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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

FORM 10-Q

☒ QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934

For the Quarterly Period Ended March 31, 2021
or
☐ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934

Commission File Number: 0-12507

ARROW FINANCIAL CORPORATION

(Exact name of registrant as specified in its charter)
New York 22-2448962
(State or other jurisdiction of incorporation or organization) (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:
Title of Each Class Trading Symbol Name of Each Exchange on Which Registered
Common Stock, Par Value $1.00 per share AROW NASDAQ Global Select Market

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for 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    ☐ No

Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). ☑ Yes     ☐ No

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

Large accelerated filer ☐ Accelerated filer ☑
Non-accelerated filer ☐ Smaller reporting company ☐
Emerging growth company ☐
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standard provided pursuant to Section 13(a) of the Exchange Act. __ ☐

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). ☐  Yes   ☑ No

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.
Class Outstanding as of April 30, 2021
Common Stock, par value $1.00 per share 15,553,329


ARROW FINANCIAL CORPORATION
FORM 10-Q
TABLE OF CONTENTS

2

PART I - FINANCIAL INFORMATION
Item 1. FINANCIAL STATEMENTS

ARROW FINANCIAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(In Thousands, Except Share and Per Share Amounts)
(Unaudited)
  March 31,
2021 		December 31,
2020 		March 31,
2020
ASSETS    
Cash and Due From Banks $ 45,602  $ 42,116  $ 32,525 
Interest-Bearing Deposits at Banks 406,605  338,875  106,004 
Investment Securities:  
Available-for-Sale at Fair Value 464,089  365,287  378,186 
Held-to-Maturity (Approximate Fair Value of $221,360 at March 31, 2021; $226,576 at December 31, 2020; and $242,804 at March 31, 2020)
214,561  218,405  238,520 
Equity Securities 1,796  1,636  1,689 
FHLB and Federal Reserve Bank Stock 5,360  5,349  5,379 
Loans 2,639,243  2,595,030  2,414,193 
Allowance for Credit Losses (26,840) (29,232) (23,637)
Net Loans 2,612,403  2,565,798  2,390,556 
Premises and Equipment, Net 43,057  42,612  40,987 
Goodwill 21,873  21,873  21,873 
Other Intangible Assets, Net 2,049  1,950  1,640 
Other Assets 86,316  84,735  73,973 
Total Assets $ 3,903,711  $ 3,688,636  $ 3,291,332 
LIABILITIES    
Noninterest-Bearing Deposits $ 751,884  $ 701,341  $ 489,151 
Interest-Bearing Checking Accounts 992,486  832,434  793,425 
Savings Deposits 1,463,229  1,423,358  1,146,683 
Time Deposits over $250,000 100,212  123,622  135,854 
Other Time Deposits 145,777  153,971  245,892 
Total Deposits 3,453,588  3,234,726  2,811,005 
Federal Funds Purchased and Securities Sold Under Agreements to Repurchase 6,795  17,486  57,909 
Federal Home Loan Bank Term Advances 45,000  45,000  50,000 
Junior Subordinated Obligations Issued to Unconsolidated Subsidiary Trusts 20,000  20,000  20,000 
Finance Leases 5,205  5,217  5,249 
Other Liabilities 30,710  31,815  37,771 
Total Liabilities 3,561,298  3,354,244  2,981,934 
STOCKHOLDERS’ EQUITY    
Preferred Stock, $1 Par Value and 1,000,000 Shares Authorized at March 31, 2021, December 31, 2020 and March 31, 2020
—  —  — 
Common Stock, $1 Par Value; 30,000,000 Shares Authorized (20,194,474 Shares Issued at March 31, 2021 and December 31, 2020 and 19,606,449 at March 31, 2020)
20,194  20,194  19,606 
Additional Paid-in Capital 354,358  353,662  336,021 
Retained Earnings 51,263  41,899  37,441 
Accumulated Other Comprehensive Loss (3,096) (816) (2,412)
Treasury Stock, at Cost (4,651,719 Shares at March 31, 2021; 4,678,736 Shares at December 31, 2020 and 4,624,348 Shares at March 31, 2020)
(80,306) (80,547) (81,258)
Total Stockholders’ Equity 342,413  334,392  309,398 
Total Liabilities and Stockholders’ Equity $ 3,903,711  $ 3,688,636  $ 3,291,332 
    See Notes to Unaudited Interim Consolidated Financial Statements.
3


ARROW FINANCIAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(In Thousands, Except Per Share Amounts)
(Unaudited)
  Three Months Ended March 31
  2021 2020
INTEREST AND DIVIDEND INCOME    
Interest and Fees on Loans $ 25,183  $ 24,874 
Interest on Deposits at Banks 85  124 
Interest and Dividends on Investment Securities:
Fully Taxable 1,506  2,193 
Exempt from Federal Taxes 920  1,035 
Total Interest and Dividend Income 27,694  28,226 
INTEREST EXPENSE    
Interest-Bearing Checking Accounts 219  487 
Savings Deposits 565  2,471 
Time Deposits over $250,000 120  533 
Other Time Deposits 222  1,000 
Federal Funds Purchased and
  Securities Sold Under Agreements to Repurchase 		2  22 
Federal Home Loan Bank Advances 193  429 
Junior Subordinated Obligations Issued to
  Unconsolidated Subsidiary Trusts 		169  228 
Interest on Financing Leases 49  50 
Total Interest Expense 1,539  5,220 
NET INTEREST INCOME 26,155  23,006 
Provision for Credit Losses (648) 2,772 
NET INTEREST INCOME AFTER PROVISION FOR CREDIT LOSSES 26,803  20,234 
NONINTEREST INCOME    
Income From Fiduciary Activities 2,378  2,213 
Fees for Other Services to Customers 2,609  2,451 
Insurance Commissions 1,640  1,632 
Net Gain (Loss) on Securities 160  (374)
Net Gain on Sales of Loans 1,415  213 
Other Operating Income 406  1,559 
Total Noninterest Income 8,608  7,694 
NONINTEREST EXPENSE    
Salaries and Employee Benefits 11,138  10,383 
Occupancy Expenses, Net 1,593  1,449 
Technology and Equipment Expense 3,459  3,352 
FDIC Assessments 270  219 
Other Operating Expense 2,218  2,351 
Total Noninterest Expense 18,678  17,754 
INCOME BEFORE PROVISION FOR INCOME TAXES 16,733  10,174 
Provision for Income Taxes 3,453  2,047 
NET INCOME $ 13,280  $ 8,127 
Average Shares Outstanding 1:
   
Basic 15,528  15,446 
Diluted 15,563  15,476 
Per Common Share:    
Basic Earnings $ 0.86  $ 0.53 
Diluted Earnings 0.85  0.53 

    1 2020 Share and Per Share Amounts have been restated for the September 25, 2020 3% stock dividend.
See Notes to Unaudited Interim Consolidated Financial Statements.
4


ARROW FINANCIAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(In Thousands)
(Unaudited)
Three Months Ended March 31
2021 2020
Net Income $ 13,280  $ 8,127 
Other Comprehensive (Loss) Income, Net of Tax:
  Net Unrealized Securities Holding (Loss) Gain
  Arising During the Period 		(3,812) 4,098 
  Net Unrealized Gain (Loss) on Cash Flow Hedge
  Agreements 		1,475  (219)
  Reclassification of Net Unrealized Gain on Cash
  Flow Hedge Agreements to Interest Expense 		(20) — 
  Amortization of Net Retirement Plan Actuarial Loss 34  27 
  Amortization of Net Retirement Plan Prior Service Cost 43  39 
Other Comprehensive (Loss) Income (2,280) 3,945 
  Comprehensive Income $ 11,000  $ 12,072 

    See Notes to Unaudited Interim Consolidated Financial Statements.

5

ARROW FINANCIAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY
(In Thousands, Except Share and Per Share Amounts)
(Unaudited)

Three Month Period Ended March 31, 2021
Common
Stock 		Additional
Paid-In
Capital 		Retained
Earnings 		Accumu-lated
Other Com-
prehensive
Loss 		Treasury
Stock 		Total
Balance at December 31, 2020 $ 20,194  $ 353,662  $ 41,899  $ (816) $ (80,547) $ 334,392 
Cumulative impact of adoption of ASU 2016-13 120 120 
Balance at January 1, 2021 as adjusted for impact of adoption of ASU 2016-13 20,194  353,662  42,019  (816) (80,547) 334,512 
Net Income —  —  13,280  —  —  13,280 
Other Comprehensive Income —  —  —  (2,280) —  (2,280)
Cash Dividends Paid, $.260 per Share
—  —  (4,036) —  —  (4,036)
Stock Options Exercised, Net  (6,927 Shares)
—  94  —  —  62  156 
Shares Issued Under the Directors’ Stock
  Plan  (3,172 Shares)
—  70  —  —  28  98 
Shares Issued Under the Employee Stock
  Purchase Plan  (4,269 Shares)
—  86  —  —  38  124 
Shares Issued for Dividend
  Reinvestment Plans (12,649 Shares)
—  342  —  —  113  455 
Stock-Based Compensation Expense —  104  —  —  —  104 
Balance at March 31, 2021 $ 20,194  $ 354,358  $ 51,263  $ (3,096) $ (80,306) $ 342,413 
Three Month Period Ended March 31, 2020
Common
Stock 		Additional
Paid-In
Capital 		Retained
Earnings 		Accumu-lated
Other Com-
prehensive
Loss 		Treasury
Stock 		Total
Balance at December 31, 2019 $ 19,606  $ 335,355  $ 33,218  $ (6,357) $ (80,094) $ 301,728 
Net Income —  —  8,127  —  —  8,127 
Other Comprehensive Income —  —  —  3,945  —  3,945 
Cash Dividends Paid, $.252 per Share 1
—  —  (3,904) —  —  (3,904)
Stock Options Exercised, Net (14,282 Shares)
—  199  —  —  144  343 
Shares Issued Under the Employee Stock
  Purchase Plan  (3,648 Shares)
—  84  —  —  37  121 
Shares Issued for Dividend
  Reinvestment Plans (16,001 Shares)
—  280  —  —  162  442 
Stock-Based Compensation Expense —  103  —  —  —  103 
Purchase of Treasury Stock
 (50,021 Shares)
—  —  —  —  (1,507) (1,507)
Balance at March 31, 2020 $ 19,606  $ 336,021  $ 37,441  $ (2,412) $ (81,258) $ 309,398 

1 Cash dividends paid per share have been adjusted for the September 25, 2020 3% stock dividend.
See Notes to Unaudited Interim Consolidated Financial Statements.



6

ARROW FINANCIAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Dollars in Thousands)
Three Months Ended March 31,
Cash Flows from Operating Activities: 2021 2020
Net Income $ 13,280  $ 8,127 
Provision for Credit Losses (648) 2,772 
Depreciation and Amortization 1,951  1,597 
Net (Gain) Loss on Securities Transactions (160) 374 
Loans Originated and Held-for-Sale (24,037) (9,322)
Proceeds from the Sale of Loans Held-for-Sale 32,093  7,975 
Net Gain on the Sale of Loans (1,415) (213)
Net Loss (Gain) on the Sale of Premises and Equipment, Other Real Estate Owned and Repossessed Assets 90  (91)
Contributions to Retirement Benefit Plans (146) (195)
Deferred Income Tax Expense (Benefit) 349  (873)
Shares Issued Under the Directors’ Stock Plan 98  — 
Stock-Based Compensation Expense 104  103 
Tax Benefit from Exercise of Stock Options 13  28 
Net Increase in Other Assets (3,077) (5,719)
Net Increase in Other Liabilities 1,624  8,563 
Net Cash Provided By Operating Activities 20,119  13,126 
Cash Flows from Investing Activities:
Proceeds from the Maturities and Calls of Securities Available-for-Sale 25,977  17,444 
Purchases of Securities Available-for-Sale (130,481) (33,201)
Proceeds from the Maturities and Calls of Securities Held-to-Maturity 4,291  7,075 
Purchases of Securities Held-to-Maturity (619) (717)
Net Increase in Loans (51,866) (27,317)
Proceeds from the Sales of Premises and Equipment, Other Real Estate Owned and Repossessed Assets 259  781 
Purchase of Premises and Equipment (1,311) (1,072)
Net (Increase) Decrease in FHLB and Federal Reserve Bank Stock (11) 4,938 
Net Cash Used By Investing Activities (153,761) (32,069)
Cash Flows from Financing Activities:
Net Increase in Deposits 218,862  194,951 
Net Decrease in Short-Term Federal Home Loan Bank Borrowings —  (130,000)
Net (Decrease) Increase in Short-Term Borrowings (10,691) 6,810 
Finance Lease Payments (12) (5)
Federal Home Loan Bank Advances —  40,000 
Repayments of Federal Home Loan Bank Term Advances —  (20,000)
Purchase of Treasury Stock —  (1,507)
Stock Options Exercised, Net 156  343 
Shares Issued Under the Employee Stock Purchase Plan 124  121 
Shares Issued for Dividend Reinvestment Plans 455  442 
Cash Dividends Paid (4,036) (3,904)
Net Cash Provided By Financing Activities 204,858  87,251 
Net Increase in Cash and Cash Equivalents 71,216  68,308 
Cash and Cash Equivalents at Beginning of Period 380,991  70,221 
Cash and Cash Equivalents at End of Period $ 452,207  $ 138,529 
Supplemental Disclosures to Statements of Cash Flow Information:
Interest on Deposits and Borrowings $ 1,626  $ 5,264 
Income Taxes —  344 
Non-cash Investing and Financing Activity:
Transfer of Loans to Other Real Estate Owned and Repossessed Assets 349  371 

See Notes to Unaudited Interim Consolidated Financial Statements.
7

NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

Note 1.     ACCOUNTING POLICIES

In the opinion of the management of Arrow Financial Corporation (Arrow, the Company, we, or us), the accompanying unaudited interim consolidated financial statements contain all of the adjustments necessary to present fairly the financial position as of March 31, 2021, December 31, 2020 and March 31, 2020; the results of operations for the three month periods ended March 31, 2021 and 2020; the consolidated statements of comprehensive income for the three month periods ended March 31, 2021 and 2020; the changes in stockholders' equity for the three month periods ended March 31, 2021 and 2020; and the cash flows for the three month periods ended March 31, 2021 and 2020. All such adjustments are of a normal recurring nature. The unaudited interim consolidated financial statements should be read in conjunction with the audited annual consolidated financial statements of Arrow for the year ended December 31, 2020 included in Arrow's Annual Report on Form 10-K for the year ended December 31, 2020.

Management’s Use of Estimates
The preparation of the consolidated financial statements in conformity with accounting principles generally accepted in the United States of America (US GAAP) requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of income and expenses during the reporting period.  Due to the uncertainty regarding the impact of the COVID-19 pandemic, management utilized estimates and assumptions in its evaluation of potential impairment of Arrow's right-of-use lease assets, goodwill and intangible assets. Our most significant estimate is the allowance for credit losses. Other estimates include the fair value of financial statements, evaluation of pension and other post-retirement liabilities, an analysis of a need for a valuation allowance for deferred tax assets and a reserve for unfunded loan commitments recorded as an other liability. Actual results could differ from those estimates.
A material estimate that is particularly susceptible to significant change in the near term is the allowance for credit losses.  In connection with the determination of the allowance for credit losses management obtains economic forecasts from reliable sources and appraisals for properties.  The allowance for credit losses is management’s best estimate of the life of loan losses as of the balance sheet date.  While management uses available information to recognize losses on loans, future adjustments to the allowance for credit losses may be necessary based on changes in economic conditions.

Allowance for Credit Losses – Loans
Accounting Standards Update (“ASU”) 2016-13, Financial Instruments - Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments (“CECL”) approach requires an estimate of the credit losses expected over the life of a loan (or pool of loans). It replaces the incurred loss approach’s threshold that required the recognition of a credit loss when it was probable a loss event was incurred. The allowance for credit losses is a valuation account that is deducted from, or added to, the loans’ amortized cost basis to present the net, lifetime amount expected to be collected on the loans. Loan losses are charged off against the allowance when management believes a loan balance is confirmed to be uncollectible. Expected recoveries do not exceed the aggregate of amounts previously charged off and expected to be charged off.
Management estimates the allowance balance using relevant available information from internal and external sources related to past events, current conditions, and a reasonable and supportable forecast. Historical credit loss experience provides the basis for the estimation of expected credit losses. Company historical loss experience was supplemented with peer information when there was insufficient loss data for the Company. Peer selection was based on a review of institutions with comparable loss experience as well as loan yield, bank size, portfolio concentration and geography. Adjustments to historical loss information are made for differences in current loan-specific risk characteristics such as differences in credit concentrations, delinquency level, collateral values and underwriting standards as well as changes in economic conditions or other relevant factors. Management judgment is required at each point in the measurement process.
Portfolio segment is defined as the level at which an entity develops and documents a systematic methodology to determine its allowance for credit losses. Upon adoption of CECL, management revised the manner in which loans were pooled for similar risk characteristics. Management developed portfolio segments for estimating loss based on type of borrower and collateral as follows:

Commercial Loans
Commercial Real Estate Loans
Consumer Loans
Residential Loans

Further details related to loan portfolio segments is included in Note 4 Loans.
Historical credit loss experience for both the Company and segment-specific peers provides the basis for the estimation of expected credit losses. The Company utilized regression analyses of peer data, of which the Company is included, where observed credit losses and selected economic factors were utilized to determine suitable loss drivers for modeling lifetime probability of default ("PD") rates. Arrow uses the discounted cash flow ("DCF") method to estimate expected credit losses for the commercial, commercial real estate, and residential segments. For each of these loan segments, Arrow generates cash flow projections at the instrument level wherein payment expectations are adjusted for estimated prepayment speed, curtailments, time to recovery, PD, and segment-specific loss given default ("LGD") risk factors. The modeling of expected prepayment speeds, curtailment rates, and time to recovery are based on historical internal data and adjusted, if necessary, based on the reasonable and supportable forecast of economic conditions.
8

For the loan segments utilizing the DCF method, (commercial, commercial real estate, and residential) management utilizes externally developed economic forecasts of the following economic factors as loss drivers: national unemployment, gross domestic product and home price index ("HPI"). The economic forecast is applied over a reasonable and supportable forecast period. Arrow utilizes a six quarter reasonable and supportable forecast period with a four quarter reversion to the historic mean on a straight-line basis.
The combination of adjustments for credit expectations (default and loss) and timing expectations (prepayment, curtailment, and time to recovery) produces an expected cash flow stream at the instrument level. Instrument effective yield is calculated, net of the impacts of prepayment assumptions, and the instrument expected cash flows are then discounted at that effective yield to produce an instrument-level net present value of expected cash flows (“NPV”). An allowance for credit loss is established for the difference between the instrument’s NPV and amortized cost basis. The contractual term excludes expected extensions, renewals, and modifications unless either of the following applies: management has a reasonable expectation at the reporting date that a troubled debt restructuring (“TDR”) will be executed with an individual borrower or the extension or renewal options are included in the original or modified contract at the reporting date and are not unconditionally cancellable by Arrow.
Arrow uses the vintage analysis method to estimate expected credit losses for the consumer loan segment. The vintage method was selected since the loans within the consumer loan segment are homogeneous, not just by risk characteristic, but loan structure. The loss rate is applied to the loan origination amounts. Arrow maintains, over the life of the loan, the loss curve by vintage year. If estimated losses computed by the vintage method need to be adjusted based on current conditions and the reasonable and supportable economic forecast, these adjustments may be incorporated over a six quarter reasonable and supportable forecast period, reverting to historical losses using a straight-line method over a two year period.
The vintage and DCF models also consider the need to qualitatively adjust expected loss estimates for information not already captured in the quantitative loss estimation process. Qualitative considerations include limitations inherent in the quantitative model; trends experienced in nonperforming and delinquent loans; changes in value of underlying collateral; changes in lending policies and procedures; nature and composition of loans; portfolio concentrations that may affect loss experience across one or more components or the portfolio; the experience, ability and depth of lending management and staff; the Company’s credit review system; and the effect of external factors; such as competition, legal and regulatory requirements. These qualitative factor adjustments may increase or decrease the Company's estimate of expected credit losses so that the allowance for credit loss is reflective of the estimate of lifetime losses that exist in the loan portfolio at the balance sheet date.
All loans not included in the vintage analysis method that exceed $250,000 which are on nonaccrual, are evaluated on an individual basis. For collateral dependent financial assets where Arrow has determined that foreclosure of the collateral is probable, or where the borrower is experiencing financial difficulty and Arrow expects repayment of the financial asset to be provided substantially through the operation or sale of the collateral, Arrow has elected a practical expedient to measure the allowance for credit loss as the difference between the fair value of the collateral less cost to sell, and the amortized cost basis of the asset as of the measurement date. In the event where the repayment of a collateral dependent financial asset is expected to be provided substantially through the operating of the collateral, Arrow will use fair value of the collateral at the reporting date when recording the net carrying amount of the asset and determining the allowance for credit losses. When repayment is expected to be from the sale of the collateral, expected credit losses are calculated as the amount by which the amortized cost basis of the financial asset exceeds the fair value of the underlying collateral less estimated cost to sell. The allowance for credit losses may be zero if the fair value of the collateral at the measurement date exceeds the amortized cost basis of the financial asset.
Except as set forth below, a loan that has been modified or renewed is considered a TDR when two conditions are met:
•The borrower is experiencing financial difficulty, and
•Concessions are made for the borrower's benefit that would not otherwise be considered for a borrower or transaction with similar credit risk characteristics.
Arrow's allowance for credit losses reflects all effects of a TDR when an individual asset is specifically identified as a reasonably expected TDR. The Company has determined that a TDR is reasonably expected no later than the point it is determined that modification is the best course of action and it is at least reasonably possible that the troubled borrower will accept some form of concession to avoid a default. Reasonably expected TDRs and executed non-performing TDRs are evaluated individually to determine the required allowance for credit losses. TDRs performing in accordance with their modified contractual terms for a reasonable period of time may be included in Arrow's existing pools based on the underlying risk characteristics of the loan to measure the allowance for credit losses. In accordance with the Coronavirus Aid, Relief, and Economic Security (CARES) Act and ASC Subtopic 310-40, as extended by the Consolidated Appropriations Act, 2021, if a qualifying loan modification was made for a borrower as the result of the COVID-19 pandemic, this modification was not considered a TDR.

Estimated Credit Losses on Off-Balance Sheet Credit Exposures Recognized as Other Liabilities
The Company estimates expected credit losses over the contractual period in which the Company has exposure to credit risk via a contractual obligation to extend credit, unless that obligation is unconditionally cancellable by the Company. The allowance for credit losses on off-balance sheet credit exposures recognized in other liabilities, is adjusted as an expense in other noninterest expense. The estimate includes consideration of the likelihood that funding will occur and an estimate of expected credit losses on commitments expected to be funded over their estimated lives. Estimating credit losses on unfunded commitments requires the Bank to consider the following categories of off-balance sheet credit exposure: unfunded commitments to extend credit, unfunded lines of credit, and standby letters of credit. Each of these unfunded commitments is then analyzed for a probability of funding to calculate a probable funding amount. The life of loan loss factor by related portfolio segment from the loan allowance for credit loss calculation is then applied to the probable funding amount to calculate the estimated credit losses on off-balance sheet credit exposures recognized as other liabilities.

Allowance for Credit Losses – Held to Maturity ("HTM") Debt Securities
Arrow's HTM debt securities are also required to utilize the CECL approach to estimate expected credit losses. Management measures expected credit losses on HTM debt securities on a collective basis by major security types that share similar risk characteristics, such as financial asset type and collateral type adjusted for current conditions and reasonable and supportable
9

forecasts. Management classifies the HTM portfolio into the following major security types: U.S. government agency or U.S. government sponsored mortgage-backed and collateralized mortgage obligations securities, and state and municipal debt securities.
The mortgage-backed and collateralized mortgage obligations HTM securities are issued by U.S. government entities and agencies. These securities are either explicitly or implicitly guaranteed by the U.S. government as to timely repayment of principal and interest, are highly rated by major rating agencies, and have a long history of no credit losses. Therefore, the Company did not record a credit loss for these securities.
State and municipal bonds carry an investment grade from an accredited ratings agency, primarily with an investment grade rating. In addition, the Company has a limited amount of New York state local municipal bonds that are not rated. The estimate of expected credit losses on the HTM portfolio is based on the expected cash flows of each individual CUSIP over its contractual life and utilized a municipal loss forecast model for determining PD and LGD rates. Management may exercise discretion to make adjustments based on environmental factors. A calculated expected credit loss for individual securities was determined using the PD and LGD rates. Arrow determined that the expected credit loss on its municipal bond portfolio was de minimis, and therefore, an allowance for credit losses was not recorded.

Allowance for Credit Losses – Available for Sale ("AFS") Debt Securities
The impairment model for AFS debt securities differs from the CECL approach utilized by HTM debt securities since AFS debt securities are measured at fair value rather than amortized cost. For AFS debt securities in an unrealized loss position, the Bank first assesses whether it intends to sell, or it is more likely than not that it will be required to sell the security before recovery of its amortized cost basis. If either of the criteria regarding intent or requirement to sell is met, the security’s amortized cost basis is written down to fair value through income. For AFS debt securities that do not meet the aforementioned criteria, in making this assessment, management considers the extent to which fair value is less than amortized cost, any changes to the rating of the security by a rating agency, adverse conditions specifically related to the security, failure of the issuer of the debt security to make scheduled interest or principal payments, among other factors. If this assessment indicates that a credit loss exists, the present value of cash flows expected to be collected from the security are compared to the amortized cost basis of the security. The cash flows are estimated using information relevant to the collectability of the security, including information about past events, current conditions and reasonable and supportable forecasts. If the present value of cash flows expected to be collected is less than the amortized cost basis, a credit loss exists and an allowance for credit losses is recorded for the credit loss, limited by the amount that the fair value is less than the amortized cost basis. Any impairment that has not been recorded through an allowance for credit losses is recognized in other comprehensive income.

