SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

(Mark One)

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

FOR THE QUARTERLY PERIOD ENDED JUNE 30, 2002

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

FOR THE TRANSITION PERIOD FROM TO

Commission file number 1-12431

Unity Bancorp, Inc.

(Exact Name of registrant as specified in its charter)

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 Issuer: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934, as amended, during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ý No o

The number of shares outstanding of each of the registrant’s classes of common equity stock, as of July 31, 2002:

Common stock, no par value: 5,396,419 shares outstanding

PART I -			CONSOLIDATED FINANCIAL INFORMATION

ITEM I -			Consolidated Financial Statements (unaudited)
			Consolidated Balance Sheets at June 30, 2002, 2001 and December 31, 2001

			Consolidated Statements Income for the three and six months ended June 30, 2002 and 2001

			Consolidated Statements of Changes in Shareholders’ Equity for the six months ended June 30, 2002 and 2001

			Consolidated Statements of Cash Flows for the six months ended June 30, 2002 and 2001

			Notes to the Consolidated Financial Statements

ITEM II -			Management’s Discussion and Analysis of Financial Condition and Results of Operations


ITEM III -			Quantitative and Qualitative Disclosures about Market Risk

PART II -			OTHER INFORMATION


ITEM 1			Legal Proceedings
ITEM 2			Changes in Securities and Use of Proceeds
ITEM 3			Defaults upon Senior Securities
ITEM 4			Submission of Matters to a Vote of Security Holders
ITEM 5			Other Information
ITEM 6			Exhibits and Reports on Form 8-K
			Exhibit Index


SIGNATURES

Unity Bancorp, Inc

Consolidated Balance Sheets

	06/30/02			12/31/01			06/30/01
*(in thousands)*	(unaudited)						(unaudited)
Assets
Cash and due from banks	$	14,409		$	16,832		$	13,416
Federal funds sold	24,000			—			8,000
Securities:
Available for sale	42,941			59,773			63,185
Held to maturity	23,848			20,923			26,031
Total securities	66,789			80,696			89,216
Loans:
SBA held for sale	10,583			17,719			8,056
SBA held to maturity	40,490			35,754			29,268
Commercial	148,562			119,262			93,323
Residential Mortgage	70,447			73,144			79,198
Consumer	26,184			26,680			27,828
Total loans	296,266			272,559			237,673
Less: Allowance for loan losses	3,563			3,165			2,664
Net loans	292,703			269,394			235,009
Premises and equipment, net	8,960			8,567			8,997
Accrued interest receivable	2,248			2,261			2,564
Other assets	1,227			1,482			1,968
Total assets	$	410,336		$	379,232		$	359,170
Liabilities and Shareholders’ Equity
Liabilities:
Deposits
Non-interest bearing	$	69,287		$	64,697		$	58,343
Interest bearing checking	149,656			119,864			109,127
Savings deposits	33,217			30,982			31,558
Time deposits, under $100,000	82,313			83,644			88,710
Time, $100,000 and over	32,839			40,767			35,090
Total deposits	367,312			339,954			322,828
Other debt	12,809			12,853			12,895
Accrued interest payable	440			366			934
Accrued expense and other liabilities	1,664			1,223			612
Total liabilities	$	382,225		$	354,396		$	337,269
Commitments and contingencies
Shareholders’ equity
Preferred stock, class A, 10%, cumulative and convertible 104 shares authorized, 6 issued and outstanding at June 30,2002 and December 31, 2001, 104 outstanding at June 30, 2001	285			285			4,929
Common stock, no par value, 12,500 shares authorized	34,584			33,248			26,234
Treasury stock, at cost, 157 shares, at June 30, 2001	—			—			(1,762		)
Retained deficit	(6,969		)	(8,692		)	(7,463		)
Accumulated other comprehensive income (loss)	211			(5		)	(37		)
Total Shareholders’ Equity	$	28,111		$	24,836		$	21,901
Total Liabilities and Shareholders’ Equity	$	410,336		$	379,232		$	359,170

Issued common shares	5,377			5,113			3,864
Outstanding common shares	5,377			5,113			3,707

See accompanying notes to the consolidated financial statements.

Unity Bancorp, Inc.

Consolidated Statements of Income

(unaudited)

	For the three months ended June 30,				For the six months ended June 30,
*(in thousands, except per share amounts)*	2002		2001		2002		2001
Interest income:
Fed funds sold and interest on deposits	$	31	$	379	$	61	$	833
Securities:
Available for sale	729		922		1,520		1,579
Held to maturity	388		366		721		839
Total securities	1,117		1,288		2,241		2,418
Loans:
SBA loans	885		806		1,784		1,657
Commercial loans	2,636		1,900		4,899		3,785
Residential Mortgage loans	1,069		1,086		2,112		2,225
Consumer loans	389		486		778		1,043
Total loan interest income	4,979		4,278		9,573		8,710
Total interest income	6,127		5,945		11,875		11,961
Interest expense:
Interest bearing checking	675		828		1,247		1,801
Savings deposits	188		182		355		360
Time deposits	1,125		1,929		2,307		3,936
Total deposit interest expense	1,988		2,939		3,909		6,097
Borrowings	196		193		393		388
Total interest expense	2,184		3,132		4,302		6,485
Net interest income	3,943		2,813		7,573		5,476
Provision for loan losses	975		150		1,575		300
Net interest income after provision for loan losses	2,968		2,663		5,998		5,176
Non-interest Income:
Deposit service charges	366		322		709		649
Loan and servicing fees	367		310		719		601
Net gains on loan sales	1,101		650		1,885		1,052
Net security gains	228		—		228		34
Other income	300		158		712		265
Total non-interest income	2,362		1,440		4,253		2,601
Non-interest expense:
Compensation and benefits	1,930		1,683		3,738		3,311
Occupancy	398		424		806		837
Processing and communications	561		520		1,072		1,002
Furniture and equipment	264		270		549		533
Professional fees	158		205		311		412
Deposit insurance	39		200		77		424
Loan servicing costs	135		64		202		139
Other expenses	415		530		797		778
Total non-interest expense	3,900		3,896		7,552		7,436
Net income before provision for income taxes	$	1,430	$	207	$	2,699	$	341
Provision for income taxes	514		5		961		11
Net income	$	916	$	202	$	1,738	$	330
Preferred stock dividends	7		131		15		260
Net income to common shareholders	$	909	$	71	$	1,723	$	70

Net income per common share - Basic	$	0.17	$	0.02	$	0.33	$	0.02
Net income per common share - Diluted	0.16		0.02		0.31		0.02

Weighted average shares outstanding – Basic	5,216		3,707		5,174		3,707
Weighted average shares outstanding – Diluted	5,556		3,739		5,552		3,720

See accompanying notes to the consolidated financial statements.

