SECURITIES AND EXCHANGE COMMISSION Washington D.C. 20549 FORM 10-K Annual Report Pursuant to Section 13 or 15(d) of The Securities Exchange Act of 1934 For the fiscal year ended December 31, 1997 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 (I.R.S. Employer Identification No.) 250 GLEN STREET, GLENS FALLS, NEW YORK 12801 (Address of principal executive offices) (Zip Code) Registrant's telephone number, including area code: (518) 745-1000 SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT - NONE SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT Common stock, Par Value $1.00 (Title of Class) Indicate by checkmark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. X Indicate by checkmark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes X No Indicate the number of shares outstanding of each of the registrant's classes of common stock, as of the latest practicable date. Class Common stock, Par Value $1.00 Per Share Outstanding at March 11, 1998 5,764,335 State the aggregate market value of the voting stock held by non-affiliates of registrant. Aggregate market value of voting stock $180,135,000 Based upon the average of the closing bid and closing asked prices on the NASDAQ Exchange March 11, 1998 DOCUMENTS INCORPORATED BY REFERENCE Portions of Registrant's Proxy Statement for the Annual Meeting of Shareholders to be held April 29, 1998 (Part III) and the Annual Report to Shareholders (Part II, Item 8)
ARROW FINANCIAL CORPORATION FORM 10-K INDEX Cautionary Statement under Federal Securities Laws PART I Item 1. Business A. General B. Lending Activities C. Supervision and Regulation D. Competition E. Statistical Disclosure (Guide 3) F. Legislative Developments G. Executive Officers of the Registrant Item 2. Properties Item 3. Legal Proceedings Item 4. Submission of Matters to a Vote of Security Holders PART II Item 5. Market for the Registrant's Common Equity and Related Stockholder Matters Item 6. Selected Financial Data Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations A. Overview B. Results of Operations I. Net Interest Income II. Provision for Loan Losses and Allowance for Loan Losses III. Other Income IV. Other Expense V. Income Taxes C. Financial Condition I. Investment Portfolio II. Loan Portfolio a. Distribution of Loans and Leases b. Risk Elements III. Summary of Loan Loss Experience IV. Deposits V. Time Certificates of $100,000 or More D. Liquidity E. Capital Resources and Dividends F. Fourth Quarter Results G. Year 2000 Preparedness Item 7A. Quantitative and Qualitative Disclosures About Market Risk Item 8. Financial Statements and Supplementary Data Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure PART III Item 10. Directors and Executive Officers of the Registrant Item 11. Executive Compensation Item 12. Security Ownership of Certain Beneficial Owners and Management Item 13. Certain Relationships and Related Transactions PART IV Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K Signatures Exhibits Index Cautionary Statement under Federal Securities Laws: The information contained in this Annual Report on Form 10-K 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," "anticipates," "believes," "should," "plans," "will," "estimates," and variations of such words and similar expressions are intended to identify such forward-looking statements (e.g., the adequacy of the allowance for loan losses to cover future losses and the risk of so-called "Year 2000" problems). 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. PART I Item 1: Business A. GENERAL Arrow Financial Corporation (the "Company"), a New York corporation, was incorporated on March 21, 1983 and is registered as a bank holding company within the meaning of the Bank Holding Company Act of 1956. The Company owns two nationally chartered banks in New York, Glens Falls National Bank and Trust Company, Glens Falls New York ("GFNB") and Saratoga National Bank and Trust Company, Saratoga Springs, New York ("SNB"), as well as several non-bank subsidiaries, the operations of which are not significant. The Company previously owned a bank in Vermont but sold all of its Vermont operations in 1996 in three separate transactions and liquidated its Vermont bank charter in 1997. 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 350 full-time equivalent employees of the Company and the subsidiary banks at December 31, 1997.
<TABLE> <CAPTION> SUBSIDIARY BANKS: GLENS (Dollars in Thousands) FALLS SARATOGA NATIONAL NATIONAL BANK & BANK & TRUST CO. TRUST CO. ("GFNB") ("SNB") <S> <C> <C> Total Assets at Year-End $750,017 $82,070 Trust Assets Under Management at Year-End (Not Included in Total Assets) $522,591 $ 4,335 Date Organized 1851 1988 Employees 344 22 State of Headquarters New York New York Offices 21 2 Counties of Operation Warren Saratoga Washington Saratoga Essex Clinton Main Office 250 Glen St. 137 So. Broadway Glens Falls, Saratoga, New York New York </TABLE> Each subsidiary bank offers a full range of commercial and consumer financial products. The banks' deposit base consists of core deposits derived principally from the communities which the banks serve. The banks target their lending activities to consumers and small and mid-sized companies in the banks' immediate geographic areas. In addition to traditional banking services, the Company offers credit card processing services for other financial institutions and, through its banks' trust departments, provides retirement planning, trust and estate administration services for individuals and pension, profit-sharing and employee benefit plan administration for corporations. B. LENDING ACTIVITIES The Company's subsidiary banks engage in a wide range of lending activities, including commercial and industrial lending primarily to small and mid-sized companies; mortgage lending for the purchase of residential and commercial properties; and consumer installment, credit card and home equity financing. The Company also maintains an active indirect lending program through its sponsorship of dealer programs, under which it purchases dealer paper from automobile and other dealers meeting pre-established specifications. 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 Part II, 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 22 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. (See "Capital Resources and Dividends" in Part II, Item 7.E of this report) 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 Bank Insurance Fund of 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 non- bank 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 or other bank holding companies 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 1997 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, repurchase its outstanding stock or expand its business through acquisitions of new subsidiaries can be restricted if capital falls below these capital adequacy guidelines or other informal capital guidelines or ratios that bank regulators may apply from time to time to specific banking organizations. In cases where banking regulators have significant concerns regarding the financial condition, assets or operations of a bank or bank holding company, the regulators may take enforcement action or impose enforcement orders, formal or informal, against the organization. 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 action or 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 Part II, Item 7 of this report, "Management's Discussion and Analysis of Financial Condition and Results of Operations," and in Part II, Item 8, "Financial Statements and Supplementary Data." <TABLE> <CAPTION> INDEX TO SECURITIES ACT GUIDE 3, STATISTICAL DISCLOSURE BY BANK HOLDING COMPANIES Required Information Location <S> <C> Distribution of Assets, Liabilities and Stockholders' Equity; Interest Rates and Interest Differential Part II, Item 7.B.I. Investment Portfolio Part II, Item 7.C.I. Loan Portfolio Part II, Item 7.C.II. Summary of Loan Loss Experience Part II, Item 7.C.III. Deposits Part II, Item 7.C.IV. Return on Equity and Assets Part II, Item 6. Short-Term Borrowings Part II, Item 8. Note 9. </TABLE> 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 were permitted to branch into any other state, except for those states which enacted legislation prior to June 1, 1997 "opting out" of interstate branching. Only Colorado and Montana elected to "opt out" of interstate branching; thus, the Company's banks may branch into all other states, including all states adjacent to New York, upon receipt of all required approvals and subject to certain conditions of state law. 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 classified as "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 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 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, in 1997, BIF-assessable deposits (like the Company's banks) were 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 federal bills affecting banks, 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. <TABLE> <CAPTION> G. EXECUTIVE OFFICERS OF THE REGISTRANT The names and ages of the principal executive officers of the Company and positions held are presented in the following table. The officers are elected annually by the Board of Directors. Name Age Positions Held and Years from Which Held <S> <C> <C> Thomas L. Hoy 49 President and CEO since January 1, 1997 and President and COO of Glens Falls National Bank since 1995. Mr. Hoy was Executive Vice President of Glens Falls National Bank prior to 1995. Mr. Hoy has been with the Company since 1974. John J. Murphy 46 Executive Vice President, Treasurer and CFO since 1993. Mr. Murphy has served as Senior Vice President, Treasurer and CFO of the Company since 1983. Mr. Murphy has been with the Company since 1973. John C. Van Leeuwen 54 Senior Vice President and Chief Credit Officer since 1995. Prior to 1995, Mr. Van Leeuwen served as Vice President and Loan Review Officer. Mr. Van Leeuwen has been with the Company since 1985. Gerard R. Bilodeau 50 Senior Vice President and Secretary since 1994. Mr. Bilodeau was Vice President and Secretary from 1993 to 1994 and was Director of Personnel prior to 1993. Mr. Bilodeau has been with the Company since 1969. </TABLE> 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 eighteen additional offices and leases two, 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 bank prior to the divestiture of those operations in 1996. The building was held for sale at December 31, 1997. Rental costs of premises did not exceed 5% of operating costs in 1997. In the opinion of management of the Company, the physical properties of the Company and the subsidiary banks are suitable and adequate. Item 3: Legal Proceedings The Company is not the subject of any material pending legal proceedings, other than ordinary routine litigation occurring in the normal course of its business. The Company's subsidiary banks are the subjects of or parties to various legal claims which arise in the normal course of their business. For example, 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: Submission of Matters to a Vote of Security Holders None in the fourth quarter of 1997. PART II Item 5: Market for the Registrant's Common Equity and Related Stockholder Matters The common stock of Arrow Financial Corporation is traded on The Nasdaq Stock MarketSM under the symbol AROW. 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 the November 1997 five percent stock dividend and the November 1996 ten percent stock dividend. <TABLE> <CAPTION> Market Price Cash (Bid) Dividends High Low Declared <S> <C> <C> <C> 1996 1st Quarter $17.500 $14.250 $.148 2nd Quarter 20.000 17.750 .148 3rd Quarter 19.750 16.875 .148 4th Quarter 22.625 19.750 .190 1997 1st Quarter $23.375 $22.125 $.190 2nd Quarter 26.375 23.375 .190 3rd Quarter 28.625 24.500 .190 4th Quarter 33.625 29.500 .210 </TABLE> The payment of dividends by the Company is at the discretion of the Board of Directors and is dependent upon, among other things, the Company's earnings, financial condition and other factors, including applicable governmental regulations and restrictions. See "Capital Resources and Dividends" in Part II, Item 7.E. of this report. There were approximately 2,696 holders of record of common stock at December 31, 1997.
