Unity Bancorp (UNTY)

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C.  20549

FORM 10-Q

(Mark One)

x                              QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

FOR THE QUARTERLY PERIOD ENDED JUNE 30, 2006

OR

o                                 TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

FOR THE TRANSITION PERIOD FROM             TO            .

Commission file number   1-12431

Unity Bancorp, Inc.
(Exact Name of Registrant as Specified in Its Charter)

 

Registrant’s Telephone Number, Including Area Code (908) 730-7630

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,  as amended, during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  Yes x   No o

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer (as defined in Exchange Act Rule 12b-2) Large accelerated filer   o   Accelerated filer   o   Non-accelerated filer     x

Indicate by check mark whether the registrant is a shell company as defined in Rule 12b-2 of the Exchange Act Yes  o No x

The number of shares outstanding of each of the registrant’s classes of common equity stock, as of August 1, 2006 common stock, no par value:  6,578,843 shares outstanding

 

					Page #
PART I	-		CONSOLIDATED FINANCIAL INFORMATION
ITEM 1	-		Consolidated Financial Statements (unaudited)
			Consolidated Balance Sheets at June 30, 2006, 2005 and December 31, 2005		3
			Consolidated Statements of Income for the three and six months ended June 30, 2006 and 2005		4
			Consolidated Statements of Changes in Shareholders’ Equity for the six months ended June 30, 2006 and 2005		5
			Consolidated Statements of Cash Flows for the six months ended June 30, 2006 and 2005		6
			Notes to the Consolidated Financial Statements		7
ITEM 2	-		Management’s Discussion and Analysis of Financial Condition and Results of Operations		10
ITEM 3	-		Quantitative and Qualitative Disclosures about Market Risk		27
ITEM 4	-		Controls and Procedures		27
PART II	-		OTHER INFORMATION		27
ITEM 1			Legal Proceedings		27
ITEM 1A			Risk Factors		27
ITEM 2			Unregistered Sales of Equity Securities and Use of Proceeds		27
ITEM 3			Defaults upon Senior Securities		27
ITEM 4			Submission of Matters to a Vote of Security Holders		28
ITEM 5			Other Information		28
ITEM 6			Exhibits		28
SIGNATURES					29
Exhibit Index					30

 

Part 1.-Consolidated Financial Information

Item 1.-Consolidated Financial Statements (unaudited)

Unity Bancorp, Inc.
Consolidated Balance Sheets

		(unaudited)						(unaudited)
(In thousands)		06/30/06			12/31/05			06/30/05
Assets
Cash and due from banks		$	13,709		$	11,945		$	11,284
Federal funds sold and interest bearing deposits		42,631			26,814			23,336
Securities:
Available for sale		68,104			65,583			78,139
Held to maturity (market value of $39,700, $40,212 and $35,650, respectively)		40,875			40,748			35,635
Total securities		108,979			106,331			113,774
Loans:
SBA held for sale		24,384			14,001			13,880
SBA held to maturity		59,111			64,660			57,315
Commercial		297,826			260,581			229,860
Residential mortgage		55,966			62,039			63,775
Consumer		47,335			47,286			46,096
Total loans		484,622			448,567			410,926
Less: Allowance for loan losses		7,257			6,892			6,239
Net loans		477,365			441,675			404,687
Premises and equipment, net		10,954			10,593			10,208
Bank owned life insurance		5,279			5,185			5,093
Accrued interest receivable		3,460			3,167			2,747
Loan servicing asset		2,424			2,438			2,177
Goodwill and other intangibles		1,611			1,618			—
Other assets		4,458			4,406			4,201
Total assets		$	670,870		$	614,172		$	577,507
Liabilities and Shareholders’ Equity
Liabilities:
Deposits
Non-interest bearing demand deposits		$	81,721		$	79,547		$	79,830
Interest bearing checking		116,497			139,076			147,315
Savings deposits		187,841			141,935			149,348
Time deposits, under $100,000		124,652			108,353			72,655
Time deposits, $100,000 and over		65,665			52,949			28,126
Total deposits		576,376			521,860			477,274
Borrowed funds		40,000			40,000			50,000
Subordinated debentures		9,279			9,279			9,279
Accrued interest payable		313			274			249
Accrued expense and other liabilities		1,456			1,830			2,294
Total liabilities		$	627,424		$	573,243		$	539,096
Commitments and contingencies		—			—			—
Shareholders’ equity
Common stock, no par value, 12,500 shares authorized		43,866			38,423			37,988
Treasury stock (23 shares)		(242		)	(242		)	(242		)
Retained earnings		1,555			3,897			1,155
Accumulated other comprehensive loss		(1,733		)	(1,149		)	(490		)
Total Shareholders’ Equity		43,446			40,929			38,411
Total Liabilities and Shareholders’ Equity		$	670,870		$	614,172		$	577,507
Issued common shares		6,602			6,559			6,435
Outstanding common shares		6,579			6,536			6,412

