UNITY BANCORP INC /NJ/ (UNTY) FY 2022 MD&A

Item 7.    Management’s Discussion and Analysis of Financial Condition and Results of Operations:

The purpose of this analysis is to provide the reader with information relevant to understanding and assessing the Company’s results of operations for each of the past three years and financial condition for each of the past two years. In order to fully appreciate this analysis, the reader is encouraged to review the consolidated financial statements and accompanying notes thereto appearing under Item 8 of this report and statistical data presented in this document.

Overview

Unity Bancorp, Inc. (the “Parent Company”) is a bank holding company incorporated in New Jersey and is registered 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”) is chartered 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 the Internet and its nineteen branch offices located in Bergen, Hunterdon, Middlesex, Ocean, Somerset, Union and Warren counties in New Jersey and Northampton County in Pennsylvania. These services include the acceptance of demand, savings and time deposits and the extension of consumer, real estate, Small Business Administration ("SBA") and other commercial credits. The Bank has multiple subsidiaries used to hold part of its investment and loan portfolios.

Results of Operations

Net income totaled $38.5 million, or $3.59 per diluted share for the year ended December 31, 2022, compared to $36.1 million, or $3.43 per diluted share for the year ended December 31, 2021.

Highlights for the year include:

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The Company’s performance ratios for the past three years are listed in the following table:

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COVID-19

The full impact of the Coronavirus Disease (“COVID-19”) pandemic remains unknown and continues to evolve. The outbreak has had a significant adverse impact on certain industries the Company serves, including retail, accommodations, restaurants and food services. 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 Bank. It is reasonably possible that estimates made in the financial statements could be materially impacted in the near term as a result of these conditions. The Company continues to monitor the impact closely, including its impact on employees, customers, communities and results of operations and the impact of other government or Federal Reserve actions.

The Coronavirus Aid, Relief, and Economic Security (CARES) Act provided funding for the SBA’s Paycheck Protection Program (PPP) and established rules for qualifying borrowers to receive loan forgiveness by the SBA under this program. The Company approved 1,224 applications and provided funding of approximately $143.0 million during the year ended December 31, 2020. As of December 31, 2022, the Company had no PPP loans originated under the CARES Act remaining on its balance sheet.

The Economic Aid to Hard-Hit Small businesses, Nonprofits and Venues (“Economic Aid”) Act provided additional assistance to the hardest-hit small businesses, nonprofits, and venues that were struggling to recover from the impact of the COVID-19 Pandemic. The Company approved 955 applications and provided funding of approximately $101.0 million under the Economic Aid Act. As of December 31, 2022, the Company had $5.9 million of PPP loans originated under the Economic Aid Act in its portfolio.

Additionally, in accordance with provisions set forth by the CARES Act and regulatory guidance, the Company provided financial assistance through loan payment deferrals and waived fees. The Company has no outstanding loans remaining that would qualify for the payment deferral period as set forth by the CARES Act and regulatory guidance.

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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 interest-earning assets and fees earned on loans, versus interest paid on interest-bearing liabilities. Interest-earning assets include loans to individuals and businesses, investment securities and interest-earning deposits. Interest-bearing liabilities include interest-bearing demand, savings and time deposits, FHLB advances and other borrowings. Net interest income is determined by the difference between the yields earned on interest-earning assets and the rates paid on interest-bearing liabilities (“net interest spread”) and the relative amounts of interest-earning assets and interest-bearing liabilities. The Company’s net interest spread is affected by regulatory, economic and

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competitive factors that influence interest rates, loan demand, deposit demand and general levels of nonperforming assets.

2022 compared to 2021

During 2022, tax-equivalent net interest income amounted to $90.1 million, an increase of $13.1 million, or 17.0 percent, when compared to the same period in 2021. The net interest margin increased 24 basis points to 4.40 percent for the year ended December 31, 2022, compared to 4.16 percent for the same period in 2021. The net interest spread was 4.15 percent for 2022, a 20 basis point increase compared to 3.95 for the same period in 2021.

During 2022, tax-equivalent interest income was $100.7 million, an increase of $16.0 million, or 18.8 percent, when compared to the same period in the prior year. This increase was mainly driven by increases in the balance of average loans, the yield on loans, the balance of average securities and the yield on securities.