Unity Bancorp, Inc

Consolidated Statements of Changes in Shareholders’ Equity

For the Six Months ended June 30, 2002 and 2001

(unaudited)

*(In thousands)*	Preferred Stock		Common Stock		Treasury Stock			Retained Deficit			Accumulated Other Comprehensive Income (loss)			Total Shareholders’ Equity
Balance, December 31, 2000	$	4,929	$	26,234	$	(1,762)		$	(7,793)		$	(294)		$	21,314
Comprehensive income:
Net Income	—		—		—			330			—			330
Unrealized holding gain on securities arising during the period, net of tax $152	—		—		—			—			257			257
Total comprehensive income	—		—		—			—			—			587
Balance, June 30, 2001	$	4,929	$	26,234	$	(1,762	)	$	(7,463	)	$	(37	)	$	21,901

Balance, December 31, 2001	$	285	$	33,248	$	—		$	(8,692	)	$	(5	)	$	24,836
Comprehensive income:
Net Income	—		—		—			1,738			—			1,738
Net unrealized holding gain on securities arising during the period, net of tax $116	—		—		—			—			216			216
Total comprehensive income	—		—		—			—			—			1,954
Preferred stock dividends	—		—		—			(15		)	—			(15		)
Warrant exercises (255 shares)	—		1,279		—			—			—			1,279
Benefit plans (9 shares)	—		57		—			—			—			57
Balance, June 30, 2002	$	285	$	34,584	$	—		$	(6,969	)	$	211		$	28,111

See accompanying notes to the consolidated financial statements.

Unity Bancorp, Inc

Consolidated Statements of Cash Flows

(unaudited)

	For the six months ended June 30,
*(In thousands)*	2002			2001
Operating activities:
Net income	$	1,738		$	330
Adjustments to reconcile net income to net cash provided by operating activities
Provision for loan losses	1,575			300
Depreciation and amortization	610			462
Net gain on sale of securities	(228		)	(34		)
Gain on sale of SBA loans held for sale	(1,885		)	(1,052		)
Origination of SBA loans held for sale	(20,664		)	(17,455		)
Proceeds from the sale of SBA loans	29,685			17,193
Net change in other assets and liabilities	548			2,726
Net cash provided by operating activities	11,379			2,470
Investing activities:
Purchases of securities held to maturity	(6,526		)	(9,292		)
Purchases of securities available for sale	(9,827		)	(38,606		)
Maturities and principal payments on securities held to maturity	3,601			16,343
Maturities and principal payments on securities available for sale	14,628			13,279
Proceeds from sale of securities available for sale	12,605			344
Purchase of loans	(10,373		)	(8,554		)
Net increase in loans	(21,668		)	(2,223		)
Purchases in premises and equipment	(877		)	(91		)
Net cash used in investing activities	(18,437		)	(28,800		)
Financing activities:
Increase in deposits	27,358			2,510
Decrease in borrowings	(44		)	(4		)
Proceeds from the issuance of common stock	1,336			—
Dividends on preferred stock	(15		)	—
Net cash provided by financing activities	28,635			2,506
Increase (Decrease) in cash and cash equivalents	21,577			(23,824		)
Cash and cash equivalents at beginning of year	16,832			45,240
Cash and cash equivalents at end of period	$	38,409		$	21,416
Supplemental disclosures:
Cash:
Interest paid	$	4,228		$	6,218
Income taxes paid	300			—
Non-Cash investing activities:
Transfer of loan to Other Real Estate Owned	—			364

See accompanying notes to the consolidated financial statements.

Unity Bancorp, Inc

Notes to the Consolidated Financial Statements (Unaudited)

June 30, 2002

NOTE 1. Organization and principles of consolidation

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”), reflect all adjustments and disclosures which are, in the opinion of management, necessary for a fair presentation of interim results. All significant intercompany balances and transactions have been eliminated in consolidation. Certain reclassifications have been made to prior years’ amounts to conform to the current year presentation. The financial information has been prepared in accordance with generally accepted accounting principles and has not been audited. In preparing the financial statements, management is required to make estimates and assumptions that affect the reported amounts of assets and liabilities as of the dates of the statements of financial condition and revenues and expenses during the reporting periods. Actual results could differ from those estimates.

Estimates that are particularly susceptible to significant changes related to the determination of the allowance for loan losses. Management believes that the allowance for loan losses is adequate. While management uses available information to recognize losses on loans, future additions to the allowance for loan losses may be necessary based on changes in economic conditions in the market. The interim unaudited consolidated financial statements included herein have been prepared in accordance with instructions for Form 10-Q and the rules and regulations of the Securities and Exchange Commission (“SEC”). The results of operations for the three and six months ended June 30, 2002 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. Interim financial statements should be read in conjunction with the Company’s consolidated financial statements and notes thereto for the year ended December 31, 2001, included in the Company’s annual report on Form 10-K.

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. The company does not believe that any existing legal claims or proceedings will have a material impact on the Company’s financial position, or results of operations.

NOTE 3. Earnings per share

The following is a reconciliation of the calculation of basic and dilutive earnings per share. Basic net income per common share is calculated by dividing net income by the weighted average common shares outstanding during the period. Diluted net income per common share is computed similarly to that of basic net income per common share, except that the denominator is increased to include the number of additional common shares that would have been outstanding if all potentially dilutive common shares, principally stock options and warrants, were issued during the reporting period.

	Three Months ended June 30,				Six Months ended June 30,
(In thousands, except per share data)	2002		2001		2002		2001
Net Income to common shareholders	$	909	$	71	$	1,723	$	70
Basic weighted-average common shares outstanding	5,216		3,707		5,174		3,707
Plus: Common stock equivalents	340		32		378		13
Diluted weighted – average common shares outstanding	5,556		3,739		5,552		3,720
Net Income per Common share:
Basic	$	0.17	$	0.02	$	0.33	$	0.02
Diluted	0.16		0.02		0.31		0.02

NOTE 4. Recent accounting pronouncements

In July, 2002, the FASB issued SFAS No. 146, Accounting for Costs Associated with Exit or Disposal Activities. The standard requires companies to recognize costs associated with exit or disposal activities when they are incurred rather than at the date of a commitment to an exit or disposal plan. The Statement is to be applied prospectively to exit or disposal activities initiated after December 31, 2002.

In April, 2002, the FASB issued SFAS No. 145. SFAS No. 145 among other things rescinds SFAS No. 4, Reporting Gains and Losses from Extinguishments of Debt. Under SFAS No. 4, gains and losses from the extinguishment of debt were required to be classified as an extraordinary item, if material. Under SFAS No. 145, gains or losses from the extinguishment of debt are to be classified as a component of operating income, rather than an extraordinary item. SFAS No. 145 is effective for fiscal years beginning after May 15, 2002, with early adoption of the provisions related to the rescission of SFAS No. 4 encouraged. Upon adoption, companies must reclassify prior period amounts previously classified as an extraordinary item. Management does not anticipate that the initial adoption of SFAS 145 will have a significant impact on the Company’s consolidated financial statements.

NOTE 5. Business Combinations and Joint Ventures

On May 20, 2002 the Company announced that it has agreed to partner in a title insurance agency. The Company will have a 40% ownership interest in a newly created title insurance agency located in Somerville NJ, and will perform core title agency services. Unity’s investment is not material to its financial statements.

