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, 2009
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						(IRS Employer Identification
incorporation or organization)						Number)
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 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, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filer			Accelerated filer   x
Non-accelerated filer       (Do not check if a smaller reporting company)				Smaller reporting company
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the 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 30, 2009
Common Stock, par value $1.00 per share						11,024,368

1

ARROW FINANCIAL CORPORATION

FORM 10-Q

September 30, 2009

INDEX

PART I - FINANCIAL INFORMATION		Page
Item 1.	Financial Statements:
	Consolidated Balance Sheets     as of September 30, 2009 and December 31, 2008	3
	Consolidated Statements of Income     for the Three and Nine-Month Periods Ended September 30, 2009 and 2008	4
	Consolidated Statements of Changes in Shareholders’ Equity     for the Nine-Month Periods Ended September 30, 2009 and 2008	5
	Consolidated Statements of Cash Flows     for the Nine-Month Periods Ended September 30, 2009 and 2008	7
	Notes to Unaudited Consolidated Interim Financial Statements	8
	Report of Independent Registered Public Accounting Firm	18
Item 2.	Management's Discussion and Analysis of    Financial Condition and Results of Operations	19
Item 3.	Quantitative and Qualitative Disclosures About Market Risk	47
Item 4.	Controls and Procedures	48
PART II - OTHER INFORMATION
Item 1.	Legal Proceedings	49
Item 1.A.	Risk Factors	49
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	49
Item 3.	Defaults Upon Senior Securities	49
Item 4.	Submission of Matters to a Vote of Security Holders	49
Item 5.	Other Information	49
Item 6.	Exhibits	50
SIGNATURES		50

2

ARROW FINANCIAL CORPORATION AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

(Dollars in Thousands) (Unaudited)

	September 30, 2009	December 31, 2008
ASSETS
Cash and Due from Banks	$    37,970	$    37,239
Interest-Bearing Bank Balances	79,375	21,099
Cash and Cash Equivalents	117,345	58,338
Securities Available-for-Sale	412,798	325,090
Securities Held-to-Maturity  (Approximate Fair Value of $166,794    at September 30, 2009 and $134,331 at December 31, 2008)	162,197	133,976
Loans	1,106,657	1,109,812
Allowance for Loan Losses	(13,841)	(13,272)
Net Loans	1,092,816	1,096,540
Premises and Equipment, Net	18,102	17,602
Other Real Estate and Repossessed Assets, Net	73	645
Goodwill	14,842	14,726
Other Intangible Assets, Net	1,511	1,652
Other Assets	16,599	16,517
Total Assets	$1,836,283	$1,665,086
LIABILITIES
Deposits:
Demand	$  197,987	$  182,613
Regular Savings, N.O.W. & Money Market Deposit Accounts	818,025	688,752
Time Deposits of $100,000 or More	163,337	157,187
Other Time Deposits	253,133	246,511
Total Deposits	1,432,482	1,275,063
Short-Term Borrowings:
Federal Funds Purchased and Securities Sold Under Agreements to Repurchase	60,592	59,339
Other Short-Term Borrowings	1,601	617
Federal Home Loan Bank Advances	160,000	160,000
Junior Subordinated Obligations Issued to Unconsolidated Subsidiary Trusts	20,000	20,000
Other Liabilities	22,304	24,265
Total Liabilities	1,696,979	1,539,284
SHAREHOLDERS’ EQUITY
Preferred Stock, $5 Par Value; 1,000,000 Shares Authorized	---	---
Common Stock, $1 Par Value; 20,000,000 Shares Authorized    (15,170,400 Shares Issued at September 30, 2009 and 14,728,543    at December 31, 2008)	15,170	14,729
Surplus	177,248	163,215
Retained Earnings	21,701	25,454
Unallocated ESOP Shares (105,167 Shares at September 30, 2009     and 122,207 Shares at December 31, 2008)	(2,204)	(2,572)
Accumulated Other Comprehensive Loss	(5,724)	(9,404)
Treasury Stock, at Cost (4,148,852 Shares at September 30,       2009 and 4,060,209 Shares at December 31, 2008)	(66,887)	(65,620)
Total Shareholders’ Equity	139,304	125,802
Total Liabilities and Shareholders’ Equity	$1,836,283	$1,665,086

 

See Notes to Unaudited Consolidated Interim Financial Statements.

3

ARROW FINANCIAL CORPORATION AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF INCOME

(In Thousands, Except Per Share Amounts)(Unaudited)

	Three Months		Nine Months
	Ended September 30,		Ended September 30,
	2009	2008	2009	2008
INTEREST AND DIVIDEND INCOME
Interest and Fees on Loans	$16,646	$17,076	$49,886	$50,273
Interest on Federal Funds Sold	---	49	---	463
Interest on Bank Balances	41	4	110	11
Interest and Dividends on Securities Available-for-Sale	3,634	4,387	10,939	12,802
Interest on Securities Held-to-Maturity	1,343	1,076	3,753	3,240
Total Interest and Dividend Income	21,664	22,592	64,688	66,789
INTEREST EXPENSE
Interest on Deposits:
Time Deposits of $100,000 or More	925	1,291	2,898	4,395
Other Deposits	3,477	3,995	10,872	13,164
Interest on Short-Term Borrowings:
Federal Funds Purchased and Securities Sold
Under Agreements to Repurchase	30	221	97	663
Other Short-Term Borrowings	---	1	---	8
Federal Home Loan Bank Advances	1,869	1,890	5,548	5,593
Junior Subordinated Obligations Issued to Unconsolidated    Subsidiary Trusts	161	292	555	913
Total Interest Expense	6,462	7,690	19,970	24,736
NET INTEREST INCOME	15,202	14,902	44,718	42,053
Provision for Loan Losses	427	253	1,348	791
NET INTEREST INCOME AFTER
PROVISION FOR LOAN LOSSES	14,775	14,649	43,370	41,262
NONINTEREST INCOME
Income from Fiduciary Activities	1,200	1,349	3,737	4,184
Fees for Other Services to Customers	1,956	2,242	5,937	6,318
Net Gains (Losses) on Securities Transactions	48	6	329	(29)
Net Gain on Sale of Merchant Bank Card Processing	---	---	2,966	---
Other-Than-Temporary Impairment on Investment Securities	---	(1,210)	---	(1,210)
Gain on Visa Stock Redemption	---	---	---	749
Gain on Sale of Premises	---	---	---	115
Insurance Commissions	727	528	1,822	1,575
Other Operating Income	45	174	996	415
Total Noninterest Income	3,976	3,089	15,787	12,117
NONINTEREST EXPENSE
Salaries and Employee Benefits	6,727	5,883	19,920	17,911
Occupancy Expense of Premises, Net	789	841	2,616	2,616
Furniture and Equipment Expense	819	820	2,493	2,385
Other Operating Expense	3,066	2,988	9,864	8,208
Total Noninterest Expense	11,401	10,532	34,893	31,120
INCOME BEFORE PROVISION FOR INCOME TAXES	7,350	7,206	24,264	22,259
Provision for Income Taxes	2,288	2,198	7,589	6,834
NET INCOME	$ 5,062	$ 5,008	$16,675	$15,425
Average Shares Outstanding:
Basic	10,912	10,812	10,902	10,896
Diluted	10,982	10,876	10,951	10,954
Per Common Share:
Basic Earnings	$    .46	$    .46	$   1.53	$   1.42
Diluted Earnings	.46	.46	1.52	1.41

See Notes to Unaudited Consolidated Interim Financial Statements.

Share and Per Share amounts have been restated to reflect the September 2009 3% stock dividend.

4

ARROW FINANCIAL CORPORATION AND SUBSIDIARIES

CONSOLIDATED STATEMENT OF CHANGES IN SHAREHOLDERS’ EQUITY

(In Thousands, Except Share and Per Share Amounts) (Unaudited)

	Shares Issued	Common Stock	Surplus	Retained Earnings	Unallo- cated ESOP Shares	Accumulated Other Com- prehensive Loss	Treasury Stock	Total
Balance at December 31, 2008	14,728,543	$14,729	$163,215	$25,454	$(2,572)	$ (9,404)	$(65,620)	$125,802
Comprehensive Income, Net of Tax:
Net Income	---	---	---	16,675	---	---	---	16,675
Amortization of Net Retirement     Plan Actuarial Loss (Pre-tax $1,041)	---	---	---	---	---	629	---	629
Accretion of Net Retirement Plan     Prior Service     Credit (Pre-tax $138)	---	---	---	---	---	(84)	---	(84)
Reclassification Adjustment for     Net Securities Gains Included     In Net Income, Net of Tax     (Pre-tax $329)	---	---	---	---	---	(199)	---	(199)
Net Unrealized Securities Holding     Gains Arising During the Period,     Net of Tax (Pre-tax $5,521)	---	---	---	---	---	3,334	---	3,334
Comprehensive Income								20,355
3% Stock Dividend 2	441,857	441	12,066	(12,507)	---	---	---	---
Cash Dividends Paid,   $.73 per Share 1	---	---	---	(7,921)	---	---	---	(7,921)
Stock Options Exercised   (58,133 Shares)	---	---	370	---	---	---	500	870
Shares Issued Under the Directors’   Stock Plan (2,324 Shares)	---	---	38	---	---	---	21	59
Shares Issued Under the Employee   Stock Purchase Plan (13,776   Shares)	---	---	217	---	---	---	119	336
Stock-Based Compensation   Expense	---	---	139	---	---	---	---	139
Tax Benefit for Disposition of   Stock Options	---	---	177	---	---	---	---	177
Allocation of ESOP Stock   (20,103 Shares)	---	---	146	---	368	---	---	514
Acquisition of Subsidiary   (4,398 Shares)	---	---	78	---	---	---	37	115
Shares Issued for Dividend Reinvestment Plans (50,135 Shares)	---	---	802	---	---	---	432	1,234
Purchase of Treasury Stock   (96,568 Shares)	---	---	---	---	---	---	(2,376)	(2,376)
Balance at September 30, 2009	15,170,400	$15,170	$177,248	$21,701	$(2,204)	$(5,724)	$(66,887)	$139,304

¹ Cash dividends paid per share have been adjusted for the September 2009 3% stock dividend.