Total interest expense was $10.6 million in 2022, an increase of $2.9 million or 37.3 percent compared to 2021. This increase was primarily driven by the increased rates and volume of savings deposits and increased volume of borrowed funds and subordinated debentures:

2021 compared to 2020

During 2021, tax-equivalent net interest income amounted to $77.0 million, an increase of $12.6 million or 19.6 percent when compared to the same period in 2020. The net interest margin increased 31 basis points to 4.16 percent for the year ended December 31, 2021 compared to 3.85 percent for the same period in 2020. The net interest spread was 3.95 percent for 2021, a 47 basis point increase compared to the same period in 2020.

During 2021, tax-equivalent interest income was $84.8 million, an increase of $5.9 million or 7.4 percent when compared to the same period in the prior year. This increase was mainly driven by the increase in the balance of average loans and the increase in the yield on loans, partially offset by a decrease in the balance of average securities and the decrease in the yield on securities.

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Total interest expense was $7.7 million in 2021, a decrease of $6.7 million or 46.5 percent compared to 2020. This decrease was driven primarily by the decreased rates on interest-bearing deposits:

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Consolidated Average Balance Sheets

The following table reflects the components of net interest income, setting forth for the periods presented herein: (1) average assets, liabilities and shareholders’ equity, (2) interest income earned on interest-earning assets and interest expense paid on interest-bearing liabilities, (3) average yields earned on interest-earning assets and average rates paid on interest-bearing liabilities, (4) net interest spread and (5) net interest income/margin on average earning assets. Rates/yields are computed on a fully tax-equivalent basis, assuming a federal income tax rate of 21 percent.

(Dollar amounts in thousands, interest amounts and interest rates/yields on a fully tax-equivalent basis)

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Consolidated Average Balance Sheets (Continued)

(Dollar amounts in thousands, interest amounts and interest rates/yields on a fully tax-equivalent basis)

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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 solely due to volume or rate variances have been allocated proportionally to both, based on their relative absolute values. Amounts have been computed on a tax-equivalent basis, assuming a federal income tax rate of 21 percent.

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Provision for Loan Losses

The provision for loan losses totaled $4.2 million for 2022, $0.2 million in 2021 and $7.0 million in 2020. During 2020 the provision for loan losses was elevated due to uncertainty and the risk of loan defaults related to COVID-19. The provision for loan losses increased $4.0 million for the year ended 2022 primarily due to the sizeable increase in total loans, as well as management's view of current economic conditions.

Each period’s loan loss provision is the result of management’s analysis of the loan portfolio and reflects changes in the size and composition of the portfolio, the level of net charge-offs, delinquencies, current economic conditions and other internal and external factors impacting the risk within the loan portfolio. Additional information may be found under the captions “Financial Condition - Asset Quality” and “Financial Condition - Allowance for Loan Losses and Reserve for Unfunded Loan Commitments.”  The current provision is considered appropriate under management’s assessment of the adequacy of the allowance for loan losses.

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Noninterest Income

The following table shows the components of noninterest income for the past three years:

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Noninterest income was $8.0 million for 2022, a $4.0 million decrease compared to $12.1 million for 2021. This decrease was primarily due to decreased realized gains on sales of mortgages and net unrealized securities losses. The decreased realized gains on sales of mortgages was primarily due to an industry-wide trend of decreased volume in conforming residential loan originations as interest rates rose in 2022.

Noninterest income was $12.1 million for 2021, a $0.9 million decrease compared to $12.9 million for 2020. This decrease was primarily due to decreased realized gains on sales of mortgages and SBA loans held for sale.

Noninterest Expense

The following table presents a breakdown of noninterest expense for the past three years:

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Noninterest expense totaled $42.6 million for the year ended December 31, 2022, an increase of $1.8 million when compared to $40.8 million in 2021. The majority of this increase is primarily attributable to increased compensation and benefits, reflecting ordinary course increases, as well as increased competition for employees.

Noninterest expense totaled $40.8 million for the year ended December 31, 2021, an increase of $1.5 million when compared to $39.3 million in 2020. The majority of this increase is primarily attributable to increased salary expenses and a one-time deferred compensation adjustment.

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Income Tax Expense

For 2022, the Company reported income tax expense of $13.0 million for an effective tax rate of 25.2%, compared to an income tax expense of $12.0 million and an effective tax rate of 25.0% in 2021 and an income tax expense of $7.5 million and an effective tax rate of 24.0% in 2020.

