LOANS (In Thousands)

Loan balances outstanding as of December 31, 2011 and 2010 consisted of the following:



	2011			2010
Commercial	$	99,791		$	97,621
Commercial real estate:
Commercial real estate - construction	11,083			7,090
Commercial real estate - other	232,149			214,291
Consumer:
Consumer – other	6,318			6,482
Consumer – automobile	322,375			334,656
Residential – prime	459,741			485,368
Total	$	1,131,457		$	1,145,508
Supplemental Information:
Unamortized deferred loan origination costs, net of deferred loan origination fees, included in the above balances	$	1,445		$	1,118
Overdrawn deposit accounts, included in the above balances	390			417
Pledged loans secured by one-to-four family residential mortgages under a blanket collateral agreement to secure borrowings from the Federal Home Loan Bank of New York	172,704			215,307
Residential real estate loans serviced for Freddie Mac, not included in the balances above	106,220			73,103
Loans held for sale at period-end, included in the above balances	893			10,294
Loans to Related Parties:
Balance at beginning of year	14,987			15,345
New Directors/Executive Officers	.			521
New loans and renewals, during the year	3,016			1,052
Repayments, during the year	(2,231		)	(1,931		)
Balance at end of year	15,772			14,987

Credit Quality Indicators

The following table provides information about loan credit quality at December 31, 2011 and 2010:



Credit Quality Indicators
As of December 31, 2011
Commercial Credit Exposure
Credit Risk Profile by Creditworthiness Category
			Commercial Real		Commercial Real
Indicator	Commercial		Estate - Construction		Estate - Other
Satisfactory	$	91,555	$	9,195	$	213,413
Special Mention	3,975		—		458
Substandard	4,261		1,888		18,278
Doubtful	—		—		—
Total	$	99,791	$	11,083	$	232,149
Consumer Credit Exposure
Credit Risk Profile Based on Payment Activity
	Consumer-Other		Consumer-Automobile		Residential-Prime
Performing	$	6,312	$	321,888	$	456,254
Nonperforming	6		487		3,487
Total	$	6,318	$	322,375	$	459,741



Credit Quality Indicators
As of December 31, 2010
Commercial Credit Exposure
Credit Risk Profile by Creditworthiness Category
			Commercial Real		Commercial Real
Indicator	Commercial		Estate - Construction		Estate - Other
Satisfactory	$	94,290	$	5,117	$	187,070
Special Mention	160		—		7,318
Substandard	3,171		1,973		19,903
Doubtful	—		—		—
Total	$	97,621	$	7,090	$	214,291
Consumer Credit Exposure
Credit Risk Profile Based on Payment Activity
	Consumer-Other		Consumer-Automobile		Residential-Prime
Performing	$	6,477	$	333,847	$	483,725
Nonperforming	5		809		1,643
Total	$	6,482	$	334,656	$	485,368

We use an internally developed system of five credit quality indicators to rate the credit worthiness of each commercial loan. The system has eight levels of credit quality (the first three have been combined in the preceding table), 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 risk rating 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 bank will sustain some loss if the deficiencies are not corrected. “Substandard” loans may include loans which are likely to require liquidation of collateral to effect repayment, and other loans where character or ability to repay has become suspect. Loss potential, while existing in the aggregate amount of substandard assets, does not have to exist in individual assets classified substandard; 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 (i.e. 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 and 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. However, this classification does not mean that the asset has absolutely no recovery or salvage value, but rather it is not practical or desirable to defer writing off this basically worthless asset even though partial recovery may be effected in the future. Commercial loans are evaluated on an annual basis, unless the credit quality indicator falls to a level of "substandard" or below, when the loan is evaluated quarterly. The credit quality indicator is one of the factors used to determine any loss, as further described in this footnote.

Past Due Loans

The following table provides an analysis of the age of the recorded investment in loans that are past due at the end of the period. Consistent with regulatory instructions, Arrow considers an amortizing loan past due 30 or more days only if the borrower is two or more payments past due. Matured loans and all other loans are considered past due 30 or more days based on the payment due date. Nonaccrual loans are included in the first three columns, unless the loan is past due less than 30 days.