See Accompanying Notes to the Consolidated Financial Statements

3

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Unity Bancorp

Consolidated Statements of Income

(unaudited)

		For the three months ended June 30,						For the six months ended June 30,
(In thousands, except per share amounts)		2006			2005			2006			2005
Interest income:
Fed funds sold and interest on deposits		$	354		$	117		$	561		$	179
Securities:
Available for sale		709			809			1,417			1,605
Held to maturity		467			348			943			622
Total securities		1,176			1,157			2,360			2,227
Loans:
SBA loans		2,179			1,448			4,332			2,807
Commercial loans		5,368			3,764			10,260			7,402
Residential mortgage loans		788			805			1,608			1,607
Consumer loans		779			652			1,523			1,244
Total loan interest income		9,114			6,669			17,723			13,060
Total interest income		10,644			7,943			20,644			15,466
Interest expense:
Interest bearing demand deposits		653			635			1,347			1,246
Savings deposits		1,704			781			2,896			1,241
Time deposits		1,671			764			3,170			1,527
Borrowed funds and subordinated debentures		583			498			1,145			922
Total interest expense		4,611			2,678			8,558			4,936
Net interest income		6,033			5,265			12,086			10,530
Provision for loan losses		250			350			550			650
Net interest income after provision for loan losses		5,783			4,915			11,536			9,880
Non-interest Income:
Service charges on deposit accounts		409			439			842			869
Service and loan fee income		406			630			801			1,166
Gain on sales of SBA loans, net		558			741			1,258			1,201
Gain on sales of mortgage loans		110			54			172			146
Gain on sales of other loans		—			—			82			—
Net security gains		—			24			—			77
Bank owned life insurance		47			46			94			93
Other income		117			261			400			434
Total non-interest income		1,647			2,195			3,649			3,986
Non-interest expense:
Compensation and benefits		2,664			2,314			5,389			4,711
Occupancy		646			501			1,294			1,094
Processing and communications		553			489			1,080			955
Furniture and equipment		381			327			774			656
Professional services		151			194			283			303
Loan servicing costs		55			169			156			346
Advertising		148			187			318			372
Deposit insurance		16			15			33			30
Other expenses		387			446			930			823
Total non-interest expense		5,001			4,642			10,257			9,290
Net income before provision for income taxes		2,429			2,468			4,928			4,576
Provision for income taxes		792			941			1,634			1,739
Net income		$	1,637		$	1,527		$	3,294		$	2,837
Net income per common share - Basic		$	0.25		$	0.24		$	0.50		$	0.44
Net income per common share - Diluted		0.24			0.23			0.48			0.42
Weighted average shares outstanding – Basic		6,574			6,414			6,565			6,399
Weighted average shares outstanding – Diluted		6,905			6,744			6,901			6,744

See Accompanying Notes to the Unaudited Consolidated Financial Statements

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Unity Bancorp, Inc.

Consolidated Statements of Changes in Shareholders’ Equity

For the six months ended June 30, 2006 and 2005

(unaudited)

 

(In thousands)		Outstanding Shares		Common Stock			Treasury  Stock			Retained Earnings			Accumulated Other Comprehensive Loss			Total Shareholders’ Equity
Balance, December 31, 2004		6,370		$	34,025		$	—		$	2,327		$	(484	)	$	35,868
Comprehensive income:
Net Income										2,837			—			2,837
Unrealized holding gain on securities arising during the period, net of tax of $26													41
Less: reclassification adjustment for gains included in net income, netof tax of $30													47
Net unrealized holding loss on securities arising during the period, net of tax benefit of $4													(6		)	(6		)
Total comprehensive income																2,831
Cash dividends declared on common stock of $.09 per share										(524		)	—			(524		)
5% Stock Dividend, including cash-in-lieu of fractional shares				3,481						(3,485		)	—			(4		)
Treasury stock purchased		(23	)	—			(242		)	—			—			(242		)
Stock options exercised		65		482			—			—			—			482
Balance, June 30, 2005		6,412		$	37,988		$	(242	)	$	1,155		$	(490	)	$	38,411

 

(In thousands)		Outstanding Shares		Common Stock			Treasury Stock			Retained Earnings			Accumulated Other Comprehensive  Loss			Total Shareholders’ Equity
Balance, December 31, 2005		6,536		38,423			$	(242	)	$	3,897		$	(1,149	)	$	40,929
Comprehensive income:
Net Income										3,294			—			3,294
Unrealized holding loss on securities arising during the period, net of tax benefit of $358													(584		)
Net unrealized holding loss on securities arising during the period, net of tax benefit of $358													(584		)	(584		)
Total comprehensive income													—			2,710
Cash dividends declared on common stock of $.10 per share										(644		)	—			(644		)
5% Stock Dividend, including cash-in-lieu of fractional shares				4,987			—			(4,992		)	—			(5		)
Stock options exercised		43		456			—			—			—			456
Balance, June 30, 2006		6,579		$	43,866		$	(242	)	$	1,555		$	(1,733	)	$	43,446

See Accompanying Notes to the Unaudited Consolidated Financial Statements.

