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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 September 30, 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 October 29, 2021
Common Stock, par value $1.00 per share 16,023,411


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)
  September 30,
2021 		December 31,
2020 		September 30,
2020
ASSETS    
Cash and Due From Banks $ 49,430  $ 42,116  $ 54,286 
Interest-Bearing Deposits at Banks 548,936  338,875  396,380 
Investment Securities:  
Available-for-Sale at Fair Value 486,900  365,287  374,928 
Held-to-Maturity (Approximate Fair Value of $203,936 at September 30, 2021; $226,576 at December 31, 2020; and $233,501 at September 30, 2020)
198,337  218,405  224,799 
Equity Securities 1,886  1,636  1,511 
FHLB and Federal Reserve Bank Stock 5,380  5,349  5,574 
Loans 2,654,751  2,595,030  2,592,455 
Allowance for Credit Losses (26,956) (29,232) (28,446)
Net Loans 2,627,795  2,565,798  2,564,009 
Premises and Equipment, Net 44,003  42,612  42,075 
Goodwill 21,873  21,873  21,873 
Other Intangible Assets, Net 2,006  1,950  1,789 
Other Assets 84,558  84,735  90,460 
Total Assets $ 4,071,104  $ 3,688,636  $ 3,777,684 
LIABILITIES    
Noninterest-Bearing Deposits $ 841,910  $ 701,341  $ 690,232 
Interest-Bearing Checking Accounts 1,035,358  832,434  912,980 
Savings Deposits 1,515,692  1,423,358  1,354,956 
Time Deposits over $250,000 73,889  123,622  112,555 
Other Time Deposits 138,714  153,971  194,135 
Total Deposits 3,605,563  3,234,726  3,264,858 
Federal Funds Purchased and Securities Sold Under Agreements to Repurchase 2,426  17,486  73,949 
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 5,181  5,217  5,228 
Other Liabilities 32,763  31,815  37,989 
Total Liabilities 3,710,933  3,354,244  3,452,024 
STOCKHOLDERS’ EQUITY    
Preferred Stock, $1 Par Value and 1,000,000 Shares Authorized at September 30, 2021, December 31, 2020 and September 30, 2020
—  —  — 
Common Stock, $1 Par Value; 30,000,000 Shares Authorized (20,800,144 Shares Issued at September 30, 2021 and 20,194,474 at December 31, 2020 and September 30, 2020)
20,800  20,194  20,194 
Additional Paid-in Capital 377,349  353,662  353,062 
Retained Earnings 47,936  41,899  33,434 
Accumulated Other Comprehensive Loss (3,719) (816) (253)
Treasury Stock, at Cost (4,780,496 Shares at September 30, 2021; 4,678,736 Shares at December 31, 2020 and 4,705,102 Shares at September 30, 2020)
(82,195) (80,547) (80,777)
Total Stockholders’ Equity 360,171  334,392  325,660 
Total Liabilities and Stockholders’ Equity $ 4,071,104  $ 3,688,636  $ 3,777,684 
    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 September 30 Nine Months Ended September 30,
  2021 2020 2021 2020
INTEREST AND DIVIDEND INCOME    
Interest and Fees on Loans $ 27,157  $ 24,706  $ 79,354  $ 74,657 
Interest on Deposits at Banks 163  64  351  229 
Interest and Dividends on Investment Securities:
Fully Taxable 1,632  1,557  4,809  5,621 
Exempt from Federal Taxes 855  969  2,682  3,017 
Total Interest and Dividend Income 29,807  27,296  87,196  83,524 
INTEREST EXPENSE    
Interest-Bearing Checking Accounts 155  264  566  1,061 
Savings Deposits 424  806  1,490  4,450 
Time Deposits over $250,000 39  292  228  1,263 
Other Time Deposits 133  576  511  2,360 
Federal Funds Purchased and
  Securities Sold Under Agreements to Repurchase 		—  17  3  55 
Federal Home Loan Bank Advances 197  219  586  865 
Junior Subordinated Obligations Issued to
  Unconsolidated Subsidiary Trusts 		173  173  513  574 
Interest on Financing Leases 48  49  146  148 
Total Interest Expense 1,169  2,396  4,043  10,776 
NET INTEREST INCOME 28,638  24,900  83,153  72,748 
Provision for Credit Losses 99  2,271  (286) 8,083 
NET INTEREST INCOME AFTER PROVISION FOR CREDIT LOSSES 28,539  22,629  83,439  64,665 
NONINTEREST INCOME    
Income From Fiduciary Activities 2,571  2,265  7,538  6,613 
Fees for Other Services to Customers 2,966  2,619  8,494  7,348 
Insurance Commissions 1,576  1,713  4,842  5,077 
Net (Loss) Gain on Securities (106) (72) 250  (552)
Net Gain on Sales of Loans 211  1,433  2,251  2,193 
Other Operating Income 476  739  1,405  2,876 
Total Noninterest Income 7,694  8,697  24,780  23,555 
NONINTEREST EXPENSE    
Salaries and Employee Benefits 11,377  10,408  33,360  31,003 
Occupancy Expenses, Net 1,403  1,427  4,480  4,221 
Technology and Equipment Expense 3,833  3,228  11,002  9,807 
FDIC Assessments 249  309  764  770 
Other Operating Expense 2,561  2,115  7,582  6,685 
Total Noninterest Expense 19,423  17,487  57,188  52,486 
INCOME BEFORE PROVISION FOR INCOME TAXES 16,810  13,839  51,031  35,734 
Provision for Income Taxes 3,821  2,793  11,483  7,402 
NET INCOME $ 12,989  $ 11,046  $ 39,548  $ 28,332 
Average Shares Outstanding 1:
   
Basic 16,027  15,936  16,015  15,917 
Diluted 16,085  15,946  16,072  15,931 
Per Common Share:    
Basic Earnings $ 0.81  $ 0.69  $ 2.47  $ 1.78 
Diluted Earnings 0.81  0.69  2.46  1.78 

    1 2020 Share and Per Share Amounts have been restated for the September 24, 2021 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 September 30 Nine Months Ended September 30
2021 2020 2021 2020
Net Income $ 12,989  $ 11,046  $ 39,548  28,332 
Other Comprehensive (Loss) Income, Net of Tax:
  Net Unrealized Securities Holding (Loss) Gain
  Arising During the Period 		(1,279) (296) (3,969) 5,823 
  Net Unrealized Gain on Cash Flow Hedge
  Agreements 		183  238  954  37 
  Reclassification of Net Unrealized Gain on Cash
  Flow Hedge Agreements to Interest Expense 		(25) —  (68) — 
  Amortization of Net Retirement Plan Actuarial Loss 17  42  51  127 
  Amortization of Net Retirement Plan Prior Service Cost 43  39  129  117 
Other Comprehensive (Loss) Income (1,061) 23  (2,903) 6,104 
  Comprehensive Income $ 11,928  $ 11,069  $ 36,645  $ 34,436 

    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)
Nine Month Period Ended September 30, 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 —  —  39,548  —  —  39,548 
Other Comprehensive Loss —  —  —  (2,903) —  (2,903)
3% Stock Dividend (605,670 Shares)
606  20,896  (21,502) —  —  — 
Cash Dividends Paid, $.757 per Share
—  —  (12,129) —  —  (12,129)
Stock Options Exercised, Net  (52,610 Shares)
—  983  —  —  470  1,453 
Shares Issued Under the Directors’ Stock
  Plan  (8,471 Shares)
—  208  —  —  76  284 
Shares Issued Under the Employee Stock
  Purchase Plan  (11,304 Shares)
—  262  —  —  101  363 
Shares Issued for Dividend
  Reinvestment Plans (37,841 Shares)
—  1,028  —  —  338  1,366 
Stock-Based Compensation Expense —  310  —  —  —  310 
Purchase of Treasury Stock
  (72,750 Shares)
—  —  —  —  (2,633) (2,633)
Balance at September 30, 2021
$ 20,800  $ 377,349  $ 47,936  $ (3,719) $ (82,195) $ 360,171 
Three Month Period Ended September 30, 2021
Common
Stock 		Additional
Paid-In
Capital 		Retained
Earnings 		Accumu-lated
Other Com-
prehensive
Loss 		Treasury
Stock 		Total
Balance at June 30, 2021 $ 20,194  $ 355,195  $ 60,494  $ (2,658) $ (80,192) $ 353,033 
Net Income —  —  12,989  —  —  12,989 
Other Comprehensive Loss —  —  —  (1,061) —  (1,061)
3% Stock Dividend (605,670 Shares)
606  20,896  (21,502) —  —  — 
Cash Dividends Paid, $.252 per Share
—  —  (4,045) —  —  (4,045)
Stock Options Exercised, Net  (30,346 Shares)
—  657  —  —  271  928 
Shares Issued Under the Directors’ Stock
  Plan  (2,627 Shares)
—  71  —  —  24  95 
Shares Issued Under the Employee Stock
  Purchase Plan  (3,387 Shares)
—  87  —  —  30  117 
Shares Issued for Dividend
  Reinvestment Plans (12,826 Shares)
—  340  —  —  115  455 
Stock-Based Compensation Expense —  103  —  —  —  103 
Purchase of Treasury Stock
  (67,649 Shares)
—  —  —  —  (2,443) (2,443)
Balance at September 30, 2021
$ 20,800  $ 377,349  $ 47,936  $ (3,719) $ (82,195) $ 360,171 
6

Nine Month Period Ended September 30, 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 —  —  28,332  —  —  28,332 
Other Comprehensive Income —  —  —  6,104  —  6,104 
3% Stock Dividend (588,025 Shares)
588  15,818  (16,406) —  —  — 
Cash Dividends Paid, $.735 per Share 1
—  —  (11,710) —  —  (11,710)
Stock Options Exercised, Net (26,039 Shares)
—  344  —  —  252  596 
Shares Issued Under the Directors’ Stock
  Plan  (4,245 Shares)
—  83  —  —  42  125 
Shares Issued Under the Employee Stock
  Purchase Plan  (13,697 Shares)
—  260  —  —  132  392 
Shares Issued for Dividend
  Reinvestment Plans (48,473 Shares)
—  887  —  —  462  1,349 
Stock-Based Compensation Expense —  315  —  —  —  315 
Purchase of Treasury Stock
 (52,257 Shares)
—  —  —  —  (1,571) (1,571)
Balance at September 30, 2020 $ 20,194  $ 353,062  $ 33,434  $ (253) $ (80,777) $ 325,660 
Three Month Period Ended September 30, 2020
Common
Stock 		Additional
Paid-In
Capital 		Retained
Earnings 		Accumu-lated
Other Com-
prehensive
Loss 		Treasury
Stock 		Total
Balance at June 30, 2020 $ 19,606  $ 336,643  $ 42,704  $ (276) $ (80,990) $ 317,687 
Net Income —  —  11,046  —  —  11,046 
Other Comprehensive Income —  —  —  23  —  23 
3% Stock Dividend (588,025 Shares)
588  15,818  (16,406) —  —  — 
Cash Dividends Paid, $.245 per Share 1
—  —  (3,910) —  —  (3,910)
Stock Options Exercised, Net (8,884 Shares)
—  107  —  —  81  188 
Shares Issued Under the Employee Stock
  Purchase Plan  (4,739 Shares)
—  84  —  —  43  127 
Shares Issued for Dividend
  Reinvestment Plans (16,443 Shares)
—  304  —  —  153  457 
Stock-Based Compensation Expense —  106  —  —  —  106 
Purchase of Treasury Stock
 (2,236 Shares)
—  —  —  —  (64) (64)
Balance at September 30, 2020
$ 20,194  $ 353,062  $ 33,434  $ (253) $ (80,777) $ 325,660 



1 Cash dividends paid per share have been adjusted for the September 24, 2021 3% stock dividend.
See Notes to Unaudited Interim Consolidated Financial Statements.



7

ARROW FINANCIAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Dollars in Thousands)
Nine Months Ended September 30,
Cash Flows from Operating Activities: 2021 2020
Net Income $ 39,548  $ 28,332 
Provision for Credit Losses (286) 8,083 
Depreciation and Amortization 5,894  4,669 
Net (Gain) Loss on Securities Transactions (250) 552 
Loans Originated and Held-for-Sale (45,930) (60,335)
Proceeds from the Sale of Loans Held-for-Sale 57,097  52,099 
Net Gain on the Sale of Loans (2,251) (2,193)
Net Loss (Gain) on the Sale of Premises and Equipment, Other Real Estate Owned and Repossessed Assets 68  (157)
Contributions to Retirement Benefit Plans (441) (540)
Deferred Income Tax Benefit (35) (2,255)
Shares Issued Under the Directors’ Stock Plan 284  125 
Stock-Based Compensation Expense 310  315 
Tax Benefit from Exercise of Stock Options 69  41 
Net Increase in Other Assets (92) (5,924)
Net Increase in Other Liabilities 1,727  4,751 
Net Cash Provided By Operating Activities 55,712  27,563 
Cash Flows from Investing Activities:
Proceeds from the Maturities and Calls of Securities Available-for-Sale 93,332  75,449 
Purchases of Securities Available-for-Sale (222,089) (86,832)
Proceeds from the Maturities and Calls of Securities Held-to-Maturity 24,266  26,570 
Purchases of Securities Held-to-Maturity (4,695) (6,848)
Net Increase in Loans (70,393) (197,577)
Proceeds from the Sales of Premises and Equipment, Other Real Estate Owned and Repossessed Assets 1,054  2,332 
Purchase of Premises and Equipment (3,942) (3,639)
Net (Increase) Decrease in FHLB and Federal Reserve Bank Stock (31) 4,743 
Purchase of Bank Owned Life Insurance —  (12,000)
Net Cash Used By Investing Activities (182,498) (197,802)
Cash Flows from Financing Activities:
Net Increase in Deposits 370,837  648,804 
Net Decrease in Short-Term Federal Home Loan Bank Borrowings —  (130,000)
Net (Decrease) Increase in Short-Term Borrowings (15,060) 22,850 
Finance Lease Payments (36) (26)
Federal Home Loan Bank Advances —  40,000 
Repayments of Federal Home Loan Bank Term Advances —  (20,000)
Purchase of Treasury Stock (2,633) (1,571)
Stock Options Exercised, Net 1,453  596 
Shares Issued Under the Employee Stock Purchase Plan 363  392 
Shares Issued for Dividend Reinvestment Plans 1,366  1,349 
Cash Dividends Paid (12,129) (11,710)
Net Cash Provided By Financing Activities 344,161  550,684 
Net Increase in Cash and Cash Equivalents 217,375  380,445 
Cash and Cash Equivalents at Beginning of Period 380,991  70,221 
Cash and Cash Equivalents at End of Period $ 598,366  $ 450,666 
Supplemental Disclosures to Statements of Cash Flow Information:
Interest on Deposits and Borrowings $ 4,224  $ 11,367 
Income Taxes 11,060  8,369 
Transfer of Loans to Other Real Estate Owned and Repossessed Assets 1,066  711 

See Notes to Unaudited Interim Consolidated Financial Statements.
8

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 September 30, 2021, December 31, 2020 and September 30, 2020; the results of operations for the nine month periods ended September 30, 2021 and 2020; the consolidated statements of comprehensive income for the nine month periods ended September 30, 2021 and 2020; the changes in stockholders' equity for the nine month periods ended September 30, 2021 and 2020; and the cash flows for the nine month periods ended September 30, 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. Arrow's historical loss experience was supplemented with peer information when there was insufficient loss data for Arrow. 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 Arrow and segment-specific peers provides the basis for the estimation of expected credit losses. Arrow utilized regression analyses of peer data, of which Arrow 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.
9

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 an eight 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 an eight quarter 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; Arrow'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 Arrow'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. Arrow 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
Arrow estimates expected credit losses over the contractual period in which Arrow has exposure to credit risk via a contractual obligation to extend credit, unless that obligation is unconditionally cancellable by Arrow. 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
10

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, Arrow 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, Arrow 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, Arrow 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 Arrow'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, Arrow has not experienced uncollectible accrued interest receivable on investment securities.