Age Analysis of Past Due Loans
As of December 31, 2011
	30-59		60-89		90 Days
	Days		Days		Or More		Total				Total
	Past Due		Past Due		Past Due		Past Due		Current		Loans
Commercial	$	538	$	197	$	17	$	752	$	99,039	$	99,791
Commercial Real Estate:
Commercial Real Estate – construction	—		—		—		0		11,083		11,083
Commercial Real Estate – other	284		—		1,825		2,109		230,040		232,149
Consumer:
Consumer-other	75		12		6		93		6,225		6,318
Consumer-automobile	3,512		670		314		4,496		317,879		322,375
Residential - Real Estate	1,544		226		3,056		4,826		454,915		459,741
Total	$	5,953	$	1,105	$	5,218	$	12,276	$	1,119,181	$	1,131,457



Age Analysis of Past Due Loans
As of December 31, 2010
	30-59		60-89		90 Days
	Days		Days		Or More		Total				Total
	Past Due		Past Due		Past Due		Past Due		Current		Loans
Commercial	$	591	$	377	$	79	$	1,047	$	96,572	$	97,619
Commercial Real Estate:
Commercial Real Estate – construction	—		—		—		—		7,090		7,090
Commercial Real Estate – other	483		—		254		737		213,554		214,291
Consumer:
Consumer-other	5		—		—		5		6,477		6,482
Consumer-automobile	3,542		1,547		508		5,597		329,061		334,658
Residential - Real Estate	212		1,884		1,145		3,241		482,127		485,368
Total	$	4,833	$	3,808	$	1,986	$	10,627	$	1,134,881	$	1,145,508

Nonaccrual Loans and Loans Past Due 90 or More Days and Still Accruing Interest

The following table presents information concerning loans on nonaccrual status and loans past due 90 or more days and still accruing interest at December 31:



Loans on Nonaccrual Status and Past Due 90 or More Days and Still Accruing Interest
As of December 31, 2011 and 2010
	2011				2010
			90 Days				90 Days
			or More				or More
	Nonaccrual		Past Due		Nonaccrual		Past Due
Commercial	$	6	17		$	94	$ ---
Commercial real estate:
Commercial real estate - construction	—		—		—		—
Commercial real estate - other	1,503		684		2,237		83
Consumer:
Consumer – other	6		—		5		—
Consumer – automobile	431		56		809		—
Residential - Real Estate	2,582		905		916		727
Total nonaccrual loans and loans past due 90 or more days and still accruing interest	$	4,528	$	1,662	$	4,061	$	810
Interest income on nonaccrual loans:
Gross income that would have been earned under original terms	$	311			$	314
Interest included in income	99				211

Impaired Loans

At December 31, 2011, all impaired loans were evaluated for impairment based on the fair value of collateral less estimated cost to sell. There was no allowance for loan losses allocated to impaired loans at December 31, 2011 and 2010. Interest income recognized in the table below, represents income earned after the loans became impaired and includes restructured loans in compliance with their modified terms and nonaccrual loans where we have recognized interest income on a cash basis.



Impaired Loans
As of and For the Years Ended December 31, 2011 and 2010
			Unpaid				Average		Interest		Cash
	Recorded		Principal		Related		Recorded		Income		Basis
	Investment		Balance		Allowance		Investment		Recognized		Interest
2011
With no related allowance recorded:
Commercial	$	66	$	66	$	—	$	74	$	2	$	—
Commercial real estate	1,953		1,953		—		1,984		57		33
Automobile	268		268		—		311		8		—
Residential real estate	2,108		2,108		—		2,100		32		—
Total	$	4,395	$	4,395	$	—	$	4,469	$	99	$	33

2010
With no related allowance recorded:
Commercial	$	13	$	13	$	—	$	13	$	4	$	—
Commercial real estate	2,032		2,032		—		1,983		123		57
Consumer - other	11		11		—		11		1		—
Automobile	280		280		—		280		16		—
Residential real estate	548		548		—		550		17		—
Total	$	2,871	$	2,871	$	—	$	2,824	$	157	$	57

Allowance for Loan Losses

Through the provision for loan losses, an allowance is maintained that reflects our best estimate of probable incurred loan losses related to specifically identified loans and losses for categories of loans in the remaining portfolio. Actual loan losses are charged against this allowance when loans are deemed uncollectible.

