LOANS (In Thousands)

Loan Categories and Past Due Loans

The following table presents loan balances outstanding as of September 30, 2013, December 31, 2012 and September 30, 2012 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 if the borrower is two or more payments past due. Loans held-for-sale of $1,561, $2,801 and $816 as of September 30, 2013, December 31, 2012 and September 30, 2012, respectively, are included in the residential real estate loan balances.



Past Due Loans
			Commercial		Commercial		Other
	Commercial		Construction		Real Estate		Consumer		Automobile		Residential		Total
September 30, 2013
Loans Past Due 30-59 Days	$	595	$	—	$	—	$	50	$	2,230	$	200	$	3,075
Loans Past Due 60-89 Days	750		—		1,173		4		654		1,999		4,580
Loans Past Due 90 or more Days	53		—		1,847		—		133		2,721		4,754
Total Loans Past Due	1,398		—		3,020		54		3,017		4,920		12,409
Current Loans	85,719		33,960		260,084		7,516		389,335		454,347		1,230,961
Total Loans	$	87,117	$	33,960	$	263,104	$	7,570	$	392,352	$	459,267	$	1,243,370

Loans 90 or More Days Past Due and Still Accruing Interest	$	—	$	—	$	—	$	—	$	11	$	916	$	927
Nonaccrual Loans	$	269	$	—	$	1,930	$	3	$	240	$	3,729	$	6,171

December 31, 2012
Loans Past Due 30-59 Days	$	1,045	$	—	$	534	$	43	$	2,427	$	407	$	4,456
Loans Past Due 60-89 Days	1,588		—		1,332		17		793		2,466		6,196
Loans Past Due 90 or more Days	494		—		1,871		—		185		1,462		4,012
Total Loans Past Due	3,127		—		3,737		60		3,405		4,335		14,664
Current Loans	102,409		29,149		241,440		6,624		345,695		432,360		1,157,677
Total Loans	$	105,536	$	29,149	$	245,177	$	6,684	$	349,100	$	436,695	$	1,172,341

Loans 90 or More Days Past Due and Still Accruing Interest	$	126	$	—	$	378	$	—	$	42	$	374	$	920
Nonaccrual Loans	$	1,787	$	—	$	2,026	$	1	$	419	$	2,400	$	6,633

September 30, 2012
Loans Past Due 30-59 Days	$	831	$	—	$	271	$	20	$	2,675	$	2,245	$	6,042
Loans Past Due 60-89 Days	1,764		—		1,051		—		485		822		4,122
Loans Past Due 90 or more Days	216		—		621		—		148		1,278		2,263
Total Loans Past Due	2,811		—		1,943		20		3,308		4,345		12,427
Current Loans	97,612		27,265		233,238		6,837		339,922		435,650		1,140,524
Total Loans	$	100,423	$	27,265	$	235,181	$	6,857	$	343,230	$	439,995	$	1,152,951

Loans 90 or More Days Past Due and Still Accruing Interest	$	—	$	—	$	—	$	—	$	—	$	150	$	150
Nonaccrual Loans	$	1,750	$	—	$	1,156	$	1	$	419	$	2,762	$	6,088

The Company disaggregates its loan portfolio into the following six 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. 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 of the borrowers.

Commercial Construction - The Company offers commercial construction and land development loans to finance projects within the communities that we serve. Many projects will ultimately be used by the borrowers’ businesses, while others are developed for resale. These real estate loans are secured by first liens on the real estate, which may include apartments, commercial structures, housing businesses, healthcare facilities, and both owner-occupied and nonowner-occupied facilities. There is enhanced risk during the construction period, since the loan is secured by an incomplete project.

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 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.

Other Consumer Loans - The Company 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, the Company also offers personal lines of credit and overdraft protection. Several loans are unsecured, which carry a higher risk of loss.

Automobile - The Company primarily finances the purchases of automobiles indirectly through dealer relationships located throughout upstate New York and Vermont. Most of these loans carry a fixed rate of interest with principal repayment terms typically ranging from three to seven years. The majority of indirect consumer loans are underwritten on a secured basis using the underlying collateral being financed.

Residential Real Estate Mortgages - Residential real estate loans consist primarily of loans secured by first or second mortgages on primary residences. We originate adjustable-rate and fixed-rate, one-to-four-family residential real estate loans for the construction, purchase or refinancing of a mortgage. These loans are collateralized primarily by owner-occupied properties generally located in the Company’s market area. Loans on one-to-four-family residential real estate are generally originated in amounts of no more than 85% of the purchase price or appraised value (whichever is lower), or have private mortgage insurance. The Company’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. 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. Our policy allows for a maximum loan to value ratio of 80%. The Company 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.

