UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)

OF THE SECURITIES EXCHANGE ACT OF 1934

For the Quarterly Period Ended September 30, 2014

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

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. x  Yes     No

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted 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 and post such files).  x  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   x  Non-accelerated filer Smaller reporting company

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).  Yes      x  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 31, 2014
Common Stock, par value $1.00 per share	12,607,102

ARROW FINANCIAL CORPORATION

FORM 10-Q

TABLE OF CONTENTS

	Page
PART I - FINANCIAL INFORMATION
Item 1. Financial Statements	3
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations	34
Item 3. Quantitative and Qualitative Disclosures About Market Risk	56
Item 4. Controls and Procedures	56
PART II - OTHER INFORMATION
Item 1. Legal Proceedings	57
Item 1.A. Risk Factors	57
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds	57
Item 3. Defaults Upon Senior Securities	57
Item 4. Mine Safety Disclosures	57
Item 5. Other Information	57
Item 6. Exhibits	58
SIGNATURES	59

# 2

PART I - Financial Information

ARROW FINANCIAL CORPORATION AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS (In Thousands, Except Share and Per Share Amounts) (Unaudited)
	September 30, 2014			December 31, 2013			September 30, 2013
ASSETS
Cash and Due From Banks	$	46,771		$	37,275		$	47,513
Interest-Bearing Deposits at Banks	17,893			12,705			24,539
Investment Securities:
Available-for-Sale	374,335			457,606			486,888
Held-to-Maturity (Approximate Fair Value of $302,567 at September 30, 2014; $302,305 at December 31, 2013; and $278,390 at September 30, 2013)	296,522			299,261			273,626
Federal Home Loan Bank and Federal Reserve Bank Stock	3,001			6,281			3,896
Loans	1,381,440			1,266,472			1,243,370
Allowance for Loan Losses	(15,293		)	(14,434		)	(14,584		)
Net Loans	1,366,147			1,252,038			1,228,786
Premises and Equipment, Net	28,206			29,154			29,386
Goodwill	22,003			22,003			22,003
Other Intangible Assets, Net	3,744			4,140			4,270
Other Assets	50,123			43,235			35,951
Total Assets	$	2,208,745		$	2,163,698		$	2,156,858
LIABILITIES
Noninterest-Bearing Deposits	$	296,384		$	278,958		$	280,326
NOW Accounts	887,865			817,366			839,213
Savings Deposits	524,906			498,779			516,010
Time Deposits of $100,000 or More	69,797			78,928			83,702
Other Time Deposits	156,404			168,299			176,124
Total Deposits	1,935,356			1,842,330			1,895,375
Federal Funds Purchased and   Securities Sold Under Agreements to Repurchase	19,654			11,777			15,977
Federal Home Loan Bank Overnight Advances	—			53,000			—
Federal Home Loan Bank Term Advances	10,000			20,000			20,000
Junior Subordinated Obligations Issued to Unconsolidated Subsidiary Trusts	20,000			20,000			20,000
Other Liabilities	23,646			24,437			22,823
Total Liabilities	2,008,656			1,971,544			1,974,175
STOCKHOLDERS’ EQUITY
Preferred Stock, $5 Par Value; 1,000,000 Shares Authorized	—			—			—
Common Stock, $1 Par Value; 20,000,000 Shares Authorized (17,079,376 Shares Issued at September 30, 2014, and 16,744,486 Shares Issued at December 31, 2013 and September 30, 2013)	17,079			16,744			16,744
Additional Paid-in Capital	239,247			229,290			228,622
Retained Earnings	26,240			27,457			24,755
Unallocated ESOP Shares (71,740 Shares at September 30, 2014, and 87,641 Shares at December 31, 2013 and September 30, 2013)	(1,450		)	(1,800		)	(1,800		)
Accumulated Other Comprehensive Loss	(4,284		)	(4,373		)	(10,293		)
Treasury Stock, at Cost (4,402,932 Shares at September 30, 2014; 4,296,723 Shares at December 31, 2013; and 4,327,741 Shares at September 30, 2013)	(76,743		)	(75,164		)	(75,345		)
Total Stockholders’ Equity	200,089			192,154			182,683
Total Liabilities and Stockholders’ Equity	$	2,208,745		$	2,163,698		$	2,156,858

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,
	2014		2013		2014		2013
INTEREST AND DIVIDEND INCOME
Interest and Fees on Loans	$	13,460	$	12,846	$	39,436	$	38,279
Interest on Deposits at Banks	12		11		41		57
Interest and Dividends on Investment Securities:
Fully Taxable	1,919		1,556		5,968		4,991
Exempt from Federal Taxes	1,369		1,461		4,276		4,352
Total Interest and Dividend Income	16,760		15,874		49,721		47,679
INTEREST EXPENSE
NOW Accounts	386		423		1,345		1,987
Savings Deposits	218		240		663		785
Time Deposits of $100,000 or More	195		297		626		921
Other Time Deposits	335		470		1,085		1,529
Federal Funds Purchased and   Securities Sold Under Agreements to Repurchase	6		5		15		14
Federal Home Loan Bank Advances	115		167		387		539
Junior Subordinated Obligations Issued to   Unconsolidated Subsidiary Trusts	144		145		427		434
Total Interest Expense	1,399		1,747		4,548		6,209
NET INTEREST INCOME	15,361		14,127		45,173		41,470
Provision for Loan Losses	444		—		1,407		200
NET INTEREST INCOME AFTER PROVISION FOR    LOAN LOSSES	14,917		14,127		43,766		41,270
NONINTEREST INCOME
Income From Fiduciary Activities	1,861		1,688		5,640		5,020
Fees for Other Services to Customers	2,353		2,403		6,924		7,056
Insurance Commissions	2,451		2,404		7,188		6,608
Net Gain on Securities Transactions	137		—		110		540
Net Gain on Sales of Loans	213		166		502		1,271
Other Operating Income	336		278		892		689
Total Noninterest Income	7,351		6,939		21,256		21,184
NONINTEREST EXPENSE
Salaries and Employee Benefits	7,781		7,856		23,303		23,114
Occupancy Expenses, Net	2,266		1,882		6,923		6,277
FDIC Assessments	273		269		828		800
Other Operating Expense	3,206		3,126		9,675		9,627
Total Noninterest Expense	13,526		13,133		40,729		39,818
INCOME BEFORE PROVISION FOR INCOME TAXES	8,742		7,933		24,293		22,636
Provision for Income Taxes	2,595		2,310		7,302		6,625
NET INCOME	$	6,147	$	5,623	$	16,991	$	16,011
Average Shares Outstanding:
Basic	12,606		12,555		12,601		12,527
Diluted	12,621		12,591		12,613		12,548
Per Common Share:
Basic Earnings	$	0.49	$	0.45	$	1.35	$	1.28
Diluted Earnings	0.49		0.45		1.35		1.28

Share and Per Share Amounts have been restated for the September 2014 2% 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,
	2014			2013		2014			2013
Net Income	$	6,147		$	5,623	$	16,991		$	16,011
Other Comprehensive Income, Net of Tax:
Net Unrealized Securities Holding (Losses) Gains      Arising During the Period	(770		)	1,210		(15		)	(2,213		)
Reclassification Adjustment for Securities Losses     (Gains) Included in Net Income	(82		)	—		(66		)	(326		)
Amortization of Net Retirement Plan Actuarial Loss	70			235		209			707
(Accretion) Amortization of Net Retirement Plan Prior      Service Credit	(13		)	1		(39		)	1
Other Comprehensive Income (Loss)	(795		)	1,446		89			(1,831		)
Comprehensive Income	$	5,352		$	7,069	$	17,080		$	14,180

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)

	Common Stock		Additional Paid-In Capital		Retained Earnings			Unallo-cated ESOP Shares			Accumu-lated Other Com- prehensive Loss			Treasury Stock			Total
Balance at December 31, 2013	$	16,744	$	229,290	$	27,457		$	(1,800	)	$	(4,373	)	$	(75,164	)	$	192,154
Net Income	—		—		16,991			—			—			—			16,991
Other Comprehensive (Loss) Income	—		—		—			—			89			—			89
2% Stock Dividend (334,890 Shares)	335		8,617		(8,952		)	—			—			—			—
Cash Dividends Paid, $.74 per Share 1	—		—		(9,256		)	—			—			—			(9,256		)
Stock Options Exercised, Net  (45,194 Shares)	—		619		—			—			—			444			1,063
Shares Issued Under the Directors’ Stock   Plan  (3,872 Shares)	—		63		—			—			—			38			101
Shares Issued Under the Employee Stock   Purchase Plan  (14,172 Shares)	—		212		—			—			—			139			351
Stock-Based Compensation Expense	—		270		—			—			—			—			270
Tax Benefit for Disposition of Stock Options	—		22		—			—			—			—			22
Purchase of Treasury Stock   (86,710 Shares)	—		—		—			—			—			(2,235		)	(2,235		)
Acquisition of Subsidiaries  (3,595 Shares)	—		56		—			—			—			35			91
Allocation of ESOP Stock  (17,308 Shares)	—		98		—			350			—			—			448
Balance at September 30, 2014	$	17,079	$	239,247	$	26,240		$	(1,450	)	$	(4,284	)	$	(76,743	)	$	200,089
Balance at December 31, 2012	$	16,416	$	218,650	$	26,251		$	(2,150	)	$	(8,462	)	$	(74,880	)	$	175,825
Net Income	—		—		16,011			—			—			—			16,011
Other Comprehensive (Loss) Income	—		—		—			—			(1,831		)	—			(1,831		)
2% Stock Dividend (328,323 Shares)	328		8,152		(8,480		)	—			—			—			—
Cash Dividends Paid, $.72 per Share 1	—		—		(9,027		)	—			—			—			(9,027		)
Stock Options Exercised, Net  (44,849 Shares)	—		524		—			—			—			441			965
Shares Issued Under the Directors’ Stock   Plan  (4,255 Shares)	—		64		—			—			—			42			106
Shares Issued Under the Employee Stock   Purchase Plan  (14,668 Shares)	—		204		—			—			—			144			348
Shares Issued for Dividend   Reinvestment Plans (33,539 Shares)	—		525		—			—			—			326			851
Stock-Based Compensation Expense	—		281		—			—			—			—			281
Tax Benefit for Disposition of Stock Options	—		17		—			—			—			—			17
Purchase of Treasury Stock  (61,075 Shares)	—		—		—			—			—			(1,512		)	(1,512		)
Acquisition of Subsidiaries  (9,503 Shares)	—		139		—			—			—			94			233
Allocation of ESOP Stock  (16,969 Shares)	—		66		—			350			—			—			416
Balance at September 30, 2013	$	16,744	$	228,622	$	24,755		$	(1,800	)	$	(10,293	)	$	(75,345	)	$	182,683

¹Cashdividends paid per share have been adjusted for the September 2014 2% stock dividend.

See Notes to Unaudited Interim Consolidated Financial Statements.

# 6

ARROW FINANCIAL CORPORATION AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

(Dollars in Thousands)

(Unaudited)

	Nine Months Ended September 30,
Cash Flows from Operating Activities:	2014			2013
Net Income	$	16,991		$	16,011
Adjustments to Reconcile Net Income to Net Cash Provided by Operating Activities:
Provision for Loan Losses	1,407			200
Depreciation and Amortization	5,622			6,908
Allocation of ESOP Stock	448			416
Gains on the Sale of Securities Available-for-Sale	(137		)	(527		)
Gains on the Sale of Securities Held-to-Maturity	—			(18		)
Losses on the Sale of Securities Held-to-Maturity	—			5
Losses on the Sale of Securities Available-for-Sale	27			—
Loans Originated and Held-for-Sale	(16,462		)	(41,545		)
Proceeds from the Sale of Loans Held-for-Sale	15,879			44,057
Net Gains on the Sale of Loans	(502		)	(1,271		)
Net Losses on the Sale of Premises and Equipment, Other Real Estate Owned and Repossessed Assets	52			87
Contributions to Retirement Benefit Plans	(656		)	(354		)
Deferred Income Tax Benefit	(418		)	(83		)
Shares Issued Under the Directors’ Stock Plan	101			106
Stock-Based Compensation Expense	270			281
Net (Increase) Decrease in Other Assets	(1,146		)	2,611
Net Increase (Decrease) in Other Liabilities	31			(653		)
Net Cash Provided By Operating Activities	21,507			26,231
Cash Flows from Investing Activities:
Proceeds from the Sale of Securities Available-for-Sale	49,917			16,284
Proceeds from the Maturities and Calls of Securities Available-for-Sale	131,861			89,857
Purchases of Securities Available-for-Sale	(100,684		)	(121,287		)
Proceeds from the Sale of Securities Held-to-Maturity	—			1,181
Proceeds from the Maturities and Calls of Securities Held-to-Maturity	45,602			35,214
Purchases of Securities Held-to-Maturity	(43,967		)	(71,573		)
Net Increase in Loans	(115,568		)	(73,948		)
Proceeds from the Sales of Premises and Equipment, Other Real Estate Owned and Repossessed Assets	1,093			1,214
Purchase of Premises and Equipment	(885		)	(1,935		)
Cash Paid for Subsidiaries, Net	(75		)	(75		)
Net Decrease in Other Investments	3,280			1,896
Purchase of Bank Owned Life Insurance	(5,245		)	—
Net Cash Used In Investing Activities	(34,671		)	(123,172		)
Cash Flows from Financing Activities:
Net Increase in Deposits	93,026			164,220
Net Decrease in Short-Term Borrowings	(45,123		)	(25,701		)
Repayments of Federal Home Loan Bank Term Advances	(10,000		)	(10,000		)
Purchase of Treasury Stock	(2,235		)	(1,512		)
Stock Options Exercised, Net	1,063			965
Shares Issued Under the Employee Stock Purchase Plan	351			348
Tax Benefit from Exercise of Stock Options	22			17
Shares Issued for Dividend Reinvestment Plans	—			851
Cash Dividends Paid	(9,256		)	(9,027		)
Net Cash Provided By Financing Activities	27,848			120,161
Net Increase in Cash and Cash Equivalents	14,684			23,220
Cash and Cash Equivalents at Beginning of Period	49,980			48,832
Cash and Cash Equivalents at End of Period	$	64,664		$	72,052
Supplemental Disclosures to Statements of Cash Flow Information:
Interest on Deposits and Borrowings	$	4,629		$	6,318
Income Taxes	7,035			6,086
Non-cash Investing and Financing Activity:
Transfer of Loans to Other Real Estate Owned and Repossessed Assets	1,137			764
Acquisition of Subsidiaries	91			233

See Notes to Unaudited Interim Consolidated Financial Statements.

# 7

NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

Note 1.     ACCOUNTING POLICIES

In the opinion of the management of Arrow Financial Corporation (Arrow), the accompanying unaudited consolidated interim financial statements contain all of the adjustments necessary to present fairly the financial position as of September 30, 2014, December 31, 2013 and September 30, 2013; the results of operations for the three and nine-month periods ended September 30, 2014 and 2013; the consolidated statements of comprehensive income for the three and nine-month periods ended September 30, 2014 and 2013; the changes in stockholders' equity for the nine-month periods ended September 30, 2014 and 2013; and the cash flows for the nine-month periods ended September 30, 2014 and 2013. All such adjustments are of a normal recurring nature. Certain prior period amounts have been reclassified to conform to the current presentation. The preparation of financial statements requires the use of management estimates. The unaudited consolidated interim financial statements should be read in conjunction with the audited annual consolidated financial statements of Arrow for the year ended December 31, 2013, included in Arrow's 2013 Form 10-K.

New Accounting Standards Updates (ASU): During 2014, through the date of this report, the FASB issued fifteen accounting standards updates, only three of which apply to Arrow.

ASU 2014-01 "Investments-Equity Method and Joint Ventures" allows an entity that invests in affordable housing projects that qualify for low-income housing tax credits to make an accounting policy election to account for their investments in qualified affordable housing projects using the proportional amortization method if certain conditions are met. Under the proportional amortization method, an entity amortizes the initial cost of the investment in proportion to the tax credits and other tax benefits received and recognizes the net investment performance in the income statement as a component of income tax expense. The standard is effective for annual years beginning after December 15, 2014, with earlier adoption allowed. We adopted the proportional amortization method in the first quarter of 2014. The adoption did not have a material impact on our financial condition or results of operations.

ASU 2014-04 "Receivables - Trouble Debt Restructurings by Creditors" provides additional guidance on when an in-substance repossession or foreclosure occurs and is effective for annual periods beginning after December 15, 2014. We are evaluating the impact of adopting this standard, and we do not expect that it will have a material impact on our financial condition or results of operations.

ASU 2014-14 "Receivables - Trouble Debt Restructurings by Creditors - Classification of Certain Government-Guaranteed Mortgage Loans upon Foreclosure" requires an entity to report a separate other receivable for the amount of the expected guarantee upon foreclosure. For Arrow, the standard is effective for the first quarter of 2015. The adoption will not have a material impact on our financial condition or results of operations.

