Edgar Filing: UNITY BANCORP INC /NJ/

UNTY - 10Q Q3

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

(Mark One)

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

For the quarterly period ended September 30, 2015

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

For the transition period from ____ to ____.

Commission File Number 1-12431

Unity Bancorp, Inc.

(Exact name of registrant as specified in its charter)


New Jersey	22-3282551
(State or other jurisdiction of incorporation or organization)	(I.R.S. Employer Identification No.)

64 Old Highway 22, Clinton, NJ	08809
(Address of principal executive offices)	(Zip Code)

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 ☒No ☐

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company (as defined in Rule 12b-2 of the Exchange Act):

Large accelerated filer ☐ Accelerated filer ☐ Nonaccelerated filer ☐ Smaller reporting company ☒

Indicate by check mark whether the registrant is a shell company as defined in Rule 12b-2 of the Exchange Act:

Yes ☐No ☒

The number of shares outstanding of each of the registrant’s classes of common equity stock, as of October 31, 2015 common stock, no par value: 8,428,865 shares outstanding.

Table of Contents

PART I	CONSOLIDATED FINANCIAL INFORMATION	Page #

ITEM 1	Consolidated Financial Statements (Unaudited)	3

	Consolidated Balance Sheets at September 30, 2015 and December 31, 2014	3

	Consolidated Statements of Income For the three and nine months ended September 30, 2015 and 2014	4

	Consolidated Statements of Comprehensive Income For the three and nine months ended September 30, 2015 and 2014	5

	Consolidated Statements of Changes in Shareholders’ Equity For the three and nine months ended September 30, 2015 and 2014	6

	Consolidated Statements of Cash Flows For the nine months ended September 30, 2015 and 2014	7

	Notes to the Consolidated Financial Statements	9

ITEM 2	Management’s Discussion and Analysis of Financial Condition and Results of Operations	35

ITEM 3	Quantitative and Qualitative Disclosures about Market Risk	52

ITEM 4	Controls and Procedures	52

PART II	OTHER INFORMATION	53

ITEM 1	Legal Proceedings	53

ITEM 1A	Risk Factors	53

ITEM 2	Unregistered Sales of Equity Securities and Use of Proceeds	53

ITEM 3	Defaults upon Senior Securities	53

ITEM 4	Mine Safety Disclosures	53

ITEM 5	Other Information	53

ITEM 6	Exhibits	53

	SIGNATURES	54

	EXHIBIT INDEX	55

	Exhibit 31.1

	Exhibit 31.2

	Exhibit 32.1

PART ICONSOLIDATED FINANCIAL INFORMATION

ITEM 1Consolidated Financial Statements (Unaudited)

Unity Bancorp, Inc.

Consolidated Balance Sheets

(Unaudited)


(In thousands)	September 30, 2015		December 31, 2014
ASSETS
Cash and due from banks	$	21,863	$	29,351
Federal funds sold and interest-bearing deposits		66,994		100,470
Cash and cash equivalents		88,857		129,821
Securities:
Securities available for sale		53,470		60,073
Securities held to maturity (fair value of $18,147 and $20,281, respectively)		18,022		20,009
Total securities		71,492		80,082
Loans:
SBA loans held for sale		13,937		5,179
SBA loans held for investment		39,728		40,401
SBA 504 loans		29,221		34,322
Commercial loans		442,970		401,949
Residential mortgage loans		255,447		220,878
Consumer loans		74,257		59,096
Total loans		855,560		761,825
Allowance for loan losses		(12,421)		(12,551)
Net loans		843,139		749,274
Premises and equipment, net		15,297		15,231
Bank owned life insurance ("BOLI")		13,285		13,001
Deferred tax assets		6,107		5,860
Federal Home Loan Bank ("FHLB") stock		4,510		6,032
Accrued interest receivable		3,704		3,518
Other real estate owned ("OREO")		1,759		1,162
Goodwill and other intangibles		1,516		1,516
Other assets		3,045		3,291
Total assets	$	1,052,711	$	1,008,788
LIABILITIES AND SHAREHOLDERS' EQUITY
Liabilities:
Deposits:
Noninterest-bearing demand	$	175,298	$	152,785
Interest-bearing demand		123,984		128,875
Savings		299,017		300,348
Time, under $100,000		124,348		113,119
Time, $100,000 and over, under $250,000		115,912		81,532
Time, $250,000 and over		27,688		17,682
Total deposits		866,247		794,341
Borrowed funds		90,000		125,000
Subordinated debentures		15,465		15,465
Accrued interest payable		460		474
Accrued expenses and other liabilities		4,474		3,385
Total liabilities		976,646		938,665
Commitments and contingencies		-		-
Shareholders' equity:
Common stock		59,205		58,785
Retained earnings		17,270		11,195
Accumulated other comprehensive (loss) income		(410)		143
Total shareholders' equity		76,065		70,123
Total liabilities and shareholders' equity	$	1,052,711	$	1,008,788

Issued and outstanding common shares		8,429		8,388

The accompanying notes to the Consolidated Financial Statements are an integral part of these statements.

Unity Bancorp, Inc.

Consolidated Statements of Income

(Unaudited)


	For the three months ended September 30,				For the nine months ended September 30,
(In thousands, except per share amounts)	2015		2014		2015		2014
INTEREST INCOME
Federal funds sold and interest-bearing deposits	$	11	$	12	$	26	$	31
FHLB stock		36		40		117		127
Securities:
Taxable		349		461		1,100		1,740
Tax-exempt		71		81		213		275
Total securities		420		542		1,313		2,015
Loans:
SBA loans		696		636		1,980		1,863
SBA 504 loans		353		419		1,068		1,251
Commercial loans		5,378		4,926		15,720		14,264
Residential mortgage loans		2,811		2,327		8,108		6,438
Consumer loans		849		589		2,322		1,628
Total loans		10,087		8,897		29,198		25,444
Total interest income		10,554		9,491		30,654		27,617
INTEREST EXPENSE
Interest-bearing demand deposits		108		98		317		318
Savings deposits		255		216		789		586
Time deposits		839		725		2,250		2,062
Borrowed funds and subordinated debentures		730		820		2,289		2,426
Total interest expense		1,932		1,859		5,645		5,392
Net interest income		8,622		7,632		25,009		22,225
Provision for loan losses		200		550		400		1,700
Net interest income after provision for loan losses		8,422		7,082		24,609		20,525
NONINTEREST INCOME
Branch fee income		399		388		1,118		1,106
Service and loan fee income		306		292		1,068		872
Gain on sale of SBA loans held for sale, net		308		295		671		633
Gain on sale of mortgage loans, net		926		263		1,957		816
BOLI income		95		400		284		593
Net security gains		-		-		28		378
Other income		241		215		683		621
Total noninterest income		2,275		1,853		5,809		5,019
NONINTEREST EXPENSE
Compensation and benefits		3,814		3,214		10,767		9,553
Occupancy		598		604		1,871		1,882
Processing and communications		631		667		1,841		1,847
Furniture and equipment		393		377		1,189		1,112
Professional services		251		159		729		617
Loan costs		265		225		647		569
OREO expenses		15		71		117		414
Deposit insurance		163		166		496		515
Advertising		203		291		728		729
Other expenses		519		467		1,619		1,406
Total noninterest expense		6,852		6,241		20,004		18,644
Income before provision for income taxes		3,845		2,694		10,414		6,900
Provision for income taxes		1,294		808		3,496		2,193
Net income	$	2,551	$	1,886	$	6,918	$	4,707

Net income per common share - Basic	$	0.30	$	0.24	$	0.82	$	0.61
Net income per common share - Diluted	$	0.30	$	0.24	$	0.81	$	0.61

Weighted average common shares outstanding - Basic		8,427		7,847		8,423		7,680
Weighted average common shares outstanding - Diluted		8,536		7,946		8,524		7,765
The accompanying notes to the Consolidated Financial Statements are an integral part of these statements.

Unity Bancorp, Inc.

Consolidated Statements of Comprehensive Income

(Unaudited)




	For the three months ended
	September 30, 2015						September 30, 2014
(In thousands)	Before tax amount		Income tax expense (benefit)		Net of tax amount		Before tax amount		Income tax expense (benefit)		Net of tax amount
Net income	$	3,845	$	1,294	$	2,551	$	2,694	$	808	$	1,886
Other comprehensive income (loss)
Investment securities available for sale:
Unrealized holding gains (losses) on securities arising during the period		14		5		9		(19)		(7)		(12)
Total unrealized gains (losses) on securities available for sale		14		5		9		(19)		(7)		(12)

Adjustments related to defined benefit plan:
Amortization of prior service cost		21		8		13		-		-		-
Total adjustments related to defined benefit plan		21		8		13		-		-		-

Total other comprehensive income (loss)		35	$	13	$	22		(19)	$	(7)	$	(12)
Total comprehensive income	$	3,880	$	1,307	$	2,573	$	2,675	$	801	$	1,874


	For the nine months ended
	September 30, 2015						September 30, 2014
(In thousands)	Before tax amount		Income tax expense (benefit)		Net of tax amount		Before tax amount		Income tax expense (benefit)		Net of tax amount
Net income	$	10,414	$	3,496	$	6,918	$	6,900	$	2,193	$	4,707
Other comprehensive (loss) income
Investment securities available for sale:
Unrealized holding (losses) gains on securities arising during the period		(125)		(50)		(75)		1,152		423		729
Less: reclassification adjustment for gains on securities included in net income		28		10		18		378		120		258
Total unrealized (losses) gains on securities available for sale		(153)		(60)		(93)		774		303		471

Adjustments related to defined benefit plan:
Initial recognition of prior service cost		(830)		(332)		(498)		-		-		-
Amortization of prior service cost		63		25		38		-		-		-
Total adjustments related to defined benefit plan		(767)		(307)		(460)		-		-		-

Total other comprehensive (loss) income		(920)	$	(367)	$	(553)		774	$	303	$	471
Total comprehensive income	$	9,494	$	3,129	$	6,365	$	7,674	$	2,496	$	5,178

The accompanying notes to the Consolidated Financial Statements are an integral part of these statements.

Unity Bancorp, Inc.

Consolidated Statements of Changes in Shareholders’ Equity

For the nine months ended September 30, 2015 and 2014

(Unaudited)


	Common stock						Accumulated other		Total
(In thousands)	Shares		Amount		Retained earnings		comprehensive (loss) income		shareholders' equity
Balance, December 31, 2014		8,388	$	58,785	$	11,195	$	143	$	70,123
Net income						6,918				6,918
Other comprehensive loss, net of tax								(553)		(553)
Dividends on common stock ($0.10 per share)				55		(843)				(788)
Common stock issued and related tax effects (1)		41		365						365
Balance, September 30, 2015		8,429	$	59,205	$	17,270	$	(410)	$	76,065


	Common stock						Accumulated other		Total
(In thousands)	Shares		Amount		Retained earnings		comprehensive income (loss)		shareholders' equity
Balance, December 31, 2013		7,577	$	52,051	$	5,598	$	(476)	$	57,173
Net income						4,707				4,707
Other comprehensive income, net of tax								471		471
Dividends on common stock ($0.07 per share)				37		(554)				(517)
Common stock issued and related tax effects (1)		32		389						389
Proceeds from rights offering		761		6,161						6,161
Balance, September 30, 2014		8,370	$	58,638	$	9,751	$	(5)	$	68,384

(1)

Includes the issuance of common stock under employee benefit plans, which includes nonqualified stock options and restricted stock expense related entries, employee option exercises and the tax benefit of options exercised

The accompanying notes to the Consolidated Financial Statements are an integral part of these statements.

Unity Bancorp, Inc.

Consolidated Statements of Cash Flows

(Unaudited)


	For the nine months ended September 30,
(In thousands)	2015		2014
OPERATING ACTIVITIES:
Net income	$	6,918	$	4,707
Adjustments to reconcile net income to net cash used in (provided by) operating activities:
Provision for loan losses		400		1,700
Net amortization of purchase premiums and discounts on securities		409		420
Depreciation and amortization		493		902
Deferred income tax expense		171		384
Net security gains		(28)		(378)
Stock compensation expense		343		306
(Gain) loss on sale of OREO		(3)		138
Gain on sale of mortgage loans held for sale, net		(1,444)		(676)
Gain on sale of SBA loans held for sale, net		(671)		(633)
Origination of mortgage loans held for sale		(77,911)		(45,066)
Origination of SBA loans held for sale		(16,008)		(8,758)
Proceeds from sale of mortgage loans held for sale, net		79,355		45,742
Proceeds from sale of SBA loans held for sale, net		7,539		7,034
BOLI income		(284)		(593)
Net change in other assets and liabilities		360		(32)
Net cash (used in) provided by operating activities		(361)		5,197
INVESTING ACTIVITIES
Purchases of securities held to maturity		(264)		(309)
Purchases of securities available for sale		(1,002)		(9,947)
Purchases of FHLB stock, at cost		(10,538)		(6,318)
Maturities and principal payments on securities held to maturity		2,181		5,793
Maturities and principal payments on securities available for sale		6,614		7,909
Proceeds from sales of securities available for sale		528		17,919
Proceeds from redemption of FHLB stock		12,060		6,803
Proceeds from sale of OREO		1,598		2,974
Net increase in loans		(87,062)		(69,673)
Proceeds from BOLI		-		435
Purchases of premises and equipment		(836)		(526)
Net cash used in investing activities		(76,721)		(44,940)
FINANCING ACTIVITIES
Net increase in deposits		71,906		43,222
Proceeds from new borrowings		25,000		25,000
Repayments of borrowings		(60,000)		(32,000)
Proceeds from exercise of stock options		-		62
Proceeds from rights offering		-		6,161
Dividends on common stock		(788)		(517)
Net cash provided by financing activities		36,118		41,928
(Decrease) increase in cash and cash equivalents		(40,964)		2,185
Cash and cash equivalents, beginning of period		129,821		99,404
Cash and cash equivalents, end of period	$	88,857	$	101,589

Unity Bancorp, Inc.

Consolidated Statements of Cash Flows (Continued)

(Unaudited)



	For the nine months ended September 30,
(In thousands)	2015		2014
SUPPLEMENTAL DISCLOSURES
Cash:
Interest paid	$	5,659	$	5,370
Income taxes paid		3,289		1,519
Noncash investing activities:
Transfer of SBA loans held for sale to held to maturity		84		83
Capitalization of servicing rights		754		326
Transfer of loans to OREO		2,194		4,317

The accompanying notes to the Consolidated Financial Statements are an integral part of these statements

Unity Bancorp, Inc.

Notes to the Consolidated Financial Statements (Unaudited)

September 30, 2015

NOTE 1. Significant Accounting Policies

The accompanying Consolidated Financial Statements include the accounts of Unity Bancorp, Inc. (the "Parent Company") and its wholly-owned subsidiary, Unity Bank (the "Bank" or when consolidated with the Parent Company, the "Company"), and reflect all adjustments and disclosures which are generally routine and recurring in nature, and in the opinion of management, necessary for a fair presentation of interim results. The Bank has multiple subsidiaries used to hold part of its investment and loan portfolios and OREO properties. All significant intercompany balances and transactions have been eliminated in consolidation. Certain reclassifications have been made to prior period amounts to conform to the current year presentation, with no impact on current earnings or shareholders’ equity. The financial information has been prepared in accordance with U.S. generally accepted accounting principles and has not been audited. In preparing the financial statements, management is required to make estimates and assumptions that affect the reported amounts of assets and liabilities and revenues and expenses during the reporting periods. Actual results could differ from those estimates. Amounts requiring the use of significant estimates include the allowance for loan losses, valuation of deferred tax and servicing assets, the carrying value of loans held for sale and other real estate owned, the valuation of securities and the determination of other-than-temporary impairment for securities and fair value disclosures. 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. The Company has evaluated subsequent events for potential recognition and/or disclosure through the date the Consolidated Financial Statements included in this Quarterly Report on Form 10-Q were available to be issued.

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”) and consist of normal recurring adjustments necessary for the fair presentation of interim results. The results of operations for the three and nine months ended September 30, 2015 are not necessarily indicative of the results which may be expected for the entire year. As used in this Form 10-Q, “we” and “us” and “our” refer to Unity Bancorp, Inc., and its consolidated subsidiary, Unity Bank, depending on the context. Certain information and financial disclosures required by U.S. generally accepted accounting principles have been condensed or omitted from interim reporting pursuant to SEC rules. Interim financial statements should be read in conjunction with the Company’s Consolidated Financial Statements and notes thereto included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2014.

Stock Transactions

Stock Option Plans

The Company has incentive and nonqualified option plans, which allow for the grant of options to officers, employees and members of the Board of Directors. Transactions under the Company’s stock option plans for the nine months ended September 30, 2015 are summarized in the following table:


	Shares		Weighted average exercise price		Weighted average remaining contractual life in years		Aggregate intrinsic value
Outstanding at December 31, 2014		418,921	$	6.76		5.5	$	1,257,968
Options granted		40,000		9.12
Options exercised		(525)		7.31
Options cancelled		-		-
Outstanding at September 30, 2015		458,396	$	6.96		5.2	$	1,409,078
Exercisable at September 30, 2015		361,901	$	6.63		4.2	$	1,254,993

Grants under the Company’s incentive and nonqualified option plans generally vest over 3 years and must be exercised within 10 years of the date of grant. The exercise price of each option is the market price on the date of grant. As of September 30, 2015, 1,920,529 shares have been reserved for issuance upon the exercise of options, 458,396 option grants are outstanding, and 1,252,548 option grants have been exercised, forfeited or expired, leaving 209,585 shares available for grant.

The fair values of the options granted during the three and nine months ended September 30, 2015 and 2014 were estimated on the date of grant using the Black-Scholes option-pricing model with the following weighted average assumptions:


	For the three months ended September 30,						For the nine months ended September 30,
	2015			2014			2015			2014
Number of options granted		-			-			40,000			41,000
Weighted average exercise price	$	-		$	-		$	9.12		$	7.90
Weighted average fair value of options	$	-		$	-		$	3.82		$	3.03
Expected life in years (1)		-			-			6.69			5.40
Expected volatility (2)		-	%		-	%		46.76	%		45.05	%
Risk-free interest rate (3)		-	%		-	%		1.80	%		1.52	%
Dividend yield (4)		-	%		-	%		1.33	%		1.02	%

(1)

The expected life of the options was estimated based on historical employee behavior and represents the period of time that options granted are expected to be outstanding.

(2)

The expected volatility of the Company’s stock price was based on the historical volatility over the period commensurate with the expected life of the options.

(3)

The risk-free interest rate is the U.S. Treasury rate commensurate with the expected life of the options on the date of grant.

(4)

The expected dividend yield is the projected annual yield based on the grant date stock price.

Upon exercise, the Company issues shares from its authorized but unissued common stock to satisfy the options. The following table presents information about options exercised during the three and nine months ended September 30, 2015 and 2014:


	For the three months ended September 30,				For the nine months ended September 30,
	2015		2014		2015		2014
Number of options exercised		525		-		525		19,950
Total intrinsic value of options exercised	$	1,302	$	-	$	1,302	$	67,417
Cash received from options exercised		-		-		-		62,445
Tax deduction realized from options exercised		520		-		520		26,926

The following table summarizes information about stock options outstanding and exercisable at September 30, 2015:


		Options outstanding						Options exercisable
Range of exercise prices		Options outstanding		Weighted average remaining contractual life (in years)		Weighted average exercise price		Options exercisable		Weighted average exercise price
$	0.00 - 4.00		89,000		3.5	$	3.85		89,000	$	3.85
	4.01 - 7.00		166,500		5.9		6.15		150,667		6.16
	7.01 - 10.00		155,450		6.2		7.97		79,788		7.46
	10.01 - 13.00		47,446		2.2		12.36		42,446		12.60
	Total		458,396		5.2	$	6.96		361,901	$	6.63

Financial Accounting Standards Board Accounting Standards Codification ("FASB ASC") Topic 718, “Compensation - Stock Compensation,” requires an entity to recognize the fair value of equity awards as compensation expense over the period during which an employee is required to provide service in exchange for such an award (vesting period). Compensation expense related to stock options and the related income tax benefit for the three and nine months ended September 30, 2015 and 2014 are detailed in the following table:


	For the three months ended September 30,				For the nine months ended September 30,
	2015		2014		2015		2014
Compensation expense	$	39,489	$	36,564	$	108,479	$	120,961
Income tax benefit		15,772		14,604		43,326		48,312

As of September 30, 2015, unrecognized compensation costs related to nonvested share-based compensation arrangements granted under the Company’s stock option plans totaled approximately $233 thousand. That cost is expected to be recognized over a weighted average period of 1.9 years.

