News Column

UNITY BANCORP INC /NJ/ - 10-Q - Management's Discussion and Analysis of Financial Condition and Results of Operations

May 9, 2014

The following discussion and analysis of financial condition and results of operations should be read in conjunction with the 2013 consolidated audited financial statements and notes thereto included in our Annual Report on Form 10-K for the year ended December 31, 2013. When necessary, reclassifications have been made to prior period data throughout the following discussion and analysis for purposes of comparability. This Quarterly Report on Form 10-Q contains certain "forward looking statements" within the meaning of the Private Securities Litigation Reform Act of 1995, which may be identified by the use of such words as "believe", "expect", "anticipate", "should", "planned", "estimated" and "potential". Examples of forward looking statements include, but are not limited to, estimates with respect to the financial condition, results of operations and business of Unity Bancorp, Inc. that are subject to various factors which could cause actual results to differ materially from these estimates. These factors include, in addition to those items contained in the Company's Annual Report on Form 10-K under Item IA-Risk Factors, as updated by our subsequent Quarterly Reports on Form 10-Q, the following: changes in general, economic, and market conditions, legislative and regulatory conditions, or the development of an interest rate environment that adversely affects Unity Bancorp, Inc.'s interest rate spread or other income anticipated from operations and investments. Overview Unity Bancorp, Inc. (the "Parent Company") is incorporated in New Jersey and is registered as a bank holding company under the Bank Holding Company Act of 1956, as amended. Its wholly-owned subsidiary, Unity Bank (the "Bank" or, when consolidated with the Parent Company, the "Company") was granted a charter by the New Jersey Department of Banking and Insurance and commenced operations on September 13, 1991. The Bank provides a full range of commercial and retail banking services through 15 branch offices located in Hunterdon, Somerset, Middlesex, Union and Warren counties in New Jersey, and Northampton County in Pennsylvania. These services include the acceptance of demand, savings, and time deposits and the extension of consumer, real estate, Small Business Administration and other commercial credits. The Bank has multiple subsidiaries used to hold part of its investment and loan portfolios and other real estate owned ("OREO") properties. Unity (NJ) Statutory Trust II is a statutory business trust and wholly owned subsidiary of Unity Bancorp, Inc. On July 24, 2006, the Trust issued $10.0 million of trust preferred securities to investors. Unity (NJ) Statutory Trust III is a statutory business trust and wholly owned subsidiary of Unity Bancorp, Inc. On December 19, 2006, the Trust issued $5.0 million of trust preferred securities to investors. These floating rate securities are treated as subordinated debentures on the Company's financial statements. However, they qualify as Tier I Capital for regulatory capital compliance purposes, subject to certain limitations. The Company does not consolidate the accounts and related activity of any of its business trust subsidiaries. Earnings Summary Net income available to common shareholders totaled $1.3 million, or $0.17 per diluted share for the quarter ended March 31, 2014, a 62.4 percent increase compared to $796 thousand, or $0.10 per diluted share for the same period a year ago. Return on average assets and average common equity for the quarter were 0.59% and 9.06%, respectively, compared to 0.59% and 5.65% for the same period a year ago. The continued improvement in our operating results is the product of our strategic initiatives, which include expansion of our in-market loan and deposit relationships, improving credit quality and core earnings growth.



First quarter highlights include:

× Loan growth of 0.8% since December 31, 2013 - 1.5% growth in commercial and

6.3% growth in SBA 504 loans.

× Deposit growth of 3.9% since December 31, 2013 - 26.4% growth in noninterest

bearing deposits.

× Core earnings growth - Net interest income increased 8.9% compared to the prior

year's quarter due to strong commercial and residential loan portfolio growth.

× A wider net interest margin of 3.57% compared to 3.52% in the prior year's

quarter.

× Improved credit quality metrics due to decreased nonperforming loans and lower

net charge-offs this quarter compared to the prior year's quarter.

× Increased the dividend to common shareholders.

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

For the three months ended March 31, 2014 2013 Net income per common share - Basic (1) $ 0.17 $



0.11

Net income per common share - Diluted (1) $ 0.17 $



0.10

Return on average assets 0.59 % 0.59 % Return on average equity (2) 9.06 % 5.65 % Efficiency ratio 71.91 % 73.91 % (1) Defined as net income adjusted for dividends accrued and accretion of



discount on perpetual preferred stock divided by weighted average shares

outstanding. (2) Defined as net income adjusted for dividends accrued and accretion of



discount on perpetual preferred stock divided by average shareholders' equity

(excluding preferred stock). 32

--------------------------------------------------------------------------------

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, Federal Home Loan Bank 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 March 31, 2014, tax-equivalent net interest income amounted to $7.3 million, an increase of $590 thousand or 8.7 percent when compared to the same period in 2013. This increase was the result of the growth in commercial and residential mortgage loans over the past year. As a result, the net interest margin increased 5 basis points to 3.57 percent for the quarter ended March 31, 2014, compared to 3.52 percent for the same period in 2013.



The

net interest spread was 3.38 percent for the first quarter of 2014, a 9 basis point increase compared to the same period in 2013.

During the three months ended March 31, 2014, tax-equivalent interest income was $9.1 million, an increase of $702 thousand or 8.4 percent when compared to the same period in the prior year. This increase was driven by the increase in average loans, partially offset by a lower average yield on the loan portfolio:



× Of the $702 thousand net increase in interest income on a tax-equivalent basis,

$943 thousand of the increase was due to the increased average volume of loans,

less $241 thousand in reduced interest income due to reduced yields on the loan

portfolio.

× The average volume of interest-earning assets increased $55.2 million to $833.5

million for the first quarter of 2014 compared to $778.4 million for the same

period in 2013. This was due primarily to an $84.5 million increase in average

loans, primarily commercial and residential mortgage loans, partially off by a

$20.5 million decrease in federal funds sold and interest-bearing deposits and

an $8.9 million decrease in average investment securities.