Accrued Interest Receivable
Upon adoption of CECL on January 1, 2021, the Company made the following elections regarding accrued interest receivable: (1) presented accrued interest receivable balances separately within the other assets balance sheet line item; (2) excluded interest receivable that is included in amortized cost of financing receivables from related disclosures requirements and (3) continued the Company's policy to write off accrued interest receivable by reversing interest income. For loans, write off typically occurs upon becoming over 90 to 120 days past due and therefore the amount of such write offs are immaterial. Historically, the Company has not experienced uncollectible accrued interest receivable on investment securities.

The following accounting standards have been adopted in the first three months of 2021:

In June 2016, the FASB issued ASU 2016-13, Financial Instruments - Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments and all related subsequent amendments thereto. ASU 2016-13 introduces new guidance that make substantive changes to the accounting for credit losses. ASU 2016-13 introduces the CECL model, which applies to financial assets subject to credit losses and measured at amortized cost, as well as certain off-balance sheet credit exposures. This includes loans, loan commitments, standby letters of credit, net investments in leases recognized by a lessor and HTM debt securities. The CECL model requires an entity to estimate credit losses expected over the life of an exposure, considering information about historical events, current conditions and reasonable and supportable forecasts and is generally expected to result in earlier recognition of credit losses. ASU 2016-13 also modifies certain provisions of the current other-than-temporary impairment model for AFS debt securities. Credit losses on AFS debt securities will be limited to the difference between the security’s amortized cost basis and its fair value and will be recognized through an allowance for credit losses rather than as a direct reduction in amortized cost basis. ASU 2016-13 also provides for a simplified accounting model for purchased financial assets with more than insignificant credit deterioration since their origination. ASU 2016-13 requires expanded disclosures including, but not limited to, (1) information about the methods and assumptions used to estimate expected credit losses, including changes in the factors that influenced management’s estimate and the reasons for those changes, (2) financing receivables and net investment in leases measured at amortized cost, further disaggregation of information about the credit quality of those assets and (3) a rollforward of the allowance for credit losses for HTM and AFS securities. The standard also changes the accounting for purchased credit-impaired debt securities and loans. ASU 2016-13 was effective for the Company on January 1, 2020. As permitted by the CARES Act, Arrow deferred the adoption of the CECL methodology in determining credit losses until January 1, 2021. Management expects that the CECL model may create more volatility in the level of our allowance for loan losses from quarter to quarter as changes in the level of allowance for loan losses will be dependent upon, among other things, macroeconomic forecasts and conditions, loan portfolio volumes and credit quality.
Arrow adopted CECL on January 1, 2021 (“Day 1”) using the modified retrospective method for all financial assets measured at amortized cost and off-balance-sheet credit exposures recognized as other liabilities. Results for reporting periods beginning after January 1, 2021 are presented under ASC 326 while prior period amounts continue to be reported in accordance with previously applicable GAAP. The Company recorded a net increase to retained earnings of $120,000 as of January 1, 2021 for the cumulative effect of adopting ASC 326. The transition adjustment includes a $1.3 million decrease to the allowance for credit losses on loans, a $1.1 million increase to the estimated credit losses on off-balance sheet credit exposures recorded as other liabilities, and a $41,000 impact to the deferred tax liability. The Company did not record an allowance for HTM debt securities on January 1, 2021 as the amount of credit risk was deemed immaterial. The Company did not record an allowance for credit losses on its AFS debt securities under the
10

newly codified AFS debt security impairment model, as the majority of these securities are government agency-backed securities for which the risk of loss is minimal. Refer to Note 3 Investment Securities and Note 4 Loans (under the captions "Allowance for Credit Losses" and "Loan Credit Quality Indicators") to the Company’s unaudited interim consolidated financial statements included in this Form 10-Q for more information.
In December 2019, the FASB issued ASU 2019-12 "Simplifying the Accounting for Income Taxes" (Topic 740), which removes certain exceptions to the general principles in Topic 740 and improves consistent application of and simplifies GAAP for other areas of Topic 740 by clarifying and amending existing guidance. This ASU is effective for fiscal years beginning after December 15, 2020 and interim periods within those fiscal years, with early adoption permitted. Arrow adopted this standard on January 1, 2021. The Company does not expect that the adoption of this standard will have a material impact on its financial position or the results of operations in periods subsequent to its adoption.

11



Note 2. CASH AND CASH EQUIVALENTS (In Thousands)

The following table is the schedule of Cash and Cash Equivalents at March 31, 2021, December 31, 2020 and March 31, 2020.
March 31, 2021 December 31, 2020 March 31, 2020
Cash and Due From Banks $ 45,602  $ 42,116  $ 32,525 
Interest-Bearing Deposits at Banks 406,605  338,875  106,004 
Total Cash and Cash Equivalents $ 452,207  380,991  138,529 
Supplemental Information:
Total required reserves, including vault cash and Federal Reserve Bank deposits 1
$ —  $ —  $ — 
Restricted cash pledged as collateral related to swap agreements and included in Cash and Due From Banks $ —  $ 500  $ — 
1.
Until March 2020, Arrow was required to maintain reserve balances with the Federal Reserve Bank of New York. In March 2020, the Federal Reserve Board reduced reserve requirement ratios to zero percent to free up liquidity in the banking industry to support lending to households and businesses.
12

Note 3.    INVESTMENT SECURITIES (In Thousands)

The following table is the schedule of Available-For-Sale Securities at March 31, 2021, December 31, 2020 and March 31, 2020:
Available-For-Sale Securities
U.S. Government & Agency
Obligations 		State and
Municipal
Obligations 		Mortgage-
Backed
Securities 		Corporate
and Other
Debt
Securities 		Total
Available-
For-Sale
Securities
March 31, 2021
Available-For-Sale Securities,
  at Amortized Cost 		$ 110,001  $ 508  $ 349,911  $ 1,000  $ 461,420 
Gross Unrealized Gains 138  —  6,276  —  6,414 
Gross Unrealized Losses (1,769) —  (1,776) (200) (3,745)
Available-For-Sale Securities,
  at Fair Value 		108,370  508  354,411  800  464,089 
Available-For-Sale Securities,
  Pledged as Collateral, at Fair Value 		352,214 
Maturities of Debt Securities,
  at Amortized Cost:
Within One Year $ —  $ 68  $ 58  $ —  $ 126 
From 1 - 5 Years 65,001  40  289,741  —  354,782 
From 5 - 10 Years 45,000  400  60,112  1,000  106,512 
Over 10 Years —  —  —  —  — 
Maturities of Debt Securities,
  at Fair Value:
Within One Year $ —  $ 68  $ 64  $ —  $ 132 
From 1 - 5 Years 63,774  40  295,370  —  359,184 
From 5 - 10 Years 44,596  400  58,977  800  104,773 
Over 10 Years —  —  —  —  — 
Securities in a Continuous
  Loss Position, at Fair Value:
Less than 12 Months $ 103,231  $ —  $ 120,780  $ —  $ 224,011 
12 Months or Longer —  —  —  800  800 
Total $ 103,231  $ —  $ 120,780  $ 800  $ 224,811 
Number of Securities in a
  Continuous Loss Position 		14  —  16  1  31 
Unrealized Losses on
  Securities in a Continuous
  Loss Position:
Less than 12 Months $ 1,769  $ —  $ 1,776  $ —  $ 3,545 
12 Months or Longer —  —  —  200  200 
Total $ 1,769  $ —  $ 1,776  $ 200  $ 3,745 
Disaggregated Details:
US Agency Obligations,
  at Amortized Cost 		$ 110,001 
US Agency Obligations,
  at Fair Value 		108,370 
US Government Agency
  Securities, at Amortized Cost 		$ 11,582 
US Government Agency
  Securities, at Fair Value 		11,658 
Government Sponsored Entity
  Securities, at Amortized Cost 		338,329 
Government Sponsored Entity
  Securities, at Fair Value 		342,753 
13

Available-For-Sale Securities
U.S. Government & Agency
Obligations 		State and
Municipal
Obligations 		Mortgage-
Backed
Securities 		Corporate
and Other
Debt
Securities 		Total
Available-
For-Sale
Securities
December 31, 2020
Available-For-Sale Securities,
  at Amortized Cost 		$ 65,002  $ 528  $ 290,967  $ 1,000  $ 357,497 
Gross Unrealized Gains 184  —  7,934  —  8,118 
Gross Unrealized Losses (74) —  (54) (200) (328)
Available-For-Sale Securities,
  at Fair Value 		65,112  528  298,847  800  365,287 
Available-For-Sale Securities,
  Pledged as Collateral,
  at Fair Value 		244,411 
Securities in a Continuous
  Loss Position, at Fair Value:
Less than 12 Months $ 29,926  $ —  $ —  $ —  $ 29,926 
12 Months or Longer —  —  4,882  800  5,682 
Total $ 29,926  $ —  $ 4,882  $ 800  $ 35,608 
Number of Securities in a
  Continuous Loss Position 		4  —  1  1  6 
Unrealized Losses on
  Securities in a Continuous
  Loss Position:
Less than 12 Months $ 74  $ —  $ —  $ —  $ 74 
12 Months or Longer —  —  54  200  254 
Total $ 74  $ —  $ 54  $ 200  $ 328 
Disaggregated Details:
US Agency Obligations,
  at Amortized Cost 		$ 65,002 
US Agency Obligations,
  at Fair Value 		65,112 
US Government Agency
  Securities, at Amortized Cost 		$ 12,696 
US Government Agency
  Securities, at Fair Value 		12,683 
Government Sponsored Entity
  Securities, at Amortized Cost 		278,271 
Government Sponsored Entity
  Securities, at Fair Value 		286,164 
14

Available-For-Sale Securities
U.S. Government & Agency
Obligations 		State and
Municipal
Obligations 		Mortgage-
Backed
Securities 		Corporate
and Other
Debt
Securities 		Total
Available-
For-Sale
Securities
March 31, 2020
Available-For-Sale Securities,
  at Amortized Cost 		$ 5,002  $ 723  $ 365,333  $ 1,000  $ 372,058 
Gross Unrealized Gains 179  —  7,484  —  7,663 
Gross Unrealized Losses —  —  (1,335) (200) (1,535)
Available-For-Sale Securities,
  at Fair Value 		5,181  723  371,482  800  378,186 
Available-For-Sale Securities,
  Pledged as Collateral, at Fair Value 		273,124 
Securities in a Continuous
  Loss Position, at Fair Value:
Less than 12 Months $ —  $ —  $ 18,846  $ —  $ 18,846 
12 Months or Longer —  —  59,262  800  60,062 
Total $ —  $ —  $ 78,108  $ 800  $ 78,908 
Number of Securities in a
  Continuous Loss Position 		—  —  27  1  28 
Unrealized Losses on Securities
  in a Continuous Loss Position:
Less than 12 Months $ —  $ —  $ 316  $ —  $ 316 
12 Months or Longer —  —  1,019  200  1,219 
Total $ —  $ —  $ 1,335  $ 200  $ 1,535 
Disaggregated Details:
US Agency Obligations,
  at Amortized Cost 		$ 5,002 
US Agency Obligations,
  at Fair Value 		5,181 
US Government Agency
  Securities, at Amortized Cost 		$ 58,089 
US Government Agency
  Securities, at Fair Value 		57,091 
Government Sponsored Entity
  Securities, at Amortized Cost 		307,244 
Government Sponsored Entity
  Securities, at Fair Value 		314,391 

At March 31, 2021, there was no allowance for credit losses for the available for sale securities portfolio.

15


The following table is the schedule of Held-To-Maturity Securities at March 31, 2021, December 31, 2020 and March 31, 2020:
Held-To-Maturity Securities
State and
Municipal
Obligations 		Mortgage-
Backed
Securities 		Total
Held-To
Maturity
Securities
March 31, 2021
Held-To-Maturity Securities,
  at Amortized Cost 		$ 191,202  $ 23,359  $ 214,561 
Gross Unrealized Gains 5,843  956  6,799 
Gross Unrealized Losses —  —  — 
Held-To-Maturity Securities,
  at Fair Value 		197,045  24,315  221,360 
Held-To-Maturity Securities,
  Pledged as Collateral, at Fair Value 		207,595 
Maturities of Debt Securities,
  at Amortized Cost:
Within One Year $ 16,513  $ 1,586  $ 18,099 
From 1 - 5 Years 139,576  21,773  161,349 
From 5 - 10 Years 34,110  —  34,110 
Over 10 Years 1,003  —  1,003 
Maturities of Debt Securities,
  at Fair Value:
Within One Year $ 16,580  $ 1,639  $ 18,219 
From 1 - 5 Years 143,850  22,676  166,526 
From 5 - 10 Years 35,599  —  35,599 
Over 10 Years 1,016  —  1,016 
Securities in a Continuous
  Loss Position, at Fair Value:
Less than 12 Months $ —  $ —  $ — 
12 Months or Longer —  —  — 
Total $ —  $ —  $ — 
Number of Securities in a
  Continuous Loss Position 		—  —  — 
Unrealized Losses on Securities
   in a Continuous Loss Position:
Less than 12 Months $ —  $ —  $ — 
12 Months or Longer —  —  — 
Total $ —  $ —  $ — 
Disaggregated Details:
US Government Agency
  Securities, at Amortized Cost 		$ 8,310 
US Government Agency
  Securities, at Fair Value 		8,597 
Government Sponsored Entity
  Securities, at Amortized Cost 		15,049 
Government Sponsored Entity
  Securities, at Fair Value 		15,718 
16

Held-To-Maturity Securities
State and
Municipal
Obligations 		Mortgage-
Backed
Securities 		Total
Held-To
Maturity
Securities
December 31, 2020
Held-To-Maturity Securities,
  at Amortized Cost 		$ 192,352  $ 26,053  $ 218,405 
Gross Unrealized Gains 7,080  1,094  8,174 
Gross Unrealized Losses (3) —  (3)
Held-To-Maturity Securities,
  at Fair Value 		199,429  27,147  226,576 
Held-To-Maturity Securities,
  Pledged as Collateral, at Fair Value 		211,176 
Securities in a Continuous
  Loss Position, at Fair Value:
Less than 12 Months $ 1,513  $ —  $ 1,513 
12 Months or Longer —  —  — 
Total $ 1,513  $ —  $ 1,513 
Number of Securities in a
  Continuous Loss Position 		4  —  4 
Unrealized Losses on
  Securities in a Continuous
  Loss Position:
Less than 12 Months $ 3  $ —  $ 3 
12 Months or Longer —  —  — 
Total $ 3  $ —  $ 3 
Disaggregated Details:
US Government Agency
  Securities, at Amortized Cost 		$ 9,440 
US Government Agency
  Securities, at Fair Value 		9,762 
Government Sponsored Entity
  Securities, at Amortized Cost 		16,613 
Government Sponsored Entity
  Securities, at Fair Value 		17,385 
March 31, 2020
Held-To-Maturity Securities,
  at Amortized Cost 		$ 204,148  $ 34,372  $ 238,520 
Gross Unrealized Gains 3,104  1,329  4,433 
Gross Unrealized Losses (149) —  (149)
Held-To-Maturity Securities,
  at Fair Value 		207,103  35,701  242,804 
Held-To-Maturity Securities,
  Pledged as Collateral, at Fair Value 		231,539 
Securities in a Continuous
  Loss Position, at Fair Value:
Less than 12 Months $ 5,625  $ —  $ 5,625 
12 Months or Longer 1,867  —  1,867 
Total $ 7,492  $ —  $ 7,492 
Number of Securities in a
  Continuous Loss Position 		16  —  16 
17

Held-To-Maturity Securities
State and
Municipal
Obligations 		Mortgage-
Backed
Securities 		Total
Held-To
Maturity
Securities
Unrealized Losses on
  Securities in a Continuous
  Loss Position:
Less than 12 Months $ 16  $ —  $ 16 
12 Months or Longer 133  —  133 
Total $ 149  $ —  $ 149 
Disaggregated Details:
US Government Agency
  Securities, at Amortized Cost 		$ 1,594 
US Government Agency
  Securities, at Fair Value 		1,655 
Government Sponsored Entity
  Securities, at Amortized Cost 		32,778 
Government Sponsored Entity
  Securities, at Fair Value 		34,046 

In the tables above, maturities of mortgage-backed securities are included based on their expected average lives. Actual maturities will differ because issuers may have the right to call or prepay obligations with or without prepayment penalties.
Securities in a continuous loss position, in the tables above for March 31, 2021, December 31, 2020 and March 31, 2020, do not reflect any deterioration of the credit worthiness of the issuing entities.
Arrow evaluates available-for-sale debt securities in unrealized loss positions at each measurement date to determine whether the decline in the fair value below the amortized cost basis (impairment) is due to credit-related factors or noncredit-related factors. Any impairment that is not credit related is recognized in other comprehensive income, net of applicable taxes. Credit-related impairment is recognized within the allowance for credit losses on the balance sheet, limited to the amount by which the amortized cost basis exceeds the fair value, with a corresponding adjustment to earnings via credit loss expense. Arrow determined that at March 31, 2021, gross unrealized losses were primarily attributable to changes in interest rates, relative to when the investment securities were purchased, and not due to the credit quality of the investment securities. Arrow does not intend to sell, nor is it more likely than not that Arrow will be required to sell the security before recovery of its amortized cost basis, which may be at maturity. Therefore, Arrow carried no allowance for credit loss at March 31, 2021 and there was no credit loss expense recognized by Arrow with respect to the securities portfolio during the three months ended March 31, 2021.  
Arrow's held to maturity debt securities are comprised of U.S. government agencies, U.S. government-sponsored enterprises or state and municipal obligations. U.S. government agencies and U.S. government-sponsored enterprise securities carry the explicit and/or implicit guarantee of the U.S. government, are widely recognized as “risk free,” and have a long history of zero credit loss. Arrow determined that the expected credit loss on its held to maturity debt portfolio was immaterial and therefore no allowance for credit loss was recorded as of March 31, 2021.

The following table is the schedule of Equity Securities at March 31, 2021, December 31, 2020 and March 31, 2020:
Equity Securities
March 31, 2021 December 31, 2020 March 31, 2020
Equity Securities, at Fair Value $1,796 $1,636 $1,689

The following is a summary of realized and unrealized gains and losses recognized in net income on equity securities during the three month period ended March 31, 2021 and 2020:
Quarterly Period Ended:
March 31, 2021 March 31, 2020
Net Gain (Loss) on Equity Securities $ 160  $ (374)
Less: Net gain (loss) recognized during the reporting period on equity securities sold during the period —  — 
Unrealized net gain (loss) recognized during the reporting period on equity securities still held at the reporting date $ 160  $ (374)
18

Note 4.    LOANS (In Thousands)

Loan Categories and Past Due Loans

The following two tables present loan balances outstanding as of March 31, 2021, and an analysis of the recorded investment in loans that are past due at these dates.  Generally, Arrow considers a loan past due 30 or more days when the borrower is two payments past due. Loans held-for-sale of $4,443, $11,085 and $1,905 as of March 31, 2021, December 31, 2020 and March 31, 2020, respectively, are included in the residential real estate balances for current loans.

Schedule of Past Due Loans by Loan Category
Commercial
Commercial Real Estate Consumer Residential Total
March 31, 2021
Loans Past Due 30-59 Days $ 63  $ 143  $ 2,233  $ 2,097  $ 4,536 
Loans Past Due 60-89 Days 34  2,723  822  156  3,735 
Loans Past Due 90 or more Days 38  1,474  592  1,700  3,804 
Total Loans Past Due 135  4,340  3,647  3,953  12,075 
Current Loans 288,416  577,167  857,524  904,061  2,627,168 
Total Loans $ 288,551  $ 581,507  $ 861,171  $ 908,014  $ 2,639,243 
December 31, 2020
Loans Past Due 30-59 Days $ 102  $ —  $ 4,976  $ 261  $ 5,339 
Loans Past Due 60-89 Days 113  —  2,713  1,279  4,105 
Loans Past Due 90 or more Days 78  1,658  1,379  1,224  4,339 
Total Loans Past Due 293  1,658  9,068  2,764  13,783 
Current Loans 240,261  570,129  850,700  920,157  2,581,247 
Total Loans $ 240,554  $ 571,787  $ 859,768  $ 922,921  $ 2,595,030 
March 31, 2020
Loans Past Due 30-59 Days $ 173  $ 461  $ 5,636  $ 1,630  $ 7,900 
Loans Past Due 60-89 Days 70  110  1,451  212  1,843 
Loans Past Due 90 or more Days 8  911  549  1,525  2,993 
Total Loans Past Due 251  1,482  7,636  3,367  12,736 
Current Loans 146,849  524,648  817,073  912,887  2,401,457 
Total Loans $ 147,100  $ 526,130  $ 824,709  $ 916,254  $ 2,414,193 
Schedule of Non Accrual Loans by Category
Commercial
March 31, 2021 Commercial Real Estate Consumer Residential Total
Loans 90 or More Days Past Due
  and Still Accruing Interest 		$ —  $ —  $ —  $ 242  $ 242 
Nonaccrual Loans 64  4,364  746  2,913  8,087 
Nonaccrual With No Allowance for Credit Loss 64  1,641  746  2,913  5,364 
Interest Income on Nonaccrual Loans —  14  —  —  — 
December 31, 2020
Loans 90 or More Days Past Due
  and Still Accruing Interest 		$ —  $ 184  $ —  $ 44  $ 228 
Nonaccrual Loans 78  1,475  1,470  3,010  6,033 
March 31, 2020
Loans 90 or More Days Past Due
  and Still Accruing Interest 		$ 5  $ 238  $ 93  $ 101  $ 437 
Nonaccrual Loans 63  1,445  715  2,720  4,943 


19


The Company disaggregates its loan portfolio into the following four categories:

Commercial - The Company offers a variety of loan options to meet the specific needs of our commercial customers including term loans, time notes and lines of credit. Such loans are made available to businesses for working capital needs such as inventory and receivables, business expansion and equipment purchases. Generally, a collateral lien is placed on equipment or other assets owned by the borrower. Generally, these loans carry a higher risk than commercial real estate loans due to the nature of the underlying collateral, which can be business assets such as equipment and accounts receivable and generally have a lower liquidation value than real estate. In the event of default by the borrower, the Company may be required to liquidate collateral at deeply discounted values. To reduce the risk, management usually obtains personal guarantees to support the borrowing, as permitted by applicable law.

Commercial Real Estate - The Company offers commercial real estate loans to finance real estate purchases, refinancings, expansions and improvements to commercial properties. Commercial real estate loans are made to finance the purchases of real property which generally consists of real estate with completed structures. These commercial real estate loans are typically secured by first liens on the real estate, which may include apartments, commercial structures, housing businesses, healthcare facilities, and both owner and non owner-occupied facilities. These loans are typically less risky than commercial loans, since they are secured by real estate and buildings, and are generally originated in amounts of no more than 80% of the appraised value of the property. However, the Company also offers commercial construction and land development loans to finance projects. Many projects will ultimately be used by the borrowers' businesses, while others are developed for resale. These real estate loans are also typically secured by first liens on the real estate, which may include apartments, commercial structures, housing businesses, healthcare facilities and both owner-occupied and non-owner-occupied facilities. There is enhanced risk during the construction period, since the loan is secured by an incomplete project.

Consumer Loans - This category is primarily comprised of automobile loans. Arrow primarily finances the purchases of automobiles indirectly through dealer relationships located throughout upstate New York and Vermont. Most automobile loans carry a fixed rate of interest with principal repayment terms typically ranging from three to seven years. Automobile loans are underwritten on a secured basis using the underlying collateral being financed. Arrow also offers a variety of consumer installment loans to finance personal expenditures. Most of these loans carry a fixed rate of interest with principal repayment terms typically ranging from one to five years, based upon the nature of the collateral and the size of the loan. In addition to installment loans, Arrow also offers personal lines of credit and overdraft protection. Several of these consumer loans are unsecured, which carry a higher risk of loss.

Residential - Residential real estate loans consist primarily of loans secured by first or second mortgages on primary residences. Arrow originates fixed-rate and adjustable-rate and fixed-rate one-to-four-family residential real estate loans for the construction, purchase real estate or refinancing of an existing mortgage. These loans are collateralized primarily by owner-occupied properties generally located in Arrow's market area. Loans on one-to-four-family residential real estate are generally originated in amounts of no more than 80% of the purchase price or appraised value (whichever is lower), or have private mortgage insurance. Arrow’s underwriting analysis for residential mortgage loans typically includes credit verification, independent appraisals, and a review of the borrower’s financial condition. Mortgage title insurance and hazard insurance are normally required. It is Arrow's general practice to underwrite our residential real estate loans to secondary market standards. Construction loans have a unique risk, because they are secured by an incomplete dwelling. This risk is reduced through periodic site inspections, including one at each loan draw period. In addition, the Company offers fixed home equity loans, as well as home equity lines of credit to consumers to finance home improvements, debt consolidation, education and other uses.  Arrow's policy allows for a maximum loan to value ratio of 80%, although periodically higher advances are allowed.  Arrow originates home equity lines of credit and second mortgage loans (loans secured by a second junior lien position on one-to-four-family residential real estate).  Risk is generally reduced through underwriting criteria, which include credit verification, appraisals, a review of the borrower's financial condition, and personal cash flows.  A security interest, with title insurance when necessary, is taken in the underlying real estate.