Restricted Stock Awards

Restricted stock is issued under the stock bonus program to reward employees and directors and to retain them by distributing stock over a period of time. The following table summarizes nonvested restricted stock activity for the nine months ended September 30, 2015:


	Shares		Average grant date fair value
Nonvested restricted stock at December 31, 2014		77,750	$	7.24
Granted		36,800		9.30
Vested		(10,875)		6.77
Forfeited		(2,000)		9.81
Nonvested restricted stock at September 30, 2015		101,675	$	7.96

Restricted stock awards granted to date vest over a period of 4 years and are recognized as compensation to the recipient over the vesting period. The awards are recorded at fair market value at the time of grant and amortized into salary expense on a straight line basis over the vesting period. As of September 30, 2015, 471,551 shares of restricted stock were reserved for issuance, of which 179,700 shares are available for grant.

Restricted stock awards granted during the three and nine months ended September 30, 2015 and 2014 were as follows:


	For the three months ended September 30,				For the nine months ended September 30,
	2015		2014		2015		2014
Number of shares granted		2,000		-		36,800		11,000
Average grant date fair value	$	9.81	$	-	$	9.30	$	7.92

Compensation expense related to restricted stock for the three and nine months ended September 30, 2015 and 2014 is detailed in the following table:


	For the three months ended September 30,				For the nine months ended September 30,
	2015		2014		2015		2014
Compensation expense	$	76,950	$	63,239	$	234,460	$	184,889
Income tax benefit		30,734		25,258		93,643		73,845

As of September 30, 2015, there was approximately $596 thousand of unrecognized compensation cost related to nonvested restricted stock awards granted under the Company’s stock incentive plans. That cost is expected to be recognized over a weighted average period of 2.7 years.

Benefit Plans

In addition to the 401(k) savings plan which covers substantially all employees, the Company has established in 2015 an unfunded supplemental defined benefit plan to provide additional retirement benefits for the President and Chief Executive Officer (“CEO”).

On June 4, 2015, the Company approved the Supplemental Executive Retirement Plan (the “SERP”) pursuant to which the President and CEO is entitled to receive certain supplemental nonqualified retirement benefits.

Upon separation from service after age 66, the President and CEO will be entitled to an annual benefit in the amount of $156,000 payable in fifteen annual installments subject to annual 2% increases. The President and CEO commenced vesting to this retirement benefit on January 1, 2014, and shall vest an additional 3% each year until fully vested on January 1, 2024. In the event that the President and CEO’s separation from service from the Registrant were to occur prior to full vesting, the President and CEO would be entitled to and shall be paid the vested portion of the retirement benefit calculated as of the date of separation from service.

Notwithstanding the foregoing, upon a Change in Control, and provided that within 6 months following the Change in Control the President and CEO is involuntary terminated for reasons other than “cause” or the President and CEO resigns for “good reason”, as such is defined in the SERP, or the President and CEO voluntarily terminates his employment after being offered continued employment in a positions that is not a “Comparable Position”, as such is also defined in the SERP, the President and CEO shall become 100% vested in the full retirement benefit.

No contributions or payments have been made or are anticipated for the year 2015. The following table summarizes the components of the net periodic pension cost of the defined benefit plan recognized during the three and nine month periods ended September 30, 2015:


(In thousands)	For the three months ended		For the nine months ended
Components of net periodic benefits cost:	September 30, 2015		September 30, 2015
Service cost	$	15	$	44
Interest cost		9		26
Amortization of prior service cost		21		62
Net periodic benefit cost	$	45	$	132

Other-Than-Temporary Impairment

The Company has a process in place to identify securities that could potentially incur credit impairment that is other-than-temporary. This process involves monitoring late payments, pricing levels, downgrades by rating agencies, key financial ratios, financial statements, revenue forecasts and cash flow projections as indicators of credit issues. Management evaluates securities for other-than-temporary impairment at least on a quarterly basis, and more frequently when economic or market concern warrants such evaluation. This evaluation considers relevant facts and circumstances in evaluating whether a credit or interest rate-related impairment of a security is other-than-temporary. Relevant facts and circumstances considered include: (1) the extent and length of time the fair value has been below cost; (2) the reasons for the decline in value; (3) the financial position and access to capital of the issuer, including the current and future impact of any specific events and (4) for fixed maturity securities, our intent to sell a security or whether it is more likely than not we will be required to sell the security before the recovery of its amortized cost which, in some cases, may extend to maturity and for equity securities, our ability and intent to hold the security for a forecasted period of time that allows for the recovery in value.

Management assesses its intent to sell or whether it is more likely than not that it will be required to sell a security before recovery of its amortized cost basis less any current-period credit losses. For debt securities that are considered other-than-temporarily impaired with no intent to sell and no requirement to sell prior to recovery of its amortized cost basis, the amount of the impairment is separated into the amount that is credit related (credit loss component) and the amount due to all other factors. The credit loss component is recognized in earnings and is the difference between the security’s amortized cost basis and the present value of its expected future cash flows. The remaining difference between the security’s fair value and the present value of future expected cash flows is due to factors that are not credit related and is recognized in other comprehensive income. For debt securities where management has the intent to sell, the amount of the impairment is reflected in earnings as realized losses.

The present value of expected future cash flows is determined using the best estimate cash flows discounted at the effective interest rate implicit to the security at the date of purchase or the current yield to accrete an asset-backed or floating rate security. The methodology and assumptions for establishing the best estimate cash flows vary depending on the type of security. The asset-backed securities cash flow estimates are based on bond specific facts and circumstances that may include collateral characteristics, expectations of delinquency and default rates, loss severity and prepayment speeds and structural support, including subordination and guarantees. The corporate bond cash flow estimates are derived from scenario-based outcomes of expected corporate restructurings or the disposition of assets using bond specific facts and circumstances including timing, security interests and loss severity.

Transfers of Financial Assets

Transfers of financial assets are accounted for as sales, when control over the assets has been surrendered. Control over transferred assets is deemed to be surrendered when (1) the assets have been isolated from the Company, (2) the transferee obtains the right (free of conditions that constrain it from taking advantage of that right) to pledge or exchange the transferred assets, and (3) the Company does not maintain effective control over the transferred assets through an agreement to repurchase them before their maturity.

Loans

Loans Held for Sale

Loans held for sale represent the guaranteed portion of Small Business Administration (“SBA”) loans and are reflected at the lower of aggregate cost or market value. The Company originates loans to customers under an SBA program that historically has provided for SBA guarantees of up to 90 percent of each loan. The Company generally sells the guaranteed portion of its SBA loans to a third party and retains the servicing, holding the nonguaranteed portion in its portfolio. The net amount of loan origination fees on loans sold is included in the carrying value and in the gain or loss on the sale. When sales of SBA loans do occur, the premium received on the sale and the present value of future cash flows of the servicing assets are recognized in income. All criteria for sale accounting must be met in order for the loan sales to occur; see details under the “Transfers of Financial Assets” heading above.

Servicing assets represent the estimated fair value of retained servicing rights, net of servicing costs, at the time loans are sold. Servicing assets are amortized in proportion to, and over the period of, estimated net servicing revenues. Impairment is evaluated based on stratifying the underlying financial assets by date of origination and term. Fair value is determined using prices for similar assets with similar characteristics, when available, or based upon discounted cash flows using market-based assumptions. Any impairment, if temporary, would be reported as a valuation allowance.

Serviced loans sold to others are not included in the accompanying Consolidated Balance Sheets. Income and fees collected for loan servicing are credited to noninterest income when earned, net of amortization on the related servicing assets.

Loans Held to Maturity

Loans held to maturity are stated at the unpaid principal balance, net of unearned discounts and deferred loan origination fees and costs. In accordance with the level yield method, loan origination fees, net of direct loan origination costs, are deferred and recognized over the estimated life of the related loans as an adjustment to the loan yield. Interest is credited to operations primarily based upon the principal balance outstanding.

Loans are reported as past due when either interest or principal is unpaid in the following circumstances: fixed payment loans when the borrower is in arrears for two or more monthly payments; open end credit for two or more billing cycles; and single payment notes if interest or principal remains unpaid for 30 days or more.

Nonperforming loans consist of loans that are not accruing interest as a result of principal or interest being in default for a period of 90 days or more or when the ability to collect principal and interest according to the contractual terms is in doubt (nonaccrual loans). When a loan is classified as nonaccrual, interest accruals are discontinued and all past due interest previously recognized as income is reversed and charged against current period earnings. 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 may be returned to an accrual status when the ability to collect is reasonably assured and when the loan is brought current as to principal and interest.

Loans are charged off when collection is sufficiently questionable and when the Company can no longer justify maintaining the loan as an asset on the balance sheet. Loans qualify for charge-off when, after thorough analysis, all possible sources of repayment are insufficient. These include: 1) potential future cash flows, 2) value of collateral, and/or 3) strength of co-makers and guarantors. All unsecured loans are charged off upon the establishment of the loan’s nonaccrual status. Additionally, all loans classified as a loss or that portion of the loan classified as a loss is charged off. All loan charge-offs are approved by the Board of Directors.

Troubled debt restructurings ("TDRs") occur when a creditor, for economic or legal reasons related to a debtor’s financial condition, grants a concession to the debtor that it would not otherwise consider. These concessions typically include reductions in interest rate, extending the maturity of a loan, or a combination of both. Interest income on accruing TDRs is credited to operations primarily based upon the principal amount outstanding, as stated in the paragraphs above.

The Company evaluates its loans for impairment. A loan is considered impaired when, based on current information and events, it is probable that the Company will be unable to collect all amounts due according to the contractual terms of the loan agreement. The Company has defined impaired loans to be all TDRs and nonperforming loans individually evaluated for impairment. Impairment is evaluated in total for smaller-balance loans of a similar nature (consumer and residential mortgage loans), and on an individual basis for all other loans. Impairment of a loan is measured based on the present value of expected future cash flows, discounted at the loan's effective interest rate, or as a practical expedient, based on a loan’s observable market price or the fair value of collateral, net of estimated costs to sell, if the loan is collateral-dependent. If the value of the impaired loan is less than the recorded investment in the loan, the Company establishes a valuation allowance, or adjusts existing valuation allowances, with a corresponding charge to the provision for loan losses.

For additional information on loans, see Note 8 to the Consolidated Financial Statements and the section titled "Loan Portfolio" under Item 2. Management's Discussion and Analysis.

Allowance for Loan Losses and Reserve for Unfunded Loan Commitments

The allowance for loan losses is maintained at a level management considers adequate to provide for probable loan losses as of the balance sheet date. The allowance is increased by provisions charged to expense and is reduced by net charge-offs.

The level of the allowance is based on management’s evaluation of probable losses in the loan portfolio, after consideration of prevailing economic conditions in the Company’s market area, the volume and composition of the loan portfolio, and historical loan loss experience. The allowance for loan losses consists of specific reserves for individually impaired credits and TDRs, reserves for nonimpaired loans based on historical loss factors and reserves based on general economic factors and other qualitative risk factors such as changes in delinquency trends, industry concentrations or local/national economic trends. This risk assessment process is performed at least quarterly, and, as adjustments become necessary, they are realized in the periods in which they become known.

Although management attempts to maintain the allowance at a level deemed adequate to provide for probable losses, future additions to the allowance may be necessary based upon certain factors including changes in market conditions and underlying collateral values. In addition, various regulatory agencies periodically review the adequacy of the Company’s allowance for loan losses. These agencies may require the Company to make additional provisions based on their judgments about information available to them at the time of their examination.

The Company maintains an allowance for unfunded loan commitments that is maintained at a level that management believes is adequate to absorb estimated probable losses. Adjustments to the allowance are made through other expenses and applied to the allowance which is maintained in other liabilities.

For additional information on the allowance for loan losses and unfunded loan commitments, see Note 9 to the Consolidated Financial Statements and the sections titled "Asset Quality" and "Allowance for Loan Losses and Reserve for Unfunded Loan Commitments" under Item 2. Management's Discussion and Analysis.

Income Taxes

The Company accounts for income taxes according to the asset and liability method. Under this method, deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax basis. Deferred tax assets and liabilities are measured using the enacted tax rates applicable to taxable income for the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date.

Valuation reserves are established against certain deferred tax assets when it is more likely than not that the deferred tax assets will not be realized. Increases or decreases in the valuation reserve are charged or credited to the income tax provision.

When tax returns are filed, it is highly certain that some positions taken would be sustained upon examination by the taxing authorities, while others are subject to uncertainty about the merits of the position taken or the amount of the position that ultimately would be sustained. The benefit of a tax position is recognized in the financial statements in the period during which, based on all available evidence, management believes it is more likely than not that the position will be sustained upon examination, including the resolution of appeals or litigation processes, if any. The evaluation of a tax position taken is considered by itself and not offset or aggregated with other positions. Tax positions that meet the more likely than not recognition threshold are measured as the largest amount of tax benefit that is more than 50 percent likely of being realized upon settlement with the applicable taxing authority. The portion of benefits associated with tax positions taken that exceeds the amount measured as described above is reflected as a liability for unrecognized tax benefits in the accompanying balance sheet along with any associated interest and penalties that would be payable to the taxing authorities upon examination.

Interest and penalties associated with unrecognized tax benefits would be recognized in income tax expense on the income statement.

NOTE 2. Litigation

The Company may, in the ordinary course of business, become a party to litigation involving collection matters, contract claims and other legal proceedings relating to the conduct of its business. In the best judgment of management, based upon consultation with counsel, the consolidated financial position and results of operations of the Company will not be affected materially by the final outcome of any pending legal proceedings or other contingent liabilities and commitments.

NOTE 3. Net Income per Share

Basic net income per common share is calculated as net income divided by the weighted average common shares outstanding during the reporting period.

Diluted net income per common share is computed similarly to that of basic net income per common share, except that the denominator is increased to include the number of additional common shares that would have been outstanding if all potentially dilutive common shares, principally stock options, were issued during the reporting period utilizing the Treasury stock method.

The following is a reconciliation of the calculation of basic and diluted income per share:



	For the three months ended September 30,				For the nine months ended September 30,
(In thousands, except per share amounts)	2015		2014		2015		2014
Net income	$	2,551	$	1,886	$	6,918	$	4,707
Weighted average common shares outstanding - Basic		8,427		7,847		8,423		7,680
Plus: Potential dilutive common stock equivalents		109		99		101		85
Weighted average common shares outstanding - Diluted		8,536		7,946		8,524		7,765
Net income per common share - Basic	$	0.30	$	0.24	$	0.82	$	0.61
Net income per common share - Diluted		0.30		0.24		0.81		0.61
Stock options and common stock excluded from the income per share calculation as their effect would have been anti-dilutive		87		120		132		115

NOTE 4. Income Taxes

The Company follows FASB ASC Topic 740, “Income Taxes,” which prescribes a threshold for the financial statement recognition of income taxes and provides criteria for the measurement of tax positions taken or expected to be taken in a tax return. ASC 740 also includes guidance on derecognition, classification, interest and penalties, accounting in interim periods, disclosure and transition of income taxes.

For the quarter ended September 30, 2015, the Company reported income tax expense of $1.3 million for an effective tax rate of 33.7 percent, compared to an income tax expense of $808 thousand and an effective tax rate of 30.0 percent for the prior year’s quarter. For the nine months ended September 30, 2015, the Company reported income tax expense of $3.5 million for an effective tax rate of 33.6 percent, compared to an income tax expense of $2.2 million and effective tax rate of 31.8 percent for the nine months ended September 30, 2014. Income for the quarter ended September 30, 2014 included tax-exempt income from a death benefit on BOLI. Excluding this death benefit income the effective tax rate would have been 33.9 percent and 33.3 percent for the three and nine month periods, respectively.

The Company did not recognize or accrue any interest or penalties related to income taxes during the three or nine months ended September 30, 2015 or 2014. The Company did not have an accrual for uncertain tax positions as of September 30, 2015 or December 31, 2014, as deductions taken and benefits accrued are based on widely understood administrative practices and procedures and are based on clear and unambiguous tax law. Tax returns for all years 2011 and thereafter are subject to future examination by tax authorities.

NOTE 5. Other Comprehensive (Loss) Income

The following tables show the changes in other comprehensive (loss) income for the three and nine months ended September 30, 2015 and 2014, net of tax:



	For the three months ended September 30,
	2015						2014
(In thousands)	Net unrealized gains (losses) on securities		Adjustments related to defined benefit plan		Accumulated other comprehensive (loss) income		Net unrealized (losses) gains on securities		Accumulated other comprehensive (loss) income

Balance at June 30	$	41	$	(473)	$	(432)	$	7	$	7

Other comprehensive (loss) income before reclassifications		9		-		9		(12)		(12)
Less amounts reclassified from accumulated other comprehensive loss		-		(13)		(13)		-		-
Period change		9		13		22		(12)		(12)
Balance at September 30	$	50	$	(460)	$	(410)	$	(5)	$	(5)


	For the nine months ended September 30,
	2015						2014
(In thousands)	Net unrealized gains (losses) on securities		Adjustments related to defined benefit plan		Accumulated other comprehensive (loss) income		Net unrealized (losses) gains on securities		Accumulated other comprehensive (loss) income

Balance at January 1	$	143	$	-	$	143	$	(476)	$	(476)

Other comprehensive (loss) income before reclassifications		(75)		(498)		(573)		729		729
Less amounts reclassified from accumulated other comprehensive loss		18		(38)		(20)		258		258
Period change		(93)		(460)		(553)		471		471
Balance at September 30	$	50	$	(460)	$	(410)	$	(5)	$	(5)

Amounts reclassified out of accumulated other comprehensive income were as follows:


Details about accumulated other comprehensive (loss) income components	Amounts reclassified from accumulated other comprehensive (loss) income				Affected line item in the statement where net income is presented
(In thousands)	For the three months ended September 30,
		2015		2014
Investment securities available for sale:
Reclassification adjustment for gains on securities included in net income	$	-	$	-	Net security gains
Adjustments related to defined benefit plan:
Amortization of prior service cost included in net periodic pension cost		(21)		-	Compensation and benefits
Effect on accumulated other loss (income) for the period		(21)		-	Total before tax
Income tax benefit (expense)		8		-	Provision for income taxes
Total reclassification for the period	$	(13)	$	-	Net income


Details about accumulated other comprehensive (loss) income components	Amounts reclassified from accumulated other comprehensive (loss) income				Affected line item in the statement where net income is presented
(In thousands)	For the nine months ended September 30,
		2015		2014
Investment securities available for sale:
Reclassification adjustment for gains on securities included in net income	$	28	$	378	Net security gains
Adjustments related to defined benefit plan:
Amortization of prior service cost included in net periodic pension cost		(63)		-	Compensation and benefits
Effect on accumulated other loss (income) for the period		(35)		378	Total before tax
Income tax benefit (expense)		15		(120)	Provision for income taxes
Total reclassification for the period	$	(20)	$	258	Net income

NOTE 6. Fair Value

Fair Value Measurement

The Company follows FASB ASC Topic 820, “Fair Value Measurement and Disclosures,” which requires additional disclosures about the Company’s assets and liabilities that are measured at fair value. Fair value is the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. In determining fair value, the Company uses various methods including market, income and cost approaches. Based on these approaches, the Company often utilizes certain assumptions that market participants would use in pricing the asset or liability, including assumptions about risk and/or the risks inherent in the inputs to the valuation technique. These inputs can be readily observable, market corroborated, or generally unobservable inputs. The Company utilizes techniques that maximize the use of observable inputs and minimize the use of unobservable inputs. The fair value hierarchy ranks the quality and reliability of the information used to determine fair values. Financial assets and liabilities carried at fair value will be classified and disclosed as follows:

Level 1 Inputs

Unadjusted quoted prices in active markets that are accessible at the measurement date for identical, unrestricted assets or liabilities.