² Included in the shares issued for the 3% stock dividend in 2009 were treasury shares of 120,841 and unallocated ESOP shares of 3,063.

See Notes to Unaudited Consolidated Interim Financial Statements.

5

ARROW FINANCIAL CORPORATION AND SUBSIDIARIES

CONSOLIDATED STATEMENT OF CHANGES IN SHAREHOLDERS’ EQUITY

(In Thousands, Except Share and Per Share Amounts) (Unaudited)

	Shares Issued	Common Stock	Surplus	Retained Earnings	Unallo- cated ESOP Shares	Accumulated Other Com- prehensive (Loss)	Treasury Stock	Total
Balance at December 31, 2007	14,728,543	$14,729	$161,476	$15,347	$(2,042)	$ (4,890)	$(62,364)	$122,256
Comprehensive Income, Net of Tax:
Net Income	---	---	---	15,425	---	---	---	15,425
Amortization of Actuarial Loss (Pre-tax $332)	---	---	---	---	---	201	---	201
Accretion of  Prior Service     Credit (Pre-tax $158)	---	---	---	---	---	(95)	---	(95)
Reclassification Adjustment for     Net Securities Losses Included     In Net Income, Net of Tax     (Pre-tax $29)	---	---	---	---	---	17	---	17
Net Unrealized Securities Holding     Losses Arising During the Period,     Net of Tax (Pre-tax $3,118)	---	---	---	---	---	(1,882)	---	(1,882)
Comprehensive Income								13,666
Cash Dividends Paid,   $.71 per Share 1	---	---	---	(7,706)	---	---	---	(7,706)
Stock Options Exercised   (51,694 Shares)	---	---	344	---	---	---	434	778
Shares Issued Under the Directors’   Stock Plan (2,753 Shares)	---	---	39	---	---	---	23	62
Shares Issued Under the Employee   Stock Purchase Plan (15,129   Shares)	---	---	192	---	---	---	127	319
Stock-Based Compensation   Expense	---	---	86	---	---	---	---	86
Tax Benefit for Disposition of   Stock Options	---	---	29	---	---	---	---	29
Acquisition by ESOP of Arrow Stock   (43,262 Shares)	---	---	---	---	(1,000)	---	---	(1,000)
Allocation of ESOP Stock   (30,940 Shares)	---	---	243	---	470	---	---	713
Acquisition of Subsidiary   (5,129 Shares)	---	---	69	---	---	---	43	112
Purchase of Treasury Stock   (180,260 Shares)	---	---	---	---	---	---	(3,918)	(3,918)
Balance at September 30, 2008	14,728,543	$14,729	$162,478	$23,066	$(2,572)	$(6,649)	$(65,655)	$125,397

 ¹ Cash dividends paid per share have been adjusted for the September 2009 3% stock dividend.

See Notes to Unaudited Consolidated Interim Financial Statements.

6

 ARROW FINANCIAL CORPORATION AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

(Dollars in Thousands)(Unaudited)

	Nine Months
	Ended September 30,
	2009	2008
Operating Activities:
Net Income	$16,675	$15,425
Adjustments to Reconcile Net Income to Net Cash Provided by Operating Activities:
Provision for Loan Losses	1,348	791
Depreciation and Amortization	2,153	2,037
Compensation Expense for Allocated ESOP Shares	146	243
Gains on the Sale of Securities Available-for-Sale	(522)	(10)
Losses on the Sale of Securities Available-for-Sale	193	39
Other-Than-Temporary Impairment on Investment Securities	---	1,210
Loans Originated and Held-for-Sale	(20,694)	(2,095)
Proceeds from the Sale of Loans Held-for-Sale	21,020	3,385
Net Gains on the Sale of Loans	(326)	(56)
Net Gains on the Sale of  Fixed Assets, Other Real Estate Owned and Repossessed Assets	(5)	(111)
Contributions to Pension Plans	(2,228)	(2,232)
Deferred Income Tax Expense	901	426
Stock-Based Compensation Expense	139	86
Shares Issued Under the Directors’ Stock Plan	59	62
Net Increase in Other Assets	(945)	(1,472)
Net (Decrease) Increase in Other Liabilities	(1,733)	281
Net Cash Provided By Operating Activities	16,181	18,009
Investing Activities:
Proceeds from the Sale of Securities Available-for-Sale	17,305	5,518
Proceeds from the Maturities and Calls of Securities Available-for-Sale	89,989	87,125
Purchases of Securities Available-for-Sale	(189,804)	(109,699)
Proceeds from the Maturities of Securities Held-to-Maturity	24,629	19,471
Purchases of Securities Held-to-Maturity	(53,011)	(36,443)
Net Decrease (Increase) in Loans	1,917	(69,843)
Proceeds from the Sales of Premises and Equipment, Other Real Estate Owned and Repossessed Assets	1,098	843
Purchases of Premises and Equipment	(1,641)	(2,038)
Net Cash Used In Investing Activities	(109,518)	(105,066)
Financing Activities:
Net Increase in Deposits	157,419	67,776
Net Increase in Short-Term Borrowings	2,237	17,345
Tax Benefit from Exercise of Stock Options	177	29
Purchases of Treasury Stock	(2,376)	(3,918)
Treasury Stock Issued for Stock-Based Plans	1,206	1,097
Treasury Stock issued for Dividend Reinvestment Plans	1,234	---
Acquisition of Unallocated Common Stock by the ESOP	---	(1,000)
Allocation of Common Stock Purchased by the ESOP	368	470
Cash Dividends Paid	(7,921)          (6,663)	(7,706)          (6,663)
Net Cash Provided By Financing Activities	152,344	74,093
Net Increase (Decrease) in Cash and Cash Equivalents	59,007	(12,964)
Cash and Cash Equivalents at Beginning of Period	58,338	51,289
Cash and Cash Equivalents at End of Period	$117,345	$38,325
Supplemental Disclosures to Statement of Cash Flow Information:
Cash Paid During the Period for:
Interest on Deposits and Borrowings	$20,229	$26,479
Income Taxes	9,875	5,945
Non-cash Investing and Financing Activities:
Transfer of Loans to Other Real Estate Owned and Repossessed Assets	459	540
Changes in the Valuation Allowance for Securities Available-for-Sale, Net of Tax	3,135	1,865
Additional Shares Issued for Acquisition of Subsidiary	115	112
Change in Retirement Plans Net Loss and Prior Service Cost, Net of Tax	545	106

See Notes to Unaudited Consolidated Interim Financial Statements.

7

ARROW FINANCIAL CORPORATION AND SUBSIDIARIES

NOTES TO UNAUDITED CONSOLIDATED INTERIM FINANCIAL STATEMENTS

September 30, 2009

1.   Financial Statement Presentation   

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, 2009 and December 31, 2008; the results of operations for the three-month and nine-month periods ended September 30, 2009 and 2008; the changes in shareholders’ equity for the nine-month periods ended September 30, 2009 and 2008; and the cash flows for the nine-month periods ended September 30, 2009 and 2008.  All such adjustments are of a normal recurring nature. When necessary, prior periods’ consolidated financial statements have been reclassified to conform to the current period financial statement presentation.  Share and per share information has been restated to reflect the 3% stock dividend issued in September 2009.  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, 2008, included in Arrow’s 2008 Form 10-K.  The net income reported for the nine months ended September 30, 2009 is not necessarily indicative of the results that may be expected for the year ending December 31, 2009.  The management of Arrow evaluated subsequent events for potential recognition and/or disclosure through November 9, 2009, the date the consolidated financial statements were issued.

2.   Accumulated Other Comprehensive Loss (In Thousands)

The following table presents the components, net of tax, of accumulated other comprehensive loss as of September 30, 2009 and December 31, 2008:

	2009	2008
Excess of Additional Pension Liability Over Unrecognized Prior Service Cost	$(11,291)	$(11,836)
Net Unrealized Holding Gains on Securities Available-for-Sale	5,567	2,432
Total Accumulated Other Comprehensive Loss	$  (5,724)	$ (9,404)

3.   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 the three-month and nine-month periods ended September 30, 2009 and 2008:

	Income	Shares	Per Share
	(Numerator)	(Denominator)	Amount
For the Three Months Ended September 30, 2009:
Basic EPS	$5,062	10,912	$.46
Dilutive Effect of Stock Options	---	70
Diluted EPS	$5,062	10,982	$.46
For the Three Months Ended September 30, 2008:
Basic EPS	$5,008	10,812	$.46
Dilutive Effect of Stock Options	---	64
Diluted EPS	$5,008	10,876	$.46
For the Nine Months Ended September 30, 2009:
Basic EPS	$16,675	10,902	$1.53
Dilutive Effect of Stock Options	---	49
Diluted EPS	$16,675	10,951	$1.52
For the Nine Months Ended September 30, 2008:
Basic EPS	$15,425	10,896	$1.42
Dilutive Effect of Stock Options	---	58
Diluted EPS	$15,425	10,954	$1.41

There were 68 and 245 stock options for the respective 2009 and 2008 three-month periods and 68 and 245 stock options for the respective 2009 and 2008 nine-month periods not included in the calculation of diluted earnings per share since the stock options’ exercise price was greater than the average market price for the respective periods.

8

4.   Securities (In Thousands, Except Per Share Amounts)

The fair value of securities, except certain state and municipal securities, is estimated based on published prices or bid quotations received from securities dealers.  The fair value of certain state and municipal securities is not readily available through market sources, so fair value estimates are based on the discounted contractual cash flows using estimated market discount rates that reflect the credit and interest rate risk inherent in the instrument.  For short-term securities the estimated fair value is the carrying amount.

Included in mutual funds and equity securities are Federal Home Loan Bank of New York (“FHLBNY”) and Federal Reserve Bank (“FRB”) stock.  FHLBNY and FRB stock are restricted investment securities and amounted to $9,007 and $827 at September 30, 2009, respectively and $8,859 and $817 at December 31, 2008, respectively.  The required level of FHLBNY stock is based on the amount of FHLBNY borrowings and is pledged to secure those borrowings.   While some Federal Home Loan Banks have stopped paying dividends and repurchasing stock upon reductions in debt levels, the FHLBNY continues to pay dividends and repurchase its stock.  Accordingly, we have not recognized any impairment on our holdings of FHLBNY common stock.  However, the FHLBNY has reported impairment issues among its holdings of mortgage-backed securities.