On June 12, 2002, the Company signed a letter of intent to acquire First Bank of Central Jersey (First Bank). First Bank has approximately $60 million in total assets, with two retail branch offices, and is headquartered in North Brunswick, New Jersey. The final terms of the acquisition, including the acquisition price are still being negotiated. The acquisition, which is subject to the execution of a definitive agreement, regulatory approval and the approval of First Bank’s shareholders, is expected to be accounted for as a tax-free stock-for-stock exchange. Under the offer terms, Unity will exchange shares of Unity common stock and warrants to purchase Unity common stock in exchange for all of the outstanding shares of First Bank. The warrants will have terms of three and five years, and exercise prices based on the value of Unity’s common stock at the consummation of the transaction. Both the shares and warrants in the transaction will be subject to adjustment based on the market price of Unity stock at the time of merger and the performance of First Bank between now and the closing of the transaction.

ITEM II

Unity Bancorp, Inc.

Management’s Discussion and Analysis of

Financial Condition and Results of Operations

The following discussion and analysis of financial condition and results of operations should be read in conjunction with the consolidated financial statements and notes. When necessary, reclassifications have been made to prior period data throughout the following discussion and analysis for purposes of comparability. This Form 10-Q contains certain “forward looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995, which may be identified by the use of such words as “believe”, “expect”, “anticipate”, “should”, “planned”, “estimated” and “potential”. Examples of forward looking statements include, but are not limited to, estimates with respect to the financial condition, results of operations and business of Unity Bancorp, Inc. that are subject to various factors which could cause actual results to differ materially from these estimates. These factors include: changes in general, economic, and market conditions, legislative and regulatory conditions, or the development of an interest rate environment that adversely affects Unity Bancorp Inc.’s interest rate spread or other income anticipated from operations and investments.

Overview and Strategy

Unity Bancorp, Inc. (the “Parent Company”) is incorporated in New Jersey and is a bank holding company under the Bank Holding Company Act of 1956, as amended. 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 12 branch offices located in Hunterdon, Somerset, Middlesex, and Union counties in New Jersey. These services include the acceptance of demand, savings, and time deposits; extension of consumer, real estate, Small Business Administration and other commercial credits, as well as personal investment advisory services through the Bank’s wholly owned subsidiary, Unity Financial Services, Inc. Unity Investment Company, Inc. is also a wholly owned subsidiary of the Bank, used to hold part of the Bank’s investment portfolio.

Unity Bancorp

Consolidated Average Balance Sheets with resultant Interest and Rates

(unaudited)

(Tax-equivalent basis, dollars in thousands)

	Three Months Ended
	June 30, 2002							June 30, 2001
	Balance			Interest		Rate		Balance			Interest		Rate
Assets
Interest-earning assets:
Federal funds sold and interest-bearing deposits with banks	$	7,850		$	31	1.58	%	$	35,073		$	379	4.33	%
Securities:
Available for sale	52,097			729		5.60		60,355			922		6.11
Held to maturity	24,608			388		6.31		23,999			366		6.12
Total securities	76,705			1,117		5.82		84,354			1,288		6.11
Loans, net of unearned discount:
SBA loans	54,946			885		6.44		35,096			806		9.19
Commercial	144,404			2,636		7.32		86,219			1,900		8.84
Residential Mortgages	71,066			1,069		6.02		73,547			1,086		5.91
Consumer	26,250			389		5.94		28,294			486		6.89
Total loans	296,666			4,979		6.72		223,156			4,278		7.68
Total interest-earning assets	381,221			6,127		6.43		342,583			5,945		6.95
Noninterest-earning assets:
Cash and due from banks	12,154							10,999
Allowance for loan losses	(3,514		)					(2,631		)
Other assets	12,165							13,715
Total noninterest-earning assets	20,805							22,083
Total Assets	$	402,026						$	364,666

Liabilities and Shareholders’ Equity
Interest-bearing liabilities:
Interest-bearing checking	$	141,044		675		1.92		$	108,193		828		3.07
Savings deposits	32,488			188		2.32		31,300			182		2.33
Time deposits	122,037			1,125		3.70		133,046			1,929		5.82
Total interest-bearing deposits	295,569			1,988		2.70		272,539			2,939		4.33
Other borrowed funds	13,442			196		5.85		12,904			193		6.00
Total interest-bearing liabilities	309,011			2,184		2.83		285,443			3,132		4.40
Noninterest-bearing liabilities:
Demand deposits	64,559							56,210
Other liabilities	1,940							1,430
Total noninterest-bearing liabilities	66,499							57,640
Shareholders’ equity	26,516							21,583
Total Liabilities and Shareholders’ Equity	$	402,026						$	364,666

Net interest spread				3,943		3.60	%				2,813		2.55	%
Tax-equivalent basis adjustment				—							—
Net interest income				$	3,943						$	2,813
Net interest margin						4.14	%						3.28	%

Unity Bancorp

Consolidated Average Balance Sheets with resultant Interest and Rates

(unaudited)

(Tax-equivalent basis, dollars in thousands)

	Three Months Ended
	June 30, 2002							June 30, 2001
	Balance			Interest		Rate		Balance			Interest		Rate
Assets
Interest-earning assets:
Federal funds sold and interest-bearing deposits with banks	$	7,763		$	61	1.58	%	$	34,075		$	833	4.93	%
Securities:
Available for sale	54,775			1,520		5.55		51,461			1,579		6.14
Held to maturity	22,701			721		6.35		27,904			839		6.01
Total securities	77,476			2,241		5.79		79,365			2,418		6.09
Loans, net of unearned discount:
SBA loans	54,374			1,784		6.56		33,667			1,657		9.84
Commercial	134,036			4,899		7.37		86,106			3,785		8.86
Residential Mortgages	71,209			2,112		5.93		75,190			2,225		5.92
Consumer	26,386			778		5.95		28,640			1,043		7.34
Total loans	286,005			9,573		6.73		223,603			8,710		7.82
Total interest-earning assets	371,244			11,875		6.43		337,043			11,961		7.12
Noninterest-earning assets:
Cash and due from banks	13,378							11,272
Allowance for loan losses	(3,431		)					(2,632		)
Other assets	12,092							13,789
Total noninterest-earning assets	22,039							22,429
Total Assets	$	393,283						$	359,472

Liabilities and Shareholders’ Equity
Interest-bearing liabilities:
Interest-bearing checking	$	134,551		1,247		1.87		$	105,860		1,801		3.43
Savings deposits	32,274			355		2.22		30,839			360		2.35
Time deposits	122,558			2,307		3.80		133,004			3,936		5.97
Total interest-bearing deposits	289,383			3,909		2.72		269,703			6,097		4.56
Other borrowed funds	13,731			393		5.77		12,903			388		6.06
Total interest-bearing liabilities	303,114			4,302		2.86		282,606			6,485		4.61
Noninterest-bearing liabilities:
Demand deposits	62,525							54,065
Other liabilities	1,729							1,329
Total noninterest-bearing liabilities	64,254							55,393
Shareholders’ equity	25,915							21,472
Total Liabilities and Shareholders’ Equity	$	393,283						$	359,472