For additional information on income taxes, see Note 11 to the Consolidated Financial Statements.

Financial Condition

Total assets increased $411.2 million or 20.2 percent, to $2.4 billion at December 31, 2022, when compared to year end 2021. This increase was primarily due to increases of $457.1 million in gross loans, mostly due to commercial, residential mortgage and residential construction loan growth, partially offset by SBA PPP loans forgiven and paid off. Total assets also included an increase of $61.6 million in total securities, offset a decrease of $130.0 million in cash and cash equivalents.

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Total deposits increased $28.6 million, due to increases of $133.9 million in time deposits and $32.1 million in interest-bearing demand deposits, offset by a decrease of $102.3 million in savings deposits and $35.0 million in noninterest-bearing demand deposits. Borrowed funds increased $343.0 million to $383.0 million at December 31, 2022.

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Total shareholders’ equity increased $33.5 million over year end 2021, due to earnings and an increase in common stock, offset by dividends paid and net accumulated other comprehensive losses.

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These fluctuations are discussed in further detail in the sections that follow.

Securities

The Company’s securities portfolio consists of available for sale (“AFS”) debt securities, held to maturity (“HTM”) debt securities and equity investments. Management determines the appropriate security classification of AFS and HTM at the time of purchase. The investment securities portfolio is maintained for asset-liability management purposes, as well as for liquidity and earnings purposes.

The following table provides the major components of AFS debt securities, HTM debt securities and equity investments at their carrying value as of December 31, 2022 and December 31, 2021:

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AFS debt securities are investments carried at fair value that may be sold in response to changing market and interest rate conditions or for other business purposes. Activity in this portfolio is undertaken primarily to manage liquidity and

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interest rate risk, to take advantage of market conditions that create economically attractive returns and as an additional source of earnings. AFS debt securities consist primarily of obligations of U.S. government sponsored entities, state and political subdivisions, mortgage-backed securities and corporate and other securities.

AFS debt securities totaled $95.4 million at December 31, 2022, an increase of $38.9 million or 68.9 percent, compared to $56.5 million at December 31, 2021. This net increase was the result of:

The weighted average life of AFS debt securities, adjusted for prepayments, amounted to 6.4 years and 6.9 years at December 31, 2022 and 2021, respectively. The effective duration of AFS debt securities amounted to 1.9 and 3.1 at December 31, 2022 and December 31, 2021, respectively.

HTM securities, which are carried at amortized cost, are investments for which there is the positive intent and ability to hold to maturity. The portfolio is comprised of obligations of the U.S. Government and its agencies, obligations of state and political subdivisions and mortgage-backed securities.

HTM debt securities totaled $35.8 million at December 31, 2022, an increase of $21.5 million, or 150.5 percent, compared to $14.3 million at December 31, 2021. The increase was due to:

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The weighted average life of HTM securities, adjusted for prepayments, amounted to 18.0 years and 14.0 years at December 31, 2022 and December 31, 2021, respectively. As of December 31, 2022, the fair value of HTM securities was $28.6 million, compared to $14.2 million at December 31, 2021. The effective duration of HTM securities amounted to 10.5 and 5.6 at December 31, 2022 and December 31, 2021, respectively.

Equity securities are investments carried at fair value that may be sold in response to changing market and interest rate conditions or for other business purposes. Activity in this portfolio is undertaken primarily to manage liquidity and interest rate risk, to take advantage of market conditions that create economically attractive returns and as an additional source of earnings. Equity securities consist of Community Reinvestment Act ("CRA") investments and the equity holdings of financial institutions.

Equity securities totaled $9.8 million at December 31, 2022, an increase of $1.2 million, or 14.3 percent, compared to $8.6 million at December 31, 2021. This net increase was the result of:

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The following table provides the remaining contractual maturities and average yields within the investment portfolios. The carrying value of securities at December 31, 2022 is distributed by contractual maturity. Mortgage-backed securities and other securities, which may have principal prepayment provisions, are distributed based on contractual maturity. Expected maturities will differ materially from contractual maturities as a result of early prepayments and calls.

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Securities with a carrying value of $835 thousand and $1.2 million at December 31, 2022 and December 31, 2021, respectively, were pledged to secure other borrowings, collateralize hedging instruments and for other purposes required or permitted by law.