Generally, this includes debt and equity securities and derivative contracts that are traded in an active exchange market (i.e. New York Stock Exchange), as well as certain U.S. Treasury, U.S. Government and sponsored entity agency mortgage-backed securities that are highly liquid and are actively traded in over-the-counter markets.

Level 2 Inputs

Quoted prices for similar assets or liabilities in active markets.

Quoted prices for identical or similar assets or liabilities in inactive markets.

Inputs other than quoted prices that are observable, either directly or indirectly, for the term of the asset or liability (i.e., interest rates, yield curves, credit risks, prepayment speeds or volatilities) or “market corroborated inputs.”

Generally, this includes U.S. Government and sponsored entity mortgage-backed securities, corporate debt securities and derivative contracts.

Level 3 Inputs

Prices or valuation techniques that require inputs that are both unobservable (i.e. supported by little or no market activity) and that are significant to the fair value of the assets or liabilities.

These assets and liabilities include financial instruments whose value is determined using pricing models, discounted cash flow methodologies, or similar techniques, as well as instruments for which the determination of fair value requires significant management judgment or estimation.

Fair Value on a Recurring Basis

The following is a description of the valuation methodologies used for instruments measured at fair value on a recurring basis:

Securities Available for Sale

The fair value of available for sale ("AFS") securities is the market value based on quoted market prices, when available, or market prices provided by recognized broker dealers (Level 1). If listed prices or quotes are not available, fair value is based upon quoted market prices for similar or identical assets or other observable inputs (Level 2) or externally developed models that use unobservable inputs due to limited or no market activity of the instrument (Level 3).

As of September 30, 2015, the fair value of the Company's AFS securities portfolio was $53.5 million. Approximately 53 percent of the portfolio was made up of residential mortgage-backed securities, which had a fair value of $28.2 million at September 30, 2015. Approximately $27.3 million of the residential mortgage-backed securities are guaranteed by the Government National Mortgage Association ("GNMA"), the Federal National Mortgage Association ("FNMA") or the Federal Home Loan Mortgage Corporation ("FHLMC"). The underlying loans for these securities are residential mortgages that are geographically dispersed throughout the United States.

All of the Company’s AFS securities were classified as Level 2 assets at September 30, 2015. The valuation of AFS securities using Level 2 inputs was primarily determined using the market approach, which uses quoted prices for similar assets or liabilities in active markets and all other relevant information. It includes model pricing, defined as valuing securities based upon their relationship with other benchmark securities.

There were no changes in the inputs or methodologies used to determine fair value during the period ended September 30, 2015, as compared to the periods ended December 31, 2014 and September 30, 2014.

The tables below present the balances of assets and liabilities measured at fair value on a recurring basis as of September 30, 2015 and December 31, 2014:


	September 30, 2015
(In thousands)	Level 1		Level 2		Level 3		Total
Securities available for sale:
U.S. Government sponsored entities	$	-	$	5,404	$	-	$	5,404
State and political subdivisions		-		10,717		-		10,717
Residential mortgage-backed securities		-		28,188		-		28,188
Corporate and other securities		-		9,161		-		9,161
Total securities available for sale	$	-	$	53,470	$	-	$	53,470


	December 31, 2014
(In thousands)	Level 1		Level 2		Level 3		Total
Securities available for sale:
U.S. Government sponsored entities	$	-	$	4,618	$	-	$	4,618
State and political subdivisions		-		11,132		-		11,132
Residential mortgage-backed securities		-		34,383		-		34,383
Corporate and other securities		-		9,940		-		9,940
Total securities available for sale	$	-	$	60,073	$	-	$	60,073

Fair Value on a Nonrecurring Basis

Certain assets and liabilities are not measured at fair value on an ongoing basis but are subject to fair value adjustments in certain circumstances (for example, when there is evidence of impairment). The following is a description of the valuation methodologies used for instruments measured at fair value on a nonrecurring basis:

Appraisal Policy

All appraisals must be performed in accordance with the Uniform Standards of Professional Appraisal Practice ("USPAP"). Appraisals are certified to the Company and performed by appraisers on the Company’s approved list of appraisers. Evaluations are completed by a person independent of Company management. The content of the appraisal depends on the complexity of the property. Appraisals are completed on a “retail value” and an “as is value”.

The Company requires current real estate appraisals on all loans that become OREO or in-substance foreclosure, loans that are classified substandard, doubtful or loss, or loans that are over $100,000 and nonperforming. Prior to each balance sheet date, the Company values impaired collateral-dependent loans and OREO based upon a third party appraisal, broker's price opinion, drive by appraisal, automated valuation model, updated market evaluation, or a combination of these methods. The amount is discounted for the decline in market real estate values (for original appraisals), for any known damage or repair costs, and for selling and closing costs. The amount of the discount ranges from 10 to 25 percent and is dependent upon the method used to determine the original value. The original appraisal is generally used when a loan is first determined to be impaired. When applying the discount, the Company takes into consideration when the appraisal was performed, the collateral’s location, the type of collateral, any known damage to the property and the type of business. Subsequent to entering impaired status and the Company determining that there is a collateral shortfall, the Company will generally, depending on the type of collateral, order a third party appraisal, broker's price opinion, automated valuation model or updated market evaluation. After receiving the third party results, the Company will discount the value 8 to 10 percent for selling and closing costs.

OREO

The fair value of OREO is determined using appraisals, which may be discounted based on management’s review and changes in market conditions (Level 3 Inputs).

Impaired Collateral-Dependent Loans

The fair value of impaired collateral-dependent loans is derived in accordance with FASB ASC Topic 310, “Receivables.” Fair value is determined based on the loan’s observable market price or the fair value of the collateral. Partially charged-off loans are measured for impairment based upon an appraisal for collateral-dependent loans. When an updated appraisal is received for a nonperforming loan, the value on the appraisal is discounted in the manner discussed above. If there is a deficiency in the value after the Company applies these discounts, management applies a specific reserve and the loan remains in nonaccrual status. The receipt of an updated appraisal would not qualify as a reason to put a loan back into accruing status. The Company removes loans from nonaccrual status generally when the borrower makes nine months of contractual payments and demonstrates the ability to service the debt going forward. Charge-offs are determined based upon the loss that management believes the Company will incur after evaluating collateral for impairment based upon the valuation methods described above and the ability of the borrower to pay any deficiency.

The valuation allowance for impaired loans is included in the allowance for loan losses in the consolidated balance sheets. At September 30,

2015, the valuation allowance for impaired loans was $984 thousand, a decrease of $177 thousand from $1.2 million at December 31, 2014.

The following tables present the assets and liabilities subject to fair value adjustments (impairment) on a non-recurring basis carried on the balance sheet by caption and by level within the hierarchy (as described above):


	Fair value at September 30, 2015
(In thousands)	Level 1		Level 2		Level 3		Total
Financial assets:
OREO	$	-	$	-	$	1,759	$	1,759
Impaired collateral-dependent loans		-		-		10,130		10,130

	Fair value at December 31, 2014
(In thousands)	Level 1		Level 2		Level 3		Total
Financial assets:
OREO	$	-	$	-	$	1,162	$	1,162
Impaired collateral-dependent loans		-		-		10,996		10,996

Fair Value of Financial Instruments

FASB ASC Topic 825, “Financial Instruments,” requires the disclosure of the estimated fair value of certain financial instruments, including those financial instruments for which the Company did not elect the fair value option. These estimated fair values as of September 30, 2015 and December 31, 2014 have been determined using available market information and appropriate valuation methodologies. Considerable judgment is required to interpret market data to develop estimates of fair value. The estimates presented are not necessarily indicative of amounts the Company could realize in a current market exchange. The use of alternative market assumptions and estimation methodologies could have had a material effect on these estimates of fair value. The methodology for estimating the fair value of financial assets and liabilities that are measured on a recurring or nonrecurring basis are discussed above. The following methods and assumptions were used to estimate the fair value of other financial instruments for which it is practicable to estimate that value:

Cash and Cash Equivalents

For these short-term instruments, the carrying value is a reasonable estimate of fair value.

Securities

The fair value of securities is based upon quoted market prices for similar or identical assets or other observable inputs (Level 2) or externally developed models that use unobservable inputs due to limited or no market activity of the instrument (Level 3).

SBA Loans Held for Sale

The fair value of SBA loans held for sale is estimated by using a market approach that includes significant other observable inputs.

Loans

The fair value of loans is estimated by discounting the future cash flows using current market rates that reflect the interest rate risk inherent in the loan, except for previously discussed impaired loans.

FHLB Stock

Federal Home Loan Bank stock is carried at cost. Carrying value approximates fair value based on the redemption provisions of the issues.

Servicing Assets

Servicing assets do not trade in an active, open market with readily observable prices. The Company estimates the fair value of servicing assets using discounted cash flow models incorporating numerous assumptions from the perspective of a market participant including market discount rates and prepayment speeds.

Accrued Interest

The carrying amounts of accrued interest approximate fair value.

OREO

The fair value of OREO is determined using appraisals, which may be discounted based on management’s review and changes in market conditions (Level 3 Inputs).

Deposit Liabilities

The fair value of demand deposits and savings accounts is the amount payable on demand at the reporting date (i.e. carrying value). The fair value of fixed-maturity certificates of deposit is estimated by discounting the future cash flows using current market rates.

Borrowed Funds and Subordinated Debentures

The fair value of borrowings is estimated by discounting the projected future cash flows using current market rates.

Standby Letters of Credit

At September 30, 2015, the Bank had standby letters of credit outstanding of $1.5 million, consistent with December 31, 2014. The fair value of these commitments is nominal.

The table below presents the carrying amount and estimated fair values of the Company’s financial instruments presented as of September 30, 2015 and December 31, 2014:


			September 30, 2015				December 31, 2014
(In thousands)	Fair value level		Carrying amount		Estimated fair value		Carrying amount		Estimated fair value
Financial assets:
Cash and cash equivalents		Level 1	$	88,857	$	88,857	$	129,821	$	129,821
Securities (1)		Level 2		71,492		71,617		80,082		80,354
SBA loans held for sale		Level 2		13,937		15,208		5,179		5,655
Loans, net of allowance for loan losses (2)		Level 2		829,202		832,715		744,095		748,093
FHLB stock		Level 2		4,510		4,510		6,032		6,032
Servicing assets		Level 3		1,312		1,312		753		753
Accrued interest receivable		Level 2		3,704		3,704		3,518		3,518
OREO		Level 3		1,759		1,759		1,162		1,162
Financial liabilities:
Deposits		Level 2		866,247		867,491		794,341		794,436
Borrowed funds and subordinated debentures		Level 2		105,465		109,020		140,465		145,333
Accrued interest payable		Level 2		460		460		474		474

(1)	Includes held to maturity (“HTM”) commercial mortgage-backed securities that are considered Level 3. These securities had book values of $3.9 million and $4.0 million at September 30, 2015 and December 31, 2014, respectively, and market values of $3.8 million and $4.0 million at September 30, 2015 and December 31, 2014, respectively.
(2)	Includes collateral-dependent impaired loans that are considered Level 3 and reported separately in the tables under the “Fair Value on a Nonrecurring Basis” heading. Collateral-dependent impaired loans, net of specific reserves totaled $10.1 million and $11.0 million at September 30, 2015 and December 31, 2014, respectively.

NOTE 7. Securities

This table provides the major components of AFS and HTM securities at amortized cost and estimated fair value at September 30, 2015 and December 31, 2014:


	September 30, 2015								December 31, 2014
(In thousands)	Amortized cost		Gross unrealized gains		Gross unrealized losses		Estimated fair value		Amortized cost		Gross unrealized gains		Gross unrealized losses		Estimated fair value
Available for sale:
U.S. Government sponsored entities	$	5,457	$	9	$	(62)	$	5,404	$	4,711	$	-	$	(93)	$	4,618
State and political subdivisions		10,686		99		(68)		10,717		11,055		112		(35)		11,132
Residential mortgage-backed securities		27,774		581		(167)		28,188		33,884		646		(147)		34,383
Corporate and other securities		9,471		60		(370)		9,161		10,188		63		(311)		9,940
Total securities available for sale	$	53,388	$	749	$	(667)	$	53,470	$	59,838	$	821	$	(586)	$	60,073
Held to maturity:
U.S. Government sponsored entities	$	4,219	$	-	$	(78)	$	4,141	$	4,440	$	-	$	(124)	$	4,316
State and political subdivisions		2,366		187		-		2,553		2,417		277		-		2,694
Residential mortgage-backed securities		6,525		160		(36)		6,649		8,164		211		(29)		8,346
Commercial mortgage-backed securities		3,928		-		(84)		3,844		4,005		13		(53)		3,965
Corporate and other securities		984		-		(24)		960		983		-		(23)		960
Total securities held to maturity	$	18,022	$	347	$	(222)	$	18,147	$	20,009	$	501	$	(229)	$	20,281

This table provides the remaining contractual maturities and yields of securities within the investment portfolios. The carrying value of securities at September 30, 2015 is distributed by contractual maturity. Mortgage-backed securities and other securities, which may have principal prepayment provisions, are distributed based on contractual maturity. Expected maturities will differ materially from contractual maturities as a result of early prepayments and calls.


	Within one year				After one through five years				After five through ten years				After ten years				Total carrying value
(In thousands, except percentages)	Amount		Yield		Amount		Yield		Amount		Yield		Amount		Yield		Amount		Yield
Available for sale at fair value:
U.S. Government sponsored entities	$	-	-	%	$	2,025	1.35	%	$	926	2.08	%	$	2,453	2.04	%	$	5,404	1.79	%
State and political subdivisions		39	6.43			1,052	2.80			6,072	2.37			3,554	2.56			10,717	2.49
Residential mortgage-backed securities		-	-			1,177	1.85			2,389	2.04			24,622	2.71			28,188	2.61
Corporate and other securities		-	-			2,775	1.13			966	1.04			5,420	1.31			9,161	1.22
Total securities available for sale	$	39	6.43	%	$	7,029	1.56	%	$	10,353	2.14	%	$	36,049	2.44	%	$	53,470	2.27	%
Held to maturity at cost:
U.S. Government sponsored entities	$	-	-	%	$	-	-	%	$	-	-	%	$	4,219	1.97	%	$	4,219	1.97	%
State and political subdivisions		264	0.75			-	-			-	-			2,102	4.73			2,366	4.29
Residential mortgage-backed securities		-	-			246	4.78			201	4.94			6,078	2.84			6,525	2.98
Commercial mortgage-backed securities		-	-			-	-			-	-			3,928	2.75			3,928	2.75
Corporate and other securities		-	-			-	-			984	2.95			-	-			984	2.95
Total securities held to maturity	$	264	0.75	%	$	246	4.78	%	$	1,185	3.29	%	$	16,327	2.84	%	$	18,022	2.86	%

The fair value of securities with unrealized losses by length of time that the individual securities have been in a continuous unrealized loss position at September 30, 2015 and December 31, 2014 are as follows:


	September 30, 2015
			Less than 12 months				12 months and greater				Total
(In thousands, except number in a loss position)	Total number in a loss position		Estimated fair value		Unrealized loss		Estimated fair value		Unrealized loss		Estimated fair value		Unrealized loss
Available for sale:
U.S. Government sponsored entities		5	$	926	$	(3)	$	2,468	$	(59)	$	3,394	$	(62)
State and political subdivisions		5		2,745		(68)		-		-		2,745		(68)
Residential mortgage-backed securities		8		3,796		(15)		4,744		(152)		8,540		(167)
Corporate and other securities		10		4,792		(163)		3,789		(207)		8,581		(370)
Total temporarily impaired securities		28	$	12,259	$	(249)	$	11,001	$	(418)	$	23,260	$	(667)
Held to maturity:
U.S. Government sponsored entities		2	$	-	$	-	$	4,141	$	(78)	$	4,141	$	(78)
Residential mortgage-backed securities		3		-		-		1,961		(36)		1,961		(36)
Commercial mortgage-backed securities		3		3,844		(84)		-		-		3,844		(84)
Corporate and other securities		1		960		(24)		-		-		960		(24)
Total temporarily impaired securities		9	$	4,804	$	(108)	$	6,102	$	(114)	$	10,906	$	(222)


	December 31, 2014
			Less than 12 months				12 months and greater				Total
(In thousands, except number in a loss position)	Total number in a loss position		Estimated fair value		Unrealized loss		Estimated fair value		Unrealized loss		Estimated fair value		Unrealized loss
Available for sale:
U.S. Government sponsored entities		4	$	-	$	-	$	4,590	$	(93)	$	4,590	$	(93)
State and political subdivisions		7		-		-		4,103		(35)		4,103		(35)
Residential mortgage-backed securities		9		6,579		(16)		5,889		(131)		12,468		(147)
Corporate and other securities		7		1,053		(46)		3,736		(265)		4,789		(311)
Total temporarily impaired securities		27	$	7,632	$	(62)	$	18,318	$	(524)	$	25,950	$	(586)
Held to maturity:
U.S. Government sponsored entities		2	$	-	$	-	$	4,316	$	(124)	$	4,316	$	(124)
Residential mortgage-backed securities		3		-		-		2,586		(29)		2,586		(29)
Commercial mortgage-backed securities		1		-		-		1,822		(53)		1,822		(53)
Corporate and other securities		1		-		-		960		(23)		960		(23)
Total temporarily impaired securities		7	$	-	$	-	$	9,684	$	(229)	$	9,684	$	(229)

Unrealized Losses

The unrealized losses in each of the categories presented in the tables above are discussed in the paragraphs that follow:

U.S. government sponsored entities and state and political subdivision securities: The unrealized losses on investments in these types of securities were caused by the increase in interest rate spreads or the increase in interest rates at the long end of the Treasury curve. The contractual terms of these investments do not permit the issuer to settle the securities at a price less than the par value of the investments. Because the Company does not intend to sell the investments and it is not more likely than not that the Company will be required to sell the investments before recovery of their amortized cost basis, which may be at maturity, the Company did not consider these investments to be other-than temporarily impaired as of September 30, 2015. There was no impairment on these securities at December 31, 2014.

Residential and commercial mortgage-backed securities: The unrealized losses on investments in mortgage-backed securities were caused by increases in interest rate spreads or the increase in interest rates at the long end of the Treasury curve. The majority of contractual cash flows of these securities are guaranteed by the FNMA, GNMA, and the FHLMC. It is expected that the securities would not be settled at a price significantly less than the par value of the investment. Because the decline in fair value is attributable to changes in interest rates and not credit quality, and because the Company does not intend to sell the investments and it is not more likely than not that the Company will be required to sell the investments before recovery of their amortized cost basis, which may be at maturity, the Company did not consider these investments to be other-than-temporarily impaired as of September 30, 2015 or December 31, 2014.

