UNITY BANCORP INC /NJ/ - Quarter Report: 2019 September (Form 10-Q)

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, 2019

( ) 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 x No ☐

Indicate by check mark whether the registrant has submitted electronically, every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).

Yes x 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 x Nonaccelerated filer ☐ Smaller reporting company x Emerging Growth Company ☐

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. Yes ☐ No ☐

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

Yes ☐ No x

The number of shares outstanding of each of the registrant’s classes of common equity stock, as of October 31, 2019 common stock, no par value: 10,869,425 shares outstanding.

Table of Contents



PART I	CONSOLIDATED FINANCIAL INFORMATION	Page #

ITEM 1	Consolidated Financial Statements (Unaudited)	3

	Consolidated Balance Sheets at September 30, 2019 and December 31, 2018	3

	Consolidated Statements of Income for the three and nine months ended September 30, 2019 and 2018	4

	Consolidated Statements of Changes in Comprehensive Income for the three months ended September 30, 2019 and 2018	5

	Consolidated Statements of Changes in Comprehensive Income for the nine months ended September, 2019 and 2018	6

	Consolidated Statements of Changes in Shareholders' Equity for the nine months ended September 30, 2019 and 2018	7

	Consolidated Statements of Cash Flows for the nine months ended September 30, 2019 and 2018	9

	Notes to the Consolidated Financial Statements	11

ITEM 2	Management’s Discussion and Analysis of Financial Condition and Results of Operations	45

ITEM 3	Quantitative and Qualitative Disclosures about Market Risk	65

ITEM 4	Controls and Procedures	65

PART II	OTHER INFORMATION	65

ITEM 1	Legal Proceedings	65

ITEM 1A	Risk Factors	66

ITEM 2	Unregistered Sales of Equity Securities and Use of Proceeds	66

ITEM 3	Defaults upon Senior Securities	66

ITEM 4	Mine Safety Disclosures	66

ITEM 5	Other Information	66

ITEM 6	Exhibits	67

	SIGNATURES	68

	EXHIBIT INDEX	69

	Exhibit 31.1

	Exhibit 31.2

	Exhibit 32.1

PART I CONSOLIDATED FINANCIAL INFORMATION

ITEM 1 Consolidated Financial Statements (Unaudited)

Unity Bancorp, Inc.

Consolidated Balance Sheets

(Unaudited)



(In thousands)	September 30, 2019			December 31, 2018
ASSETS
Cash and due from banks	$	29,426		$	20,028
Federal funds sold, interest-bearing deposits and repos	137,334			125,487
Cash and cash equivalents	166,760			145,515
Securities:
Debt securities available for sale (amortized cost of $47,220 in 2019 and $47,762 in 2018)	47,295			46,713
Securities held to maturity (fair value of $14,639 in 2019 and $14,802 in 2018)	14,332			14,875
Equity securities with readily determinable fair values (amortized cost of $2,398 in 2019 and $2,394 in 2018)	2,364			2,144
Total securities	63,991			63,732
Loans:
SBA loans held for sale	13,053			11,171
SBA loans held for investment	36,380			39,333
Commercial loans	723,249			694,102
Residential mortgage loans	456,963			436,056
Consumer loans	138,829			123,904
Total loans	1,368,474			1,304,566
Allowance for loan losses	(16,002		)	(15,488		)
Net loans	1,352,472			1,289,078
Premises and equipment, net	21,700			23,371
Bank owned life insurance ("BOLI")	25,302			24,710
Deferred tax assets	5,768			5,350
Federal Home Loan Bank ("FHLB") stock	10,899			10,795
Accrued interest receivable	6,858			6,399
Other real estate owned ("OREO")	1,723			56
Goodwill	1,516			1,516
Prepaid expenses and other assets	7,319			8,635
Total assets	$	1,664,308		$	1,579,157
LIABILITIES AND SHAREHOLDERS' EQUITY
Liabilities:
Deposits:
Noninterest-bearing demand	$	279,238		$	270,152
Interest-bearing demand	179,661			185,792
Savings	394,333			394,727
Time, under $100,000	208,755			184,022
Time, $100,000 to $250,000	133,401			116,147
Time, $250,000 and over	77,974			56,847
Total deposits	1,273,362			1,207,687
Borrowed funds	210,000			210,000
Subordinated debentures	10,310			10,310
Accrued interest payable	420			406
Accrued expenses and other liabilities	15,332			12,266
Total liabilities	1,509,424			1,440,669
Shareholders' equity:
Common stock	89,753			88,484
Retained earnings	65,199			50,161
Accumulated other comprehensive loss	(68		)	(157		)
Total shareholders' equity	154,884			138,488
Total liabilities and shareholders' equity	$	1,664,308		$	1,579,157

Issued and outstanding common shares	10,869			10,780

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)	2019			2018			2019		2018
INTEREST INCOME
Federal funds sold, interest-bearing deposits and repos	$	271		$	187		$	724	$	563
FHLB stock	82			101			275		359
Securities:
Taxable	463			465			1,400		1,442
Tax-exempt	26			28			81		88
Total securities	489			493			1,481		1,530
Loans:
SBA loans	943			1,050			2,880		3,365
Commercial loans	9,467			8,784			27,892		24,718
Residential mortgage loans	5,606			4,803			16,702		13,666
Consumer loans	2,197			1,776			6,382		5,003
Total loans	18,213			16,413			53,856		46,752
Total interest income	19,055			17,194			56,336		49,204
INTEREST EXPENSE
Interest-bearing demand deposits	438			330			1,289		813
Savings deposits	1,194			1,049			3,500		2,768
Time deposits	2,577			1,739			7,023		4,042
Borrowed funds and subordinated debentures	442			509			1,695		1,997
Total interest expense	4,651			3,627			13,507		9,620
Net interest income	14,404			13,567			42,829		39,584
Provision for loan losses	750			500			1,600		1,550
Net interest income after provision for loan losses	13,654			13,067			41,229		38,034
NONINTEREST INCOME
Branch fee income	373			357			1,120		1,107
Service and loan fee income	522			465			1,533		1,441
Gain on sale of SBA loans held for sale, net	—			253			554		1,383
Gain on sale of mortgage loans, net	545			597			1,525		1,442
BOLI income	138			464			435		810
Net security gains (losses)	18			2			216		(6		)
Other income	1,114			341			1,758		900
Total noninterest income	2,710			2,479			7,141		7,077
NONINTEREST EXPENSE
Compensation and benefits	5,353			5,704			15,384		15,274
Occupancy	651			675			1,997		2,057
Processing and communications	749			709			2,213		2,072
Furniture and equipment	711			586			2,086		1,732
Professional services	274			270			839		682
Loan collection and OREO (recoveries) expenses	(48		)	(331		)	9		(320		)
Other loan expenses	89			51			202		137
Deposit insurance	—			191			301		593
Advertising	334			370			1,056		1,051
Director fees	171			175			499		502
Other expenses	445			401			1,409		1,373
Total noninterest expense	8,729			8,801			25,995		25,153
Income before provision for income taxes	7,635			6,745			22,375		19,958
Provision for income taxes	1,676			1,255			4,842		3,841
Net income	$	5,959		$	5,490		$	17,533	$	16,117

Net income per common share - Basic	$	0.55		$	0.51		$	1.62	$	1.50
Net income per common share - Diluted	$	0.54		$	0.50		$	1.59	$	1.48

Weighted average common shares outstanding - Basic	10,863			10,743			10,836		10,713
Weighted average common shares outstanding - Diluted	11,036			10,936			11,019		10,910

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, 2019									September 30, 2018
(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	$	7,635		$	1,676		$	5,959		$	6,745		$	1,255		$	5,490
Other comprehensive income (loss)
Debt securities available for sale:
Unrealized holding gains (losses) on securities arising during the period	153			42			111			(293		)	(82		)	(211		)
Less: reclassification adjustment for gains on securities included in net income	18			3			15			2			—			2
Total unrealized gains (losses) on debt securities available for sale	135			39			96			(295		)	(82		)	(213		)

Adjustments related to defined benefit plan:
Amortization of prior service cost	20			5			15			21			6			15
Total adjustments related to defined benefit plan	20			5			15			21			6			15

Net unrealized losses from cash flow hedges:
Unrealized holding losses on cash flow hedges arising during the period	(177		)	(51		)	(126		)	(7		)	(2		)	(5		)
Total unrealized losses on cash flow hedges	(177		)	(51		)	(126		)	(7		)	(2		)	(5		)
Total other comprehensive loss	(22		)	(7		)	(15		)	(281		)	(78		)	(203		)
Total comprehensive income	$	7,613		$	1,669		$	5,944		$	6,464		$	1,177		$	5,287

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 nine months ended
	September 30, 2019									September 30, 2018
(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	$	22,375		$	4,842		$	17,533		$	19,958		$	3,841		$	16,117
Other comprehensive income (loss)
Debt securities available for sale:
Unrealized holding gains (losses) on securities arising during the period	1,340			358			982			(1,236		)	(371		)	(865		)
Less: reclassification adjustment for gains on securities included in net income	216			45			171			9			1			8
Total unrealized gains (losses) on debt securities available for sale	1,124			313			811			(1,245		)	(372		)	(873		)

Adjustments related to defined benefit plan:
Amortization of prior service cost	62			(59		)	121			63			167			(104		)
Total adjustments related to defined benefit plan	62			(59		)	121			63			167			(104		)

Net unrealized (losses) gains from cash flow hedges:
Unrealized holding (losses) gains on cash flow hedges arising during the period	(1,169		)	(326		)	(843		)	658			55			603
Total unrealized (losses) gains on cash flow hedges	(1,169		)	(326		)	(843		)	658			55			603
Total other comprehensive income (loss)	17			(72		)	89			(524		)	(150		)	(374		)
Total comprehensive income	$	22,392		$	4,770		$	17,622		$	19,434		$	3,691		$	15,743

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

Consolidated Statements of Changes in Shareholders’ Equity

For the nine months ended September 30, 2019 and 2018

(Unaudited)



	Common stock						Accumulated other			Total
(In thousands)	Shares	Amount		Retained earnings			comprehensive (loss) income			shareholders' equity
Balance, December 31, 2018	10,780	$	88,484	$	50,161		$	(157	)	$	138,488
Net income	—	—		5,740			—			5,740
Other comprehensive loss, net of tax	—	—		—			(50		)	(50		)
Dividends on common stock ($0.07 per share)	—	26		(756		)	—			(730		)
Common stock issued and related tax effects (1)	42	269		—			—			269
Balance, March 31, 2019	10,822	$	88,779	$	55,145		$	(207	)	$	143,717
Net income	—	—		5,834			—			5,834
Other comprehensive income, net of tax	—	—		—			154			154
Dividends on common stock ($0.08 per share)	—	31		(870		)	—			(839		)
Common stock issued and related tax effects (1)	34	517		—			—			517
Balance, June 30, 2019	10,856	$	89,327	$	60,109		$	(53	)	$	149,383
Net income	—	—		5,959			—			5,959
Other comprehensive loss, net of tax	—	—		—			(15		)	(15		)
Dividends on common stock ($0.08 per share)	—	31		(869		)	—			(838		)
Common stock issued and related tax effects (1)	13	395		—			—			395
Balance, September 30, 2019	10,869	89,753		$	65,199		$	(68	)	$	154,884

Consolidated Statements of Changes in Shareholders’ Equity

For the nine months ended September 30, 2019 and 2018

(Unaudited)



	Common stock						Accumulated other			Total
(In thousands)	Shares	Amount		Retained earnings			comprehensive income (loss)			shareholders' equity
Balance, December 31, 2017	10,615	$	86,782	$	31,117		$	206		$	118,105
Net income	—	—		5,229			—			5,229
Other comprehensive loss, net of tax	—	—		—			(166		)	(166		)
Dividends on common stock ($0.06 per share)	—	25		(643		)	—			(618		)
Common stock issued and related tax effects (1)	94	554		—			—			554
Retained earnings impact due to adoption of ASU 2016-01 (2)	—	—		(56		)	56			—
Tax rate adjustment to AOCI (3)	—	—		66			(66		)	—
Balance, March 31, 2018	10,709	$	87,361	$	35,713		$	30		$	123,104
Net Income	—	—		5,398			—			5,398
Other comprehensive loss, net of tax	—	—		—			(5		)	(5		)
Dividends on common stock ($0.07 per share)	—	28		(750		)	—			(722		)
Common stock issued and related tax effects (1)	22	366		—			—			366
Retained earnings impact due to adoption of ASU 2016-01 (2)	—	—		16			(16		)	—
Tax rate adjustment to AOCI (3)	—	—		9			(9		)	—
Balance, June 30, 2018	10,731	$	87,755	$	40,386		—			$	128,141
Net Income	—	—		5,490			—			5,490
Other comprehensive loss, net of tax	—	—		—			(203		)	(203		)
Dividends on common stock ($0.07 per share)	—	28		(755		)	—			(727		)
Common stock issued and related tax effects (1)	25	366		—			—			366
Balance, September 30, 2018	10,756	$	88,149	$	45,121		$	(203	)	$	133,067

(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.

(2) As a result of ASU 2016-01, "Financial Instruments Overall (Subtopic 825-10): Recognition and Measurement of Financial Assets and Financial Liabilities", the Company reclassed $40 thousand of gains (losses) on available for sale equity securities sitting in accumulated other comprehensive income to retained earnings.

(3) As a result of ASU 2018-02, "Income Statement - Reporting Comprehensive Income (Topic 220): Reclassification of Certain Tax Effects from Accumulated Other Comprehensive Income", the Company reclassed $75 thousand from accumulated other comprehensive income to retained earnings.

