SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549

FORM 10-Q

Commission file number   1-12431

Unity Bancorp, Inc.
(Exact Name of registrant as specified in its charter)

Registrant’s telephone number, including area code  (908) 730-7630

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

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer (as defined in Exchange Act Rule 12b-2) Large accelerated filer o   Accelerated filer o   Non-accelerated filer x

Indicate by check mark whether the registrant is a shell company as defined in Rule 12b-2 of the Exchange Act Yes o   No x

The number of shares outstanding of each of the registrant’s classes of common equity stock, as of May 12, 2006: common stock, no par value:  6,574,604 shares outstanding

Part 1.-Consolidated Financial Information

Item 1.-Consolidated Financial Statements

Unity Bancorp, Inc

Consolidated Balance Sheets

See Accompanying Notes to the Consolidated Financial Statements

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Unity Bancorp

Consolidated Statements of Income
(unaudited)

See Accompanying Notes to the Consolidated Financial Statements

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Unity Bancorp, Inc

Consolidated Statements of Changes in Shareholders’ Equity
For the three months ended March 31, 2006 and 2005
(unaudited)

See Accompanying Notes to the Consolidated Financial Statements.

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Unity Bancorp, Inc

Consolidated Statements of Cash Flows
(unaudited)

See Accompanying Notes to the Consolidated Financial Statements.

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Unity Bancorp, Inc.

Notes to the Consolidated Financial Statements (Unaudited)
March 31, 2006

NOTE 1. Summary of Significant Accounting Policies

The accompanying consolidated financial statements include the accounts of Unity Bancorp, Inc. (the “Parent Company”) and its wholly-owned subsidiary, Unity Bank (the “Bank”, or when consolidated with the Parent Company, the “Company”), and reflect all adjustments and disclosures which are, in the opinion of management, necessary for a fair presentation of interim results. Unity Investment Services, Inc., a wholly-owned subsidiary of the Bank, is used to hold part of the Bank’s investment portfolio. Unity Participation Company, Inc., a wholly-owned subsidiary of the Bank is used for holding and administering certain loan participations. All significant inter-company balances and transactions have been eliminated in consolidation. Certain reclassifications have been made to prior year amounts to conform to the current year presentation. The financial information has been prepared in accordance with 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 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 relate 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 months ended March 31, 2006 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, 2005, included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2005.

Stock Based Compensation

As of January 1, 2006, the Company adopted Statement of Financial Accounting Standards No. 123R, “Share-Based Payment” (Statement 123R) using the “modified prospective application.”  Statement 123R requires public companies to recognize compensation expense related to stock-based compensation awards over the period during which an employee is required to provide service for the award. The following table represents the impact of the adoption of SFAS 123R on the Company’s financial statements for the quarter ended March 31, 2006.

Prior to January 1, 2006, the Company applied Accounting Principles Board Opinion 25 and related Interpretations in accounting for its Option Plans. No stock-based compensation cost was reflected in net income, as all options granted under those plans had an exercise price equal to the market value of their underlying common stock on the date of grant. The following table illustrates the effect on net income and earnings per share if the Company had applied the fair value recognition provisions of FASB Statement No. 123, “Accounting for Stock-Based Compensation” as amended, to stock based compensation.

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Proforma

The total intrinsic value of the stock options exercised during the three months ended March 31, 2006 and 2005 was $109 thousand and $158 thousand, respectively.  As of March 31, 2006, there was approximately $63 thousand of unrecognized compensation cost related to non-vested share-based compensation arrangements granted under the Company’s stock incentive plans. That cost is expected to be recognized over a weighted-average period of 2.4 years.

During the quarter-end March 31, 2006, the Company granted 15,750 options at $13.33 per option. The Company used the Black Scholes option-pricing model to calculate the $2.98 fair value of these options. The fair value of each option granted during the first quarter of 2006 was estimated on of the date of grant using the Black-Scholes option-pricing model with the following weighted average assumptions:

·                  Expected life of 4.19 years

·                  Expected volatility of 23.5 percent

·                  Risk free interest rate of 3.99 percent

·                  Dividend yield of 1.36 percent

There were no options granted during the first quarter of 2005.

Transactions under the Company’s stock options plans during the first quarter of 2006 are summarized as follows:

The following table summarizes information about stock options outstanding at March 31, 2006:

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On April 27, 2006, the Company announced a 5 percent stock distribution payable on June 30, 2006 to all shareholders of record as of June 16, 2006 and accordingly, all share amounts have been restated to include the effect of the distribution.

NOTE 2. Litigation

From time to time, the Company is subject to 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.

NOTE 3. Earnings per share

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

*                    Non-interest expense divided by net interest income plus non-interest income less securities gains.