Corporate and other securities: Included in this category are corporate debt securities, Community Reinvestment Act (“CRA”) investments, asset-backed securities, and one trust preferred security. The unrealized losses on corporate debt securities were due to widening credit spreads or the increase in interest rates at the long end of the Treasury curve and the unrealized losses on CRA investments were caused by decreases in the market value of underlying bonds and rate changes. The Company evaluated the prospects of the issuers and forecasted a recovery period; and as a result determined it did not consider these investments to be other-than-temporarily impaired as of September 30, 2015 or December 31, 2014. The unrealized loss on the trust preferred security was caused by an inactive trading market and changes in market credit spreads. At September 30, 2015 and December 31, 2014, this category consisted of one single-issuer trust preferred security. The contractual terms do not allow the security to be settled at a price less than the par value. Because the Company does not intend to sell the security and it is not more likely than not that the Company will be required to sell the security before recovery of its amortized cost basis, which may be at maturity, the Company did not consider this security to be other-than-temporarily impaired as of September 30, 2015 or December 31, 2014.

Realized Gains and Losses

Gross realized gains (losses) on securities for the three and nine months ended September 30, 2015 and 2014 are detailed in the table below:


	For the three months ended September 30,				For the nine months ended September 30,
(In thousands)	2015		2014		2015		2014
Available for sale:
Realized gains	$	-	$	-	$	28	$	385
Realized losses		-		-		-		(7)
Total securities available for sale		-		-		28		378
Held to maturity:
Realized gains		-		-		-		-
Realized losses		-		-		-		-
Total securities held to maturity		-		-		-		-
Net gains on sales of securities	$	-	$	-	$	28	$	378

The net realized gains are included in noninterest income in the Consolidated Statements of Income as net security gains. There were no gross realized gains or losses for the three months ended September 30, 2015. For the nine months ended September 30, 2015, there was a gross gain of $28 thousand.

For the nine months ended September 30, 2014, the Company sold one corporate bond totaling $500 thousand in book value, resulting in pre-tax gains of approximately $28 thousand.

There were no realized gains or losses for the three months ended September 30, 2014, and there were gross realized gains of $385 thousand for the nine months ended September 30, 2014. There were no gross realized losses for the three months ended September 30, 2014 and there were gross realized losses of $7 thousand for the nine months ended September 30, 2014. The net realized gains during 2014 were a result of the following:

For the nine months ended September 30, 2014, the Company sold approximately $17.5 million in book value of available for sale municipal securities, mortgage-backed securities, asset-backed securities, and corporate bonds, resulting in pre-tax gains of approximately $385 thousand.

Pledged Securities

Securities with a carrying value of $18.3 million and $50.4 million at September 30, 2015 and December 31, 2014, respectively, were pledged to secure Government deposits, secure other borrowings and for other purposes required or permitted by law. Securities pledged for Government deposits totaled $0 and $32.1 million at September 30, 2015 and December 31, 2014, respectively. In June 2015, the FHLB issued a letter of credit in the name of Unity Bank naming the NJ Dept. of Banking and Insurance as beneficiary. The letter of credit will take the place of securities previously pledged to the state for the Bank’s municipal deposits. For additional information on amounts pledged to secure Government deposits at September 30, 2015, see section titled “Borrowed Funds and Subordinated Debentures” under Item 2. Management Discussion and Analysis.

Note 8. Loans

The following table sets forth the classification of loans by class, including unearned fees, deferred costs and excluding the allowance for loan losses as of September 30, 2015 and December 31, 2014:


(In thousands)	September 30, 2015		December 31, 2014
SBA loans held for investment	$	39,728	$	40,401
SBA 504 loans		29,221		34,322
Commercial loans
Commercial other		45,679		40,607
Commercial real estate		373,427		339,693
Commercial real estate construction		23,864		21,649
Residential mortgage loans		255,447		220,878
Consumer loans
Home equity		43,533		41,451
Consumer other		30,724		17,645
Total loans held for investment	$	841,623	$	756,646
SBA loans held for sale		13,937		5,179
Total loans	$	855,560	$	761,825

Loans are made to individuals as well as commercial entities. Specific loan terms vary as to interest rate, repayment, and collateral requirements based on the type of loan requested and the credit worthiness of the prospective borrower. Credit risk tends to be geographically concentrated in that a majority of the loan customers are located in the markets serviced by the Bank. As a preferred SBA lender, a portion of the SBA portfolio is to borrowers outside the Company’s market area. However, during late 2008, the Company withdrew from SBA lending outside of its primary trade area, but continues to offer SBA loan products as an additional credit product within its primary trade area. Loan performance may be adversely affected by factors impacting the general economy or conditions specific to the real estate market such as geographic location and/or property type. A description of the Company's different loan segments follows:

SBA Loans: SBA 7(a) loans, on which the SBA has historically provided guarantees of up to 90 percent of the principal balance, are considered a higher risk loan product for the Company than its other loan products. The guaranteed portion of the Company’s SBA loans is generally sold in the secondary market with the nonguaranteed portion held in the portfolio as a loan held for investment. SBA loans are for the purpose of providing working capital, financing the purchase of equipment, inventory or commercial real estate and for other business purposes. Loans are guaranteed by the businesses' major owners. SBA loans are made based primarily on the historical and projected cash flow of the business and secondarily on the underlying collateral provided.

SBA 504 Loans: The SBA 504 program consists of real estate backed commercial mortgages where the Company has the first mortgage and the SBA has the second mortgage on the property. SBA 504 loans are made based primarily on the historical and projected cash flow of the business and secondarily on the underlying collateral provided. Generally, the Company has a 50 percent loan to value ratio on SBA 504 program loans at origination.

Commercial Loans: Commercial credit is extended primarily to middle market and small business customers. 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. Loans will generally be guaranteed in full or for a meaningful amount by the businesses' major owners. Commercial loans are made based primarily on the historical and projected cash flow of the business and secondarily on the underlying collateral provided.

Residential Mortgage and Consumer Loans: The Company originates mortgage and consumer loans including principally residential real estate and home equity lines and loans. Each loan type is evaluated on debt to income, type of collateral and loan to collateral value, credit history and Company’s relationship with the borrower.

Inherent in the lending function is credit risk, which is the possibility a borrower may not perform in accordance with the contractual terms of their loan. A borrower’s inability to pay their obligations according to the contractual terms can create the risk of past due loans and, ultimately, credit losses, especially on collateral deficient loans. The Company minimizes its credit risk by loan diversification and adhering to credit administration policies and procedures. Due diligence on loans begins when we initiate contact regarding 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 on-going internal reviews for credit quality which in part is derived from ongoing collection and review of borrowers’ financial information, as well as independent credit reviews by an outside firm.

The Company's extension of credit is governed by the Credit Risk Policy which was established to control the quality of the Company's loans. These policies and procedures are reviewed and approved by the Board of Directors on a regular basis.

Credit Ratings

For SBA 7(a), SBA 504 and commercial loans, management uses internally assigned risk ratings as the best indicator of credit quality. A loan’s internal risk rating is updated at least annually and more frequently if circumstances warrant a change in risk rating. The Company uses a 1 through 10 loan grading system that follows regulatorily accepted definitions.

Pass: Risk ratings of 1 through 6 are used for loans that are performing, as they meet, and are expected to continue to meet, all of the terms and conditions set forth in the original loan documentation, and are generally current on principal and interest payments. These performing loans are termed “Pass”.

Special Mention: Criticized loans are assigned a risk rating of 7 and termed “Special Mention”, as the borrowers exhibit potential credit weaknesses or downward trends deserving management’s close attention. If not checked or corrected, these trends will weaken the Bank’s collateral and position. While potentially weak, these borrowers are currently marginally acceptable and no loss of interest or principal is anticipated. As a result, special mention assets do not expose an institution to sufficient risk to warrant adverse classification. Included in “Special Mention” could be turnaround situations, such as borrowers with deteriorating trends beyond one year, borrowers in startup or deteriorating industries, or borrowers with a poor market share in an average industry. "Special Mention" loans may include an element of asset quality, financial flexibility, or below average management. Management and ownership may have limited depth or experience. Regulatory agencies have agreed on a consistent definition of “Special Mention” as an asset with potential weaknesses which, if left uncorrected, may result in deterioration of the repayment prospects for the asset or in the Bank’s credit position at some future date. This definition is intended to ensure that the “Special Mention” category is not used to identify assets that have as their sole weakness credit data exceptions or collateral documentation exceptions that are not material to the repayment of the asset.

Substandard: Classified loans are assigned a risk rating of an 8 or 9, depending upon the prospect for collection, and deemed “Substandard”. A risk rating of 8 is used for borrowers with well-defined weaknesses that jeopardize the orderly liquidation of debt. The loan is inadequately protected by the current paying capacity of the obligor or by the collateral pledged, if any. Normal repayment from the borrower is in jeopardy, although no loss of principal is envisioned. There is a distinct possibility that a partial loss of interest and/or principal will occur if the deficiencies are not corrected. Loss potential, while existing in the aggregate amount of substandard assets, does not have to exist in individual assets classified “Substandard”.

A risk rating of 9 is used for borrowers that have all the weaknesses inherent in a loan with a risk rating of 8, with the added characteristic that the weaknesses make collection of debt in full, on the basis of currently existing facts, conditions, and values, highly questionable and improbable. Serious problems exist to the point where partial loss of principal is likely. The possibility of loss is extremely high, but because of certain important, reasonably specific pending factors that may work to strengthen the assets, the loans’ classification as estimated losses is deferred until a more exact status may be determined. Pending factors include proposed merger, acquisition, or liquidation procedures; capital injection; perfecting liens on additional collateral; and refinancing plans. Partial charge-offs are likely.

Loss: Once a borrower is deemed incapable of repayment of unsecured debt, the risk rating becomes a 10, the loan is termed a “Loss”, and charged-off immediately. Loans to such borrowers are considered uncollectible and of such little value that continuance as active assets of the Bank is not warranted. This classification does not mean that the loan has absolutely no recovery or salvage value, but rather it is not practical or desirable to defer writing off these basically worthless assets even though partial recovery may be affected in the future.

For residential mortgage and consumer loans, management uses performing versus nonperforming as the best indicator of credit quality. Nonperforming 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 ability to collect principal and interest according to the contractual terms is in doubt. These credit quality indicators are updated on an ongoing basis, as a loan is placed on nonaccrual status as soon as management believes there is sufficient doubt as to the ultimate ability to collect interest on a loan.

At September 30, 2015, the Company owned $96 thousand of residential consumer properties that were included in OREO in the Consolidated Balance Sheets. Additionally, there were $1.9 million of residential consumer loans in the process of foreclosure.

The tables below detail the Company’s loan portfolio by class according to their credit quality indicators discussed in the paragraphs above as of September 30, 2015:


	September 30, 2015
	SBA, SBA 504 & Commercial loans - Internal risk ratings
(In thousands)	Pass		Special mention		Substandard		Total
SBA loans held for investment	$	35,438	$	2,539	$	1,751	$	39,728
SBA 504 loans		23,823		4,956		442		29,221
Commercial loans
Commercial other		42,132		2,436		1,111		45,679
Commercial real estate		348,381		19,808		5,238		373,427
Commercial real estate construction		23,166		698		-		23,864
Total commercial loans		413,679		22,942		6,349		442,970
Total SBA, SBA 504 and commercial loans	$	472,940	$	30,437	$	8,542	$	511,919

	Residential mortgage & Consumer loans - Performing/Nonperforming
(In thousands)			Performing		Nonperforming		Total
Residential mortgage loans			$	253,535	$	1,912	$	255,447
Consumer loans
Home equity				42,774		759		43,533
Consumer other				30,724		-		30,724
Total consumer loans				73,498		759		74,257
Total residential mortgage and consumer loans			$	327,033	$	2,671	$	329,704

The tables below detail the Company’s loan portfolio by class according to their credit quality indicators discussed in the paragraphs above as of December 31, 2014:


	December 31, 2014
	SBA, SBA 504 & Commercial loans - Internal risk ratings
(In thousands)	Pass		Special mention		Substandard		Total
SBA loans held for investment	$	35,827	$	2,250	$	2,324	$	40,401
SBA 504 loans		24,415		5,967		3,940		34,322
Commercial loans
Commercial other		38,054		1,270		1,283		40,607
Commercial real estate		315,015		20,555		4,123		339,693
Commercial real estate construction		21,649		-		-		21,649
Total commercial loans		374,718		21,825		5,406		401,949
Total SBA, SBA 504 and commercial loans	$	434,960	$	30,042	$	11,670	$	476,672

	Residential mortgage & Consumer loans - Performing/Nonperforming
(In thousands)			Performing		Nonperforming		Total
Residential mortgage loans			$	220,233	$	645	$	220,878
Consumer loans
Home equity				40,908		543		41,451
Consumer other				17,643		2		17,645
Total consumer loans				58,551		545		59,096
Total residential mortgage and consumer loans			$	278,784	$	1,190	$	279,974

Nonperforming and Past Due Loans

Nonperforming 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 ability to collect principal and interest according to the contractual terms is in doubt. Loans past due 90 days or more and still accruing interest are not included in nonperforming loans and generally represent loans that are well collateralized and in a continuing process expected to result in repayment or restoration to current status. The risk of loss is difficult to quantify and is subject to fluctuations in collateral values, general economic conditions and other factors. The improved state of the economy has resulted in a substantial reduction in nonperforming loans and loan delinquencies. The Company values its collateral through the use of appraisals, broker price opinions, and knowledge of its local market.

The following tables set forth an aging analysis of past due and nonaccrual loans as of September 30, 2015 and December 31, 2014:


	September 30, 2015
(In thousands)	30-59 days past due		60-89 days past due		90+ days and still accruing		Nonaccrual (1)		Total past due		Current		Total loans
SBA loans held for investment	$	934	$	84	$	-	$	1,584	$	2,602	$	37,126	$	39,728
SBA 504 loans		-		-		-		276		276		28,945		29,221
Commercial loans
Commercial other		-		15		-		973		988		44,691		45,679
Commercial real estate		430		48		-		5,238		5,716		367,711		373,427
Commercial real estate construction		-		-		-		-		-		23,864		23,864
Residential mortgage loans		2,387		322		272		1,912		4,893		250,554		255,447
Consumer loans
Home equity		356		48		-		759		1,163		42,370		43,533
Consumer other		-		-		-		-		-		30,724		30,724
Total loans held for investment	$	4,107	$	517	$	272	$	10,742	$	15,638	$	825,985	$	841,623
SBA loans held for sale		-		-		-		-		-		13,937		13,937
Total loans	$	4,107	$	517	$	272	$	10,742	$	15,638	$	839,922	$	855,560

(1)

At September 30, 2015, nonaccrual loans included $2.8 million of TDRs and $225 thousand of loans guaranteed by the SBA. The remaining $3.3 million of TDRs are in accrual status because they are performing in accordance with their restructured terms.


	December 31, 2014
(In thousands)	30-59 days past due		60-89 days past due		90+ days and still accruing		Nonaccrual (1)		Total past due		Current		Total loans
SBA loans held for investment	$	1,093	$	147	$	161	$	3,348	$	4,749	$	35,652	$	40,401
SBA 504 loans		1,639		-		-		2,109		3,748		30,574		34,322
Commercial loans
Commercial other		-		-		-		1,129		1,129		39,478		40,607
Commercial real estate		2,812		-		7		3,592		6,411		333,282		339,693
Commercial real estate construction		-		-		-		-		-		21,649		21,649
Residential mortgage loans		2,887		658		722		645		4,912		215,966		220,878
Consumer loans
Home equity		639		213		-		543		1,395		40,056		41,451
Consumer other		-		6		-		2		8		17,637		17,645
Total loans held for investment	$	9,070	$	1,024	$	890	$	11,368	$	22,352	$	734,294	$	756,646
SBA loans held for sale		-		-		-		-		-		5,179		5,179
Total loans	$	9,070	$	1,024	$	890	$	11,368	$	22,352	$	739,473	$	761,825

(1)

At December 31, 2014, nonaccrual loans included $3.0 million of TDRs and $1.6 million of loans guaranteed by the SBA. The remaining $3.5 million of TDRs are in accrual status because they are performing in accordance with their restructured terms.

Impaired Loans

The Company has defined impaired loans to be all nonperforming loans individually evaluated for impairment and TDRs. Management considers a loan impaired when, based on current information and events, it is determined that the Company will not be able to collect all amounts due according to the loan contract. Impairment is evaluated on an individual basis for SBA, SBA 504, and commercial loans.

The following table provides detail on the Company’s impaired loans that are individually evaluated for impairment with the associated allowance amount, if applicable, as of September 30, 2015:


	September 30, 2015
(In thousands)	Unpaid principal balance		Recorded investment		Specific reserves
With no related allowance:
SBA loans held for investment (1)	$	1,159	$	596	$	-
SBA 504 loans		1,999		1,999		-
Commercial loans
Commercial other		962		962		-
Commercial real estate		2,053		2,053		-
Total commercial loans		3,015		3,015		-
Total impaired loans with no related allowance		6,173		5,610		-

With an allowance:
SBA loans held for investment (1)		1,728		1,184		657
Commercial loans
Commercial other		34		11		11
Commercial real estate		4,309		4,309		316
Total commercial loans		4,343		4,320		327
Total impaired loans with a related allowance		6,071		5,504		984

Total individually evaluated impaired loans:
SBA loans held for investment (1)		2,887		1,780		657
SBA 504 loans		1,999		1,999		-
Commercial loans
Commercial other		996		973		11
Commercial real estate		6,362		6,362		316
Total commercial loans		7,358		7,335		327
Total individually evaluated impaired loans	$	12,244	$	11,114	$	984

(1)

Balances are reduced by amount guaranteed by the SBA of $225 thousand at September 30, 2015.

The following table provides detail on the Company’s impaired loans that are individually evaluated for impairment with the associated allowance amount, if applicable, as of December 31, 2014:


	December 31, 2014
(In thousands)	Unpaid principal balance		Recorded investment		Specific reserves
With no related allowance:
SBA loans held for investment (1)	$	1,719	$	1,093	$	-
SBA 504 loans		2,202		2,202		-
Commercial loans
Commercial other		878		877		-
Commercial real estate		2,017		1,927		-
Total commercial loans		2,895		2,804		-
Total impaired loans with no related allowance		6,816		6,099		-

With an allowance:
SBA loans held for investment (1)		1,521		1,127		502
SBA 504 loans		1,676		1,676		510
Commercial loans
Commercial other		364		252		41
Commercial real estate		3,003		3,003		108
Total commercial loans		3,367		3,255		149
Total impaired loans with a related allowance		6,564		6,058		1,161

Total individually evaluated impaired loans:
SBA loans held for investment (1)		3,240		2,220		502
SBA 504 loans		3,878		3,878		510
Commercial loans
Commercial other		1,242		1,129		41
Commercial real estate		5,020		4,930		108
Total commercial loans		6,262		6,059		149
Total individually evaluated impaired loans	$	13,380	$	12,157	$	1,161

(1)

Balances are reduced by amount guaranteed by the SBA of $1.6 million at December 31, 2014.

The following tables present the average recorded investments in impaired loans and the related amount of interest recognized during the time period in which the loans were impaired for the nine months ended September 30, 2015 and 2014. The average balances are calculated based on the month-end balances of impaired loans. When the ultimate collectability of the total principal of an impaired loan is in doubt and the loan is on nonaccrual status, all payments are applied to principal under the cost recovery method, and therefore no interest income is recognized. The interest income recognized on impaired loans noted below represents primarily accruing TDRs and nominal amounts of income recognized on a cash basis for well-collateralized impaired loans.


	For the three months ended September 30,
	2015				2014
(In thousands)	Average recorded investment		Interest income recognized on impaired loans		Average recorded investment		Interest income recognized on impaired loans
SBA loans held for investment (1)	$	1,773	$	30	$	3,118	$	72
SBA 504 loans		2,010		27		3,344		27
Commercial loans
Commercial other		987		35		161		-
Commercial real estate		5,732		37		5,535		44
Commercial real estate construction		-		-		-		23
Total	$	10,502	$	129	$	12,158	$	166

(1)

Balances are reduced by the average amount guaranteed by the SBA of $306 thousand and $732 thousand for the three months ended September 30, 2015 and 2014, respectively.


