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

 

 

PART I	-	CONSOLIDATED FINANCIAL INFORMATION
ITEM 1	-	Consolidated Financial Statements (unaudited)
		Consolidated Balance Sheets at September 30, 2003, 2002 and December 31, 2002
		Consolidated Statements of Income for the three and nine months ended September 30, 2003 and 2002
		Consolidated Statements of Changes in Shareholders’ Equity for the nine months ended September 30, 2003 and 2002
		Consolidated Statements of Cash Flows for the nine months ended September 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

 

(in thousands)		(unaudited) 09/30/03			12/31/02			(unaudited) 09/30/02
Assets
Cash and due from banks		$	13,478		$	12,237		$	14,686
Federal funds sold and money market investments		22,472			18,000			20,000
Securities:
Available for sale		68,390			55,570			51,230
Held to maturity (fair value of 16,020 at 9/30/03, 26,856 at 12/31/03, and 26,009, at 9/30/02)		15,633			26,184			25,218
Total securities		84,023			81,754			76,448
Loans:
SBA held for sale		10,626			14,396			14,124
SBA held to maturity		47,907			49,784			43,989
Commercial		176,567			163,813			154,321
Residential mortgage		51,994			56,297			64,189
Consumer		34,535			27,504			26,955
Total loans		321,629			311,794			303,578
Less: Allowance for loan losses		4,960			4,094			3,786
Net loans		316,669			307,700			299,792
Premises and equipment, net		7,280			8,669			8,772
Accrued interest receivable		2,199			2,579			2,368
Other assets		4,388			1,935			1,924
Total assets		$	450,509		$	432,874		$	423,990
Liabilities and Shareholders’ Equity
Liabilities:
Deposits
Non-interest bearing		$	87,797		$	75,567		$	71,496
Interest bearing checking		182,018			176,640			165,017
Savings deposits		38,037			34,663			36,545
Time deposits, under $100,000		66,660			75,883			76,887
Time depostis, $100,000 and over		24,939			19,832			24,149
Total deposits		399,451			382,585			374,094
Other debt		11,512			12,768			12,787
Trust preferred securities		9,000			9,000			9,000
Accrued interest payable		190			280			294
Accrued expense and other liabilities		792			1,135			1,145
Total liabilities		$	420,945		$	405,768		$	397,320
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		31,852			31,827			32,159
Retained deficit		(1,497		)	(5,006		)	(6,015		)
Accumulated other comprehensive (loss) income		(791		)	285			241
Total Shareholders’ Equity		29,564			$	27,106		26,670
Total Liabilities and Shareholders’ Equity		$	450,509		$	432,874		$	423,990
Issued  and outstanding common shares		5,399			5,393			5,349

 

See Accompanying Notes to the Consolidated Financial Statements

 

3

 

Unity Bancorp, Inc.

Consolidated Statements of Income

(unaudited)

 

(in thousands, except per share amounts)		For the three months ended September 30,						For the nine months ended September 30,
		2003			2002			2003			2002
Interest income:
Fed funds sold and interest on deposits		$	49		$	69		$	106		$	130
Securities:
Available for sale		517			564			1,621			2,084
Held to maturity		226			362			815			1,083
Total securities		743			926			2,436			3,167
Loans:
SBA loans		1,089			922			3,120			2,706
Commercial loans		3,080			2,862			9,362			7,761
Residential mortgage loans		741			1,054			2,381			3,166
Consumer loans		437			394			1,214			1,172
Total loan interest income		5,347			5,232			16,077			14,805
Total interest income		6,139			6,227			18,619			18,102
Interest expense:
Interest bearing demand deposits		607			760			2,078			2,007
Savings deposits		108			199			316			554
Time deposits		662			986			2,073			3,293
Other debt and trust preferred securities		296			200			904			593
Total interest expense		1,673			2,145			5,371			6,447
Net interest income		4,466			4,082			13,248			11,655
Provision for loan losses		375			375			1,225			1,950
Net interest income after provision for loan losses		4,091			3,707			12,023			9,705
Non-interest Income:
Deposit service charges		436			407			1,529			1,116
Loan and servicing fees		574			363			1,479			1,082
Net gains on SBA loan sales		831			729			2,337			2,614
Net security (losses) gains		(25		)	—			103			228
Other income		309			123			772			835
Total non-interest income		2,125			1,622			6,220			5,875
Non-interest expense:
Compensation and benefits		2,135			1,867			5,997			5,605
Processing and communications		516			564			1,638			1,636
Occupancy		436			422			1,374			1,228
Furniture and equipment		257			271			776			820
Professional fees		217			204			664			515
Loan servicing costs		225			104			511			306
Advertising		162			102			437			344
Deposit insurance		16			42			47			119
Other expenses		203			254			979			809
Total non-interest expense		4,167			3,830			12,423			11,382
Net income before provision for income taxes		2,049			1,499			5,820			4,198
Provision for income taxes		747			537			2,151			1,498
Net income		$	1,302		$	962		$	3,669		$	2,700
Preferred stock dividends		—			8			—			23
Net income to common shareholders		$	1,302		$	954		$	3,669		$	2,677
Net income per common share - Basic		$	0.24		$	0.17		$	0.68		$	0.49
Net income per common share - Diluted		0.23			0.16			0.65			0.46
Weighted average shares outstanding – Basic		5,398			5,652			5,395			5,507
Weighted average shares outstanding – Diluted		5,661			5,946			5,647			5,868