Approximately 63 percent of the total investment portfolio had a fixed rate of interest at December 31, 2022, compared to 48 percent at December 31, 2021.

For additional information on securities, see Note 2 to the Consolidated Financial Statements.

Loans

The loan portfolio, which represents the Company’s largest asset group, is a significant source of both interest and fee income. The portfolio consists of SBA, commercial, residential mortgage, consumer and residential construction loans. Each of these segments is subject to differing levels of credit and interest rate risk.

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Total loans were $2.1 billion at December 31, 2022, an increase of $457.1 million or 27.7 percent when compared to year end 2021. Commercial, residential mortgage, residential construction and SBA loans increased $255.8 million, $195.7 million, $42.9 million and $2.9 million, respectively, partially offset by a decrease of $40.5 million in SBA PPP loans, reflecting forgiveness and payoff of these loans.

The following table sets forth the classification of loans by major category, including unearned fees, deferred costs and excluding the allowance for loan losses as of December 31, 2022 and December 31, 2021:

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Average loans increased $165.3 million or 10.0 percent from $1.7 billion in 2021, to $1.8 billion in 2022. The increase in average loans was due to increases in average commercial, residential mortgage, residential construction, SBA and consumer loans. The yield on the overall loan portfolio increased 12 basis points to 5.13 percent for the year ended December 31, 2022, compared to 5.01 percent for the prior year.

SBA 7(a) loans, on which the SBA historically has provided guarantees of up to 90 percent of the principal balance, are considered a higher risk loan product for the Company than its other loan products. These loans are made to small businesses for the purposes of providing working capital and for 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 historical financial information. Finally, many SBA borrowers do not have an ongoing and continuous banking relationship with the Bank, and work with the Bank on a single transaction. The guaranteed portion of the Company’s SBA loans may be sold in the secondary market.

SBA 7(a) loans held for sale, carried at the lower of cost or market, amounted to $27.9 million at December 31, 2022, an increase of $555.0 thousand from $27.4 million at December 31, 2021. SBA 7(a) loans held for investment amounted to $38.5 million at December 31, 2022, an increase of $2.4 million from $36.1 million at December 31, 2021. The yield on SBA 7(a) loans, which is generally floating and adjusts quarterly to the Prime Rate, was 6.60 percent for the year ended December 31, 2022, compared to 6.10 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. Approximately $72.1 million and $87.4 million in SBA loans were sold but serviced by the Company at December 31, 2022 and December 31, 2021, respectively, and are not included on the Company’s balance sheet. There is no direct relationship or correlation between the guarantee percentages and the level of charge-offs and recoveries on the Company’s SBA 7(a) loans. Charge-offs taken on SBA 7(a) loans effect the unguaranteed portion of the loan. SBA loans are underwritten to the same credit standards irrespective of the guarantee percentage.

Commercial loans are generally made in the Company’s marketplace for the purpose of providing working capital, financing the purchase of equipment, inventory or commercial real estate and for other business purposes. These loans

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amounted to $1.2 billion at December 31, 2022, an increase of $255.8 million from year end 2021. The yield on commercial loans was 5.10 percent for 2022, compared to 4.98 percent for the same period in 2021. The SBA 504 program, which consists of real estate backed commercial mortgages where the Company has the first mortgage and the SBA has the second mortgage on the property, is included in the Commercial loan portfolio. The Commercial Real Estate sub-category includes both owner occupied and non-owner occupied commercial real estate related loans.

Residential mortgage loans consist of loans secured by 1 to 4 family residential properties. These loans amounted to $605.1 million at December 31, 2022, an increase of $195.7 million from year end 2021. Sales of mortgage loans totaled $74.4 million and $286.4 million for 2022 and 2021, respectively. Approximately $13.7 million and $18.8 million in residential loans were sold but serviced by the Company at December 31, 2022 and December 31, 2021, respectively, and are not included on the Company’s balance sheet. The yield on residential mortgages was 4.62 percent for 2022, compared to 4.47 percent for 2021. Residential mortgage loans maintained in portfolio are generally to individuals that do not qualify for conventional financing. In extending credit to this category of borrowers, the Bank considers other mitigating factors such as credit history, equity and liquid reserves of the borrower. As a result, the residential mortgage loan portfolio of the Bank includes fixed and adjustable rate mortgages with rates that exceed the rates on conventional fixed-rate mortgage loan products but are not considered high priced mortgages.