× The yield on interest-earning assets increased 6 basis points to 4.39 percent

for the three months ended March 31, 2014 when compared to the same period in

2013. This was due to increased yields on our investment portfolio as a result

of an early payoff on a FNMA DUS Bond and from FHLB stock. The yield on our

loan portfolio declined 24 basis points to 4.39 percent. Total interest expense was $1.7 million for the three months ended March 31, 2014, an increase of $112 thousand or 6.9 percent compared to the same period in 2013. This increase was driven by the increase in average time deposits, partially offset by lower rates on these deposits compared to a year ago:



× Of the $112 thousand increase in interest expense, $291 thousand of the

increase was due to an increase in the volume of average interest-bearing

liabilities, primarily time deposits, partially offset by a $179 thousand

decrease due to the decrease in the rates paid on interest-bearing liabilities.

× Interest-bearing liabilities averaged $693.9 million for the first quarter of

2014, an increase of $66.6 million or 10.6 percent, compared to the prior

year's quarter. The increase in interest-bearing liabilities was a result of an

increase in average time deposits and interest-bearing demand deposits,

partially offset by a decrease in average savings deposits.

× The average cost of interest-bearing liabilities decreased 3 basis points to

1.01 percent. The cost of interest-bearing deposits increased 1 basis point to

0.63 percent for the first quarter of 2014 and the cost of borrowed funds and

subordinated debentures decreased 4 basis points to 3.50 percent. Our net interest income continues to be impacted by the sustained low interest rate environment. The Federal Open Market Committee ("FOMC") of the Federal Reserve Board forecasts the overnight federal funds rate will continue to remain at 25 basis points through late 2015. This rate environment has resulted in a tighter net interest margin as our earning assets continue to re-price at lower rates. Partially offsetting these declines are lower funding costs; however, the reduction in yield on earning assets is anticipated to exceed the benefits of further declines in the cost of funds from already low levels. The following table reflects the components of net interest income, setting forth for the periods presented herein: (1) average assets, liabilities and shareholders' equity, (2) interest income earned on interest-earning assets and interest expense paid on interest-bearing liabilities, (3) average yields earned on interest-earning assets and average rates paid on interest-bearing liabilities, (4) net interest spread, and (5) net interest income/margin on average earning assets. Rates/Yields are computed on a fully tax-equivalent basis, assuming a federal income tax rate of 34 percent. 33

--------------------------------------------------------------------------------



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 March 31, 2014 March 31, 2013 Average Average Balance Interest Rate/Yield Balance Interest Rate/Yield ASSETS Interest-earning assets: Federal funds sold and interest-bearing deposits $ 42,029$ 9 0.09 % $ 62,530$ 14 0.09 % Federal Home Loan Bank stock 3,988 47 4.78 3,989 44 4.47 Securities: Taxable 92,808 726 3.13 100,062 647 2.59 Tax-exempt 16,841 155 3.68 18,475 178 3.85 Total securities (A) 109,649 881 3.21 118,537 825 2.79 Loans: SBA loans 54,790 583 4.26 65,386 777 4.75 SBA 504 loans 31,719 399 5.10 41,135 651 6.42 Commercial loans 364,343 4,601 5.12 304,790 4,001 5.32 Residential mortgage loans 181,058 2,058 4.55 135,886 1,550 4.56 Consumer loans 45,939 495 4.37 46,111 509 4.48 Total loans (B) 677,849 8,136 4.85 593,308 7,488 5.09 Total interest-earning assets $ 833,515$ 9,073 4.39 % $ 778,364$ 8,371 4.33 % Noninterest-earning assets: Cash and due from banks 23,389 19,737 Allowance for loan losses (13,410) (14,998) Other assets 43,599 37,905 Total noninterest-earning assets 53,578 42,644 Total assets $ 887,093$ 821,008 LIABILITIES AND SHAREHOLDERS' EQUITY Interest-bearing liabilities: Interest-bearing demand deposits $ 131,187$ 111 0.34 % $ 118,668$ 101 0.35 % Savings deposits 266,321 182 0.28 295,520 177 0.24 Time deposits 205,130 644 1.27 122,695 546 1.80 Total interest-bearing deposits 602,638 937 0.63 536,883 824 0.62 Borrowed funds and subordinated debentures 91,265 799 3.50 90,465 800 3.54 Total interest-bearing liabilities $ 693,903$ 1,736 1.01 % $ 627,348$ 1,624 1.04 % Noninterest-bearing liabilities: Noninterest-bearing demand deposits 132,167 113,000 Other liabilities 3,169 3,242 Total noninterest-bearing liabilities 135,336 116,242 Total shareholders' equity 57,854 77,418 Total liabilities and shareholders' equity $ 887,093$ 821,008 Net interest spread $ 7,337 3.38 % $ 6,747 3.29 % Tax-equivalent basis adjustment (50) (58) Net interest income $ 7,287$ 6,689 Net interest margin 3.57 %

3.52 %



(A) Yields related to securities exempt from federal and state income taxes are

stated on a fully tax-equivalent basis. They are reduced by the nondeductible

portion of interest expense, assuming a federal tax rate of 34 percent and

applicable state rates.

(B) The loan averages are stated net of unearned income, and the averages include

loans on which the accrual of interest has been discontinued. 34

-------------------------------------------------------------------------------- The rate volume table below presents an analysis of the impact on interest income and expense resulting from changes in average volume and rates over the periods presented. Changes that are not due to volume or rate variances have been allocated proportionally to both, based on their relative absolute values. Amounts have been computed on a tax-equivalent basis, assuming a federal income tax rate of 34 percent. For the three months ended March 31, 2014 versus March 31, 2013 Increase (decrease) due to change in: (In thousands on a tax-equivalent basis) Volume Rate Net Interest income: Federal funds sold and interest-bearing deposits $ (5) $ - $ (5) Federal Home Loan Bank stock - 3 3 Securities (64) 120 56 Loans 1,012 (364) 648 Total interest income $ 943$ (241) $ 702 Interest expense: Demand deposits $ 13$ (3) $ 10 Savings deposits (20) 25 5 Time deposits 291 (193) 98 Total interest-bearing deposits 284 (171) 113 Borrowed funds and subordinated debentures 7 (8) (1) Total interest expense 291 (179) 112 Net interest income - fully tax-equivalent $ 652$ (62) $ 590 Decrease in tax-equivalent adjustment 8 Net interest income $ 598 Provision for Loan Losses