	For the nine months ended September 30,
	2015				2014
(In thousands)	Average recorded investment		Interest income recognized on impaired loans		Average recorded investment		Interest income recognized on impaired loans
SBA loans held for investment (1)	$	1,881	$	69	$	3,111	$	127
SBA 504 loans		2,625		79		2,760		82
Commercial loans
Commercial other		1,059		92		101		2
Commercial real estate		5,096		108		6,607		167
Commercial real estate construction		-		-		97		23
Total	$	10,661	$	348	$	12,676	$	401

(1)

Balances are reduced by the average amount guaranteed by the SBA of $458 thousand and $1.2 million for the nine months ended September 30, 2015 and 2014, respectively.

TDRs

The Company's loan portfolio also includes certain loans that have been modified as TDRs. TDRs occur when a creditor, for economic or legal reasons related to a debtor’s financial condition, grants a concession to the debtor that it would not otherwise consider, unless it results in a delay in payment that is insignificant. These concessions typically include reductions in interest rate, extending the maturity of a loan, or a combination of both. When the Company modifies a loan, management evaluates for any possible impairment using either the discounted cash flows method, where the value of the modified loan is based on the present value of expected cash flows, discounted at the contractual interest rate of the original loan agreement, or by using the fair value of the collateral less selling costs if the loan is collateral-dependent. If management determines that the value of the modified loan is less than the recorded investment in the loan, impairment is recognized by segment or class of loan, as applicable, through an allowance estimate or charge-off to the allowance. This process is used, regardless of loan type, and for loans modified as TDRs that subsequently default on their modified terms.

TDRs of $6.1 million and $6.5 million are included in the impaired loan numbers as of September 30, 2015 and December 31, 2014, respectively. The decrease was due to principal pay downs. At September 30, 2015, there were specific reserves of $407 thousand on TDRs, $177 thousand on performing TDRs and $230 thousand on nonperforming TDRs. At December 31, 2014, there were specific reserves of $223 thousand on TDRs, $24 thousand on performing TDRs and $199 thousand on nonperforming TDRs. At September 30, 2015, $2.8 million of TDRs were in nonaccrual status, compared to $3.0 million at December 31, 2014. The remaining TDRs are in accrual status since they continue to perform in accordance with their restructured terms.

To date, the Company’s TDRs consisted of interest rate reductions and maturity extensions. There has been no principal forgiveness. There were no loans modified during the three or nine months ended September 30, 2015 and 2014 that were deemed to be TDRs.

There were no loans modified as a TDR within the previous 12 months that subsequently defaulted at some point during the three or nine months ended September 30, 2015. During 2015, there was one loan modified as a TDR within the previous 12 months where a concession was made and the loan subsequently defaulted at some point during the nine months ended September 30, 2014. In this case, subsequent default is defined as being transferred to nonaccrual status. There were no additional defaults during the previous year to date period.


	For the nine months ended September 30,
	2015				2014
(In thousands, except number of contracts)	Number of contracts		Recorded investment		Number of contracts		Recorded investment
SBA loans held for investment		-	$	-		1	$	131
Total		-	$	-		1	$	131

Note 9. Allowance for Loan Losses and Reserve for Unfunded Loan Commitments

Allowance for Loan Losses

The Company has an established methodology to determine the adequacy of the allowance for loan losses that assesses the risks and losses inherent in the loan portfolio. At a minimum, the adequacy of the allowance for loan losses is reviewed by management on a quarterly basis. For purposes of determining the allowance for loan losses, the Company has segmented the loans in its portfolio by loan type. Loans are segmented into the following pools: SBA 7(a), SBA 504, commercial, residential mortgages, and consumer loans. Certain portfolio segments are further broken down into classes based on the associated risks within those segments and the type of collateral underlying each loan. Commercial loans are divided into the following four classes: commercial real estate, commercial real estate construction, unsecured business line of credit and commercial other. Consumer loans are divided into two classes as follows: Home equity and other.

The standardized methodology used to assess the adequacy of the allowance includes the allocation of specific and general reserves. The same standard methodology is used, regardless of loan type. Specific reserves are made to individual impaired loans and TDRs (see Note 1 for additional information on this term). The general reserve is set based upon a representative average historical net charge-off rate adjusted for the following environmental factors: delinquency and impairment trends, charge-off and recovery trends, changes in the volume of restructured loans, volume and loan term trends, changes in risk and underwriting policy trends, staffing and experience changes, national and local economic trends, industry conditions and credit concentration changes. Within the five-year historical net charge-off rate, the Company weights the past three years more heavily as it believes it is more indicative of future charge-offs. All of the environmental factors are ranked and assigned a basis points value based on the following scale: low, low moderate, moderate, high moderate and high risk. Each environmental factor is evaluated separately for each class of loans and risk weighted based on its individual characteristics.

For SBA 7(a), SBA 504 and commercial loans, the estimate of loss based on pools of loans with similar characteristics is made through the use of a standardized loan grading system that is applied on an individual loan level and updated on a continuous basis. The loan grading system incorporates reviews of the financial performance of the borrower, including cash flow, debt-service coverage ratio, earnings power, debt level and equity position, in conjunction with an assessment of the borrower's industry and future prospects. It also incorporates analysis of the type of collateral and the relative loan to value ratio.

For residential mortgage and consumer loans, the estimate of loss is based on pools of loans with similar characteristics. Factors such as credit score, delinquency status and type of collateral are evaluated. Factors are updated frequently to capture the recent behavioral characteristics of the subject portfolios, as well as any changes in loss mitigation or credit origination strategies, and adjustments to the reserve factors are made as needed.

According to the Company’s policy, a loss (“charge-off”) is to be recognized and charged to the allowance for loan losses as soon as a loan is recognized as uncollectable. All credits which are 90 days past due must be analyzed for the Company’s ability to collect on the credit. Once a loss is known to exist, the charge-off approval process is immediately expedited. This charge-off policy is followed for all loan types.

The allocated allowance is the total of identified specific and general reserves by loan category. The allocation is not necessarily indicative of the categories in which future losses may occur. The total allowance is available to absorb losses from any segment of the portfolio. An unallocated component is maintained to cover uncertainties that could affect management’s estimate of probable losses. The unallocated component of the allowance reflects the margin of imprecision inherent in the underlying assumptions used in methodologies for estimating allocated and general reserves in the portfolio. The unallocated portion of the allowance decreased during the quarter ended September 30, 2015 to $51 thousand from $105 thousand at December 31, 2014. The decrease in the unallocated was due to improvements in current period charge off percentages offset by a larger loan portfolio requiring a larger general reserve and increased loan volume.

The following tables detail the activity in the allowance for loan losses by portfolio segment for the three months ended September 30, 2015 and 2014:


	For the three months ended September 30, 2015
(In thousands)	SBA held for investment		SBA 504		Commercial		Residential		Consumer		Unallocated		Total
Balance, beginning of period	$	1,998	$	879	$	6,059	$	2,545	$	756	$	167	$	12,404
Charge-offs		(86)		-		(10)		(50)		(52)		-		(198)
Recoveries		10		-		5		-		-		-		15
Net (charge-offs) recoveries		(76)		-		(5)		(50)		(52)		-		(183)
Provision for loan losses charged to expense		(11)		(89)		146		186		84		(116)		200
Balance, end of period	$	1,911	$	790	$	6,200	$	2,681	$	788	$	51	$	12,421


	For the three months ended September 30, 2014
(In thousands)	SBA held for investment		SBA 504		Commercial		Residential		Consumer		Unallocated		Total
Balance, beginning of period	$	2,505	$	929	$	6,282	$	2,171	$	741	$	230	$	12,858
Charge-offs		(232)		-		(72)		(201)		(211)		-		(716)
Recoveries		111		-		95		20		-		-		226
Net (charge-offs) recoveries		(121)		-		23		(181)		(211)		-		(490)
Provision for loan losses charged to expense		(102)		(69)		148		371		287		(85)		550
Balance, end of period	$	2,282	$	860	$	6,453	$	2,361	$	817	$	145	$	12,918

The following tables detail the activity in the allowance for loan losses by portfolio segment for the nine months ended September 30, 2015 and 2014:


	For the nine months ended September 30, 2015
(In thousands)	SBA held for investment		SBA 504		Commercial		Residential		Consumer		Unallocated		Total
Balance, beginning of period	$	1,883	$	1,337	$	6,270	$	2,289	$	667	$	105	$	12,551
Charge-offs		(220)		(589)		(257)		(50)		(89)		-		(1,205)
Recoveries		49		-		576		49		1		-		675
Net (charge-offs) recoveries		(171)		(589)		319		(1)		(88)		-		(530)
Provision for loan losses charged to expense		199		42		(389)		393		209		(54)		400
Balance, end of period	$	1,911	$	790	$	6,200	$	2,681	$	788	$	51	$	12,421


	For the nine months ended September 30, 2014
(In thousands)	SBA held for investment		SBA 504		Commercial		Residential		Consumer		Unallocated		Total
Balance, beginning of period	$	2,587	$	957	$	6,840	$	2,132	$	573	$	52	$	13,141
Charge-offs		(485)		(92)		(660)		(378)		(593)		-		(2,208)
Recoveries		129		-		135		20		1		-		285
Net (charge-offs) recoveries		(356)		(92)		(525)		(358)		(592)		-		(1,923)
Provision for loan losses charged to expense		51		(5)		138		587		836		93		1,700
Balance, end of period	$	2,282	$	860	$	6,453	$	2,361	$	817	$	145	$	12,918

The following tables present loans and their related allowance for loan losses, by portfolio segment, as of September 30, 2015 and December 31, 2014:


	September 30, 2015
(In thousands)	SBA held for investment		SBA 504		Commercial		Residential		Consumer		Unallocated		Total
Allowance for loan losses ending balance:
Individually evaluated for impairment	$	657	$	-	$	327	$	-	$	-	$	-	$	984
Collectively evaluated for impairment		1,254		790		5,873		2,681		788		51		11,437
Total	$	1,911	$	790	$	6,200	$	2,681	$	788	$	51	$	12,421
Loan ending balances:
Individually evaluated for impairment	$	1,780	$	1,999	$	7,335	$	-	$	-	$	-	$	11,114
Collectively evaluated for impairment		37,948		27,222		435,635		255,447		74,257		-		830,509
Total	$	39,728	$	29,221	$	442,970	$	255,447	$	74,257	$	-	$	841,623


	December 31, 2014
(In thousands)	SBA held for investment		SBA 504		Commercial		Residential		Consumer		Unallocated		Total
Allowance for loan losses ending balance:
Individually evaluated for impairment	$	502	$	510	$	149	$	-	$	-	$	-	$	1,161
Collectively evaluated for impairment		1,381		827		6,121		2,289		667		105		11,390
Total	$	1,883	$	1,337	$	6,270	$	2,289	$	667	$	105	$	12,551
Loan ending balances:
Individually evaluated for impairment	$	2,220	$	3,878	$	6,059	$	-	$	-	$	-	$	12,157
Collectively evaluated for impairment		38,181		30,444		395,890		220,878		59,096		-		744,489
Total	$	40,401	$	34,322	$	401,949	$	220,878	$	59,096	$	-	$	756,646

Changes in Methodology:

The Company did not make any changes to its allowance for loan losses methodology in the current period.

Reserve for Unfunded Loan Commitments

In addition to the allowance for loan losses, the Company maintains a reserve for unfunded loan commitments at a level that management believes is adequate to absorb estimated probable losses. Adjustments to the reserve are made through other expense and applied to the reserve which is classified as other liabilities. At September 30, 2015, a $148 thousand commitment reserve was reported on the balance sheet as an “other liability”, compared to a $151 thousand commitment reserve at December 31, 2014.

Note 10. New Accounting Pronouncements

ASU 2014-09, “Revenue from Contracts with Customers (Topic 606).” This ASU has three sections:

Section A – Summary and amendments that creates revenue from contracts with customers (Topic 606) and Other Assets and Deferred Costs – Contracts with Customers (Subtopic 340-40);

Section B – Conforming amendments to other topics and subtopics in the codification and status tables;

Section C – Background information and basis for conclusions.

The accounting changes in this update have been revised to defer the effective date for public business entities for annual reporting periods beginning after December 15, 2017 and the interim periods within that year. Early adoption is permitted as of the first interim or annual period beginning after December 15, 2016. The Company is currently evaluating the impact of the standard.

ASU 2015-01, “Income Statement-Extraordinary and Unusual Items (Subtopic 225-20): Simplifying Income Statement Presentation by Eliminating the Concept of Extraordinary Items.” ASU 2015-01 seeks to eliminate from generally accepted accounting principles (“GAAP”) the concept of extraordinary items. Presently, an event or transaction is presumed to be an ordinary and usual activity of the reporting entity unless evidence clearly supports its classification as an extraordinary item. The guidance was issued as part of an initiative to reduce complexity in accounting standards. The amendments in this update are effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2015. A reporting entity may apply the amendments prospectively. A reporting entity also may apply the amendments retrospectively to all prior periods presented in the financial statements. Early adoption is permitted provided that the guidance is applied from the beginning of the fiscal year of adoption. The effective date is the same for both public business entities and all other entities. The Company does not expect adoption of this guidance to have a material effect on the financial condition or results of operations of the Company.

Note 11. Subsequent Event

Subsequent to September 30, 2015, the Company accepted an offer from the FHLB to modify the rate and terms of two existing borrowings. A $10 million FHLB advance with a rate of 4.03% with an original maturity of November 2, 2016 will be modified into a 5 year no-call 1 year (callable quarterly) at a rate of 2.02%. Secondly, a $10 million FHLB advance with a rate of 4.19% with an original maturity of December 15, 2016 will be modified into a 5 year no-call 1 year (callable quarterly) at a rate of 2.15%.

ITEM 2Management'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 2014 consolidated audited financial statements and notes thereto included in our Annual Report on Form 10-K for the year ended December 31, 2014. 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, in addition to those items contained in the Company’s Annual Report on Form 10-K under Item IA-Risk Factors, as updated by our subsequent Quarterly Reports on Form 10-Q, the following: changes in general, economic, and market conditions, legislative and regulatory conditions, or the development of an interest rate environment that adversely affects Unity Bancorp, Inc.’s interest rate spread or other income anticipated from operations and investments.

Overview

Unity Bancorp, Inc. (the “Parent Company”) is incorporated in New Jersey and is registered as a bank holding company under the Bank Holding Company Act of 1956, as amended. Its 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 September 13, 1991. The Bank provides a full range of commercial and retail banking services through 15 branch offices located in Hunterdon, Somerset, Middlesex, Union and Warren counties in New Jersey, and Northampton County in Pennsylvania as well as a loan production office in Bergen County, New Jersey. These services include the acceptance of demand, savings, and time deposits and the extension of consumer, real estate, SBA and other commercial credits. The Bank has multiple subsidiaries used to hold part of its investment and loan portfolios and OREO properties.

Unity (NJ) Statutory Trust II is a statutory business trust and wholly owned subsidiary of Unity Bancorp, Inc. On July 24, 2006, the Trust issued $10.0 million of trust preferred securities to investors. Unity (NJ) Statutory Trust III is a statutory business trust and wholly owned subsidiary of Unity Bancorp, Inc. On December 19, 2006, the Trust issued $5.0 million of trust preferred securities to investors. These floating rate securities are treated as subordinated debentures on the Company’s financial statements. However, they qualify as Tier I Capital for regulatory capital compliance purposes, subject to certain limitations. The Company does not consolidate the accounts and related activity of any of its business trust subsidiaries.

Earnings Summary

Net income totaled $2.6 million, or $0.30 per diluted share for the three months ended September 30, 2015, a 35 percent increase compared to $1.9 million, or $0.24 per diluted share for the same period a year ago. Return on average assets and average common equity for the quarter were 1.00% and 13.54%, respectively, compared to 0.82% and 11.89% for the same period a year ago. The continued improvement in operating results is the product of strategic initiatives, which include expansion of in-market loan and deposit relationships, improving credit quality and core earnings growth.

Third quarter highlights include:

12.3% loan growth since year-end 2014 – 25.7% growth in consumer loans, 15.7% growth in residential mortgage loans, and 10.2% growth in commercial loans.

14.7% increase in noninterest-bearing demand deposits since year-end 2014.

13.0% increase in net interest income compared to the prior year’s quarter due to strong loan growth.

Net interest margin of 3.60% this quarter compared to 3.56% in the prior year’s quarter.

Improved credit quality metrics and reduced loan loss provision – $307 thousand decrease in net charge-offs compared to the prior year’s quarter and a 9.1% decrease in nonperforming loans.

For the nine months ended September 30, 2015, net income totaled $6.9 million, or $0.81 per diluted share, compared to $4.7 million or $0.61 per diluted share in the prior year’s period. Return on average assets and average common equity for the nine month periods were 0.95% and 12.69%, respectively, compared to 0.70% and 10.47% for the same period a year ago.

The Company's quarterly and year-to-date performance ratios may be found in the table below.


	For the three months ended September 30,						For the nine months ended September 30,
	2015			2014			2015			2014
Net income per common share - Basic (1)	$	0.30		$	0.24		$	0.82		$	0.61
Net income per common share - Diluted (1)	$	0.30		$	0.24		$	0.81		$	0.61
Return on average assets		1.00	%		0.82	%		0.95	%		0.70	%
Return on average equity (2)		13.54	%		11.89	%		12.69	%		10.47	%
Efficiency ratio		62.88	%		65.80	%		64.97	%		69.40	%

(1)

Defined as net income divided by weighted average shares outstanding.

(2)

Defined as net income divided by average shareholders' equity.

Net Interest Income

The primary source of the Company’s operating income is net interest income, which is the difference between interest and dividends earned on earning assets and fees earned on loans, and interest paid on interest-bearing liabilities. Earning assets include loans to individuals and businesses, investment securities, interest-earning deposits and federal funds sold. Interest-bearing liabilities include interest-bearing demand, savings and time deposits, FHLB advances and other borrowings. Net interest income is determined by the difference between the yields earned on earning assets and the rates paid on interest-bearing liabilities (“net interest spread”) and the relative amounts of earning assets and interest-bearing liabilities. The Company’s net interest spread is affected by regulatory, economic and competitive factors that influence interest rates, loan demand, deposit flows and general levels of nonperforming assets.

During the quarter ended September 30, 2015, tax-equivalent net interest income amounted to $8.7 million, an increase of $986 thousand or 12.9 percent when compared to the same period in 2014. The net interest margin increased 4 basis points to 3.60 percent for the quarter ended September 30, 2015, compared to 3.56 percent for the same period in 2014. The net interest spread was 3.39 percent for the third quarter of 2015, a 1 basis point increase compared to the same period in 2014.

During the three months ended September 30, 2015, tax-equivalent interest income was $10.6 million, an increase of $1.1 million or 11.1 percent when compared to the same period in the prior year. This increase was mainly driven by the increase in the balance of average loans:

Of the $1.1 million net increase in interest income on a tax-equivalent basis, $1.3 million of the increase was due to increased average earning assets, primarily loans, partially offset by $268 thousand in reduced interest income due to decreased yields on the security and loan portfolios.

The average volume of interest-earning assets increased $99.2 million to $954.4 million for the third quarter of 2015 compared to $855.2 million for the same period in 2014. This was due primarily to a $119.8 million increase in average loans, primarily commercial and residential mortgage loans, partially offset by a $15.9 million decrease in average investment securities and a $4.3 million decrease in federal funds sold and interest-bearing deposits.

The yield on interest-earning assets decreased 3 basis points to 4.40 percent for the three months ended September 30, 2015 when compared to the same period in 2014. The yield on the loan portfolio decreased 14 basis points to 4.75 percent.