The following tables present the amortized cost basis of collateral-dependent loans by class of loans as of March 31, 2021:
March 31, 2021 Collateral Type -Residential Real Estate Collateral Type - Commercial Real Estate Total Loans
Commercial $ —  $ —  $ — 
Commercial Real Estate —  3,851  3,851 
Consumer —  —  — 
Residential 1,156  —  1,156 
Total $ 1,156  $ 3,851  $ 5,007 

20

Allowance for Credit Losses

As previously mentioned in Note 1 Accounting Policies, Arrow's January 1, 2021 adoption of CECL resulted in a significant change to the methodology for estimating the allowance for credit losses as compared to December 31, 2020.
The Day 1 decrease in the allowance for credit loss on loans relating to adoption of ASU 2016-13 was $1.3 million. The Company made a policy election to report accrued interest receivable in the other assets line item on the balance sheet. Accrued interest receivable on loans totaled $6.1 million at March 31, 2021 and was excluded from the estimate of credit losses.
Loan segments were selected by class code and application code to ensure each segment is comprised of loans with homogenous loan characteristics and similar risk profiles. The resulting loan segments are commercial, commercial real estate, consumer and residential real estate loans. The consumer segment is mainly comprised of automobile loans, and since they are relatively short-term in nature, with similar dollar amounts and collateral, the vintage analysis method was selected to determine the credit loss reserve. The vintage method utilizes Arrow loan data exclusively as the method calculates a loss rate based on the total origination balance of the loans by year and the charge-off and recovery rate of the same origination year. Arrow maintains, over the life of the loan, the loss curve by vintage year. The discounted cash flow method (DCF) is used to calculate the reserve for credit losses for the commercial, commercial real estate and residential real estate segments. Please see Note 1 for a full explanation.
The Day 1 and March 31, 2021 allowance for credit losses calculation incorporated a reasonable and supportable forecast period to account for economic conditions utilized in the measurement. The quantitative model utilized an economic forecast sourced from reputable third-parties that reflected economic improvement with a reduction of approximately 1% in the national unemployment rate during the six quarter forecast period, while forecasted gross domestic product peaked in the second quarter of 2021 and remained more favorable for the remainder of the forecast period as compared to the economic forecast used for the Day 1 adoption. The home price index forecast improved significantly in the second and third quarters of 2021 and remained more favorable as compared to the economic forecast used for the Day 1 adoption. The improved economic forecast at March 31, 2021, resulted in a net decrease in the allowance for credit losses of $1.1 million, including the increases due to the increase in loan volume. Management evaluated the results of the quantitative model and determined that qualitative factor adjustments were necessary to reflect the expected life of loss for Arrow's loan portfolio. Management's evaluation considers the allowance for credit losses for loans to be appropriate as of March 31, 2021.

The following table details activity in the allowance for credit losses on loans for the three months ended March 31, 2021 and March 31, 2020. Arrow adopted ASU 2016-13 on January 1, 2021. Results for the periods beginning after January 1, 2021 are presented under ASC 326 and prior periods continue to be reported in accordance with previously applicable US GAAP.

Allowance for Credit Losses
Commercial Commercial Real Estate Consumer Residential Total
Rollforward of the Allowance for Credit Losses for the Quarterly Period:
December 31, 2020 $ 2,173  $ 9,990  $ 11,562  $ 5,507  $ 29,232 
Impact of ASU 2016-13 2,084  2,064  (9,383) 3,935  (1,300)
Balance as of January 1, 2021 as adjusted for ASU 2016-13 4,257  12,054  2,179  9,442  27,932 
Charge-offs (3) —  (627) (3) (633)
Recoveries —  —  189  —  189 
Provision 43  (110) 688  (1,269) (648)
March 31, 2021 $ 4,297  $ 11,944  $ 2,429  $ 8,170  $ 26,840 

Allowance for Loan Losses
Commercial Commercial Real Estate Consumer Residential Total
Rollforward of the Allowance for Loan Losses for the Quarterly Period:
December 31, 2019 $ 1,386  $ 5,830  $ 9,408  $ 4,563  $ 21,187 
Charge-offs (14) —  (467) —  $ (481)
Recoveries —  —  159  —  $ 159 
Provision 267  1,235  904  366  $ 2,772 
March 31, 2020 $ 1,639  $ 7,065  $ 10,004  $ 4,929  $ 23,637 

Estimated Credit Losses on Off-Balance Sheet Credit Exposures Recognized as Other Liabilities

Financial instrument credit losses apply to off-balance sheet credit exposures such as unfunded loan commitments and standby letters of credit. A liability for expected credit losses for off-balance sheet exposures is recognized if the entity has a present contractual obligation to extend the credit and the obligation is not unconditionally cancellable by the entity. The Day 1 adoption of ASU 2016-13, created an allowance for credit loss on off-balance sheet exposures recognized as other liabilities of $1.1 million. Subsequent changes in this allowance are reflected in other operating expenses within the non interest expense category. As of March 31, 2021, the total unfunded commitment off-balance sheet credit exposure was $993 thousand.

21


Individually Evaluated Loans

All loans not included in the vintage analysis method that exceed $250,000, which are on nonaccrual status, are evaluated on an individual basis. Arrow made the policy election to apply practical expedient for collateral dependent financial assets when the borrower is experiencing financial difficulty and the repayment is expected through the sale of the collateral. This allows Arrow to use fair value of the collateral at the reporting date adjusted for estimated cost to sell when recording the net carrying amount of the asset and determining the allowance for credit losses for a financial asset. In the event where the repayment of a collateral dependent financial asset is expected to be provided substantially through the operating of the collateral, Arrow will use fair value of the collateral at the reporting date when recording the net carrying amount of the asset and determining the allowance for credit losses. As of March 31, 2021, there were six total relationships identified to be evaluated for loss on an individual basis which had an amortized cost basis of $5.0 million and only one loan had an allowance for credit loss of $556 thousand.

Allowance for Credit Losses - Collectively and Individually Evaluated
Commercial Commercial Real Estate Consumer Residential Total
March 31, 2021
Ending Loan Balance - Collectively Evaluated $ 288,551  $ 577,656  $ 861,171  $ 906,858  $ 2,634,236 
Allowance for Credit Losses - Loans Collectively Evaluated 4,297  11,388  2,429  8,170  26,284 
Ending Loan Balance - Individually Evaluated —  3,851  —  1,156  5,007 
Allowance for Credit Losses - Loans Individually Evaluated —  556  —  —  556 

The following table presents information pertaining to the allowance for loan losses as of December 31, 2020 and March 31, 2020, as determined in accordance with ASC 310, prior to the adoption of ASU 2016-13:

Allowance for Loan Losses - Collectively and Individually Evaluated for Impairment
Commercial Commercial Real Estate Consumer Residential Total
December 31, 2020
Ending Loan Balance - Collectively Evaluated for Impairment $ 240,507  $ 570,659  $ 859,657  $ 921,504  $ 2,592,327 
Allowance for Loan Losses - Loans Collectively Evaluated for Impairment 2,154  9,990  11,562  5,485  $ 29,191 
Ending Loan Balance - Individually Evaluated for Impairment 47  1,128  111  1,417  2,703 
Allowance for Loan Losses - Loans Individually Evaluated for Impairment 19  —  —  22  41 
March 31, 2020
Ending Loan Balance - Collectively Evaluated for Impairment $ 147,066  $ 524,993  $ 824,598  $ 915,301  $ 2,411,958 
Allowance for Loan Losses - Loans Collectively Evaluated for Impairment 1,635  7,065  10,004  4,892  23,596 
Ending Loan Balance - Individually Evaluated for Impairment 34  1,137  111  953  2,235 
Allowance for Loan Losses - Loans Individually Evaluated for Impairment 4  —  —  37  41 


Through the provision for credit losses, an allowance for credit losses is maintained that reflects the best estimate of the calculated expected credit losses in the Company’s loan portfolio as of the balance sheet date. Additions are made to the allowance for credit losses through a periodic provision for credit losses. Actual credit losses are charged against the allowance for credit losses when loans are deemed uncollectible and recoveries of amounts previously charged off are recorded as credits to the allowance for credit losses.
Arrow's loan officers and risk managers meet at least quarterly to discuss and review the conditions and risks associated with certain criticized and classified commercial-related relationships. In addition, the independent internal loan review department performs periodic reviews of the credit quality indicators on individual loans in the commercial loan portfolio.
Management considers the need to qualitatively adjust expected credit loss estimates for information not already captured in the loss estimation process. These qualitative factor adjustments may increase or decrease management’s estimate of expected credit losses. Adjustments are not made for information that has already been considered and included in the loss estimation process.

22

Management considers the qualitative factors that are relevant to Arrow as of the reporting date, which may include, but are not limited to the following factors:
•The nature and volume of Arrow's financial assets;
•The existence, growth, and effect of any concentrations of credit;
•The volume and severity of past due loans, the volume of nonaccrual loans, and the volume and severity of adversely classified or graded loans;
•The value of the underlying collateral for loans that are not collateral-dependent;
•Arrow's lending policies and procedures, including changes in underwriting standards and practices for collections, write-offs, and recoveries;
•The quality of Arrow's loan review function;
•The experience, ability, and depth of Arrow's lending, investment, collection, and other relevant management/staff;
•The effect of other external factors such as the regulatory, legal and technological environments; competition; and events such as natural disasters;
•Actual and expected changes in international, national, regional, and local economic and business conditions and developments in which the institution operates that affect the collectability of financial assets; and
•Other qualitative factors not reflected in quantitative loss rate calculations.




























23


Loan Credit Quality Indicators

The following table presents credit quality indicators by total loans amortized cost basis by origination year as of March 31, 2021.

Term Loans Amortized Cost Basis by Origination Year Revolving Loans Amortized Cost Basis Revolving Loan Converted to Term Total
March 31, 2021 2021 2020 2019 2018 2017 Prior
Commercial:
Risk rating
Satisfactory $ 78,184  $ 126,061  $ 18,202  $ 15,693  $ 10,004  $ 12,234  $ 14,006  $ —  $ 274,384 
Special mention —  5,031  66  —  —  2  —  —  5,099 
Substandard —  5,507  —  —  —  3,514  47  —  9,068 
Doubtful —  —  —  —  —  —  —  —  — 
Total Commercial Loans $ 78,184  $ 136,599  $ 18,268  $ 15,693  $ 10,004  $ 15,750  $ 14,053  $ —  $ 288,551 
Commercial Real Estate:
Risk rating
Satisfactory $ 24,511  $ 298,907  $ 49,957  $ 44,902  $ 24,558  $ 83,690  $ 3,161  $ —  $ 529,686 
Special mention —  17,825  2,010  —  142  2,115  —  —  22,092 
Substandard 2,021  10,853  4,006  163  —  12,661  25  —  29,729 
Doubtful —  —  —  —  —  —  —  —  — 
Total Commercial Real Estate Loans $ 26,532  $ 327,585  $ 55,973  $ 45,065  $ 24,700  $ 98,466  $ 3,186  $ —  $ 581,507 
Consumer:
Risk rating
Performing $ 95,223  $ 321,575  $ 225,191  $ 135,646  $ 56,508  $ 25,834  $ 448  $ —  $ 860,425 
Nonperforming —  141  181  189  167  68  —  —  746 
Total Consumer Loans $ 95,223  $ 321,716  $ 225,372  $ 135,835  $ 56,675  $ 25,902  $ 448  $ —  $ 861,171 
Residential:
Risk rating
Performing $ 34,833  $ 156,500  $ 114,523  $ 107,176  $ 110,308  $ 266,377  $ 115,142  $ —  $ 904,859 
Nonperforming —  203  —  27  149  2,544  232  —  3,155 
Total Residential Loans $ 34,833  $ 156,703  $ 114,523  $ 107,203  $ 110,457  $ 268,921  $ 115,374  $ —  $ 908,014 

For the purposes of the table above, nonperforming consumer and residential loans were those loans on nonaccrual status or are 90 days or more past due and still accruing interest.
The recorded investment of consumer mortgage loans secured by residential real estate properties for which formal foreclosure proceedings are in process is $1.4 million.
For the allowance calculation, an internally developed system of five credit quality indicators is used to rate the credit worthiness of each commercial loan defined as follows:
1) Satisfactory - "Satisfactory" borrowers have acceptable financial condition with satisfactory record of earnings and sufficient historical and projected cash flow to service the debt.  Borrowers have satisfactory repayment histories and primary and secondary sources of repayment can be clearly identified;
2) Special Mention - Loans in this category have potential weaknesses that deserve management’s close attention.  If left uncorrected, these potential weaknesses may result in deterioration of the repayment prospects for the asset or in the institution’s credit position at some future date.  "Special mention" assets are not adversely classified and do not expose an institution to sufficient risk to warrant adverse classification.  Loans which might be assigned this credit quality indicator include loans to borrowers with deteriorating financial strength and/or earnings record and loans with potential for problems due to weakening economic or market conditions;
3) Substandard - Loans classified as “substandard” are inadequately protected by the current sound net worth or paying capacity of the borrower or the collateral pledged, if any.  Loans in this category have well defined weaknesses that jeopardize the repayment. They are characterized by the distinct possibility that the Company will sustain some loss if the deficiencies are not corrected. “Substandard” loans may include loans which are likely to require liquidation of collateral to effect repayment, and other loans where character or ability to repay has become suspect. Loss potential, while existing in the aggregate amount of substandard assets, does not have to exist in individual assets classified substandard;

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4) Doubtful - Loans classified as “doubtful” have all of the weaknesses inherent in those classified as “substandard” with the added characteristic that the weaknesses make collection or liquidation in full, on the basis of current existing facts, conditions, and values, highly questionable and improbable.  Although possibility of loss is extremely high, classification of these loans as “loss” has been deferred due to specific pending factors or events which may strengthen the value (e.g. possibility of additional collateral, injection of capital, collateral liquidation, debt restructure, economic recovery, etc).  Loans classified as “doubtful” need to be placed on non-accrual; and
5) Loss - Loans classified as “loss” are considered uncollectible with collateral of such little value that their continuance as bankable assets is not warranted.  As of the date of the balance sheet, all loans in this category have been charged-off to the allowance for loan losses.  

Commercial loans are generally evaluated on an annual basis depending on the size and complexity of the loan relationship, unless the credit related quality indicator falls to a level of "special mention" or below, when the loan is evaluated quarterly.  The credit quality indicator is one of the factors used in assessing the level of incurred risk of loss in our commercial related loan portfolios.

The following table presents information pertaining to loan credit quality indicators as of December 31, 2020 and March 31, 2020, as determined in accordance with ASC 310, prior to the adoption of ASU 2016-13:

Loan Credit Quality Indicators
Commercial
Commercial Real Estate Consumer Residential Total
December 31, 2020
Credit Risk Profile by Creditworthiness Category:
Satisfactory $ 229,351  $ 525,609  $ 754,960 
Special Mention 1,574  16,213  17,787 
Substandard 9,629  29,965  39,594 
Doubtful —  —  — 
Performing $ 858,298  $ 919,867  $ 1,778,165 
Nonperforming 1,470  3,054  4,524 
March 31, 2020
Credit Risk Profile by Creditworthiness Category:
Satisfactory $ 140,218  $ 497,243  $ 637,461 
Special Mention 28  255  283 
Substandard 6,854  28,632  35,486 
Doubtful —  —  — 
Credit Risk Profile Based on Payment Activity:
Performing $ 823,901  $ 913,433  $ 1,737,334 
Nonperforming 808  2,821  3,629 










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Impaired Loans

The following table presents information on impaired loans as of December 31, 2020 and March 31, 2020 based on whether the impaired loan has a recorded related allowance or has no recorded related allowance, as determined in accordance with ASC 310, prior to the adoption of ASU 2016-13:
Impaired Loans
Commercial
Commercial Real Estate Consumer Residential Total
December 31, 2020
Recorded Investment:
With No Related Allowance $ —  $ 1,124  $ 112  $ 1,174  $ 2,410 
With a Related Allowance 46  —  —  244  290 
Unpaid Principal Balance:
With No Related Allowance —  1,128  111  1,174  2,413 
With a Related Allowance 47  —  —  244  291 
March 31, 2020
Recorded Investment:
With No Related Allowance $ —  $ 1,137  $ 112  $ 697  $ 1,946 
With a Related Allowance 33  —  —  256  289 
Unpaid Principal Balance:
With No Related Allowance —  1,137  111  697  $ 1,945 
With a Related Allowance 34  —  —  256  290 
March 31, 2020
Average Recorded Balance:
With No Related Allowance $ —  $ 569  $ 110  $ 698  $ 1,377 
With a Related Allowance 34  —  —  258  292 
Interest Income Recognized:
With No Related Allowance —  10  —  —  10 
With a Related Allowance —  —  —  —  — 
Cash Basis Income:
With No Related Allowance —  —  —  —  — 
With a Related Allowance —  —  —  —  — 

At December 31, 2020 and March 31, 2020, all impaired loans were considered to be collateral dependent and were therefore evaluated for impairment based on the fair value of collateral less estimated cost to sell. Interest income recognized in the table above represents income earned after the loan became impaired and includes restructured loans in compliance with their modified terms and nonaccrual loans where interest income was recognized on a cash basis.

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Loans Modified in Trouble Debt Restructurings

The following table presents information on loans modified in trouble debt restructurings during the periods indicated.
Loans Modified in Trouble Debt Restructurings During the Period
Commercial
Commercial Real Estate Consumer Residential Total
For the Quarter Ended:
March 31, 2021
Number of Loans —  —  —  —  — 
Pre-Modification Outstanding Recorded Investment $ —  $ —  $ —  $ —  $ — 
Post-Modification Outstanding Recorded Investment —  —  —  —  — 
Subsequent Default, Number of Contracts —  —  —  —  — 
Subsequent Default, Recorded Investment —  —  —  —  — 
March 31, 2020
Number of Loans —  —  1  —  1 
Pre-Modification Outstanding Recorded Investment $ —  $ —  $ 16  $ —  $ 16 
Post-Modification Outstanding Recorded Investment —  —  16  —  16 
Subsequent Default, Number of Contracts —  —  —  —  — 
Subsequent Default, Recorded Investment —  —  —  —  — 

In general, prior to the novel coronavirus (COVID-19) pandemic, loans requiring modification are restructured to accommodate the projected cash-flows of the borrower. Such modifications may involve a reduction of the interest rate, a significant deferral of payments or forgiveness of a portion of the outstanding principal balance. As indicated in the table above, no loans modified during the preceding twelve months subsequently defaulted as of March 31, 2021. The Consolidated Appropriations Act, 2021 extended certain provisions of the CARES Act including, if a short-term loan modification (e.g. six months) is made for a borrower as the result of the COVID-19 pandemic, and who was current on contractual payments as of December 31, 2019, this modification is not considered a TDR.


Note 5.    COMMITMENTS AND CONTINGENCIES (In Thousands)

The following table presents the notional amount and fair value of Arrow's off-balance sheet commitments to extend credit and commitments under standby letters of credit as of March 31, 2021, December 31, 2020 and March 31, 2020:
Commitments to Extend Credit and Letters of Credit
March 31, 2021 December 31, 2020 March 31, 2020
Notional Amount:
Commitments to Extend Credit $ 437,920  $ 399,882  $ 376,519 
Standby Letters of Credit 3,775  3,703  3,301 
Fair Value:
Commitments to Extend Credit $ —  $ —  $ — 
Standby Letters of Credit 12  28  29 
    
Arrow is party to financial instruments with off-balance sheet risk in the normal course of business to meet the financing needs of its customers.  These financial instruments include commitments to extend credit and standby letters of credit.  Commitments to extend credit include home equity lines of credit, commitments for residential and commercial construction loans and other personal and commercial lines of credit.  Those instruments involve, to varying degrees, elements of credit and interest rate risk in excess of the amount recognized in the consolidated balance sheets.  The contract or notional amounts of those instruments reflect the extent of the involvement Arrow has in particular classes of financial instruments.
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Arrow's exposure to credit loss in the event of nonperformance by the other party to the financial instrument for commitments to extend credit and standby letters of credit is represented by the contractual notional amount of those instruments.  Arrow uses the same credit policies in making commitments and conditional obligations as it does for on-balance sheet instruments.
Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract.  Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee.  Since many of the commitments are not expected to be fully drawn upon, the total commitment amounts do not necessarily represent future cash requirements.  Arrow evaluates each customer's creditworthiness on a case-by-case basis.  Home equity lines of credit are secured by residential real estate.  Construction lines of credit are secured by underlying real estate.  For other lines of credit, the amount of collateral obtained, if deemed necessary by Arrow upon extension of credit, is based on management's credit evaluation of the counterparty.  Collateral held varies, but may include accounts receivable, inventory, property, plant and equipment, and income-producing commercial properties.  Most of the commitments are variable rate instruments.
Arrow does not issue any guarantees that would require liability-recognition or disclosure, other than its standby letters of credit.
Arrow has issued conditional commitments in the form of standby letters of credit to guarantee payment on behalf of a customer and guarantee the performance of a customer to a third party.  Standby letters of credit generally arise in connection with commercial lending relationships. The credit risk involved in issuing these instruments is essentially the same as that involved in extending loans to customers. Contingent obligations under standby letters of credit at March 31, 2021, December 31, 2020 and March 31, 2020 represent the maximum potential future payments Arrow could be required to make.  Typically, these instruments have terms of 12 months or less and expire unused; therefore, the total amounts do not necessarily represent future cash requirements.  Each customer is evaluated individually for creditworthiness under the same underwriting standards used for commitments to extend credit and on-balance sheet instruments. Company policies governing loan collateral apply to standby letters of credit at the time of credit extension.  Loan-to-value ratios will generally range from 50% for movable assets, such as inventory, to 100% for liquid assets, such as bank CD's.  Fees for standby letters of credit range from 1% to 3% of the notional amount.  Fees are collected upfront and amortized over the life of the commitment. The carrying amount and fair value of Arrow's standby letters of credit at March 31, 2021, December 31, 2020 and March 31, 2020, were insignificant.  The fair value of standby letters of credit is based on the fees currently charged for similar agreements or the cost to terminate the arrangement with the counterparties.
The fair value of commitments to extend credit is determined by estimating the fees to enter into similar agreements, taking into account the remaining terms and present creditworthiness of the counterparties, and for fixed rate loan commitments, the difference between the current and committed interest rates.  Arrow provides several types of commercial lines of credit and standby letters of credit to its commercial customers.  The pricing of these services is not isolated as Arrow considers the customer's complete deposit and borrowing relationship in pricing individual products and services.  The commitments to extend credit also include commitments under home equity lines of credit, for which Arrow charges no fee.  The carrying value and fair value of commitments to extend credit are not material and Arrow does not expect to incur any material loss as a result of these commitments.
In the normal course of business, Arrow and its subsidiary banks become involved in a variety of routine legal proceedings.  At present, there are no legal proceedings pending or threatened, which in the opinion of management and counsel, would result in a material loss to Arrow.
Except as noted below, Arrow, including its subsidiary banks, is not currently the subject of any material pending legal proceedings, other than ordinary routine litigation occurring in the normal course of their business. On an ongoing basis, Arrow is often the subject of, or a party to, various legal claims by other parties against Arrow, by Arrow against other parties, or involving Arrow, which arise in the normal course of business. Except as noted below, the various pending legal claims against Arrow will not, in the opinion of management based upon consultation with counsel, result in any material liability.
On July 1, 2020, Daphne Richard, a customer of GFNB filed a putative class action complaint against GFNB in the United States District Court for the Northern District of New York. The complaint alleges that GFNB assessed overdraft fees on certain transactions drawn on her checking account without having sufficiently disclosed its overdraft-fee practices in its account agreement. Ms. Richard, on behalf of two purported classes, seeks compensatory damages, disgorgement of profits, statutory damages, treble damages, enjoinment of the conduct complained of, and costs and fees. The complaint is similar to complaints filed against other financial institutions pertaining to overdraft fees. Arrow denies any wrongdoing and the case is being vigorously defended.







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Note 6.    COMPREHENSIVE INCOME (In Thousands)

The following table presents the components of other comprehensive income for the three month periods ended March 31, 2021 and 2020:
Schedule of Comprehensive Income
Three Months Ended March 31
Tax
Before-Tax (Expense) Net-of-Tax
Amount Benefit Amount
2021
Net Unrealized Securities Holding Loss on Securities Available-for-Sale Arising During the Period $ (5,121) $ 1,309  $ (3,812)
Net Unrealized Gain on Cash Flow Swap 1,982  (507) 1,475 
Reclassification of Net Unrealized Gain on Cash Flow Hedge Agreements to Interest Expense (28) 8  (20)
Amortization of Net Retirement Plan Actuarial Loss 46  (12) 34 
Amortization of Net Retirement Plan Prior Service Cost 59  (16) 43 
  Other Comprehensive Loss $ (3,062) $ 782  $ (2,280)
2020
Net Unrealized Securities Holding Gain on Securities Available-for-Sale Arising During the Period $ 5,504  $ (1,406) $ 4,098 
Net Unrealized Loss on Cash Flow Swap (294) 75  (219)
Amortization of Net Retirement Plan Actuarial Loss 36  (9) 27 
Amortization of Net Retirement Plan Prior Service Cost 54  (15) 39 
  Other Comprehensive Income $ 5,300  $ (1,355) $ 3,945 


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The following table presents the changes in accumulated other comprehensive income by component:
Changes in Accumulated Other Comprehensive Income (Loss) by Component (1)
Unrealized (Loss) and Gain on Available-for-Sale Securities Unrealized Gain (Loss) on Cash Flow Swap Defined Benefit Plan Items Total
Net Actuarial Loss Net Prior Service Cost
For the Quarter-To-Date periods ended:
December 31, 2020 $ 5,799  $ 485  $ (5,929) $ (1,171) $ (816)
Other comprehensive income or loss before reclassifications (3,812) 1,475  —  —  (2,337)
Amounts reclassified from accumulated other comprehensive income —  (20) 34  43  57 
Net current-period other comprehensive income (3,812) 1,455  34  43  (2,280)
March 31, 2021 $ 1,987  $ 1,940  $ (5,895) $ (1,128) $ (3,096)
December 31, 2019 $ 465  $ —  $ (5,847) $ (975) $ (6,357)
Other comprehensive income or loss before reclassifications 4,098  (219) —  —  3,879 
Amounts reclassified from accumulated other comprehensive income —  —  27  39  66 
Net current-period other comprehensive income 4,098  (219) 27  39  3,945 
March 31, 2020 $ 4,563  $ (219) $ (5,820) $ (936) $ (2,412)

(1) All amounts are net of tax.
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The following table presents the reclassifications out of accumulated other comprehensive income:
Reclassifications Out of Accumulated Other Comprehensive Income
Details about Accumulated Other Comprehensive Income (Loss) Components Amounts Reclassified from Accumulated Other Comprehensive Income Affected Line Item in the Statement Where Net Income Is Presented
For the Quarter-to-date periods ended:
March 31, 2021
Reclassification of Net Unrealized Gain on Cash Flow Hedge Agreements to Interest Expense $ 28  Interest expense
Amortization of defined benefit pension items:
Prior-service costs (59)
(1)
Salaries and Employee Benefits
Actuarial loss (46)
(1)
Salaries and Employee Benefits
(77) Total before Tax
20  Provision for Income Taxes
Total reclassifications for the period $ (57) Net of Tax
March 31, 2020
Amortization of defined benefit pension items:
Prior-service costs $ (54)
(1)
Salaries and Employee Benefits
Actuarial loss (36)
(1)
Salaries and Employee Benefits
(90) Total before Tax
24  Provision for Income Taxes
Total reclassifications for the period $ (66) Net of Tax
(1) These accumulated other comprehensive income components are included in the computation of net periodic pension cost.