NOTE 4. Recent Accounting Pronouncements

In March 2006, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards (“SFAS”) No. 156, “Accounting for Servicing of Financial Assets.”   SFAS No. 140, Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities, establishes, among other things, the accounting for all separately recognized servicing assets and servicing liabilities.  SFAS No. 156 amends Statement 140 to require that all separately recognized servicing assets and servicing liabilities be initially measured at fair value, if practicable. This Statement permits, but does not require, the subsequent measurement of separately recognized servicing assets and servicing liabilities at fair value. An entity that uses derivative instruments to mitigate the risks inherent in servicing assets and servicing liabilities is required to account for those derivative instruments at fair value. Under this Statement, an entity can elect subsequent fair value measurement to account for its separately recognized servicing assets and servicing liabilities. By electing that option, an entity may simplify its accounting because this Statement permits income statement recognition of the potential offsetting changes in fair value of those servicing assets and servicing liabilities and derivative instruments in the same accounting period. The Statement is effective in the first fiscal year beginning after September 15, 2006 with earlier adoption permitted. The Company does not expect the adoption of Statement No. 156 to have a material impact on its financial statements.

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

The following discussion and analysis of financial condition and results of operations should be read in conjunction with the 2005 consolidated audited financial statements and notes thereto. When necessary, reclassifications have been made to prior period data throughout the following discussion and analysis for purposes of comparability. This Quarterly Report on Form 10-Q contains certain “forward looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995, which may be identified by the use of such words as “believe”, “expect”, “anticipate”, “should”, “planned”, “estimated” and “potential”. Examples of forward looking statements include, but are not limited to, estimates with respect to the financial condition, results of operations and business of Unity Bancorp, Inc. that are subject to various factors which could cause actual results to differ materially from these estimates. These factors include: changes in general, economic, and market conditions, legislative and regulatory conditions, or the development of an interest rate environment that adversely affects Unity Bancorp, Inc.’s interest rate spread or other income anticipated from operations and investments.

Overview

Unity Bancorp, Inc. (the “Parent Company”) is incorporated in New Jersey and is a bank holding company under the Bank Holding Company Act of 1956, as amended. It’s wholly-owned subsidiary, Unity Bank (the “Bank” or, when consolidated with the Parent Company, the “Company”) was granted a charter by the New Jersey Department of Banking and Insurance and commenced operations on September 13, 1991. The Bank provides a full range of commercial and retail banking services through 14 branch offices located in Hunterdon, Somerset, Middlesex, Union and Warren counties in New Jersey and a loan production office in Long Island, New York. These services include the acceptance of demand, savings, and time deposits and the extension of consumer, real estate, Small Business Administration and other commercial credits. Unity Investment Services, Inc., a wholly-owned subsidiary of the Bank, is used to hold part of the Bank’s investment portfolio. Unity Participation Company, Inc., a wholly-owned subsidiary of the Bank is used for holding and administering certain loan participations.

Unity (NJ) Statutory Trust I is a statutory Business Trust and wholly-owned subsidiary of Unity Bancorp, Inc. On September 26, 2002, the trust issued $9.0 million of capital securities to investors. These floating rate securities are treated as subordinated debentures on the financial statements. However, they qualify as Tier I Capital for regulatory capital compliance purposes. In accordance with Financial Accounting Interpretation No. 46, Consolidation of Variable Interest Entities, as revised December 2003, the Company does not consolidate the accounts and related activity of Unity (NJ) Statutory Trust I.

Earnings Summary

Net income for the three months ended March 31, 2006 was $1.7 million, an increase of $347 thousand or 26.5 percent, compared to net income of $1.3 million for the same period in 2005. This was the result of increased net interest income and non-interest income, offset in part by higher operating expenses.

Quarterly performance highlights include:

·                  Earnings per basic share increased to $0.25 for the first quarter of 2006 compared to $0.21 for the same period in 2005.

·                  Earnings per diluted share increased to $0.24 for the first quarter of 2006 compared to $0.19 for the same period a year ago.

·                  Return on average assets improved to 1.08 percent from 1.03 percent for the quarters ended March 31, 2006 and 2005, respectively.

·                  Return on average equity equaled 16.26 percent and 14.63 percent for the quarters ended March 31, 2006 and 2005, respectively.

·                  The efficiency ratio improved to 65.25 percent for the first quarter of 2006 compared to 66.37 percent for the same period a year ago.

During the first quarter of 2006, financial institutions continued to be pressured by a flat yield curve as the Federal Reserve Board raised short term rates two more times. Since this rate cycle began in June 2004, the Federal Reserve raised short-term interest rates fifteen times for a total of 375 basis points. This has resulted in the Federal Funds rate increasing from 1.00 percent to 4.75 percent while the Prime-lending rate increased from 4.00 percent to 7.75 percent.  Despite this challenging interest rate environment, the Company was able to grow net interest income due to strong growth in interest earning assets. However, the flat yield curve and the competitive pricing of deposits in the New Jersey market place may put further pressure on the net interest margin in 2006.

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      Net interest income, our largest component of operating income, increased $788 thousand or 15 percent to $6.1 million for the three months ended March 31, 2006 compared to the same period in 2005. This increase was the result of a $98 million increase in average earning assets partially offset by a reduced net interest margin and spread.   Net interest margin (net interest income as a percentage of average interest earning assets) decreased 18 basis points to 4.12 percent for the current quarter compared to 4.30 percent for the same period a year ago. Over the same period, net interest spread  (the difference between the rate earned on average interest-earning assets and the rate paid on average interest-bearing liabilities) decreased 27 basis points to 3.65 percent from 3.92 percent a year ago.