Allowance for Loan Losses

The following table presents a roll-forward of the allowance for loan losses and other information pertaining to the allowance for loan losses:



Allowance for Loan Losses
				Commercial		Commercial			Other
	Commercial			Construction		Real Estate			Consumer			Automobile			Residential			Unallocated			Total
Roll-forward of the Allowance for Loan Losses for the Quarterly Periods:
June 30, 2013	$	1,552		$	646	$	3,293		$	299		$	4,357		$	3,408		$	1,123		$	14,678
Charge-offs	(62		)	—		—			(7		)	(114		)	—			—			(183		)
Recoveries	8			—		—			2			79			—			—			89
Provision	209			4		15			(29		)	(14		)	(159		)	(26		)	—
September 30, 2013	$	1,707		$	650	$	3,308		$	265		$	4,308		$	3,249		$	1,097		$	14,584

June 30, 2012	$	2,098		$	528	$	3,295		$	355		$	4,571		$	3,451		$	913		$	15,211
Charge-offs	—			—		(39		)	(27		)	(105		)	—			—			(171		)
Recoveries	2			—		—			8			47			—			—			57
Provision	22			19		(82		)	(11		)	119			38			45			150
September 30, 2012	$	2,122		$	547	$	3,174		$	325		$	4,632		$	3,489		$	958		$	15,247



Allowance for Loan Losses
				Commercial			Commercial			Other
	Commercial			Construction			Real Estate			Consumer			Automobile			Residential			Unallocated			Total
Roll-forward of the Allowance for Loan Losses for the Year-to-Date Periods:
December 31, 2012	$	2,344		$	601		$	3,050		$	304		$	4,536		$	3,405		$	1,058		$	15,298
Charge-offs	(850		)	—			(11		)	(20		)	(284		)	—			—			(1,165		)
Recoveries	48			—			—			2			201			—			—			251
Provision	165			49			269			(21		)	(145		)	(156		)	39			200
September 30, 2013	$	1,707		$	650		$	3,308		$	265		$	4,308		$	3,249		$	1,097		$	14,584

December 31, 2011	$	1,927		$	602		$	3,136		$	350		$	4,496		$	3,414		$	1,078		$	15,003
Charge-offs	(15		)	—			(206		)	(69		)	(281		)	(33		)	—			(604		)
Recoveries	5			—			—			17			156			—			—			178
Provision	205			(55		)	244			27			261			108			(120		)	670
September 30, 2012	$	2,122		$	547		$	3,174		$	325		$	4,632		$	3,489		$	958		$	15,247

September 30, 2013
Allowance for loan losses - Loans Individually Evaluated for Impairment	$	—		$	—		$	—		$	—		$	—		$	—		$	—		$	—
Allowance for loan losses - Loans Collectively Evaluated for Impairment	$	1,707		$	650		$	3,308		$	265		$	4,308		$	3,249		$	1,097		$	14,584
Ending Loan Balance - Individually Evaluated for Impairment	$	25		$	—		$	1,497		$	—		$	169		$	1,720		$	—		$	3,411
Ending Loan Balance - Collectively Evaluated for Impairment	$	87,092		$	33,960		$	261,607		$	7,570		$	392,183		$	457,547		$	—		$	1,239,959

December 31, 2012
Allowance for loan losses - Loans Individually Evaluated for Impairment	$	853		$	—		$	—		$	—		$	—		$	—		$	—		$	853
Allowance for loan losses - Loans Collectively Evaluated for Impairment	$	1,491		$	601		$	3,050		$	304		$	4,536		$	3,405		$	1,058		$	14,445
Ending Loan Balance - Individually Evaluated for Impairment	$	1,432		$	—		$	2,528		$	—		$	203		$	1,090		$	—		$	5,253
Ending Loan Balance - Collectively Evaluated for Impairment	$	104,104		$	29,149		$	242,649		$	6,684		$	348,897		$	435,605		$	—		$	1,167,088



Allowance for Loan Losses
			Commercial		Commercial		Other
	Commercial		Construction		Real Estate		Consumer		Automobile		Residential		Unallocated		Total
September 30, 2012
Allowance for loan losses - Loans Individually Evaluated for Impairment	$	809	$	—	$	—	$	—	$	—	$	—	$	—	$	809
Allowance for loan losses - Loans Collectively Evaluated for Impairment	$	1,313	$	547	$	3,174	$	325	$	4,632	$	3,489	$	958	$	14,438
Ending Loan Balance - Individually Evaluated for Impairment	$	1,553	$	—	$	1,574	$	—	$	204	$	1,512	$	—	$	4,843
Ending Loan Balance - Collectively Evaluated for Impairment	$	98,870	$	27,265	$	233,607	$	6,857	$	343,026	$	438,483	$	—	$	1,148,108

Through the provision for loan losses, an allowance for loan losses is maintained that reflects our best estimate of the inherent risk of loss in the Company’s loan portfolio as of the balance sheet date. Additions are made to the allowance for loan losses through a periodic provision for loan losses. Actual loan losses are charged against the allowance for loan losses when loans are deemed uncollectible and recoveries of amounts previously charged off are recorded as credits to the allowance for loan losses.