The provision for loan losses totaled $600 thousand for the three months ended March 31, 2014, compared to $650 thousand for the three months ended March

31,

2013. 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. The reduced provision reflects a lower level of net charge-offs for the quarter and year-to-date periods, as well as a lower level of nonperforming assets. 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 months ended March 31, 2014 and 2013:

For the three months ended March 31, (In thousands) 2014 2013 Branch fee income $ 377 $ 347 Service and loan fee income 295 304 Gain on sale of SBA loans held for sale, net 83 241 Gain on sale of mortgage loans, net 365 477 BOLI income 96 70 Net security gains 110 226 Other income 200 160 Total noninterest income $ 1,526 $ 1,825 Our noninterest income consists primarily of branch and loan fee income, gains on the sale of SBA and residential mortgage loans, gains on the sale of securities, and BOLI income. For the three months ended March 31, 2014, noninterest income amounted to $1.5 million, a decrease of $299 thousand from the prior year period. The decrease was driven by a reduced volume of sales of residential mortgage loans and SBA loans and lower levels of security gains realized. 35

--------------------------------------------------------------------------------



Changes in our noninterest income for the three months ended March 31, 2014 versus 2013 reflect:

· Branch fee income, which consists of deposit service charges and overdraft

fees, increased $30 thousand, when compared to the same period in 2013 due to

increased overdraft fees.

· Service and loan fee income decreased $9 thousand when compared to the same

periods in the prior year, due to lower SBA servicing income and prepayment

penalties, partially offset by increased payoff charges and processing fee

income.

· SBA loan sales amounted to $928 thousand with net gains on sale of $83 thousand

for the quarter, compared to $2.3 million sold and a gain of $241 thousand in

the prior year's quarter.

· Gains on sales of residential mortgage loans decreased $112 thousand when

compared to the same period in the prior year. During the quarter, $17.4

million in residential mortgage loans were sold at a gain of $365 thousand,

compared to $22.6 million sold at a gain of $477 thousand during the prior

year's quarter. Approximately, $7.5 million of the sold loans were from our

portfolio, with the remainder consisting of new production. Net gains on

mortgage servicing assets were approximately $145 thousand during the quarter.

· BOLI income increased $26 thousand to $96 thousand for the three months ended

March 31, 2014, compared to $70 thousand in the prior year's quarter.

· Net realized gains on the sale of securities amounted to $110 thousand,

compared to net gains of $226 thousand for the same period in the prior

year. For additional information, see Note 7 - Securities.

· Other income, which includes check card related income and miscellaneous

service charges, increased $40 thousand, when compared to the same periods in

the prior year, primarily due to an increase in VISA check card interchange and

other OREO noninterest income. Noninterest Expense



The following table presents a breakdown of noninterest expense for the three months ended March 31, 2014 and 2013:

For the three months ended March 31, (In thousands) 2014 2013 Compensation and benefits $ 3,217 $ 3,176 Occupancy 659 694 Processing and communications 582 561 Furniture and equipment 357 365 Professional services 211 190 Loan costs 170 177 OREO expenses 247 127 Deposit insurance 178 149 Advertising 151 120 Other expenses 486 567 Total noninterest expense $ 6,258 $ 6,126



Noninterest expense totaled $6.3 million and $6.1 million for the three months ended March 31, 2014 and 2013, respectively.

Changes in noninterest expense for the three months ended March 31, 2014 versus 2013 reflect:

· Compensation and benefits expense, the largest component of noninterest

expense, increased $41 thousand, due to merit increases, bonus accrual and

benefits expenses, partially offset by decreased mortgage commissions.

· Occupancy expense decreased $35 thousand due to the reduction in lease and

leasehold depreciation expense related to the three branch sites that were

purchased a year ago. These savings were partially offset by the increase in

snow removal expenses.

· Processing and communications expenses increased $21 thousand, primarily due to

increased data processing expense and internet expense.

· Furniture and equipment expense decreased $8 thousand, primarily due to

decreased depreciation expense on furniture and equipment and software,

partially offset by increased equipment maintenance expense.

· Professional service fees increased $21 thousand for the three months ended

March 31, 2014, primarily due to increased audit related expenses.

· Loan costs decreased $7 thousand, due to lower property tax expense and

appraisal costs, offset by higher forced place insurance and loan legal

expenses.

· OREO expenses increased $120 thousand when compared to the same period in the

prior year. OREO expenses remain elevated as we work through the collection

process and incur expenses such as maintenance expenses, delinquent taxes, and

losses on sale of OREO.

· Deposit insurance expense increased $29 thousand when compared to the same

period in the prior year due to the Company's growth in assets.

· Advertising expense increased $31 thousand for the quarter due to increased

marketing expense and community relations expenses.

· Other expenses decreased $81 thousand for the quarter due to lower employee

recruiter fees, director fees, printing and office supplies and provision for loan commitments. 36

--------------------------------------------------------------------------------

Income Tax Expense For the quarter ended March 31, 2014, the Company reported income tax expense of $662 thousand for an effective tax rate of 33.9 percent, compared to an income tax expense of $538 thousand and effective tax rate of 31.0 percent for the prior year's quarter. The increase was due to state tax payments, which are generally paid in the first quarter.