Note 2.    INVESTMENT SECURITIES (In Thousands)

The following table is the schedule of Available-For-Sale Securities at September 30, 2014, December 31, 2013 and September 30, 2013:

Available-For-Sale Securities
	U.S. Agency Obligations		State and Municipal Obligations		Mortgage- Backed Securities - Residential		Corporate and Other Debt Securities		Mutual Funds and Equity Securities		Total Available- For-Sale Securities
September 30, 2014
Available-For-Sale Securities,   at Amortized Cost	$	134,485	$	91,799	$	126,108	$	17,027	$	1,120	$	370,539
Available-For-Sale Securities,   at Fair Value	134,051		92,150		130,101		16,756		1,277		374,335
Gross Unrealized Gains	1		355		4,046		9		157		4,568
Gross Unrealized Losses	435		4		53		280		—		772
Available-For-Sale Securities,   Pledged as Collateral											292,850
Maturities of Debt Securities, at Amortized Cost:
Within One Year	—		35,472		6,465		—				41,937
From 1 - 5 Years	128,653		54,172		107,842		16,027				306,694
From 5 - 10 Years	5,832		1,515		11,801		—				19,148
Over 10 Years	—		640		—		1,000				1,640
Maturities of Debt Securities, at Fair Value:
Within One Year	—		35,539		6,529		—				42,068
From 1 - 5 Years	128,247		54,438		111,100		15,956				309,741
From 5 - 10 Years	5,804		1,533		12,472		—				19,809
Over 10 Years	—		640		—		800				1,440

# 8

Available-For-Sale Securities
	U.S. Agency Obligations		State and Municipal Obligations		Mortgage- Backed Securities - Residential		Corporate and Other Debt Securities		Mutual Funds and Equity Securities		Total Available- For-Sale Securities
Securities in a Continuous Loss Position, at Fair Value:
Less than 12 Months	$	90,968	$	450	$	5,528	$	—	$	—	$	96,946
12 Months or Longer	27,994		2,665		4,515		10,752		—		45,926
Total	$	118,962	$	3,115	$	10,043	$	10,752	$	—	$	142,872
Number of Securities in a   Continuous Loss Position	35		18		7		15		—		75
Unrealized Losses on Securities in a Continuous Loss Position:
Less than 12 Months	$	296	$	—	$	18	$	—	$	—	$	314
12 Months or Longer	139		4		35		280		—		458
Total	$	435	$	4	$	53	$	280	$	—	$	772
December 31, 2013
Available-For-Sale Securities,   at Amortized Cost	$	136,868	$	127,224	$	171,321	$	17,142	$	1,120	$	453,675
Available-For-Sale Securities,   at Fair Value	136,475		127,389		175,778		16,798		1,166		457,606
Gross Unrealized Gains	2		306		4,714		10		46		5,078
Gross Unrealized Losses	395		141		257		354		—		1,147
Available-For-Sale Securities,   Pledged as Collateral											243,769
Securities in a Continuous Loss Position, at Fair Value:
Less than 12 Months	$	60,664	$	29,967	$	15,190	$	7,375	$	—	$	113,196
12 Months or Longer	33,849		4,597		11,841		6,063		—		56,350
Total	$	94,513	$	34,564	$	27,031	$	13,438	$	—	$	169,546
Number of Securities in a   Continuous Loss Position	26		107		13		19		—		165
Unrealized Losses on Securities in a Continuous Loss Position:
Less than 12 Months	$	336	$	120	$	108	$	92	$	—	$	656
12 Months or Longer	59		21		149		262		—		491
Total	$	395	$	141	$	257	$	354	$	—	$	1,147
September 30, 2013
Available-For-Sale Securities,   at Amortized Cost	$	150,184	$	134,059	$	179,235	$	17,180	$	1,120	$	481,778
Available-For-Sale Securities,   at Fair Value	149,774		133,919		185,215		16,798		1,182		486,888
Gross Unrealized Gains	2		175		6,041		—		62		6,280
Gross Unrealized Losses	412		315		61		382		—		1,170
Available-For-Sale Securities,   Pledged as Collateral											314,693
Securities in a Continuous Loss Position, at Fair Value:
Less than 12 Months	$	105,517	$	58,710	$	8,482	$	15,998	$	—	$	188,707
12 Months or Longer	4,992		3,513		—		800		—		9,305
Total	$	110,509	$	62,223	$	8,482	$	16,798	$	—	$	198,012

# 9

Available-For-Sale Securities
	U.S. Agency Obligations		State and Municipal Obligations		Mortgage- Backed Securities - Residential		Corporate and Other Debt Securities		Mutual Funds and Equity Securities		Total Available- For-Sale Securities
Number of Securities in a   Continuous Loss Position	30		230		4		22		—		286
Unrealized Losses on Securities in a Continuous Loss Position:
Less than 12 Months	$	405	$	304	$	61	$	182	$	—	$	952
12 Months or Longer	7		11		—		200		—		218
Total	$	412	$	315	$	61	$	382	$	—	$	1,170

The following table is the schedule of Held-To-Maturity Securities at September 30, 2014, December 31, 2013 and September 30, 2013:

Held-To-Maturity Securities
	State and Municipal Obligations		Mortgage- Backed Securities - Residential		Corporate and Other Debt Securities		Total Held-To Maturity Securities
September 30, 2014
Held-To-Maturity Securities,   at Amortized Cost	$	178,699	$	116,823	$	1,000	$	296,522
Held-To-Maturity Securities,   at Fair Value	184,116		117,451		1,000		302,567
Gross Unrealized Gains	5,535		672		—		6,207
Gross Unrealized Losses	118		44		—		162
Held-To-Maturity Securities,   Pledged as Collateral							277,636
Maturities of Debt Securities, at Amortized Cost:
Within One Year	33,517		—		—		33,517
From 1 - 5 Years	86,414		61,257		—		147,671
From 5 - 10 Years	56,509		55,566		—		112,075
Over 10 Years	2,259		—		1,000		3,259
Maturities of Debt Securities, at Fair Value:
Within One Year	33,608		—		—		33,608
From 1 - 5 Years	89,028		61,578		—		150,606
From 5 - 10 Years	59,121		55,873		—		114,994
Over 10 Years	2,359		—		1,000		3,359
Securities in a Continuous Loss Position, at Fair Value:
Less than 12 Months	$	2,289	$	9,221	$	—	$	11,510
12 Months or Longer	13,058		4,366		—		17,424
Total	$	15,347	$	13,587	$	—	$	28,934
Number of Securities in a   Continuous Loss Position	58		5		—		63
Unrealized Losses on Securities in a Continuous Loss Position:
Less than 12 Months	$	15	$	32	$	—	$	47
12 Months or Longer	103		12		—		115
Total	$	118	$	44	$	—	$	162

# 10

Held-To-Maturity Securities
	State and Municipal Obligations		Mortgage- Backed Securities - Residential		Corporate and Other Debt Securities		Total Held-To Maturity Securities
December 31, 2013
Held-To-Maturity Securities,   at Amortized Cost	$	198,206	$	100,055	$	1,000	$	299,261
Held-To-Maturity Securities,   at Fair Value	202,390		98,915		1,000		302,305
Gross Unrealized Gains	4,762		24		—		4,786
Gross Unrealized Losses	578		1,164		—		1,742
Held-To-Maturity Securities,   Pledged as Collateral							298,261
Securities in a Continuous Loss Position, at Fair Value:
Less than 12 Months	$	23,633	$	85,339	$	—	$	108,972
12 Months or Longer	5,111		—		—		5,111
Total	$	28,744	$	85,339	$	—	$	114,083
Number of Securities in a   Continuous Loss Position	101		36		—		137
Unrealized Losses on Securities in a Continuous Loss Position:
Less than 12 Months	$	519	$	1,164	$	—	$	1,683
12 Months or Longer	59		—		—		59
Total	$	578	$	1,164	$	—	$	1,742
September 30, 2013
Held-To-Maturity Securities,   at Amortized Cost	$	194,065	$	78,561	$	1,000	$	273,626
Held-To-Maturity Securities,   at Fair Value	198,548		78,842		1,000		278,390
Gross Unrealized Gains	5,018		314		—		5,332
Gross Unrealized Losses	535		33		—		568
Held-To-Maturity Securities,   Pledged as Collateral							272,626
Securities in a Continuous Loss Position, at Fair Value:
Less than 12 Months	$	27,814	$	29,714	$	—	$	57,528
12 Months or Longer	171		—		—		171
Total	$	27,985	$	29,714	$	—	$	57,699
Number of Securities in a   Continuous Loss Position	97		13		—		110
Unrealized Losses on Securities in a Continuous Loss Position:
Less than 12 Months	$	532	$	33	$	—	$	565
12 Months or Longer	2		—		—		2
Total	$	534	$	33	$	—	$	567

In the tables above, maturities of mortgage-backed-securities - residential are included based on their expected average lives.  Actual maturities will differ from the table below because issuers may have the right to call or prepay obligations with or without prepayment penalties.

# 11

In the available-for-sale category at September 30, 2014, U.S. agency obligations consisted solely of U.S. Government Agency securities with an amortized cost of $134.5 million and a fair value of $134.1 million. Mortgage-backed securities - residential consisted of U.S. Government Agency securities with an amortized cost of $26.0 million and a fair value of $26.6 million and government sponsored entity (GSE) securities with an amortized cost of $100.1 million and a fair value of $103.5 million. In the held-to-maturity category at September 30, 2014, mortgage-backed securities-residential consisted of U.S Government Agency securities with an amortized cost of $4.5 million and a fair value of $4.6 million and GSE securities with an amortized cost of $112.3 million and a fair value of $112.9 million.

In the available-for-sale category at December 31, 2013, U.S. agency obligations consisted solely of U.S. Government Agency securities with an amortized cost of $136.9 million and a fair value of $136.5 million. Mortgage-backed securities-residential consisted of U.S. Government Agency securities with an amortized cost of $31.5 million and a fair value of $32.2 million and GSE securities with an amortized cost of $139.8 million and a fair value of $143.6 million. In the held-to-maturity category at December 31, 2013, mortgage-backed securities-residential consisted of U.S. Government Agency securities with an amortized cost of $4.9 million and a fair value of $4.7 million and GSE securities with an amortized cost of $95.2 million and a fair value of $94.2 million.

In the available-for-sale category at September 30, 2013, U.S. agency obligations consisted solely of U.S. Government Agency securities with an amortized cost of $150.2 million and a fair value of $149.8 million. Mortgage-backed securities-residential consisted of US Government Agency securities with an amortized cost of $32.5 million and a fair value of $33.6 million and GSE securities with an amortized cost of $146.7 million and a fair value of $151.6 million. In the held-to-maturity category at September 30, 2013, mortgage-backed securities-residential consisted of U.S. Government Agency securities with an amortized cost of $5.0 million and a fair value of $4.9 million and GSE securities with an amortized cost of $73.6 million and a fair value of $73.9 million.

Securities in a continuous loss position, in the tables above for September 30, 2014, December 31, 2013 and September 30, 2013, do not reflect any deterioration of the credit worthiness of the issuing entities.  U.S. Agency issues, including agency-backed collateralized mortgage obligations and mortgage-backed securities, are all rated at least Aaa by Moody's or AA+ by Standard and Poor's.  The state and municipal obligations are general obligations supported by the general taxing authority of the issuer, and in some cases are insured. Obligations issued by school districts are supported by state aid.  For any non-rated municipal securities, credit analysis is performed in-house based upon data that has been submitted by the issuers to the NY State Comptroller. That analysis reflects satisfactory credit worthiness of the municipalities.  Corporate and other debt securities continue to be rated above investment grade according to Moody's and Standard and Poor's. Subsequent to September 30, 2014, and through the date of filing this report, there were no securities downgraded below investment grade.  

The unrealized losses on these temporarily impaired securities are primarily the result of changes in interest rates for fixed rate securities where the interest rate received is less than the current rate available for new offerings of similar securities, changes in market spreads as a result of shifts in supply and demand, and/or changes in the level of prepayments for mortgage related securities.   Because we do not currently intend to sell any of our temporarily impaired securities, and because it is not more likely-than-not that we would be required to sell the securities prior to recovery, the impairment is considered temporary.

# 12

Note 3.    LOANS (In Thousands)

Loan Categories and Past Due Loans

The following table presents loan balances outstanding as of September 30, 2014, December 31, 2013 and September 30, 2013 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 $1,149, $64 and $1,561 as of September 30, 2014, December 31, 2013 and September 30, 2013, respectively, are included in the residential real estate balances for current loans.

Past Due Loans
			Commercial		Commercial		Other
	Commercial		Construction		Real Estate		Consumer		Automobile		Residential		Total
September 30, 2014
Loans Past Due 30-59 Days	$	109	$	—	$	—	$	24	$	2,938	$	389	$	3,460
Loans Past Due 60-89 Days	210		—		232		8		1,058		1,379		2,887
Loans Past Due 90 or more Days	485		—		1,832		9		257		3,064		5,647
Total Loans Past Due	804		—		2,064		41		4,253		4,832		11,994
Current Loans	96,042		26,709		311,835		7,372		415,300		512,188		1,369,446
Total Loans	$	96,846	$	26,709	$	313,899	$	7,413	$	419,553	$	517,020	$	1,381,440
Loans 90 or More Days Past Due   and Still Accruing Interest	$	328	$	—	$	—	$	—	$	—	$	243	$	571
Nonaccrual Loans	$	241	$	—	$	2,073	$	10	$	428	$	4,296	$	7,048
December 31, 2013
Loans Past Due 30-59 Days	$	304	$	—	$	200	$	37	$	3,233	$	529	$	4,303
Loans Past Due 60-89 Days	601		—		1,200		19		1,041		1,527		4,388
Loans Past Due 90 or more Days	177		—		2,034		—		98		3,113		5,422
Total Loans Past Due	1,082		—		3,434		56		4,372		5,169		14,113
Current Loans	86,811		27,815		284,685		7,593		389,832		455,623		1,252,359
Total Loans	$	87,893	$	27,815	$	288,119	$	7,649	$	394,204	$	460,792	$	1,266,472
Loans 90 or More Days Past Due   and Still Accruing Interest	$	28	$	—	$	—	$	—	$	—	$	624	$	652
Nonaccrual Loans	$	352	$	—	$	2,048	$	—	$	219	$	3,860	$	6,479
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

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, primarily within the communities that we serve. Many projects will ultimately be used by the borrowers’ businesses, while others are developed for resale.

# 13

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. 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 an existing 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. It is our general practice to underwrite our residential real estate loans to secondary market standards. Construction loans have a unique risk, because they are secured by an incomplete dwelling. This risk is reduced through periodic site inspections, including one at each loan draw period. In addition, the Company offers fixed home equity loans as well as home equity lines of credit to consumers to finance home improvements, debt consolidation, education and other uses.  Our policy allows for a maximum loan to value ratio of 80%, although periodically higher advances are allowed.  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, 2014	$	2,055		$	445		$	3,770		$	266		$	4,414		$	3,133		$	953		$	15,036
Charge-offs	(26		)	—			—			(8		)	(185		)	(46		)	—			(265		)
Recoveries	24			—			—			3			51			—			—			78
Provision	90			(45		)	(19		)	(7		)	256			187			(18		)	444
September 30, 2014	$	2,143		$	400		$	3,751		$	254		$	4,536		$	3,274		$	935		$	15,293
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

# 14

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, 2013	$	1,886		$	417		$	3,545		$	272		$	4,206		$	3,026		$	1,082		$	14,434
Charge-offs	(192		)	—			—			(34		)	(452		)	(91		)	—			(769		)
Recoveries	49			—			—			4			168			—			—			221
Provision	400			(17		)	206			12			614			339			(147		)	1,407
September 30, 2014	$	2,143		$	400		$	3,751		$	254		$	4,536		$	3,274		$	935		$	15,293
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
September 30, 2014
Allowance for loan losses - Loans Individually Evaluated for Impairment	$	—		$	—		$	—		$	—		$	—		$	82		$	—		$	82
Allowance for loan losses - Loans Collectively Evaluated for Impairment	$	2,143		$	400		$	3,751		$	254		$	4,536		$	3,192		$	935		$	15,211
Ending Loan Balance - Individually Evaluated for Impairment	$	201		$	—		$	1,493		$	—		$	123		$	2,200		$	—		$	4,017
Ending Loan Balance - Collectively Evaluated for Impairment	$	96,645		$	26,709		$	312,406		$	7,413		$	419,430		$	514,820		$	—		$	1,377,423
December 31, 2013
Allowance for loan losses - Loans Individually Evaluated for Impairment	$	—		$	—		$	—		$	—		$	—		$	—		$	—		$	—
Allowance for loan losses - Loans Collectively Evaluated for Impairment	$	1,886		$	417		$	3,545		$	272		$	4,206		$	3,026		$	1,082		$	14,434
Ending Loan Balance - Individually Evaluated for Impairment	$	221		$	—		$	1,785		$	—		$	173		$	2,309		$	—		$	4,488
Ending Loan Balance - Collectively Evaluated for Impairment	$	87,672		$	27,815		$	286,334		$	7,649		$	394,031		$	458,483		$	—		$	1,261,984
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

# 15

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. 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 satisfactory, special mention and substandard). Additional description of the credit risk classifications is detailed in the Credit Quality Indicators section of this note.

We determine the annualized 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.

# 16

Credit Quality Indicators

The following table presents the credit quality indicators by loan category at September 30, 2014, December 31, 2013 and September 30, 2013:

Loan Credit Quality Indicators
			Commercial		Commercial		Other
	Commercial		Construction		Real Estate		Consumer		Automobile		Residential		Total
September 30, 2014
Credit Risk Profile by Creditworthiness Category:
Satisfactory	$	82,232	$	26,709	$	289,686							$	398,627
Special Mention	4,969		—		7,032								12,001
Substandard	9,645		—		17,181								26,826
Doubtful	—		—		—								—
Credit Risk Profile Based on Payment Activity:
Performing							$	7,403	$	419,125	$	512,481	939,009
Nonperforming							10		428		4,539		4,977
December 31, 2013
Credit Risk Profile by Creditworthiness Category:
Satisfactory	79,966		27,815		267,612								375,393
Special Mention	204		—		634								838
Substandard	7,723		—		19,873								27,596
Doubtful	—		—		—								—
Credit Risk Profile Based on Payment Activity:
Performing							7,649		393,985		456,308		857,942
Nonperforming							—		219		4,484		4,703
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

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

# 17

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.  Large 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, 2014
Recorded Investment:
With No Related Allowance	$	201	$	—	$	1,493	$	—	$	123	$	1,667	$	3,484
With a Related Allowance	—		—		—		—		—		533		533
Unpaid Principal Balance:
With No Related Allowance	201		—		1,493		—		123		1,667		3,484
With a Related Allowance	—		—		—		—		—		533		533
December 31, 2013
Recorded Investment:
With No Related Allowance	$	221	$	—	$	1,785	$	—	$	173	$	2,309	$	4,488
With a Related Allowance	—		—		—		—		—		—		—
Unpaid Principal Balance:
With No Related Allowance	221		—		1,785		—		173		2,309		4,488
With a Related Allowance	—		—		—		—		—		—		—
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	—		—		—		—		—		—		—
For the Quarter Ended:
September 30, 2014
Average Recorded Balance:
With No Related Allowance	$	205	$	—	$	1,493	$	—	$	124	$	1,394	$	3,216
With a Related Allowance	—		—		—		—		—		554		554
Interest Income Recognized:
With No Related Allowance	2		—		—		—		2		—		4
With a Related Allowance	—		—		—		—		—		—		—
Cash Basis Income:
With No Related Allowance	—		—		—		—		—		—		—
With a Related Allowance	—		—		—		—		—		—		—
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	—		—		—		—		—		—		—

# 18

Impaired Loans
			Commercial		Commercial		Other
	Commercial		Construction		Real Estate		Consumer		Automobile		Residential		Total
For the Year-To-Date Period Ended:
September 30, 2014
Average Recorded Balance:
With No Related Allowance	$	211	$	—	$	1,639	$	—	$	148	$	1,988	$	3,986
With a Related Allowance	—		—		—		—		—		267		267
Interest Income Recognized:
With No Related Allowance	7		—		—		—		6		1		14
With a Related Allowance	—		—		—		—		—		—		—
Cash Basis Income:
With No Related Allowance	—		—		—		—		—		—		—
With a Related Allowance	—		—		—		—		—		—		—
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

At September 30, 2014, December 31, 2013 and September 30, 2013, 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 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.