 

See Accompanying Notes to the Consolidated Financial Statements

 

4

 

Unity Bancorp, Inc.

Consolidated Statements of Changes in Shareholders’ Equity

For the nine months ended September 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		—			—			2,700			—			2,700
Unrealized holding gain on securities arising during the period, net of tax $116		—			—			—			246			246
Total comprehensive income		—			—			—			—			2,946
Preferred stock dividends		—			—			(23		)	—			(23		)
Warrant exercises (332 shares)		—			1,356			—			—			1,356
Benefit plans (18 shares)		—			102			—			—			102
Repurchase and retirement of Common stock (369 shares)					(2,547		)							(2,547		)
Balance, September 30, 2002		$	285		$	32,159		$	(6,015	)	$	241		$	26,670
Balance, December 31, 2002		$	—		$	31,827		$	(5,006	)	$	285		$	27,106
Comprehensive income:
Net Income		—			—			3,669			—			3,669
Net unrealized holding loss on securities arising during the period, net of tax $721		—			—			—			(1,076		)	(1,076		)
Total comprehensive income														2,593
Cash dividend declared on common stock								(160		)				(160		)
Employee stock option plans (6 shares)		—			25			—			—			25
Balance, September 30, 2003		$	—		$	31,852		$	(1,497	)	$	(791	)	$	29,564

 

See Accompanying Notes to the Consolidated Financial Statements.

 

5

 

Unity Bancorp, Inc

Consolidated Statements of Cash Flows

(unaudited)

 

		For the nine months ended September 30,
(In thousands)		2003			2002
Operating activities:
Net income		$	3,669		$	2,700
Adjustments to reconcile net income to net cash provided by operating activities
Provision for loan losses		1,225			1,950
Depreciation and amortization		687			872
Net gain on sale of securities		(403		)	(228		)
Write-down on AFS security		300			—
Gain on sale of SBA loans held for sale		(2,337		)	(2,614		)
Origination of SBA loans held for sale		(22,670		)	(29,798		)
Proceeds from the sale of SBA loans		28,777			36,007
Net change in other assets and other liabilities		(2,412		)	(901		)
Net cash provided by operating activities		6,836			7,988
Investing activities:
Purchases of securities held to maturity		(2,216		)	(10,502		)
Purchases of securities available for sale		(64,473		)	(28,072		)
Maturities and principal payments on securities held to maturity		12,767			6,207
Maturities and principal payments on securities available for sale		35,693			24,634
Proceeds from sale of securities available for sale		16,063			12,605
Purchase of loans		(3,835		)	(10,373		)
Net increase in loans		(10,417		)	(25,682		)
Purchases of premises and equipment		(340		)	(913		)
Net cash used in investing activities		(16,758		)	(32,096		)
Financing activities:
Increase in deposits		16,866			34,140
Decrease in borrowings		(1,256		)	(66		)
Proceeds from the issuance of common stock		25			1,458
Issuance of Trust preferred securities		—			9,000
Purchase of common stock		—			(2,547		)
Dividends on preferred stock		—			(23		)
Net cash provided by financing activities		15,635			41,962
Increase in cash and cash equivalents		5,713			17,854
Cash and cash equivalents at beginning of year		30,237			16,832
Cash and cash equivalents at end of period		$	35,950		$	34,686
Supplemental disclosures:
Cash:
Interest paid		$	5,461		$	6,519
Income taxes paid		3,413			1,709
Non-cash investing activities:
Transfer of loans to Other Real Estate Owned		409			53

 

See Accompanying Notes to the Consolidated Financial Statements.