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Unity Bancorp, Inc.

Consolidated Statements of Cash Flows

(unaudited)

 

		For the six months ended June 30,
(In thousands)		2006			2005
Operating activities:
Net income		$	3,294		$	2,837
Adjustments to reconcile net income to net cash provided by (used in) operating activities:
Provision for loan losses		550			650
Depreciation and amortization		778			715
Net gain on sale of securities		—			(77		)
Gain on sale of SBA loans held for sale		(1,258		)	(1,201		)
Gain on sale of mortgage loans		(172		)	(146		)
Gain on sale of other loans		(82		)	—
Origination of SBA loans held for sale		(18,514		)	(21,144		)
Proceeds from the sale of SBA loans		18,455			16,039
Net change in other assets and liabilities		(498		)	704
Net cash provided by (used in) operating activities		2,553			(1,623		)
Investing activities:
Purchases of securities held to maturity		(4,360		)	(15,676		)
Purchases of securities available for sale		(7,808		)	(7,074		)
Maturities and principal payments on securities held to maturity		4,182			3,575
Maturities and principal payments on securities available for sale		4,309			5,785
Proceeds from sale of securities available for sale		—			1,175
Proceeds from the sale of other real estate owned		239			345
Net increase in loans		(34,935		)	(31,355		)
Purchases of premises and equipment		(855		)	(1,978		)
Net cash used in investing activities		(39,228		)	(45,203		)
Financing activities:
Net increase in deposits		54,516			43,376
Proceeds from new borrowings		—			20,000
Repayments of borrowings		—			(5,000		)
Proceeds from the issuance of common stock		370			375
Purchase of treasury stock		—			(242		)
Dividends paid		(630		)	(469		)
Net cash provided by financing activities		54,256			58,040
Increase in cash and cash equivalents		17,581			11,214
Cash and cash equivalents at beginning of year		38,759			23,406
Cash and cash equivalents at end of period		$	56,340		$	34,620
Supplemental disclosures:
Cash:
Interest paid		$	8,519		$	4,863
Income taxes paid		2,462			831
Non-Cash investing activities
Transfer of loan to Other Real Estate Owned		61			—

 

See Accompanying Notes to the Consolidated Financial Statements.

6

Unity Bancorp, Inc.

Notes to the Consolidated Financial Statements (Unaudited)

June 30, 2006

NOTE 1. Summary of Significant Accounting Policies

The accompanying consolidated financial statements include the accounts of Unity Bancorp, Inc. (the “Parent Company”) and its wholly-owned subsidiary, Unity Bank (the “Bank”, or when consolidated with the Parent Company, the “Company”), and reflect all adjustments and disclosures which are, in the opinion of management, necessary for a fair presentation of interim results.  Unity Investment Services, Inc. a wholly-owned subsidiary of the Bank, is used to hold part of the Bank’s investment portfolio.  Unity Participation Company, Inc. a wholly-owned subsidiary of the Bank is used to hold part of the Bank’s loan portfolio.  All significant inter-company balances and transactions have been eliminated in consolidation.  Certain reclassifications have been made to prior year amounts to conform to the current year presentation.  The financial information has been prepared in accordance with U.S. generally accepted accounting principles and has not been audited.  In preparing the financial statements, management is required to make estimates and assumptions that affect the reported amounts of assets and liabilities as of the dates of the statements of financial condition and revenues and expenses during the reporting periods.  Actual results could differ from those estimates.

Estimates that are particularly susceptible to significant changes relate to the determination of the allowance for loan losses.  Management believes that the allowance for loan losses is adequate.  While management uses available information to recognize losses on loans, future additions to the allowance for loan losses may be necessary based on changes in economic conditions in the market. The interim unaudited consolidated financial statements included herein have been prepared in accordance with instructions for Form 10-Q and the rules and regulations of the Securities and Exchange Commission (“SEC”).  The results of operations for the three and six months ended June 30, 2006 are not necessarily indicative of the results which may be expected for the entire year.  As used in this Form 10-Q, “we” and “us” and “our” refer to Unity Bancorp, Inc. and its consolidated subsidiary, Unity Bank, depending on the context. Interim financial statements should be read in conjunction with the Company’s consolidated financial statements and notes thereto for the year ended December 31, 2005, included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2005.

Stock Based Compensation

The Company has incentive and non-qualified option plans, which allow for the grant of options to officers, employees and members of the Board of Directors.  The period during which the option is vested is generally 3 years, but no option may be exercised after 10 years from the date of the grant.  The exercise price of each option is the market price on the date of grant.  As of June 30, 2006, 1,379,154 shares have been reserved for issuance upon the exercise of options, 743,421 option grants are outstanding, 370,146 option grants have been exercised, forfeited or expired leaving 265,587 shares available for grant.