# 19

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, 2014
Number of Loans	—		—		—		—		1		—		1
Pre-Modification Outstanding Recorded Investment	$	—	$	—	$	—	$	—	$	12	$	—	$	12
Post-Modification Outstanding Recorded Investment	$	—	$	—	$	—	$	—	$	12	$	—	$	12
September 30, 2013
Number of Loans	—		—		—		—		2		—		2
Pre-Modification Outstanding Recorded Investment	$	—	$	—	$	—	$	—	$	16	$	—	$	16
Post-Modification Outstanding Recorded Investment	$	—	$	—	$	—	$	—	$	16	$	—	$	16
For the Year-To-Date Period Ended:
September 30, 2014
Number of Loans	—		—		—		—		2		1		3
Pre-Modification Outstanding Recorded Investment	$	—	$	—	$	—	$	—	$	14	$	574	$	588
Post-Modification Outstanding Recorded Investment	$	—	$	—	$	—	$	—	$	14	$	574	$	588
September 30, 2013
Number of Loans	—		—		—		—		7		—		7
Pre-Modification Outstanding Recorded Investment	$	—	$	—	$	—	$	—	$	57	$	—	$	57
Post-Modification Outstanding Recorded Investment	$	—	$	—	$	—	$	—	$	57	$	—	$	57

In general, loans requiring modification are restructured to accommodate the projected cashflows of the borrower. As indicated in the table above, no loans modified during the preceding twelve months subsequently defaulted as of September 30, 2014.

Note 4.    GUARANTEES (In Thousands)

The following table presents the balance for standby letters of credit for the periods ended September 30, 2014, December 31, 2013 and September 30, 2013:

Loan Commitments and Letters of Credit
	September 30, 2014		December 31, 2013		September 30, 2013
Notional Amount:
Commitments to Extend Credit	$	255,587	$	237,940	$	243,254
Standby Letters of Credit	3,157		3,345		3,525
Fair Value:
Commitments to Extend Credit	$	—	$	—	$	—
Standby Letters of Credit	52		65		56

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

# 20

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 expected to expire without being 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 commitments 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 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 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, 2014, December 31, 2013 and September 30, 2013 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 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 typically range from 1% to 3% of the notional amount.  Fees are collected upfront and are amortized over the life of the commitment. The fair values of Arrow's standby letters of credit at September 30, 2014, December 31, 2013 and September 30, 2013, in the table above, were the same as the carrying amounts.  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.

# 21

Note 5.    COMPREHENSIVE INCOME (In Thousands)

The following table presents the components of other comprehensive income for the three and nine months ended September 30, 2014 and 2013 :

Schedule of Comprehensive Income
	Three Months Ended September 30,									Nine Months Ended September 30,
				Tax									Tax
	Before-Tax			(Expense)			Net-of-Tax			Before-Tax			(Expense)			Net-of-Tax
	Amount			Benefit			Amount			Amount			Benefit			Amount
2014
Net Unrealized Securities Holding Losses Arising During the Period	$	(1,274	)	$	504		$	(770	)	$	(25	)	$	10		$	(15	)
Reclassification Adjustment for Securities Gains Included in Net Income	(137		)	55			(82		)	(110		)	44			(66		)
Amortization of Net Retirement Plan Actuarial Loss	116			(46		)	70			346			(137		)	209
Accretion of Net Retirement Plan Prior Service Credit	(22		)	9			(13		)	(65		)	26			(39		)
Other Comprehensive (Loss) Income	$	(1,317	)	$	522		$	(795	)	$	146		$	(57	)	$	89
2013
Net Unrealized Securities Holding Gains (Losses) Arising During the Period	$	2,003		$	(793	)	$	1,210		$	(3,664	)	$	1,451		$	(2,213	)
Reclassification Adjustment for Securities Gains Included in Net Income	—			—			—			(540		)	214			(326		)
Amortization of Net Retirement Plan Actuarial Loss	390			(155		)	235			1,173			(466		)	707
Accretion of Net Retirement Plan Prior Service Credit	1			—			1			1			—			1
Other Comprehensive Income (Loss)	$	2,394		$	(948	)	$	1,446		$	(3,030	)	$	1,199		$	(1,831	)

# 22

The following table presents the changes in accumulated other comprehensive income by component:

Changes in Accumulated Other Comprehensive Income (Loss) by Component (1)
	Unrealized			Defined Benefit Plan Items
	Gains and
	Losses on						Net Prior
	Available-for-			Net Gain			Service
	Sale Securities			(Loss)			(Cost ) Credit			Total
For the Quarter-To-Date periods ended:
June 30, 2014	$	3,145		$	(6,558	)	$	(76	)	$	(3,489	)
Other comprehensive income before reclassifications	(770		)	—			—			(770		)
Amounts reclassified from accumulated other comprehensive income	(82		)	70			(13		)	(25		)
Net current-period other comprehensive income	(852		)	70			(13		)	(795		)
September 30, 2014	$	2,293		$	(6,488	)	$	(89	)	$	(4,284	)
June 30, 2013	$	1,876		$	(13,564	)	$	(51	)	$	(11,739	)
Other comprehensive income before reclassifications	1,210			—			—			1,210
Amounts reclassified from accumulated other comprehensive income	—			235			1			236
Net current-period other comprehensive income	1,210			235			1			1,446
September 30, 2013	$	3,086		$	(13,329	)	$	(50	)	$	(10,293	)
For the Year-To-Date periods ended:
December 31, 2013	$	2,374		$	(6,697	)	$	(50	)	$	(4,373	)
Other comprehensive income before reclassifications	(15		)	—			—			(15		)
Amounts reclassified from accumulated other comprehensive income	(66		)	209			(39		)	104
Net current-period other comprehensive income	(81		)	209			(39		)	89
September 30, 2014	$	2,293		$	(6,488	)	$	(89	)	$	(4,284	)
December 31, 2012	$	5,625		$	(14,036	)	$	(51	)	$	(8,462	)
Other comprehensive income before reclassifications	(2,213		)	—			—			(2,213		)
Amounts reclassified from accumulated other comprehensive income	(326		)	707			1			382
Net current-period other comprehensive income	(2,539		)	707			1			(1,831		)
September 30, 2013	$	3,086		$	(13,329	)	$	(50	)	$	(10,293	)

(1) All amounts are net of tax. Amounts in parentheses indicate debits.

# 23

The following table presents the reclassifications out of accumulated other comprehensive income:

Reclassifications Out of Accumulated Other Comprehensive Income (1)
	Amounts Reclassified
Details about Accumulated Other	from Accumulated Other				Affected Line Item in the Statement
Comprehensive Income (Loss) Components	Comprehensive Income				Where Net Income Is Presented
For the Quarter-to-date periods ended:
September 30, 2014
Unrealized gains and losses on available-for-sale securities
	$	137			Gain on Securities Transactions
	137				Total before Tax
	(55		)		Provision for Income Taxes
	$	82			Net of Tax
Amortization of defined benefit pension items
Prior-service costs	$	22		(2)	Salaries and Employee Benefits
Actuarial gains/(losses)	(116		)	(2)	Salaries and Employee Benefits
	(94		)		Total before Tax
	37				Provision for Income Taxes
	$	(57	)		Net of Tax
Total reclassifications for the period	$	25			Net of Tax
September 30, 2013
Unrealized gains and losses on available-for-sale securities
	$	—			Gain on Securities Transactions
	—				Total before Tax
	—				Provision for Income Taxes
	$	—			Net of Tax
Amortization of defined benefit pension items
Prior-service costs	$	(1	)	(2)	Salaries and Employee Benefits
Actuarial gains/(losses)	(390		)	(2)	Salaries and Employee Benefits
	(391		)		Total before Tax
	155				Provision for Income Taxes
	$	(236	)		Net of Tax
Total reclassifications for the period	$	(236	)		Net of Tax

# 24

Reclassifications Out of Accumulated Other Comprehensive Income (1)
	Amounts Reclassified
Details about Accumulated Other	from Accumulated Other				Affected Line Item in the Statement
Comprehensive Income (Loss) Components	Comprehensive Income				Where Net Income Is Presented
For the Year-to-date periods ended:
September 30, 2014
Unrealized gains and losses on available-for-sale securities
	$	110			Gain on Securities Transactions
	110				Total before Tax
	(44		)		Provision for Income Taxes
	$	66			Net of Tax
Amortization of defined benefit pension items
Prior-service costs	$	65		(2)	Salaries and Employee Benefits
Actuarial gains/(losses)	(346		)	(2)	Salaries and Employee Benefits
	(281		)		Total before Tax
	111				Provision for Income Taxes
	$	(170	)		Net of Tax
Total reclassifications for the period	$	(104	)		Net of Tax
September 30, 2013
Unrealized gains and losses on available-for-sale securities
	$	540			Gain on Securities Transactions
	540				Total before Tax
	(214		)		Provision for Income Taxes
	$	326			Net of Tax
Amortization of defined benefit pension items
Prior-service costs	(1		)	(2)	Salaries and Employee Benefits
Actuarial gains/(losses)	$	(1,173	)	(2)	Salaries and Employee Benefits
	(1,174		)		Total before Tax
	466				Provision for Income Taxes
	$	(708	)		Net of Tax
Total reclassifications for the period	$	(382	)		Net of Tax

(1) Amounts in parentheses indicate debits to profit/loss.

(2) These accumulated other comprehensive income components are included in the computation of net periodic pension cost (see pension footnote for additional details.).

# 25

Note 6.    STOCK BASED COMPENSATION PLANS

Under our 2013 Long-Term Incentive Plan, we granted options in the first quarter of 2014 to purchase shares of our common stock. The fair values of the options were estimated on the date of grant using the Black-Scholes option-pricing model. The fair value of our grants is expensed over the four year vesting period. Share and per share amounts have been restated for the September 2013 2% stock dividend.

The following table presents a roll-forward of our stock option plans and grants issued during 2014:

.

Schedule of Share-based Compensation Arrangements
	Stock Option Plans
Roll-Forward of Shares Outstanding:
Outstanding at January 1, 2014	397,187
Granted	75,518
Exercised	(46,099		)
Forfeited	—
Outstanding at September 30, 2014	426,606
Exercisable at Period-End	287,529
Vested and Expected to Vest	139,077
Roll-Forward of Shares Outstanding - Weighted Average Exercise Price:
Outstanding at January 1, 2014	$	22.44
Granted	24.51
Exercised	23.05
Forfeited	—
Outstanding at September 30, 2014	22.74
Exercisable at Period-End	21.91
Vested and Expected to Vest	24.46
Grants Issued During 2014 - Weighted Average Information:
Fair Value	5.92
Fair Value Assumptions:
Dividend Yield	3.97		%
Expected Volatility	35.30		%
Risk Free Interest Rate	2.19		%
Expected Lives (in years)	6.85

The following table presents information on the amounts expensed for the periods ended September 30, 2014 and 2013:

Share-Based Compensation Expense
	For the Three Months Ended September 30,				For the Nine Months Ended September 30,
	2014		2013		2014		2013
Share-Based Compensation Expense	$	90	$	92	$	270	$	281

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

# 26

Note 7.    RETIREMENT PLANS (Dollars in Thousands)

The following tables provide the components of net periodic benefit costs for the three and nine-month periods ended September 30:

				Select
	Employees'			Executive		Postretirement
	Pension			Retirement		Benefit
	Plan			Plan		Plans
Net Periodic Benefit Cost
For the Three Months Ended September 30, 2014:
Service Cost	$	377		$	—	$	52
Interest Cost	298			55		49
Expected Return on Plan Assets	(722		)	—		—
Amortization of Prior Service (Credit) Cost	(11		)	18		(29		)
Amortization of Net Loss	86			23		7
Net Periodic Benefit Cost	$	28		$	96	$	79
Plan Contributions During the Period	$	—		$	119	$	72
For the Three Months Ended September 30, 2013:
Service Cost	$	367		$	5	$	51
Interest Cost	315			33		56
Expected Return on Plan Assets	(716		)	—		—
Amortization of Prior Service (Credit) Cost	10			19		(28		)
Amortization of Net Loss	311			38		41
Net Periodic Benefit Cost	$	287		$	95	$	120
Plan Contributions During the Period	$	—		$	133	$	77
Net Periodic Benefit Cost
For the Nine Months Ended September 30, 2014:
Service Cost	$	1,130		$	—	$	158
Interest Cost	896			164		221
Expected Return on Plan Assets	(2,167		)	—		—
Amortization of Prior Service Cost (Credit)	(33		)	54		(86		)
Amortization of Net Loss	258			68		20
Net Periodic Benefit Cost	$	84		$	286	$	313
Plan Contributions During the Period	$	—		$	356	$	300
Estimated Future Contributions in the Current Fiscal Year	$	—		$	119	$	72
For the Nine Months Ended September 30, 2013:
Service Cost	$	1,101		$	32	$	153
Interest Cost	944			81		206
Expected Return on Plan Assets	(2,148		)	—		—
Amortization of Prior Service (Credit) Cost	28			59		(86		)
Amortization of Net Loss	935			114		124
Net Periodic Benefit Cost	$	860		$	286	$	397
Plan Contributions During the Period	$	—		$	354	$	252

We are not required to make a contribution to our qualified pension plan in 2014, and currently, we do not expect to make a contribution in 2014. Arrow makes contributions to its other post-retirement benefit plans in an amount equal to benefit payments for the year.

# 27

Note 8.    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, 2014 and 2013.  All share and per share amounts have been adjusted for the September 2013 2% stock dividend.

Earnings Per Share
	Quarterly Period Ended:				Year-to-Date Period Ended:
	September 30, 2014		September 30, 2013		September 30, 2014		September 30, 2013
Earnings Per Share - Basic:
Net Income	$	6,147	$	5,623	$	16,991	$	16,011
Weighted Average Shares - Basic	12,606		12,555		12,601		12,527
Earnings Per Share - Basic	$	0.49	$	0.45	$	1.35	$	1.28
Earnings Per Share - Diluted:
Net Income	$	6,147	$	5,623	$	16,991	$	16,011
Weighted Average Shares - Basic	12,606		12,555		12,601		12,527
Dilutive Average Shares Attributable to Stock Options	15		36		12		21
Weighted Average Shares - Diluted	12,621		12,591		12,613		12,548
Earnings Per Share - Diluted	$	0.49	$	0.45	$	1.35	$	1.28
Antidilutive Shares Excluded from the Calculation of Earnings Per Share	—		47		—		47

# 28

Note 9.    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	)

# 29

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.

# 30

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		—		—

# 31

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.

# 32

Report of Independent Registered Public Accounting Firm

The Board of Directors and Stockholders

Arrow Financial Corporation:

We have reviewed the consolidated balance sheets of Arrow Financial Corporation and subsidiaries (the Company) as of September 30, 2014 and 2013, and the related consolidated statements of income and comprehensive income for the three and nine-month periods ended September 30, 2014 and 2013, and the related consolidated statements of changes in stockholders' equity and cash flows for the nine-month periods ended September 30, 2014 and 2013. These consolidated financial statements are the responsibility of the Company's management.

We conducted our reviews in accordance with the standards of the Public Company Accounting Oversight Board (United States). A review of 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 Public Company Accounting Oversight Board (United States), 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.

Based on our reviews, we are not aware of any material modifications that should be made to the consolidated financial statements referred to above for them to be in conformity with U.S. generally accepted accounting principles.

We have previously audited, in accordance with standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheet of Arrow Financial Corporation and subsidiaries as of December 31, 2013, 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 14, 2014, 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, 2013, is fairly stated, in all material respects, in relation to the consolidated balance sheet from which it has been derived.

/s/ KPMG LLP

Albany, New York

November 7, 2014

# 33

ARROW FINANCIAL CORPORATION AND SUBSIDIARIES

MANAGEMENT'S DISCUSSION AND ANALYSIS OF

FINANCIAL CONDITION AND RESULTS OF OPERATIONS

September 30, 2014

Note on Terminology - In this Quarterly Report on Form 10-Q, 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.

The Company and Its Subsidiaries - Arrow is a two-bank holding company headquartered in Glens Falls, New York. Our 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. Our non-bank subsidiaries include Capital Financial Group, Inc. (an insurance agency specializing in selling and servicing group health care policies); three property and casualty insurance agencies: Loomis & LaPann, Inc., Upstate Agency LLC, and McPhillips Agency which is a division of Glens Falls National Insurance Agencies LLC; North Country Investment Advisers, Inc. (a registered investment adviser that provides investment advice to our proprietary mutual funds); Glens Falls National Community Development Corporation (which invests in qualifying community development projects); and Arrow Properties, Inc. (a real estate investment trust, or REIT). All of these are wholly- owned or majority owned subsidiaries of Glens Falls National.    

Our Peer Group - At certain points in this Report, our performance is compared with that of our “peer group” of financial institutions. Unless otherwise specifically stated, this peer group is comprised of the group of 344 domestic bank holding companies with $1 to $3 billion in total consolidated assets as identified in the Federal Reserve Board’s “Bank Holding Company Performance Report” for June 30, 2014 (the most recent such Report currently available), and peer group data has been derived from such Report.

Forward Looking Statements - This Quarterly Report on Form 10-Q contains statements that are not historical in nature but rather are based on our 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 “expects,” “believes,” “anticipates,” “estimates” and variations of such words and similar expressions are intended to identify such forward-looking statements. 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 our general perceptions of market conditions and trends in business activity, both our own and in the banking industry generally, as well as current management strategies for future operations and development.

Examples of Forward-Looking Statements:
Topic	Page	Location
Impact of market rate structure on net interest margin, loan yields and deposit rates	44	1st paragraph under "Quarterly Taxable Equivalent Yield on Loans"
	45	Last paragraph under "Quarterly Taxable Equivalent Yield on Loans"
	56	Last paragraph under "Quantitative and Qualitative Disclosures about Market Risk
Provision for loan losses	47	1st paragraph in section
Future level of nonperforming assets	48	Last 3 paragraphs under "Risk Elements"
Future level of residential real estate loans	44	2nd paragraph under "Residential Real Estate Loans"
Future level of indirect consumer loans	44	Last paragraph under "Automobile Loans"
Future level of commercial loans	44	3rd paragraph under "Commercial, Commercial Real Estate and Construction and Land Development Loans"
Future compliance with regulatory capital standards	39	1st paragraph under "Regulatory Capital and Increase in Stockholders' Equity"
	48	"Important Future Changes to Regulatory Capital Standards"
Liquidity	51	2nd full paragraph
Fees for other services to customers	52	3rd paragraph under "Noninterest Income"
Impact of changes in mortgage rates	46	Paragraph under "Investment Sales, Purchases and Maturities"
VISA	40	"VISA Class B Common Stock"

Forward-looking statements contained herein are not guarantees of future performance and involve certain risks and uncertainties that are difficult to quantify or, in some cases, to identify.  In the case of all such forward-looking statements, 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:  

# 34

a. rapid and dramatic changes in economic and market conditions, such as the U.S. economy experienced in the early stages of the 2008-2009 "financial crisis;"

b.sharp fluctuations in interest rates, economic activity, and consumer spending patterns;

c.sudden changes in the market for products we provide, such as real estate loans;

d. significant new banking laws and regulations, including an assortment of banking regulations recently issued or still to be issued under the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (the Dodd-Frank Act or Dodd-Frank);

e. unexpected or enhanced competition from new or unforeseen sources;

f. network attacks or unauthorized access to computer systems and network infrastructure, interruptions of service and other security risks; and

g. similar uncertainties inherent in banking operations, the financial world, or governmental finance generally, such as periodic heightened concerns about U.S. or state governmental budgets, deficits, spending and taxes.

