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Table of Contents

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

(Mark One)

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

For the quarterly period ended March 31, 2021

OR

  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

Securities registered pursuant to Section 12(b) of the Exchange Act:

Title of each class

Trading Symbol(s)

Name of each exchange on which registered

Common stock

UNTY

NASDAQ

Securities registered pursuant to Section 12(g) of the Exchange Act: None

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

Indicate by check mark whether the registrant 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 such files). Yes     No

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and "emerging growth company" in Rule 12b-2 of the Exchange Act.:

Large accelerated filer  

Accelerated filer  

Nonaccelerated filer  

Smaller reporting company  

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.

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

The number of shares outstanding of each of the registrant’s classes of common equity stock, as of April 30, 2021 common stock, no par value: 10,417,385 shares outstanding.

Table of Contents

Table of Contents

    

Page #

PART I

CONSOLIDATED FINANCIAL INFORMATION

ITEM 1

Consolidated Financial Statements (Unaudited)

3

Consolidated Balance Sheets at March 31, 2021 and December 31, 2020

3

Consolidated Statements of Income for the three months ended March 31, 2021 and 2020

4

Consolidated Statements of Comprehensive Income for the three months ended March 31, 2021 and 2020

5

Consolidated Statements of Changes in Shareholders’ Equity for the three months ended March 31, 2021 and 2020

6

Consolidated Statements of Cash Flows for the three months ended March 31, 2021 and 2020

7

Notes to the Consolidated Financial Statements

8

ITEM 2

Management’s Discussion and Analysis of Financial Condition and Results of Operations

45

ITEM 3

Quantitative and Qualitative Disclosures about Market Risk

66

ITEM 4

Controls and Procedures

66

PART II

OTHER INFORMATION

66

ITEM 1

Legal Proceedings

66

ITEM 1A

Risk Factors

67

ITEM 2

Unregistered Sales of Equity Securities and Use of Proceeds

67

ITEM 3

Defaults upon Senior Securities

67

ITEM 4

Mine Safety Disclosures

67

ITEM 5

Other Information

67

ITEM 6

Exhibits

68

EXHIBIT INDEX

69

Exhibit 31.1

Exhibit 31.2

Exhibit 32.1

SIGNATURES

70

2

Table of Contents

PART I        CONSOLIDATED FINANCIAL INFORMATION

ITEM 1        Consolidated Financial Statements (Unaudited)

Unity Bancorp, Inc.

Consolidated Balance Sheets

(Unaudited)

(In thousands)

    

March 31, 2021

    

December 31, 2020

ASSETS

Cash and due from banks

$

25,911

$

22,750

Federal funds sold and interest-bearing deposits

 

213,666

 

196,561

Cash and cash equivalents

 

239,577

 

219,311

Securities:

Debt securities available for sale (amortized cost of $32,549 in 2021 and $45,921 in 2020)

 

32,330

 

45,617

Equity securities with readily determinable fair values (amortized cost of $2,112 in 2021 and $2,112 in 2020)

 

2,221

 

1,954

Total securities

 

34,551

 

47,571

Loans:

 

  

 

  

SBA loans held for sale

 

8,809

 

9,335

SBA loans held for investment

 

38,296

 

39,587

SBA PPP loans

169,117

118,257

Commercial loans

 

853,078

 

839,788

Residential mortgage loans

 

448,149

 

467,586

Consumer loans

60,502

66,100

Consumer construction loans

 

90,497

 

87,164

Total loans

 

1,668,448

 

1,627,817

Allowance for loan losses

 

(22,965)

 

(23,105)

Net loans

 

1,645,483

 

1,604,712

Premises and equipment, net

 

20,043

 

20,226

Bank owned life insurance ("BOLI")

 

26,535

 

26,514

Deferred tax assets

 

9,116

 

9,183

Federal Home Loan Bank ("FHLB") stock

 

9,269

 

10,594

Accrued interest receivable

 

9,831

 

10,429

Goodwill

 

1,516

 