<TABLE> <CAPTION> Item 6: Selected Financial Data FIVE YEAR SUMMARY OF SELECTED DATA Arrow Financial Corporation and Subsidiaries (Dollars In Thousands, Except Per Share Data) 1997 1996 1995 1994 1993 <S> <C> <C> <C> <C> <C> Consolidated Statements of Income Data: Interest and Dividend Income $54,861 $54,875 $60,718 $52,514 $51,836 Less: Interest Expense 23,887 21,826 24,865 18,202 19,583 Net Interest Income 30,974 33,049 35,853 34,312 32,253 Less: Provision for Loan Losses 1,303 896 1,170 (950) 690 Net Interest Income After Provision for Loan Losses 29,671 32,153 34,683 35,262 31,563 Other Income 8,109 23,804 14,473 9,049 9,086 Net Gains (Losses) on Securities Transactions 74 (101) 23 (481) 26 Less: Other Expense 21,702 24,774 29,769 31,374 32,118 Income Before Income Taxes, Extra- ordinary Item and Cumulative Effect of Accounting Change 16,152 31,082 19,410 12,456 8,557 Provision for Income Taxes 5,155 10,822 6,986 1,131 381 Income Before Accounting Change 10,997 20,260 12,424 11,325 8,176 Cumulative Effect of a Change in Accounting for Income Taxes --- --- --- --- 1,457 Net Income $10,997 $20,260 $12,424 $11,325 $ 9,633 Basic Earnings Per Common Share: Income Before Accounting Change $ 1.88 $ 3.28 $ 1.89 $ 1.71 $ 1.25 Accounting Change --- --- --- --- .22 Net Income $ 1.88 $ 3.28 $ 1.89 $ 1.71 $ 1.47 Diluted Earnings Per Common Share: Income Before Accounting Change $ 1.86 $ 3.24 $ 1.88 $ 1.65 $ 1.25 Accounting Change --- --- --- --- .22 Net Income $ 1.86 $ 3.24 $ 1.88 $ 1.65 $ 1.47 Per Common Share: Cash Dividends $ .78 $ .63 $ .49 $ .31 $ .09 Book Value 12.82 12.29 10.39 8.83 7.56 Tangible Book Value 10.41 11.98 10.06 8.57 7.29 Consolidated Year-End Balance Sheet Data: Total Assets $831,559 $652,603 $789,790 $746,431 $733,442 Securities Available-for-Sale 221,837 171,743 178,645 53,868 55,892 Securities Held-to-Maturity 44,082 30,876 13,921 129,735 125,832 Loans and Leases, Net of Unearned Income 485,810 393,511 517,787 507,553 502,784 Nonperforming Assets 3,999 2,754 6,765 7,825 20,136 Deposits 720,915 541,747 694,453 650,485 659,427 Other Borrowed Funds 24,755 22,706 15,297 24,865 12,487 Long-Term Debt --- --- --- 5,007 5,289 Shareholders' Equity 73,871 74,296 67,504 58,405 50,069 Selected Key Ratios: Return on Average Assets 1.49% 2.86% 1.60% 1.52% 1.33% Return on Average Equity 15.19 28.78 19.45 20.79 21.03 Dividend Payout 41.49 19.47 25.89 19.08 5.84 Average Equity to Average Assets 9.80 9.95 8.22 7.34 6.32 Per share amounts have been adjusted for the 1997 five percent, the 1996 ten percent and the 1995 and 1994 four percent stock dividends. </TABLE>
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, 1997 and the financial condition of the Company as of December 31, 1997 and 1996. Per share amounts have been restated to reflect the five percent stock dividend paid in November 1997 and the ten percent stock dividend paid in November 1996. 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 $11.0 million for 1997 compared to net income of $20.3 million for 1996 and $12.4 million for 1995. As indicated in the following table "Summary of Core Earnings," net income from each year included nonrecurring items. For 1997, the principal nonrecurring item was a favorable tax settlement with New York State over a combined reporting issue. For 1996 the major item was the $10.3 million in net after-tax gains from the sale of the Company's Vermont bank, and for 1995 the major item was a settlement the Company received from its financial institution bond carrier for losses suffered in earlier periods. Net income on a recurring basis, increased $157 thousand, or 1.6% from 1996 to 1997 and basic earnings per share increased $.12, or 7.5%, from $1.60 in 1996 to $1.72 in 1997. The earnings per share increase was bolstered by the repurchase of 335 thousand shares of the Company's common stock during 1997, at an average cost of $23.87. The following analysis adjusts net income for nonrecurring items to arrive at a comparative presentation of the Company's "core" earnings: <TABLE> <CAPTION> SUMMARY OF CORE EARNINGS (In Thousands, Except Per Share Data) 1997 1996 1995 <S> <C> <C> <C> Net Income, as Reported $10,997 $20,260 $12,424 Nonrecurring Items, Net of Tax: State Tax Settlement (464) --- --- Divestiture of Vermont Banking Operations --- (10,267) --- Bond Settlement --- --- (3,250) OREO Transactions (70) 174 136 Severance Benefits --- --- 388 Net Securities Transactions (44) 57 (12) Other (361) (323) (218) Recurring Net Income $10,058 $ 9,901 $ 9,468 Recurring Basic Earnings Per Share $ 1.72 $ 1.60 $ 1.44 </TABLE> At the end of the second quarter of 1997, the Company completed the acquisition of six branches from Fleet Bank, extending the Company's market area northward to Plattsburgh, New York. Effects of the acquisition are discussed throughout the following narrative and in Note 23 to the Consolidated Financial Statements. At December 31, 1997, the Company's tangible book value per share (shareholders' equity reduced by intangible assets including goodwill, mortgage servicing rights and intangible pension plan assets) amounted to $10.41, a decrease of $1.57 from the prior year-end. The decrease was attributable to goodwill acquired in the Fleet transaction and treasury stock purchases, offset in part by retained current year earnings. At year-end, the average of the Company's bid and asked stock price was $33.75, resulting in a trading multiple of 3.24 to tangible book value. During the fourth quarter of 1997, the Company increased its quarterly cash dividend to $.21 and for the year, cash dividends of $.78 represented an increase of $.15 from $.63 in 1996. The combined 1997 return on the Company's December 31, 1996 stock price was 52.7%, based on the average of the bid and asked prices. Nonperforming assets amounted to $4.0 million at December 31, 1997, an increase of $1.2 million from the prior year-end. The increase was primarily attributable to one large commercial loan placed on nonaccrual status during the year. At year-end, the allowance for loan losses, at $6.2 million, represented 168% of nonperforming loans. Acquisition of Six Fleet Branches On June 27, 1997, the Company completed the acquisition of six branches in Upstate New York from Fleet Bank, a subsidiary of Fleet Financial Group, Hartford, CT. The branches, located in the towns of Plattsburgh (2), Lake Luzerne, Port Henry, Ticonderoga and Warrensburg became branches of Glens Falls National Bank. Glens Falls National Bank 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 Glens Falls National Bank were approximately $140 million and the total amount of branch- related loans acquired was approximately $34 million. Under the purchase agreement, Glens Falls National Bank also acquired from Fleet an additional $10 million of residential real estate loans not related to the branches. 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 charter of GMB was liquidated in 1997 and remaining net assets distributed to the Company. All significant assets relating to the business or operations of GMB have been sold, except for the building which served as GMB's main office in Rutland, Vermont, which was being held for sale at December 31, 1997 and 1996. Total loans and deposits transferred in the three Vermont sale transactions 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 1997 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 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. <TABLE> <CAPTION> COMPARISON OF NET INTEREST INCOME (Dollars In Thousands) (Fully Taxable Basis) Years Ended December 31, Change From Prior Year 1997 1996 1995 1997 1996 Amount Percent Amount Percent <S> <C> <C> <C> <C> <C> <C> <C> Interest Income $55,705 $55,517 $61,411 $ 188 .3% $(5,894) (9.6)% Interest Expense 23,887 21,826 24,865 2,061 9.4 (3,039) (12.2) Net Interest Income $31,818 $33,691 $36,546 $(1,873) (5.6) $(2,855) (7.8) </TABLE> On a tax-equivalent basis, net interest income was $31.8 million in 1997, a decrease of $1.9 million or, 5.6% from $33.7 million in 1996. Factors contributing to the $1.9 million decrease in net interest income are discussed in the following section. 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.
<TABLE> <CAPTION> CHANGE IN NET INTEREST INCOME (In Thousands) (Fully Taxable Basis) 1997 to 1996 1996 to 1995 Change in Net Interest Income Change in Net Interest Income Due to: Due to: Volume Rate Total Volume Rate Total <S> <C> <C> <C> <C> <C> <C> Interest and Dividend Income: Federal Funds Sold $ 363 $ 30 $ 393 $ (560) $ (105) $ (665) Securities Available-for-Sale Taxable 626 493 1,119 6,962 198 7,160 Non-Taxable 60 --- 60 (79) --- (79) Securities Held-to-Maturity: Taxable 1,394 9 1,403 (7,197) 527 (6,670) Non-Taxable 517 (27) 490 251 6 257 Loans and Leases (1,882) (1,395) (3,277) (4,928) (969) (5,897) Total Interest and Dividend Income 1,078 (890) 188 (5,551) (343) (5,894) Interest Expense: Deposits: Interest-Bearing Demand Deposits 383 297 680 (244) 56 (188) Regular and Money Market Savings (326) (108) (434) (1,298) (272) (1,570) Time Deposits of $100,000 or More 426 110 536 657 (220) 437 Other Time Deposits 848 204 1,052 (1,543) (17) (1,560) Total Deposits 1,331 503 1,834 (2,428) (453) (2,881) Short-Term Borrowings 196 31 227 122 (50) 72 Long-Term Debt --- --- --- (230) --- (230) Total Interest Expense 1,527 534 2,061 (2,536) (503) (3,039) Net Interest Income $ (449) $(1,424) $(1,873) $(3,015) $ 160 $(2,855) </TABLE> The following table reflects the components of the Company's net interest income, setting forth, for years ended December 31, 1997, 1996 and 1995 (I) average balances of assets, liabilities and shareholders' equity, (II) interest and dividend 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. The yield on securities available-for-sale is based on the amortized cost of the securities. Nonaccrual loans are included in average loans and leases, while unearned income has been eliminated. AVERAGE CONSOLIDATED BALANCE SHEETS AND NET INTEREST INCOME ANALYSIS <TABLE> <CAPTION> Arrow Financial Corporation and Subsidiaries (Fully Taxable Basis using a marginal tax rate of 35%) (Dollars In Thousands) Years Ended December 31, 1997 1996 Interest Rate Interest Rate Average