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

In June 2016, the Financial Accounting Standards Board (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 Arrow 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 Accounting Standards Codification (ASC) 326 while prior period amounts continue to be reported in accordance with previously applicable GAAP. Arrow 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. Arrow did not record an allowance for HTM debt securities on January 1, 2021 as the amount of credit risk was deemed immaterial. Arrow did not record an allowance for credit losses on its AFS debt securities under the
11

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. Arrow 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.


Note 2. CASH AND CASH EQUIVALENTS (In Thousands)

The following table is the schedule of Cash and Cash Equivalents at September 30, 2021, December 31, 2020 and September 30, 2020.
September 30, 2021 December 31, 2020 September 30, 2020
Cash and Due From Banks $ 49,430  $ 42,116  $ 54,286 
Interest-Bearing Deposits at Banks 548,936  338,875  396,380 
Total Cash and Cash Equivalents $ 598,366  380,991  450,666 
Supplemental Information:
Restricted cash pledged as collateral related to swap agreements and included in Cash and Due From Banks $ —  $ 500  $ 2,350 
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Note 3.    INVESTMENT SECURITIES (In Thousands)

The following table is the schedule of Available-For-Sale Securities at September 30, 2021, December 31, 2020 and September 30, 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
September 30, 2021
Available-For-Sale Securities,
  at Amortized Cost 		$ 110,001  $ 400  $ 373,042  $ 1,000  $ 484,443 
Gross Unrealized Gains 96  —  5,225  —  5,321 
Gross Unrealized Losses (792) —  (1,872) (200) (2,864)
Available-For-Sale Securities,
  at Fair Value 		109,305  400  376,395  800  486,900 
Available-For-Sale Securities,
  Pledged as Collateral, at Fair
  Value 		361,014 
Maturities of Debt Securities,
  at Amortized Cost:
Within One Year $ —  $ —  $ 125  $ —  $ 125 
From 1 - 5 Years 110,001  40  368,296  —  478,337 
From 5 - 10 Years —  360  4,621  1,000  5,981 
Over 10 Years —  —  —  —  — 
Maturities of Debt Securities,
  at Fair Value:
Within One Year $ —  $ —  $ 132  $ —  $ 132 
From 1 - 5 Years 109,305  40  371,649  —  480,994 
From 5 - 10 Years —  360  4,614  800  5,774 
Over 10 Years —  —  —  —  — 
Securities in a Continuous
  Loss Position, at Fair Value:
Less than 12 Months $ 74,695  $ —  $ 190,532  $ —  $ 265,227 
12 Months or Longer 29,513  —  —  800  30,313 
Total $ 104,208  $ —  $ 190,532  $ 800  $ 295,540 
Number of Securities in a
  Continuous Loss Position 		14  —  27  1  42 
Unrealized Losses on
  Securities in a Continuous
  Loss Position:
Less than 12 Months $ 305  $ —  $ 1,872  $ —  $ 2,177 
12 Months or Longer 487  —  —  200  687 
Total $ 792  $ —  $ 1,872  $ 200  $ 2,864 
Disaggregated Details:
US Agency Obligations,
  at Amortized Cost 		$ 110,001 
US Agency Obligations,
  at Fair Value 		109,305 
US Government Agency
  Securities, at Amortized Cost 		$ 10,119 
US Government Agency
  Securities, at Fair Value 		10,165 
Government Sponsored Entity
  Securities, at Amortized Cost 		362,923 
Government Sponsored Entity
  Securities, at Fair Value 		366,230 
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
September 30, 2020
Available-For-Sale Securities,
  at Amortized Cost 		$ 35,001  $ 593  $ 329,887  $ 1,000  $ 366,481 
Gross Unrealized Gains 184  —  8,700  —  8,884 
Gross Unrealized Losses (18) —  (219) (200) (437)
Available-For-Sale Securities,
  at Fair Value 		35,167  593  338,368  800  374,928 
Available-For-Sale Securities,
  Pledged as Collateral, at Fair
  Value 		308,879 
Securities in a Continuous
  Loss Position, at Fair Value:
Less than 12 Months $ 29,982  $ —  $ 13,847  $ —  $ 43,829 
12 Months or Longer —  —  54,239  800  55,039 
Total $ 29,982  $ —  $ 68,086  $ 800  $ 98,868 
Number of Securities in a
  Continuous Loss Position 		4  —  26  1  31 
Unrealized Losses on Securities
  in a Continuous Loss Position:
Less than 12 Months $ 18  $ —  $ 36  $ —  $ 54 
12 Months or Longer —  —  183  200  383 
Total $ 18  $ —  $ 219  $ 200  $ 437 
Disaggregated Details:
US Agency Obligations,
  at Amortized Cost 		$ 35,001 
US Agency Obligations,
  at Fair Value 		35,167 
US Government Agency
  Securities, at Amortized Cost 		$ 69,575 
US Government Agency
  Securities, at Fair Value 		69,407 
Government Sponsored Entity
  Securities, at Amortized Cost 		260,312 
Government Sponsored Entity
  Securities, at Fair Value 		268,961 

At September 30, 2021, there was no allowance for credit losses for the available for sale securities portfolio.

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The following table is the schedule of Held-To-Maturity Securities at September 30, 2021, December 31, 2020 and September 30, 2020:
Held-To-Maturity Securities
State and
Municipal
Obligations 		Mortgage-
Backed
Securities 		Total
Held-To
Maturity
Securities
September 30, 2021
Held-To-Maturity Securities,
  at Amortized Cost 		$ 179,952  $ 18,385  $ 198,337 
Gross Unrealized Gains 4,834  765  5,599 
Gross Unrealized Losses —  —  — 
Held-To-Maturity Securities,
  at Fair Value 		184,786  19,150  203,936 
Held-To-Maturity Securities,
  Pledged as Collateral, at Fair Value 		192,929 
Maturities of Debt Securities,
  at Amortized Cost:
Within One Year $ 23,281  $ 940  $ 24,221 
From 1 - 5 Years 140,014  17,445  157,459 
From 5 - 10 Years 15,791  —  15,791 
Over 10 Years 866  —  866 
Maturities of Debt Securities,
  at Fair Value:
Within One Year $ 23,448  $ 959  $ 24,407 
From 1 - 5 Years 143,994  18,191  162,185 
From 5 - 10 Years 16,473  —  16,473 
Over 10 Years 871  —  871 
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 		$ 6,302 
US Government Agency
  Securities, at Fair Value 		6,506 
Government Sponsored Entity
  Securities, at Amortized Cost 		12,083 
Government Sponsored Entity
  Securities, at Fair Value 		12,644 
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 
17

Held-To-Maturity Securities
State and
Municipal
Obligations 		Mortgage-
Backed
Securities 		Total
Held-To
Maturity
Securities
September 30, 2020
Held-To-Maturity Securities,
  at Amortized Cost 		$ 195,735  $ 29,064  $ 224,799 
Gross Unrealized Gains 7,488  1,257  8,745 
Gross Unrealized Losses (43) —  (43)
Held-To-Maturity Securities,
  at Fair Value 		203,180  30,321  233,501 
Held-To-Maturity Securities,
  Pledged as Collateral, at Fair Value 		221,844 
Securities in a Continuous
  Loss Position, at Fair Value:
Less than 12 Months $ 1,476  $ —  $ 1,476 
12 Months or Longer —  —  — 
Total $ 1,476  $ —  $ 1,476 
Number of Securities in a
  Continuous Loss Position 		4  —  4 
Unrealized Losses on
  Securities in a Continuous
  Loss Position:
Less than 12 Months $ 42  $ —  $ 42 
12 Months or Longer 1  —  1 
Total $ 43  $ —  $ 43 
Disaggregated Details:
US Government Agency
  Securities, at Amortized Cost 		$ 10,669 
US Government Agency
  Securities, at Fair Value 		11,049 
Government Sponsored Entity
  Securities, at Amortized Cost 		18,392 
Government Sponsored Entity
  Securities, at Fair Value 		19,272 

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 September 30, 2021, December 31, 2020 and September 30, 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 September 30, 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 September 30, 2021 and there was no credit loss expense recognized by Arrow with respect to the securities portfolio during the three months ended September 30, 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 September 30, 2021.

18

The following table is the schedule of Equity Securities at September 30, 2021, December 31, 2020 and September 30, 2020:
Equity Securities
September 30, 2021 December 31, 2020 September 30, 2020
Equity Securities, at Fair Value $1,886 $1,636 $1,511

The following is a summary of realized and unrealized gains and losses recognized in net income on equity securities during the three and nine month period ended September 30, 2021 and 2020:
For the Three Months Ended September 30, For the Nine Months Ended September 30,
2021 2020 2021 2020
Net (Loss) Gain on Equity Securities $ (106) $ (72) $ 250  $ (552)
Less: Net (loss) gain recognized during the reporting period on equity securities sold during the period —  —  —  — 
Unrealized net (loss) gain recognized during the reporting period on equity securities still held at the reporting date $ (106) $ (72) $ 250  $ (552)
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Note 4.    LOANS (In Thousands)

Loan Categories and Past Due Loans

The following two tables present loan balances outstanding as of September 30, 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 $2,169, $11,085 and $10,580 as of September 30, 2021, December 31, 2020 and September 30, 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
September 30, 2021
Loans Past Due 30-59 Days $ 729  $ —  $ 4,809  $ 368  $ 5,906 
Loans Past Due 60-89 Days 63  —  2,543  1,295  3,901 
Loans Past Due 90 or more Days 75  1,641  1,010  1,951  4,677 
Total Loans Past Due 867  1,641  8,362  3,614  14,484 
Current Loans 187,324  613,440  912,827  926,676  2,640,267 
Total Loans $ 188,191  $ 615,081  $ 921,189  $ 930,290  $ 2,654,751 
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 
September 30, 2020
Loans Past Due 30-59 Days $ 43  $ —  $ 4,238  $ 428  $ 4,709 
Loans Past Due 60-89 Days 79  85  2,853  765  3,782 
Loans Past Due 90 or more Days 22  1,475  1,303  1,517  4,317 
Total Loans Past Due 144  1,560  8,394  2,710  12,808 
Current Loans 275,777  539,673  841,132  923,065  2,579,647 
Total Loans $ 275,921  $ 541,233  $ 849,526  $ 925,775  $ 2,592,455 
Schedule of Non Accrual Loans by Category
Commercial
September 30, 2021 Commercial Real Estate Consumer Residential Total
Loans 90 or More Days Past Due
  and Still Accruing Interest 		$ —  $ —  $ —  $ 555  $ 555 
Nonaccrual Loans 91  7,766  1,101  1,765  10,723 
Nonaccrual With No Allowance for Credit Loss 91  4,983  1,101  1,765  7,940 
Interest Income on Nonaccrual Loans —  111  —  —  111 
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 
September 30, 2020
Loans 90 or More Days Past Due
  and Still Accruing Interest 		$ —  $ —  $ —  $ 121  $ 121 
Nonaccrual Loans 72  1,475  1,559  2,898  6,004 


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Arrow 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 one-to-four-family residential real estate loans for the construction, purchase of 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 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 September 30, 2021:
September 30, 2021 Collateral Type -Residential Real Estate Collateral Type - Commercial Real Estate Total Loans
Commercial $ —  $ —  $ — 
Commercial Real Estate —  7,254  7,254 
Consumer —  —  — 
Residential 676  —  676 
Total $ 676  $ 7,254  $ 7,930 

Allowance for Credit Losses

As mentioned in Note 1 Accounting Policies, Arrow adopted CECL on January 1, 2021.
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 - non-PPP, commercial PPP, 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
21

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 September 30, 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 0.2% in the national unemployment rate during the six-quarter forecast period, while forecasted gross domestic product declined approximately 1.0%. The home price index forecast increased approximately 2.2% from the previous quarter level. Key assumptions utilized in the CECL calculation include loan segmentation, loan loss regression analysis, reasonable and supportable forecast period, reversion period, discounted cash flow inputs including economic forecast data and prepayment and curtailment speeds and qualitative factors. Key assumptions are reviewed and approved on a quarterly basis. Driven by current economic forecasts, loan growth and net charge offs during the quarter, the third quarter provision for credit losses was $99 thousand. The provision is directionally consistent with both the latest economic forecasts as well as third quarter activity. Management's evaluation considers the allowance for credit losses for loans to be appropriate as of September 30, 2021.

The following table details activity in the allowance for credit losses on loans for the three and nine months ended September 30, 2021 and September 30, 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:
June 30, 2021 $ 2,241  $ 13,606  $ 2,443  $ 8,720  $ 27,010 
Charge-offs (17) —  (427) —  (444)
Recoveries —  —  291  —  291 
Provision 200  65  (19) (147) 99 
September 30, 2021 $ 2,424  $ 13,671  $ 2,288  $ 8,573  $ 26,956 
December 31, 2020 $ 2,173  $ 9,990  $ 11,562  $ 5,507  $ 29,232 
Impact of Adoption ASC 326 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 (37) —  (1,480) (3) (1,520)
Recoveries —  —  830  —  830 
Provision (1,796) 1,617  759  (866) (286)
September 30, 2021 $ 2,424  $ 13,671  $ 2,288  $ 8,573  $ 26,956 

Allowance for Loan Losses
Commercial Commercial Real Estate Consumer Residential Total
Rollforward of the Allowance for Loan Losses for the Quarterly Period:
June 30, 2020 $ 1,917  $ 8,361  $ 10,639  $ 5,383  $ 26,300 
Charge-offs (17) (5) (370) —  $ (392)
Recoveries —  —  267  —  $ 267 
Provision 419  1,013  609  230  $ 2,271 
September 30, 2020 $ 2,319  $ 9,369  $ 11,145  $ 5,613  $ 28,446 


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 September 30, 2021, the total unfunded commitment off-balance sheet credit exposure was $1.8 million.




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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 a 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 September 30, 2021, there were six total relationships identified to be evaluated for loss on an individual basis which had an amortized cost basis of $7.9 million and only one loan had an allowance for credit loss of $616 thousand.

Allowance for Credit Losses - Collectively and Individually Evaluated
Commercial Commercial Real Estate Consumer Residential Total
September 30, 2021
Ending Loan Balance - Collectively Evaluated $ 188,191  $ 607,827  $ 921,189  $ 929,614  $ 2,646,821 
Allowance for Credit Losses - Loans Collectively Evaluated 2,424  13,055  2,288  8,573  26,340 
Ending Loan Balance - Individually Evaluated —  7,254  —  676  7,930 
Allowance for Credit Losses - Loans Individually Evaluated —  616  —  —  616 

The following table presents information pertaining to the allowance for loan losses as of December 31, 2020 and September 30, 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 
September 30, 2020
Ending Loan Balance - Collectively Evaluated for Impairment $ 275,874  $ 540,105  $ 849,402  $ 924,348  $ 2,589,729 
Allowance for Loan Losses - Loans Collectively Evaluated for Impairment 2,301  9,369  11,145  5,585  28,400 
Ending Loan Balance - Individually Evaluated for Impairment 47  1,128  124  1,427  2,726 
Allowance for Loan Losses - Loans Individually Evaluated for Impairment 18  —  —  28  46 


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.

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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.




























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Loan Credit Quality Indicators

The following table presents credit quality indicators by total loans amortized cost basis by origination year as of September 30, 2021.