Financial Condition at March 31, 2014

Total assets increased $40.1 million or 4.3 percent, to $961.2 million at March 31, 2014, compared to $921.1 million at December 31, 2013. This increase was primarily due to increases of $28.8 million in cash and cash equivalents, $5.3 million in loans, and $1.9 million in securities. Total deposits increased $28.9 million, due to the increase of $36.0 million in noninterest-bearing demand deposits, $3.5 million in interest-bearing demand deposits, and $2.8 million in time deposits, partially offset by a decrease of $13.4 million in savings deposits. The increase in noninterest-bearing demand deposits was due to a $30.0 million short-term deposit from one customer on March 31, 2014, of which $25.0 million was wired out on April 4, 2014. Borrowed funds increased $8.0 million over year-end 2013. There were no changes to subordinated debentures. Total shareholders' equity increased $1.6 million over year-end 2013, primarily due to retained earnings. These fluctuations are discussed in further detail in the paragraphs that follow. Securities Portfolio The Company's securities portfolio consists of available for sale ("AFS") and held to maturity ("HTM") investments. Management determines the appropriate security classification of available for sale or held to maturity at the time of purchase. The investment securities portfolio is maintained for asset-liability management purposes, as well as for liquidity and earnings purposes. AFS securities are investments carried at fair value that may be sold in response to changing market and interest rate conditions or for other business purposes. Activity in this portfolio is undertaken primarily to manage liquidity and interest rate risk, to take advantage of market conditions that create economically attractive returns and as an additional source of earnings. AFS securities consist primarily of obligations of U.S. Government sponsored entities, obligations of state and political subdivisions, mortgage-backed securities, and corporate and other securities.



AFS securities totaled $86.2 million at March 31, 2014, an increase of $5.0 million or 6.2 percent, compared to $81.1 million at December 31, 2013. This net increase was the result of:

· $9.9 million in purchases, consisting primarily of mortgage-backed securities,

one corporate bond and one agency security, and

· $510 thousand of appreciation in the market value of the portfolio. At March

31, 2014, the portfolio had net unrealized losses of $269 thousand compared to

net unrealized losses of $778 thousand at December 31, 2013. These net

unrealized gains (losses) are reflected net of tax in shareholders' equity as

accumulated other comprehensive income (loss), partially offset by

· $2.8 million in sales net of realized gains, which consisted of municipal

securities, one asset-backed security, and one mortgage-backed security,

· $2.5 million in principal payments, maturities and called bonds, and

· $114 thousand in net amortization of premiums.

The weighted average life of AFS securities, adjusted for prepayments, amounted to 4.9 years at March 31, 2014 and 5.4 years at December 31, 2013.

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 $23.3 million at March 31, 2014, a decrease of $3.1 million or 11.7 percent, from year-end 2013. This decrease was the result of:

· $3.1 million in principal payments and maturities, and

· $16 thousand in net amortization of premiums.

The weighted average life of HTM securities, adjusted for prepayments, amounted to 6.8 years and 8.5 years at March 31, 2014 and December 31, 2013, respectively. As of March 31, 2014 and December 31, 2013, the fair value of HTM securities was $22.7 million and $25.5 million, respectively. The average balance of taxable securities amounted to $92.8 million for the three months ended March 31, 2014, compared to $100.1 million for the same period in 2013. The average yield earned on taxable securities increased 54 basis points, to 3.13 percent for the three months ended March 31, 2014, from 2.59 percent for the same period in the prior year. The change in yield was related to the early prepayment of $105 thousand on a FNMA DUS bond. The average balance of tax-exempt securities amounted to $16.8 million for the three months ended March 31, 2014, compared to $18.5 million for the same period in 2013. The average yield earned on tax-exempt securities decreased 17 basis points, to 3.68 percent for the three months ended March 31, 2014, from 3.85 percent for the same period in 2013. Securities with a carrying value of $72.2 million and $74.5 million at March 31, 2014 and December 31, 2013, respectively, were pledged to secure Government deposits, secure other borrowings and for other purposes required or permitted by law. 37

--------------------------------------------------------------------------------



Approximately 87 percent of the total investment portfolio had a fixed rate of interest at March 31, 2014.

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

Loan Portfolio The loan portfolio, which represents the Company's largest asset group, is a significant source of both interest and fee income. The portfolio consists of SBA, SBA 504, commercial, residential mortgage and consumer loans. Each of these segments is subject to differing levels of credit and interest rate risk. Total loans increased $5.3 million or 0.8 percent to $684.0 million at March 31, 2014, compared to $678.7 million at year-end 2013. Commercial loans, SBA 504 loans, and consumer loans increased $5.6 million, $2.0 million, and $970 thousand, respectively, partially offset by declines of $1.9 million and $1.3 million in residential mortgages and SBA loans, respectively. 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 March 31, 2014 and December 31, 2013: March 31, 2014 December 31, 2013 (In thousands, except percentages) Amount % of total Amount % of total SBA loans held for investment $ 47,737 7.0 % $ 48,918 7.2 % SBA 504 loans 33,550 4.9 31,564 4.7 Commercial loans 368,909 53.9 363,340 53.5 Residential mortgage loans 180,129 26.3 182,067 26.8 Consumer loans 47,109 6.9 46,139 6.8 Total loans held for investment 677,434 99.0 672,028 99.0 SBA loans held for sale 6,517 1.0 6,673 1.0 Total loans $ 683,951 100.0 % $ 678,701 100.0 % Average loans increased $84.5 million or 14.2 percent from $593.3 million for the three months ended March 31, 2013, to $677.8 million for the same period in 2014. The increase in average loans was due to increases in commercial and residential mortgage loans, partially offset by declines in all other portfolio types. The yield on the overall loan portfolio fell 24 basis points to 4.85 percent for the three months ended March 31, 2014, compared to 5.09 percent for the same period in the prior year. This decrease was the result of new loan volume at lower rates and existing variable rate loan products repricing lower as rates remain low. 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 $6.5 million at March 31, 2014, a decrease of $156 thousand from $6.7 millionDecember 31, 2013. SBA 7(a) loans held to maturity amounted to $47.7 million at March 31, 2014, a decrease of $1.2 million from $48.9 million at December 31, 2013. The yield on SBA loans, which are generally floating and adjust quarterly to the Prime rate, was 4.26 percent for the three months ended March 31, 2014, compared to 4.75 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 $95.1 million and $96.4 million in SBA loans were sold but serviced by the Company at March 31, 2014 and December 31, 2013, respectively, and are not included on the Company's balance sheet. There is no relationship or correlation between the guarantee percentages and the level of charge-offs and recoveries on the Company's SBA 7(a) loans. Charge-offs taken on SBA 7(a) loans effect the unguaranteed portion of the loan. SBA loans are underwritten to the same credit standards irrespective of the guarantee percentage. The SBA 504 program consists of real estate backed commercial mortgages where the Company has the first mortgage and the SBA has the second mortgage on the property. Generally, the Company has a 50 percent LTV ratio on SBA 504 program loans at origination. At March 31, 2014, SBA 504 loans totaled $33.6 million, an increase of $2.0 million from $31.6 million at December 31, 2013. The yield on SBA 504 loans decreased 132 basis points to 5.10 percent for the three months ended March 31, 2014, from 6.42 percent for the same period in 2013. 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 $368.9 million at 38

