securities held-to-maturity, see Note 3 to the Consolidated Financial Statements in Part II, Item 8
Item 8: Financial Statements and Supplementary Data
The following audited financial statements and supplementary data are incorporated herein by reference to the Company's Annual Report to Shareholders for December 31, 1996, which Annual Report is attached as Exhibit 13 to this Report:
Independent Auditors' Report
Financial Statements:
Consolidated Balance Sheets as of December 31, 1996 and 1995
Consolidated Statements of Income for the Years Ended December 31, 1996, 1995 and 1994
Consolidated Statements of Changes in Shareholders' Equity for the Years Ended December 31, 1996, 1995 and 1994
Consolidated Statements of Cash Flows for the Years Ended December 31, 1996, 1995 and 1994
Notes to Consolidated Financial Statements
Supplementary Data: (Unaudited)
Quarterly Financial Data for the Years Ended December 31, 1996 and 1995
Item 9:
Item 9: Changes in and Disagreements with Accountants on Accounting and Financial Disclosure. - None.
PART III
Item 10:
Item 10: Directors and Executive Officers of the Registrant
Item 1, "Election of Directors and Information with Respect to Directors and Officers" of the Company's Proxy Statement for its Annual Meeting of Shareholders to be held April 30, 1997 is incorporated herein by reference. Required information regarding the Company's Executive Officers is contained in Part I, Item 1.E., "Executive Officers of the Registrant."
Item 11:
Item 11: Executive Compensation
Item 1, "Election of Directors and Information with Respect to Directors and Officers" of the Company's Proxy Statement for its Annual Meeting of Shareholders to be held April 30, 1997 is incorporated herein by reference.
Item 12:
Item 12: Security Ownership of Certain Beneficial Owners and Management
Item 1, "Election of Directors and Information with Respect to Directors and Officers" of the Company's Proxy Statement for its Annual Meeting of Shareholders to be held April 30, 1997 is incorporated herein by reference.
Item 13:
Item 13: Certain Relationships and Related Transactions
Item 1, "Election of Directors and Information with Respect to Directors and Officers" of the Company's Proxy Statement for its Annual Meeting of Shareholders to be held April 30, 1997 is incorporated herein by reference.
PART IV
Item 14:
Item 14: Exhibits, Financial Statement Schedules and Reports on Form 8-K
A) Documents filed as part of this report:
I Financial Statements:
The following financial statements, the notes thereto, and the independent auditors' reports thereon are filed as part of this report, incorporated by reference from Exhibit 13 to this Report, the 1996 Annual Report to Shareholders. See the index to such financial statements in Part II, Item 8 of this report.
Independent Auditors' Report Consolidated Balance Sheets as of December 31, 1996 and 1995 Consolidated Statements of Income for the Years Ended December 31, 1996, 1995 and 1994 Consolidated Statements of Changes in Shareholders' Equity for the Years Ended December 31, 1996, 1995 and 1994 Consolidated Statements of Cash Flows for the Years Ended December 31, 1996, 1995 and 1994 Notes to Consolidated Financial Statements
II Schedules:
All schedules are omitted since the required information is either not applicable or not required or is contained in the respective financial statements or in the notes thereto.
III. Exhibits:
The following exhibits are incorporated by reference herein.
Exhibit Number Exhibit
2.1 Purchase and Assumption Agreement among Arrow Financial Corporation, Arrow Vermont Corporation, Green Mountain Bank and Mascoma Savings Bank, dated June 1, 1995 incorporated herein by reference from the Registrant's Current Report on Form 8-K, filed on August 4, 1995, Exhibit 2.1.
2.2 Supplement to Purchase and Assumption Agreement among Arrow Financial Corporation, Arrow Vermont Corporation, Green Mountain Bank and Mascoma Savings Bank, dated January 12, 1996 incorporated herein by reference from the Registrant's Current Report on Form 8-K, filed January 30, 1996, Exhibit 2.2.
2.3 Purchase and Assumption Agreement among Arrow Financial Corporation, Arrow Vermont Corporation, Green Mountain Bank and ALBANK, FSB, dated February 26, 1996 incorporated herein by reference from the Registrant's Current Report on Form 8-K, filed March 14, 1996, Exhibit 2.1.
2.4 Amendment to Purchase and Assumption Agreement among Arrow Financial Corporation, Arrow Vermont Corporation, Green Mountain Bank and ALBANK, FSB, dated September 26, 1996 incorporated herein by reference from the Registrant's Current Report on Form 8-K filed October 11, 1996, Exhibit 2.3.
2.5 Service Purchasing Agreement among Arrow Financial Corporation, Arrow Vermont Corporation, Green Mountain Bank and ALBANK, FSB, dated February 26, 1996 incorporated herein by reference from the Registrant's Current Report on Form 8-K filed March 14, 1996, Exhibit 2.2.
2.6 Amendment to Service Purchasing Agreement among Arrow Financial Corporation, Arrow Vermont Corporation, Green Mountain Bank and ALBANK, FSB, dated September 26, 1996 incorporated herein by reference from the Registrant's Current Report on Form 8-K, filed October 11, 1996, Exhibit 2.4.
2.7 Stock Purchase Agreement among Arrow Financial Corporation, Arrow Vermont Corporation, Green Mountain Bank and Vermont National Bank, dated February 27, 1996 incorporated herein by reference from the Registrant's Current Report on Form 8-K filed March 14, 1996, Exhibit 2.3.