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. These loans amounted to $78.2 million at December 31, 2022, an increase of $220.0 thousand from December 31, 2021. The yield on consumer loans was 5.27 percent for 2022, compared to 4.73 percent for 2021.

Residential construction loans consist of short-term loans for the purpose of funding the costs of building a home. These loans amounted to $163.5 million at December 31, 2022, an increase of $42.9 million from December 31, 2021. The yield on residential construction loans was 6.17 percent for 2022, compared to 5.97 percent for 2021.

There are no concentrations of loans to any borrowers or group of borrowers exceeding 10 percent of the total loan portfolio.

In the normal course of business, the Company may originate loan products whose terms could give rise to additional credit risk. Interest-only loans, loans with high LTV 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 December 31, 2022, approximately 96 percent of the Company’s loan portfolio was secured by real estate compared to 92 percent at December 31, 2021.

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The following table shows the maturity distribution or repricing of the loan portfolio and the allocation of fixed and floating interest rates at December 31, 2022:

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The following table shows the balance of loans and the allocation of variable, hybrid and fixed interest rates based upon maturity or repricing date as of December 31, 2022:

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For additional information on loans, see Note 3 to the Consolidated Financial Statements.

Troubled Debt Restructurings

At December 31, 2022, there were three loans totaling $1.4 million that were classified as TDRs, compared to three loans totaling $1.0 million at December 31, 2021. Restructured loans that are placed in nonaccrual status may be removed after six months of contractual payments and the borrower showing the ability to service the debt going forward. The 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.

The following table presents a breakdown of performing and nonperforming TDRs by class as of December 31, 2022 and December 31, 2021:

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The following table shows the types of modifications done by class through December 31, 2022:

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For additional information on TDRs, see Note 3 to the Consolidated Financial Statements.

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Asset Quality

The following table sets forth information concerning nonperforming assets and loans past due 90 days or more and still accruing interest at December 31, 2022 and December 31, 2021:

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Nonperforming loans were $9.1 million at December 31, 2022, a $621 thousand decrease from $9.7 million at year end 2021. Since year end 2021, nonperforming loans in the commercial and consumer loan segments decreased, partially offset by an increase in nonperforming residential construction, SBA and residential mortgage loans. In addition, there were no loans past due 90 days or more and still accruing interest at December 31, 2022 and 2021, respectively.

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 categorized by their non-passing risk rating and performing loan status. Potential problem loans totaled $14.7 million at December 31, 2022, a decrease of $1.9 million from $16.6 million at December 31, 2021.

For additional information on asset quality, see Note 3 to the Consolidated Financial Statements.

Allowance for Loan Losses and Reserve for Unfunded Loan Commitments

The allowance for loan losses totaled $25.2 million at December 31, 2022, compared to $22.3 million at December 31, 2021, with resulting allowance to total loan ratios of 1.20 percent and 1.35 percent, respectively. Net charge-offs amounted to $1.3 million for 2022, compared to $984 thousand for 2021.

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The following table is a summary of the changes to the allowance for loan losses for December 31, 2022 and 2021, including net charge-offs to average loan ratios for each major loan category:

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The following table sets forth, for each of the major lending categories, the amount of the allowance for loan losses allocated to each category and the percentage of total loans represented by such category, as of December 31, 2022 and 2021. The allocated allowance is the total of identified specific and general reserves by loan category. The allocation is not necessarily indicative of the categories in which future losses may occur. The total allowance is available to absorb losses from any segment of the portfolio.

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See Note 4 to the accompanying Consolidated Financial Statements for more information regarding the Allowance for Loan Losses and Reserve for Unfunded Loan Commitments.

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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.

The following table shows period-end deposits and the concentration of each category of deposits for the past two years:

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The following table details the maturity distribution of time deposits as of December 31, 2022 and 2021:

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Total deposits increased $28.6 million to $1.8 billion at December 31, 2022. This increase in deposits was due to increases of $133.9 million in time deposits and $32.1 million in interest-bearing demand deposits, partially offset by a decrease of $102.3 million in savings deposits and $35.0 million in noninterest-bearing demand deposits. Further, brokered certificates of deposits, which are disclosed in time deposits above, increased $69.3 million, to $189.6 million at December 31, 2022, compared to $120.3 million at December 31, 2021.