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Note 7.    STOCK-BASED COMPENSATION (Dollars In Thousands, Except Share and Per Share Amounts)

Arrow has established three stock-based compensation plans: a Long Term Incentive Plan, an Employee Stock Purchase Plan (ESPP) and an Employee Stock Ownership Plan (ESOP). All share and per share data have been adjusted for the September 25, 2020 3% stock dividend.

Long Term Incentive Plan
The Long Term Incentive Plan provides for the grant of incentive stock options, non-qualified stock options, restricted stock, restricted stock units, performance units and performance shares. The Compensation Committee of the Board of Directors administers the Long Term Incentive Plan.

Stock Options - Options may be granted at a price no less than the greater of the par value or fair market value of such shares on the date on which such option is granted, and generally expire ten years from the date of grant.  The options usually vest over a four-year period.

The following table summarizes information about stock option activity for the year to date period ended March 31, 2021.
Shares Weighted Average Exercise Price
Outstanding at January 1, 2021
264,090  $ 28.84 
Granted 55,500  29.55 
Exercised (6,927) 22.52 
Forfeited (1,034) 19.70 
Outstanding at March 31, 2021
311,629  29.14 
Vested at Period-End 179,681  27.73 
Expected to Vest 131,948  31.05 
Stock Options Granted
Weighted Average Grant Date Information:
Fair Value of Options Granted $ 4.85 
Fair Value Assumptions:
Dividend Yield 3.41  %
Expected Volatility 26.53  %
Risk Free Interest Rate 0.49  %
Expected Lives (in years) 8.75


The following table presents information on the amounts expensed related to stock options for the three month periods ended March 31, 2021 and 2020:
For the Three Months Ended March 31,
2021 2020
Amount expensed $ 72  $ 76 

Restricted Stock Units - The Company grants restricted stock units which gives the recipient the right to receive shares of Company stock upon vesting. The fair value of each restricted stock unit is the market value of Company stock on the date of grant. 100% of the restricted stock unit awards vest three years from the grant date. Once vested, the restricted stock units become vested units and are no longer forfeitable. Vested units settle upon retirement of the recipient. Unvested restricted stock unit awards will generally be forfeited if the recipient ceases to be employed by the Company, with limited exceptions.

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The following table summarizes information about restricted stock unit activity for the periods ended March 31, 2021 and 2020.
Restricted Stock Units Weighted Average Grant Date Fair Value
Non-vested at January 1, 2021 11,663  $ 31.62 
Granted 4,738  29.40 
Vested (3,582) 30.71 
Non-vested at March 31, 2021 12,819  31.05 
Non-vested at January 1, 2020 7,721  30.27 
Granted 3,942  34.25 
Non-vested at March 31, 2020 11,663  31.62 


The following table presents information on the amounts expensed related to restricted stock units for the periods ended March 31, 2021 and 2020:
For the Three Months Ended March 31,
2021 2020
Amount expensed $ 32  $ 27 

    
Employee Stock Purchase Plan
Arrow sponsors an ESPP under which employees may purchase Arrow's common stock at a discount below market price. The current amount of the discount is 5% . Under current accounting guidance, a stock purchase plan with a discount of 5% or less is not considered a compensatory plan.

Employee Stock Ownership Plan
Arrow maintains an ESOP, pursuant to which substantially all employees of Arrow and its subsidiaries are eligible to participate upon satisfaction of applicable service requirements. The Company makes cash contributions to the ESOP each year.

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Note 8.    RETIREMENT BENEFIT PLANS (Dollars in Thousands)

Arrow sponsors qualified and non-qualified defined benefit pension plans and other postretirement benefit plans for its employees. Arrow maintains a non-contributory pension plan, which covers substantially all employees.  Effective December 1, 2002, all active participants in the qualified defined benefit pension plan were given a one-time irrevocable election to continue participating in the traditional plan design, for which benefits were based on years of service and the participant’s final compensation (as defined), or to begin participating in the new cash balance plan design.  All employees who first participate in the plan after December 1, 2002 automatically participate in the cash balance plan design.  The interest credits under the cash balance plan are based on the 30-year U.S. Treasury rate in effect for November of the prior year with a minimum interest credit of 3%.  The service credits under the cash balance plan are equal to 6.0% of eligible salaries for employees who become participants on or after January 1, 2003.  For employees in the plan prior to January 1, 2003, the service credits are scaled based on the age of the participant, and range from 6.0% to 12.0%. The funding policy is to contribute up to the maximum amount that can be deducted for federal income tax purposes and to make all payments required under The Employee Retirement Income Security Act (ERISA).  Arrow also maintains a supplemental non-qualified unfunded retirement plan to provide eligible employees of Arrow and its subsidiaries with benefits in excess of qualified plan limits imposed by federal tax law.
Arrow has multiple non-pension postretirement benefit plans.  The health care, dental and life insurance plans are contributory, with participants’ contributions adjusted annually.  Arrow’s policy is to fund the cost of postretirement benefits based on the current cost of the underlying policies.  However, the health care plan provision allows for grandfathered participants to receive automatic increases of Company contributions each year based on the increase in inflation, limited to a maximum of 5%.  
As of December 31, 2020, Arrow used the sex-distinct amount-weighted Pri-2012 mortality tables for employees, healthy annuitants and contingent survivors, adjusted for mortality improvements with the Scale MP-2020 mortality improvement scale on a generational basis for the Pension Plan and the sex-distinct amount-weighted White Collar tables for employees and healthy annuitants, adjusted for mortality improvements with the scale MP-2020 mortality improvement scale on a generational basis for the Select Executive Retirement Plan. As of December 31, 2020, Arrow updated its mortality assumption used for the Postretirement Plan to the sex-distinct Pri.H-2012 headcount-weighted mortality tables for employees and healthy annuitants, adjusted for mortality improvements with the Scale MP-2020 mortality improvement scale on a generational basis. The change in mortality tables resulted in a decrease in liabilities for the Employees' Pension Plan, the Select Executive Retirement Plan and the Postretirement Benefit Plan.
The interest rates used in determining the present value of a lump sum payment/annuitizing cash balance accounts were changed to the segment rates in effect for the January 1, 2020 plan year (0.53%, 2.31%, 3.09%) as of December 31, 2020.
Effective January 1, 2021, Glens Falls National Bank and Trust Company amended the Arrow Financial Corporation Employees' Pension Plan. The plan change was adopted January 1, 2021 and the amendment was valued as of December 31, 2020. The plan amendment is the following:
Effective January 1, 2021, the benefit payable to or on behalf of each participant:
• whose employment with the employer (or any predecessor employer, except as noted below) terminated on or before
January 1, 2016;
• who satisfied the requirements for early, normal, or late retirement as of such termination;
• who never participated in the United Vermont Bancorporation Plan and;
• who is, or whose beneficiary is, receiving monthly benefit payments from the Plan as of January 1, 2021 (including a
participant or beneficiary who shall commence receiving benefits from the Plan as of January 1, 2021), shall be increased
by three percent (3%).
The foregoing increase was applied to the monthly benefit actually payable to the Participant, or to the Participant's Beneficiary, as of January 1, 2021, determined after all applicable adjustments, regardless of whether such benefit had been determined under the Company's plan or the plan of a predecessor employer that had been merged into the Plan.
The plan amendment caused a $351,638 increase in the projected benefit obligation creating a positive service cost which will be amortized over 9.70 years (the average expected future service of active plan participants.)
Effective January 1, 2021, Glens Falls National Bank and Trust Company amended the Arrow Financial Corporation Employees' Select Executive Retirement Plan. The plan change was adopted January 1, 2021 and the amendment was valued as of December 31, 2020. The plan amendment provides a special adjustment to the monthly benefit payment for certain retirees. The plan amendment caused a $122,797 increase in the projected benefit obligation creating a positive prior service cost which will be amortized over 12.5 years.
The following tables provide the components of net periodic benefit costs for the three month periods ended March 31, 2021 and 2020.
Employees' Select Executive Postretirement
Pension Retirement Benefit
Plan Plan Plans
Net Periodic (Benefit) Cost
For the Three Months Ended March 31, 2021:
Service Cost 1
$ 460  $ 118  $ 31 
Interest Cost 2
340  45  67 
Expected Return on Plan Assets 2
(950) —  — 
Amortization of Prior Service Cost 2
20  12  27 
Amortization of Net Loss 2
—  38  8 
Net Periodic (Benefit) Cost $ (130) $ 213  $ 133 
Plan Contributions During the Period $ —  $ 118  $ 28 
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For the Three Months Ended March 31, 2020:
Service Cost 1
$ 430  $ 103  $ 33 
Interest Cost 2
417  54  78 
Expected Return on Plan Assets 2
(904) —  — 
Amortization of Prior Service Cost 2
16  11  27 
Amortization of Net Loss 2
1  33  2 
Net Periodic (Benefit) Cost $ (40) $ 201  $ 140 
Plan Contributions During the Period $ —  $ 117  $ 78 
Footnotes:
1. Included in Salaries and Employee Benefits on the Consolidated Statements of Income
2. Included in Other Operating Expense on the Consolidated Statements of Income

A contribution to the qualified pension plan was not required during the period ended March 31, 2021 and currently, additional contributions in 2021 are not expected. Arrow makes contributions to its other post-retirement benefit plans in an amount equal to benefit payments for the year.


Note 9.    EARNINGS PER COMMON SHARE (In Thousands, Except Per Share Amounts)

The following table presents a reconciliation of the numerator and denominator used in the calculation of basic and diluted earnings per common share (“EPS”) for periods ended March 31, 2021 and 2020.  All share and per share amounts have been adjusted for the September 25, 2020, 3% stock dividend.
Earnings Per Share
Three Months Ended
March 31, 2021 March 31, 2020
Earnings Per Share - Basic:
Net Income $ 13,280  $ 8,127 
Weighted Average Shares - Basic 15,528  15,446 
Earnings Per Share - Basic $ 0.86  $ 0.53 
Earnings Per Share - Diluted:
Net Income $ 13,280  $ 8,127 
Weighted Average Shares - Basic 15,528  15,446 
Dilutive Average Shares Attributable to Stock Options 35  30 
Weighted Average Shares - Diluted 15,563  15,476 
Earnings Per Share - Diluted $ 0.85  $ 0.53 
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Note 10.    FAIR VALUES (Dollars In Thousands)

FASB ASC Subtopic 820-10 defines fair value, establishes a framework for measuring fair value in GAAP and requires certain disclosures about fair value measurements. There are no nonfinancial assets or liabilities measured at fair value on a recurring basis. The only assets or liabilities that Arrow measured at fair value on a recurring basis at March 31, 2021, December 31, 2020 and March 31, 2020 were securities available-for-sale, equity securities and derivatives. Arrow held no securities or liabilities for trading on such dates.
The table below presents the financial instrument's fair value and the amounts within the fair value hierarchy based on the lowest level of input that is significant to the fair value measurement:
Fair Value of Assets and Liabilities Measured on a Recurring and Nonrecurring Basis
Fair Value Measurements at Reporting Date Using:
Fair Value Quoted Prices
In Active Markets for Identical Assets
(Level 1) 		Significant Other
Observable Inputs
(Level 2) 		Significant Unobservable Inputs
(Level 3)
Fair Value of Assets and Liabilities Measured on a Recurring Basis:
March 31, 2021
Assets:
Securities Available-for Sale:
   U.S. Government & Agency Obligations $ 108,370  $ —  $ 108,370  $ — 
   State and Municipal Obligations 508  —  508  — 
   Mortgage-Backed Securities 354,411  —  354,411  — 
   Corporate and Other Debt Securities 800  —  800  — 
Total Securities Available-for-Sale 464,089  —  464,089  — 
Equity Securities 1,796  —  1,796  — 
Total Securities Measured on a Recurring Basis 465,885  —  465,885  — 
Derivatives, included in other assets 2,298  —  2,298  — 
Total Measured on a Recurring Basis $ 468,183  $ —  $ 468,183  $ — 
Liabilities:
Derivatives, included in other liabilities 2,298  —  2,298  — 
Total Measured on a Recurring Basis $ 2,298  $ —  $ 2,298  $ — 
December 31, 2020
Assets:
Securities Available-for Sale:
   U.S. Government & Agency Obligations $ 65,112  $ —  $ 65,112  $ — 
   State and Municipal Obligations 528  —  528  — 
   Mortgage-Backed Securities 298,847  —  298,847  — 
   Corporate and Other Debt Securities 800  —  800  — 
Total Securities Available-for-Sale 365,287  —  365,287  — 
Equity Securities 1,636  —  1,636  — 
36

Fair Value of Assets and Liabilities Measured on a Recurring and Nonrecurring Basis
Fair Value Measurements at Reporting Date Using:
Fair Value Quoted Prices
In Active Markets for Identical Assets
(Level 1) 		Significant Other
Observable Inputs
(Level 2) 		Significant Unobservable Inputs
(Level 3)
Total Securities Measured on a Recurring Basis 366,923  —  366,923  — 
Derivatives, included in other liabilities 5,080  —  5,080  — 
Total Measured on a Recurring Basis $ 372,003  $ —  $ 372,003  $ — 
Liabilities:
Derivatives, included in other liabilities 5,080  —  5,080  — 
Total Measured on a Recurring Basis $ 5,080  $ —  $ 5,080  $ — 
March 31, 2020
Assets:
Securities Available-for Sale:
   U.S. Government & Agency Obligations $ 5,181  $ —  $ 5,181  $ — 
   State and Municipal Obligations 723  —  723  — 
   Mortgage-Backed Securities 371,482  —  371,482  — 
   Corporate and Other Debt Securities 800  —  800  — 
Total Securities Available-for-Sale 378,186  —  378,186  — 
Equity Securities 1,689  —  1,689  — 
Total Securities Measured on a Recurring Basis $ 379,875  $ —  $ 379,875  $ — 
Derivatives, included in other assets 5,191  $ —  5,191  — 
Total Measured on a Recurring Basis $ 385,066  $ —  $ 385,066  $ — 
Liabilities:
Derivatives, included in other liabilities 5,191  —  5,191  — 
Total Measured on a Recurring Basis $ 5,191  $ —  $ 5,191  $ — 
Fair Value Quoted Prices
In Active Markets for Identical Assets
(Level 1) 		Significant Other
Observable Inputs
(Level 2) 		Significant Unobservable Inputs
(Level 3) 		Losses Recognized in Earnings
Fair Value of Assets and Liabilities Measured on a Nonrecurring Basis:
March 31, 2021
Collateral Dependent Evaluated Loans $ 2,423  $ —  $ —  $ 2,423 
Other Real Estate Owned and Repossessed Assets, Net 242  —  —  242  — 
December 31, 2020
Collateral Dependent Impaired Loans $ 594  $ —  $ —  $ 594 
Other Real Estate Owned and Repossessed Assets, Net 155  —  —  155  — 
March 31, 2020
Collateral Dependent Impaired Loans $ 582  $ —  $ —  $ 582 
Other Real Estate Owned and Repossessed Assets, Net 942  —  —  942  — 

37

The fair value of financial instruments is determined under the following hierarchy:
•Level 1 - Unadjusted quoted prices in active markets that are accessible at the measurement date for identical, unrestricted assets or liabilities;
•Level 2 - Quoted prices for similar assets or liabilities in active markets, quoted prices for identical or similar assets or liabilities in markets that are not active, or inputs that are observable, either directly or indirectly, for substantially the full term of the asset or liability;
•Level 3 - Prices or valuation techniques that require inputs that are both significant to the fair value measurement and unobservable (i.e., supported by little or no market activity).

Fair Value Methodology for Assets and Liabilities Measured on a Recurring Basis

The fair value of Level 1 securities available-for-sale are based on unadjusted, quoted market prices from exchanges in active markets. The fair value of Level 2 securities available-for-sale are based on an independent bond and equity pricing service for identical assets or significantly similar securities and an independent equity pricing service for equity securities not actively traded.  The pricing services use a variety of techniques to arrive at fair value including market maker bids, quotes and pricing models.  Inputs to the pricing models include recent trades, benchmark interest rates, spreads and actual and projected cash flows.  The fair value of Level 2 derivatives is determined using inputs that are observable in the market place obtained from third parties including yield curves, publicly available volatilities, and floating indexes.

Fair Value Methodology for Assets and Liabilities Measured on a Nonrecurring Basis

The fair value of collateral dependent evaluated loans and other real estate owned was based on third-party appraisals less estimated cost to sell. The appraisals may be adjusted by management for qualitative factors such as economic conditions and estimated liquidation expenses. Other assets which might have been included in this table include mortgage servicing rights, goodwill and other intangible assets. Arrow evaluates each of these assets for impairment at least annually, with no impairment recognized for these assets at March 31, 2021, December 31, 2020 and March 31, 2020.

Fair Value Methodology for Financial Instruments Not Measured on a Recurring or Nonrecurring Basis

The fair value for securities held-to-maturity is determined utilizing an independent bond pricing service for identical assets or significantly similar securities.  The pricing service uses a variety of techniques to arrive at fair value including market maker bids, quotes and pricing models.  Inputs to the pricing models include recent trades, benchmark interest rates, spreads and actual and projected cash flows.
ASU 2016-01 "Recognition and Measurement of Financial Assets and Financial Liabilities" requires that the fair value for loans must be disclosed using the "exit price" notion which is a reasonable estimate of what another party might pay in an orderly transaction. Fair values for loans are calculated for portfolios of loans with similar financial characteristics.  Loans are segregated by type such as commercial, commercial real estate, residential mortgage, indirect auto and other consumer loans.  Each loan category is further segmented into fixed and adjustable interest rate terms and by performing and nonperforming categories.  The fair value of performing loans is calculated by determining the estimated future cash flow, which is the contractual cash flow adjusted for estimated prepayments. The discount rate is determined by starting with current market yields, and first adjusting for a liquidity premium. This premium is separately determined for each loan type. Then a credit loss component is determined utilizing the credit loss assumptions used in the allowance for credit loss model. Finally, a discount spread is applied separately for consumer loans vs. commercial loans based on market information and utilization of the swap curve.  
The fair value of time deposits is based on the discounted value of contractual cash flows, except that the fair value is limited to the extent that the customer could redeem the certificate after imposition of a premature withdrawal penalty.  The discount rates are estimated using the Federal Home Loan Bank of New York ("FHLBNY") yield curve, which is considered representative of Arrow’s time deposit rates. The fair value of all other deposits is equal to the carrying value.
The fair value of FHLBNY advances is calculated by the FHLBNY.
The carrying amount of FHLBNY and FRB stock approximates fair value. If the stock was redeemed, the Company will receive an amount equal to the par value of the stock.
The book value of the outstanding trust preferred securities (Junior Subordinated Obligations Issued to Unconsolidated Subsidiary Trusts) are considered to approximate fair value since the interest rates are variable (indexed to LIBOR) and Arrow is well-capitalized.

38

Fair Value by Balance Sheet Grouping

The following table presents a summary of the carrying amount, the fair value or an amount approximating fair value and the fair value hierarchy of Arrow’s financial instruments:
Schedule of Fair Values by Balance Sheet Grouping
Fair Value Hierarchy
Carrying Value Fair Value Level 1 Level 2 Level 3
March 31, 2021
Cash and Cash Equivalents $ 452,207  $ 452,207  $ 452,207  $ —  $ — 
Securities Available-for-Sale 464,089  464,089  —  464,089  — 
Securities Held-to-Maturity 214,561  221,360  —  221,360  — 
Equity Securities 1,796  1,796  —  1,796  — 
Federal Home Loan Bank and Federal
  Reserve Bank Stock 		5,360  5,360  —  5,360  — 
Net Loans 2,612,403  2,603,225  —  —  2,603,225 
Accrued Interest Receivable 8,258  8,258  —  8,258  — 
Derivatives, included in other assets 2,298  2,298  2,298 
Deposits 3,453,588  3,452,595  —  3,452,595  — 
Federal Funds Purchased and Securities
  Sold Under Agreements to Repurchase 		6,795  6,795  —  6,795  — 
Federal Home Loan Bank Term Advances 45,000  46,176  —  46,176  — 
Junior Subordinated Obligations Issued
  to Unconsolidated Subsidiary Trusts 		20,000  20,000  —  20,000  — 
Accrued Interest Payable 237  237  —  237  — 
Derivatives, included in other liabilities 2,298  2,298  —  2,298  — 
39

Schedule of Fair Values by Balance Sheet Grouping
Fair Value Hierarchy
Carrying Value Fair Value Level 1 Level 2 Level 3
December 31, 2020
Cash and Cash Equivalents $ 380,991  $ 380,991  $ 380,991  $ —  $ — 
Securities Available-for-Sale 365,287  365,287  —  365,287  — 
Securities Held-to-Maturity 218,405  226,576  —  226,576  — 
Equity Securities 1,636  1,636  —  1,636 
Federal Home Loan Bank and Federal
  Reserve Bank Stock 		5,349  5,349  —  5,349  — 
Net Loans 2,565,798  2,558,903  —  —  2,558,903 
Accrued Interest Receivable 7,495  7,495  —  7,495  — 
Derivatives, included in other assets 5,080  5,080  —  5,080  — 
Deposits 3,234,726  3,234,387  —  3,234,387  — 
Federal Funds Purchased and Securities
  Sold Under Agreements to Repurchase 		17,486  17,486  —  17,486  — 
Federal Home Loan Bank Term Advances 45,000  46,474  —  46,474  — 
Junior Subordinated Obligations Issued
  to Unconsolidated Subsidiary Trusts 		20,000  20,000  —  20,000  — 
Accrued Interest Payable 326  326  —  326  — 
Derivatives, included in other liabilities 5,080  5,080  —  5,080  — 
March 31, 2020
Cash and Cash Equivalents $ 138,529  $ 138,529  $ 138,529  $ —  $ — 
Securities Available-for-Sale 378,186  378,186  —  378,186  — 
Securities Held-to-Maturity 238,520  242,804  —  242,804  — 
Equity Securities 1,689  1,689  —  1,689 
Federal Home Loan Bank and Federal
  Reserve Bank Stock 		5,379  5,379  —  5,379  — 
Net Loans 2,390,556  2,368,033  —  —  2,368,033 
Accrued Interest Receivable 7,856  7,856  —  7,856  — 
Derivatives, included in other assets 5,191  5,191  —  5,191  — 
Deposits 2,811,005  2,811,668  —  2,811,668  — 
Federal Funds Purchased and Securities
  Sold Under Agreements to Repurchase 		57,909  57,909  —  57,909  — 
Federal Home Loan Bank Term Advances 50,000  51,194  —  51,194  — 
Junior Subordinated Obligations Issued
  to Unconsolidated Subsidiary Trusts 		20,000  20,000  —  20,000  — 
Accrued Interest Payable 1,392  1,392  —  1,392  — 
Derivatives, included in other liabilities 5,191  5,191  —  5,191  — 
40

Note 11.    LEASES (Dollars In Thousands)

The Company is a lessee in its leases, which are mainly for financial services locations in addition to leases for corporate vehicles. These leases generally require the Company to pay third-party expenses on behalf of the Lessor, which are referred to as variable payments. Under some leases, the Company pays the variable payments to the lessor, and in other leases, the Company pays the variable payments directly to the applicable third party. None of the Company's current leases include any residual value guarantees or any subleases, and there are no significant rights and obligations of the Company for leases that have not commenced as of the reporting date.
Arrow leases four of its branch offices, at market rates, from Stewart’s Shops Corp.  Mr. Gary C. Dake, President of Stewart’s Shops Corp., serves as a director on the board of directors of each of Arrow and Saratoga National Bank and Trust Company.