1,516

Prepaid expenses and other assets

 

8,897

 

8,858

Total assets

$

2,004,818

$

1,958,914

LIABILITIES AND SHAREHOLDERS’ EQUITY

 

  

 

  

Liabilities:

 

  

 

  

Deposits:

 

  

 

  

Noninterest-bearing demand

$

465,511

$

459,677

Interest-bearing demand

 

217,714

 

204,236

Savings

 

502,300

 

455,449

Time, under $100,000

 

272,298

 

264,671

Time, $100,000 to $250,000

 

94,933

 

95,595

Time, $250,000 and over

 

75,637

 

78,331

Total deposits

 

1,628,393

 

1,557,959

Borrowed funds

 

170,000

 

200,000

Subordinated debentures

 

10,310

 

10,310

Accrued interest payable

 

255

 

248

Accrued expenses and other liabilities

 

14,674

 

16,486

Total liabilities

 

1,823,632

 

1,785,003

Shareholders’ equity:

 

  

 

  

Common stock

92,180

 

91,873

Retained earnings

 

98,331

 

90,669

Treasury stock

(8,791)

(7,442)

Accumulated other comprehensive loss

 

(534)

 

(1,189)

Total shareholders’ equity

 

181,186

 

173,911

Total liabilities and shareholders’ equity

$

2,004,818

$

1,958,914

Shares issued

10,996

10,961

Shares outstanding

10,422

10,456

Treasury shares

574

505

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

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Unity Bancorp, Inc.

Consolidated Statements of Income

(Unaudited)

For the three months ended March 31, 

(In thousands, except per share amounts)

2021

    

2020

INTEREST INCOME

  

 

  

Federal funds sold and interest-bearing deposits

$

24

$

188

FHLB stock

 

63

 

109

Securities:

 

 

Taxable

 

292

 

511

Tax-exempt

 

10

 

22

Total securities

 

302

 

533

Loans:

 

  

 

  

SBA loans

 

783

 

985

SBA PPP loans

1,730

Commercial loans

 

10,474

 

9,933

Residential mortgage loans

 

5,128

 

5,770

Consumer loans

857

960

Consumer construction loans

 

1,215

 

1,107

Total loans

 

20,187

 

18,755

Total interest income

 

20,576

 

19,585

INTEREST EXPENSE

 

  

 

  

Interest-bearing demand deposits

 

309

 

378

Savings deposits

 

431

 

951

Time deposits

 

1,463

 

2,447

Borrowed funds and subordinated debentures

 

355

 

565

Total interest expense

 

2,558

 

4,341

Net interest income

 

18,018

 

15,244

Provision for loan losses

 

500

 

1,500

Net interest income after provision for loan losses

 

17,518

 

13,744

NONINTEREST INCOME

 

  

 

  

Branch fee income

 

295

 

317

Service and loan fee income

 

625

 

376

Gain on sale of SBA loans held for sale, net

 

245

 

473

Gain on sale of mortgage loans, net

 

1,750

 

1,051

BOLI income

 

129

 

173

Net security gains (losses)

 

310

 

(170)

Other income

 

372

 

325

Total noninterest income

 

3,726

 

2,545

NONINTEREST EXPENSE

 

  

 

  

Compensation and benefits

 

6,063

 

5,439

Processing and communications

 

807

 

708

Occupancy

 

706

 

624

Furniture and equipment

 

649

 

655

Professional services

 

380

 

269

Advertising

 

268

 

290

Deposit insurance

 

214

 

88

Director fees

 

208

 

200

BSA expenses

168

63

Other loan expenses

 

143

 

89

Loan collection and OREO (recoveries) expenses

 

(49)

 

186

Other expenses

 

245

 

712

Total noninterest expense

 

9,802

 

9,323

Income before provision for income taxes

 

11,442

 

6,966

Provision for income taxes

 

2,946

 

1,598

Net income

$

8,496

$

5,368

Net income per common share - Basic

$

0.81

$

0.49

Net income per common share - Diluted

$

0.80

$

0.49

Weighted average common shares outstanding – Basic

 

10,437

 

10,883

Weighted average common shares outstanding – Diluted

 

10,565

 

11,037

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

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Unity Bancorp, Inc.