Income/ Earned/ Average Income/ Earned/ Balance Expense Paid Balance Expense Paid <S> <C> <C> <C> <C> <C> <C> Federal Funds Sold $ 18,752 $ 1,035 5.52% $ 12,150 $ 642 5.28% Securities Available- for-Sale: (1) Taxable 183,261 12,219 6.67 173,703 11,100 6.39 Non-Taxable 1,142 65 5.73 80 5 5.75 Securities Held-to-Maturity: Taxable 20,413 1,464 7.17 959 61 6.36 Non-Taxable 22,713 1,834 8.08 16,316 1,344 8.24 Loans & Leases 439,103 39,088 8.90 459,946 42,365 9.21 Total Earning Assets 685,384 55,705 8.13 663,154 55,517 8.37 Allowance For Loan Losses (6,021) (10,102) Cash and Due From Banks 26,341 25,303 Other Assets 32,732 28,975 Total Assets $738,436 $707,330 Deposits: Interest-Bearing Demand Deposits $144,204 4,467 3.10 $131,438 3,787 2.88 Regular and Money Market Savings 146,529 4,183 2.85 157,892 4,617 2.92 Time Deposits of $100,000 or More 87,956 4,734 5.38 79,996 4,198 5.25 Other Time Deposits 171,820 9,385 5.46 156,236 8,333 5.33 Total Interest-Bearing Deposits 550,509 22,769 4.14 525,562 20,935 3.98 Short-Term Borrowings 22,491 1,118 4.97 18,524 891 .81 Long-Term Debt. --- --- --- --- --- --- Total Interest- Bearing Funds 573,000 23,887 4.17 544,086 21,826 4.01 Demand Deposits 78,704 77,479 Other Liabilities 14,339 15,374 Total Liabilities 666,043 636,939 Shareholders' Equity 72,393 70,391 Total Liabilities and Shareholders' Equity $738,436 $707,330 Net Interest Income (Fully Taxable Basis) 31,818 33,691 Reversal of Tax Equivalent Adjustment (844) (642) Net Interest Income $30,974 33,049 Net Interest Spread 3.96% 4.36% Net Interest Margin 4.64% 5.08% (1) Yields do not give effect to changes in fair value that are reflected as a component of shareholders' equity. </TABLE>
<TABLE> <CAPTION> Years Ended December 31, 1995 Interest Rate Average Income/ Earned/ Balance Expense Paid <S> <C> <C> <C> Federal Funds Sold $ 22,596 $ 1,307 5.78% Securities Available- for-Sale: (1) Taxable 64,621 3,940 6.10 Non-Taxable 1,454 84 5.78 Securities Held-to-Maturity: Taxable 113,499 6,731 5.93 Non-Taxable 13,271 1,087 8.19 Loans & Leases 513,266 48,262 9.40 Total Earning Assets 728,707 61,411 8.43 Allowance For Loan Losses (12,288) Cash and Due From Banks 28,081 Other Assets 32,929 Total Assets $777,429 Deposits: Interest-Bearing Demand Deposits $139,879 3,975 2.84 Regular and Money Market Savings 201,932 6,187 3.06 Time Deposits of $100,000 or More 67,029 3,761 5.61 Other Time Deposits 185,166 9,893 5.34 Total Interest-Bearing Deposits 594,006 23,816 4.01 Short-Term Borrowings 15,855 819 5.17 Long-Term Debt. 2,619 230 8.78 Total Interest- Bearing Funds 612,480 24,865 4.06 Demand Deposits 88,961 Other Liabilities 12,097 Total Liabilities 713,538 Shareholders' Equity 63,891 Total Liabilities and Shareholders' Equity $777,429 Net Interest Income (Fully Taxable Basis) 36,546 Reversal of Tax Equivalent Adjustment (693) Net Interest Income $35,853 Net Interest Spread 4.37% Net Interest Margin 5.02% (1) Yields do not give effect to changes in fair value that are reflected as a component of shareholders' equity. </TABLE>
<TABLE> <CAPTION> CHANGES IN NET INTEREST INCOME DUE TO RATE YIELD ANALYSIS December 31, 1997 1996 1995 <S> <C> <C> <C> Yield on Earning Assets 8.13% 8.37% 8.43% Cost of Interest-Bearing Liabilities 4.17 4.01 4.06 Net Interest Spread 3.96% 4.36% 4.37% Net Interest Margin 4.64% 5.08% 5.02% </TABLE> The following items have a major impact on changes in net interest income due to rate: general interest rate changes, the ratio of the Company's rate sensitive assets to rate sensitive liabilities (interest rate sensitive gap) during periods of interest rate changes and the level 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: <TABLE> <CAPTION> Federal Reserve Board's Discount Rate Changes 1994 - 1997 Date New Rate Old Rate <S> <C> <C> January 31, 1996 5.00% 5.25% February 1, 1995 5.25 4.75 November 15, 1994 4.75 4.00 August 16, 1994 4.00 3.50 May 17, 1994 3.50 3.00 </TABLE> Although the Federal Reserve Board did not raise the discount rate during 1997, its open market operations early in 1997 led directly to a 25 basis point increase in the federal funds overnight rate. This increase in the cost of federal funds was mirrored in an overall increase in the cost of funds to the Company, while at the same time its yield on earning assets decreased. The net interest margin for 1997, at 4.64%, represented a 44 basis point decrease from the net interest margin of 5.08% in 1996. This reflects a 24 basis point decrease in the yield on earning assets and a 16 basis point increase in the cost of paying liabilities from 1996 to 1997. A significant shift in the mix of earning assets between the two periods accounted for most of the decrease in the yield on earning assets. After the sale of the remaining Vermont branches at the end of September 1996, and particularly after the June 1997 acquisition of the six Fleet branches, the Company maintained a significantly larger portion of its earning assets in securities and federal funds sold, which were at lower yields than the Company's loan portfolio. This was due to the fact that the Vermont banking operations maintained a high loan to deposit ratio during the 1996 period whereas the loan to deposit ratio of the Fleet branches acquired was much lower; the lower-yielding liquid assets received from Fleet are only gradually being reinvested in securities and loans. Moreover, in the 1996 period, the yield on loans in the Vermont portfolio was temporarily boosted as a result of unexpected payments on certain restructured loans reported in that period as interest income. Moreover, the New York based loan portfolio experienced a shift in the mix of loan products favoring lower yielding indirect loans. The shrinking net interest margin between 1996 and 1997 was the primary factor contributing to the $2.1 million decrease in net interest income between the periods. As indicated in the table "Change in Net Interest Income," presented earlier in this discussion on net interest income, the decrease in net interest income attributable to rate from 1996 to 1997 was $1.4 million. In the 1995 to 1996 analysis, the Company experienced minimal impact on net interest income resulting from changes in interest rates. Throughout 1996, interest rates, on both the asset and liability side, 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%. 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 earning assets and interest-bearing liabilities is included later in this report under Item 7.E. "Interest Rate Risk." <TABLE> <CAPTION> CHANGES IN NET INTEREST INCOME DUE TO VOLUME AVERAGE BALANCES (Dollars in Thousands) Change % Change 1997 1996 1995 1997 1996 1997 1996 <S> <C> <C> <C> <C> <C> <C> <C> Earning Assets $685,384 $663,154 $728,707 $ 22,230 $(65,553) 3.4 % (9.0)% Interest-Bearing Liabilities 573,000 544,086 612,480 28,914 (68,394) 5.3 (11.2) Demand Deposits 78,704 77,479 88,961 1,225 (11,482) 1.6 (12.9) Total Assets 738,436 707,330 777,429 31,106 (70,099) 4.4 (9.0) Earning Assets to Total Assets 92.82% 93.75% 93.73% .94% .02% (1.0) 0.0 </TABLE> In general, changes in the volume of earning assets and paying liabilities will result in corresponding changes in net interest income. However, changes due to volume can be enhanced or restricted by shifts within the relative mix of earning assets or interest-bearing liabilities between instruments of different rates. Average earning assets increased by $22.2 million, or 3.4%, between 1996 and 1997. However, average interest bearing liabilities increased even more, by 5.3%, between the two years. The negative impact of faster growth in interest-bearing liabilities than in earning assets was exacerbated by shifts within average earning assets between the two years. The disposition of the Vermont bank in 1996 involved the sale of an operation with a relatively high loan-to-deposit ratio. The acquisition of six branches from Fleet Bank in June 1997, on the other hand, involved the acquisition of a relatively small percentage of loans (approximately $44 million) and a relatively high level of lower yielding-liquid assets (approximately $80 million in cash) with the latter initially being invested in federal funds and only gradually being reinvested in higher- yielding securities and loans. Between 1995 and 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 continuing New York operations are discussed later in this report under Item 7.C. "Financial Condition." In general, the New York banks experienced significant growth during 1997 and 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. 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, 1997, nonperforming loans amounted to $3.7 million, an increase of 40.7% from the balance at December 31, 1996. The increase is primarily attributable to one large commercial loan placed on nonaccrual status during 1997. During 1997, loan losses charged against the allowance, net of recoveries, were $1.4 million, or .32% of average loans for the period. The provision for loan losses charged to expense for 1997 was $1.3 million, or .30% of average loans for the period. A purchase acquisition adjustment to the allowance of $700 thousand for loans acquired in the Fleet branch transaction represented the allowance for inherent risk of loss in the loans acquired. The Company believes the amount is materially consistent with the general loss reserve on the books of Fleet applicable to these loans. At December 31, 1997 the allowance for loan losses was $6.2 million. The allowance for loan losses was 168% of the amount of nonperforming loans at that date. During 1996, loan losses charged against the allowance, net of recoveries, were $581 thousand, or .13% of average loans for the period. However, the allowance for loan losses was significantly reduced during the year by $6.8 million. This was the amount of the reserve attributable to loans transferred in the divestiture of the Vermont banking operations. 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% and .40% 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 net credit of $950 thousand, compared to a provision of $690 thousand in 1993. As a ratio of average loans, the provisions were (.19)% in 1994 and .14% for 1993.