Non-interest income increased $211 thousand or 11.8 percent to $2.0 million for the three months ended March 31, 2006 compared to $1.8 million for the three months ended March 31, 2005.   This increase was due primarily to higher levels of gains on the sale of SBA loans and increased referral fees on commercial loans during the quarter, partially offset by decreased service and loan fee income and lower levels of gains on the sale of mortgage loans.

Non-interest expense was $5.3 million for the three months ended March 31, 2006, an increase of $608 thousand or 13.1 percent compared to $4.6 million for the same period a year ago. The increase was due primarily to increased compensation and benefits expense, occupancy expense, furniture and equipment, processing and communications, professional services and other expenses.

For the first quarter of 2006, the provision for income taxes was $842 thousand compared to $798 thousand for the same period a year ago. The current 2006 tax provision represents an effective tax rate of approximately 34 percent as compared to 38 percent for the prior year. The lower effective tax rate for 2006 is related to a subsidiary the company opened in January of 2006 reflecting a lower state tax rate. Management anticipates an effective rate of approximately 34 percent for the remainder of 2006.

Net Interest Income

Tax-equivalent interest income totaled $10.0 million for the three months ended March 31, 2006, an increase of $2.5 million or 33 percent, compared to $7.5 million a year ago. Of the $2.5 million increase in interest income, $1.8 million is attributable to an increase in the volume of earning assets, while $718 thousand is attributable to an increase in the yield on earning assets. The average volume of earning assets increased $98 million to $588.5 million at March 31, 2006 compared to $490.5 million at March 31, 2005. This was due to an $84.7 million increase in average total loans plus a $9.2 million increase in federal funds sold and interest bearing deposits and a $4.1 million increase in average total securities. The impact of the higher interest rate environment in the first quarter of 2006 is evident in the rates earned on variable rate instruments such as SBA loans, commercial loans and consumer home equity lines of credit, as well as federal funds sold and interest bearing deposits. Key interest rate increases during the quarter included:

·               The average interest rate earned on federal funds sold and interest bearing deposits increased 188 basis points to 4.31 percent for the three months ended March 31, 2006 compared to 2.43 percent for the same period a year ago.

·               The average interest rate earned on SBA loans equaled 10.02 percent during the quarter, an increase of 165 basis points over the comparable quarter in 2005, due to the quarterly re-pricing of these loans with changes in the Prime rate.

·               The average interest rate earned on Consumer loans increased 84 basis points to 6.49 percent for the three months ended March 31, 2006 compared to 5.65 percent for the same period a year ago due to the re-pricing of Prime based home equity products.

·               The average interest rate earned on Commercial loans was 7.31 percent for the quarter, an increase of 36 basis points over the comparable quarter in 2005.

The higher interest rate environment also increased interest expense and the cost of funds. Total interest expense was $3.9 million for the three months ended March 31, 2006, an increase of $1.7 million or 75 percent, compared to $2.3 million for the same period a year ago. Of the $1.7 million increase in interest expense, $852 thousand is related to an increase in average interest-bearing liabilities while $837 thousand is due to an increase in the cost of funds. Over the past twelve months, average interest bearing liabilities increased $97.2 million as average interest bearing deposits increased $88.1 million and borrowed funds and subordinated debentures increased $9.1 million. Total interest-bearing deposits were $448.7 million on average, an increase of $88.1 million or 24.4 percent compared to $360.7 million from the same period a year ago. The increase in average interest-bearing deposits was a result of increases in the savings and time deposit categories, partially offset by a decline in interest-bearing checking accounts.  Average borrowed funds increased $9.1 million to $49.3 million as of March 31, 2006 due to the addition of a $10 million FHLB advance at 3.70 percent during the second quarter of 2005.  The rate paid on interest bearing liabilities

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increased 93 basis points to 3.21 percent for the three months ended March 31, 2006 from 2.28 percent in the same period in 2005. The cost of interest bearing deposits increased 100 basis points to 3.06 percent as the rates paid on all deposit products increased. This increase is attributed to the competitive pricing pressures within the New Jersey deposit marketplace, as well as, a shift in the mix of our funding base into higher cost savings and time deposits. The cost of borrowed funds and subordinated debentures increased 35 basis points to 4.63 percent compared to the prior year period.

Tax-equivalent net interest income increased $788 thousand to $6.1 million for the quarter ended March 31, 2006 compared to $5.3 million for the same period a year ago. Net interest margin fell 18 basis points to 4.12 percent compared to 4.30 percent for the same period a year ago. The tightening of the net interest margin was primarily the result of the higher cost of deposits to fund loan growth. The net interest spread was 3.65 percent for the three months ended March 31, 2006 compared to 3.92 percent for the same period a year ago.

The following table presents, on a fully taxable equivalent basis, a summary of the Company’s interest-earning assets and their average yields, and interest-bearing liabilities and their average costs for the three-month period ended March 31, 2006 and 2005.

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Unity Bancorp, Inc.
Consolidated Average Balance Sheets with resultant Interest and Rates
(unaudited)
(Tax-equivalent basis, dollars in thousands)