The following includes quantitative data related to the Company's leases as of and for the three months ended March 31, 2021 and March 31, 2020:
Three Months Ended
Finance Lease Amounts: Classification March 31, 2021 March 31, 2020
Right-of-Use Assets Premises and Equipment, Net $ 4,947  $ 5,124 
Lease Liabilities Finance Leases 5,205  5,249 
Operating Lease Amounts:
Right-of-Use Assets Other Assets $ 5,435  $ 5,529 
Lease Liabilities Other Liabilities 5,522  5,602 
Other Information:
Cash Paid For Amounts Included In The Measurement Of Lease Liabilities:
Operating Outgoing Cash Flows From Finance Leases $ 49  $ 50 
Operating Outgoing Cash Flows From Operating Leases 261  158 
Financing Outgoing Cash Flows From Finance Leases 12  5 
Right-of-Use Assets Obtained In Exchange For New Finance Lease Liabilities —  — 
Right-of-Use Assets Obtained In Exchange For New Operating Lease Liabilities 331  — 
Weighted-average Remaining Lease Term - Finance Leases (Yrs.) 28.9 29.9
Weighted-average Remaining Lease Term - Operating Leases (Yrs.) 12.5 13.7
Weighted-average Discount Rate—Finance Leases 3.75  % 3.75  %
Weighted-average Discount Rate—Operating Leases 3.13  % 3.36  %

Lease cost information for the Company's leases is as follows:
Three Months Ended
March 31, 2021 March 31, 2020
Lease Cost:
Finance Lease Cost:
   Reduction of Right-of-Use Assets $ 44  $ 44 
   Interest on Lease Liabilities 49  50 
Operating Lease Cost 209  207 
Short-term Lease Cost 5  7 
Variable Lease Cost 104  55 
Total Lease Cost $ 411  $ 363 
41

Future Lease Payments at March 31, 2021 are as follows:
Operating
Leases
Financing
Leases
Twelve Months Ended:
3/31/2022 $ 799  $ 243 
3/31/2023 766  243 
3/31/2024 641  243 
3/31/2025 570  254 
3/31/2026 526  265 
Thereafter 3,516  7,733 
Total Undiscounted Cash Flows $ 6,818  $ 8,981 
Less: Net Present Value Adjustment 1,296  3,776 
   Lease Liability $ 5,522  $ 5,205 
42



Note 12.    DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES (In Thousands)

Arrow is exposed to certain risks arising from both its business operations and economic conditions. Arrow principally manages its exposures to a wide variety of business and operational risks through management of its core business activities. Arrow manages economic risks, including interest rate, primarily by managing the amount, sources and duration of its assets and liabilities and through the use of derivative instruments. Specifically, Arrow enters into derivative financial instruments to manage exposures that arise from business activities that result in the receipt or payment of future known and uncertain cash amounts, the value of which are determined by interest rates. Arrow's derivative financial instruments are used to manage differences in the amount, timing and duration of known or expected cash receipts and its known or expected cash payments principally related to certain fixed rate borrowings. Arrow also has interest rate derivatives that result from a service provided to certain qualifying customers and, therefore, are not used to manage interest rate risk in the Company’s assets or liabilities. The Company manages a matched book with respect to its derivative instruments in order to minimize its net risk exposure resulting from such transactions.

Derivatives Not Designated as Hedging Instruments
Arrow enters into interest rate swap agreements with its commercial customers to provide them with a long-term fixed rate, while simultaneously entering into offsetting interest rate swap agreements with a counterparty to swap the fixed rate to a variable rate to manage interest rate exposure.
These interest rate swap agreements are not designated as a hedge for accounting purposes. As the interest rate swap agreements have substantially equivalent and offsetting terms, they do not present any material exposure to the Arrow's consolidated statements of income. Arrow records its interest rate swap agreements at fair value and is presented on a gross basis within other assets and other liabilities on the consolidated balance sheets. Changes in the fair value of assets and liabilities arising from these derivatives are included, net, in other income in the consolidated statement of income.

The following table depicts the fair value adjustment recorded related to the notional amount of derivatives outstanding as well as the notional amount of the interest rate swap agreements.
Derivatives Not Designated as Hedging Instruments - Interest Rate Swap Agreements
March 31, 2021 December 31, 2020 March 31, 2020
Fair value adjustment included in other assets $ 2,298  $ 5,080  $ 5,191 
Fair value adjustment included in other liabilities 2,298  5,080  5,191 
Notional amount 175,113  176,637  121,559 

Derivatives Designated as Hedging Instruments
Arrow has entered into interest rate swaps to synthetically fix the variable rate interest payments associated with $20 million in outstanding subordinated trust securities. These agreements are designated as cash flow hedges.
For derivatives designated and that qualify as cash flow hedges of interest rate risk, the gain or loss on the derivative is recorded in Accumulated Other Comprehensive Income ("AOCI") and subsequently reclassified into interest expense in the same period during which the hedge transaction affects earnings. Amounts reported in AOCI related to derivatives will be reclassified to interest expense as interest payments are made on Arrow's Junior Subordinated Obligations Issued to Unconsolidated Subsidiary Trusts borrowings.

The following table indicates the effect of cash flow hedge accounting on AOCI and on the unaudited interim consolidated statement of income.
Derivatives Designated as Hedging Instruments - Cash Flow Hedge Agreements
March 31, 2021 December 31, 2020 March 31, 2020
Amount of gain (loss) recognized in AOCI $ 1,982  $ 651  $ (294)
Amount of gain reclassified from AOCI interest expense 28  —  — 


Note 13.    COVID-19 PANDEMIC

The spread of COVID-19 and the resulting “shelter in place” and “stay at home” orders, travel restrictions and other precautions have caused significant disruptions in the United States economy, which could in turn disrupt the business, activities, and operations of Arrow’s customers, as well as Arrow's business and operations. The pandemic has also caused significant disruption in the financial markets both globally and in the United States.
Arrow has taken steps to mitigate the risk of harm to its employees and customers and to its operations from the pandemic. In particular, Arrow, when necessary, has limited access to facilities to appointments only and encouraged customers to use contact-free alternatives like digital banking and ATMs. Arrow has also minimized contact for a large portion of its employee base through remote working, minimal travel and in-person meetings and social distancing.



43




Report of Independent Registered Public Accounting Firm
To the Stockholders and Board of Directors
Arrow Financial Corporation:

Results of Review of Interim Financial Information

We have reviewed the consolidated balance sheets of Arrow Financial Corporation and subsidiaries (the Company) as of March 31, 2021 and 2020, the related consolidated statements of income, comprehensive income, changes in stockholders’ equity, and cash flows for the three-month periods ended March 31, 2021 and 2020 and the related notes (collectively, the consolidated interim financial information). Based on our reviews, we are not aware of any material modifications that should be made to the consolidated interim financial information for it to be in conformity with U.S. generally accepted accounting principles.

We have previously audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the consolidated balance sheet of the Company as of December 31, 2020, and the related consolidated statements of income, comprehensive income, changes in stockholders’ equity, and cash flows for the year then ended (not presented herein); and in our report dated March 10, 2021, we expressed an unqualified opinion on those consolidated financial statements. In our opinion, the information set forth in the accompanying consolidated balance sheet as of December 31, 2020, is fairly stated, in all material respects, in relation to the consolidated balance sheet from which it has been derived.

Change in Accounting Principle
As discussed in Note 1 to the consolidated interim financial information, the Company has changed its method of accounting for the recognition and measurement of credit losses as of January 1, 2021 due to the adoption of Accounting Standards Codification Topic 326, Financial Instruments – Credit Losses.

Basis for Review Results
This consolidated interim financial information is the responsibility of the Company’s management. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.

We conducted our reviews in accordance with the standards of the PCAOB. A review of consolidated interim financial information consists principally of applying analytical procedures and making inquiries of persons responsible for financial and accounting matters. It is substantially less in scope than an audit conducted in accordance with the standards of the PCAOB, the objective of which is the expression of an opinion regarding the financial statements taken as a whole. Accordingly, we do not express such an opinion.


/s/ KPMG LLP

Albany, New York
May 6, 2021


44

Item 2.
ARROW FINANCIAL CORPORATION AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
March 31, 2021

NOTE ON TERMINOLOGY
In this Quarterly Report on Form 10-Q (this Report), the terms "Arrow," "the registrant," "the Company," "we," "us," and "our" generally refer to Arrow Financial Corporation and its subsidiaries as a group, except where the context indicates otherwise. At certain points in this Form 10-Q, Arrow's performance is compared with that of the Company's "peer group" of financial institutions. Unless otherwise specifically stated, the peer group for the purposes of this Form 10-Q is comprised of the group of 147 domestic bank holding companies with $3 to $10 billion in total consolidated assets as identified in the Federal Reserve Board’s "Bank Holding Company Performance Report" for December 31, 2020 (the most recent such report currently available), and peer group data contained herein has been derived from such report.

THE COMPANY AND ITS SUBSIDIARIES
Arrow is a two-bank holding company headquartered in Glens Falls, New York.  The banking subsidiaries are Glens Falls National Bank and Trust Company (Glens Falls National) whose main office is located in Glens Falls, New York, and Saratoga National Bank and Trust Company (Saratoga National) whose main office is located in Saratoga Springs, New York.  Active subsidiaries of Glens Falls National include Upstate Agency, LLC (an insurance agency that sells property and casualty insurance and also specializes in selling and servicing group health care policies and life insurance), North Country Investment Advisers, Inc. (a registered investment adviser that provides investment advice to Arrow's proprietary mutual funds) and Arrow Properties, Inc. (a real estate investment trust, or REIT). Arrow also owns directly two subsidiary business trusts, organized in 2003 and 2004, which issued trust preferred securities (TRUPs), which are still outstanding.

FORWARD LOOKING STATEMENTS
This Report on Form 10-Q contains statements that are not historical in nature but rather are based on Arrow's beliefs, assumptions, expectations, estimates and projections about the future. These statements are "forward-looking statements" within the meaning of Section 21E of the Securities Exchange Act of 1934, as amended, and involve a degree of uncertainty and attendant risk. Words such as "may," "will," "expect," "believe," "anticipate," "estimate," "continue," and variations of such words and similar expressions are intended to identify such forward-looking statements. Examples of forward-looking statements include statements regarding Arrow's asset quality, the level of allowance for credit losses, the sufficiency of liquidity sources, interest rate change exposure, changes in accounting standards, and the Company's tax plans and strategies. Some of these statements, such as those included in the interest rate sensitivity analysis in Part I, Item 3, entitled "Quantitative and Qualitative Disclosures About Market Risk," are merely presentations of what future performance or changes in future performance would look like based on hypothetical assumptions and on simulation models. Other forward-looking statements are based on Arrow's general perceptions of market conditions and trends in business activity, both Arrow's and in the banking industry generally, as well as current management strategies for future operations and development.

These forward-looking statements may not be exhaustive, are not guarantees of future performance and involve certain risks and uncertainties that are difficult to quantify or, in some cases, to identify.  You should not place undue reliance on any such forward-looking statements. In the case of all forward-looking statements, our actual outcomes and results may differ materially from what the statements predict or forecast.  Factors that could cause or contribute to such differences include, but are not limited to the following, which are or may be amplified by the novel coronavirus (COVID-19) pandemic:
•the current and rapidly evolving COVID-19 pandemic and its impact on economic, market and social conditions;
•other rapid and dramatic changes in economic and market conditions;
•sharp fluctuations in interest rates, economic activity, or consumer spending patterns;
•sudden changes in the market for products provided, such as real estate loans;
•significant changes in banking or other laws and regulations, including both enactment of new legal or regulatory measures or the modification or elimination of pre-existing measures;
•significant changes in U.S. monetary or fiscal policy, including new or revised monetary programs or targets adopted or announced by the Federal Reserve ("monetary tightening or easing") or significant new federal legislation materially affecting the federal budget ("fiscal tightening or expansion");
•competition from other sources (e.g., non-bank entities);
•similar uncertainties inherent in banking operations or business generally, including technological developments and changes; and
•other risks detailed from time to time within our filings with the Securities and Exchange Commission ("SEC").

Arrow is under no duty to update any of the forward-looking statements after the date of this Report to conform such statements to actual results. All forward-looking statements, express or implied, included in this Report and the documents incorporated by reference and that are attributable to the Company are expressly qualified in their entirety by this cautionary statement. This cautionary statement should also be considered in connection with any subsequent written or oral forward-looking statements that Arrow or any persons acting on our behalf may issue. This Report should be read in conjunction with our Annual Report on Form 10-K for the year ended December 31, 2020 (the 2020 Annual Report) and our other filings with the SEC.

45

USE OF NON-GAAP FINANCIAL MEASURES
The SEC has adopted Regulation G, which applies to certain public disclosures, including earnings releases, made by registered companies that contain "non-GAAP financial measures."  GAAP is generally accepted accounting principles in the United States of America.  Under Regulation G, companies making public disclosures containing non-GAAP financial measures must also disclose, along with each non-GAAP financial measure, certain additional information, including a reconciliation of the non-GAAP financial measure to the closest comparable GAAP financial measure and a statement of Arrow's reasons for utilizing the non-GAAP financial measure as part of its financial disclosures.  The SEC has exempted from the definition of "non-GAAP financial measures" certain commonly used financial measures that are not based on GAAP.  When these exempted measures are included in public disclosures, supplemental information is not required.  The following measures used in this Report, which are commonly utilized by financial institutions, have not been specifically exempted by the SEC and may constitute "non-GAAP financial measures" within the meaning of the SEC's rules, although Arrow is unable to state with certainty that the SEC would so regard them.

Tax-Equivalent Net Interest Income and Net Interest Margin: Net interest income, as a component of the tabular presentation by financial institutions of Selected Financial Information regarding their recently completed operations, as well as disclosures based on that tabular presentation, is commonly presented on a tax-equivalent basis.  That is, to the extent that some component of the institution's net interest income, which is presented on a before-tax basis, is exempt from taxation (e.g., is received by the institution as a result of its holdings of state or municipal obligations), an amount equal to the tax benefit derived from that component is added to the actual before-tax net interest income total.  This adjustment is considered helpful in comparing one financial institution's net interest income to that of another institution or in analyzing any institution’s net interest income trend line over time, to correct any analytical distortion that might otherwise arise from the fact that financial institutions vary widely in the proportions of their portfolios that are invested in tax-exempt securities, and from the fact that even a single institution may significantly alter over time the proportion of its own portfolio that is invested in tax-exempt obligations.  Moreover, net interest income is itself a component of a second financial measure commonly used by financial institutions, net interest margin, which is the ratio of net interest income to average earning assets.  For purposes of this measure as well, tax-equivalent net interest income is generally used by financial institutions, again to provide a better basis of comparison from institution to institution and to better demonstrate a single institution’s performance over time. Arrow follows these practices.

The Efficiency Ratio: Financial institutions often use an "efficiency ratio" as a measure of expense control.  The efficiency ratio typically is defined as the ratio of noninterest expense to net interest income and noninterest income.  Net interest income as utilized in calculating the efficiency ratio is typically the same as the net interest income presented in Selected Financial Information table discussed in the preceding paragraph, i.e., it is expressed on a tax-equivalent basis.  Moreover, many financial institutions, in calculating the efficiency ratio, also adjust both noninterest expense and noninterest income to exclude from these items (as calculated under GAAP) certain recurring component elements of income and expense, such as intangible asset amortization (which is included in noninterest expense under GAAP but may be excluded therefrom for purposes of calculating the efficiency ratio) and securities gains or losses (which are reflected in the calculation of noninterest income under GAAP but may be excluded therefrom for purposes of calculating the efficiency ratio).  Arrow makes these adjustments.

Tangible Book Value per Share:  Tangible equity is total stockholders’ equity less intangible assets.  Tangible book value per share is tangible equity divided by total shares issued and outstanding.  Tangible book value per share is often regarded as a more meaningful comparative ratio than book value per share as calculated under GAAP, that is, total stockholders’ equity including intangible assets divided by total shares issued and outstanding.  Intangible assets include many items, but in our case, essentially represents goodwill.

Adjustments for Certain Items of Income or Expense:  In addition to our regular utilization in our public filings and disclosures of the various non-GAAP measures commonly utilized by financial institutions discussed above, Arrow may also elect from time to time, in connection with our presentation of various financial measures prepared in accordance with GAAP, such as net income, earnings per share (EPS), return on average assets (ROA), and return on average equity (ROE), to provide as well certain comparative disclosures that adjust these GAAP financial measures, typically by removing them from the impact of certain transactions or other material items of income or expense that are unusual or unlikely to be repeated.  Arrow will do so only if it believes that provision of the resulting non-GAAP financial measures may improve the average investor's understanding of our results of operations by separating out items that have a disproportional positive or negative impact on the particular period in question or by otherwise permitting a better comparison from period-to-period in our results of operations with respect to our fundamental lines of business, including the commercial banking business.
Arrow believes that the non-GAAP financial measures disclosed from time-to-time are useful in evaluating our performance and that such information should be considered as supplemental in nature, and not as a substitute for or superior to, the related financial information prepared in accordance with GAAP.  Non-GAAP financial measures may differ from similar measures presented by other companies.
    

46


Arrow Financial Corporation
Selected Quarterly Information
(Dollars In Thousands, Except Per Share Amounts - Unaudited)
Quarter Ended 3/31/2021 12/31/2020 9/30/2020 6/30/2020 3/31/2020
Net Income $ 13,280  $ 12,495  $ 11,046  $ 9,159  $ 8,127 
Transactions in Net Income (Net of Tax):          
Net Changes in Fair Value of Equity Investments 119  66  (53) (80) (279)
Share and Per Share Data:1
       
Period End Shares Outstanding 15,543  15,516  15,489  15,461  15,432 
Basic Average Shares Outstanding 15,528  15,499  15,472  15,441  15,446 
Diluted Average Shares Outstanding 15,563  15,515  15,481  15,448  15,476 
Basic Earnings Per Share $ 0.86  $ 0.81  $ 0.71  $ 0.59  $ 0.53 
Diluted Earnings Per Share 0.85  0.81  0.71  0.59  0.53 
Cash Dividend Per Share 0.260  0.260  0.252  0.252  0.252 
Selected Quarterly Average Balances:        
  Interest-Bearing Deposits at Banks $ 334,155  $ 349,430  $ 242,928  $ 155,931  $ 32,787 
  Investment Securities 593,822  590,151  592,457  607,094  603,748 
  Loans 2,618,362  2,610,834  2,582,253  2,518,198  2,394,346 
  Deposits 3,254,815  3,256,238  3,082,499  2,952,432  2,670,009 
  Other Borrowed Funds 82,659  95,047  136,117  129,383  170,987 
  Stockholders’ Equity 340,708  331,899  324,269  316,380  306,527 
  Total Assets 3,712,020  3,721,954  3,583,322  3,437,155  3,180,857 
Return on Average Assets, annualized 1.45  % 1.34  % 1.23  % 1.07  % 1.03  %
Return on Average Equity, annualized 15.81  % 14.98  % 13.55  % 11.64  % 10.66  %
Return on Average Tangible Equity, annualized 2
17.00  % 16.13  % 14.61  % 12.58  % 11.55  %
Average Earning Assets $ 3,546,339  $ 3,550,415  $ 3,417,638  $ 3,281,223  $ 3,030,881 
Average Paying Liabilities 2,639,240  2,674,795  2,545,435  2,457,690  2,362,515 
Interest Income 27,694  28,372  27,296  28,002  28,226 
Tax-Equivalent Adjustment 3
235  251  284  281  288 
Interest Income, Tax-Equivalent 3
27,929  28,623  27,580  28,283  28,514 
Interest Expense 1,539  1,918  2,396  3,160  5,220 
Net Interest Income 26,155  26,454  24,900  24,842  23,006 
Net Interest Income, Tax-Equivalent 3
26,390  26,705  25,184  25,123  23,294 
Net Interest Margin, annualized 2.99  % 2.96  % 2.90  % 3.05  % 3.05  %
Net Interest Margin, Tax Equivalent, annualized 3
3.02  % 2.99  % 2.93  % 3.08  % 3.09  %
Efficiency Ratio Calculation: 4
       
Noninterest Expense $ 18,678  $ 18,192  $ 17,487  $ 17,245  $ 17,754 
Less: Intangible Asset Amortization 54  56  56  57  58 
Net Noninterest Expense $ 18,624  $ 18,136  $ 17,431  $ 17,188  $ 17,696 
Net Interest Income, Tax-Equivalent 3
$ 26,390  $ 26,705  $ 25,184  $ 25,123  $ 23,294 
Noninterest Income 8,608  9,103  8,697  7,164  7,694 
Less: Net Changes in Fair Value of Equity Invest. 160  88  (72) (106) (374)
Net Gross Income $ 34,838  $ 35,720  $ 33,953  $ 32,393  $ 31,362 
Efficiency Ratio 4
53.46  % 50.77  % 51.34  % 53.06  % 56.42  %
Period-End Capital Information:          
Total Stockholders’ Equity (i.e. Book Value) $ 342,413  $ 334,392  $ 325,660  $ 317,687  $ 309,398 
Book Value per Share 1
22.03  21.55  21.02  20.55  20.05 
Goodwill and Other Intangible Assets, net 23,922  23,823  23,662  23,535  23,513 
Tangible Book Value per Share 1,2
20.49  20.02  19.50  19.03  18.53 
Capital Ratios:5
         
Tier 1 Leverage Ratio 9.37  % 9.07  % 9.17  % 9.32  % 9.87  %
Common Equity Tier 1 Capital Ratio 13.56  % 13.39  % 13.20  % 13.07  % 12.84  %
Tier 1 Risk-Based Capital Ratio 14.39  % 14.24  % 14.06  % 13.94  % 13.72  %
Total Risk-Based Capital Ratio 15.55  % 15.48  % 15.28  % 15.10  % 14.76  %
Assets Under Trust Admin. & Investment Mgmt. $ 1,725,754  $ 1,659,029  $ 1,537,128  $ 1,502,866  $ 1,342,531 
47

Arrow Financial Corporation
Selected Quarterly Information - Continued
(Dollars In Thousands, Except Per Share Amounts - Unaudited)
Footnotes:
1.
Share and Per Share Data have been restated for the September 25, 2020, 3% stock dividend.
2.
Non-GAAP Financial Measures Reconciliation: Tangible Book Value, Tangible Equity and Return on Tangible Equity exclude goodwill and other intangible assets, net from total equity.  These are non-GAAP financial measures which Arrow believes provide investors with information that is useful in understanding our financial performance. See "Use of Non-GAAP Financial Measures" on page 46.
3/31/2021 12/31/2020 9/30/2020 6/30/2020 3/31/2020
Total Stockholders' Equity (GAAP) $ 342,413  $ 334,392  $ 325,660  $ 317,687  $ 309,398 
Less: Goodwill and Other Intangible assets, net 23,922  23,823  23,662  23,535  23,513 
Tangible Equity (Non-GAAP) $ 318,491  $ 310,569  $ 301,998  $ 294,152  $ 285,885 
Period End Shares Outstanding 15,543  15,516  15,489  15,461  15,432 
Tangible Book Value per Share
     (Non-GAAP) 		$ 20.49  $ 20.02  $ 19.50  $ 19.03  $ 18.53 
Net Income 13,280  12,495  11,046  9,159  8,127 
Return on Average Tangible Equity (Net Income/Tangible Equity - Annualized) 17.00  % 16.13  % 14.61  % 12.58  % 11.55  %
3.
Non-GAAP Financial Measures Reconciliation: Net Interest Margin, Tax-Equivalent is the ratio of our annualized tax-equivalent net interest income to average earning assets. This is also a non-GAAP financial measure which Arrow believes provides investors with information that is useful in understanding our financial performance. See "Use of Non-GAAP Financial Measures" on page 46.
3/31/2021 12/31/2020 9/30/2020 6/30/2020 3/31/2020
Interest Income (GAAP) $ 27,694  $ 28,372  $ 27,296  $ 28,002  $ 28,226 
Add: Tax-Equivalent adjustment
     (Non-GAAP) 		235  251  284  281  288 
Interest Income - Tax Equivalent
     (Non-GAAP) 		$ 27,929  $ 28,623  $ 27,580  $ 28,283  $ 28,514 
Net Interest Income (GAAP) $ 26,155  $ 26,454  $ 24,900  $ 24,842  $ 23,006 
Add: Tax-Equivalent adjustment
     (Non-GAAP) 		235  251  284  281  288 
Net Interest Income - Tax Equivalent
     (Non-GAAP) 		$ 26,390  $ 26,705  $ 25,184  $ 25,123  $ 23,294 
Average Earning Assets $ 3,546,339  $ 3,550,415  $ 3,417,638  $ 3,281,223  $ 3,030,881 
Net Interest Margin (Non-GAAP)* 3.02  % 2.99  % 2.93  % 3.08  % 3.09  %
4.
Non-GAAP Financial Measures: Financial Institutions often use the "efficiency ratio", a non-GAAP ratio, as a measure of expense control. Arrow believes that the efficiency ratio provides investors with information that is useful in understanding our financial performance. Arrow defines efficiency ratio as the ratio of our noninterest expense to our net gross income (which equals tax-equivalent net interest income plus noninterest income, as adjusted). There is no GAAP financial measure that is closely comparable to the efficiency ratio. See "Use of Non-GAAP Financial Measures" on page 46.
5.
For the current quarter, all of the regulatory capital ratios in the table above, as well as the Total Risk-Weighted Assets and Common Equity Tier 1 Capital amounts listed in the table below, are estimates based on, and calculated in accordance with, bank regulatory capital rules. All prior quarters reflect actual results. The CET1 ratio at March 31, 2021 listed in the tables (i.e., 13.56%) exceeds the sum of the required minimum CET1 ratio plus the fully phased-in Capital Conservation Buffer (i.e., 7.00%).
  3/31/2021 12/31/2020 9/30/2020 6/30/2020 3/31/2020
Total Risk Weighted Assets $ 2,404,456  $ 2,357,094  $ 2,321,637  $ 2,283,430  $ 2,275,902 
Common Equity Tier 1 Capital 326,039  315,696  306,356  298,362  292,165 
Common Equity Tier 1 Capital Ratio 13.56  % 13.39  % 13.20  % 13.07  % 12.84  %
* Quarterly ratios have been annualized.