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)	2019			2018
OPERATING ACTIVITIES:
Net income	$	17,533		$	16,117
Adjustments to reconcile net income to net cash provided by operating activities:
Provision for loan losses	1,600			1,550
Net amortization of purchase premiums and discounts on securities	126			170
Depreciation and amortization	1,144			1,359
Deferred income tax benefit	(418		)	(1,337		)
Stock compensation expense	932			786
Gain on sale of OREO	(16		)	(169		)
Gain on sale of mortgage loans held for sale, net	(1,337		)	(1,155		)
Gain on sale of SBA loans held for sale, net	(554		)	(1,383		)
Origination of mortgage loans held for sale	(78,209		)	(65,304		)
Origination of SBA loans held for sale	(8,306		)	(7,718		)
Proceeds from sale of mortgage loans held for sale, net	79,546			66,459
Proceeds from sale of SBA loans held for sale, net	9,629			18,597
BOLI income	(435		)	(810		)
Net change in other assets and liabilities	3,793			1,715
Net cash provided by operating activities	25,028			28,877
INVESTING ACTIVITIES
Purchases of debt securities available for sale	(3,225		)	—
Purchases of FHLB stock, at cost	(63,261		)	(51,797		)
Maturities and principal payments on securities held to maturity	525			954
Maturities and principal payments on debt securities available for sale	3,658			4,026
Proceeds from redemption of FHLB stock	63,158			55,215
Proceeds from sale of OREO	269			439
Net increase in loans	(67,788		)	(122,540		)
Proceeds from BOLI	(157		)	493
Purchases of premises and equipment	(654		)	(1,134		)
Net cash used in investing activities	(67,475		)	(114,344		)
FINANCING ACTIVITIES
Net increase in deposits	65,675			176,336
Proceeds from new borrowings	210,000			180,000
Repayments of borrowings	(210,000		)	(275,000		)
Proceeds from exercise of stock options	424			500
Dividends on common stock	(2,407		)	(2,067		)
Net cash provided by financing activities	63,692			79,769
Decrease in cash and cash equivalents	21,245			(5,698		)
Cash and cash equivalents, beginning of period	145,515			150,254
Cash and cash equivalents, end of period	$	166,760		$	144,556

Unity Bancorp, Inc.

Consolidated Statements of Cash Flows (Continued)

(Unaudited)



	For the nine months ended September 30,
(In thousands)	2019		2018
SUPPLEMENTAL DISCLOSURES
Cash:
Interest paid	$	13,493	$	9,550
Income taxes paid	5,957		4,241
Noncash investing activities:
Establishment of lease liability and right-of-use asset	3,234		—
Capitalization of servicing rights	215		708
Transfer of loans to OREO	$	2,151	$	127

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, 2019

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, 2019 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, 2018.

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)	2019		2018		2019		2018
Net income	$	5,959	$	5,490	$	17,533	$	16,117
Weighted average common shares outstanding - Basic	10,863		10,743		10,836		10,713
Plus: Potential dilutive common stock equivalents	173		193		183		197
Weighted average common shares outstanding - Diluted	11,036		10,936		11,019		10,910
Net income per common share - Basic	$	0.55	$	0.51	$	1.62	$	1.50
Net income per common share - Diluted	0.54		0.50		1.59		1.48
Stock options and common stock excluded from the income per share calculation as their effect would have been anti-dilutive	251		40		237		103

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.

On July 1, 2018, New Jersey's Assembly Bill 4202 was signed into law. Assembly Bill 4202, effective January 1, 2018, imposed a temporary surtax on corporations earning New Jersey allocated income in excess of $1 million at a rate of 2.5 percent for tax years beginning on or after January 1, 2018, through December 31, 2019, and at 1.5 percent for tax years beginning on or after January 1, 2020, through December 31, 2021. In addition, effective for periods on or after January 1, 2019, New Jersey is adopting mandatory unitary combined reporting for its Corporation Business Tax.

For the quarter ended September 30, 2019, the Company reported income tax expense of $1.7 million for an effective tax rate of 22.0 percent, compared to an income tax expense of $1.3 million and an effective tax rate of 18.6 percent for the prior year’s quarter. For the nine months ended September 30, 2019, the Company reported income tax expense of $4.8 million for an effective tax rate of 21.6 percent, compared to an income tax expense of $3.8 million and an effective tax rate of 19.2 percent for the nine months ended September 30, 2018. The Company did not recognize or accrue any interest or penalties related to income taxes during the three or nine months ended September 30, 2019 or 2018. The Company did not have an accrual for uncertain tax positions as of September 30, 2019 or December 31, 2018, 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 2014 and thereafter are subject to future examination by tax authorities.

NOTE 5. Other Comprehensive Income (Loss)

The following tables show the changes in other comprehensive (loss) income for the three and nine months ended September 30, 2019 and 2018, net of tax:



	For the three months ended September 30, 2019
(In thousands)	Net unrealized (losses) gains on securities			Adjustments related to defined benefit plan			Net unrealized gains (losses) from cash flow hedges			Accumulated other comprehensive loss income
Balance, beginning of period	$	(6	)	$	(325	)	$	313		$	(18	)
Other comprehensive income (loss) before reclassification	111			—			(126		)	(15		)
Less amounts reclassified from accumulated other comprehensive income (loss)	15			(15		)	—			—
Period change	96			15			(126		)	(15		)
Balance, end of period	$	90		$	(310	)	$	187		$	(33	)



	For the three months ended September 30, 2018
(In thousands)	Net unrealized (losses) gains on securities			Adjustments related to defined benefit plan			Net unrealized gains (losses) from cash flow hedges			Accumulated other comprehensive income (loss)
Balance, beginning of period	$	(995	)	$	(460	)	$	1,490		$	35
Other comprehensive loss before reclassification	(211		)	—			(5		)	(216		)
Less amounts reclassified from accumulated other comprehensive income (loss)	2			(15		)	—			(13		)
Period change	(213		)	15			(5		)	(203		)
Balance, end of period (1)	$	(1,208	)	$	(445	)	$	1,485		$	(168	)

(1) AOCI does not reflect the net reclassification of $35 thousand to Retained Earnings as a result of ASU 2016-01, "Financial Instruments Overall (Subtopic 825-10): Recognition and Measurement of Financial Assets and Financial Liabilities" & ASU 2018-02, "Income Statement - Reporting Comprehensive Income (Topic 220): Reclassification of Certain Tax Effects from Accumulated Other Comprehensive Income".



	For the nine months ended September 30, 2019
(In thousands)	Net unrealized (losses) gains on securities			Adjustments related to defined benefit plan			Net unrealized gains (losses) from cash flow hedges			Accumulated other comprehensive (loss) income
Balance, beginning of period	$	(721	)	$	(431	)	$	1,030		$	(122	)
Other comprehensive income (loss) before reclassification	982			—			(843		)	139
Less amounts reclassified from accumulated other comprehensive income (loss)	171			(121		)	—			50
Period change	811			121			(843		)	89
Balance, end of period	$	90		$	(310	)	$	187		$	(33	)



	For the nine months ended September 30, 2018
(In thousands)	Net unrealized (losses) gains on securities			Adjustments related to defined benefit plan			Net unrealized gains from cash flow hedges		Accumulated other comprehensive income (loss)
Balance, beginning of period	$	(335	)	$	(341	)	$	882	$	206
Other comprehensive (loss) income before reclassification	(865		)	—			603		(262		)
Less amounts reclassified from accumulated other comprehensive income	8			104			—		112
Period change	(873		)	(104		)	603		(374		)
Balance, end of period (1)	$	(1,208	)	$	(445	)	$	1,485	$	(168	)

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:

Debt Securities Available for Sale

The fair value of available for sale ("AFS") debt 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, 2019, the fair value of the Company's AFS debt securities portfolio was $47.3 million. Approximately 50 percent of the portfolio was made up of residential mortgage-backed securities, which had a fair value of $23.8 million at September 30, 2019. Approximately $23.4 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 debt securities were classified as Level 2 assets at September 30, 2019. The valuation of AFS debt 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.

Equity Securities with Readily Determinable Fair Values

The fair value of equity 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, 2019, the fair value of the Company's equity securities portfolio was $2.4 million.

All of the Company’s equity securities were classified as Level 2 assets at September 30, 2019. The valuation of 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.

There were no changes in the inputs or methodologies used to determine fair value during the period ended September 30, 2019, as compared to the periods ended December 31, 2018 and September 30, 2018.

Loans Held for Sale

Fair value for loans held for sale is derived from quoted market prices for similar loans, in which case they are characterized as Level 2 assets in the fair value hierarchy.

The tables below present the balances of assets and liabilities measured at fair value on a recurring basis as of September 30, 2019 and December 31, 2018:



	Fair Value Measurements at September 30, 2019 Using
(In thousands)	Assets/Liabilities Measured at Fair Value		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
Measured on a recurring basis:
Assets:
Debt Securities available for sale:
U.S. Government sponsored entities	$	5,742	$	—	$	5,742	$	—
State and political subdivisions	4,379		—		4,379		—
Residential mortgage-backed securities	23,842		—		23,842		—
Corporate and other securities	13,332		—		13,332		—
Total debt securities available for sale	$	47,295	$	—	$	47,295	$	—

Equity securities with readily determinable fair values	2,364		—		2,364		—
Total equity securities	$	2,364	$	—	$	2,364	$	—

Loans held for sale	14,437		—		14,437		—
Total loans held for sale	$	14,437	$	—	$	14,437	$	—

Interest rate swap agreements	264		—		264		—
Total swap agreements	$	264	$	—	$	264	$	—

	Fair Value Measurements at December 31, 2018 Using
(In thousands)	Assets/Liabilities Measured at Fair Value		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
Measured on a recurring basis:
Assets:
Debt Securities available for sale:
U.S. Government sponsored entities	$	5,642	$	—	$	5,642	$	—
State and political subdivisions	4,498		—		4,498		—
Residential mortgage-backed securities	26,613		—		26,613		—
Corporate and other securities	9,960		—		9,960		—
Total debt securities available for sale	$	46,713	$	—	$	46,713	$	—

Equity securities with readily determinable fair values	2,144		—		2,144		—
Total equity securities	$	2,144	$	—	$	2,144	$	—

Loans held for sale	12,177		—		12,177		—
Total loans held for sale	$	12,177	$	—	$	12,177	$	—

Interest rate swap agreements	1,433		—		1,433		—
Total swap agreements	$	1,433	$	—	$	1,433	$	—

Fair Value on a Nonrecurring Basis

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 Measurements at September 30, 2019 Using
(In thousands)	Assets/Liabilities Measured at Fair Value		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)		Net Credit During Period
Measured on a non-recurring basis:
Financial assets:
OREO	$	1,723	$	—	$	—	$	1,723	$	(231	)
Impaired collateral-dependent loans	1,229		—		—		1,229		(109		)

	Fair Value Measurements at December 31, 2018 Using
(In thousands)	Assets/Liabilities Measured at Fair Value		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)		Net Credit During Period
Measured on a non-recurring basis:
Financial assets:
OREO	$	56	$	—	$	—	$	56	$	(196	)
Impaired collateral-dependent loans	2,625		—		—		2,625		(335		)

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”.

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, 2019, the valuation allowance for impaired loans was $558 thousand, a decrease of $109 thousand from $667 thousand at December 31, 2018.

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, 2019 and December 31, 2018 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.

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, 2019, the Bank had standby letters of credit outstanding of $4.8 million, compared to $5.7 million at December 31, 2018. 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, 2019 and December 31, 2018:



		September 30, 2019				December 31, 2018
(In thousands)	Fair value level	Carrying amount		Estimated fair value		Carrying amount		Estimated fair value
Financial assets:
Cash and cash equivalents	Level 1	$	166,760	$	166,760	$	145,515	$	145,515
Securities (1)	Level 2	63,991		64,297		63,732		63,600
SBA loans held for sale	Level 2	13,053		14,437		11,171		12,177
Loans, net of allowance for loan losses (2)	Level 2	1,339,419		1,341,272		1,277,907		1,268,909
FHLB stock	Level 2	10,899		10,899		10,795		10,795
Servicing assets	Level 3	2,138		2,138		2,375		2,375
Accrued interest receivable	Level 2	6,858		6,858		6,399		6,399
OREO	Level 3	1,723		1,723		56		56
Financial liabilities:
Deposits	Level 2	1,273,362		1,275,256		1,207,687		1,204,731
Borrowed funds and subordinated debentures	Level 2	220,310		219,838		220,310		218,879
Accrued interest payable	Level 2	420		420		406		406


(1)	Includes held to maturity (“HTM”) corporate securities that are considered Level 3. These securities had book values of $3.5 million and $3.6 million at September 30, 2019 and December 31, 2018, respectively, with market values of $3.6 million and $3.4 million. Includes one corporate bond with a book value and market value of $1.0 million at September 30, 2019 and December 31, 2018.


(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 $1.2 million and $2.6 million at September 30, 2019 and December 31, 2018, respectively.

Limitations

Fair value estimates are made at a point in time, based on relevant market information and information about the financial instrument. These estimates do not reflect any premium or discount that could result from offering for sale at one time the Company's entire holdings of a particular financial instrument. Because no market exists for a significant portion of the Company's financial instruments, fair value estimates are based on judgments regarding future expected loss experience, current economic conditions, risk characteristics of various financial instruments and other factors. These estimates are subjective in nature and involve uncertainties and matters of significant judgment and therefore cannot be determined with precision. Changes in assumptions could significantly affect the estimates.

Fair value estimates are based on existing on- and off-statement of condition financial instruments without attempting to estimate the value of anticipated future business and the value of assets and liabilities that are not considered financial instruments. In addition, the tax ramifications related to the effect of fair value estimates have not been considered in the above estimates.