In addition, restricted stock is issued under the stock bonus program to reward employees and directors and to retain them by distributing stock over a period of time.  Restricted stock awards granted during the six months ended June 30, 2006 and 2005 , totaled 8,253 shares and 0 shares, respectively.  The fair market value per share for these grants was $14.12.  These shares vest over a period of 4 years and are recognized as compensation to the employees over the vesting period.  Compensation expense related to the restricted stock awards totaled $41 thousand and $10 thousand for the six months ended June 30, 2006 and 2005, respectively.  For the quarters-ended, June 30, 2006 and 2005, compensation expense related to restricted stock totaled $22 thousand and $6 thousand respectively.  As of June 30, 2006, 110,250 shares of restricted stock were reserved for issuance, of which 35,196 shares are outstanding and 75,054 shares are available for grant.

As of January 1, 2006, the Company adopted Statement of Financial Accounting Standards No. 123R, “Share-Based Payment” (Statement 123R) using the “modified prospective application.”  Statement 123R requires public companies to recognize compensation expense related to stock-based compensation awards over the period during which an employee is required to provide service for the award.  The provisions apply to all awards granted after the required effective date including existing awards not vested, modified, repurchased or canceled.  Prior to January 1, 2006, the Company applied Accounting Principles Board Opinion 25 and related Interpretations in accounting for its Option Plans. No stock-based compensation cost was reflected in net income, as all options granted under those plans had an exercise price equal to the market value of their underlying common stock on the date of grant.

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The following table represents the impact of the adoption of SFAS 123R on the Company’s financial statements for the quarter ended June 30, 2006.

		Under SFAS 123 R			Under  APB 25			Difference
Net income before provision for income taxes		$	2,429		$	2,436		$	7
Net income		$	1,637		$	1,642		$	5
Net income per common share – Basic		$	0.25		$	0.25		$	0.0
Net income per common share - Diluted		$	0.24		$	0.24		$	0.0

 

The following table represents the impact of the adoption of SFAS 123R on the Company’s financial statements for the six months ended June 30, 2006.

		Under SFAS 123 R			Under APB 25			Difference
Net income before provision for income taxes		$	4,928		$	4,940		$	12
Net income		$	3,294		$	3,300		$	6
Net income per common share – Basic		$	0.50		$	0.50		$	0.0
Net income per common share - Diluted		$	0.48		$	0.48		$	0.0

 

The following table illustrates the effect on net income and earnings per share for the three and six month periods ended June 30, 2005 if the Company had applied the fair value recognition provisions of FASB Statement No. 123, “Accounting for Stock-Based Compensation” as amended, to stock based compensation.

Proforma

		Three Months Ended		Six Months Ended
(In thousands, except per share data)		June 30, 2005		June 30, 2005
Net income to common shareholders as reported:
As reported		1,527		2,837
Pro forma		1,511		2,805
Income per share:
Basic as reported		0.24		0.44
Basic Pro forma		0.24		0.44
Diluted as reported		0.23		0.42
Diluted Pro forma		0.22		0.42

 

During the six months ended June 30, 2006 and 2005, the Company granted 15,750 options at an exercise price of $13.33 per share and 5,513 options at an exercise price of $10.89 per share, respectively.  The Company used the Black Scholes option-pricing model to calculate the $2.98 and $2.44 fair value of these options.  The fair value of the options granted during each period were estimated on the date of grant using the Black-Scholes option-pricing model with the following weighted average assumptions:

·      Expected life of 4.19 years

·      Expected volatility of 23.5 percent

·      Risk free interest rate of 3.99 percent

·      Dividend yield of 1.36 percent

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Transactions under the Company’s stock options plans during the six months ended June 30, 2006 are summarized as follows:

		Number of  Shares		Exercise Price per Share		Weighted  Average Exercise  Price			Weighted  Average  Remaining Contractual Life  (in years)		Aggregate Intrinsic Value
Outstanding at December 31, 2005		754,131		$2.31 - 12.64		$	5.81
Options Granted		15,750		13.33		13.33
Options Exercised		(23,310	)	2.98 -9.77		5.89
Options Expired		(3,150	)	9.77 - 11.88		11.53
Outstanding at June 30, 2006		743,421		$2.31 - 13.33		$	5.94		5.76		$	6,550,132
Exercisable at June 30, 2006		722,148		$2.31 – 12.64		$	6.11		5.59		$	6,239,182

 

As of June 30, 2006, there was approximately $52 thousand of unrecognized compensation cost related to non-vested share-based compensation arrangements granted under the Company’s stock incentive plans.  That cost is expected to be recognized over a weighted-average period of 2.0 years.