48



Average Consolidated Balance Sheets and Net Interest Income Analysis
(Dollars In Thousands)
Quarter Ended March 31: 2021 2020
Interest Rate Interest Rate
Average Income/ Earned/ Average Income/ Earned/
Balance Expense Paid Balance Expense Paid
Interest-Bearing Deposits at Banks $ 334,155  $ 85  0.10  % $ 32,787  $ 124  1.52  %
Investment Securities:
Fully Taxable 403,340  1,506  1.51  399,307  2,193  2.21 
Exempt from Federal Taxes 190,482  920  1.96  204,441  1,035  2.04 
Loans 2,618,362  25,183  3.90  2,394,346  24,874  4.18 
Total Earning Assets 3,546,339  27,694  3.17  3,030,881  28,226  3.75 
Allowance for Credit Losses (27,811) (22,186)
Cash and Due From Banks 35,779  34,211 
Other Assets 157,713  137,951 
Total Assets $ 3,712,020  $ 3,180,857 
Deposits:
Interest-Bearing Checking Accounts $ 859,972  219  0.10  $ 707,747  487  0.28 
Savings Deposits 1,435,555  565  0.16  1,092,980  2,471  0.91 
Time Deposits of $250,000 or More 109,644  120  0.44  126,046  533  1.70 
Other Time Deposits 151,410  222  0.59  264,755  1,000  1.52 
Total Interest-Bearing Deposits 2,556,581  1,126  0.18  2,191,528  4,491  0.82 
Short-Term Borrowings 12,458  2  0.07  92,444  208  0.90 
FHLBNY Term Advances & Other Long-Term Debt 65,000  362  2.26  73,297  471  2.58 
Finance Leases 5,201  49  3.82  5,246  50  3.83 
Total Interest-Bearing Liabilities 2,639,240  1,539  0.24  2,362,515  5,220  0.89 
Noninterest-bearing deposits 698,234  478,481 
Other Liabilities 33,838  33,334 
Total Liabilities 3,371,312  2,874,330 
Stockholders’ Equity 340,708  306,527 
Total Liabilities and Stockholders’ Equity $ 3,712,020  $ 3,180,857 
Net Interest Income $ 26,155  $ 23,006 
Net Interest Spread 2.93  % 2.86  %
Net Interest Margin 2.99  % 3.05  %


49

OVERVIEW
    
The following discussion and analysis focuses on and reviews the results of operations for the three month period ended March 31, 2021 and the financial condition as of March 31, 2021 and 2020.  The discussion below should be read in conjunction with the selected quarterly and annual information set forth above and the Consolidated Financial Statements and other financial data presented elsewhere in this Report.  When necessary, prior-year financial information has been reclassified to conform to the current-year presentation.

COVID-19 Pandemic:
In March 2020, the World Health Organization recognized COVID-19 as a pandemic. In response, the United States federal government and various state and local governments have, among other actions, imposed travel and business restrictions and required or advised communities in which we do business to adopt stay-at-home orders and social distancing guidelines, causing some businesses to adjust, reduce or suspend operating activities. Like many businesses, Arrow expects operations and financial results to continue to be adversely impacted by the COVID-19 pandemic. The severity, magnitude and duration of the current pandemic are still uncertain, rapidly changing and hard to predict.
In the first quarter of 2021, Arrow's banking and insurance locations temporarily paused walk-in access to lobbies in response to a rise in community COVID-19 rates. Full access was restored in mid-March and continues to be managed with safety measures such as required face coverings, social distancing and personal protective equipment including shields and hand sanitizing stations, along with frequent cleanings.
Also in the first quarter of 2021, Arrow reopened its Paycheck Protection Program ("PPP") online portal for a new round of funding and saw continued demand from our customers. As of March 31, 2021, Arrow originated more than $212.8 million in PPP loans for more than 1,600 small businesses, $70.1 million of which occurred in the first quarter of 2021.
Arrow continues to monitor the impact of the pandemic on our business and closely watch local COVID-19 levels. Currently, remote work is encouraged whenever feasible for our employees, work-related travel remains paused and in-person meetings have been minimized.
As Arrow cannot predict the duration or scope of the pandemic or its impact on economic and financial markets or its impact on the business, Arrow is currently unable to reasonably estimate the overall impact on Arrow.

Summary of Q1 2021 Financial Results: Net income for the first quarter of 2021 was $13.3 million, compared to $8.1 million in the first quarter of 2020. Net interest income increased to $26.2 million in the first quarter of 2021, compared to $23.0 million for the comparable quarter of 2020.
Diluted earnings per share (EPS) for the quarter was $0.85, an increase of 60.4% from the EPS of $0.53 reported for the first quarter of 2020. Return on average equity (ROE) for the first quarter of 2021 increased to 15.81%, as compared to a ROE of 10.66% for the quarter ended March 31, 2020. Return on average assets (ROA) for the first quarter of 2021 was 1.45%, an increase from an ROA of 1.03% for the quarter ended March 31, 2020.
Total loans reached $2.6 billion as of March 31, 2021. Loan growth for the first quarter of 2021 was $44.2 million and increased $225.1 million, or 9.3%, from March 31, 2020. Total outstanding commercial loans increased $196.8 million, or 29.2%, as compared to March 31, 2020. The increase in commercial loans includes $162.8 million in remaining PPP loans. The consumer loan portfolio grew by $36.5 million, or 4.4%, as compared to March 31, 2020, primarily within the indirect automobile lending program. Total outstanding residential real estate loans, net of approximately $28.8 million of loans sold, decreased $14.9 million for the first quarter of 2021. Residential real estate loans decreased $8.2 million, or 0.9%, as compared to March 31, 2020.
At March 31, 2021, deposit balances reached $3.5 billion. Deposit growth for the first quarter of 2021 was $218.9 million and increased $642.6 million, or 22.9%, from the prior-year level. Noninterest-bearing deposits represented 21.8% of total deposits at March 31, 2021, compared to 17.4% of total deposits on March 31, 2020. At March 31, 2021, other time deposits were $145.8 million, a decrease of $100.1 million compared to the prior year. Municipal deposits increased $119.5 million, or 15.0% from March 31, 2020.
Net interest income for the first quarter increased to $26.2 million, up 13.7% from $23.0 million in the comparable quarter of 2020. Loan growth generated $25.2 million in interest and fees on loans for the first quarter of 2021, an increase of 1.3% from the $24.9 million from the quarter ending March 31, 2020. Interest and fees related to PPP loans produced $1.3 million in revenue in the first quarter of 2021. Interest expense for the first quarter of 2021 was $1.5 million. This is a decrease of $3.7 million, or 70.5%, from the $5.2 million in expense for the quarter ending March 31, 2020. The net interest margin was 2.99% for the quarter, compared to 3.05% for the first quarter of 2020. The decrease in net interest margin from the prior year was due to a variety of factors, including lower interest rates and increased cash balances.
Noninterest income for the three months ended March 31, 2021 was $8.6 million, compared to $7.7 million in the comparable 2020 quarter. Favorable market conditions contributed to the net gain on the sale of loans of $1.4 million for the first quarter of 2021, an increase from $213 thousand for the comparable prior year quarter. In addition, income from fiduciary activities as well as fees for other services for the three months ended March 31, 2021 increased over the comparable quarter of 2020. Other operating income decreased in the first quarter of 2021 as compared to the first quarter of 2020 as a result of several factors, including the reduction of income related to interest rate swap agreements and the net difference of gains and losses from the sale of other real estate owned and fixed assets; offset by an increase in income related to bank-owned life insurance.
Noninterest expense for the first quarter of 2021 increased 5.2% to $18.7 million, from $17.8 million for the first quarter of 2020. The largest component of noninterest expense is salaries and benefits paid to our employees, which totaled $11.1 million for the first quarter of 2021.
Asset quality remained solid at March 31, 2021, as evidenced by low levels of nonperforming assets and charge-offs. Net loan losses, expressed as an annualized percentage of average loans outstanding, were 0.07% for the three-month period ended March 31, 2021, an increase from 0.05% for the three-month period ended March 31, 2020. Nonperforming loans at March 31, 2021 were $8.4
50

million, up $2.9 million from the level at March 31, 2020. Nonperforming assets of $8.7 million at March 31, 2021, represented 0.22% of period-end assets, an increase from 0.20% at March 31, 2020.
Arrow adopted CECL effective January 1, 2021. Arrow recorded a net increase to retained earnings of $120 thousand upon adoption of the new accounting standard. The transition adjustment at January 1, 2021 included a $1.30 million decrease in the allowance for credit losses on loans, and a $1.14 million establishment of an allowance for estimated credit losses on off-balance sheet credit exposures, net of the corresponding $41 thousand increase in deferred tax liabilities. For the first quarter of 2021, the provision for credit losses was ($648) thousand reflecting improving economic forecasts. The allowance for loan losses was $26.8 million on March 31, 2021, which represented 1.02% of loans outstanding, as compared to 0.98% on March 31, 2020.
The changes in net income, net interest income and net interest margin between the three month periods are discussed in detail under the heading "RESULTS OF OPERATIONS," beginning on page 64.

Regulatory Capital and Increase in Stockholders' Equity: At March 31, 2021, Arrow continued to exceed all required minimum capital ratios under the current bank regulatory capital rules as implemented under Dodd-Frank (the "Capital Rules") at both the holding company and bank levels.  At that date, both subsidiary banks, as well as the holding company, continued to qualify as "well-capitalized" under the capital classification guidelines as defined by the Capital Rules.  Because of continued profitability and strong asset quality, the regulatory capital levels throughout recent years have consistently remained well in excess of the various required regulatory minimums in effect from time to time, as they do at present.
The federal bank regulators have issued a final rule to implement the “community bank leverage ratio”, introducing an optional simplified measure of capital adequacy for qualifying community banking organizations ("CBLR").  To qualify for the CBLR framework, a community banking organization must satisfy certain requirements, including having a leverage ratio of greater than 9%, less than $10 billion in total consolidated assets, and limited amounts of off-balance-sheet exposures and trading assets and liabilities.  A qualifying community banking organization that opts into the CBLR framework and meets all the requirements under the CBLR framework will be considered to have met the well-capitalized ratio requirements under the “prompt corrective action” regulations and will not be required to report or calculate risk-based capital ratios. Subsequently, Section 4012 of the Coronavirus Aid, Relief, and Economic Security (CARES) Act required the federal banking agencies to temporarily lower the threshold for election of the CBLR framework, issuing two interim final rules to set the CBLR at 8% as of the second quarter of 2020 and then gradually re-establish the CBLR at 9%.
Under the final rule, the CBLR remained at 8% through the end of 2020. Community banks that have a leverage ratio of 8% or greater and meet certain other criteria may elect to use the CBLR framework. Beginning in 2021, the CBLR increased to 8.5% for the calendar year. Community banks will have until January 1, 2022, before the leverage ratio requirement to use the CBLR framework will return to 9%. The final rule also maintains a two-quarter grace period for a qualifying community banking organization whose leverage ratio falls no more than one percentage point below the applicable CBLR requirement.
The CBLR final rule became effective as of January 1, 2020, and Arrow and both subsidiary banks have opted out of utilizing the CBLR framework. Therefore, the Capital Rules promulgated under Dodd-Frank will remain applicable to Arrow.
Stockholders’ equity was $342.4 million at March 31, 2021, an increase of $8.0 million, or 2.4%, from the December 31, 2020 level of $334.4 million, and an increase of $33.0 million, or 10.7%, from the prior-year level. The increase in stockholders' equity over the first three months of 2021 principally reflected the following factors: (i) $13.3 million of net income for the period, plus (ii) issuance of $937 thousand of common stock through employee benefit and dividend reinvestment plans, plus (iii) cumulative impact of adoption of ASU 2016-13 of $120 thousand; reduced by (iv) other comprehensive income of $2.3 million, and (v) cash dividends of $4.0 million. The components of the change in stockholders’ equity since year-end 2020 are presented in the Consolidated Statement of Changes in Stockholders’ Equity on page 6, and are discussed in more detail in the next section.
At March 31, 2021, book value per share was $22.03, up by 9.9% over the prior-year level. Tangible book value per share (a non-GAAP measure that deducts intangible assets from stockholders' equity) was $20.49, an increase of $1.96,or 10.6%, over the level as of March 31, 2020. See the disclosure on page 46 related to the use of non-GAAP financial measures including tangible book value.
On March 31, 2021, Arrow's closing stock price was $33.31, representing a trading multiple of 1.63 to tangible book value. In the first quarter of 2021, Arrow paid a quarterly cash dividend of $0.26. Further discussion of dividends is included in the Capital Components; Stock Repurchases; Dividends section located on page 62.

Loan Quality: Net charge-offs for the first quarter of 2021 were $444 thousand as compared to $322 thousand for the comparable 2020 quarter. The ratio of net charge-offs to average loans (annualized) was 0.07% for the three month period ended March 31, 2021, consistent with the three month period ended December 31, 2020 and an increase from 0.05% for the three month period ended March 31, 2020. Arrow adopted CECL effective January 1, 2021. Arrow recorded a net decrease of $1.30 million in the allowance for credit losses on loans. For the first quarter of 2021, the provision for credit losses was ($648) thousand reflecting improving economic forecasts. At March 31, 2021, the allowance for credit losses was $26.8 million representing 1.02% of total loans, which is an increase from the March 31, 2020 ratio of 0.98%.
Nonperforming loans were $8.4 million at March 31, 2021, representing 0.32% of period-end loans, an increase from the March 31, 2020 ratio of 0.23%. The ratio continues to compare favorably with the weighted average ratio of the peer group of 0.67% at December 31, 2020.

Loan Segments: As of March 31, 2021, total loans grew by $44.2 million, or 1.7%, as compared to the balance at December 31, 2020. The largest increase was in commercial and commercial real estate loans, which increased by $57.7 million, or 7.1%, from December 31, 2020. The majority of the increase in commercial loans resulted from the origination of approximately $70.1 million of additional PPP loans. In addition, consumer loans expanded $1.4 million, or 0.2%. The decrease in the real estate loan portfolio is net of approximately $28.8 million of loans sold in the first quarter of 2021. The economic factors resulting from the COVID-19 pandemic, including but not limited to restrictions on non-essential businesses, may adversely impact loan growth for all or a portion of 2021.

51

•Commercial and Commercial Real Estate Loans: Combined, these loans comprise 33.0% of the total loan portfolio at period-end. Commercial property values in Arrow's service area have largely remained stable, however, there remains uncertainty surrounding market conditions due to the pandemic. Appraisals on nonperforming and watched CRE loan properties are updated as deemed necessary, usually when the loan is downgraded or when there has been significant market deterioration since the last appraisal. The temporary closure of nonessential business in New York impacted, and may continue to impact, Arrow's customer base. Government intervention, with programs such as the PPP, may mitigate the economic risk to both Arrow and its customers, however the full impact cannot be determined at this time.
•Consumer Loans: These loans (primarily automobile loans) comprised 32.6% of the total loan portfolio at period-end. Consumer automobile loans at March 31, 2021, were $857 million, or 99.5% of this portfolio segment. In the first three months of 2021, Arrow did not experience any significant increase in the delinquency rate or in the percentage of nonperforming loans in this segment. The vast majority of automobile loans are initiated through the purchase of vehicles by consumers with automobile dealers. As of March 31, 2021, the physical sale of vehicles through dealerships is occurring, however, it had been curtailed for a portion of 2020 as part of the response to the COVID-19 pandemic in New York and Vermont, our primary dealer network.
•Residential Real Estate Loans: These loans, including home equity loans, made up 34.5% of the total loan portfolio at period-end. The residential real estate market in Arrow's service area has been stable in recent periods. Arrow originated nearly all of the residential real estate loans currently held in the loan portfolio and applies conservative underwriting standards to loan originations. Arrow typically sells a portion of residential real estate mortgage originations into the secondary market. The ratio of the sales of originations to total originations tends to fluctuate from period to period based on market conditions and other factors. Sales increased in 2020 and in the first quarter of 2021, due to a variety of factors, including strong demand for residential mortgages in our operating markets, favorable market conditions for mortgage sales and strategic balance sheet and interest-rate risk management decisions. The rate at which mortgage loan originations are sold in future periods will depend on various circumstances, including prevailing mortgage rates, other lending opportunities, capital and liquidity needs, and the availability of a market for such transactions. Due to the COVID-19 pandemic, it is not yet possible to determine the long term economic impact on our residential real estate loan portfolio.

Liquidity and Access to Credit Markets: Arrow has not experienced any liquidity events or special concerns in recent years or thus far in 2021. Arrow’s liquidity position provides the necessary flexibility to address any unexpected near-term disruptions that may develop as a result of the COVID-19 pandemic such as: reduced cash-flows from the investment and loan portfolios and aggressive funding of programs associated with response efforts.  Interest-bearing cash balances at March 31, 2021 were $406.6 million compared to $106.0 million at March 31, 2020.  Deposit growth provided an abundance of liquidity to fund Arrow's asset growth. However, contingent lines of credit are also available. Operating collateralized lines of credit are established and available through the FHLBNY and FRB, totaling $1.4 billion. The terms of Arrow's lines of credit have not changed significantly in recent periods (see the general liquidity discussion on page 63). Historically, Arrow has principally relied on asset-based liquidity (i.e., funds in overnight investments and cash flow from maturing investments and loans) with liability-based liquidity as a secondary source of funds (the main liability-based sources are an overnight borrowing arrangement with correspondent banks, an arrangement for overnight borrowing and term credit advances from the FHLBNY, and an additional arrangement for short-term advances at the Federal Reserve Bank discount window). Regular liquidity stress tests and tests of the contingent liquidity plan are performed to ensure that an adequate amount of available funds can be generated to meet a wide variety of potential liquidity crises.

Visa Class B Common Stock: Arrow's subsidiary bank, Glens Falls National, like other Visa member banks, bears some indirect contingent liability for Visa's direct liability arising out of certain antitrust claims involving merchant discounts to the extent that Visa's liability might exceed the amount funded in its litigation escrow account. On December 13, 2019 the Court granted final approval to a settlement in this class action lawsuit. But, on January 3, 2020 an appeal of the final-approved order was filed with the court. It is unknown how long the appeals process will take. When the appeals process is resolved and assuming the balance in the litigation escrow account is sufficient to cover the litigation claims and related expenses, Arrow could potentially realize a gain on the receipt of Visa Class A common stock. At March 31, 2021, Glens Falls National held 27,771 shares of Visa Class B common stock, and utilizing the conversion ratio to Class A common stock at that time, these Class B shares would convert to 45,000 shares of Visa Class A common stock. Since the litigation settlement is not certain, the Company has not recognized any economic value for these shares.
52

CHANGE IN FINANCIAL CONDITION

Summary of Selected Consolidated Balance Sheet Data
(Dollars in Thousands)
March 31, 2021
At Period-End


December 31,
2020
March 31, 2020 $ Change
From December 		$ Change
From
March 		% Change
From December (not annualized) 		% Change
From
March
Interest-Bearing Bank Balances $ 406,605  $ 338,875  $ 106,004  $ 67,730  $ 300,601  20.0  % 283.6  %
Securities Available-for-Sale 464,089  365,287  378,186  98,802  85,903  27.0  % 22.7  %
Securities Held-to-Maturity 214,561  218,405  238,520  (3,844) (23,959) (1.8) % (10.0) %
Equity Securities 1,796  1,636  1,689  160  107  9.8  % 6.3  %
Loans (1)
2,639,243  2,595,030  2,414,193  44,213  225,050  1.7  % 9.3  %
Allowance for loan losses 26,840  29,232  23,637  (2,392) 3,203  (8.2) % 13.6  %
Earning Assets (1)
3,731,654  3,524,582  3,143,971  207,072  587,683  5.9  % 18.7  %
Total Assets $ 3,903,711  $ 3,688,636  $ 3,291,332  $ 215,075  $ 612,379  5.8  % 18.6  %
Noninterest-Bearing Deposits $ 751,884  $ 701,341  $ 489,151  $ 50,543  $ 262,733  7.2  % 53.7  %
Interest-Bearing Checking
  Accounts 		992,486  832,434  793,425  160,052  199,061  19.2  % 25.1  %
Savings Deposits 1,463,229  1,423,358  1,146,683  39,871  316,546  2.8  % 27.6  %
Time Deposits over $250,000 100,212  123,622  135,854  (23,410) (35,642) (18.9) % (26.2) %
Other Time Deposits 145,777  153,971  245,892  (8,194) (100,115) (5.3) % (40.7) %
Total Deposits $ 3,453,588  $ 3,234,726  $ 2,811,005  $ 218,862  $ 642,583  6.8  % 22.9  %
Federal Funds Purchased and
  Securities Sold Under
  Agreements to Repurchase 		$ 6,795  $ 17,486  $ 57,909  $ (10,691) $ (51,114) (61.1) % (88.3) %
FHLBNY Advances - Overnight —  —  —  —  —  —  % —  %
FHLBNY Advances - Term 45,000  45,000  50,000  —  (5,000) —  % (10.0) %
Junior Subordinated Obligations Issued to Unconsolidated
  Subsidiary Trusts 		20,000  20,000  20,000  —  —  —  % —  %
Stockholders' Equity 342,413  334,392  309,398  8,021  33,015  2.4  % 10.7  %
(1) Includes Nonaccrual Loans.
    
Changes in Earning Assets: The loan portfolio at March 31, 2021, was $2.6 billion, an increase of $44.2 million, or 1.7%, from the December 31, 2020 level and up by $225.1 million, or 9.3%, from the March 31, 2020 level. The following trends were experienced in our largest segments:
•Commercial and commercial real estate loans: This segment of the loan portfolio increased by $57.7 million, or 7.1%, during the first three months of 2021. The majority of the increase resulted from the origination of approximately of $70.1 million of additional PPP loans.
•Consumer loans (primarily automobile loans through indirect lending): As of March 31, 2021, these loans, primarily auto loans, increased by $1.4 million, or 0.2%, from the December 31, 2020 balance. The physical sale of vehicles through dealerships in New York State and Vermont has resumed after a pause in early 2020 as a result of the COVID-19 pandemic. However, while certain restrictions and guidelines have been lifted or relaxed, they may be reinstituted in response to the continuing effects of the pandemic.
•Residential real estate loans: This segment decreased during the first three months of 2021 by $14.9 million, or 1.6%. In the first three months of 2021, Arrow sold $28.8 million, or 50.9%, of originations. Arrow expects to continue to sell a portion of mortgage loan originations in upcoming periods if market conditions and strategic balance sheet and interest-rate risk management decisions warrant. It is not currently possible to determine the long term economic impact of the COVID-19 pandemic. Historic low interest rates have, however, increased near-term demand for refinancing and new purchase loans, both with existing and new customers.


Changes in Sources of Funds: Deposit balances reached $3.5 billion, up $642.6 million, or 22.9%, from the prior-year level. Deposit growth for the first quarter of 2021 was $218.9 million. Noninterest-bearing deposits represented 21.8% of total deposits at March 31, 2021, compared to 17.4% of total deposits on March 31, 2020. At March 31, 2021, other time deposits were $145.8 million, a decrease of $100.1 million compared to the prior year. Municipal deposits increased $119.5 million, or 15.0% from March 31, 2020.
53

Municipal Deposits: Fluctuations in balances of interest-bearing checking accounts are largely the result of timing and behavior of municipal deposits.  Municipal deposits on average represent 20% to 25% of total deposits, although slightly higher at March 31, 2021. Municipal deposits are typically placed in interest-bearing checking, savings and various time deposit accounts.
In general, there is a seasonal pattern to municipal deposits which dip to a low point in August each year.  Account balances tend to increase throughout the fall and into early winter from tax deposits, flatten out after the beginning of the ensuing calendar year, and increase again at the end of March from the electronic deposit of NYS Aid payments to school districts.  In addition to seasonal behavior, the overall level of municipal deposit balances fluctuates from year-to-year as a result of local economic factors as well as competition from other banks and non-bank entities. Municipal deposits may also be impacted by increased stimulus payments in response to the COVID-19 pandemic.

FINANCIAL CONDITION
Investment Portfolio Trends
The table below presents the changes in the period-end balances for available-for-sale, held-to-maturity and equity securities from December 31, 2020 to March 31, 2021 (in thousands).
(Dollars in Thousands)
Fair Value at Period-End Net Unrealized Gains (Losses)
For Period Ended
3/31/2021 12/31/2020 Change 3/31/2021 12/31/2020 Change
Securities Available-for-Sale:
U.S. Agency Securities $ 108,370  $ 65,112  $ 43,258  $ (1,631) $ 110  $ (1,741)
State and Municipal Obligations 508  528  (20) —  —  — 
Mortgage-Backed Securities
354,411  298,847  55,564  4,500  7,880  (3,380)
Corporate and Other Debt Securities 800  800  —  (200) (200) — 
Total $ 464,089  $ 365,287  $ 98,802  $ 2,669  $ 7,790  $ (5,121)
Securities Held-to-Maturity:
State and Municipal Obligations $ 197,045  $ 199,429  $ (2,384) $ 5,843  $ 7,077  $ (1,234)
Mortgage-Backed Securities 24,315  27,147  (2,832) 956  1,094  (138)
Total $ 221,360  $ 226,576  $ (5,216) $ 6,799  $ 8,171  $ (1,372)
Equity Securities $ 1,796  $ 1,636  $ 160  $ —  $ —  $ — 
At March 31, 2021, Arrow held no investment securities in the securities portfolios that consisted of or included, directly or indirectly, obligations of foreign governments or governmental agencies of foreign issuers.
In the periods referenced above, Mortgage-Backed Securities consisted solely of mortgage pass-through securities and Collateralized Mortgage Obligations ("CMOs") issued or guaranteed by U.S. federal agencies.  Mortgage pass-through securities provide to the investor monthly portions of principal and interest pursuant to the contractual obligations of the underlying mortgages. CMOs are pools of mortgage-backed securities, the repayments on which have generally been separated into two or more components (tranches), where each tranche has a separate estimated life and yield.  Arrow's practice has been to purchase pass-through securities and CMOs that are issued or guaranteed by U.S. federal agencies, and the tranches of CMOs purchased are generally those having shorter average lives and/or durations. Lower market interest rates and/or payment deferrals on underlying loans that make up mortgage-backed security collateral may impact cashflows.
Arrow evaluates available-for-sale debt securities in unrealized loss positions at each measurement date to determine whether the decline in the fair value below the amortized cost basis (impairment) is due to credit-related factors or noncredit-related factors. Any impairment that is not credit related is recognized in other comprehensive income, net of applicable taxes. Credit-related impairment is recognized within the allowance for credit losses on the balance sheet, limited to the amount by which the amortized cost basis exceeds the fair value, with a corresponding adjustment to earnings via credit loss expense. Arrow determined that at March 31, 2021, gross unrealized losses were primarily attributable to changes in interest rates, relative to when the investment securities were purchased, and not due to the credit quality of the investment securities. Arrow does not intend to sell, nor is it more likely than not that Arrow will be required to sell the security before recovery of its amortized cost basis, which may be at maturity. Therefore, Arrow carried no allowance for credit loss at March 31, 2021 and there was no credit loss expense recognized by Arrow with respect to the securities portfolio during the three months ended March 31, 2021.
Arrow's held to maturity debt securities are comprised of U.S. government agencies, U.S. government-sponsored enterprises and state and municipal obligations. U.S. government agencies and U.S. government-sponsored enterprise securities carry the explicit and/or implicit guarantee of the U.S. government, are widely recognized as “risk free,” and have a long history of zero credit loss. Arrow determined that the expected credit loss on its held to maturity debt portfolio was immaterial and therefore no allowance for credit loss was recorded as of March 31, 2021.
Change in Net Unrealized Securities Gains (Losses): Nearly all of the change in net unrealized gains or losses during recent periods has been attributable to changes in the market rates during the periods in question, with no change in the credit-worthiness of the issuers.