Term Loans Amortized Cost Basis by Origination Year Revolving Loans Amortized Cost Basis Revolving Loan Converted to Term Total
September 30, 2021 2021 2020 2019 2018 2017 Prior
Commercial:
Risk rating
Satisfactory $ 81,914  $ 38,970  $ 13,966  $ 12,860  $ 8,511  $ 3,917  $ 12,796  $ —  $ 172,934 
Special mention —  652  51  —  —  5,499  —  —  6,202 
Substandard 3,575  4,496  636  —  31  295  22  —  9,055 
Doubtful —  —  —  —  —  —  —  —  — 
Total Commercial Loans $ 85,489  $ 44,118  $ 14,653  $ 12,860  $ 8,542  $ 9,711  $ 12,818  $ —  $ 188,191 
Commercial Real Estate:
Risk rating
Satisfactory $ 96,419  $ 290,785  $ 47,605  $ 41,215  $ 22,661  $ 62,203  $ 2,935  $ —  $ 563,823 
Special mention —  16,829  1,227  —  139  1,976  —  —  20,171 
Substandard 7,248  10,359  3,950  146  —  9,384  —  —  31,087 
Doubtful —  —  —  —  —  —  —  —  — 
Total Commercial Real Estate Loans $ 103,667  $ 317,973  $ 52,782  $ 41,361  $ 22,800  $ 73,563  $ 2,935  $ —  $ 615,081 
Consumer:
Risk rating
Performing $ 330,952  $ 264,963  $ 175,448  $ 97,563  $ 37,112  $ 13,572  $ 477  $ —  $ 920,087 
Nonperforming 203  319  332  160  30  58  —  —  1,102 
Total Consumer Loans $ 331,155  $ 265,282  $ 175,780  $ 97,723  $ 37,142  $ 13,630  $ 477  $ —  $ 921,189 
Residential:
Risk rating
Performing $ 124,536  $ 154,071  $ 101,678  $ 94,621  $ 97,457  $ 231,375  $ 124,231  $ —  $ 927,969 
Nonperforming —  336  —  155  213  1,586  31  —  2,321 
Total Residential Loans $ 124,536  $ 154,407  $ 101,678  $ 94,776  $ 97,670  $ 232,961  $ 124,262  $ —  $ 930,290 
Total Loans $ 644,847  $ 781,780  $ 344,893  $ 246,720  $ 166,154  $ 329,865  $ 140,492  $ —  $ 2,654,751 

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 $1.3 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
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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;
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 September 30, 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 
September 30, 2020
Credit Risk Profile by Creditworthiness Category:
Satisfactory $ 264,094  $ 493,982  $ 758,076 
Special Mention 1,485  12,620  14,105 
Substandard 10,342  34,631  44,973 
Doubtful —  —  — 
Credit Risk Profile Based on Payment Activity:
Performing $ 847,967  $ 922,756  $ 1,770,723 
Nonperforming 1,559  3,019  4,578 










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Impaired Loans

The following table presents information on impaired loans as of December 31, 2020 and September 30, 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 
September 30, 2020
Recorded Investment:
With No Related Allowance $ —  $ 1,124  $ 124  $ 1,178  $ 2,426 
With a Related Allowance 46  —  —  249  295 
Unpaid Principal Balance:
With No Related Allowance —  1,128  124  1,178  $ 2,430 
With a Related Allowance 47  —  —  249  296 
September 30, 2020
Average Recorded Balance:
With No Related Allowance $ 2  $ 1,127  $ 120  $ 938  $ 2,187 
With a Related Allowance 46  —  —  253  299 
Interest Income Recognized:
With No Related Allowance —  —  —  —  — 
With a Related Allowance —  —  —  —  — 
Cash Basis Income:
With No Related Allowance —  —  —  —  — 
With a Related Allowance —  —  —  —  — 

At December 31, 2020 and September 30, 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:
September 30, 2021
Number of Loans —  —  —  —  — 
Pre-Modification Outstanding Recorded Investment $ —  $ —  $ —  $ —  $ — 
Post-Modification Outstanding Recorded Investment —  —  —  —  — 
Subsequent Default, Number of Contracts —  —  —  —  — 
Subsequent Default, Recorded Investment —  —  —  —  — 
September 30, 2020
Number of Loans —  —  —  —  — 
Pre-Modification Outstanding Recorded Investment $ —  $ —  $ —  $ —  $ — 
Post-Modification Outstanding Recorded Investment —  —  —  —  — 
Subsequent Default, Number of Contracts —  —  —  —  — 
Subsequent Default, Recorded Investment —  —  —  —  — 
For the Year-To-Date Period Ended:
September 30, 2021
Number of Loans —  —  —  —  — 
Pre-Modification Outstanding Recorded Investment $ —  $ —  $ —  $ —  $ — 
Post-Modification Outstanding Recorded Investment —  —  —  —  — 
Subsequent Default, Number of Contracts —  —  —  —  — 
Subsequent Default, Recorded Investment —  —  —  —  — 
September 30, 2020
Number of Loans —  —  2  —  2 
Pre-Modification Outstanding Recorded Investment $ —  $ —  $ 32  $ —  $ 32 
Post-Modification Outstanding Recorded Investment —  —  32  —  32 
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 September 30, 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.


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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 September 30, 2021, December 31, 2020 and September 30, 2020:
Commitments to Extend Credit and Letters of Credit
September 30, 2021 December 31, 2020 September 30, 2020
Notional Amount:
Commitments to Extend Credit $ 431,452  $ 399,882  $ 364,861 
Standby Letters of Credit 3,392  3,703  3,330 
Fair Value:
Commitments to Extend Credit $ —  $ —  $ — 
Standby Letters of Credit 21  28  30 
    
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.
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 September 30, 2021, December 31, 2020 and September 30, 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 September 30, 2021, December 31, 2020 and September 30, 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.
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
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institutions pertaining to overdraft fees. Arrow denies any wrongdoing. The parties engaged in an initial mediation session in September 2021. Settlement discussions are ongoing.

Note 6.    COMPREHENSIVE INCOME (LOSS) (In Thousands)

The following table presents the components of other comprehensive income (loss) for the three and nine month periods ended September 30, 2021 and 2020:
Schedule of Comprehensive (Loss) Income
Three Months Ended September 30 Nine Months Ended September 30,
Tax Tax
Before-Tax (Expense) Net-of-Tax Before-Tax Benefit Net-of-Tax
Amount Benefit Amount Amount (Expense) Amount
2021
Net Unrealized Securities Holding Loss on Securities Available-for-Sale Arising During the Period $ (1,719) $ 440  $ (1,279) $ (5,333) $ 1,364  $ (3,969)
Net Unrealized Gain on Cash Flow Swap 245  (62) 183  1,281  (327) 954 
Reclassification of Net Unrealized Gain on Cash Flow Hedge Agreements to Interest Expense (34) 9  (25) (92) 24  (68)
Amortization of Net Retirement Plan Actuarial Loss 22  (5) 17  68  (17) 51 
Amortization of Net Retirement Plan Prior Service Cost 59  (16) 43  175  (46) 129 
  Other Comprehensive Loss $ (1,427) $ 366  $ (1,061) $ (3,901) $ 998  $ (2,903)
2020
Net Unrealized Securities Holding (Loss) Gain on Securities Available-for-Sale Arising During the Period $ (397) $ 101  $ (296) $ 7,823  $ (2,000) $ 5,823 
Net Unrealized Gain on Cash Flow Swap 317  (79) 238  48  (11) 37 
Amortization of Net Retirement Plan Actuarial Loss 57  (15) 42  171  (44) 127 
Amortization of Net Retirement Plan Prior Service Cost 53  (14) 39  159  (42) 117 
  Other Comprehensive Income $ 30  $ (7) $ 23  $ 8,201  $ (2,097) $ 6,104 


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The following table presents the changes in accumulated other comprehensive income (loss) 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:
June 30, 2021 $ 3,109  $ 1,213  $ (5,895) $ (1,085) $ (2,658)
Other comprehensive income or loss before reclassifications (1,279) 183  —  —  (1,096)
Amounts reclassified from accumulated other comprehensive income —  (25) 17  43  35 
Net current-period other comprehensive income (1,279) 158  17  43  (1,061)
September 30, 2021 $ 1,830  $ 1,371  $ (5,878) $ (1,042) $ (3,719)
June 30, 2020 $ 6,584  $ (201) $ (5,762) $ (897) $ (276)
Other comprehensive income or loss before reclassifications (296) 238  —  —  (58)
Amounts reclassified from accumulated other comprehensive income —  —  42  39  81 
Net current-period other comprehensive income (296) 238  42  39  23 
September 30, 2020 $ 6,288  $ 37  $ (5,720) $ (858) $ (253)
For the Year-To-Date periods ended:
December 31, 2020 $ 5,799  $ 485  $ (5,929) $ (1,171) $ (816)
Other comprehensive income or loss before reclassifications (3,969) 954  —  —  (3,015)
Amounts reclassified from accumulated other comprehensive income —  (68) 51  129  112 
Net current-period other comprehensive income (3,969) 886  51  129  (2,903)
September 30, 2021 $ 1,830  $ 1,371  $ (5,878) $ (1,042) $ (3,719)
December 31, 2019 $ 465  $ —  $ (5,847) $ (975) $ (6,357)
Other comprehensive income or loss before reclassifications 5,823  37  —  —  5,860 
Amounts reclassified from accumulated other comprehensive income —  —  127  117  244 
Net current-period other comprehensive income 5,823  37  127  117  6,104 
September 30, 2020 $ 6,288  $ 37  $ (5,720) $ (858) $ (253)

(1) All amounts are net of tax.
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The following table presents the reclassifications out of accumulated other comprehensive income (loss):
Reclassifications Out of Accumulated Other Comprehensive Income (Loss)
Details about Accumulated Other Comprehensive Income (Loss) Components Amounts Reclassified from Accumulated Other Comprehensive Income (Loss) Affected Line Item in the Statement Where Net Income Is Presented
For the Quarter-to-date periods ended:
September 30, 2021
Reclassification of Net Unrealized Gain on Cash Flow Hedge Agreements to Interest Expense $ 34  Interest expense
Amortization of defined benefit pension items:
Prior-service costs (59)
(1)
Salaries and Employee Benefits
Actuarial loss (22)
(1)
Salaries and Employee Benefits
(47) Total before Tax
12  Provision for Income Taxes
Total reclassifications for the period $ (35) Net of Tax
September 30, 2020
Amortization of defined benefit pension items:
Prior-service costs $ (53)
(1)
Salaries and Employee Benefits
Actuarial loss (57)
(1)
Salaries and Employee Benefits
(110) Total before Tax
29  Provision for Income Taxes
Total reclassifications for the period $ (81) Net of Tax
For the Year-to-date periods ended:
September 30, 2021
Reclassification of Net Unrealized Gain on Cash Flow Hedge Agreements to Interest Expense $ 92 
Amortization of defined benefit pension items:
Prior-service costs (175)
(1)
Salaries and Employee Benefits
Actuarial loss (68)
(1)
Salaries and Employee Benefits
(151) Total before Tax
39  Provision for Income Taxes
Total reclassifications for the period $ (112) Net of Tax
Total reclassifications for the period $ (112) Net of Tax
September 30, 2020
Amortization of defined benefit pension items:
Prior-service costs $ (159)
(1)
Salaries and Employee Benefits
Actuarial loss (171)
(1)
Salaries and Employee Benefits
(330) Total before Tax
86  Provision for Income Taxes
Total reclassifications for the period $ (244) Net of Tax
(1) These accumulated other comprehensive income (loss) 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 24, 2021 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 September 30, 2021.
Shares Weighted Average Exercise Price
Outstanding at January 1, 2021
272,024  $ 28.00 
Granted 57,165  28.69 
Exercised (54,189) 28.81 
Forfeited (1,580) 22.25 
Outstanding at September 30, 2021
273,420  28.42 
Vested at Period-End 140,690  26.77 
Expected to Vest 132,730  30.16 
Stock Options Granted
Weighted Average Grant Date Information:
Fair Value of Options Granted $ 4.71 
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 and nine month periods ended September 30, 2021 and 2020:
For the Three Months Ended September 30, For the Nine Months Ended September 30,
2021 2020 2021 2020
Amount expensed $ 71  $ 76  $ 212  $ 227 

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 September 30, 2021 and 2020.
Restricted Stock Units Weighted Average Grant Date Fair Value
Non-vested at January 1, 2021 12,012  $ 30.70 
Granted 4,880  28.54 
Vested (3,689) 29.82 
Non-vested at September 30, 2021
13,203  30.15 
Non-vested at January 1, 2020 7,952  29.39 
Granted 4,060  33.25 
Non-vested at September 30, 2020
12,012  30.70 


The following table presents information on the amounts expensed related to restricted stock units for the periods ended September 30, 2021 and 2020:
For the Three Months Ended September 30, For the Nine Months Ended September 30,
2021 2020 2021 2020
Amount expensed $ 32  $ 30  $ 98  $ 88 

    
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.

34

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.
The Arrow Financial Corporation Employees' Pension Plan was amended effective January 1, 2021. The plan change was adopted January 1, 2021 and the amendment was valued as of December 31, 2020. The plan amendment included 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.)
The Arrow Financial Corporation Employees' Select Executive Retirement Plan was amended effective January 1, 2021. 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- and nine-month periods ended September 30, 2021 and 2020.
Employees' Select Executive Postretirement
Pension Retirement Benefit
Plan Plan Plans
Net Periodic (Benefit) Cost
For the Three Months Ended September 30, 2021:
Service Cost 1
$ 484  $ 146  $ 27 
Interest Cost 2
340  48  62 
Expected Return on Plan Assets 2
(945) —  — 
Amortization of Prior Service Cost 2
20  12  27 
Amortization of Net Loss (Gain) 2
—  44  (22)
Net Periodic (Benefit) Cost $ (101) $ 250  $ 94 
Plan Contributions During the Period $ —  $ 118  $ 32 
35

For the Three Months Ended September 30, 2020:
Service Cost 1
$ 416  $ 102  $ 30 
Interest Cost 2
387  48  78 
Expected Return on Plan Assets 2
(902) —  — 
Amortization of Prior Service Cost 2
15  11  27 
Amortization of Net Loss 2
20  37  — 
Net Periodic (Benefit) Cost $ (64) $ 198  $ 135 
Plan Contributions During the Period $ —  $ 116  $ 54 
Net Periodic Benefit Cost
For the Nine Months Ended September 30, 2021:
Service Cost 1
$ 1,451  $ 437  $ 82 
Interest Cost 2
1,023  143  186 
Expected Return on Plan Assets 2
(2,835) —  — 
Amortization of Prior Service Cost 2
59  36  80 
Amortization of Net Loss (Gain) 2
—  134  (66)
Net Periodic (Benefit) Cost $ (302) $ 750  $ 282 
Plan Contributions During the Period $ —  $ 354  $ 87 
Estimated Future Contributions in the Current Fiscal Year $ —  $ 118  $ 32 
For the Nine Months Ended September 30, 2020:
Service Cost 1
$ 1,247  $ 306  $ 92 
Interest Cost 2
1,159  144  233 
Expected Return on Plan Assets 2
(2,706) —  — 
Amortization of Prior Service Cost 2
47  32  80 
Amortization of Net Loss 2
61  110  — 
Net Periodic (Benefit) Cost $ (192) $ 592  $ 405 
Plan Contributions During the Period $ —  $ 349  $ 191 
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 September 30, 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.


