Unity Bancorp - 10-Q quarterly report FY

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C.  20549

FORM 10-Q

(Mark One)

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

FOR THE QUARTERLY PERIOD ENDED June 30, 2005

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)

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)  Yeso No ý

The number of shares outstanding of each of the registrant’s classes of common equity stock, as of August 12, 2005 common stock, no par value:  6,114,155 shares outstanding

Unity Bancorp, Inc.

Consolidated Statements of Changes in Shareholders’ Equity

For the six months ended June 30, 2005 and 2004

(unaudited)

See Accompanying Notes to the Unaudited Consolidated Financial Statements.

5

Unity Bancorp, Inc.

Notes to the Consolidated Financial Statements (Unaudited)

June 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 subsidiaries, Unity (NJ) Statutory Trust I and 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 six months ended June 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 subsidiaries, Unity Bank and Unity (NJ) Statutory Trust I, 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 May 26, 2005 the Company announced a 5% stock distribution payable on June 30, 2005 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.

7

NOTE 2. Litigation

On February 20, 2003, the Bank was named as a defendant in a lawsuit initiated by Commerce Bank, N.A. and Commerce Bank/Shore, N.A. in the Superior Court of New Jersey, Essex County alleging that the Bank, as payor of certain checks written against certain deposit accounts held at the Bank, improperly refused to honor approximately $4,000,000 of checks. Commerce Bank, N.A. and Commerce Bank/Shore, N.A. have petitioned the Superior Court of New Jersey, Essex County for compensatory and consequential damages of $4,028,584, interest, attorney’s fees and costs of suit.  On March 12, 2004, the Court granted Commerce Bank, N.A. partial summary judgment in the amount of $1,800,000 of its claim.  Although the Bank has reviewed the relevant circumstances and believes it acted properly, on March 28, 2005, the Bank agreed to settle the lawsuit with Commerce Bank and the other party to the litigation.  After the close of the second quarter, the settlement was paid primarily out of a deposit account the Bank had been holding to satisfy any liability, and as such, the settlement will not have an impact on the financial conditions or results of operations of the Company.

During the third quarter of 2004, the Company entered into a settlement agreement with its former Chairman Robert J. Van Volkenburgh thereby settling the pending litigation initiated by Mr. Van Volkenburgh.  Effective immediately upon the execution of the agreement, the parties exchanged general releases and dismissed the litigation with prejudice.  The Company’s payment of the settlement amount called for by the settlement agreement requires the approval of the Federal Deposit Insurance Corporation (“FDIC”) under applicable regulations.  The settlement agreement was approved by the FDIC subsequent to the quarter end.  The charge for the settlement agreement, $275 thousand, was recognized in the third quarter of 2004 and reduced net income by approximately $165 thousand after tax or $0.03 per diluted share.

From time to time, the Company is subject to other 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

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.

8

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 next reporting period, that begins after June 15, 2005, or December 15, 2005 for small business issuers.  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 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 June 30, 2005 was $1.5 million, an increase of $180 thousand or 13.4 percent, compared to net income of $1.3 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 $0.25 for the second quarter of 2005 compared to $0.22 for the same period in 2004.

•                  Earnings per diluted common share increased to $0.24 for the second quarter of 2005 compared to $0.21 for the same period a year ago.

•                  Return on average assets remained stable at 1.13 percent for each of the quarters ended June 30, 2005 and 2004.

•                  Return on average common equity equaled 16.50 percent and 17.24 percent for the quarters June 30, 2005 and 2004, respectively.

•                  The efficiency ratio improved to 62.43 percent for the second quarter of 2005 compared to 63.08 percent for the same period a year ago.

9

Net income for the six months ended June 30, 2005 was $2.8 million, an increase of $296 thousand or 11.6 percent, compared to net income of $2.5 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 $0.47 for the six months ended June 30, 2005 compared to $0.42 for the same period in 2004.

