SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C.  20549

 

FORM 10-Q

 

 

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

 

The number of shares outstanding of each of the registrant’s classes of common equity stock, as of August 10, 2003: common stock, no par value:  5,399,196 shares outstanding

 

 

PART I	-		CONSOLIDATED FINANCIAL INFORMATION
ITEM 1	-		Consolidated Financial Statements (unaudited)
			Consolidated Balance Sheets at June 30, 2003, 2002 and December 31, 2002
			Consolidated Statements of Income for the three and six months ended June 30, 2003 and 2002
			Consolidated Statements of Changes in Shareholders’ Equity for the six months ended June 30, 2003 and 2002
			Consolidated Statements of Cash Flows for the six months ended June 30, 2003 and 2002
			Notes to the Consolidated Financial Statements
ITEM 2	-		Management’s Discussion and Analysis of Financial Condition and Results of Operations
ITEM 3	-		Quantitative and Qualitative Disclosures about Market Risk
ITEM 4	-		Controls and Procedures
PART II	-		OTHER INFORMATION
ITEM 1			Legal Proceedings
ITEM 2			Changes in Securities and Use of Proceeds
ITEM 3			Defaults upon Senior Securities
ITEM 4			Submission of Matters to a Vote of Security Holders
ITEM 5			Other Information
ITEM 6			Exhibits and Reports on Form 8-K
SIGNATURES
Exhibit Index

 

2

 

Part 1.-Consolidated Financial Information

Item 1.-Consolidated Financial Statements

 

Unity Bancorp, Inc

Consolidated Balance Sheets

 

		(unaudited)						(unaudited)
(in thousands)		06/30/03			12/31/02			06/30/02
Assets
Cash and due from banks		$	14,907		$	12,237		$	14,409
Federal funds sold and money market investments		19,000			18,000			24,000
Securities:
Available for sale		58,731			55,570			42,941
Held to maturity		21,053			26,184			23,848
Total securities		79,784			81,754			66,789
Loans:
SBA held for sale		12,176			14,396			10,583
SBA held to maturity		51,319			49,784			40,490
Commercial		182,113			163,813			148,562
Residential mortgage		47,198			56,297			70,447
Consumer		32,415			27,504			26,184
Total loans		325,221			311,794			296,266
Less: Allowance for loan losses		4,649			4,094			3,563
Net loans		320,572			307,700			292,703
Premises and equipment, net		8,475			8,669			8,960
Accrued interest receivable		2,397			2,579			2,248
Other assets		3,635			1,935			1,227
Total assets		$	448,770		$	432,874		$	410,336
Liabilities and Shareholders’ Equity
Liabilities:
Deposits
Non-interest bearing		$	90,593		$	75,567		$	69,287
Interest bearing checking		183,068			176,640			149,656
Savings deposits		36,452			34,663			33,217
Time deposits, under $100,000		66,389			75,883			82,313
Time depostis, $100,000 and over		20,596			19,832			32,839
Total deposits		397,098			382,585			367,312
Other debt		12,717			12,768			12,809
Trust preferred securities		9,000			9,000			—
Accrued interest payable		200			280			440
Accrued expense and other liabilities		517			1,135			1,664
Total liabilities		$	419,532		$	405,768		$	382,225
Commitments and contingencies		—			—			—
Shareholders’ equity
Preferred stock, class A, 10%, 104 shares authorized 6 thousand issued and outstanding		—			—			285
Common stock, no par value, 12,500 shares authorized		31,827			31,827			34,584
Retained deficit		(2,639		)	(5,006		)	(6,969		)
Accumulated other comprehensive income		50			285			211
Total Shareholders’ Equity		29,238			$	27,106		28,111
Total Liabilities and Shareholders’ Equity		$	448,770		$	432,874		$	410,336
Issued common shares		5,393			5,393			5,646
Outstanding common shares		5,393			5,393			5,646

 

See Accompanying Notes to the Consolidated Financial Statements

 

3

 

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)		2003			2002			2003			2002
Interest income:
Fed funds sold and interest on deposits		$	41		$	31		$	57		$	61
Securities:
Available for sale		559			729			1,104			1,520
Held to maturity		282			388			589			721
Total securities		841			1,117			1,693			2,241
Loans:
SBA loans		1,019			885			2,061			1,784
Commercial loans		3,263			2,636			6,282			4,899
Residential mortgage loans		763			1,069			1,640			2,112
Consumer loans		363			389			747			778
Total loan interest income		5,408			4,979			10,730			9,573
Total interest income		6,290			6,127			12,480			11,875
Interest expense:
Interest bearing demand deposits		683			675			1,471			1,247
Savings deposits		102			188			208			355
Time deposits		667			1,125			1,411			2,307
Other debt and trust preferred securities		307			196			608			393
Total interest expense		1,759			2,184			3,698			4,302
Net interest income		4,531			3,943			8,782			7,573
Provision for loan losses		400			975			850			1,575
Net interest income after provision for loan losses		4,131			2,968			7,932			5,998
Non-interest Income:
Deposit service charges		523			366			1,093			709
Loan and servicing fees		484			367			905			719
Net gains on SBA loan sales		687			1,101			1,506			1,885
Net security gains		45			228			128			228
Other income		249			300			463			712
Total non-interest income		1,988			2,362			4,095			4,253
Non-interest expense:
Compensation and benefits		1,952			1,930			3,862			3,738
Occupancy		460			398			938			806
Processing and communications		548			561			1,122			1,072
Furniture and equipment		278			264			519			549
Professional fees		195			158			447			311
Deposit insurance		15			39			31			77
Loan servicing costs		166			135			286			202
Other expenses		587			415			1,051			797
Total non-interest expense		4,201			3,900			8,256			7,552
Net income before provision for income taxes		1,918			1,430			3,771			2,699
Provision for income taxes		703			514			1,404			961
Net income		$	1,215		$	916		$	2,367		$	1,738
Preferred stock dividends		—			7			—			15
Net income to common shareholders		$	1,215		$	909		$	2,367		$	1,723
Net income per common share - Basic		$	0.23		$	0.17		$	0.44		$	0.32
Net income per common share - Diluted		0.22			0.16			0.42			0.30
Weighted average shares outstanding – Basic		5,393			5,477			5,393			5,433
Weighted average shares outstanding – Diluted		5,610			5,834			5,640			5,830

 

See Accompanying Notes to the Consolidated Financial Statements

 

4

 

Unity Bancorp, Inc

Consolidated Statements of Changes in Shareholders’ Equity

For the Six months ended June 30, 2003 and 2002

(unaudited)

 

(In thousands)		Preferred Stock			Common Stock			Retained Deficit			Accumulated Other Comprehensive Income (loss)			Total Shareholders’ Equity
Balance, December 31, 2001		$	285		$	33,248		$	(8,692	)	$	(5	)	$	24,836
Comprehensive income:
Net Income		—			—			1,738			—			1,738
Unrealized holding gain on securities arising during the period, net of tax $116		—			—			—			257			257
Total comprehensive income		—			—			—			—			1,954
Preferred stock dividends		—			—			(15		)	—			(15		)
Warrant exercises (255 shares)		—			1,279			—			—			1,279
Benefit plans (9 shares)		—			57			—			—			57
Balance, June 30, 2002		$	285		$	34,584		$	(6,969	)	$	211		$	28,111
Balance, December 31, 2002		$	—		$	31,827		$	(5,006	)	$	285		$	27,106
Comprehensive income:
Net Income		—			—			2,367			—			2,367
Net unrealized holding loss on securities arising during the period, net of tax $144		—			—			—			(235		)	(235		)
Total comprehensive income		—			—			—			—			2,132
Balance, June 30, 2003		$	—		$	31,827		$	(2,639	)	$	50		$	29,238

 

See Accompanying Notes to the Consolidated Financial Statements.