36

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 September 30, 2021 and 2020.  All share and per share amounts have been adjusted for the September 24, 2021, 3% stock dividend.
Earnings Per Share
Three Months Ended Year-to-Date Period Ended:
September 30, 2021 September 30, 2020 September 30, 2021 September 30, 2020
Earnings Per Share - Basic:
Net Income $ 12,989  $ 11,046  $ 39,548  $ 28,332 
Weighted Average Shares - Basic 16,027  15,936  16,015  15,917 
Earnings Per Share - Basic $ 0.81  $ 0.69  $ 2.47  $ 1.78 
Earnings Per Share - Diluted:
Net Income $ 12,989  $ 11,046  $ 39,548  $ 28,332 
Weighted Average Shares - Basic 16,027  15,936  16,015  15,917 
Dilutive Average Shares Attributable to Stock Options 58  10  57  14 
Weighted Average Shares - Diluted 16,085  15,946  16,072 15,931 
Earnings Per Share - Diluted $ 0.81  $ 0.69  $ 2.46  $ 1.78 
37

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 September 30, 2021, December 31, 2020 and September 30, 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:
September 30, 2021
Assets:
Securities Available-for Sale:
   U.S. Government & Agency Obligations $ 109,305  $ —  $ 109,305  $ — 
   State and Municipal Obligations 400  —  400  — 
   Mortgage-Backed Securities 376,395  —  376,395  — 
   Corporate and Other Debt Securities 800  —  800  — 
Total Securities Available-for-Sale 486,900  —  486,900  — 
Equity Securities 1,886  —  1,886  — 
Total Securities Measured on a Recurring Basis 488,786  —  488,786  — 
Derivatives, included in other assets 2,287  —  2,287  — 
Total Measured on a Recurring Basis $ 491,073  $ —  $ 491,073  $ — 
Liabilities:
Derivatives, included in other liabilities 2,287  —  2,287  — 
Total Measured on a Recurring Basis $ 2,287  $ —  $ 2,287  $ — 
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  — 
38

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  $ — 
September 30, 2020
Assets:
Securities Available-for Sale:
   U.S. Government & Agency Obligations $ 35,167  $ —  $ 35,167  $ — 
   State and Municipal Obligations 593  —  593  — 
   Mortgage-Backed Securities 338,368  —  338,368  — 
   Corporate and Other Debt Securities 800  —  800  — 
Total Securities Available-for-Sale 374,928  —  374,928  — 
Equity Securities 1,511  —  1,511  — 
Total Securities Measured on a Recurring Basis $ 376,439  $ —  $ 376,439  $ — 
Derivatives, included in other assets 6,366  $ —  6,366  — 
Total Measured on a Recurring Basis $ 382,805  $ —  $ 382,805  $ — 
Liabilities:
Derivatives, included in other liabilities 6,366  —  6,366  — 
Total Measured on a Recurring Basis $ 6,366  $ —  $ 6,366  $ — 
Fair Value Quoted Prices
In Active Markets for Identical Assets
(Level 1) 		Significant Other
Observable Inputs
(Level 2) 		Significant Unobservable Inputs
(Level 3) 		Gains (Losses) Recognized in Earnings
Fair Value of Assets and Liabilities Measured on a Nonrecurring Basis:
September 30, 2021
Collateral Dependent Evaluated Loans $ 2,456  $ —  $ —  $ 2,456 
Other Real Estate Owned and Repossessed Assets, Net 351  —  —  351  13 
December 31, 2020
Collateral Dependent Impaired Loans $ 594  $ —  $ —  $ 594 
Other Real Estate Owned and Repossessed Assets, Net 155  —  —  155  — 
September 30, 2020
Collateral Dependent Impaired Loans $ 594  $ —  $ —  $ 594 
Other Real Estate Owned and Repossessed Assets, Net 126  —  —  126  — 

39

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 September 30, 2021, December 31, 2020 and September 30, 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.

40

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
September 30, 2021
Cash and Cash Equivalents $ 598,366  $ 598,366  $ 598,366  $ —  $ — 
Securities Available-for-Sale 486,900  486,900  —  486,900  — 
Securities Held-to-Maturity 198,337  203,936  —  203,936  — 
Equity Securities 1,886  1,886  —  1,886  — 
Federal Home Loan Bank and Federal
  Reserve Bank Stock 		5,380  5,380  —  5,380  — 
Net Loans 2,627,795  2,632,843  —  —  2,632,843 
Accrued Interest Receivable 7,899  7,899  —  7,899  — 
Derivatives, included in other assets 2,287  2,287  2,287 
Deposits 3,605,563  3,604,271  —  3,604,271  — 
Federal Funds Purchased and Securities
  Sold Under Agreements to Repurchase 		2,426  2,426  —  2,426  — 
Federal Home Loan Bank Term Advances 45,000  45,906  —  45,906  — 
Junior Subordinated Obligations Issued
  to Unconsolidated Subsidiary Trusts 		20,000  20,000  —  20,000  — 
Accrued Interest Payable 137  137  —  137  — 
Derivatives, included in other liabilities 2,287  2,287  —  2,287  — 
41

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  — 
September 30, 2020
Cash and Cash Equivalents $ 450,666  $ 450,666  $ 450,666  $ —  $ — 
Securities Available-for-Sale 374,928  374,928  —  374,928  — 
Securities Held-to-Maturity 224,799  233,501  —  233,501  — 
Equity Securities 1,511  1,511  —  1,511 
Federal Home Loan Bank and Federal
  Reserve Bank Stock 		5,574  5,574  —  5,574  — 
Net Loans 2,564,009  2,560,043  —  —  2,560,043 
Accrued Interest Receivable 7,962  7,962  —  7,962  — 
Derivatives, included in other assets 6,366  6,366  —  6,366  — 
Deposits 3,264,858  3,265,208  —  3,265,208  — 
Federal Funds Purchased and Securities
  Sold Under Agreements to Repurchase 		73,949  73,949  —  73,949  — 
Federal Home Loan Bank Term Advances 50,000  51,576  —  51,576  — 
Junior Subordinated Obligations Issued
  to Unconsolidated Subsidiary Trusts 		20,000  20,000  —  20,000  — 
Accrued Interest Payable 841  841  —  841  — 
Derivatives, included in other liabilities 6,366  6,366  —  6,366  — 
42

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. Arrow also leases one administrative office from an entity controlled by Elizabeth Miller, who serves as a director on the board of directors of each of Arrow and Glens Falls National Bank and Trust Company.

The following includes quantitative data related to the Company's leases as of and for the nine months ended September 30, 2021 and September 30, 2020:
Nine Months Ended
Finance Lease Amounts: Classification September 30, 2021 September 30, 2020
Right-of-Use Assets Premises and Equipment, Net $ 4,859  $ 5,036 
Lease Liabilities Finance Leases 5,181  5,228 
Operating Lease Amounts:
Right-of-Use Assets Other Assets $ 6,786  $ 5,496 
Lease Liabilities Other Liabilities 6,965  5,577 
Other Information:
Cash Paid For Amounts Included In The Measurement Of Lease Liabilities:
Operating Outgoing Cash Flows From Finance Leases $ 146  $ 148 
Operating Outgoing Cash Flows From Operating Leases 571  567 
Financing Outgoing Cash Flows From Finance Leases 36  26 
Right-of-Use Assets Obtained In Exchange For New Finance Lease Liabilities —  — 
Right-of-Use Assets Obtained In Exchange For New Operating Lease Liabilities 2,126  294 
Weighted-average Remaining Lease Term - Finance Leases (Yrs.) 28.46 29.40
Weighted-average Remaining Lease Term - Operating Leases (Yrs.) 11.76 13.10
Weighted-average Discount Rate—Finance Leases 3.75  % 3.75  %
Weighted-average Discount Rate—Operating Leases 2.85  % 3.27  %

Lease cost information for the Company's leases is as follows:
Three Months Ended Nine Months Ended
September 30, 2021 September 30, 2020 September 30, 2021 September 30, 2020
Lease Cost:
Finance Lease Cost:
   Reduction of Right-of-Use Assets $ 44  $ 44  $ 133  $ 133 
   Interest on Lease Liabilities 48  49  146  148 
Operating Lease Cost 238  214  737  624 
Short-term Lease Cost 15  11  28  32 
Variable Lease Cost 69  77  203  165 
Total Lease Cost $ 414  $ 395  $ 1,247  $ 1,102 
43

Future Lease Payments at September 30, 2021 are as follows:
Operating
Leases
Financing
Leases
Twelve Months Ended:
9/30/2022 $ 964  $ 243 
9/30/2023 928  243 
9/30/2024 780  247 
9/30/2025 705  259 
9/30/2026 648  268 
Thereafter 4,359  7,599 
Total Undiscounted Cash Flows $ 8,384  $ 8,859 
Less: Net Present Value Adjustment 1,419  3,678 
   Lease Liability $ 6,965  $ 5,181 
44



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
September 30, 2021 December 31, 2020 September 30, 2020
Fair value adjustment included in other assets $ 2,287  $ 5,080  $ 6,366 
Fair value adjustment included in other liabilities 2,287  5,080  6,366 
Notional amount 172,026  176,637  166,329 

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
Nine Months Ended Twelve Months Ended Nine Months Ended
September 30, 2021 December 31, 2020 September 30, 2020
Amount of gain recognized in AOCI $ 1,281  $ 651  $ 48 
Amount of gain reclassified from AOCI to interest expense 92  —  — 


Note 13.    COVID-19 PANDEMIC

The COVID-19 pandemic caused significant disruptions in the United States economy, which impacted the activities and operations of Arrow and its customers. The pandemic also caused disruption in the financial markets both globally and in the United States.
Arrow continues to monitor the impact of the pandemic, both during recovery as well as any potential setbacks, including emerging variants, and continues to mitigate the risk of harm to its employees and customers and to its operations from the pandemic. Arrow encourages customers to use contact-free alternatives such as digital banking and ATMs.



45


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 September 30, 2021 and 2020, the related consolidated statements of income, comprehensive income, and changes in stockholders’ equity for the three‑month and nine‑month periods ended September 30, 2021 and 2020, and the related consolidated statement of cash flows for the nine‑month periods ended September 30, 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
November 4, 2021

46

Item 2.
ARROW FINANCIAL CORPORATION AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
September 30, 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 145 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 June 30, 2021 (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 Arrow'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, some of which may be amplified by the COVID-19 pandemic, including emerging variants:
•the 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 stimulus 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 Arrow 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.

47

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 Arrow's 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.
    

48


Arrow Financial Corporation
Selected Quarterly Information
(Dollars In Thousands, Except Per Share Amounts - Unaudited)
Quarter Ended 9/30/2021 6/30/2021 3/31/2021 12/31/2020 9/30/2020
Net Income $ 12,989  $ 13,279  $ 13,280  $ 12,495  $ 11,046 
Transactions in Net Income (Net of Tax):          
Net Changes in Fair Value of Equity Investments (79) 145  119  66  (53)
Share and Per Share Data:1
       
Period End Shares Outstanding 16,020  16,039  16,009  15,981  15,954 
Basic Average Shares Outstanding 16,027  16,024  15,994  15,964  15,936 
Diluted Average Shares Outstanding 16,085  16,085  16,030  15,981  15,946 
Basic Earnings Per Share $ 0.81  $ 0.83  $ 0.83  $ 0.78  $ 0.69 
Diluted Earnings Per Share 0.81  0.83  0.82  0.78  0.69 
Cash Dividend Per Share 0.252  0.252  0.252  0.252  0.245 
Selected Quarterly Average Balances:        
  Interest-Bearing Deposits at Banks $ 416,500  $ 369,034  $ 334,155  $ 349,430  $ 242,928 
  Investment Securities 675,980  668,089  593,822  590,151  592,457 
  Loans 2,641,726  2,651,449  2,618,362  2,610,834  2,582,253 
  Deposits 3,435,933  3,395,271  3,254,815  3,256,238  3,082,499 
  Other Borrowed Funds 72,187  74,957  82,659  95,047  136,117 
  Stockholders’ Equity 359,384  350,203  340,708  331,899  324,269 
  Total Assets 3,902,041  3,851,921  3,712,020  3,721,954  3,583,322 
Return on Average Assets, annualized 1.32  % 1.38  % 1.45  % 1.34  % 1.23  %
Return on Average Equity, annualized 14.34  % 15.21  % 15.81  % 14.98  % 13.55  %
Return on Average Tangible Equity, annualized 2
15.36  % 16.32  % 17.00  % 16.13  % 14.61  %
Average Earning Assets $ 3,734,206  $ 3,688,572  $ 3,546,339  $ 3,550,415  $ 3,417,638 
Average Paying Liabilities 2,705,283  2,721,961  2,639,240  2,674,795  2,545,435 
Interest Income 29,807  29,695  27,694  28,372  27,296 
Tax-Equivalent Adjustment 3
292  293  235  251  284 
Interest Income, Tax-Equivalent 3
30,099  29,988  27,929  28,623  27,580 
Interest Expense 1,169  1,335  1,539  1,918  2,396 
Net Interest Income 28,638  28,360  26,155  26,454  24,900 
Net Interest Income, Tax-Equivalent 3
28,930  28,653  26,390  26,705  25,184 
Net Interest Margin, annualized 3.04  % 3.08  % 2.99  % 2.96  % 2.90  %
Net Interest Margin, Tax Equivalent, annualized 3
3.07  % 3.12  % 3.02  % 2.99  % 2.93  %
Efficiency Ratio Calculation: 4
       
Noninterest Expense $ 19,423  $ 19,087  $ 18,678  $ 18,192  $ 17,487 
Less: Intangible Asset Amortization 51  53  54  56  56 
Net Noninterest Expense $ 19,372  $ 19,034  $ 18,624  $ 18,136  $ 17,431 
Net Interest Income, Tax-Equivalent 3
$ 28,930  $ 28,653  $ 26,390  $ 26,705  $ 25,184 
Noninterest Income 7,694  8,478  8,608  9,103  8,697 
Less: Net Changes in Fair Value of Equity Invest. (106) 196  160  88  (72)
Net Gross Income $ 36,730  $ 36,935  $ 34,838  $ 35,720  $ 33,953 
Efficiency Ratio 4
52.74  % 51.53  % 53.46  % 50.77  % 51.34  %
Period-End Capital Information:          
Total Stockholders’ Equity (i.e. Book Value) $ 360,171  $ 353,033  $ 342,413  $ 334,392  $ 325,660 
Book Value per Share 1
22.48  22.01  21.39  20.91  20.41 
Goodwill and Other Intangible Assets, net 23,879  23,955  23,922  23,823  23,662 
Tangible Book Value per Share 1,2
20.99  20.52  19.89  19.43  18.93 
Capital Ratios:5
         
Tier 1 Leverage Ratio 9.39  % 9.29  % 9.37  % 9.07  % 9.17  %
Common Equity Tier 1 Capital Ratio 13.71  % 13.79  % 13.56  % 13.39  % 13.20  %
Tier 1 Risk-Based Capital Ratio 14.51  % 14.61  % 14.39  % 14.24  % 14.06  %
Total Risk-Based Capital Ratio 15.66  % 15.78  % 15.55  % 15.48  % 15.28  %
Assets Under Trust Admin. & Investment Mgmt. $ 1,778,659  $ 1,804,854  $ 1,725,754  $ 1,659,029  $ 1,537,128 
49

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 24, 2021, 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 48.
9/30/2021 6/30/2021 3/31/2021 12/31/2020 9/30/2020
Total Stockholders' Equity (GAAP) $ 360,171  $ 353,033  $ 342,413  $ 334,392  $ 325,660 
Less: Goodwill and Other Intangible assets, net 23,879  23,955  23,922  23,823  23,662 
Tangible Equity (Non-GAAP) $ 336,292  $ 329,078  $ 318,491  $ 310,569  $ 301,998 
Period End Shares Outstanding 16,020  16,039  16,009  15,981  15,954 
Tangible Book Value per Share
     (Non-GAAP) 		$ 20.99  $ 20.52  $ 19.89  $ 19.43  $ 18.93 
Net Income 12,989  13,279  13,280  12,495  11,046 
Return on Average Tangible Equity (Net Income/Tangible Equity - Annualized) 15.36  % 16.32  % 17.00  % 16.13  % 14.61  %
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 48.
9/30/2021 6/30/2021 3/31/2021 12/31/2020 9/30/2020
Interest Income (GAAP) $ 29,807  $ 29,695  $ 27,694  $ 28,372  $ 27,296 
Add: Tax-Equivalent adjustment
     (Non-GAAP) 		292  293  235  251  284 
Interest Income - Tax Equivalent
     (Non-GAAP) 		$ 30,099  $ 29,988  $ 27,929  $ 28,623  $ 27,580 
Net Interest Income (GAAP) $ 28,638  $ 28,360  $ 26,155  $ 26,454  $ 24,900 
Add: Tax-Equivalent adjustment
     (Non-GAAP) 		292  293  235  251  284 
Net Interest Income - Tax Equivalent
     (Non-GAAP) 		$ 28,930  $ 28,653  $ 26,390  $ 26,705  $ 25,184 
Average Earning Assets $ 3,734,206  $ 3,688,572  $ 3,546,339  $ 3,550,415  $ 3,417,638 
Net Interest Margin (Non-GAAP)* 3.07  % 3.12  % 3.02  % 2.99  % 2.93  %
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 48.
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 September 30, 2021 listed in the tables (i.e., 13.71%) exceeds the sum of the required minimum CET1 ratio plus the fully phased-in Capital Conservation Buffer (i.e., 7.00%).
  9/30/2021 6/30/2021 3/31/2021 12/31/2020 9/30/2020
Total Risk Weighted Assets $ 2,511,910  $ 2,438,445  $ 2,404,456  $ 2,357,094  $ 2,321,637 
Common Equity Tier 1 Capital 344,507  336,265  326,039  315,696  306,356 
Common Equity Tier 1 Capital Ratio 13.71  % 13.79  % 13.56  % 13.39  % 13.20  %
* Quarterly ratios have been annualized.