•                  Earnings per diluted common share increased to $0.44 for the six months ended June 30, 2005 compared to $0.40 for the same period a year ago.

•                  Return on average assets remained stable at 1.08 percent for each of the six month periods ended June 30, 2005 and 2004.

•                  Return on average common equity equaled 15.62 percent and 16.19 percent for the six months ended June 30, 2005 and 2004, respectively.

•                  The efficiency ratio improved to 64.34 percent for the six months ended June 30, 2005 compared to 65.71 percent for the same period a year ago.

From June 2004 through June 30, 2005, the Federal Reserve has raised short-term interest rates nine times for a total of 225 basis points.  During this period the Federal Funds rate has increased from 1.0 percent to 3.25 percent while the Prime-lending rate increased from 4.0 percent to 6.25 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.

The higher average interest rate environment during 2005 has been advantageous to Unity as seen in the growth of net interest income and the improvement in the net interest margin.  Net interest income, our largest component of operating income, increased $771 thousand or 17.2 percent to $5.3 million for the three months ended June 30, 2005 compared to the same period in 2004.  This increase was the result of a $55.1 million increase in average interest-earning assets combined with an higher net interest margin and spread.  Net interest margin (net interest income as a percentage of average interest-earning assets) increased 18 basis points to 4.12 percent for the current quarter compared to 3.94 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, increased 13 basis points to 3.68 percent from 3.55 percent a year ago.  For the six months ended June 30, 2005, net interest income was $10.5 million, an increase of $1.4 million or 15.6 percent, compared to $9.1 million during the same period a year ago.  The net interest margin increased 15 basis points to 4.22 percent for the six months ended June 30, 2005 compared to the same period a year ago.  The higher net interest margin for the three and six month periods ended June 30, 2005 were the result of growth in interest-earning assets and a higher interest rate environment.  The increases in the net interest margin and net interest spread, which were seen during the quarter and six months ended June 30, 2005, are not expected to continue due to the competitive pricing of deposits in the New Jersey market place and the resulting higher cost of deposits.

Non-interest income increased $300 thousand or 15.8 percent to $2.2 million for the three months ended June 30, 2005 compared to $1.9 million for the three months ended June 30, 2004.  This increase was due primarily to increased service and loan fee income, commercial loan referral fees, gains on the sale of Small Business Administration “SBA” loans and income on bank owned life insurance, partially offset by decreased service charges on deposits.  For the six months ended June 30, 2005, non-interest income was $3.99 million, an increase of $210 thousand or 5.6 percent compared to $3.78 million during the same period a year ago. This increase was due primarily to increased service and loan fee income, income on bank owned life insurance and other income, partially offset by decreased gains on the sale of SBA loans and service charges on deposits.

Non-interest expense was $4.64 million for the three months ended June 30, 2005, an increase of $623 thousand or 15.5 percent compared to $4.02 million for the same period a year ago. The increase was due primarily to increases in compensation and benefits, advertising and furniture and equipment.  For the six-month period ended June 30, 2005, non-interest expense increased $868 thousand or 10.3 percent to $9.3 million compared to the six-month period ended June 30, 2004.  The increase was due primarily to increased compensation, furniture and equipment, advertising and occupancy costs, partially offset by lower professional services expenses.

During the second quarter of 2005, the Company recorded income tax expense of $941 thousand compared to $773 thousand for the same period a year ago.  Year to date, the Company has recorded income tax expense of $1.7 million, an increase of $314 thousand compared to the first six 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.