 

5

 

Unity Bancorp, Inc

Consolidated Statements of Cash Flows

(unaudited)

 

		For the six months ended June 30,
(In thousands)		2003			2002
Operating activities:
Net income		$	2,367		$	1,738
Adjustments to reconcile net income to net cash provided by operating activities
Provision for loan losses		850			1,575
Depreciation and amortization		479			610
Net gain on sale of securities		(448		)	(228		)
Write-down on AFS security		300			—
Gain on sale of SBA loans held for sale		(1,506		)	(1,885		)
Origination of SBA loans held for sale		(14,650		)	(20,664		)
Proceeds from the sale of SBA loans		18,376			29,685
Net change in other assets and other liabilities		(2,410		)	548
Net cash provided by operating activities		3,358			11,379
Investing activities:
Purchases of securities held to maturity		(2,216		)	(6,526		)
Purchases of securities available for sale		(42,322		)	(9,827		)
Maturities and principal payments on securities held to maturity		7,347			3,601
Maturities and principal payments on securities available for sale		23,201			14,628
Proceeds from sale of securities available for sale		16,108			12,605
Purchase of loans		(3,835		)	(10,373		)
Net increase in loans		(12,223		)	(21,668		)
Purchases of premises and equipment		(210		)	(877		)
Net cash used in investing activities		(14,150		)	(18,437		)
Financing activities:
Increase in deposits		14,513			27,358
Decrease in borrowings		(51		)	(44		)
Proceeds from the issuance of common stock		—			1,336
Dividends on preferred stock		—			(15		)
Net cash provided by financing activities		14,462			28,635
Increase in cash and cash equivalents		3,670			21,577
Cash and cash equivalents at beginning of year		30,237			16,832
Cash and cash equivalents at end of period		$	33,907		$	38,409
Supplemental disclosures:
Cash:
Interest paid		$	3,778		$	4,228
Income taxes paid		2,578			300
Non-cash investing activities:
Transfer of loans to Other Real Estate Owned		186			—

 

See Accompanying Notes to the Consolidated Financial Statements.

 

6

 

Unity Bancorp, Inc

Notes to the Consolidated Financial Statements (Unaudited)

June 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 six months ended June 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 six months ended June 30, 2003 and 2002.

 

SFAS 148 Proforma Restatement

 

		Three months ended June 30,						Six months ended June 30,
(In thousands, except per share data)		2003			2002			2003			2002
Net income to common shareholders as reported:
As reported		$	1,215		$	909		$	2,367		$	1,723
Pro forma		1,167			832			2,271			1,584
Income per share:
Basic as reported		$	0.23		$	0.17		$	0.44		$	0.32
Basic Pro forma		0.22			0.15			0.42			0.29
Diluted as reported		$	0.22		$	0.16		$	0.42		$	0.30
Diluted Pro forma		0.21			0.14			0.40			0.27

 

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.

 

7

 

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.

 

		Three Months ended June 30,						Six Months ended June 30,
(In thousands, except per share data)		2003			2002			2003			2002
Net Income to common shareholders		$	1,251		$	909		$	2,367		$	1,723
Basic weighted-average common shares outstanding		5,393			5,477			5,393			5,433
Plus: Common stock equivalents		217			357			247			397
Diluted weighted –average common shares outstanding		5,610			5,834			5,640			5,830
Net Income per Common share:
Basic		$	0.23		$	0.17		$	0.44		$	0.32
Diluted		0.22			0.16			0.42			0.30

 

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 June 30, 2003.  The adoption of this Statement is not expected to have a significant effect on the Company’s consolidated financial statements.

 

8

 

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.

 

9

 

Unity Bancorp, Inc.

Consolidated Average Balance Sheets with resultant Interest and Rates

(unaudited)

(Tax-equivalent basis, dollars in thousands)

 

		Three Months Ended
		June 30, 2003								June 30, 2002
		Balance			Interest			Rate		Balance			Interest			Rate
Assets
Interest-earning assets:
Federal funds sold, interest-bearing deposits with banks and money market investments		$	11,058		$	41		1.49	%	$	7,850		$	31		1.58	%
Securities:
Available for sale		56,557			567			4.01		52,097			729			5.60
Held to maturity		22,865			282			4.93		24,608			388			6.31
Total securities		79,422			849			4.28		76,705			1,117			5.82
Loans, net of unearned discount:
SBA loans		65,950			1,019			6.18		54,946			885			6.44
Commercial		176,984			3,263			7.39		144,404			2,636			7.32
Residential Mortgages		50,050			763			6.10		71,066			1,069			6.02
Consumer		30,198			363			4.82		26,250			389			5.94
Total loans		323,182			5,408			6.70		296,666			4,979			6.72
Total interest-earning assets		413,662			6,298			6.10		381,221			6,127			6.43
Noninterest-earning assets:
Cash and due from banks		14,964								12,154
Allowance for loan losses		(4,591		)						(3,514		)
Other assets		14,216								12,165
Total noninterest-earning assets		24,589								20,805
Total Assets		$	438,251							$	402,026
Liabilities and Shareholders’ Equity
Interest-bearing liabilities:
Interest-bearing checking		$	184,592		683			1.48		$	141,044		675			1.92
Savings deposits		36,001			102			1.14		32,488			188			2.32
Time deposits		89,898			667			2.98		122,037			1,125			3.70
Total interest-bearing deposits		310,491			1,452			1.88		295,569			1,988			2.70
Other borrowed funds		21,902			307			5.62		13,442			196			5.85
Total interest-bearing liabilities		332,393			1,759			2.12		309,011			2,184			2.83
Noninterest-bearing liabilities:
Demand deposits		76,168								64,559
Other liabilities		1,265								1,940
Total noninterest-bearing liabilities		77,433								66,499
Shareholders’ equity		28,425								26,516
Total Liabilities and Shareholders’ Equity		$	438,251							$	402,026
Net interest spread					4,539			3.98	%				3,943			3.60	%
Tax-equivalent basis adjustment					(8		)						—
Net interest income					$	4,531							$	3,943
Net interest margin								4.39	%							4.14	%

 

10

 

Unity Bancorp, Inc.