 

6

 

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

 

		Three months ended September 30,						Nine months ended September 30,
(In thousands, except per share data)		2003			2002			2003			2002
Net income to common shareholders as reported:
As reported		$	1,302		$	954		$	3,669		$	2,677
Pro forma		1,254			877			3,525			2,446
Income per share:
Basic as reported		$	0.24		$	0.17		$	0.68		$	0.49
Basic Pro forma		0.23			0.16			0.65			0.46
Diluted as reported		$	0.23		$	0.16		$	0.65		$	0.46
Diluted Pro forma		0.22			0.15			0.62			0.42

 

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 September 30,						Nine months ended September 30,
(In thousands, except per share data)		2003			2002			2003			2002
Net Income to common shareholders		$	1,302		$	954		$	3,669		$	2,677
Basic weighted-average common shares outstanding		5,398			5,652			5,395			5,507
Plus: Common stock equivalents		263			294			252			361
Diluted weighted –average common shares outstanding		5,661			5,946			5,647			5,868
Net Income per Common share:
Basic		$	0.24		$	0.17		$	0.68		$	0.49
Diluted		0.23			0.16			0.65			0.46

 

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.

 

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
		September 30, 2003								September 30, 2002
		Balance			Interest			Rate		Balance			Interest			Rate
Assets
Interest-earning assets:
Federal funds sold, interest-bearing deposits with banks and money market investments		$	17,241		$	49		1.13	%	$	17,003		$	69		1.61	%
Securities:
Available for sale		67,120			541			3.22		50,131			564			4.50
Held to maturity		16,461			226			5.49		23,570			362			6.14
Total securities		83,581			767			3.67		73,701			926			5.03
Loans, net of unearned discount:
SBA loans		64,364			1,089			6.77		57,908			922			6.37
Commercial		177,538			3,080			6.88		151,342			2,862			7.50
Residential Mortgages		51,545			741			5.75		67,319			1,054			6.26
Consumer		35,136			437			4.93		26,644			394			5.87
Total loans		328,583			5,347			6.47		303,213			5,232			6.87
Total interest-earning assets		429,405			6,163			5.71		393,917			6,227			6.30
Noninterest-earning assets:
Cash and due from banks		17,102								12,408
Allowance for loan losses		(4,999		)						(3,805		)
Other assets		13,120								12,166
Total noninterest-earning assets		25,223								20,769
Total Assets		$	454,628							$	414,686
Liabilities and Shareholders’ Equity
Interest-bearing liabilities:
Interest-bearing checking		$	185,316		607			1.30		$	163,065		760			1.85
Savings deposits		39,827			108			1.08		35,894			199			2.20
Time deposits		91,444			662			2.87		106,054			986			3.69
Total interest-bearing deposits		316,587			1,377			1.73		305,013			1,945			2.53
Other borrowed funds		21,457			296			5.47		13,315			200			5.63
Total interest-bearing liabilities		338,044			1,673			1.96		318,328			2,145			2.67
Noninterest-bearing liabilities:
Demand deposits		86,895								65,866
Other liabilities		505								2,233
Total noninterest-bearing liabilities		87,400								68,099
Shareholders’ equity		29,184								28,259
Total Liabilities and Shareholders’ Equity		$	454,628							$	414,686
Net interest spread					4,490			3.75	%				4,082			3.63	%
Tax-equivalent basis adjustment					(24		)						—
Net interest income					$	4,466							$	4,082
Net interest margin								4.18	%							4.15	%

 

10

 