Total interest expense was $1.9 million for the three months ended September 30, 2015, an increase of $73 thousand or 3.9 percent compared to the same period in 2014. This increase was driven by the increase in average time deposits and increased rates on savings deposits compared to a year ago:

Of the $73 thousand increase in interest expense, $55 thousand was due to an increase in the volume of average interest-bearing liabilities, primarily time and savings deposits and $18 thousand was due to increased rates on interest-bearing liabilities.

Interest-bearing liabilities averaged $755.4 million for the third quarter of 2015, an increase of $54.3 million or 7.7 percent, compared to the prior year’s quarter. The increase in interest-bearing liabilities was primarily due to an increase in average time and savings deposits, partially offset by a decrease in borrowed funds and subordinated debentures.

The average cost of interest-bearing liabilities decreased 4 basis points to 1.01 percent. The cost of interest-bearing deposits increased 3 basis points to 0.71 percent for the third quarter of 2015 and the cost of borrowed funds and subordinated debentures decreased 3 basis points to 3.47 percent.

During the nine months ended September 30, 2015, tax-equivalent net interest income amounted to $25.1 million, an increase of $2.8 million or 12.3 percent when compared to the same period in 2014. The net interest margin increased 11 basis points to 3.65 percent for the nine months ended September 30, 2015, compared to 3.54 percent for the same period in 2014. The net interest spread was 3.44 percent for the first nine months of 2015, a 7 basis point increase compared to the same period in 2014.

During the nine months ended September 30, 2015, tax-equivalent interest income was $30.8 million, an increase of $3.0 million or 10.8 percent when compared to the same period in the prior year. This increase was driven by the increase in the balance of average loans:

Of the $3.0 million net increase in interest income on a tax-equivalent basis, $3.4 million of the increase was due to increased average earning assets, primarily loans, partially offset by $442 thousand in reduced interest income due to decreased yields on the security and loan portfolios.

The average volume of interest-earning assets increased $76.3 million to $920.5 million for the first nine months of 2015 compared to $844.2 million for the same period in 2014. This was due primarily to a $112.5 million increase in average loans, primarily residential mortgage and commercial loans, partially offset by a $23.6 million decrease in average investment securities and a $12.2 million decrease in federal funds sold and interest-bearing deposits.

The yield on interest-earning assets increased 8 basis points to 4.47 percent for the nine months ended September 30, 2015 when compared to the same period in 2014. The yield on the loan portfolio decreased 5 basis points to 4.82 percent.

Total interest expense was $5.6 million for the nine months ended September 30, 2015, an increase of $253 thousand or 4.7 percent compared to the same period in 2014. This increase was driven by the increase in average savings deposits and time deposits, and increased rates on savings deposits compared to a year ago:

Of the $253 thousand increase in interest expense, $172 thousand was due to increased rates on interest-bearing liabilities, and $81 thousand was due to an increase in the volume of average interest-bearing liabilities, primarily savings and time deposits.

Interest-bearing liabilities averaged $731.9 million for nine months ended September 30, 2015, an increase of $35.5 million or 5.1 percent, compared to the prior year’s period. The increase in interest-bearing liabilities was a result of an increase in average savings deposits and time deposits, partially offset by a decrease in average interest-bearing demand deposits.

The average cost of interest-bearing liabilities increased 1 basis point to 1.03 percent for the nine months ended September 30, 2015. The cost of interest-bearing deposits increased 4 basis points to 0.69 percent for the nine months ended September 30, 2015 and the cost of borrowed funds and subordinated debentures decreased 1 basis point to 3.49 percent.

Although our net interest income has increased over the periods noted above, we have been impacted by the sustained low interest rate environment. Recent remarks by the Federal Reserve Open Market Committee (“FOMC”) of the Federal Reserve Board indicate that an increase to the federal funds target rate will be appropriate when the committee sees further improvement in the labor market and inflation moves back to its 2 percent objective over the medium term.

The following table reflects the components of net interest income, setting forth for the periods presented herein: (1) average assets, liabilities and shareholders’ equity, (2) interest income earned on interest-earning assets and interest expense paid on interest-bearing liabilities, (3) average yields earned on interest-earning assets and average rates paid on interest-bearing liabilities, (4) net interest spread, and (5) net interest income/margin on average earning assets. Rates/Yields are computed on a fully tax-equivalent basis, assuming a federal income tax rate of 34 percent.

Consolidated Average Balance Sheets

(Dollar amounts in thousands, interest amounts and interest rates/yields on a fully tax-equivalent basis)


	For the three months ended
	September 30, 2015							September 30, 2014
	Average Balance		Interest		Rate/Yield			Average Balance		Interest		Rate/Yield
ASSETS
Interest-earning assets:
Federal funds sold and interest-bearing deposits	$	34,465	$	11		0.13	%	$	38,754	$	12		0.12	%
FHLB stock		3,517		36		4.06			3,948		40		4.02
Securities:
Taxable		61,542		349		2.25			75,685		461		2.44
Tax-exempt		11,612		105		3.59			13,348		119		3.57
Total securities (A)		73,154		454		2.46			89,033		580		2.61
Loans:
SBA loans		53,325		696		5.18			53,400		636		4.76
SBA 504 loans		29,268		353		4.79			34,310		419		4.85
Commercial loans		433,285		5,378		4.92			380,983		4,926		5.13
Residential mortgage loans		254,765		2,811		4.38			201,793		2,327		4.61
Consumer loans		72,641		849		4.64			53,000		589		4.41
Total loans (B)		843,284		10,087		4.75			723,486		8,897		4.89
Total interest-earning assets	$	954,420	$	10,588		4.40	%	$	855,221	$	9,529		4.43	%

Noninterest-earning assets:
Cash and due from banks		24,990							29,873
Allowance for loan losses		(12,619)							(12,980)
Other assets		44,098							44,656
Total noninterest-earning assets		56,469							61,549
Total assets	$	1,010,889						$	916,770

LIABILITIES AND SHAREHOLDERS' EQUITY
Interest-bearing liabilities:
Total interest-bearing demand deposits	$	125,405	$	108		0.34	%	$	116,646	$	98		0.33	%
Total savings deposits		290,413		255		0.35			271,356		216		0.32
Total time deposits		256,216		839		1.30			221,584		725		1.30
Total interest-bearing deposits		672,034		1,202		0.71			609,586		1,039		0.68
Borrowed funds and subordinated debentures		83,383		730		3.47			91,574		820		3.50
Total interest-bearing liabilities	$	755,417	$	1,932		1.01	%	$	701,160	$	1,859		1.05	%

Noninterest-bearing liabilities:
Noninterest-bearing demand deposits		176,085							148,724
Other liabilities		4,663							3,921
Total noninterest-bearing liabilities		180,748							152,645
Total shareholders' equity		74,724							62,965
Total liabilities and shareholders' equity	$	1,010,889						$	916,770

Net interest spread			$	8,656		3.39	%			$	7,670		3.38	%
Tax-equivalent basis adjustment				(34)							(38)
Net interest income			$	8,622						$	7,632
Net interest margin						3.60	%						3.56	%

(A)

Yields related to securities exempt from federal and state income taxes are stated on a fully tax-equivalent basis. They are reduced by the nondeductible portion of interest expense, assuming a federal tax rate of 34 percent and applicable state rates.

(B)

The loan averages are stated net of unearned income, and the averages include loans on which the accrual of interest has been discontinued.

Consolidated Average Balance Sheets

(Dollar amounts in thousands, interest amounts and interest rates/yields on a fully tax-equivalent basis)


	For the nine months ended
	September 30, 2015							September 30, 2014
	Average Balance		Interest		Rate/Yield			Average Balance		Interest		Rate/Yield
ASSETS
Interest-earning assets:
Federal funds sold and interest-bearing deposits	$	30,657	$	26		0.11	%	$	42,869	$	31		0.10	%
FHLB stock		3,694		117		4.23			4,028		127		4.22
Securities:
Taxable		64,121		1,100		2.29			84,634		1,740		2.74
Tax-exempt		11,798		315		3.57			14,920		407		3.64
Total securities (A)		75,919		1,415		2.49			99,554		2,147		2.87
Loans:
SBA loans		49,678		1,980		5.33			54,047		1,863		4.60
SBA 504 loans		30,720		1,068		4.65			33,491		1,251		4.99
Commercial loans		420,682		15,720		5.00			371,951		14,264		5.13
Residential mortgage loans		241,675		8,108		4.49			189,365		6,438		4.53
Consumer loans		67,488		2,322		4.60			48,918		1,628		4.45
Total loans (B)		810,243		29,198		4.82			697,772		25,444		4.87
Total interest-earning assets	$	920,513	$	30,756		4.47	%	$	844,223	$	27,749		4.39	%

Noninterest-earning assets:
Cash and due from banks		26,537							25,900
Allowance for loan losses		(12,583)							(13,141)
Other assets		43,637							44,559
Total noninterest-earning assets		57,591							57,318
Total assets	$	978,104						$	901,541

LIABILITIES AND SHAREHOLDERS' EQUITY
Interest-bearing liabilities:
Total interest-bearing demand deposits	$	125,216	$	317		0.34	%	$	125,341	$	318		0.34	%
Total savings deposits		289,445		789		0.36			266,384		586		0.29
Total time deposits		229,512		2,250		1.31			213,339		2,062		1.29
Total interest-bearing deposits		644,173		3,356		0.69			605,064		2,966		0.65
Borrowed funds and subordinated debentures		87,714		2,289		3.49			91,304		2,426		3.50
Total interest-bearing liabilities	$	731,887	$	5,645		1.03	%	$	696,368	$	5,392		1.02	%

Noninterest-bearing liabilities:
Noninterest-bearing demand deposits		168,852							141,598
Other liabilities		4,463							3,477
Total noninterest-bearing liabilities		173,315							145,075
Total shareholders' equity		72,902							60,098
Total liabilities and shareholders' equity	$	978,104						$	901,541

Net interest spread			$	25,111		3.44	%			$	22,357		3.37	%
Tax-equivalent basis adjustment				(102)							(132)
Net interest income			$	25,009						$	22,225
Net interest margin						3.65	%						3.54	%

(A)

(B)

The loan averages are stated net of unearned income, and the averages include loans on which the accrual of interest has been discontinued

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 tax-equivalent basis, assuming a federal income tax rate of 34 percent.


	For the three months ended September 30, 2015 versus September 30, 2014						For the nine months ended September 30, 2015 versus September 30, 2014
	Increase (decrease) due to change in:						Increase (decrease) due to change in:
(In thousands on a tax-equivalent basis)	Volume		Rate		Net		Volume		Rate		Net
Interest income:
Federal funds sold and interest-bearing deposits	$	(2)	$	1	$	(1)	$	(8)	$	3	$	(5)
FHLB stock		(4)		-		(4)		(10)		-		(10)
Securities		(94)		(32)		(126)		(465)		(267)		(732)
Loans		1,427		(237)		1,190		3,932		(178)		3,754
Total interest income	$	1,327	$	(268)	$	1,059	$	3,449	$	(442)	$	3,007
Interest expense:
Demand deposits	$	7	$	3	$	10	$	(1)	$	-	$	(1)
Savings deposits		16		23		39		54		149		203
Time deposits		114		-		114		156		32		188
Total interest-bearing deposits		137		26		163		209		181		390
Borrowed funds and subordinated debentures		(82)		(8)		(90)		(128)		(9)		(137)
Total interest expense		55		18		73		81		172		253
Net interest income - fully tax-equivalent	$	1,272	$	(286)	$	986	$	3,368	$	(614)	$	2,754
Decrease in tax-equivalent adjustment						4						30
Net interest income					$	990					$	2,784

Provision for Loan Losses

Provision for loan losses totaled $200 thousand for the three months ended September 30, 2015, compared to $550 thousand for the three months ended September 30, 2014. For the nine months ended September 30, 2015, the provision for loan losses totaled $400 thousand, compared to $1.7 million for the same period in 2014. Each period’s loan loss provision is the result of management’s analysis of the loan portfolio and reflects changes in the size and composition of the portfolio, the level of net charge-offs, delinquencies, current economic conditions and other internal and external factors impacting the risk within the loan portfolio. Additional information may be found under the captions “Financial Condition - Asset Quality” and “Financial Condition - Allowance for Loan Losses and Reserve for Unfunded Loan Commitments.” The current provision is considered appropriate under management’s assessment of the adequacy of the allowance for loan losses.

Noninterest Income

The following table shows the components of noninterest income for the three and nine months ended September 30, 2015 and 2014:


	For the three months ended September 30,				For the nine months ended September 30,
(In thousands)	2015		2014		2015		2014
Branch fee income	$	399	$	388	$	1,118	$	1,106
Service and loan fee income		306		292		1,068		872
Gain on sale of SBA loans held for sale, net		308		295		671		633
Gain on sale of mortgage loans, net		926		263		1,957		816
BOLI income		95		400		284		593
Net security gains		-		-		28		378
Other income		241		215		683		621
Total noninterest income	$	2,275	$	1,853	$	5,809	$	5,019

Our noninterest income consists primarily of branch and loan fee income, gains on the sale of SBA and residential mortgage loans, gains on the sale of securities, and BOLI income. For the three months ended September 30, 2015, noninterest income increased $422 thousand to $2.3 million, compared to the same period last year. For the nine months ended September 30, 2015, noninterest income increased $790 thousand to $5.8 million, compared to the same period a year ago. Quarterly and year-to-date noninterest income increased due to higher gains on the sale of mortgage loans, offset by a decrease in BOLI income from the prior year’s period which included a death benefit.

Changes in our noninterest income for the three and nine months ended September 30, 2015 versus 2014 reflect:

For the three months ended September 30, 2015, branch fee income, which consists of deposit service charges and overdraft fees, increased $11 thousand when compared to the same period in 2014, due to high overdraft volume and an increase in commercial analysis service charges. For the nine months ended September 30, 2015, branch fee income increased $12 thousand when compared to the same period in 2014, for the same reasons applicable to the three month period.

For the three and nine months ended September 30, 2015, service and loan fee income increased $14 thousand and $196 thousand, respectively, when compared to the same periods in the prior year. These increases were due to increased loan processing and mortgage application fees.

Net gains on SBA loan sales for the three months ended September 30, 2015 amounted to $308 thousand on $3.4 million in sales, compared to net gains on SBA loan sales of $295 thousand on $3.2 million in sales in the same period in the prior year. For the nine months ended September 30, 2015, net gains on SBA loan sales amounted to $671 thousand on $6.9 million in sales, compared to net gains of $633 thousand on $6.4 million in sales in the same period in the prior year.

During the quarter, $57.7 million in residential mortgage loans were originated, of which $35.7 million were sold at a gain of $926 thousand, compared to $40.1 million originated and $16.5 million sold at a gain of $263 thousand during the prior year’s quarter. For the nine month period, $144.7 million in residential mortgage loans were originated, of which $77.9 million were sold at a gain of $2.0 million, compared to $98.7 million originated and $45.1 million sold at a gain of $816 thousand in the prior year’s period. All residential mortgage loans originated in 2015 that are held in portfolio for investment are adjustable rate mortgages or fixed rate mortgages with maturities of 15 year or less.

For the three and nine months ended September 30, 2015, BOLI income decreased $305 thousand and $309 thousand, respectively, when compared to the same periods in the prior year primarily due to a death benefit included in the prior year.

There were no sales of securities for the three months ended September 30, 2015 and 2014. Net realized gains on securities amounted to $28 thousand and $378 thousand for the nine months ended September 30, 2015 and September 30, 2014, respectively. For additional information, see Note 7 - Securities.

For the three and nine months ended September 30, 2015, other income, which includes check card related income and miscellaneous service charges, increased $26 thousand and $62 thousand, respectively, when compared to the same period in the prior year primarily due to increases in VISA check card interchange fees.

Noninterest Expense

The following table presents a breakdown of noninterest expense for the three and nine months ended September 30, 2015 and 2014:


	For the three months ended September 30,				For the nine months ended September 30,
(In thousands)	2015		2014		2015		2014
Compensation and benefits	$	3,814	$	3,214	$	10,767	$	9,553
Occupancy		598		604		1,871		1,882
Processing and communications		631		667		1,841		1,847
Furniture and equipment		393		377		1,189		1,112
Professional services		251		159		729		617
Loan costs		265		225		647		569
OREO expenses		15		71		117		414
Deposit insurance		163		166		496		515
Advertising		203		291		728		729
Other expenses		519		467		1,619		1,406
Total noninterest expense	$	6,852	$	6,241	$	20,004	$	18,644

Noninterest expense increased $611 thousand to $6.9 million for the three months ended September 30, 2015, while year-to-date expenses increased $1.4 million to $20.0 million. The majority of the increase in each period was due to higher compensation and benefits expense.

Changes in noninterest expense for the three and nine months ended September 30, 2015 versus 2014 reflect:

Compensation and benefits expense, the largest component of noninterest expense, increased $600 thousand and $1.2 million for the three and nine months ended September 30, 2015, respectively. Expenses have increased over the past twelve months due to increased head count in loan origination and support staff. In addition, mortgage commission expense increased due to the larger volume of mortgages originated and benefits expense increased due to the addition of a SERP for our CEO.

Occupancy expense remained relatively flat for the quarter-to-date period. For the nine months ended September 30, 2015 occupancy expense decreased $11 thousand primarily due to lower landscaping expense.

Processing and communications expenses decreased $36 thousand and $6 thousand for the three and nine months ended September 30, 2015, respectively, primarily due to decreased bill pay expense in both periods.

Furniture and equipment expense increased $16 thousand and $77 thousand for the three and nine months ended September 30, 2015, respectively, primarily due to higher software maintenance expense.

Professional service fees increased $92 thousand and $112 thousand for the three and nine months ended September 30, 2015, respectively, due to audit expenses related to Federal Deposit Insurance Corporation Improvement Act (“FDICIA”) testing as the Bank exceeded $1 billion in assets.

Loan costs increased $40 thousand and $78 thousand for the three and nine months ended September 30, 2015, respectively. The quarter-to-date increase was primarily due to higher forced place insurance, and the year-to-date increase was due to higher loan property tax expense and mortgage servicing expense.

OREO expenses decreased $56 thousand and $297 thousand for the three and nine months ended September 30, 2015, respectively. Expenses decreased for the quarterly and nine month periods due to lower property tax, maintenance, utility and legal costs to hold these properties.

Deposit insurance expense decreased $3 thousand and $19 thousand for the three and nine months ended September 30, 2015, respectively, when compared to the same periods in the prior year. These decreases are due to a lower quarterly assessment resulting from a lower rate as our financial ratios continue to improve.

Advertising expense decreased $88 thousand for the three months ended September 30, 2015, due to decreased marketing expense. Advertising expense remained relatively flat for the year-to-date period.

Other expenses increased $52 thousand and $213 thousand for the three and nine months ended September 30, 2015, respectively, due to higher director fees.

Income Tax Expense

Financial Condition at September 30, 2015

Total assets increased $43.9 million or 4.4 percent, to $1.1 billion at September 30, 2015, when compared to year-end 2014. This increase was primarily due to increases of $93.9 million in net loans, partially offset by decreases of $41.0 million in cash and cash equivalents and $8.6 million in securities. Total deposits increased $71.9 million, due to increases of $55.6 million and $22.5 million in time deposits and noninterest-bearing demand deposits, respectively, partially offset by decreases of $4.9 million and $1.3 million in interest-bearing demand deposits and savings deposits. Borrowed funds decreased $35.0 million due to an overnight borrowing at September 30, 2015 of $25.0 million compared to $50.0 million at year-end 2014 and the maturity of a $10.0 million non-repo borrowing during the nine months ended September 30, 2015. There were no changes to subordinated debentures. Total shareholders’ equity increased $5.9 million over year-end 2014, primarily due to earnings less the dividends paid for the nine months ended September 30, 2015. These fluctuations are discussed in further detail in the paragraphs that follow.