Net interest spread				7,573		3.57	%				5,476		2.51	%
Tax-equivalent basis adjustment				—							—
Net interest income				$	7,573						$	5,476
Net interest margin						4.08	%						3.25	%

Results of Operations for the three and six months ended June 30, 2002

Net Income

Net income for the three months ended June 30, 2002, was $916 thousand, or $0.17 per basic and $0.16 per diluted common share, compared to a net income of $202 thousand, or $0.02 per basic and diluted common share for the same period in 2001. Net income for the six months ended June 30, 2002, was $1.7 million, or $0.33 per basic and $0.31 per diluted share, compared to a net income of $330 thousand, or $0.02 per basic and diluted share for the same period in 2001. After consideration of the preferred stock dividends, net income to common shareholders was $909 thousand for the three months ended and $1.7 million for the six months ended June 30, 2002, compared to a net income of $71 thousand and $70 thousand, respectively, for the three and six month periods ended June 30, 2001. The improved operating results for the three and six months ended were primarily the result of increases in interest income and non-interest income, and continued expense controls. The following are key performance indicators for the three and six months ended June 30, 2002, and 2001.

(In thousands)	Three Months ended June 30,						Six Months ended June 30,
	2002			2001			2002			2001
Net Income	$	916		$	202		$	1,738		$	330
Preferred stock dividends	7			131			15			260
Net Income to common stockholders	909			71			1,723			70
Net Income per common share-basic	0.17			0.02			0.33			0.02
Net Income per common share-diluted	0.16			0.02			0.31			0.02
Performance Ratios:
Return on average assets	0.91		%	0.22		%	0.89		%	0.18		%
Return on average common equity	13.90			1.56			13.56			0.78
Efficiency ratio	64.18			91.61			65.11			92.45

Net Interest Income

Interest income was $6.1 million for the three months ended June 30, 2002, compared to $5.9 million a year ago. Interest-earning assets averaged $381.2 million, an increase of $38.6 million, or 11.3 percent, compared to the prior year period. The increases in average earning assets occurred primarily due to a $73.5 million increase in the loan portfolio, partially offset by a decrease of $27.2 million in federal funds sold and a $8.3 million decrease in securities available for sale. The rate earned on interest-earning assets decreased 52 basis points to 6.43 percent for the three months ended June 30, 2002, compared to the same period a year ago, due to a lower rate environment. Of the $182 thousand increase in interest income, $1.1 million can be attributed to the increase in interest earning assets, partially offset by a decline of $920 thousand due to the reduction in yield.

Interest expense decreased $948 thousand or 30.3 percent for the three months ended June 30, 2002, compared to the same period a year ago. Interest-bearing liabilities averaged $309.0 million for the three months ended June 30, 2002, an increase of $23.6 million, or 8.3 percent, compared to the prior year period. The increases in average interest bearing liabilities were the result of an increase in interest-bearing deposits. The rate paid on interest bearing liabilities decreased 157 basis points from the same period in 2001 to 2.83 percent. Total interest-bearing deposits were $295.6 million, an increase of $23.0 million from the same period a year ago. The increase in interest-bearing deposits was as a result of increases in interest-bearing demand deposits, partially offset by the planned reduction of higher costing time deposits. The rate paid on interest bearing deposits was 2.70 percent for the quarter ended June 30, 2002, a decrease of 163 basis points from the same period a year ago.

Net interest income was $3.9 million for the three months ended June 30, 2002, an increase of $1.1 million or 40.2 percent from the same period a year ago. The rise in net interest income was due to the increase in net interest spread and margin. The net interest spread (the difference between the rate earned on average interest-earning assets and the rate paid on average interest-bearing liabilities) was 3.60 percent for the three months ended June 30, 2002 compared to 2.55 for the same period a year ago. Net interest margin (net interest income as a percentage of average interest earning assets) was 4.14 percent for the quarter compared to 3.28 percent for the same period a year ago.

Interest income was $11.9 million for the six months ended June 30, 2002, compared to $12.0 million a year ago. Interest-earning assets averaged $371.2 million, an increase of $34.2 million, or 10.1 percent, compared to the prior year period. The increases in average earning assets occurred primarily due to the $62.4 million increase in the loan portfolio,

partially offset by a decrease of $26.3 million in Federal funds sold and $1.9 million in investment securities. The rate earned on interest-earning assets decreased 69 basis points to 6.43 percent for the six months ended June 30, 2002, compared to the same period a year ago, primarily due to a lower rate environment. The increase in interest earning assets contributed $2.0 million to the increase in interest income, offset by the $2.1 million decline due to yield.

Interest expense decreased $2.2 million or 33.7 percent for the six months ended June 30, 2002, compared to the same period a year ago. Interest-bearing liabilities averaged $303.1 million for the six months ended June 30, 2002, an increase of $20.5 million or 7.3 percent compared to the prior year period. The increase in average interest bearing liabilities occurred primarily in interest-bearing deposits. The increase in interest-bearing liabilities contributed $132 thousand in additional expense offset by the decline of $2.3 million in interest expense as a result of lower rates paid on interest bearing liabilities. The rate paid on interest bearing liabilities decreased 175 basis points to 2.86 percent. Total interest-bearing deposits were $289.4 million, an increase of $20.0 million from the same period a year ago. The increase in interest-bearing deposits was as a result of an increase in interest bearing demand deposits offset by the planned reduction in higher costing time deposits. The rate paid on interest bearing deposits was 2.72 percent for the six months ended June 30, 2002, a decrease of 184 basis points from last year.

Net interest income was $7.6 million for the six months ended June 30, 2002, an increase of $2.1 million, or 38.3 percent, from the same period a year ago. The rise in net interest income was due to the increase in net interest spread and margin. The net interest spread (the difference between the rate earned on average interest-earning assets and the rate paid on average interest-bearing liabilities) was 3.57 percent for the six months ended June 30, 2002 compared to 2.49 for the same period a year ago. Net interest margin (net interest income as a percentage of average interest earning assets) was 4.08 percent for the six months ended compared to 3.25 percent for the same period a year ago.