The following table summarizes information about stock options outstanding at June 30, 2006:

		Options Outstanding							Options Exercisable
Range of  Exercise Prices		Shares  Outstanding		Weighted  Average  Remaining  Contractual  Life (in years)		Weighted  Average Exercise Price			Shares Exercisable		Weighted  Average Exercise Price
$0.00-$4.00		332,493		4.9 years		$	3.29		332,493		$	3.29
$4.01-$8.00		181,104		6.1 years		5.58			181,104		5.58
$8.01 - $12.00		208,551		6.5 years		9.75			204,869		9.73
$12.01 - $16.00		21,273		9.1 years		13.15			3,682		12.64
		743,421		5.8 years		$	5.94		722,148		$	6.11

 

The total intrinsic value of the stock options exercised during the six months ended June 30, 2006 and 2005 was $203 thousand and $267 thousand, respectively.   The total intrinsic value of the stock options exercised during the quarters ended June 30, 2006 and 2005 was $85 thousand and $106 thousand, respectively.

On June 30, 2006, the Company paid a 5 percent stock distribution to all shareholders of record as of June 16, 2006 and accordingly, all share amounts have been restated to include the effect of the distribution.

NOTE 2. Litigation

From time to time, the Company is subject to legal proceedings and claims in the ordinary course of business.  The Company currently is not aware of any such legal proceedings or claims that it believes will have, individually or in the aggregate, a material adverse effect on the business, financial condition, or the results of the operation of the Company.

NOTE 3. Earnings per share

The following is a reconciliation of the calculation of basic and diluted earnings per share.  Basic net income per common share is calculated by dividing net income to common shareholders by the weighted average common shares outstanding during the reporting period.  Diluted net income per common share is computed similarly to that of basic net income per common share, except that the denominator is increased to include the number of additional common shares that would have been outstanding if all potentially dilutive common shares, principally stock options, were issued during the reporting period utilizing the Treasury stock method.

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		Three Months ended June 30,						Six Months ended June 30,
(In thousands, except per share data)		2006			2005			2006			2005
Net Income to common shareholders		$	1,637		$	1,527		$	3,294		$	2,837
Basic weighted-average common shares outstanding		6,574			6,414			6,565			6,399
Plus: Common stock equivalents		331			330			336			345
Diluted weighted –average common shares outstanding		6,905			6,744			6,901			6,744
Net Income per Common share:
Basic		$	0.25		$	0.24		$	0.50		$	0.44
Diluted		0.24			0.23			0.48			0.42
Return on average assets		1.03		%	1.13		%	1.05		%	1.08		%
Return on average common equity		15.39		%	16.50		%	15.82		%	15.62		%
Efficiency ratio*		65.12		%	62.43		%	65.19		%	64.34		%

 

* Non-interest expense divided by net interest income plus non-interest income less securities gains

NOTE 4. Recent accounting pronouncements

In March 2006, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards (“SFAS”) No. 156, “Accounting for Servicing of Financial Assets.”   SFAS No. 140, Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities, establishes, among other things, the accounting for all separately recognized servicing assets and servicing liabilities.   SFAS No. 156 amends Statement 140 to require that all separately recognized servicing assets and servicing liabilities be initially measured at fair value, if practicable.  This Statement permits, but does not require, the subsequent measurement of separately recognized servicing assets and servicing liabilities at fair value.  An entity that uses derivative instruments to mitigate the risks inherent in servicing assets and servicing liabilities is required to account for those derivative instruments at fair value.  Under this Statement, an entity can elect subsequent fair value measurement to account for its separately recognized servicing assets and servicing liabilities.  By electing that option, an entity may simplify its accounting because this Statement permits income statement recognition of the potential offsetting changes in fair value of those servicing assets and servicing liabilities and derivative instruments in the same accounting period.  The Statement is effective in the first fiscal year beginning after September 15, 2006 with earlier adoption permitted.  The Company does not expect the adoption of Statement No. 156 to have a material impact on its financial statements.

In June 2006, the Financial Accounting Standards Board (FASB) issued FASB Interpretation No. 48 “Accounting for Uncertainty in Income Taxes”.  The Interpretation clarifies the accounting for uncertainty in income taxes recognized in an enterprise’s financial statements in accordance with FASB Statement No. 109 “Accounting for Income Taxes”.  This Interpretation presents a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return.  The Interpretation is effective for fiscal years beginning after December 15, 2006.  The Company does not expect the adoption of Interpretation No. 48 to have a material impact on its financial statements.

ITEM 2.  Management’s Discussion and Analysis of Financial Condition and Results of Operations

The following discussion and analysis of financial condition and results of operations should be read in conjunction with the 2005 consolidated audited financial statements and notes thereto included in our Annual Report on Form 10-K for the year ended December 31, 2005.  When necessary, reclassifications have been made to prior period data throughout the following discussion and analysis for purposes of comparability. This Quarterly Report on Form 10-Q contains certain “forward looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995, which may be identified by the use of such words as “believe”, “expect”, “anticipate”, “should”, “planned”, “estimated” and “potential”.  Examples of forward looking statements include, but are not limited to, estimates with respect to the financial condition, results of operations and business of Unity Bancorp, Inc. that are subject to various factors which could cause actual results to differ materially from these estimates.  These factors include: changes in general, economic, and market conditions, legislative and regulatory conditions, or the development of an interest rate environment that adversely affects Unity Bancorp, Inc.’s interest rate spread or other income anticipated from operations and investments.