Consolidated Statements of Comprehensive Income

(Unaudited)

For the three months ended

March 31, 2021

March 31, 2020

    

    

    

    

Income tax

    

Before tax

Income tax

Net of tax

Before tax

expense

Net of tax

(In thousands)

amount

expense

amount

     

amount

(benefit)

amount

Net income

$

11,442

2,946

8,496

$

6,966

1,598

5,368

Other comprehensive income (loss) income

Debt securities available for sale:

 

Unrealized holding gains (losses) on securities arising during the period

 

395

89

306

(166)

(35)

(131)

Less: reclassification adjustment for gains (losses) on securities included in net income

 

310

65

245

(170)

(36)

(134)

Total unrealized gains on securities available for sale

 

85

 

24

 

61

 

4

 

1

 

3

Adjustments related to defined benefit plan:

 

  

 

  

 

  

 

  

 

  

 

  

Amortization of prior service cost

 

21

6

15

21

6

15

Total adjustments related to defined benefit plan

 

21

 

6

 

15

 

21

 

6

 

15

Net unrealized gains (losses) from cash flow hedges:

 

  

 

  

 

  

 

  

 

  

 

  

Unrealized holding gains (losses) on cash flow hedges arising during the period

 

807

228

579

(1,410)

(406)

(1,004)

Total unrealized gains (losses) on cash flow hedges

 

807

 

228

 

579

 

(1,410)

 

(406)

 

(1,004)

Total other comprehensive income (loss)

 

913

 

258

 

655

 

(1,385)

 

(399)

 

(986)

Total comprehensive income

$

12,355

$

3,204

$

9,151

$

5,581

$

1,199

$

4,382

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

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Unity Bancorp, Inc.

Consolidated Statements of Changes in Shareholders’ Equity

For the three months ended March 31, 2021 and 2020

(Unaudited)

    

    

    

Accumulated

    

other

Total

Stock

Retained

comprehensive

Treasury

shareholders’

(In thousands)

Shares

Amount

earnings

(loss) income

aa

stock

equity

Balance, December 31, 2020

 

10,456

$

91,873

$

90,669

$

(1,189)

$

(7,442)

$

173,911

Net income

 

8,496

 

8,496

Other comprehensive income, net of tax

 

655

 

655

Dividends on common stock ($0.08 per share)

 

30

(834)

 

(804)

Common stock issued and related tax effects (1)

 

36

277

 

277

Treasury stock purchased, at cost

(70)

(1,349)

(1,349)

Balance, March 31, 2021

10,422

 

92,180

 

98,331

 

(534)

(8,791)

 

181,186

    

    

    

Accumulated

    

other

Total

Stock

Retained

comprehensive

Treasury

shareholders’

(In thousands)

Shares

Amount

earnings

income (loss)

stock

aa

equity

Balance, December 31, 2019

 

10,881

$

90,113

$

70,442

$

154

$

$

160,709

Net income

 

 

 

5,368

 

 

5,368

Other comprehensive loss, net of tax

 

 

 

 

(986)

 

(986)

Dividends on common stock ($0.08 per share)

 

 

30

 

(871)

 

 

(841)

Common stock issued and related tax effects (1)

 

13

 

227

 

 

 

227

Acquisition of treasury stock, at cost

(11)

(172)

(172)

Balance, March 31, 2020

10,883

 

90,370

 

74,939

 

(832)

 

(172)

 

164,305

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

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

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Unity Bancorp, Inc.