Included in corporate and other debt securities are corporate bonds and trust preferred securities which were highly rated at the time of purchase.  At December 31, 2008, corporate and other debt securities included a corporate bond issued by Lehman Brothers Holdings (“Lehman”) that was deemed to be other-than-temporarily impaired. This Lehman bond, which was sold during the third quarter of 2009, had a carrying value of $2,010 prior to the recognition of $1,610 of other-than-temporary impairment charged to earnings for the year ended December 31, 2008.  Based on consideration of the status of the issuer, the other-than-temporary impairment was considered to be attributable to credit matters and accordingly was not reversed upon the adoption of FSP FAS 115-2 and FAS 124-2 (FASB ASC Subtopic 320-10). The carrying value and approximate fair value for this security was $400 at the time of its sale in the third quarter of 2009, when we recorded an additional and final loss of $60.

All of our collateralized mortgage obligations and residential mortgage-backed securities are guaranteed by federal agencies or government sponsored enterprises.  Our practice has been to purchase mortgage-backed securities and CMOs with tranches having shorter expected lives.  

A summary of the amortized costs and the approximate fair values of securities at September 30, 2009 and December 31, 2008 is presented below:

Securities Available-for-Sale:

	Amortized Cost	Fair Value	Gross Unrealized Gains	Gross Unrealized Losses
September 30, 2009:
U.S. Treasury and Agency Obligations	$ 139,778	$ 140,604	$   843	$  17
State and Municipal Obligations	19,386	19,481	97	2
Collateralized Mortgage Obligations	144,664	151,127	6,463	---
Mortgage-Backed Securities – Residential	86,848	89,254	2,425	19
Corporate and Other Debt Securities	1,455	1,305	---	150
Mutual Funds and Equity Securities	11,448	11,027	23	444
Total Securities Available-for-Sale	$403,579	$412,798	$9,851	$632
December 31, 2008:
U.S. Treasury and Agency Obligations	$  11,375	$  11,528	$   153	$  ---
State and Municipal Obligations	15,410	15,446	36	---
Collateralized Mortgage Obligations	183,256	185,830	2,594	20
Mortgage-Backed Securities – Residential	91,900	93,849	2,038	89
Corporate and Other Debt Securities *	7,911	7,433	---	478
Mutual Funds and Equity Securities	11,210	11,004	4	210
Total Securities Available-for-Sale	$321,062	$325,090	$4,825	$797
* Amortized cost is net of the other-than-temporary impairment charged to earnings for the Lehman bond, noted above.

9

4.     Securities, continued

Securities Held-to-Maturity:

		Amortized Cost	Fair Value	Gross Unrealized Gains	Gross Unrealized Losses
September 30, 2009:
State and Municipal Obligations		$161,197	$165,794	$4,662	$65
Corporate Debt Securities		1,000	1,000	---	---
Total Securities Held-to-Maturity		$162,197	$166,794	$4,662	$65
December 31, 2008:
State and Municipal Obligations		$133,976	$134,331	$1,146	$791

A summary of the maturities of securities as of September 30, 2009 is presented below.  Mutual funds and equity securities, which have no stated maturity, are included in the over ten-year category.  Collateralized mortgage obligations and residential mortgage-backed securities are included in the schedule based on their expected average lives.  Actual maturities may differ from the table below because issuers may have the right to call or prepay obligations with or without prepayment penalties.

  

Maturities of Investment Securities:		Available-for-Sale		Held-to-Maturity
		Amortized Cost	Fair Value	Amortized Cost	Fair Value
Within One Year:
U.S. Treasury and Agency Obligations		$ 96,014	$  96,583	$         ---	$          ---
State and Municipal Obligations		9,369	9,413	45,422	45,568
Collateralized Mortgage Obligations		22,987	23,325	---	---
Mortgage-Backed Securities – Residential		4,435	4,443	---	---
Corporate and Other Debt Securities		---	---	---	---
Total		132,805	133,764	45,422	45,568
From 1 - 5 Years:
U.S. Treasury and Agency Obligations		43,764	44,021	---	---
State and Municipal Obligations		5,456	5,488	40,814	41,947
Collateralized Mortgage Obligations		63,124	66,272	---	---
Mortgage-Backed Securities – Residential		47,195	49,071	---	---
Corporate and Other Debt Securities		66	66	---	---
Total		159,605	164,918	40,814	41,947
From 5 - 10 Years:
State and Municipal Obligations		1,480	1,492	61,292	64,037
Collateralized Mortgage Obligations		58,553	61,530
Mortgage-Backed Securities – Residential		9,685	10,206	---	---
Total		69,718	73,228	61,292	64,037
Over 10 Years:
State and Municipal Obligations		3,081	3,088	13,669	14,242
Mortgage-Backed Securities – Residential		25,533	25,534	---	---
Corporate and Other Debt Securities		1,389	1,239	1,000	1,000
Mutual Funds and Equity Securities		11,448	11,027	---	---
Total		41,451	40,888	14,669	15,242
Total Securities		$403,579	$412,798	$162,197	$166,794

Other-Than-Temporary Impairment

Management evaluates securities for other-than-temporary impairment (“OTTI”) at least on a quarterly basis by segregating the portfolio by type and applying the appropriate OTTI model. The assessment of whether an other-than-temporary decline exists involves a high degree of subjectivity and judgment and is based on the information available to management at a point in time.

10

4.     Securities, continued

If an entity intends to sell or it is more likely than not it will be required to sell the security before recovery of its amortized cost basis, the OTTI shall be recognized in earnings equal to the entire difference between the investment’s amortized cost basis and its fair value at the balance sheet date. If an entity does not intend to sell the security and it is not more likely than not that the entity will be required to sell the security before recovery of its amortized cost basis, the OTTI shall be separated into the amount representing the credit loss and the amount related to all other factors. The amount of the total OTTI related to the credit loss is determined based on the present value of cash flows expected to be collected and is recognized in earnings. The amount of the total OTTI related to other factors is recognized in other comprehensive income, net of applicable taxes. The previous amortized cost basis less the OTTI recognized in earnings becomes the new amortized cost basis of the investment.  Information on temporarily impaired securities at September 30, 2009 and December 31, 2008, segregated according to the length of time such securities had been in a continuous unrealized loss position, is summarized as follows:

The table above for September 30, 2009 consists of 25 securities where the current fair value is less than the related amortized cost.  These unrealized losses do not reflect any deterioration of the credit worthiness of the issuing entities.  Agency-backed CMOs are all rated AAA, as are the mortgage-backed securities.  The municipal obligations are partially insured, all are supported by the general taxing authority of the municipality and, in the cases of school districts, are supported by state aid.  For any non-rated municipal securities, third party credit analysis shows no deterioration in the credit worthiness of the municipalities.  Corporate and other debt securities consist of one private placement trust preferred and one trust preferred pool, both of which are performing.  The private placement trust preferred is rated AAA by Standard & Poor’s; the trust preferred pool is rated investment grade, with the privately issued securities securing the note performing.  Mutual funds and equity securities include four common stock holdings that show unrealized losses which are not deemed to be other-than-temporarily impaired.  For the past 3 quarters, the unrealized loss for the equity securities has ranged from 13% to 30%.  Unrealized losses on all debt securities are considered to be temporary because they are primarily the result of changes in interest rates for fixed rate debt securities where the interest rate received is less than the current rate available for new offerings of similar debt 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 as well as consideration of credit ratings where applicable.  Since we do not intend to sell the securities and it is not more likely than not that we will be required to sell the securities before recovery to their amortized cost basis, we do not consider these securities to be other-than-temporarily impaired at September 30, 2009.

11

4.     Securities, continued

The table above for December 31, 2008 consists of 133 securities where the current fair value is less than the related amortized cost.  These unrealized losses do not reflect any deterioration of the credit worthiness of the issuing entities.  Agency-backed CMOs are all rated Aaa, as are the mortgage-backed securities.  The municipal obligations are partially insured, with the remainder supported by the general taxing authority of the municipality and, in the cases of school districts, are supported by state aid.  For any non-rated municipal securities, third party credit analysis shows no deterioration in the credit worthiness of the municipalities.  Corporate and other debt securities consist of three corporate bonds, one private placement trust preferred, and one trust preferred pool.  The three corporate bond issues are rated investment grade, and are performing.  The private placement trust preferred is rated AAA by Standard & Poor’s; the trust preferred pool is rated investment grade, with the privately issued securities securing the note performing. Mutual funds and equity securities include four common stock holdings that show unrealized losses which are not deemed to be other-than-temporarily impaired.  

5.   Retirement Plans (In Thousands)

The following table provides the components of net periodic benefit costs for the three months ended September 30:

	Pension Benefits		Postretirement Benefits
	2009	2008	2009	2008
Service Cost	$264	$267	$39	$ 46
Interest Cost	446	436	96	105
Expected Return on Plan Assets	(514)	(635)	---	---
Accretion of Prior Service Credit	(19)	(24)	(27)	(29)
Amortization of Net Loss	323	87	24	24
Net Periodic Benefit Cost	$500	$131	$132	$146

The following table provides the components of net periodic benefit costs for the nine months ended September 30:

	Pension Benefits		Postretirement Benefits
	2009	2008	2009	2008
Service Cost	$  792	$  794	$115	$133
Interest Cost	1,340	1,296	291	309
Expected Return on Plan Assets	(1,544)	(1,886)	---	---
Accretion of Prior Service Credit	(57)	(70)	(81)	(88)
Amortization of Net Loss	969	259	72	73
Net Periodic Benefit Cost	$1,500	$  393	$397	$427

We made a $2,000 contribution to our qualified pension plan and a $228 contribution to our non-qualified defined benefit pension plan in the first nine months of 2009.  We do not expect to make any additional contributions to our qualified plan during the remainder of 2009.  The expected contribution for the nonqualified pension plan is $304 for all of 2009.  Arrow makes contributions for its postretirement benefits in an amount equal to actual expenses for the year.  The expected contribution for our postretirement benefit plan is estimated to be $330 for the 2009 year.