50

Arrow Financial Corporation
Selected Year-to-Date Information
(Dollars In Thousands, Except Per Share Amounts - Unaudited)
Nine Months Ended 9/30/2021 9/30/2020
Net Income $ 39,548  $ 28,332 
Transactions Recorded in Net Income (Net of Tax):    
Net Changes in Fair Value of Equity Investments 186  (412)
Share and Per Share Data: 1
 
Period End Shares Outstanding 16,020  15,954 
Basic Average Shares Outstanding 16,015  15,917 
Diluted Average Shares Outstanding 16,072  15,931 
Basic Earnings Per Share $ 2.47  $ 1.78 
Diluted Earnings Per Share 2.46  1.78 
Cash Dividend Per Share 0.76  0.74 
Selected Year-to-Date Average Balances:  
  Interest-Bearing Deposits at Banks $ 373,531  $ 144,244 
  Investment Securities 646,264  601,069 
  Loans 2,637,265  2,498,573 
  Deposits 3,362,670  2,902,307 
  Other Borrowed Funds 76,563  145,463 
  Stockholders’ Equity 350,167  315,757 
  Total Assets 3,822,689  3,401,114 
Return on Average Assets, annualized 1.38  % 1.11  %
Return on Average Equity, annualized 15.10  % 11.99  %
Return on Average Tangible Equity, annualized 2
16.21  % 12.95  %
Average Earning Assets 3,657,060  3,243,886 
Average Paying Liabilities 2,689,070  2,455,544 
Interest Income 87,196  83,524 
Tax-Equivalent Adjustment 3
820  853 
Interest Income, Tax-Equivalent 3
88,016  84,377 
Interest Expense 4,043  10,776 
Net Interest Income 83,153  72,748 
Net Interest Income, Tax-Equivalent 3
83,973  73,601 
Net Interest Margin, annualized 3.04  % 3.00  %
Net Interest Margin, Tax Equivalent, annualized 3
3.07  % 3.03  %
Efficiency Ratio Calculation: 4
 
Noninterest Expense $ 57,188  $ 52,486 
Less: Intangible Asset Amortization 158  171 
Net Noninterest Expense 57,030  52,315 
Net Interest Income, Tax-Equivalent 3
83,973  73,601 
Noninterest Income 24,780  23,555 
Less: Net Changes in Fair Value of Equity Securities 250  (552)
Net Gross Income 108,503  97,708 
Efficiency Ratio 4
52.56  % 53.54  %


51


Arrow Financial Corporation
Selected Year-to-Date Information - Continued
(Dollars In Thousands, Except Per Share Amounts - Unaudited)

Footnotes:
1.
Share and Per Share Data have been restated for the September 24, 2021, 3% stock dividend.
2.
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 48.
9/30/2021 9/30/2020
Total Stockholders' Equity (GAAP) $ 360,171  $ 325,660 
Less: Goodwill and Other Intangible assets, net 23,879  23,662 
Tangible Equity (Non-GAAP) $ 336,292  $ 301,998 
Period End Shares Outstanding 16,020  15,954 
Tangible Book Value per Share (Non-GAAP) $ 20.99  $ 18.93 
Net Income 39,548  28,332 
Return on Average Tangible Equity (Net Income/Tangible Equity - Annualized) 16.21  % 12.95  %
3.
Net Interest Margin 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 48.
9/30/2021 9/30/2020
Interest Income (GAAP) $ 87,196  $ 83,524 
Add: Tax-Equivalent adjustment (Non-GAAP) 820  853 
Net Interest Income - Tax Equivalent (Non-GAAP) 88,016  84,377 
Net Interest Income (GAAP) 83,153  72,748 
Add: Tax-Equivalent adjustment (Non-GAAP) 820  853 
Net Interest Income - Tax Equivalent (Non-GAAP) $ 83,973  $ 73,601 
Average Earning Assets $ 3,657,060  $ 3,243,886 
Net Interest Margin (Non-GAAP)* 3.07  % 3.03  %
4.
Financial Institutions often use the "efficiency ratio", a non-GAAP ratio, as a measure of expense control. Arrow believes the efficiency ratio provides investors with information that is useful in understanding financial performance. The efficiency ratio is defined as the ratio of our noninterest expense to our net gross income (which equals our tax-equivalent net interest income plus noninterest income, as adjusted). See "Use of Non-GAAP Financial Measures" on page 48.
 * Year-to-date ratios have been annualized.
52


Average Consolidated Balance Sheets and Net Interest Income Analysis
(Dollars In Thousands)
Quarter Ended September 30: 2021 2020
Interest Rate Interest Rate
Average Income/ Earned/ Average Income/ Earned/
Balance Expense Paid Balance Expense Paid
Interest-Bearing Deposits at Banks $ 416,500  $ 163  0.16  % $ 242,928  $ 64  0.10  %
Investment Securities:
Fully Taxable 494,869  1,632  1.31  395,349  1,557  1.57 
Exempt from Federal Taxes 181,111  855  1.87  197,108  969  1.96 
Loans 2,641,726  27,157  4.08  2,582,253  24,706  3.81 
Total Earning Assets 3,734,206  29,807  3.17  3,417,638  27,296  3.18 
Allowance for Credit Losses (27,040) (26,310)
Cash and Due From Banks 38,036  37,905 
Other Assets 156,839  154,089 
Total Assets $ 3,902,041  $ 3,583,322 
Deposits:
Interest-Bearing Checking Accounts $ 923,002  156  0.07  $ 764,614  264  0.14 
Savings Deposits 1,496,938  424  0.11  1,314,241  806  0.24 
Time Deposits of $250,000 or More 71,435  39  0.22  121,027  292  0.96 
Other Time Deposits 141,721  133  0.37  209,436  576  1.09 
Total Interest-Bearing Deposits 2,633,096  751  0.11  2,409,318  1,938  0.32 
Short-Term Borrowings 2,012  —  —  60,894  17  0.11 
FHLBNY Term Advances & Other Long-Term Debt 65,000  370  2.26  70,000  392  2.23 
Finance Leases 5,175  48  3.68  5,223  49  3.73 
Total Interest-Bearing Liabilities 2,705,283  1,169  0.17  2,545,435  2,396  0.37 
Noninterest-bearing deposits 802,837  673,181 
Other Liabilities 34,537  40,437 
Total Liabilities 3,542,657  3,259,053 
Stockholders’ Equity 359,384  324,269 
Total Liabilities and Stockholders’ Equity $ 3,902,041  $ 3,583,322 
Net Interest Income $ 28,638  $ 24,900 
Net Interest Spread 3.00  % 2.81  %
Net Interest Margin 3.04  % 2.90  %


53



Average Consolidated Balance Sheets and Net Interest Income Analysis
(GAAP Basis)
(Dollars In Thousands)
Nine Months Ended September 30: 2021 2020
Interest Rate Interest Rate
Average Income/
Earned/
Average Income/
Earned/
Balance Expense Paid Balance Expense Paid
Interest-Bearing Deposits at Banks
$ 373,531  $ 351  0.13  % $ 144,244  $ 229  0.21  %
Investment Securities:
Fully Taxable 459,527  4,809  1.40  % 399,958  5,621  1.88  %
Exempt from Federal Taxes
186,737  2,682  1.92  % 201,111  3,017  2.00  %
Loans 2,637,265  79,354  4.02  % 2,498,573  74,657  3.99  %
Total Earning Assets 3,657,060  87,196  3.19  % 3,243,886  83,524  3.44  %
Allowance for Credit Losses (27,235) (24,037)
Cash and Due From Banks 36,272  34,624 
Other Assets 156,592  146,641 
Total Assets $ 3,822,689  $ 3,401,114 
Deposits:
Interest-Bearing Checking Accounts $ 902,772  566  0.08  $ 737,647  1,061  0.19 
Savings Deposits 1,471,467  1,490  0.14  1,207,896  4,450  0.49 
Time Deposits of $250,000 or More
92,111  228  0.33  127,659  1,263  1.32 
Other Time Deposits 146,157  511  0.47  236,879  2,360  1.33 
Total Interest-Bearing Deposits
2,612,507  2,795  0.14  2,310,081  9,134  0.53 
Short-Term Borrowings 6,375  3  0.06  69,132  241  0.47 
FHLBNY Term Advances & Other Long-Term Debt 65,000  1,099  2.26  71,095  1,253  2.35 
Finance Leases 5,188  146  3.76  5,236  148  3.78 
Total Interest-Bearing Liabilities
2,689,070  4,043  0.20  2,455,544  10,776  0.59 
Noninterest-bearing deposits 750,163  592,226 
Other Liabilities 33,289  37,587 
Total Liabilities 3,472,522  3,085,357 
Stockholders’ Equity 350,167  315,757 
Total Liabilities and Stockholders’ Equity
$ 3,822,689  $ 3,401,114 
Net Interest Income $ 83,153  $ 72,748 
Net Interest Spread 2.99  % 2.85  %
Net Interest Margin 3.04  % 3.00  %
54

OVERVIEW
    
The following discussion and analysis focuses on and reviews the results of operations for the three-month and nine-month period ended September 30, 2021 and the financial conditions as of September 30, 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 the third quarter of 2021, Arrow complied with the New York State HERO Act by implementing required face coverings for employees. The Arrow Business Continuity Plan Committee continues to meet regularly to evaluate pandemic metrics and our response, including our plans with respect to the pending Occupational Safety and Health Administration ("OSHA") guidance concerning vaccination requirements for large employers, which is being issued in response to President Biden's COVID-19 Action Plan announced on September 9, 2021.
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, including with respect to emerging variants, Arrow is currently unable to reasonably estimate the overall impact on the Company.

Summary of Q3 2021 Financial Results: Net income for the third quarter of 2021 was $13.0 million, compared to $11.0 million in the third quarter of 2020.
Diluted earnings per share (EPS) for the quarter was $0.81, an increase of 17.4% from EPS of $0.69 reported for the third quarter of 2020. Return on average equity (ROE) for the third quarter of 2021 increased to 14.34%, as compared to a ROE of 13.55% for the quarter ended September 30, 2020. Return on average assets (ROA) for the third quarter of 2021 was 1.32%, an increase from an ROA of 1.23% for the quarter ended September 30, 2020.
Total loans were $2.7 billion as of September 30, 2021. Loan growth for the third quarter of 2021 was $10.7 million and increased $62.3 million, or 2.4%, from September 30, 2020. Total outstanding commercial loans decreased $37.8 million, or 4.5%, in the third quarter. PPP loans, included in the commercial portfolio, decreased $56.7 million in the third quarter. The consumer loan portfolio grew by $28.6 million, or 3.2% in the third quarter, primarily within the indirect automobile lending program. Total outstanding residential real estate loans, net of approximately $4.0 million of loans sold, increased $19.8 million for the third quarter of 2021.
At September 30, 2021, deposit balances were $3.6 billion. Deposits increased in the third quarter of 2021 by $167.5 million and increased by $340.7 million, or 10.4%, from the prior-year level. Municipal deposits increased $118.4 million in the third quarter and $134.0 million, or 15.8% from September 30, 2020. Non-municipal deposits increased $49.1 million for the quarter, or 8.6% from September 30, 2020. Noninterest-bearing deposits represented 23.4% of total deposits at September 30, 2021, compared to 21.1% of total deposits at September 30, 2020. At September 30, 2021, other time deposits were $138.7 million, a decrease of $55.4 million compared to the prior year.
Net interest income for the third quarter was $28.6 million, up 15.0% from $24.9 million in the comparable quarter of 2020. Interest and fees on loans were $27.2 million for the third quarter of 2021, an increase of 9.9% from $24.7 million for the quarter ending September 30, 2020. Interest and fees related to PPP loans, included in the $27.2 million, were $2.5 million in the third quarter of 2021. Interest expense for the third quarter of 2021 was $1.2 million, a decrease of $1.2 million, or 51.2%, from the $2.4 million in expense for the comparable quarter ending September 30, 2020. The net interest margin was 3.04% for the quarter, compared to 2.90% for the third quarter of 2020. The increase in net interest margin from the prior year was due to a variety of factors, including the timing of the forgiveness of PPP loans partially offset by lower interest rates and increased cash balances.
Noninterest income for the three months ended September 30, 2021 was $7.7 million, compared to $8.7 million in the comparable 2020 quarter. Income from fiduciary activities for the three months ended September 30, 2021, increased by $306 thousand over the comparable quarter of 2020. Fees and other services to customers increased $347 thousand over the comparable quarter of 2020. Interchange fees related to increased customer activity of debit card usage was the largest driver of the increase. Gain on sales of loans decreased $1.2 million from the third quarter of 2020 as a result of the strategic decision to retain more newly originated real estate loans.
Noninterest expense for the third quarter of 2021 was $19.4 million, an increase from $17.5 million for the third quarter of 2020. The largest component of noninterest expense was salaries and benefits paid to our employees, which totaled $11.4 million for the third quarter of 2021. The increase was due to a special employee recognition bonus of approximately $500 thousand in the aggregate which occurred in the third quarter. Technology expenses increased from the prior year in part due to variable costs related to increased utilization of consumer banking technology. Other non-interest expense included an increase in the reserve for estimated credit losses on off-balance sheet credit exposures of $300 thousand in the third quarter.
For the third quarter of 2021, the provision for credit losses was $99 thousand. The allowance for credit losses was $27.0 million on September 30, 2021, which represented 1.02% of loans outstanding, as compared to 1.10% on September 30, 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 69.