<TABLE> <CAPTION> SUMMARY OF THE ALLOWANCE AND PROVISION FOR LOAN LOSSES (Dollars In Thousands) (Loans and Leases, Net of Unearned Income) Years-Ended December 31, 1997 1996 1995 1994 1993 <S> <C> <C> <C> <C> <C> Loans and Leases at End of Period $485,810 $393,511 $517,787 $507,553 $502,784 Average Loans and Leases 439,103 459,946 513,266 502,224 89,326 Total Assets at End of Period 831,599 652,603 789,790 746,431 733,442 Nonperforming Assets: Nonaccrual Loans: Construction and Land Development $ --- $ --- $ 104 $ 327 $ 2,534 Commercial Real Estate 119 83 1,299 1,050 2,649 Commercial Loans 1,951 1,487 1,979 1,017 2,596 Other 1,251 727 862 1,224 2,082 Total Nonaccrual Loans 3,321 2,297 4,244 3,618 9,861 Loans Past Due 90 or More Days and Still Accruing Interest 363 321 111 231 364 Restructured Loans in Compliance with Modified Terms --- --- --- 580 2,405 Total Nonperforming Loans 3,684 2,618 4,355 4,429 12,630 Other Real Estate Owned 315 136 2,410 3,396 7,506 Total Nonperforming Assets $ 3,999 $ 2,754 $ 6,765 $ 7,825 $ 20,136 Allowance for Loan Losses: Balance at Beginning of Period $ 5,581 $ 12,106 $ 12,338 $ 16,078 $ 17,328 Allowance Acquired (Transferred) 700 (6,841) --- --- --- Loans Charged-off: Commercial, Financial and Agricultural (596) (185) (579) (997) (973) Real Estate - Commercial --- (104) (369) (689) (106) Real Estate - Construction --- (2) (101) (1,181) (377) Real Estate - Residential (121) (57) (160) (143) (151) Installment Loans to Individuals (881) (598) (562) (476) (480) Lease Financing Receivables --- --- --- --- --- Total Loans Charged-off (1,598) (946) (1,771) (3,486) (3,087) Recoveries of Loans Previously Charged-off: Commercial, Financial and Agricultural 27 84 76 260 694 Real Estate - Commercial 2 48 104 35 75 Real Estate - Construction --- --- 10 68 55 Real Estate - Residential 3 12 8 143 37 Installment Loans to Individuals 173 222 171 188 285 Lease Financing Receivables --- --- --- 2 1 Total Recoveries of Loans Previously Charged-off 205 366 369 696 1,147 Net Loans Charged-off (1,393) (580) (1,402) (2,790) (1,940) Provision for Loan Losses Charged to Expense 1,303 896 1,170 (950) 690 Balance at End of Period $ 6,191 $ 5,581 $ 12,106 $ 12,338 $ 16,078 Nonperforming Asset Ratio Analysis: Net Loans Charged-off as a Percentage of Average Loans .32% .13% .27% .56% .40% Provision for Loan Losses as a Percentage of Average Loans .30 19 .23 (.19) .14 Allowance for Loan Losses as a Percentage of Period-end Loans 1.27 1.42 2.34 2.43 3.20 Allowance for Loan Losses as a Percentage of Nonperforming Loans 168.05 213.18 277.98 278.57 127.30 Nonperforming Loans as a Percentage of Period-end Loans .76 .67 .84 .87 2.51 Nonperforming Assets as a Percentage of Period-end Total Assets .48 .42 .86 1.05 2.75 </TABLE> III. OTHER INCOME The majority of other (i.e., noninterest) income is derived from fees and commissions from fiduciary services, deposit account service charges, computer processing fees to correspondents and other "core" or recurring sources. Additionally, other income is influenced by transactions involving the sale of securities available-for-sale. <TABLE> <CAPTION> ANALYSIS OF OTHER INCOME (Dollars In Thousands) Change December 31, Amount Percent 1997 1996 1995 1997 1996 1997 1996 <S> <C> <C> <C> <C> <C> <C> <C> Income from Fiduciary Activities $ 2,672 $ 3,458 $ 3,752 $ (786) $ (294) (22.7)% (7.8)% Fees for Other Services 3,723 3,959 4,669 (236) (710) (6.0) (15.2) Net Securities Gains (Losses) 74 (101) 23 175 (124) --- --- Net Gain on Divestiture of Vermont Operations --- 15,330 --- (15,330) 15,330 --- --- Other Operating Income 1,714 1,057 6,052 657 (4,995) 62.2 (82.5) Total Other Income $ 8,183 $23,703 $14,496 $(15,520) $ 9,207 (65.5) 63.5 </TABLE> Without regard to the $15.3 million net pre-tax gain on the divestiture of the Vermont operations in 1996 and the impact of net securities transactions in both years, other income for 1997 decreased $365 thousand, or 4.3%, from the 1996 period. Income from fiduciary activities decreased $786 thousand, or 22.7%, from 1996 to 1997. The Vermont trust business, which was sold in August 1996, had represented approximately one half of the Company's income from fiduciary activities. The Company did not acquire any trust business from Fleet in the June 1997 branch acquisition. Income from the New York based trust business increased by $249 thousand, or 10.3% from 1996 to 1997, but this was not enough to offset the decrease in trust income resulting from the Vermont sale. Trust assets under management were $526.9 million at December 31, 1997, an increase of $92.3 million, or 21.2%, from December 31, 1996. Fees for other services include deposit service charges, credit card merchant processing fees, safe deposit box fees and loan servicing fees. These fees amounted to $3.7 million in 1997, a decrease of $236 thousand, or 6.0%, from 1996. The decrease was primarily attributable to loan servicing fees related to serviced loans transferred in the disposition of Vermont operations in September 1996. To a lesser extent, the decrease was attributable to the fact that the Company sold deposit balances in 1996 of $108 million, which contributed fee income for nine months in that period, and purchased $140 million of deposit balances from Fleet in June 1997, which contributed service fee income for only six months in that year. 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 and other real estate owned. Other operating income for 1997 amounted to $1.7 million, an increase of $657 thousand, or 62.2%, from 1996. The increase was primarily attributable to one-time receipts in 1996 relating to an insurance settlement and unexpected payments related to the former Vermont operations. Without regard to these two items, the period-to-period change would have been an increase of $126 thousand, or 11.9%, from 1996, and was attributable to an increase in miscellaneous other revenues. During 1997, the Company realized net gains of $74 thousand on the sale of securities classified as available-for-sale. Proceeds from these sales amounted to $37.0 million with gross gains of $137 thousand, offset in part by gross losses of $63 thousand. The primary purpose of the sales was to extend the average maturity of the portfolio. In the prior year comparison, 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 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, 1997 and 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 relating to the Vermont operations and amounts reserved for liquidation-related costs and expenses. 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. 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 49% 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 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 amounted to $1.1 million for both 1996 and 1995. IV. OTHER EXPENSE Other (i.e., noninterest) expense is a means of measuring the delivery cost of services, products and business activities of the Company. The key components of other expense are presented in the following table. <TABLE> <CAPTION> ANALYSIS OF OTHER EXPENSE (Dollars In Thousands) Change December 31, Amount Percent 1997 1996 1995 1997 1996 1997 1996 <S> <C> <C> <C> <C> <C> <C> <C> Salaries and Benefits $12,726 $14,971 $16,710 $(2,245) $(1,739) (15.0)% (10.4)% Net Occupancy Expense 1,561 1,790 2,040 (229) (250) (12.8) (12.3) Furniture and Equipment 1,792 1,677 1,930 115 (253) 6.9 (13.1) Other Operating Expense 5,623 6,336 9,089 (713) (2,753) (11.3) (30.3) Total Other Expense $21,702 $24,774 $29,769$ 3,072) $(4,995) (12.4) (16.8) </TABLE> Other expense for 1997 amounted to $21.7 million, a decrease of $3.1 million, or 12.4%, from 1996. Most of the decrease was in the area of employee salaries and benefits. With the sale of the Vermont operations in 1996, the Company reduced the number of its employees by 83 (71 full time equivalent), most of whom continued as employees of the purchasers. Upon acquisition of the Fleet branches in June 1997, the Company retained all 34 employees (32 full time equivalent). The net reduction in staff was primarily responsible for the $2.2 million decrease in salaries and benefits, offset in part by normal salary increases. Occupancy expenses and other operating expenses decreased by 12.8% and 11.3%, respectively, from 1996 to 1997. The decreases are, again, primarily attributable to the fact that the decrease in expenses resulting from the sale of the Vermont operations in 1996 outweighed the increase in expenses resulting from the acquisition of six Fleet branches in June 1997. Furniture and equipment expense increased by $115 thousand, or 6.9%, from 1996 to 1997, primarily due to an investment in data processing equipment at the end of 1996. In the prior year comparison, 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. V. INCOME TAXES The following table sets forth the Company's provision for income taxes and effective tax rates for the periods presented. <TABLE> <CAPTION> INCOME TAXES AND EFFECTIVE RATES (Dollars in Thousands) Years Ended December 31, 1997 1996 1995 <S> <C> <C> <C> Provision for Income Taxes $5,155 $10,822 $6,986 Effective Tax Rate 31.9% 34.8% 36.0% </TABLE> The provisions for federal and state income taxes amounted to $5.2 million, $10.8 million and $7.0 million for 1997, 1996 and 1995, respectively. The effective income tax rates for 1997, 1996 and 1995 were 31.9%, 34.8% and 36.0%, respectively. The decrease in the effective income tax rate from 1996 to 1997 was primarily attributable to a favorable settlement with the New York Department of Taxation and Finance over a combined reporting issue in the first quarter of 1997. The decrease in the effective income tax rate from 1995 to 1996 was primarily attributable to increases in the Company's tax exempt loan and securities portfolios.
C. FINANCIAL CONDITION I. INVESTMENT PORTFOLIO Investment securities are 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, 1997, the Company held no trading securities. Securities Available-for-Sale: The following table sets forth the carrying value of the Company's securities available-for-sale portfolio, at year-end 1997, 1996 and 1995. <TABLE> <CAPTION> SECURITIES AVAILABLE-FOR-SALE (In Thousands) December 31, 1997 1996 1995 <S> <C> <C> <C> U.S. Treasury and Agency Obligations $ 76,006 $ 95,733 $114,502 State and Municipal Obligations 2,999 --- 338 Collateralized Mortgage Obligations 67,207 42,894 44,173 Other Mortgage-Backed Securities 64,057 21,732 10,478 Corporate and Other Debt Securities 9,145 9,184 7,300 Mutual Funds and Equity Securities 2,423 2,200 1,854 Total $221,837 $171,743 $178,645 </TABLE> 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 ("CMOs") 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 CMOs with shorter maturities. Regulatory agencies have devised a high-risk test for mortgage-backed securities, including CMO's. Under the test a mortgage-backed product will not be considered high risk if the following conditions are met: (I) Average Life Test - if the product has an average life of less than 10 years; (II) Average Life Sensitivity Test - if 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 - if 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 securities 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, 1997. CMO's are included in the table based on their expected average life and other mortgage-backed securities by final maturity date. <TABLE> <CAPTION> MATURITIES OF SECURITIES AVAILABLE-FOR-SALE (In Thousands) After After Within 1 But 5 But After One Within Within 10 Year 5 Years 10 Years Years Total <S> <C> <C> <C> <C> <C> U.S. Treasury and Agency Obligations $19,033 $ 40,794 $16,179 $ -- $ 76,006 State and Municipal Obligations 2,999 --- --- --- 2,999 Collateralized Mortgage Obligations 965 51,594 13,645 1,003 67,207 Other Mortgage-Backed Securities 455 8,130 7,412 48,060 64,057 Corporate and Other Debt Securities 1,014 7,131 1,000 -- 9,145 Mutual Funds and Equity Securities --- --- --- 2,423 2,423 Total $24,466 $107,649 $38,236 $51,486 $221,837 </TABLE> The following table sets forth the tax-equivalent yields of the Company's securities available-for- sale portfolio at December 31, 1997. <TABLE> <CAPTION> YIELDS ON SECURITIES AVAILABLE-FOR-SALE (Fully Tax-Equivalent Basis) After After Within 1 But 5 But After One Within Within 10 Year 5 Years 10 Years Years Total <S> <C> <C> <C> <C> <C> U.S. Treasury and Agency Obligations 6.14% 6.34% 6.89% ---% 6.41% State and Municipal Obligations 6.14 --- --- --- 6.14 Collateralized Mortgage Obligations 7.02 6.66 6.90 6.98 6.72 Other Mortgage-Backed Securities 6.00 7.23 7.30 6.96 7.03 Corporate and Other Debt Securities 7.59 7.30 7.10 --- 6.52 Mutual Funds and Equity Securities --- --- --- 6.93 6.93 Total 6.23 6.62 6.79 6.96 6.69 </TABLE> The yields for debt securities shown in the table above are calculated by dividing annual interest, including accretion of discounts and amortization of premiums, by the carrying value of the securities at December 31, 1997. 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 1997, the Company realized net gains of $74 thousand on the sale of securities available- for-sale. Proceeds from these sales amounted to $37.0 million with gross gains of $137 thousand, offset in part by gross losses of $63 thousand. Proceeds were reinvested in available-for-sale securities. The primary purpose of the sales was to extend the average maturity of the available- for-sale portfolio. During 1996, the Company realized net losses of $101 thousand on the sale of $51.1 million of securities from the available-for-sale portfolio. Proceeds from sales early in the year were used to provide funds in completing the sale of eight branches of the Vermont bank to Mascoma Savings Bank, a transaction in which the deposit liabilities assumed by the purchaser substantially exceeded the loans and other branch-related assets acquired including 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. At December 31, 1997 and 1996, the weighted average maturity was 2.40 and 2.71 years, respectively, for debt securities in the available-for-sale portfolio. At December 31, 1997 the net unrealized gain on securities available-for-sale amounted to $1.3 million. The net unrealized gain or loss, net of tax, is 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. <TABLE> <CAPTION> SECURITIES HELD-TO-MATURITY (In Thousands) December 31, 1997 1996 1995 <S> <C> <C> <C> State and Municipal Obligations $24,800 $19,765 $13,921 Other Mortgage-Backed Securities 19,282 11,111 --- Total $44,082 $30,876 $13,921 </TABLE> 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 of this report. The following table sets forth the maturities of the Company's portfolio of securities held-to-maturity, as of December 31, 1997. Other mortgage-backed securities are allocated to maturity periods based on final maturity date.