		Nine months ended
		September 30, 2003								September 30, 2002
		Balance			Interest			Rate		Balance			Interest			Rate
Assets
Interest-earning assets:
Federal funds sold, interest-bearing deposits with banks and money market investments		$	11,573		$	106		1.22	%	$	10,877		$	130		1.60	%
Securities:
Available for sale		59,178			1,653			3.72		53,210			2,084			5.22
Held to maturity		21,679			815			5.01		22,994			1,083			6.28
Total securities		80,857			2,468			4.07		76,204			3,167			5.54
Loans, net of unearned discount:
SBA loans		66,304			3,120			6.27		55,565			2,706			6.49
Commercial		174,056			9,362			7.19		139,868			7,761			7.42
Residential Mortgages		52,358			2,381			6.06		69,898			3,166			6.04
Consumer		31,313			1,214			5.18		26,473			1,172			5.92
Total loans		324,031			16,077			6.62		291,804			14,805			6.78
Total interest-earning assets		416,461			18,651			5.97		378,885			18,102			6.38
Noninterest-earning assets:
Cash and due from banks		15,705								13,051
Allowance for loan losses		(4,645		)						(3,557		)
Other assets		13,462								12,117
Total noninterest-earning assets		24,522								21,611
Total Assets		$	440,983							$	400,496
Liabilities and Shareholders’ Equity
Interest-bearing liabilities:
Interest-bearing checking		$	182,877		2,078			1.52		$	144,160		2,007			1.86
Savings deposits		36,870			316			1.15		33,494			554			2.21
Time deposits		91,633			2,073			3.02		116,996			3,293			3.76
Total interest-bearing deposits		311,380			4,467			1.92		294,650			5,854			2.66
Other borrowed funds		21,754			904			5.56		13,591			593			5.83
Total interest-bearing liabilities		333,134			5,371			2.16		308,241			6,447			2.80
Noninterest-bearing liabilities:
Demand deposits		78,703								63,651
Other liabilities		897								1,899
Total noninterest-bearing liabilities		79,600								65,550
Shareholders’ equity		28,249								26,705
Total Liabilities and Shareholders’ Equity		$	440,983							$	400,496
Net interest spread					13,280			3.81	%				11,655			3.58	%
Tax-equivalent basis adjustment					(32		)						—
Net interest income					$	13,248							$	11,655
Net interest margin								4.25	%							4.10	%

 

11

 

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.

 

		Three Months ended September 30,						Nine months ended September 30,
(In thousands)		2003			2002			2003				2002
Net Income		$	1,302		$	962		$	3,669			$	2,700
Preferred stock dividends		—			8			—				23
Net Income to common stockholders		1,302			954			3,669				2,677
Net Income per common share-basic		0.24			0.17			0.68				0.49
Net Income per common share-diluted		0.23			0.16			0.65				0.46
Performance Ratios:
Return on average assets		1.14		%	0.92		%	1.11		%		0.90		%
Return on average common equity		17.70			13.53			17.37				13.55
Efficiency ratio		62.98			67.15			64.15				65.78

 

*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

 

12

 

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

 

		Amount of Increase (Decrease)
		Three months ended September 30, 2003 versus September 30, 2002						Nine months ended September 30, 2003 versus September 30, 2002
		Due to change in:						Due to change in:
		Volume		Rate		Total		Volume		Rate		Total
Interest Income
SBA		107		60		167		509		(95	)	414
Commercial		468		(250	)	218		1,848		(247	)	1,601
Residential mortgage		(232	)	(81	)	(313	)	(795	)	10		(785	)
Consumer		113		(70	)	43		199		(157	)	42
Total Loans		456		(341	)	115		1,761		(489	)	1,272
Available for sale securities		162		(185	)	(23	)	215		(646	)	(431	)
Held to maturity securities		(100	)	(36	)	(136	)	(59	)	(209	)	(268	)
Federal funds sold and interest bearing deposits		1		(21	)	(20	)	8		(32	)	(24	)
Total Interest Earning assets		519		(583	)	(64	)	1,925		(1,376	)	549
Interest Expense
Interest bearing checking		94		(247	)	(153	)	479		(408	)	71
Savings deposits		21		(112	)	(91	)	51		(289	)	(238	)
Time deposits		(124	)	(200	)	(324	)	(639	)	(581	)	(1,220	)
Total Interest Bearing Deposits		(9	)	(559	)	(568	)	(109	)	(1,278	)	(1,387	)
Borrowings		113		(17	)	96		340		(29	)	311
Total interest-bearing liabilities		104		(576	)	(472	)	231		(1,307	)	(1,076	)
Net interest income		415		(7	)	408		1,694		(69	)	1,625
Tax equivalent adjustment						(24	)					(32	)
Increase in net interest income						384						1,593

 

Provision for Loan Losses

The provision for loan losses was $375 thousand for the three months ended September 30, 2003 flat from September 30, 2002 and $1.2 million for the nine months ended September 30, 2003, a decrease of $725 thousand, from the comparable period in 2002. The decrease from a year ago was primarily attributable to lower levels of net charge offs during the first nine 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

 