10

Net Interest Income

Tax-equivalent interest income totaled $7.96 million for the three months ended June 30, 2005, an increase of $1.75 million or 28.3 percent, compared to $6.20 million a year ago.  Of the $1.75 million increase in interest income, $972 thousand is due to an increase in the volume of interest-earning assets, while $781 thousand is attributable to an increase in the yield on interest-earning assets. The average volume of interest-earning assets increased $55.1 million to $512.6 million at June 30, 2005 compared to $457.5 million at June 30, 2004.  This was due to a $54.8 million increase in average total loans plus an $11.6 million increase in average total securities, partially offset by an $11.3 million decline in federal funds sold and interest bearing deposits.  The impact of the higher interest rate environment in the second quarter of 2005 is 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:

•                  Federal funds sold and interest bearing deposits earned 2.81 percent for the three months ended June 30, 2005, an increase of 156 basis points compared to 1.25 percent for the same period a year ago.

•                  SBA loans earned 8.45 percent during the quarter, an increase of 208 basis points over the comparable quarter in 2004, due to the quarterly re-pricing of these loans with changes in the Prime rate.

•                  Consumer loans earned 5.88 percent for the three months ended June 30, 2005, an increase of 117 basis points compared to 4.71 percent for the same period a year ago due to the re-pricing of Prime based home equity lines of credit.

•                  Commercial loans earned 6.99 percent for the quarter, an increase of 46 basis points over the comparable quarter in 2004.

The higher interest rate environment also increased interest expense and the cost of funds.  Total interest expense was $2.68 million for the three months ended June 30, 2005, an increase of $984 thousand or 58.1 percent, compared to $1.69 million for the same period a year ago. Of the $984 thousand increase in interest expense, $479 thousand is related to an increase in average interest-bearing liabilities while $505 thousand is due to an increase in the cost of funds.  Quarter over quarter, average interest-bearing liabilities increased $63.5 million as average interest-bearing deposits increased $48.7 million and borrowed funds and subordinated debentures increased $14.8 million. Total interest-bearing deposits were $379.2 million on average, an increase of $48.7 million or 14.7 percent compared to $330.5 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 $14.8 million to $44.0 million as of June 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 65 basis points to 2.54 percent for the three months ended June 30, 2005 from 1.89 percent in the same period in 2004.  The cost of interest-bearing deposits increased 62 basis points to 2.31 percent as the rates paid on all deposit products increased while the cost of borrowed funds and subordinated debentures increased 39 basis points to 4.54 percent.

Tax-equivalent net interest income increased $769 thousand to $5.28 million for the quarter ended June 30, 2005 compared to $4.51 million for the same period a year ago.  Net interest margin widened 18 basis points to 4.12 percent compared to 3.94 percent for the same period a year ago.  The widened net interest margin was primarily the result of a higher interest rate environment.  The net interest spread was 3.68 percent for the three months ended June 30, 2005 compared to 3.55 percent for the same period a year ago.

Tax-equivalent interest income totaled $15.49 million for the six months ended June 30, 2005, an increase of $3.0 million or 24.3 percent, compared to $12.46 million a year ago.  Of the $3.0 million increase in interest income, $1.77 million is due to an increase in the volume of earning assets, while $1.26 million is attributable to an increase in the yield on interest-earning assets. The average volume of interest-earning assets increased $50.6 million to $500.0 million at June 30, 2005 compared to $449.5 million at June 30, 2004.  This was due to a $51.5 million increase in average total loans plus a $7.8 million increase in average total securities, partially offset by an $8.8 million decline in federal funds sold and interest bearing deposits.  Key interest rate increases during the six months ended June 30, 2005 included:

•                  Federal funds sold and interest bearing deposits earned 2.67 percent for the six months ended June 30, 2005, an increase of 160 basis points compared to 1.07 percent for the same period a year ago.

•                  SBA loans earned 8.41 percent during the six months ended June 30, 2005, an increase of 195 basis points over the comparable period in 2004, due to the quarterly re-pricing of these loans with changes in the Prime rate.

•                  Consumer loans earned 5.77 percent for the six months ended June 30, 2005, an increase of 96 basis points compared to 4.81 percent for the same period a year ago due to the re-pricing of Prime based home equity products.

•                  Commercial loans earned 6.97 percent for the six months ended June 30, 2005, an increase of 30 basis points over 2004.

11