Consolidated Average Balance Sheets with resultant Interest and Rates

(unaudited)

(Tax-equivalent basis, dollars in thousands)

 

		Six months ended
		June 30, 2003								June 30, 2002
		Balance			Interest			Rate		Balance			Interest			Rate
Assets
Interest-earning assets:
Federal funds sold, interest-bearing deposits with banks and money market investments		$	8,692		$	57		1.32	%	$	7,763		$	61		1.58	%
Securities:
Available for sale		55,141			1,112			4.03		54,775			1,520			5.55
Held to maturity		24,331			589			4.84		22,701			721			6.35
Total securities		79,472			1,701			4.28		77,476			2,241			5.79
Loans, net of unearned discount:
SBA loans		67,290			2,061			6.13		54,374			1,784			6.56
Commercial		172,286			6,282			7.35		134,036			4,899			7.37
Residential Mortgages		52,771			1,640			6.22		71,209			2,112			5.93
Consumer		29,370			747			5.13		26,386			778			5.95
Total loans		321,717			10,730			6.71		286,005			9,573			6.73
Total interest-earning assets		409,881			12,488			6.12		371,244			11,875			6.42
Noninterest-earning assets:
Cash and due from banks		14,995								13,378
Allowance for loan losses		(4,465		)						(3,431		)
Other assets		13,636								12,092
Total noninterest-earning assets		24,166								22,039
Total Assets		$	434,047							$	393,283
Liabilities and Shareholders’ Equity
Interest-bearing liabilities:
Interest-bearing checking		$	181,637		1,471			1.63		$	134,551		1,247			1.87
Savings deposits		35,367			208			1.19		32,274			355			2.22
Time deposits		91,729			1,411			3.10		122,558			2,307			3.80
Total interest-bearing deposits		308,733			3,090			2.02		289,383			3,909			2.72
Other borrowed funds		21,905			608			5.60		13,731			393			5.77
Total interest-bearing liabilities		330,638			3,698			2.26		303,114			4,302			2.86
Noninterest-bearing liabilities:
Demand deposits		74,539								62,525
Other liabilities		1,096								1,729
Total noninterest-bearing liabilities		75,635								64,254
Shareholders’ equity		27,774								25,915
Total Liabilities and Shareholders’ Equity		$	434,047							$	393,283
Net interest spread					8,790			3.86	%				7,573			3.56	%
Tax-equivalent basis adjustment					(8		)						—
Net interest income					$	8,782							$	7,573
Net interest margin								4.29	%							4.08	%

 

11

 

Results of Operations for the three and six months end June 30, 2003

 

Net Income

 

Net income for the three months ended June 30, 2003, was $1.2 million, or $0.23 per basic and $0.22 per diluted common share, compared to a net income of $916 thousand, or $0.17 per basic and $0.16 per diluted common share for the same period in 2002. Net income for the six months ended June 30, 2003, was $2.4 million, or $0.44 per basic and $0.42 per diluted common share, compared to a net income of $1.7 million, or $0.32 per basic and $0.30 per diluted common share for the same period in 2002. The improved operating results for the three and six months ended June 30, 2003 were primarily the result of increases in net interest income, and continued expense controls. The following are key performance indicators for the three and six months ended June 30, 2003, and 2002.

 

		Three Months ended June 30,						Six Months ended June 30,
(In thousands)		2003			2002			2003			2002
Net Income		$	1,215		$	916		$	2,367		$	1,738
Preferred stock dividends		—			7			—			15
Net Income to common stockholders		1,215			909			2,367			1,723
Net Income per common share-basic		0.23			0.17			0.44			0.32
Net Income per common share-diluted		0.22			0.16			0.42			0.30
Performance Ratios:
Return on average assets		1.11		%	0.91		%	1.10		%	0.89		%
Return on average common equity		17.14			13.90			17.19			13.56
Efficiency ratio		64.81			64.18			64.72			65.11

 

*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 was $6.3 million for the three months ended June 30, 2003, an increase of $171 thousand or  2.8 percent, compared to $6.2 million a year ago.  Interest-earning assets averaged $413.7 million, an increase of  $32.4 million, or 8.5 percent, compared to the prior year period. The increases in average earning assets occurred primarily due to a $26.5 million increase in the loan portfolio. The rate earned on interest-earning assets decreased 33 basis points to 6.10 percent for the three months ended June 30, 2003, compared to the same period a year ago, due to a lower rate environment. Of the $171 increase in interest income $550 thousand is attributable to an increase in interest earning assets, offset by a decline of $379 thousand due to the reduction in yield.

 

Interest expense was $1.8 million for the three months ended June 30, 2003, a decrease of $425 thousand or  19.5 percent, compared to $2.2 million the same period a year ago. Interest-bearing liabilities averaged $332.4 million for the three months ended June 30, 2003, an increase of $23.4 million, or 7.6 percent, compared to $309.0 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 for the three months ended June 30, 2003 decreased 71 basis points to 2.12 percent from the same period in 2002.

 

Total interest-bearing deposits were $310.5 million on average, an increase of $14.9 million or 5.0 percent compared to $295.6 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 1.88 percent for the three months ended June 30, 2003, a decrease of 82 basis points from the same period a year ago.

 

Net interest income was $4.5 million for the three months ended June 30, 2003, an increase of $588 thousand, or 14.9 percent, compared to the $3.9 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 3.98 percent for the three months ended June 30, 2003 compared to 3.60 percent for the same period a year ago. Net interest margin (net interest income as a percentage of average interest earning assets) was 4.39 percent for the three months ended June 30, 2003 compared to 4.14 percent for the same period a year ago.

 

Interest income was $12.5 million for the six months ended June 30, 2003, an increase of $613 thousand or  5.2 percent, compared to $11.9 million a year ago.  Interest-earning assets averaged $409.9 million, an increase of  $38.6 million, or 10.4 percent, compared to the prior year period. The increases in average earning assets occurred due to a $35.7 million increase in the loan portfolio, and a $2.0 million increase in the securities portfolio. The rate earned on interest-earning assets decreased 30 basis points to 6.12 percent for the six months ended June 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 $613 increase in interest income $1.4 million is attributable to an increase in interest earning assets, offset by a decline of $761 thousand due to the reduction in yield.

 

12

 

Interest expense was $3.7 million for the six months ended June 30, 2003, a decrease of $604 thousand or  14.0 percent, compared to $4.3 million the same period a year ago. Interest-bearing liabilities averaged $330.6 million for the six months ended June 30, 2003, an increase of $27.5 million, or 9.1 percent, compared to $303.1 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 60 basis points from the same period in 2002 to 2.26 percent.

 

Total interest-bearing deposits were $308.7 million on average, an increase of $19.4 million or 6.7 percent compared to $289.4 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 2.02 percent for the six months ended June 30, 2003, a decrease of 70 basis points from the same period a year ago.