Securities Portfolio

The Company’s securities portfolio consists of AFS and HTM investments. Management determines the appropriate security classification of AFS and HTM at the time of purchase. The investment securities portfolio is maintained for asset-liability management purposes, as well as for liquidity and earnings purposes.

AFS securities are investments carried at fair value that may be sold in response to changing market and interest rate conditions or for other business purposes. Activity in this portfolio is undertaken primarily to manage liquidity and interest rate risk, to take advantage of market conditions that create economically attractive returns and as an additional source of earnings. AFS securities consist primarily of obligations of U.S. Government sponsored entities, obligations of state and political subdivisions, mortgage-backed securities, and corporate and other securities.

AFS securities totaled $53.5 million at September 30, 2015, a decrease of $6.6 million or 11.0 percent, compared to $60.1 million at December 31, 2014. This net decrease was the result of:

-	$6.6 million in principal payments and maturities,
-	$500 thousand on the sale of a corporate bond, net of gain,
-	$339 thousand in net amortization of premiums,
-	$153 thousand decline in the market value of the portfolio. At September 30, 2015, the portfolio had net unrealized gains of $82 thousand compared to net unrealized gains of $235 thousand at December 31, 2014. These net unrealized gains are reflected net of tax in shareholders’ equity as accumulated other comprehensive gains, partially offset by
-	$1.0 million for the purchase of one agency security.

The weighted average life of AFS securities, adjusted for prepayments, amounted to 4.9 years and 4.0 years at September 30, 2015 and December 31, 2014, respectively.

HTM securities, which are carried at amortized cost, are investments for which there is the positive intent and ability to hold to maturity. The portfolio is comprised primarily of U.S. Government sponsored entities, obligations of state and political subdivisions, mortgage-backed securities, and corporate and other securities.

HTM securities were $18.0 million at September 30, 2015, a decrease of $2.0 million or 9.9 percent, from year-end 2014. This decrease was the result of:


-	$2.2 million in principal payments and maturities and
-	$70 thousand in net amortization of premiums, partially offset by
-	$264 thousand for the purchase of one bond anticipation note.

The weighted average life of HTM securities, adjusted for prepayments, amounted to 6.5 years and 6.4 years at September 30, 2015 and December 31, 2014, respectively. As of September 30, 2015 and December 31, 2014, the fair value of HTM securities was $18.1 million and $20.3 million, respectively.

The average balance of taxable securities amounted to $64.1 million for the nine months ended September 30, 2015, compared to $84.6 million for the same period in 2014. The average yield earned on taxable securities decreased 45 basis points, to 2.29 percent for the nine months ended September 30, 2015, from 2.74 percent for the same period in the prior year. This decrease was due to sales, paydowns, and maturities of higher yielding securities. The average balance of tax-exempt securities amounted to $11.8 million for the nine months ended September 30, 2015, compared to $14.9 million for the same period in 2014. The average yield earned on tax-exempt securities decreased 7 basis points, to 3.57 percent for the nine months ended September 30, 2015, from 3.64 percent for the same period in 2014.

Securities with a carrying value of $18.3 million and $50.4 million at September 30, 2015 and December 31, 2014, respectively, were pledged to secure Government deposits, secure other borrowings and for other purposes required or permitted by law. The decrease in pledged securities was due to the FHLB issuing a letter of credit in the name of Unity Bank naming the NJ Department of Banking and Insurance as beneficiary, thereby reducing the Bank’s obligation to pledge securities to secure certain public deposits. For additional information on amounts pledged to secure Government deposits at September 30, 2015, see section titled “Borrowed Funds and Subordinated Debentures” under Item 2. Management Discussion and Analysis.

Approximately 87 percent of the total investment portfolio had a fixed rate of interest at September 30, 2015.

See Note 7 to the accompanying Consolidated Financial Statements for more information regarding Securities.

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 SBA, SBA 504, commercial, residential mortgage and consumer loans. Each of these segments is subject to differing levels of credit and interest rate risk.

Total loans increased $93.7 million or 12.3 percent to $855.6 million at September 30, 2015, compared to $761.8 million at year-end 2014. Commercial loans, residential mortgages, consumer loans, and SBA loans increased $41.0 million, $34.6 million, $15.2 million, and $8.1 million, respectively, partially offset by a decline of $5.1 million in SBA 504 loans.

The following table sets forth the classification of loans by major category, including unearned fees and deferred costs and excluding the allowance for loan losses as of September 30, 2015 and December 31, 2014:


	September 30, 2015					December 31, 2014
(In thousands, except percentages)	Amount		% of total			Amount		% of total
SBA loans held for investment	$	39,728		4.6	%	$	40,401		5.3	%
SBA 504 loans		29,221		3.4			34,322		4.5
Commercial loans		442,970		51.8			401,949		52.7
Residential mortgage loans		255,447		29.9			220,878		29.0
Consumer loans		74,257		8.7			59,096		7.8
Total loans held for investment		841,623		98.4			756,646		99.3
SBA loans held for sale		13,937		1.6			5,179		0.7
Total loans	$	855,560		100.0	%	$	761,825		100.0	%

Average loans increased $112.5 million or 16.1 percent to $810.2 million for the nine months ended September 30, 2015 from $697.8 million for the same period in 2014. The increase in average loans was due to increases in residential mortgages, commercial loans, and consumer loans, partially offset by a decline in SBA 7(a) loans and SBA 504 loans. The yield on the overall loan portfolio decreased 5 basis points to 4.82 percent for the nine months ended September 30, 2015 when compared to the same period in the prior year.

SBA 7(a) loans, on which the SBA historically has provided guarantees of up to 90 percent of the principal balance, are considered a higher risk loan product for the Company than its other loan products. These loans are made for the purposes of providing working capital or financing the purchase of equipment, inventory or commercial real estate. Generally, an SBA 7(a) loan has a deficiency in its credit profile that would not allow the borrower to qualify for a traditional commercial loan, which is why the SBA provides the guarantee. The deficiency may be a higher loan to value (“LTV”) ratio, lower debt service coverage (“DSC”) ratio or weak personal financial guarantees. In addition, many SBA 7(a) loans are for start up businesses where there is no history or financial information. Finally, many SBA borrowers do not have an ongoing and continuous banking relationship with the Bank, but merely work with the Bank on a single transaction. The guaranteed portion of the Company’s SBA loans are generally sold in the secondary market with the nonguaranteed portion held in the portfolio as a loan held for investment.

SBA 7(a) loans held for sale, carried at the lower of cost or market, amounted to $13.9 million at September 30, 2015, an increase of $8.8 million from $5.2 million at December 31, 2014. SBA 7(a) loans held to maturity amounted to $39.7 million at September 30, 2015, a decrease of $673 thousand from $40.4 million at December 31, 2014. The yield on SBA loans, which are generally floating and adjust quarterly to the Prime rate, was 5.33 percent for the nine months ended September 30, 2015, compared to 4.60 percent in the prior year. The increase in the yield between the nine months ended September 30, 2015 versus the same period in 2014 was attributable to an increase in performing loans in this category.

The guarantee rates on SBA 7(a) loans range from 50 percent to 90 percent, with the majority of the portfolio having a guarantee rate of 75 percent at origination. The guarantee rates are determined by the SBA and can vary from year to year depending on government funding and the goals of the SBA program. The carrying value of SBA loans held for sale represents the guaranteed portion to be sold into the secondary market. The carrying value of SBA loans held to maturity represents the unguaranteed portion, which is the Company's portion of SBA loans originated, reduced by the guaranteed portion that is sold into the secondary market. Approximately $74.5 million and $92.2 million in SBA loans were sold but serviced by the Company at September 30, 2015 and December 31, 2014, respectively, and are not included on the Company’s balance sheet. There is no relationship or correlation between the guarantee percentages and the level of charge-offs and recoveries on the Company’s SBA 7(a) loans. Charge-offs taken on SBA 7(a) loans effect the unguaranteed portion of the loan. SBA loans are underwritten to the same credit standards irrespective of the guarantee percentage.

The SBA 504 program consists of real estate backed commercial mortgages where the Company has the first mortgage and the SBA has the second mortgage on the property. Generally, the Company has a 50 percent LTV ratio on SBA 504 program loans at origination. At September 30, 2015, SBA 504 loans totaled $29.2 million, a decrease of $5.1 million from $34.3 million at December 31, 2014. The yield on SBA 504 loans decreased 34 basis points to 4.65 percent for the nine months ended September 30, 2015, from 4.99 percent for the same period in 2014. The decrease in yield was caused by an SBA 504 loan placed in nonaccrual status during the third quarter of 2014 with foreclosure occurring during 2015.

Commercial loans are generally made in the Company’s marketplace 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 $443.0 million at September 30, 2015, an increase of $41.0 million from year-end 2014. The yield on commercial loans was 5.00 percent for the nine months ended September 30, 2015, compared to 5.13 percent for the same period in 2014.

Residential mortgage loans consist of loans secured by 1 to 4 family residential properties. These loans amounted to $255.4 million at September 30, 2015, an increase of $34.6 million from year-end 2014. Sales of mortgage loans totaled $77.9 million for the nine months ended September 30, 2015. Approximately, $21.6 million of the loans sold were from portfolio, with the remainder consisting of new production. The yield on residential mortgages was 4.49 percent for the nine months ended September 30, 2015, compared to 4.53 percent for the same period in 2014. Residential mortgage loans maintained in portfolio are generally to individuals that do not qualify for conventional financing. In extending credit to this category of borrowers, the Bank considers other mitigating factors such as credit history, equity and liquid reserves of the borrower. As a result, the residential mortgage loan portfolio of the Bank includes adjustable rate mortgages with rates that exceed the rates on conventional fixed-rate mortgage loan products and yet are not considered high priced mortgages.

Consumer loans consist of home equity loans, construction 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 $74.3 million, an increase of $15.2 million from year-end 2014. The yield on consumer loans was 4.60 percent for the nine months ended September 30, 2015, compared to 4.45 percent for the same period in 2014.

There are no concentrations of loans to any borrowers or group of borrowers exceeding 10 percent of the total loan portfolio and no foreign loans in the portfolio. As a preferred SBA lender, a portion of the SBA portfolio is to borrowers outside the Company’s market area. During late 2008, the Company withdrew from SBA lending outside of its primary trade area, but continues to offer SBA loan products as an additional credit product within its primary trade area.

In the normal course of business, the Company may originate loan products whose terms could give rise to additional credit risk. Interest-only loans, loans with high LTV or debt service ratios, construction loans with payments made from interest reserves and multiple loans supported by the same collateral (e.g. home equity loans) are examples of such products. However, these products are not material to the Company’s financial position and are closely managed via credit controls that mitigate their additional inherent risk. Management does not believe that these products create a concentration of credit risk in the Company’s loan portfolio. The Company does not have any option adjustable rate mortgage loans.

The majority of the Company’s loans are secured by real estate. Declines in the market values of real estate in the Company’s trade area impact the value of the collateral securing its loans. This could lead to greater losses in the event of defaults on loans secured by real estate. At September 30, 2015 and December 31, 2014, approximately 96 percent of the Company’s loan portfolio was secured by real estate.

TDRs

TDRs occur when a creditor, for economic or legal reasons related to a debtor’s financial condition, grants a concession to the debtor that it would not otherwise consider. These concessions typically include reductions in interest rate, extending the maturity of a loan, or a combination of both. When the Company modifies a loan, management evaluates for any possible impairment using either the discounted cash flows method, where the value of the modified loan is based on the present value of expected cash flows, discounted at the contractual interest rate of the original loan agreement, or by using the fair value of the collateral less selling costs. If management determines that the value of the modified loan is less than the recorded investment in the loan, impairment is recognized by segment or class of loan, as applicable, through an allowance estimate or charge-off to the allowance. This process is used, regardless of loan type, and for loans modified as TDRs that subsequently default on their modified terms.

At September 30, 2015, there were eight loans totaling $6.1 million that were classified as TDRs by the Company and deemed impaired, compared to eight such loans totaling $6.5 million at December 31, 2014. Nonperforming loans included $2.8 million of TDRs as of September 30, 2015, compared to $3.0 million at December 31, 2014. Restructured loans that are placed in nonaccrual status may be removed after 6 months of contractual payments and the borrower showing the ability to service the debt going forward. The remaining TDRs are in accrual status since they are performing in accordance with the restructured terms. There are no commitments to lend additional funds on these loans.

The following table presents a breakdown of performing and nonperforming TDRs by class as of September 30, 2015 and December 31, 2014:


	September 30, 2015						December 31, 2014
(In thousands)	Performing TDRs		Nonperforming TDRs		Total TDRs		Performing TDRs		Nonperforming TDRs		Total TDRs
SBA loans held for investment	$	421	$	163	$	584	$	441	$	295	$	736
SBA 504 loans		1,723		-		1,723		1,769		-		1,769
Commercial real estate		1,124		2,645		3,769		1,338		2,665		4,003
Total	$	3,268	$	2,808	$	6,076	$	3,548	$	2,960	$	6,508

Through September 30, 2015, our TDRs consisted of interest rate reductions, interest only periods and maturity extensions. There has been no principal forgiveness. The following table shows the types of modifications done to date by class through September 30, 2015:


	September 30, 2015
(In thousands)	SBA held for investment		SBA 504		Commercial real estate		Total
Type of modification:
Principal only	$	9	$	-	$	-	$	9
Interest only with reduced interest rate		-		-		2,645		2,645
Interest only with nominal principal		21		-		-		21
Interest with extra principal		-		-		914		914
Previously modified back to original terms		554		1,723		210		2,487
Total TDRs	$	584	$	1,723	$	3,769	$	6,076

Asset Quality

Inherent in the lending function is credit risk, which is the possibility a borrower may not perform in accordance with the contractual terms of their loan. A borrower’s inability to pay their obligations according to the contractual terms can create the risk of past due loans and, ultimately, credit losses, especially on collateral deficient loans. The Company minimizes its credit risk by loan diversification and adhering to strict credit administration policies and procedures. Due diligence on loans begins when we initiate contact regarding 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 on-going internal reviews for credit quality, as well as independent credit reviews by an outside firm.

The risk of loss is difficult to quantify and is subject to fluctuations in collateral values, general economic conditions and other factors. In some cases, these factors have also resulted in significant impairment to the value of loan collateral. The Company values its collateral through the use of appraisals, broker price opinions, and knowledge of its local market.

Nonperforming assets consist of nonperforming loans and OREO. Nonperforming 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 ability to collect 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 or more and still accruing interest are not included in nonperforming loans. Loans past due 90 days or more and still accruing generally represent loans that are well collateralized and in a continuing process that are expected to result in repayment or restoration to current status.

The following table sets forth information concerning nonperforming assets and loans past due 90 days or more and still accruing interest at each of the periods presented:


(In thousands)	September 30, 2015			December 31, 2014			September 30, 2014
Nonperforming by category:
SBA loans held for investment (1)	$	1,584		$	3,348		$	2,627
SBA 504 loans		276			2,109			2,109
Commercial loans		6,211			4,721			4,011
Residential mortgage loans		1,912			645			2,098
Consumer loans		759			545			367
Total nonperforming loans (2)	$	10,742		$	11,368		$	11,212
OREO		1,759			1,162			1,658
Total nonperforming assets	$	12,501		$	12,530		$	12,870
Past due 90 days or more and still accruing interest:
SBA loans held for investment	$	-		$	161		$	-
Commercial loans		-			7			-
Residential mortgage loans		272			722			-
Total past due 90 days or more and still accruing interest	$	272		$	890		$	-
Nonperforming loans to total loans		1.26	%		1.49	%		1.51	%
Nonperforming loans and TDRs to total loans (3)		1.64			1.96			2.07
Nonperforming assets to total loans and OREO		1.46			1.64			1.73
Nonperforming assets to total assets		1.19			1.24			1.33
(1) Guaranteed SBA loans included above	$	225		$	1,569		$	200
(2) Nonperforming TDRs included above		2,808			2,960			3,473
(3) Performing TDRs		3,268			3,548			4,194

Nonperforming loans were $10.7 million at September 30, 2015, a $626 thousand decrease from $11.4 million at year-end 2014 and a $470 thousand decrease from $11.2 million at September 30, 2014. Since year-end 2014, nonperforming loans in the SBA and SBA 504 loan segments decreased, partially offset by an increase in commercial, residential mortgage and consumer loan segments. Included in nonperforming loans at September 30, 2015 are approximately $225 thousand of loans guaranteed by the SBA, compared to $1.6 million at December 31, 2014 and $200 thousand at September 30, 2014. In addition, there were $272 thousand in loans past due 90 days or more and still accruing interest at September 30, 2015, compared to $890 thousand and zero at December 31, 2014 and September 30, 2014, respectively.

OREO properties totaled $1.8 million at September 30, 2015, an increase of $597 thousand from $1.2 million at year-end 2014 and a $101 thousand increase from $1.7 million at September 30, 2014. During the nine months ended September 30, 2015, the Company took title to four new properties valued at $2.2 million that resulted in a charge to the allowance of $350 thousand. Seven OREO properties were sold, resulting in net gains of $3 thousand.

The Company also monitors potential problem loans. Potential problem loans are those loans 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 nonperforming loans as they continue to perform. Potential problem loans totaled $1.9 million at September 30, 2015, a decrease of $1.6 million from $3.5 million at December 31, 2014. The decrease is due to the deletion of four loans totaling $1.5 million as well as the payoff of a loan totaling $1.6 million, partially offset by the addition of one loan totaling $1.6 million.

See Note 8 to the accompanying Consolidated Financial Statements for more information regarding Asset Quality.

Allowance for Loan Losses and Reserve for Unfunded Loan Commitments

Management reviews the level of the allowance for loan losses on a quarterly basis. The standardized methodology used to assess the adequacy of the allowance includes the allocation of specific and general reserves. Specific reserves are made to individual impaired loans, which have been defined to include all nonperforming loans and TDRs. The general reserve is set based upon a representative average historical net charge-off rate adjusted for certain environmental factors such as: delinquency and impairment trends, charge-off and recovery trends, volume and loan term trends, risk and underwriting policy trends, staffing and experience changes, national and local economic trends, industry conditions and credit concentration changes.

When calculating the five-year historical net charge-off rate, the Company weights the past three years more heavily. The Company believes using this approach is more indicative of future charge-offs. All of the environmental factors are ranked and assigned a basis points value based on the following scale: low, low moderate, moderate, high moderate, and high risk. The factors are evaluated separately for each type of loan. For example, commercial loans are broken down further into commercial and industrial loans, commercial mortgages, construction loans, etc. Each type of loan is risk weighted for each environmental factor based on its individual characteristics.

According to the Company’s policy, a loss (“charge-off”) is to be recognized and charged to the allowance for loan losses as soon as a loan is recognized as uncollectable. All credits which are 90 days past due must be analyzed for the Company's ability to collect on the credit. Once a loss is known to exist, the charge-off approval process is immediately expedited.

The allowance for loan losses totaled $12.4 million at September 30, 2015, compared to $12.6 million and $12.9 million at December 31, 2014 and September 30, 2014, respectively, with resulting allowance to total loan ratios of 1.45 percent, 1.65 percent, and 1.74 percent, respectively. Net charge-offs amounted to $530 thousand for the nine months ended September 30, 2015, compared to $1.9 million for the same period in 2014. Net (recoveries) charge-offs to average loan ratios are shown in the table below for each major loan category.