Readers are cautioned not to place undue reliance on forward-looking statements in this Report, which speak only as of the date hereof. We undertake no obligation to revise or update these forward-looking statements to reflect the occurrence of unanticipated events. This Quarterly Report should be read in conjunction with our Annual Report on Form 10-K for the year ended December 31, 2013.

USE OF NON-GAAP FINANCIAL MEASURES

The Securities and Exchange Commission (SEC) has adopted Regulation G, which applies to all 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 the Company’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 new rules, although we are 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, 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 other institutions 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 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, as opposed to actual net interest income, again to provide a better basis of comparison from institution to institution and to better demonstrate a single institution’s performance over time.  We follow 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, once again, typically expressed on a tax-equivalent basis (see preceding paragraph).  Moreover, most 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 (deducted from noninterest expense) and securities gains or losses (excluded from noninterest income).  We follow these practices.

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 includes many items, but essentially represents goodwill for Arrow.

Adjustments for Certain Items of Income or Expense:  In addition to our disclosures of net income, earnings per share (i.e. EPS), return on average assets (i.e. ROA), return on average equity (i.e. ROE) and other financial measures in accordance with GAAP, we may also provide comparative disclosures that adjust these GAAP financial measures by removing the impact of certain transactions or other material items of income or expense.  We believe that the resulting non-GAAP financial measures may improve an understanding of our results of operations by separating out items that have a disproportional positive or negative impact on the particular period in question. Additionally, we believe that the adjustment for certain items allows 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. When we provide such non-GAAP measure, we disclose that they are non-GAAP and furnish required accompanying information.

We believe that the non-GAAP financial measures disclosed by us 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.  Our non-GAAP financial measures may differ from similar measures presented by other companies.

# 35

Selected Quarterly Information - Unaudited(dollars in thousands)
Quarter Ended	09/30/2014			06/30/2014			03/31/2014			12/31/2013			09/30/2013
Net Income	$	6,147		$	5,524		$	5,320		$	5,784		$	5,623
Transactions Recorded in Net Income (Net of Tax):
Net (Loss) Gain on Securities Transactions	83			(16		)	—			—			—
Net Gain on Sales of Loans	129			100			74			114			100
Share and Per Share Data:1
Period End Shares Outstanding	12,605			12,597			12,597			12,607			12,576
Basic Average Shares Outstanding	12,606			12,595			12,602			12,586			12,555
Diluted Average Shares Outstanding	12,621			12,616			12,613			12,634			12,591
Basic Earnings Per Share	$	0.49		$	0.44		$	0.42		$	0.46		$	0.45
Diluted Earnings Per Share	0.49			0.44			0.42			0.46			0.45
Cash Dividend Per Share	0.25			0.25			0.25			0.25			0.24
Selected Quarterly Average Balances:
Interest-Bearing Deposits at Banks	$	15,041		$	22,486		$	17,184		$	46,853		$	14,096
Investment Securities	653,702			712,088			755,008			762,768			744,928
Loans	1,361,347			1,328,639			1,284,649			1,254,957			1,224,840
Deposits	1,861,115			1,900,399			1,887,589			1,904,922			1,800,181
Other Borrowed Funds	67,291			60,900			68,375			62,038			92,073
Shareholders’ Equity	199,518			196,478			194,127			184,506			179,634
Total Assets	2,154,307			2,183,611			2,176,038			2,176,264			2,095,017
Return on Average Assets	1.13		%	1.01		%	0.99		%	1.05		%	1.06		%
Return on Average Equity	12.22		%	11.28		%	11.11		%	12.44		%	12.42		%
Return on Tangible Equity2	14.04		%	12.99		%	12.84		%	14.50		%	14.55		%
Average Earning Assets	$	2,030,090		$	2,063,213		$	2,056,841		$	2,064,578		$	1,983,864
Average Interest-Bearing Liabilities	1,626,327			1,680,149			1,678,080			1,686,993			1,614,873
Interest Income, Tax-Equivalent	17,834			17,837			17,439			17,633			17,032
Interest Expense	1,399			1,555			1,594			1,713			1,747
Net Interest Income, Tax-Equivalent	16,435			16,282			15,845			15,920			15,285
Tax-Equivalent Adjustment	1,074			1,142			1,173			1,174			1,158
Net Interest Margin 3	3.21		%	3.17		%	3.12		%	3.06		%	3.06		%
Efficiency Ratio Calculation:
Noninterest Expense	$	13,526		$	13,737		$	13,466		$	13,385		$	13,133
Less: Intangible Asset Amortization	(94		)	(94		)	(106		)	(108		)	(108		)
Net Noninterest Expense	$	13,432		$	13,643		$	13,360		$	13,277		$	13,025
Net Interest Income, Tax-Equivalent	$	16,435		$	16,282		$	15,845		$	15,920		$	15,285
Noninterest Income	7,351			7,019			6,886			6,877			6,939
Less: Net Securities (Gain) Loss	(137		)	27			—			—			—
Net Gross Income	$	23,649		$	23,328		$	22,731		$	22,797		$	22,224
Efficiency Ratio	56.80		%	58.48		%	58.77		%	58.24		%	58.61		%
Period-End Capital Information:
Total Stockholders’ Equity (i.e. Book Value)	$	200,089		$	197,616		$	194,491		$	192,154		$	182,683
Book Value per Share	15.87			15.69			15.44			15.24			14.53
Intangible Assets	25,747			25,868			25,999			26,143			26,273
Tangible Book Value per Share 2	13.83			13.63			13.38			13.17			12.44
Capital Ratios:
Tier 1 Leverage Ratio	9.68		%	9.39		%	9.30		%	9.19		%	9.37		%
Tier 1 Risk-Based Capital Ratio	14.41		%	14.49		%	14.55		%	14.70		%	14.59		%
Total Risk-Based Capital Ratio	15.48		%	15.57		%	15.62		%	15.77		%	15.69		%
Assets Under Trust Administration   and Investment Management	$1,199,930			$1,214,841			$1,182,661			$1,174,891			$1,111,085

¹Share and Per Share Data have been restated for the September 29, 2014 2% stock dividend.

²Tangible Book Value and Tangible Equity exclude intangible assets from total equity.  These are non-GAAP financial measures which we believe provide investors with information that is useful in understanding our financial performance (see page 35).

³Net 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 we believe provides investors with information that is useful in understanding our financial performance (see page 35).

# 36

Selected Nine-Month Period Information (Dollars In Thousands, Except Per Share Amounts)
Year-to-Date Period Ended	09/30/2014			09/30/2013
Net Income	16,991			$	16,011
Transactions Recorded in Net Income (Net of Tax):
Net Securities (Loss) Gain	66			326
Net Gain on Sales of Loans	303			767
Period-End Shares Outstanding	12,605			12,576
Basic Average Shares Outstanding	12,601			12,527
Diluted Average Shares Outstanding	12,613			12,548
Basic Earnings Per Share	$	1.35		$	1.28
Diluted Earnings Per Share	1.35			1.28
Cash Dividends Per Share	0.74			0.72
Average Assets	$	2,171,239		$	2,078,027
Average Equity	196,728			178,468
Return on Average Assets	1.05		%	1.03		%
Return on Average Equity	11.55		%	11.99		%
Average Earning Assets	$	2,049,949		$	1,963,363
Average Interest-Bearing Liabilities	1,661,329			1,615,615
Interest Income, Tax-equivalent 1	53,110			51,080
Interest Expense	4,548			6,209
Net Interest Income, Tax-equivalent 1	48,562			44,871
Tax-equivalent Adjustment	3,389			3,401
Net Interest Margin 1	3.17		%	3.06		%
Efficiency Ratio Calculation1
Noninterest Expense	$	40,729		$	39,818
Less: Intangible Asset Amortization	(294		)	(344		)
Net Noninterest Expense	$	40,435		$	39,474
Net Interest Income, Tax-equivalent 1	$	48,562		$	44,871
Noninterest Income	21,256			21,184
Less: Net Securities Gain	(110		)	(540		)
Net Gross Income, Adjusted	$	69,708		$	65,515
Efficiency Ratio 1	58.01		%	60.25		%
Period-End Capital Information:
Tier 1 Leverage Ratio	9.43		%	9.10		%
Total Stockholders' Equity (i.e. Book Value)	$	200,089		$	182,683
Book Value per Share	15.87			14.53
Intangible Assets	25,747			26,273
Tangible Book Value per Share 1	13.83			12.44
Asset Quality Information:
Net Loans Charged-off as a   Percentage of Average Loans, Annualized	0.06		%	0.10		%
Provision for Loan Losses as a   Percentage of Average Loans, Annualized	0.14		%	0.02		%
Allowance for Loan Losses as a   Percentage of Period-end Loans	1.11		%	1.17		%
Allowance for Loan Losses as a   Percentage of Nonperforming Loans	192.00		%	193.32		%
Nonperforming Loans as a   Percentage of Period-end Loans	0.58		%	0.61		%
Nonperforming Assets as a   Percentage of Period-end Total Assets	0.38		%	0.37		%
1See “Use of Non-GAAP Financial Measures” on page 35.

# 37

Average Consolidated Balance Sheets and Net Interest Income Analysis (see “Use of Non-GAAP Financial Measures” on page 35) (Fully Taxable Basis using a marginal tax rate of 35%) (Dollars In Thousands)
Quarter Ended September 30:	2014								2013
				Interest			Rate					Interest			Rate
	Average			Income/			Earned/		Average			Income/			Earned/
	Balance			Expense			Paid		Balance			Expense			Paid
Interest-Bearing Deposits at Banks	$	15,041		$	12		0.32	%	$	14,096		$	11		0.31	%
Investment Securities:
Fully Taxable	383,827			1,924			1.99		416,015			1,559			1.49
Exempt from Federal Taxes	269,875			2,347			3.45		328,913			2,544			3.07
Loans	1,361,347			13,551			3.95		1,224,840			12,918			4.18
Total Earning Assets	2,030,090			17,834			3.49		1,983,864			17,032			3.41
Allowance for Loan Losses	(14,961		)						(14,670		)
Cash and Due From Banks	31,485								32,457
Other Assets	107,693								93,366
Total Assets	$	2,154,307							$	2,095,017
Deposits:
NOW Accounts	$	801,998		386			0.19		$	749,654		423			0.22
Savings Deposits	530,057			218			0.16		509,014			240			0.19
Time Deposits of $100,000 or More	69,351			195			1.12		85,757			297			1.37
Other Time Deposits	157,630			335			0.84		178,375			470			1.05
Total Interest-Bearing Deposits	1,559,036			1,134			0.29		1,522,800			1,430			0.37
Short-Term Borrowings	37,291			23			0.24		52,073			40			0.30
FHLBNY Term Advances and Other Long-Term Debt	30,000			242			3.20		40,000			277			2.75
Total Interest-Bearing Liabilities	1,626,327			1,399			0.34		1,614,873			1,747			0.43
Demand Deposits	302,079								277,381
Other Liabilities	26,383								23,129
Total Liabilities	1,954,789								1,915,383
Stockholders’ Equity	199,518								179,634
Total Liabilities and Stockholders’ Equity	$	2,154,307							$	2,095,017
Net Interest Income (Tax-equivalent Basis)				16,435								15,285
Reversal of Tax Equivalent Adjustment				(1,074		)	0.21	%				(1,158		)	0.23	%
Net Interest Income				$	15,361							$	14,127
Net Interest Spread							3.15	%							2.98	%
Net Interest Margin							3.21	%							3.06	%

# 38

Average Consolidated Balance Sheets and Net Interest Income Analysis (see “Use of Non-GAAP Financial Measures” on page 35) (Fully Taxable Basis using a marginal tax rate of 35%) (Dollars In Thousands)
Nine-Month Period Ended September 30:	2014								2013
				Interest			Rate					Interest			Rate
	Average			Income/			Earned/		Average			Income/			Earned/
	Balance			Expense			Paid		Balance			Expense			Paid
Interest-Bearing Deposits at Banks	$	18,229		$	41		0.30	%	$	27,192		$	57		0.28	%
Investment Securities:
Fully Taxable	411,730			5,981			1.94		431,904			5,003			1.55
Exempt from Federal Taxes	294,831			7,401			3.36		310,815			7,537			3.24
Loans	1,325,159			39,687			4.00		1,193,452			38,483			4.31
Total Earning Assets	2,049,949			53,110			3.46		1,963,363			51,080			3.48
Allowance for Loan Losses	(14,650		)						(14,859		)
Cash and Due From Banks	30,167								31,026
Other Assets	105,773								98,497
Total Assets	$	2,171,239							$	2,078,027
Deposits:
NOW Accounts	$	841,529		1,345			0.21		$	779,063		1,987			0.34
Savings Deposits	520,243			663			0.17		481,465			785			0.22
Time Deposits of $100,000 or More	72,251			626			1.16		88,026			921			1.40
Other Time Deposits	161,788			1,085			0.90		183,196			1,529			1.12
Total Interest-Bearing Deposits	1,595,811			3,719			0.31		1,531,750			5,222			0.46
Short-Term Borrowings	30,170			54			0.24		37,235			76			0.27
FHLBNY Term Advances and Other Long-Term Debt	35,348			775			2.93		46,630			911			2.61
Total Interest-Bearing Liabilities	1,661,329			4,548			0.37		1,615,615			6,209			0.51
Demand Deposits	287,126								259,900
Other Liabilities	26,056								24,044
Total Liabilities	1,974,511								1,899,559
Stockholders’ Equity	196,728								178,468
Total Liabilities and Stockholders’ Equity	$	2,171,239							$	2,078,027
Net Interest Income (Tax-equivalent Basis)				48,562								44,871
Reversal of Tax Equivalent Adjustment				(3,389		)	0.22	%				(3,401		)	0.23	%
Net Interest Income				$	45,173							$	41,470
Net Interest Spread							3.09	%							2.97	%
Net Interest Margin							3.17	%							3.06	%

OVERVIEW

We reported net income for the third quarter of 2014 of $6.1 million, representing diluted earnings per share (EPS) of $0.49. This EPS result was an increase of four cents, or 8.9%, from the EPS of $0.45 reported for the third quarter of 2013. Return on average equity (ROE) for the 2014 quarter continued to be strong at 12.22%, although that represented a decrease from the ROE of 12.42% for the quarter ended September 30, 2013. Return on average assets (ROA) for the 2014third quarter was 1.13%, an increase from ROA of 1.06% for the quarter ended September 30, 2013. Although net income increased from the 2013 third quarter, average equity increased at a faster pace, with the result that the return on average equity fell between the two comparative quarters. Net interest income for the 2014 third quarter was $16.4 million on a tax-equivalent basis, an increase of $1.2 million, or 7.5%, from net interest income of $15.3 million on a tax equivalent basis for the quarter ended September 30, 2013. The net interest margin also increased from the year earlier quarter by 15 basis points, from 3.06% to 3.21%. Total assets were $2.209 billion at September 30, 2014, which represented an increase of $45.0 million, or 2.1%, from the level at December 31, 2013, and an increase of $51.9 million, or 2.4%, from the September 30, 2013 level.

The changes in net income, net interest income and net interest margin between the nine-month periods are more fully described under the heading "RESULTS OF OPERATIONS," beginning on page 51.

Stockholders’ equity was $200.1 million at September 30, 2014, an increase of $17.4 million, or 9.5%, from the year earlier level. Stockholders' equity was also up $7.9 million, or 4.1%, from the December 31, 2013 level of $192.2 million. The components of the change in stockholders’ equity since year-end 2013 are presented in the Consolidated Statement of Changes in Stockholders’ Equity on page 6, and are discussed in more detail in the next section.

Regulatory Capital and Increase in Stockholders' Equity: At period-end, we continued to exceed all current regulatory minimum capital requirements at both the holding company and bank levels, by a substantial amount. As of September 30, 2014 both of our banks, as well as our holding company, qualified as "well-capitalized" under federal bank regulatory guidelines. Our regulatory capital levels have

# 39

consistently remained well in excess of required minimums during recent years, despite the economic downturn, because of our continued profitability and strong asset quality. Even when the new enhanced capital requirements, announced by the federal bank regulatory authorities in June 2013, go into effect on January 1, 2015, we expect that Arrow and our subsidiary banks will continue to meet all of these enhanced standards. See the discussions of "Two Sets of Current Capital Standards" under the “Current Regulatory Capital Standards" section beginning on page 49, and “Important Future Changes to Regulatory Capital Standards” under the "CAPITAL RESOURCES" section beginning on page 48.

At September 30, 2014, our tangible book value per share (calculated based on stockholders' equity reduced by goodwill and other intangible assets) amounted to $13.83, an increase of $0.66, or 5.0%, from December 31, 2013 and an increase of $1.39, or 11.2%, from the level as of September 30, 2013. Our total stockholders' equity at September 30, 2014 increased 9.5% over the year-earlier level, and our total book value per share increased by 9.2% over the year earlier level. In the past nine months, total shareholders' equity increased 4.1% and our total book value per share increased by the same 4.1%. The increase in stockholders' equity over the first nine months of 2014 principally reflected the following factors: (i) $17.0 million net income for the period and (ii) issuance of $1.5 million of common stock through our employee benefit and dividend reinvestment plans; offset in part by (iii) cash dividends of $9.3 million; and (iv) repurchases of our own common stock of $2.2 million. As of September 30, 2014, our closing stock price was $25.07, representing a trading multiple of 1.81 to our tangible book value. As adjusted for a 2% stock dividend distributed September 29, 2014, the Board of Directors declared and the Company paid quarterly cash dividends of $.240 per share for the first three quarters of 2013, and cash dividends of $.245 per share for the last quarter of 2013 and the first three quarters of 2014.

Loan Quality: The credit quality of our loan portfolio has continued in recent periods to be significantly stronger than the average for our peer group of U.S. bank holding companies with $1 billion to $3 billion in total assets (see page 34 for information on how we define our peer group).