(in thousands)		Three months ended September 30,								Nine months ended September 30,
		2003			2002			Percent Change		2003			2002			Percent Change
Deposit service charges		$	436		$	407		7.1	%	$	1,529		$	1,116		37.0	%
Loan and servicing fees		574			363			58.1		1,479			1,082			36.7
Net gains on SBA loan sales		831			729			14.0		2,337			2,614			(10.6	)
Net security gains		(25		)	—			(100.0	)	403			228			76.8
Write-down on security		—			—			—		(300		)	—			(100.0	)
Other income		309			123			151.2		772			835			(7.5	)
Total non-interest income		$	2,125		$	1,622		31.0	%	6,220			$	5,875		5.9	%

 

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 $2.1 million for the three months ended September 30, 2003, an increase of $503 thousand compared with 2002, and was $6.2 million for the nine months ended September 30, 2003, an increase of $345 thousand, compared to the same period a year ago.

 

Deposit service charges increased $29 thousand, or 7.1 percent, for the three months ended September 30, 2003, compared to the same period a year ago, and increased $413 thousand, or 37.0 percent, for the nine months ended September 30, 2003, compared with the same period a year ago. Deposit service charges increased for the three and nine months as a result of higher fees and the growth in the deposit base.

 

Loan and servicing fees increased $211 thousand, or 58.1 percent, for the three months ended September 30, 2003, compared to the same period a year ago, and increased $397 thousand, or 36.7 percent, for the nine months ended September 30, 2003, compared to the same period a year ago. The growth in loan and servicing fees for the three and nine months ended is attributed to the growth of the serviced SBA loan portfolio, which amounted to $137.2 million at September 30, 2003, compared to $122.9 million at September 30, 2002 and loan prepayment penalties.

 

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 $9.6 million in the three months ended, and $26.4 million for the nine months ended September 30, 2003, compared to $9.4 million and $33.4 million, respectively, for the three and nine month periods ended September 30, 2002. Gains on SBA loan sales were $831 thousand for the three months ended, and $2.3 million for the nine months ended September 30, 2003 compared to $729 thousand and $2.6 million, respectively, for the same periods a year ago. The decrease in gains on the sale of SBA loans for the nine months ended September 30, 2003, is a result of lower volume of SBA loans sold partially offset by higher premiums received on sales.

 

Net security gains decreased $25 thousand, for the three months ended September 30, 2003, compared to the same period a year ago, and decreased $125 thousand, or 54.8 percent, for the nine months ended September 30, 2003, compared to the same period a year ago. Security gains for the nine months ended September 30, 2003, include a $300 thousand 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 increased $186 thousand for the three months ended September 30, 2003, compared with 2002 and decreased $63 thousand for the nine months then ended, compared with the same period a year ago. The increase for the three months ended September 30, 2003 was related to increased referral fee income on commercial loans and title insurance income. The decrease for the nine months ended September 30, 2003 was primarily due to an decrease in commercial loan referral fees which amounted to $144 thousand for the nine months ended September 30, 2003, compared to $501 thousand nine month period ended 2002.

 

14

 

Non-Interest Expense

 

		Three months ended September 30,								Nine months ended September 30,
		2003			2002			Percent Change		2003			2002			Percent Change
Compensation and benefits		$	2,135		$	1,867		14.4	%	$	5,997		$	5,605		7.0	%
Processing and communications		516			564			(8.5	)	1,638			1,636			0.1
Occupancy		436			422			3.3		1,374			1,228			11.9
Furniture and equipment		257			271			(5.2	)	776			820			(5.4	)
Professional services		217			204			6.4		664			515			28.9
Loan servicing costs		225			104			116.3		511			306			67.0
Advertising		162			102			58.8		437			344			27.0
Deposit insurance		16			42			(61.9	)	47			119			(60.5	)
Other expense		203			254			(20.1	)	979			809			21.0
Total non-interest expense		$	4,167		$	3,830		8.8	%	12,423			$	11,382		9.1	%

 

Compensation and benefits expense increased $268 thousand, or 14.4 percent, for the three months ended September 30, 2003, compared to the same period a year ago, and increased $392 thousand, or 7.0 percent for the nine months ended September 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 168 at September 30, 2003, compared to 149 at September 30, 2002.

 

Processing and communications expense decreased $48 thousand, or 8.5 percent, for the three months ended September 30, 2003, compared to the same period a year ago and was flat for the nine months ended September 30, 2003 compared to the same period a year ago. The decrease for the three months ended was primarily related to lower costs related to payroll processing and lower fees related to ordering coin and currency.