6.   Stock-Based Compensation Plans (Dollars In Thousands)

In the first quarter of 2009 we granted options to purchase 71,264 shares of our common stock and we granted additional options to purchase 1,030 shares in the third quarter of 2009.  Both were granted under our 2008 Long-Term Incentive Plan.  No stock options were granted in 2008.  The weighted-average fair value of options granted during the first quarter of 2009 was $4.61.  The fair value was estimated on the date of grant using the Black-Scholes option-pricing model with the following weighted-average assumptions: dividend yield – 4.70%; expected volatility – 33.2%; risk free interest rate – 2.10%; and an expected life of 7.78 years.  The weighted-average fair value of options granted during the third quarter of 2009 was $7.21.  The fair value was estimated on the date of grant using the Black-Scholes option-pricing model with the following weighted-average assumptions: dividend yield – 3.60%; expected volatility – 33.2%; risk free interest rate – 3.20%; and an expected life of 7.78 years.   The fair value of our grants is expensed over the four year vesting period.  The expense for the third quarter of 2009 and 2008 was $49 and $29, respectively.  The expense for the first nine months of 2009 and 2008 was $140 and $86, respectively.

12

6.   Stock-Based Compensation Plans, continued

The following table presents the activity in Arrow’s stock option plans for the first nine months of 2009 and 2008 (restated for the September 2009 3% stock dividend):

	2009		2008
Options:	Shares	Weighted- Average Exercise Price	Shares	Weighted- Average Exercise Price
Outstanding at January 1	447,572	$21.19	535,144	$20.17
Granted	72,294	22.00	---	---
Exercised	(59,879)	14.53	(53,245)	14.62
Forfeited	(1,052)	23.24	(1,494)	25.11
Outstanding at September 30	458,935	22.18	480,405	20.77
Exercisable at September 30	330,243	22.25	398,663	20.50

Arrow also sponsors an Employee Stock Purchase Plan under which employees purchase Arrow’s common stock at a 5% discount below market price.  Under FASB ASC 718-50-25-1.a.2., a stock purchase plan with a discount of 5% or less is not considered a compensatory plan.   

7.   Guarantees (In Thousands)

We do not issue any guarantees that would require liability-recognition or disclosure, other than standby and other letters of credit.  Standby and other letters of credit are conditional commitments that are issued to guarantee the performance of a customer to a third party.  Those guarantees are primarily issued to support public and private borrowing arrangements, including bond financing and similar transactions.  The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loan facilities to customers.  Typically, these instruments have terms of twelve months or less.  Since a large percentage of these instruments expire unused, the total amounts do not necessarily represent future cash requirements.  Some have automatic renewal provisions.

For letters of credit, the amount of the collateral obtained, if any, is based on management’s credit evaluation of the counter-party.  We had approximately $14,653 of standby letters of credit outstanding on September 30, 2009, most of which will expire within one year and some of which were not collateralized.  At that date, all the letters of credit were for private borrowing arrangements.  The fair value of our standby letters of credit at September 30, 2009 was insignificant.

8.  Fair Value Disclosures (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.  The only assets or liabilities that Arrow measured at fair value on a recurring basis at September 30, 2009 and December 31, 2008 were securities available-for-sale:

		Fair Value Measurements at Reporting Date Using:
Description	Total	Quoted Prices In Active Markets for Identical Assets (Level 1)	Significant Other Observable Inputs (Level 2)	Significant Unobservable Inputs (Level 3)
As of September 30, 2009:
Securities Available-for Sale	$412,798	$      ---	$412,505	$293
As of December 31, 2008:
Securities Available-for Sale	$325,090	$      ---	$324,535	$555

13

8.  Fair Value Disclosures, continued

The following table is a reconciliation of the beginning and ending balances for Level 3 assets of Arrow, i.e., as to which fair value is measured using significant unobservable inputs, all of which are securities available-for-sale for the periods January 1, 2009 to September 30, 2009 and January 1, 2008 to December 31, 2008:

	January 1, 2009 To September 30, 2009	January 1, 2008 To December 31, 2008
Beginning Balance	$555	$   ---
Transfers In	---	1,006
Principal payment received	(19)	(5)
Purchases, issuances and settlements	(340)	---
Total net gains (losses) (realized/unrealized):
Included in earnings	(60)	---
Included in earnings, as a result of other-than-temporary impairment	---	(400)
Included in other comprehensive income (loss)	157	(46)
Ending Balance	$293	$  555
	September 30, 2009	December 31, 2008
The amount of total losses for the year-to-date period included in earnings relating to assets (all levels) still held at September 30, 2009 and December 31, 2008, as a result of other-than-temporary impairment	$---	$1,610

Securities available-for-sale 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.  There were no assets or liabilities measured at fair value on a nonrecurring basis at September 30, 2009.  

Regarding the fair value for our Level 3 trust preferred pooled security, the price provided by our third-party pricing service was not determined to reflect the fair value of this security due to the lack of trades and market for this type of security. We obtained additional value estimates from unobservable inputs including an estimated discount rate based on securities with similar durations and ratings, plus an appropriate spread for the lack of marketability and liquidity as well as anticipated cash flows for this security. We determined the fair value based on a net present value of the anticipated cash flows using the calculated discount rate.

The only asset or liability that Arrow measured at fair value on a nonrecurring basis at December 31, 2008 was other real estate owned (there were none at September 30, 2009):

		Fair Value Measurements Using:
Description	Total	Quoted Prices In Active Markets for Identical Assets (Level 1)	Significant Other Observable Inputs (Level 2)	Significant Unobservable Inputs (Level 3)	Total Gains (Losses)
As of December 31, 2008:
Other Real Estate Owned	$142	$---	$142	$---	$---

Other real estate owned, in the table above, consists of one property acquired during the first quarter of 2008.  Fair value was obtained from an appraisal by an independent third party appraiser and was based on a comparison to recent sales of similar properties.  The charge to reduce the property to its fair value, less estimated cost to sell, was recorded as a loan charge-off, prior to the transfer to other real estate owned.  The property was sold in the second quarter of 2009 with no additional loss recognized.

Other assets and liabilities which might have been included in this table include collateral-dependent impaired loans, 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, 2009 or December 31, 2008.  

14

8.  Fair Value Disclosures, continued

The following table presents a summary at September 30, 2009 of the carrying amount and fair value of Arrow’s financial instruments not carried at fair value or an amount approximating fair value:

	Carrying Amount	Fair Value
Securities Held-to-Maturity	$  162,197	$  166,794
Net Loans	1,092,816	1,114,766
Time Deposits	416,470	425,323
Federal Home Loan Bank Advances	160,000	169,140
Junior Subordinated Obligations Issued to Unconsolidated Subsidiary Trusts	20,000	20,000
Accrued Interest Receivable	7,399	7,399
Accrued Interest Payable	2,637	2,637

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 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.

  

9.  Visa Inc. IPO, Mandatory Class B Share Redemption and Litigation Liability

On March 28, 2008, VISA Inc. distributed to member banks , in a mandatory redemption of 38.7% of its Class B shares held by the member banks, some of the proceeds realized by Visa from the IPO of its Class A shares on March 19, 2008.  With another portion of the IPO proceeds, Visa established a $3 billion escrow to cover certain, but not all, litigation liabilities.  During the first quarter of 2008, we recorded the following transactions:

·

A gain of $749 thousand from the mandatory redemption by Visa of 38.7% of our Class B Visa Inc. shares, reflected in noninterest income, and

·

A reversal of $306 thousand of the $600 thousand accrual at December 31, 2007, representing our proportional share of Visa litigation costs, reflected as a reduction in 2008 other operating expense.

Accordingly, at September 30, 2009, we have a remaining liability of $294 thousand included as a component of Other Liabilities in the consolidated balance sheet, representing our estimate of the fair value of potential losses related to the remaining covered VISA litigation.  Class B shares which were not redeemed will be converted to Class A shares, at a conversion ratio to be determined based on member banks’ actual liability for litigation expenses, on the later of three years from March 18, 2008 or the settlement of litigation indemnified by member banks.  However, the remaining Class B shares are available to fund future Visa litigation liabilities indemnified by the member banks until that time.  

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10.  Recently Issued Accounting Standards

In June 2009, the Financial Accounting Standards Board (FASB) issued FASB Statement No. 168 “The FASB Accounting Standards Codification^TM and the Hierarchy of Generally Accepted Accounting Principles—a replacement of FASB Statement No. 162.”  Effective for interim and annual financial statements issued after September 15, 2009, the FASB Accounting Standards Codification^TM (FASB ASC) became the sole source of authoritative U.S. generally accepted accounting principles (GAAP) recognized by the FASB to be applied by nongovernmental entities.  Rules and interpretive releases of the Securities and Exchange Commission (SEC) under authority of federal securities laws are also sources of authoritative GAAP for SEC registrants. On the effective date of this Statement, the FASB ASC superseded all then-existing non-SEC accounting and reporting standards. All other nongrandfathered non-SEC accounting literature not included in the Codification became nonauthoritative. FASB updates to the codification will be promulgated as “Accounting Standards Updates” (ASU). This Statement did not have a material impact on our financial condition or results of operation.  

ASU 2009-05, Fair Value Measurements and Disclosures (Topic 820) – Measuring Liabilities at Fair Value:  ASU 2009-05 allows companies to use as the fair value of a liability the perspective of an investor that holds the related obligation as an asset.  Effective for financial statements issued on September 30, 2009, the standard did not change the way we determine the fair value of our liabilities (see footnote 8).

FASB ASC Subtopic 810-10: On June 12, 2009 the FASB issued FASB Statement No. 167, “Amendments to FASB Interpretation No. 46(R).”  The FASB’s objective in issuing this Statement was to improve financial reporting by enterprises involved with variable interest entities. The FASB undertook this project to address (1) the effects on certain provisions of FASB Interpretation No. 46 (revised December 2003), Consolidation of Variable Interest Entities, as a result of the elimination of the qualifying special-purpose entity concept in FASB Statement No. 166, Accounting for Transfers of Financial Assets, and (2) constituent concerns about the application of certain key provisions of Interpretation 46(R), including those in which the accounting and disclosures under the Interpretation do not always provide timely and useful information about an enterprise’s involvement in a variable interest entity.  This Statement shall be effective as of the beginning of each reporting entity’s first annual reporting period that begins after November 15, 2009, for interim periods within that first annual reporting period, and for interim and annual reporting periods thereafter.  Earlier application is prohibited.  The adoption of this Statement will not have a material impact on our financial condition or results of operation.