NOTE 7. Securities

This table provides the major components of debt securities available for sale ("AFS"), held to maturity ("HTM") and equity securities with readily determinable fair values ("equity securities") at amortized cost and estimated fair value at September 30, 2019 and December 31, 2018:



	September 30, 2019									December 31, 2018
(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	$	5,753	$	—	$	(11	)	$	5,742	$	5,758	$	—	$	(116	)	$	5,642
State and political subdivisions	4,356		39		(16		)	4,379		4,614		4		(120		)	4,498
Residential mortgage-backed securities	23,659		294		(111		)	23,842		27,159		74		(620		)	26,613
Corporate and other securities	13,452		171		(291		)	13,332		10,231		123		(394		)	9,960
Total debt securities available for sale	$	47,220	$	504	$	(429	)	$	47,295	$	47,762	$	201	$	(1,250	)	$	46,713
Held to maturity:
U.S. Government sponsored entities	$	2,298	$	—	$	(20	)	$	2,278	$	2,527	$	—	$	(94	)	$	2,433
State and political subdivisions	951		156		—			1,107		951		110		—			1,061
Residential mortgage-backed securities	3,094		68		(8		)	3,154		3,312		17		(52		)	3,277
Commercial mortgage-backed securities	3,481		100		(24		)	3,557		3,570		—		(138		)	3,432
Corporate and other securities	4,508		35		—			4,543		4,515		84		—			4,599
Total securities held to maturity	$	14,332	$	359	$	(52	)	$	14,639	$	14,875	$	211	$	(284	)	$	14,802
Equity securities:
Total equity securities	$	2,398	$	65	$	(99	)	$	2,364	$	2,394	$	—	$	(250	)	$	2,144

This table provides the remaining contractual maturities and yields of securities within the investment portfolios. The carrying value of securities at September 30, 2019 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	$	999	1.71	%	$	4,743	1.83	%	$	—	—	%	$	—	—	%	$	5,742	1.81	%
State and political subdivisions	376		3.14		601		3.92		2,259		2.44		1,143		2.74		4,379		2.78
Residential mortgage-backed securities	—		—		393		2.05		2,276		2.36		21,173		2.87		23,842		2.81
Corporate and other securities	—		—		3,787		3.43		7,640		4.45		1,905		5.06		13,332		4.25
Total debt securities available for sale	$	1,375	2.10	%	$	9,524	2.61	%	$	12,175	3.68	%	$	24,221	3.04	%	$	47,295	3.09	%
Held to maturity at cost:
U.S. Government sponsored entities	$	—	—	%	$	—	—	%	$	—	—	%	$	2,298	1.98	%	$	2,298	1.98	%
State and political subdivisions	—		—		—		—		495		5.06		456		5.85		951		5.44
Residential mortgage-backed securities	—		—		37		5.22		356		2.99		2,701		3.53		3,094		3.49
Commercial mortgage-backed securities	—		—		—		—		—		—		3,481		2.76		3,481		2.76
Corporate and other securities	—		—		—		—		4,508		5.73		—		—		4,508		5.73
Total securities held to maturity	$	—	—	%	$	37	5.22	%	$	5,359	5.49	%	$	8,936	2.95	%	$	14,332	3.90	%
Equity securities at fair value:
Total equity securities	$	—	—	%	$	—	—	%	$	—	—	%	$	2,364	2.14	%	$	2,364	2.13	%

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, 2019 and December 31, 2018 are as follows:



	September 30, 2019
		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	$	2,755	$	—		$	2,987	$	(11	)	$	5,742	$	(11	)
State and political subdivisions	1	—		—			1,143		(16		)	1,143		(16		)
Residential mortgage-backed securities	11	3,532		(15		)	4,431		(96		)	7,963		(111		)
Corporate and other securities	5	3,215		(8		)	3,705		(283		)	6,920		(291		)
Total temporarily impaired securities	22	$	9,502	$	(23	)	$	12,266	$	(406	)	$	21,768	$	(429	)
Held to maturity:
U.S. Government sponsored entities	2	$	2,278	$	(20	)	$	—	$	—		$	2,278	$	(20	)
Residential mortgage-backed securities	2	—		—			772		(8		)	772		(8		)
Commercial mortgage-backed securities	1	1,504		(24		)	—		—			1,504		(24		)
Total temporarily impaired securities	5	$	3,782	$	(44	)	$	772	$	(8	)	$	4,554	$	(52	)



	December 31, 2018
		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	$	—	$	—		$	5,642	$	(116	)	$	5,642	$	(116	)
State and political subdivisions	4	—		—			3,129		(120		)	3,129		(120		)
Residential mortgage-backed securities	31	4,445		(23		)	20,480		(597		)	24,925		(620		)
Corporate and other securities	5	971		(30		)	5,787		(364		)	6,758		(394		)
Total temporarily impaired securities	45	$	5,416	$	(53	)	$	35,038	$	(1,197	)	$	40,454	$	(1,250	)
Held to maturity:
U.S. Government sponsored entities	2	$	—	$	—		$	2,434	$	(94	)	$	2,434	$	(94	)
Residential mortgage-backed securities	5	1,277		(15		)	821		(37		)	2,098		(52		)
Commercial mortgage-backed securities	2	—		—			3,432		(138		)	3,432		(138		)
Total temporarily impaired securities	9	$	1,277	$	(15	)	$	6,687	$	(269	)	$	7,964	$	(284	)

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, 2019 or December 31, 2018.

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, 2019 or December 31, 2018.

Corporate and other securities: Included in this category are corporate and other debt securities. The unrealized losses on corporate and other debt securities were due to widening credit spreads. 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, 2019 or December 31, 2018. The unrealized loss on the trust preferred security was caused by an inactive trading market and charges in market credit spreads. 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 likely than not that the Company will hold the security, the Company did not consider this security to be other-than-temporarily impaired as of September 30, 2019 or December 31, 2018.

Realized Gains and Losses

There were no realized gains or losses for the three and nine months ended September 30, 2019, or 2018.

Equity Securities

Included in this category are Community Reinvestment Act ("CRA") investments and the equity holdings of financial institutions. Equity securities are defined to include (a) preferred, common and other ownership interests in entities including partnerships, joint ventures and limited liability companies and (b) rights to acquire or dispose of ownership interest in entities at fixed or determinable prices.

The Company follows ASU 2016-01, "Financial Instruments - Overall (Subtopic 825-10) - Recognition and Measurement of Financial Assets and Financial Liabilities," which aims to simplify accounting for financial instruments and to converge the guidance between U.S. GAAP and IFRS. ASU 2016-01 also includes guidance on how entities account for equity investments, present and disclose financial instruments, and measure the valuation allowance on deferred tax assets related to available-for-sale debt securities. The guidance in ASU 2016-01 requires an entity to disaggregate the net gains and losses on the equity investments recognized in the income statement during a reporting period into realized and unrealized gains and losses. As a result, equity securities are no longer carried at fair value through other comprehensive income (OCI) or by applying the cost method to those equity securities that do not have readily determinable values. Equity securities are generally required to be measured at fair value with unrealized holding gains and losses reflected in net income. The Company adopted this standard as of January 1, 2018.

The following is a summary of unrealized and realized gains and losses recognized in net income on equity securities during the three and nine months ended September 30, 2019 and 2018:



	For the three months ended September 30,				For the nine months ended September 30,
(In thousands)	2019		2018		2019		2018
Net gains (losses) recognized during the period on equity securities	$	18	$	2	$	216	$	(6	)
Less: Net gains (losses) recognized during the period on equity securities sold during the period	—		—		—		—
Unrealized gains (losses) recognized during the reporting period on equity securities still held at the reporting date	$	18	$	2	$	216	$	(6	)

Pledged Securities

Securities with a carrying value of $5.5 million and $4.3 million for September 30, 2019 and December 31, 2018, respectively, were pledged to secure Government deposits, secure other borrowings and for other purposes required or permitted by law.

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, 2019 and December 31, 2018:



(In thousands)	September 30, 2019		December 31, 2018
SBA loans held for investment	$	36,380	$	39,333
Commercial loans
SBA 504 loans	26,208		29,155
Commercial other	105,449		104,587
Commercial real estate	541,510		510,370
Commercial real estate construction	50,082		49,990
Residential mortgage loans	456,963		436,056
Consumer loans
Home equity	67,087		59,887
Consumer construction and other	71,742		64,017
Total loans held for investment	$	1,355,421	$	1,293,395
SBA loans held for sale	13,053		11,171
Total loans	$	1,368,474	$	1,304,566

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. 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.

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. 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. 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. Generally, the Company has a 50 percent loan to value ratio on SBA 504 program loans at origination.

Residential Mortgage and Consumer Loans: The Company originates mortgage and consumer loans including principally residential real estate and home equity lines and loans and consumer construction lines. The Company originates qualified mortgages which are generally sold in the secondary market and nonqualified mortgages which are generally held for investment. 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. This policy and the underlying procedures are reviewed and approved by the Board of Directors on a regular basis.

Credit Ratings

For SBA 7(a) 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 regulatory 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, 2019, the Company owned $1.7 million in residential consumer properties that were included in OREO in the Consolidated Balance Sheets, compared to one residential consumer property, which was fully charged off at December 31, 2018. Additionally, there were $4.0 million of residential consumer loans in the process of foreclosure at September 30, 2019, compared to $5.3 million at December 31, 2018.

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, 2019:



	September 30, 2019
	SBA & Commercial loans - Internal risk ratings
(In thousands)	Pass		Special mention		Substandard		Total
SBA loans held for investment	$	34,575	$	1,417	$	388	$	36,380
Commercial loans
SBA 504 loans	26,160		—		48		26,208
Commercial other	103,466		1,983		—		105,449
Commercial real estate	535,360		5,227		923		541,510
Commercial real estate construction	50,082		—		—		50,082
Total commercial loans	715,068		7,210		971		723,249
Total SBA and commercial loans	$	749,643	$	8,627	$	1,359	$	759,629

	Residential mortgage & Consumer loans - Performing/Nonperforming
(In thousands)			Performing		Nonperforming		Total
Residential mortgage loans			$	452,536	$	4,427	$	456,963
Consumer loans
Home equity			67,064		23		67,087
Consumer construction and other			71,742		—		71,742
Total consumer loans			138,806		23		138,829
Total residential mortgage and consumer loans			$	591,342	$	4,450	$	595,792

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, 2018:



	December 31, 2018
	SBA & Commercial loans - Internal risk ratings
(In thousands)	Pass		Special mention		Substandard		Total
SBA loans held for investment	$	37,198	$	601	$	1,534	$	39,333
Commercial loans
SBA 504 loans	28,105		—		1,050		29,155
Commercial other	103,806		322		459		104,587
Commercial real estate	504,022		2,879		3,469		510,370
Commercial real estate construction	49,990		—		—		49,990
Total commercial loans	685,923		3,201		4,978		694,102
Total SBA and commercial loans	$	723,121	$	3,802	$	6,512	$	733,435

	Residential mortgage & Consumer loans - Performing/Nonperforming
(In thousands)			Performing		Nonperforming		Total
Residential mortgage loans			$	431,845	$	4,211	$	436,056
Consumer loans
Home equity			59,861		26		59,887
Consumer construction and other			64,017		—		64,017
Total consumer loans			123,878		26		123,904
Total residential mortgage and consumer loans			$	555,723	$	4,237	$	559,960

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 the process of collection. The risk of loss is difficult to quantify and is subject to fluctuations in collateral values, general economic conditions and other factors. 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, 2019 and December 31, 2018:



	September 30, 2019
(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	$	663	$	—	$	—	$	503	$	1,166	$	35,214	$	36,380
Commercial loans
SBA 504 loans	1,822		—		—		—		1,822		24,386		26,208
Commercial other	156		—		—		416		572		104,877		105,449
Commercial real estate	1,673		—		—		213		1,886		539,624		541,510
Commercial real estate construction	—		—		—		—		—		50,082		50,082
Residential mortgage loans	6,020		2,261		—		4,427		12,708		444,255		456,963
Consumer loans
Home equity	252		201		140		23		616		66,471		67,087
Consumer construction and other	—		—		—		—		—		71,742		71,742
Total loans held for investment	$	10,586	$	2,462	$	140	$	5,582	$	18,770	$	1,336,651	$	1,355,421
SBA loans held for sale	—		—		—		—		—		13,053		13,053
Total loans	$	10,586	$	2,462	$	140	$	5,582	$	18,770	$	1,349,704	$	1,368,474


(1)	At September 30, 2019, nonaccrual loans included $63 thousand of loans guaranteed by the SBA.



	December 31, 2018
(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	$	—	$	—	$	—	$	1,560	$	1,560	$	37,773	$	39,333
Commercial loans
SBA 504 loans	—		—		—		—		—		29,155		29,155
Commercial other	—		—		—		30		30		104,557		104,587
Commercial real estate	301		—		—		1,046		1,347		509,023		510,370
Commercial real estate construction	—		—		—		—		—		49,990		49,990
Residential mortgage loans	3,801		1,204		98		4,211		9,314		426,742		436,056
Consumer loans
Home equity	396		—		—		26		422		59,465		59,887
Consumer construction and other	300		—		—		—		300		63,717		64,017
Total loans held for investment	$	4,798	$	1,204	$	98	$	6,873	$	12,973	$	1,280,422	$	1,293,395
SBA loans held for sale	—		—		—		—		—		11,171		11,171
Total loans	$	4,798	$	1,204	$	98	$	6,873	$	12,973	$	1,291,593	$	1,304,566


(1)	At December 31, 2018, nonaccrual loans included $89 thousand of loans guaranteed by the SBA.

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 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, 2019:



	September 30, 2019
(In thousands)	Unpaid principal balance		Recorded investment		Specific reserves
With no related allowance:
SBA loans held for investment (1)	$	531	$	367	$	—
Commercial loans
Commercial real estate	213		213		—
Total commercial loans	213		213		—
Total impaired loans with no related allowance	744		580		—

With an allowance:
SBA loans held for investment (1)	238		73		72
Commercial loans
Commercial other	916		416		416
Commercial real estate	718		718		70
Total commercial loans	1,634		1,134		486
Total impaired loans with a related allowance	1,872		1,207		558

Total individually evaluated impaired loans:
SBA loans held for investment (1)	769		440		72
Commercial loans
Commercial other	916		416		416
Commercial real estate	931		931		70
Total commercial loans	1,847		1,347		486
Total individually evaluated impaired loans	$	2,616	$	1,787	$	558


(1)	Balances are reduced by amount guaranteed by the SBA of $63 thousand at September 30, 2019.

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, 2018:



	December 31, 2018
(In thousands)	Unpaid principal balance		Recorded investment		Specific reserves
With no related allowance:
SBA loans held for investment (1)	$	359	$	353	$	—
Commercial loans
Commercial real estate	1,046		1,046		—
Total commercial loans	1,046		1,046		—
Total impaired loans with no related allowance	1,405		1,399		—

With an allowance:
SBA loans held for investment (1)	1,257		1,118		540
Commercial loans
Commercial other	30		30		30
Commercial real estate	745		745		97
Total commercial loans	775		775		127
Total impaired loans with a related allowance	2,032		1,893		667

Total individually evaluated impaired loans:
SBA loans held for investment (1)	1,616		1,471		540
Commercial loans
Commercial other	30		30		30
Commercial real estate	1,791		1,791		97
Total commercial loans	1,821		1,821		127
Total individually evaluated impaired loans	$	3,437	$	3,292	$	667


(1)	Balances are reduced by amount guaranteed by the SBA of $89 thousand at December 31, 2018.

Impaired loans decreased $1.5 million at September 30, 2019 compared to December 31, 2018. The decrease in impaired loans was primarily due to one commercial loan note sale totaling $1.0 million, one SBA loan taken into OREO totaling $328 thousand, one SBA loan note sale totaling $293 thousand, and the removal of one SBA loan totaling $276 thousand, partially offset by the addition of two SBA loans totaling $629 thousand. Additionally, one SBA loan was reduced in 2019 through a short sale of $184 thousand, and two SBA loans were reduced through charge-offs totaling $154 thousand.