We use a two-step process to determine the provision for loans losses and the amount of the allowance for loan losses. We evaluate nonaccrual loans over $250 thousand and all troubled debt restructured loans individually for impairment as described in Note 1, while we evaluate the remainder of the portfolio on a pooled basis as described below.

Homogenous Loan Pools: Under our pooled analysis, we group homogeneous loans as follows, each with its own estimated loss-rate:


i.)	Secured and unsecured commercial loans,


ii.)	Secured construction and development loans,


iii.)	Secured commercial loans – non-owner occupied,


iv.)	Secured commercial loans – owner occupied,


v.)	One to four family residential real estate loans,


vi.)	Home equity loans,


vii.)	Indirect loans – low risk tiers (based on credit scores),


viii.)	Indirect loans – high risk tiers, and


ix.)	Other consumer loans.

Within the group of other commercial and commercial real estate loans, we sub-group loans based on our internal system of risk-rating, which is applied to all commercial and commercial real estate loans. We establish loss rates for each of these pools.

Estimated losses reflect consideration of all significant factors that affect the collectability of the portfolio as of December 31, 2011. In our evaluation, we do both a quantitative and qualitative analysis of the homogeneous pools.

Quantitative Analysis: Quantitatively, we determine the historical loss rate for each homogeneous loan pool. During the past five years we have had little charge-off activity on loans secured by residential real estate. Indirect consumer lending (principally automobile loans) represents a significant component of our total loan portfolio and is the only category of loans that has a history of losses that lends itself to a trend analysis. We have had one small loss on commercial real estate loans in the past five years. Losses on commercial loans (other than those secured by real estate) are also historically low, but can vary widely from year-to-year; this is the most complex category of loans in our loss analysis. Our net charge-offs for the past five years have been at or near historical lows for our Company. Annualized net charge-offs have ranged from .04% to .09% of average loans during this period.

Qualitative Analysis: While historical loss experience provides a reasonable starting point for our analysis, historical losses, or even recent trends in losses, do not by themselves form a sufficient basis to determine the appropriate level for the allowance. Therefore, we have also considered and adjusted historical loss factors for qualitative and environmental factors that are likely to cause credit losses associated with our existing portfolio. These included:


•	Changes in the volume and severity of past due, nonaccrual and adversely classified loans


•	Changes in the nature and volume of the portfolio and in the terms of loans


•	Changes in the value of the underlying collateral for collateral dependent loans


•	Changes in lending policies and procedures, including changes in underwriting standards and collection, charge-off, and recovery practices not considered elsewhere in estimating credit losses


•	Changes in the quality of the loan review system


•	Changes in the experience, ability, and depth of lending management and other relevant staff


•	Changes in international, national, regional, and local economic and business conditions and developments that affect the collectibility of the portfolio


•	The existence and effect of any concentrations of credit, and changes in the level of such concentrations


•	The effect of other external factors such as competition and legal and regulatory requirements on the level of estimated credit losses in the existing portfolio or pool

For each homogeneous loan pool, we estimate a loss factor expressed in basis points for each of the qualitative factors above, and for historical credit losses. We update and change, if necessary, the loss-rates assigned to various pools based on the analysis of loss trends and the change in qualitative and environmental factors.

From June 2004 to June 2006, the Federal Reserve Bank increased prevailing short-term rates in an effort to slow down national economic growth and check potential increases in the inflation rate. However, from August 2007 through December 2008, the Federal Reserve Bank began to cut rates in response to the growing financial crisis in credit markets and evidence of a significant economic recession. In our market area there was little impact from these developments in credit markets and the national economy on unemployment rates, job growth and business failures until the last quarter of 2008; overall, our market area has not experienced in subsequent quarters the degree of negative impact on lending, credit and property values that the U.S. as a whole has experienced, although this may change in upcoming periods.