-------------------------------------------------------------------------------- March 31, 2014, an increase of $5.6 million from year-end 2013. The yield on commercial loans was 5.12 percent for the three months ended March 31, 2014, compared to 5.32 percent for the same period in 2013. Residential mortgage loans consist of loans secured by 1 to 4 family residential properties. These loans amounted to $180.1 million at March 31, 2014, a decrease of $1.9 million from year-end 2013. Sales of mortgage loans totaled $17.4 million for the three months ended March 31, 2014. Approximately, $7.5 million of the sold loans were from our portfolio, with the remainder consisting of new production. The yield on residential mortgages was 4.55 percent for the three months ended March 31, 2014, compared to 4.56 percent for the same period in 2013. Consumer loans consist of home equity loans and loans for the purpose of financing the purchase of consumer goods, home improvements, and other personal needs, and are generally secured by the personal property being purchased. These loans amounted to $47.1 million, an increase of $970 thousand from year-end 2013. The yield on consumer loans was 4.37 percent for the three months ended March 31, 2014, compared to 4.48 percent for the three months ended March 31, 2013. There are no concentrations of loans to any borrowers or group of borrowers exceeding 10 percent of the total loan portfolio and no foreign loans in the portfolio. As a preferred SBA lender, a portion of the SBA portfolio is to borrowers outside the Company's lending area. During late 2008, the Company withdrew from SBA lending outside of its primary trade area, but continues to offer SBA loan products as an additional credit product within its primary trade area. In the normal course of business, the Company may originate loan products whose terms could give rise to additional credit risk. Interest-only loans, loans with high LTV 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 March 31, 2014 and December 31, 2013, approximately 96 percent of the Company's loan portfolio was secured by real estate. Troubled Debt Restructurings 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. 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 March 31, 2014, there were ten loans totaling $7.8 million that were classified as TDRs by the Company and deemed impaired, compared to ten loans totaling $7.9 million at December 31, 2013. Nonperforming loans included $448 thousand of TDRs as of March 31, 2014, compared to $467 thousand at December 31, 2013. Restructured loans that are placed in nonaccrual status may be removed after 6 months of contractual payments and the business showing the ability to service the debt going forward. The remaining TDRs are in accrual status since they are performing in accordance with the restructured terms. There are no commitments to lend additional funds on these loans. 39

--------------------------------------------------------------------------------



The following table presents a breakdown of performing and nonperforming TDRs by class as of March 31, 2014 and December 31, 2013:

March 31, 2014 December 31, 2013 (In thousands) Performing TDRs Nonperforming TDRs Total TDRs Performing TDRs Nonperforming TDRs Total TDRs SBA loans held for investment $ 530 $ 448 $ 978 $ 534 $ 467 $ 1,001 SBA 504 loans 1,813 - 1,813 1,827 - 1,827 Commercial real estate 5,020 - 5,020 5,091 - 5,091 Total $ 7,363 $ 448 $ 7,811$ 7,452 $ 467 $ 7,919 Through March 31, 2014, our TDRs consisted of interest rate reductions, interest only periods and maturity extensions. There has been no principal forgiveness. The following table shows the types of modifications done to date by class through March 31, 2014: March 31, 2014 SBA held for Commercial (In thousands) investment SBA 504 real estate Total Type of modification: Principal only $ 21 $ - $ - $ 21 Interest only with reduced interest rate - - 2,684 2,684 Interest only with nominal principal 94 - - 94 Interest with extra principal - - 1,479 1,479 Previously modified back to original terms 863 1,813 857 3,533 Total TDRs $ 978$ 1,813$ 5,020$ 7,811 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. The current state of the economy and the downturn in the real estate market has resulted in increased loan delinquencies and defaults. 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. In response to the credit risk in its portfolio, the Company has increased staffing in its credit monitoring department and increased efforts in the collection and analysis of borrowers' financial statements and tax returns. Nonperforming assets consist of nonperforming loans and other real estate owned ("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. 40

--------------------------------------------------------------------------------



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) March 31, 2014 December 31, 2013 March 31, 2013 Nonperforming by category: SBA loans held for investment (1) $ 3,876 $ 2,746 $ 4,441 SBA 504 loans 424 1,101 1,235 Commercial loans 1,374 4,029 4,372 Residential mortgage loans 4,988 5,727 4,554 Consumer loans 1,384 1,680 302