Our 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, our independent internal loan review department performs periodic reviews of the risk ratings on individual loans in our commercial loan portfolio.

We use a two-step process to determine the provision for loan losses and the amount of the allowance for loan losses. We measure impairment on our impaired loans on a quarterly basis. Our impaired loans are generally nonaccrual loans over $250 thousand and all troubled debt restructured loans. Our impaired loans are generally considered to be collateral dependent with the specific reserve, if any, determined based on the value of the collateral less estimated costs to sell.

The remainder of the portfolio is evaluated on a pooled basis, as described below. For each homogeneous loan pool, we estimate a total loss factor based on the historical net loss rates adjusted for applicable qualitative factors. We update the total loss factors assigned to each loan category on a quarterly basis. For the commercial, commercial construction, and commercial real estate categories, we further segregate the loan categories by credit risk profile (pools of loans graded pass, special mention and accruing substandard). Additional description of the credit risk classifications is detailed in the Credit Quality Indicators section of this note.

We determine the historical net loss rate for each loan category using a trailing three-year net charge-off average. While historical net loss experience provides a reasonable starting point for our analysis, historical net losses, or even recent trends in net losses, do not by themselves form a sufficient basis to determine the appropriate level of the allowance for loan losses. Therefore, we also consider and adjust historical net loss factors for qualitative factors that impact the inherent risk of loss associated with our loan categories within our total loan portfolio. These include:


•	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

Further, due to the imprecise nature of the loan loss estimation process, the risk attributes of our loan portfolio may not be fully captured in data related to the determination of loss factors used to determine our analysis of the adequacy of the allowance for loan losses. Management, therefore, has established an unallocated portion within the allowance for loan losses reflecting the imprecision that naturally exists in the allowance for loan loss estimation process. The unallocated allowance for loan losses is not considered a significant component of the overall allowance for loan loss estimation process.

Credit Quality Indicators

The following table presents the credit quality indicators by loan category at September 30, 2013, December 31, 2012 and September 30, 2012:



Loan Credit Quality Indicators
			Commercial		Commercial		Other
	Commercial		Construction		Real Estate		Consumer		Automobile		Residential		Total
September 30, 2013
Credit Risk Profile by Creditworthiness Category:
Satisfactory	$	78,706	$	33,133	$	241,437							$	353,276
Special Mention	2,313		—		3,004								5,317
Substandard	6,098		827		18,663								25,588
Doubtful	—		—		—								—
Credit Risk Profile Based on Payment Activity:
Performing							$	7,567	$	392,112	$	454,620	854,299
Nonperforming							3		240		4,647		4,890

December 31, 2012
Credit Risk Profile by Creditworthiness Category:
Satisfactory	97,085		27,913		225,312								350,310
Special Mention	192		—		1,419								1,611
Substandard	6,872		1,236		18,446								26,554
Doubtful	1,387		—		—								1,387
Credit Risk Profile Based on Payment Activity:
Performing							6,683		348,676		433,922		789,281
Nonperforming							1		424		2,773		3,198

September 30, 2012
Credit Risk Profile by Creditworthiness Category:
Satisfactory	93,095		25,993		214,239								333,327
Special Mention	279		—		1,537								1,816
Substandard	7,049		1,272		19,405								27,726
Doubtful	—		—		—								—
Credit Risk Profile Based on Payment Activity:
Performing							6,856		342,811		437,082		786,749
Nonperforming							1		419		2,913		3,333

We use an internally developed system of five credit quality indicators 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 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. 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.

For the purposes of the table above, nonperforming consumer loans are those loans on nonaccrual status or are 90 days or more past due and still accruing interest.