Consolidated Statements of Cash Flows

(Unaudited)

For the three months ended March 31, 

(In thousands)

    

2021

    

2020

OPERATING ACTIVITIES:

 

  

 

  

Net income

$

8,496

$

5,368

Adjustments to reconcile net income to net cash provided by operating activities:

 

  

 

Provision for loan losses

 

500

 

1,500

Net amortization of purchase premiums and discounts on securities

 

62

 

59

Depreciation and amortization

 

469

 

317

PPP deferred fees and costs

1,937

Deferred income tax benefit

 

(191)

 

(347)

Net security gains

 

(43)

 

(301)

Stock compensation expense

 

374

 

365

Valuation writedowns on OREO

 

 

200

Gain on sale of mortgage loans, net

 

(2,001)

 

(622)

Gain on sale of SBA loans held for sale, net

 

(245)

 

(473)

Origination of mortgage loans sold

 

(101,869)

 

(38,562)

Origination of SBA loans held for sale

 

(1,312)

 

(2,595)

Proceeds from sale of mortgage loans, net

 

103,870

 

39,184

Proceeds from sale of SBA loans held for sale, net

 

2,416

 

5,850

BOLI income

 

(129)

 

(173)

Net change in other assets and liabilities

 

(685)

 

1,714

Net cash provided by operating activities

 

11,649

 

11,484

INVESTING ACTIVITIES

 

  

 

  

Purchases of FHLB stock, at cost

 

(16,450)

 

(22,275)

Maturities and principal payments on debt securities available for sale

 

6,305

 

2,198

Proceeds from sales of debt securities available for sale

 

7,048

 

6,029

Proceeds from sales of equity securities

 

 

111

Proceeds from redemption of FHLB stock

 

17,775

 

27,405

Net increase in SBA PPP loans

(52,492)

Net decrease (increase) in loans

 

8,364

 

(17,277)

Proceeds from BOLI

 

107

 

117

Purchases of premises and equipment

 

(224)

 

(166)

Net cash used in investing activities

 

(29,567)

 

(3,858)

FINANCING ACTIVITIES

 

  

 

  

Net increase in deposits

 

70,434

 

128,504

Proceeds from new borrowings

 

130,000

 

109,000

Repayments of borrowings

 

(160,000)

 

(223,000)

Proceeds from exercise of stock options

 

80

 

34

Fair market value of shares withheld to cover employee tax liability

 

(177)

 

(172)

Dividends on common stock

 

(804)

 

(841)

Purchase of treasury stock

(1,349)

(172)

Net cash provided by financing activities

 

38,184

 

13,353

Increase in cash and cash equivalents

 

20,266

 

20,979

Cash and cash equivalents, beginning of period

 

219,311

 

158,016

Cash and cash equivalents, end of period

$

239,577

$

178,995

SUPPLEMENTAL DISCLOSURES

 

  

 

  

Cash:

 

  

 

  

Interest paid

$

2,550

$

4,559

Income taxes paid

3,320

1,782

Noncash investing activities:

  

  

Transfer of SBA loans held for sale to held to maturity

1,024

Capitalization of servicing rights

$

19

$

486

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

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Unity Bancorp, Inc.

Notes to the Consolidated Financial Statements (Unaudited)

March 31, 2021

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 markets served by the Company have been significantly impacted by the COVID-19 pandemic, which started during the first quarter of 2020. The Company continues to assess the financial impact of the COVID-19 pandemic.

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 months ended March 31, 2021 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, 2020.

Risks and Uncertainties

On March 11, 2020, the World Health Organization declared the outbreak of COVID-19 a global pandemic. The COVID-19 pandemic has adversely affected local, national and global economic activity. Actions taken to help mitigate the spread of COVID-19 include restrictions on travel, localized quarantines, and government-mandated closures of certain businesses. The spread of the outbreak has caused significant disruptions to the U.S. economy and has disrupted banking and other financial activity in the areas in which the Company operates.

On March 3, 2020, the Federal Open Market Committee reduced the targeted federal funds interest rate range by 50 basis points to 1.00 percent to 1.25 percent. This range was further reduced to 0 percent to 0.25 percent on March 16, 2020. On March 27, 2020, the Coronavirus Aid, Relief, and Economic Security Act (“CARES Act”) was enacted to, among other provisions, provide emergency assistance for individuals, families and businesses affected by the COVID-19 pandemic. These reductions in interest rates and other effects of the COVID-19 pandemic may materially and adversely affect the Company’s financial condition and results of operations in future periods. It is unknown how long the adverse conditions associated with the COVID-19 pandemic will last and what the complete financial effect will be to the Company. It is possible that estimates made in the financial statements could be materially and adversely impacted as a result of these conditions.