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

Rate Volume Table

	Amount of Increase (Decrease)
	Three months ended June 30, 2002 versus June 30, 2001						Six months ended June 30, 2002 versus June 30, 2001
	Due to change in:						Due to change in:
	Volume		Rate		Total		Volume		Rate		Total
Interest Income
Commercial	1,108		(288	)	79		1,833		(719	)	127
SBA	367		(372	)	736		798		(671	)	1,114
Residential mortgage	(37	)	20		(17	)	(117	)	4		(113	)
Consumer	(33	)	(64	)	(97	)	(78	)	(187	)	(265	)
Total Loans	1,405		(704	)	701		2,436		(1,573	)	863

Available for sale securities	(120	)	(73	)	(193	)	98		(157	)	(59	)
Held to maturity securities	9		13		22		(163	)	45		(118	)
Federal funds sold and interest bearing deposits	(192	)	(156	)	(348	)	(411	)	(361	)	(772	)
Total Interest Earning assets	1,102		(920	)	182		1,960		(2,046	)	(86	)

Interest Expense
Interest bearing checking	209		(362	)	(153	)	405		(959	)	(554	)
Savings deposits	8		(2	)	6		16		(21	)	(5	)
Time deposits	(149	)	(655	)	(804	)	(289	)	(1,340	)	(1,629	)
Total Interest Bearing Deposits	68		(1,019	)	(951	)	132		(2,320	)	(2,188	)
Borrowings	8		(5	)	3		24		(19	)	5
Total interest-bearing liabilities	76		(1,024	)	(948	)	156		(2,339	)	(2,183	)
Net interest income	1,026		104		1,130		1,804		293		2,097
Increase in net interest income					1,130						2,097

Provision for Loan Losses

The provision for loan losses was $975 thousand for the three months ended June 30, 2002, an increase of $825 thousand, compared to $150 thousand for the same period a year ago. The provision for loan losses was $1.6 million for the six months ended June 30, 2002, an increase of $1.3 million compared to $300 thousand for the same period a year ago. The increase from a year ago was primarily attributable to increased charge offs, the increase in past due loans, the increase

and change in the composition of the loan portfolio, and the analysis of the estimated potential losses inherent in the loan portfolio. “See Asset Quality”. The provision is based on management’s assessment of the adequacy of the allowance for loan losses, described under the section titled Allowance for Loan Losses. The current provision is considered appropriate under the assessment of the adequacy of the allowance for loan losses.

Non-Interest Income

	Three months ended June 30,						Six months ended June 30,
(in thousands)	2002		2001		Percent Change		2002		2001		Percent Change
Deposit service charges	$	366	$	322	13.7	%	$	709	$	649	9.2	%
Loan and servicing fees	367		310		18.4		719		601		19.6
Net gains on loan sales	1,101		650		69.4		1,885		1,052		79.2
Net security gains	228		—		—		228		34		570.5
Other income	300		158		89.9		712		265		168.6
Total non-interest income	$	2,362	$	1,440	64.0	%	4,253		$	2,601	63.5	%

Non-interest income consists of service charges on deposits, loan and servicing fees, net gains on sales of securities and loans and other income. Non-interest income was $2.4 million for the three months ended June 30, 2002, an increase of $922 thousand compared with 2001, and was $4.3 million for the six months ended June 30, 2002, an increase of $1.7 million, compared to the same period a year ago.

Deposit service charges increased $44 thousand, or 13.7 percent, for the three months ended June 30, 2002, compared to the same period a year ago, and increased $60 thousand, or 9.2 percent, for the six months ended June 30, 2002, compared with the same period a year ago. Deposit service charges increased for the three and six months as a result of higher fees and the growth in the deposit base.

Loan and servicing fees increased $57 thousand, or 18.4 percent, for the three months ended June 30, 2002, and increased $118 thousand, or 19.6 percent, for the six months ended June 30, 2002. The growth in loan and servicing fees for the three and six months ended is attributed to the growth of the serviced SBA loan portfolio, which amounted to $116.2 million at June 30, 2002, compared to $94.2 million at June 30, 2001.

Net gains on loan sales include participation in the SBA’s guaranteed loan program. Under the program, the SBA guarantees up to 85 percent of the principal of a qualifying loan. The guaranteed portion of the loan is then sold into the secondary market. The premium received on the sale of the loans sold is recorded as a gain on the sale. SBA loan sales, all without recourse, totaled $13.6 million in the three months ended, and $27.8 million for the six months ended June 30, 2002, compared to $10.4 million and $16.1 million, respectively, for the three and six month periods ended June 30, 2001. Gains on SBA loan sales were $1.1 million for the three months ended, and $1.9 million for the six months ended June 30, 2002 compared to $650 thousand and $1.1 million, respectively, for the same periods a year ago. The increase in gains on the sale of SBA loans is a result of the increase of SBA loans being sold and higher premiums received on sales.

Other non-interest income increased $142 thousand for the three months ended June 30, 2002, compared with 2001 and increased $447 thousand for the six months then ended, compared with the same period a year ago. The increase was primarily due to an increase in commercial loan referral fees which amounted to $194 thousand for the three months ended and $491 for the six months ended June 30, 2002, compared to $48 thousand and $76 thousand, respectively for the three and six month periods ended 2001.

Non-Interest Expense

	Three months ended June 30,						Six months ended June 30,
	2002		2001		Percent Change		2002		2001		Percent Change
Compensation and benefits	$	1,930	$	1,683	14.7	%	$	3,738	$	3,311	12.9	%
Occupancy	398		424		(6.1	)	806		837		(3.7	)
Processing and communications	561		520		7.9		1,072		1,002		7.0
Furniture and equipment	264		270		(2.2	)	549		533		3.0
Professional services	158		205		(22.9	)	311		412		(24.5	)
FDIC insurance	39		200		(80.5	)	77		424		(81.8	)
Loan servicing costs	135		64		110.0		202		139		45.3
Other expense	415		530		(21.7	)	797		778		2.4
Total non-interest expense	$	3,900	$	3,896	0.1	%	7,552		$	7,436	1.6	%

Compensation and benefits expense increased $247 thousand, or 14.7 percent, for the three months ended June 30, 2002, compared to the same period a year ago, and increased $427 thousand, or 12.9 percent for the six months ended June 30, 2002, compared to the same period a year ago. The increase in compensation and benefits was a result of merit increases effective January 1, 2002, compensation incentives not awarded in 2001 and the increase in the number of employees. Total full time equivalent employees amounted to 153 at June 30, 2002, compared to 145 at June 30, 2001.

Occupancy expense decreased $26 thousand, or 6.1 percent, for the three months ended June 30, 2002, compared to the same period a year ago, and decreased $31 thousand, or 3.7 percent, for the six months ended June 30, 2002, compared to the same period a year ago. The decrease for the three and six month periods is related to lower maintenance costs.

Processing and communications expense increased $41 thousand, or 7.9 percent, for the three months ended June 30, 2002, compared to the same period a year ago, and increased $70 thousand, or 7.0 percent, for the six months ended June 30, 2002, compared to the same period a year ago. The increase for the three and six month periods is primarily as a result of higher items processing costs related to the growth in the deposit and loan portfolios.

Furniture and equipment expense decreased $6 thousand, or 2.2 percent, for the three months ended June 30, 2002, compared to the same period a year ago, and increased $16 thousand, or 3.0 percent, for the six months ended June 30, 2002, compared to the same period a year ago.

Professional fees decreased $47 thousand, or 22.9 percent, for the three months ended June 30, 2002, compared to the same period a year ago, and decreased $101 thousand, or 24.5 percent, for the six months ended June 30, 2002, compared to the same period a year ago. The decrease is due to reduced legal and accounting costs.

Deposit insurance decreased $161 thousand for the three months ended June 30, 2002, compared to the same period a year ago, and decreased $347 thousand for the six months ended June 30, 2002, compared to the same period a year ago. The decrease is due to a reduced insurance assessment related to the Company’s improved financial and regulatory condition.