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Investment Sales, Purchases and Maturities
There were no sales of investment securities within the three month periods ended March 31, 2021 or 2020.

The following table summarizes purchases of investment securities within the available-for-sale and held-to-maturity portfolios for the three month periods ended March 31, 2021 and 2020, as well as proceeds from the maturity and calls of investment securities within each portfolio for the respective periods presented:
(In Thousands)
Three Months Ended
Purchases: 3/31/2021 3/31/2020
Available-for-Sale Portfolio
U.S. Agency Securities $ 45,000  $ — 
Mortgage-Backed Securities 85,481  33,201 
Total Purchases $ 130,481  $ 33,201 
Maturities & Calls $ 25,976  $ 17,444 

(In Thousands) Three Months Ended
Purchases: 3/31/2021 3/31/2020
Held-to-Maturity Portfolio
State and Municipal Obligations $ 619  $ 717 
Maturities & Calls $ 4,291  $ 7,075 

Loan Trends
The following three tables present, for each of the last five quarters, the quarterly average balances by loan type, the percentage of total loans represented by each loan type and the annualized yield of each loan category.

Quarterly Average Loan Balances
(Dollars in Thousands)
Quarter Ended
3/31/2021 12/31/2020 9/30/2020 6/30/2020 3/31/2020
Commercial $ 267,758  $ 260,527  $ 276,296  $ 234,732  $ 140,486 
Commercial Real Estate 579,506  569,309  538,914  530,808  518,931 
Consumer 860,954  856,903  841,009  840,734  818,892 
Residential Real Estate 910,144  924,095  926,034  911,924  916,037 
Total Loans $ 2,618,362  $ 2,610,834  $ 2,582,253  $ 2,518,198  $ 2,394,346 

Percentage of Total Quarterly Average Loans
Quarter Ended
3/31/2021 12/31/2020 9/30/2020 6/30/2020 3/31/2020
Commercial 10.2  % 10.0  % 9.3  % 9.3  % 5.9  %
Commercial Real Estate 22.1  % 21.8  % 21.1  % 21.1  % 21.6  %
Consumer 32.9  % 32.8  % 33.4  % 33.4  % 34.2  %
Residential Real Estate 34.8  % 35.4  % 36.2  % 36.2  % 38.3  %
Total Loans 100.0  % 100.0  % 100.0  % 100.0  % 100.0  %

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Quarterly Yield on Loans
Quarter Ended
3/31/2021 12/31/2020 9/30/2020 6/30/2020 3/31/2020
Commercial 4.17  % 4.50  % 3.63  % 3.84  % 4.52  %
Commercial excluding PPP loans 3.91  % 3.99  % 4.02  % 4.04  % 4.52  %
Commercial Real Estate 3.81  % 3.84  % 3.91  % 4.05  % 4.34  %
Consumer 3.94  % 3.95  % 3.95  % 3.90  % 3.97  %
Residential Real Estate 3.79  % 3.83  % 3.86  % 4.08  % 4.20  %
Total Loans 3.90  % 3.94  % 3.81  % 4.01  % 4.18  %
    
The average yield on the loan portfolio decreased to 3.90% for the first quarter of 2021 from 4.18% for the first quarter of 2020. Market rates declined in 2020, which impacted the new loan yields for fixed rate loans, and variable loan yields as these loans reached their repricing dates. Commercial loan yields were affected by PPP loans originated in 2020 and the first quarter of 2021. Commercial loan yields began to rise in the fourth quarter of 2020 due to fees from forgiven PPP loans being recognized in full. Residential real estate yields declined each quarter of 2020 consistent with overall market behavior as well as the effect of variable home equity loans.

Maintenance of High Quality in the Loan Portfolio: There has been no significant fluctuations in the quality of the loan portfolio or any segment thereof. In general, residential real estate loans have historically been underwritten to secondary market standards for prime loans and Arrow has not engaged in subprime mortgage lending as a business line. Similarly, high underwriting standards have generally been applied to commercial and commercial real estate lending operations and generally in the indirect lending program as well. The economic events related to the COVID-19 pandemic, specifically elevated unemployment and the temporary mandated closure of nonessential business, may impact the ability of our borrowers to satisfy their obligations.

Commercial Loans and Commercial Real Estate Loans: Substantially all commercial and commercial real estate loans in the loan portfolio were extended to businesses or borrowers located in Arrow's regional markets. A portion of the loans in the commercial portfolio have variable rates tied to Prime, LIBOR or FHLBNY rates.
Many of the commercial and commercial real estate loans are in industries that have been heavily impacted by the COVID-19 pandemic. As of March 31, 2021, Arrow originated an additional round of over 600 PPP loans totaling approximately $70.1 million. The PPP loans have an interest rate of 1% and Arrow expects to earn approximately $2.3 million in fees related this additional round of loans. Arrow is recognizing the fees earned over the life of the loan and will accelerate recognition of the fees if the loan is forgiven by the Small Business Administration. Additional government intervention, if any, may mitigate the economic risk to both Arrow and its customers, however, the extent of such intervention and its impact cannot be determined at this time.

Consumer Loans: At March 31, 2021, consumer loans (primarily automobile loans originated through dealerships located in upstate New York and Vermont) continue to be a significant component of Arrow's business, comprising approximately one third of the total loan portfolio. The physical sale of vehicles through dealerships in New York State and Vermont resumed in 2020 and continued into 2021 as certain restrictions have been lifted. Arrow believes, the volume of originations of consumer loans have been impacted, in part, by the COVID-19 pandemic, however, the magnitude of the impact cannot be determined.
New consumer loan volume for the first three months of 2021 was $99.8 million, up from the $95.9 million originated in the first three months of 2020.
For credit quality purposes, Arrow assigns potential automobile loan customers into one of four tiers, ranging from lower to higher quality in terms of anticipated credit risk. Arrow's experienced lending staff not only utilizes credit evaluation software tools but also reviews and evaluates each loan individually prior to the loan being funded. Arrow believes that this disciplined approach to evaluating risk has contributed to maintaining the strong credit quality in this portfolio. The COVID-19 pandemic has created elevated unemployment, which may impact borrowers' ability to satisfy their obligations to Arrow. Government intervention may mitigate a significant portion of the credit risk, however, the extent of such intervention and its impact cannot be determined at this time.

Residential Real Estate Loans: In recent years, residential real estate loans, including home equity loans, have represented the largest category of the total loan portfolio. Gross originations for residential real estate loans (including refinancings of mortgage loans) for the first three months of 2021 were $56.6 million, as compared to $32.4 million for the first three months of 2020 as a result of historically low interest rates and strong demand for residential real estate. Arrow has also sold portions of these originations in the secondary market. In the first three months of 2021, Arrow sold $28.8 million, or 50.9%, of originations while retaining the mortgage servicing rights. In the first three months of 2020, $8.2 million, or 25.5%, of originations were sold. Sales of loans increased from the previous year, due to a variety of factors, including strong demand for residential mortgages in our operating markets, favorable market conditions for mortgage sales and strategic balance sheet and interest-rate risk management decisions. Due to the COVID-19 pandemic, it is not yet possible to determine the long term economic impact on our residential real estate loan portfolio.


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Deposit Trends
The following tables provide information on trends in the balance and mix of the deposit portfolio by presenting, for each of the last five quarters, the quarterly average balances by deposit type and the percentage of total deposits represented by each deposit type. The quarterly average balances of both noninterest-bearing deposits and interest-bearing checking and savings accounts have increased significantly from prior year levels. Time deposits, over $250,000 as well as other time deposits, have decreased over the same period short-term. Market rates have remained at historic lows in the first quarter of 2021.

Quarterly Average Deposit Balances
(Dollars in Thousands)
Quarter Ended
3/31/2021 12/31/2020 9/30/2020 6/30/2020 3/31/2020
Noninterest-Bearing Deposits $ 698,234  $ 676,490  $ 673,181  $ 624,125  $ 478,481 
Interest-Bearing Checking Accounts 859,972  874,314  764,614  740,284  707,747 
Savings Deposits 1,435,555  1,407,837  1,314,241  1,215,296  1,092,980 
Time Deposits over $250,000 109,644  115,492  121,027  135,978  126,046 
Other Time Deposits 151,410  182,105  209,436  236,749  264,755 
Total Deposits $ 3,254,815  $ 3,256,238  $ 3,082,499  $ 2,952,432  $ 2,670,009 

Percentage of Total Quarterly Average Deposits
Quarter Ended
3/31/2021 12/31/2020 9/30/2020 6/30/2020 3/31/2020
Noninterest-Bearing Deposits 21.5  % 20.8  % 21.8  % 21.1  % 17.9  %
Interest-Bearing Checking Accounts 26.4  27.0  24.8  25.1  26.5 
Savings Deposits 44.2  43.1  42.7  41.2  41.0 
Time Deposits over $250,000 3.4  3.5  3.9  4.6  4.7 
Other Time Deposits 4.7  5.6  6.8  8.0  9.9 
Total Deposits 100.0  % 100.0  % 100.0  % 100.0  % 100.0  %
    
Quarterly Cost of Deposits
Quarter Ended
3/31/2021 12/31/2020 9/30/2020 6/30/2020 3/31/2020
Demand Deposits —  % —  % —  % —  % —  %
Interest-Bearing Checking Accounts 0.10  % 0.11  % 0.14  % 0.17  % 0.28  %
Savings Deposits 0.16  % 0.18  % 0.24  % 0.39  % 0.91  %
Time Deposits over $250,000 0.44  % 0.70  % 0.96  % 1.30  % 1.70  %
Other Time Deposits 0.59  % 0.92  % 1.09  % 1.33  % 1.52  %
Total Deposits 0.14  % 0.18  % 0.25  % 0.37  % 0.68  %
    
During the quarter ended March 31, 2021, the total cost of deposits continued to decrease. In March 2020, the Federal Reserve lowered the target overnight borrowing rate, the "Fed Funds" rate, to a range of 0.00%-0.25% in response to the economic uncertainty related to the COVID-19 pandemic. Although the Fed Funds rate is widely expected to remain unchanged for the foreseeable future, Arrow is well positioned for a variety of rate environments, see Part I, Item 3, entitled "Quantitative and Qualitative Disclosures About Market Risk," for further discussion.
Non-Deposit Sources of Funds
Arrow's other sources of funds include securities sold under agreements to repurchase, overnight advances and term advances from the FHLBNY. The securities sold under agreements to repurchase are short-term in nature and are collateralized by investment securities. The term advances from the FHLBNY are fixed rate non-callable advances with original maturities of three to five years.
The $20 million principal amount of Junior Subordinated Obligations Issued to Unconsolidated Subsidiary Trusts listed on the consolidated balance sheet as of March 31, 2021 (i.e., previously issued TRUPs) will, subject to certain limits, continue to qualify as Tier 1 regulatory capital for Arrow until such TRUPs mature or are redeemed. This is further discussed under "Capital Resources" beginning on page 60 of this Report. In the first quarter of 2020, Arrow entered into an interest rate swap agreement to synthetically fix the variable rate interest payments associated with $20 million in outstanding subordinated trust securities.
57

ASSET QUALITY
The following table presents information related to the allowance and provision for credit losses for the past five quarters.

Summary of the Allowance and Provision for Credit Losses
(Dollars in Thousands, Loans Stated Net of Unearned Income)
3/31/2021 12/31/2020 9/30/2020 6/30/2020 3/31/2020
Loan Balances:
Period-End Loans $ 2,639,243  $ 2,595,030  $ 2,592,455  $ 2,561,915  $ 2,414,193 
Average Loans, Year-to-Date 2,618,362  2,526,791  2,498,573  2,456,272  2,394,346 
Average Loans, Quarter-to-Date 2,618,362  2,610,834  2,582,253  2,518,198  2,394,346 
Period-End Assets 3,903,711  3,688,636  3,777,684  3,547,177  3,291,332 
Allowance for credit losses, Year-to-Date:
Allowance for credit losses, Beginning of Period $ 29,232  $ 21,187  $ 21,187  $ 21,187  21,187 
Impact of the Adoption of ASU 2016-13 (1,300) —  —  —  — 
Provision for Credit Losses, YTD (648) 9,319  8,083  5,812  2,772 
Loans Charged-off, YTD (633) (1,989) (1,360) (968) (481)
Recoveries of Loans Previously Charged-off 189  715  536  269  159 
Net Charge-offs, YTD (444) (1,274) (824) (699) $ (322)
Allowance for credit losses, End of Period $ 26,840  $ 29,232  $ 28,446  $ 26,300  $ 23,637 
Allowance for credit losses, Quarter-to-Date:
Allowance for credit losses, Beginning of Period $ 29,232  $ 28,446  $ 26,300  $ 23,637  $ 21,187 
Impact of the Adoption of ASU 2016-13 (1,300) —  —  —  — 
Provision for Credit Losses, QTD (648) 1,237  2,271  3,040  2,772 
Loans Charged-off, QTD (633) (630) (392) (487) (481)
Recoveries of Loans Previously Charged-off 189  179  267  110  159 
Net Charge-offs, QTD (444) (451) (125) (377) (322)
Allowance for credit losses, End of Period $ 26,840  $ 29,232  $ 28,446  $ 26,300  $ 23,637 
Nonperforming Assets, at Period-End:
Nonaccrual Loans $ 8,087  $ 6,033  $ 6,004  $ 5,461  $ 4,943 
Loans Past Due 90 or More Days
  and Still Accruing Interest 		242  228  121  901  437 
Restructured and in Compliance with
  Modified Terms 		97  145  157  150  136 
Total Nonperforming Loans 8,426  6,406  6,282  6,512  5,516 
Repossessed Assets 242  155  126  116  160 
Other Real Estate Owned —  —  —  595  782 
Total Nonperforming Assets $ 8,668  $ 6,561  $ 6,408  $ 7,223  $ 6,458 
Asset Quality Ratios:
Allowance to Nonperforming Loans 318.54  % 456.32  % 452.82  % 403.87  % 428.52  %
Allowance to Period-End Loans 1.02  % 1.13  % 1.10  % 1.03  % 0.98  %
Provision to Average Loans (Quarter) (1)
(0.10) % 0.19  % 0.35  % 0.49  % 0.47  %
Provision to Average Loans (YTD) (1)
(0.10) % 0.37  % 0.43  % 0.48  % 0.47  %
Net Charge-offs to Average Loans (Quarter) (1)
0.07  % 0.07  % 0.02  % 0.06  % 0.05  %
Net Charge-offs to Average Loans (YTD) (1)
0.07  % 0.05  % 0.04  % 0.06  % 0.05  %
Nonperforming Loans to Total Loans 0.32  % 0.25  % 0.24  % 0.25  % 0.23  %
Nonperforming Assets to Total Assets 0.22  % 0.18  % 0.17  % 0.20  % 0.20  %
  (1) Annualized

Provision for Credit Losses
Through the provision for credit losses, an allowance for credit losses is maintained that reflects the best estimate of the calculated expected credit losses in Arrow's loan portfolio as of the balance sheet date. Additions are made to the allowance for credit losses through a periodic provision for credit losses. Actual credit losses are charged against the allowance for credit losses when loans are deemed uncollectible and recoveries of amounts previously charged off are recorded as credits to the allowance for credit losses.
Arrow's loan officers and risk managers meet at least quarterly to discuss and review the conditions and risks associated with certain criticized and classified commercial-related relationships. In addition, the independent internal loan review department performs periodic reviews of the credit quality indicators on individual loans in the commercial loan portfolio.
Arrow adopted CECL on January 1, 2021. The transition adjustment includes a $1.3 million decrease to the allowance for credit losses on loans.
58

In the first quarter of 2021, Arrow recorded a $(648) thousand provision for loan losses. For the the first quarter of 2020, a provision of $2.8 million was recorded.
See Notes 1 and 4 to the unaudited interim consolidated financial statements for additional discuss related to the adoption of CECL.
The ratio of the allowance for credit losses to total loans was 1.02% at March 31, 2021, a decrease from 1.13% at December 31, 2020 and an increase of 4 basis points from 0.98% at March 31, 2020.
The accounting policy relating to the allowance for credit losses is considered to be a critical accounting policy, given the uncertainty involved in evaluating the level of the allowance required to cover credit losses in the loan portfolio, and the material effect that such judgments may have on the results of operations. The process for determining the provision for credit losses is described in Note 4 to the unaudited interim consolidated financial statements.

Risk Elements
Nonperforming assets at March 31, 2021 amounted to $8.7 million, up from the $6.6 million total at December 31, 2020 and an increase of $2.2 million, from $6.5 million at March 31, 2020. For the three month periods ended March 31, 2021 and 2020, ratios of nonperforming assets to total assets have remained below the average ratios for the peer group. (See page 45 for a discussion of the peer group.) At December 31, 2020, the ratio of loans past due 90 or more days plus nonaccrual loans plus other real estate owned to total assets was 0.18%, below the 0.52% ratio of the peer group at such date (the latest date for which peer group information is available). At March 31, 2021 the ratio was 0.22%, which is below the most recent ratio for the peer group.
The following table presents the balance of other non-current loans at period-end as to which interest income was being accrued (i.e. loans 30 to 89 days past due, as defined in bank regulatory guidelines). These non-current loans are not included in nonperforming assets, but entail heightened risk.
Loans Past Due 30-89 Days and Accruing Interest
($ in 000's)
3/31/2021 12/31/2020 3/31/2020
Commercial Loans $ 98  $ 215  $ 244 
Commercial Real Estate Loans 143  —  — 
Residential Real Estate Loans 2,034  1,337  1,632 
Consumer Loans - Primarily Indirect Automobile 3,020  7,651  7,015 
   Total Loans Past Due 30-89 Days
   and Accruing Interest 		$ 5,295  $ 9,203  $ 8,891 
    
At March 31, 2021, the loans in the above-referenced category totaled $5.3 million, a decrease of $3.9 million, or 42.5%, from the $9.2 million of such loans at December 31, 2020. The March 31, 2021 total of non-current loans equaled 0.20% of loans then outstanding, compared to 0.35% at December 31, 2020 and 0.37% at March 31, 2020. The decrease from December 31, 2020 is primarily attributable to a decrease in delinquent automobile loans loans.
The number and dollar amount of performing loans that demonstrate characteristics of potential weakness from time-to-time (potential problem loans) typically is a very small percentage of the loan portfolio. See the table of Credit Quality Indicators in Note 4 to the unaudited interim consolidated financial statements. Arrow considers all performing commercial and commercial real estate loans classified as substandard or lower (as reported in Note 4) to be potential problem loans. These loans will continue to be closely monitored and Arrow expects to collect all payments of contractual principal and interest in full on these classified loans. Total nonperforming assets at period-end increased by $2.1 million from December 31, 2020 and $2.2 million from March 31, 2020. The majority of the increase is due to a $2.7 million commercial real estate loan being classified as nonaccrual during the first quarter of 2021.
The economic impact of the COVID-19 pandemic, specifically unemployment levels and the temporary mandated closure of nonessential businesses, may impact the borrowers' ability to satisfy their obligations, and may therefore result in increased delinquencies. Government interventions, on both the federal and state level, have been deployed to mitigate a significant portion of the credit risk. Arrow cannot make a determination as to the overall impact on its business of the COVID-19 pandemic at this time.
As of March 31, 2021, Arrow held no property in other real estate owned. At this time, Arrow does not expect to acquire a significant number of other real estate properties in the near term as a result of payment defaults or the foreclosure process.

59

Loan Deferrals Related to COVID-19 Pandemic
The COVID-19 pandemic has created economic uncertainty resulting in elevated unemployment as well as the temporary closure of nonessential businesses. In the table below, loans deferred by industry sector as the result of the COVID-19 pandemic are presented and compared to total loans by sector as of March 31, 2021. In accordance with the CARES Act, the deferrals listed below are not considered troubled debt restructurings. As of March 31, 2021, Arrow originated an additional $70.1 million of PPP loans in 2021. These loans are included in the loan balances by sector as listed below, however, these loans are not considered deferred as of March 31, 2021.
COVID-19 Deferrals by Loan Category at March 31, 2021
(Dollars in Thousands)
Balances by Sector Deferrals
Total % of Total Loans Balance % of Loan Segment % of Total Loans
Commercial and Commercial Real Estate Loans:
Lessors of Non-Residential Real Estate $ 162,269  6.1  % $ —  —  % —  %
Lessors of Residential Real Estate 136,086  5.2  % —  —  % —  %
Health Care and Social Assistance 119,373  4.5  % 515  0.1  % —  %
Hotels and Motels 115,249  4.4  % 2,722  0.3  % 0.1  %
Arts/Recreation/Restaurants/Vacation Camps 58,551  2.2  % —  —  % —  %
Retail 40,233  1.5  % —  —  % —  %
Construction & Related 35,588  1.3  % —  —  % —  %
Other 202,709  7.7  % 7,029  0.7  % 0.3  %
Total Commercial and Commercial Real Estate Loans 870,058  33.0  % 10,266  1.2  % 0.4  %
Consumer Loans 861,171  32.6  % 1,126  0.1  % —  %
Residential Real Estate Loans 908,014  34.4  % 3,519  0.4  % 0.1  %
Total Loans $ 2,639,243  $ 14,911  0.6  %

Outstanding PPP Loans as of March 31, 2021
(Dollars In Thousands)
PPP Funding to Date $ 212,751 
Loans Fully Forgiven to Date (46,701)
Loans Partial Forgiven to Date (3,287)
Outstanding PPP Loans $ 162,763 
Income Earned on PPP Loans for the Quarter Ended March 31, 2021
(Dollars In Thousands)
Interest Earned at Rate of 1% $ 338 
Fees Recognized for the Quarter Ended March 31, 2021 1,003 
Income Earned on PPP Loans $ 1,341 



CAPITAL RESOURCES

Regulatory Capital Standards
Capital Adequacy Requirements. An important area of banking regulation is the federal banking system's promulgation and enforcement of minimum capitalization standards for banks and bank holding companies.
As reported in the Regulatory Reform section above, the federal bank regulators have issued a final rule to implement the Community Bank Leverage Ratio ("CBLR"), introducing an optional simplified measure of capital adequacy for qualifying community banks that satisfy certain requirements, including having a leverage ratio of greater than 9%, less than $10 billion in total consolidated assets, and limited amounts of off-balance-sheet exposures and trading assets and liabilities.  A qualifying community bank that opts into the CBLR framework and meets all requirements under the CBLR framework will be considered to have met the well-capitalized ratio requirements under the “prompt corrective action” regulations and will not be required to report or calculate risk-based capital ratios.  The CBLR is calculated as the ratio of “tier 1 capital” divided by “average total consolidated assets.”  This final rule was effective as of January 1, 2020, and qualifying community banks can utilize the CBLR framework for purposes of filing their call reports or Form FR Y-9C, as applicable, for the first quarter of 2020 (i.e., as of March 31, 2020). Arrow elected to opt out of utilizing the CBLR framework. The Capital Rules promulgated under Dodd-Frank will remain applicable to Arrow.




60

The following is a summary of certain definitions of capital under the various capital measures in the Dodd-Frank Capital Rules:

Common Equity Tier 1 Capital (CET1): Equals the sum of common stock instruments and related surplus (net of treasury stock), retained earnings, accumulated other comprehensive income (AOCI), and qualifying minority interests, minus applicable regulatory adjustments and deductions. Such deductions will include AOCI, if the organization has exercised its irrevocable option not to include AOCI in capital (the Company made such an election). Mortgage-servicing assets, deferred tax assets, and investments in financial institutions are limited to 15 percent of CET1 in the aggregate and 10 percent of CET1 for each such item individually.
Additional Tier 1 Capital: Equals the sum of noncumulative perpetual preferred stock, tier 1 minority interests, grandfathered TRUPs, and Troubled Asset Relief Program instruments, minus applicable regulatory adjustments and deductions.
Tier 2 Capital: Equals the sum of subordinated debt and preferred stock, total capital minority interests not included in Tier 1, and allowance for loan and lease losses (not exceeding 1.25% of risk-weighted assets) minus applicable regulatory adjustments and deductions.
The following table presents the minimum regulatory capital ratios applicable to the holding company and banks under the current Capital Rules:
Capital Ratio 2021
Minimum CET1 Ratio 4.500  %
Capital Conservation Buffer ("Buffer") 2.500  %
Minimum CET1 Ratio Plus Buffer 7.000  %
Minimum Tier 1 Risk-Based Capital Ratio 6.000  %
Minimum Tier 1 Risk-Based Capital Ratio Plus Buffer 8.500  %
Minimum Total Risk-Based Capital Ratio 8.000  %
Minimum Total Risk-Based Capital Ratio Plus Buffer 10.500  %
Minimum Leverage Ratio 4.000  %

These minimum capital ratios, especially the CET1 ratio (4.5%) and the enhanced Tier 1 risk-based capital ratio (6.0%), represent a heightened and more restrictive capital regime than institutions like Arrow previously had to meet under the prior capital rules.
At March 31, 2021, Arrow's holding company and both of its subsidiary banks exceeded by a substantial amount each of the applicable minimum capital ratios established under the Capital Rules, including the minimum CET1 Ratio, the minimum Tier 1 Risk-Based Capital Ratio, the minimum Total Risk-Based Capital Ratio, and the minimum Leverage Ratio, including in the case of each risk-based ratio, the capital buffer.

