Unity Bancorp - 10-Q quarterly report FY

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C.  20549

FORM 10-Q

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) Yes o No ý

The number of shares outstanding of each of the registrant’s classes of common equity stock, as of October 31, 2003: common stock, no par value:  5,407,017 shares outstanding

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Part 1.-Consolidated Financial Information

Item 1.-Consolidated Financial Statements

Unity Bancorp, Inc.

Consolidated Balance Sheets

See Accompanying Notes to the Consolidated Financial Statements

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Unity Bancorp, Inc.

Consolidated Statements of Income

(unaudited)

See Accompanying Notes to the Consolidated Financial Statements

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Unity Bancorp, Inc.

Consolidated Statements of Changes in Shareholders’ Equity

For the nine months ended September 30, 2003 and 2002

(unaudited)

See Accompanying Notes to the Consolidated Financial Statements.

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Unity Bancorp, Inc

Consolidated Statements of Cash Flows

(unaudited)

See Accompanying Notes to the Consolidated Financial Statements.

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Unity Bancorp, Inc

Notes to the Consolidated Financial Statements (Unaudited)

September 30, 2003

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”), reflect all adjustments and disclosures which are, in the opinion of management, necessary for a fair presentation of interim results.  All significant intercompany 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 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 related 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, 2003 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, 2002, included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2002.

The Company applies Accounting Principles Board Opinion 25 and related Interpretations in accounting for its Option Plans. No stock-based employee 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 is the expanded disclosure of SFAS 148, for the three and nine months ended September 30, 2003 and 2002.

The SEC's rules and regulations require that the Company's independent auditor complete a review of the interim financial statements prior to the filing of its Form 10-Q.  The Company has commenced an inquiry concerning certain expense reimbursement requests made by its President.  The President has taken a voluntary leave of absence pending completion of the inquiry.  The Company has appointed David D. Dallas as interim Chief Executive Officer.  Due to the ongoing inquiry into this matter, the Company's independent auditor is not able to complete its review of the interim financial statements for the three and nine-month periods ended September 30, 2003 and therefore this Form 10-Q is filed with the Commission without such review.  The Company anticipates amending its September 30, 2003 Form 10-Q when the inquiry is finalized and the independent auditors' review is complete.

SFAS 148 Proforma Restatement

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. The Bank has reviewed the relevant circumstances and believes that it acted properly and that the outcome of the lawsuit will not have a material impact on the consolidated financial position or results of operations of the Company.

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 operating results of the Company.

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NOTE 3. Earnings per share

The following is a reconciliation of the calculation of basic and dilutive 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 and warrants, were issued during the reporting period. On January 27, 2003 the Company announced a 5% stock dividend payable on March 12, 2003, and, accordingly, all share amounts have been restated to include the effect of the dividend.

NOTE 4. Recent accounting pronouncements

Statement of Financial Accounting Standards No. 150, “Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity,” was issued in May 2003.  Statement 150 requires instruments within its scope to be classified as a liability (or, in some cases, as an asset). Statement 150 is generally effective for financial instruments entered into or modified after May 31, 2003, and otherwise is effective at the beginning of the first interim period beginning after June 15, 2003 (i.e. July 1, 2003 for calendar year entities).  For financial instruments created before June 1, 2003 and still existing at the beginning of the interim period of adoption, transition generally should be applied by reporting the cumulative effect of a change in an accounting principle by initially measuring the financial instruments at fair value or other measurement attributes of the Statement.  The adoption of Statement 150 did not have any effect on the Company’s consolidated financial statements.

Statement of Financial Accounting Standards No. 149, “Amendment of Statement 133 on Derivative Instruments and Hedging Activities,” was issued on April 30, 2003.  The Statement amends and clarifies accounting for derivative instruments, including certain derivative instruments embedded in other contracts, and for hedging activities under Statement 133.  This statement is effective for contracts entered into or modified after September 30, 2003.  The adoption of this Statement is not expected to have a significant effect on the Company’s consolidated financial statements.