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Overview

Unity Bancorp, Inc. (the “Parent Company”) is incorporated in New Jersey and is registered as a bank holding company under the Bank Holding Company Act of 1956, as amended.  It’s wholly-owned subsidiary, Unity Bank (the “Bank” or, when consolidated with the Parent Company, the “Company”) was granted a charter by the New Jersey Department of Banking and Insurance and commenced operations on September 13, 1991.  The Bank provides a full range of commercial and retail banking services through 14 branch offices located in Hunterdon, Somerset, Middlesex, Union and Warren counties in New Jersey and a loan production office in Long Island, New York.  These services include the acceptance of demand, savings, and time deposits and the extension of consumer, real estate, Small Business Administration and other commercial credits. Unity Investment Services, Inc., a wholly-owned subsidiary of the Bank, is used to hold part of the Bank’s investment portfolio. Unity Participation Company, Inc., a wholly-owned subsidiary of the Bank is used for holding and administering certain loan participations.

Unity (NJ) Statutory Trust I is a statutory Business Trust and wholly-owned subsidiary of Unity Bancorp, Inc.  On September 26, 2002, the trust issued $9.0 million of capital securities to investors.  These floating rate securities are treated as subordinated debentures on the financial statements.  However, they qualify as Tier I Capital for regulatory capital compliance purposes.  In accordance with Financial Accounting Interpretation No. 46, Consolidation of Variable Interest Entities, as revised December 2003, the Company does not consolidate the accounts and related activity of Unity (NJ) Statutory Trust I.

Effective July 24, the Parent Company formed Unity (NJ) Statutory Trust II as a wholly owned subsidiary. The Trust issued $10 million of trust preferred securities to investors. The floating rate securities are treated as subordinated debentures on the Company’s financial statements, and bear interest at 159 basis points above the three month Libor rate. The securities were initially priced at 7.05%, and the rate resets quarterly.  In accordance with Financial Accounting Interpretation No. 46, Consolidation of Variable Interest Entities, as revised December 2003, the Company does not consolidate the accounts and related activity of Unity (NJ) Statutory Trust II.

Earnings Summary

Net income for the three months ended June 30, 2006 was $1.6 million, an increase of $110 thousand or 7.2 percent, compared to net income of $1.5 million for the same period in 2005. This was the result of increased net interest income and a lower provision for loan losses, offset in part by lower non-interest income and higher operating expenses.

Quarterly performance highlights include:

·       Earnings per basic share increased to $0.25 for the second quarter of 2006 compared to $0.24 for the same period in 2005.

·       Earnings per diluted share increased to $0.24 for the second quarter of 2006 compared to $0.23 for the same period a year ago.

·       Return on average assets equaled 1.03 percent and 1.13 percent for each of the quarters ended June 30, 2006 and 2005, respectively.

·       Return on average common equity equaled 15.39 percent and 16.50 percent for the quarters ended June 30, 2006 and 2005, respectively.

·       The efficiency ratio equaled 65.12 percent for the second quarter of 2006 compared to 62.43 percent for the same period a year ago.

Net income for the six months ended June 30, 2006 was $3.3 million, an increase of $457 thousand or 16.1 percent, compared to net income of $2.8 million for the same period in 2005.  This was the result of increased net interest income and a lower provision for loan losses, offset in part by lower non-interest income and higher operating expenses.

Year to date performance highlights include:

·       Earnings per basic share increased to $0.50 for the six months ended June 30, 2006 compared to $0.44 for the same period in 2005.

·       Earnings per diluted share increased to $0.48 for the six months ended June 30, 2006 compared to $0.42 for the same period a year ago.

·       Return on average assets equaled 1.05 percent and 1.08 percent for each of the six month periods ended June 30, 2006 and 2005, respectively.

·       Return on average common equity equaled 15.82 percent and 15.62 percent for the six months ended June 30, 2006 and 2005, respectively.

·       The efficiency ratio equaled 65.19 percent for the six months ended June 30, 2006 compared to 64.34 percent for the same period a year ago.

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During the first six months of 2006, financial institutions continued to be pressured by a flat yield curve as the Federal Reserve Board raised short term rates four more times.  Since this rate cycle began in June 2004, the Federal Reserve raised short-term interest rates seventeen times for a total of 425 basis points.  This has resulted in the Federal Funds rate increasing from 1.00 percent to 5.25 percent while the Prime-lending rate increased from 4.00 percent to 8.25 percent.   Despite this challenging interest rate environment, the Company was able to grow net interest income due to strong growth in interest earning assets.  However, the flat yield curve and the competitive pricing of deposits in the New Jersey market place may put further pressure on the net interest margin in 2006.