 

Net interest income was $8.8 million for the six months ended June 30, 2003, an increase of $1.2 million, or  16.0 percent, compared to the $7.6 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 3.86 percent for the six months ended June 30, 2003 compared to 3.56 percent for the same period a year ago. Net interest margin (net interest income as a percentage of average interest earning assets) was 4.29 percent for the six months ended June 30, 2003 compared to 4.08 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

 

		Amount of Increase (Decrease)
		Three months ended June 30, 2003 versus June 30, 2002						Six months ended June 30, 2003 versus June 30, 2002
		Due to change in:						Due to change in:
		Volume		Rate		Total		Volume		Rate		Total
Interest Income
SBA		171		(37	)	134		400		(123	)	277
Commercial		602		25		627		1,396		(13	)	1,383
Residential mortgage		(320	)	14		(306	)	(571	)	99		(472	)
Consumer		53		(79	)	(26	)	83		(114	)	(31	)
Total Loans		506		(77	)	429		1,308		(151	)	1,157
Available for sale securities		58		(220	)	(162	)	10		(418	)	(408	)
Held to maturity securities		(26	)	(80	)	(106	)	49		(181	)	(132	)
Federal funds sold and interest bearing deposits		12		(2	)	10		7		(11	)	(4	)
Total Interest Earning assets		550		(379	)	171		1,374		(761	)	613
Interest Expense
Interest bearing checking		182		(174	)	8		398		(174	)	224
Savings deposits		19		(105	)	(86	)	31		(178	)	(147	)
Time deposits		(263	)	(195	)	(458	)	(517	)	(379	)	(896	)
Total Interest Bearing Deposits		(62	)	(474	)	(536	)	(88	)	(731	)	(819	)
Borrowings		119		(8	)	111		227		(12	)	215
Total interest-bearing liabilities		57		(482	)	(425	)	139		(743	)	(604	)
Net interest income		493		103		596		1,235		(18	)	1,217
Tax equivalent adjustment						(8	)					(8	)
Increase in net interest income						588						1,209

 

Provision for Loan Losses

     

The provision for loan losses was $400 thousand for the three months ended June 30, 2003 and $850 thousand for the six months ended June 30, 2003, a decrease of $575 thousand, and $725 thousand, respectively, from the comparable periods in 2002. The decrease from a year ago was primarily attributable to lower levels of charge offs, during the first six months of 2003 “See Financial Condition-Asset Quality.”  The provision is based on management’s assessment of the adequacy of the allowance for loan losses, described under the caption “Financial Condition-Allowance for Loan Losses.” The current provision is considered appropriate under the assessment of the adequacy of the allowance for loan losses.

 

13

 

Non-Interest Income

 

		Three months ended June 30,								Six months ended June 30,
(in thousands)		2003			2002			Percent Change		2003			2002			Percent Change
Deposit service charges		$	523		$	366		42.9	%	$	1,093		$	709		54.2	%
Loan and servicing fees		484			367			31.9		905			719			25.9
Net gains on SBA loan sales		687			1,101			(37.6	)	1,506			1,885			(20.1	)
Net security gains		345			228			51.3		428			228			87.7
Valuation write-down on security		(300		)	—			(100.0	)	(300		)	—			(100.0	)
Other income		249			300			(17.0	)	463			712			(35.0	)
Total non-interest income		$	1,988		$	2,362		(15.8	)%	4,095			$	4,253		(3.7	)%

 

Non-interest income consists of service charges on deposits, loan and servicing fees, net gains on sales of securities and loans and other income. Non-interest income was $2.0 million for the three months ended June 30, 2003, an decrease of $374 thousand compared with 2002, and was $4.1 million for the six months ended June 30, 2003, an decrease of $158 thousand, compared to the same period a year ago.

 

Deposit service charges increased $157 thousand, or 42.9 percent, for the three months ended June 30, 2003, compared to the same period a year ago, and increased $384 thousand, or 54.2 percent, for the six months ended June 30, 2003, compared with the same period a year ago. Deposit service charges increased for the three and six months as a result of higher fees and the growth in the deposit base.

 

Loan and servicing fees increased $117 thousand, or 31.9 percent, for the three months ended June 30, 2003, compared to the same period a year ago, and increased $186 thousand, or 25.9 percent, for the six months ended June 30, 2003, compared to the same period a year ago. The growth in loan and servicing fees for the three and six months ended is attributed to the growth of the serviced SBA loan portfolio, which amounted to $134.5 million at June 30, 2003, compared to $116.2 million at June 30, 2002.

 

Net gains on loan sales includes participation in the SBA’s guaranteed loan program. Under the program, the SBA guarantees up to 75 percent of the principal of a qualifying loan.  The guaranteed portion of the loan is then sold into the secondary market. SBA loan sales, all without recourse, totaled $7.8 million in the three months ended, and $16.8 million for the six months ended June 30, 2003, compared to $13.6 million and $27.8 million, respectively, for the three and six month periods ended June 30, 2002. Gains on SBA loan sales were $687 thousand for the three months ended, and $1.6 million for the six months ended June 30, 2003 compared to $1.1 million and $1.9 million, respectively, for the same periods a year ago. The decrease in gains on the sale of SBA loans is a result of lower volume of SBA loans sold partially offset by higher premiums received on sales and higher servicing fees.

 

Net security gains increased $117 thousand, or 51.3 percent, for the three months ended June 30, 2003, compared to the same period a year ago, and increased $200 thousand, or 87.7 percent, for the six months ended June 30, 2003, compared to the same period a year ago. Security gains for the three months ended June 30, 2003, were partially offset by a $300 thousand valuation write-down on a $1.0 million asset-backed AFS security.  Although the Company continues to receive all contractual payments, and the bond is rated A- by Moodys, the default rates on the underlying collateral is higher than anticipated. If the underlying collateral continues to deteriorate the future market value of the bond may be impaired.

 

Other non-interest income decreased $51 thousand for the three months ended June 30, 2003, compared with 2002 and decreased $249 thousand for the six months then ended, compared with the same period a year ago. The decrease was primarily due to an decrease in commercial loan referral fees which amounted to $24 thousand for the three months ended and $73 thousand for the six months ended June 30, 2003, compared to $194 thousand and $491 thousand, respectively for the three and six month periods ended 2002.

 

14

 

Non-Interest Expense

 

		Three months ended June 30,								Six months ended June 30,
		2003			2002			Percent Change		2003			2002			Percent Change
Compensation and benefits		$	1,952		$	1,930		1.1	%	$	3,862		$	3,738		3.3	%
Occupancy		460			398			15.6		938			806			16.4
Processing and communications		548			561			(2.3	)	1,122			1,072			4.7
Furniture and equipment		278			264			5.3		519			549			(5.5	)
Professional services		195			158			23.4		447			311			43.7
Deposit insurance		15			39			(61.5	)	31			77			(59.7	)
Loan servicing costs		166			135			23.0		286			202			41.6
Other expense		587			415			41.4		1,051			797			31.9
Total non-interest expense		$	4,201		$	3,900		7.7	%	8,256			$	7,552		9.3	%

 

Compensation and benefits expense increased $22 thousand, or 1.1 percent, for the three months ended June 30, 2003, compared to the same period a year ago, and increased $124 thousand, or 3.3 percent for the six months ended June 30, 2003, compared to the same period a year ago. The increase in compensation and benefits was a result of merit increases effective January 1, 2003, and an increase in the employee base. Total full time equivalent employees amounted to 171 at June 30, 2003, compared to 153 at June 30, 2002.

 

Occupancy expense increased $62 thousand, or 15.6 percent, for the three months ended June 30, 2003, compared to the same period a year ago, and increased $132 thousand, or 16.4 percent, for the six months ended June 30, 2003, compared to the same period a year ago. The increase for the three and six months ended was due to higher property taxes, depreciation and maintenance expenses.