Loan servicing expense increased $71 thousand, or 110.0 percent for the three months ended June 30, 2002, compared to the same period a year ago, and increased $63 thousand, or 45.3 percent, for the six months ended June 30, 2002, compared to the same period a year ago. The increase in loan servicing expenses for the current three and six month periods is primarily related to higher legal costs related to loan collections.

Other expense decreased $115 thousand, or 21.7 percent, for the three months ended June 30, 2002, compared to the same period a year ago, and decreased $19 thousand, or 2.4 percent, for the six months ended June 30, 2002, compared to the same period a year ago. The decrease is the result of lower advertising expenses.

Income Tax Expense

For the second quarter of 2002, the provision for income taxes was $514 thousand compared to $5 thousand for the same period a year ago and $961 thousand for the six months ended compared to $11 thousand for the same period a year ago. In 2001, the Company reversed tax valuation reserves to substantially offset tax expense. The current 2002 tax provision represents an effective tax rate of 36 percent. Management anticipates an effective rate of 36 percent for the remainder of 2002.

Financial Condition at June 30, 2002

Total assets at June 30, 2002, were $410.3 million compared to $359.2 million a year ago and $379.2 million from year-end 2001. The increases in assets were the result of deposit generation used to fund loan growth.

Securities

Securities available for sale are investments carried at fair value that may be sold in response to changing market and interest rate conditions or for other business purposes. Securities held to maturity, which are carried at amortized cost, are investments for which there is the positive intent and ability to hold to maturity. Management determines the appropriate security classification of available for sale or held to maturity at the time of purchase. The investment securities portfolio is maintained for asset-liability management purposes, as an additional source of liquidity, and as an additional source of earnings. The portfolio is comprised of U.S. Treasury securities, obligations of U.S. Government and government sponsored agencies, collateralized mortgage obligations and corporate and equity securities. Approximately 86 percent of the total investment portfolio has a fixed rate of interest. In the normal course of business, the Company accepts government deposits that require investment securities to be held as collateral. As of June 30, 2002, $6.4 million of securities were required to be pledged for governmental deposits.

Securities available for sale were $42.9 million at June 30, 2002, a decrease of $16.8 million, or 28.2 percent from year-end 2001. During the first six months of 2002, $9.8 million of securities available for sale were purchased, partially offsetting $14.6 million of maturities and paydowns and $12.4 million in securities sales. The yield on securities available for sale was 5.55 percent for the six months ended June 30, 2002, compared to 6.14 percent a year ago, reflecting declines in market rates of interest.

Securities held to maturity were $23.8 million at June 30, 2002, an increase of $2.9 million, or 14.0 percent, from year-end 2001. During the first six months of 2002, $6.5 million of held to maturity securities were purchased and primarily funded by $3.6 million of maturities and paydowns. The yield on securities held to maturity was 6.35 percent for the six months ended June 30, 2002 compared to 6.01 for the same period a year ago, reflecting the maturity of lower yielding investments and the purchase of higher yielding instruments. As of June 30, 2002, and December 31, 2001 the market value of held to maturity securities was $24.4 million and $21.1 million, respectively.

Loan Portfolio

The loan portfolio, which represents the Company’s largest asset group, is a significant source of both interest and fee income. The portfolio consists of commercial, Small Business Administration (“SBA”), residential mortgage and consumer loans. Elements of the loan portfolio are subject to differing levels of credit and interest rate risk. Loans increased $23.7 million, or 8.7 percent to $296.3 million at June 30, 2002, from year-end 2001.

SBA loans provide guarantees of up to 85 percent of the principal from the SBA. SBA loans are generally sold in the secondary market with the non-guaranteed portion held in the portfolio. SBA loans amounted to $40.5 million at June 30, 2002, an increase of $4.7 million from year-end 2001. SBA loans held for sale, carried at the lower of aggregate cost or market, amounted to $10.6 million at June 30, 2002, a decrease of $7.1 million from year-end 2001. The SBA held for sale portfolio decreased due to the increased volume of loan sales in 2002, while the Company held SBA loans in portfolio for longer periods during 2001. SBA loans are often originated outside of the Company’s market place. The yield on SBA loans which are generally floating and tied to prime was 6.56 percent for the six months ended June 30, 2002 compared to 9.84 percent for the same period a year ago.

Commercial loans are generally made in the Company’s market place for the purpose of providing working capital, financing the purchase of equipment, inventory or commercial real estate and for other business purposes. These loans amounted to $148.6 million at June 30, 2002, an increase of $29.3 million, or 24.6 percent, from year-end 2001. The increase in the portfolio was a result of originations exceeding prepayments. Included in commercial loans as of June 30, 2002 are $2.6 million of financed commercial leases. The yield on these commercial loans was 7.37 percent for the six months ended June 30, 2002 compared to 8.86 percent for the same period a year ago. The Company no longer engages in lease financing.

Residential mortgage loans consist of loans secured by residential properties. These loans amounted to $70.4 million at June 30, 2002, a decrease of $2.7 million from year-end 2001. The decrease in residential mortgages was a result of pay-downs in the portfolio partially offset by purchases totaling $10.7 million. The Company does not originate a material amount of mortgage loans held for investment. The yield on residential mortgages was 5.93 percent for the six months ended June 30, 2002 compared to 5.92 percent for the same period a year ago.

Consumer loans consist of home equity loans and loans for the purpose of financing the purchase of consumer goods, home improvements, and other personal needs, and are generally secured by the personal property being purchased. These loans amounted to $26.2 million at June 30, 2002, a decrease of $0.5 million from year-end December 2001. The decrease in the consumer loan portfolio was primarily the result of loan pay-downs. The yield on consumer loans was 5.95 percent for the six months ended June 30, 2002, compared to 7.34 percent for the same period a year ago.

The declines in yield throughout the loan portfolio reflect the declining interest rate environment in 2001.

Asset Quality

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

Non-performing loans consist of loans that are not accruing interest (nonaccrual loans) as a result of principal or interest being in default for a period of 90 days or more or when the collectibility of principal and interest according to the contractual terms is in doubt. When a loan is classified as nonaccrual, interest accruals discontinue and all past due interest previously recognized as income is reversed and charged against current period income. Generally, until the loan becomes current, any payments received from the borrower are applied to outstanding principal until such time as management determines that the financial condition of the borrower and other factors merit recognition of a portion of such payments as interest income. Loans past due 90 days and still accruing interest are not included in non-performing loans. Management believes these loans to be well collateralized and in the process of collection. The Company had no loans 90 days past due and still accruing at June 30, 2002. Credit risk is minimized by loan diversification and adhering to credit administration policies and procedures. Due diligence on loans begins upon the origination of a loan with a borrower. Documentation, including a borrower’s credit history, materials establishing the value and liquidity of potential collateral, the purpose of the loan, the source of funds for repayment of the loan, and other factors are analyzed before a loan is submitted for approval. The loan portfolio is then subject to ongoing internal reviews for credit quality.