Due to the imprecise nature of the loan loss estimation process and ever changing economic conditions, the risk attributes of our portfolio may not be adequately captured in data related to the formula-based loan loss components used to determine allocations in our analysis of the adequacy of the allowance for loan losses. Management, therefore, has established and held an unallocated portion within the allowance for loan losses reflecting the uncertainty of future economic conditions within our market area. The unallocated portion of the allowance was $1.1 million, or 7.2% of the total allowance for loan losses, at December 31, 2011 and $1.3 million, or 8.7% of the total allowance for loan losses, at December 31, 2010.

The following summarizes the changes in the allowance for credit losses during the years and the period-end recorded investment in loans for the years ended December 31, 2011 and 2010:



Allowance for Loan Losses
				Commercial		Commercial			Other
	Commercial			Construction		Real Estate			Consumer			Automobile			Residential			Unallocated			Total

Balance January 1, 2010	$	1,304		$	—	$	4,000		$	—		$	4,901		$	2,954		$	855		$	14,014
Charge-offs	(30		)	—		—			—			(864		)	—			—			(894		)
Recoveries	5			—		—			—			262			—			—			267
Provision	758			135		(1,007		)	328			461			209			418			1,302
Balance December 31, 2010	$	2,037		$	135	$	2,993		$	328		$	4,760		$	3,163		$	1,273		$	14,689
Charge-offs	(105		)	—		—			(42		)	(480		)	(147		)	—			(774		)
Recoveries	17			—		—			28			198			—			—			243
Provision	336			454		174			36			(9		)	49			(195		)	845
Balance December 31, 2011	$	2,285		$	589	$	3,167		$	350		$	4,469		$	3,065		$	1,078		$	15,003

The following tables presents information on loans and allowance for loan losses collectively and individually evaluated for impairment:



Loans and Allowance for Loan Losses Individually and Collectively Evaluated for Impairment
			Commercial		Commercial		Other
	Commercial		Construction		Real Estate		Consumer		Automobile		Residential		Total
December 31, 2011
Loans:
Ending loan balance: Individually evaluated for impairment	$	66	$	—	$	1,953	$	—	$	268	$	2,108	$	4,395
Ending loan balance: Collectively evaluated for impairment	99,725		11,083		230,196		6,318		322,107		457,633		1,127,062
Ending loan balance	$	99,791	$	11,083	$	232,149	$	6,318	$	322,375	$	459,741	$	1,131,457
Allowance for Loan Losses:
Ending balance: Collectively evaluated for impairment	$	2,285	$	589	$	3,167	$	350	$	4,469	$	3,065	$	13,925
December 31, 2010
Loans:
Ending loan balance: Individually evaluated for impairment	$	13	$	—	$	2,032	$	11	$	280	$	548	$	2,884
Ending loan balance: Collectively evaluated for impairment	97,608		7,090		212,259		6,471		334,376		484,820		1,142,624
Ending loan balance	$	97,621	$	7,090	$	214,291	$	6,482	$	334,656	$	485,368	$	1,145,508
Allowance for Loan Losses:
Ending balance: Collectively evaluated for impairment	$	2,037	$	135	$	2,993	$	328	$	4,760	$	3,163	$	13,416

In general, loans requiring modification are restructured to accommodate the projected cash-flows of the borrower. No loans modified during the preceding twelve months subsequently defaulted as of December 31, 2011. The following table presents information on loans that were modified during the year ending on December, 2011:



Loans Modified in Trouble Debt Restructurings During 2011
	Number of Loans	Pre-Modification Outstanding Recorded Investment		Post-Modification Outstanding Recorded Investment
Commercial	1	$	63	$	63
Commercial Real Estate	1	917		917
Automobile	14	121		121
Residential Real Estate	1	242		242
Total	17	$	1,343	$	1,343

There were no subsequent defaults on loans modified in trouble debt restructurings during 2011.