FASB ASC Subtopic 860-10:  On June 12, 2009, the FASB issued FASB Statement No. 166, “Accounting for Transfers of Financial Assets – an Amendment of FASB Statement No. 140.”  The FASB’s objective in issuing this Statement was to improve the relevance, representational faithfulness, and comparability of the information that a reporting entity provides in its financial statements about a transfer of financial assets; the effects of a transfer on its financial position, financial performance, and cash flows; and a transferor’s continuing involvement, if any, in transferred financial assets.   The Board undertook this project to address (1) practices that have developed since the issuance of FASB Statement No. 140, “Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities,” that are not consistent with the original intent and key requirements of that Statement and (2) concerns of financial statement users that many of the financial assets (and related obligations) that have been derecognized should continue to be reported in the financial statements of transferors.  This Statement must be applied as of the beginning of each reporting entity’s first annual reporting period that begins after November 15, 2009, for interim periods within that first annual reporting period and for interim and annual reporting periods thereafter. Earlier application is prohibited.   This Statement must be applied to transfers occurring on or after the effective date.  Additionally, on and after the effective date, the concept of a qualifying special-purpose entity is no longer relevant for accounting purposes.   Therefore, formerly qualifying special-purpose entities (as defined under previous accounting standards) should be evaluated for consolidation by reporting entities on and after the effective date in accordance with the applicable consolidation guidance.   If the evaluation on the effective date results in consolidation, the reporting entity should apply the transition guidance provided in the pronouncement that requires consolidation.  Additionally, the disclosure provisions of this Statement should be applied to transfers that occurred both before and after the effective date of this Statement.  The adoption of this Statement will not have a material impact on our financial condition or results of operation.

FASB ASC Subtopic 855-10:  In May 2009, SFAS No. 165, “Subsequent Events” was issued which establishes general standards of accounting for and disclosure of events that occur after the balance sheet date but before financial statements are issued or available to be issued. SFAS 65 sets forth (i) the period after the balance sheet date during which management of a reporting entity should evaluate events or transactions that may occur for potential recognition or disclosure in the financial statements, (ii) the circumstances under which an entity should recognize events or transactions occurring after the balance sheet date in its financial statements and (iii) the disclosures that an entity should make about events or transactions that occurred after the balance sheet date. This pronouncement was effective for the period ended June 30, 2009 and did not have a significant impact on the Company’s financial statements.  We have evaluated subsequent events through November 9, 2009, which is the date of the financial statement filing.

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10.  Recently Issued Accounting Standards, continued

FASB ASC Subtopic 820-10:  On April 9, 2009, the FASB issued FASB Staff Position (FSP) 157-4, “Determining Fair Value When the Volume and Level of Activity of the Asset or Liability Have Significantly Decreased and Identifying Transactions That Are Not Orderly,” which provided additional guidance for estimating fair value in accordance with FAS 157, “Fair Value Measurements”, when the volume and level of activity for the asset or liability have significantly decreased.  This FSP provides guidance to determine if a market is active or inactive in order to obtain fair value, which is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date under current market conditions. This FSP amends FAS 157 to require certain disclosures to discuss the inputs and valuation techniques used to measure fair value, and is effective for interim and annual reporting periods ending after June 15, 2009, with early adoption permitted for periods ending after March 15, 2009 and shall be applied prospectively. Arrow adopted FSP 157-4 in the second quarter of 2009. The adoption of this FSP did not have a material impact on our financial condition or results of operation.

FASB ASC Subtopic 320-10:  The FASB issued FSP FAS 115-2 and FAS 124-2 “Recognition and Presentation of Other-Than-Temporary Impairments,” on April 9, 2009, which provided clarity and consistency in applying accounting rules surrounding the accounting for assets considered to be other-than-temporarily-impaired by improving the presentation and disclosure in the financial statements. This FSP is effective for interim and annual reporting periods ending after June 15, 2009, with early adoption permitted for periods ending after March 15, 2009 and shall be applied prospectively. Arrow adopted FSP FAS 115-2 and FAS 124-2 in the second quarter of 2009. The adoption of this FSP did not have a material impact on our financial condition or results of operation.  

FASB ASC Subtopic 825-10:  Also on April 9, 2009, the FASB issued FSP FAS 107-1 and APB 28-1, "Interim Disclosures about Fair Value of Financial Instruments" which amends FASB Statement No. 107, “Disclosures about Fair Value of Financial Instruments,” to require disclosures about fair value of financial instruments for interim reporting periods of publicly traded companies as well as in annual financial statements. This FSP also amends APB Opinion No. 28, “Interim Financial Reporting,” to require those disclosures in summarized financial information at interim reporting periods.  This FSP is effective for interim and annual reporting periods ending after June 15, 2009.  Arrow adopted this FSP in the second quarter 2009.  Since this FSP only relates to disclosures about fair values and, as such, did not have a material impact on our financial condition or results of operations.

FASB ASC Subtopic 715-20:  In December 2008 the FASB adopted FSP FAS 132(R)-1, "Employers’ Disclosures about Postretirement Benefit Plan Assets," which amends FASB Statement No. 132 (revised 2003), “Employers’ Disclosures about Pensions and Other Postretirement Benefits,” to provide guidance on an employer’s disclosures about plan assets of a defined benefit pension or other postretirement plan.  An employer shall disclose information about how investment allocation decisions are made, including factors that are pertinent to an understanding of investment policies and strategies and an employer shall disclose separately for pension plans and other postretirement benefit plans the fair value of each major category of plan assets as of each annual reporting date for which a statement of financial position is presented. Asset categories shall be based on the nature and risks of assets in an employer’s plan.  In addition, an employer shall disclose information that enables users of financial statements to assess the inputs and valuation techniques used to develop fair value measurements of plan assets at the annual reporting date. For fair value measurements using significant unobservable inputs (Level 3, under FAS 157), an employer shall disclose the effect of the measurements on changes in plan assets for the period and an employer shall provide users of financial statements with an understanding of significant concentrations of risk in plan assets.  The FSP is effective for fiscal years ending on or after December 15, 2009 and only relates to disclosures about fair values and, as such, will not have a material impact on our financial condition or results of operations.

FASB ASC Subtopic 805-10:  In December 2007, the FASB issued revised Statement of Financial Accounting Standards (“SFAS”) No. 141, "Business Combinations."  SFAS No. 141(R) retains the fundamental requirements of SFAS No. 141 that the acquisition method of accounting (formerly the purchase method) be used for all business combinations; that an acquirer be identified for each business combination; and that intangible assets be identified and recognized separately from goodwill.  SFAS No. 141(R) requires the acquiring entity in a business combination to recognize the assets acquired, the liabilities assumed and any non-controlling interest in the acquiree at the acquisition date, measured at their fair values as of that date, with limited exceptions.  Additionally, SFAS No. 141(R) changes the requirements for recognizing assets acquired and liabilities assumed arising from contingencies and recognizing and measuring contingent consideration.  SFAS No. 141(R) also enhances the disclosure requirements for business combinations.  SFAS No. 141(R) applies prospectively to business combinations for which the acquisition date is on or after the beginning of the first annual reporting period beginning on or after December 15, 2008 and may not be applied before that date.  The impact that SFAS No. 141(R) is expected to have on our financial condition or results of operations is indeterminable as it is prospective in nature.  While the adoption of SFAS No. 141(R) did not have an impact on the Company’s consolidated financial position or results of operations upon its adoption on January 1, 2009, the adoption of SFAS No. 141(R) would have a significant impact on business combinations, if any, entered into by the Company subsequent to January 1, 2009.

17

Report of Independent Registered Public Accounting Firm

The Board of Directors and Shareholders

Arrow Financial Corporation:

We have reviewed the consolidated balance sheet of Arrow Financial Corporation and subsidiaries (the “Company”) as of September 30, 2009, the related consolidated statements of income for the three and nine-month periods ended September 30, 2009 and 2008 and the related consolidated statements of changes in shareholders’ equity and cash flows for the nine-month periods ended September 30, 2009 and 2008.  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 review, 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, 2008, and the related consolidated statements of income, changes in shareholders’ equity and cash flows for the year then ended (not presented herein); and in our report dated March 5, 2009, 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, 2008, is fairly stated, in all material respects, in relation to the consolidated balance sheet from which it has been derived.

Albany, New York

November 9, 2009

18

Item 2.

ARROW FINANCIAL CORPORATION AND SUBSIDIARIES

MANAGEMENT'S DISCUSSION AND ANALYSIS OF

FINANCIAL CONDITION AND RESULTS OF OPERATIONS

SEPTEMBER 30, 2009

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.  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), North Country Investment Advisers, Inc. (a registered investment adviser that provides investment advice to our proprietary mutual funds), U.S. Benefits, Inc. (a provider of administrative and recordkeeping services for more complex retirement plans) and Arrow Properties, Inc., (a real estate investment trust, or REIT).

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 300 domestic bank holding companies with $1 to $3 billion in total consolidated assets as identified in the Federal Reserve Board’s (“FRB”) Bank Holding Company Performance Report as of June 30, 2009.  Unless otherwise specified, the peer group data contained herein has been derived from the FRB’s June 30, 2009 Report, which is the most recent FRB Report currently available.   

Forward Looking Statements - The information contained in 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 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 activity, both locally and nationally, or anticipated trends or developments unique to our own business, as well as current management strategies for our future operations and development.  Examples of forward-looking statements in this Report are referenced in the table below:

Topic	Page	Location
Estimation of potential losses related to Visa obligation	25	3rd paragraph
Impact of Financial Downturn	25	Last paragraph
Impact of market rate structure on net interest margin,   loan yields and deposit rates	28	Next to last paragraph
	30	4th & last paragraphs
	31	1st paragraph
	31	4th paragraph
	34	1st paragraph under table
	34	2nd paragraph under table
Provision for loan losses	36	1st paragraph under table
Change in the level of loan losses and nonperforming loans and assets	37	5th paragraph
Future level of residential real estate loans	33	2nd paragraph
Future level of indirect consumer loans	33	7th paragraph
Future level of commercial loans	34	1st paragraph
Gain on the sale of residential real estate loans	43	2nd paragraph
Impact of changing economy	38	2nd paragraph
Impact of economic downturn	39	2nd paragraph
Liquidity	41	1st paragraph
Impact of changing stock market prices	42	3rd paragraph under table
	45	2nd paragraph under table

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These statements 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 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, possible sudden and significant changes in economic and market conditions, fluctuations in interest rates (more likely upward than downward), asset inflation or deflation, continuing oscillations in levels of business activity generally; new developments in state and federal regulation; enhanced competition; emerging technologies; loss of key personnel; unanticipated business opportunities; and similar uncertainties, inherent in banking operations or business generally.  

