UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C.  20549

FORM 10-Q

(Mark One)

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 ý  No o

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12 b-2 of

the Exchange Act) Yes o  No ý

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

The number of shares outstanding of each of the registrant’s classes of common equity stock, as of

November 8, 2005 common stock, no par value:  6,204,697 shares outstanding

Unity Bancorp

Consolidated Statements of Income

(unaudited)

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 nine months ended September 30, 2005 and 2004

(unaudited)

See Accompanying Notes to the Unaudited Consolidated Financial Statements.

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Unity Bancorp, Inc.

Notes to the Consolidated Financial Statements (Unaudited)

September 30, 2005

 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.  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 nine months ended September 30, 2005 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, 2004, included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2004.

Stock Based Compensation

      The Company applies Accounting Principles Board Opinion 25 and related Interpretations in accounting for its Option Plans. No stock-based compensation cost is reflected in net income, as all options granted under those plans have an exercise price equal to the market value of their underlying common stock on the date of grant.  The following table illustrates the effect on net income and earnings per share 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.   On June 30, 2005 the Company paid a 5% stock dividend to all shareholders of record as of June  15, 2005 and accordingly, all share amounts have been restated to include the effect of the distribution.

Proforma

Treasury Stock

          Treasury stock is accounted for under the cost method and accordingly is presented as a reduction in shareholders’ equity.

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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.

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

NOTE 4. Recent accounting pronouncements

     FASB Staff Position No. FAS 115-1 and FAS 124-1, “The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments” (the “FSP”), was issued on November 3, 2005 and addresses the determination of when an investment is considered impaired; whether the impairment is other than temporary; and how to measure an impairment loss. The FSP also addresses accounting considerations subsequent to the recognition of an other-than-temporary impairment on a debt security, and requires certain disclosures about unrealized losses that have not been recognized as other-than-temporary impairments. The FSP replaces the impairment guidance in EITF Issue No. 03-1 with references to existing authoritative literature concerning other-than-temporary determinations (principally Statement of Financial Accounting Standards No. 115 and SEC Staff Accounting Bulletin 59). Under the FSP, impairment losses must be recognized in earnings equal to the entire difference between the security’s cost and its fair value at the financial statement date, without considering partial recoveries subsequent to that date. The FSP also requires that an investor recognize an other-than-temporary impairment loss when a decision to sell a security has been made and the investor does not expect the fair value of the security to fully recover prior to the expected time of sale.  The FSP is effective for reporting periods beginning after December 15, 2005. The Company does not expect that the application of the FSP will have a material impact on its financial condition, results of operations or financial statement disclosures.

      In May 2005, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards (“SFAS”) No. 154, “Accounting Changes and Error Corrections, a replacement of APB Opinion No. 20 and FASB Statement No. 3.”  SFAS No. 154 requires retroactive application to prior periods’ financial statement of a voluntary change in accounting principle unless it is impracticable.  SFAS No. 154 is effective for accounting changes and corrections of errors made in fiscal years beginning after December 15, 2005, with earlier application permitted for accounting changes and corrections of errors made occurring in fiscal years beginning after June 1, 2005.

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     On April 14, 2005 the Securities and Exchange Commission amended the compliance dates for the Financial Accounting Standard Board’s Statement of Financial Accounting Standards No. 123 (revised 2004), Share-Based Payment (Statement No. 123R).  The Commission’s new rule allows companies to implement Statement No. 123R at the beginning of the next fiscal year, instead of the reporting period that begins after June 15, 2005, or December 15, 2005 for small business issuers (January 1, 2006 for the Company).  The Commission’s new rule does not change the accounting required by Statement No. 123R; it changes only the dates for compliance with the standard.  The Company has evaluated the impact of implementation of Statement No. 123R and does not believe that it will be material.

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 2004 consolidated audited financial statements and notes thereto.  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.

Overview

      Unity Bancorp, Inc. (the “Parent Company”) is incorporated in New Jersey and is 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 March 13, 1991.  The Bank provides a full range of commercial and retail banking services through 13 branch offices located in Hunterdon, Somerset, Middlesex, and Union counties in New Jersey.  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.