Total nonperforming loans (2) $ 12,046 $ 15,283

$ 14,904 OREO 2,467 633 1,052 Total nonperforming assets $ 14,513 $ 15,916 $ 15,956 Past due 90 days or more and still accruing interest: SBA loans held for investment $ - $ - $ 212 SBA 504 loans - - 415 Commercial loans - 14 - Residential mortgage loans 5 5 4 Consumer loans - - 1 Total past due 90 days or more and still accruing interest $ 5 $ 19 $ 632 Nonperforming loans to total loans 1.76 % 2.25 % 2.50 % Nonperforming loans and TDRs to total loans (3) 2.84 3.35 5.02 Nonperforming assets to total loans and OREO 2.11 2.34 2.67 Nonperforming assets to total assets 1.51 1.73 1.93 (1) Guaranteed SBA loans included above $ 1,320 $ 540 $ 1,863 (2) Nonperforming TDRs included above 448 467 1,084 (3) Performing TDRs 7,363 7,452 15,068 Nonperforming loans were $12.0 million at March 31, 2014, a $3.2 million decrease from $15.3 million at year-end 2013 and a $2.9 million decrease from $14.9 million at March 31, 2013. Since year-end 2013, nonperforming loans in all segments decreased, except SBA loans held for investment. Included in nonperforming loans at March 31, 2014 are approximately $1.3 million of loans guaranteed by the SBA, compared to $540 thousand at December 31, 2013 and $1.8 million at March 31, 2013. In addition, there were $5 thousand in loans past due 90 days or more and still accruing interest at March 31, 2014, compared to $19 thousand and $632 thousand at December 31, 2013 and March 31, 2013, respectively. Other real estate owned ("OREO") properties totaled $2.5 million at March 31, 2014, an increase of $1.8 million from $633 thousand at year-end 2013. During the three months ended March 31, 2014, the Company took title to four new properties totaling $2.4 million and there were no valuation writedowns. Three OREO properties were sold, resulting in a net loss of $128 thousand on the sales. 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 $9.3 million at March 31, 2014, an increase of $3.5 million from $5.7 million at December 31, 2013. The increase is due to the addition of four loans totaling $5.3 million during the year, partially offset by the removal of two loans totaling $1.4 million.



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

41

--------------------------------------------------------------------------------



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. Beginning in 2013 and continuing in 2014, the Company has decreased its loan loss provision in response to improvements in the inherent credit risk within its loan portfolio. The improved inherent credit risk was evidenced by a decrease in delinquent and nonperforming loans, as the economy continued to improve. The allowance for loan losses totaled $12.8 million at March 31, 2014, compared to $14.3 millionMarch 31, 2013 with resulting allowance to total loan ratios of 1.87 percent, and 2.40 percent, respectively. Net charge-offs amounted to $934 thousand for the three months ended March 31, 2014, compared to $1.1 million for the same period in 2013. Net charge-offs to average loan ratios are shown in the table below for each major loan category. For the three months ended March 31, (In thousands, except percentages) 2014



2013

Balance, beginning of period $ 13,141 $



14,758

Provision for loan losses charged to expense 600 650 Less: Chargeoffs SBA loans held for investment 53 570 SBA 504 loans 92 200 Commercial loans 454 375 Residential mortgage loans 172 125 Consumer loans 179 59 Total chargeoffs 950 1,329 Add: Recoveries SBA loans held for investment 7 137 SBA 504 loans - 25 Commercial loans 9 101 Residential mortgage loans - 2 Consumer loans - 1 Total recoveries 16 266 Net chargeoffs 934 1,063 Balance, end of period $ 12,807 $ 14,345 Selected loan quality ratios: Net chargeoffs to average loans: SBA loans held for investment 0.34 % 2.69 % SBA 504 loans 1.18 1.73 Commercial loans 0.50 0.36 Residential mortgage loans 0.39 0.37 Consumer loans 1.58 0.51 Total loans 0.56 0.73 Allowance to total loans 1.87 2.40 Allowance to nonperforming loans 106.32 96.25 42

-------------------------------------------------------------------------------- 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 March 31, 2014, a $120 thousand commitment reserve was reported on the balance sheet as an "other liability", compared to an $103 thousand commitment reserve at December 31, 2013.



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 $28.9 million to $767.6 million at March 31, 2014, from $738.7 million at December 31, 2013. This increase in deposits was due to increases of $36.0 million in noninterest-bearing demand deposits, $3.5 million in interest-bearing demand deposits, and $2.8 million in time deposits, partially offset a decrease of $13.4 million in savings deposits. The increase in noninterest-bearing demand deposits was due to a $30.0 million short-term deposit that came into the Bank on March 31, 2014, of which $25.0 million was wired out on April 4, 2014. The decrease in savings deposits was due to a decline of $14.1 million in municipal savings deposits from year-end. The Company's deposit composition at March 31, 2014, consisted of 33.0 percent savings deposits, 27.1 percent time deposits, 22.4 percent noninterest-bearing demand deposits and 17.5 percent interest-bearing demand deposits.



Borrowed Funds and Subordinated Debentures

Borrowed funds consist primarily of fixed rate advances from the Federal Home Loan Bank ("FHLB") of New York and repurchase agreements. These borrowings are used as a source of liquidity or to fund asset growth not supported by deposit generation. Residential mortgages and investment securities collateralize the borrowings from the FHLB, while investment securities are pledged against the repurchase agreements. Borrowed funds and subordinated debentures totaled $130.5 million and $122.5 million at March 31, 2014 and December 31, 2013, respectively, and are broken down in the following table: (In thousands) March 31, 2014 December 31, 2013 FHLB borrowings: Fixed rate advances $ 30,000$ 30,000 Overnight advances 40,000 32,000 Repurchase agreements 30,000 30,000 Other repurchase agreements 15,000 15,000 Subordinated debentures 15,465 15,465 At March 31, 2014, the Company had $58.2 million of additional credit available at the FHLB. Pledging additional collateral in the form of 1 to 4 family residential mortgages or investment securities can increase the line with the FHLB. Interest Rate Sensitivity The principal objectives of the asset and liability management function are to establish prudent risk management guidelines, evaluate and control the level of interest-rate risk in balance sheet accounts, determine the level of appropriate risk given the business focus, operating environment, capital, and liquidity requirements, and actively manage risk within the Board approved guidelines. The Company seeks to reduce the vulnerability of the operations to changes in interest rates, and actions in this regard are taken under the guidance of the Asset/Liability Management Committee ("ALCO") of the Board of Directors. The ALCO reviews the maturities and re-pricing of loans, investments, deposits and borrowings, cash flow needs, current market conditions, and interest rate levels. 43