<TABLE> <CAPTION> MATURITIES OF SECURITIES HELD-TO-MATURITY (In Thousands) After After Within 1 But 5 But After One Within Within 10 Year 5 Years 10 Years Years Total <S> <C> <C> <C> <C> <C> State and Municipal Obligations $2,667 $3,125 $11,185 $ 7,823 $24,800 Other Mortgage-Backed Securities --- --- --- 19,282 19,282 Total Securities Held-to- Maturity $2,667 $3,125 $11,185 $27,105 $44,082 </TABLE> The following table sets forth the tax-equivalent yields of the Company's portfolio of securities held-to-maturity at December 31, 1997. <TABLE> <CAPTION> YIELDS ON SECURITIES HELD-TO-MATURITY (Fully Tax-Equivalent Basis) After After Within 1 But 5 But After One Within Within 10 Year 5 Years 10 Years Years Total <S> <C> <C> <C> <C> <C> State and Municipal Obligations 6.71% 8.77% 8.30 8.06% 8.11% Other Mortgage-Backed Securities --- --- --- 7.22 7.22 Total Securities Held-to- Maturity 6.71 8.77 8.30 7.46 7.72 </TABLE> The yields for debt securities shown in the tables above are calculated by dividing annual interest, including accretion of discounts and amortization of premiums, by the carrying value of the securities at December 31, 1997. Yields on obligations of states and municipalities were computed on a fully tax-equivalent basis using a marginal tax rate of 35%. During 1997, 1996 and 1995, the Company sold no securities from the held-to-maturity portfolio. The weighted-average maturity of the held-to- maturity portfolio was 5.7 years and 7.5 years at December 31, 1997 and 1996, respectively. II. LOAN PORTFOLIO The amounts and respective percentages of loans and leases outstanding represented by each principal category on the dates indicated were as follows:
<TABLE> <CAPTION> a. DISTRIBUTION OF LOANS AND LEASES (Dollars In Thousands) December 31, 1997 1996 1995 1994 1993 Amount % Amount % Amount % Amount % Amount % <S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C> Commercial, Financial and Agricultural $ 46,124 9 $ 48,372 12 $ 79,993 15 $ 74,455 15 $ 82,317 16 Real Estate - Commercial 50,680 10 36,302 9 71,622 14 81,704 16 95,981 19 Real Estate - Construction 2,072 1 971 1 2,051 1 5,136 1 8,702 2 Real Estate - Residential 208,258 43 168,429 43 238,298 46 230,943 45 221,066 44 Installment Loans to Individuals 178,642 37 139,395 35 125,762 24 115,291 23 94,656 19 Lease Financing Receivables 34 -- 42 -- 61 -- 24 -- 62 -- Total Loans and Leases 485,810 100 393,511 100 517,787 100 507,553 100 502,784 100 Allowance for Loan Losses (6,191) (5,581) (12,106) (12,338) (16,078) Total Loans and Leases, Net $479,619 $387,930 $505,681 $495,215 $486,706 </TABLE> On June 27, 1997, the Company acquired $44.2 million of loans from Fleet Bank in connection with its acquisition of six Fleet branches (consumer loans - $16.6 million, home equity loans - $7.1 million, commercial loans - $5.6 million, commercial real estate loans - $4.8 million, and residential real estate loans - $10.1 million). The remaining increase in loans and leases from 1996 to 1997 was $48.1 million, or 12.2%, and represented loan growth from the continuing New York operations. Within the installment loan portfolio, the Company has focused on growth in its indirect lending program. Indirect loans are vehicle acquisition loans to consumers financed through local dealerships where, by prior arrangement, the Company acquires the dealer paper. At year- end 1993, indirect loans amounted to $57.3 million or 61% of installment loans. By December 31, 1997, indirect loans amounted to $141.7 million, or 79% of installment loans. While the yields on the consumer portfolios (other than credit card loans) typically are lower than on the commercial portfolios, the Company has historically experienced fewer loan losses in consumer loans than commercial loans, in proportion to outstanding average loan balances. Accordingly, the shift in the mix of the loan portfolio from 1996 to 1997 continued a trend where the increased balance of consumer loans as a percentage of total loans was offset by decreases in the commercial loan portfolio. During 1996, the Company transferred substantially all of the loans in its Vermont banking operation in two branch sale transactions, to Mascoma Savings Bank in January 1996 and to ALBANK in September 1996. The Vermont loan portfolio had a higher percentage of commercial loans than the loan portfolios of the Company's New York banks. Consequently, the divestiture of the Vermont banking operations is largely responsible for the shift in the mix of the loan portfolio from commercial to consumer loans between year-end 1995 and year-end 1996. Also, the Company concentrated its lending efforts in 1996 in the area of residential real estate loans and installment loans to individuals (primarily automobile loans). The following table indicates the changing mix in the Company's New York loan portfolio by presenting the quarterly average balance for the Company's significant loan products for the past five quarters. In addition, the table presents the percentage of total loans represented by each category as well as the annualized tax-equivalent yield. Since the final disposition of the Vermont operations occurred in September 1996, prior to the earliest period presented, there are no Vermont loans reflected in the table and the effect of loans acquired in the Fleet transaction, at the end of June 1997, are reflected only in the third and fourth quarters of 1997. <TABLE> <CAPTION> LOAN PORTFOLIO Quarterly Average Loan Balances (Dollars In Thousands) Quarter Ending Dec 1997 Sep 1997 Jun 1997 Mar 1997 Dec 1996 <S> <C> <C> <C> <C> <C> Commercial and Commercial Real Estate $100,604 $102,211 $ 92,874 $ 89,673 $ 84,059 Residential Real Estate 147,928 142,863 129,289 127,032 125,897 Home Equity 36,601 37,100 30,399 30,012 29,863 Indirect Consumer Loans 139,401 128,086 114,141 107,371 105,227 Direct Consumer Loans 49,747 51,185 34,212 33,300 32,013 Credit Card Loans 7,602 7,582 7,769 8,153 8,514 Total Loans $481,883 $469,027 $408,684 $395,541 $385,573 Percentage of Total Quarterly Average Loans Commercial and Commercial Real Estate 20.9% 21.8% 22.7% 22.7% 21.8% Residential Real Estate 30.7 30.5 31.6 32.1 32.7 Home Equity 7.6 7.9 7.4 7.6 7.7 Indirect Consumer Loans 28.9 27.3 27.9 27.1 27.3 Direct Consumer Loans 10.3 10.9 8.5 8.4 8.3 Credit Card Loans 1.6 1.6 1.9 2.1 2.2 Total Loans 100.0% 100.0% 100.0% 100.0% 100.0% Quarterly Tax-Equivalent Yield on Loans Commercial and Commercial Real Estate 9.62% 9.56% 9.73% 9.61% 9.36% Residential Real Estate 8.23 8.33 8.40 8.47 8.30 Home Equity 9.10 9.20 9.23 9.10 9.08 Indirect Consumer Loans 8.24 8.39 8.35 8.29 8.35 Direct Consumer Loans 9.18 9.00 9.09 9.16 9.33 Credit Card Loans 16.07 16.46 16.84 16.76 16.46 Total Loans 8.81 8.86 8.97 8.96 8.99 </TABLE> The following table indicates the respective maturities and repricing structure of the Company's commercial, financial and agricultural loans and its real estate - construction loans at December 31, 1997. For purposes of determining relevant maturities, loans are assumed to mature at (but not before) their scheduled repayment dates as required by contractual terms. Demand loans and overdrafts are included in the "Within 1 Year" maturity category. <TABLE> <CAPTION> MATURITY AND REPRICING OF COMMERCIAL LOANS (In Thousands) After 1 After Within But Within Five 1 Year 5 Years Years Total <S> <C> <C> <C> <C> Commercial, Financial and Agricultural $24,528 $16,035 $ 5,561 $46,124 Real Estate - Construction 129 65 1,878 2,072 Total $24,657 $16,100 $ 7,439 $48,196 Fixed Interest Rates $ 4,611 $ 9,545 $ 7,439 $21,595 Variable Interest Rates 20,046 6,555 --- 26,601 Total $24,657 $16,100 $ 7,439 $48,196 </TABLE> COMMITMENTS AND LINES OF CREDIT Letters of credit represent extensions of credit granted in the normal course of business which are not reflected in the financial statements because they were not yet funded. As of December 31, 1997, the total contingent liability for standby letters of credit amounted to $653 thousand. In addition to these instruments, the Company has issued lines of credit to customers, including home equity lines of credit, credit card lines of credit, commitments for residential and commercial construction and other personal and commercial lines of credit, which also may be unfunded or only partially funded from time to time. Commercial lines, generally issued for a period of one year, are usually extended to provide for the working capital requirements of the borrower. At December 31, 1997, the Company had outstanding unfunded loan commitments in the aggregate amount of approximately $77.3 million. b. RISK ELEMENTS NONACCRUAL, PAST DUE AND RESTRUCTURED LOANS The Company designates loans as impaired when the payment of interest and/or principal is due and unpaid for a designated period (generally 90 days) or when the likelihood of the full repayment of principal and interest is, in the opinion of management, uncertain. Loans are charged-off against the allowance for loan losses for amounts in excess of the fair value of collateral less estimated costs to sell upon reaching 120 days delinquent. There were no material commitments to lend additional funds on outstanding impaired loans at December 31, 1997. Loans and leases past due 90 days or more and still accruing interest, as identified in the following table, are those loans and leases which were contractually past due 90 days or more but because of expected repayments were still accruing interest. For years prior to 1995, loans were classified as "restructured" in accordance with SFAS No. 15, "Accounting by Debtors and Creditors for Troubled Debt Restructurings." On January 1, 1995, the Company adopted Statement of Financial Accounting Standards (SFAS) No. 114, "Accounting by Creditors for Impairment of a Loan." SFAS No. 114, as amended, requires that impaired loans, except for large groups of smaller-balance homogeneous loans, be measured based on (I) the present value of expected future cash flows discounted at the loan's effective interest rate, (II) the loan's observable market price or (III) the fair value of the collateral if the loan is collateral dependent. The Company applies the provisions of SFAS No. 114 to all impaired commercial and commercial real estate loans over $250,000, and to all loans restructured subsequent to adoption. Reserves for losses for the remaining smaller-balance loans are evaluated under SFAS No. 5. Under the provisions of SFAS No. 114, the Company determines impairment for collateralized loans based on fair value of the collateral less estimated cost to sell. For other loans, impairment is determined by comparing the recorded value of the loan to the present value of the expected cash flows, discounted at the loan's effective interest rate. The Company determines the interest income recognition method on a loan by loan basis. Based upon the borrowers' payment histories and cash flow projections, interest recognition methods include full accrual, cash basis and cost recovery. The Company's nonaccrual, past due and restructured loans and leases were as follows: <TABLE> <CAPTION> SCHEDULE OF NONPERFORMING LOANS (Dollars In Thousands) December 31, 1997 1996 1995 1994 1993 <S> <C> <C> <C> <C> <C> Nonaccrual Loans: Construction and Land Development $ --- $ --- $ 104 $ 327 $ 2,534 Commercial Real Estate 119 83 1,299 1,050 2,649 Commercial Loans 1,951 1,487 1,979 1,017 2,596 Other 1,251 727 862 1,224 2,082 Total Nonaccrual Loans 3,321 2,297 4,244 3,618 9,861 Loans Past Due 90 Days or More and Still Accruing Interest 363 321 111 231 364 Restructured Loans in Compliance with Modified Terms --- --- --- 580 2,405 Total Nonperforming Loans $3,684 $2,618 $4,355 $4,429 $12,630 Total Nonperforming Loans as a Percentage of Period-End Loans .76% .67% .84% .87% 2.51% </TABLE> The following table presents additional disclosures required by SFAS No. 114 relating to impaired loans accounted for under SFAS No. 114. All loans reported in the schedule below are included in nonaccrual loans in the schedule of nonperforming loans above. The reserves for loans accounted for under SFAS No. 114 in the schedule below are a component of the allowance for loan losses discussed earlier in this report under Item 7.B.II., "Provision for Loan Losses and Allowance for Loan Losses."