Regulatory Capital and Increase in Stockholders' Equity: At September 30, 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.
55

In 2020, federal bank regulators introduced an optional simplified measure of capital adequacy for qualifying community banking organizations (CBLR).  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.
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 remain applicable to Arrow and both subsidiary banks.
Stockholders’ equity was $360.2 million at September 30, 2021, an increase of $25.8 million, or 7.7%, from the December 31, 2020 level of $334.4 million, and an increase of $34.5 million, or 10.6%, from the prior-year level. The increase in stockholders' equity over the first nine months of 2021 principally reflected the following factors: (i) $39.5 million of net income for the period, plus (ii) issuance of $3.8 million 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 $2.9 million, (v) cash dividends of $12.1 million and (vi) repurchases of common stock of $2.6 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 September 30, 2021, book value per share was $22.48, up by 10.1% over the prior-year level. Tangible book value per share (a non-GAAP measure that deducts intangible assets from stockholders' equity) was $20.99, an increase of $2.06,or 10.9%, over the level as of September 30, 2020. See the disclosure on page 48 related to the use of non-GAAP financial measures including tangible book value.
On September 30, 2021, Arrow's closing stock price was $34.36, representing a trading multiple of 1.64 to tangible book value. In the third quarter of 2021, Arrow paid a quarterly cash dividend of $0.25. On September 24, 2021, a 3% stock dividend was distributed. This is the 13th consecutive year Arrow has declared a stock dividend. Further discussion of dividends is included in the Capital Components; Stock Repurchases; Dividends section located on page 67.

Loan Quality: Net charge-offs for the third quarter of 2021 were $153 thousand as compared to $125 thousand for the comparable 2020 quarter. The ratio of net charge-offs to average loans (annualized) was 0.02% for the three month period ended September 30, 2021, a decrease from 0.07% for the three month period ended December 31, 2020 and consistent with the three month period ended September 30, 2020.
For the third quarter of 2021, the provision for credit losses was $99 thousand and the expense for estimated credit losses on off-balance sheet credit exposures was $300 thousand. The allowance for credit losses was $27.0 million on September 30, 2021, which represented 1.02% of loans outstanding, as compared to 1.10% on September 30, 2020.
Nonperforming loans were $11.3 million at September 30, 2021, representing 0.43% of period-end loans, an increase from the September 30, 2020 ratio of 0.24%. The increase was due to two commercial real estate loans being classified as nonaccrual during 2021. The ratio continues to compare favorably with the weighted average ratio of the peer group of 0.58% at June 30, 2021. Nonperforming assets of $11.7 million at September 30, 2021 represented 0.29% of period-end assets up from 0.17% at September 30, 2020.

Loan Segments: As of September 30, 2021, total loans grew by $59.7 million, or 2.3%, as compared to the balance at December 31, 2020. The largest increase was in consumer loans which increased $61.4 million, or 7.1%, primarily comprised of automobile loans. Commercial and commercial real estate loans, decreased by $9.1 million, or 1.1%, from December 31, 2020. PPP loans, included in the commercial portfolio, decreased $54.6 million from December 31, 2020, which includes $91.2 million of new loans originated and $145.8 million of loans forgiven. The real estate loan portfolio increased $7.4 million in 2021. The increase is net of approximately $48.7 million of loans sold in 2021.

•Commercial and Commercial Real Estate Loans: Combined, these loans comprise 30.3% 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 commercial real estate 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.
•Consumer Loans: These loans (primarily automobile loans) comprised 34.7% of the total loan portfolio at period-end. Consumer automobile loans at September 30, 2021, were 99.4% of this portfolio segment. In the first nine 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 September 30, 2021, demand is strong. However, supply constraints, with both new and used vehicles, may limit the potential growth in this category.
•Residential Real Estate Loans: These loans, including home equity loans, made up 35.0% 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 for the majority 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. In the third quarter of 2021, sales decreased as the result of the strategic decision to grow the residential loan portfolio. 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.

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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.  Interest-bearing cash balances at September 30, 2021 were $548.9 million compared to $396.4 million at September 30, 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 67). 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.

Reference Rate Reform: On March 5, 2021, the ICE Benchmark Administration, the administrator of London Interbank Offered Rate (LIBOR) (the "IBA"), and the United Kingdom’s Financial Conduct Authority, the regulatory supervisor for the IBA, announced certain future dates that LIBOR settings will cease to be provided by any administrator. For Arrow, U.S. Dollar LIBOR indices utilized by its existing financial instruments will cease after June 30, 2023. In addition, regulators have issued statements indicating that financial institutions should not issue new LIBOR-based financial instruments after January 1, 2022. To prepare for the upcoming cessation of LIBOR, Arrow established a committee in 2020 comprised of bank management to prepare for the discontinuance of LIBOR, which is widely used to reprice floating rate financial instruments. Based on a review of existing floating rate financial instruments, management has determined that the financial products tied to LIBOR will not be subject to cessation until June 30, 2023. This review also identified that only a few legacy contracts do not include appropriate fallback language. Management anticipates that the appropriate fallback provisions for these contracts will be implemented and allow for an orderly transition prior to the June 30, 2023 cessation of U.S. Dollar LIBOR. In addition, management is evaluating replacement indices other than LIBOR, for new financial instruments issued after January 1, 2022. Arrow is confident that the transition from LIBOR will be completed in a timely manner and will not have a material impact on the consolidated financial statements or Arrow's operations.

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 September 30, 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, Arrow has not recognized any economic value for these shares.

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CHANGE IN FINANCIAL CONDITION

Summary of Selected Consolidated Balance Sheet Data
(Dollars in Thousands)
At Period-End
9/30/2021 12/31/2020 9/30/2020 $ Change
From December 		$ Change
From
September 		% Change
From December (not annualized) 		% Change
From September
Interest-Bearing Bank Balances $ 548,936  $ 338,875  $ 396,380  $ 210,061  $ 152,556  62.0  % 38.5  %
Securities Available-for-Sale 486,900  365,287  374,928  121,613  111,972  33.3  % 29.9  %
Securities Held-to-Maturity 198,337  218,405  224,799  (20,068) (26,462) (9.2) % (11.8) %
Equity Securities 1,886  1,636  1,511  250  375  15.3  % 24.8  %
Loans (1)
2,654,751  2,595,030  2,592,455  59,721  62,296  2.3  % 2.4  %
Allowance for loan losses 26,956  29,232  28,446  (2,276) (1,490) (7.8) % (5.2) %
Earning Assets (1)
3,896,190  3,524,582  3,595,647  371,608  300,543  10.5  % 8.4  %
Total Assets $ 4,071,104  $ 3,688,636  $ 3,777,684  $ 382,468  $ 293,420  10.4  % 7.8  %
Noninterest-Bearing Deposits $ 841,910  $ 701,341  $ 690,232  $ 140,569  $ 151,678  20.0  % 22.0  %
Interest-Bearing Checking
  Accounts 		1,035,358  832,434  912,980  202,924  122,378  24.4  % 13.4  %
Savings Deposits 1,515,692  1,423,358  1,354,956  92,334  160,736  6.5  % 11.9  %
Time Deposits over $250,000 73,889  123,622  112,555  (49,733) (38,666) (40.2) % (34.4) %
Other Time Deposits 138,714  153,971  194,135  (15,257) (55,421) (9.9) % (28.5) %
Total Deposits $ 3,605,563  $ 3,234,726  $ 3,264,858  $ 370,837  $ 340,705  11.5  % 10.4  %
Federal Funds Purchased and
  Securities Sold Under
  Agreements to Repurchase 		$ 2,426  $ 17,486  $ 73,949  $ (15,060) $ (71,523) (86.1) % (96.7) %
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 360,171  334,392  325,660  25,779  34,511  7.7  % 10.6  %
(1) Includes Nonaccrual Loans.
    
Changes in Earning Assets: The loan portfolio at September 30, 2021, was $2.7 billion, an increase of $59.7 million, or 2.3%, from the December 31, 2020 level and up by $62.3 million, or 2.4%, from the September 30, 2020 level. The following trends were experienced in our largest segments:
•Commercial and commercial real estate loans: This segment of the loan portfolio decreased by $9.1 million, or 1.1%, during the first nine months of 2021. The primary factor in the decrease is the net change in PPP loans. Over $91.2 million of new PPP loans were originated and $145.8 million loans forgiven during the first nine months of 2021.
•Consumer loans (primarily automobile loans through indirect lending): As of September 30, 2021, these loans, primarily auto loans originated through dealerships in New York State and Vermont, increased by $61.4 million, or 7.1%, from the December 31, 2020 balance. Current demand for auto loans is strong, however, the volume of loan originations may be impacted by supply constraints currently affecting the entire industry.
•Residential real estate loans: This segment increased during the first nine months of 2021 by $7.4 million, or 0.8%. In the first nine months of 2021, Arrow sold $48.7 million, or 27.9%, of originations. Arrow may 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.

Changes in Sources of Funds: Deposit balances reached $3.6 billion, up $340.7 million, or 10.4%, from the prior-year level. Deposits increased in the third quarter of 2021 by $167.5 million. Noninterest-bearing deposits represented 23.4% of total deposits at September 30, 2021, compared to 21.1% of total deposits on September 30, 2020. At September 30, 2021, other time deposits were $138.7 million, a decrease of $55.4 million compared to the prior year. Municipal deposits increased $134.0 million, or 15.8% from September 30, 2020. Federal home loan term advances were $45.0 million, a decrease from $50.0 million at September 30, 2020.
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Municipal Deposits: Fluctuations in balances of interest-bearing checking accounts are largely the result of timing and behavior of municipal deposits.  Municipal deposits have historically averaged between 20% to 25% of total deposits. In the most recent quarters, that percentage has increased. 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 have been impacted by increased stimulus payments in response to the COVID-19 pandemic including the American Rescue Plan Act of 2021.

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 September 30, 2021 (in thousands).
(Dollars in Thousands)
Fair Value at Period-End Net Unrealized Gains (Losses)
For Period Ended
9/30/2021 12/31/2020 Change 9/30/2021 12/31/2020 Change
Securities Available-for-Sale:
U.S. Agency Securities $ 109,305  $ 65,112  $ 44,193  $ (696) $ 110  $ (806)
State and Municipal Obligations 400  528  (128) —  —  — 
Mortgage-Backed Securities
376,395  298,847  77,548  3,353  7,880  (4,527)
Corporate and Other Debt Securities 800  800  —  (200) (200) — 
Total $ 486,900  $ 365,287  $ 121,613  $ 2,457  $ 7,790  $ (5,333)
Securities Held-to-Maturity:
State and Municipal Obligations $ 184,786  $ 199,429  $ (14,643) $ 4,834  $ 7,077  $ (2,243)
Mortgage-Backed Securities 19,150  27,147  (7,997) 765  1,094  (329)
Total $ 203,936  $ 226,576  $ (22,640) $ 5,599  $ 8,171  $ (2,572)
Equity Securities $ 1,886  $ 1,636  $ 250  $ —  $ —  $ — 

At September 30, 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 September 30, 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 September 30, 2021 and there was no credit loss expense recognized by Arrow with respect to the securities portfolio during the three months ended September 30, 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 September 30, 2021.
Changes in net unrealized gains or losses during recent periods has been primarily 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 nine month periods ended September 30, 2021 or 2020.

The following table summarizes purchases of investment securities within the available-for-sale and held-to-maturity portfolios for the nine month periods ended September 30, 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 Nine Months Ended
Purchases: 9/30/2021 9/30/2020 9/30/2021 9/30/2020
Available-for-Sale Portfolio
U.S. Agency Securities $ 15,000  $ —  $ 60,000  — 
Mortgage-Backed Securities 76,608  30,000  162,089  $ 86,832 
Total Purchases $ 91,608  $ 30,000  $ 222,089  $ 86,832 
Maturities & Calls $ 40,245  $ 32,809  $ 93,332  $ 75,449 

(In Thousands) Three Months Ended Nine Months Ended
Purchases: 9/30/2021 9/30/2020 9/30/2021 9/30/2020
Held-to-Maturity Portfolio
State and Municipal Obligations $ 991  $ 1,842  $ 4,695  $ 6,848 
Maturities & Calls $ 6,985  $ 10,384  $ 24,266  $ 26,570 

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
9/30/2021 6/30/2021 3/31/2021 12/31/2020 9/30/2020
Commercial $ 215,490  $ 265,391  $ 267,758  $ 260,527  $ 276,296 
Commercial Real Estate 606,661  591,718  579,506  569,309  538,914 
Consumer 903,869  884,986  860,954  856,903  841,009 
Residential Real Estate 915,706  909,354  910,144  924,095  926,034 
Total Loans $ 2,641,726  $ 2,651,449  $ 2,618,362  $ 2,610,834  $ 2,582,253 

Percentage of Total Quarterly Average Loans
Quarter Ended
9/30/2021 6/30/2021 3/31/2021 12/31/2020 9/30/2020
Commercial 8.1  % 10.0  % 10.2  % 10.0  % 9.3  %
Commercial Real Estate 23.0  % 22.3  % 22.1  % 21.8  % 21.1  %
Consumer 34.2  % 33.4  % 32.9  % 32.8  % 33.4  %
Residential Real Estate 34.7  % 34.3  % 34.8  % 35.4  % 36.2  %
Total Loans 100.0  % 100.0  % 100.0  % 100.0  % 100.0  %

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Quarterly Yield on Loans
Quarter Ended
9/30/2021 6/30/2021 3/31/2021 12/31/2020 9/30/2020
Commercial 4.81  % 6.35  % 4.17  % 4.50  % 3.63  %
Commercial excluding PPP loans 3.91  % 3.89  % 3.91  % 3.99  % 4.02  %
Commercial Real Estate 3.80  % 3.80  % 3.81  % 3.84  % 3.91  %
Consumer 3.93  % 3.92  % 3.94  % 3.95  % 3.95  %
Residential Real Estate 3.76  % 3.77  % 3.79  % 3.83  % 3.86  %
Total Loans 4.08  % 4.04  % 3.90  % 3.94  % 3.81  %
    
The average yield on the loan portfolio decreased to 4.08% for the first quarter of 2021 from 3.81% for the first quarter of 2020. Market rates declined in 2020 and have increased in 2021, which impacts 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. In 2021, PPP loans generated $7.0 million in revenue. The majority of PPP revenue, over $6 million, is the result of fees received, many accelerated due to three quarters of the PPP loan portfolio forgiven as of September 30, 2021. Residential real estate yields declined in each of the five quarters presented 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.

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 market indices, such as Prime, LIBOR or FHLBNY.
Many of the commercial and commercial real estate loans are in industries that have been heavily impacted by the COVID-19 pandemic, especially within the hospitality and service industries. Arrow believes the commercial loan portfolio will maintain its strong credit quality as the Company expects tourism to normalize and economic conditions to continue to improve.

Consumer Loans: At September 30, 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.
New consumer loan volume for the first nine months of 2021 was $364.8 million, up from the $292.8 million originated in the first nine 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.

Residential Real Estate Loans: Gross originations for residential real estate loans (including refinancings of mortgage loans) for the first nine months of 2021 were $174.2 million, as compared to $157.0 million for the first nine 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 nine months of 2021, Arrow sold $48.7 million, or 27.9%, of originations while retaining the mortgage servicing rights. In the first nine months of 2020, $50.5 million, or 32.2%, of originations were sold. In the third quarter of 2021, sales decreased as the result of the strategic decision to grow the residential loan portfolio. The rate at which mortgage loan originations are sold in future periods will depend on a variety of factors, including demand for residential mortgages in our operating markets, market conditions for mortgage sales and strategic balance sheet and interest-rate risk management decisions.

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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 and other time deposits have decreased throughout the five quarter period. Market rates have remained near historic lows in the third quarter of 2021.