The Company’s deposit composition at December 31, 2022, consisted of 33.1 percent savings deposits, 27.6 percent noninterest-bearing demand deposits, 23.8 percent time deposits and 15.5 percent interest-bearing demand deposits. The change in the composition of the portfolio from December 31, 2021 reflects a 45.9 percent increase in time deposits and a 13.2 percent increase in interest-bearing demand deposits, partially offset by a 14.7 percent decrease in savings deposits and a 6.6 percent decrease in noninterest-bearing demand deposits.

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The following table shows average deposits and the concentration of each category of deposits for the past two years:

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For additional information on deposits, see Note 6 to the Consolidated Financial Statements.

Borrowed Funds and Subordinated Debentures

As part of the Company’s overall funding and liquidity management program, from time to time the Company borrows from the Federal Home Loan Bank of New York. Residential mortgages and commercial loans collateralize these borrowings.

Borrowed funds and subordinated debentures totaled $393.3 million and $50.3 million at December 31, 2022 and December 31, 2021, respectively, and are broken down in the following table:

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In December 2022, the FHLB issued a $140.0 million municipal deposits letter of credit in the name of Unity Bank naming the New Jersey Department of Banking and Insurance as beneficiary, to secure municipal deposits as required under New Jersey law, compared to a letter of credit with a balance of $112.0 million as of December 31, 2021.

At December 31, 2022, the Company had $198.0 million of additional credit available at the FHLB. Pledging additional collateral in the form of 1 to 4 family residential mortgages, commercial loans and investment securities can increase the line with the FHLB.

For the year ending December 31, 2022, average FHLB borrowings were $102.5 million with a weighted average cost of 2.96%. The maximum borrowing during the year was $383.0 million.

Subordinated Debentures

On July 24, 2006, Unity (NJ) Statutory Trust II, a statutory business trust and wholly-owned subsidiary of Unity Bancorp, Inc., issued $10.0 million of floating rate capital trust pass through securities to investors due on July 24, 2036. The subordinated debentures are redeemable in whole or part, prior to maturity but after July 24, 2011. The floating interest rate on the subordinated debentures is three-month LIBOR plus 159 basis points and reprices quarterly. The floating interest rate was 6.319% at December 31, 2022 and 1.806% at December 31, 2021. The Company is currently evaluating its LIBOR-based exposure for this instrument.

Market Risk

Market risk for the Company is primarily limited to interest rate risk, which is the impact that changes in interest rates would have on future earnings. The Company’s Risk Management Committee (“RMC”) manages this risk. The principal

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objectives of RMC 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 Board-approved guidelines. The RMC reviews the maturities and repricing of loans, investments, deposits and borrowings, cash flow needs, current market conditions and interest rate levels.

The following table presents the Company’s EVE and NII sensitivity exposure related to an instantaneous and sustained parallel shift in market interest rate of 100, 200 and 300 bps, which were all in compliance with Board approved tolerances at December 31, 2022 and December 31, 2021:

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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. The Company’s liquidity is monitored by management and the Board of Directors which reviews historical funding requirements, the 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. The goal is to maintain sufficient asset-based liquidity to cover potential funding requirements in order to minimize 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, additional borrowings 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. As the Consolidated Bank comprises the majority of the assets of the Company, the Consolidated Statement of Cash Flows is indicative of the Consolidated Bank’s activity. At December 31, 2022, the balance of cash and cash equivalents was $114.8 million, a decrease of $130.0 million from December 31, 2021. A discussion of the cash provided by and used in operating, investing and financing activities follows.

Operating activities provided $42.7 million and $32.5 million in net cash for the years ended December 31, 2022 and 2021, respectively. The primary sources of funds were net income from operations and adjustments to net income, such as the provision for loan losses and depreciation and amortization.

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Investing activities used $541.3 million and $40.5 million in net cash for the years ended December 31, 2022 and 2021, respectively. Cash was primarily used to originate loans, purchase FHLB stock and other investment securities, partially offset by cash inflows from proceeds from the SBA forgiveness of PPP loans.

Financing activities provided $368.6 million and $33.5 million in net cash for the years ended December 31, 2022 and 2021, respectively, primarily due to the proceeds of new borrowings and an increase in the Company’s deposits.