 

Processing and communications expense decreased $13 thousand, or 2.3 percent, for the three months ended June 30, 2003, compared to the same period a year ago and increased $50 thousand, or 4.7 percent, for the six months ended June 30, 2003 compared to the same period a year ago. The increase is primarily as a result of higher items processing costs related to the growth in the deposit and loan portfolios and the increase in postage rates.

 

Furniture and equipment expense increased $14 thousand, or 5.3 percent, for the three months ended June 30, 2003, compared to the same period a year ago and decreased $30 thousand, or 5.5 percent for the six months ended June 30, 2003, compared to the same period a year ago. The increase for the three months ended is primarily related to an increase in maintenance expense. The decline in furniture and equipment for the six months ended is primarily related to lower depreciation expense as a result of assets being fully depreciated.

 

Professional fees increased $37 thousand, or 23.4 percent, for the three months ended June 30, 2003, compared to the same period a year ago and increased $136 thousand or 43.7 percent for the six months ended June 30, 2003, compared to the same period a year ago.  The increase for the three and six months ended is due to legal fees related to the law-suit initiated by Commerce Bank, N.A. See “Part II-Other Information-Item 1. Legal Proceedings”.

 

Deposit insurance decreased $37 thousand for the three months ended June 30, 2003, compared to the same period a year ago, and decreased $46 thousand for the six months ended June 30, 2003, compared to the same period a year ago.  The decrease for the three and six months ended is due to a reduced insurance premium assessment.

 

Loan servicing expense increased $31 thousand, or 23.0 percent for the three months ended June 30, 2003, compared to the same period a year ago, and increased $84 thousand, or 41.6 percent for the six months ended June 30, 2003, compared to the same period a year ago.  The increase in loan servicing expenses for the three and six month periods is primarily related to higher legal costs related to loan collections on the commercial and SBA portfolios.

 

Other expense increased $172 thousand, or 41.4 percent, for the three months ended June 30, 2003, compared to the same period a year ago, and increased $254 thousand or 31.9 percent, for the six months ended June 30, 2003 compared to the same period a year ago. The increase is the result of higher stationary and supplies expense, taxes on OREO properties, higher advertising expenses a credit for data processing expense that was received in 2002.

 

Income Tax Expense

 

For the second quarter of 2003, the provision for income taxes was $703 thousand compared to $514 thousand for the same period a year ago and was $1.4 million for the six months ended June 30, 2003 compared to $961 thousand for the same period a year ago. The current 2003 tax provision represents an effective tax rate of approximately 37 percent as compared 36 percent for the prior year. Management anticipates an effective rate of approximately 37 percent for the remainder of 2003.

 

15

 

Financial Condition at June 30, 2003

 

Total assets at June 30, 2003 were $448.8 million compared to $410.3 million a year ago and $432.9 million from year-end 2002. The increases in assets were the result of deposit generation used to fund loan growth.

 

Securities

 

Securities available for sale are investments carried at fair value that may be sold in response to changing market and interest rate conditions or for other business purposes.  Securities held to maturity, which are carried at amortized cost, are investments for which there is the positive intent and ability to hold to maturity. Management determines the appropriate security classification of available for sale or held to maturity at the time of purchase. The investment securities portfolio is maintained for asset-liability management purposes, as an additional source of liquidity, and as an additional source of earnings.  The portfolio is comprised of U.S. Treasury securities, obligations of U.S. Government and government sponsored agencies, collateralized mortgage obligations and corporate and equity securities. Approximately 91 percent of the total investment portfolio has a fixed rate of interest. In the normal course of business, the Company accepts government deposits that require investment securities to be held as collateral.  As of June 30, 2003, $1.0 million of securities were required to be pledged for governmental deposits.

 

Securities available for sale were $58.7 million at June 30, 2003, an increase of $3.2 million from year-end 2002. During the first six months of 2003, $42.3 million of securities available for sale were purchased, partially offset by $23.2 million of maturities and paydowns and $16.1 million in securities sales. The yield on securities available for sale was 4.03 percent for the six months ended June 30, 2003, compared to 5.55 percent a year ago, reflecting declines in market rates of interest. Included in securities available for sale at June 30, 2003 is a $300 thousand reserve for an asset-backed security.  Although the Company continues to receive all contractual payments and the bond is rated A- by Moodys, the default rates on the underlying collateral is higher than anticipated, which may cause a future default on the bond’s cash flows.

 

Securities held to maturity were $21.1 million at June 30, 2003, a decrease of $5.1 million, or 19.6 percent, from year-end 2002. During the first six months of 2003, $2.2 million of held to maturity securities were purchased and primarily funded by $7.3 million of maturities and paydowns. The yield on securities held to maturity was 4.84 percent for the six months ended June 30, 2003 compared to 6.35 for the same period a year ago, reflecting the maturity of higher yielding investments and the declines in market rates of interest. As of June 30, 2003 and December 31, 2002, the market value of held to maturity securities was $21.7 million and $26.1 million, respectively.

 

Loan Portfolio

 

The loan portfolio, which represents the Company’s largest asset group, is a significant source of both interest and fee income. The portfolio consists of commercial, Small Business Administration (“SBA”), residential mortgage and consumer loans. Elements of the loan portfolio are subject to differing levels of credit and interest rate risk. Loans increased $13.4 million, or 4.3 percent to $325.2 million at June 30, 2003, from year-end 2002.

 

SBA loans provide guarantees of up to 75 percent of the principal from the SBA. SBA loans are generally sold in the secondary market with the non-guaranteed portion held in the portfolio. SBA loans amounted to $51.3 million at June 30, 2003, an increase of $1.5 million from year-end 2002. SBA loans held for sale, carried at the lower of aggregate cost or market, amounted to $12.2 million at June 30, 2003, a decrease of $2.2 million from year-end 2002. The SBA held for sale portfolio decreased due to increased loan sales in 2003. The yield on SBA loans which are generally floating and tied to prime was 6.13 percent for the six months ended June 30, 2003 compared to 6.56 percent for the same period a year ago.

 

Commercial loans are generally made in the Company’s market place for the purpose of providing working capital, financing the purchase of equipment, inventory or commercial real estate and for other business purposes. These loans amounted to $182.1 million at June 30, 2003, an increase of $18.3 million, or 11.2 percent, from year-end 2002. The yield on these commercial loans was 7.35 percent for the six months ended June 30, 2003 compared to 7.37 percent for the same period a year ago.

 

Residential mortgage loans consist of loans secured by residential properties. These loans amounted to $47.2 million at June 30, 2003, a decrease of $9.1 million from year-end 2002. The decrease in residential mortgages was a result of pay-downs in the portfolio. The Company does not originate a material amount of residential mortgage loans held for investment. The yield on residential mortgages was 6.22 percent for the six months ended June 30, 2003 compared to 5.93 percent for the same period a year ago. The increase in rate is attributed to the payoff of lower rate adjustable rate mortgages.

 

Consumer loans consist of home equity loans and loans for the purpose of financing the purchase of consumer goods, home improvements, and other personal needs, and are generally secured by the personal property being purchased. These loans amounted to $32.4 million at June 30, 2003, an increase of $4.9 million from year-end December 2002. The increase in the consumer loan portfolio was primarily the result of an increase in home equity loans. The yield on consumer loans was 5.13 percent for the six months ended June 30, 2003, compared to 5.95 percent for the same period a year ago.