Our net charge-offs for the third quarter of 2014 were $187 thousand as compared to $94 thousand for the 2013 quarter. Our ratio of net charge-offs to average loans (annualized) for the first three quarters of 2014 and 2013 were 0.06% and 0.10%, respectively. By contrast, our peer group's ratio of net charge-offs to average loans for first six months of 2014 was 0.16%. At September 30, 2014, our allowance for loan losses was $15.3 million representing 1.11% of total loans, down three basis points from the December 31, 2013 ratio, due to a general improvement in the credit quality in the loan portfolio.

Nonperforming loans were $8.0 million at September 30, 2014, representing 0.58% of period-end loans. By way of comparison, this ratio for our peer group was 1.26% at June 30, 2014, and this peer ratio represented a significant improvement from the peer group's ratios of earlier years. For example, our peer group's nonperforming loans ratio was 3.60% at year-end 2010, the high-point after the onset of the 2008 recession, while our ratio has remained quite low and stable from 2008 through the date of this Report.

During the first nine months of 2014, we experienced increases in outstanding balances of all three of our major loan portfolio segments, without any significant deterioration in our credit quality:

Residential Real Estate Loans: These loans, including home equity loans, made up approximately 37% of our portfolio at period-end. The residential real estate market in our service area has been stable in recent periods. During the worst of the financial crisis, we did not experience a notable increase in our foreclosure or loss rates on our residential real estate loans, nor have we in ensuing periods, primarily due to the fact that we never have originated or participated in underwriting high-risk mortgage loans, such as so called “Alt A,” “negative amortization,” “option ARM's” or “negative equity” loans. We originated all of the residential real estate loans currently held in our portfolio and apply conservative underwriting standards to our originations.

Commercial Loans: These loans comprised approximately 32% of our loan portfolio at period-end. Current unemployment rates in our region remain elevated from pre-crisis levels, although the local economy continues to be stable and in some areas recovering. Similarly, commercial property values in our region remain stable, and did not show significant deterioration even in the worst phases of the financial crisis. We update the appraisals on our nonperforming and watched commercial loan properties as deemed necessary, usually when the loan is downgraded or when we perceive significant market deterioration since our last appraisal.

Automobile Loans (Primarily Through Indirect Lending): These loans comprised approximately 30% of our loan portfolio. In the first nine months of 2014, we did not experience any significant change in our delinquency rate or level of nonperforming loans.

Liquidity and Access to Credit Markets: We have not experienced any liquidity problems or special concerns during 2014 to date, nor did we during 2013 or 2012. The terms of our lines of credit with our correspondent banks, the FHLBNY and the Federal Reserve Bank have not changed. In general, we rely 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 (our main liability-based sources are overnight borrowing arrangements with our correspondent banks, term credit arrangement advances from the FHLBNY and the Federal Reserve Bank discount window). During the recent financial crisis, many financial institutions, small and large, relied extensively on the Fed's discount window to support their liquidity positions, but we had no such need. We regularly perform a liquidity stress test and periodically test our contingent liquidity plan to ensure that we can generate an adequate amount of available funds to meet a wide variety of potential liquidity crises, including a severe crisis.

VISA Class B Common Stock: We continue to believe, based on such information as is available to us as a Visa member bank, that the multi-billion dollar balance that Visa maintains in the escrow fund that it has established to cover certain litigation-related liability to third parties is substantially sufficient to defray such liability, including expenses, and thus that any contingent liability that we and other Visa member banks may have for such losses is not material. Member banks contingent liability, if any, would be payable out of the equity attributable to their holdings of Visa Class B Common Stock. The Company continues not to recognize any economic value for its remaining shares of Visa Class B common stock.

# 40

CHANGE IN FINANCIAL CONDITION

Summary of Selected Consolidated Balance Sheet Data

(Dollars in Thousands)

	At Period-End						$ Change			$ Change			% Change		% Change
	September 30, 2014		December 31, 2013		September 30, 2013		From December			From September			From December		From September
Interest-Bearing Bank Balances	$	17,893	$	12,705	$	24,539	$	5,188		$	(6,646	)	40.8	%	(27.1	)%
Securities Available-for-Sale	374,335		457,606		486,888		(83,271		)	(112,553		)	(18.2	)%	(23.1	)%
Securities Held-to-Maturity	296,522		299,261		273,626		(2,739		)	22,896			(0.9	)%	8.4	%
Loans (1)	1,381,440		1,266,472		1,243,370		114,968			138,070			9.1	%	11.1	%
Allowance for Loan Losses	15,293		14,434		14,584		859			709			6.0	%	4.9	%
Earning Assets (1)	2,073,191		2,042,325		2,032,319		30,866			40,872			1.5	%	2.0	%
Total Assets	2,208,745		2,163,698		2,156,858		45,047			51,887			2.1	%	2.4	%
Demand Deposits	296,384		278,958		280,326		17,426			16,058			6.2	%	5.7	%
NOW Accounts	887,865		817,366		839,213		70,499			48,652			8.6	%	5.8	%
Savings Deposits	524,906		498,779		516,010		26,127			8,896			5.2	%	1.7	%
Time Deposits of $100,000 or More	69,797		78,928		83,702		(9,131		)	(13,905		)	(11.6	)%	(16.6	)%
Other Time Deposits	156,404		168,299		176,124		(11,895		)	(19,720		)	(7.1	)%	(11.2	)%
Total Deposits	$	1,935,356	$	1,842,330	$	1,895,375	$	93,026		$	39,981		5.0	%	2.1	%
Federal Funds Purchased and   Securities Sold Under Agreements   to Repurchase	$	19,654	$	11,777	$	15,977	$	7,877		$	3,677		66.9	%	23.0	%
FHLB Advances - Overnight	—		53,000		—		(53,000		)	—			(100.0	)%	—	%
FHLB Advances - Term	10,000		20,000		20,000		(10,000		)	(10,000		)	(50.0	)%	(50.0	)%
Stockholders' Equity	200,089		192,154		182,683		7,935			17,406			4.1	%	9.5	%

(1) Includes Nonaccrual Loans

Municipal Deposits:Fluctuations in balances of our NOW accounts and time deposits of $100,000 or more are largely the result of municipal deposit seasonality factors. Over the past twelve months, municipal deposits on average have ranged from 28% to over 33% of our total deposits. As of September 30, 2014, municipal deposits represented 32.7% of total deposits. Municipal deposits typically are invested in NOW accounts and time deposits of short duration. Many of our municipal deposit relationships are subject to annual renewal, by formal or informal agreement.

In general, there is a seasonal pattern to municipal deposits starting with a low point during July and August. Account balances tend to increase throughout the fall and remain elevated during the winter months, due to tax deposits, and generally receive an additional boost at the end of March from the electronic deposit of state aid to school districts. In addition to these seasonal fluctuations within accounts, the overall level of municipal deposit balances fluctuates from year-to-year as some municipalities move their accounts in and out of our banks due to competitive factors. Often, the balances of municipal deposits at the end of a quarter are not representative of the average balances for that quarter.

The recent financial crisis had a significant negative impact on municipal tax revenues in many regions, and consequently on municipal funds available for deposit. To date, this has not resulted in either a sustained decrease in municipal deposit levels at our banks, adjusted for seasonal fluctuations (in fact, we have experienced an increase in such deposits in the first nine months of 2014 - see following paragraph), or an overall increase in the average rate we pay on such deposits (despite the continuing strong competition for such deposits). However, if in the future interest rates begin to rise significantly or the competition for municipal deposits otherwise becomes more intense, we may experience either or both of these adverse developments, i.e., a sustained decrease in municipal deposit levels and/or an overall increase in the average rate we pay on such deposits.

Changes in Sources of Funds: In recent periods, for cost reasons and because of the sustained growth of customer deposits even at very low rates, we have lessened our reliance on wholesale funding sources and increased our reliance on customer deposits as a source of day-to-day funding. Our total deposits increased$93.0 million, or 5.0%, from December 31, 2013 to September 30, 2014, mainly due to an increase in our municipal deposits. Our non-municipal deposit balances also increased over the past nine months, although we are still experiencing a shift in balances from time deposits to savings and NOW accounts. At September 30, 2014 we were a net seller of overnight funds (held as interest-bearing balances at the Federal Reserve Bank), while we borrowed $53.0 million of overnight funds from the FHLB of New York at December 31, 2013. At September 30, 2014, our term advances from the FHLB were down to $10.0 million, as we paid-off one $10 million advance during the second quarter of 2014.

Changes in Earning Assets: Our loan portfolio increased by $115.0 million, or 9.1%, from December 31, 2013 to September 30, 2014. We experienced the following trends in our three largest segments:

1. Commercial and commercial real estate loans. Our September 30, 2014 balance for this segment increased by $33.6 million, or 8.3%, from the December 31, 2013 total. The increase was fueled by our acquisition of several large loan participations on loans extended by regional banks to their commercial borrowers, while demand generally continued to be strong to moderate.

2. Residential real estate loans. The period-end balance increased by $56.2 million, or 12.2%, from December 31, 2013. We continued to sell some of our residential mortgage originations during the nine-month period to Freddie Mac, although a smaller percentage than we sold in the same period the prior year. Demand for new mortgage loans was modest throughout the period.

# 41

3. Automobile loans (primarily through indirect lending). The balance of these loans at September 30, 2014, increased by $25.3 million, or 6.4%, from the December 31, 2013 balance, reflecting a modest resurgence of automobile sales region-wide and an expansion of our dealer network for indirect lending, as dealer sales in the region rebounded from a slow start to the year due to the effects of a cold and snowy winter in the northeast.

Most of our incoming cash flows for the first nine months of 2014 came from a combination of an increase in deposit balances and to a slightly lesser extent from maturing investments. The investment securities portfolio decreased by a net of $86.0 million, or 11.4% during the first nine months of 2014. In addition to funding loan growth, we used the proceeds to pay off $10 million of FHLB term advances and eliminate our overnight borrowing position.

Deposit Trends

The following two tables provide information on trends in the balance and mix of our 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 principal change over the period was the steady drop-off in time deposits, including time deposits of $100,000 or more, and corresponding steady increases in lower or no-cost deposits, including demand deposits, NOW accounts and savings deposits.

Quarterly Average Deposit Balances

(Dollars in Thousands)

	Quarter Ended
	9/30/2014		6/30/2014		3/31/2014		12/31/2013		9/30/2013
Demand Deposits	$	302,079	$	281,150	$	277,884	$	279,967	$	277,381
NOW Accounts	801,998		865,910		857,286		855,106		749,654
Savings Deposits	530,057		520,028		510,428		517,542		509,014
Time Deposits of $100,000 or More	69,351		71,656		75,819		81,804		85,757
Other Time Deposits	157,630		161,655		166,172		170,503		178,375
Total Deposits	$	1,861,115	$	1,900,399	$	1,887,589	$	1,904,922	$	1,800,181

Percentage of Total Quarterly Average Deposits

	Quarter Ended
	9/30/2014		06/30/2014		03/31/2014		12/31/2013		09/30/2013
Demand Deposits	16.2	%	14.8	%	14.7	%	14.7	%	15.4	%
NOW Accounts	43.1		45.5		45.5		44.8		41.6
Savings Deposits	28.5		27.4		27.0		27.2		28.3
Time Deposits of $100,000 or More	3.7		3.8		4.0		4.3		4.8
Other Time Deposits	8.5		8.5		8.8		9.0		9.9
Total Deposits	100.0	%	100.0	%	100.0	%	100.0	%	100.0	%

For a variety of reasons, we typically experience little growth in average deposit balances in the first quarter of each calendar year (even though municipal balances tend to grow sharply at the very end of the first quarter), little net growth or a small contraction in the second quarter of the year (when municipal deposits normally drop off), and a return to growth in the third and fourth quarters (when municipal deposits tend to increase, sometimes substantially, to and through year-end). This pattern has held true in recent periods. Growth in average deposit balances from the third quarter of 2013 to the third quarter of 2014 came primarily from municipal deposits.

Quarterly Cost of Deposits

	Quarter Ended
	9/30/2014		6/30/2014		3/31/2014		12/31/2013		9/30/2013
Demand Deposits	—	%	—	%	—	%	—	%	—	%
NOW Accounts	0.19		0.23		0.22		0.22		0.22
Savings Deposits	0.16		0.17		0.17		0.18		0.19
Time Deposits of $100,000 or More	1.12		1.13		1.23		1.34		1.37
Other Time Deposits	0.84		0.89		0.95		1.01		1.05
Total Deposits	0.24		0.27		0.28		0.30		0.32

In keeping with industry trend lines, average rates paid by us on deposits decreased steadily over the five quarters ending September 30, 2014, for deposits generally and all deposit categories. Over the same period, our average yield on loans also decreased, for loans generally and across almost all loan categories (see "Quarterly Taxable Equivalent Yield on Loans," page 44).

# 42

Non-Deposit Sources of Funds

We have several sources of funding other than deposits. Historically, we have borrowed funds from the Federal Home Loan Bank ("FHLB") under a variety of programs, including fixed and variable rate short-term borrowings and borrowings in the form of "structured advances." These structured advances typically have original maturities of 3 to 10 years and are callable by the FHLB at certain dates. If the advances are called, we may elect to receive replacement advances from the FHLB at the then prevailing FHLB rates of interest. In recent periods, we have reduced our utilization of FHLB advances as a source of funds.

We have also relied in the past (most recently in 2004), on the issuance of trust preferred securities (or TRUPs) to supplement our funding needs. The $20 million principal amount of Junior Subordinated Obligations Issued to Unconsolidated Subsidiary Trusts (i.e., TRUPs) listed on our consolidated balance sheet as of September 30, 2014 currently qualifies as Tier 1 regulatory capital under regulatory capital adequacy guidelines, as discussed under “Capital Resources” beginning on page 48 of this Report. These trust preferred securities are subject to early redemption by us if the proceeds cease to qualify as Tier 1 capital of Arrow for any reason, or if certain other unanticipated but negative events should occur, such as any adverse change in tax laws that denies the Company the ability to deduct interest paid on these obligations for federal income tax purposes. Under Dodd-Frank, no future issuances of TRUPs by banking organizations of our size will qualify as Tier 1 regulatory capital. Under the final bank capital rules recently issued by the federal bank authorities pursuant to Dodd-Frank, our outstanding TRUPs should continue to be eligible for treatment as Tier 1 capital until they mature or are earlier redeemed by us.

Loan Trends

The following two tables present, for each of the last five quarters, the quarterly average balances by loan type and the percentage of total loans represented by each loan type. Over the last five quarters, the average balances of all loan types have fairly steadily increased, except for other consumer loans (i.e., non-automobile loans), which have remained stable and represent only 1.9% of the total portfolio.

Quarterly Average Loan Balances

(Dollars in Thousands)

	Quarter Ended
	9/30/2014		6/30/2014		3/31/2014		12/31/2013		9/30/2013
Commercial and Commercial Real Estate	$	435,729	$	431,614	$	412,507	$	397,503	$	386,973
Residential Real Estate	358,503		343,816		332,142		322,080		316,582
Home Equity	112,880		107,580		103,694		99,722		94,726
Consumer Loans - Automobile	428,092		419,407		409,723		408,273		398,329
Other Consumer Loans (1)	26,143		26,222		26,583		27,379		28,230
Total Loans	$	1,361,347	$	1,328,639	$	1,284,649	$	1,254,957	$	1,224,840

Percentage of Total Quarterly Average Loans

	Quarter Ended
	9/30/2014		6/30/2014		3/31/2014		12/31/2013		9/30/2013
Commercial and Commercial Real Estate	32.0	%	32.5	%	32.1	%	31.7	%	31.6	%
Residential Real Estate	26.3		25.9		25.9		25.6		25.9
Home Equity	8.3		8.1		8.1		8.0		7.7
Consumer Loans - Automobile	31.5		31.5		31.9		32.5		32.5
Other Consumer Loans (1)	1.9		2.0		2.0		2.2		2.3
Total Loans	100.0	%	100.0	%	100.0	%	100.0	%	100.0	%

⁽¹⁾ The category “Other Consumer Loans”, in the tables above, includes home improvement loans secured by mortgages, which are otherwise reported with residential real estate loans in tables of period-end balances.

Maintenance of High Quality in the Loan Portfolio

For many reasons, including our conservative credit underwriting standards, we largely avoided the negative impact on asset quality that many other banks suffered during the financial crisis. Throughout the crisis and up to the date of this Report, we have not experienced a significant deterioration in our loan portfolios. In general, we underwrite our residential real estate loans to secondary market standards for prime loans. We have never engaged in subprime mortgage lending as a business line, whether in residential mortgage loans, car loans or other consumer loans. We never extended or purchased any so-called "Alt-A", "negative amortization", "option ARM", or "negative equity" mortgage loans. On occasion we have made loans to borrowers having a FICO score of 650 or below (a standard industry marker for a subprime loan), where special circumstances justify doing so, or have had extensions of credit outstanding to borrowers who have developed credit problems after origination resulting in deterioration of their FICO scores.

Residential Real Estate Loans: In recent years, residential real estate and home equity loans have represented the largest single segment of our loan portfolio (comprising approximately 37% of the entire portfolio at September 30, 2014), eclipsing both our commercial and commercial real estate loans (32% of the portfolio) and automobile loans (30% of the portfolio). Our gross originations for residential real estate loans (including refinancings of pre-existing mortgage loans) were $97.8 million and $96.6 million for the first nine months of 2014 and 2013, respectively. These origination totals exceeded the sum of repayments and prepayments in the respective quarters, but in each period we also sold a portion of these originations (in the 2013 period, a significant portion thereof) on or immediately after origination. In the first nine months of 2013, we sold $42.8 million, or 44.3% of our originations, whereas in the first nine months of 2014, we only sold

# 43

$15.5 million, or 15.8% of our originations. During 2014, we introduced competitive products for variable rate (adjustable) residential real estate and construction loans. None of these variable rate loans were subprime loans. We did not sell any of these variable rate loans to the secondary market.

Even though short-term rates have remained very low since 2008, rates on conventional real estate mortgages have fluctuated over the past few years in response to several programs undertaken by the Federal Reserve. If the current historically unprecedented low-rate environment for newly originated residential real estate loans persists for an extended additional period of time, we may continue to sell a significant portion of our loan originations and, as a result, may even experience a decrease in our outstanding balances in this segment of our portfolio. Moreover, if our local economy or real estate market suffers a major downturn, the demand for residential real estate loans in our service area may decrease, which also may negatively impact our real estate portfolio and our financial performance. Management believes it is not possible at this point to project whether mortgage rates or interest rates generally will experience meaningful and substantial increases in upcoming periods, or what the overall effect of any such increase will be on our mortgage loan portfolio or our loan portfolio generally, or on our net interest income, net income or financial results, in upcoming periods.