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 three and nine months ended September 30, 2019 and 2018. 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 nominal amounts of income recognized on a cash basis for well-collateralized impaired loans.



	For the three months ended September 30,
	2019				2018
(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)	$	255	$	4	$	1,275	$	—
Commercial loans
Commercial other	700		3		11		—
Commercial real estate	831		9		2,524		55
Total	$	1,786	$	16	$	3,810	$	55


(1)	Balances are reduced by the average amount guaranteed by the SBA of $270 thousand and $120 thousand for the three months ended September 30, 2019 and 2018, respectively.



	For the nine months ended September 30,
	2019				2018
(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)	$	685	$	13	$	1,003	$	(2	)
Commercial loans
Commercial other	236		3		10		—
Commercial real estate	1,369		26		2,190		80
Total	$	2,290	$	42	$	3,203	$	78


(1)	Balances are reduced by the average amount guaranteed by the SBA of $146 thousand and $82 thousand for the nine months ended September 30, 2019 and 2018, 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, a combination of both, or a reduction in principal amount. 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.

The Company had one performing TDR with a balance of $718 thousand and $745 thousand as of September 30, 2019, and December 31, 2018, respectively, which was included in the impaired loan numbers as of such dates. At September 30, 2019, and December 31, 2018, there were specific reserves on the performing TDR of $70 thousand and $97 thousand, respectively. The loan remains in accrual status since it continues to perform in accordance with the restructured terms.

To date, the Company’s TDRs consisted of interest rate reductions, interest only periods, principal balance reductions, and maturity extensions. There were no loans modified during the three or nine months ended September 30, 2019 and 2018 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, 2019. In this case, the subsequent default is defined as 90 days past due or transferred to nonaccrual status.

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), 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 five classes: commercial real estate, commercial real estate construction, unsecured business line of credit, commercial other, and SBA 504. 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) 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.

The following tables detail the activity in the allowance for loan losses by portfolio segment for the three months ended September 30, 2019 and 2018:



	For the three months ended September 30, 2019
(In thousands)	SBA held for investment			Commercial			Residential			Consumer			Total
Balance, beginning of period	$	1,321		$	9,144		$	4,198		$	1,302		$	15,965
Charge-offs	(99		)	(500		)	(130		)	—			(729		)
Recoveries	13			3			—			—			16
Net (charge-offs) recoveries	(86		)	(497		)	(130		)	—			(713		)
(Credit) provision for loan losses charged to expense	(68		)	778			52			(12		)	750
Balance, end of period	$	1,167		$	9,425		$	4,120		$	1,290		$	16,002



	For the three months ended September 30, 2018
(In thousands)	SBA held for investment			Commercial		Residential		Consumer			Total
Balance, beginning of period	$	1,637		$	8,355	$	3,493	$	1,149		$	14,634
Charge-offs	(169		)	—		—		—			(169		)
Recoveries	1			5		—		17			23
Net (charge-offs) recoveries	(168		)	5		—		17			(146		)
Provision for loan losses charged to expense	66			317		119		(2		)	500
Balance, end of period	$	1,535		$	8,677	$	3,612	$	1,164		$	14,988

The following tables detail the activity in the allowance for loan losses portfolio segment for the nine months ended September 30, 2019 and 2018:



	For the nine months ended September 30, 2019
(In thousands)	SBA held for investment			Commercial			Residential			Consumer			Total
Balance, beginning of period	$	1,655		$	8,705		$	3,900		$	1,228		$	15,488
Charge-offs	(492		)	(501		)	(130		)	(1		)	(1,124		)
Recoveries	16			12			—			10			38
Net (charge-offs) recoveries	(476		)	(489		)	(130		)	9			(1,086		)
Provision for loan losses charged to expense	(12		)	1,209			350			53			1,600
Balance, end of period	$	1,167		$	9,425		$	4,120		$	1,290		$	16,002



	For the nine months ended September 30, 2018
(In thousands)	SBA held for investment			Commercial		Residential		Consumer			Total
Balance, beginning of period	$	1,471		$	7,825	$	3,130	$	1,130		$	13,556
Charge-offs	(354		)	—		—		(22		)	(376		)
Recoveries	68			25		13		152			258
Net (charge-offs) recoveries	(286		)	25		13		130			(118		)
Provision (credit) for loan losses charged to expense	350			827		469		(96		)	1,550
Balance, end of period	$	1,535		$	8,677	$	3,612	$	1,164		$	14,988

The following tables present loans and their related allowance for loan losses, by portfolio segment, as of September 30, 2019 and December 31, 2018:



	September 30, 2019
(In thousands)	SBA held for investment		Commercial		Residential		Consumer		Total
Allowance for loan losses ending balance:
Individually evaluated for impairment	$	72	$	486	$	—	$	—	$	558
Collectively evaluated for impairment	1,095		8,939		4,120		1,290		15,444
Total	$	1,167	$	9,425	$	4,120	$	1,290	$	16,002
Loan ending balances:
Individually evaluated for impairment	$	440	$	1,347	$	—	$	—	$	1,787
Collectively evaluated for impairment	35,940		721,902		456,963		138,829		1,353,634
Total	$	36,380	$	723,249	$	456,963	$	138,829	$	1,355,421



	December 31, 2018
(In thousands)	SBA held for investment		Commercial		Residential		Consumer		Total
Allowance for loan losses ending balance:
Individually evaluated for impairment	$	540	$	127	$	—	$	—	$	667
Collectively evaluated for impairment	1,115		8,578		3,900		1,228		14,821
Total	$	1,655	$	8,705	$	3,900	$	1,228	$	15,488
Loan ending balances:
Individually evaluated for impairment	$	1,471	$	1,821	$	—	$	—	$	3,292
Collectively evaluated for impairment	37,862		692,281		436,056		123,904		1,290,103
Total	$	39,333	$	694,102	$	436,056	$	123,904	$	1,293,395

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, 2019, a $278 thousand commitment reserve was reported on the balance sheet as an “other liability”, compared to a $290 thousand commitment reserve at December 31, 2018.

NOTE 10. New Accounting Pronouncements

ASU 2016-13, "Financial Instruments - Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments." ASU 2016-13 was issued to replace the incurred loss impairment methodology in current GAAP with an expected credit loss methodology and requires consideration of a broader range of information to determine credit loss estimates. Financial assets measured at amortized cost will be presented at the net amount expected to be collected by using an allowance for credit losses. Purchased credit impaired loans will receive an allowance account at the acquisition date that represents a component of the purchase price allocation. Credit losses relating to available-for-sale debt securities will be recorded through an allowance for credit losses, with such allowance limited to the amount by which fair value is below amortized cost. For public business entities, ASU 2016-13 is effective for interim and annual reporting periods beginning after December 15, 2019.

In May 2019, FASB issued ASU 2019-05, "Financial Instruments - Credit Losses (Topic 326): Targeted Transition Relief." ASU 2019-05 was issued to address concerns with the adoption of ASU 2016-13. ASU 2019-05 gives entities the ability to irrevocable elect the fair value option in Subtopic 825-10 for certain existing financial assets upon transition to ASU 2016-03. Financial assets that are eligible for this fair value election are those that qualify under Subtopic 825-10 and are within the scope of Subtopic 326-10, "Financial Instruments - Credit Losses - Measured at Amortized Costs." An exception to this is held-to-maturity debt securities, which do not qualify for this transition election. The effective date for the amendment is the same as the effective date in ASU 2016-03. The Company is currently evaluating the impact of the adoption of ASU 2016-13 on its consolidated financial statements.

ASU 2017-04, "Goodwill and Other (Topic 350): Simplifying the Test for Goodwill Impairment." ASU 2017-04 was issued in an effort to simplify accounting in a new standard. The amendments in this update require that an entity perform its annual or interim goodwill impairment test by comparing the fair value of a reporting unit with its carrying amount. The amendment states that an entity should recognize an impairment charge for the amount by which the carrying amount exceeds the reporting unit's fair value, but the loss recognized should not exceed the total amount of goodwill allocated to that reporting unit. For public business entities, ASU 2017-04 is effective for fiscal years beginning after December 15, 2019. Early adoption is permitted for interim or annual goodwill impairment tests performing on testing dates after January 1, 2017. The Company does not expect this ASU to have a material impact on the Company's consolidated financial statements since the fair values of our reporting units were not lower than their respective carrying amounts at the time of our goodwill impairment analysis for 2018.

NOTE 11. Derivative Financial Instruments and Hedging Activities

Derivative Financial Instruments

The Company has derivative financial instruments in the form of interest rate swap agreements, which derive their value from underlying interest rates. These transactions involve both credit and market risk. The notional amounts are amounts on which calculations, payments, and the value of the derivatives are based. Notional amounts do not represent direct credit exposures. Direct credit exposure is limited to the net difference between the calculated amounts to be received and paid, if any. Such difference, which represents the fair value of the derivative instrument, is reflected on the Company’s balance sheet as other assets or other liabilities.

The Company is exposed to credit-related losses in the event of nonperformance by the counterparties to any derivative agreement. The Company controls the credit risk of its financial contracts through credit approvals, limits and monitoring procedures, and does not expect any counterparties to fail their obligations. The Company deals only with primary dealers.

Derivative instruments are generally either negotiated OTC contracts or standardized contracts executed on a recognized exchange. Negotiated OTC derivative contracts are generally entered into between two counterparties that negotiate specific agreement terms, including the underlying instrument, amount, exercise prices and maturity.

Risk Management Policies – Hedging Instruments

The primary focus of the Company’s asset/liability management program is to monitor the sensitivity of the Company’s net portfolio value and net income under varying interest rate scenarios to take steps to control its risks. On a quarterly basis, the Company evaluates the effectiveness of entering into any derivative agreement by measuring the cost of such an agreement in relation to the reduction in net portfolio value and net income volatility within an assumed range of interest rates.

Interest Rate Risk Management – Cash Flow Hedging Instruments

The Company has variable rate debt as a source of funds for use in the Company’s lending and investment activities and for other general business purposes. These debt obligations expose the Company to variability in interest payments due to changes in interest rates. If interest rates increase, interest expense increases. Conversely, if interest rates decrease, interest expense decreases. Management believes it is prudent to limit the variability of a portion of its interest payments and, therefore hedges its variable-rate interest payments. To meet this objective, management enters into interest rate swap agreements whereby the Company receives variable interest rate payments and makes fixed interest rate payments during the contract period.

The Company had interest rate swaps designated as cash flow hedging instruments with a notional amount of $60.0 million at September 30, 2019 and September 30, 2018, respectively. On February 16, 2019, a $10.0 million swap instrument matured, resulting in a reduction in fair value of $27 thousand. On July 5, 2019, the Company entered into a new swap agreement with a notional value of $10.0 million. A summary of the Company’s outstanding interest rate swap agreements used to hedge variable rate debt at September 30, 2019 and 2018, respectively is as follows:

໿



	For the three months ended September 30,						For the nine months ended September 30,
(In thousands, except percentages, years and contracts)	2019			2018			2019			2018
Notional amount	$	60,000		$	60,000		$	60,000		$	60,000
Fair value	264			2,066			264			2,066
Weighted average pay rate	1.42		%	1.26		%	1.36		%	1.26		%
Weighted average receive rate	2.49		%	2.33		%	2.59		%	1.76		%
Weighted average maturity in years	1.50			2.12			1.72			2.49
Number of contracts	4			4			4			4

During the three and nine months ended September 30, 2019, the Company received variable rate London Interbank Offered Rate ("LIBOR") payments from and paid fixed rates in accordance with its interest rate swap agreements. At September 30, 2019 and 2018, the unrealized gain relating to interest rate swaps was recorded as a derivative asset and is included in Prepaid expenses and other assets in the Company's Balance Sheet, and the unrealized loss as a derivative liability and is included in Accrued expenses and other liabilities. Changes in the fair value of the interest rate swaps designated as hedging instruments of the variability of cash flows associated with long-term debt are reported in other comprehensive income. The following table presents the net (losses) gains recorded in other comprehensive income and the consolidated financial statements relating to the cash flow derivative instruments at September 30, 2019 and 2018, respectively:



	For the three months ended September 30,						For the three months ended September 30,
(In thousands)	2019			2018			2019			2018
(Decrease) Increase in the fair value of interest rate swaps	$	(177	)	$	(7	)	$	(1,077	)	$	659

NOTE 12. Employee Benefit Plans

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. 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. Transactions under the Company’s stock option plans for the nine months ended September 30, 2019 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, 2018	584,178		$	13.00	7.1	$	4,574,680
Options granted	55,000		20.61
Options exercised	(57,234	)	7.41
Options forfeited	(5,333	)	19.38
Options expired	—		—
Outstanding at September 30, 2019	576,611		$	14.22	6.9	$	4,573,458
Exercisable at September 30, 2019	338,089		$	10.28	5.5	$	4,011,761

On April 25, 2019, The Company adopted the 2019 Equity Compensation Plan providing for grants of up to 500,000 shares to be allocated between incentive and non-qualified stock options, restricted stock awards, performance units and deferred stock. The Plan replaced all previously approved and established equity plans then currently in effect. As of September 30, 2019, 7,500 shares of restricted stock have been awarded from the plan leaving 492,500 shares available for future grants.