The following table sets forth information concerning non-accrual loans and non-performing assets for the quarters ended June 30, 2002 and 2001, and December 31, 2001:

Non-performing loans (In thousands)	June 30, 2002			December 31, 2001			June 30, 2001

Non-performing loans
SBA	$	2,388		$	2,015		$	17
Commercial	1,239			989			2,124
Residential mortgage	74			—			—
Consumer	248			180			138
Total non-performing loans	3,949			3,184			2,279
OREO	153			258			507
Total Non-Performing Assets	4,102			$	3,442		$	4,785

Past Due 90 days or more and still accruing interest
SBA	—			13			7
Commercial	—			—			1,956
Residential mortgage	—			—			—
Consumer	—			56			36
Total accruing loans 90 days or more past due	—			$	69		1,999


Non-Performing assets to total assets	1.00		%	0.91		%	1.33		%
Non-Performing assets to loans and OREO	1.38		%	1.26		%	2.01		%
Allowance for loans losses as a percentage of non-performing loans	90.23		%	99.40		%	62.27		%
Allowance for loan losses to total loans	1.20		%	1.16		%	1.12		%

Non-performing loans amounted to $3.9 million at June 30, 2002, an increase of $765 thousand from $3.2 million at year-end 2001. There were no loans past due 90 days or more and still accruing interest at June 30, 2002. Included in non-accrual loans at June 30, 2002 are $1.2 million of loans guaranteed by the SBA. Also included in

non-accrual loans at June 30, 2002 is an $896 thousand receivable due on a payment bond which is expected to be paid in the third quarter. The $896 thousand is the remaining balance on a $1.1 million loan made to a finance company, which was secured by a payment bond issued by a surety company unrelated to the borrower.

Potential problem loans are those where information about possible credit problems of borrowers causes management to have doubts as to the ability of such borrowers to comply with loan repayment terms. These loans are not included in non-performing loans as they continue to perform. Potential problem loans, which consist primarily of commercial loans, were $0.3 million at June 30, 2002 and $0.3 million at December 31, 2001.

Allowance for Loan Losses

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

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

The allowance for loan losses totaled $3.6 million, $3.2 million, and $2.7 million at June 30, 2002, December 31, 2001, and June 30, 2001, respectively with resulting allowance to total loan ratios of 1.20 percent, 1.16 percent and 1.12 percent respectively. Net charge offs amounted to $592 thousand and $1.2 million, respectively, for the three and six months ended June 30, 2002, compared to $36 thousand and $194 thousand for the three and six months ended June 30, 2001. The increase in net charge offs for the three and six months ended is primarily due to charge offs on commercial lease loans and a credit to a finance company.

The following is a reconciliation summary of the allowance for loan losses the three and six months ended June 30, 2002 and 2001:

Allowance for Loan Loss Activity	Three months ended June 30,				Six Months ended June 30,
*(In thousands)*	2002		2001		2002		2001
Balance, beginning of period	3,180		2,550		3,165		2,558
Provision charged to expense	975		150		1,575		300

Charge-offs:
SBA	22		—		22		45
Commercial	574		14		1,118		154
Residential mortgage	13		48		13		48
Consumer	34		10		104		13
Total Charge-offs	643		72		1,257		260
Recoveries:
SBA	2		—		29		15
Commercial	35		5		35		10
Residential mortgage	—		30		—		39
Consumer	14		1		16		2
Total recoveries	51		36		80		66
Total net charge-offs	592		36		1,177		194
Balance, end of period	3,563		2,664		3,563		2,664
Selected loan quality ratios:
Net charge offs to average loans (quarter to date)	0.80	%	0.06	%	0.83	%	0.17	%
Allowance for loan losses to total loans at period end)	1.20	%	1.12	%	1.20	%	1.12	%
Allowance for loan losses to non-performing loans	90.23	%	116.89	%	90.23	%	116.89	%

Deposits

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

Total deposits increased $27.4 million to $367.3 million at June 30, 2002 from $340.0 million at December 31, 2001. The increase in deposits was primarily the result of a $4.6 million increase in demand deposits and $32.0 million increase in interest bearing checking and savings, partially offset by a decline in time deposits totaling $9.3 million. The decline in time deposits is the result of promotional high rate deposits maturing in a lower interest rate environment. Included in time deposits are $12.2 million of Government deposits, as compared to $19.9 million at December 31, 2001. These deposits are generally short in duration, and are very sensitive to price competition. The Company has significantly reduced its reliance on these deposits as a source of funds, and believes the current portfolio of these deposits to be appropriate.

Other Debt

Other debt, which includes $10.0 million in advances from the Federal Home Loan Bank (“FHLB”), and $2.8 million of lease obligations, amounted to $12.8 million at June 30, 2002, a decline of $44 thousand from year-end 2001. The 4.92% borrowings from the FHLB mature in 2010 and are callable at any time.

Interest Rate Sensitivity

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

The Company utilizes Modified Duration of Equity and Economic Value of Portfolio Equity (“EVPE”) models to measure the impact of longer-term asset and liability mismatches beyond two years. The modified duration of equity measures the potential price risk of equity to changes in interest rates. A longer modified duration of equity indicates a greater degree of risk to rising interest rates. Because of balance sheet optionality, an EVPE analysis is also used to dynamically model the present value of asset and liability cash flows, with rate shocks of 200 basis points. The economic value of equity is likely to be different as interest rates change. Like the simulation model, results falling outside prescribed ranges require action by the ALCO. The Company’s variance in the economic value of equity, as a percentage of assets with rate shocks of 200 basis points at June 30 2002, is a decline of 1.3 percent in a rising rate environment and an increase of 0.3 percent in a falling rate environment. Both variances are within the board-approved guidelines of +/- 3.00 percent. At December 31, 2001 the economic value of equity with rate shocks of 200 basis points was a decline of 1.4 percent in a rising rate environment and an increase of 0.1 percent in a falling rate environment.

Operating, Investing, and Financing Cash

Cash and cash equivalents amounted to $38.4 million at June 30, 2002, an increase of $21.6 million from December 31, 2001. Net cash provided by operating activities for the six months ended June 30, 2002, amounted to $11.4 million, primarily from proceeds from the sales of loans held for sale, net income from operations and the provision for loan losses partially offset by originations of loans held for sale. Net cash used in investing activities amounted to $18.4 million for the six months ended June 30, 2002, primarily from the funding of and purchases in the loan portfolio, increased investment in securities, partially offset by maturities of securities. Net cash provided by financing activities, amounted to $28.6 million for the six months ended June 30, 2002, attributable to deposit growth of $27.4 million and the proceeds from the issuance of common stock.

Liquidity

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

Holding Company

The principal source for funds for the holding company is dividends paid by the Bank. At June 30, 2002, the Holding Company had $779 thousand in cash and $108 thousand in marketable securities. Expenses at the Holding Company are minimal and the management believes that the Holding Company has adequate liquidity.

Consolidated Bank

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

At June 30, 2002, $10.5 million was available for additional borrowings from the FHLB of New York. Pledging additional collateral in the form of 1-4 family residential mortgages or investment securities can increase the line with the FHLB. The maximum borrowing line available if additional collateral was pledged as of June 30, 2002 amounted to $39.2 million. An additional source of liquidity is Federal Funds sold, which were $24.0 million at June 30, 2002.