 

Occupancy expense increased $14 thousand, or 3.3 percent, for the three months ended September 30, 2003, compared to the same period a year ago, and increased $146 thousand, or 11.9 percent, for the nine months ended September 30, 2003, compared to the same period a year ago. The increase for the three and nine months ended was due to a new branch opening, higher property taxes, depreciation and maintenance expenses.

 

Furniture and equipment expense decreased $14 thousand, or 5.2 percent, for the three months ended September 30, 2003, compared to the same period a year ago and decreased $44 thousand, or 5.4 percent for the nine months ended September 30, 2003, compared to the same period a year ago. The decline in furniture and equipment expense for the three and nine months ended was primarily related to lower depreciation expense as a result of assets being fully depreciated.

 

Professional fees increased $13 thousand, or 6.4 percent, for the three months ended September 30, 2003, compared to the same period a year ago and increased $149 thousand or 28.9 percent for the nine months ended September 30, 2003, compared to the same period a year ago.  The increase in professional fees for the nine 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”.

 

Loan servicing expense increased $121 thousand, or 116.3 percent for the three months ended September 30, 2003, compared to the same period a year ago, and increased $205 thousand, or 67.0 percent for the nine months ended September 30, 2003, compared to the same period a year ago.  The increase in loan servicing expense for the three and nine month periods was primarily related to higher legal costs related to loan collections on the commercial and SBA portfolios.

 

Advertising expense increased $60 thousand, or 58.8 percent, for the three months ended September 30, 2003, compared to the same period a year ago and increased $93 thousand or 27.0 percent for the nine months ended September 30, 2003, compared to the same period a year ago. The increase in advertising expense is related to higher marketing expense in order to attract new business.

 

Deposit insurance decreased $26 thousand for the three months ended September 30, 2003, compared to the same period a year ago, and decreased $72 thousand for the nine months ended September 30, 2003, compared to the same period a year ago.  The decrease for the three and nine months ended was due to a reduced insurance premium assessment.

 

Other expense decreased $51 thousand, or 20.1 percent, for the three months ended September 30, 2003, compared to the same period a year ago, and increased $170 thousand or 21.0 percent, for the nine months ended September 30, 2003 compared to the same period a year ago. The decrease for the three months ended was related to the unwinding of the capital lease treatment on occupied branches. The increase for the nine months ended was the result of higher stationary and supplies expense, taxes on OREO properties and a credit for data processing expense that was received in 2002.

 

Income Tax Expense

For the third quarter of 2003, the provision for income taxes was $747 thousand compared to $537 thousand for the same period a year ago and was $2.2 million for the nine months ended September 30, 2003 compared to $1.5 million for the same period a year ago. The current 2003 tax provision represents an effective tax rate of approximately 37 percent as compared to 36 percent for the prior year. Management anticipates an effective rate of approximately 37 percent for the remainder of 2003.

 

15

 

Financial Condition at September 30, 2003

 

Total assets at September 30, 2003 were $450.5 million compared to $424.0 million a year ago and $432.9 million from year-end 2002. The increase in assets were primarily 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 September 30, 2003, $6.2 million of securities were pledged for governmental deposits.

 

Securities available for sale were $68.4 million at September 30, 2003, an increase of $12.8 million from year-end 2002. During the first nine months of 2003, $64.5 million of securities available for sale were purchased, partially offset by $35.7 million of maturities and paydowns and $16.1 million in securities sales. The yield on securities available for sale was 3.72 percent for the nine months ended September 30, 2003, compared to 5.22 percent a year ago, reflecting declines in market rates of interest. Included in securities available for sale at September 30, 2003 is a $312 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 $15.6 million at September 30, 2003, a decrease of $10.6 million, or 40.3 percent, from year-end 2002. During the first nine months of 2003, $2.2 million of held to maturity securities were purchased and primarily funded by $12.8 million of maturities and paydowns. The yield on securities held to maturity was 5.01 percent for the nine months ended September 30, 2003 compared to 6.28 percent for the same period a year ago, reflecting the maturity of higher yielding investments and the declines in market rates of interest. As of September 30, 2003 and December 31, 2002, the market value of held to maturity securities was $16.0 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 $9.8 million, or 3.2 percent to $321.6 million at September 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 $47.9 million at September 30, 2003, a decrease of $1.9 million from year-end 2002. SBA loans held for sale, carried at the lower of aggregate cost or market, amounted to $10.6 million at September 30, 2003, a decrease of $3.8 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 6.27 percent for the nine months ended September 30, 2003 compared to 6.49 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 $176.6 million at September 30, 2003, an increase of $12.8 million, or 7.8 percent, from year-end 2002. The yield on these commercial loans was 7.19 percent for the nine months ended September 30, 2003 compared to 7.42 percent for the same period a year ago.