 

The decline in yield throughout the loan portfolio reflects the declining interest rate environment.

 

16

 

Asset Quality

 

Inherent in the lending function is the possibility a customer may not perform in accordance with the contractual terms of the loan.  A borrower’s inability to pay its obligations according to the contractual terms can create the risk of past due loans and ultimately credit losses, especially on collateral deficient loans.

 

Non-performing loans consist of loans that are not accruing interest (nonaccrual loans) as a result of principal or interest being in default for a period of 90 days or more or when the collectibility of principal and interest according to the contractual terms is in doubt. When a loan is classified as nonaccrual, interest accruals discontinue and all past due interest previously recognized as income is reversed and charged against current period income.  Generally, until the loan becomes current, any payments received from the borrower are applied to outstanding principal until such time as management determines that the financial condition of the borrower and other factors merit recognition of a portion of such payments as interest income.

     

Loans past due 90 days and still accruing interest, are not included in non-performing loans. The Company had  $759 thousand of loans 90 days past due and still accruing at June 30, 2003, compared to $366 thousand at December 31, 2002. These loans generally consist of loans where customers continue to make the monthly principal and interest payments, however, the loans have matured and are pending renewal.

 

Credit risk is minimized by loan diversification and adhering to credit administration policies and procedures.  Due diligence on loans begins upon the origination of a loan with a borrower.  Documentation, including a borrower’s credit history, materials establishing the value and liquidity of potential collateral, the purpose of the loan, the source of funds for repayment of the loan, and other factors are analyzed before a loan is submitted for approval.  The loan portfolio is then subject to ongoing internal reviews for credit quality.

 

The following table sets forth information concerning non-accrual loans and non-performing assets at June 30, 2003 and 2002, and December 31, 2002:

 

Non-performing loans (In thousands)		June 30, 2003			Dec. 31, 2002			June 30, 2002
Non-performing loans
SBA		$	2,700		$	2,882		$	2,388
Commercial		319			—			1,239
Residential mortgage		98			461			74
Consumer		193			214			248
Total non-performing loans		3,310			3,557			3,949
OREO		238			196			153
Total Non-Performing Assets		$	3,548		$	3,753		4,102
Past Due 90 days or more and still accruing interest
SBA		749			—			—
Commercial		3			365			—
Residential mortgage		—			—			—
Consumer		7			1			—
Total accruing loans 90 days or more past due		759			$	366		—
Non-Performing assets to total assets		0.79		%	0.87		%	1.00		%
Non-Performing assets to loans and OREO		1.09		%	1.20		%	1.38		%
Allowance for loans losses as a percentage of non-performing loans		140.45		%	115.10		%	90.23		%
Allowance for loan losses to total loans		1.43		%	1.31		%	1.20		%

 

Non-performing assets amounted to $3.5 million at June 30, 2003, a decrease of $247 thousand from year-end 2002.  Loans past due 90 days or more and still accruing interest at June 30, 2003 amounted to $759 million compared to $366 thousand at December 31, 2002. Loans past due 90 days or more generally consist of loans where customers continue to make the monthly payments, however, the loans have matured and are pending renewal. Included in non-performing assets at June 30, 2003 are $1.4 million of loans guaranteed by the SBA.

 

Potential problem loans are those where information about possible credit problems of borrowers causes management to have doubts as to the ability of such borrowers to comply with loan repayment terms.  These loans are not included in non-performing loans as they continue to perform.  Potential problem loans, which consist primarily of commercial loans, were $2.0 million at June 30, 2003 and $366 thousand at December 31, 2002.  The increase in potential problem loans is primarily related to a $1.1 million hotel loan where the borrower is experiencing cash flow problems. Although he loan is well collaterialized it is possible that in future periods the loan could be classified as non-performing.

 

17

 

Allowance for Loan Losses

 

The determination of the adequacy of allowance for loan losses is a critical accounting policy of the Company and is maintained at a level deemed sufficient by management to absorb estimated credit losses as of the balance sheet date.  Management utilizes a standardized methodology to assess the adequacy of the allowance for loan losses.  This process consists of the identification of specific reserves for identified problem loans based on loan grades and the calculation of general reserves based on minimum reserve levels by loan type.  Risks within the loan portfolio are analyzed on a continuous basis by management, and periodically by an independent credit review function and by the audit committee.  A risk system, consisting of multiple grading categories, is utilized as an analytical tool to assess risk and to quantify the appropriate level of loss reserves.  Along with the risk system, management further evaluates risk characteristics of the loan portfolio under current economic conditions and considers such factors as the financial condition of the borrowers, past and expected loss experience based upon current conditions in the portfolio, and other factors management feels deserve recognition in establishing an adequate reserve.  This risk assessment process, which includes the determination of the adequacy of the allowance for loan losses, is performed at least quarterly, and, as adjustments become necessary, they are realized in the periods in which they become known.

 

Provisions charged to expense increase the allowance and the allowance is reduced by net charge-offs.  Although management attempts to maintain the allowance at a level deemed adequate to provide for potential losses, future additions to the allowance may be necessary based upon certain factors including obtaining updated financial information about the borrower’s financial condition and changes in market conditions.  In addition, various regulatory agencies periodically review the adequacy of the allowance for loan losses.  These agencies have in the past and may in the future require the Bank to make additional adjustments based on their judgments about information available to them at the time of their examination.

 

The allowance for loan losses totaled $4.6 million, $4.1 million, and $3.6 million at June 30, 2003, December 31, 2002, and June 30, 2002, respectively with resulting allowance to total loan ratios of 1.43 percent, 1.31 percent and 1.20 percent respectively. Net charge offs amounted to $133 thousand for the three months ended June 30, 2003, compared to $592 thousand for the same period a year ago and amounted to $295 thousand for the six months ended June 30, 2003, compared to $1.2 million for the same period a year ago.

 

The following is a reconciliation summary of the allowance for loan losses for the three and six months ended June 30, 2003 and 2002:

 

Allowance for Loan Loss Activity		Three months ended June 30,				Six Months ended June 30,
(In thousands)		2003		2002		2003		2002
Balance, beginning of period		4,382		3,180		4,094		3,165
Provision charged to expense		400		975		850		1,575
Charge-offs:
SBA		129		22		189		22
Commercial		30		574		174		1,118
Residential mortgage		—		13		—		13
Consumer		8		34		39		104
Total Charge-offs		167		643		402		1,257
Recoveries:
SBA		28		2		32		29
Commercial		—		35		50		35
Residential mortgage		—		—		—		—
Consumer		6		14		25		16
Total recoveries		34		51		107		80
Total net charge-offs		133		592		295		1,177
Balance, end of period		4,649		3,563		4,649		3,563
Selected loan quality ratios:
Net charge offs to average loans		0.17	%	0.80	%	0.18	%	0.83	%
Allowance for loan losses to total loans at period end		1.43	%	1.20	%	1.43	%	1.20	%
Allowance for loan losses to  non-performing loans		140.45	%	90.23	%	140.45	%	90.23	%

 

Deposits

 

Deposits, which include non-interest and interest bearing demand deposits and interest-bearing savings and time deposits, are the primary source of the Company’s funds.  The Company offers a variety of products designed to attract and retain customers, with primary focus on building and expanding relationships. For the first six months of 2003 the Company realized continued growth in deposits.  This growth was achieved through emphasis on customer service, competitive rate structures and selective marketing.  The Company attempts to establish a comprehensive relationship with business borrowers, seeking deposits as well as lending relationships.