FASB Interpretation No. 46, Consolidation of Variable Interest Entities(“FIN 46”) was issued in January 2003.  FIN 46 applies immediately to enterprises that hold a variable interest in variable interest entities created after January 31, 2003.  It applies in the first fiscal year or interim period beginning after June 15, 2003 to enterprises that hold a variable interest in variable interest entities created before February 1, 2003.  FIN 46 applies to public enterprises as of the beginning of the applicable interim or annual period, and it applies to nonpublic enterprises no later than the end of the applicable annual period.  FIN 46 may be applied prospectively with a cumulative-effect adjustment as of the date on which it is first applied or by restating previously issued financial statements for one or more years with a cumulative-effect adjustment as of the beginning of the first year restated.  FIN 46 provides guidance on the identification of entities controlled through means other than voting rights.  FIN 46 specifies how a business enterprise should evaluate its interest in a variable interest entity to determine whether to consolidate that entity.  A variable interest entity must be consolidated by its primary beneficiary if the entity does not effectively disperse risks among the parties involved. In its current form, FIN 46 may require the Company to de-consolidate its investment in Unity (NJ) Statutory Trust I in future financial statements.  The potential de-consolidation of subsidiary trusts of bank holding companies formed in connection with the issuance of trust preferred securities, like Unity (NJ) Statutory Trust I, appears to be an unintended consequence of FIN 46.  In July 2003, the Board of Governors of the Federal Reserve System instructed bank holding companies to continue to include the trust preferred securities in their Tier 1 capital for regulatory capital purposes until notice is given to the contrary.  There can be no assurance that the Federal Reserve will continue to allow institutions to include trust preferred securities in Tier 1 capital for regulatory capital purposes.  As of September 30, 2003, assuming the Company was not allowed to include the $9.0 million in trust preferred securities issued by Unity (NJ) Statutory Trust I in Tier 1 capital, the Company would remain “adequately capitalized.” On October 9, 2003, the effective date was deferred until the end of the first interim or annual period ending after December 15, 2003, for certain interests held by a public entity in certain variable interest entities or potential variable interest entities created before February 1, 2003.

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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 2002 consolidated financial statements and notes.  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 and Strategy

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 12 branch offices located in Hunterdon, Somerset, Middlesex, and Union counties in New Jersey.  These services include the acceptance of demand, savings, and time deposits; extension of consumer, real estate, Small Business Administration and other commercial credits, as well as personal investment advisory services through the Bank’s wholly-owned subsidiary, Unity Financial Services, Inc.  Unity Investment Company, Inc. is also a wholly-owned subsidiary of the Bank, used to hold a portion of the Bank’s investment portfolio.

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Unity Bancorp, Inc.

Consolidated Average Balance Sheets with resultant Interest and Rates

(unaudited)

(Tax-equivalent basis, dollars in thousands)

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Results of Operations for the three and nine months end September 30, 2003

Net Income

Net income for the three months ended September 30, 2003, was $1.3 million, or $0.24 per basic and $0.23 per diluted common share, compared to a net income of $954 thousand, or $0.17 per basic and $0.16 per diluted common share for the same period in 2002. Net income for the nine months ended September 30, 2003, was $3.7 million, or $0.68 per basic and $0.65 per diluted common share, compared to a net income of $2.7 million, or $0.49 per basic and $0.46 per diluted common share for the same period in 2002. The improved operating results for the three and nine months ended September 30, 2003 was primarily the result of increases in net interest income, non-interest income and continued expense controls. The following are key performance indicators for the three and nine months ended September 30, 2003, and 2002.

*The efficiency ratio is calculated by taking total non-interest expenses, divided by total interest income plus total non-interest income less securities gains.

Net Interest Income

Interest income (on a tax-equivalent basis) was $6.2 million for the three months ended September 30, 2003, flat from a year ago.  Interest-earning assets averaged $429.4 million, an increase of $35.5 million, or 9.0 percent, compared to the same period in 2002. The increases in average earning assets occurred primarily due to a $25.4 million increase in the loan portfolio and a $9.9 million increase in the securities portfolio. The rate earned on interest-earning assets decreased 59 basis points to 5.71 percent for the three months ended September 30, 2003, compared to the same period a year ago, due to a lower rate environment. Of the $64 thousand decrease in interest income, $583 thousand is attributable to a reduction in yield, partially offset by an increase of $519 thousand due to the increase in average interest earning assets.