 

Residential mortgage loans consist of loans secured by residential properties. These loans amounted to $52.0 million at September 30, 2003, a decrease of $4.3 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 6.06 percent for the nine months ended September 30, 2003 compared to 6.04 percent for the same period a year ago.

 

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 $34.5 million at September 30, 2003, an increase of $7.0 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 5.18 percent for the nine months ended September 30, 2003, compared to 5.92 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 $231 thousand of loans 90 days past due and still accruing at September 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 September 30, 2003 and 2002, and December 31, 2002:

 

Non-performing loans (In thousands)		Sept. 30, 2003			Dec. 31, 2002			Sept. 30, 2002
Non-performing loans
SBA		$	854		$	1,301		$	1,299
SBA Guaranteed		1,200			1,368			1,368
Commercial		1,554			213			88
Residential mortgage		123			461			75
Consumer		148			214			169
Total non-performing loans		3,879			3,557			2,999
OREO		396			196			206
Total Non-Performing Assets		$	4,275		$	3,753		3,205
Past Due 90 days or more and still accruing interest
SBA		95			—			41
Commercial		6			365			724
Residential mortgage		63			—			—
Consumer		67			1			10
Total accruing loans 90 days or more past due		231			$	366		775
Non-Performing assets to total assets		0.94		%	0.87		%	0.75		%
Non-Performing assets to loans and OREO		1.32		%	1.20		%	1.06		%
Allowance for loans losses as a percentage of non-performing loans		128.70		%	115.10		%	126.24		%
Allowance for loan losses to total loans		1.54		%	1.31		%	1.25		%

 

Non-performing assets amounted to $4.3 million at September 30, 2003, an increase of $522 thousand from year-end 2002.  The increase in non-performing assets is primarily related to a $1.3 million loan on a commercial mortgage that is well collateralized, however the borrower has defaulted due to cash flow problems. Loans past due 90 days or more and still accruing interest at September 30, 2003 amounted to $231 thousand compared to $366 thousand at December 31, 2002. Included in non-performing assets at September 30, 2003 are $1.2 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 $231 thousand at September 30, 2003 and $366 thousand at December 31, 2002.

 

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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 $5.0 million, $4.1 million, and $3.8 million at September 30, 2003, December 31, 2002, and September 30, 2002, respectively, with resulting allowance to total loan ratios of 1.54 percent, 1.31 percent and 1.25 percent respectively. Net charge offs amounted to $64 thousand for the three months ended September 30, 2003, compared to $152 thousand for the same period a year ago and amounted to $359 thousand for the nine months ended September 30, 2003, compared to $1.3 million for the same period a year ago.

 

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

 

Allowance for Loan Loss Activity (In thousands)		Three months ended September 30,				Nine months ended September 30,
		2003		2002		2003		2002
Balance, beginning of period		4,649		3,563		4,094		3,165
Provision charged to expense		375		375		1,225		1,950
Charge-offs:
SBA		112		188		301		210
Commercial		55		2		229		1,120
Residential mortgage		—		—		—		13
Consumer		42		8		81		112
Total Charge-offs		209		198		611		1,455
Recoveries:
SBA		40		2		72		31
Commercial		101		35		151		70
Residential mortgage		—		—		—		—
Consumer		4		9		29		25
Total recoveries		145		46		252		126
Total net charge-offs		64		152		359		1,329
Balance, end of period		4,960		3,786		4,960		3,786
Selected loan quality ratios:
Net charge offs to average loans		0.08	%	0.20	%	0.15	%	0.61	%
Allowance for loan losses to total loans at period end		1.54	%	1.25	%	1.54	%	1.25	%
Allowance for loan losses to  non-performing loans		128.70	%	126.24	%	128.70	%	126.24	%

 

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 nine 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.