Parent Company Liquidity

The Parent Company’s cash needs are funded by dividends paid and rental payments on corporate headquarters by the Bank. Other than its investment in the Bank, Unity Risk Management Inc., and Unity Statutory Trust II, the Parent Company does not actively engage in other transactions or business. Only expenses specifically for the benefit of the Parent Company are paid using its cash, which typically includes the payment of operating expenses, cash dividends on common stock and payments on trust preferred debt.

At December 31, 2022, the Parent Company had $2.2 million in cash and cash equivalents and $5.7 million in investment securities valued at fair market value, compared to $1.7 million in cash and cash equivalents and $5.0 million in investment securities at December 31, 2021.

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Off-Balance Sheet Arrangements and Contractual Obligations

The following table shows the amounts and expected maturities or payment periods of off-balance sheet arrangements and contractual obligations as of December 31, 2022:

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Standby letters of credit represent guarantees of payment issued by the Bank on behalf of a client that is used as "payment of last resort" should the client fail to fulfill a contractual commitment with a third party. Standby letters of credit are typically short-term in duration, maturing in one year or less.

Time deposits have stated maturity dates. For additional information on time deposits, see Note 8 to the Consolidated Financial Statements.

Borrowed funds and subordinated debentures include fixed and adjustable rate borrowings from the Federal Home Loan Bank and subordinated debentures. The borrowings have defined terms and under certain circumstances are callable at the option of the lender. For additional information on borrowed funds and subordinated debentures, see Note 7 to the Consolidated Financial Statements.

Capital Adequacy

A significant measure of the strength of a financial institution is its capital base. Shareholders’ equity increased $33.5 million to $239.2 million at December 31, 2022 compared to $205.7 million at December 31, 2021, primarily due to net income of $38.5 million. Other increases were due to $3.0 million from the issuance of common stock under employee benefit plans, net of tax. These increases were partially offset by (i) $42 thousand in treasury stock purchased at cost, (ii) $4.4 million in dividends paid on common stock, and (iii) $3.6 million in accumulated other comprehensive loss, net of tax.

For additional information on shareholders’ equity, see Note 13 to the Consolidated Financial Statements.

On September 17, 2019, the federal banking agencies issued a final rule providing simplified capital requirements for certain community banking organizations (banks and holding companies) with less than $10 billion in total consolidated assets, implementing provisions of The Economic Growth, Regulatory Relief, and Consumer Protection Act (“EGRRCPA”). Under the rule, a qualifying community banking organization would be eligible to elect the community bank leverage ratio framework or continue to measure capital under the existing Basel III requirements. The new rule, effective beginning January 1, 2020, allowed qualifying community banking organizations (“QCBO”) to opt into the new community bank leverage ratio (“CBLR”) in their call report beginning in the first quarter of 2020.

A QCBO is defined as a bank, a savings association, a bank holding company or a savings and loan holding company with:

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The Bank has opted into the CBLR and is therefore not required to comply with the Basel III capital requirements.

As of December 31, 2022, the Bank’s CBLR was 10.34% and the Company’s CBLR was 10.45%.

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

Forward-Looking Statements

This report contains certain forward-looking statements, either expressed or implied, which are provided to assist the reader in understanding anticipated future financial performance. These statements involve certain risks, uncertainties, estimates and assumptions by management.

Factors that may cause actual results to differ from those results expressed or implied, include, but are not limited to those listed under “Item 1A - Risk Factors” in this Annual Report; the impact of the COVID-19 pandemic, the overall economy and the interest rate environment; the ability of customers to repay their obligations; the adequacy of the allowance for loan losses; competition; significant changes in tax, accounting or regulatory practices and requirements; and technological changes. Although management has taken certain steps to mitigate the negative effect of the aforementioned items, significant unfavorable changes could severely impact the assumptions used and have an adverse effect on future profitability.

Critical Accounting Policies and Estimates

New Authoritative Accounting Guidance

See Note 1 of the consolidated financial statements for a description of recent accounting pronouncements, including the dates of adoption and the anticipated effect on our results of operations and financial condition.

Allowance for Loan Losses and 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 and 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 judgments about information available at the time of the 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.

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For additional information on the allowance for loan losses and unfunded loan commitments, see Note 4 to the Consolidated Financial Statements.

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. If tax reform results in a decline in the corporate tax rates the Company would have to write-down its deferred tax asset.

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.

For additional information on income taxes, see Note 11 to the Consolidated Financial Statements.

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