Net interest income, our largest component of operating income, increased $768 thousand or 14.6 percent to $6.0 million for the three months ended June 30, 2006 compared to the same period in 2005.  This increase was the result of a $94 million increase in average earning assets partially offset by a reduced net interest margin and spread.    Net interest margin (net interest income as a percentage of average interest earning assets) decreased 13 basis points to 3.99 percent for the current quarter compared to 4.12 percent for the same period a year ago.  Over the same period, net interest spread  (the difference between the rate earned on average interest-earning assets and the rate paid on average interest-bearing liabilities) decreased 22 basis points to 3.46 percent from 3.68 percent a year ago.  For the six months ended June 30, 2006, net interest income was $12.1 million, an increase of $1.6 million or 14.8 percent, compared to $10.5 million during the same period a year ago.  The net interest margin decreased 17 basis points to 4.05 percent for the six months ended June 30, 2006 compared to the same period a year ago.

Non-interest income decreased $548 thousand or 25 percent to $1.6 million for the three months ended June 30, 2006 compared to $2.2 million for the three months ended June 30, 2005.    This decrease was due primarily to decreased service and loan fee income, gains on the sale of Small Business Administration  (“SBA”) loans and commercial loan referral fees, partially offset by increased gains on Mortgage loan sales.  For the six months ended June 30, 2006, non-interest income was $3.7 million, a decrease of $337 thousand or 8.5 percent compared to $4.0 million during the same period a year ago.  This decrease was due primarily to decreased service and loan fee income, service charges on deposits and other income, partially offset by increased gains on Mortgage loan sales, SBA loan sales and other loan sales.

Non-interest expense was $5.0 million for the three months ended June 30, 2006, an increase of $359 thousand or 7.7 percent compared to $4.6 million for the same period a year ago.   For the six-month period ended June 30, 2006, non-interest expense increased $967 thousand or 10.4 percent to $10.3 million compared to the six-month period ended June 30, 2005.  The increase in both periods was due primarily to increased compensation and benefits, occupancy, furniture and equipment and processing and communications, partially offset by lower loan servicing, professional services and advertising expenses.

For the quarter ended June 30, 2006, the provision for income taxes was $792 thousand compared to $941 thousand for the same period a year ago. The provision for income taxes decreased $105 thousand to $1.6 million at June 30, 2006 compared to the same period a year ago.   The current 2006 tax provision represents an effective tax rate of approximately 33.2 percent as compared to 38 percent for the prior year. The lower effective tax rate for 2006 is related to a higher proportion of revenue being generated at a subsidiary with a lower effective tax rate.  Management anticipates an effective rate of approximately 33 percent for the remainder of 2006.

Net Interest Income

Tax-equivalent interest income totaled $10.7 million for the three months ended June 30, 2006, an increase of $2.7 million or 33.9 percent, compared to $8.0 million a year ago.  Of the $2.7 million increase in interest income, $1.7 million is due to an increase in the volume of interest-earning assets, while $955 thousand is attributable to an increase in the yield on interest-earning assets. The average volume of interest-earning assets increased $94.0 million to $606.6 million at June 30, 2006 compared to $512.6 million at June 30, 2005.  This was due to an $86.4 million increase in average total loans plus a $13.3 million increase in average federal funds sold and interest bearing deposits, offset in part by a $5.7 million decrease in average total securities.  The impact of the higher interest rate environment in the second quarter of 2006 was evident in the rates earned on variable rate instruments such as SBA loans, commercial loans and consumer home equity lines of credit, as well as federal funds sold and interest bearing deposits.  Key interest rate increases during the quarter included:

·      The average interest rate earned on federal funds sold and interest bearing deposits increased 192 basis points to 4.73 percent for the three months ended June 30, 2006 compared to 2.81 percent for the same period a year ago.

·      The average interest rate earned on SBA loans equaled 10.41 percent during the quarter, an increase of 196 basis points over the comparable quarter in 2005, due to the quarterly re-pricing of these loans with changes in the Prime rate.

·      The average interest rate earned on Consumer loans increased 81 basis points to 6.69 percent for the three months ended June 30, 2006 compared to 5.88 percent for the same period a year ago due to the re-pricing of Prime based home equity products.

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·     The average interest rate earned on Commercial loans was 7.50 percent for the quarter, an increase of 51 basis points over the comparable quarter in 2005.