      On July 25, 2005, Unity announced that the Bank had agreed to purchase the Phillipsburg, New Jersey branch of InterState Net Bank, expanding the Bank’s market into Warren County. The branch acquisition will add approximately $22 million in related deposits and loans to Unity’s existing branch network. The purchase price is approximately $1.5 million. The transaction, which has received regulatory approval, is expected to close during the fourth quarter of 2005.

      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.

Earnings Summary

      Net income for the three months ended September 30, 2005 was $1.6 million, an increase of $188 thousand or 13.1 percent, compared to net income of $1.4 million for the same period in 2004. This was the result of increased net interest income and non- interest income, offset in part by higher operating expenses and a higher provision for loan losses.

      Quarterly performance highlights include:

•                  Earnings per basic common share increased to $0.26 for the third quarter of 2005 compared to $0.24 for the same period in 2004.

•                  Earnings per diluted common share increased to $0.25 for the third quarter of 2005 compared to $0.22 for the same period a year ago.

•                  Return on average assets equaled at 1.09 percent and 1.17 percent for the quarters ended September 30, 2005 and 2004.

•                  Return on average common equity equaled 16.36 percent and 17.39 percent for the quarters September 30, 2005 and 2004, respectively.

•                  The efficiency ratio improved to 58.17 percent for the third quarter of 2005 compared to 62.55 percent for the same period a year ago.

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      Net income for the nine months ended September 30, 2005 was $4.5 million, an increase of $484 thousand or 12.2 percent, compared to net income of $4.0 million for the same period in 2004.  This increase was the result of increased net interest income and non-interest income, offset in part by higher operating expenses and a higher provision for loan losses.

      Year to date performance highlights include:

•                  Earnings per basic common share increased to $0.73 for the nine months ended September 30, 2005 compared to $0.66 for the same period in 2004.

•                  Earnings per diluted common share increased to $0.69 for the nine months ended September 30, 2005 compared to $0.62 for the same period a year ago.

•                  Return on average assets equaled 1.08 percent and 1.11 percent for the nine months ended September 30, 2005 and 2004, respectively.

•                  Return on average common equity equaled 15.82 percent and 16.61 percent for the nine months ended September 30, 2005 and 2004, respectively.

•                  The efficiency ratio improved to 62.16 percent for the nine months ended September 30, 2005 compared to 64.60 percent for the same period a year ago.

                From June 2004 through September 2005, the Federal Reserve raised short-term interest rates eleven times for a total of 275 basis points.  During this period the Federal Funds rate has increased from 1.0 percent to 3.75 percent while the Prime-lending rate increased from 4.0 percent to 6.75 percent.  Rising rates positively impact a bank’s revenue when variable rate earning assets such as Prime based commercial loans re-price at a higher rate; however, a higher interest rate environment also puts pressure on a bank’s cost of funds as its deposit and borrowing costs rise.  During the third quarter of 2005, the Company began to realize the effect of these rising rates as the net interest margin and net interest spread began to contract due to the competitive pricing of deposits in the New Jersey market place and the resulting higher cost of deposits.

      Net interest income, our largest component of operating income, increased $758 thousand or 15.2 percent to $5.7 million for the three months ended September 30, 2005 compared to the same period in 2004.  This increase was the result of a $93.3 million increase in average interest-earning assets partially offset by a lower net interest margin and spread.    Net interest margin (net interest income as a percentage of average interest-earning assets) decreased 18 basis points to 4.12 percent for the current quarter compared to 4.30 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 19 basis points to 3.69 percent from 3.88 percent a year ago.  For the nine months ended September 30, 2005, net interest income was $16.3 million, an increase of $2.2 million or 15.4 percent, compared to $14.1 million during the same period a year ago.  The net interest margin remained stable at 4.16 percent and 4.15 percent for the nine months ended September 30, 2005 and 2004, respectively.

      Non-interest income increased $147 thousand or 7.4 percent to $2.1 million for the three months ended September 30, 2005 compared to $2.0 million for the three months ended September 30, 2004.  For the nine months ended September 30, 2005, non-interest income was $6.1 million, an increase of $357 thousand or 6.2 percent compared to $5.8 million during the same period a year ago. These increases were due primarily to increased service charges on deposits, service and loan fee income, gains on Mortgage loan sales, income on bank owned life insurance and other income, partially offset by decreased gains on the sale of SBA loans.