 

Total deposits increased $14.5 million to $397.1 million at June 30, 2003 from $382.6 million at December 31, 2002. The increase in deposits was primarily the result of a $15.0 million increase in demand deposits and $8.2 million increase in interest

 

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bearing checking and savings, partially offset by a decline in time deposits. The decline in time deposits is the result of the disintermediation into the Company’s higher yielding checking product “Opportunity Checking.” Included in deposits at June 30, 2003 are $21.7 million of Government deposits, as compared to $27.8 million at December 31, 2002.  These deposits are very sensitive to price competition.

 

Other Debt

 

Other debt, which includes $10.0 million in advances from the Federal Home Loan Bank (“FHLB”), and $2.7 million of lease obligations, amounted to $12.7 million at June 30, 2003, a decline of $51 thousand from year-end 2002. The 4.92% borrowings from the FHLB mature in 2010 and are callable at any time.

 

Trust Preferred Securities

 

On September 2002, Unity (NJ) Statutory Trust I a statutory business trust and wholly-owned subsidiary of Unity Bancorp Inc., issued $9.0 million of floating rate capital trust pass through securities to investors due on September 26, 2032. The capital securities have preference over the common securities with respect to liquidation and other distributions and qualify as Tier I capital. The Subordinate Debentures are redeemable in whole or part, prior to maturity but after September 26, 2007. The floating interest rate on the Subordinate Debentures is three-month LIBOR plus 3.40% and re-prices quarterly. The rate at June 30, 2003 was 4.40%. The additional capital raised with respect to the issuance of the floating rate capital pass through securities was used to bolster the Company’s capital and for general corporate purposes, including, capital contributions to Unity Bank.

 

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Interest Rate Sensitivity

 

The principal objectives of the asset and liability management function are to establish prudent risk management guidelines, evaluate and control the level of interest rate risk in balance sheet accounts, determine the level of appropriate risk given the business focus, operating environment, capital, and liquidity requirements, and actively manage risk within the Board approved guidelines.  The Company seeks to reduce the vulnerability of the operations to changes in interest rates, and actions in this regard are taken under the guidance of the Asset/Liability Management Committee (“ALCO”) of the Board of Directors.  The ALCO reviews the maturities and repricing of loans, investments, deposits and borrowings, cash flow needs, current market conditions, and interest rate levels.

 

The Company utilizes Modified Duration of Equity and Economic Value of Portfolio Equity (“EVPE”) models to measure the impact of longer-term asset and liability mismatches beyond two years.  The modified duration of equity measures the potential price risk of equity to changes in interest rates.  A longer modified duration of equity indicates a greater degree of risk to rising interest rates.  Because of balance sheet optionality, an EVPE analysis is also used to dynamically model the present value of asset and liability cash flows, with rate shocks of 200 basis points.  The economic value of equity is likely to be different as interest rates change.  Like the simulation model, results falling outside prescribed ranges require action by the ALCO.  The Company’s variance in the economic value of equity, as a percentage of assets with rate shocks of 200 basis points at June 30, 2003, is a decline of 0.93 percent in a rising rate environment and a decrease of 0.56 percent in a falling rate environment.  Both variances are within the board-approved guidelines of +/- 3.00 percent.  At December 31, 2002 the economic value of equity with rate shocks of 200 basis points was a decline of 1.05 percent in a rising rate environment and a decrease of 1.07 percent in a falling rate environment.

 

Operating, Investing, and Financing Cash

 

Cash and cash equivalents amounted to $33.9 million at June 30, 2003, an increase of $3.7 million from December 31, 2002. Net cash provided by operating activities for the six months ended June 30, 2003, amounted to $3.4 million, primarily from proceeds from the sales of loans held for sale, net income from operations partially offset by originations of loans held for sale. Net cash used in investing activities amounted to $14.1 million for the six months ended June 30, 2003, primarily from the funding of and purchases in the loan portfolio. Net cash provided by financing activities, amounted to $14.5 million for the six months ended June 30, 2003, attributable to deposit growth.

 

Liquidity

 

The Company’s liquidity is a measure of its ability to fund loans, withdrawals or maturities of deposits and other cash outflows in a cost-effective manner.

 

Parent Company

 

At June 30, 2003, the Parent Company had $1.3 million in cash compared to $5.8 million at December 31, 2002. The decrease in cash at the parent company was due to the capitalization of Unity Bank. Expenses at the Parent Company are minimal and the management believes that the Parent Company has adequate liquidity to fund its obligations.

 

Consolidated Bank

     

Liquidity is a measure of the ability to fund loans, withdrawals or maturities of deposits and other cash outflows in a cost-effective manner.  The principal sources of funds are deposits, scheduled amortization and repayments of loan principal, sales and maturities of investment securities and funds provided by operations.  While scheduled loan payments and maturing investments are relatively predictable sources of funds, deposit flows and loan prepayments are greatly influenced by general interest rates, economic conditions and competition.

 

At June 30, 2003, $6.0 million was available for additional borrowings from the FHLB of New York.  Pledging additional collateral in the form of 1-4 family residential mortgages or investment securities can increase the line with the FHLB. The maximum borrowing line available if additional collateral was pledged as of June 30, 2003 amounted to approximately $59.1 million. An additional source of liquidity is Federal Funds sold, which were $19.0 million at June 30, 2003.

 

As of June 30, 2003, deposits included $21.7 million of Government deposits, as compared to $27.3 million at December 31, 2002.  These deposits are generally short in duration, and are sensitive to price competition.  The Company believes the current portfolio of these deposits to be appropriate.  Included in the portfolio are $21.0 million of deposits from four municipalities.  The withdrawal of these deposits, in whole or in part would not create a liquidity shortfall for the Company.

 

At June 30, 2003, the Bank had approximately $99.9 million of loan commitments, which will generally either expire or be funded within one year. The Company believes it has the necessary liquidity to honor all commitments. Many of these commitments will expire and never be funded. In addition, approximately $26.6 million of these commitments are for SBA loans, which may be sold into the secondary market.

 

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Regulatory Capital

 

A significant measure of the strength of a financial institution is its capital base.  Federal regulators have classified and defined capital into the following components: (1) tier 1 capital, which includes tangible shareholders’ equity for common stock and qualifying preferred stock, and (2) tier 2 capital, which includes a portion of the allowance for loan losses, certain qualifying long-term debt and preferred stock which does not qualify for tier 1 capital.  Minimum capital levels are regulated by risk-based capital adequacy guidelines, which require a bank to maintain certain capital as a percent of assets, and certain off-balance sheet items adjusted for predefined credit risk factors (risk-adjusted assets).  A bank is required to maintain, at a minimum, tier 1 capital as a percentage of risk-adjusted assets of 4.0 percent and combined tier 1 and tier 2 capital as a percentage of risk-adjusted assets of 8.0 percent.