The fair values of the options granted during the nine months ended September 30, 2019 and 2018 were estimated on the date of grant using the Black-Scholes option-pricing model with the following weighted average assumptions. No options were granted during the three months ended September 30, 2019 and 2018:



	For the three months ended September 30,						For the nine months ended September 30,
	2019			2018			2019			2018
Number of options granted	—			—			55,000			114,500
Weighted average exercise price	$	—		$	—		$	20.61		$	20.24
Weighted average fair value of options	$	—		$	—		$	6.21		$	5.97
Expected life in years (1)	0.00			0.00			8.23			6.35
Expected volatility (2)	—		%	—		%	27.08		%	26.40		%
Risk-free interest rate (3)	—		%	—		%	2.55		%	2.48		%
Dividend yield (4)	—		%	—		%	1.36		%	1.14		%

(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, 2019 and 2018:



	For the three months ended September 30,				For the nine months ended September 30,
	2019		2018		2019		2018
Number of options exercised	4,800		23,366		57,234		100,973
Total intrinsic value of options exercised	$	38,127	$	462,533	$	742,737	$	1,699,924
Cash received from options exercised	$	61,134	$	108,156	$	424,198	$	500,114
Tax deduction realized from options	$	11,491	$	130,018	$	223,453	$	477,849

The following table summarizes information about stock options outstanding and exercisable at September 30, 2019:



	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 - $6.00	61,761	2.9	$	5.60	61,761	$	5.60
$6.01 - $12.00	196,817	5.5	8.70		196,817	8.70
$12.01 - $18.00	67,533	7.3	15.78		43,335	15.80
$18.01 - $24.00	250,500	8.9	20.26		36,176	20.27
Total	576,611	6.9	$	14.22	338,089	$	10.28

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, 2019 and 2018 are detailed in the following table:



	For the three months ended September 30,				For the nine months ended September 30,
	2019		2018		2019		2018
Compensation expense	$	155,942	$	115,345	$	446,544	$	357,007
Income tax benefit	45,067		32,424		129,051		100,355

As of September 30, 2019, unrecognized compensation costs related to nonvested share-based compensation arrangements granted under the Company’s stock option plans totaled approximately $993 thousand. That cost is expected to be recognized over a weighted average period of 2.0 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. 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. The following table summarizes nonvested restricted stock activity for the nine months ended September 30, 2019:



	Shares		Average grant date fair value
Nonvested restricted stock at December 31, 2018	105,312		$	16.55
Granted	37,650		20.52
Cancelled	(1,350	)	17.92
Vested	(35,438	)	14.11
Nonvested restricted stock at September 30, 2019	106,174		$	18.76

Restricted stock awards granted during the three and nine months ended September 30, 2019 and 2018 were as follows:



	For the three months ended September 30,				For the nine months ended September 30,
	2019		2018		2019		2018
Number of shares granted	7,500		—		37,650		38,300
Average grant date fair value	$	20.00	$	—	$	20.52	$	20.64

Compensation expense related to restricted stock for the three and nine months ended September 30, 2019 and 2018 is detailed in the following table:



	For the three months ended September 30,				For the nine months ended September 30,
	2019		2018		2019		2018
Compensation expense	$	172,558	$	143,854	$	485,466	$	429,990
Income tax benefit	49,869		40,437		140,299		120,870

As of September 30, 2019, there was approximately $1.5 million 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.

401(k) Savings Plan

The Bank has a 401(k) savings plan covering substantially all employees. Under the Plan, an employee can contribute up to 80 percent of their salary on a tax deferred basis. The Bank may also make discretionary contributions to the Plan. The Bank contributed $150 thousand and $146 thousand during the three months ended September 30, 2019 and 2018, respectively, and $490 thousand and $458 thousand during the nine months ended September 30, 2019 and 2018, respectively.

Deferred Fee Plan

The Company has a deferred fee plan for Directors and executive management. Directors of the Company have the option to elect to defer up to 100 percent of their respective retainer and Board of Director fees, and each member of executive management has the option to elect to defer up to 100 percent of their year end cash bonuses. Director and executive deferred fees totaled $22 thousand during the three months ended September 30, 2019 and 2018, and $354 thousand and $282 thousand during the nine months ended September 30, 2019, and 2018 respectively. The interest paid on the deferred balances totaled $28 thousand and $18 thousand during the three months ended September 30, 2019 and 2018, and $78 thousand and $49 thousand during the nine months ended September 30, 2019, and 2018 respectively. The fees distributed on the deferred balances totaled $2 thousand during the three months ended September 30, 2019 and 2018, and $9 thousand during the nine months ended September 30, 2019, and 2018.

Benefit Plans

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

On June 4, 2015, the Company approved the Supplemental Executive Retirement Plan (“SERP”) pursuant to which the President and CEO is entitled to receive certain supplemental nonqualified retirement benefits. The Retirement Benefit shall be an amount equal to sixty percent (60%) of the average of Executive's base salary for the thirty-six (36) months immediately preceding executive's separation from service after age 66, adjusted annually thereafter by two percent (2%). The total benefit is to be made payable in fifteen annual installments. The future payments are estimated to total $6.6 million. A discount rate of four percent (4%) was used to calculate the present value of the benefit obligation.

The President and CEO commenced vesting in this retirement benefit on January 1, 2014, and vests an additional three percent (3%) each year until fully vested on January 1, 2024. In the event that the President and CEO’s separation from service from the company 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 involuntarily 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 position that is not a “Comparable Position”, as such is also defined in the SERP, the President and CEO shall become one hundred percent (100%) vested in the full retirement benefit.

No contributions or payments have been made during the three and nine months ended September 30, 2019. The following table summarizes the components of the net periodic pension cost of the defined benefit plan recognized during the three and nine months ended September 30, 2019 and 2018:



	For the three months ended September 30,				For the nine months ended September 30,
(In thousands)	2019		2018		2019		2018
Service cost (1)	$	235	$	953	$	454	$	1,159
Interest cost	36		16		99		47
Amortization of prior service cost	20		20		62		62
Net periodic benefit cost	$	291	$	989	$	615	$	1,268

(1) On September 27, 2018 the Company approved a change in calculation of the Retirement Benefit resulting in an additional $850 thousand in expense.

The following table summarizes the changes in benefit obligations of the defined benefit plan during the nine months ended September 30, 2019 and 2018:



	For the nine months ended September 30,
(In thousands)	2019		2018
Benefit obligation, beginning of year	$	2,747	$	1,187
Service cost (1)	454		1,159
Interest cost	99		47
Benefit obligation, end of period	$	3,300	$	2,393

(1) On September 27, 2018 the Company approved a change in calculation of the Retirement Benefit resulting in an additional $850 thousand in expense.

On October 22, 2015, the Company entered into an Executive Incentive Retirement Plan (the “Plan”) with certain key executive officers. The Plan has an effective date of January 1, 2015.

The Plan is an unfunded, nonqualified deferred compensation plan. For any Plan Year, a guaranteed annual Deferral Award percentage of seven and one half percent (7.5%) of the participant’s annual base salary will be credited to each Participant’s Deferred Benefit Account. A discretionary annual Deferral Award equal to seven and one half percent (7.5%) of the participant’s annual base salary may be credited to the Participant’s account in addition to the guaranteed Deferral Award, if the Bank exceeds the benchmarks set forth in the Annual Executive Bonus Matrix. The total Deferral Award shall never exceed fifteen percent (15%) of the participant's base salary for any given Plan Year. Each Participant shall be one hundred percent (100%) vested in all Deferral Awards as of the date they are awarded.

As of September 30, 2019, the Company had total year to date expenses of $85 thousand related to the Plan. The Plan is reflected on the Company’s balance sheet as accrued expenses.

Certain members of management are also enrolled in a split-dollar life insurance plan with a post retirement death benefit of $250 thousand. Total expenses related to this plan were $1 thousand and $8 thousand for the three months ended September 30, 2019 and 2018, and $4 thousand and $10 thousands for the nine months ended September 30, 2019 and 2018, respectively.

NOTE 13. 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 as tier 1 capital. The Bank is currently subject to various regulatory capital requirements administered by the FDIC. 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 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 Bank must meet specific capital guidelines. Prompt corrective action provisions are not applicable to bank holding companies. Under the Federal Reserve's small bank holding company policy, holding companies with less than $3.0 billion in consolidated assets, like the Parent Company, are exempt from the FRB's consolidated capital requirements.

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 2013, 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 included new risk-based capital and leverage ratios that were 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 raised 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 remained 8.0%. The new risk-based capital requirements (except for the capital conservation buffer) became effective for the Bank on January 1, 2015.

The new rules also included 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 Bank and the Company have made the election to opt out of the treatment of AOCI on the appropriate March 31, 2015 filings.

The following table summarizes the Company’s and the Bank’s regulatory capital ratios at September 30, 2019 and December 31, 2018, as well as the minimum regulatory capital ratios required for the Bank to be deemed “well-capitalized.”



	At September 30, 2019				Required for capital adequacy purposes effective				To be well-capitalized under prompt corrective action regulations
	Company		Bank		January 1, 2019				Bank
Leverage ratio	10.54	%	10.11	%	4.00	%			5.00	%
CET1	12.24	%	12.53	%	7.00	%	(1	)	6.50	%
Tier I risk-based capital ratio	13.04	%	12.53	%	8.50	%	(1	)	8.00	%
Total risk-based capital ratio	14.28	%	13.78	%	10.50	%	(1	)	10.00	%



	At December 31, 2018				Required for capital adequacy purposes effective								To be well-capitalized under prompt corrective action regulations
	Company		Bank		January 1, 2018				January 1, 2019				Bank
Leverage ratio	9.90	%	9.52	%	4.000	%			4.00	%			5.00	%
CET1	11.40	%	11.80	%	6.375	%	(2	)	7.00	%	(1	)	6.50	%
Tier I risk-based capital ratio	12.24	%	11.80	%	7.875	%	(2	)	8.50	%	(1	)	8.00	%
Total risk-based capital ratio	13.49	%	13.05	%	9.875	%	(2	)	10.50	%	(1	)	10.00	%

(1) Includes 2.5% capital conservation buffer.
(2) Includes 1.875% capital conservation buffer.

NOTE 14. Leases

The Company follows ASU 2016-02, "Leases (Topic 842)," which revised certain aspects of recognition, measurement, presentation, and disclosure of leasing transactions. ASU 2016-02 requires that a lessee recognize the assets and liabilities on its balance sheet that arise from all leases with a term greater than 12 months. The core principle requires the lessee to recognize a liability to make lease payments and a "right-of-use" asset. The Company adopted this standard as of January 1, 2019. In accordance with ASU 2018-01, we have elected to apply ASU 2016-02 as of the beginning of the period of adoption and will not restate comparative periods. Financial results for reporting periods beginning on or after January 1, 2019 are presented under the new guidance (Topic 842), while prior period amounts are not adjusted and continue to be reported in accordance with previous guidance (Topic 840).

Operating leases in which we are the lessee are recorded as right-of-use ("ROU") assets and lease liabilities and are included in Prepaid expenses and other assets and Accrued expenses and other liabilities, respectively, on our Consolidated Balance Sheets. We do not currently have any finance leases in which we are the lessee.

Operating lease ROU assets represent our right to use an underlying asset during the lease term and operating lease liabilities represent our obligation to make lease payments arising from the lease. ROU assets and lease liabilities are recognized at lease commencement based on the present value of the remaining lease payments using a discount rate that represents our incremental borrowing rate. The incremental borrowing rate was calculated for each lease by taking a variable rate FHLB ARC product (based on Libor plus a spread) and then swapping it to a fixed rate borrowing by adding a fixed mid swap rate for the desired term. The borrowing rate for each lease is unique based on the lease term. Operating lease expense, which is comprised of amortization of the ROU asset and the implicit interest accreted on the operating lease liability, is recognized on a straight-line basis over the lease term, and is recorded in Occupancy expense in the Consolidated Statements of Income.

Our leases relate primarily to bank branches, office space and equipment with remaining lease terms of generally 1 to 10 years. Certain lease arrangements contain extension options which typically range from 1 to 5 years at the then fair market rental rates. As these extension options are not generally considered reasonably certain of exercise, they are not included in the lease term.

Certain real estate leases have lease payments that adjust based on annual changes in the Consumer Price Index ("CPI"). The leases that are dependent upon CPI are initially measured using the index or rate at the commencement date and are included in the measurement of the lease liability.

As of September 30, 2019, operating lease ROU assets and operating lease liabilities were $2.9 million, respectively.

The table below summarizes our net lease cost:



(In thousands)	For the three months ended September 30, 2019		For the nine months ended September 30, 2019
Operating lease cost	$	156	$	441
Net lease cost	$	156	$	441

The table below summarizes the cash and non-cash activities associated with our leases:



(In thousands)	For the three months ended September 30, 2019		For the nine months ended September 30, 2019
Cash paid for amounts included in the measurement of lease liabilities:
Operating cash flows from operating leases	$	148	$	416
ROU assets obtained in exchange for new finance lease liabilities	$	43	$	3,295

The table below summarizes other information related to our operating leases:



(In thousands, except percentages and years)	September 30, 2019
Weighted average remaining lease term in years	6.95
Weighted average discount rate	5.47		%
Operating lease right-of-use assets	$	2,901

The table below summarizes the maturity of remaining lease liabilities:



(In thousands)	September 30, 2019
2019 (excluding the nine months ended September 30, 2019)	$	141
2020	558
2021	529
2022	478
2023	413
2024 and thereafter	1,411
Total lease payments	$	3,530
Less: Interest	(605		)
Present value of lease liabilities	$	2,925

As of September 30, 2019, the Corporation had not entered into any material leases that have not yet commenced.

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 2018 consolidated audited financial statements and notes thereto included in our Annual Report on Form 10-K for the year ended December 31, 2018. 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 19 branch offices located in Bergen, Hunterdon, Middlesex, Somerset, Union and Warren counties in New Jersey, and Northampton County in Pennsylvania. 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.

The Company has two other wholly-owned subsidiaries: Unity (NJ) Statutory Trust II and Unity Risk Management, Inc. On July 24, 2006, the Trust issued $10.0 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. Unity Risk Management, Inc. is the Company's captive insurance company that insures risks to the Bank not covered by the traditional commercial insurance market. The Company does not

consolidate the accounts and related activity of Unity (NJ) Statutory Trust II, but it does consolidate the accounts of Unity Risk Management, Inc.

Earnings Summary

Net income totaled $6.0 million, or $0.54 per diluted share for the quarter ended September 30, 2019, compared to $5.5 million, or $0.50 per diluted share for the same period a year ago. Return on average assets and average common equity for the quarter were 1.53% and 15.57%, respectively, compared to 1.50% and 16.64% for the same period a year ago.

Third quarter highlights include:


•	Net interest income increased 6.2% compared to the prior year's quarter due to loan growth.


•	Net interest margin equaled 3.90% this quarter compared to 3.92% in the prior year's quarter.


•	Noninterest income increased 9.3% compared to the prior year's quarter primarily due to the gain on the sale of the Union, NJ building.


•	Noninterest expense decreased slightly compared to the prior year's quarter. Quarterly noninterest expense included an FDIC assessment credit of $146 thousand.


•	The effective tax rate was 22.0% compared to 18.6% in the prior year's quarter due to recent New Jersey tax legislation changes.