      Non-interest expense was $4.6 million for the three months ended September 30, 2005, an increase of $226 thousand or 5.2 percent compared to $4.4 million for the same period a year ago. The increase was due primarily to increases in compensation and benefits, processing and communications, furniture and equipment and advertising expenses.   For the nine-month period ended September 30, 2005, non-interest expense increased $1.1 million or 8.6 percent to $13.9 million compared to the nine-month period ended September 30, 2004.  The increase was due primarily to increased compensation, occupancy, furniture and equipment, processing and communications, and advertising, partially offset by lower professional services and loan servicing expenses.

        During the third quarter of 2005, the Company recorded income tax expense of $993 thousand compared to $852 thousand for the same period a year ago.   Year to date, the Company has recorded income tax expense of $2.7 million, an increase of $455 thousand compared to the first nine months of 2004.  The current 2005 tax provision represents an effective tax rate of approximately 38.0 percent as compared to 36.0 percent for 2004.

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Net Interest Income

      Tax-equivalent interest income totaled $8.90 million for the three months ended September 30, 2005, an increase of $2.16 million or 32.1 percent, compared to $6.74 million a year ago.  Of the $2.16 million increase in interest income, $1.5 million is due to an increase in the volume of interest-earning assets, while $660 thousand is attributable to an increase in the yield on interest-earning assets. The average volume of interest-earning assets increased $93.3 million to $557.8 million at September 30, 2005 compared to $464.5 million at September 30, 2004.  This was due to an $84.2 million increase in average total loans, an $8.6 million increase in average federal funds sold and interest bearing deposits and a $574 thousand increase in average securities.  The impact of the higher interest rate environment in the third quarter of 2005 was evident in the rates earned on variable rate instruments such as SBA loans, consumer home equity lines of credit and federal funds sold and interest bearing deposits.  Key interest rate increases during the quarter included:

•               Federal funds sold and interest bearing deposits earned 2.96 percent for the three months ended September 30, 2005, an increase of 106 basis points compared to 1.90 percent for the same period a year ago.

•               SBA loans earned 8.97 percent during the quarter, an increase of 198 basis points over the comparable quarter in 2004, due to the quarterly re-pricing of these loans with changes in the Prime rate.

•               Commercial loans earned 6.96 percent during the quarter, an increase of 21 basis points over the comparable quarter in 2004.

•               Residential mortgage loans earned 5.50 percent for the three months ended September 30, 2005, an increase of 23 basis points over the prior period.

•               Consumer loans earned 5.67 percent for the three months ended September 30, 2005, an increase of 106 basis points compared to 4.61 percent for the same period a year ago due to the re-pricing of Prime based home equity lines of credit.

      The higher interest rate environment also increased interest expense and the cost of funds.  Total interest expense was $3.15 million for the three months ended September 30, 2005, an increase of $1.40 million or 80.6 percent, compared to $1.74 million for the same period a year ago. Of the $1.4 million increase in interest expense, $744 thousand is related to an increase in average interest-bearing liabilities while $661 thousand is due to an increase in the cost of funds.  Quarter over quarter, average interest-bearing liabilities increased $104.6 million as average interest-bearing deposits increased $85.1 million and borrowed funds and subordinated debentures increased $19.5 million. Total interest-bearing deposits were $417.9 million on average, an increase of $85.1 million or 25.6 percent compared to $332.8 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 $19.50 million to $50.9 million as of September 30, 2005 due to the addition of a $10 million FHLB advance at 2.95 percent during the fourth quarter of 2004 and a $10 million FHLB advance at 3.70 percent during the second quarter of 2005.   The rate paid on interest bearing liabilities increased 76 basis points to 2.66 percent for the three months ended September 30, 2005 from 1.90 percent in the same period in 2004.  The cost of interest-bearing deposits increased 78 basis points to 2.48 percent as the rates paid on all deposit products increased and the mix of deposit growth consisted primarily of higher costing saving and time deposit.  The cost of borrowed funds and subordinated debentures increased 10 basis points to 4.21 percent.