As of June 30, 2002, deposits included $26.6 million of Government deposits, as compared to $33.2 million at December 31, 2001. These deposits are generally short in duration, and are sensitive to price competition. The Company has reduced its reliance on these deposits as a source of funds, and believes the current portfolio of these deposits to be appropriate. Included in the portfolio are $26.0 million of deposits from three municipalities. The withdrawal of these deposits, in whole or in part would not create a liquidity shortfall for the Company. At June 30, 2002, the Bank had approximately $85.0 million of loan commitments, which will generally either expire or be funded within one year. The Company believes it has the necessary liquidity to honor all commitments. Many of these commitments will expire and never be funded. In addition, approximately $28.1 million of these commitments are for SBA loans, which may be sold into the secondary market.

Capital

A significant measure of the strength of a financial institution is its capital base. Federal regulators have classified and defined capital into the following components: (1) tier 1 capital, which includes tangible shareholders’ equity for

common stock and qualifying preferred stock, and (2) tier 2 capital, which includes a portion of the allowance for loan losses, certain qualifying long-term debt and preferred stock which does not qualify for tier 1 capital. Minimum capital levels are regulated by risk-based capital adequacy guidelines, which require a bank to maintain certain capital as a percent of assets, and certain off-balance sheet items adjusted for predefined credit risk factors (risk-adjusted assets). A bank is required to maintain, at a minimum, tier 1 capital as a percentage of risk-adjusted assets of 4.0 percent and combined tier 1 and tier 2 capital as a percentage of risk-adjusted assets of 8.0 percent.

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

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

	Actual			For Capital Adequacy Purposes				To Be Well Capitalized Under Prompt Corrective Action Provisions
*(In thousands)*	Amount	Ratio		Amount		Ratio		Amount		Ratio
As of June 30, 2002
Leverage Ratio	27,858	6.93	%	³	16,077	4.00	%	³	20,097	5.00	%
Tier I risk-based ratio	27,858	9.47	%	³	11,659	4.00	%	³	17,488	6.00	%
Total risk-based ratio	31,421	10.68	%	³	23,317	8.00	%	³	29,146	10.00	%
As of December 31, 2001
Leverage Ratio	24,786	6.63	%	³	14,977	4.00	%	³	18,721	5.00	%
Tier I risk-based ratio	24,786	9.53	%	³	10,405	4.00	%	³	15,607	6.00	%
Total risk-based ratio	27,951	10.75	%	³	20,810	8.00	%	³	26,012	10.00	%

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

	Actual				For Capital Adequacy Purposes				To Be Well Capitalized Under Prompt Corrective Action Provisions
*(In thousands)*	Amount		Ratio		Amount		Ratio		Amount		Ratio
As of June 30, 2002
Leverage Ratio	26,895		6.69	%	³	16,065	4.00	%	³	20,082	5.00	%
Tier I risk-based ratio	26,895		9.15	%	³	11,661	4.00	%	³	17,492	6.00	%
Total risk-based ratio	30,458		10.36	%	³	23,322	8.00	%	³	29,153	10.00	%
As of December 31, 2001
Leverage Ratio	23,384	%	6.25	%	³	14,970	4.00	%	³	18,713	5.00	%
Tier I risk-based ratio	23,384	%	9.00	%	³	10,394	4.00	%	³	15,591	6.00	%
Total risk-based ratio	26,549	%	10.22	%	³	20,788	8.00	%	³	25,986	10.00	%

Shareholders’ Equity

Shareholders’ equity increased $3.3 million, or 13.2 percent, to $28.1 million at June 30, 2002 compared to $24.8 million at December 31, 2001. This increase was the result of the $1.7 million in net income and $1.3 million from the exercise of common stock warrants and employee stock plans, and $215 thousand increase in accumulated other comprehensive income. As of June 30, 2002 the Company had 757 thousand common stock warrants exercisable at $5.50 per share, which expire in October 2002. The Company believes that the majority of these warrants will be exercised. On July 12, 2002 the Company increased the number of authorized common stock from 7,500,000 at December 31, 2001 to 12,500,000 at June 30, 2002.

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.

Looking ahead

This report contains certain forward-looking statements; either expressed or implied, which are provided to assist the reader to understand anticipated future financial performance. These forward-looking statements involve certain risks, uncertainties, estimates and assumptions made by management. Factors that may cause actual results to differ from those results expressed or implied include, but are not limited to, the interest rate environment and the overall economy, the ability of customers to repay their obligations, the adequacy of the allowance for loan losses, including realizable collateral valuations, charge offs and recoveries, competition and technological changes. Although management has taken certain steps to mitigate any negative effect of the above-mentioned items, significant unfavorable changes could severely impact the assumptions used and have an adverse affect on profitability.

ITEM III Quantitative and Qualitative Disclosures about Market Risk

During 2002, there have been no significant changes in the Company’s assessment of market risk as reported in Item 6 of the Company’s Form 10-K. See the interest rate sensitivity in Management’s discussion and analysis.

PART II – OTHER INFORMATION

Item 1. Legal Proceedings

Item 2. Changes in Securities – None

Item 3. Defaults Upon Senior Securities - None

Item 4. Submission of Matters to a Vote of Security Holders

The annual meeting of the shareholders of Unity Bancorp was held on May 16, 2002. The following is a description of the matters voted on at the meeting.

Proposal I: Election of Directors

	SHARES
	FOR	WITHHELD

Frank Ali	4,492,139	86,049
Mark S. Brody	4,492,943	85,245
Donna S. Butler	4,490,464	87,724
David D. Dallas	4,492,568	85,620
Robert H. Dallas, II	4,487,823	90,365
Peter P. DeTommaso	4,494,143	84,045
Anthony J. Feraro	4,492,943	85,245
James A. Hughes	4,492,443	85,745
Samuel Stothoff	4,493,643	84,545

Proposal II: Amendment of shares of common stock from 7,500,000 to 12,500,000

FOR		AGAINST		ABSTAIN
3,917,956		652,287		7,944

Proposal III: Change of Company’s State of Incorporation from Delaware to New Jersey

FOR		AGAINST		ABSTAIN
2,711,244		495,331		27,342

Proposal IV: Approval of 2002 Stock Option Plan

FOR		AGAINST		ABSTAIN
2,711,244		495,331		27,342

Item 5. Other Information - None

Item 6. Exhibits and Reports on Form 8K

(a) Exhibits

99 Certification pursuant to section 906 of the Sarbanes-Oxley Act

(b) Reports on Form 8K

Date of Report		Item Number
July 22, 2002		Item 5 Other-Effective July 12, 2002, the Registrant completed a merger, the sole result of which is the re-domicile of the Registrant from Delaware to New Jersey. In addition, the Registrant’s Certificate of Incorporation reflects an increase in the total number of shares authorized, as approved by the Registrant’s shareholders, to 12,500,000.

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, hereunto duly authorized.

		UNITY BANCORP, INC.


Dated: August 14, 2002		By:	/s/ JAMES A. HUGHES
			JAMES A. HUGHES,
	Executive Vice President and Chief Financial Officer