For the nine months ended September 30, 2019, net income totaled $17.5 million, or $1.59 per diluted share, compared to $16.1 million, or $1.48 per diluted share, in the prior year's period. Return on average assets and average common equity for the nine month periods were 1.54% and 16.02%, respectively, compared to 1.52% and 17.14% for the same period a year ago.

The Company's quarterly performance ratios may be found in the table below.



	For the three months ended September 30,						For the nine months ended September 30,
	2019			2018			2019			2018
Net income per common share - Basic (1)	$	0.55		$	0.51		$	1.62		$	1.50
Net income per common share - Diluted (2)	$	0.54		$	0.50		$	1.59		$	1.48
Return on average assets	1.53		%	1.50		%	1.54		%	1.52		%
Return on average equity (3)	15.57		%	16.64		%	16.02		%	17.14		%
Efficiency ratio (4)	51.06		%	54.86		%	52.25		%	53.90		%

(1) Defined as net income divided by weighted average shares outstanding.

(2) Defined as net income divided by the sum of the weighted average shares and the potential dilutive impact of the exercise of outstanding options.

(3) Defined as net income divided by average shareholders' equity.

(4) Defined as noninterest expense divided by the sum of the net interest income plus noninterest income less any gains or losses on securities.

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, 2019, tax-equivalent net interest income amounted to $14.4 million, an increase of $837 thousand or 6.2 percent when compared to the same period in 2018. The net interest margin decreased 2 basis points to 3.90 percent for the quarter ended September 30, 2019, compared to 3.92 percent for the same period in 2018. The net interest spread was 3.48 percent for the third quarter of 2019, an 11 basis point decrease compared to the same period in 2018.

During the three months ended September 30, 2019, tax-equivalent interest income was $19.1 million, an increase of $1.9 million or 10.8 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, partially offset by a decrease in the balance of average securities.


•	Of the $1.9 million net increase in interest income on a tax-equivalent basis, $1.1 million of the increase was due to increased average earning assets, and $745 thousand was due to increased yields on the earning assets.

•

The average volume of interest-earning assets increased $94.6 million to $1.5 billion for the third quarter of 2019 compared to $1.4 billion for the same period in 2018. This was due primarily to a $86.0 million increase in average loans, primarily residential mortgage, commercial and consumer loans, and a $11.7 million increase in average federal funds, interest-bearing deposits and repos, partially offset by a $2.4 million decrease in investment securities.


•	The yield on total interest-earning assets increased 19 basis points to 5.16 percent for the three months ended September 30, 2019 when compared to the same period in 2018. The yield on the loan portfolio increased 20 basis points to 5.36 percent.

Total interest expense was $4.7 million for the three months ended September 30, 2019, an increase of $1.0 million or 28.2 percent compared to the same period in 2018. This increase was driven primarily by the increased volume of time deposits and increased rates paid on time deposits, savings deposits, and interest-bearing deposits, partially offset by the decreased volume of borrowed funds and subordinated debentures compared to a year ago:


•	Of the $1.0 million increase in interest expense, $675 thousand was due to increased rates on interest-bearing liabilities and $349 thousand was due to an increase in the volume of average interest-bearing liabilities.


•	Interest-bearing liabilities averaged $1.1 billion for the third quarter of 2019, an increase of $59.0 million or 5.7 percent, compared to the prior year’s quarter. The increase in interest-bearing liabilities was due to an increase in interest-bearing deposits, partially offset by a decrease in borrowed funds and subordinated debentures.


•	The average cost of total interest-bearing liabilities increased 30 basis points to 1.68 percent. The cost of interest-bearing deposits increased 33 basis points to 1.66 percent for the third quarter of 2019 and the cost of borrowed funds and subordinated debentures increased 5 basis points to 1.90 percent.

During the nine months ended September 30, 2019, tax-equivalent net interest income amounted to $42.8 million, an increase of $3.2 million or 8.2 percent when compared to the same period in 2018. The net interest margin increased 2 basis points to 3.97 percent for the nine months ended September 30, 2019, compared to 3.95 percent for the same period in 2018. The net interest spread was 3.56 percent for the first nine months of 2019, a 9 basis point decrease compared to the same period in 2018.

During the nine months ended September 30, 2019, tax-equivalent interest income was $56.4 million, an increase of $7.1 million or 14.5 percent when compared to the same period in the prior year. This increase was driven by the increase in the balance of average loans, partially offset by a decrease in the balance of average securities.


•	Of the $7.1 million increase in interest income on a tax-equivalent basis, $3.8 million of the increase was due to increased average earning assets, and $3.3 million was due to increased yields on the earning assets.


•	The average volume of interest-earning assets increased $103.6 million to $1.4 billion for the first nine months of 2019 compared to $1.3 billion for the same period in 2018. This was due primarily to a $108.7 million increase in average loans, primarily residential mortgage, commercial and consumer loans, partially offset by a $4.0 million decrease in investment securities.


•	The yield on total interest-earning assets increased 31 basis points to 5.22 percent for the nine months ended September 30, 2019 when compared to the same period in 2018. The yield on the loan portfolio increased 30 basis points to 5.41 percent.

Total interest expense was $13.5 million for the nine months ended September 30, 2019, an increase of $3.9 million or 40.4 percent compared to the same period in 2018. This increase was driven primarily by the increased rates and volume of interest-bearing deposits, partially offset by the decreased volume of borrowed funds and subordinated debentures:


•	Of the $3.9 million increase in interest expense, $2.5 million was due to increased rates on interest-bearing deposits, $1.7 million from the increase in the volume of average interest-bearing deposits and $255 thousand from the increased rates on borrowed funds and subordinated debentures, partially offset by a $557 thousand decrease in the volume of borrowed funds and subordinated debentures.


•	Interest-bearing liabilities averaged $1.1 billion for the nine months ended September 30, 2019, an increase of $69.9 million or 6.8 percent, compared to the prior year's period. The increase in interest-bearing liabilities was a result of an increase in interest-bearing deposits partially offset by a decrease in borrowed funds and subordinated debentures.


•	The average cost of total interest-bearing liabilities increased to 1.66 percent for the nine months ended September 30, 2019. The cost of interest-bearing deposits increased 45 basis points to 1.61 percent for the nine months ended September 30, 2019 and the cost of borrowed funds and subordinated debentures increased 26 basis points to 2.12 percent.

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 21 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, 2019								September 30, 2018
	Average Balance			Interest			Rate/Yield		Average Balance			Interest			Rate/Yield
ASSETS
Interest-earning assets:
Federal funds sold, interest-bearing deposits and repos	$	51,744		$	271		2.08	%	$	40,060		$	187		1.85	%
FHLB stock	5,138			82			6.33		5,805			101			6.90
Securities:
Taxable	58,144			463			3.16		59,916			465			3.08
Tax-exempt	4,418			32			2.87		5,095			35			2.73
Total securities (A)	62,562			495			3.14		65,011			500			3.05
Loans:
SBA loans	47,187			943			7.93		56,837			1,050			7.33
Commercial loans	713,785			9,467			5.26		683,632			8,784			5.10
Residential mortgage loans	450,105			5,606			4.94		404,439			4,803			4.71
Consumer loans	136,239			2,197			6.40		116,421			1,776			6.05
Total loans (B)	1,347,316			18,213			5.36		1,261,329			16,413			5.16
Total interest-earning assets	$	1,466,761		$	19,061		5.16	%	$	1,372,205		$	17,201		4.97	%

Noninterest-earning assets:
Cash and due from banks	24,345								25,560
Allowance for loan losses	(16,224		)						(14,909		)
Other assets	70,484								65,645
Total noninterest-earning assets	78,605								76,296
Total assets	$	1,545,365							$	1,448,501

LIABILITIES AND SHAREHOLDERS' EQUITY
Interest-bearing liabilities:
Total interest-bearing demand deposits	$	176,953		$	438		0.98	%	$	173,515		$	330		0.75	%
Total savings deposits	398,676			1,194			1.19		407,287			1,049			1.02
Total time deposits	432,035			2,577			2.37		350,747			1,739			1.97
Total interest-bearing deposits	1,007,664			4,209			1.66		931,549			3,118			1.33
Borrowed funds and subordinated debentures	92,326			442			1.90		109,408			509			1.85
Total interest-bearing liabilities	$	1,099,990		$	4,651		1.68	%	$	1,040,957		$	3,627		1.38	%

Noninterest-bearing liabilities:
Noninterest-bearing demand deposits	279,150								266,833
Other liabilities	14,364								9,805
Total noninterest-bearing liabilities	293,514								276,638
Total shareholders' equity	151,861								130,906
Total liabilities and shareholders' equity	$	1,545,365							$	1,448,501

Net interest spread				$	14,410		3.48	%				$	13,574		3.59	%
Tax-equivalent basis adjustment				(6		)						(7		)
Net interest income				$	14,404							$	13,567
Net interest margin							3.90	%							3.92	%


(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 21 percent, as well as all 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, 2019								September 30, 2018
	Average Balance			Interest			Rate/Yield		Average Balance			Interest			Rate/Yield
ASSETS
Interest-earning assets:
Federal funds sold, interest-bearing deposits and repos	$	43,021		$	724		2.25	%	$	42,772		$	563		1.76	%
FHLB stock	5,768			275			6.37		7,131			359			6.73
Securities:
Taxable	58,271			1,400			3.21		61,538			1,442			3.13
Tax-exempt	4,491			101			3.01		5,214			109			2.80
Total securities (A)	62,762			1,501			3.20		66,752			1,551			3.11
Loans:
SBA loans	48,238			2,880			7.98		62,517			3,365			7.20
Commercial loans	706,280			27,892			5.28		657,879			24,718			5.02
Residential mortgage loans	445,145			16,702			5.02		387,651			13,666			4.71
Consumer loans	131,714			6,382			6.48		114,658			5,003			5.83
Total loans (B)	1,331,377			53,856			5.41		1,222,705			46,752			5.11
Total interest-earning assets	$	1,442,928		$	56,356		5.22	%	$	1,339,360		$	49,225		4.91	%

Noninterest-earning assets:
Cash and due from banks	25,019								24,325
Allowance for loan losses	(15,979		)						(14,429		)
Other assets	70,243								65,380
Total noninterest-earning assets	79,283								75,276
Total assets	$	1,522,211							$	1,414,636

LIABILITIES AND SHAREHOLDERS' EQUITY
Interest-bearing liabilities:
Total interest-bearing demand deposits	$	177,789		$	1,289		0.97	%	$	173,381		$	813		0.63	%
Total savings deposits	397,029			3,500			1.18		403,916			2,768			0.92
Total time deposits	408,718			7,023			2.30		299,970			4,042			1.80
Total interest-bearing deposits	983,536			11,812			1.61		877,267			7,623			1.16
Borrowed funds and subordinated debentures	107,101			1,695			2.12		143,492			1,997			1.86
Total interest-bearing liabilities	$	1,090,637		$	13,507		1.66	%	$	1,020,759		$	9,620		1.26	%

Noninterest-bearing liabilities:
Noninterest-bearing demand deposits	271,118								258,787
Other liabilities	14,129								9,382
Total noninterest-bearing liabilities	285,247								268,169
Total shareholders' equity	146,327								125,708
Total liabilities and shareholders' equity	$	1,522,211							$	1,414,636

Net interest spread				$	42,849		3.56	%				$	39,605		3.65	%
Tax-equivalent basis adjustment				(20		)						(21		)
Net interest income				$	42,829							$	39,584
Net interest margin							3.97	%							3.95	%


(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 21 percent, as well as all 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.

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 21 percent.

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	For the three months ended September 30, 2019 versus September 30, 2018									For the nine months ended September 30, 2019 versus September 30, 2018
	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, interest-bearing deposits and repos	$	59		$	25		$	84		$	3		$	158		$	161
FHLB stock	(11		)	(8		)	(19		)	(66		)	(18		)	(84		)
Securities	(18		)	14			(4		)	(93		)	44			(49		)
Loans	1,086			714			1,800			3,931			3,173			7,104
Total interest income	$	1,116		$	745		$	1,861		$	3,775		$	3,357		$	7,132
Interest expense:
Demand deposits	$	6		$	102		$	108		$	22		$	454		$	476
Savings deposits	(23		)	168			145			(47		)	779			732
Time deposits	447			391			838			1,688			1,293			2,981
Total interest-bearing deposits	430			661			1,091			1,663			2,526			4,189
Borrowed funds and subordinated debentures	(81		)	14			(67		)	(557		)	255			(302		)
Total interest expense	349			675			1,024			1,106			2,781			3,887
Net interest income - fully tax-equivalent	$	767		$	70		$	837		$	2,669		$	576		$	3,245
Decrease in tax-equivalent adjustment							1									1
Net interest income							$	838								$	3,246

Provision for Loan Losses

Provision for loan losses totaled $750 thousand for the three months ended September 30, 2019, compared to $500 thousand for the three months ended September 30, 2018. For the nine months ended September 30, 2019 and 2018, the provision for loan losses totaled $1.6 million. 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, 2019 and 2018:



	For the three months ended September 30,				For the nine months ended September 30,
(In thousands)	2019		2018		2019		2018
Branch fee income	$	373	$	357	$	1,120	$	1,107
Service and loan fee income	522		465		1,533		1,441
Gain on sale of SBA loans held for sale, net	—		253		554		1,383
Gain on sale of mortgage loans, net	545		597		1,525		1,442
BOLI income	138		464		435		810
Net security gains (losses)	18		2		216		(6		)
Other income	1,114		341		1,758		900
Total noninterest income	$	2,710	$	2,479	$	7,141	$	7,077

For the three months ended September 30, 2019, noninterest income increased $231 thousand to $2.7 million, compared to the same period last year. Year-to-date, noninterest income increased $64 thousand to $7.1 million. The increase in noninterest income for both periods was primarily due to the gain on the sale of the Union, NJ building.

Changes in our noninterest income for the three and nine months ended September 30, 2019 vs. 2018 reflect:


•	Branch fee income increased during the quarterly and yearly periods due to increased service charges.


•	Service and loan fee income increased $57 thousand and $92 thousand for the three and nine months ended September 30, 2019, respectively, due to increased loan prepayment penalties and late charges.


•	The Company elected not to sell SBA loans during the third quarter of 2019. During the prior year's quarter, SBA loan sales totaled $17.2 million with a net gain of $253 thousand. Year-to-date, SBA loan sales totaled $9.1 million in 2019 and $17.2 million in 2018 with net gains on sale of $554 thousand and $1.4 million, respectively.