Quarterly Average Deposit Balances
(Dollars in Thousands)
Quarter Ended
9/30/2021 6/30/2021 3/31/2021 12/31/2020 9/30/2020
Noninterest-Bearing Deposits $ 802,837  $ 748,267  $ 698,234  $ 676,490  $ 673,181 
Interest-Bearing Checking Accounts 923,002  924,651  859,972  874,314  764,614 
Savings Deposits 1,496,938  1,481,232  1,435,555  1,407,837  1,314,241 
Time Deposits over $250,000 71,435  95,673  109,644  115,492  121,027 
Other Time Deposits 141,721  145,448  151,410  182,105  209,436 
Total Deposits $ 3,435,933  $ 3,395,271  $ 3,254,815  $ 3,256,238  $ 3,082,499 

Percentage of Total Quarterly Average Deposits
Quarter Ended
9/30/2021 6/30/2021 3/31/2021 12/31/2020 9/30/2020
Noninterest-Bearing Deposits 23.4  % 22.0  % 21.5  % 20.8  % 21.8  %
Interest-Bearing Checking Accounts 26.9  27.2  26.4  27.0  24.8 
Savings Deposits 43.5  43.7  44.0  43.1  42.7 
Time Deposits over $250,000 2.1  2.8  3.4  3.5  3.9 
Other Time Deposits 4.1  4.3  4.7  5.6  6.8 
Total Deposits 100.0  % 100.0  % 100.0  % 100.0  % 100.0  %
    
Quarterly Cost of Deposits
Quarter Ended
9/30/2021 6/30/2021 3/31/2021 12/31/2020 9/30/2020
Demand Deposits —  % —  % —  % —  % —  %
Interest-Bearing Checking Accounts 0.07  % 0.08  % 0.10  % 0.11  % 0.14  %
Savings Deposits 0.11  % 0.14  % 0.16  % 0.18  % 0.24  %
Time Deposits over $250,000 0.22  % 0.29  % 0.44  % 0.70  % 0.96  %
Other Time Deposits 0.37  % 0.43  % 0.59  % 0.92  % 1.09  %
Total Deposits 0.09  % 0.11  % 0.14  % 0.18  % 0.25  %
    
During the quarter ended September 30, 2021, the total cost of deposits continued to decrease. In response to the economic uncertainty related to the COVID-19 pandemic, in 2020, the Federal Reserve lowered the target overnight borrowing rate, the "Fed Funds" rate, to a range of 0.00%-0.25%. Although the Fed Funds rate is widely expected to remain unchanged for the remainder of 2021, 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 and term advances from the FHLBNY. The securities sold under agreements to repurchase are offered to existing customers, 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 September 30, 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 65 of this Report. In the first quarter of 2020, Arrow entered into interest rate swap agreements to synthetically fix the variable rate interest payments associated with $20 million in outstanding subordinated trust securities.
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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)
9/30/2021 6/30/2021 3/31/2021 12/31/2020 9/30/2020
Loan Balances:
Period-End Loans $ 2,654,751  $ 2,644,082  $ 2,639,243  $ 2,595,030  $ 2,592,455 
Average Loans, Year-to-Date 2,637,265  2,634,997  2,618,362  2,526,791  2,498,573 
Average Loans, Quarter-to-Date 2,641,726  2,651,449  2,618,362  2,610,834  2,582,253 
Period-End Assets 4,071,104  3,896,191  3,903,711  3,688,636  3,777,684 
Allowance for credit losses, Year-to-Date:
Allowance for credit losses, Beginning of Period $ 29,232  $ 29,232  $ 29,232  $ 21,187  21,187 
Impact of the Adoption of ASU 2016-13 (1,300) (1,300) (1,300) —  — 
Provision for Credit Losses, YTD (286) (385) (648) 9,319  8,083 
Loans Charged-off, YTD (1,520) (1,076) (633) (1,989) (1,360)
Recoveries of Loans Previously Charged-off 830  539  189  715  536 
Net Charge-offs, YTD (690) (537) (444) (1,274) $ (824)
Allowance for credit losses, End of Period $ 26,956  $ 27,010  $ 26,840  $ 29,232  $ 28,446 
Allowance for credit losses, Quarter-to-Date:
Allowance for credit losses, Beginning of Period $ 27,010  $ 26,840  $ 29,232  $ 28,446  $ 26,300 
Impact of the Adoption of ASU 2016-13 —  —  1,300  —  — 
Provision for Credit Losses, QTD 99  263  (648) 1,237  2,271 
Loans Charged-off, QTD (444) (443) (633) (630) (392)
Recoveries of Loans Previously Charged-off 291  350  189  179  267 
Net Charge-offs, QTD (153) (93) (444) (451) (125)
Allowance for credit losses, End of Period $ 26,956  $ 27,010  $ 26,840  $ 29,232  $ 28,446 
Nonperforming Assets, at Period-End:
Nonaccrual Loans $ 10,723  $ 7,102  $ 8,087  $ 6,033  $ 6,004 
Loans Past Due 90 or More Days
  and Still Accruing Interest 		555  595  242  228  121 
Restructured and in Compliance with
  Modified Terms 		67  78  97  145  157 
Total Nonperforming Loans 11,345  7,775  8,426  6,406  6,282 
Repossessed Assets 272  99  242  155  126 
Other Real Estate Owned 79  99  —  —  — 
Total Nonperforming Assets $ 11,696  $ 7,973  $ 8,668  $ 6,561  $ 6,408 
Asset Quality Ratios:
Allowance to Nonperforming Loans 237.60  % 347.40  % 318.54  % 456.32  % 452.82  %
Allowance to Period-End Loans 1.02  % 1.02  % 1.02  % 1.13  % 1.10  %
Provision to Average Loans (Quarter) (1)
0.01  % 0.04  % (0.10) % 0.19  % 0.35  %
Provision to Average Loans (YTD) (1)
(0.01) % (0.06) % (0.10) % 0.37  % 0.43  %
Net Charge-offs to Average Loans (Quarter) (1)
0.02  % 0.01  % 0.07  % 0.07  % 0.02  %
Net Charge-offs to Average Loans (YTD) (1)
0.03  % 0.08  % 0.07  % 0.05  % 0.04  %
Nonperforming Loans to Total Loans 0.43  % 0.29  % 0.32  % 0.25  % 0.24  %
Nonperforming Assets to Total Assets 0.29  % 0.20  % 0.22  % 0.18  % 0.17  %
  (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 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 included a $1.3 million decrease to the allowance for credit losses on loans. CECL calculates losses over the life of a loan or financial instrument. Arrow and its subsidiaries utilize a loss
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projection model updated with data from our core systems, and incorporates various assumptions to produce the CECL reserve. A CECL Steering Committee was created to provide a management governance function to review, critically challenge and approve components of the CECL reporting process. One key responsibility of the CECL Steering Committee is to review annually the key assumptions utilized in the CECL calculation including loan segmentation, loan loss regression analysis, reasonable and supportable forecast period, reversion period, discounted cash flow inputs including economic forecast data and prepayment and curtailment speeds and qualitative factors.
Driven by current economic forecasts, loan growth and net charge offs during the quarter, the third quarter provision for credit losses was $99 thousand. The provision is directionally consistent with both the latest economic forecasts as well as third quarter activity. For the the third quarter of 2020, a provision of $2.3 million was recorded. In addition, Arrow recorded an expense for estimated credit losses on off-balance sheet credit exposures in other liabilities of $300 thousand in the third quarter of 2021.
See Notes 1 and 4 to the unaudited interim consolidated financial statements for additional discussion related to the adoption of CECL.
The ratio of the allowance for credit losses to total loans was 1.02% at September 30, 2021, a decrease from 1.13% at December 31, 2020 and a decrease of 8 basis points from 1.10% at September 30, 2020. Net of outstanding PPP loans, the allowance for credit losses was 1.04% of loans outstanding as of September 30, 2021.
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 September 30, 2021 amounted to $11.7 million, up from the $6.6 million total at December 31, 2020 and an increase of $5.3 million, from $6.4 million at September 30, 2020 as a result of two commercial real estate loans being classified as nonaccrual during 2021. One commercial loan was placed was placed on non-accrual status in the third quarter since it required additional deferral assistance. The current arrangement calls for past due accrued interest being deferred and for ongoing interest-only payments through April 2022 after which full payments are slated to begin. As this loan was made under the SBA program, Arrow's loan to value is 55% of September 30, 2021. For the three month periods ended September 30, 2021 and 2020, ratios of nonperforming assets to total assets have remained below the average ratios for the peer group. (See page 47 for a discussion of the peer group.) At June 30, 2021, the ratio of loans past due 90 or more days plus nonaccrual loans plus other real estate owned to total assets was 0.20%, below the 0.43% ratio of the peer group at such date (the latest date for which peer group information is available). At September 30, 2021 the ratio was 0.29%, which is below the most recent ratio for the peer group.
The following table presents the balance of other non-current loans at period-end as to which interest income was being accrued (i.e. loans 30 to 89 days past due, as defined in bank regulatory guidelines). These non-current loans are not included in nonperforming assets, but entail heightened risk.
Loans Past Due 30-89 Days and Accruing Interest
($ in 000's)
9/30/2021 12/31/2020 9/30/2020
Commercial Loans $ 792  $ 215  $ 122 
Commercial Real Estate Loans —  —  85 
Residential Real Estate Loans 1,663  1,337  1,224 
Consumer Loans - Primarily Indirect Automobile 7,287  7,651  6,963 
   Total Loans Past Due 30-89 Days
   and Accruing Interest 		$ 9,742  $ 9,203  $ 8,394 
    
At September 30, 2021, the loans in the above-referenced category totaled $9.7 million, an increase of $0.5 million, or 5.9%, from the $9.2 million of such loans at December 31, 2020. The September 30, 2021 total of non-current loans equaled 0.37% of loans then outstanding, compared to 0.35% at December 31, 2020 and 0.32% at September 30, 2020. The change from December 31, 2020 is primarily attributable to a decrease in delinquent automobile loans loans offset by an increase in commercial and residential real estate 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 $5.1 million from December 31, 2020 and $5.3 million from September 30, 2020. The majority of the increase is due to two commercial real estate loans being classified as nonaccrual during 2021.
The COVID-19 pandemic 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 September 30, 2021, Arrow held one residential 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.

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Loan Deferrals Related to COVID-19 Pandemic
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 September 30, 2021. In accordance with the CARES Act, the deferrals listed below are not considered troubled debt restructurings. As of September 30, 2021, Arrow originated an additional $91.4 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 September 30, 2021.
COVID-19 Deferrals by Loan Category at September 30, 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 $ 169,183  6.4  % $ —  —  % —  %
Lessors of Residential Real Estate 142,314  5.4  % —  —  % —  %
Health Care and Social Assistance 111,383  4.2  % —  —  % —  %
Hotels and Motels 107,227  4.0  % 4,733  0.6  % 0.2  %
Arts/Recreation/Restaurants/Vacation Camps 47,060  1.8  % —  —  % —  %
Retail 35,426  1.3  % —  —  % —  %
Construction & Related 18,705  0.7  % —  —  % —  %
Other 171,973  6.5  % —  —  % —  %
Total Commercial and Commercial Real Estate Loans 803,271  30.3  % 4,733  0.6  % 0.2  %
Consumer Loans 921,189  34.7  % 480  0.1  % —  %
Residential Real Estate Loans 930,291  35.0  % 1,043  0.1  % —  %
Total Loans $ 2,654,751  $ 6,256  0.2  %

Outstanding PPP Loans as of September 30, 2021
(Dollars In Thousands)
PPP Funding to Date $ 234,195 
Loans Fully Forgiven to Date (170,445)
Loans Partially Forgiven to Date (3,652)
Outstanding PPP Loans $ 60,098 
Income Earned on PPP Loans for the Periods Ended
 September 30, 2021
(Dollars In Thousands)
Three Months Ended Nine Months Ended
Interest Earned at Rate of 1% $ 212  $ 928 
Fees Recognized 2,318  6,029 
Income Earned on PPP Loans $ 2,530  $ 6,957 



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, Arrow elected to opt out of utilizing the CBLR framework. The Capital Rules promulgated under Dodd-Frank will remain applicable to Arrow.

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 (Arrow 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.
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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 September 30, 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 September 30, 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 13.71  % 14.51  % 15.66  % 9.39  %
Glens Falls National Bank & Trust Co. 14.16  % 14.16  % 15.24  % 8.94  %
Saratoga National Bank & Trust Co. 13.53  % 13.53  % 14.79  % 9.50  %
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 September 30, 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.

Capital Components; Stock Repurchases; Dividends
Stockholders' Equity: Stockholders’ equity was $360.2 million at September 30, 2021, an increase of $25.8 million, or 7.7%, from the December 31, 2020 level of $334.4 million, and an increase of $34.5 million, or 10.6%, from the prior-year level. The increase in stockholders' equity over the first nine months of 2021 principally reflected the following factors: (i) $39.5 million of net income for the period, plus (ii) issuance of $3.8 million 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 $2.9 million, (v) cash dividends of $12.1 million and (vi) repurchases of common stock of $2.6 million.


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Trust Preferred Securities: In each of 2003 and 2004, Arrow 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 interest rate swap agreements 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 September 30, 2021, Arrow repurchased $1.5 million of common stock under the 2021 Repurchase Program. 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: Arrow's common stock is traded on NasdaqGS® under the symbol AROW. The high and low stock prices for the past seven quarters listed below represent actual sales transactions, as reported by NASDAQ. On October 27, 2021, the Board of Directors declared a 2021 fourth quarter cash dividend of $0.26 payable on December 15, 2021. Per share amounts and share counts in the following tables have been restated for the September 24, 2021 3% stock dividend.
Cash
Market Price Dividends
Low High Declared
2020
First Quarter $ 19.59  $ 35.86  $ 0.245 
Second Quarter 22.21  29.86  0.245 
Third Quarter 23.86  28.28  0.245 
Fourth Quarter 23.80  31.07  0.252 
2021
First Quarter $ 27.82  $ 35.42  $ 0.252 
Second Quarter 32.25  37.15  0.252 
Third Quarter 32.73  36.49  0.252 
Fourth Quarter (dividend payable December 15, 2021) TBD TBD 0.260 

Quarter Ended September 30
2021 2020
Cash Dividends Per Share $ 0.252  $ 0.245 
Diluted Earnings Per Share 0.81  0.69 
Dividend Payout Ratio 31.11  % 35.51  %
Total Equity (in thousands) 360,171  $ 325,660 
Shares Issued and Outstanding (in thousands) 16,020  15,954 
Book Value Per Share $ 22.48  $ 20.41 
Intangible Assets (in thousands) 23,879  23,662 
Tangible Book Value Per Share $ 20.99  $ 18.93 


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 times 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
67

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 $486.9 million at September 30, 2021, an increase of $121.6 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 September 30, 2021 of $548.9 million compared to $338.9 million at December 31, 2020.
In addition to liquidity from cash, short-term investments, investment securities and loans, Arrow 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 September 30, 2021.
To support the borrowing relationship with the FHLBNY, Arrow has pledged collateral, including residential mortgage, home equity and commercial real estate loans. At September 30, 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 $731 million. Brokered deposits have also been identified as an available source of funding accessible in a relatively short time period. At September 30, 2021, there were no outstanding brokered deposits. Arrow paid down $45 million in brokered deposits in the first half 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 September 30, 2021, the amount available under this facility was approximately $641 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, Arrow believes that the available liquidity is sufficient to meet all reasonably likely events or occurrences. At September 30, 2021, Arrow's basic liquidity ratio, including FHLBNY collateralized borrowing capacity, was 32.3% of total assets, or $1.15 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 September 30, 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.
68

RESULTS OF OPERATIONS
Three Months Ended September 30, 2021 Compared With
Three Months Ended September 30, 2020

Summary of Earnings Performance
(Dollars in Thousands, Except Per Share Amounts)
Three Months Ended
September 30, 2021 September 30, 2020 Change % Change
Net Income $ 12,989  $ 11,046  $ 1,943  17.6  %
Diluted Earnings Per Share 0.81  0.69  0.12  17.4  %
Return on Average Assets 1.32  % 1.23  % 0.09  % 7.3  %
Return on Average Equity 14.34  % 13.55  % 0.79  % 5.8  %
    