	For the three months ended September 30,						For the nine months ended September 30,
(In thousands, except percentages)	2015			2014			2015			2014
Balance, beginning of period	$	12,404		$	12,858		$	12,551		$	13,141
Provision for loan losses charged to expense		200			550			400			1,700
Less: Chargeoffs
SBA loans held for investment		86			232			220			485
SBA 504 loans		-			-			589			92
Commercial loans		10			72			257			660
Residential mortgage loans		50			201			50			378
Consumer loans		52			211			89			593
Total chargeoffs		198			716			1,205			2,208
Add: Recoveries
SBA loans held for investment		10			111			49			129
Commercial loans		5			95			576			135
Residential mortgage loans		-			20			49			20
Consumer loans		-			-			1			1
Total recoveries		15			226			675			285
Net chargeoffs		183			490			530			1,923
Balance, end of period	$	12,421		$	12,918		$	12,421		$	12,918
Selected loan quality ratios:
Net chargeoffs (recoveries) to average loans:
SBA loans held for investment		0.57	%		0.90	%		0.46	%		0.88	%
SBA 504 loans		-			-			2.56			0.37
Commercial loans		-			(0.02)			(0.10)			0.19
Residential mortgage loans		0.08			0.36			-			0.25
Consumer loans		0.28			1.58			0.17			1.62
Total loans		0.09			0.27			0.09			0.37
Allowance to total loans		1.45			1.74			1.45			1.74
Allowance to nonperforming loans		115.63			115.22			115.63			115.22

In addition to the allowance for loan losses, the Company maintains a reserve for unfunded loan commitments that is maintained at a level that management believes is adequate to absorb estimated probable losses. Adjustments to the reserve are made through other expense and applied to the reserve which is maintained in other liabilities. At September 30, 2015, a $148 thousand commitment reserve was reported on the balance sheet as an “other liability”, compared to a $151 thousand commitment reserve at December 31, 2014.

See Note 9 to the accompanying Consolidated Financial Statements for more information regarding the Allowance for Loan Losses and Reserve for Unfunded Loan Commitments.

Deposits

Deposits, which include noninterest-bearing demand deposits, interest-bearing demand deposits, savings deposits 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. The Company continues to focus on establishing a comprehensive relationship with business borrowers, seeking deposits as well as lending relationships.

Total deposits increased $71.9 million to $866.2 million at September 30, 2015, from $794.3 million at December 31, 2014. This increase in deposits was due to increases of $55.6 million in time deposits and $22.5 million in noninterest bearing demand deposits, partially offset by decreases of $1.3 million in savings deposits and $4.9 million in interest-bearing demand deposits. The increase in time deposits was primarily due to new CD promotions. The increase in noninterest-bearing demand deposits is attributable to growth in commercial customer relationships.

The Company’s deposit composition at September 30, 2015, consisted of 34.5 percent savings deposits, 31.0 percent time deposits, 20.2 percent noninterest-bearing demand deposits and 14.3 percent interest-bearing demand deposits.

Borrowed Funds and Subordinated Debentures

Borrowed funds consist primarily of fixed rate advances from the FHLB of New York and repurchase agreements. These borrowings are used as a source of liquidity or to fund asset growth not supported by deposit generation. Residential mortgages collateralize the borrowings from the FHLB, while investment securities are pledged against the repurchase agreements.

Borrowed funds and subordinated debentures totaled $105.5 million and $140.5 million at September 30, 2015 and December 31, 2014, respectively, and are broken down in the following table:


(In thousands)	September 30, 2015		December 31, 2014
FHLB borrowings:
Fixed rate advances	$	50,000	$	60,000
Overnight advances		25,000		50,000
Other repurchase agreements		15,000		15,000
Subordinated debentures		15,465		15,465
Total borrowed funds and subordinated debentures	$	105,465	$	140,465

In September 2015, the FHLB issued a $55 million municipal deposit letter of credit in the name of Unity Bank naming the NJ Department of Banking and Insurance as beneficiary. The letter of credit will take the place of securities previously pledged to the state for the Bank’s municipal deposits.

At September 30, 2015, the Company had $59.1 million of additional credit available at the FHLB. Pledging additional collateral in the form of 1 to 4 family residential mortgages and investment securities can increase the line with the FHLB.

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 re-pricing 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. 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, 2015, is a decline of 0.99 percent in a rising-rate environment and a decrease of 0.88 percent in a falling-rate environment. The variances in the EVPE at September 30, 2015 are within the Board-approved guidelines of +/- 3.00 percent. At December 31, 2014, the economic value of equity as a percentage of assets with rate shocks of 200 basis points was a decline of 0.73 percent in a rising-rate environment and a decrease of 1.03 percent in a falling-rate environment.

Liquidity

Consolidated Bank Liquidity

Liquidity measures the ability to satisfy current and future cash flow needs as they become due. A bank’s liquidity reflects its ability to meet loan demand, to accommodate possible outflows in deposits and to take advantage of interest rate opportunities in the marketplace. Our liquidity is monitored by management and the Board of Directors through a Risk Management Committee, which reviews historical funding requirements, our current liquidity position, sources and stability of funding, marketability of assets, options for attracting additional funds, and anticipated future funding needs, including the level of unfunded commitments. Our goal is to maintain sufficient asset-based liquidity to cover potential funding requirements in order to minimize our dependence on volatile and potentially unstable funding markets.

The principal sources of funds at the Bank are deposits, scheduled amortization and prepayments of investment and 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 inflows and outflows and loan prepayments are greatly influenced by general interest rates, economic conditions and competition. The Consolidated Statement of Cash Flows provides detail on the Company’s sources and uses of cash, as well as an indication of the Company’s ability to maintain an adequate level of liquidity. At September 30, 2015, the balance of cash and cash equivalents was $88.9 million, a decrease of $41.0 million from December 31, 2014. A discussion of the cash provided by and used in operating, investing and financing activities follows.

Operating activities used $361 thousand and provided $5.2 million in net cash for the nine months ended September 30, 2015 and 2014, respectively. The primary sources of funds were net income from operations and adjustments to net income, such as the provision for loan losses, depreciation and amortization, and proceeds from the sale of mortgage and SBA loans held for sale, partially offset by originations of mortgage and SBA loans held for sale.

Investing activities used $76.7 million and $44.9 million in net cash for the nine months ended September 30, 2015 and 2014, respectively. Cash was primarily used to fund new loans, partially offset by cash inflows from sales, maturities and paydowns on securities and proceeds from the sale of OREO.

Securities. The Consolidated Bank’s available for sale investment portfolio amounted to $53.3 million and $59.9 million at September 30, 2015 and December 31, 2014, respectively. This excludes the Parent Company’s securities discussed under the heading “Parent Company Liquidity” below. Projected cash flows from securities over the next twelve months are $12.1 million.

Loans. The SBA loans held for sale portfolio amounted to $13.9 million and $5.2 million at September 30, 2015 and December 31, 2014, respectively. Sales of these loans provide an additional source of liquidity for the Company.

Outstanding Commitments. The Company was committed to advance approximately $147.7 million to its borrowers as of September 30, 2015, compared to $150.9 million at December 31, 2014. At September 30, 2015, $63.3 million of these commitments expire within one year, compared to $74.1 million at December 31, 2014. The Company had $1.5 million in standby letters of credit at both September 30, 2015 and December 31, 2014, which are included in the commitments amount noted above. The estimated fair value of these guarantees is not significant. The Company believes it has the necessary liquidity to honor all commitments. Many of these commitments will expire and never be funded.

Financing activities provided $36.1 million in net cash for the nine months ended September 30, 2015, compared to $41.9 million for the same period in the prior year, primarily due to an increase in the Company’s deposits and proceeds from new borrowings partially offset by repayments of borrowings.

Deposits. As of September 30, 2015, deposits included $114.5 million of Government deposits, as compared to $89.8 million at year-end 2014. These deposits are generally short in duration and are very sensitive to price competition. The Company believes that the current level of these types of deposits is appropriate. Included in the portfolio were $97.7 million of deposits from eleven municipalities with account balances in excess of $1.5 million. The withdrawal of these deposits, in whole or in part, would not create a liquidity shortfall for the Company.

Borrowed Funds. Total FHLB borrowings amounted to $75.0 million and $110.0 million as of September 30, 2015 and December 31, 2014, respectively. Third party repurchase agreements totaled $15.0 million as of both September 30, 2015 and December 31, 2014. As a member of the Federal Home Loan Bank of New York (“FHLB”), the Company can borrow additional funds based on the market value of collateral pledged. At September 30, 2015, pledging provided an additional $59.1 million in borrowing potential from the FHLB. In addition, the Company can pledge additional collateral in the form of 1 to 4 family residential mortgages or investment securities to increase this line with the FHLB.

Parent Company Liquidity

The Parent Company’s cash needs are funded by dividends paid by the Bank. Other than its investment in the Bank and Unity Statutory Trusts II and III, the Parent Company does not actively engage in other transactions or business. Only expenses specifically for the benefit of the Parent Company are paid using its cash, which typically includes the payment of operating expenses and cash dividends on common stock.

At September 30, 2015, the Parent Company had $402 thousand in cash and cash equivalents and $202 thousand in investment securities valued at fair market value, compared to $198 thousand in cash and cash equivalents and $197 thousand in investment securities at December 31, 2014.

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, qualifying preferred stock and certain qualifying hybrid instruments, and (2) tier 2 capital, which includes a portion of the allowance for loan losses, subject to limitations, certain qualifying long-term debt, preferred stock and hybrid instruments, which do not qualify for tier 1 capital. The Parent Company and its subsidiary Bank are subject to various regulatory capital requirements administered by banking regulators. Quantitative measures of capital adequacy include the leverage ratio (tier 1 capital as a percentage of tangible assets), tier 1 risk-based capital ratio (tier 1 capital as a percent of risk-weighted assets), total risk-based capital ratio (total risk-based capital as a percent of total risk-weighted assets), and common equity tier 1 capital ratio.

Minimum capital levels are regulated by risk-based capital adequacy guidelines, which require the Company and the Bank to maintain certain capital as a percentage of assets and certain off-balance sheet items adjusted for predefined credit risk factors (risk-weighted assets). Failure to meet minimum capital requirements can initiate certain mandatory and possibly discretionary actions by regulators that, if undertaken, could have a direct material effect on the Company’s financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action applicable to banks, the Company and the Bank must meet specific capital guidelines. Prompt corrective action provisions are not applicable to bank holding companies.

In September 2010, the Group of Governors and Heads of Supervision, the oversight body of the Basel Committee on Banking Supervision, adopted Basel III, which constitutes a set of capital reform measures designed to strengthen the regulation, supervision and risk management of banking organizations worldwide. In order to implement Basel III and certain additional capital changes required by the Dodd-Frank Act, the FDIC approved, as an interim final rule in July 2014, the regulatory capital requirements substantially similar to final rules issued by the Board of Governors of the Federal Reserve System (“Federal Reserve”) for U.S. state nonmember banks and the Office of the Comptroller of the Currency for national banks.

The interim final rule includes new risk-based capital and leverage ratios that will be phased-in from 2015 to 2019 for most state nonmember banks. The rule includes a new common equity Tier 1 capital (“CET1”) to risk-weighted assets ratio of 4.5% and a common equity Tier 1 capital conservation buffer of 2.5% of risk-weighted assets, which is in addition to the Tier 1 and Total risk-based capital requirements. The interim final rule also raises the minimum ratio of Tier 1 capital to risk-weighted assets from 4.0% to 6.0% and requires a minimum leverage ratio of 4.0%. The required minimum ratio of total capital to risk-weighted assets will remain 8.0%. The new risk-based capital requirements (except for the capital conservation buffer) became effective for the Company and the Bank on January 1, 2015.

The new rules also include a one-time opportunity to opt-out of the changes to treatment of accumulated other comprehensive income (“AOCI”) components. By making the election to opt-out, the institution may continue treating AOCI items in a manner consistent with risk-based capital rules in place prior to January 2015. The permanent opt-out election must be made on the Call Report, FR Y-9C or FR Y-9SP, as applicable, for the first reporting period after January 1, 2015 and a parent holding company must make the same election as its subsidiary bank. If the institution does not elect to opt-out, then the institution will not have an opportunity to change its methodology in future periods. The Bank and the Company have made the election to opt out of the treatment of AOCI on the appropriate March 31, 2015 filings.

In addition to the risk-based guidelines, regulators require that a bank or holding company, which meets the regulator’s highest performance and operation standards, maintain a minimum leverage ratio of 4 percent. For those institutions 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 institution 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
						For capital					under prompt corrective
	Actual					adequacy purposes					action provisions
(In thousands)	Amount		Ratio			Amount		Ratio			Amount		Ratio
As of September 30, 2015
Leverage ratio	$	90,013		8.92	%	≥ $	40,373		4.00	%		N/A		N/A
CET1		75,013		9.37			36,012		4.50			N/A		N/A
Tier 1 risk-based capital ratio		90,013		11.25			48,016		6.00			N/A		N/A
Total risk-based capital ratio		100,048		12.50			64,022		8.00			N/A		N/A
As of December 31, 2014
Leverage ratio	$	83,615		8.71	%	≥ $	38,405		4.00	%		N/A		N/A
Tier 1 risk-based capital ratio		83,615		11.57			28,900		4.00			N/A		N/A
Total risk-based capital ratio		92,691		12.83			57,799		8.00			N/A		N/A

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


											To be well-capitalized
						For capital					under prompt corrective
	Actual					adequacy purposes					action provisions
(In thousands)	Amount		Ratio			Amount		Ratio			Amount		Ratio
As of September 30, 2015
Leverage ratio	$	80,981		8.03	%	≥ $	40,346		4.00	%	≥ $	50,433		5.00	%
CET1		80,981		10.13			35,983		4.50			51,975		6.50
Tier 1 risk-based capital ratio		80,981		10.13			47,977		6.00			63,969		8.00
Total risk-based capital ratio		99,508		12.44			63,969		8.00			79,962		10.00
As of December 31, 2014
Leverage ratio	$	74,819		7.80	%	≥ $	38,381		4.00	%	≥ $	47,976		5.00	%
Tier 1 risk-based capital ratio		74,819		10.37			28,874		4.00			43,310		6.00
Total risk-based capital ratio		92,388		12.80			57,747		8.00			72,184		10.00

The following chart compares the risk-based capital required under previous rules to those prescribed under the interim final rule under the phase-in period stated above:


	Treatment at
	December 31, 2014		September 30, 2015
Leverage ratio	4.00	%	4.00	%
CET1	N/A		4.50	%
Additional tier 1	N/A		1.50	%
Tier 1 capital ratio	4.00	%	6.00	%
Tier 2	4.00	%	2.00	%
Total capital ratio	8.00	%	8.00	%
Capital conservation buffer	N/A		2.50	%

The interim final rule also implements revisions and clarifications consistent with Basel III regarding the various components of Tier 1 capital, including common equity, unrealized gains and losses and instruments that will no longer qualify as Tier 1 capital. The interim final rule also sets forth certain changes for the calculation of risk-weighted assets that the Bank implemented as of January 1, 2015. The new capital rules will require the Company and the Bank to meet a capital conservation buffer requirement. To meet the requirement when it is fully phased in, common equity Tier 1 capital must be maintained at an amount that exceeds the buffer level of 2.5% above each of the minimum risk-weighted asset ratios. The requirement will be phased in over a four year period, starting January 1, 2016.

At September 30, 2015 and December 31, 2014, Unity Bank is “well-capitalized” under the applicable regulatory capital adequacy guidelines.

Shareholders’ Equity

Shareholders’ equity increased $5.9 million to $76.1 million at September 30, 2015 compared to $70.1 million at December 31, 2014. Items impacting shareholders’ equity included net income of $6.9 million and $365 thousand from the issuance of common stock under employee benefit plans, partially offset by a $553 thousand in accumulated other comprehensive loss related to a decrease in the fair value of AFS securities and prior service costs, net of tax, recorded in conjunction with a defined benefit plan discussed in Note 1. Additionally, $788 thousand of common stock dividends were paid. The issuance of common stock under employee benefit plans includes nonqualified stock options and restricted stock expense related entries, employee option exercises and the tax benefit of options exercised.

Repurchase Plan

On October 21, 2002, the Company authorized the repurchase of up to 10 percent of its outstanding common stock. The amount and timing of purchases is dependent upon a number of factors, including the price and availability of the Company’s shares, general market conditions and competing alternate uses of funds. There were no shares repurchased during the three or nine months ended September 30, 2015 or 2014. The Company currently has no plans on repurchasing its common stock.

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 3Quantitative and Qualitative Disclosures about Market Risk

During the nine months ended September 30, 2015, 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, 2014. (See Interest Rate Sensitivity in Management's Discussion and Analysis herein.)

ITEM 4Controls 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, 2015. 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.

No significant change in the Company’s internal control over financial reporting has occurred during the quarterly period covered by this report that has materially affected, or is reasonably likely to materially affect, the Company’s controls over financial reporting.

PART IIOTHER INFORMATION

ITEM 1Legal Proceedings

From time to time, the Company is subject to other legal proceedings and claims in the ordinary course of business. The Company currently is not aware of any such legal proceedings or claims that it believes will have, individually or in the aggregate, a material adverse effect on the business, financial condition, or the results of the operation of the Company.

ITEM 1ARisk Factors

Information regarding this item as of September 30, 2015 appears under the heading, “Risk Factors” within the Company’s Form 10-K for the year ended December 31, 2014, other than as set forth below.

As our assets exceeded $1.0 billion, we may become subject to additional regulatory reporting requirements which could increase our compliance costs and subject us to additional regulatory scrutiny.

If and when the Bank’s total assets exceed $1.0 billion, at year end, it will be subject to further reporting requirements under the rules of the FDIC as of and for the fiscal year in which it exceeds such threshold. Pursuant to these rules, management will be required to prepare a report that contains an assessment by management of the Bank’s effectiveness of internal control structure and procedures for financial reporting as of the end of such fiscal year. The Bank will also be required to obtain an independent public accountant’s attestation report concerning its internal control structure over financial reporting that includes the call report and/or the FR Y-9C report. The rules that must be met for management to assess the Bank’s internal controls over financial reporting are complex, and require significant documentation, testing and possible remediation. The effort to comply with regulatory requirements relating to internal controls will likely cause us to incur increased expenses and will cause a diversion of management’s time and other internal resources. We also may encounter problems or delays in completing the implementation of any changes necessary to make a favorable assessment of the Bank’s internal controls over financial reporting. In addition, in connection with the attestation process, the Bank may encounter problems or delays in completing the implementation of any requested improvements or receiving a favorable attestation from its independent registered public accounting firm. If the Bank cannot favorably assess the effectiveness of its internal controls over financial reporting, or if its independent registered public accounting firm is unable to provide an unqualified attestation report on the Bank’s internal controls, investor confidence and the price of our common stock could be adversely affected and we may be subject to additional regulatory scrutiny.

ITEM 2Unregistered Sales of Equity Securities and Use of Proceeds - None

ITEM 3Defaults upon Senior Securities - None

ITEM 4Mine Safety Disclosures - N/A

ITEM 5Other Information - None

ITEM 6Exhibits

	(a) Exhibits	Description
	Exhibit 10.1	Executive Incentive Retirement Plan approved on October 22, 2015 between the Registrant, the Bank and Alan Bedner, Janice Bolomey, and John Kauchak (1)
	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

(1)

Incorporated by reference from Exhibit 10.1 of current report on Form 8-K filed October 27, 2015.

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 6, 2015	/s/ Alan J. Bedner, Jr.
	Alan J. Bedner, Jr.
	Executive Vice President and Chief Financial Officer

EXHIBIT INDEX

QUARTERLY REPORT ON FORM 10-Q

Exhibit No.	Description
31.1	Exhibit 31.1-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
31.2	Exhibit 31.2-Certification of Alan J. Bedner, Jr. 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 James A. Hughes and Alan J. Bedner, Jr. 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
101.INS	XBRL Instance Document
101.SCH	XBRL Taxonomy Extension Schema Document
101.CAL	XBRL Taxonomy Extension Calculation Linkbase Document
101.LAB	XBRL Taxonomy Extension Label Linkbase Document
101.PRE	XBRL Taxonomy Extension Presentation Linkbase Document
101.DEF	XBRL Taxonomy Extension Definitions Linkbase Document