•

During the quarter, $35.2 million in residential mortgage loans were sold at a gain of $545 thousand, compared to $29.0 million in loans sold at a gain of $597 thousand during the prior year's quarter. Year-to-date, $78.2 million in residential mortgage loans were sold at a gain of $1.5 million compared to $65.3 million in loans sold at a gain of $1.4 million during the prior year's period. Residential mortgage loans are sold as a tool to manage liquidity needs within the bank.


•	Bank owned life insurance ("BOLI") decreased $326 thousand and $375 thousand for the three and nine months ended September 30, 2019, respectively. The decrease in both periods was primarily due to a death benefit claim in the third quarter of 2018.

•

There were no gains on the sale of securities for the three and nine months ended September 30, 2019 or 2018. Due to the adoption of ASU 2016-01 in January of 2018, there were unrealized gains of $18 thousand and $2 thousand for the three months ended September 30, 2019 and 2018, respectively, compared to an unrealized gain of $216 thousand and an unrealized loss of $6 thousand for the nine months ended September 30, 2019 and 2018, respectively, resulting from market value changes of equity securities.


•	Other income increased in the quarterly and year-to-date periods primarily due to the gain on the sale of the Union, NJ building.

Noninterest Expense

The following table presents a breakdown of noninterest expense for the three and nine months ended September 30, 2019 and 2018:



	For the three months ended September 30,						For the nine months ended September 30,
(In thousands)	2019			2018			2019		2018
Compensation and benefits	$	5,353		$	5,704		$	15,384	$	15,274
Occupancy	651			675			1,997		2,057
Processing and communications	749			709			2,213		2,072
Furniture and equipment	711			586			2,086		1,732
Professional services	274			270			839		682
Loan collection & OREO (recoveries) expenses	(48		)	(331		)	9		(320		)
Other loan expenses	89			51			202		137
Deposit insurance	—			191			301		593
Advertising	334			370			1,056		1,051
Director fees	171			175			499		502
Other expenses	445			401			1,409		1,373
Total noninterest expense	$	8,729		$	8,801		$	25,995	$	25,153

Noninterest expense decreased $72 thousand to $8.7 million for the three months ended September 30, 2019, while year-to-date expense increased $842 thousand to $26.0 million.

Changes in noninterest expense for the three and nine months ended September 30, 2019 versus 2018 reflect:

•

Compensation and benefits expense, the largest component of noninterest expense, decreased $351 thousand and increased $110 thousand for the three and nine months ended September 30, 2019, versus 2018 respectively. The quarterly decrease was the result of an $850 thousand supplemental executive retirement ("SERP") benefit expense in the prior year's quarter, while the yearly increase was primarily due to increased salary expenses and year end bonuses paid to employees.


•	Occupancy expense has decreased $24 thousand and $60 thousand for three and nine months ended September 30, 2019, versus 2018 respectively.


•	Processing and communications expenses increased $40 thousand and $141 thousand for the three and nine months ended September 30, 2019, versus 2018, respectively, primarily due to increased electronic banking expenses.


•	Furniture and equipment expense increased $125 thousand and $354 thousand for the three and nine months ended September 30, 2019, versus 2018 respectively, primarily due to investment in software and equipment to remain efficient, secure and competitive technologically.


•	Professional service fees increased $4 thousand and $157 for the three and nine months ended September 30, 2019, versus 2018, respectively, primarily due to higher consulting expenses.


•	Loan collection & OREO expenses increased $283 thousand and $329 thousand for the three and nine months ended September 30, 2019, versus 2018 respectively. The increases were primarily due to a $317 thousand settlement related to an OREO property in the third quarter of 2018.


•	Other loan expense increased $38 thousand and $65 thousand for the three and nine months ended September 30, 2019, versus 2018 respectively.


•	Deposit insurance expense decreased $191 thousand and $292 thousand for the three and nine months ended September 30, 2019, primarily due to an FDIC assessment credit of $146 thousand during the third quarter of 2019.


•	Advertising expenses decreased $36 thousand and increased $5 thousand for the three and nine months ended September 30, 2019, versus 2018 respectively.


•	Director fees remained relatively flat for the three and nine months ended September 30, 2019, versus 2018.


•	Other expenses increased $44 thousand and $36 thousand for the three and nine months ended September 30, 2019, versus 2018, respectively, primarily due to higher officer and employee expenses.

Income Tax Expense

On July 1, 2018, New Jersey's Assembly Bill 4202 was signed into law. Assembly Bill 4202, effective January 1, 2018, imposed a temporary surtax on corporations earning New Jersey allocated income in excess of $1 million at a rate of 2.5% for tax years beginning on or after January 1, 2018 through December 31, 2019, and at 1.5% for years beginning on or after January 1, 2020, through December 31, 2021. In addition, effective for periods on or after January 1, 2019, New Jersey is adopting mandatory unitary combined reporting for its Corporation Business Tax. As a result, the Company anticipates its effective tax rate to increase due to the New Jersey state tax legislation.

For additional information on income taxes, see Note 4 to the Consolidated Financial Statements.

Financial Condition at September 30, 2019

Total assets increased $85.2 million or 5.4 percent, to $1.7 billion at September 30, 2019, when compared to year end 2018. This increase was primarily due to an increase of $63.4 million in net loans and $21.2 million in cash and cash equivalents.

Total deposits increased $65.7 million, due to increases of $63.1 million in time deposits and $9.1 million in noninterest-bearing demand deposits, partially offset by decreases of $6.1 million in interest-bearing demand deposits and $394 thousand in savings deposits.

Total shareholders’ equity increased $16.4 million over year end 2018, primarily due to earnings and an increase in common stock, partially offset by dividends paid during the nine months ended September 30, 2019.

These fluctuations are discussed in further detail in the paragraphs that follows.

Securities Portfolio

The Company’s securities portfolio consists of AFS, HTM and equity 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 debt 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 debt 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 debt securities totaled $47.3 million at September 30, 2019, an increase of $582 thousand or 1.3 percent, compared to $46.7 million at December 31, 2018. This net increase was the result of:


•	$3.2 million from the purchase of two corporate bonds,


•	$1.1 million of appreciation in the market value of the portfolio. At September 30, 2019, the portfolio had a net unrealized gain of $74 thousand compared to a net unrealized loss of $1.0 million at December 31, 2018. These net unrealized gains and losses are reflected net of tax in shareholders’ equity as accumulated other comprehensive income, partially offset by


•	$3.7 million in principal payments and maturities, and


•	$108 thousand in net amortization.

The weighted average life of AFS debt securities, adjusted for prepayments, amounted to 4.2 years and 6.2 years at September 30, 2019 and December 31, 2018, 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 $14.3 million at September 30, 2019, a decrease of $542 thousand or 3.7 percent, compared to $14.9 million at December 31, 2018. This decrease was the result of:


•	$525 thousand in principal payments and maturities, and


•	$17 thousand in net amortization of premiums.

The weighted average life of HTM securities, adjusted for prepayments, amounted to 4.5 years and 5.4 years at September 30, 2019 and December 31, 2018, respectively. As of September 30, 2019 and December 31, 2018, the fair value of HTM securities was $14.6 million and $14.8 million, respectively.

Equity 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. Equity securities consist of Community Reinvestment Act ("CRA") investments and the Company's current other equity holdings. These securities were transferred from available for sale and reclassified into equity securities on the balance sheet as a result of the adoption of ASU 2016-01 in January 2018.

Equity securities totaled $2.4 million as of September 30, 2019, an increase of $220 thousand or 10.3 percent, compared to $2.1 million at December 31, 2018. This net increase was primarily the result of market value adjustments throughout the year.

The average balance of taxable securities amounted to $58.3 million for the nine months ended September 30, 2019, compared to $61.5 million for the same period in 2018. The average yield earned on taxable securities increased 8 basis points to 3.21 percent for the nine months ended September 30, 2019, compared to 3.13 percent during the same period in the prior year. The average balance of tax-exempt securities amounted to $4.5 million for the nine months ended September 30, 2019, compared to $5.2 million for the same period in 2018. The average yield earned on tax-exempt securities increased 21 basis points, to 3.01 percent for the nine months ended September 30, 2019, from 2.80 percent for the same period in 2018.

Securities with a carrying value of $5.5 million and $4.3 million at September 30, 2019 and December 31, 2018, respectively, were pledged to secure Government deposits, secure other borrowings and for other purposes required or permitted by law.

Approximately 77 percent of the total investment portfolio had a fixed rate of interest at September 30, 2019.

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

Total loans increased $63.9 million or 4.9 percent to $1.4 billion at September 30, 2019, compared to year end 2018. Commercial, residential mortgage, and consumer loans increased $29.1 million, $20.9 million, and $14.9 million respectively, partially offset by a decrease of $1.1 million in SBA 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, 2019 and December 31, 2018:



	September 30, 2019				December 31, 2018
(In thousands, except percentages)	Amount		% of total		Amount		% of total
SBA loans held for investment	$	36,380	2.7	%	$	39,333	3.0	%
Commercial loans	723,249		52.8		694,102		53.2
Residential mortgage loans	456,963		33.4		436,056		33.4
Consumer loans	138,829		10.1		123,904		9.5
Total loans held for investment	1,355,421		99.0		1,293,395		99.1
SBA loans held for sale	13,053		1.0		11,171		0.9
Total loans	$	1,368,474	100.0	%	$	1,304,566	100.0	%

Average loans increased $108.7 million or 8.9 percent to $1.3 billion for the nine months ended September 30, 2019 from $1.2 billion for the same period in 2018. The increase in average loans was due to increases in residential mortgages, commercial, and consumer loans, partially offset by a decline in SBA loans. The yield on the overall loan portfolio increased 30 basis points to 5.41 percent for the nine months ended September 30, 2019 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 $13.1 million at September 30, 2019, an increase of $1.9 million from $11.2 million at December 31, 2018. SBA 7(a) loans held to maturity amounted to $36.4 million at September 30, 2019, a decrease of $3.0 million from $39.3 million at December 31, 2018. The yield on SBA loans, which are generally floating and adjust quarterly to the Prime rate, was 7.98 percent for the nine months ended September 30, 2019, compared to 7.20 percent in the prior year.

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 $92.7 million and $101.1 million in SBA loans were sold but serviced by the Company at September 30, 2019 and December 31, 2018, 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.

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 $723.2 million at September 30, 2019, an increase of $29.1 million from year end 2018. The yield on commercial loans was 5.28 percent for the nine months ended September 30, 2019, compared to 5.02 percent for the same period in 2018. The SBA 504 program, which consists of real estate backed commercial mortgages where the Company has the first mortgage and the SBA has the second mortgage on the property, is included in the Commercial loan portfolio. Generally, the Company has a 50 percent LTV ratio on SBA 504 program loans at origination.

Residential mortgage loans consist of loans secured by 1 to 4 family residential properties. These loans amounted to $457.0 million at September 30, 2019, an increase of $20.9 million from year end 2018. Sales of mortgage loans totaled $78.2 million for the nine months ended September 30, 2019. Approximately $10.6 million of the loans sold were from portfolio, with the

remainder consisting of new production. The yield on residential mortgages was 5.02 percent for the nine months ended September 30, 2019, compared to 4.71 percent for the same period in 2018. Residential mortgage loans retained 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 but which 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 $138.8 million, an increase of $14.9 million from year end 2018 primarily related to consumer construction loans. The yield on consumer loans was 6.48 percent for the nine months ended September 30, 2019, compared to 5.83 percent for the same period in 2018.

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.

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, 2019, and December 31, 2018, approximately 94 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, 2019, the Company had one loan totaling $718 thousand that was classified as a TDR and deemed impaired, compared to one such loan totaling $745 thousand at December 31, 2018. The TDR was a commercial real estate loan which was modified in 2017 to reduce the principal balance. The loan remains in accrual status since it continues to perform in accordance with the restructured terms. Restructured loans that are placed in nonaccrual status may be removed after six months of contractual payments and the borrower showing the ability to service the debt going forward.

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, except percentages)	September 30, 2019			December 31, 2018			September 30, 2018
Nonperforming by category:
SBA loans held for investment (1)	$	503		$	1,560		$	1,297
Commercial loans	629			1,076			1,234
Residential mortgage loans	4,427			4,211			3,536
Consumer loans	23			26			128
Total nonperforming loans	$	5,582		$	6,873		$	6,195
OREO	1,723			56			56
Total nonperforming assets	$	7,305		$	6,929		$	6,251
Past due 90 days or more and still accruing interest:
Residential mortgage loans	$	—		$	98		$	546
Consumer loans	140			—			—
Total past due 90 days or more and still accruing interest	$	140		$	98		$	546
Nonperforming loans to total loans	0.41		%	0.53		%	0.48		%
Nonperforming loans and TDRs to total loans (2)	0.46			0.58			0.54
Nonperforming assets to total loans and OREO	0.53			0.53			0.49
Nonperforming assets to total assets	0.44			0.44			0.40
(1) Guaranteed SBA loans included above	$	63		$	89		$	104
(2) Performing TDRs	$	718		$	745		$	755

Nonperforming loans were $5.6 million at September 30, 2019, a $1.3 million decrease from $6.9 million at year end 2018 and a $613 thousand decrease from $6.2 million at September 30, 2018. Since year end 2018, nonperforming loans in the SBA, commercial, and consumer loan segments decreased, partially offset by an increase in the residential loan segment. Included in nonperforming loans at September 30, 2019 are approximately $63 thousand of loans guaranteed by the SBA, compared to $89 thousand at December 31, 2018, and $104 thousand at September 30, 2018. In addition, there was $140 thousand of loans past due 90 days or more and still accruing interest at September 30, 2019, compared to $98 thousand and $546 thousand at December 31, 2018, and September 30, 2018, respectively.