3.(I) Certificate of Incorporation of the Registrant, as amended, incorporated herein by reference from the Registrant's Annual Report on Form 10-K for the year ended December 31, 1990, Exhibit 3.(a).
10.1 1985 Incentive Stock Option Plan of the Registrant, incorporated herein by reference from Registrant's 1933 Act Registration Statement on Form S-8 (file number 2-98736; filed on July 1, 1985). *
10.2 1985 Non-Qualified Stock Option Plan of the Registrant, incorporated herein by reference from Registrant's 1933 Act Registration Statement on Form S-8 (file number 2-98735; filed July 1, 1985). *
10.3 Short-term Incentive Award Plan of Glens Falls National Bank and Trust Company, incorporated herein by reference from Registrant's 1933 Act Registration Statement on Form S-2 (file number 33-10109; filed December 16, 1986). *
10.4 Employment Agreement between the Registrant and Michael F. Massiano dated December 31, 1990, incorporated herein by reference from Registrant's Annual Report on Form 10-K for the year ended December 31, 1990, Exhibit 10.(k). *
10.5 Employment Agreement between the Registrant and John J. Murphy dated December 31, 1990, incorporated herein by reference from Registrant's Annual Report on Form 10-K for the year ended December 31, 1992, Exhibit 10(g)(1). *
10.6 Employment Agreement between the Registrant, its subsidiary bank, Glens Falls National Bank & Trust Company, and Thomas L. Hoy dated December 31, 1990, incorporated herein by reference from Registrant's Annual Report on Form 10-K for the year ended December 31, 1992, Exhibit 10(j)(1). *
10.7 Select Executive Retirement Plan of the Registrant effective January 1, 1992 incorporated herein by reference from Registrant's Annual Report on Form 10-K for December 31, 1992, Exhibit 10(m). *
10.8 Employee Stock Purchase Plan of the Registrant, incorporated herein by reference from Registrant's 1933 Act Registration Statement on Form S-8 (File number 33-48225; filed May 15, 1992). *
10.9 Long Term Incentive Plan of the Registrant, incorporated herein by reference from Registrant's 1933 Act Registration Statement on Form S-8 (File number 33-66192; filed July 19, 1993). *
10.10 Directors Deferred Compensation Plan of Registrant, incorporated herein by reference from Registrant's Annual Report on Form 10-K for December 31, 1993, Exhibit 10(n). *
10.11 Senior Officers Deferred Compensation Plan of the Registrant, incorporated herein by reference from Registrant's Annual Report on Form 10-K for December 31, 1993, Exhibit 10(o).*
10.12 Automatic Dividend Reinvestment Plan of the Registrant incorporated herein by reference from Registrant's Annual Report on Form 10-K for December 31, 1995, Exhibit 10.11.*
* Management contracts or compensation plans required to be filed as an exhibit.
The following exhibits are submitted herewith:
Exhibit Number Exhibit
3.(ii) By-Laws of the Registrant
11 Computation of Earnings per Share
13 Annual Report to Shareholders
21 Subsidiaries of the Company
23 Consent of Independent Certified Public Accountants
27 Financial Data Schedule (submitted with electronic filing only)
(B) The following Current Reports on Form 8-K were filed during the fourth quarter of 1996:
Filed October 11, 1996:
Amendment to Purchase and Assumption Agreement among Arrow Financial Corporation, Arrow Vermont Corporation, Green Mountain Bank and ALBANK, FSB, dated September 26, 1996.
Filed October 11, 1996:
Amendment to Service Purchasing Agreement among Arrow Financial Corporation, Arrow Vermont Corporation, Green Mountain Bank and ALBANK, FSB, dated September 26, 1996.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
ARROW FINANCIAL CORPORATION
Date: March 26, 1997 By: /s/ Thomas L. Hoy Thomas L. Hoy President and Chief Executive Officer
Date: March 26, 1997 By: /s/ John J. Murphy John J. Murphy Executive Vice President, Treasurer and Chief Financial Officer (Principal Financial and Accounting Officer)
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below on March 26, 1997 by the following persons in the capacities indicated.
/s/ John J. Carusone,Jr. John J. Carusone Director
/s/ Michael B. Clarke Michael B. Clarke Director
/s/ George C. Frost George C. Frost Director
/s/ Kenneth C. Hopper, M.D. Kenneth C. Hopper, M.D. Director
/s/ Thomas L. Hoy Thomas L. Hoy Director and President
/s/ Edward F. Huntington Edward F. Huntington Director
/s/ David G. Kruczlnicki David G. Kruczlnicki Director
/s/ Michael F. Massiano Michael F. Massiano Director & Chairman
/s/ David L. Moynehan David L. Moynehan Director
/s/ Doris E. Ornstein Doris E. Ornstein Director
/s/ Daniel L. Robertson Daniel L. Robertson Director
EXHIBITS INDEX
Exhibit Number Exhibit
3.(ii) By-Laws of the Registrant
11 Computation of Earnings per Share
13 Annual Report to Shareholders
21 Subsidiaries of the Company
23 Consent of Independent Certified Public Accountants
27 Financial Data Schedule (submitted with electronic filing only)