Commercial, Commercial Real Estate and Commercial Construction Loans: Over the last decade, we have experienced moderate and occasionally strong demand for commercial and commercial real estate loans. These loan balances have generally increased in dollar amount and have slightly increased as a percentage of the overall loan portfolio. For the first nine months of 2014, loan growth was strong in this category, as outstanding balances increased by $33.6 million over the December 31, 2013 level, enhanced by several large loan participations acquired by us from regional lenders to their commercial borrowers.

Substantially all commercial and commercial real estate loans in our portfolio originated or participated in by us were extended to businesses or borrowers located in our regional market. Many of the loans in the commercial portfolio have variable rates tied to prime, FHLBNY rates or U.S. Treasury indices. We have not experienced any significant weakening in the quality of our commercial loan portfolio in recent years.

It is entirely possible, however, that we may experience a reduction in the demand for such loans and/or a weakening in the quality of our commercial and commercial real estate loan portfolio in upcoming periods. Generally, however, the business sector, at least in our service area, appeared to be in reasonably good financial condition at period-end.

Automobile Loans (primarily through indirect lending): At September 30, 2014, our automobile loans (primarily loans originated through dealerships located in upstate New York and Vermont) represented the third largest category of loans in our portfolio, and continued to be a significant component of our business comprising almost a third of our loan portfolio.

Beginning in 2012, there was a nation-wide resurgence in automobile sales and financing, due in the view of many to an aging fleet and a modest resurgence in consumer optimism. Although our new automobile loan volume for the first three months of 2014 slowed down somewhat due to a cold and snowy winter, our automobile loan portfolio still grew in the first nine months of 2014 by $25.3 million, or 6.4%, from our December 31, 2013 balance.

It has been widely noted that the recent upsurge in auto lending was accompanied by a general weakening of underwriting standards. To some extent this was true for us, as well. We designate the credit quality of our automobile borrowers in four groups and in recent periods have originated a slightly higher ratio of loans in the lower two tiers. However, we saw no significant change in our net charge-offs on automobile loans for the first nine months of 2014. Our experienced lending staff not only utilizes credit evaluation software tools but also reviews and evaluates each loan individually. We believe our disciplined approach to evaluating risk has contributed to maintaining our strong loan quality in this portfolio. If weakness in auto demand returns, our portfolio is likely to experience limited, if any, overall growth, either in real terms or as a percentage of the total portfolio, regardless of whether the auto company lending affiliates continue to offer highly-subsidized loans.

The following table indicates the annualized tax-equivalent yield of each loan category for the past five quarters.

Quarterly Taxable Equivalent Yield on Loans

	Quarter Ended
	9/30/2014		6/30/2014		3/31/2014		12/31/2013		9/30/2013
Commercial and Commercial Real Estate	4.43	%	4.47	%	4.49	%	4.65	%	4.52	%
Residential Real Estate	4.40		4.50		4.55		4.53		4.62
Home Equity	2.93		2.93		2.95		2.94		2.98
Automobile	3.26		3.32		3.41		3.54		3.68
Other Consumer Loans	5.46		5.49		5.54		5.72		5.95
Total Loans	3.95		4.01		4.06		4.15		4.18

In summary, average yields in our total loan portfolio have steadily declined over the last year, dropping 23 basis points, or 5.5%, from the third quarter of 2013 to the third quarter of 2014. This decrease continued a long-term trend, resulting principally from the Federal Reserve's multi-year policy of generating and maintaining ultra-low rates in financial markets generally, on both short-term and long-term debt, as well as continuing competition for loans from other lenders. To the extent that this declining rate environment may be "bottoming out" or even in the early stages of reversing itself, due to recent Federal Reserve tapering of its monetary easing policy, the impact of such a change, if it is in fact occurring, has not yet revealed itself in our loan portfolio. Nor would we expect that any bottoming out of prevailing rates would have an immediate impact on our portfolio yields generally.

In the third quarter of 2014, the average yield on our loan portfolio declined by 6 basis points from the second quarter of 2014, from 4.01% to 3.95%. Our three largest segments, in the table above (commercial and commercial real estate, residential real estate and automobile) all experienced a decrease in yields in the current quarter from the prior quarter. Yields in the other two categories were relatively unchanged. The 6 basis point decrease in average yield on our total loan portfolio in the just-completed quarter, as compared

# 44

to the prior quarter, was not matched by a similar decrease in our average cost of deposits during the quarter; our average deposit cost decreased by 3 basis points from the prior quarter. Despite the more rapid drop in average loan yield than average deposit cost, our net-interest margin in the third quarter of 2014 increased by 4 basis points over the net interest margin in the 2014 second quarter, from 3.17% to 3.21%. The principal reason for the margin increase was a significant shift in our asset portfolio from lower-yielding investment securities to higher yielding loans.

In general, the yield (tax-equivalent interest income divided by average loans) on our loan portfolio and other earning assets has been impacted by changes in prevailing interest rates. We expect that such will likely continue to be the case; that is, that loan yields will continue to rise and fall with changes in prevailing market rates, although the timing and degree of responsiveness will be influenced by a variety of other factors, including the extent of federal government and Federal Reserve participation in the home mortgage market, the makeup of our loan portfolio, the shape of the yield curve, consumer expectations and preferences, and the rate at which the portfolio expands. Additionally, there is a significant amount of cash flow from normal amortization and prepayments in all loan categories, and much of this cash flow reprices at current rates for credit, as new loans are generated at the current yields. Thus, even if prevailing rates for loans stabilize in upcoming periods, our average rate on our portfolio may continue to decline as older credits in our portfolio bearing generally higher rates continue to mature and either roll over or are redeployed into lower priced loans.

Investment Portfolio Trends

The following table presents the changes in the period-end balances for the securities available-for-sale and the securities held-to-maturity investment portfolios from December 31, 2013 to September 30, 2014 (in thousands). The principal change in our investment portfolio over the nine-month period was a substantial reduction in securities available-for-sale, which declined during the period by $83.3 million, or 18.2%, as proceeds from maturing or sold securities were re-deployed into the loan portfolio.

	Fair Value at Period-End							Net Unrealized Gains (Losses)
	09/30/2014		12/31/2013		Change			09/30/2014			12/31/2013			Change
Securities Available-for-Sale:
U.S. Agency Securities	$	134,051	$	136,475	$	(2,424	)	$	(434	)	$	(393	)	$	(41	)
State and Municipal Obligations	92,150		127,389		(35,239		)	351			165			186
Mortgage-Backed Securities-Residential	130,101		175,778		(45,677		)	3,993			4,457			(464		)
Corporate and Other Debt Securities	16,756		16,798		(42		)	(271		)	(344		)	73
Mutual Funds and Equity Securities	1,277		1,166		111			157			46			111
Total	$	374,335	$	457,606	$	(83,271	)	$	3,796		$	3,931		$	(135	)
Securities Held-to-Maturity:
State and Municipal Obligations	$	184,116	$	202,390	$	(18,274	)	$	5,417		$	4,184		$	1,233
Mortgage-Backed Securities-Residential	117,451		98,915		18,536			628			(1,140		)	1,768
Corporate and Other Debt Securities	1,000		1,000		—			—			—			—
Total	$	302,567	$	302,305	$	262		$	6,045		$	3,044		$	3,001

At period end, we held no investment securities in our portfolio that consisted of or included, directly or indirectly, obligations of foreign governments or governmental agencies or foreign issues of any sort.

As of both period-ends presented in the above table, all listed mortgage-backed securities and collateralized mortgage obligations (CMO’s) in our portfolio were guaranteed by U.S. agency or government sponsored enterprises (GSEs), such as Fannie Mae or Freddie Mac. Mortgage-backed securities provide to the investor monthly portions of principal and interest payments pursuant to the contractual obligations of the underlying mortgages. In the case of most CMOs, the principal and interest payments on the pooled mortgages are separated into two or more components (tranches), with each tranche having a separate estimated life, risk profile and yield. Our practice has been to purchase only those CMOs that are guaranteed by GSEs or other federal agencies and only those CMO tranches with shorter maturities and no more than moderate extension risk. Included in corporate and other debt securities are trust preferred securities issued by other financial institutions that were highly rated at the time of purchase.

Other-Than-Temporary Impairment

Each quarter we evaluate all investment securities with a fair value less than amortized cost, both in the available-for-sale portfolio and the held-to-maturity portfolio, to determine if there exists other-than-temporary impairment for any such security as defined under generally accepted accounting principles. There were no other-than-temporary impairment losses in the first nine months of 2014.

Increase in Net Unrealized Securities Gains (Losses): Nearly all of the change in our net unrealized gains or losses is attributable to changes in the yield curve between the two period-ends, that is, there has been little or no change in the credit-worthiness of the issuers.

# 45

Investment Sales, Purchases and Maturities

(In Thousands)

	Three Months Ended				Nine Months Ended
Sales	09/30/2014		09/30/2013		09/30/2014		09/30/2013
Available-For-Sale Portfolio:
Mortgage-Backed Securities-Residential	$	9,044	$	—	$	9,044	$	10,666
U.S. Agency Securities	—		—		40,729		5,057
Other	11		11		34		34
Total	9,055		11		49,807		15,757
Net Gains on Securities Transactions	137		—		110		527
Proceeds on the Sales of Securities	$	9,192	$	11	$	49,917	$	16,284
Held-to-Maturity Portfolio:
State and Municipal Obligations	$	—	$	—	$	—	$	1,168
Net Gains on Securities Transactions	—		—		—		13
Proceeds on the Sales of Securities	$	—	$	—	$	—	$	1,181

In recent years, the generally steady decline in prevailing interest rates to historically low levels has increased the likelihood of greater mortgage refinancing activity. We regularly review our holdings of collateralized mortgage obligations for those mortgages that revealed higher credit scores and/or moderate loan-to-value ratios, i.e., where refinancing may appear to be a greater probability. We also regularly review the underlying prepayment speed of individual issues to identify mortgage pools that may experience accelerating principal payments. If the multi-year widespread decline in mortgage rates may in fact be ending, and/or if such rates may now begin to increase, we would expect that refinancings as well as pre-payments of outstanding mortgage loans may diminish in upcoming periods.

Investment Purchases - Available-for-Sale Portfolio

	Three Months Ended				Nine Months Ended
	09/30/2014		09/30/2013		09/30/2014		09/30/2013
Purchases
U.S. Agency Securities	$	43,158	$	—	$	96,343	$	39,002
State and Municipal Obligations	—		13,504		4,308		73,668
Other	11		11		33		8,617
Total Purchases	$	43,169	$	13,515	$	100,684	$	121,287
Maturities & Calls	$	24,569	$	29,178	$	131,861	$	89,857

Investment Purchases - Held-to-Maturity Portfolio

	Three Months Ended				Nine Months Ended
	09/30/2014		09/30/2013		09/30/2014		09/30/2013
Purchases
State and Municipal Obligations	$	7,587	$	8,288	$	14,530	$	37,400
Mortgage-Backed Securities-Residential	—		34,173		29,437		34,173
Total Purchases	$	7,587	$	42,461	$	43,967	$	71,573
Maturities & Calls	$	8,167	$	17,309	$	45,602	$	35,214

# 46

Asset Quality

The following table presents information related to our allowance and provision for loan losses for the past five quarters.

Summary of the Allowance and Provision for Loan Losses

(Dollars in Thousands, Loans Stated Net of Unearned Income)

	9/30/2014			06/30/2014			3/31/2014			12/31/2013			9/30/2013
Loan Balances:
Period-End Loans	$	1,381,440		$	1,344,124		$	1,310,423		$	1,266,472		$	1,243,370
Average Loans, Year-to-Date	1,325,159			1,306,766			1,284,649			1,208,954			1,193,452
Average Loans, Quarter-to-Date	1,361,347			1,328,639			1,284,649			1,254,957			1,224,840
Period-End Assets	2,208,745			2,153,051			2,221,581			2,163,698			2,156,858
Allowance for Loan Losses, Year-to-Date:
Allowance for Loan Losses, Beginning of Period	$	14,434		$	14,434		$	14,434		$	15,298		$	15,298
Provision for Loan Losses, YTD	1,407			963			458			200			200
Loans Charged-off, YTD	(769		)	(504		)	(336		)	(1,411		)	(1,165		)
Recoveries of Loans Previously Charged-off	221			143			80			347			251
Net Charge-offs, YTD	(548		)	(361		)	(256		)	(1,064		)	(914		)
Allowance for Loan Losses, End of Period	$	15,293		$	15,036		$	14,636		$	14,434		$	14,584
Allowance for Loan Losses, Quarter-to-Date:
Allowance for Loan Losses, Beginning of Period	$	15,036		$	14,636		$	14,434		$	14,584		$	14,678
Provision for Loan Losses, QTD	444			505			458			—			—
Loans Charged-off, QTD	(265		)	(168		)	(336		)	(246		)	(183		)
Recoveries of Loans Previously Charged-off	78			63			80			96			89
Net Charge-offs, QTD	(187		)	(105		)	(256		)	(150		)	(94		)
Allowance for Loan Losses, End of Period	$	15,293		$	15,036		$	14,636		$	14,434		$	14,584
Nonperforming Assets, at Period-End:
Nonaccrual Loans	$	7,048		$	6,185		$	6,284		$	6,479		$	6,171
Restructured	346			398			380			641			446
Loans Past Due 90 or More Days   and Still Accruing Interest	571			1,325			347			652			927
Total Nonperforming Loans	7,965			7,908			7,011			7,772			7,544
Repossessed Assets	66			40			138			63			18
Other Real Estate Owned	326			326			198			81			481
Total Nonperforming Assets	$	8,357		$	8,274		$	7,347		$	7,916		$	8,043
Asset Quality Ratios:
Allowance to Nonperforming Loans	192.00		%	190.14		%	208.76		%	185.71		%	193.32		%
Allowance to Period-End Loans	1.11			1.12			1.12			1.14			1.17
Provision to Average Loans (Quarter) (1)	0.13			0.15			0.14			—			—
Provision to Average Loans (YTD) (1)	0.14			0.15			0.14			0.02			0.02
Net Charge-offs to Average Loans (Quarter) (1)	0.05			0.03			0.08			0.05			0.03
Net Charge-offs to Average Loans (YTD) (1)	0.06			0.06			0.08			0.09			0.10
Nonperforming Loans to Total Loans	0.58			0.59			0.53			0.61			0.61
Nonperforming Assets to Total Assets	0.38			0.38			0.33			0.37			0.37
(1) Annualized

Provision 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 impaired loans as well as the inherent risk of loss related to the remaining portfolio. Loan charge-offs are recorded to this allowance when loans are deemed uncollectible, in whole or in part.

In the third quarter of 2014, we made a $444 thousand provision for loan losses, compared to provisions of $505 thousand for the second quarter of 2014, a provision of $458 for the first quarter of 2014 and no provisions for the third and fourth quarters of 2013. A variety of factors and events during the third 2014 quarter dictated the amount of the provision, including a significant increase in loan balances and a small increase in our qualitative factors, offset, in part, by a modest decrease in substandard loans (see Note 3 to our unaudited interim consolidated financial statements for a discussion on how we classify our credit quality indicators as well as the balance in each category).

# 47

The ratio of the allowance for loan losses to total loans was 1.11% at September 30, 2014, down three basis points from 1.14% at December 31, 2013. While the overall size of the allowance grew, due primarily to loan portfolio growth, the decline in the allowance as a percentage of total loans was principally due to improvements in substandard loans and the fact that the outstanding balance of our loan portfolio grew at a faster pace than the allowance.

    We consider our accounting policy relating to the allowance for loan losses to be a critical accounting policy, given the uncertainty involved in evaluating the level of the allowance required to cover credit losses inherent in the loan portfolio, and the material effect that such judgments may have on our results of operations. Our process for determining the provision for loan losses is described in Note 3 to our unaudited interim consolidated financial statements.

Risk Elements

Our nonperforming assets at September 30, 2014 amounted to $8.4 million, an increase of $441 thousand, or 5.6%, from the December 31, 2013 total and an increase of $314 thousand or 3.9%, from the year earlier total. Our recent ratios of nonperforming assets to total assets remain significantly below our peer group averages for the corresponding dates. At September 30, 2014, our ratio of loans past due 90 or more days plus nonaccrual loans plus other real estate owned to total assets was .38%, nearly unchanged from our ratio at September 30, 2013. Both ratios are well below the comparable ratios of our peer group at June 30, 2014 (the latest date for which peer group information is available).

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 our nonperforming assets but entail heightened risk.

Loans Past Due 30-89 Days and Accruing Interest
	9/30/2014		12/31/2013		9/30/2013
Commercial Loans	$	235	$	905	$	1,321
Commercial Real Estate Loans	—		1,400		1,173
Other Consumer Loans	32		56		54
Automobile Loans	3,974		4,229		2,860
Residential Real Estate Loans	1,620		1,698		1,736
Total Delinquent Loans	$	5,861	$	8,288	$	7,144

At September 30, 2014, our loans in this category totaled $5.9 million, a decrease of $2.4 million, or 29.3%, from the $8.3 million of such loans at December 31, 2013. The year-end 2014 total of non-current loans equaled 0.42% of such loans then outstanding, whereas the year-end 2013 total equaled .65% of loans then outstanding. The decrease from December 31, 2013 is primarily attributable to a substantial decrease in non-current commercial real estate loans, as one large loan was brought current.

The number and dollar amount of our performing loans that demonstrate characteristics of potential weakness from time-to-time (potential problem loans) typically is a very small percentage of our portfolio. See the table of Credit Quality Indicators in Note 3 to our unaudited interim consolidated financial statements. We consider all performing commercial and commercial real estate loans classified as substandard or lower (as reported in Note 3) to be potential problem loans. The dollar amount of such loans at September 30, 2014 ($24.6 million) was down slightly from the dollar amount of such loans at December 31, 2013 ($25.4 million) . The amount of such loans depends principally on economic conditions in our geographic market area of northeastern New York State. The economy in this area has been relatively strong in recent years, but any general weakening of the U.S. economy in upcoming periods would likely have an adverse effect on the economy in our market area as well, and on our commercial and commercial real estate portfolio.

As of September 30, 2014, we held for sale two real estate properties in other real estate owned. As a result of our conservative underwriting standards, we do 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, nor do we expect significant losses to be incurred generally in our residential real estate portfolio.

We do not currently anticipate significant increases in our nonperforming assets, other non-current loans as to which interest income is still being accrued or potential problem loans, but can give no assurances in this regard.

CAPITAL RESOURCES

Important Future Changes to Regulatory Capital Standards (To Be Phased-In from 2015 to 2019)

Please see our discussion in our Form 10-K for December 31, 2013 on the impact of the Dodd-Frank Act on regulatory capital standards for U.S. insured depository financial institutions, and specifically, on the new higher regulatory capital standards that were set for banks by bank regulators in July 2013 and will become effective in stages over upcoming years.