OREO properties totaled $1.7 million at September 30, 2019, an increase of $1.7 million from $56 thousand at December 31, 2018, and September 30, 2018, respectively. During the nine months ended September 30, 2019, the Company took title to four new properties valued at $1.7 million that resulted in a charge to the allowance of $175 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 $1.5 million at September 30, 2019, a decrease of $3.0 million from $4.5 million at December 31, 2018. The decrease is due to the deletion of seven loans totaling $4.5 million, offset by the addition of six loans totaling $1.5 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 $16.0 million at September 30, 2019 compared to $15.5 million and $15.0 million at December 31, 2018 and September 30, 2018, respectively, with resulting allowance to total loan ratios of 1.17 percent at September 30, 2019 and September 30, 2018, and 1.19 percent at December 31, 2018. Net charge-offs amounted to $1.1 million for the nine months ended September 30, 2019, compared to net charge-offs of $118 thousand for the same period in 2018. Net 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)	2019			2018			2019			2018
Balance, beginning of period	$	15,965		$	14,634		$	15,488		$	13,556
Provision for loan losses charged to expense	750			500			1,600			1,550
Less: Chargeoffs
SBA loans held for investment	99			169			492			354
Commercial loans	500			—			501			—
Residential mortgage loans	130			—			130			—
Consumer loans	—			—			1			22
Total chargeoffs	729			169			1,124			376
Add: Recoveries
SBA loans held for investment	13			1			16			68
Commercial loans	3			5			12			25
Residential mortgage loans	—			—			—			13
Consumer loans	—			17			10			152
Total recoveries	16			23			38			258
Net chargeoffs	713			146			1,086			118
Balance, end of period	$	16,002		$	14,988		$	16,002		$	14,988
Selected loan quality ratios:
Net chargeoffs (recoveries) to average loans:
SBA loans held for investment	0.72		%	1.17		%	1.32		%	0.61		%
Commercial loans	0.28			—			0.09			(0.01		)
Residential mortgage loans	0.11			—			0.04			—
Consumer loans	—			(0.06		)	(0.01		)	(0.15		)
Total loans	0.21			0.05			0.11			0.01
Allowance to total loans	1.17			1.17			1.17			1.17
Allowance to nonperforming loans	286.67		%	241.94		%	286.67		%	241.94		%

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, 2019, a $278 thousand commitment reserve was reported on the balance sheet as an “other liability”, compared to a $290 thousand commitment reserve at December 31, 2018.

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 $65.7 million to $1.3 billion at September 30, 2019, from $1.2 billion at December 31, 2018. This increase in deposits was due to increases of $63.1 million in time deposits and $9.1 million in noninterest-bearing demand deposits, partially offset by a decrease of $6.1 million in total interest-bearing demand deposits and $394 thousand in savings deposits. The increase in time deposits is attributable to a new time deposit promotion.

The Company’s deposit composition at September 30, 2019, consisted of 33.0 percent time deposits, 31.0 percent savings deposits, 21.9 percent noninterest-bearing demand deposits and 14.1 percent interest-bearing demand deposits.

Borrowed Funds and Subordinated Debentures

Borrowed funds consist or previously consisted primarily of adjustable and fixed rate advances from the Federal Home Loan Bank of New York. These borrowings are used as a source of liquidity or to fund asset growth not supported by deposit generation. Residential mortgages and commercial loans collateralize the borrowings from the FHLB.

Borrowed funds and subordinated debentures totaled $220.3 million at September 30, 2019 and December 31, 2018, respectively, and are broken down in the following table:



(In thousands)	September 30, 2019		December 31, 2018
FHLB borrowings:
Fixed rate advances	$	40,000	$	—
Adjustable rate advances	$	50,000	$	50,000
Overnight advances	120,000		160,000
Subordinated debentures	10,310		10,310
Total borrowed funds and subordinated debentures	$	220,310	$	220,310

The following transactions impacted borrowed funds and subordinated debentures:

FHLB Borrowings

At September 30, 2019, the Company had $40 million in fixed rate advances, compared to none at December 31, 2018. The terms of this transaction are as follows:


•	A $40.0 million FHLB borrowing with a maturity date of August 22, 2024, at a rate of 1.810%.

At September 30, 2019 and December 31, 2018, the $50.0 million FHLB adjustable rate ("ARC") advances consisted of two $20.0 million and one $10.0 million advances. These ARC advances roll over every six months. The Company has opted to use swap instruments to hedge rates in a fluctuating rate environment. Each ARC advance has a swap instrument which modifies the borrowing to a 5 year fixed rate borrowing. The terms of these transactions are as follows:


•	A $20.0 million ARC FHLB borrowing with a maturity date of December 9, 2019, at a rate of LIBOR plus 0.115%. The swap instrument modifies the borrowing to a 5 year fixed rate borrowing at 1.845% that matures December 7, 2020.


•	A $20.0 million ARC FHLB borrowing with a maturity date of January 6, 2020, at a rate of LIBOR plus 0.150%. The swap instrument modifies the borrowing to a 5 year fixed rate borrowing at 1.198% and matures on July 5, 2021.


•	A $10.0 million ARC FHLB borrowing with a maturity date of February 18, 2020, at a rate of LIBOR plus 0.140%. The swap instrument modifies the borrowing to a 5 year fixed rate borrowing at 1.243% that matures on February 16, 2021.

At September 30, 2019, there were FHLB overnight borrowings of $120.0 million at a rate of 2.100%, compared to $160.0 million at a rate of 2.600% at December 31, 2018.

In September 2019, the FHLB issued a $11.0 million municipal deposit letter of credit in the name of Unity Bank naming the NJ Department of Banking and Insurance as beneficiary, to secure municipal deposits as required under New Jersey law.

At September 30, 2019, the Company had $266.3 million of additional credit available at the FHLB. Pledging additional collateral in the form of 1 to 4 family residential mortgages, commercial loans and investment securities can increase the line with the FHLB.

Subordinated Debentures

On July 24, 2006, Unity (NJ) Statutory trust II, a statutory business trust and wholly-owned subsidiary of Unity Bancorp, Inc., issued $10.0 million of floating rate capital trust pass through securities to investors due on July 24, 2036. The subordinated debentures are redeemable in whole or part, prior to maturity but after July 24, 2011. The floating interest rate on the subordinated debentures is the three-month LIBOR plus 159 basis points and reprices quarterly. The floating interest rate was 3.749% at September 30, 2019 and 4.414% at December 31, 2018. At December 31, 2018, the subordinated debentures had a

swap instrument which modified the borrowing to a 3 year fixed rate at 0.885%. The swap instrument matured on February 16, 2019. A new swap instrument was implemented on July 5, 2019 which modified the borrowing to a 3 year fixed rate at 1.845%.

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, 2019, is a decline of 0.02 percent in a rising-rate environment and a decline of 0.42 percent in a falling-rate environment. The variances in the EVPE at September 30, 2019 are within the Board-approved guidelines of +/- 3.00 percent. In a falling rate environment with rate shocks of 200 basis points, benchmark interest rates are assumed to have floors of 0.00%. At December 31, 2018, the economic value of equity as a percentage of assets with rate shocks of 200 basis points was a decline of 0.68 percent in a rising-rate environment and an increase of 0.33 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, borrowings, 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, 2019, the balance of cash and cash equivalents was $166.8 million, an increase of $21.2 million from December 31, 2018. A discussion of the cash provided by and used in operating, investing and financing activities follows.

Operating activities provided $25.0 million and $28.9 million in net cash for the nine months ended September 30, 2019 and 2018, respectively. The primary sources of funds were net income from operations and adjustments to net income, such as the 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 $67.5 million and $114.3 million in net cash for the nine months ended September 30, 2019 and 2018, respectively. Cash was primarily used to fund new loans and purchase FHLB stock, partially offset by proceeds from redemption of FHLB stock.


•	Securities. The Consolidated Bank’s available for sale investment portfolio amounted to $47.3 million and $46.7 million at September 30, 2019 and December 31, 2018, 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 $14.2 million.


•	Loans. The SBA loans held for sale portfolio amounted to $13.1 million and $11.2 million at September 30, 2019 and December 31, 2018, respectively. Sales of these loans provide an additional source of liquidity for the Company.

•

Outstanding Commitments. The Company was committed to advance approximately $278.2 million to its borrowers as of September 30, 2019, compared to $289.9 million at December 31, 2018. At September 30, 2019, $135.8 million of these commitments expire within one year, compared to $161.1 million at December 31, 2018. The Company had $4.8 million and $5.7 million in standby letters of credit outstanding at September 30, 2019 and December 31, 2018, respectively, 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 $63.7 million in net cash for the nine months ended September 30, 2019, compared to $79.8 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, 2019, deposits included $114.2 million of Government deposits, as compared to $121.9 million at year end 2018. 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 $89.4 million of deposits from nine municipalities with account balances in excess of $5.0 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 $210.0 million as of September 30, 2019 and December 31, 2018. 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, 2019, pledging provided an additional $266.3 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, commercial loans or investment securities to increase this line with the FHLB.

Parent Company Liquidity

The Parent Company’s cash needs are funded by dividends and rental payments on corporate headquarters paid by the Bank. Other than its investment in the Bank, Unity Risk Management, Inc. and Unity Statutory Trust II, 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, cash dividends on common stock and payments on trust preferred debt.

At September 30, 2019, the Parent Company had $2.2 million in cash and cash equivalents and $1.4 million in investment securities valued at fair market value, compared to $1.2 million in cash and cash equivalents and $1.2 million in investment securities at December 31, 2018.

Regulatory Capital

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, certain qualifying long-term debt, preferred stock and hybrid instruments which do not qualify as tier 1 capital. Minimum capital levels are regulated by risk-based capital adequacy guidelines, which require the Bank to maintain certain capital as a percent of assets and certain off-balance sheet items adjusted for predefined credit risk factors (risk-weighted assets). A bank is required to maintain, at a minimum, tier 1 capital as a percentage of risk-weighted assets of 4 percent and combined tier 1 and tier 2 capital as a percentage of risk-weighted assets of 8 percent. In addition, banks are required to meet a leverage capital requirement, which measures tier 1 capital against average assets. Banks which are highly rated and not experiencing significant growth are required to maintain a leverage ratio of 3 percent while all other banks are expected to maintain a leverage ratio 1 to 2 percentage points higher. Finally, the Bank is required to maintain a ratio of common equity tier 1 capital, consisting solely of common equity, to risk-weighted assets of at least 4.5%. Under the FRB's small bank holding company policy, bank holding companies with less than $3.0 billion in consolidated assets, like the Parent Company, are not subject to consolidated capital requirements.

The following table summarizes the Company's and the Bank's regulatory capital ratios at September 30, 2019 and December 31, 2018, as well as the minimum regulatory capital ratios required for the Bank to be deemed "well-capitalized."



	At September 30, 2019				Required for capital adequacy purposes effective				To be well-capitalized under prompt corrective action regulations
	Company		Bank		January 1, 2019				Bank
Leverage ratio	10.54	%	10.11	%	4.00	%			5.00	%
CET1	12.24	%	12.53	%	7.00	%	(1	)	6.50	%
Tier I risk-based capital ratio	13.04	%	12.53	%	8.50	%	(1	)	8.00	%
Total risk-based capital ratio	14.28	%	13.78	%	10.50	%	(1	)	10.00	%



	At December 31, 2018				Required for capital adequacy purposes effective								To be well-capitalized under prompt corrective action regulations
	Company		Bank		January 1, 2018				January 1, 2019				Bank
Leverage ratio	9.90	%	9.52	%	4.000	%			4.00	%			5.00	%
CET1	11.40	%	11.80	%	6.375	%	(2	)	7.00	%	(1	)	6.50	%
Tier I risk-based capital ratio	12.24	%	11.80	%	7.875	%	(2	)	8.50	%	(1	)	8.00	%
Total risk-based capital ratio	13.49	%	13.05	%	9.875	%	(2	)	10.50	%	(1	)	10.00	%

(1) Includes 2.5% capital conservation buffer.
(2) Includes 1.875% capital conservation buffer.

For additional information on regulatory capital, see Note 13 to the Consolidated Financial Statements.

Shareholders’ Equity

Shareholders’ equity increased $16.4 million to $154.9 million at September 30, 2019 compared to $138.5 million at December 31, 2018, primarily due to net income of $17.5 million. Other items impacting shareholders’ equity included $2.4 million in dividends paid on common stock, $1.2 million from the issuance of common stock under employee benefit plans and $89 thousand in accumulated other comprehensive income net of tax. 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 July 16, 2019, the Company authorized the repurchase of up to 525 thousand shares, or approximately 5 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. The new plan replaces the Company's prior share repurchase program, which has since been terminated. There were no shares repurchased during the nine months ended September 30, 2019 or 2018.

Impact of Inflation and Changing Prices

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

ITEM 3 Quantitative and Qualitative Disclosures about Market Risk

During the nine months ended September 30, 2019, 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, 2018. (See Interest Rate Sensitivity in Management's Discussion and Analysis herein.)

ITEM 4 Controls and Procedures

The Company's management, with the participation of the Company's Chief Executive Officer and Chief Financial Officer, has evaluated the effectiveness of the Company's disclosure controls and procedures as of September 30, 2019. 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.


b)	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 II OTHER INFORMATION

ITEM 1 Legal 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 1A Risk Factors

Information regarding this item as of September 30, 2019 appears under the heading, “Risk Factors” within the Company’s Form 10-K for the year ended December 31, 2018, as supplemented by the Company's subsequent quarterly reports on Form 10-Q and as set forth below:

Reforms to and uncertainty regarding LIBOR may adversely affect the business.

In 2017, a committee of private-market derivative participants and their regulators convened by the Federal Reserve, the Alternative Reference Rates Committee, or “ARRC”, was created to identify an alternative reference interest rate to replace LIBOR. The ARRC announced Secured Overnight Financing Rate, or “SOFR”, a broad measure of the cost of borrowing cash overnight collateralized by Treasury securities, as its preferred alternative to LIBOR. The Chief Executive of the United Kingdom Financial Conduct Authority, which regulates LIBOR, announced its intention to stop persuading or compelling banks to submit rates for the calculation of LIBOR to the administrator of LIBOR after 2021. Subsequently, the Federal Reserve Bank announced final plans for the production of SOFR, which resulted in the commencement of its published rates by the Federal Reserve Bank of New York on April 2, 2018. Whether or not SOFR attains market traction as a LIBOR replacement tool remains in question and the future of LIBOR at this time is uncertain. The uncertainty as to the nature and effect of such reforms and actions and the political discontinuance of LIBOR may adversely affect the value of and return on the Company’s financial assets and liabilities that are based on or are linked to LIBOR, the Company’s results of operations or financial condition. In addition, these reforms may also require extensive changes to the contracts that govern these LIBOR based products, as well as the Company’s systems and processes.

ITEM 2 Unregistered Sales of Equity Securities and Use of Proceeds

ITEM 3 Defaults upon Senior Securities - None

ITEM 4 Mine Safety Disclosures - N/A

ITEM 5 Other Information - None

ITEM 6 Exhibits



(a) Exhibits		Description
	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

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 5, 2019	/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