      Tax-equivalent net interest income increased $757 thousand to $5.75 million for the quarter ended September 30, 2005 compared to $4.99 million for the same period a year ago.  Net interest margin compressed 18 basis points to 4.12 percent compared to 4.30 percent for the same period a year ago.  The reduced net interest margin was primarily the result of the higher  costs of funding our asset growth.  The net interest spread was 3.69 percent for the three months ended September 30, 2005 compared to 3.88 percent for the same period a year ago.

      Tax-equivalent interest income totaled $24.39 million for the nine months ended September 30, 2005, an increase of $5.2 million or 27.1 percent, compared to $19.19 million a year ago.  Of the $5.20 million increase in interest income, $3.38 million is due to an increase in the volume of earning assets, while $1.82 million is attributable to an increase in the yield on interest-earning assets. The average volume of interest-earning assets increased $68.4 million to $522.9 million at September 30, 2005 compared to $454.5 million at September 30, 2004.  This was due to a $64.8 million increase in average total loans plus a $6.5 million increase in average total securities, partially offset by an $3.0 million decline in federal funds sold and interest bearing deposits.  Key interest rate increases during the nine months ended September 30, 2005 included:

•               Federal funds sold and interest bearing deposits earned 2.78 percent for the nine months ended September 30, 2005, an increase of 161 basis points compared to 1.17 percent for the same period a year ago.

•               SBA loans earned 8.52 percent during the nine months ended September 30, 2005, an increase of 187 basis points over the comparable period in 2004, due to the quarterly re-pricing of these loans with changes in the Prime rate.

•               Commercial loans earned 6.93 percent during the nine months ended September 30, 2005, an increase of 23 basis points over the comparable period in 2004.

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•               Consumer loans earned 5.69 percent for the nine months ended September 30, 2005, an increase of 95 basis points compared to 4.74 percent for the same period a year ago due to the re-pricing of Prime based home equity products.

                Total interest expense was $8.08 million for the nine months ended September 30, 2005, an increase of $3.04 million or 60.2 percent, compared to $5.05 million for the same period a year ago. Of the $3.04 million increase in interest expense, $1.6 million is related to an increase in average interest-bearing liabilities while $1.4 million is due to an increase in the cost of funds.  For the nine-month periods ended September 30, 2005 and 2004, average interest bearing liabilities increased $75.8 million as average interest bearing deposits increased $57.9 million and borrowed funds and subordinated debentures increased $18.0 million. Total interest-bearing deposits were $388.9 million on average, an increase of $57.9 million or 17.5 percent compared to $331.0 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 increased $18.0 million to $45.9 million as of September 30, 2005 due to the addition of a $10 million FHLB advance at 2.95 percent during the fourth quarter of 2004 and a $10 million FHLB advance at 3.70 percent during the second quarter of 2005. The rate paid on interest bearing liabilities increased 61 basis points to 2.49 percent for the nine months ended September 30, 2005 from 1.88 percent in the same period in 2004.  The cost of interest bearing deposits increased 60 basis points to 2.28 percent as the rates paid on all deposit products increased and the mix of deposit growth consisted primarily of higher costing saving and time deposit.    It is expected that the cost of deposits will continue to rise due to the competitive pricing in the New Jersey market place.  The cost of borrowed funds and subordinated debentures increased 5 basis points to 4.26 percent for the nine months ended September 30, 2005 compared to 2004.

      Tax-equivalent net interest income increased $2.2 million to $16.31 million for the nine months ended September 30, 2005 compared to $14.15 million for the same period a year ago.  Net interest margin remained stable at 4.16 and 4.15 percent for the nine months ended September 30, 2005 and 2004, respectively.  The net interest spread was 3.74 percent for the nine months ended September 30, 2005 compared to 3.76 percent for the same period a year ago.  The stable net interest margin and net interest spread for the nine months ended September 30, 2005 and 2004 was due to growth in higher earning assets, primarily commercial loans, while management was able to control the rising cost of funds.  Due to the competitive pricing of deposits within the New Jersey market place and the flat yield curve the net interest margin and net interest spread are expected to remain under pressure.

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