Impaired Loans

The following table presents information on impaired loans based on whether the impaired loan has a recorded related allowance or has no recorded related allowance:



Impaired Loans
			Commercial		Commercial		Other
	Commercial		Construction		Real Estate		Consumer		Automobile		Residential		Total
September 30, 2013
Recorded Investment:
With No Related Allowance	$	25	$	—	$	1,497	$	—	$	169	$	1,720	$	3,411
With a Related Allowance	—		—		—		—		—		—		—
Unpaid Principal Balance:
With No Related Allowance	25		—		1,497		—		169		1,720		3,411
With a Related Allowance	—		—		—		—		—		—		—

December 31, 2012
Recorded Investment:
With No Related Allowance	$	45	$	—	$	2,528	$	—	$	203	$	1,090	$	3,866
With a Related Allowance	1,387		—		—		—		—		—		1,387
Unpaid Principal Balance:
With No Related Allowance	45		—		2,695		—		203		1,090		4,033
With a Related Allowance	1,387		—		—		—		—		—		1,387

September 30, 2012
Recorded Investment:
With No Related Allowance	$	52	$	—	$	1,574	$	—	$	204	$	1,512	$	3,342
With a Related Allowance	1,501		—		—		—		—		—		1,501
Unpaid Principal Balance:
With No Related Allowance	52		—		1,741		—		204		1,512		$	3,509
With a Related Allowance	1,501		—		—		—		—		—		1,501

For the Quarter Ended:
September 30, 2013
Average Recorded Balance:
With No Related Allowance	$	29	$	—	$	1,489	$	—	$	177	$	1,399	$	3,094
With a Related Allowance	—		—		—		—		—		—		—
Interest Income Recognized:
With No Related Allowance	1		—		—		—		1		2		4
With a Related Allowance	—		—		—		—		—		—		—
Cash Basis Income:
With No Related Allowance	—		—		—		—		—		—		—
With a Related Allowance	—		—		—		—		—		—		—



Impaired Loans
			Commercial		Commercial		Other
	Commercial		Construction		Real Estate		Consumer		Automobile		Residential		Total
September 30, 2012
Average Recorded Balance:
With No Related Allowance	$	55	$	—	$	1,600	$	—	$	209	$	1,501	$	3,365
With a Related Allowance	1,571		—		—		—		—		—		1,571
Interest Income Recognized:
With No Related Allowance	2		—		10		—		4		3		19
With a Related Allowance	—		—		—		—		—		—		—
Cash Basis Income:
With No Related Allowance	—		—		10		—		—		—		10
With a Related Allowance	—		—		—		—		—		—		—
For the Year-To-Date Period Ended:
September 30, 2013
Average Recorded Balance:
With No Related Allowance	$	35	$	—	$	2,013	$	—	$	186	$	1,405	$	3,639
With a Related Allowance	694		—		—		—		—		—		694
Interest Income Recognized:
With No Related Allowance	3		—		—		—		6		6		15
With a Related Allowance	72		—		—		—		—		—		72
Cash Basis Income:
With No Related Allowance	—		—		—		—		—		—		—
With a Related Allowance	72		—		—		—		—		—		72

September 30, 2012
Average Recorded Balance:
With No Related Allowance	$	59	$	—	$	1,717	$	—	$	229	$	1,703	$	3,708
With a Related Allowance	687		—		—		—		—		—		687
Interest Income Recognized:
With No Related Allowance	5		—		54		—		9		7		75
With a Related Allowance	—		—		—		—		—		—		—
Cash Basis Income:
With No Related Allowance	—		—		54		—		—		—		54
With a Related Allowance	—		—		—		—		—		—		—

At September 30, 2013, December 31, 2012 and September 30, 2012, 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. There was no allowance for loan losses allocated to impaired loans at September 30, 2013. Interest income recognized in the table above, 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.

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		Other
	Commercial		Construction		Real Estate		Consumer		Automobile		Residential		Total
For the Quarter Ended:
September 30, 2013
Number of Loans	—		—		—		—		2		—		2
Pre-Modification Outstanding Recorded Investment	$	—	$	—	$	—	$	—	$	16	$	—	$	16
Post-Modification Outstanding Recorded Investment	$	—	$	—	$	—	$	—	$	16	$	—	$	16

September 30, 2012
Number of Loans	—		—		2		—		5		—		7
Pre-Modification Outstanding Recorded Investment	$	—	$	—	$	47	$	—	$	41	$	—	$	88
Post-Modification Outstanding Recorded Investment	$	—	$	—	$	47	$	—	$	41	$	—	$	88

For the Year-To-Date Period Ended:
September 30, 2013
Number of Loans	—		—		—		—		7		—		7
Pre-Modification Outstanding Recorded Investment	$	—	$	—	$	—	$	—	$	57	$	—	$	57
Post-Modification Outstanding Recorded Investment	$	—	$	—	$	—	$	—	$	57	$	—	$	57

September 30, 2012
Number of Loans	—		—		2		—		12		—		14
Pre-Modification Outstanding Recorded Investment	$	—	$	—	$	47	$	—	$	101	$	—	$	148
Post-Modification Outstanding Recorded Investment	$	—	$	—	$	47	$	—	$	101	$	—	$	148

In general, loans requiring modification are restructured to accommodate the projected cash-flows of the borrower. As indicated in the table above, no loans modified during the preceding twelve months subsequently defaulted as of September 30, 2013.