-------------------------------------------------------------------------------- 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 March 31, 2014, is a decline of 0.88 percent in a rising-rate environment and an increase of 0.29 percent in a falling-rate environment. The variances in the EVPE at March 31, 2014 are within the Board-approved guidelines of +/- 3.00 percent. At December 31, 2013, the economic value of equity as a percentage of assets with rate shocks of 200 basis points was a decline of 1.09 percent in a rising-rate environment and an increase of 0.45 percent in a falling-rate environment. Liquidity Consolidated Bank Liquidity Liquidity measures the ability to satisfy current and future cash flow needs as they become due. A bank's liquidity reflects its ability to meet loan demand, to accommodate possible outflows in deposits and to take advantage of interest rate opportunities in the marketplace. Our liquidity is monitored by management and the Board of Directors through a Risk Management Committee, which reviews historical funding requirements, our current liquidity position, sources and stability of funding, marketability of assets, options for attracting additional funds, and anticipated future funding needs, including the level of unfunded commitments. Our goal is to maintain sufficient asset-based liquidity to cover potential funding requirements in order to minimize our dependence on volatile and potentially unstable funding markets. The principal sources of funds at the Bank are deposits, scheduled amortization and prepayments of investment and loan principal, sales and maturities of investment securities and funds provided by operations. While scheduled loan payments and maturing investments are relatively predictable sources of funds, deposit inflows and outflows and loan prepayments are greatly influenced by general interest rates, economic conditions and competition. The Consolidated Statement of Cash Flows provides detail on the Company's sources and uses of cash, as well as an indication of the Company's ability to maintain an adequate level of liquidity. At March 31, 2014, the balance of cash and cash equivalents was $128.2 million, an increase of $28.8 million from December 31, 2013. A discussion of the cash provided by and used in operating, investing and financing activities follows. Operating activities provided $2.1 million and $2.0 million in net cash for the three months ended March 31, 2014 and 2013, respectively. The primary sources of funds were net income from operations and adjustments to net income, such as the provision for loan losses, depreciation and amortization, and proceeds from the sale of mortgage and SBA loans held for sale, partially offset by originations of mortgage and SBA loans held for sale. Investing activities used $10.2 million and $19.3 million in net cash for the three months ended March 31, 2014 and 2013, respectively. Cash was primarily used to purchase securities, and fund new loans, partially offset by cash inflows from maturities and paydowns on securities and proceeds from the sale of securities and OREO.



× Securities. The Consolidated Bank's available for sale investment portfolio

amounted to $86.0 million and $81.0 million at March 31, 2014 and December 31,

2013, 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 $13.9 million.

× Loans. The SBA loans held for sale portfolio amounted to $6.5 million and $6.7

million at March 31, 2014 and December 31, 2013, respectively. Sales of these

loans provide an additional source of liquidity for the Company.

× Outstanding Commitments. The Company was committed to advance approximately

$120.2 million to its borrowers as of March 31, 2014, compared to $103.2

million at December 31, 2013. At March 31, 2014, $43.5 million of these

commitments expire within one year, compared to $45.6 million at December 31,

2013. The Company had $1.4 million in standby letters of credit at both March

31, 2014 and December 31, 2013, which are included in the commitments amount

noted above. The estimated fair value of these guarantees is not

significant. The Company believes it has the necessary liquidity to honor all

commitments. Many of these commitments will expire and never be funded. Financing activities provided $36.8 million in net cash for the three months ended March 31, 2014, compared to $3.1 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 March 31, 2014, deposits included $70.4 million of Government

deposits, as compared to $82.5 million at year-end 2013. 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 $65.0 million of deposits from nine

municipalities. The withdrawal of these deposits, in whole or in part, would

not create a liquidity shortfall for the Company. 44

--------------------------------------------------------------------------------



× Borrowed Funds. Total FHLB borrowings amounted to $100.0 million and $92.0

million as of March 31, 2014 and December 31, 2013, respectively. Third party

repurchase agreements totaled $15.0 million as of both March 31, 2014 and

December 31, 2013. 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 March 31, 2014, pledging provided an additional $46.7

million in borrowing potential from the FHLB. In addition, the Company can

pledge additional collateral in the form of 1 to 4 family residential mortgages

or investment securities to increase this line with the FHLB. Parent Company Liquidity The Parent Company's cash needs are funded by dividends paid by the Bank. Other than its investment in the Bank and Unity Statutory Trusts II and III, the Parent Company does not actively engage in other transactions or business. Only expenses specifically for the benefit of the Parent Company are paid using its cash, which typically includes the payment of operating expenses and, prior to the redemption of the preferred stock issued as part of the CPP, cash dividends on the preferred stock issued to the U.S. Treasury.



At March 31, 2014, the Parent Company had $712 thousand in cash and cash equivalents and $177 thousand in investment securities valued at fair market value, compared to $724 thousand in cash and cash equivalents and $167 thousand in investment securities at December 31, 2013.