Net income was $13.0 million and diluted earnings per share (EPS) of $.81 for the third quarter of 2021, compared to net income of $11.0 million and diluted EPS of $.69 for the third quarter of 2020. Return on average assets for the third quarter of 2021 was 1.32%, up from 1.23% in the third quarter of 2020. In addition, return on average equity increased to 14.34% for the third quarter of 2021, from 13.55% in the third 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
September 30, 2021 September 30, 2020 Change % Change
Interest and Dividend Income $ 29,807  $ 27,296  $ 2,511  9.2  %
Interest Expense 1,169  2,396  (1,227) (51.2) %
Net Interest Income 28,638  24,900  3,738  15.0  %
Average Earning Assets(1)
3,734,206  3,417,638  316,568  9.3  %
Average Interest-Bearing Liabilities 2,705,283  2,545,435  159,848  6.3  %
Yield on Earning Assets(1)
3.17  % 3.18  % (0.01) % (0.3) %
Cost of Interest-Bearing Liabilities 0.17  0.37  (0.20) (54.1)
Net Interest Spread 3.00  2.81  0.19  6.8 
Net Interest Margin 3.04  2.90  0.14  4.8 
Net Interest Income excluding PPP loans $ 26,109  $ 23,779  $ 2,330  9.8  %
Net Interest Margin excluding PPP loans 2.84  % 2.88  % (0.04) % (1.4) %
(1) Includes Nonaccrual Loans.
Net interest income for the recently completed quarter increased by $3.7 million, or 15.0%, from the third quarter of 2020, due to a variety of factors including the timing of the forgiveness of PPP loans offset by lower interest rates and increased cash balances. Interest and fees on loans generated $27.2 million in income for the third quarter of 2021, an increase of 9.9% from the $24.7 million from the quarter ending September 30, 2020. Interest expense for the third quarter of 2021 was $1.2 million, a decrease of $1.2 million, or 51.2% from the $2.4 million in expense for the comparable quarter ending September 30, 2020. Net interest margin increased 14 basis points in the third quarter of 2021 to 3.04%, from 2.90% during the third quarter of 2020. Average earning asset yields were 1 basis point lower as compared to the third quarter of 2020. The cost of interest-bearing liabilities decreased 20 basis points from the quarter ended September 30, 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 63, the provision for loan losses for the third quarter of 2021 was $99 thousand, compared to a provision of $2.3 million for the third quarter of 2020.

69

Noninterest Income
Summary of Noninterest Income
(Dollars in Thousands)
Three Months Ended
September 30, 2021 September 30, 2020 Change % Change
Income From Fiduciary Activities $ 2,571  $ 2,265  $ 306  13.5  %
Fees for Other Services to Customers 2,966  2,619  347  13.2  %
Insurance Commissions 1,576  1,713  (137) (8.0) %
Net Loss on Securities Transactions (106) (72) (34) (47.2) %
Net Gain on the Sale of Loans 211  1,433  (1,222) (85.3) %
Other Operating Income 476  739  (263) (35.6) %
Total Noninterest Income $ 7,694  $ 8,697  $ (1,003) (11.5) %
    
Total noninterest income in the current quarter was $7.7 million, a decrease of $1.0 million from the comparable quarter of 2020. Income from fiduciary activities for the third quarter of 2021 increased by 13.5% from the third quarter of 2020. Fees for other services to customers were $3.0 million for the third quarter of 2021, an increase of $347 thousand or 13.2% from the third quarter of 2020. Interchange fees related to increased customer activity of debit card usage was the largest driver of the increase. Insurance commissions were $1.6 million for the third quarter of 2021, a decrease of $137 thousand or 8.0% from the third quarter of 2020. The decrease is related to a decline in the employee benefits sector of the business. Net loss on security transactions of $106 thousand for the third quarter of 2021 was the result of a decrease in the fair value of equity securities. Net gain on the sale of loans in the third quarter of 2021 decreased by $1.2 million from the third quarter of 2020 as a result of a strategic decision to retain more residential loan originations. See page 56 for the discussion of loan sales. Other operating income decreased $263 thousand from the comparable quarter in 2020, due to a variety of factors including fees received as part of interest rate swap agreements decreasing $306 thousand and an increase in income of $57 thousand related to additional bank owned life insurance.

Noninterest Expense
Summary of Noninterest Expense
(Dollars in Thousands)
Three Months Ended
September 30, 2021 September 30, 2020 Change % Change
Salaries and Employee Benefits $ 11,377  $ 10,408  $ 969  9.3  %
Occupancy Expense of Premises, Net 1,403  1,427  (24) (1.7) %
Technology and Equipment Expense 3,833  3,228  605  18.7  %
FDIC and FICO Assessments 249  309  (60) (19.4) %
Amortization 52  56  (4) (7.1) %
Other Operating Expense 2,509  2,059  450  21.9  %
Total Noninterest Expense $ 19,423  $ 17,487  $ 1,936  11.1  %
Efficiency Ratio 52.74  % 51.34  % 1.4  % 2.7  %
    
Noninterest expense for the third quarter of 2021 was $19.4 million, an increase of $1.9 million, or 11.1%, from the third quarter of 2020. Salaries and benefit expenses increased $969 thousand, or 9.3%, from the comparable quarter in 2020. The increase is primarily due to a special employee recognition bonus which occurred in the third quarter. Technology expenses increased $605 thousand, or 18.7%, from the third quarter of 2020 in part due to variable costs related to increased utilization of consumer banking technology. Other non-interest expense includes the expense for estimated credit losses on off-balance sheet credit exposures of $300 thousand in the third quarter.

Income Taxes
Summary of Income Taxes
(Dollars in Thousands)
Three Months Ended
September 30, 2021 September 30, 2020 Change % Change
Provision for Income Taxes $ 3,821  $ 2,793  $ 1,028  36.8  %
Effective Tax Rate 22.7  % 20.2  % 2.5  % 12.4  %
The increase in the effective tax rate in the first three months ended September 30, 2021 compared to the three-months ended September 30, 2020 was primarily due to the reduction of tax exempt investments held and the related investment income combined with the increase in the New York State corporate tax rate which was effective January 1, 2021.




70

RESULTS OF OPERATIONS
Nine Months Ended September 30, 2021 Compared With
Nine Months Ended September 30, 2020

Summary of Earnings Performance
(Dollars in Thousands, Except Per Share Amounts)
Nine Months Ended
September 30, 2021 September 30, 2020 Change % Change
Net Income $ 39,548  $ 28,332  $ 11,216  39.6  %
Diluted Earnings Per Share 2.46  1.78  0.68  38.2 
Return on Average Assets 1.38  % 1.11  % 0.27  % 24.3 
Return on Average Equity 15.10  % 11.99  % 3.11  % 25.9 
    
Net income was $39.5 million and diluted earnings per share (EPS) of $2.46 for the first nine months of 2021, compared to net income of $28.3 million and diluted EPS of $1.78 for the first nine months of 2020. Return on average assets for the first nine months of 2021 was 1.38%, an increase from 1.11% for the first nine months of 2020. In addition, return on average equity increased to 15.10% for the first nine months of 2021 from 11.99% for the first nine months of 2020.
    
The following narrative discusses the period-to-period changes in net interest income, noninterest income, noninterest expense and income taxes.

Net Interest Income
Summary of Net Interest Income
(Dollars in Thousands)
Nine Months Ended
September 30, 2021 September 30, 2020 Change % Change
Interest and Dividend Income $ 87,196  $ 83,524  $ 3,672  4.4  %
Interest Expense 4,043  10,776  (6,733) (62.5) %
Net Interest Income 83,153  72,748  10,405  14.3  %
Average Earning Assets (1)
3,657,060  3,243,886  413,174  12.7  %
Average Interest-Bearing Liabilities 2,689,070  2,455,544  233,526  9.5  %
Yield on Earning Assets (1)
3.19  % 3.44  % (0.25) % (7.3) %
Cost of Interest-Bearing Liabilities 0.20  0.59  (0.39) (66.10)
Net Interest Spread 2.99  2.85  0.14  4.91 
Net Interest Margin 3.04  3.00  0.04  1.33 
Net Interest Income excluding PPP loans $ 76,196  $ 71,627  $ 4,569  6.4  %
Net Interest Margin excluding PPP loans 2.88  % 2.99  % (0.11) % (3.7) %
(1) Includes Nonaccrual Loans.
Net interest income for the first nine months of 2021 increased $10.4 million, or 14.3%, from the first nine months of 2020. The increase is due in part to $7.0 million of revenue related to PPP loans. Other factors offsetting net interest income include lower market rates and increased cash balances. Total loans at September 30, 2021 increased $62.3 million from September 30, 2020. Investments increased $85.9 million from September 30, 2020. At September 30, 2021, deposit balances reached $3.6 billion. Deposit growth from September 30, 2020 to September 30, 2021 was $340.7 million, or 10.4%. Net interest margin for the first nine months of 2021 increased 4 basis points to 3.04%, from 3.00% for the first nine months of 2020. Average earning asset yields were 25 basis points lower as compared to the first nine months of 2020 due primarily to the increased cash balances and lower market rates partially offset by revenue related to PPP loans. The cost of interest-bearing liabilities decreased 39 basis points from the first nine months of 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 63, the provision for loan losses for the first nine months of 2021 was $(286) thousand, compared to a provision of $8.1 million for the first nine months of 2020.

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Noninterest Income
Summary of Noninterest Income
(Dollars in Thousands)
Nine Months Ended
September 30, 2021 September 30, 2020 Change % Change
Income From Fiduciary Activities 7,538  6,613  $ 925  14.0  %
Fees for Other Services to Customers 8,494  7,348  1,146  15.6 
Insurance Commissions 4,842  5,077  (235) (4.6)
Net Gain (Loss) on Securities 250  (552) 802  (145.3)
Net Gain on the Sale of Loans 2,251  2,193  58  2.6 
Other Operating Income 1,405  2,876  (1,471) (51.1)
Total Noninterest Income $ 24,780  $ 23,555  $ 1,225  5.2  %

Total noninterest income for the first nine months of 2021 was $24.8 million, an increase of $1.2 million from the first nine months of 2020. Income from fiduciary activities for the first nine months of 2021 increased by 14.0% from the first nine months of 2020 due to market performance and stable customer base. Fees for other services to customers were $8.5 million for the first nine months of 2021 representing an increase of $1.1 million, or 15.6%, from the prior year comparative period. The growth was driven by interchange fees related to increased debit card usage. Insurance commissions were $4.8 million for the first nine months of 2021. The decrease in insurance commissions as compared to the first nine months of 2020 is primarily related to continued competition and the loss of some employee benefit relationships. Expense control initiatives are ongoing to ensure expenses appropriately align with the decrease in revenue. Net gain on security transactions of $250 thousand for the first nine months of 2021 was the result of the increase in the fair value of equity securities. Net gain on the sale of loans for the first nine months of 2021 was flat to the comparable period in 2020. For the majority of the year, loan sale activity exceeded prior year activity due in part to strong demand for residential mortgages in our operating markets and favorable market conditions for mortgage sales. In the third quarter, sales slowed as a result of the decision to grow the residential loan portfolio. See page 56 for the discussion of loan sales. Other operating income decreased $1.5 million from the comparable period in 2020, due primarily to fees received as part of interest rate swap agreements decreasing by $1.4 million.

Noninterest Expense
Summary of Noninterest Expense
(Dollars in Thousands)
Nine Months Ended
September 30, 2021 September 30, 2020 Change % Change
Salaries and Employee Benefits $ 33,360  $ 31,003  $ 2,357  7.6  %
Occupancy Expense of Premises, Net 4,480  4,221  259  6.1 
Technology and Equipment Expense 11,002  9,807  1,195  12.2 
FDIC and FICO Assessments 764  770  (6) (0.8)
Amortization 158  171  (13) (7.6)
Other Operating Expense 7,424  6,514  910  14.0 
Total Noninterest Expense $ 57,188  $ 52,486  $ 4,702  9.0 
Efficiency Ratio 52.56  % 53.54  % (0.98) % (1.8) %

Noninterest expense for the first nine months of 2021 was $57.2 million, an increase of $4.7 million, or 9.0%, from the first nine months of 2020. Salaries and benefit expenses increased $2.4 million, or 7.6%, from the comparable period in 2020. In the third quarter, a special employee recognition bonus occurred. Technology expenses increased $1.2 million, or 12.2%, from the first nine months of 2020 due to variable costs related to increased utilization of consumer banking technology as well as additional expenses to optimize digital delivery channels. Other non-interest expense increased $910 thousand for the first nine months of 2021 as compared to the first nine months of 2020. Other non-interest expense includes the expense for estimated credit losses on off-balance sheet credit exposures of $655 thousand for the first nine months of 2021.

Income Taxes
Summary of Income Taxes
(Dollars in Thousands)
Nine Months Ended
September 30, 2021 September 30, 2020 Change % Change
Provision for Income Taxes $ 11,483  $ 7,402  $ 4,081  55.1  %
Effective Tax Rate 22.5  % 20.7  % 1.8  % 8.7  %
The increase in the effective tax rate in the first nine months of 2021 over the first nine months of 2020 was primarily due to the reduction of tax exempt investments held and the related investment income combined with the increase in the New York State corporate tax rate which was effective January 1, 2021.
72

Item 3.
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
In addition to credit risk in the loan portfolio and liquidity risk, discussed earlier, Arrow'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 Arrow's position (i.e., assets and operations) less valuable.  Arrow'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.  
Arrow''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 September 30, 2021:
Change in Interest Rate
+ 200 basis points - 100 basis points
Calculated change in Net Interest Income - Year 1 1.38% (2.19)%
Calculated change in Net Interest Income - Year 2 6.35% (13.02)%

Historically, there has existed an inverse relationship between changes in prevailing rates and Arrow's net interest income, suggesting that liabilities and sources of funds generally reprice more quickly than earning assets (near-term liability sensitivity). In recent months, sharply higher cash balances funded by an increase in core deposits has contributed to a more pronounced shift toward asset sensitivity. As the economy continues to recover from the COVID-19 pandemic, a reversal of this trend may, or may not, occur. When net interest income is simulated over a longer time frame, 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, Arrow 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 September 30, 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 September 30, 2021, that materially affected, or are reasonably likely to materially affect, Arrow's internal control over financial reporting.
73

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. The parties engaged in an initial mediation session in September 2021. Settlement discussions are ongoing.
Item 1.A.
Risk Factors
The Risk Factors identified in Arrow's Annual Report on Form 10-K for the year ended December 31, 2020 continue to represent the most significant risks to Arrow'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 September 30, 2021 of common stock (our only class of equity securities registered pursuant to Section 12 of the Securities Exchange Act of 1934):
Third 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
July 1,584  $ 35.34  —  $ 5,000,000 
August 68,836  35.07  41,241  3,539,562 
September 16,158  34.43  —  3,539,562 
   Total 86,578  34.95  41,241 
1 The total number of shares purchased by Arrow 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: July - DRIP purchases (1,584 shares); August - DRIP purchases (964 shares), stock-for-stock option exercises (26,631 shares) and repurchased under the 2021 Repurchase Program (41,241 shares); and September - DRIP purchases (14,351 shares) and stock-for stock option exercises (1,807 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 third 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

74

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
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

    















75


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
November 4, 2021 /s/Thomas J. Murphy
Date Thomas J. Murphy
President and Chief Executive Officer
November 4, 2021 /s/Edward J. Campanella
Date Edward J. Campanella
Senior Vice President, Treasurer and
Chief Financial Officer
(Principal Financial Officer and
Principal Accounting Officer)


76
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