Readers are cautioned not to place undue reliance on these forward-looking statements, 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, except as may be required in connection with regular or periodic reports filed under Section 13(a) of the Securities Exchange Act of 1934 or other registration statements or disclosures filed under the federal securities laws.  This Quarterly Report should be read in conjunction with our Annual Report on Form 10-K for the period ended December 31, 2008.

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.  As a parallel measure with Regulation G, the SEC stipulated in Item 10 of its Regulation S-K that public companies must make the same types of supplemental disclosures whenever they include non-GAAP financial measures in their filings with the SEC.  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 or SEC filings, supplemental information is not required.  The following measures used in this Report, which although commonly utilized by financial institutions have not been specifically exempted by the SEC, 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 back to the net interest income total.  This adjustment is considered helpful in comparing one financial institution's net interest income to that of another institution, to correct any distortion that might otherwise arise from the fact that the two institutions typically will have different proportions of tax-exempt items in their portfolios.  Moreover, net interest income is itself a component of a second financial measure commonly used by financial institutions, net interest margin, which is the ratio of net interest income to average earning assets.  For purposes of this measure as well, tax-equivalent net interest income is generally used by financial institutions, again to provide a better basis of comparison from institution to institution.  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 typically expressed on a tax-equivalent basis.  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), as well as certain nonrecurring components, such as gain or loss from the sale of a business line.  We follow these practices.

Tangible Book Value per Share and Tangible Equity:  Tangible equity is total shareholders’ 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 shareholders’ equity including intangible assets divided by total shares issued and outstanding.  Intangible assets as a category of assets include many items, but essentially represents goodwill for Arrow.      

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Selected Quarterly Information:

(Dollars In Thousands, Except Per Share Amounts)

	Sep 2009		Jun 2009	Mar 2009	Dec 2008	Sep 2008
Net Income	$5,062		$4,931	$6,682	$5,012	$5,008
Transactions Recorded in Net Income (Net of Tax):
Net Gain on Sale of Merchant Bank Card Processing1	$---		$161	$1,630	$      ---	$      ---
Other-Than-Temporary Impairment (OTTI) 2	---		---	---	(242)	(731)
Income from Restitution Payment  3	---		272	---	---	---
FDIC Special Assessment 4	---		(475)	---	---	---
Net Securities Gains 2	29		2	167	249	4
Net Gains on Sales of Loans 5	10		141	46	31	8
Period-End Shares Outstanding	10,916		10,909	10,901	10,863	10,825
Basic Average Shares Outstanding	10,912		10,901	10,892	10,840	10,812
Diluted Average Shares Outstanding	10,982		10,948	10,922	10,906	10,876
Basic Earnings Per Share	.46		.45	$.61	$.42	$.46
Diluted Earnings Per Share	.46		.45	.61	.42	.46
Cash Dividends Per Share	.24		.24	.24	.24	.24
Average Assets	$1,778,893		$1,725,739	$1,681,096	$1,687,366	$1,657,666
Average Equity	136,397		133,718	128,507	127,136	124,601
Return on Average Assets	1.13%		1.15%	1.61%	1.18%	1.20%
Return on Average Equity	14.72		14.79	21.09	15.68	15.99
Average Earning Assets	$1,706,626		$1,653,637	$1,610,007	$1,615,240	$1,580,408
Average Paying Liabilities	1,417,218		1,382,451	1,346,413	1,345,344	1,308,191
Interest Income, Tax-equivalent 6	22,499		22,245	22,262	23,446	23,302
Interest Expense	6,462		6,716	6,792	7,541	7,690
Net Interest Income, Tax-equivalent 6	16,037		15,529	15,470	15,905	15,612
Tax-equivalent Adjustment	835		744	739	727	710
Net Interest Margin 6	3.73%		3.77%	3.90%	3.92%	3.93%
Efficiency Ratio Calculation:6
Noninterest Expense	$11,401		$12,119	$11,373	$11,273	$10,532
Less: Intangible Asset Amortization	(79)		(79)	(89)	(89)	(89)
Net Noninterest Expense	$11,322		$12,040	$11,284	$11,184	$10,443
Net Interest Income, Tax-Equivalent 6	$16,037		$15,529	$15,470	$15,905	$15,612
Noninterest Income	3,976		4,844	6,967	4,152	3,089
Less: Net Securities Gains & OTTI	(48)		(4)	(277)	(12)	1,204
Less: Net Gain on Sale of     Merchant Bank Card Processing	---		(266)	(2,700)	---	---
Adjusted Gross Income	$19,965		$20,103	$19,460	$20,045	$19,905
Efficiency Ratio 6	56.71%		59.89%	57.99%	55.79%	52.46%
Period-End Capital Information:
Tier 1 Leverage Ratio	8.37%		8.77%	8.64%	8.39%	8.32%
Total Shareholders’ Equity (i.e. Book Value)	$139,304		$134,586	$132,539	$125,802	$125,397
Book Value per Share	12.76		12.71	12.52	11.93	11.93
Intangible Assets	16,353		16,440	16,450	16,378	16,457
Tangible Book Value per Share6	11.26		11.15	10.97	10.38	10.36
Asset Quality Information:
Net Loans Charged-off as a   Percentage of Average Loans, Annualized	.08%		.09%	.12%	.14%	.07%
Provision for Loan Losses as a   Percentage of Average Loans, Annualized	.15		.15	.18	.32	.09
Allowance for Loan Losses as a   Percentage of Loans, Period-end	1.25		1.25	1.22	1.20	1.16
Allowance for Loan Losses as a   Percentage of Nonperforming Loans, Period-end	299.07		383.40	352.65	338.05	444.08
Nonperforming Loans as a   Percentage of Loans, Period-end	.42		.32	.35	.35	.26
Nonperforming Assets as a   Percentage of Total Assets, Period-end	.26		.23	.27	.30	.24
1  See page 25		4 See page 25, 44, 46
2 See page 26		5 See page 43, 45, 46
3 See pages 27, 44, 45		6 See “Use of Non-GAAP Financial Measures” on page 20.

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Selected Nine-Month Period Information:

(Dollars In Thousands, Except Per Share Amounts)

				Sep 2009	Sep 2008
Net Income				$16,675	$15,425
Transactions Recorded in Net Income (Net of Tax):
Net Gain on Sale of Merchant Bank Card Processing	see page 25			$1,791	$---
Reversal of VISA Related Litigation Exposure	see page 25			---	185
Gain on Redemption of VISA Inc. Class B Shares	see page 25			---	452
Other-Than-Temporary Impairment (OTTI)	see page 26			---	(731)
Income from Restitution Payment	see page 44, 45			271	---
FDIC Special Assessment	see page 25			(475)	---
Net Securities Gains (Losses)	see page 35			199	(17)
Net Gain on the Sale of Premises	see page 45			---	69
Net Gain on Sales of Loans	see page 45, 46			197	32
Period-End Shares Outstanding				10,916	10,825
Basic Average Shares Outstanding				10,902	10,896
Diluted Average Shares Outstanding				10,951	10,954
Basic Earnings Per Share				$1.53	$1.42
Diluted Earnings Per Share				1.52	1.41
Cash Dividends				.73	.71
Average Assets				$1,728,934	$1,629,719
Average Equity				132,903	125,155
Return on Average Assets				1.29%	1.26%
Return on Average Equity				16.77	16.46
Average Earning Assets				$1,657,111	$1,553,046
Average Paying Liabilities				1,382,287	1,289,771
Interest Income, Tax-equivalent 1				67,006	68,995
Interest Expense				19,970	24,736
Net Interest Income, Tax-equivalent 1				47,036	44,259
Tax-equivalent Adjustment				2,318	2,206
Net Interest Margin 1				3.79%	3.81%
Efficiency Ratio Calculation 1
Noninterest Expense				$34,893	$31,120
Less: Intangible Asset Amortization				(247)	(271)
Net Noninterest Expense				34,646	30,849
Net Interest Income, Tax-equivalent 1				47,036	44,259
Noninterest Income				15,787	12,117
Less: Net Securities (Gains) Losses				(329)	1,239
Less: Net Gain on Sale of Merchant Bank Card Processing				(2,966)	---
Less: Gain on Redemption of VISA Inc. Class B Shares				---	(749)
Net Gross Income, Adjusted				59,528	56,866
Efficiency Ratio 1				58.20%	54.25%
Period-End Capital Information:
Tier 1 Leverage Ratio				8.37%	8.32%
Total Shareholders’ Equity (i.e. Book Value)				$139,304	$125,397
Book Value per Share				12.76	11.58
Intangible Assets				16,353	16,457
Tangible Book Value per Share  1				11.26	10.06
Asset Quality Information:
Net Loans Charged-off as a   Percentage of Average Loans, Annualized				.09%	.05%
Provision for Loan Losses as a   Percentage of Average Loans, Annualized				.16	.10
Allowance for Loan Losses as a   Percentage of Period-end Loans				1.25	1.16
Allowance for Loan Losses as a   Percentage of Nonperforming Loans				299.07	444.08
Nonperforming Loans as a   Percentage  of Period-end Loans				.42	.26
Nonperforming Assets as a   Percentage of Period-end Total Assets				.26	.24

 ¹ See “Use of Non-GAAP Financial Measures” on page 20

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Average Consolidated Balance Sheets and Net Interest Income Analysis

(see “Use of Non-GAAP Financial Measures” on page 20)

(Tax-equivalent Basis using a marginal tax rate of 35%)

(Dollars In Thousands)