Regulatory Capital A significant measure of the strength of a financial institution is its capital base. Federal regulators have classified and defined capital into the following components: (1) tier 1 capital, which includes tangible shareholders' equity for common stock, qualifying preferred stock and certain qualifying hybrid instruments, and (2) tier 2 capital, which includes a portion of the allowance for loan losses, subject to limitations, certain qualifying long-term debt, preferred stock and hybrid instruments, which do not qualify for tier 1 capital. The parent company and its subsidiary bank are subject to various regulatory capital requirements administered by banking regulators. Quantitative measures of capital adequacy include the leverage ratio (tier 1 capital as a percentage of tangible assets), tier 1 risk-based capital ratio (tier 1 capital as a percent of risk-weighted assets) and total risk-based capital ratio (total risk-based capital as a percent of total risk-weighted assets). Minimum capital levels are regulated by risk-based capital adequacy guidelines, which require the Company and the Bank to maintain certain capital as a percentage of assets and certain off-balance sheet items adjusted for predefined credit risk factors (risk-weighted assets). Failure to meet minimum capital requirements can initiate certain mandatory and possibly discretionary actions by regulators that, if undertaken, could have a direct material effect on the Company's financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Company and the Bank must meet specific capital guidelines. However, prompt corrective action provisions are not applicable to bank holding companies. 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 must be maintained. In addition to the risk-based guidelines, regulators require that a bank or holding company, which meets the regulator's highest performance and operation standards, maintain a minimum leverage ratio of 3 percent. For those institutions with higher levels of risk or that are experiencing or anticipating significant growth, the minimum leverage ratio will be proportionately increased. Minimum leverage ratios for each institution are evaluated through the ongoing regulatory examination process. On April 15, 2014, the Company filed an S-1 registration statement announcing a common stock rights offering to existing shareholders. This purpose of this rights offering is to provide the Company with additional capital to grow its earning assets. The offering is expected to be completed late in the second quarter or early in the third quarter. To be well-capitalized For capital under prompt corrective Actual adequacy purposes action provisions (In thousands) Amount Ratio Amount Ratio Amount Ratio As of March 31, 2014 Leverage ratio $ 72,535 8.19 % ? $ 35,443 4.00 % N/A N/A Tier I risk-based capital ratio 72,535 10.77 26,942 4.00 N/A N/A Total risk-based capital ratio 81,010 12.03 53,884 8.00 N/A N/A As of December 31, 2013 Leverage ratio $ 70,852 8.08 % ? $ 35,084 4.00 % N/A N/A Tier I risk-based capital ratio 70,852 10.74 26,400 4.00 N/A N/A Total risk-based capital ratio 79,164 11.99 52,800 8.00 N/A N/A 45

--------------------------------------------------------------------------------



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

To be well-capitalized For capital under prompt corrective Actual adequacy purposes action provisions (In thousands) Amount Ratio Amount Ratio Amount Ratio As of March 31, 2014 Leverage ratio $ 63,177 7.14 % ? $ 35,417 4.00 % ? $ 44,272 5.00 % Tier I risk-based capital ratio 63,177 9.39 26,915 4.00 40,373 6.00 Total risk-based capital ratio 80,144 11.91 53,831 8.00 67,288 10.00 As of December 31, 2013 Leverage ratio $ 61,493 7.02 % ? $ 35,058 4.00 % ? $ 43,823 5.00 % Tier I risk-based capital ratio 61,493 9.33 26,373 4.00 39,560 6.00 Total risk-based capital ratio 78,296 11.88 52,747 8.00 65,933 10.00 The Group of Governors and Heads of Supervision, the oversight body of the Basel Committee on Banking Supervision, adopted Basel III in September 2010, 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, on July 9, 2013, the FDIC approved, as an interim final rule, the regulatory capital requirements for U.S. state nonmember banks, such as us, substantially similar to final rules issued by the Board of Governors of the Federal Reserve System ("Federal Reserve") and the Office of the Comptroller of the Currency. The interim final rule includes new risk-based capital and leverage ratios that will be phased-in from 2015 to 2019 for most state nonmember banks, including us. The rule includes a new common equity Tier 1 capital to risk-weighted assets ratio of 4.5% and a common equity Tier 1 capital conservation buffer of 2.5% of risk-weighted assets, which is in addition to the Tier 1 and Total risk-based capital requirements. The interim final rule also raises the minimum ratio of Tier 1 capital to risk-weighted assets from 4.0% to 6.0% and requires a minimum leverage ratio of 4.0%. The required minimum ratio of total capital to risk-weighted assets will remain 8.0%. The new risk-based capital requirements (except for the capital conservation buffer) will become effective for the Bank on January 1, 2015. The capital conservation buffer will be phased in over four years beginning on January 1, 2016, with a maximum buffer of 0.625% of risk-weighted assets for 2016, 1.25% for 2017, 1.875% for 2018, and 2.5% for 2019 and thereafter. Failure to maintain the required capital conservation buffer will result in limitations on capital distributions and on discretionary bonuses to executive officers. The following chart compares the risk-based capital required under existing rules to those prescribed under the interim final rule under the phase-in period described above: Current Treatment Treatment in Final Rule Leverage ratio 4.00 % 4.00 % Common equity tier 1 capital N/A 4.50 % (CET1) ratio Additional tier 1 N/A 1.50 % Tier 1 capital ratio 4.00 % 6.00 % Tier 2 4.00 % 2.00 % Total capital ratio 8.00 % 8.00 % Capital conservation buffer N/A 2.50 % The interim final rule also implements revisions and clarifications consistent with Basel III regarding the various components of Tier 1 capital, including common equity, unrealized gains and losses and instruments that will no longer qualify as Tier 1 capital. The interim final rule also sets forth certain changes for the calculation of risk-weighted assets that the Bank will be required to implement beginning January 1, 2015. Management is currently evaluating the provisions of the interim final rule and its expected impact. Based on our current capital composition and levels, management does not presently anticipate that the interim final rule presents a material risk to our financial condition or results of operations. Shareholders' Equity Shareholders' equity increased $1.6 million to $58.8 million at March 31, 2014 compared to $57.2 million at December 31, 2013. Items impacting shareholders' equity included net income of $1.3 million, $174 thousand from the issuance of common stock under employee benefit plans, and a $310 thousand increase in other comprehensive income related to unrealized gains on available for sale securities, partially offset by a decrease of $140 thousand in dividends accrued on common stock. The issuance of common stock under employee benefit plans includes nonqualified stock options and restricted stock expense related entries, employee option exercises and the tax benefit of options exercised. Repurchase Plan On October 21, 2002, the Company authorized the repurchase of up to 10 percent of its outstanding common stock. The amount and timing of purchases is dependent upon a number of factors, including the price and availability of the Company's shares, general market conditions and competing alternate uses of funds. There were no shares repurchased during the three month periods ended March 31, 2014 or 2013. 46

--------------------------------------------------------------------------------



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.


For more stories on investments and markets, please see HispanicBusiness' Finance Channel



Source: Edgar Glimpses


Story Tools






HispanicBusiness.com Facebook Linkedin Twitter RSS Feed Email Alerts & Newsletters