<TABLE> <CAPTION> SCHEDULE OF IMPAIRED LOANS ACCOUNTED FOR UNDER SFAS NO. 114 (In Thousands) December 31, 1997 Recorded Allowance for Carrying Investment Loan Losses Amount Measured at the Present Value of Expected Cash Flows: <S> <C> <C> <C> Commercial Loans $1,935 $ 225 $1,710 </TABLE </TABLE> <TABLE> <CAPTION> December 31, 1996 Recorded Allowance for Carrying Investment Loan Losses Amount Measured at the Present Value of Expected Cash Flows: <S> <C> <C> <C> Commercial Loans $1,301 $ 195 $1,106 </TABLE> At December 31, 1997, nonaccrual loans amounted to $3.3 million, an increase of $1.0 million from December 31, 1996. The increase was primarily attributable to one large commercial loan placed on nonaccrual status during 1997. Loans past due 90 or more days and still accruing interest amounted to $363 thousand at December 31, 1997, an increase of $42 thousand from December 31, 1996. Total nonperforming loans, at year-end 1997, represented .76% of period- end loans, an increase from .67% at year-end 1996. During 1997 income recognized on year-end balances of nonaccrual loans was $90 thousand. Income that would have been recognized during that period on nonaccrual loans if such had been current in accordance with their original terms and had been outstanding throughout the period (or since origination if held for part of the period) was $246 thousand. At December 31, 1996, nonaccrual loans amounted to $2.3 million. Nearly all of the nonaccrual loans in the Vermont portfolio were transferred in the 1996 branch sales. The New York based nonaccrual loans at December 31, 1996 were virtually unchanged from the level at the prior year-end. Over one-half of the nonaccrual balance at December 31, 1996 was attributable to one borrower whose loan was restructured in 1996. Payments on that loan were current in accordance with the restructured terms as of December 31, 1996 and all payments in 1996 were used to reduce the carrying amount of the loan. During 1996 income recognized on year-end balances of nonaccrual loans was $48 thousand. Income that would have been recognized during that period on nonaccrual loans if such had been current in accordance with their original terms and had been outstanding throughout the period (or since origination if held for part of the period) was $232 thousand. Nonperforming loans amounted to $4.4 million at December 31, 1995, $74 thousand below the balance at year-end 1994. The increase in nonaccrual commercial loans between year-end 1994 and 1995 was primarily attributable to the aggregate borrowing of one commercial borrower, which was placed on nonaccrual status during 1995. Otherwise, nonaccrual loans at December 31, 1995 would have decreased from the prior year-end balance. All loans reported as restructured and in compliance with modified terms at December 31, 1994 were still in compliance with modified terms at year-end 1995 and thus classified as performing at that date. During 1995, income recognized on year-end balances of nonaccrual loans was $116 thousand. Income that would have been recognized during that period on nonaccrual loans if such had been current in accordance with their original terms and had been outstanding throughout the period (or since origination if held for part of the period) was $435 thousand. Nonperforming loans amounted to $4.4 million at December 31, 1994, a decrease of $8.2 million or 64.9% from the prior year-end. Of the $12.6 million in nonperforming loans at December 31, 1993, $2.5 million was transferred to OREO in 1994, $2.4 million of loans reported as restructured at year-end 1993 was returned to performing status in 1994 in accordance with SFAS No. 15, and another $3.5 million was charged, during 1994, against the allowance for loan losses. The small remaining difference represented the improvement in nonaccrual loans, net of loans newly classified as nonperforming. POTENTIAL PROBLEM LOANS On at least a quarterly basis, the Company applies an internal credit quality rating system to past due commercial loans. Loans are placed on nonaccrual status when the likely amount of future principal and interest payments are expected to be less than the contractual amounts. Because of its aggressive approach toward placing loans on nonaccrual status, the Company has not separately identified any potential problem loans in this report not included in the classifications discussed above. The level of problem loans is for the most part dependent on economic conditions in northeastern New York State. In general, the economy in the Company's geographic market area is quite strong. In the "capital district" in an around Albany, unemployment is significantly below the national average, and north of the capital district, the total number of jobs has held steady over recent periods with nominal growth in the job rate. However, unemployment remains above the national average in the Glens Falls and Plattsburgh areas. FOREIGN OUTSTANDINGS - None LOAN CONCENTRATIONS The loan portfolio is well diversified. There are no concentrations of credit that exceed 10% of the portfolio, other than the general categories reported in the preceding Section II.a.of this report. For a further discussion, see Note 21 to the Consolidated Financial Statements in Part II, Item 8 of this report. OTHER REAL ESTATE OWNED Other real estate owned (OREO) consists of real property acquired in foreclosure. OREO is carried at the lower of fair value less estimated cost to sell or cost in accordance with Statement of Position (SOP) 92-3 "Accounting for Foreclosed Assets." Also, in compliance with SOP 92-3, the Company's subsidiary banks have established allowances for OREO losses. The allowances are established and monitored on a property by property basis and reflect management's ongoing estimate of the difference between the property's carrying amount and cost, when the carrying amount is less than cost. For all periods, all OREO was held for sale. <TABLE> <CAPTION> DISTRIBUTION OF OTHER REAL ESTATE OWNED (Net of Allowance) (In Thousands) December 31, 1997 1996 1995 1994 1993 <S> <C> <C> <C> <C> <C> Single Family 1 - 4 Units $ 227 $ --- $ 82 $1,073 $1,189 Commercial Real Estate 86 86 2,328 2,128 3,418 Construction & Land Development 2 50 --- 195 2,899 Other Real Estate Owned, Net $ 315 $ 136 $2,410 $3,396 $7,506 </TABLE> The following table summarizes changes in the net carrying amount of other real estate owned at December 31 for each of the periods presented. <TABLE> <CAPTION> SCHEDULE OF CHANGES IN OTHER REAL ESTATE OWNED (Net of Allowance) (In Thousands) 1997 1996 1995 1994 1993 <S> <C> <C> <C> <C> <C> Balance at Beginning of Year $ 136 $2,410 $ 3,396 $ 7,506 $ 5,548 Properties Acquired Through Foreclosure 307 302 642 2,493 7,804 Adjustment for Change in Fair Value --- (85) (161) (398) (638) Sale (128) (2,491) (1,467) (6,205) (5,208) Balance at End of Year $ 315 $ 136 $ 2,410 $ 3,396 $ 7,506 </TABLE> The following is a summary of changes in the allowance for OREO losses: <TABLE> <CAPTION> ALLOWANCE FOR OTHER REAL ESTATE OWNED LOSSES (In Thousands) 1997 1996 1995 1994 1993 <S> <C> <C> <C> <C> <C> Balance at Beginning of Year $ 108 $ 370 $ 369 $ 1,150 $1,120 Additions --- 85 161 398 638 Charge-Offs (43) (347) (160) (1,179) (608) Balance at End of Year $ 65 $ 108 $ 370 $ 369 $1,150 </TABLE> During 1997, the Company acquired six properties totaling $307 thousand through foreclosure. Also during the year, the Company sold properties with a carrying amount of $128 thousand for net gains of $110 thousand. During 1996, the Company acquired five properties totaling $302 thousand through foreclosure. Also during the year, the Company recognized losses of $330 thousand on the sale of OREO properties with a carrying amount of $2.5 million (including OREO disposed of in the Vermont branch sale transactions) and further reduced the carrying amount of the two properties remaining in OREO at December 31, 1996 by $85 thousand. During 1995, the Company acquired $642 thousand of OREO through foreclosure. The Company recognized losses of $48 thousand on the sale of OREO properties carried on the books at $1.5 million. During 1994, the Company acquired $2.5 million of OREO through foreclosure. The Company recognized losses of $1.4 million on the sale of OREO properties carried on the books at $6.2 million. Approximately 65% of the sales took place at an auction of OREO properties held during the second quarter of 1994.