 

In addition to the risk-based guidelines, regulators require that a bank which meets the regulator’s highest performance and operation standards maintain a minimum leverage ratio (tier 1 capital as a percentage of tangible assets) of 4 percent.  For those banks with higher levels of risk or that are experiencing or anticipating significant growth, the minimum leverage ratio will be proportionately increased.  Minimum leverage ratios for each bank are evaluated through the ongoing regulatory examination process.

     

The Company’s capital amounts and ratios are presented in the following table.

 

												To Be Well Capitalized Under Prompt Corrective Action Provisions
						For Capital
		Actual				Adequacy Purposes
(In thousands)		Amount		Ratio				Amount		Ratio				Amount		Ratio
As of June 30, 2003
Leverage Ratio		37,438		8.61	%	³		17,391		4.00	%	³		21,739		5.00	%
Tier I risk-based ratio		37,438		10.88	%	³		13,761		4.00	%	³		20,642		6.00	%
Total risk-based ratio		41,738		12.13	%	³		27,522		8.00	%	³		34,403		10.00	%
As of December 31, 2002
Leverage Ratio		35,688		8.38	%	³		17,038		4.00	%	³		21,298		5.00	%
Tier I risk-based ratio		35,688		11.05	%	³		12,919		4.00	%	³		19,379		6.00	%
Total risk-based ratio		39,789		12.32	%	³		25,839		8.00	%	³		32,299		10.00	%

 

The Bank’s capital amounts and ratios are presented in the following table.

 

												To Be Well Capitalized Under Prompt Corrective Action Provisions
						For Capital
		Actual				Adequacy Purposes
(In thousands)		Amount		Ratio		Amount				Ratio				Amount		Ratio
As of June 30, 2003
Leverage Ratio		30,012		6.88	%	³		17,439		4.00	%	³		21,324		5.00	%
Tier I risk-based ratio		30,012		8.72	%	³		13,760		4.00	%	³		19,989		6.00	%
Total risk-based ratio		40,312		11.72	%	³		27,520		8.00	%	³		33,315		10.00	%
As of December 31, 2002
Leverage Ratio		29,509		6.96	%	³		16,956		4.00	%	³		21,195		5.00	%
Tier I risk-based ratio		29,509		9.16	%	³		21,893		4.00	%	³		19,339		6.00	%
Total risk-based ratio		33,541		10.41	%	³		25,786		8.00	%	³		32,232		10.00	%

 

Shareholders’ Equity

     

Shareholders’ equity increased $2.1 million, or 7.9 percent, to $29.2 million at June 30, 2003 compared to $27.1 million at December 31, 2002.  This increase was the result of the $2.4 million in net income partially offset by $235 thousand decrease in accumulated other comprehensive income. 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.

 

Impact of Inflation and Changing Prices

     

The financial statements and notes thereto, presented elsewhere herein, have been prepared in accordance with generally accepted accounting principles, which require the measurement of financial position and operating results in terms of historical dollars without considering the change in the relative purchasing power of money over time and due to inflation.  The impact of inflation is reflected in the increased cost of the operations.  Unlike most industrial companies, nearly all the Company’s assets and liabilities are monetary.  As a result, interest rates have a greater impact on performance than do the effects of general levels of inflation.  Interest rates do not necessarily move in the same direction or to the same extent as the prices of goods and services.

 

ITEM 3.            Quantitative and Qualitative Disclosures about Market Risk

 

During 2003, there have been no significant changes in the Company’s assessment of market risk as reported in Item 6 of the Company’s Annual Report on Form 10-K for the year ended December 31, 2002. (See Interest Rate Sensitivity in Management’s Discussion and Analysis Herein.)

 

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ITEM 4.            Controls and Procedures

 

The Company’s management, with the participation of the Company’s Chief Executive Officer and Chief Financial Officer, has evaluated the effectiveness of the Company’s disclosure controls and procedures as of June 30, 2003.  Based on this evaluation, the Company’s Chief Executive Officer and Chief Financial Officer concluded that the Company’s disclosure controls and procedures are effective for recording, processing, summarizing and reporting the information the Company is required to disclose in the reports it files under the Securities Exchange Act of 1934, within the time periods specified in the SEC’s rules and forms.  Such evaluation did not identify any change in the Company’s internal control over financial reporting that occurred during the quarter ended June 30, 2003 that has materially affected, or is reasonably likely to materially affect, the Company’s internal control over financial reporting.

 

PART II – OTHER INFORMATION

 

Item 1.  Legal Proceedings

 

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 $4,028,584.44, 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.

 

Item 2. Changes in Securities – None

 

Item 3.  Defaults Upon Senior Securities-None

 

Item 4.  Submission of Matters to a Vote of Security Holders - None

 

Item 5.  Other Information - None

 

Item 6.  Exhibits and Reports on Form 8K

 

(a)		Exhibits
		Exhibit 31.1	Certification of Chief Executive Officer Pursuant to Rule 13a-14(a) or Rule  15d-14(a) and Section 302 of the Sarbanes-Oxley Act of 2002
		Exhibit 31.2	Certification of Chief Financial Officer Pursuant to Rule 13a-14(a) or Rule  15d-14(a) and Section 302 of the Sarbanes-Oxley Act of 2002
		Exhibit 32.1	Certification of Chief Executive Officer and Chief Financial Officer Pursuant to Rule 13a-14(b) or Rule 15d-14(b) and 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
(b)		Reports on Form 8-K
		During the quarter ended June 30, 2003, the Company filed the following Reports on Form 8-K.
		The Current Report on Form 8-K dated April 21, 2003, under “Item 9. Regulation FD Disclosure” incorporating the April 21, 2003 press release announcing the Company’s earnings for the first quarter of 2003.
		The Current Report on Form 8-K dated April 21, 2003 under “Item 9 Regulation FD Disclosure” incorporating the April 21, 2003 message of the Company’s President.
		The Current Report on Form 8-K dated June 20, 2003 under “Item 9 Regulation FD Disclosure” incorporating the Company’s June 19, 2003 press release advising that James A. Hughes, Unity Bank’s Chief Financial Officer made a Unity Bank presentation at the June 17, 2003 Northeast Super-Community Bank Conference held in Boston, Massachusetts.

 

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SIGNATURES

 

Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

 

 

		UNITY BANCORP, INC.
Dated:  August 14, 2003		By:	/s/ JAMES A. HUGHES
			JAMES A. HUGHES,
	Executive Vice President and Chief Financial Officer

 

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EXHIBIT INDEX

 

QUARTERLY REPORT ON FORM 10-Q

 

EXHIBIT NO.		DESCRIPITION
31.1		Certification of Anthony Feraro Required by Rule 13a-14(a) or Rule 15d-14(a) and section 302 of the Sarbanes-Oxley Act of.
31.2		Certification of James A. Hughes Required by Rule 13a-14(a) or Rule 15d-14(a) and section 302 of the Sarbanes-Oxley Act of 2002.
32.1		Certification of Anthony Feraro and James A. Hughes Required by Rule 13a-14(b) or Rule 15d-14(b) and section 906 of the Sarbanes-Oxley Act of 2002, 18 U.S.C. Section 1350

 

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