Quarter Ended September 30,	2009			2008
		Interest	Rate		Interest	Rate
	Average	Income/	Earned/	Average	Income/	Earned/
	Balance	Expense	Paid	Balance	Expense	Paid
Federal Funds Sold	$            ---	$      ---	---%	$    10,158	$   49	1.92%
Interest-Bearing Bank Balances	62,301	41	0.26	929	4	1.71
Securities Available-for-Sale:
Taxable	366,000	3,520	3.82	345,281	4,224	4.87
Non-Taxable	17,013	189	4.41	18,608	249	5.32
Securities Held-to-Maturity:
Taxable	1,254	21	6.64	272	3	4.39
Non-Taxable	160,237	2,015	4.99	121,869	1,622	5.29
Loans	1,099,821	16,713	6.03	1,083,291	17,151	6.30
Total Earning Assets	1,706,626	22,499	5.23	1,580,408	23,302	5.87
Allowance For Loan Losses	(13,721)			(12,732)
Cash and Due From Banks	28,208			35,673
Other Assets	57,780			54,317
Total Assets	$1,778,893			$1,657,666
Deposits:
Interest-Bearing  NOW Deposits	$  443,841	1,144	1.02	$  353,171	1,167	1.31
Regular and Money  Market Savings	310,991	503	0.64	288,307	863	1.19
Time Deposits of  $100,000 or More	167,681	925	2.19	178,041	1,291	2.88
Other Time Deposits	253,359	1,830	2.87	242,069	1,965	3.23
Total Interest-Bearing Deposits	1,175,872	4,402	1.49	1,061,588	5,286	1.98
Short-Term Borrowings	61,346	30	0.19	63,198	222	1.40
Long-Term Debt	180,000	2,030	4.47	183,405	2,182	4.73
Total Interest-Bearing Liabilities	1,417,218	6,462	1.81	1,308,191	7,690	2.34
Demand Deposits	199,611			200,193
Other Liabilities	25,667			24,681
Total Liabilities	1,642,496			1,533,065
Shareholders’ Equity	136,397			124,601
Total Liabilities and Shareholders’ Equity	$1,778,893			$1,657,666
Net Interest Income (Tax-equivalent Basis)		16,037			15,612
Net Interest Spread			3.42			3.53
Net Interest Margin			3.73			3.93
Reversal of Tax-Equivalent Adjustment		(835)	(.19)		(710)	(.18)
Net Interest Income, As Reported		$15,202			$14,902

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Average Consolidated Balance Sheets and Net Interest Income Analysis

(see “Use of Non-GAAP Financial Measures” on page 20)

(Tax-equivalent Basis using a marginal tax rate of 35%)

(Dollars In Thousands)

Nine Months Ended September 30,	2009			2008
		Interest	Rate		Interest	Rate
	Average	Income/	Earned/	Average	Income/	Earned/
	Balance	Expense	Paid	Balance	Expense	Paid
Federal Funds Sold	$             ---	$         ---	---%	$    23,186	$    463	2.67%
Interest-Bearing Bank Balances	55,929	110	0.26	672	11	2.19
Securities Available-for-Sale:
Taxable	339,884	10,616	4.18	331,027	12,151	4.90
Non-Taxable	14,129	523	4.95	23,153	993	5.73
Securities Held-to-Maturity:
Taxable	900	43	6.39	279	10	4.79
Non-Taxable	147,116	5,623	5.11	116,303	4,867	5.59
Loans	1,099,153	50,091	6.09	1,058,426	50,500	6.37
Total Earning Assets	1,657,111	67,006	5.41	1,553,046	68,995	5.93
Allowance For Loan Losses	(13,523)			(12,571)
Cash and Due From Banks	28,034			33,967
Other Assets	57,312			55,277
Total Assets	$1,728,934			$1,629,719
Deposits:
Interest-Bearing  NOW Deposits	$   439,854	3,674	1.12	$   354,305	3,865	1.46
Regular and Money  Market Savings	299,629	1,564	0.70	279,603	2,667	1.27
Time Deposits of  $100,000 or More	155,308	2,898	2.49	174,181	4,395	3.37
Other Time Deposits	249,953	5,634	3.01	242,942	6,632	3.65
Total Interest-Bearing Deposits	1,144,744	13,770	1.61	1,051,031	17,559	2.23
Short-Term Borrowings	57,543	97	0.23	56,949	671	1.57
Long-Term Debt	180,000	6,103	4.53	181,791	6,506	4.78
Total Interest-Bearing Liabilities	1,382,287	19,970	1.93	1,289,771	24,736	2.56
Demand Deposits	188,938			190,456
Other Liabilities	24,806			24,337
Total Liabilities	1,596,031			1,504,564
Shareholders’ Equity	132,903			125,155
Total Liabilities and Shareholders’ Equity	$1,728,934			$1,629,719
Net Interest Income (Tax-equivalent Basis)		47,036			44,259
Net Interest Spread			3.48			3.37
Net Interest Margin			3.79			3.81
Reversal of Tax-Equivalent Adjustment		(2,318)	(.19)		(2,206)	(.19)
Net Interest Income, As Reported		$44,718			$42,053

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OVERVIEW

Sale of Merchant Bank Card Processing to TransFirst:  As we previously reported, on March 2, 2009, our bank subsidiaries, Glens Falls National Bank and Trust Company and Saratoga National Bank and Trust Company, sold their merchant bank card processing business for an initial cash payment at closing of $3 million to TransFirst LLC (TransFirst) and a bank designated by TransFirst.  In connection with the sale, we entered into a relationship with TransFirst under which TransFirst will provide merchant bank card processing to merchant customers of our subsidiary banks.  The gain was offset, in part, by an estimated $300 thousand cost to terminate certain pre-existing agreements for a net gain of $2.7 million, which we recognized in the first quarter of 2009.  In the second quarter of 2009, a post-closing adjustment to the purchase price substantially eliminated the termination fees related to the pre-existing agreements such that our net gain on the sale of the business as adjusted increased $266 thousand to approximately $2.97 million.

VISA Transactions in 2008 and 2009:  On March 28, 2008, VISA Inc. distributed to its member banks, including Glens Falls National Bank and Trust Company, by way of a mandatory redemption of 38.7% of Visa’s Class B shares held by the member banks, some of the proceeds realized by Visa from the initial public offering and sale of its Class A shares just then completed.  With another portion of the IPO proceeds, Visa established a $3 billion escrow fund to cover certain, but not all, of its continuing litigation liabilities, which its member banks are otherwise required to bear.  Accordingly, during the first quarter of 2008, we recorded the following transactions:

•

 A gain of $749 thousand from the mandatory redemption by Visa from us of 38.7% of our Class B Visa Inc. shares, reflected as an increase in noninterest income, and

•

 A reversal of $306 thousand of the $600 thousand accrual previously recorded by us at December 31, 2007, representing our then estimated proportional share of Visa litigation costs, which reversal was reflected as a reduction in 2008 other operating expense.

In October 2008, Visa announced that it had settled a lawsuit with Discover Financial Services, which was part of the covered litigation for which the Visa member banks remained contingently liable. In December 2008, Visa deposited an additional $1.1 billion into the escrow fund for covered litigation. On July 16, 2009, Visa announced that it had deposited an additional $700 million into the escrow fund.  These developments reduced the Company’s proportionate exposure for covered litigation but also reduced the ultimate value of its remaining Class B Visa shares.  However, the Company had not previously recognized the value of its remaining Class B shares in accordance with SEC guidance, thus the Company did not recognize any income or expense as a result of the reduced value of those shares upon Visa’s settlement of the litigation in any of the periods presented. The estimation of the Company’s proportionate share of any potential losses related to the covered litigation is extremely difficult and involves a high degree of uncertainty. Management has determined that the remaining $294 thousand liability included in “Other Liabilities” on our year-end 2008 consolidated balance sheet remained the fair value of our proportionate share of the remaining covered Visa litigation obligation as of September 30, 2009, but this value is subject to change depending upon future developments in the covered litigation.

FDIC Special Assessment & Prepayment:  The FDIC announced during the second quarter of 2009 that they would levy a special assessment on all FDIC insured financial institutions to rebuild the FDIC’s insurance fund which has recently been depleted by bank failures.  The special assessment will equal 0.05% of an institution’s total assets less Tier 1 capital.  Institutions were instructed to estimate and accrue the expense in the second quarter of 2009.  We determined that our expense would be $787 thousand, which we accrued on June 30, 2009.  During the third quarter of 2009 the FDIC announced that they would not impose another special assessment in the remainder of 2009, but would provide cash for the fund by requiring insured institutions to prepay their projected assessments for the fourth quarter of 2009 and all of 2010, 2011 and 2012 in the fourth quarter of 2009.  We estimate that our prepayment will be approximately $6.54 million.  This amount will be amortized, as required by bank regulatory guidance, into expense during the relevant periods to which such assessment relates.  

Financial Downturn; Impact on Company.

Continued Financial Market Turmoil:  From fall 2007 to March 2009, the Dow Jones Industrial Average (Dow Jones) fell from a high of over 14,000 to a low of under 7,000, with the most dramatic change occurring during the fourth quarter of 2008 and the first quarter of 2009.  Beginning in 2008, the financial markets and particularly the banking sector felt the impact of losses on subprime mortgages and other credit portfolios and loss of short-term liquidity, resulting in the September 2008 failure of Lehman Brothers Holdings (Lehman) and the distressed sales of Bear Stearns and Merrill Lynch.  In the ensuing period, the number of bank failures, while not at historic highs, has risen to levels not seen for several years.  Community banks such as ours that do not underwrite subprime residential real estate loans and do not invest in private issue collateralized debt obligations have not typically experienced the significant losses in their loan or investment portfolios or the liquidity concerns that many of the larger financial institutions have experienced.  However, the magnitude of turmoil in the markets has had a significant impact on the operations of all banks, including ours, and to the extent the U.S. economy continues in its present weakened state, our financial condition and results of operations will likely be negatively impacted, to some extent, in forthcoming periods.