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On July 27, 2017, the U.K. Financial Conduct Authority, which regulates LIBOR, announced that it will no longer persuade or compel banks to submit rates for the calculation of LIBOR to the LIBOR administrator after 2021. The announcement also indicates that the continuation of LIBOR on the current basis cannot and will not be guaranteed after 2021. Consequently, at this time, it is not possible to predict whether and to what extent banks will continue to provide LIBOR submissions to the LIBOR administrator or whether any additional reforms to LIBOR may be enacted in the United Kingdom or elsewhere. Similarly, it is not possible to predict whether LIBOR will continue to be viewed as an acceptable benchmark for certain loans and liabilities including our subordinated notes, what rate or rates may become accepted alternatives to LIBOR or the effect of any such changes in views or alternatives on the values of the loans and liabilities, whose interest rates are tied to LIBOR. Uncertainty as to the nature of such potential changes, alternative reference rates, the elimination or replacement of LIBOR, or other reforms may adversely affect the value of, and the return on our loans and our investment securities.

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, the intent to sell a security or whether it is more likely than not the Company 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.

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Loans

Loans Held for Sale

Loans held for sale represent the guaranteed portion of Small Business Administration (“SBA”) loans, excluding loans originated under the Paycheck Protection Program, 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 for Investment

Loans held for investment 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

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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.

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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. However, when a net loss rather than net income is recognized, diluted earnings per share equals basic earnings per share.

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

For the three months ended March 31, 

(In thousands, except per share amounts)

    

2021

    

2020

    

Net income

$

8,496

$

5,368

Weighted average common shares outstanding - Basic

 

10,437

 

10,883

Plus: Potential dilutive common stock equivalents

 

128

 

154

Weighted average common shares outstanding - Diluted

 

10,565

 

11,037

Net income per common share - Basic

$

0.81

$

0.49

Net income per common share - Diluted

 

0.80

 

0.49

Stock options and common stock excluded from the income per share calculation as their effect would have been anti-dilutive

 

154

 

363

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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. The bill, effective January 1, 2018, imposed a temporary surtax on corporations earning New Jersey allocated taxable 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, New Jersey adopted mandatory unitary combined reporting for its Corporation Business Tax, which became effective for periods on or after January 1, 2019.

On September 29, 2020, New Jersey’s Assembly Bill 4721 was signed into law. The bill, retroactively effective January 1, 2020, extends the 2.5% corporate income surtax until December 31, 2023. The Division of Taxation will waive any underpayment penalties on 2020 estimated tax payments related to the retroactive increase. In addition, if the federal corporate tax rate is increased to a rate of at least 35% of taxable income, the surtax will be suspended.

For the quarter ended March 31, 2021, the Company reported income tax expense of $2.9 million for an effective tax rate of 25.7 percent, compared to an income tax expense of $1.6 million and an effective tax rate of 22.9 percent for the prior year’s quarter. The Company did not recognize or accrue any interest or penalties related to income taxes during the three months ended March 31, 2021 or 2020. The Company did not have an accrual for uncertain tax positions as of March 31, 2021 or December 31, 2020, 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 2016 and thereafter are subject to future examination by tax authorities.

NOTE 5. Other Comprehensive (Loss) Income

The following tables show the changes in other comprehensive (loss) income for the three months ended March 31, 2021 and 2020, net of tax:

For the three months ended March 31, 2021

 

 

Adjustments

 

Net unrealized

 

Accumulated

 

Net unrealized

 

related to

 

(losses) gains

 

other

 

(losses) gains on

 

defined benefit

 

from cash flow

 

comprehensive

(In thousands)

securities