During 1993, the Company acquired $7.8 million in OREO through foreclosure. For the year, the Company recognized net gains of $366 thousand on the sale of $5.2 million of OREO properties. These net gains partially offset the $638 thousand provision for estimated OREO losses taken during the year. III. SUMMARY OF LOAN LOSS EXPERIENCE The Company monitors credit quality through a continuous review of the entire loan portfolio. All significant loans (primarily commercial and commercial real estate) are reviewed at least semi-annually, and those under special supervision are reviewed at least quarterly. The boards of directors of the Company's subsidiary banks, upon recommendations from management, determine the extent of charge-offs and have the final decision-making responsibility in authorizing charge-offs. Additionally, regulatory examiners perform periodic examinations of the banks' loan and lease portfolios and report on these examinations to the boards of directors. Provisions for loan losses are determined by the managements of the subsidiary banks, and are based upon an overall evaluation of the appropriate levels of the allowances for loan losses. Factors incorporated in such determination include the existing risk characteristics of the portfolio, prevailing national and local economic conditions, historical loss experience and expected performance within a range of anticipated future economic conditions. The Company's management believes that the banks' allowances for loan losses are adequate to absorb losses inherent in the loan portfolio. The table in Part II, Item 7.B.II. "Provision for Loan Losses and Allowance for Loan Losses" presents a summary of the activity in the Company's allowance for loan losses.
ALLOCATION OF THE ALLOWANCE FOR LOAN AND LEASE LOSSES The allowance for loan losses is a general allowance applicable to losses inherent in the loan portfolio. For internal operating purposes, the allowance is not allocated among loan categories. In the following table, the allowance has been allocated solely for purposes of complying with disclosure requirements of the Securities and Exchange Commission. However, this allocation should not be interpreted as a projection of (I) likely sources of future charge-offs, (II) likely proportional distribution of future charge-offs among loan categories or (III) likely amounts of future charge-offs. Since management regards the allowance as a general balance and has assigned an unallocated value to the schedule, the amounts presented do not represent the total balance available to absorb future charge-offs that might occur within the principal categories. Subject to the qualifications noted above, an allocation of the allowance for loan losses by principal classification and the proportion of the related loan balance is presented below as of December 31 for each of the years indicated. <TABLE> <CAPTION> ALLOCATION OF THE ALLOWANCE FOR LOAN AND LEASE LOSSES (Dollars in Thousands) 1997 1996 1995 1994 1993 <S> <C> <C> <C> <C> <C> Commercial, Financial and Agricultural $1,972 $1,946 $ 2,913 $ 2,329 $ 3,908 Real Estate-Commercial 219 353 1,755 1,841 3,324 Real Estate-Construction 17 49 305 1,994 2,027 Real Estate-Residential Mortgage 902 890 1,616 2,098 1,893 Installment Loans to Individuals 2,882 1,959 2,365 1,363 2,032 Lease Financing Receivables -- -- -- -- -- Unallocated 199 384 3,152 2,713 2,894 Total Loans and Leases $6,191 $5,581 $12,106 $12,338 $16,078 PERCENT OF LOANS IN EACH CATEGORY TO TOTAL LOANS Commercial, Financial and Agricultural 9% 12% 15% 15% 16% Real Estate-Commercial 10 9 14 16 19 Real Estate-Construction 1 1 1 1 2 Real Estate-Residential Mortgage 43 43 46 45 44 Installment Loans to Individuals 37 35 24 23 19 Lease Financing Receivables -- -- -- -- -- Total Loans and Leases 100% 100% 100% 100% 100% </TABLE> IV. DEPOSITS The following table sets forth the average balances of and average rates paid on deposits for the periods indicated. <TABLE> <CAPTION> AVERAGE DEPOSIT BALANCES Years Ended December 31, (Dollars In Thousands) 1997 1996 1995 Average Average Average Balance Rate Balance Rate Balance Rate <S> <C> <C> <C> <C> <C> <C> Demand Deposits $ 78,704 --% $ 77,479 --% $ 88,961 --% Interest-Bearing Demand Deposits 144,204 3.10 131,438 2.88 139,879 2.84 Regular and Money Market Savings 146,529 2.85 157,892 2.92 201,932 3.06 Time Deposits of $100,000 or More 87,956 5.38 79,996 5.25 67,029 5.61 Other Time Deposits 171,820 5.46 156,236 5.33 185,166 5.34 Total Deposits $629,213 3.62 $603,041 3.47 $682,967 3.49 </TABLE> On June 27, 1997, the Company assumed $140 million of deposit balances in the Fleet branch acquisition (demand - $17.3 million, interest- bearing demand deposits - $23.6 million, regular and money market savings - $42.7 million, and other time deposits - $56.2 million). These balances, accordingly, had a six month impact on average deposits for 1997. The deposit balances in the Vermont branches that were sold in September 1996 impacted average deposit balances for nine months in that year. During 1996, average deposits of $85.4 million were attributable to the Vermont banking operations. The following table presents the quarterly average balance by deposit type and the percentage of total deposits represented by each deposit type for each of the most recent five quarters. Consequently, there are no Vermont balances in the table, and the effect of the Fleet branch acquisition is reflected only in the last two quarters of 1997.
<TABLE> <CAPTION> DEPOSIT PORTFOLIO Quarterly Average Deposit Balances (Dollars In Thousands) Quarter Ending Dec 1997 Sep 1997 Jun 1997 Mar 1997 Dec 1996 <S> <C> <C> <C> <C> <C> Demand Deposits $ 91,309 $ 93,907 $ 65,976 $ 63,147 $ 67,240 Interest-Bearing Demand Deposits 170,321 155,461 128,067 122,318 125,559 Regular and Money Market Savings 159,591 167,821 128,350 129,791 133,974 Time Deposits of $100,000 or More 96,851 78,927 87,350 88,704 80,462 Other Time Deposits 198,018 201,125 147,910 139,261 133,041 Total Deposits $716,090 $697,241 $557,653 $543,221 $540,276 Percentage of Total Quarterly Average Deposits Demand Deposits 12.8% 13.5% 11.8% 11.6% 12.4% Interest-Bearing Demand Deposits 23.8 22.3 23.0 22.5 23.3 Regular and Money Market Savings 22.3 24.1 23.0 23.9 24.7 Time Deposits of $100,000 or More 13.5 11.3 15.7 16.3 14.9 Other Time Deposits 27.6 28.8 26.5 25.7 24.7 Total Deposits 100.0% 100.0% 100.0% 100.0% 100.0% Quarterly Cost of Deposits Interest-Bearing Demand Deposits 3.16% 2.98% 3.21% 3.05% 3.04% Regular and Money Market Savings 2.79 2.87 2.83 2.94 2.93 Time Deposits of $100,000 or More 5.45 5.45 5.37 5.25 5.21 Other Time Deposits 5.50 5.42 5.54 5.38 5.34 Total Deposits 3.63 3.54 3.70 3.63 3.52 </TABLE> <TABLE> <CAPTION> Federal Reserve Bank Discount Rate Changes 1994 - 1997 Date New Rate Old Rate <S> <C> <C> January 31, 1996 5.00% 5.25% February 1, 1995 5.25 4.75 November 15, 1994 4.75 4.00 August 16, 1994 4.00 3.50 May 17, 1994 3.50 3.00 </TABLE> Although the last change by the Federal Reserve Board did not raise the discount rate during 1997, its open market operations early in the year led directly to a 25 basis point increase in the federal funds overnight rate. The 11 basis point increase in the cost of deposits from the fourth quarter of 1996 to the fourth quarter of 1997 was primarily attributable to these actions. V. TIME DEPOSITS OF $100,000 OR MORE <TABLE> <CAPTION> The maturities of time deposits of $100,000 or more at December 31, 1997 are presented below. (In Thousands) Maturing in: <S> <C> Under Three Months $ 78,772 Three to Six Months 11,230 Six to Twelve Months 7,900 1999 5,523 2000 2,069 2001 726 2002 and Beyond 400 Total $106,620 </TABLE> D. 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 need 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 balance sheet cash flow. At purchase, selection of these securities is based on their marketability and collateral value, as well as their yield and maturity. In addition to liquidity arising from balance sheet cash flows, the Company has supplemented liquidity with additional off-balance sheet sources such as credit lines with the Federal Home Loan Bank and has identified wholesale and retail repurchase agreements and brokered certificates of deposit as appropriate funding alternatives. The Company measures its basic liquidity as a ratio of liquid assets to short-term liabilities, both with and without the availability of borrowing arrangements. Understanding that excess liquidity will have a negative impact on earnings, the Company establishes a target range for its liquidity ratios. At year-end 1997, the Company still exceeded the upper limit of this range due to the liquidity resulting from the Fleet branch acquisition. Since June 1997, the Company has been reinvesting this excess liquidity in market-area loans as opportunities arise. E. CAPITAL RESOURCES AND DIVIDENDS Shareholders' equity was $73.9 million at December 31, 1997, a decrease of $425 thousand, or 0.6%, from the prior year-end. The decrease in shareholders' equity during 1997 primarily resulted from $7.5 million of stock repurchases during the year, which together with $4.6 million of cash dividends more than offset 1997 net income of $11.0 million and a $556 thousand increase in the net unrealized gain on securities available-for-sale, net of tax. In 1996, the Board of Directors authorized repurchase programs under which management was given the authority to repurchase at its discretion from time to time, in market or privately negotiated transactions, up to $20 million of the Company's outstanding common stock. Pursuant to these programs, the Company repurchased nearly $17 million of outstanding stock in the past two years. Such repurchases have been substantially reduced since the acquisition of six branches from Fleet Bank on June 27, 1997. The maintenance of appropriate capital levels is a management priority. Overall capital adequacy is monitored on an ongoing basis by management and reviewed regularly by the Board of Directors. The Company's principal capital planning goal is to provide an adequate return to shareholders while retaining a sufficient base to provide for future expansion and comply with all regulatory standards. Under regulatory capital guidelines, the Company and the subsidiary banks are required to satisfy certain risk-based capital measures. The minimum ratio of "Tier 1" capital to risk-weighted assets is 4.0% and the minimum ratio of total capital to risk-weighted assets is 8.0%. For the Company, Tier 1 capital is comprised of shareholders' equity less intangible assets. Total capital includes a portion of the allowance for loan losses. In addition to the risk-based capital measures, the federal bank regulatory agencies require banks and bank holding companies to satisfy another capital guideline, the Tier 1 leverage ratio (Tier 1 capital to quarterly average assets less intangible assets). The minimum Tier 1 leverage ratio is 3.0% for the most highly rated institutions. The guidelines provide that other institutions should maintain a Tier 1 leverage ratio that is at least 1.0% to 2.0% higher than the 3.0% minimum level for top-rated institutions.