The higher interest rate environment also increased interest expense and the cost of funds.  Total interest expense was $4.6 million for the three months ended June 30, 2006, an increase of $1.9 million or 72.2 percent, compared to $2.7 million for the same period a year ago. Of the $1.9 million increase in interest expense, $976 thousand is related to an increase in average interest-bearing liabilities while $957 thousand is due to an increase in the cost of funds.  Quarter over quarter, average interest-bearing liabilities increased $93.8 million as average interest-bearing deposits increased $88.5 million and borrowed funds and subordinated debentures increased $5.2 million. Total interest-bearing deposits were $467.7 million on average, an increase of $88.5 million or 23.3 percent compared to $379.2 million from the same period a year ago.  The increase in average interest-bearing deposits was as a result of increases in the savings and time deposit categories, partially offset by a decline in interest-bearing checking accounts.   Average borrowed funds and subordinated debentures increased $5.2 million to $49.3 million as of June 30, 2006 due to the addition of a $10 million FHLB advance at 3.70 percent during the second quarter of 2005.   The rate paid on interest bearing liabilities increased 104 basis points to 3.58 percent for the three months ended June 30, 2006 from 2.54 percent in the same period in 2005.  The cost of interest-bearing deposits increased 114 basis points to 3.45 percent as the rates paid on all deposit products increased while the cost of borrowed funds and subordinated debentures increased 21 basis points to 4.75 percent.

Tax-equivalent net interest income increased $768 thousand to $6.05 million for the quarter ended June 30, 2006 compared to $5.28 million for the same period a year ago.  Net interest margin constricted 13 basis points to 3.99 percent compared to 4.12 percent for the same period a year ago.  The tighter net interest margin was primarily the result of the higher cost of deposits to fund loan growth. The net interest spread was 3.46 percent for the three months ended June 30, 2006 compared to 3.68 percent for the same period a year ago.

Tax-equivalent interest income totaled $20.7 million for the six months ended June 30, 2006, an increase of $5.2 million or 33.4 percent, compared to $15.5 million a year ago.  Of the $5.2 million increase in interest income, $3.5 million is due to an increase in the volume of earning assets, while $1.6 million is attributable to an increase in the yield on interest-earning assets. The average volume of interest-earning assets increased $97.6 million to $597.6 million at June 30, 2006 compared to $500.0 million at June 30, 2005.  This was due to an $85.5 million increase in average total loans plus an $11.2 million increase in average federal funds sold and interest bearing deposits partially offset by a $774 thousand decrease in average total securities.  Key interest rate increases during the six months ended June 30, 2006 included:

·      The average interest rate earned on federal funds sold and interest bearing deposits increased 190 basis points to 4.57 percent for the six months ended June 30, 2006 compared to 2.67 percent for the same period a year ago.

·      The average interest rate earned on SBA loans equaled 10.22 percent for the six months ended June 30, 2006, an increase of 181 basis points over the comparable period in 2005, due to the quarterly re-pricing of these loans with changes in the Prime rate.

·      The average interest rate earned on Consumer loans increased 82 basis points to 6.59 percent for the six months ended June 30, 2006 compared to 5.77 percent for the same period a year ago due to the re-pricing of Prime based home equity products.

·      The average interest rate earned on Commercial loans was 7.41 percent for the six months ended June 30, 2006, an increase of 44 basis points over the comparable period in 2005.

Total interest expense was $8.6 million for the six months ended June 30, 2006, an increase of $3.6 million or 73.4 percent, compared to $4.9 million for the same period a year ago. Of the $3.6 million increase in interest expense, $1.8 million is related to an increase in average interest-bearing liabilities while $1.8 million is due to an increase in the cost of funds.  Comparing the six-month periods ended June 30, 2006 and 2005, average interest bearing liabilities increased $95.5 million in the current year as average interest bearing deposits increased $88.3 million and borrowed funds and subordinated debentures increased $7.2 million. Total interest-bearing deposits were $458.3 million on average, an increase of $88.3 million or 23.9 percent compared to $370.0 million from the same period a year ago.  The increase in average interest-bearing deposits was a result of increases in the savings and time deposit categories, partially offset by a decline in interest-bearing checking accounts.   Average borrowed funds increased $7.2 million to $49.3 million as of June 30, 2006 due to the addition of a $10 million FHLB advance at 3.70 percent during the second quarter of 2005. The rate paid on interest bearing liabilities increased 98 basis points to 3.40 percent for the six months ended June 30, 2006 from 2.42 percent in the same period in 2005.  The cost of interest bearing deposits increased 107 basis points to 3.26 percent as the rates paid on all deposit products increased.  It is expected that the cost of deposits will continue to rise due to competitive pricing in the New Jersey marketplace.  The cost of borrowed funds and subordinated debentures increased 27 basis points to 4.69 percent for the six months ended June 30, 2006 compared to 2005.

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Tax-equivalent net interest income increased $1.6 million to $12.1 million for the six months ended June 30, 2006 compared to $10.5 million for the same period a year ago.  Net interest margin contracted 17 basis points to 4.05 percent compared to 4.22 percent for the same period a year ago.  The tighter net interest margin was primarily the result of the high cost of deposits in the New Jersey market place.  The net interest spread was 3.55 percent for the six months ended June 30, 2006 compared to 3.81 percent for the same period a year ago.

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