FAIR VALUE OF FINANCIAL INSTRUMENTS (In Thousands)

FASB ASC Subtopic 820-10 defines fair value, establishes a framework for measuring fair value in generally accepted accounting principles (GAAP) and requires certain disclosures about fair value measurements. We do not have any 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, 2014, December 31, 2013 and September 30, 2013 were securities available-for-sale. 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)		Total Gains (Losses)
Fair Value of Assets and Liabilities Measured on a Recurring Basis:
September 30, 2014
Securities Available-for Sale:
U.S. Agency Obligations	$	134,051	$	—	$	134,051	$	—
State and Municipal Obligations	92,150		—		92,150		—
Mortgage-Backed Securities - Residential	130,101		—		130,101		—
Corporate and Other Debt Securities	16,756		—		16,756		—
Mutual Funds and Equity Securities	1,277		—		1,277		—
Total Securities Available-for-Sale	$	374,335	$	—	$	374,335	$	—
December 31, 2013
Securities Available-for Sale:
U.S. Agency Obligations	$	136,475	$	—	$	136,475	$	—
State and Municipal Obligations	127,389		—		127,389		—
Mortgage-Backed Securities - Residential	175,778		—		175,778		—
Corporate and Other Debt Securities	16,798		—		16,798		—
Mutual Funds and Equity Securities	1,166		—		1,166		—
Total Securities Available-for Sale	$	457,606	$	—	$	457,606	$	—
September 30, 2013
Securities Available-for Sale:
U.S. Agency Obligations	$	149,774	$	—	$	149,774	$	—
State and Municipal Obligations	133,919		—		133,919		—
Mortgage-Backed Securities - Residential	185,215		—		185,215		—
Corporate and Other Debt Securities	16,798		—		16,798		—
Mutual Funds and Equity Securities	1,182		—		1,182		—
Total Securities Available-for Sale	$	486,888	$	—	$	486,888	$	—

Fair Value of Assets and Liabilities Measured on a Nonrecurring Basis:
September 30, 2014
Other Real Estate Owned and Repossessed Assets, Net	$	392	$	—	$	—	$	392	$	(139	)
Impaired Loans	533		—		—		533		(82		)
December 31, 2013
Other Real Estate Owned and Repossessed Assets, Net	$	144	$	—	$	—	$	144	$	(79	)
September 30, 2013
Other Real Estate Owned and Repossessed Assets, Net	$	499	$	—	$	—	$	499	$	(180	)

We determine the fair value of financial instruments 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; and


•	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 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.

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

The fair value of collateral dependent impaired loans was based on third-party appraisals of the collateral. The fair value of other real estate owned was based on third-party appraisals. 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 on a quarterly basis, with no impairment recognized for these assets at September 30, 2014, December 31, 2013 and September 30, 2013.

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 Amount		Fair Value		Level 1		Level 2		Level 3
September 30, 2014
Cash and Cash Equivalents	$	64,664	$	64,664	$	64,664	$	—	$	—
Securities Available-for-Sale	374,335		374,335		—		374,335		—
Securities Held-to-Maturity	296,522		302,567		—		302,567		—
Federal Home Loan Bank and Federal Reserve Bank Stock	3,001		3,001		3,001		—		—
Net Loans	1,366,147		1,371,368		—		—		1,371,368
Accrued Interest Receivable	6,629		6,629		6,629		—		—
Deposits	1,935,356		1,929,377		1,709,155		220,222		—
Federal Funds Purchased and Securities Sold Under Agreements to Repurchase	19,654		19,654		19,654		—		—
Federal Home Loan Bank Term Advances	10,000		10,340		10,340		—		—
Junior Subordinated Obligations Issued to Unconsolidated Subsidiary Trusts	20,000		20,000		—		20,000		—
Accrued Interest Payable	357		357		357		—		—

December 31, 2013
Cash and Cash Equivalents	$	49,980	$	49,980	$	49,980	$	—	$	—
Securities Available-for-Sale	457,606		457,606		—		457,606		—
Securities Held-to-Maturity	299,261		302,305		—		302,305		—
Federal Home Loan Bank and Federal Reserve Bank Stock	6,281		6,281		6,281		—		—
Net Loans	1,252,038		1,266,020		—		—		1,266,020
Accrued Interest Receivable	5,745		5,745		5,745		—		—
Deposits	1,842,330		1,839,613		1,595,103		244,510		—
Federal Funds Purchased and Securities Sold Under Agreements to Repurchase	11,777		11,777		11,777		—		—
Federal Home Loan Bank Term Advances	73,000		74,629		53,000		21,629		—
Junior Subordinated Obligations Issued to Unconsolidated Subsidiary Trusts	20,000		20,000		—		20,000		—
Accrued Interest Payable	439		439		439		—		—

September 30, 2013
Cash and Cash Equivalents	$	72,052	$	72,052	$	72,052	$	—	$	—
Securities Available-for-Sale	486,888		486,888		—		486,888		—
Securities Held-to-Maturity	273,626		278,390		—		278,390		—
Federal Home Loan Bank and Federal Reserve Bank Stock	3,896		3,896		3,896		—		—
Net Loans	1,228,786		1,246,005		—		—		1,246,005
Accrued Interest Receivable	6,614		6,614		6,614		—		—
Deposits	1,895,375		1,891,086		1,635,549		255,537		—
Federal Funds Purchased and Securities Sold Under Agreements to Repurchase	15,977		15,977		15,977		—		—
Federal Home Loan Bank Term Advances	20,000		20,823		—		20,823		—
Junior Subordinated Obligations Issued to Unconsolidated Subsidiary Trusts	20,000		20,000		—		20,000		—
Accrued Interest Payable	472		472		472		—		—

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

Securities held-to-maturity are fair valued 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.

Fair values for loans are estimated for portfolios of loans with similar financial characteristics. Loans are segregated by type such as commercial, commercial real estate, residential mortgage, indirect 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 discounting scheduled cash flows through the estimated maturity using estimated market discount rates that reflect the credit and interest rate risk inherent in the loan. The estimate of maturity is based on historical experience with repayments for each loan classification, modified, as required, by an estimate of the effect of current economic and lending conditions. Fair value for nonperforming loans is generally based on recent external appraisals. If appraisals are not available, estimated cash flows are discounted using a rate commensurate with the risk associated with the estimated cash flows. Assumptions regarding credit risk, cash flows and discount rates are judgmentally determined using available market information and specific borrower information.

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 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 estimated based on the discounted value of contractual cash flows. The discount rate is estimated using current rates on FHLBNY advances with similar maturities and call features.

Based on Arrow’s capital adequacy, 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.