The table below sets forth the capital ratios of the Company and its subsidiary banks as of December 31, 1997: <TABLE> <CAPTION> Risk-Based Capital Ratios: Arrow GFNB SNB <S> <C> <C> <C> Tier 1 12.2% 12.6% 9.7% Total Capital 13.5 13.9 10.8 Tier 1 Leverage Ratio 7.3 7.2 7.6 </TABLE> At December 31, 1997, all subsidiary banks and the Company exceeded the minimum capital ratios established by these guidelines, and qualified as "well-capitalized", the highest category, in the capital classification scheme set by federal bank regulatory agencies pursuant to FDICIA (see the disclosure under "Legislative Developments" in Part I, Item 1.F. of this report). The principal source of funds for the payment of shareholder dividends by the Company has been dividends declared and paid to the Company by its bank subsidiaries. As of December 31, 1997, the maximum amount that could have been paid by GFNB to the Company was approximately $13.2 million. See Part II, Item 5 "Market for the Registrant's Common Equity and Related Stockholder Matters" for a recent history of the Company's cash dividend payments.
F. FOURTH QUARTER RESULTS The Company reported earnings of $2.8 million for the fourth quarter of 1997, an increase of $376 thousand, or 15.4%, from the fourth quarter of 1996. Basic earnings per common share for the respective quarters was $.49 and $.40, respectively. The increase in earnings was primarily attributable to the fact the fourth quarter of 1997 fully reflects the increase in earning assets from the acquisition of six branches from Fleet Bank in June 1997. The average number of shares outstanding decreased from period to period as a result of the repurchase program discussed earlier. The Fleet branch purchase is also the primary factor in changes to other income and expense, as well as explaining changes to net interest income and the provision for loan losses. <TABLE> <CAPTION> SELECTED FOURTH QUARTER FINANCIAL INFORMATION (Dollars In Thousands, Except Per Share Amounts) For the Quarter Ended December 31, 1997 1996 <S> <C> <C> Interest and Dividend Income $15,266 $12,153 Interest Expense 6,850 5,025 Net Interest Income 8,416 7,128 Provision for Loan Losses 331 224 Net Interest Income after Provision for Loan Losses 8,085 6,904 Other Income 2,005 2,155 Other Expense 5,914 5,255 Income Before Income Taxes 4,176 3,804 Provision for Income Taxes 1,366 1,370 Net Income $ 2,810 $ 2,434 Weighted Average Number of Shares and Equivalents Outstanding Basic 5,759 6,057 Diluted 5,859 6,139 Basic Earnings Per Common Share $ .49 $ .40 Diluted Earnings Per Common Share .48 .40 Diluted "Core" Earnings Per Common Share .47 .36 Cash Dividends Per Common Share .21 .19 AVERAGE BALANCES: Assets $826,281 $648,944 Earning Assets 767,873 606,396 Loans 481,883 385,573 Deposits 716,090 540,276 Shareholders' Equity 72,878 74,027 SELECTED RATIOS (Annualized): Return on Average Assets 1.35% 1.49% Return on Average Equity 15.30% 13.04% Net Interest Margin (Tax-Equivalent Basis) 4.48% 4.77% Net Charge-offs to Average Loans .30% .20% </TABLE> Per share amounts have been adjusted for the 1997 five percent stock dividend.
G. YEAR 2000 PREPAREDNESS The Company's regulators have adopted regulations and examination procedures relating to Year 2000 preparedness. The Year 2000 presents potential financial risk to companies which have data processing systems that, because of date formats, are unable to distinguish the Year 2000. Banking regulators have required financial institutions to evaluate all application software which is date dependent pursuant to a plan that is fully implemented and tested by the end of 1998. The Company has developed such a plan, which follows the regulatory model. Financial institutions have an additional risk, inasmuch as they may have loans to businesses with Year 2000 compliance issues. The Company is working closely with its commercial borrowers in this respect. Nearly all of the software used by the Company was acquired from and is maintained by third parties. The Company estimates that total expenditures related to its Year 2000 Plan will be in the range of $250-500 thousand. The most significant expense relates to testing software at offsite locations. Currently, no substantial risk to the Company's operations or capital is anticipated. Management continues to monitor the adequacy of the Company's preparations. Item 7A: 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 carrying out the asset/liability management to management's Asset/Liability Committee ("ALCO"). In this capacity ALCO develops guidelines and strategies impacting the Company's asset/liability management related activities based upon estimated market risk sensitivity, policy limits and overall market interest rate levels and trends. Interest rate risk is the most significant market risk affecting the Company. Interest rate risk is the exposure of the Company's net interest income to changes in interest rates. Interest rate risk is directly related to the different maturities and repricing characteristics of interest-bearing assets and liabilities, as well as to prepayment risks for mortgage-related assets, early withdrawal of time deposits, and the fact that the speed and magnitude of responses to interest rate changes varies by product. The ALCO utilizes the results of a detailed and dynamic simulation model to quantify the estimated exposure of net interest income to sustained interest rate changes. While ALCO routinely monitors simulated net interest income sensitivity over a rolling two-year horizon, it also utilizes additional tools to monitor potential longer-term interest rate risk. The simulation model captures the impact of changing interest rates on the interest income received and interest expense paid on all interest-bearing assets and liabilities reflected on the Company's consolidated balance sheet. This sensitivity analysis is compared to ALCO policy limits which specify a maximum tolerance level for net interest income exposure over a one year horizon, assuming no balance sheet growth and a 200 basis point upward and downward shift in interest rates. A parallel and pro rata shift in rates over a 12 month period is assumed. As of December 31, 1997, under this analysis, a 200 basis point increase in interest rates resulted in a 3.4% decrease in net interest income and a 200 basis point decrease in interest rates resulted in a 3.2% increase in net interest income. These amount were well within the Company's ALCO policy limits. The preceding sensitivity analysis does not represent a Company forecast and should not be relied upon as being indicative of expected operating results. These hypothetical estimates are based upon numerous assumptions including: the nature and timing of interest rate levels including yield curve shape, prepayments on loans and securities, deposit decay rates, pricing decisions on loans and deposits, reinvestment/replacement of asset and liability cashflows, and others. While assumptions are developed based upon current economic and local market conditions, the Company cannot make any assurance as to the predictive nature of these assumptions including how customer preferences or competitor influences might change. Also, as market conditions vary from those assumed in the sensitivity analysis, actual results will differ due to: prepayment/refinancing levels likely deviating from those assumed, the varying impact of interest rate changes on caps or floors on adjustable rate assets, the potential effect of changing debt service levels on customers with adjustable rate loans, depositor early withdrawals and product preference changes, and other internal/external variables. Furthermore, the sensitivity analysis does not reflect actions that ALCO might take in responding to or anticipating changes in interest rates.
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, 1997, which Annual Report is attached as Exhibit 13 to this Report: Independent Auditors' Report Financial Statements: Consolidated Balance Sheets as of December 31, 1997 and 1996 Consolidated Statements of Income for the Years Ended December 31, 1997, 1996 and 1995 Consolidated Statements of Changes in Shareholders' Equity for the Years Ended December 31, 1997, 1996 and 1995 Consolidated Statements of Cash Flows for the Years Ended December 31, 1997, 1996 and 1995 Notes to Consolidated Financial Statements Supplementary Data: (Unaudited) Summary of Quarterly Financial Data for the Years Ended December 31, 1997 and 1996 Item 9: Changes in and Disagreements with Accountants on Accounting and Financial Disclosure. - None. PART III Item 10: Directors and Executive Officers of the Registrant Item 1, "Election of Directors and Information with Respect to Directors and Officers" of the Company's Proxy Statement for its Annual Meeting of Shareholders to be held April 29, 1998 is incorporated herein by reference. Required information regarding the Company's Executive Officers is contained in Part I, Item 1.E., "Executive Officers of the Registrant." Item 11: Executive Compensation Item 1, "Election of Directors and Information with Respect to Directors and Officers" of the Company's Proxy Statement for its Annual Meeting of Shareholders to be held April 29, 1998 is incorporated herein by reference. Item 12: Security Ownership of Certain Beneficial Owners and Management Item 1, "Election of Directors and Information with Respect to Directors and Officers" of the Company's Proxy Statement for its Annual Meeting of Shareholders to be held April 29, 1998 is incorporated herein by reference. Item 13: Certain Relationships and Related Transactions Item 1, "Election of Directors and Information with Respect to Directors and Officers" of the Company's Proxy Statement for its Annual Meeting of Shareholders to be held April 29, 1998 is incorporated herein by reference. PART IV Item 14: Exhibits, Financial Statement Schedules and Reports on Form 8-K (a) List of Documents filed as part of this report: 1. Financial Statements The following financial statements, the notes thereto, and the independent auditors' report thereon are filed as part of this report, incorporated by reference from Exhibit 13 to this Report, the 1997 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, 1997 and 1996 Consolidated Statements of Income for the Years Ended December 31, 1997, 1996 and 1995 Consolidated Statements of Changes in Shareholders' Equity for the Years Ended December 31, 1997, 1996 and 1995 Consolidated Statements of Cash Flows for the Years Ended December 31, 1997, 1996 and 1995 Notes to Consolidated Financial Statements 2. 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. 2.8 Purchase and Assumption Agreement between Fleet Bank and Glens Falls National Bank and Trust Company, dated March 21, 1997, incorporated herein by reference from the Registrant's Current Report on Form 8-K dated June 27, 1997, Exhibit 2.1. 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). 4.1 Shareholder Protections Rights Agreement dated as of May 1, 1997, between Arrow Financial Corporation and Glens Falls National Bank and Trust Company, as Rights Agent, incorporated herein by reference from the Registrant's Statement on Form 8-A, dated May 16, 1997, Exhibit 4. 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). * 10.7 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 10.5 Employment Agreement among the Registrant, its subsidiary bank, Glens Falls National Bank & Trust Company, and Thomas L. Hoy dated November 26, 1997. * 10.6 Employment Agreement among the Registrant, its subsidiary bank, Glens Falls National Bank and Trust Company and John J. Murphy dated November 26, 1997. * 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) * Management contracts or compensation plans required to be filed as an exhibit. (B) Current Reports on Form 8-K filed during the fourth quarter of 1997: None
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 25, 1998 By: /s/ Thomas L. Hoy Thomas L. Hoy President and Chief Executive Officer Date: March 25, 1998 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 25, 1998 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/ Kenneth C. Hopper, M.D. Kenneth C. Hopper, M.D. Director /s/ Thomas L. Hoy Thomas L. Hoy Director and President /s/ Dr. Edward F. Huntington Dr. 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 10.5 Employment Agreement among the Registrant, its subsidiary bank, Glens Falls National Bank & Trust Company, and Thomas L. Hoy dated November 26, 1997. * 10.6 Employment Agreement among the Registrant, its subsidiary bank, Glens Falls National Bank and Trust Company and John J. Murphy dated November 26, 1997. * 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) * Management contracts or compensation plans required to be filed as an exhibit.