In general, the new standards, which will begin to take effect for banking organizations like us in 2015, set higher minimum capital ratios, expand the risk-weighted categories of assets and add a new capital ratio, a "common equity tier 1 capital ratio" (CET1). The new rules as part of their general thrust in requiring enhanced capital for all banks also introduce a new concept, a so-called "capital conservation buffer" (required to equal at least 2.5% of total risk-based assets when fully phased-in by 2019), which will be added to each of the new minimum capital ratios (which by themselves will be somewhat higher under the new rules than the current minimum ratios).

Under the new rules, outstanding TRUPs previously issued by small- to medium-sized financial institutions such as Arrow will continue to qualify as tier 1 capital, up to a limit of 25% of tier 1 capital (including such TRUP's and other grandfathered tier 1 capital components), until the TRUPs mature or are redeemed. Also under the new rules, accumulated other comprehensive income (AOCI) may be deducted from capital, if the organization exercises its irrevocable option not to include AOCI in capital. We estimate that if

# 48

the new capital rules, which are being phased-in from 2015 through 2019, had been fully effective on September 30, 2014, our holding company and each of our banks still would have met each of the higher minimum capital requirements for financial institutions under these new rules, including the capital conservation buffer.

Current Regulatory Capital Standards

The discussion and disclosure below on current regulatory capital standards is qualified in its entirety by reference to the fact that, as discussed above, new, more stringent regulatory capital standards have recently been issued by bank regulators, as required under the Dodd-Frank Act, and will become effective in stages over upcoming periods beginning in 2015.

Regulatory capital, although a financial measure that is not provided for or governed by GAAP, nevertheless has been exempted by the SEC from the definition of "non-GAAP financial measures" in the SEC's Regulation G governing disclosure by registered companies of non-GAAP financial measures. Thus, certain information which is generally required to be presented in connection with our disclosure of non-GAAP financial measures need not be provided, and has not been provided, for the regulatory capital measures discussed below.

Two Sets of Current Capital Standards: Our holding company and our subsidiary banks are currently subject to two sets of regulatory capital measures, the risk-based capital guidelines and a leverage ratio test. The risk-based guidelines assign risk weightings to all assets and certain off-balance sheet items of financial institutions, which generally results in a substantial discounting of low-risk or risk-free assets from their GAAP book values on the balance sheet; that is, a significant dollar amount of such assets "disappears" from the balance sheet in the risk-weighting process. The guidelines then establish an 8% minimum ratio of qualified total capital to total risk-weighted assets. At least half of total capital must be "Tier 1" capital, which consists of common equity and common equity equivalents, retained earnings, a limited amount of permanent preferred stock and (for small- to medium-sized holding companies) a limited amount of trust preferred securities (see the discussion below on these securities), minus intangible assets, net of associated deferred tax liabilities. Up to half of total capital may consist of so-called "Tier 2" capital, comprising a limited amount of subordinated debt, other preferred stock, certain other qualifying capital instruments and a limited amount of the allowance for loan losses.

The second regulatory capital measure, the leverage ratio test, establishes minimum limits on the ratio of Tier 1 capital to total tangible assets, without risk weighting (i.e, discounting) of assets. For top-rated companies, the minimum leverage ratio currently is 4%, but lower-rated or rapidly expanding companies may be required by bank regulators to meet substantially higher minimum leverage ratios. Federal banking law mandates certain actions to be taken by banking regulators for financial institutions that are deemed undercapitalized as measured under any of these regulatory capital guidelines. The law establishes five categories of capitalization for financial institutions ranging from "well-capitalized” (the highest ranking) to "critically undercapitalized" (the lowest ranking). Federal banking law also ties the ability of banking organizations to engage in certain types of non-banking financial activities to such organizations' continuing to qualify for inclusion in one of the two highest-ranking of these capitalization categories, i.e., as "well-capitalized" or "adequately capitalized."

Capital Ratios:The table below sets forth the capital ratios of our holding company and subsidiary banks, Glens Falls National and Saratoga National, as of September 30, 2014:

			Tier 1		Total
	Tier 1		Risk-Based		Risk-Based
	Leverage		Capital		Capital
	Ratio		Ratio		Ratio
Arrow Financial Corporation	9.68	%	14.41	%	15.48	%
Glens Falls National Bank & Trust Co.	9.33	%	14.36	%	15.44	%
Saratoga National Bank & Trust Co.	9.58	%	12.27	%	13.30	%
Regulatory Minimum	4.00		4.00		8.00
FDICIA's "Well-Capitalized" Standard	5.00		6.00		10.00

At September 30, 2014 our holding company and both banks exceeded the minimum capital ratios established under the currently applicable regulatory guidelines, and also qualified as "well-capitalized", the highest category, in the capital classification scheme set by federal bank regulatory agencies (see the further discussion under "Supervision and Regulation" in Part I Item 1.C. of this Report). The minimum capital ratios listed in the above table are those currently effective for financial institutions, not the higher minimum capital ratios that will become effective in upcoming periods.

Capital Components; Stock Repurchases; Dividends

Stockholders' Equity:Stockholders' equity was $200.1 million at September 30, 2014, an increase of $7.9 million, or 4.1%, from the prior year-end.  The most significant contributions to this increase in stockholders' equity were net income of $17.0 million and equity received from our various stock-based compensation and dividend reinvestment plans of $1.5 million. These positive factors were offset, in part, by cash dividends of $9.3 million and purchases of our own common stock of $2.2 million.  See the Consolidated Statement of Changes in Stockholders' Equity on page 6 of this report for all of the changes in stockholders' equity between December 31, 2013 and September 30, 2014.

# 49

Trust Preferred Securities Under Dodd-Frank: In each of 2003 and 2004, we issued $10 million of trust preferred securities (TRUPs) in a private placement. Under the Federal Reserve Board's historical approach to regulatory capital, TRUPs typically qualified as Tier 1 capital for all bank holding companies, of any size, 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, this treatment continues to apply to small- and medium-sized banking organizations like ours, but only with respect to such TRUPs issued before the Dodd-Frank Act's grandfathering date. Any trust preferred securities issued by banking organizations, including ours, on or after the grandfathering date do not and will not qualify as Tier 1 capital under the new bank regulatory capital guidelines. Thus, our currently outstanding TRUPs will continue to qualify as Tier 1 capital until maturity or redemption, but no additional TRUPs issued by us would so qualify.

Stock Repurchase Program: At its regular meeting in October 2014, the Board of Directors approved a 12-month stock repurchase program (the "2015 program") authorizing the repurchase, at the discretion of senior management, during calendar year 2015 of up to $5 million of Arrow's common stock in open market or privately negotiated transactions. This program replaced a similar $5 million stock repurchase program which was approved by the Board in November 2013 for calendar year 2014 (the "2014 program"). Under the 2014 program, management is authorized to effect stock repurchases from time-to-time, to the extent that it believes the Company's stock is reasonably priced and such repurchases appear to be an attractive use of available capital and in the best interests of stockholders. Through September 30, 2014, 60,625 shares having an aggregate purchase price of $1.5 million had been repurchased by the Company under the 2014 program.

Dividends:Our common stock is traded on NasdaqGS® - AROW. The high and low stock prices for the past five quarters listed below represent actual sales transactions, as reported by NASDAQ. On October 22, 2014, our Board of Directors declared a 2014 fourth quarter cash dividend of $.25 payable on December 15, 2014. Per share amounts in the following table have been restated for our September 2014 2% stock dividend.

					Cash
	Market Price				Dividends
	Low		High		Declared
2013
First Quarter	$	22.68	$	24.58	$	0.240
Second Quarter	22.50		24.47		0.240
Third Quarter	23.77		26.67		0.240
Fourth Quarter	24.42		27.45		0.245
2014
First Quarter	$	24.02	$	26.94	$	0.245
Second Quarter	24.31		26.46		0.245
Third Quarter	24.82		26.46		0.245
Fourth Quarter (dividend payable December 15, 2014)					0.250

	Quarter Ended September 30,
	2014			2013
Cash Dividends Per Share	$	0.245		$	0.240
Diluted Earnings Per Share	0.49			0.45
Dividend Payout Ratio	50.00		%	53.33		%
Total Equity (in thousands)	$	200,089		$	182,683
Shares Issued and Outstanding (in thousands)	12,605			12,576
Book Value Per Share	$	15.87		$	14.53
Intangible Assets (in thousands)	$	25,747		$	26,273
Tangible Book Value Per Share	$	13.83		$	12.44

LIQUIDITY

The objective of effective liquidity management is to ensure that we have the ability to raise cash when we need it at a reasonable cost.  We must be capable of meeting expected and unexpected obligations to our customers at any time.  Given the uncertain nature of customer demands as well as the need to maximize earnings, we must have available reasonably priced sources of funds, both on- and off-balance sheet, that can be accessed quickly in time of need.

Our primary sources of available liquidity have been and remain overnight investments in federal funds sold, interest bearing bank balances at the Federal Reserve Bank, and cash flow from maturing investment securities and loans.  In addition, certain investment securities are selected at purchase as available-for-sale based on their marketability and collateral value, as well as their yield and maturity.  Our securities available-for-sale portfolio was $374.3 million at September 30, 2014, a decrease of $83.3 million, or 18.2%, from the year-end 2013 level. Due to the potential for volatility in market values, we are not always able to assume that securities may be sold on short notice at their carrying value, even to provide needed liquidity.

In addition to liquidity from federal funds, short-term balances at the Federal Reserve Bank, investment securities and loans, we have supplemented available operating liquidity with additional off-balance sheet sources such as federal funds lines of credit and

# 50

credit lines with the Federal Home Loan Bank of New York ("FHLBNY"). Our federal funds lines of credit are with two correspondent banks totaling $35 million, but we did not draw on these lines through September 30, 2014.

To support our borrowing relationship with the FHLBNY, we have pledged collateral, including mortgage-backed securities and residential mortgage loans. Our unused borrowing capacity at the FHLBNY was approximately $183.1 million at September 30, 2014. In addition we have identified brokered certificates of deposit as an appropriate off-balance sheet source of funding accessible in a relatively short time period. Also, our two bank subsidiaries have each established a borrowing facility with the Federal Reserve Bank of Net York, pledging certain consumer loans as collateral for potential "discount window" advances, which we maintain for contingency liquidity purposes. At September 30, 2014, the amount available under this facility was approximately $300.8 million, with no advances then outstanding.    

We measure and monitor our 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 our investment securities portfolio, cash flows from our loan portfolio, our stable core deposit base and our significant borrowing capacity, we believe that our liquidity is sufficient to meet all funding needs that may arise in connection with any reasonably likely events or occurrences. At September 30, 2014, our basic liquidity ratio, including our FHLB collateralized borrowing capacity, was 10.6% of total assets, or $183 million, well in excess of our internally-set minimum target ratio of 4% of total assets, an excess of $95 million.

Throughout the recent years of financial instability, our liquidity position has remained strong, and depositors and investors in the wholesale funding markets have showed no hesitations in placing or maintaining their funds with our banks. The financial markets have been challenging for many financial institutions, and the widely accepted view is that during the 2008-2010 crisis a lack of liquidity was as great a problem for many troubled institutions as a capital shortfall. As a result, liquidity premiums widened and many banks experienced certain liquidity constraints, including substantially increased pricing to retain deposit balances. Because of Arrow's favorable credit quality and strong balance sheet, Arrow did not experience any significant liquidity constraints during the crisis or thereafter through the date of this Report and was never forced to pay premium rates to obtain retail deposits or other funds from any source.

RESULTS OF OPERATIONS

Three Months Ended September 30, 2014 Compared With

Three Months Ended September 30, 2013

Summary of Earnings Performance

(Dollars in Thousands, Except Per Share Amounts)

	Quarter Ended
	09/30/2014			09/30/2013			Change			% Change
Net Income	$	6,147		$	5,623		$	524		9.3	%
Diluted Earnings Per Share	0.49			0.45			0.04			8.9
Return on Average Assets	1.13		%	1.06		%	0.07		%	6.6
Return on Average Equity	12.22		%	12.42		%	(0.20		)%	(1.6	)

We reported earnings (net income) of $6.1 million and diluted earnings per share (EPS) of $.49 for the third quarter of 2014, compared to net income of $5.6 million and diluted EPS of $.45 for the third quarter of 2013.

We experienced net gains of $83 thousand, net of tax, on the sale of securities in the 2014 quarter. There were no securities sales in the 2013 quarter.

    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

(Taxable Equivalent Basis, Dollars in Thousands)

	Quarter Ended
	09/30/2014			09/30/2013			Change			% Change
Interest and Dividend Income	$	17,834		$	17,032		$	802		4.7	%
Interest Expense	1,399			1,747			(348		)	(19.9	)
Net Interest Income	16,435			15,285			1,150			7.5
Tax-Equivalent Adjustment	1,074			1,158			(84		)	(7.3	)
Average Earning Assets (1)	2,030,090			1,983,864			46,226			2.3
Average Interest-Bearing Liabilities	1,626,327			1,614,873			11,454			0.7
Yield on Earning Assets (1)	3.49		%	3.41		%	0.08		%	2.3
Cost of Interest-Bearing Liabilities	0.34			0.43			(0.09		)	(20.9	)
Net Interest Spread	3.15			2.98			0.17			5.7
Net Interest Margin	3.21			3.06			0.15			4.9

(1) Includes Nonaccrual Loans

# 51

Between the third quarter of 2013 and the third quarter of 2014, our net interest margin (net interest income on a tax-equivalent basis divided by average earning assets, annualized) increased by 15 basis points, from 3.06% to 3.21%, representing a 4.9% increase in our margin. (See the discussion under “Use of Non-GAAP Financial Measures,” on page 35, regarding our net interest margin and net interest income, which are commonly used non-GAAP financial measures.) Among other things, this increase in net interest margin reflected a decrease in the cost of a few of our municipal NOW accounts, which renewed during the third quarter of 2014, as well as the sale during the quarter of a substantial portion of our available-for-sale securities portfolio and the redeployment of most of the proceeds into higher-yielding loans. Neither of these occurrences should be expected to recur in upcoming periods. Rather, in management's view, despite this positive recent development in our net interest margin, our persistent multi-year experience of margin compression may well continue in upcoming periods, and if rates do begin to move broadly upward, our liabilities generally may reprice more rapidly than our assets. Net interest income for the just completed quarter, on a taxable equivalent basis, increased by $1.15 million, or 7.5%, from the third quarter of 2013, as the increase in our net interest margin between the periods was enhanced by the positive impact of a 2.3% increase in the level of our average earning assets. The impact of recent interest rate changes on our net interest margin and net interest income 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 47, the provision for loan losses for the third quarter of 2014 was $444 thousand, compared to no provision for the 2013 quarter.

Noninterest Income

Summary of Noninterest Income

(Dollars in Thousands)

	Quarter Ended
	09/30/2014		09/30/2013		Change			% Change
Income From Fiduciary Activities	$	1,861	$	1,688	$	173		10.2	%
Fees for Other Services to Customers	2,353		2,403		(50		)	(2.1	)
Insurance Commissions	2,451		2,404		47			2.0
Net (Loss) Gain on Securities Transactions	137		—		137			—
Net Gain on the Sale of Loans	213		166		47			28.3
Other Operating Income	336		278		58			20.9
Total Noninterest Income	$	7,351	$	6,939	$	412		5.9

Total noninterest income in the just completed quarter was $7.4 million, an increase of $412 thousand, or 5.9%, from total noninterest income of $6.9 million for the third quarter of 2013. We experienced increases in all categories, except for fees for other services to customers.

Insurance commission income rose from $2.4 million for the third quarter of 2013 to $2.5 million for the third quarter of 2014, an increase of $47 thousand, or 2.0%. This increase was attributable to organic growth within our four agencies. Income from fiduciary activities in the 2014 quarter increased by $173 thousand, or 10.2%, from the comparable 2013 quarter. This source of noninterest income typically tracks the dollar value of assets under administration. At quarter-end 2014, the market value of assets under trust administration and investment management amounted to $1.200 billion, an increase of $88.8 million, or 8.0%, from September 30, 2013. The increase was generally attributable to a significant rise in the equity markets between the reporting dates and the addition of new accounts.

Fees for other services to customers includes service charges on deposit accounts, debit card interchange fees, revenues related to the sale of mutual funds to our customers by third party providers and servicing income on sold loans. Effective October 1, 2011 Visa announced new, reduced debit interchange rates and related modifications to comply with new debit card interchange fee rules promulgated by the Federal Reserve under the Dodd-Frank Act. This reduced rate structure has had, and will continue to have, a slight but noticeable negative impact on our fee income. However, debit card usage by our customers continues to grow which has offset at least in part, the negative effect of reduced debit interchange rates. If this usage continues to grow, it will continue to offset the negative impact of reduced interchange fees. Generally, we do not believe that Visa's new limits on interchange fees resulting from Dodd-Frank will have a material adverse impact on our financial condition or results of operations in future periods. However, there is currently a lawsuit challenging the existing post Dodd-Frank fee structure as too high. The Federal Reserve Bank successfully asked the court to permit retention of the current fee structure until the case is settled. Fees for Other Services to Customers was down $50 thousand, or 2.1%, primarily due to a decrease in revenues related to the sale of mutual funds to our customers by third party providers.

The increase in other operating income in the third quarter of 2014 versus the third quarter of 2013 was primarily attributable to income from an insurance referral partnership with other New York community banks and to an increase in income from our investment in bank-owned life insurance policies.

# 52

Noninterest Expense

Summary of Noninterest Expense

(Dollars in Thousands)

	Quarter Ended
	09/30/2014			09/30/2013			Change			% Change
Salaries and Employee Benefits	$	7,781		$	7,856		$	(75	)	(1.0	)%
Occupancy Expense of Premises, Net	1,176			1,063			113			10.6
Furniture and Equipment Expense	1,090			819			271			33.1
FDIC and FICO Assessments	273			269			4			1.5
Amortization	94			108			(14		)	(13.0	)
Other Operating Expense	3,112			3,018			94			3.1
Total Noninterest Expense	$	13,526		$	13,133		$	393		3.0
Efficiency Ratio	56.80		%	58.61		%	(1.81		)%	(3.1	)

Noninterest expense for the third quarter of 2014 was $13.5 million, an increase of $393 thousand, or 3.0%, from the expense for the third quarter of 2013. For the third quarter of 2014, our efficiency ratio was 56.80%. This ratio, which is a commonly used non-GAAP financial measure in the banking industry, is a comparative measure of a financial institution's operating efficiency. The efficiency ratio (a ratio where lower is better) is the ratio of noninterest expense (excluding, under our definition, intangible asset amortization) to (i) net interest income (on a tax-equivalent basis) plus (ii) noninterest income (excluding net securities gains or losses). The efficiency ratio is further discussed on page 35 of this Report under the heading “Use of Non-GAAP Financial Measures.” The efficiency ratio included by the Federal Reserve Board in its "Peer Holding Company Performance Reports" excludes net securities gains or losses from the denominator (as does our calculation), but unlike our ratio does not exclude intangible asset amortization from the numerator. The favorable change in our efficiency ratio between the periods reflected the fact that our core gross income grew faster than our operating expenses. Our efficiency ratios in recent periods have also compared favorably to the ratios of our peer group, after adjusting for the definitional difference. For the year quarter ended June 30, 2014 (the most recent reporting period for which peer group information is available), the peer group efficiency ratio was 70.44%, and our ratio was 59.06% (not adjusted).