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Decision Not to Participate in U.S. Treasury TARP CCP:  As previously disclosed in our Current Report on Form 8-K filed with the SEC on January 27, 2009, our Board of Directors determined in late January 2009, after we had applied to the U.S. Treasury Department and federal bank regulators to participate in the U.S. Government’s Capital Purchase Plan (“CPP”, an element of the larger Troubled Assets Relief Program (“TARP”)), and after we had been preliminarily approved by the Department of Treasury for participation, that we would not proceed ahead and issue shares of our preferred stock to the Treasury Department in return for TARP funds but rather would decline to participate.  The basic reason for the Board’s decision, as discussed in the Form 8-K, was that the Company’s financial and liquidity positions remained sufficiently strong at year-end 2008 such that the extra capital was not needed and the potential loss of Board and management flexibility entailed in CPP participation would be too costly to warrant participation.  Many other financial institutions, which received approval for TARP participation and in some cases took the TARP funds, came to the same conclusion and either elected not to participate or, if they did participate, are seeking to return their TARP funds to the US Treasury and cease participation.  As of the date of this report, there have been no changes to our capital or liquidity positions that would suggest that our decision was incorrect.

Economic Recession and Economic Downturn—Impact on Loan Quality:  When the economic recession began in December 2007, our market area of northeastern New York was relatively sheltered from falling real estate values and increasing unemployment.  As the recession became stronger and deeper in late 2008 and early 2009, even northeastern New York began to feel the impact of the worsening national economy, reflected in a regional slow-down in real estate sales and increasing unemployment.  By year-end 2008, we had experienced a small but measurable decline in the credit quality of our loan portfolio, although by standard measures our portfolio through mid-year 2009 continues to appear stronger than the average for our peer group.  Our levels of nonperforming assets and delinquent loans at September 30, 2009 remained consistent with December 31, 2008 levels, but were elevated when compared with September 30, 2008 results (see the table “Summary of the Allowance and Provision for Loan Losses” on page 36 of this Report).  Nonperforming loans amounted to $4.6 million at September 30, 2009, an increase of $702 thousand from year-end 2008.  The ratio of nonperforming loans to period-end loans was .42% at September 30, 2009, up 7 basis points from year-end 2008.  By way of comparison, this ratio for our peer group increased by 97 basis points from 2.36% at December 31, 2008 to 3.33% at June 30, 2009.  On an annualized basis, the ratio of our loans charged-off (net of recoveries) to average loans was .08 for the third quarter of 2009, just one basis point above the .07% ratio for the third quarter of 2008.  Our allowance for loan losses, as a percentage of period-end loans, rose from 1.20% at December 31, 2008 to 1.25% at September 30, 2009.

Recent trends in our three major loan portfolio segments are as follows:

o

Commercial and Commercial Real Estate Loans:  We lend to small and medium sized businesses, which typically do not encounter liquidity problems, since we often also provide support for their supplementary liquidity needs.  However, current unemployment rates in our region are higher than in the past few years and the number of jobs has decreased, and some small and medium-sized businesses that borrow from us are experiencing revenue fall-off and financial pressure.  

o

Residential Real Estate Loans:  We have not experienced a notable increase in our foreclosure rates, primarily due to the fact that we did not originate or participate in underwriting subprime loans as a business line.

o

Indirect Consumer Loans:  These loans comprise over 31% of our loan portfolio and consist primarily of automobile loans financed through local dealerships where we acquire the dealer paper.  We have experienced moderate but not significant increases in our delinquency rate and level of charge-offs during the fourth quarter of 2008 and the first three quarters of 2009.

Economic Downturn—Impact on Investment Securities; Other-Than-Temporary Impairment (OTTI):  When the U.S. credit markets suffered a meltdown in the third quarter of 2009, we held a $2.0 million par value senior unsecured bond issued by Lehman. On September 15, 2008, Lehman declared bankruptcy resulting in a significant decline in the fair value of the bond.  We deemed the decline to be other-than-temporary in the third quarter 2008, and, accordingly, recognized a non-cash other-than-temporary impairment charge to earnings of $731 thousand net of tax in the third quarter of 2008 (a $.07 reduction in diluted earnings per share) and an additional $242 thousand charge to earnings in the fourth quarter of 2008 (a $.02 reduction in diluted earnings per share).  The remaining estimated fair value of our Lehman bond of $400 thousand was included in non-performing assets at December 31, 2008 and the end of the first two quarters of 2009.  During the third quarter of 2009, we sold the Lehman bond for $340 thousand and recorded an additional loss of $60 thousand at that time.

At September 30, 2009 the remaining corporate bonds and other debt securities in our investment securities portfolio amounted to only $1.3 million.  We did not hold any preferred or common stock of Fannie Mae or Freddie Mac in the third quarter of 2008, when the federal government took over those entities.   As of September 30, 2009, we had not experienced any impairment issues with our holdings of mortgage-backed securities or CMO’s.  Mortgage-backed securities held by the company are comprised of pass-through securities backed by conventional residential mortgages and guaranteed by government agencies or government sponsored entities. We do not hold any private-label mortgage-backed securities or securities backed by subprime or other high risk non-traditional mortgage loans.

Economic Downturn—Impact on Liquidity:  We did not experience and have not experienced any liquidity issues during 2008 or thus far in 2009.  The terms of our lines of credit with our correspondent banks, the FHLBNY and the Federal Reserve Bank, have not changed in recent periods, except for some increases in the maximum borrowing capacity.  In general, to satisfy our liquidity needs we have relied on asset-based liquidity (i.e. funds in overnight investments and cash flow from maturing investments and loans) with liability-based liquidity as a secondary source (overnight lending arrangements with our correspondent banks, FHLBNY overnight and term advances and the Federal Reserve Bank discount window).  During the recent period of bank failures, some institutions experienced a run on deposits, even though there was no reasonable expectation that depositors would lose any of their insured deposits.  We maintain, and periodically test, a contingency liquidity plan whose purpose is to ensure that we can generate an adequate amount of cash to meet a wide variety of potential liquidity crises.  (See our general liquidity discussion on page 40.)   

Increase in Shareholder Equity:  At September 30, 2009, our tangible book value per share (a non-GAAP financial measure [see page 20] calculated based on shareholders’ equity reduced by intangible assets including goodwill and other intangible assets) amounted to $11.26, an increase of $1.19, or 11.8%, from year-end 2008.  Our total shareholders’ equity at period-end 2009 increased 10.7% over the year-end 2008 level.  Major changes to shareholders’ equity during the 2009 nine-month period included: i) $16.7 million of net income; ii) a $3.1 million net unrealized gain in securities available-for-sale, offset by; iii) cash dividends of $7.9 million; and iv) repurchases of our own common stock of $2.4 million.  As of the last trading day of the 2009 period, our closing stock price was $27.20 resulting in a trading multiple of 2.42 to our tangible book value.  We also continue to remain classified as “well-capitalized” under regulatory guidelines.  As mentioned above, due to our strong financial and liquidity positions at year-end, we elected in January 2009 not to participate in the U.S. Treasury’s Capital Purchase Program (a component of TARP), even though we had been approved to participate by the Treasury Department.

Quarterly cash dividends of $.24 per share were paid for each of the first three quarters of 2009, as adjusted for the 3% stock dividend distributed in September 2009, and on October 29, 2009, the Board declared a cash dividend of $.25 for the fourth quarter of 2009 which is payable on December 15, 2009.

Other Key Financial Results

We reported earnings of $5.062 million for the third quarter of 2009, an increase of $54 thousand, or 1.1%, as compared to $5.008 million for the third quarter of 2008.  Diluted earnings per share were $.46 for both respective quarters.   However, the recognition of an other-than-temporary loss on our Lehman bond, mentioned above, in the 2008 quarter had a $.07 negative impact on the 2008 third quarter diluted earnings per share.  

The annualized returns on average assets were 1.13% and 1.20% for the third quarters of 2009 and 2008, respectively, a decrease of 7 basis points in the current quarter, or 5.8%.  The annualized returns on average equity were 14.72% and 15.99% for the third quarters of 2009 and 2008, respectively, again representing a decrease of 1.27 basis points, or 7.9%.  

For the year-to-date periods, we reported earnings of $16.675 million for the first nine months of 2009, an increase of $1.250 million, or 8.1%, as compared to $15.425 million for the first nine months of 2008.  Diluted earnings per share were $1.52 and $1.41, for the respective periods, an increase of $.11, or 7.8%.   Certain events had a net $.14 positive impact on diluted earnings per share for the 2009 nine-month period, while certain events in the 2008 nine-month period had a net $.01 negative impact.  These transactions are discussed elsewhere in this report, and include for the 2009 period: an FDIC special assessment, a gain on the sale of our merchant bank card processing and the receipt of a court-ordered restitution payment relating to a former customer of our now-dissolved Vermont subsidiary bank dating back to the early 1990’s. Transactions for the 2008 period include the transactions related to our participation as a Visa member bank and the other-than-temporary impairment charge to earnings related to the Lehman bond.

The annualized returns on average assets were 1.29% and 1.26% for the first nine months of 2009 and 2008, respectively, an increase of 3 basis points, or 2.4%.  The annualized returns on average equity were 16.77% and 16.46% for the first nine months of 2009 and 2008, respectively, an increase of 0.31 basis points, or 1.9%.  

Total assets were $1.836 billion at September 30, 2009, which represented an increase of $163.2 million, or 9.8%, above the level at September 30, 2008, and an increase of $171.2 million, or 10.3%, from the December 31, 2008 level.  The increase from the year-end total was primarily attributable to an increase in deposit balances deployed in our investment portfolios along with proceeds from the net cash-flow on our loan portfolio, which decreased by $3.2 million from year-end 2008.

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Shareholders’ equity was $139.3 million at September 30, 2009, an increase of $13.9 million, or 11.1%, from the year earlier level.  Shareholders' equity increased $13.5 million from the December 31, 2008 level of $125.8 million.  The components of the change in shareholders’ equity since year-end 2008 are presented in the Consolidated Statement of Changes in Shareholders’ Equity on page 5, and are discussed in more detail in the preceding section entitled, “Increase in Shareholder Equity.”  Our risk-based capital ratios and Tier 1 leverage ratios for our holding company and both of our banks continued to exceed regulatory minimum requirements at period-end.  At September 30, 2009 both of our banks, as well as the holding company, qualified as "well-capitalized" under federal bank regulatory guidelines.

CHANGE IN FINANCIAL CONDITION

Summary of Selected Consolidated Balance Sheet Data

(Dollars in Thousands)