Interest expense was $1.7 million for the three months ended September 30, 2003, a decrease of $472 thousand or 28.2 percent, compared to $2.1 million for the same period a year ago. Interest-bearing liabilities averaged $338.0 million for the three months ended September 30, 2003, an increase of $19.7 million, or 6.2 percent, compared to $318.3 million for the same period in 2002. The increases in average interest bearing liabilities was the result of an increase in interest-bearing deposits and other borrowed funds utilized to fund loan growth and security purchases. The rate paid on interest bearing liabilities for the three months ended September 30, 2003 decreased 71 basis points to 1.96 percent from the same period in 2002.

Total interest-bearing deposits were $316.6 million on average, an increase of $11.6 million or 3.8 percent compared to $305.0 million for the same period a year ago. The increase in average interest-bearing deposits was as a result of increases in interest-bearing demand deposits and savings deposits, partially offset by the reduction of time deposits. The rate paid on interest bearing deposits was 1.73 percent for the three months ended September 30, 2003, a decrease of 80 basis points from the same period a year ago.

Net interest income was $4.5 million for the three months ended September 30, 2003, an increase of $384 thousand, or 9.4 percent, compared to $4.1 million from the same period a year ago. The rise in net interest income was due to the increase in net interest spread earned on a larger portfolio of net earning assets. The net interest spread (the difference between the rate earned on average interest-earning assets and the rate paid on average interest-bearing liabilities) was 3.75 percent for the three months ended September 30, 2003 compared to 3.63 percent for the same period a year ago. Net interest margin (net interest income as a percentage of average interest earning assets) was 4.18 percent for the three months ended September 30, 2003 compared to 4.15 percent for the same period a year ago.

Interest income (on a tax-equivalent basis) was $18.7 million for the nine months ended September 30, 2003, an increase of $549 thousand or 3.0 percent, compared to $18.1 million a year ago.  Interest-earning assets averaged $416.5 million, an increase of $37.6 million, or 9.9 percent, compared to the prior year period. The increases in average earning assets occurred due to a $32.2 million increase in the loan portfolio, and a $4.7 million increase in the securities portfolio. The rate earned on interest-earning assets decreased 41 basis points to 5.97 percent for the nine months ended September 30, 2003, compared to the same period a year ago, due to a lower rate environment and partially offset by an increase in interest earning assets. Of the $549

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thousand increase in interest income, $1.9 million is attributable to an increase in interest earning assets, partially offset by a decline of $1.4 thousand due to the reduction in yield.

Interest expense was $5.4 million for the nine months ended September 30, 2003, a decrease of $1.1 million or 16.7 percent, compared to $6.4 million for the same period a year ago. Interest-bearing liabilities averaged $333.1 million for the nine months ended September 30, 2003, an increase of $24.9 million, or 8.1 percent, compared to $308.2 million for the prior year period. The increases in average interest bearing liabilities was the result of an increase in interest-bearing deposits and other borrowed funds utilized to fund loan growth. The rate paid on interest bearing liabilities decreased 64 basis points from the same period in 2002 to 2.16 percent.

Total interest-bearing deposits for the nine months ended September 30, 2003 were $311.4 million on average, an increase of $16.7 million or 5.7 percent compared to $294.7 million from the same period a year ago. The increase in average interest-bearing deposits was as a result of increases in interest-bearing demand deposits, partially offset by the reduction of time deposits. The rate paid on interest bearing deposits was 1.92 percent for the nine months ended September 30, 2003, a decrease of 74 basis points from the same period a year ago.

Net interest income was $13.2 million for the nine months ended September 30, 2003, an increase of $1.6 million, or 13.7 percent, compared to $11.7 million from the same period a year ago. The rise in net interest income was due to the increase in net interest spread earned on a larger portfolio of net earning assets. The net interest spread (the difference between the rate earned on average interest-earning assets and the rate paid on average interest-bearing liabilities) was 3.81 percent for the nine months ended September 30, 2003 compared to 3.58 percent for the same period a year ago. Net interest margin (net interest income as a percentage of average interest earning assets) was 4.25 percent for the nine months ended September 30, 2003 compared to 4.10 percent for the same period a year ago.

The rate volume table below presents an analysis of the impact on interest income and expense resulting from changes in average volume and rates over the periods presented. Changes that are not due to volume or rate variances have been allocated proportionally to both, based on their relative absolute values. Amounts have been computed on a full tax-equivalent basis, assuming a federal income tax rate of 34.0 percent.

Rate Volume Table