Salaries and employee benefits expense decreased 1.0% in the third quarter of 2014 over the 2013 quarter, representing the offsetting effects of a 5.7% increase in salaries and a 16.6% decrease in benefits. The decrease in our benefit expenses was primarily attributable to lower pension costs.

The increase in occupancy expense was distributed among all categories including maintenance, utilities, depreciation, taxes, rental expense and insurance.

The increase in furniture and equipment expense was attributable to increases in maintenance, depreciation and data processing expenses.

The category demonstrating the largest increase in other operating expense between the periods was third party computer processing expenses, offset to a large extent by reductions in costs to carry real estate acquired through foreclosure and legal expenses.

Income Taxes

Summary of Income Taxes

(Dollars in Thousands)

	Quarter Ended
	09/30/2014			09/30/2013			Change		% Change
Provision for Income Taxes	$	2,595		$	2,310		$	285	12.3	%
Effective Tax Rate	29.7		%	29.1		%	0.6		2.1

The provisions for federal and state income taxes amounted to $2.6 million and $2.3 million for the respective three-month periods of 2014 and 2013. The increase in the effective tax rate was primarily attributable to a one-time historical rehabilitation tax credit in the 2013 period.

RESULTS OF OPERATIONS

Nine Months Ended September 30,2014 Compared With

Nine Months Ended September 30,2013

Summary of Earnings Performance

(Dollars in Thousands, Except Per Share Amounts)

	Nine Month Period Ended
	09/30/2014			09/30/2013			Change			% Change
Net Income	$	16,991		$	16,011		$	980		6.1	%
Diluted Earnings Per Share	1.35			1.28			0.07			5.5
Return on Average Assets	1.05		%	1.03		%	0.02		%	1.9
Return on Average Equity	11.55		%	11.99		%	(0.44		)%	(3.7	)

# 53

We reported earnings (net income) of $17.0 million and diluted earnings per share (EPS) of $1.35 for the nine-month period of 2014, an improvement over net income of $16.0 million and diluted EPS of $1.28 for the 2013nine-month period.

There were net losses on the sales of securities in the 2014nine-month period of $66 thousand, net of tax, compared to net gains of $326 thousand, net of tax, in the 2013nine-month period. Moreover, our net gain on sales of loans, net of tax, in the 2014 nine-month period was only $303 thousand, compared to $767 thousand for the 2013 period.

    The following narrative discusses the changes between the respective nine-month periods in net interest income, noninterest income, noninterest expense and income taxes.

Net Interest Income

Summary of Net Interest Income

(Taxable Equivalent Basis, Dollars in Thousands)

	Nine Month Period Ended
	09/30/2014			09/30/2013			Change			% Change
Interest and Dividend Income	$	53,110		$	51,080		$	2,030		4.0	%
Interest Expense	4,548			6,209			(1,661		)	(26.8	)
Net Interest Income	48,562			44,871			3,691			8.2
Tax-Equivalent Adjustment	3,389			3,401			(12		)	(0.4	)
Average Earning Assets (1)	2,049,949			1,963,363			86,586			4.4
Average Interest-Bearing Liabilities	1,661,329			1,615,615			45,714			2.8
Yield on Earning Assets (1)	3.46		%	3.48		%	(0.02		)%	(0.6	)
Cost of Interest-Bearing Liabilities	0.37			0.51			(0.14		)	(27.5	)
Net Interest Spread	3.09			2.97			0.12			4.0
Net Interest Margin	3.17			3.06			0.11			3.6

(1) Includes Nonaccrual Loans

Our net interest margin (net interest income on a tax-equivalent basis divided by average earning assets, annualized) increased by 11 basis points, from 3.06% to 3.17%, between the 2013nine-month period and the 2014nine-month period, representing a 3.6% increase in the margin. (See the discussion under “Use of Non-GAAP Financial Measures,” on page 35, regarding our net interest margin and net interest income, which are commonly used non-GAAP financial measures.) Net interest income for the just completed nine-month period, on a taxable equivalent basis, increased by $3.7 million, or 8.2%, from the 2013nine-month period, as the increase in our net interest margin between the periods was enhanced by the positive impact of a 4.4% increase in the level of our average earning assets. The reasons for the change in net interest income and net interest margin between the two periods, and management's views regarding possible future changes in our net interest income and net interest margin, are discussed above under "RESULTS OF OPERATIONS --Three Months Ended September 30, 2014 Compared with Three Months Ended September 30, 2013 -- Net Interest Income" on page 51. The impact of recent interest rate changes in the U.S. economy generally on our net interest margin and net interest income 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 47, the provision for loan losses for the nine-month periods ended September 30, 2014 and 2013 was $1,407 thousand and $200 thousand, respectively.

Noninterest Income

Summary of Noninterest Income

(Dollars in Thousands)

	Nine Month Period Ended
	09/30/2014		09/30/2013		Change			% Change
Income From Fiduciary Activities	$	5,640	$	5,020	$	620		12.4	%
Fees for Other Services to Customers	6,924		7,056		(132		)	(1.9	)
Insurance Commissions	7,188		6,608		580			8.8
Net (Loss) Gain on Securities Transactions	110		540		(430		)	(79.6	)
Net Gain on the Sale of Loans	502		1,271		(769		)	(60.5	)
Other Operating Income	892		689		203			29.5
Total Noninterest Income	$	21,256	$	21,184	$	72		0.3

Total noninterest income in the just completed nine-month period was $21.3 million, an increase of $72 thousand, or 0.3%, from total noninterest income of $21.2 million for the 2013 period. We experienced increases in insurance commissions, income from fiduciary activities and other operating income. These increases more than offset a decrease in the net gain on the sale of securities in the 2014 quarter, a decrease in fees for other services to customers and a decrease in net gains on the sale of loans as we began to taper our sale of loans to the secondary market during the second half of 2013 and the first nine months of 2014.

Insurance commission income rose from $6.6 million for the first nine months of 2013 to $7.2 million for the first nine months of 2014, an increase of $580 thousand, or 8.8%. This increase was attributable to an increase in annual contingent commission income received from certain insurance carriers in the 2014 period and from organic growth from our four insurance agencies. Income from fiduciary

# 54

activities increased $620 thousand, or 12.4%, from the comparable 2013 period. See our discussion on the changes in the market value of assets under trust administration and investment management, in the section above under the heading "RESULTS OF OPERATIONS--Three Months Ended September 30, 2014 Compared with Three Months Ended September 30, 2013--Summary of Non-Interest Income."

Fees for other services to customers includes service charges on deposit accounts, debit card interchange fees, revenues related to the sale of mutual funds to our customers by third party providers and servicing income on sold loans. The decrease in fees for other services to customers between the 2013 nine-month period and the 2014 nine-moth period was primarily attributable to decreased revenues in the 2014 period related to the sale of mutual funds to our customers by third party providers. See the discussion above under the heading "RESULTS OF OPERATIONS--Three Months Ended September 30, 2014 Compared with Three Months Ended September 30, 2013--Summary of Non-Interest Income."

The increase in other operating income in the 2014 period versus the 2013 period, was primarily due to a decrease in losses on the sale of other real estate owned in the 2014 period, gains recognized in our investment in business incubator types of limited partnerships and an increase in income from our investment in bank-owned life insurance.

Noninterest Expense

Summary of Noninterest Expense

(Dollars in Thousands)

	Nine Month Period Ended
	09/30/2014			09/30/2013			Change			% Change
Salaries and Employee Benefits	$	23,303		$	23,114		$	189		0.8	%
Occupancy Expense of Premises, Net	3,749			3,389			360			10.6
Furniture and Equipment Expense	3,174			2,888			286			9.9
FDIC and FICO Assessments	828			800			28			3.5
Amortization	294			344			(50		)	(14.5	)
Other Operating Expense	9,381			9,283			98			1.1
Total Noninterest Expense	$	40,729		$	39,818		$	911		2.3
Efficiency Ratio	58.01		%	60.25		%	(2.24		)%	(3.7	)

Noninterest expense for the 2014nine-month period was $40.7 million, an increase of $911 thousand, or 2.3%, from the expense for the 2013nine-month period. For the 2014nine-month period, our efficiency ratio was 58.01% versus 60.3% in the 2013 period. This ratio, which is a commonly used non-GAAP financial measure in the banking industry, is a comparative measure of a financial institution's operating efficiency. The efficiency ratio (a ratio where lower is better) is the ratio of noninterest expense (excluding, under our definition, intangible asset amortization) to (i) net interest income (on a tax-equivalent basis) plus (ii) noninterest income (excluding net securities gains or losses). See the discussion on page 35 of this Report under the heading “Use of Non-GAAP Financial Measures.” The efficiency ratio included by the Federal Reserve Board in its "Peer Holding Company Performance Reports" excludes net securities gains or losses from the denominator (as does our calculation), but unlike our ratio does not exclude intangible asset amortization from the numerator. The favorable change in our efficiency ratio between the periods reflected the fact that our core gross income grew faster than our operating expenses. Our efficiency ratios in recent periods have also compared favorably to the ratios of our peer group, after adjusting for the definitional difference. For the quarter ended June 30, 2014 (the most recent reporting period for which peer group information is available), the peer group efficiency ratio was 70.44%, and our ratio was 59.06% (not adjusted).

Salaries and employee benefits expense increased only 0.8% for the 2014nine-month period, compared to the 2013 period, representing a 5.0% increase in salaries offset, in part, by an 8.8% decrease in benefits. The decrease in our benefit expenses was primarily attributable to lower pension costs.

The increase in occupancy expense was distributed among all categories including maintenance, utilities, depreciation, taxes, rental expense and insurance.

The increase in furniture and equipment expense was primarily attributable to increases in data processing expenses.

The subcategory of other operating expense demonstrating the largest increase between the periods was third party computer processing expenses, which was offset, to a large part, by reductions in other subcategories, including costs to carry real estate acquired through foreclosure, legal and telecommunications expenses.

Income Taxes

Summary of Income Taxes

(Dollars in Thousands)

	Nine Month Period Ended
	09/30/2014			09/30/2013			Change		% Change
Provision for Income Taxes	$	7,302		$	6,625		$	677	10.2	%
Effective Tax Rate	30.1		%	29.3		%	0.8		2.7

The provisions for federal and state income taxes amounted to 7.3 million and $6.6 million for the respective nine-month periods of 2014 and 2013. The increase in the effective tax rate was primarily attributable to a one-time historical rehabilitation tax credit in the 2013 period and decrease in the relative effect of tax-exempt interest.

# 55

Item 3.

QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

In addition to credit risk in our loan portfolio and liquidity risk, discussed on page 50 of this Report, we have market risk in our business activities. Market risk is the possibility that changes in future market rates (interest rates) or prices (fees for products and services) will make our position less valuable. The ongoing monitoring and management of market risk, principally interest rate risk, is an important component of our 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 our asset/liability profile based upon estimated market risk sensitivity, policy limits and overall market interest rate levels and trends. As of the date of this report, we have not made use of derivatives, such as interest rate swaps, in our risk management process.

Interest rate risk is the exposure of our net interest income to changes in interest rates. Interest rate risk is directly related to the different maturities and repricing characteristics of interest-bearing assets and liabilities, as well as to the risk of prepayment of loans and early withdrawal of time deposits, and the fact that the speed and magnitude of responses to interest rate changes vary by product.

The ALCO utilizes the results of a detailed and dynamic simulation model to quantify the estimated exposure of net interest income to sustained interest rate changes. While ALCO routinely monitors simulated net interest income sensitivity over a rolling two-year horizon, it also utilizes additional tools to monitor potential longer-term interest rate risk.

Our current simulation model captures the impact of changing interest rates on the interest income received and interest expense paid on all interest rate-sensitive assets and liabilities reflected on our consolidated balance sheet. This sensitivity analysis is compared to pre-established ALCO policy limits which specify a maximum tolerance level for net interest income exposure over a one year horizon. Our current sensitivity analysis model examines both a hypothetical upward shift of interest rates (currently, 200 basis points) and a hypothetical downward shift in interest rates (currently, 100 basis points, subject to certain limitations), and assumes no subsequent change in the balance sheet and a repricing of interest-bearing assets and liabilities at their earliest reasonably predictable repricing date. For repricing purposes, we normally assume a parallel and pro-rata shift in rates for both assets and liabilities, over a 12 month period.

We occasionally need to make ad hoc adjustments to our model. During recent years, the Federal Reserve's targeted federal funds rate has remained within a range of 0 to .25%. The resulting abnormally low short-term rates have led us to revise our standard model for the decreasing interest rate simulation for short-term liabilities and assets. We have applied our usual 100 basis point downward shift in interest rates for liabilities and assets on the long end of the yield curve, but we have been limited by an absolute floor of a zero interest rate for the modeling of our short-term liabilities and assets. Consequently, for purposes of determining the effect of a downward shift in rates under our current simulation model, we have made no downward shift in interest rates for our short-term liabilities and assets, even if such rates slightly exceed zero at the measurement date. We also assume that hypothetical interest rate shifts, upward or downward, affect assets and liabilities simultaneously, depending upon the contractual maturities of the particular assets and liabilities in question. In practice, however, shifts in prevailing interest rates typically affect our liability portfolios (primarily deposits) more rapidly than our asset portfolios, irrespective of differences in contractual maturities.

Applying the simulation model analysis as of September 30, 2014, a 200 basis point increase in all interest rates demonstrated a 3.38% decrease in net interest income over the ensuing 12 month period, and a 100 basis point decrease in long-term interest rates (with no decrease in short-term rates, or adjusted as discussed above) demonstrated a 1.33% decrease in net interest income, when compared with our base projection. These amounts were well within our ALCO policy limits. The preceding sensitivity analysis does not represent a forecast on our part and should not be relied upon as being indicative of expected operating results.

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, we 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 may differ due to: prepayment/refinancing levels 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 balance sheet growth or actions that ALCO might take in responding to or anticipating changes in interest rates.

In general, our interest-bearing liabilities will reprice more rapidly in a rising rate environment than our interest-earning assets, resulting in a short-term decrease in net interest income as reported in the simulation analysis, above. However, many of our interest-earning assets have relatively short lives and within a relatively few quarters after the first year period following a rise in rates we would expect a positive impact from the repricing of these interest-earning assets.

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, 2014. Based upon that evaluation, senior management, including the Chief Executive Officer and Chief Financial Officer, concluded that our disclosure controls and procedures were effective. Further, there were no changes made in our internal control over financial reporting that occurred during the most recent fiscal quarter that had materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

# 56

PART II - OTHER INFORMATION

Item 1.

Legal Proceedings

We are not the subject of any material pending legal proceedings, other than ordinary routine litigation occurring in the normal course of our business. On an ongoing basis, we are the subject of, or a party to, various legal claims against us, by us against other parties, or involving us, which arise in the normal course of our business. The various pending legal claims against us will not, in the opinion of management based upon consultation with counsel, result in any material liability.

Item 1.A.

Risk Factors

We believe that the risk factors identified in our Annual Report on Form 10-K for the year ended December 31, 2013, continue to represent the most significant risks to our future results of operations and financial conditions, without modification or amendment. Please refer to such risk factors listed in Part I, Item 1A. of our Annual Report on Form 10-K for the fiscal year ended December 31, 2013.

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 of its common stock during the three months ended September 30, 2014:

Third Quarter 2014 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 3
July	2,654	$	25.58	—	$	3,891,140
August	12,897	26.00		—	3,891,140
September	35,634	26.04		15,300	3,491,990
Total	51,185	26.00		15,300

¹ Share amounts and average prices listed in columns A and B (total number of shares purchased and the average price paid per share) include, in addition to shares repurchased under the Company’s publicly announced stock repurchase program, shares purchased in open market transactions under the Arrow Financial Corporation Automatic Dividend Reinvestment Plan (DRIP) by the administrator of the DRIP and shares surrendered (or deemed surrendered) to Arrow by holders of options to acquire Arrow common stock in connection with the exercise of such options. In the months indicated, the total number of shares purchased listed in column A included the following numbers of shares purchased through such additional methods: July – DRIP market purchases (1,411 shares), exercise of stock options (1,243 shares); August – DRIP market purchases (3,837 shares), exercise of stock options (9,060 shares); September – DRIP market purchases (20,334 shares).

² Shares repurchased by the Company under its publicly-announced stock repurchase program (i.e., the $5 million stock repurchase program authorized by the Board of Directors in November 2013 and effective January 1, 2014 (the “2014 Repurchase Program”)) during the quarter.

³ Represents the dollar amount of repurchase authority remaining at each month-end during the quarter under the 2014 Repurchase Program, the Company’s only publicly-announced stock repurchase program in effect at the end of each such month.

Item 3.

Defaults Upon Senior Securities - None

Item 4.

Mine Safety Disclosures - None

Item 5.

Other Information - None

# 57

Item 6.

Exhibits

Exhibit Number	Exhibit
10.1	Employee Pension Plan of the Registrant, as amended and restated,    dated October 22, 2014.*
15	Awareness Letter
31.1	Certification of Chief Executive Officer under SEC Rule 13a-14(a)/15d-14(a)
31.2	Certification of Chief Financial Officer under SEC Rule 13a-14(a)/15d-14(a)
32	Certification of Chief Executive Officer under 18 U.S.C. Section 1350 and    Certification of Chief Financial Officer under 18 U.S.C. Section 1350
101.INS	XBRL Instance Document
101.SCH	XBRL Taxonomy Extension Schema Document
101.CAL	XBRL Taxonomy Extension Calculation Linkbase Document
101.DEF	XBRL Taxonomy Extension Definition Linkbase Document
101.LAB	XBRL Taxonomy Extension Labels Linkbase Document
101.PRE	XBRL Taxonomy Extension Presentation Linkbase Document
* Management contract or compensation plan requred to be filed as an exhibit.

# 58

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 7, 2014	/s/Thomas J. Murphy
Date	Thomas J. Murphy, President and
	Chief Executive Officer
November 7, 2014	/s/Terry R. Goodemote
Date	Terry R. Goodemote, Executive Vice President,
	Treasurer and Chief Financial Officer
	(Principal Financial Officer and
	Principal Accounting Officer)

# 59