 

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Total deposits increased $16.9 million to $399.5 million at September 30, 2003 from $382.6 million at December 31, 2002. The increase in deposits was primarily the result of a $12.2 million increase in demand deposits and $8.8 million increase in interest 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 September 30, 2003 are $21.3 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 $1.5 million of lease obligations, amounted to $11.5 million at September 30, 2003, a decline of $1.3 million from year-end 2002. The reduction in other debt is related to the unwinding of capital lease obligations on occupied properties. The 4.92% borrowings from the FHLB mature in 2010 and are callable at any time.

 

Trust Preferred Securities

In 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 September 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 September 30, 2003, is a decline of 1.4 percent in a rising rate environment and a decrease of 0.5 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 $36.0 million at September 30, 2003, an increase of $5.7 million from December 31, 2002. Net cash provided by operating activities for the nine months ended September 30, 2003, amounted to $7.0 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 $16.7 million for the nine months ended September 30, 2003, primarily from the funding of loans and purchases in the securities portfolio. Net cash provided by financing activities, amounted to $15.5 million for the nine months ended September 30, 2003, attributable to deposit growth partially offset by a decrease in other debt and the payment of a cash dividend to common shareholders.

 

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 September 30, 2003, the Parent Company had $1.5 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 September 30, 2003, $5.5 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 September 30, 2003 amounted to approximately $61.1 million. An additional source of liquidity is Federal Funds sold, which were $22.5 million at September 30, 2003.

 

As of September 30, 2003, deposits included $21.3 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 $20.3 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 September 30, 2003, the Bank had approximately $98.6 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 $26.7 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.

 

		Actual				For Capital Adequacy Purposes						To Be Well Capitalized Under Prompt Corrective Action Provisions
(In thousands)		Amount		Ratio				Amount		Ratio				Amount		Ratio
As of September 30, 2003
Leverage Ratio		38,692		8.50	%	³		18,217		4.00	%	³		22,771		5.00	%
Tier I risk-based ratio		38,692		11.39	%	³		13,589		4.00	%	³		20,383		6.00	%
Total risk-based ratio		42,938		12.64	%	³		27,178		8.00	%	³		33,972		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. 

 

		Actual				For Capital Adequacy Purposes						To Be Well Capitalized
												Under Prompt Corrective Action Provisions
(In thousands)		Amount		Ratio				Amount		Ratio				Amount		Ratio
As of September 30, 2003
Leverage Ratio		31,308		6.97	%	³		17,960		4.00	%	³		22,450		5.00	%
Tier I risk-based ratio		31,308		9.27	%	³		13,513		4.00	%	³		20,270		6.00	%
Total risk-based ratio		41,531		12.29	%	³		27,026		8.00	%	³		33,783		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 $2.5 million, or 9.1 percent, to $29.6 million at September 30, 2003 compared to $27.1 million at December 31, 2002.  This increase was the result of the $3.7 million in net income partially offset by $1.1 million decrease in accumulated other comprehensive income and payment of a cash dividend of $160 thousand. On September 22, 2003 the Company announced a $0.03 cash dividend payable to shareholders on October 31, 2003. 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.

 

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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.)

 

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 September 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 September 30, 2003 that has materially affected, or is reasonably likely to materially affect, the Company’s internal control over financial reporting.

 

In November 2003, the Company's Audit Committee commenced an inquiry concerning certain expense reimbursement requests made by the Company's President, who has taken a voluntary leave of absence pending completion of the inquiry.  The President has advised the Company that he intends to fully cooperate with such inquiry.

 

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

Pending the completion of the Audit Committee's inquiry described in Part I Item 4, on November 19, 2003 the Company's Board of Directors granted David D. Dallas Chief Executive Officer authority.

 

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 September 30, 2003, the Company filed the following Reports on Form 8-K.
	The Current Report on Form 8-K dated September 22, 2003 under “Item 9 Regulation FD Disclosure” incorporating the September 22, 2003 press release announcing the declaration of a .03 per common share payable on October 31, 2003 to common shareholders of record as of October 15, 2003.
	The Current Report on Form 8-K dated July 16, 2003, under “Item 9. Regulation FD Disclosure” incorporating the July 16, 2003 press release announcing the Company’s earnings for the second quarter of 2003.

 

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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:   November 19, 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		Exhibit 31.1-Certification of David D. Dallas Required by Rule 13a-14(a) or Rule 15d-14(a) and section 302 of the Sarbanes-Oxley Act of.
31.2		Exhibit 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		Exhibit 32.1-Certification of David D. Dallas 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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