Prompt Corrective Action Capital Classifications. Under applicable banking law, federal banking regulators are required to take prompt corrective action with respect to depository institutions that do not meet certain minimum capital requirements.  For these purposes, the regulators have established five capital classifications for banking institutions, ranging from the highest category of "well-capitalized" to the lowest category of "critically under-capitalized". Under the current capital classifications, a banking institution is considered "well-capitalized" if it meets the following capitalization standards on the date of measurement: a CET1 risk-based capital ratio of 6.50% or greater, a Tier 1 risk-based capital ratio of 8.00% or greater, a total risk-based capital ratio of 10.00% or greater, and a Tier 1 leverage ratio of 5.00% or greater, provided the institution is not subject to any regulatory order or written directive regarding capital maintenance. Federal banking law also ties the ability of banking organizations to engage in certain types of activities and to utilize certain procedures to such organizations' continuing to qualify for inclusion in one of the two highest rankings of these capitalization categories, i.e., as "well-capitalized" or "adequately capitalized."

Current Capital Ratios: The table below sets forth the regulatory capital ratios of Arrow's holding company and two subsidiary banks, Glens Falls National and Saratoga National, under the current Capital Rules, as of March 31, 2021:

Common Equity Tier 1 Capital Ratio Tier 1 Risk-Based Capital Ratio Total Risk-Based Capital Ratio Tier 1 Leverage Ratio
Arrow Financial Corporation 13.56  % 14.39  % 15.55  % 9.37  %
Glens Falls National Bank & Trust Co. 14.08  % 14.08  % 15.18  % 9.02  %
Saratoga National Bank & Trust Co. 13.14  % 13.14  % 14.39  % 9.00  %
FDICIA's Prompt Corrective Action - "Well-Capitalized" Standard (2019) 6.50  % 8.00  % 10.00  % 5.00  %
Regulatory Minimum
7.00%(1)
8.50%(1)
10.50%(1)
4.00  %
(1) Including the fully phased-in 2.50% capital conservation buffer

At March 31, 2021, Arrow and its subsidiary banks exceeded the minimum regulatory capital ratios established under the current Capital Rules and each also qualified as "well-capitalized", the highest category in the new capital classification scheme established by federal bank regulatory agencies under the "prompt corrective action" standards, as described above.
61


Capital Components; Stock Repurchases; Dividends
Stockholders' Equity: Stockholders’ equity was $342.4 million at March 31, 2021, an increase of $8.0 million, or 2.4%, from the December 31, 2020 level of $334.4 million, and an increase of $33.0 million, or 10.7%, from the prior-year level. The increase in stockholders' equity over the first three months of 2021 principally reflected the following factors: (i) $13.3 million of net income for the period, plus (ii) issuance of $937 thousand of common stock through employee benefit and dividend reinvestment plans, plus (iii) cumulative impact of adoption of ASU 2016-13 of $120 thousand; reduced by (iv) other comprehensive income of $2.3 million, and (v) cash dividends of $4.0 million.

Trust Preferred Securities: In each of 2003 and 2004, the Company issued $10 million of trust preferred securities (TRUPs) in a private placement. Under the Federal Reserve Board's regulatory capital rules then in effect, TRUPs proceeds typically qualified as Tier 1 capital for bank holding companies such as Arrow, but only in amounts up to 25% of Tier 1 capital, net of goodwill less any associated deferred tax liability. Under the Dodd-Frank Act, any trust preferred securities that Arrow might issue on or after the grandfathering date set forth in Dodd-Frank (May 19, 2010) would not qualify as Tier 1 capital under bank regulatory capital guidelines. For Arrow, TRUPs outstanding prior to the grandfathering cutoff date set forth in Dodd-Frank (May 19, 2010) would continue to qualify as Tier 1 capital until maturity or redemption, subject to limitations. Thus, Arrow's outstanding TRUPs continue to qualify as Tier 1 regulatory capital, subject to such limitations.
In the first quarter of 2020, Arrow entered into an interest rate swap agreement to synthetically fix the variable rate interest payments associated with $20 million in outstanding subordinated trust securities. The effective fixed rate is 3.43% until maturity. These agreements are designated as cash flow hedges.

Stock Repurchase Program: In January 2021, the Board of Directors approved a $5.0 million stock repurchase program, effective for the period January 27, 2021 through December 31, 2021 (the 2021 Repurchase Program), under which management is authorized, in its discretion, to permit Arrow to repurchase up to $5 million of shares of Arrow's common stock, in the open market or in privately negotiated transactions, to the extent management believes Arrow's stock is reasonably priced and such repurchases appear to be an attractive use of available capital and in the best interests of shareholders. As of March 31, 2021, no purchases have occurred under the 2021 Repurchase Program to repurchase Arrow shares. This does not include repurchases of Arrow's Common Stock other than through its 2021 Repurchase Program, i.e., repurchases of Arrow shares on the market utilizing funds accumulated under Arrow's Dividend Reinvestment Plan and the surrender or deemed surrender of Arrow stock to the Company in connection with employees' stock-for-stock exercises of compensatory stock options to buy Arrow stock.

Dividends: The Company's common stock is traded on NasdaqGS® under the symbol AROW. The high and low stock prices for the past five quarters listed below represent actual sales transactions, as reported by NASDAQ. On April 28, 2021, the Board of Directors declared a 2021 second quarter cash dividend of $0.26 payable on June 15, 2021. Per share amounts and share counts in the following tables have been restated for the September 25, 2020 3% stock dividend.
Cash
Market Price Dividends
Low High Declared
2020
First Quarter $ 20.18  $ 36.93  $ 0.252 
Second Quarter 22.87  30.76  0.252 
Third Quarter 24.58  29.13  0.252 
Fourth Quarter 24.51  32.00  0.260 
2021
First Quarter $ 28.65  $ 36.48  $ 0.260 
Second Quarter (dividend payable June 15, 2021) TBD TBD 0.260 
Quarter Ended March 31
2021 2020
Cash Dividends Per Share $ 0.260  $ 0.252 
Diluted Earnings Per Share 0.85  0.53 
Dividend Payout Ratio 30.59  % 47.55  %
Total Equity (in thousands) 342,413  $ 309,398 
Shares Issued and Outstanding (in thousands) 15,543  15,432 
Book Value Per Share $ 22.03  $ 20.05 
Intangible Assets (in thousands) 23,922  23,513 
Tangible Book Value Per Share $ 20.49  $ 18.53 


62

LIQUIDITY
The objective of effective liquidity management is to ensure that Arrow has the ability to raise cash when needed at a reasonable cost.  This includes the capability of meeting expected and unexpected obligations to Arrow's customers at any time. Given the uncertain nature of customer demands and the need to maximize earnings, Arrow must have available reasonably priced sources of funds, both on- and off-balance sheet, that can be accessed quickly in time of need. Arrow’s liquidity position provides the necessary flexibility to address any unexpected near-term disruptions such as reduced cash flows from the investment and loan portfolio, unexpected deposit runoff, or increased loan originations.
Arrow's primary sources of available liquidity are overnight investments in federal funds sold, interest bearing bank balances at the Federal Reserve Bank of New York, and cash flow from investment securities and loans.  Certain investment securities are categorized as available-for-sale at time of purchase based on their marketability and collateral value, as well as their yield and maturity. The securities available-for-sale portfolio was $464.1 million at March 31, 2021, an increase of $98.8 million, from the year-end 2020 level. Due to the potential for volatility in market values, Arrow may not always be able to sell securities on short notice at their carrying value, even to provide needed liquidity. Arrow also held interest-bearing cash balances at March 31, 2021 of $406.6 million compared to $338.9 million at December 31, 2020.
In addition to liquidity from cash, short-term investments, investment securities and loans, the Company has supplemented available operating liquidity with additional off-balance sheet sources such as a federal funds lines of credit with correspondent banks and credit lines with the FHLBNY. The federal funds lines of credit are with two correspondent banks totaling $52 million which were not drawn on during the three months ended March 31, 2021.
To support the borrowing relationship with the FHLBNY, Arrow has pledged collateral, including residential mortgage, home equity and commercial real estate loans. At March 31, 2021, Arrow had outstanding collateralized obligations with the FHLBNY of $45 million; as of that date, the unused borrowing capacity at the FHLBNY was approximately $838 million. Brokered deposits have also been identified as an available source of funding accessible in a relatively short time period. At March 31, 2021, there were no outstanding brokered deposits. Arrow paid down $45 million in brokered deposits in the first quarter of 2021. Also, Arrow's two bank subsidiaries have each established a borrowing facility with the Federal Reserve Bank of New York, pledging certain consumer loans as collateral for potential "discount window" advances, which are maintained for contingency liquidity purposes. At March 31, 2021, the amount available under this facility was approximately $615 million in the aggregate, and there were no advances then outstanding.
Arrow performs regular liquidity stress tests and tests of the contingent liquidity plan to ensure that an adequate amount of available funds can be generated to meet a wide variety of potential liquidity events.
Arrow measures and monitors basic liquidity as a ratio of liquid assets to total short-term liabilities, both with and without the availability of borrowing arrangements. Based on the level of overnight funds investments, available liquidity from the investment securities portfolio, cash flows from the loan portfolio, the stable core deposit base and the significant borrowing capacity, the Company believes that the available liquidity is sufficient to meet all reasonably likely events or occurrences. At March 31, 2021, Arrow's basic liquidity ratio, including FHLBNY collateralized borrowing capacity, was 33.0% of total assets, or $1.13 billion in excess of Arrow's internally-set minimum target ratio of 4%.
Arrow did not experience any significant liquidity constraints in the three month period ended March 31, 2021 and did not experience any such constraints in recent prior years. Arrow has not at any time during such period been forced to pay above-market rates to obtain retail deposits or other funds from any source.

RECENTLY ISSUED ACCOUNTING STANDARDS

The following accounting standards have been issued and become effective for the Company at a future date:
    
Arrow has evaluated the accounting standards that have been issued and effective at a future date and determined that these standards will not have a material impact on its financial position or the results of operations.
63

RESULTS OF OPERATIONS
Three Months Ended March 31, 2021 Compared With
Three Months Ended March 31, 2020

Summary of Earnings Performance
(Dollars in Thousands, Except Per Share Amounts)
Three Months Ended
March 31, 2021 March 31, 2020 Change % Change
Net Income $ 13,280  $ 8,127  $ 5,153  63.4  %
Diluted Earnings Per Share 0.85  0.53  0.32  60.4  %
Return on Average Assets 1.45  % 1.03  % 0.42  % 40.8  %
Return on Average Equity 15.81  % 10.66  % 5.15  % 48.3  %
    
Net income was $13.3 million and diluted earnings per share (EPS) of $.85 for the first quarter of 2021, compared to net income of $8.1 million and diluted EPS of $.53 for the first quarter of 2020. Return on average assets (ROA) for the first quarter of 2021 was 1.45%, up from 1.03% in the first quarter of 2020. In addition, return on average equity (ROE) increased to 15.81% for the first quarter of 2021, from 10.66% in the first quarter of 2020.
        
The following narrative discusses the quarter-to-quarter changes in net interest income, noninterest income, noninterest expense and income taxes.

Net Interest Income
Summary of Net Interest Income
(Dollars in Thousands)
Three Months Ended
March 31, 2021 March 31, 2020 Change % Change
Interest and Dividend Income $ 27,694  $ 28,226  $ (532) (1.9) %
Interest Expense 1,539  5,220  (3,681) (70.5) %
Net Interest Income 26,155  23,006  3,149  13.7  %
Average Earning Assets(1)
3,546,339  3,030,881  515,458  17.0  %
Average Interest-Bearing Liabilities 2,639,240  2,362,515  276,725  11.7  %
Yield on Earning Assets(1)
3.17  % 3.75  % (0.58) (15.5) %
Cost of Interest-Bearing Liabilities 0.24  0.89  (0.65) (73.0)
Net Interest Spread 2.93  2.86  0.07  2.4 
Net Interest Margin 2.99  3.05  (0.06) (2.0)
Net Interest Income excluding PPP loans $ 24,814  $ 23,006  $ 1,808  7.9  %
Net Interest Margin excluding PPP loans 2.84  % 3.05  % (0.21) (6.9) %
(1) Includes Nonaccrual Loans.
Net interest income for the recently completed quarter increased by $3.1 million, or 13.7%, from the first quarter of 2020, due to a variety of factors including; balance sheet growth, lower market rates, and a more favorable funding mix with higher deposit balances. Total loans increased $44.2 million in the first quarter of 2021. At March 31, 2021, deposit balances reached $3.5 billion. Deposit growth for the first quarter of 2021 was $218.9 million and increased $642.6 million, or 22.9%, from the prior-year level. Noninterest-bearing deposits represented 21.8% of total deposits at March 31, 2021, compared to 17.4% of total deposits on March 31, 2020. Net interest margin decreased 6 basis points in the first quarter of 2021 to 2.99%, from 3.05% during the first quarter of 2020. Average earning asset yields were 58 basis points lower as compared to the first quarter of 2020 due primarily to the increased cash balances and lower market rates. The cost of interest-bearing liabilities decreased 65 basis points from the quarter ended March 31, 2020. Arrow defines net interest margin as net interest income divided by average earning assets, annualized. Further detailed information is presented above under the section entitled "Average Consolidated Balance Sheets and Net Interest Income Analysis." The impact of recent interest rate changes on Arrow's deposit and loan portfolios are discussed above in this Report under the sections entitled "Deposit Trends" and "Loan Trends."
As discussed previously under the heading "Asset Quality" beginning on page 58, the provision for loan losses for the first quarter of 2021 was $(648) thousand, compared to a provision of $2.8 million for the first quarter of 2020.

64

Noninterest Income
Summary of Noninterest Income
(Dollars in Thousands)
Three Months Ended
March 31, 2021 March 31, 2020 Change % Change
Income From Fiduciary Activities $ 2,378  $ 2,213  $ 165  7.5  %
Fees for Other Services to Customers 2,609  2,451  158  6.4  %
Insurance Commissions 1,640  1,632  8  0.5  %
Net Gain (Loss) on Securities Transactions 160  (374) 534  142.8  %
Net Gain on the Sale of Loans 1,415  213  1,202  564.3  %
Other Operating Income 406  1,559  (1,153) (74.0) %
Total Noninterest Income $ 8,608  $ 7,694  $ 914  11.9  %
    
Total noninterest income in the current quarter was $8.6 million, an increase of $0.9 million from the comparable quarter of 2020. Income from fiduciary activities for the first quarter of 2021 increased by 7.5% from the first quarter of 2020. Fees for other services to customers were $2.6 million for the first quarter of 2021. Insurance commissions were $1.6 million for the first quarter of 2021 consistent with the first quarter of 2020. Net gain on security transactions of $160 thousand for the first quarter of 2021 was the result in the increase in the fair value of equity securities. Net gain on the sale of loans in the first quarter of 2021 increased by $1.2 million from the first quarter of 2020. See page 52 for the discussion of loan sales. Other operating income decreased $1.2 million from the comparable quarter in 2020, due to a variety of factors. In the first quarter of 2020, Arrow had a gain on the sale of OREO properties of $110 thousand. In the first quarter of 2021, Arrow had a loss on the disposal of fixed assets of $87 thousand. Fees received as part of interest rate swap agreements decreased $866 thousand. Arrow purchased additional bank owned life insurance during 2020 which generated an increase in income of $91 thousand as compared to the prior year comparable quarter.


Noninterest Expense
Summary of Noninterest Expense
(Dollars in Thousands)
Three Months Ended
March 31, 2021 March 31, 2020 Change % Change
Salaries and Employee Benefits $ 11,138  10,383  $ 755  7.3  %
Occupancy Expense of Premises, Net 1,593  1,449  144  9.9  %
Technology and Equipment Expense 3,459  3,352  107  3.2  %
FDIC and FICO Assessments 270  219  51  23.3  %
Amortization 54  58  (4) (6.9) %
Other Operating Expense 2,164  2,293  (129) (5.6) %
Total Noninterest Expense $ 18,678  $ 17,754  $ 924  5.2  %
Efficiency Ratio 53.46  % 56.42  % (2.96) (5.2) %
    
Noninterest expense for the first quarter of 2021 was $18.7 million, an increase of $0.9 million, or 5.2%, from the first quarter of 2020. Salaries and benefit expenses increased $0.8 million, or 7.3%, from the comparable quarter in 2020.
FDIC assessment increased $51 thousand or 23.3%, from the first quarter of 2020 as the result of the increased assets of Arrow's subsidiaries.
Other operating expense decreased $126 thousand, or 5.5%, from the first quarter of 2020. The majority of the decrease, $147 thousand, related to the decrease in the allowance for credit losses on off-balance sheet credit exposures.


Income Taxes
Summary of Income Taxes
(Dollars in Thousands)
Three Months Ended
March 31, 2021 March 31, 2020 Change % Change
Provision for Income Taxes $ 3,453  $ 2,047  $ 1,406  68.7  %
Effective Tax Rate 20.6  % 20.1  % 0.5  2.5  %
The increase in the effective tax rate in the first three months ended March 31, 2021 compared to the three-months ended March 31, 2020 was primarily due to the reduction of tax exempt investments held and the related investment income
65

Item 3.
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
In addition to credit risk in the 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 (interest rates) or prices (market value of financial instruments) will make the Company's position (i.e., assets and operations) less valuable.  The Company's primary market risk is interest rate volatility. The ongoing monitoring and management of interest rate risk is an important component of the asset/liability management process, which is governed by policies that are reviewed and approved annually by the Board of Directors.  The Board of Directors delegates responsibility for carrying out asset/liability oversight and control to management's Asset/Liability Committee ("ALCO").  In this capacity ALCO develops guidelines and strategies impacting the asset/liability profile based upon estimated market risk sensitivity, policy limits and overall market interest rate levels and trends.  
Changes in market interest rates, whether increases or decreases, can trigger repricing and changes in the pace of payments for both assets and liabilities (prepayment risk). This may individually or in combination affect net interest income, net interest margin, and ultimately net income, either positively or negatively. ALCO utilizes the results of a detailed and dynamic simulation model to quantify this interest rate risk by projecting net interest income in various interest rate scenarios.  
The Company's standard simulation model applies a parallel shift in interest rates, ramped over a 12-month period, to capture the impact of changing interest rates on net interest income.  The results are 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 a 100 basis point downward shift in interest rates. Additional tools to monitor potential longer-term interest rate risk, including periodic stress testing involving hypothetical sudden and significant interest rate spikes, are also evaluated.
The following table summarizes the percentage change in net interest income as compared to the base scenario, which assumes no change in market interest rates as generated from the standard simulation model. The results are presented for each of the first two years of the simulation period for the 200 basis point increase in interest rate scenario and the 100 basis point decrease in interest rate scenario.
As of March 31, 2021:
Change in Interest Rate
+ 200 basis points - 100 basis points
Calculated change in Net Interest Income - Year 1 (0.73)% (1.49)%
Calculated change in Net Interest Income - Year 2 (0.69)% (14.24)%

Historically, there has existed an inverse relationship between changes in prevailing rates and the Company's net interest income, suggesting that liabilities and sources of funds generally reprice more quickly than earning assets (near-term liability sensitivity). However, when net interest income is simulated over a longer time frame, this exposure is limited, and actually reverses, as asset yields continue to reprice while the cost of funding reaches assumed ceilings or floors (long-term asset sensitivity). Additionally, short-term interest rates are at historic lows, at or near zero. Accordingly, the results in the -100 basis points scenario effectively represents a flattening of the yield curve, with all rate terms dropping to zero, rather than a parallel shift in interest rates across the entire yield curve.
The hypothetical estimates underlying the sensitivity analysis are based upon numerous assumptions, including: the nature and timing of changes in interest rates including yield curve shape, prepayments on loans and securities, deposit decay rates, pricing decisions on loans and deposits, reinvestment/replacement of asset and liability cash flows, 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, unanticipated shifts in the yield curve 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. The COVID-19 pandemic may impact markets, rates, behavior and other estimates used in the above scenarios.

Item 4.
CONTROLS AND PROCEDURES
Senior management, including the Chief Executive Officer and Chief Financial Officer, has evaluated the effectiveness of the design and operation of Arrow's disclosure controls and procedures (as defined in Rule 13a-15(e) under the Securities Exchange Act of 1934, as amended) as of March 31, 2021. Based upon that evaluation, senior management, including the Chief Executive Officer and Chief Financial Officer, concluded that disclosure controls and procedures were effective. Arrow adopted ASU No. 2016-13, "Financial Instruments: Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments" on January 1, 2021. Arrow implemented new controls and modified existing controls as part of the adoption. The new controls were implemented to account for the additional complexity of the expected credit loss model, review of economic forecasts, and other assumptions used in the estimation of the model. There were no other changes in Arrow's internal control over financial reporting that occurred during the quarter ended March 31, 2021, that materially affected, or are reasonably likely to materially affect, Arrow's internal control over financial reporting.
66

PART II - OTHER INFORMATION
Item 1.
Legal Proceedings
Except as noted below, Arrow, including its subsidiary banks, is not currently the subject of any material pending legal proceedings, other than ordinary routine litigation occurring in the normal course of their business. On an ongoing basis, Arrow is often the subject of, or a party to, various legal claims by other parties against Arrow, by Arrow against other parties, or involving Arrow, which arise in the normal course of business. Except as noted below, the various pending legal claims against Arrow will not, in the opinion of management based upon consultation with counsel, result in any material liability.
On July 1, 2020, Daphne Richard, a customer of GFNB filed a putative class action complaint against GFNB in the United States District Court for the Northern District of New York. The complaint alleges that GFNB assessed overdraft fees on certain transactions drawn on her checking account without having sufficiently disclosed its overdraft-fee practices in its account agreement. Ms. Richard, on behalf of two purported classes, seeks compensatory damages, disgorgement of profits, statutory damages, treble damages, enjoinment of the conduct complained of, and costs and fees. The complaint is similar to complaints filed against other financial institutions pertaining to overdraft fees. Arrow denies any wrongdoing and the case is being vigorously defended.
Item 1.A.
Risk Factors
The Risk Factors identified in the Company's Annual Report on Form 10-K for the year ended December 31, 2020 continue to represent the most significant risks to the Company's future results of operations and financial conditions, without further modification or amendment.
Item 2.
Unregistered Sales of Equity Securities and Use of Proceeds
Unregistered Sales of Equity Securities
None.

Issuer Purchases of Equity Securities
The following table presents information about purchases by Arrow during the three months ended March 31, 2021 of common stock (our only class of equity securities registered pursuant to Section 12 of the Securities Exchange Act of 1934):
First Quarter
2021
Calendar Month
(A)
Total Number of
Shares Purchased 1
(B)
Average Price
Paid Per Share 1
(C)
Total Number of
Shares Purchased as
Part of Publicly
Announced
Plans or Programs 2
(D)
Maximum
Approximate Dollar
Value of Shares that
May Yet be
Purchased Under the
Plans or Programs 2
January 1,282  $ 30.79  —  $ 5,000,000 
February 1,500  31.87  —  5,000,000 
March 13,774  35.84  —  5,000,000 
   Total 16,556  35.09  — 
1 The total number of shares purchased by the Company and the average price paid per share listed in columns (A) and (B) consist of (i) any shares purchased in such periods in open market or private transactions under the Arrow Financial Corporation Automatic Dividend Reinvestment Plan (the "DRIP") by the administrator of the DRIP, (ii) shares surrendered or deemed surrendered to Arrow in such periods by holders of options to acquire Arrow common stock received by them under Arrow's long-term incentive plans in connection with their stock-for-stock exercise of such options and (iii) shares purchased under the publicly-announced 2021 Repurchase Program. In the months indicated, the listed number of shares purchased included the following number of shares purchased by Arrow through such methods: January - DRIP purchases (1,282 shares); February - DRIP purchases (1,500 shares); and March - DRIP purchases (13,774 shares).
2 Includes only those shares acquired by Arrow pursuant to its publicly-announced stock repurchase programs. Arrow's only publicly-announced stock repurchase program in effect for the first quarter of 2021 was the 2021 Repurchase Program approved by the Board of Directors and announced in January 2021, under which the Board authorized management, in its discretion, to repurchase from time to time from the period January 27, 2021 through December 31, 2021, in the open market or in privately negotiated transactions, up to $5 million of Arrow common stock subject to certain exceptions.

Item 3.
Defaults Upon Senior Securities - None

67

Item 4.
Mine Safety Disclosures - None
Item 5.
Other Information - None
Item 6.
Exhibits
Exhibit Number Exhibit
3.(i)
3.(ii)
15
31.1
31.2
32
10.1
10.2
10.3
10.4
10.5
101.INS XBRL Instance Document
101.SCH XBRL Taxonomy Extension Schema Document
101.CAL XBRL Taxonomy Extension Calculation Linkbase Document
101.DEF XBRL Taxonomy Extension Definition Linkbase Document
101.LAB XBRL Taxonomy Extension Labels Linkbase Document
101.PRE XBRL Taxonomy Extension Presentation Linkbase Document
* Management contracts or compensation plans required to be filed as an exhibit.

    















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SIGNATURES
    Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this Report to be signed on its behalf by the undersigned thereunto duly authorized.
ARROW FINANCIAL CORPORATION
Registrant
May 6, 2021 /s/Thomas J. Murphy
Date Thomas J. Murphy
President and Chief Executive Officer
May 6, 2021 /s/Edward J. Campanella
Date Edward J. Campanella
Senior Vice President, Treasurer and
Chief Financial Officer
(Principal Financial Officer and
Principal Accounting Officer)


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